The Jakarta index has soared and Indonesia's economy could now accelerate. But will corruption and religious tension spoil the story? We'll soon know, says Jonathan Compton.
Investors in emerging markets often overlook Indonesia. It receives a fraction of the media coverage of much smaller Asian economies, such as Hong Kong or Singapore. Yet it has it all. It is the largest country in Southeast Asia. It's the fourth-biggest country in the world by population, with 268 million people. It contains abundant natural resources coal, metals, oil, timber and agricultural products while the seas around its 18,000 islands (of which about 1,000 are permanently occupied) teem with fish.
This century its economic growth has reached 4.5%-5.5% per annum, meaning the economy doubles in size every 15 years. This helps explain why Indonesia's Jakarta index has risen more than fivefold in sterling terms since New Year's Day 2000, while British stocks have returned around 20% and their US counterparts about double that. What's more, Indonesia is about to reach an economic tipping point something that should turbo charge its growth
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Growth could move up a gear...
There are several reasons for this. The first is great demographics: 27% of the population is under 14. This group will soon provide a rapidly expanding pool of labour and eager new consumers and savers; meanwhile, the costs of an ageing population are absent, as over-65s comprise just 6% of the total. There is also a rapid shift in population from the land to the cities. Urbanisation invariably leads to considerable gains in overall productivity, as seen recently in China and in Europe in the 19th century.
Although GDP-per-head in Indonesia has more than doubled since 2000, it is still relatively low at around $4,200. In about four years' time, at this rate, it will have exceeded $5,000, a threshold historically associated with domestic consumption taking off and credit becoming more widely available. This in turn leads to a rapid expansion in the services sector. Consumption, credit availability and services are the three main supports for all advanced economies.
There is also ample room for Indonesia to borrow more to fund expansion. Public debt is below 30% of GDP (compared with 90% in Britain). If an emerging market has to rely purely on domestic savings which in Indonesia are low compared with similar countries to finance development, then investment in vital infrastructure, plant and equipment will be lacklustre, implying lower future productivity and growth.
Finally, Indonesia has embarked on structural reforms such as paring back onerous regulations governing foreign investment and improving infrastructure in some key areas. This bodes especially well for tourism. The country abounds in ancient monuments, spectacular topography, forests, wildlife and pristine beaches, and is also incredibly cheap.Yet it attracts fewer tourists than tiny Singapore.
In terms of revenue from tourism it earns half that of user-unfriendly destinations, such as Russia. The scope, then, is enormous. Despite all this potential, however, it's interesting to note that Indonesia is still considered an economic minnow. The value of all its listed companies is about the same as Warren Buffett's Berkshire Hathaway. This is due to the country's political, ethnic and religious history and, most of all, endemic corruption. These have hampered growth in the past and continue to threaten Indonesia's future.
.... if simmering tensions abate
After World War II the Dutch attempted to reclaim their largest colony, but were expelled following a vicious war. At that stage Indonesia was less a country, more a resurgent Javanese empire. Although Java comprises just 7% of the land mass, it accounts for nearly 60% of the population and dominates the economy. Yet Indonesia has over 300 languages and an array of ethnic groups, many of which wanted their own independence.
Until 1966 President Sukarno then until 1998, his successor President Suharto ruthlessly crushed these movements, often forcibly resettling Javanese to swamp local populations. Both presidents ruled as military dictators espousing cod-socialism while enriching themselves and their cronies. Policy was xenophobic and inward looking.
The racial divisions are particularly acute between those classified as ethnic Indonesians, known as Pribumis, and those of Chinese origin. The latter account for about 4% of the population. The problem is that this minority is estimated to control at least 60% of all private business and dominate the firms listed on the stockmarket.
Overlaying the ethnic divides are religious ones. Nominally, Indonesia is a secular state with enshrined freedom of religion, but only six faiths are recognised (leaving another 200 or so in limbo). On the compulsory ID cards only these six appear, along with a blank space; until 2017 if this was left blank it meant no access to services such as education. Almost 90% of the population is registered as Muslim. Agnosticism and atheism are not recognised, while blasphemy remains a crime for which many are jailed, most recently the Chinese Christian ex-governor of Jakarta for "misinterpreting" a verse from the Koran.
In areas where non-Pribumis and non-Muslims are significant or the majority (such as Bali, where the majority are Hindu) religious attacks by Muslims are common.
A tenth of the population is officially Christian, 2% Hindu and 1% Buddhist. The majority of local Chinese are Christian or Buddhist; those following other minority religions who are not Chinese also tend to control a disproportionate share of the economy. This has created considerable envy, worsened by President Suharto especially, who surrounded himself with a clique of Chinese Indonesians, who as a result became fabulously wealthy.
The Asian crisis: a new beginning
The 1997 Asian financial crisis was the watershed that started to turn Indonesia from a kleptocratic dictatorship and failing state into a unified, democratic nation. It had suffered particularly badly because of President Suharto's economic mismanagement and spectacular overborrowing in foreign currencies. Despite large foreign-currency reserves and a trade surplus, the rupiah (the local currency) swooned from 2,600 to the dollar to over 14,000 in the crisis, thus making repayment of foreign dollar loans impossible, while the stockmarket plunged by more than 80%. The collapse brought all the previously suppressed problems to the fore. Anti-Chinese riots were rife, resulting in hundreds of deaths.
The crisis negated all the gains of the boom years. Nominal GDP-per-capita in dollar terms contracted by 42% in 1997 and did not regain the pre-crisis level until eight years later. In 1998 Suharto was ousted in a bloodless coup and the once moribund parliament slowly developed a backbone. But it was not until 2004 that for the first time a president was directly elected in a clean contest. Essentially, the post-war experiment of a new Javanese empire had failed. Thus in my view the history of Indonesia as an independent nation started only two decades ago.
The boom that Indonesia has enjoyed this century has stemmed from better government policies, improvements in the regulatory environment and greater encouragement of vital foreign investment. It was a considerable plus that 2014 saw the election of President Joko Widodo, the first successful candidate to lack family wealth or a high-ranking military or political background. These improvements are a hint that Indonesia could become a significant economic power and home for investment. The next 12 months will determine whether this is likely to occur.
A fork in the road
The risks are clear. Top of the list is endemic corruption. Indonesia has always been high on global-corruption league tables, hence also near the bottom for "ease of doing business". In a recent poll one in four adults reported that they had bribed a policeman in the last 12 months. The judiciary has been perennially corrupt, biased and arbitrary. The government has set up a super-judiciary to investigate corruption within the system and has claimed some meaningful scalps, but it is a slow process.
Another risk is a return to religious intolerance. The dominant religion is Sunni Islam. Saudi Arabia has been very active through education and funding in spreading Wahhabism an extreme puritanical brand of Sunni Islam that has some supporters in parliament and has evidently permeated society. In a survey earlier this year, 24% of Indonesian women agreed that a husband is justified in beating his wife if she goes out without his permission. Meanwhile, political attacks on President Widodo often accuse him of not being sufficiently religious or a proper Indonesian.
What investors should watch out for
Then there are still colossal infrastructure problems, over which the government can no longer delay taking action. An extreme example is that the capital is the fastest-sinking city in the world, up to 2.5 metres in North Jakarta over the last ten years with forecasts that two-thirds of the city will be underwater by 2050. The prime causes are illegal groundwater extraction and construction another example of corruption.
Although I have highlighted the superb returns from the Indonesian stockmarket this century, I would not invest a penny at present. This year will be pivotal. Vital foreign investment into emerging markets is ebbing. Indonesian export growth has slowed and the balance of payments looks wobbly. In April for the first time there will be simultaneous elections for the president, parliament and local assemblies. If the moderates win and the government shows signs it can navigate these problems intelligently, then any downturn will be brief and the prospects bright. Otherwise the danger is that Indonesia will revert to being a backwater.
Jonathan Compton was MD at Bedlam Asset Management and has spent 30 years in fund management, stockbroking and corporate finance.
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