Tag Archives: capital flows

The Weekly Mishmash: December 14

Posted on by emmuser
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1.  EM: Who is vulnerable?
Markus Jäger, Deutsche Bank

The EM economies most hit by the current spike in global risk aversion are those that attracted the largest inflows of ‘fickle’ capital in recent years. In response to financial market volatility, most EM policymakers have opted to let their currencies depreciate rather than tap foreign reserves.

Poland and Turkey have low foreign reserve levels relative to other EMs as seen in the Deutsche Bank chart, but Jäger believes they are still sufficient to avert a crisis. In particular, he points to Poland’s flexible credit line with the IMF, which reduces the economy’s vulnerability to a drying-up of capital inflows.

EM Muser: I looked at this issue in a post back in October: Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators. Turkey, and to a lesser extent Poland, also stood out as vulnerable based on my analysis. In addition to low levels of foreign reserves, both are running current account deficits. Turkey’s is particularly large and is estimated to reach a very high 10% of GDP for 2011.

I agree with Jäger that the flexible credit line will help insulate Poland from crisis. However, I think Turkey looks quite vulnerable, at least in the near-term. Its high external financing needs leave it very exposed to a sudden stop in capital inflows. Right now it’s largely a confidence game.

2.  Indonesia: Land Bill to Help Infrastructure and Enhance ‘Structural Goldilocks’
Deyi Tan and Seen Meng Chew, Morgan Stanley

Indonesia’s parliament passed a long-awaited bill that will move forward much needed infrastructure projects on December 14, according to Reuters. Prior to its passage, analysts at Morgan Stanley detailed why this would be a positive step forward. They believe the increase in infrastructure spending will help raise Indonesia’s potential growth to around 7.0-7.5% by 2015.

EM Muser: As I argued in a post last month, Indonesia is a relative bright spot in today’s global economy. (See: Indonesia: Ugly Duckling No More.) The country boasts a large domestic market, a growing population, low debt levels, relative political stability and smart policy making.

The passage of this land bill represents another reason to be bullish on Indonesia especially since analysts viewed weak infrastructure as one of the major structural constraints on growth. The bill is also likely to prompt sovereign ratings upgrades. (December 15 Update: Fitch raised Indonesia’s credit rating to investment grade following the bill’s passage. Moody’s and S&P continue to rate Indonesia below investment grade.)

3.  EMEA Weekly: Russian election special – how much can you cheat?
Danske Bank

Following December 4 parliamentary elections, roughly 50,000 people took to the streets in the biggest protests in over a decade. The ruling United Russia party narrowly won with 47% of the vote amid widespread fraud allegations. The boiling over of dissatisfaction with the government surprised analysts and overshadowed news of the expected approval of Russia’s WTO entry later this month.

Despite the outpouring of anger, Danske does not expect widespread protests in Russia like those seen in the Middle East and North Africa earlier this year. Moreover, Danske still expects Vladimir Putin to emerge victorious in the March presidential election as “he is the only viable option.”

EM Muser: The protests spurred Russian billionaire Mikhail Prokhorov to announce himself as a challenger to Putin in the coming presidential race. Skeptics believe Prokhorov’s candidacy is government-sanctioned in an effort to defuse growing tensions. In any case, the March presidential race just got more exciting and political uncertainty in Russia will remain elevated.

4.  How the role of equities may shrink
McKinsey Global Institute

A new McKinsey report points to the transformation of emerging-market households into a powerful new investor class. Their share of global financial wealth is expected to rise from 21% to as much as 36% of global financial wealth by the end of 2020.

EM investors behave differently than those in mature economies and are less likely to invest in equities, according to McKinsey. “This shift is being exacerbated by aging and other trends in the developed world that are dampening investor appetite for equities. As a result, equities could decline from 28% of global financial assets in 2010 to 22% in 2020.”

EM Muser: If McKinsey is right, then demand for equities in EM markets will not keep up with supply. This, in turn, will raise companies’ cost of equity. While this is bad news for growing companies in these markets, it could result in higher returns for EM equity investors. (Unfortunately, I was only able to access the summary. If anyone is able to send me the full report, I’d greatly appreciate it.)

Indonesia: Ugly Duckling No More

Posted on by emmuser
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The Indonesian economy has transformed from an ugly duckling in the late 1990s into something of a swan today.  No economy in the world will prove fully immune to fallout from the eurozone debt crisis, and Indonesia is no exception. Nevertheless, Southeast Asia’s biggest economy has a lot going for it, from a young population to low debt levels to a balanced growth model that is not overly export-dependent. Not only are Indonesia’s economic fundamentals stronger than Western economies like the U.S. and Europe, they’re also in better shape than most other emerging markets.

Overall, Indonesia has a bright economic future. In the very short-run, investors will pull money out of emerging market assets and stay on the sidelines out of fear, and we’re already seeing this happen (see here).  However, robust emerging markets, like Indonesia, will prove too attractive to resist for long. Similar to the country’s experience in 2008-09, I expect capital outflows to quickly reverse.

Below I detail why Indonesia’s economy is a stand-out among emerging markets and why the economy is well prepared to weather a global downturn.

Indonesia’s Many Attractions

  • Robust economic growth

Indonesia’s economy has expanded by an average of  5.7% per year in the 2005-10 period. Even in 2009, when many of the world’s economies contracted, Indonesia’s GDP still grew by an enviable 4.6%, which was significantly higher than the ASEAN-5 average of 1.7%.

Source: IMF World Economic Outlook, September 2011

  • Not overly export-dependent

Indonesia is less trade-reliant than its ASEAN peers. Exports amounted to only 25% of GDP last year, compared to 97% in Malaysia and 71% in Thailand. With the biggest population in Southeast Asia, domestic demand is an important growth engine and helps insulate the economy against a sharp contraction in global trade.

Renowned economist Nouriel Roubini is among the country’s cheerleaders: “Some countries in the region are better positioned for long-term, even growth – countries like Indonesia or India, with 50 – 60 per cent of GDP coming from domestic consumption.”

  • Upbeat consumers

Consumer confidence is on the slide globally, but Indonesian consumers remain relatively upbeat about their financial situation for next year, making them the third-most confident country in the world, according to a recent Nielsen survey.

Source: Nielsen

  • Low debt levels

High debt levels can stunt growth and leave a country vulnerable to a dry-up in financing if their sustainability is in question. Indonesia, however, has refrained from embarking on a leveraging binge. Both the country’s public and external debt burdens are low, even in comparison with other emerging markets. (See my recent post – Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators - to get a look at how Indonesia’s external debt burden stacks up against EM peers.)

Source: IMF World Economic Outlook, September 2011

  • Abundant natural resources

Indonesia is a leading exporter of both coal and natural gas. Mining and forestry are also important economic activities. Despite illegal logging, the country still has the world’s third largest area of tropical forest, behind only Brazil and the DRC. Indonesia is also a biodiversity hotspot, according to the World Bank, with a diversity of plant and animal species that is almost unparalleled elsewhere in the world.

  • Large, young population

Indonesia is home to an estimated 245 million people, and over half are under the age of 30. Young populations tend to consume more and exert less pressure on public finances (eg. lower pension burdens and lower healthcare spending). Indonesia is set to continue benefiting from this demographic dividend in coming years. According to the UN, the working-age population will rise to 70% of the total by 2025.

Source: UN World Population Prospects

  • Relatively stable political conditions

The first democratic elections in the post-Suharto period took place in 1999, and Indonesia became the world’s third largest democracy. Under the leadership of President Susilo Bambang Yudhoyono, the country is politically stable. His public approval rating stands at an enviable 46.2%, according to a recent survey. Meanwhile, the threat of separatist violence in northern Aceh province receded following a peace accord signed with the Free Aceh movement in 2005. Corruption, however, remains a serious issue.

  • Healthy banking sector

Indonesia has one of the best capitalised banking systems in the world. Stress tests indicate that even in an extreme scenario, involving defaults in the US and Europe, the banking sector’s capital adequacy ratio will remain above 15%, according to the Bank of Indonesia’s latest financial stability report.

Meanwhile, with an average loan-to-deposit ratio of 82%, Indonesian banks are not reliant on volatile external funding to finance lending growth. This contrasts with countries like Hungary, South Korea or Brazil where ratios are in excess of 100%. While Indonesian banks enjoy high profitability, some deterioration in asset quality is expected in coming quarters.

Source: Fitch Ratings

  • Smart policymaking

The central bank has taken a number of measures to stem hot money inflows into state debt securities. As of May 13, Bank of Indonesia (BOI) extended the minimum holding period of its bank certificates, SBIs, from one month to six months. This was a smart move that makes Indonesia somewhat less vulnerable to a large capital flow reversal.

Meanwhile, policymakers have amassed a large cache of international reserves, enabling the BOI to credibly back up its pledge to intervene and smooth exchange rate volatility. As a result, Indonesia is less likely to experience huge capital outflows. That is because the BOI’s pledge should minimise foreign investors’ concern that a sharp slide in the rupiah will wipe out their gains. (See the excellent piece by Deyi Tan and Seen Meng Chew of Morgan Stanley that discusses the structural improvement in Indonesia’s currency volatility). As seen in the graph below, the rupiah is showing much more stability against the USD and euro relative to 2008-09.

Source: Oanda

The BOI has cut rates twice, and the policy rate now stands at 6%. While this monetary loosening was controversial, I believe the BOI is ahead of the curve, as these cuts will help cushion the blow of the global slowdown on Indonesia’s domestic economy.

Still Not the Time to Sit Back and Relax

Despite policymaker efforts, capital outflows remain a clear and present danger. Foreign ownership of tradeable government securities is relatively high, at 33% as of June 2011. This is a sign of market confidence in Indonesia, but it also makes the economy vulnerable to outflows during times of global financial stress like now.

Such outflows occurred at the height of the global financial crisis in Q4 2008 and occurred once again in Q3 2011 as seen in the graph below. Nevertheless, the outflows in Q4 2008 quickly reversed, and we expect the outflows in Q3 2011 to be temporary as well.

*Estimate

Source: Bank of Indonesia

Bottom Line

Indonesia has come a long way since the Asian crisis in the late 1990s. Despite the storm clouds on the horizon, Southeast Asia’s biggest economy looks on course to be a star performer in coming years. Structural improvements have enhanced the economy’s resilience, and a reversal in capital flows is no longer a showstopper.