seekingalpha.com--Many investors look to emerging markets to find growth opportunities for their portfolios. China, Brazil and India are probably the largest and most popular, but smaller countries such as Malaysia, Chile and Thailand also attract investors’ attention. One country that has been underrepresented in the investing media, aside from a spate of recent coverage, is Indonesia. Market Vectors added the country (IDX) to its small but growing stable of eclectic funds in January, and the timing could not have been better.
First, some background on the country. The fourth-largest country by population has one of the 20 largest economies in the world. The nation is endowed with natural resources that had allowed it to remain a net exporter of oil until last year, when it quit OPEC, but it continues to be a net exporter of coal and agricultural produce. Close proximity to China has aided the country’s development, as has a commitment to economic reform in the wake of the devastating Asian Crisis. Finally, as the world’s most populous Muslim nation, Indonesia seeks to develop itself into an Islamic financial center.
Politically, Indonesia is a newcomer to democratic government. Although it held elections, the government was headed by military President Suharto from 1967 to 1998, until the Asian Crisis led to nationwide protests. In 1999 and 2004, the nation held openly contested elections, and another is under way this year. Incumbent President Yudhoyono’s party won a victory in April’s parliamentary elections, and he appears poised to win re-election, as opinion polls have shifted decisively in his favor.
Suharto’s legacy remains partially in the form of endemic corruption. Transparency International ranks Indonesia among the bottom quarter of nations on that score. A Corruption Eradication Commission (known as the KPK) was created by parliament to crack down on corrupt officials, but The Jakarta Post reports, “Indonesia Corruption Watch (ICW) revealed recently that under now-suspended Antasari’s command, many cases implicating high-powered government officials were held up or only half-completed, with vested political interests interfering in the KPK’s investigations.” Antasari’s command was suspended after he was arrested on murder charges stemming from the assassination of a businessman in March. Inside Indonesia reports that the corruption problem grew worse in the wake of Suharto’s resignation because political decentralization also led to the decentralization of bribery. Businesses that once could engage in “one-stop shopping” and be assured of their position now face uncertainty.
Economically, the defining moment for Indonesia was the 1997-1998 Asian Crisis. After two months of intense pressure, the Thai baht depreciated rapidly in July, and Indonesia felt the effects. The country allowed its currency to trade in a wider band, and it fell from a level of 2,436 rupiah per U.S. dollar at the beginning of the crisis to about 3,000 in the fall. It appeared the worst was over, but then the rupiah began a rapid plunge. Volatile trading allowed for some sharp recoveries, but by June 1998, the rupiah had fallen to 16,800 per U.S. dollar, a collapse of more than 80 percent.
Indonesia’s economy contracted rapidly, and in dollar terms the collapse exceeded the currency depreciation. Rapid currency depreciation led to a rapid increase in the cost of living for ordinary Indonesians, and Suharto’s regime could not withstand the popular unrest. A $43 billion IMF loan that helped stabilize the country came with extensive economic reforms attached. These included tighter credit policies, fiscal restraint, and privatization efforts that laid the groundwork for nearly a decade of growth. Last year, the country signed a free-trade deal with Japan, and economic reform is at least a buzzword for politicians running in this year’s elections.
While these reforms were beneficial, economists remain concerned over the island nation’s economic position. In March, The New York Times listed several nations on the watch list for possible credit crises. Many were Eastern European countries (Latvia being the most recent to experience a major credit event), but Eswar Prasad of Brookings, formerly of the IMF, added four Southeast Asian nations: the Philippines, Malaysia, Vietnam and Indonesia. Thailand, meanwhile, is not on the list. A comparison of the U.S. dollar exchange rates shows why: Over the past year, the Thai baht has traded within a 10 percent range of the U.S. dollar. The Indonesian rupiah has been far more volatile. During last autumn’s dollar rally, the rupiah fell more than 30 percent. In March, about the same time the dollar began its slide, the rupiah reversed. In the three months between March and June, the rupiah gained almost 20 percent compared to the baht’s 6 percent gain.
Those recent currency gains supported a rapid advance in the nation’s stock market. From 1,256 on March 2, the Jakarta Exchange advanced 62 percent to close at 2,033 on June 4. With the currency gains added on, the rally was even greater, and Market Vectors Indonesia Index ETF (IDX) popped 123 percent over the same period. Indonesia’s economy looks a lot better than it did in March. Lower interest rates provided a boost, but after seven consecutive monthly reductions there’s still plenty of room to cut. June’s reduction left a rate of 7 percent. Interest rates are still high due to 6 percent inflation (as of May), but in a world where the Federal Reserve and European Central Bank are desperate for inflation, this isn’t considered such a negative. Economic growth was 4.4 percent in the first quarter, allowing Indonesia to join China, India and Australia among a handful of nations in
the region reporting positive growth. Government finances aren’t a problem either—debt to GDP is less than 30 percent of the economy.
There’s a lot of risk in Indonesia, but also a lot of promise. For investors, however, Indonesia is a relatively difficult nation to invest in. Most international and emerging market funds have very little exposure, if any, and there are only a couple of ADRs that do not trade on the pink sheets: Indosat (IIT) and Telekom Indonesia (TLK). Lack of coverage shows in Market Vectors’ choice of index as well—while many of the funds track established indexes, IDX tracks the Market Vectors Indonesia Index. According to Van Eck, “The Index provides exposure to publicly traded companies that are domiciled and primarily listed in Indonesia, or that generate at least 50% of their revenues in Indonesia.” Given the relatively small size of the island’s economy, all the holdings are domestic firms.
Indosat and Telekom Indonesia are not the largest of the 25 holdings in the fund; they represent only 2.93 percent and 5.42 percent of the fund, respectively. At the top is Bumi Resources (9.19 percent), a large coal miner. Behind it is Astra International (7.15 percent), a conglomerate with major interests in the auto sector. Three other holdings among the top ten are Perusahaan Gas Negara (5.47 percent), the largest national gas company in the country; Tambang Batubara Bukit Asam (4.72 percent), a partially state-owned coal miner; and United Tractors (5.28 percent), a company that started as a Komatsu dealer in 1972 and has expanded into mining contracting and coal mining.
The rest of the top ten are banking firms, which gives the fund a 29.1 percent weight in the financial sector as of April 30. Next is energy at 20 percent, materials at 16.6 percent and consumer staples at 12.2 percent. Indonesia’s near-term fortunes may be tied to Chinese resource demand and regional financial stability, but its long-term prosperity will depend on the political system’s ability to reform itself and the economy. Whether you decide for or against an investment in this ETF, Indonesia will play an increasingly pivotal role as economic activity shifts from the Atlantic to the Pacific.
