Indonesia facing pressure of fund outflow

Foreign investors have pulled out across EMs in the wake of the US dollar strength


It HAS been a turbulent year for the Indonesian equity market. Tormented by negative sentiment and panic sells since mid-April has seen the market experience increased volatility.

The sound economic fundamentals of the Indonesian economy have been eclipsed by events like the trade war between the US and China, and concerns on the trajectory of Indonesia’s benchmark interest rates.

Foreign investors have pulled out across emerging markets (EMs) in the wake of the US dollar strength due to a yield spike in US Treasury, as well as rising inflation expectations in the US that could prompt the US Federal Reserve to step up its pace of monetary tightening.

The weaker rupiah has shaken investors’ confidence in the Asean’s largest economy.

The gross domestic product of Indonesia expanded by 5.06% yearon- year (YoY) in the first quarter versus the estimate of 5.19% growth forecast by economists.

Private consumption grew by 4.95% YoY which remains below the much desired 5% level.

Although 2017 was tough for the consumption segment, we still see positive catalysts for 2018.

The electric price hike effect in 2017 will continue to fade, while lower inflation target shall drive the middle-income segment’s consumption to a higher level.

The after-effects of the government’s budget allocation of the “Transfer to the Regions” and “Village Funds” (amounting to 251.9 trillion rupiah or RM71.03 billion) are likely to give a steam to the middlelower segment’s consumption in 2018.

Last but not least, we see that the Asian Games 2018 will give a positive impact, though to a lesser extent than the previous two catalysts.

Investment growth remains high, supported by the need to finish infrastructure projects ahead of the regional elections in 2018 and presidential election in 2019.

We still expect a 5.2%-5.3% growth on the back of better investment and gradual recovery of consumption in the foreseeable future.

On the monetary front, after easing rates in 2016 and 2017, Bank Indonesia raised its benchmark interest rates twice in May from 4.25% to 4.75% to support the Indonesian rupiah.

Foreign reserves are high but are below their February 2018 peak due to interventions to limit currency depreciation.

The Indonesian central bank also signals more possible rate hikes to protect the rupiah in order to maintain financial stability.

The central bank is confident the rate hike should not immediately impact economic growth as it seeks to compensate with looser macroprudential measures in order to spur lending to offset higher interest rates.

We think Bank Indonesia is trying to conduct a more proactive and forward- looking policy, particularly with regard to a possible higher current account deficit, as well as inflationary pressure stemming from the higher energy prices.

We doubt an aggressive tightening is on the cards given the economic fundamentals are better than in 2013.

From a valuation standpoint, the Jakarta Composite Index is trading at price earnings (PE) multiple of 15.4 times and 13.8 times based on estimated earnings for 2018 and 2019 respectively, and below to its estimated fair PE ratio of 16 times (as of May 31).

The Indonesian equity market will most likely remain volatile in the months to come due to uncertainties over the trade terms negotiation between the US and China and the strength of the dollar.

One should note Indonesia’s fundamentals will help it weather external factors.