Indonesia has serious issues to address: Invesco

The investor exodus from Indonesia continues, with the Indonesia Stock Exchange dropping 2% in one day on September 2, after $2.8 billion in stock market outflows this summer.

Investors’ rush for the exits is due to a combination of factors – the weakening currency, a widening account deficit and expectations that the US Federal Reserve will curb bond purchases under its quantitative easing programme.

More recently, skittish behaviour can be attributed to fears over military action in Syria and the Indonesian central bank raising interest rates to 7% on Friday, from 6.5% in an effort to curb risky lending practices.

The result is extreme stock market volatility. Jalil Rasheed, investment director at US fund house Invesco, is not surprised by the explosive nature of the Indonesian stock market, which is down 23% year-to-date in US dollar terms.

He points out that Indonesia, as well as other Southeast Asian nations, have been “on steroids for the past four to five years” and as such were due for a correction.

This near-term volatility will likely continue, he says.

“I don’t deny that Indonesia has some serious issues to address,” Singapore-based Jalil tells AsianInvestor. “Indonesia finds itself in a difficult time. If [the central bank] had increased interest rates and reduced subsidiaries progressively, they wouldn’t be in this position. But they waited too long. And now the country has to do a lot in a very short space of time, which will have a knee-jerk reaction on markets.”

Herald van der Linde, head of equity strategy for Asia Pacific at HSBC, agrees that the nation’s governmental bodies waited too long before cutting subsidies, which cost the government $20 billion per year, or 3% of the total GDP.

“The fuel price increases, which just went through in June, should have happened a year ago,” Van der Linde says. “They probably waited too long. They should have been more proactive.”

June's subsidy cuts by the Indonesian government effectively raised gas prices by 44% and diesel prices by 22%. This is the first fuel rise since 2008, and at $0.66 per litre, Indonesian fuel prices are among the lowest in the world.

It is hoped that this price hike, according to an HSBC report released yesterday, will curb demand for oil imports, the single largest cause for the trade deficit, which stood at $2.3 billion in July.

And while the weakening rupiah will increase the near-term cost of imported goods – Van der Linde, on a trip to Jakarta this week, noted that the cost of a bottle of wine rose by 10% on September 1 – ongoing weakness in the rupiah could dampen import demand, while making exports more attractive, HSBC’s report says.

Yesterday the rupiah weakened to 11,065 to one US dollar.

Stock markets were aggravated by the Indonesian central bank’s unannounced move to raise interest rates to 7%, although Van der Linde says this actually shows the government is keen to shift its growth focus toward "quality over quantity", a positive long-term signal.

Ultimately, all of these factors have not changed the fundamentals of local companies, Jalil argues, saying the firm’s Asean fund is still invested in a number of Indonesian financials, consumer, oil and gas-related companies.

“We can’t control the markets. And anyone who says otherwise is lying. But what we do know is that the individual health of the stocks we hold are in good shape,” Jalil says. “There is a market meltdown now. But we know the sell-off is not an indication that the individual quality of the companies are bad. It’s just people exiting the markets.”

Much of the recent outflows can be attributed to US investors pulling money from Indonesian ETFs, according to other market reports.

One sector in particular that Jalil is encouraged by is coal mining companies, although he declines to name them.

“There are some very well run coal mining companies that have been completely hammered. They’ve fallen between 20-30% year-to-date because people have taken the view that coal prices are dropping, so they don’t want to be invested,” Jalil says. “That’s a short-term view. We’re invested with a long-term view.”

Van der Linde agrees. “This really is a macro issue, not a micro issue,” he says. “There’s not a hell of a lot of stress at the company levels.”

Both differ on whether now is the right time to buy into stock markets, however. Jalil, a long-only investor, is in the buying camp, arguing that “if you know the company, and there’s nothing wrong with it, now is a great time to go in”.

Van der Linde is sceptical, anticipating that currency weakness and the country’s account deficit issue will “linger on” to next year at least. If the country manages to reduce its deficit going into next year, “then I think there will be a good buying opportunity of certain stocks”.

While subsidies cost Indonesian’s government some $20 billion each year, its foreign exchange reserves stood at $93 billion as of July 31, down from $106 billion a year ago, but offering four-and-a-half months’ of import cover.