Indonesia Outlook Remains Solid After Elections This Week

Indonesia goes to the polls Wednesday. President Joko Widodo is widely expected to win a second term. Political continuity and solid economic fundamentals should help Indonesian assets outperform this year.

POLITICAL OUTLOOK

Elections will be held this Wednesday. The presidential and parliamentary vote will be held simultaneously for the first time ever. Nearly 200 mln eligible voters will cast their ballots at 800,000 polling stations spread across more than 17,000 islands.

President Joko Widodo (Jokowi) remains highly popular, regularly leading all polls ahead of the election. Recent polls show Jokowi ahead 55.7-38.8%, up from 53.5-37.5% in mid-March. The economy has fallen short of his pledge of 7% growth, but Jokowi’s popularity has not suffered much, it seems. He cut costly fuel subsidies and opened the country to foreign investment.

Former General Prabowo Subianto will stage a rematch with Jokowi. He is backed by the Great Indonesia Movement Party (Gerindra). In the 2014 election, Jokowi beat Prabowo 53-47%. Recall that Prabowo disputed the 2014 election and withdrew before the count was completed. Before that, Prabowo ran and lost to Susilo Bambang Yudhoyono in 2009 as the running mate of Megawati Sukarnoputri.

Despite Jokowi’s clean image, corruption remains one of the country’s biggest challenges. Indonesia scores relatively low in the World Bank’s Ease of Doing Business rankings (73 out of 190). The worst components are starting a business and enforcing contracts, while the best are getting electricity and resolving insolvency. It does slightly worse in Transparency International’s Corruption Perceptions Index (96 out of 180 and tied with Brazil, Colombia, Panama, Peru, Thailand, and Zambia).

 

A BRIEF HISTORY LESSON

The Indonesian Democratic Party (PDI) was one of the few rival political parties allowed during President Suharto’s long reign. Ten parties participated in the 1971 legislative elections, with five of them forming a coalition in parliament called the Democracy Development Faction. These five were forced to merge in 1973 by Suharto, who wanted to limit the total number of political parties.

Megawati Sukarnoputri was elected leader of PDI in 1993. She is the daughter of Indonesia’s first post-independence leader President Sukarno, whom Suharto ousted in 1967. Yet her election was not recognized by the government, who preferred Budi Harjono. Because of this, PDI was effectively split into two factions.

The fall of President Suharto in 1998 saw the creation of several political parties to challenge his Golkar party. PDI-Struggle (PDI-P) was founded then by Megawati Sukarnoputri as a splinter group from PDI. In the 1999 parliamentary elections, PDI-P won the most seats with 33% of the vote. Megawati was denied the presidency by Abdurrahman Wahid (also known as Gus Dur), who was able to win the presidency when his National Awakening Party (PKB) allied with other Muslim parties to form the so-called Central Axis in parliament.

Gus Dur’s term was plagued by economic and political instability, leading him to become increasingly erratic. Coupled with some corruption scandals, this led parliament to formally impeach him in July 2001. He was replaced by runner-up Megawati. That year, parliament declared that starting in 2004, the president would be elected by the popular vote. Previously, the president was elected by parliament.

In the 2004 election, Susilo Bambang Yudhoyono became the nation’s first directly elected president by beating incumbent Megawati Sukarnoputri in the runoff election. Yudhoyono won a second term in 2009, beating Megawati again with a commanding 60.8% of the vote in the first round. In 2014, Yudhoyono completed his second five-year term and could not seek re-election.

After joining the PDI-P in 2004, Jokowi first came to prominence after he was elected in 2005 as the mayor of Surakarta. After two well-regarded terms as mayor and then one term as Governor of Jakarta, Jokowi was chosen by PDI-P leader Megawati to be the party’s presidential candidate in 2014. He easily won over Prabowo Subianto (Gerindra) with 53% of the vote in the first round.

 

ECONOMIC OUTLOOK

Jokowi is benefitting from a robust economy. The IMF expects GDP growth of 5.2% in both 2019 and 2020 vs. 5.2% in 2018. GDP rose 5.2% y/y in Q4, but data in Q1 so far suggest some deceleration as we move into 2019. As such, we see slight downside risks to these growth forecasts.

Price pressures remain low. CPI rose 2.5% y/y in March, the lowest since November 2009 and below the 3-5% target range. Pipeline price pressures are still easing. WPI rose 1.5% y/y in March, the low for this cycle after eight straight months of decelerating. These readings suggest potential for further deceleration in consumer inflation.

The central bank has ended its tightening cycle. It started this cycle back in May 2018 and hiked a total of 175 bp over the course of last year to take the policy rate up to 6% currently. This was largely in response to the plunging rupiah. Bank Indonesia has stood pat since the last 25 bp hike in November. The next policy meeting is April 25 and no change is expected.

The fiscal accounts bear watching. The OECD sees the budget deficit narrowing to -2.0% in 2019 and -1.8% in 2020 from an estimated -2.3% in 2018. We may see some deterioration in H1 2019 in the runup to the elections, while the medium-term trajectory is at risk given campaign pledges by both candidates to boost spending.

The external accounts are likely to worsen modestly. Exports are contracting y/y in recent months, pushing the 12-month total trade balance into deficit beginning in August. That deficit has since grown to the highest level since September 2013. The OECD sees the current account deficit narrowing to -2.7% of GDP this year and -2.6% in 2020 from an estimated -3.0% in 2018. However, we see upside risks to these deficit forecasts given the deterioration in the trade balance.

Foreign reserves have edged higher recently. Reserves troughed just below $115 bln in September but have risen to $124.5 bln in March. This is the highest since last April and covers over 6 months of imports and are equivalent to two and a half times the stock of short-term external debt. Lastly, Indonesia’s Net International Investment Position has fallen to only -30% of GDP, the lowest on record.

 

INVESTMENT OUTLOOK

The rupiah is outperforming after underperforming last year. In 2018, IDR fell-6% and was only slightly better than the worst performers ARS (-50.5%), TRY (-28%), RUB (-17.5%), BRL (-14.5%), and ZAR (-14%). So far in 2019, IDR is amongst the best EM performers at +2.4%, trailing only RUB (+8.4%), CLP (+4.6%), MXN (+4%), COP (+3.6%), CNY (+2.5), and THB (+2.5%). Our EM FX model shows the rupiah to have NEUTRAL fundamentals, and so we expect this outperformance to ebb a bit.

USD/IDR is trading just above the 14000 area. The pair is on track to test the June 2018 low near 13839. However, a clean break below the 14035 area would set up a test of the January 2018 low near 13263.   Much will depend on the external environment.

Indonesian equities are underperforming after outperforming last year. In 2018, MSCI Indonesia fell -5% and compares to -17.5% for MSCI EM. So far in 2019, MSCI Indonesia is up 2.7% vs. a 14% gain for MSCI EM. This is underperformance is expected to continue, as Indonesia has an UNDERWEIGHT in our EM Equity Allocation model.

Indonesian bonds are outperforming. The yield on 10-year local currency government bonds is -35 bp YTD and is behind only the best EM performers Argentina (-243 bp), Chile (-81 bp). Mexico (-72 bp), Russia (-51 bp), and Peru (-41 bp). With inflation likely to remain low and the central bank likely to start an easing cycle this year, we think Indonesian bonds will continue to outperform.

Our own sovereign ratings model showed Indonesia’s implied rating was steady at BBB+/Baa1/BBB+. Actual ratings of BBB-/Baa2/BBB are still enjoying some upgrade potential.