Why Indonesia A Favourite with Emerging Market Investors

JAKARTA, KOMPAS.com - Indonesia’s stock market rallied to a record high this month, while net foreign ownership of the country’s government debt is also at a record, as investors are attracted by strong growth and political stability. Here are some questions and answers on why Indonesia is a favourite with emerging market investors.

Why Indonesia?

Indonesia showed resilience during the financial crisis. Its economy should expand around 6 percent next year, slower than China or India, but maintaining 2010’s steady growth.

The economy is being driven by exports of resources such as palm oil and coal, for which global demand is picking up, plus a growing base of young consumers buying cars and mobile phones in the world’s fourth most populous nation.

Its lack of reliance on exports, in contrast to Asian peers Malaysia and Taiwan, means investors can bet on a growth story that will be relatively decoupled from the slow growth in Europe and the United States.

President Susilo Bambang Yudhoyono was re-elected last year, boosting investor confidence. While progress on his promise to combat graft and on other institutional investor-friendly reforms has been limited, the police have containing the threat from militants while the government’s debt levels have fallen.

Debt is seen at 27 percent of GDP this year compared with about 80 percent in 2001, according to data from Bank Danamon. That’s led to credit rating upgrades: Fitch in January rated Indonesia one notch below the coveted investment grade, which would put it on a par with BRIC nations and allow many institutional investors who avoid junk bonds to invest.

Many economists and the government see investment grade in 2011. Total returns from owning Indonesian bonds in dollar terms have been a mouthwatering 20 percent after 40 percent returns last year, while the stock market has climbed over 40 percent this year, after last year’s 87 percent rally.  And a strengthening rupiah , up over 4 percent, boosts local currency assets.

What are investors buying?

Investors are buying banks and consumer stocks. Top vehicle seller PT Astra International , cigarette firm PT Gudang Garam and noodle maker PT Indofood Sukses Makmur have all outperformed the index.

PT Bank Negara Indonesia is the top performing major bank, up over 100 percent this year. Its valuation is still reasonable at a price-to-book of 2.2, versus 4.9 for PT Bank Central Asia , the largest lender by value.

Demand for new listings is expected to stay strong in a relatively small market. With firms looking to take advantage of the rally, 2011 will see more offerings such as state carrier Garuda and U.S. miner Newmont’s local unit.

Indonesian stocks saw net foreign buying of $2.3 billion this year up to Dec 14, more than double the last year’s net inflows of $936 million, according to Thomson Reuters data.

The central bank’s short-term debt paper, or SBIs, has also been an investor favourite, paying a juicy 6 percent, but the central bank in recent months has stopped issuing the lowest one- and three-month tenors and imposed a 28-day holding period, cutting liquidity and pushing investors towards longer tenors or government debt, and this trend is likely to continue.

While bond yields have risen in recent weeks mirroring a broad rise across Asia as some investors took profits into the year-end, net foreign holdings have risen to a record 196 trillion rupiah, or above 30 percent of all tradeable debt, suggesting much of the money invested is staying put.

In a sea change from recent years, foreigners have been big buyers of longer-term debt, snapping up 10 to 20 year papers as low interest rates and ample liquidity encouraged offshore buyers to add duration.

Ten-year bonds offer a yield of 7.74 percent, 0.6 percentage points above equivalent Mexican debt and 3.8 percentage points over Thai bonds. Foreign direct investment is also picking up and is expected to grow slightly next year to over $14 billion, led by North Asian firms.

There are also tentative signs more Western firms are willing to take the risk, after many have been put off for years by corruption, poor infrastructure and red tape.

What are the risks?

For stocks, valuations are looking expensive, particularly for banks, and the index’s PE ratio is at 16.4, above Bangkok’s 12.9, Hong Kong’s 14.1 and Turkey’s 9.6. Corporate governance is another risk. Regulators earlier this year queried the financial reports of top coal miner Bumi Resources and other firms controlled by the powerful Bakrie family.

Bumi’s stock slid around 30 percent by mid-year though has since recovered. For bond investors, there is still the risk that the central bank will misjudge inflation, historically the Achilles heel.

Inflation accelerated to above the central bank’s upper target of 6 percent last month, and could pick up further in coming months on higher food and electricity prices. The central bank sees rate hikes as a policy of last resort as it fears attracting greater capital inflows, but most economists expect a rate hike by the second quarter.

If earlier or steeper rate hikes look more likely, this could cut demand for dated bonds and hurt the rupiah. Another factor that could inhibit fresh inflows next year is if U.S.

Treasury yields continued to rise at a sharp pace, which would diminish the relative allure of these bonds given spreads over Treasuries would be at tighter levels.