Two sides of capital flow and impact on equity market

Freddy Hendradjaja ,  Analyst   |  Fri, 04/11/2008 12:32 PM  |  Business

If you are an investor in the Indonesian equity market, you must be wondering what happened to the market in past few months.

The Jakarta Composite Index (JCI), as of April 4, has declined 16.64 percent from the beginning of the year, including 4.85 percent since the start of this month, at 2.277,09 points.

After reaching 2.830,26 on Jan. 14, it was thought the index could surpass 3,000. What instead happened was the JCI had its second biggest correction of the year on Jan. 22.

Everybody was looking for answers; one possible answer that many already have discussed is that foreign investors withdrew their high-return investments in Indonesia to cover their losses in other investments exposed to the troubled U.S. subprime market.

Do we have serious problems in our economy? We do have some concerns, of course. March figures posted 0.95 percent month-on-month and 8.17 percent year-on-year inflation. The rupiah is weakening amid the strengthening of other major currencies against the U.S. dollar.

And rising global oil prices forced the government to anticipate increasing the national budget deficit from 1.7 percent to 2.1 percent of gross domestic product.

But haven't we endured worse situations before?

The economy still shows some good signs, which were outlined in the equity market outlook published by Danareksa Sekuritas. Investment grew 12.1 percent year-on-year in the fourth quarter of 2007. Corporations have more confidence, with higher capital expenditures in 2007 and seemingly strong planned expenditures in 2008 and 2009.

They are also in a healthier position with net gearing position set to be below 20 percent in 2009.

So, what is the problem? The problem, at least one of the problems, is actually the one which has given the Indonesian stock market greater recognition in the eyes of global investors in recent years; its ever-growing capital inflow.

Liquidity has increased tremendously since local and global investors began showing an interest in our market over the past years.

For local investors, equity instruments were a more interesting choice than time deposits with all-time low rates. For global investors, Indonesia was one of few emerging markets able to produce the highest returns.

Market transaction value rose significantly from Rp 750 billion about four years ago to easily reach Rp 5 to 6 trillion daily transactions now. Market capitalization increased from Rp 680 trillion in 2004 to Rp 1.988 trillion in 2007.

However, the number of listed companies whose shares were actively being traded did not increase as much as the increasing pace of money flows into the equity market.

There were approximately 100 companies or less being traded on the bourse four years ago, and just about the same number four years later. There are 200 or 300 other listed companies, but they are too small to attract major investors to purchase their stocks.

What is the connection with the massive correction that just happened? With transaction value up about eight times from four years ago, and an insignificant increase in actively traded listed companies, the magnitude of any transaction now produces a much bigger effect on price increases or decreases.

Here is a simple analogy: compare a market with originally only 10 buyers and sellers and 10 cars being traded, to a market with the same amount of cars being traded but the amount of buyers and sellers up to 100?

The price of cars in the second market might be more expensive than in the first market. The law of supply and demand works: rare goods will have inflated prices and when people dislike the goods, then prices will fall sharply and quickly.

This is what happened in our equity market.

With so much money in our equity market we only have two presentable companies that represent the telecommunications industry; only three in the coal mining industry; five in banking; only one in the automotive industry, and a lack of companies in other industries.

So how to prevent this from happening again?

We can't. At least for now. Until there are new significant initial public offerings to create new goods (read: stocks) to be bought and sold by investors.

Not just more new IPOs, but they should also be significant enough to create more liquidity in our market so investors have more selection.

So we should applaud the good intention of the Indonesian Stock Exchange in pushing new equity offerings this year, and we hope the stock exchange and the government keep this intention amid a less than supportive market and economic conditions.

Money flow matters, but more selection of sufficiently liquid listed companies will help our equity market become more stable.

The writer is an analyst at Danareksa Sekuritas

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