Indonesia equities, measured by MSCI Indonesia, have underperformed in the year to date compared with MSCI EM, but we remain positive on the country. Even the intermittent protests, for different causes since the April 2019 election, and which have resurfaced in recent weeks, are not remarkable by Indonesia’s standards (with its history of fatal violence in political protests) and certainly do not justify the weakness in the equity market.
Here, we briefly revisit the investment debate. In our view the appropriately modest reform agenda, easing of interest rates, fairly valued FX rate and relatively healthy starting points for macroeconomic forecasts offset the decline in commodity prices (which appear to have stabilised since June anyway).
1. Almost five years before the next election – President Joko Widodo (“Jokowi”) is early on in his second term (which runs to 2024) and, while protests greeted his victory and some of his policies (ie reforms on labour flexibility, social conservatism, anti-corruption oversight), these have been relatively subdued by Indonesian standards.
2. Modest reform mandate – Jokowi is pushing a reform agenda (eg tax cuts, greater labour flexibility for new hires, more foreign ownership opportunity) that, in our view, appropriately balances the need for structural change and the constraint of managing consensus in the world’s most geographically fragmented nation (which means, for example: 1) a lot of diverse interest groups, distant from the federal centre, need to be carried along in any change; and 2) to expect sweeping changes in his cabinet personnel is unrealistic). Indonesia does not have the authoritarian tools available to, for example, Egypt or the Philippines.
3. Easing cycle – Policy interest rates are easing, following the tightening cycle of last year, and inflation remains within the target zone (around 3.5% in 2019 and 2020, according to IMF forecasts, compared with the central bank's 2.5% to 4.5% target band).
4. Benign macroeconomic indicators – Macroeconomic indicators are benign: growth is steady, if unspectacular by “Asian tiger” standards, with over 5% real GDP growth expected in each of the next five years, according to IMF forecasts (GDP rose 5.02% in Q3 versus 5.05% in Q2); the FX rate is close to fair value (on an REER basis) and FX reserves are comfortable, at over eight months of import cover; the current account is in deficit, but not by an alarming amount (less than 3% of GDP, according to IMF forecasts for 2020 and 2021); and the fiscal balance is also in deficit but, again, not by an alarming amount (less than 3% of GDP, according to IMF forecasts for 2020 and 2021).
5. Lower, but at least now more stable, commodity prices – Prices of the commodities exported by Indonesia (coal, palm oil, LPG, rubber, crude oil) have dropped substantially over the past year, but the drivers of this fall are now very well understood (anaemic global growth, US-China trade tension) and these commodity prices have stabilised since June 2019.