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ata flows show that foreigners have been net buyers of all the Asian stock markets since May, with the exceptions of Thailand and the Philippines on the back of politics and fiscal concerns. In Asia ex Japan, Korea and India have received the largest inflows year-to-date according to Bloomberg.

While we expect capital inflows will continue to come in over the long run into both Asia and Indonesia, movements in the next one to two quarters are likely to be held hostage by increased uncertainties over the global economic growth outlook.

We are concern over continued high government debt problems and deflation in the developed world in the second half of this year. Although we do not expect a double dip recession to occur, we believe that the global economic recovery will shift into a lower gear amid the current fiscal pressure.

Another risk that could unfold is a US equity collapse. However, if US stocks can move sideways from current levels, as we expect, Asian markets including Indonesia should be able to outperform and move higher from current levels, which has broken through the 3,000 psychological barrier.

However, if equities in the developed markets (i.e. US and Europe) were to plunge, only bonds and cash would provide safe havens for investors. In this event, Asian markets including Indonesia would also plummet in our view.

Closer to home, investors’ uneasiness over slowing global economic growth is reflected in lower Indonesian market’s daily turnover (Exhibit 1). July’s average daily turnover has fallen to US$291 million, equal to the lowest 2010 monthly average daily trade back in February. This figure is also 18 percent lower than the 2009 daily average turnover of $353 million. With the World Cup fever out of the way, this persistently low daily average turnover is a source of concern at least in the short term.

Over the longer run, however, flows and Emerging Asia equities, including Indonesia will move higher due to three main reasons:

First, for well-known reasons, GDP growth will be established at a pace much faster than in the developed countries. Given low debt levels, both private and government spending remains well-placed to sustain solid growth even on withdrawn stimulus measures like in China.

Second, interest rates will move up to curb inflationary pressure and risk of overheating. This poses as a short-term challenge for local equities. Recently, the Indonesian central bank has stated that they expect July’s inflation to reach 1 percent, the highest this year.

However, as we expect Asian currencies to remain strong coupled with relatively muted commodity prices, we expect upcoming policy tightening to be relatively mild (i.e. around 150bps for Indonesia in 2010-11, assuming inflation of 6 percent in 2010).

Therefore, we do not expect corporate earnings growth to experience major slowdowns. This is reflected in our basket of stocks with aggregate EPS growth for the market at 16.4 percent in 2010, remaining sustainable in 2011 at 16.5 percent year-on-year.

Finally, price-to-earnings ratios across the region remain reasonable, ranging around 10-20 times. The ratio for Indonesia is currently at 17.3 times for 2010, falling to 14.5 times in 2011, translating to next year’s PEG of 0.9 times, still well below the maximum investable threshold of 1.2 times.

In summary, while short-term headwinds may slow capital inflows into the markets, medium-to-longer term equity prospects remain attractive.

The writer is the senior vice president and head of Indonesia research at Bahana Securities