Indonesia's Getting All The Applause

While most Asian countries are coming to terms with a stuttering global recovery plus a China that is hiking rates, coupled with the REDS in Thailand - Indonesia is getting all the positives from international investing community. The strong political will to push through "real eradication of corruption" over the past 5 years are now bearing fruit.

• Overview: With attractive yields, a strong domestic currency, a recent debt ratings upgrade and the revival of the global carry trade, Indonesia’s bond market was attractive in 2009, which helped the government to finance its budget deficit by issuing sovereign, Islamic and samurai bonds. Yields declined in 2009 due to monetary easing by the central bank and the faster-than-expected economic recovery. The yield curve steepened in June 2009 as rising inflationary pressures increased the expectation of monetary tightening in early 2010. In 2010, the government’s bond issuance is expected to decrease due to the smaller budget. But, with the expected economic recovery and attractive yields, Indonesia’s debt market will remain attractive to investors.

• Indonesia’s debt market offers higher returns compared to the equity market, thus attracting more foreign investment. Faster economic recovery, global liquidity, attractive yields, and the potential for further ratings upgrades will buoy the debt market in 2010. Monetary tightening starting in Q2 2010 will further widen Indonesia’s interest rate differentials with Japan and the U.S. will boost carry trade. Any slowdown in the U.S dollar-funded carry trade will cause only temporary volatility in the market as investors will soon switch to the yen-funded carry trade, given attractive IDR-JPY spreads and low currency volatility.

Ratings

• On March 12, 2010, Standard & Poor’s (S&P) raised Indonesia’s long-term foreign-currency rating to ‘BB’, the highest level in 12 years, from ‘BB-‘ with a positive outlook. S&P also affirmed Indonesia’s long-term local currency rating of ‘BB+’ and short-term foreign and local currency rating of ‘B.’ According to S&P’s statement, the upgrade was driven by improving government debt conditions and rising foreign exchange reserves, helping reduce Indonesia’s vulnerability to external shocks. S&P believes that Indonesia’s government debt ratio will continue to improve, given appropriate fiscal policies and double-digits nominal GDP growth. However, Indonesia's relatively high external debt, low per capita GDP, high level of corruption and lack of infrastructure constrain further rating upgrades. S&P expects continued economic and political reforms, as well as management of inflation and external debt in order to bring about any further ratings upgrades.

• On January 24, 2010, Fitch upgraded Indonesia’s long-term foreign and local-currency credit ratings from BB to BB+, the highest level since the 1997 financial crisis, with a stable outlook. BB+ is one level below investment grade. Fitch also upgraded the country ceiling to BBB- from BB+ and affirmed the short-term foreign currency rating at B. Ngiam Ai Ling, the director of Asian sovereigns at Fitch noted that Indonesia’s ratings upgrade was supported by the economy’s resilience to the global cues in 2008-09 thanks to “the improvement in public finances, a fundamental sovereign rating strength, and a material easing of external financing constraints.” The public debt to GDP ratio has shown a downward trend while the country’s foreign exchange reserves have increased. These factors will help Indonesia weather any abrupt capital outflows.

Current Performance

• Yield Curve: In March 2010, Indonesia’s yield curve turned steeper relative to January 2010 as inflation expectations rose. In March, the two-year bond yield was around 4.7% (January: 5.7%), the five-year bond yield was 8.1% (January: 8.2%), 10-year bond yield was 9.6% (January: 10.2%) and the 20-year bond yield was 10.8% (January: 10.9%).

• Foreign holding in Indonesia’s bond market increased in 2009 thanks to global risk appetite, attractive Indonesian yields, credit ratings upgrades and positive economic outlook. Relatively high interest rates, prospects of monetary tightening in 2010, an appreciating domestic currency and global liquidity make Indonesian bonds an attractive carry trade asset funded by USD and JPY. Indonesia’s debt market offers higher returns compared to the equity market, and attracted over US$11 billion in foreign investment in 2009. Large debt inflows have put upward pressure on the Indonesian currency and hurt export competitiveness vis-à-vis other Asian countries. However, Indonesia is unlikely to impose capital controls in the debt market as it needs to finance its fiscal deficit. However, some analysts argue that Indonesia might restrict foreign investment in the central bank’s one-month short-term bills (known as SBI) if capital inflows remain buoyant in 2010.

• The budget deficit is expected to reach 1.6% of GDP in 2010 from over 2.0% of GDP in 2009 (can someone please compare that with Singapore, Malaysia and Thailand??!!). Indonesia’s finance ministry announced that in order to finance the fiscal deficit, gross debt issuance would reach US$18.5 billion in 2010, 20% higher than in 2009. The government will diversify its funding sources by issuing local and foreign currency bonds, samurai bonds and sukuk bonds. The government plans to finance 75% of the bond issues via domestic sources and shift foreign investors into debt with maturity of over five years.

Bond Issuance

• Indonesia began 2010 with a successful sale of US$2 billion in U.S. dollar denominated bonds, maturing at 10 years with a yield of 6%. Indonesia's budget deficit will drop from 2009. Due to favorable growth prospects and macroeconomic stability, Indonesia's ratings have either been upgraded or remained stable, depending on the agency. To meet its funding needs, Indonesia will issue a range of bonds in 2010, including local currency, Islamic, samurai, and U.S. dollar denominated. A strong Indonesian rupiah will increase the attractiveness of local currency bonds while expected increases in inflation in mid-2010 will steepen the yield curve.

• On January 13, 2010, Bloomberg reported that Indonesia sold US$2 billion in U.S. dollar bonds with 10-year maturities at 6% yield. Indonesia had planned US$4 billion in sales but scrapped plans for 30-year bond issues as investor appetite for emerging market debt waned slightly in the recent weeks.

• Corporate bond sales are up more three times from the same period in 2009 as investors are seeking higher yielding assets and infrastructure companies look to expand to meet plans to double spending on infrastructure this year. Poor infrastructure continues to be cited by analysts and investors as one of the key impediments to stronger growth in Indonesia. PT Macquarie Securities Indonesia is quoted in estimating that Indonesia could reach growth rates of 8-9% with the proper investment in power and roads.
  

Outlook

• Economist Jahanna Chua at Citigroup said in a March 12, 2010 report titled “S&P Finally Upgrades: Outlook Positive” that, with strong and improving fiscal and external liquidity positions, Indonesia’s ratings might upgraded to high double B in 2010 and Indonesia could become investment grade by 2011-12.

• Sovereign Analyst Aninda Mitra at Moody’s said that “ongoing flexibility in the economic policy fame work” and robust economic recovery backed by limited economic openness, a well diversified economy, low leverage and a large domestic consumption base have helped improve Indonesia’s debt ratings. Implementation of structural reforms will sustain Indonesia’s credit ratings.

Indonesia’s stock market, the Jakarta Composite Index (JCI), surged 87% in 2009, making it the second-best-performing equity market in Asia. Robust GDP growth, the prospect of a faster-than-expected economic recovery and improvement in exports and IPOs are sustaining investor sentiment.

• The JCI's improvement has been led by reduced global risk aversion and capital inflows, Indonesia's superior economic performance relative to other ASEAN countries and abating political uncertainty after parliamentary and presidential elections in April and July 2009, respectively. Positive economic growth in Q1 and Q2 2009 based on robust domestic demand improved investors' risk appetite, bringing them back to the market.

• While strengthening commodity prices will be an upside for the stock market ahead, the revival of global risk aversion and capital outflows, reduction in capital expenditure and greater-than-expected slowdown in GDP growth are risks.

• In 2008, the market was hit by global risk aversion and capital outflows, commodity correction and sluggish growth as a result of the global recession. This led to significant government intervention. In late 2008, the government broadened the limit for firms to buy back shares from 10% to 20% of their paid-up capital, with government funding of US$420 million. Firms no longer required shareholder approval to do so. The central bank kept the option of conducting open-market operations or letting regulators halt trading if the index falls below a certain level.

• Credit Suisse forecasts Indonesia’s stock market will continue to surge 32% in 2010 on the back of companies' strong balance sheets and high economic growth. Companies are raising debts to expand their business while the economy is strong. However, the central bank’s monetary tightening policy will be a risk to Indonesia’s stock market in 2010, and a short-term correction is expected before it rebounds.

• The Indonesian stock market is still attractive to international funds. Political stabilization has improved investor sentiment, resulting in stronger foreign investment inflows. The country's large population has allowed for robust domestic consumption, reducing Indonesia's dependence on global trade. The government's US$7.2 billion stimulus package and promising economic policies will continue to attract foreign investment.

The Indonesian currency, the rupiah, appreciated 16% against the U.S. dollar (USD) in 2009, making it Asia's best performing currency for the year. However, we also need to be aware that the rupiah was Asia's worst performing currency of the decade, dropping 24%. The rupiah's rally in 2009 was led by strong capital inflows into Indonesia's equity and debt markets.

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• The rupiah's appreciation in 2009 has been due to a number of factors: a stock market rally, improved bond yields, the revival of global risk appetite, relatively robust economic growth, positive election results, the central bank's monetary easing policy, the revival of the carry trade, an upgraded Moody's rating, a trade surplus, USD weakness and agreements for bilateral and multilateral currency swaps.

• The central bank has been intervening in the FX market to ease the external debt burden and contain currency appreciation as exports continue to contract. Intervention will continue as long as inflation is subdued to allow the central bank to build up reserves. In 2010, the central bank may allow the currency to appreciate to contain import inflation, but this will largely depend on the strength of the export recovery and the recovery in global oil and commodity prices.

• According to Milan Zavadjil, an IMF senior resident representative, the rupiah is not overvalued. Given Indonesia's current account surplus and robust economic growth, the rupiah is in the line with fundamentals.

• EIU: The revival of global interest in the carry trade, combined with Indonesia's stable political situation and strong economic growth amid the global economic downturn, has boosted investor sentiment regarding Indonesia'a asset markets and caused the rupiah to appreciate.

p/s photos: Bianca Bai Xin Hui

The Nasties Of Hot Money In Asia

Is there "hot money" in the system? Yes, the Fed's and ECB's low interest rates policy has already started the USD carry trade a few months back, and it could add a Euro carry trade to its banner soon. So, where do you think the money is headed or has been residing? Its Asia. The easy way to see where it has been headed over the past few months is to look at Asia's strongest currency this year. At the top of the heap was the Indonesian rupiah, followed by the Korean won and then the Indian rupee. So much so that the central banks at South Korea and Indonesia have expressed strong concerns over the inflow of hot money into their system. Beware of the current gains you have been seeing in stocks, property and currency in these two countries. They could just as easily disappear overnight. It also appears that the new favoured son by these carry trades is Taiwan.

Hence, we may well appreciate the efforts of Bank Negara a bit more over the past 18 months because Zeti refused to join in the bandwagon to "allow" the ringgit to appreciate too much. Rightly or wrongly, much of the hot money bypassed Malaysia and the ringgit because the ringgit is still not "that accessible and free-floated". By maintaining a disciplined approach, Bank Negara has basically staved off any future problems that may have to do with hot money moving too fast into the system and then too fast out of the system.

Many have been wondering why the Malaysian markets did not rise by as much as their regional peers. In fact Malaysian stock market has been in the bottom quartile in performance when compared to other Asian bourses. A huge part of the answer lies in the currency issue just discussed. Safe to say that taking that point further, we may argue that much of the rise in asset prices in other Asian markets may have been mostly "inflated" by the liquidity rush.

Is the region in grave danger of a collapse when these funds exit? What would cause the funds to exit? Well, if the Fed starts to raise rates, not likely over the next 6 months at least. Well, if there is a fresh war or political instability somewhere that causes people to rush to the reserve currency, and/or a massive jump towards risk aversion. The key I guess, is to monitor the rumblings and big trades in USD and the interest rate policy discussions.

On November 10, 2009, Taiwan's Financial Supervisory Commission barred foreign investors from parking their money in time deposits after bringing funds into the country. Plus, foreign investors will not be allowed to extend the deposit maturity beyond three months. Until now, foreign investors were allowed to deposit 30% of the inflows in time deposits for three months with a possible extension for another three months. Portfolio investors can still invest 30% of the net inflows in government bonds, money market instruments, money market funds and derivatives. As of October 2009, foreign investors had parked US$15.5 billion in Taiwan dollar accounts, almost five times the level considered appropriate by the central bank. The central bank has voiced concerns that beside investing in Taiwanese stocks, foreign investors were putting money into Taiwan Dollar deposits to earn interest plus currency arbitrage given the appreciating Taiwan dollar.

The move follows large capital inflows into Taiwan's dollar accounts recently which is putting upward pressure on the Taiwan Dollar and hurting export competitiveness. The central bank has been intervening in the FX market and had recently hinted at capital controls to contain currency strength.

This need not be an explosive issue as it seems that the central bankers in the affected countries are aware of the situation. The danger is when the central bankers do not have the political will to act as they should, or they act too slow to temper the liquidity inflow. One can easily reduce the inflow with various measures, so as to minimise the ill-effects of withdrawal of these kind of hot money.

Funnily, the US Federal Reserve Bank of Philadelphia president Charles Plosser said that the capital flows into Asia are a result of a stronger recovery in the region. He added that the flows are not such that he would consider them to be threatening or inconsistent with fundamentals. OMG, the danger is when enough people in high places in Asia believe that diatribe. These are not long term FDI, its short term, its a play on currency outlook and interest rate differentials, is short term - how in the world can Plosser say its not threatening. It can move asset prices up by 30%-50% in 6 months, and we know its seriously never going to be long term, so when they exit, how can Plosser say that it won't be threatening???!!!


p/s photos: Reon Kadena

Susilo Ensures More Stability & Better Economic Prospects

# July 8: Exit polls show that current President Susilo Bambang Yudhoyono won the Presidential elections by winning twice as many votes as his competitors. Yudhoyono got over 60.9% of votes which gives him the majority count to defeat the two opponents and lead to a single-round victory. Indonesia held its second direct election after ending the authoritarian rule. His competitors included former President Megawati Sukarnoputri and the President's deputy Jusuf Kalla who won over 25% and 12% of votes respectively.
# Yudhoyono's win will seal political stability and will be a positive for the booming equity and currency markets. He has selected Boediono (the former central bank governor) as his running mate, raising credibility in running credible macroeconomic policies. Improving regulation, reforming labor laws and tax policies to raise foreign investment will be his challenges. Continuing with his anti-corruption and anti-extremism approach, and targeted policies for the poor will also boost investor sentiment.
# Given Yudoyono's Democratic party's majority win in April 2009 Parliamentary elections, he will have enough support to implement policies. President Yodhoyono's Democratic Party won over 20% seats in the April 2009 Parliamentary elections which is enough to nominate Yodhoyono as the Presidential candidate without forming a coalition. Parties had to secure at least 20% of seats in the House of People's Representatives (DPR, the legislature) or 25% of the vote to be eligible to nominate presidential candidates for election in July 2009.
# Factors benefiting Yudoyono: Under Yudoyono's rule, GDP growth has risen from 5% in 2004 to 6.5% in 2008 which has benefited job growth and consumer spending. Indonesia is among the few Asian countries to avoid a recession in 2009 and having strong domestic demand. Capital inflows into stock and debt market have boosted these asset markets and raised investment. FDI has improved. Resource sectors and rural incomes have benefited from the recent commodity boom. Government has used fiscal stimulus measures (tax incentive for firms, spending on infrastructure, public services, job creation) to reduce impact of recession on the economy and job losses. Government cut fuel prices in January 2009 and has offered targeted financial support for the poor. The ruling party and President Yudhoyono have encouraged a democratic and secular system and tried to reduce extremism and violence. Yudhoyono has also helped reduce corruption.
# Reform challenges: Foreign investment in resource based sectors has been a point of debate due to impact on poor and social implications. Domestic and foreign investment is also deterred by regulations and red tape, poor infrastructure and investor protection, especially in commodity sectors. This has constrained the much needed foreign investment and technology transfer to develop the commodity sector. Labor laws have led to high structural unemployment and deterred investors. Tax system is also a negative for investors. Fuel subsidies burden the fiscal deficit.
# Indonesia has the potential to achieve higher growth rates provided Yudhoyono emerges with a strong mandate to cut regulations that hinder companies and investment.
# The election has helped consolidate democracy in Indonesia. Yudhoyono and his Democratic Party (PD) is the strongest force in parliament. This will deepen and quicken the pace of reforms and help Indonesia attain higher growth.
# Yudhoyono is considered positive for business and foreign investment, partly on perception of anti-corruption strategy and tendency to appoint qualified policymakers.
# Reform expectations could prove unrealistic. The PD will still require the support of other parties to pass legislation, ensuring that policy-making frustrations will persist during Yudhoyono's second term. Yudhoyono has pledged to double infrastructure spending, privatize state-owned companies and improve Indonesia's attractiveness to foreign investors, which can raise Indonesia's medium- and long-term growth. This will also require additional investments in infrastructure, curtailing corruption and bureaucracy, regulatory reform and stabilization of the currency markets.
# The result of presidential elections will not be a big event for the market as the market-friendly incumbent was expected to return. Nevertheless, removing political uncertainty will further boost capital inflows.
# Yodhoyono seems to have made the best of the tools at his disposal. Small fiscal deficit can provide more fiscal stimulus. Strong private consumption, buoyed by tax cuts and handouts, supported GDP growth in Q1 2009. Rupiah, appreciated against the U.S. dollar since November 2008, has been steadied by various stand-by-loans and currency swap agreement. Stock market has boomed in 2009.
# Golkar and PDIP parties might unify and pose challenge to Yudhoyono, not in the presidential race, but as a challenging opposition to legislative reforms in parliament.
# As long as Indonesia continues to be led by secular parties and leaders who do not pose threat to ethnic minorities (e.g. Chinese business establishment), the investor community is unlikely to be concerned.


p/s photos: Pace Wu Pei Ci