Indonesian stocks will bounce back

Indonesia's stock market had a tough 2013, falling 22% in US dollar terms. But this year the Jakarta Composite index has regained the top spot among Asian equity markets. And Nomura Securities reckons "the worst might be over".

Last year's jitters over reduced quantitative easing (QE) by the US Federal Reserve hit stocks and the rupiah hard. The prospect of money fleeing emerging markets reminded investors that Indonesia was among those most dependent on foreign capital: its current-account deficit exceeded 4% of GDP in the third quarter.

But the external deficit has since improved, leaving Indonesia less vulnerable to foreign money leaving. The deficit fell to just 2.1% in the fourth quarter as imports fell and the recovering global economy lifted manufacturing exports.

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The signs of improvement have helped stabilise the currency, so the central bank is unlikely to have to raise interest rates again (to improve the return on Indonesian assets and thus keep foreign cash in the country).

A stable currency in turn makes it more likely that inflation, boosted by last year's cut in fuel subsidies, will now ease off again. Having hit 8% a year in 2013, it should be back to the 4.5%-5.5% target later this year, reckons the central bank.

So the economic outlook is improving. Moreover, as Assif Shameen points out in Barron's, the frontrunner in elections due this spring favours further structural reforms and "has a reputation as Mr Clean" in a country "riddled with corruption".

Indonesia's long-term advantages, such as a huge domestic market, little public or private debt, and a wide range of commodities, haven't gone away. Add this all up and the market can gain another 17% this year, reckons Citigroup.

Our favourite play, the US-listed Indonesia fund (NYSE: IF), currently looks cheap on an unusually large discount to net asset value of 13%.