By SHERMAN TAM CHENG WEI / Pic By BLOOMBERG
The Indonesian equity market has gone through a bumpy ride beginning with the global sell-off in February as rising risk factors saw outflows.
The Jakarta Composite Index (JCI) clocked a negative return of 7.2% on a year-to-date (YTD) basis as of May 17, as investors sold rupiah assets.
As foreign holdings of Indonesian equities and bonds are high (about 40% of the total), Indonesian assets are usually hit harder than its Asean counterparts in times of heightened global market uncertainty.
Indonesia saw the highest foreign capital outflows in the Asean region at about US$2.4 billion (RM9.53 billion) on a YTD basis after the US dollar rose, as yields on US treasuries moved higher on rising inflation expectation in the US.
Jittery investors with concerns on global economic growth moved to adopt a risk- off mode and scaled down their exposure to emerging markets (EMs) like Indonesia.
The fund outflows have weaken the Indonesian rupiah and a weak currency is usually unfavourable for the EM because it reduces the total return foreign investors make.
We think the recent lacklustre performance of Indonesian equities can also be attributed to concerns on its own benchmark interest rate.
Considering the pressures on the rupiah caused by recent capital outflow, Bank Indonesia decided to hike its benchmark interest rate by 25 basis points to 4.5%, marking the first interest-rate increase since November 2014.
Although a higher benchmark interest rate should provide a cushion to the falling rupiah, it will also bring pressure for Indonesian equities because higher interest rate tends to cloud corporates’ future outlook.
We opine the rate hike was necessary as Indonesia has a high share of imported inflation.
Any further weakening of the rupiah would increase inflationary pressures, and thus disrupt the broader price stability seen over the past few years.
With the country heading into election this year, the prospect of higher inflation driving up living costs is something the government does not want to risk.
From a valuation stand-point, the JCI is trading at a price-earnings (PE) ratio of 14.9 times and 13.3 times based on estimated earnings for 2018 and 2019 respectively, below its estimated fair PE ratio of 16 times (as of May 17).
We maintain our positive view for economic growth moving forward. Investors should stay focus on its improving fundamentals when assessing the equity market’s prospects.
Given that global economic growth is expected to remain robust, the recent correction has brought valuations to a more attractive level and provides long-term investors an attractive entry point.
What are the risks? Like Thailand and Malaysia, foreign fund flow is the key driver for the rise in the Indonesian market.
If the US Federal Reserve raises its interest rate more aggressively than market expectations, we would see another exodus of foreign fund from Indonesia, hence causing a further correction in the equity market.