Indonesia’s status as an emerging market country often unfairly lumps it in with other countries that deserve skepticism, including Turkey and Argentina, whose currencies have tumbled this year, leading to a broader EM turmoil.
But compared to its peers, Indonesia is stable. Its government debt as a share of GDP is the lowest in Asia and it has come a long way since the 1998 Asian financial crisis, and is now recognised as a solid, investment grade rated credit by the main three ratings agencies.
Still, it has felt investors’ wrath recently. Last week, the rupiah fell to its weakest level against the dollar since the 1998 crisis. Portfolio investments into Indonesia dropped in 2018’s first quarter, and were very marginal in the second, showing that financing is scarcer. In addition, the benchmark Jakarta Stock Exchange Composite Index has provided negative returns of close to 8% to equity investors year-to-date.
These are worrying factors, but it is worth noting that Indonesia is nowhere near a crisis. Nevertheless, investor concerns are not completely misplaced. Rather than assume Indonesia’s downfall is imminent due to a collapsing emerging market, investors need to consider the country’s economic profile for what it is.
Sure, the government’s share of foreign exchange debt is shrinking, but it is still about 20% of GDP exposure. Indonesia’s numerous state-owned enterprises also weigh on its debt profile. At the same time, Indonesia’s funding needs have risen, its current account deficit is widening, and a weakening rupiah could be a big setback to the country’s debt servicing abilities.
The island nation has become a popular sovereign bond issuer, and is often lauded for the sophisticated execution of its deals. So far this year, it has raised more than $6bn from the international bond market through three deals, denominated in dollars, euros and yen. In 2017, it had raised more than $11bn from four transactions.
But the government’s increased activity in the debt market has only dug a deeper deficit hole, which cannot be filled with the issuance of more debt. Foreign investors are also becoming more discerning as the market softens, and Indonesia will feel that blow. If the sovereign tries to sell another dollar bond before the end of 2018, it will likely have to entice investors more the usual, and cough up a decent new issue premium.
Some of the country’s corporate debt issuers are already facing pressure. Many of the worst-performing credits in the secondary market last week were Indonesian, with the sovereign and quasi-sovereign oil and natural gas company Pertamina notably topping the list. The sovereign generated excess returns of minus 1.11% versus US Treasuries last week. High yield credits, including Indika Energy and Star Energy Geothermal, were also among the worst performers. These credits, and those related to them, will continue to find the market unforgiving.
The business profiles of these companies also throw light on another concern around Indonesia — its reliance on commodities. As a large coal exporter, Indonesia is closely tied to buyers in China. With China facing its own issues thanks to a possible trade war with the US, coal imports in the country could slow down, which would then impact Indonesia.
Admittedly, Indonesia’s regulators know it i’s facing a rough end of 2018, and they have responded appropriately, steadily raising interest rates and cutting spending to reassure the market. The central bank’s meetings have all been realistic and transparent, as the country prepares for emerging market contagion, and its own economic woes catching up with it. This month, the central bank again took a hawkish tone, raising rates by 25bp to 5.5%.
Indonesia learned important lessons during the Asian financial crisis and so is better positioned to face turbulence now.
But investors should continue keeping a close eye on Indonesia. While there is no need to flee the country yet, it is better to be critical now rather than pay the price later.