Indonesian Outperformance Unlikely to Continue

indonesia political map

Despite having relatively weak fundamentals, Indonesian assets have outperformed for the most part. Weak fundamentals are likely to persist in 2016, and should weigh on Indonesian assets if EM sentiment continues to deteriorate.


After winning the July 2014 election handily, President Jokowi has struggled to implement his reform program. He had some initial success in cutting fuel subsidies, but his efforts have since been less successful. Jokowi has shifted his focus on boosting infrastructure spending, which will probably be easier to push through than the more controversial structural reforms such as tax and labor market reforms.

The next elections are not due until 2019. However, Jokowi’s popularity has fallen and this led him to reshuffle his cabinet back in August. He also made some management changes to state-owned enterprises, but the sense of drift in the government remains palpable.

Despite being a net oil importer, Indonesia rejoined OPEC as its 13th member in December. It left the group in 2009. Both Indonesia and OPEC stand to benefit from a seemingly awkward relationship. Indonesia said its membership will help serve as a link between oil exporters and importers. It has likely secured better access to oil and oil extraction technology, while OPEC will have a member gateway in Asia that happens to oversee the Strait of Malacca, a major oil tanker route.


The economy remains sluggish. GDP growth is forecast to accelerate modestly to around 5% in 2016 and nearly 6% in 2017 vs. an estimated 4.8% in 2015. GDP rose 4.7% y/y in Q3, about the same as in Q1 and Q2. As such, we see downside risks to the 2016 and 2017 forecasts. Jokowi’s campaign pledge to boost growth to 7% during his first term was always unrealistic, and recent data simply confirms this.

Price pressures remains low, with CPI up only 4.1% y/y in January. This is near the center of the 3-5% target range, and suggests that the easing cycle will continue. Bank Indonesia cut the policy rate 25 bp to 7.25% in January, restarting the easing cycle that had been on hold since February 2015. The next policy meeting is February 18. While that may be too soon for another cut, we see the easing cycle continuing as the year progresses.

Fiscal policy is a not a big concern yet. The budget deficit is expected to narrow to around -2% of GDP in both 2016 and 2017. However, there are upside risks given sluggish growth as well as Jokowi’s plans to stimulate growth via infrastructure spending.

The external accounts are in decent shape. Lower oil prices will help reduce imports, and this has outweighed downward pressure on exports since the 12-month trade surplus is the largest since mid-2012. The current account deficit is seen remaining near -2% of GDP this year before widening to -3% next year. Foreign reserves fell steadily over the course of 2015 and edged near $100 bln before stabilizing.


The rupiah has outperformed lately within EM. In 2015, IDR was in the middle of the EM pack at -10% vs. USD. This compares to the worst performers ARS (-35%), BRL (-33%), and ZAR (-25%) as well as best performers TWD (-4%), CNY (-4%, and INR (-5%). So far this year, IDR is outperforming in EM at +1.3% YTD, running behind only a few others that include BRL (+1.5%), SGD (+1.6%), THB (-1.7%), and MYR (+3%). This outperformance is unlikely to persist given that our EM FX model shows IDR as having VERY WEAK fundamentals.

Indonesian equities have outperformed within EM. Last year, MSCI Indonesia was down -12% vs. -16.6% for MSCI EM. So far in 2016, MSCI Indonesia is +6% YTD, and compares to -8.7% YTD for MSCI EM. This outperformance should ebb, as our EM Equity model has Indonesia at a VERY UNDERWEIGHT position.

Indonesian bonds have done well this year. The yield on 10-year local currency government bonds is down -68 bp YTD, and is the best performer within EM. Compare this to the worst performers Russia (+69 bp), Colombia (+45 bp), and Peru (+25 bp). With inflation likely to remain low and the easing cycle likely to continue, we think Indonesian bonds could continue outperforming.

We note that foreign investors have returned to Indonesia in recent weeks. The share of foreign ownership of government bonds has risen to nearly 41% at the end of January, the highest on record. Foreign equity investment is at $60 mln YTD. While that may not sound like much, it is the only country in Asia to have net inflows this year.