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.