Saratoga Investama Sedaya wants to make money while Indonesia can still bask in the warmth of international investor approval.
The investment company, which derives much of its value in the investments it holds in other Indonesian companies, intends to launch an initial public offering (IPO) in June that could raise the equivalent of US$395 million, making it the largest from the nation in two years. It’s not the only one eyeing a market entrance; cement maker Semen Baturaja launched an IPO on May 29 that could raise up to US$163 million.
Indonesian companies well understand that international investors have been interested in returns and yield in a largely low interest rate environment. And as a country Indonesia is appealing. It’s high growth (boasting gross domestic product expansion of 6.2% during 2012), has a relatively stable political environment and is on the cusp of investment grade.
Both institutional and foreign direct investors have been keen to take advantage. Foreign direct investment (FDI) hit a record for the first three months of 2013, reaching IDR65.5 trillion (US$6.7 billion), while overall investment for the quarter was IDR93 trillion.
Yet despite these positive developments a sense of anxiety in the air has begun to emerge. The desire of Indonesian companies to list in the coming weeks almost smacks of desperation.
There is good reason for this. In April Indonesia recorded a trade deficit of US$1.5 billion in April as the value of some of its key commodity exports fell. That is likely to impact economic growth.
Added to this the second four-year term of president Susilo Bambang Yudhoyono ends in 2014. He is not allowed another one, so the country will hold an election for a new leader and new government, adding to the atmosphere of uncertainty. Yudhoyono and the coalition of parties that he leads will try and avoid doing anything unpopular. Increasingly, only populist policies look likely to be enacted.
The trouble is that Indonesia needs to make some unpalatable political choices if it is to maintain its economic lustre. As we discuss in the accompanying story on page 40, Indonesia has both current account and fiscal deficits, and the latter will worsen unless the government scales back its spending on generous and popular fuel subsidies. But doing so would risk the opprobrium of voters – something it does not want.
Plus there is the risk of a more general capital pullback from emerging markets if the US Federal Reserve begins to wrap up its sustained experiment with quantitative easing.
This confluence of factors is causing an uncertain political and financial environment that could well curtail the momentum of the country’s stock and bond markets. Indonesia’s bull market run is at risk of petering out.
An impressive stretch
For over 18 months Indonesia has been the apple of foreign investors’ eyes. Its strong economic growth was largely due rising demand in the country’s domestically-orientated economy, while inflation has been largely under control.
This helped underpin investor confidence about the prospects of Indonesia’s shares and bonds. The country’s Jakarta Composite Index (JCI), an equity benchmark, has shot up from 3,857.88 at the beginning of 2012 to hit 5,068.63 on May 31 this year, a rise of 31.38%.
International investors have been particularly keen to get more exposure in the country as a result. The country enjoyed US$3.4 billion of international investor inflows into its government bonds in this year to the end of May, according to Bloomberg, in addition to US$5 billion of buying in 2012.
Foreign investors now own a major proportion of the country’s stocks and 34% of its bonds, while yields are roughly one-third where they were in 2008.
This sustained market confidence has convinced a rising number of Indonesian companies to consider issuing stock, with the IPO of investment company Saratoga being the latest and boldest attempt.
It is selling its shares between IDR6,100 and IDR7,800, meaning it could raise up to IDR3.87 trillion including a greenshoe option. That would make it Indonesia’s biggest IPO in the country since the IDR4.75 trillion privatisation of state-owned airline Garuda Indonesia in January 2011. The deal is set to list on June 28.
But it’s not all been good news. On May 2 Standard & Poor’s (S&P) cut its outlook on Indonesia’s ‘BB+’ rating from positive to stable, citing a stalling of the momentum of local reform efforts – something local observers say has been noticeable for over a year.
That news caused the Jakarta Composite Index (JCI) to drop from 5,060.92 on May 1 to 4,994.05 on May 2 and then 4,925.48, a cumulative 2.7% fall that was the index’s largest since August 30, 2012, according to Bloomberg. Meanwhile a government bond auction on May 6 saw a small increase in yields.
However the JCI quickly rallied, trading up to 5,214.98 on May 20 and closing at 5,068.63 on May 31, largely because there were no signs of reciprocal action at S&P’s peers, Moody’s and Fitch Ratings, which rate Indonesia at ‘Baa3’/’BBB-’.
Tougher times ahead
But Indonesia’s outlook could yet worsen. The government is likely to have to drop its fuel subsidies to hit a projected 2.5% fiscal deficit target. It is discussing increasing the price of low-octane gasoline by 44.5% to IDR6,500 a litre and raising diesel 22.2% to IDR5,500 a litre.
Such price hikes would be unpopular, but failing to do so could cause the government to breach a fiscal rule that caps annual deficits at 3% of GDP.
However this increase in fuel prices will feed inflation, which could force new Bank Indonesia governor Agus Martowardojo to act, most likely by raising interest rates. That would likely hurt the performance of outstanding local stocks and bonds.
Added to this concern, Indonesian debt chief Robert Pakpahan reportedly told the media on May 22 that the government would have to issue an additional IDR60.8 trillion of new bonds to hit its fiscal deficit target this year, according to The Wall Street Journal.
The likelihood of higher rates and higher government bond supply mean that existing debt could well see yields rise, denting its appeal. Indonesian bonds immediately reacted to the news of the extra supply, with its 2023 benchmark bond yield hitting a seven-month high of 577 basis points on May 24.
Another major uncertainty for Indonesia’s market performance is the future of the Federal Reserve’s strategy. The de facto central bank of the US has been largely responsible for the bull markets across Asia over the past few years, courtesy of quantitative easing (QE) efforts that led mounds of money to be pushed into higher-yielding regional assets.
That could be about to change. Fed Reserve chairman Ben Bernanke hinted on May 27 that he could scale back the organisation’s US$85 billion a month purchase of Treasury bonds as signs of economic confidence are improving in the world’s largest economy. A slowing or end of that purchasing, combined with hopes of US capital market performance, could well cause international investors to start pulling some of their money back from Asia once more, affecting Indonesia as well as other emerging markets.
“Indonesia has been a massive beneficiary of the US’ looser monetary policy,” says a Jakarta-based strategist at an international bank. “The nearer we get to the end of that policy cycle the more there will need to be a reconfiguration of the discount rates of many markets, not just Indonesia. Couple that with a slightly slowing growth rate and rising interest rates and the market won’t be as appealing as it’s been early in the year.”
Looking vulnerable
A combination of Indonesia’s strong performance to date, uncertain prospects and high foreign ownership of stocks and bonds, leaves it looking vulnerable to a foreign investor pull back.
A major reversal of fund flows is not likely to be immediate. Indeed, the reason for Saratoga to feel confident to press ahead with its IPO is its belief that investor demand for its deal will remain strong, for the coming few weeks at least.
But signs are beginning to emerge that the bull run is over. The JCI slipped over 1% on May 31 on the back of concerns about tightening global liquidity if the Fed turns off the QE tap. According to the Indonesia Stock Exchange foreign investors were net sellers to the tune of IDR355.9 billion in May – the first time they had sold more than they had bought since July 2012.
This could just be the beginning, particularly if the Fed makes definitive sounds about an end to quantitative easing and the Indonesian government cuts fuel subsidies. Analysts already recommend that investors hedge rupiah exposures, as a currency that might suffer against a rejuvenated dollar.
If a sell-off does occur, Indonesia’s bonds are likely to feel the squeeze first. They look as if they already have little performance left to offer, while they are exposed to a potential interest rate-rising environment.
“The [bond] market has been fantastic, and investors have managed to get a relatively easy double-digit return every year. But this year it’s going to be a different story,” says Soufat Hartawan, fixed income fund manager for Schroders Investment Management. “It is now becoming more difficult, and investors have to be more tactical.”
Equities, although better-placed against inflation and rate-rising pressure than bonds, are unlikely to remain immune either, particularly as an election with an uncertain outcome approaches. Again, big returns to date and an uncertain outlook are the main reasons for this.
Yet for all the uncertainty, it would be unwise to become too pessimistic on Indonesia’s outlook.
“We took a view earlier in the year that there seemed to be some early signals of cyclical slowdown in Indonesia and it is coming off of a high base,” says the strategist. “The country’s economic growth won’t fall off a cliff relative to the rest of world; instead we are likely to see more stable economic growth and a stable FX rate as opposed to higher growth and a less stable FX rate.”
He anticipates that the country’s stocks could see some market correction following a good run so far this year, noting that the country remains a “slim overweight”.
“It would be easy to get too bearish on Indonesia,” the strategist notes. “It’s becoming a tougher market that’s feeling a little toppish, with rising rates and a currency that’s being tested. But that would suggest trimming some profits off the top of some good performance so far this year; there’s no need to get too negative.”
It’s wise not to become too downbeat about Indonesia. It remains a domestically-focused economy with a strong growth rate, relatively low public debt and manageable public and current account deficits. Even a rise in inflation should be manageable.
But it’s hard to escape the conclusion that the months to come will be more challenging than the past year. Indonesian companies keen to issue new equity and bonds had best make their plans quickly. Because the country looks set for less sunny weather ahead.