Indonesia — still worth watching

Pic by BLOOMBERG

A supportive global business environment and sound domestic fundamentals has enabled the Indonesian economy to begin 2017 on a strong footing.

Real gross domestic product (GDP) growth has been robust and strengthening while inflation has continued to be relatively low.

The resource-rich Indonesian economy grew 5% year-on-year (YoY) in the second quarter (2Q).

This was viewed as a disappointing figure as it was a slightly slower consensus and unchanged from the 1Q number.

President Joko Widodo, or better known as Jokowi, is serving the last two years of his presidency and has yet to realise his promise to drive the growth rate to 7% during his five-year term, which ends in 2019. This year, he has set a target of 5.2% growth.

Indonesia’s private consumption, which accounts for more than half of its GDP, rose slightly faster in 2Q compared to the 1Q.

Rising investments have offset a notable drop in government spending and a disappointing performance from the external sector.

That said, growth prospects remain bright. Economic growth is expected to accelerate in the second half of the year (2H17) as the government is committed to ambitious infra- structure programme while the reform agenda should revive the business environment and private investment.

The upbeat consumer confidence and a healthy global backdrop also bode well for growth.

The latest gross fixed capital formation data suggest investment remains robust with a 5.4% YoY growth with higher investment in buildings and structures.

Other leading indicators such as overall cement consumption and commercial vehicle sales also point to continued strengthening of investment.

From an inflation point of view, the monthly headline inflation for 1H17 averaged 3.9% YoY, higher than the average of 3.2% recorded in 2H16.

Inflationary effects from upward adjustment in administrative prices including electricity prices in January, March and May, were partly offset by a slack growth in food prices.

In August 2017, prices of food such as fish and vegetables, fell from a month earlier.

Going forward, we expect the economy growth to gain traction amid a low inflation and interest-rate backdrop, while private consumption remains robust.

The outlook for exports remains positive due to the recovery in global economy. The Indonesian government has also revised its state budget higher to 2.67% of its GDP in July in order to make more funds available for infrastructure development, improvement of prisons as well as preparations for the 2018 Asian Games that will be hosted by Indonesia.

We foresee the revised budget deficit should continue to support the Indonesian economy.

On the monetary front, after a surprising rate cut of 25 basis points (bps) in August, the Indonesian central bank once again wrong footed most analyst by lowering its seven-day reverse repurchase rate again by 25bps from 4.5% to 4.25%. The rate cut is clearly aimed to lift the economic growth rate as the bank has now cut the benchmark rate by 200bps since the start of 2016.

The move was motivated by an improving inflation outlook and expectations of only one more rate hike in the US by the end of 2017.

At this point, risks are now tilted towards external pressures as major central banks around the world begin to tighten their monetary policy.

The rate cut by Bank Indonesia may spur consumer spending and help to boost sentiment for property and automotive sectors as the bank forecast inflation will average 4% for the year.

The central bank also plans to ease other monetary policy measures such as mortgage down payment and bank liquidity rules.

The Indonesian rupiah is still trading below its fair value as of the end of July 2017, making the currency attractive from valuation perspective.

The benchmark Jakarta Composite Index (JCI) has posted a 13.5% gain (local cur- rency terms, as of Oct 5) since the beginning of year 2017, outperforming its regional counterparts.

The index has performed well on earnings pickup and Indonesian government’s infra- structure spending backdrop.

As of Oct 5, the JCI was trading at a price-earnings (PE) multiple of 17.5 times, sitting at a slight premium above its fair PE value of 16 times.

The year-to-date rally has stretched valuations. The gains have come even after a slow- down in its economy growth and sales activities.

The benchmark index remains attractive with the valuations for 2018 and 2019 at 14.6 times and 13.5 times PE respectively, implying a discount in terms of valuation.

Moving into the 3Q, earnings revision for Indonesian equities has been moving sideways.

Nevertheless, the weaker numbers should be largely temporary as commodity capital expenditure cycle and the recent cut in borrowing rates should slowly trickle down to the wider economy later in the year. As such, we expect the corporate earnings to be revised upwards in the near future.

To sum up, Indonesia’s economy prospects and stable political outlook paint a cautiously optimistic picture with Bank Indonesia expecting retail sales to remain robust and inflation rate is likely to pick up by the end of this year.

Data from the central bank also showed Indonesian households are more confident and optimistic about the near future, pointing towards steadier economic growth moving forward.