Investors in Indonesia are brimming with confidence. The Jakarta Composite index hit a new record above 5,200 last week. It has gained 25% this year, making it one of the best-performing emerging markets.
The reason for all this optimism is incoming president, Joko Widodo, who was elected in July and takes office in October.
The hope is that this former owner of a furniture business, whogained a reputation as "a hands-on manager" when he ran Jakarta province for two years, "will finally get to grips" with some of Indonesia's long-standing problems, says Peter Thal Larsen on Breakingviews.
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Indonesia's macroeconomic positionhas improved vastly in the past two decades, with inflation now in singledigits and public debt down to only25% of GDP. But corruption andred tape have hampered growth, and fuel subsidies for low-income households gobble up huge sums that could bespent on education, health and investment.
Around $30bn, or a fifth of next year's budget, is earmarked for subsidies. Widodo's ability to cut these back "will be an early test of his determination to push through sensible but unpopular reforms".
Reduced subsidies will free up cash for more infrastructure, which is urgently needed. In the past decade Indonesia has only spent 3%-4% of GDP on improving its infrastructure. Better ports, airports and railways would entice more foreign investment.
Widodo has signalled that he could start to pare back subsidies as soon as October or November. Investors will be watching Widodo carefully in the next few weeks. If he drags his feet on subsidies, "hopes of reform would be dashed and that could lead to prolonged selling pressure in the market", says Wilianto Ie of Maybank Kim Eng.
It doesn't help matters that if US interest rates rise, money will leave emerging markets for safer American assets.
Any setback would be a buying opportunity, given Indonesia's long-term potential. Half of the population is under 30, and the huge population and very low household debt mean that consumption should continue to offset lower exports of the country's wide range of raw materials.
Our favourite Indonesia play, the US-listed Aberdeen Indonesia Fund (NYSE: IF), already looks good value on a discount of more than 9% to its net asset value.
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