When the Dutch returned and tried to reestablish colonial rule, armed Indonesians resisted. The Dutch were forced to recognize an independent Indonesia in 1949. The Jakarta index is booming, but Indonesia remains risky
Indonesia's benchmark stockmarket index has hit record highs recently, buoyed by a combination of beneficial factors that include strong economic growth, falling interest rates, optimism about forthcoming company results and the approval of a new investment law. However, like many emerging markets, Indonesia remains vulnerable to changes in investors' appetite for risk, especially with valuations currently higher than in most other markets in the region. Nonetheless, the prospect of accelerating economic growth and a big pick-up in capital spending in 2007 suggest that, barring major shocks, investors will remain bullish for the time being.
On April 17th the Jakarta Stock Exchange (JSX) Composite Index closed at 1,965.4, a fresh all-time high, and there is increasing optimism that it will breach the 2,000 level soon. The market has hit ever higher record levels in recent weeks. Although its April 17th close is only about 9% higher than at the end of 2006, this marks a 69% gain since the end of 2005. Last year the JSX Composite Index was one of Asia's star performers, outperforming most other markets including even India's soaring Sensex, although perhaps unsurprisingly the JSX's growth was still eclipsed by the 130% rise in Shanghai's composite index.
A healthy macroeconomic picture, supported by political stability, has been one of the key factors in the JSX's recent success. Indonesian GDP growth hit a two-year high in the fourth quarter of 2006, and the central bank's key interest rate has fallen to 9% from 12.75% a year ago. Lower interest rates are widely expected to have boosted corporate results due out soon, and this may explain some of the market's recent success.
The Economist Intelligence Unit expects interest rates to fall further during 2007, lowering borrowing costs both for businesses and consumers. This is reflected in our optimism that there will be a pick-up in private consumption and fixed investment growth in 2007. Consumer spending accounts for around 62% of GDP and in Indonesia's case is helpful in insulating companies to some degree from the vagaries of external demand. This could be useful in light of the expected slowdown in the US this year. We forecast private consumption growth will rise to almost 4% this year (from 3.2% last year). This should be good news, in turn, for many of the listed companies that sell to the domestic market and depend on robust demand there for their profits.
Meanwhile, we expect gross fixed investment to grow by 10.6% in 2007 and to increase by almost the same amount next year as well, up from 2.9% growth in 2006. Investors are likely to have been reassured by the recent passage of a new investment law. Although the law is no panacea--it is short on all-important implementation details, and other systemic problems in the business environment will continue to deter less adventurous investors--it is nonetheless a step in the right direction in terms of making Indonesia more investor-friendly. Indeed, its approval may already have contributed to recent rises in the JSX Composite Index, with investors anticipating increased inflows of foreign capital on the basis of measures in the law that provide for equal treatment, in principle, for foreign and domestic investors. The law also reduces the number of sectors closed to foreign investors and includes provisions for tax breaks and other incentives.
Despite this optimistic picture, there are also grounds for caution. The market remains volatile. Three times since the start of the year it has suffered sharp falls, partly as a result of contagion from problems in other markets (although to be fair, most other Asian markets have suffered similar fates). But Indonesia remains a high-risk market, and it is inherently vulnerable during bouts of global or regional market turbulence. Moreover, the very scale of the JSX Composite Index's gains also makes a corresponding downward correction that much more of a worry. In the 24 months to March, Indonesian equities rose by around 80%, compared with a median of around 45% in ASEAN. Valuations may also be on the high side. The average price-earnings (P/E) ratio of the JSX is currently 20.2, lower than China (22), New Zealand (22.5) and Japan (26.6) but higher than in most other Asian markets. In Singapore the average P/E ratio is 15.3, and in Thailand it is 10.4, although this probably indicates that political instability has lowered valuations.
Other factors may also affect Indonesia's stockmarket prospects in the months ahead. In terms of the macroeconomic environment, in 2007 the central bank will have less scope to lower interest rates than in 2006 as the differential with rates in OECD countries will narrow. So falling rates, on their own, will play a smaller role in driving the stockmarket's performance. Notwithstanding our optimism about Indonesia's domestic economic prospects, conditions for exporters will also become more challenging as the US economy slows (although, happily, we expect this to be offset by the strength of demand in Japan and China). By next year, the 2009 presidential and parliamentary elections will also be in sight, and though still a relatively distant prospect, the approach of these elections may increase uncertainty and volatility, possibly causing international investors to become more risk-averse and to reduce their exposure to Indonesia.
