Positive signs in Indonesia

The economy is ticking along û now all Indonesia needs is more investment flows.
HereÆs a sentence you may not have expected to read: investors are once again bullish on Indonesia. ôIndonesiaÆs vital stats are much improved and are on an improving trend,ö says Peter Eliot, managing director, head of markets & banking, and Citi country officer for Indonesia. ôForeign investors sometimes think differently from domestic investors when it comes to Indonesia. So there are times when foreigners are bullish and domestic investors are bearish. Right now, both foreign and domestic investors lean toward the bullish.ö

The caveat though, is that most of the investors are a bit more realistic than they once were about Indonesia. They see the positives but are willing to note there are some potential negatives. The rose tinted glasses are gone.

But the view is at least partly sunny these days. ThereÆs improved macro economic performance and sound monetary management. The current account is positive û thereÆs $52 billion in reserves, driven largely by commodity exports. Realised foreign direct investment in the five months to May rose to $3.71 billion from $3.14 billion in the same period last year, according to the National Investment Coordinating Board. While thatÆs not pre-financial crisis inflows, itÆs an improvement.

The Indonesian economy grew by 6% in the first six months of this year, which is a good sign. Sure, thatÆs below the governmentÆs 6.3% growth target û but the government is always overly optimistic). Plus, itÆs well above the 5.5% it grew last year. And while IndonesiaÆs consumer price index also grew 6% during the same period, that was below the governmentÆs forecast of 6.5%.

Inflation has been slowing. Consumer prices in June are likely to have risen by less than 0.2% from May, according to forecasts late in the month made by the central bank. Only crude palm oil û which is widely used for cooking in Indonesia but has a modest impact on the overall basket of items used to determine consumer inflation û has risen in price. As a result, in early June the government increased the export tax on palm oil in an effort to try to stabilise domestic prices.

If the government can keep a lid on inflation then itÆs likely the central bank will continue to cut rates. This is a double-edged sword. On May 12, Bank Indonesia Governor Abdullah said he thought the central bank could cut the BI rate to 7.5% this year (itÆs currently at 8.25%), a goal many analysts view as realistic. Of course, the aim is that lowering borrowing costs could encourage spending û from the corporate sector as well as the man on the street.

But one concern that several analysts have expressed is that the risk is, as Macquarie researchers phrased it in a June 8 report, ôthat BI moves faster rather than slower on the interest-rate front.ö

ôThe government wants to see higher growth and more employment, so lowering rates could kick-start investment, the danger is that they could overdo it,ö adds Suresh Narang, Deutsche BankÆs chief country officer in Indonesia. ôThis could cause real-money investors to flee.ö

The rupiah has been strengthening in recent months û it hit a three-year closing high of Rp8,670 to the US dollar on May 22. Macquarie forecasts it will end this year at Rp8,800 and Rp8,600 by the end of next year. (On May 9, the central bank said it was ôcomfortableö if the rupiah trades between Rp8,500 and Rp9,500 to the greenback.) But hereÆs the thing to remember, many analysts say the strength of the rupiah is driven by portfolio inflows, so potentially scaring off real-money investors who are longer-term holders of local currency bonds is worth being concerned about.

ôIf the central bank brings rates down too aggressively and the carry trade goes away, the question will be whereÆs the Indonesia premium?ö notes Eliot, who is chairman of the Foreign Bankers Association.

But provided the central bank moves carefully, and doesnÆt scare off foreign investors who have otherwise begun to believe in Indonesia, the numbers arenÆt so bad. And in the June 7 central bank statement Abdullah said the bank plans to implement ôa cautious, measured monetary policyö. So thereÆs reason to believe that monetary managers may keep a cool head.

This may be why many bankers say they anticipate further foreign investment into the country. All you have to do is look around. Carrefour is on the ground and putting in more stores, similarly Shell is looking to add more gas stations. And while the big names capture the headlines for oil and gas investments, there are also a lot of one-rig investors with ten gallon hats straight from Texas who have won concessions in Indonesia. Those little investments add up.

And then there are the investors who are pouring money into Indonesia not necessarily because they believe in the Indonesia story but rather because they believe in the bankers.

ôWe have done four fundraising exercises in the past couple of months and every time we hit the road we come across a bunch of fund managers managing a significant amount of money. Some of them have never been to Asia, not to mention Indonesia, and they have no memory of the Crisis, but theyÆre putting in big orders. ItÆs almost as crazy as it was in 1995 and 1996 when you could raise millions with a one- or two-page memo,ö says JPMorganÆs Gita Wirjawan, senior country officer and president director for Indonesia.

Wirjawan says that one saving grace is that this time around we have China and India underpinning the mad rush to Asia, which may provide more stability to the investment story.

Though thereÆs a certain amount of reckless spending, thereÆs also sound reasons to look to Indonesia. Property, for example, is cheap compared to the rest of the region. And one sector that may help ease concerns is surprisingly the local banking business. The 10 larger domestic banks registered an average return on assets of 1.7% and net interest margin of 6% in 2006, which puts it among the strongest in Asia. While asset quality issues remain û with the non-performing loan ratio doubling to 10.8% at the end of the first half of 2006 before declining to 7.5% at the end of the year, the overall picture is not as bleak as it may first appear. Fitch Ratings point out that the bulk of the problems lay with the legacy loans at Bank Mandiri and Bank Negara Indonesia, two systemically important banks, which accounted for close to 30% of banking system assets. Indeed, there was much milder deterioration in loan quality at the now foreign-owned private national banks, which analysts says is due to the improved risk management standards that have been introduced.

That said, there are negatives. When commodity prices drop, and they will eventually, that will hurt Indonesia, which has been sailing along on a combination of high commodity prices and a world awash in liquidity, which as Eliot notes, ôcan mask a lot of sinsö.

Those sins are plentiful. ThereÆs still not much certainty of contractual rights. One can never forecast what the courts will decide. ItÆs generous to say that some of the businesses are plagued with weak accounting and governance practices. Unemployment remains rampant, and thatÆs dangerous in a nation that some say has potential as a breeding ground for terrorism. Indeed, if thereÆs a terrorist attack anywhere in the world, it comes to haunt Indonesia as people remember Jakarta and Bali as places that have experienced multiple bombing attacks. (Given that your car is inspected every time it pulls into a parking lot, and you canÆt enter any public building without being screened û itÆs hard to forget this concern). But when security ratchets up, people re-think whether or not they want to travel or invest in Indonesia. And while many of the banks look stronger û thereÆs still a large concentration of risk in the state-owned banks. What happens if there is some sort of macro shock û will those big banks with non-performing loans collapse?

Plus, each day that passes by puts us closer to 2009 elections, which means that pragmatic, long-term beneficial decisions will be put off for short-term politically expedient ones. ôIÆm telling clients that I still would be taking a positive view on a portfolio perspective till the end of this year. Beyond that, itÆs hard to say because then everyone is going to be talking about politics,ö says Wirjawan.

While these arenÆt cautionary calls that are putting off investors right now and confidence is on the rise, itÆs hard to talk about Indonesia without a bit of scepticism born from dashed past hopes. ThatÆs why you donÆt often read sentences like, ôinvestors are once again bullish on Indonesiaö. Everyone knows to add the caveat. In fact, it feels a bit like watching England compete for the World Cup in football: theyÆve got all the right players in place but, since 1966, they havenÆt been able to win.

If the English can be ever hopeful, why canÆt the rest of the world root on for Indonesia for once?

This article first appeared in FinanceAsia magazine, July 2007.
¬ Haymarket Media Limited. All rights reserved.
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