Indonesia's failure to develop its manufacturing export sector has resulted in a lucky side effect. While its Asian neighbours have suffered severe contractions in growth, the regional giant's dependence on domestic consumption and long-term global demand for its natural resources has maintained its economic engine in working order. And anti-corruption measures and signs of improved corporate governance are forcing a reassessment of its place in investor's portfolios.
"It is no exaggeration to say that Indonesia has joined the Bric countries [Brazil, Russia, India and China] as an attractive destination for investment and its potential for growth and higher living standards. Increasingly, I now talk about the "Brici" countries," said Sarah-Jane Wagg, president director of UBS Securities Indonesia.
The Jakarta Composite Index is up more than 1,000 points since the beginning of the year, reaching 2,468 on September 24, which is 122% higher than the 1,111 nadir it slumped to on October 28, 2008 in the immediate aftermath of the Lehman Brothers collapse.
Yet, as Arief Wana, head of research for Indonesia at Credit Suisse pointed out: "The stock market is still 15% lower than 1997 despite the surge this year; and trading with a current 2009 estimated price-earnings ratio of 15.2 times and an expected 2010 multiple of 13 times based on forecast earnings of 17%, the market is the third cheapest in the region after Thailand and the Philippines our price-to-book to return-on-equity matrix." Wana predicts that the index will reach 2,700 by the end of next year. He especially likes stocks linked to consumption, such as United Tractors, BRI (microfinance), Astra and Indofood, and also companies that will be benefit from construction, such as cement makers.
The surge in the market has largely been driven by foreign portfolio inflows, reflected in the strength of the currency. There was $2 billion of inflows reported in the first quarter this year, and this will undoubtedly have increased in the second and third quarters as investor sentiment globally has improved.
Portfolio outflows in the fourth quarter 2008 alone amounted to $4.5 billion. Indonesia's rupiah touched Rp9,575 against the US dollar on September 17, having spiked above 12,500 in late November. On the previous day, Moody's Investor Services upgraded Indonesia's credit rating to Ba2, two levels below investment grade, pointing to the economy's "resilience to the global recession".
International bond investors had already recognised the country's improving credentials: Indonesia raised $3 billion with a 10-year US dollar bond priced at 850 basis points over US treasury yields six months ago, and by the end of September the yield spread had tightened to just 315bp.
However, "domestic investors are also more significant players in the stock market compared with five or six years ago", noted UBS's Wagg. Pension funds and mutual funds are growing, life insurance is booming and etrading has opened up the market to greater retail participation. Promotion of local company listings in Jakarta rather than in other jurisdictions should also enhance the depth and size of the stock market.
Clearly the capital markets are working more effectively, confidence is returning and expectations are high that new debt and equity deals will start paying good fees to investment bankers.
For instance, Deutsche Bank is currently looking at five debt raising issues and two prospective IPOs. Activity will mostly centre on the resources sector, as well as subordinated debt issuance by banks, said Suresh Narang, chief country officer and head of global markets at Deutsche Bank. The international bond market is already open to Indonesian borrowers. For example, state-owned electricity company (PLN) successfully raised $750 million with a 10-year US dollar bond offering that was 11 times subscribed, attracting orders from more than 300 investors and immediately traded at a two percentage point premium.
A couple of sub-investment grade corporate borrowers, tyre-maker Gajah Tungall and retailer Matahari, completed successful bond exchanges during the summer, and the latter even raised additional cash, which led analysts to declare the Asian high-yield market open.
Other new issues are expected during the fourth quarter, particularly by companies in the natural resources and energy sector.
In equity capital markets, state-owned construction company, Perusahaan Pembangunan, is planning to raise $140 million, while cement makers, including Semen Gresik, are keen to raise capacity so are likely to tap the equity market, said Citi's Indonesia country business manager Tigor Siahaan.
In the plantation sector, most companies are in good shape as crude palm oil prices have moved back up to $700 a tonne (compared with costs of around $300 a tonne), and many of the big players continue to expand, said Siahaan. Earlier this year, Golden Agri-Resources, the world's second biggest oil palm company, announced its intention to raise more equity capital.
However, there are risks, such as a sudden fall in commodity prices, or market volatility caused by disruptive family-led corporate actions - for instance a repeat of the Bakrie Group-Bumi Resources saga that froze the markets last autumn, when the highly indebted Bakrie desperately clung on to its controlling stake in Bumi despite mortgaging its shares against loans. But perhaps the greatest constraint is that some foreign investors still believe that Indonesia is simply inherently risky.
To play down that reputation for volatility and mitigate a legacy marred by political upheaval and corporate shenanigans, Wagg is relentless in promoting wider coverage of Indonesia, including highlighting the country's opportunities to UBS management.
In a paper published on August 4, Martin Hohensee, Deutsche Bank's Asia strategist argued that Indonesia's credit rating should be upgraded, and pointed out that an "overlay of the Organisation for Economic Cooperation and Development survey on regulatory openness with a UN survey on attractiveness as a foreign direct investment destination" showed that "only four countries in the world...are...both more open and more attractive a destination [than Indonesia]: Germany, the US, the UK, and Brazil".
"Unfortunately, Indonesia remains below the radar of many banks and investors, who also fail to sufficiently differentiate it from other countries in the region," said UBS's Wagg.
This article first appeared in the October 2009 issue of FinanceAsia magazine.