Year 2003 was good and 2004 should be even better

Year 2003 was good and 2004 should be even better

David Chang, Market Analyst, Jakarta

The year 2003 turned out to be better-than-expected for the
economy and the outlook for 2004 appears to be even better. Being
an election year, 2004 may see some volatility in the bond and
equity markets, but the domestic economy is likely to benefit
from the lengthy election process. While Asian stock markets are
likely to be upbeat during the first half of 2004, boosted by
signs of U.S. economic recovery, Indonesia should see stronger
recovery in the second half of the year.

A relatively stable political environment enabled a modest GDP
growth of an estimated 4.0 percent in 2003, moderately higher
than the 3.7 percent growth in 2002, despite a relatively weak
and turbulent global economy.

The outlook for the rupiah against the weakening U.S. dollar
is expected to remain stable as the U.S. Federal Reserve has also
made a firm commitment to keep U.S. interest rates low for a
"considerable period." This will likely ease the Indonesian
government's task of achieving its currency and interest rate
objectives, even with the challenging business environment and
political constraints during the first semester of this year.

The rating upgrades by Moody's, Standard and Poor's and Fitch
have seen a relative strengthening of the rupiah against the
sliding dollar and boosted investor sentiment in both the bond
and equity markets. This will also continue to raise foreign
investor confidence in Indonesia, and boost the corporate
earnings in 2004 through lower interest expenses, reduced
inflation and higher consumer spending.

However, politics will inevitably remain the key factor for
sustained economic growth and social stability for Indonesia in
the future. Any disruption in the political process is likely to
have significantly damaging effects on business and investor
confidence. The run-up to the elections is likely to be fraught
with surprises and uncertainties, but the outcome is unlikely to
startle the nation.

I believe that the outcome of the elections will not produce a
dramatic shift from the current government's macroeconomic or
reform policy, if the Indonesian Democratic Party of Struggle
(PDI-P) or a coalition among any of the four other main
opposition parties form a new government.

The gradual decline in interest rates and unprecedented growth
in bond-based mutual funds created a strong demand for bonds in
2003. There were 188 mutual funds which managed a total of Rp
72.8 trillion, as of November 2003, which represented a 56.2
percent jump from only Rp 46.6 trillion in December 2002. As 90
percent are bond funds, they resulted in the sharp rise in bond
prices and a flood of new bond issues in 2003.

The bond market provided an attractive source of finance to
corporate and state-owned enterprises due to strong demand for
bonds, and because commercial banks were still reluctant or
unable to extend loans. In 2003, Indonesian companies issued a
whopping 53 bond issues (denominated in rupiah) which raised
Rp 25 trillion (US$2.9 billion), against only 13 issues which
raised Rp 7.9 trillion in 2002.

While the government only issued 3 rupiah-denominated bonds,
it raised Rp 11.7 trillion ($1.3 billion) last year, compared to
25 issues which raised Rp 192.4 trillion in 2002. To meet
regulatory capital requirements, the banking industry was the
biggest sector for new bond issues accounting for a total of 11
issues which raised Rp 5.9 trillion in 2003.

As interest rates declined steadily in 2003, there were strong
demands for fixed-rate corporate bonds because investors were
keen to lock in their funds on higher-yield bonds in anticipation
of falling interest rates and rising bond prices. Hence about
92.3 percent, or Rp 23.1 trillion in value, of total new bonds
issued in 2003 were fixed-rate bonds. All of the government's
new bond issues in 2003, totaling Rp 11.7 trillion, were also of
the fixed-rate variety.

In 2004, the Indonesian government is expected to issue about
Rp 32.5 trillion worth of treasury bonds, as Rp 21.1 trillion
will mature during the year. In addition, about 25 companies have
indicated their plans to issue bonds to raise between Rp 10
trillion and Rp 12 trillion primarily for debt refinancing. The
bond market however may be less favorable in 2004 compared to
last year.

Corporate bonds are currently yielding between 12.0 percent
and 15.1 percent, while government bonds between 8.3 percent and
13.1 percent. The corporate bonds yield curve appears flatter
compared to those of government bonds, yielding an average of
13.5 percent. This implies that investors for corporate bonds
still prefer shorter term bonds and are not prepared to take on
longer term corporate risks.

Besides lower interest rates, there are 3 other reasons why
corporate bond prices are expected to be higher in 2004. Firstly,
there will not be as many new corporate bond issues. Secondly, a
positive political outlook would likely boost bond market
sentiment. Thirdly, bond prices are expected to recover from the
large, but temporary, redemption on bond mutual funds.

Last year, almost every stock market went up, and Indonesia,
like a megastar in the spotlight, was one of the best performing
markets in the Asia-Pacific region. Despite the regional market
volatility, the Jakarta Stock Exchange Composite Index closed
691.9 points at year-end 2003, which was 62.8 percent higher than
the previous year, and the highest level in three years. Other
markets in the Asian region also performed better-than-expected
last year despite initial investor fears of the effects of SARS,
terrorism and the Iraq war.

The Indonesian government's asset sale and divestment program
through the Indonesian Bank Restructuring Agency (IBRA) drew much
foreign investor interest into Indonesian equities. Other
divestments this year should continue to attract strategic
foreign investors who have long-term interests in Indonesia.
Acquisitions by foreign investors are expected to boost investor
sentiment on the local stock market.

Although there were only 6 measly IPOs in 2003, against 21 in
2002, 3 hefty issues of state-owned companies attracted
significant foreign investor interest in the stock market.
Upcoming IPOs of other state-owned companies should continue to
attract interests in the market. The unfavorable bond market and
optimism in the stock market is expected to encourage more
companies to raise funds through the equity market in 2004, which
could provide more exciting opportunities for investors.

The legislative and presidential elections in 2004 may cause
some volatility in the stock market through October, and
uncertainty about the political outcome of the elections could
also keep many investors on the sidelines during the first half
of the year.

Violence and skirmishes during the campaign period could
inevitably cause a major shock to the economy. However, they may
only be temporary setbacks, and should eventually provide entry
opportunities for the risk-taking investors, as there is expected
to be strong support for the market.

If the election goes smoothly, I expect the JCI to reach 800
before the end of 2004. Strong macroeconomic factors and
increased political expenditures during the election period are
expected to bolster the performance of some companies within the
telecommunications, cigarette, automotive, pharmaceutical and
retail sectors.

The writer is a director in securities company PT Paramitra
Alfa Sekuritas.