Indonesia’s exacting exclusive club doubts

Gary Kleiman December 8, 2016 2:40 PM (UTC+8)
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Indonesian stocks were relatively unaffected by the “Trump tantrum” after an initial scare which also tanked the rupiah 2%, with the MSCI index up 9% through end-November as the top ASEAN performer behind Thailand.

Investors kept local bond positions at 40% of the total on the belief the consumer driven-economy is not as vulnerable as the rest of the region to the next US administration’s threatened trade retaliation. They supported the decision to again drop out of OPEC as its sole East Asian member in disagreement over production cuts, given budget revenue needs to meet the deficit target. Indonesia previously quit the cartel in 2009 when it became a net oil importer, and commodity price direction will continue as a major “downside risk,” according to the IMF’s November Article IV consultation. Tighter global monetary policy into 2017 is another challenge the Fund cited after the central bank slashed interest rates 150 basis points this year to maintain 5% GDP growth and accelerate single digit credit expansion, as domestic banks remain wary of corporate and personal loan exposure despite low leverage in the system.

The IMF and economists’ consensus forecast is for 5% growth again next year, below President Jokowi Widodo’s original 7% goal. Consumption represents over half of output, and is due to slow especially from low-income households as infrastructure-led investment takes up the slack. The government unveiled massive transport projects, but spending pulled back 3% in the third quarter as tax collection reached only two-thirds the target and jeopardized the 3 percent of GDP fiscal deficit rule. An amnesty was supposed to bring in between US$40-70 billion from abroad according to the authorities, but as of the first phase ending in September less than US$10 billion was repatriated, and Morgan Stanley estimates a total in the US$30 billion range.

Inflation may increase from the current 3.5% with further electricity subsidy cuts and exchange rate pass-through should the central bank refrain from intervention as in the immediate US election aftermath. Governor Agus Martowardojo attributed depreciation then to speculation in Singapore’s non-deliverable forward market, where rupiah daily transaction volume there is around US$5 billion.

Portfolio inflows have been the main source of current account deficit coverage, but starting next year net FDI alone will be enough to offset the 2 percent of GDP gap, DBS bank predicts. After the TPP’s failure, Indonesia could further benefit on this front if the 15-country Economic Partnership with China is concluded soon.

Equity valuations have been expensive, so the bond market has increasingly drawn foreign buyers with primary issuance jumping 35% through November, as compared with 5% for the region. Diversification is underway with big state-owned enterprises now just two-thirds of activity, down from the previous three-quarters. Bond investors are ultimately comforted by a crisis management protocol from 2008, which directs public sector banks, insurers and pension funds to support the market in emergencies.

They also note that the country is tied this year with Saudi Arabia for Islamic-style sukuk placement at US$2.5 billion, ranking third globally behind Malaysia and the UAE, and that the 5% premium over US Treasuries will continue to be attractive after likely Federal Reserve rate hikes.

However loan growth was at a post crisis nadir in September of 6.5% annually on preparation for a bad loan onslaught, despite the 4 percent headline rate at leading stock exchange listings like Bank Mandiri. The central bank will relax reserve requirements in 2017 to free liquidity, and macro-prudential consumer borrowing limits could also be eased further.

The deposit insurance body recently assured the public that wealthy account-holders have kept their money in the system with no suggestion of a run, as advocated on social media in protest against Christian Jakarta Governor Basuki “Ahok” Tjahaja Purnama for alleged anti-Islam blasphemy. He succeeded Jokowi in the post, and is running for re-election against a former education minister and president’s son with a 70% opinion approval rating for able municipal stewardship despite the religious clash.

Internal political pressures will continue to roil banking and other sectors, even with passing immunity to external forces that could sound their own fiscal and monetary policy alarms in future spasms.

Gary Kleiman
Pioneer and recognized expert in the field of global emerging economies and financial markets. Founder of first consulting firm dedicated to providing independent analysis and advice to public and private sector clients in 1987, and research coverage and firsthand experience covers 75 countries in all developing regions. Advisor on financial vulnerability issues, risk management, portfolio allocation, and financial sector and capital markets strategy and development.
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