Monday, December 13, 2010

Indonesia: inflation is a short-term risk

On this blog back in April we argued that the Indonesian stock market was not overvalued and that local authorities were not correct in pointing out that a bubble was emerging.

In April the Jakarta Composite Index was up 13% in US$ terms since the beginning of 2010, eight months later it is up 36%. So what next?

From a macro perspective all indicators point to a strong year in 2011.

2010 E

2011 F

Real GDP Growth (%)



GDP per Capita (US$)



Fiscal Balance (% GDP)



M2 (% GDP)



Current Acct Bal (% GDP)



Gross FX Reserves (US$ bn)



Source: Bank Indonesia, CEIC, Credit Suisse

The main worry is inflation, which will accelerate to 7% y/y in 2011 versus 6.5% in 2010 as food and energy prices rise. However we would expect inflation in the country to realign closer to global inflation rates in the medium term as the government continues to cut subsidies in various sectors. Bank Indonesia is traditionally highly responsive to rising prices but this time is proving slower to act. This is partly due to the strong Rupiah, according to some estimates now at 2.1 standard deviation above it long-term REER (Real Effective Exchange Rate) average. The ability of Bank Indonesia to keep the Rupiah stable is a key factor in managing inflation.

Strong capital inflows have forced the central bank to sterilize, a costly exercise since local interest rates are almost 5% above US Treasuries. Foreign ownership of Rupiah-denominated government securities has reached 30% of outstanding securities.

Valuation of the stock market appears slightly stretched at this point and fairly high compared to the Asia ex Japan universe in terms of price to book value.

Trailing Price to Book Value

Trailing Dividend Yield

Current 5-yr average

Current 5-yr average


4.5x 4.0x

2.2% 2.8%

Asia ex Japan

2.1x 2.1x

2.1% 2.5%

Source: Deutsche Bank

In a nutshell, rising inflation could trigger a correction in the stock market. This for us would represent an opportunity to buy stocks of companies geared to domestic demand. Private consumption now represents 56% of GDP, up nearly 5% y/y. According to the World Bank, the country’s dependency ratio (ie. the non-working age to working age population ratio) will decline from 45% currently to 40% in 2020 boosted by a young labor force.

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