BBH MarketView: Indonesia Well-Placed

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We believe Indonesia is well-placed to ride out the sporadic turbulence we’ve seen in global financial markets.  With a large domestic market and strong economic team in place, the nation is not as vulnerable as others in EM.

POLITICAL OUTLOOK

President Jokowi has nearly completed half of his 5-year term.  The next elections will be held in 2019.  Presidential and parliamentary elections will be held then at the same time, the first time this has occurred.

After some initial success in cutting fuel subsidies, structural reforms stalled.  Jokowi changed tack and focused more on boosting the country’s competitiveness.  Indonesia now ranks 109 out of 189 in the World Bank’s “Ease of Doing Business” rankings, up from 120 last year.  While the ranking remains somewhat weak, the direction is good.

Jokowi has enjoyed some recent success.  A tax amnesty bill was just passed that should boost revenues.  This is especially important as plans to increase infrastructure spending will put pressure on the budget.  A recent cabinet shuffle brought Sri Mulyani Indrawati back as Finance Minister, a post she held from 2005-2010.  She is well-respected by the markets.

ECONOMIC OUTLOOK

The economy remains sluggish.  GDP growth is forecast to remain steady around 5% in 2016 and then accelerate modestly to around 5.5% in 2017 and 6% in 2018.  GDP rose 4.9% y/y in Q1.  This was slightly stronger than expected, but was boosted by a low basis for comparison.  Infrastructure spending should boost growth a bit.

Price pressures are still low, with CPI rising 3.5% y/y in June vs. the cycle low of 3.3% in May.  That was the lowest rate since December 2009, and supports the continuation of the easing cycle.  With inflation right near the bottom of the 3-5% target range, another rate cut is likely at the August meeting when the central bank moves to a new benchmark policy rate.  It has already cut rates four times to 6.5% this year.

Fiscal policy has remained prudent but bears watching.  The IMF estimates that the budget deficit came in around -3% of GDP in 2015.  It is expected to remain steady this year before narrowing slightly to -2.5% of GDP in 2017.  The tax amnesty should help offset increased government infrastructure spending, but the net impact is still unknown.

The external accounts are in solid shape.  Lower commodity prices have hurt exports, but slow growth has helped reduce imports.  The current account gap was about -2% of GDP in 2015, and is expected to widen slightly to -2.5% in 2016 and -3% in 2017.  Foreign reserves rose to $110 bln in June, the highest since May 2015.  Reserves now cover about 6 months of import and are nearly twice as large as short-term external debt.

Indonesia’s three biggest export markets are China, Japan, and the US.  Its main exports include crude oil and gas, foodstuffs, plywood, rubber, and textiles.

INVESTMENT OUTLOOK

The rupiah has generally outperformed within EM.  In 2015, IDR lost -10% vs. USD.  This compares to the worst performers ARS (-35%), BRL (-33%), ZAR (-25%), COP (-25%), and RUB (-20%).  So far this year, IDR is up 5% YTD and is lagging only the best performers BRL (+20%), RUB (+11%), ZAR (+7.5%), CLP (+6%), and MYR (+5%).

USD/IDR is trading near the bottom of this year’s trading range.  The 13000 area should prove tough to break below.

Indonesian equities continue to outperform.  Last year, MSCI Indonesia was -12% while MSCI EM was -17%.  So far in 2016, MSCI Indonesia is up 16% YTD, and compares to up 9% YTD for MSCI EM.

Indonesian bonds have outperformed this year.  The yield on 10-year local currency government bonds is -169 bp YTD.  This is behind only Brazil (-452 bp) and ahead of Peru (-158 bp) and Colombia (-106 bp).  With inflation likely to remain low and the central bank likely to continue easing, we think Indonesian bonds will continue outperforming.

Our own sovereign ratings model shows Indonesia to be correctly rated at Baa3/BBB- by Moody’s and Fitch.  S&P inexplicable has kept its rating at sub-investment grade BB+, but a one notch upgrade to BBB- is warranted.