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Indonesia: A Tempting Market for Investors to Buy and Hold September 9, 2010
Indonesia market remains the top market performer in 1H 2010. Its economic growth continues to be robust, which was supported by strong private consumption, investment and exports. Besides, Indonesia's sound economic fundamentals have sheltered it from the economic crisis. Based on this impressive performance, should investors invest in Indonesia?
Author : iFAST Research Team


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Key Points:

  • Jakarta Composite Index (JCI) has rebounded by 184.71% from its lowest point in 2008. This compares with Straits Times Index (STI), FTSE Bursa Malaysia Kuala Lumpur Composite Index (KLC) and Stock Exchange of Thailand Index (SET), which have recovered by 87.63%, 73.10% and 142.07% respectively.
  • Indonesia’ Gross National Income (GNI) per capita is relatively lower than its regional peers. Improvement in GNI per capita could lead to a stronger private consumption that supports GDP growth.
  • Foreign Direct Investment (FDI) rebounded significantly from US$0.54 billion in 4Q 2009 to US$2.50 billion in 2Q 2010. We expect to see more FDI flowing into Indonesia.
  • Increasing exports contribution to Gross Domestic Production (GDP) will assists Indonesia in its economic expansion in the future.
  • Reference rate is expected to rise by 50 basis points to 7.0% in 4Q 2010.
  • Currently, its high bond yield makes its equities relatively unattractive. However, we believe Indonesia equity market is a buy for long-term investors when global economy recovery outlook becomes more certain in 2011.

Indonesia stays attractive

In 2009, Indonesia, which is represented by the Jakarta Composite Index (JCI), was one of the best performing markets with a return of 87.0% in local currency terms.  While most of the Asian countries such as Singapore and South Korea showed a single digit year-to-date (YTD) returns for 2010, Indonesia remains as the top market performer with an attractive double-digit YTD return of 22.5% (data as at 27 August 2010), the strongest returns among the Asian countries. These robust YTD returns have certainly made Indonesia market remains attractive to investors when comparing against the negative YTD returns of S&P 500 and MSCI Emerging Markets.

Chart 1 shows that the JCI has outperformed the STI, KLCI and SET since 2007. The recovery of JCI from the 2008 economic crisis is much stronger than its neighbourhood countries such as Singapore, Malaysia and Thailand.  This was evidenced by the 184.71% rebound in JCI from its lowest point in 2008. On the other hand, STI, KLCI and SET have recovered by 87.63%, 73.10% and 142.07% respectively (data as at 3 Sep 2010).    

What support the Indonesia’s economic growth?

The recently released Indonesia GDP figure for 2Q 2010 grew 6.2% year-on-year, which is slightly better than an expected 6.0% growth. On quarter-on-quarter basis, the GDP grew by 2.8%, which was quicker than the 1.93% quarter-on-quarter increase in 1Q 2010. The accelerated economic growth in Indonesia since 3Q 2009 was mainly driven by private consumption, investment and exports, while government consumption continued to be the negative contributor. Chart 2 shows that private consumption was the major component in GDP which amounted to 58% of GDP, while investment was the second major component which constituted 24%, followed by net export which comprised 10%. 

Table 1:

Year-on-year Changes (%)

2Q 2010

1Q 2010

4Q 2009

3Q 2009

GDP

6.20

5.69

5.43

4.16

By Expenditure

 

 

 

 

Private Consumption

4.98

3.92

3.96

4.75

Government Consumption

-9.01

-8.81

16.97

10.32

Investment

8.03

7.81

4.18

3.24

Exports

14.60

19.99

3.67

-7.79

Imports

17.74

22.60

-14.67

-14.67

Source: Statistics Department of Indonesia, iFAST Compilations

1.  Private consumption could grow stronger

GNI per capita is the dollar value of a country’s final income in a year divided by its population. It reflects the average income of a country’s citizen. Table 2 shows that Indonesia has a significant lower GNI per capita (purchasing power parity adjusted) than Singapore, Malaysia, Thailand and South Korea, which implies that Indonesia still have ample room to grow and improve its GNI per capita.

Assuming over the long run, Indonesia’s GNI per capita is going to rise to the same level of Malaysia or Singapore, private consumption could grow stronger as higher household disposable income indicates that consumers have stronger spending power. Flowing through, a stronger growth in private consumption could enhance GDP growth in the future, as Indonesia’s private consumption contributed around 58% to GDP.

Table 2:

 

GNI per capita 2009 (International dollar)

Private consumption as % of GDP

Indonesia

4,060.00

58.34

Singapore

49,850.00

34.86

Malaysia

13,530.00

52.06

Thailand

7,640.00

53.65

South Korea

27,310.00

54.46

Source: World Bank, iFAST Compilations

As an example, we can look at passenger cars per 1,000 people statistics. Passenger cars per 1,000 people is a good economic indicator of the wealth and spending power of a country. Based on South Korea experience, passenger cars per 1,000 people increased exponentially when GNI per capita reached about 8,000 international dollars. Currently, the GNI per capita for Indonesia in 2009 were 4,060 international dollars, which has grown at a compounded annual growth rate (CAGR) of 9.16% per annum for the past 5 years. We believe that Indonesia GNI per capita CAGR for the next 5 years could be higher than that based on the recent strong economy performance after the global financial crisis. This would means that Indonesia GNI per capita could hit the 8,000 international dollars mark within the next 5 years, and from there we should see an exponential jump in passenger cars per 1,000 people – a proxy to rising domestic consumption.

2. More FDI for Indonesia

The re-election of President Susilo Bambang Yudhoyono in 2009 has helped to boost investor confidence over Indonesia market as his stronger mandate and new coalition government will enabled him to further improve Indonesia’s political and social stability. His administration has made progress into reducing corruption in the country, rebuilding the aging infrastructure and reforming the sluggish civil services in order to attract foreign direct investment (FDI).

Chart 4 shows that the FDI rebounded significantly from US$0.54 billion in 4Q 2009 to US$2.50 billion in 2Q 2010. More FDI is expected to flow into Indonesia due to better investor confidence which stemmed from Indonesia strong market growth, its resilience during economic crisis and also its political reform.

3. Strengthening exports contribution to GDP

Heavily relying on private consumption to continue lift up its economy growth could be slow as the government has to increase the disposable income per capita before private consumption increases, and this might be a time-consuming process. Nevertheless, Indonesia could tap on its gifted natural resources especially for palm oil, coal and tin to support its economic growth. The government is now in its efforts to improve the infrastructure and transportation facilities as it aims to increase exports. Capital spending may rise by Rp26.6 trillion or 28% to Rp121.7 trillion in 2011 as the government is planning to build more roads, bridges and seaports to help keep a low distribution cost.

Chart 5 shows that the exports contribution to GDP was relatively low in Indonesia as compared with Singapore, Malaysia and Thailand. This has made its economy more resilient during the global economic crisis. At the same time, it also indicates that potential to expand its exports contribution to GDP in the future is high.

As we mentioned above, improvement in household disposable income could lead to higher private consumption, which in turn could lead to more imports in the future. The higher imports may offset the effects of strengthened exports, making the net export contribution to GDP to be stagnant. However, taking a closer look at Indonesia’s imports in Jun 2010, it can be seen that Indonesia imports were mainly raw materials / semi-finished goods (74.64%) and capital goods (17.92%). The imports of consumption goods were low.

Table 3

US$ Million

Jun 2010

% of Imports

Total Imports

11713.2

100.00%

Consumption Goods

870.7

7.43%

Raw Materials / Auxiliary Goods

8743

74.64%

Capital Goods

2099.5

17.92%

Source: Statistics Department of Indonesia

Capital goods (i.e machinery, plant & equipment) are goods that are used by companies in the production of other goods. An increase in imports of capital goods would indicate that an economy is growing and is likely to expand its domestic manufacturing activities, which is the case for Indonesia as its capital goods import rose by 35.91% year-on-year in 1H10.

An expansion in manufacturing activities would certainly entails a higher consumption of raw materials and/or semi-finished goods, and this could lead to higher imports. Nevertheless, the net effect to the economy is positive even though we highlight that rising imports could offset Indonesia’s exports. This is assuming that the goods produced from imported raw materials are purely for domestic consumption, but this might not be the case as expansion in manufacturing activities could also increase the exports of manufactured goods.

4. Easy monetary policy

The Bank Indonesia has maintained an easy monetary policy by keeping the reference rate unchanged for 12th consecutive months at 6.5% to support economy recovery, even when annual inflation in August accelerated to 6.44%, its highest level since April 2009. With the current robust economic growth, the Bank Indonesia may have more reasons to start raising the reference rate in order to combat the accelerating inflation.

Given that the Rupiah has risen 4.3% against the US dollar this year (data as at 3 Sep 2010), this may temporarily ease the current inflationary pressures and allow the Bank Indonesia to defer the hike of reference rate to 4Q 2010. The reference rate is likely to increase by 50 basis points to 7.0%, which is still lower than the 9.5% in Oct 2008 before the Bank Indonesia started to cut reference rate to the current level.

Conclusion

The long-term growth prospect for Indonesia remains positive, supported by IMF projection that Indonesia’s economy will expand by 6% in 2010. With continued robust private consumption, strong foreign capital inflow to its financial markets and the strengthening contribution of exports to GDP, the Indonesian government aims for an average 6.6% annual GDP growth over the next 5 years, and reaching a 7.7% GDP growth by 2014.

The earnings growth for 2010 and 2011 are expected to be strong at 103.9% and 19.8% respectively. The estimated PE ratios for 2010 and 2011 are trading at a low 15.4X and 12.9X as compare with its 5 years historical average of 18.6X (data as at 27 Aug 2010). However, Indonesia’s 5-year bond yield is 7.5%, the second highest yield in Asia after India (7.7%).  With earnings yield for 2010 likely to be around 6.5%, this means that the excess yield is at a negative 1.0%, which in our view, makes equities relatively less attractive than bonds. This, coupled with our view that the equity market will be trading sideways or possibly having a mild correction for the next two to three quarters amid uncertainty in the global economy recovery, we therefore advocate investors to invest into Indonesia bond market to be on the safe side and ride out this short term uncertainty.

In addition, S&P, Moody and Fitch Rating have also raised Indonesia’s sovereign debt ratings to BB, Ba2 and BB+ respectively, the highest grade over the past 11 years, indicating Indonesia’s resilience to the global crisis and improved public finances. The credit rating of Indonesia could be further upgraded if the inflation pressure in Indonesia diminishes, the external debt burden declines and the government’s balance sheet improves further. This will be good news for bond investors as better fundamental leads to lower default risk, making Indonesia’s bonds more investable. On the other hand, Bank Indonesia would start rising the reference rate as inflation pressure is emerging. This will drive the bond prices lower, and bond investors could take this opportunity to invest in Indonesia’s bonds.

Alternatively, forward looking investors should take note on the low 12.9x estimated PE ratio for 2011. This indicates that the Indonesia stock market has not factored in the strong 2011 earnings. Therefore, investors should start looking at investing in the equity market in 2011 when the volatility subsides.


 


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