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span class="inline inline-left">To make a case against investing in Indonesia at the moment is easy. First, the tapering of the US Federal Reserve'€™s cheap money has diminished perceptions about Indonesia as an attractive investment destination. Meanwhile, on the domestic macro front, both foreign and local investors are currently concerned about the country'€™s widening current-account deficit, the region'€™s worst performing currency in 2013 (a rupiah depreciation of more than 25 percent) and slower economic growth due to Bank Indonesia'€™s (BI) monetary tightening (e.g. BI'€™s 175 basis points (bps) benchmark rate raised to 7.5 percent) that threaten higher borrowing costs across the archipelago.

At the micro level, foreign fund-management companies we spoke to, fear that corporate earnings downgrades by brokers covering Indonesia are far from over, limiting upward movements in stock prices, for at least the next three or four months. Hence, we were not surprised that in our recent Daiwa-Bahana road shows in Singapore, Hong Kong and Tokyo, most of the 70 fund managers/buy-side analysts we visited had underweight positions, some with zero exposure in Indonesia.

However, we think that all of this pessimism is overdone. At this stage of the market cycle, we still expect Indonesia'€™s 2014 gross domestic product (GDP) growth to reach 5.2 percent. And even if GDP growth were to dip below the 5 percent level as it did in the 2009 economic crisis, that would still be a faster clip than other past emerging market darlings of foreign investors, including Brazil and South Africa, which are both estimated to grow at below 3 percent in 2014.

We continue to believe that a silver lining exists for investors in Indonesia with a medium-term investment horizon. Over the next six to nine months, we expect overall market improvements to stem from an improving rupiah-US dollar exchange rate on the back of a better current-account deficit due to:

 1. Fewer imports as the economy slows and higher exports as economies around the globe recover '€” this should allow Indonesia'€™s 2014 current-account deficit to improve to negative 2.6 percent of GDP from an expected negative 3.4 percent in 2013 (Q2: negative 4.4 percent);

2. Continued high foreign direct investment (FDI), as companies relocate away from China into Southeast Asia, including Indonesia, due to labor shortages and skyrocketing wages '€” we expect FDI to reach US$42 billion in 2014 (2013: $38 billion), before further increasing to $47 billion in 2015;

3. Interest rates peaking with the possibility of lower inflation as medium-term government policy responses come into effect '€” at this stage, we still expect another 100 bps hike to 8.5 percent in terms of BI'€™s benchmark rate to take place in the early part of 2014;

4. Bottoming-out of corporate earnings '€” with corporate earnings downgrades by analysts likely to be finished by the first quarter of 2014, we believe companies will begin to experience improved earnings growth, at least on a quarter-on-quarter basis starting in the second quarter (to be released in July 2014).

5. Potential fund inflows on deep discounts and election euphoria '€” assuming smooth and successful 2014 elections, we expect foreign investors will be more willing to come back into the market, particularly given that the Indonesian market is already more than 25 percent cheaper in dollar terms.

In the lead up to the 2014 elections, the political climate is likely to heat up, but we expect cooler heads to maintain stable conditions on the ground. Given that this is President Susilo Bambang Yudhoyono'€™s final term, the prospect of a new leader on the ground means a continued fluid political situation for now with the Indonesian Democratic Party of Struggle (PDI-P) currently the most popular political party according to most polls.

Nevertheless, we are hopeful that the new president, whomever that may be, will be market friendly and will continue to be pro-democracy, bringing reforms that should bode well for both longer-term economic growth and a sustainable market performance ahead.

In the event of a PDI-P win and in particular a landslide victory by Joko '€œJokowi'€ Widodo, we expect market sentiment to improve. This would be accomplished through the appointment of strong technocrats as ministers, allowing for a turnaround in policy neglect that has left the economy with structural flaws.

In this regard, it is worth noting that the PDI-P has had a strong track record in the past, and was not averse to raising fuel prices when Megawati Soekarnoputri was in power in 2001-2004. Graphic 1 shows that fuel prices were raised five times or up 25 percent to Rp 1,810 per liter.

Assuming a further fuel price hike could occur in 2015, say from Rp 6,500 per liter to the current market level of Rp 9,750 per liter (i.e. subsidy free), Indonesia'€™s 2015 current-account deficit could narrow from 1.9 percent to less than 1 percent (graphic 2), based on our estimate. This would provide a significant positive catalyst for market sentiment, in our view. We note that in Thailand (GDP/capita: $5,000), consumers pay around $1.15 per liter for gasoline '€” with Indonesia'€™s GDP/capita reaching $5,000 by 2016, a similar fuel price regime would eradicate the country'€™s current-account deficit.

In order to accomplish the difficult steps of removing fuel subsidies, a strong and decisive leader with popular grassroots support must be in place, we believe. For this very reason, a successful 2014 presidential election must materialize in order for the Indonesian market to follow in the footstep of India'€™s election euphoria.

Assuming a smooth and successful political transition ahead, we expect the rupiah exchange rate to strengthen to the Rp 11,300 level on foreign funds flow, allowing our 2014 index target for the Indonesian market to reach 5,000, backed in part by more than 15 percent year-on-year index earnings per share growth. Other market supports are in the form of the severity of the underweight positions of foreign investors in Indonesia while local large funds we recently visited are in possession of cash to be invested in the coming months.

In conclusion, we recognize that existing pessimism within the Indonesian markets could translate to additional pressure in the short term, but hope and profits will come for investors thinking medium-to-long term and willing to add exposure at presently deep-discounted stock prices in dollar terms, amid the current pervasiveness of negative sentiment.