T

em>The Indonesian stock market is one of the best performing in the region with the stock index more than doubling from the 1300 level, in early 2009, to its current 2800 level, a year later. With the strong interest in Indonesia's stocks and government bonds, The Jakarta Post Senior Editor, Manggi Habir, met recently with Hario Soeprobo, Head of First State Investment (FSI) in Indonesia and his team, comprising of Putut Andanawarih, Director FSI, Hazrina (Hani) Dewi, Head of Investments and Suryanto (Anto) Sandjaja, Senior Investment Manager to better understand recent capital market movements, the nature of the flow of funds, where it is going into and issues going forward.

Manggi: How would you describe the funds flow movement in Indonesia's capital markets and how different is it from a year ago?

Hani: There is considerable liquidity in the global market and some of it is coming into Indonesia. It was in November 2009, that foreign inflows started to pick up in a significant way. On average trading value per day, during late 2008 to early 2009, was about Rp 1.5 to 2 trillion daily. Now it has more than doubled to about Rp 4 to 5 trillion a day.

If we look at net foreign inflows during late 2009 to January 2010, there was a noticeable positive trend. The gain (stock market index) during this period was a significant 30-40 percent and the peak reached at 2,600 was similar to levels back in mid-2008, before it topped out, so investors started to take profit.

As a result, the positive net inflow reversed, turning negative and the index dipped slightly to 2,475 in February.

Putut: You have to remember that during this time (February 2010) global investor sentiment was also negative, with China curbing its bank lending, Greece facing debt and fiscal problems and the US Fed starting to raise its discount rate. As a result, foreign investor interest took a dive. But local retail investors also were taking profits. After seeing their equity investments drop from a high of 2,600 points, in 2008, to a low of 1,300 in 2009, local investors decided to exit and get their capital back.

Hani: Since early March, foreign inflow is coming in again and it is now actually higher. The index recovered and is now at a 2,800 high. This is also reflected in the bond and debt market, where foreign ownership of government bonds (SUN) has already reached Rp 128 trillion, which is an all time high.

Foreign exchange reserves also have been moving up to their current level of US$70 billion, coming among others from portfolio investment. One positive development is that investors are moving from short-term Bank Indonesia certificates (SBIs) to more long-term government bonds (SUN). In other words, investors are starting to take a longer view on the Indonesian economy.

Putut: The reason for this growing interest in Indonesia is our favorable report card. One, is the big jump in Indonesia's stock index since the low of 2008. Two, is our positive economic growth, where the country was among three nations (in Asia), whose GDP growth exceeded 4 percent. Last, is the relative stability of the rupiah, which has held its value, even when major currencies like the euro weakened.

Manggi: What instruments are the funds going into and to what sectors specifically?

Putut: On fixed income, which is the bigger portion of portfolio investments, the instruments are mostly government bonds. Should the sovereign ratings improve further, the market demand for these instruments will rise. There is also a strong demand for US dollar denominated government bonds.

Hani: Our economy is driven by two factors. One is domestic demand, given the country's sizable population and the other is the price trend for our natural resources.

On natural resources, we feel that coal still carries growth opportunities. This is due to power plant construction in Indonesia as well as in India and China. Coal outlook looks favorable at least for the next 2 to 3 years.

Companies that benefit from domestic demand would be consumer goods, food and auto companies, like Unilever, Indofood and Astra. The problem in this sector is that we don't have enough large companies with stock listings that are sufficiently liquid. The Astra share price has grown so much that its market capitalization, for the first time, is larger than Telekom. For both Unilever and Indofood, I don't think the sales volume will grow much. Both need to increase prices to be able to experience significant earnings growth, which they have recently done. The slightly stronger currency has also helped keep costs down and maintained respective margins.

Other sectors tied to domestic demand are telecommunication, cement, property and cigarettes, each with its own opportunities and challenges. For Telekom, the problem is the high expectations for a company, whose earnings have grown by 30 to 40 percent for the past five years. As a result, people expect you to grow by this level forever and when the sector matures and comes down to a growth level of 15 to 20 percent, which compared to other sectors is still respectable, but nobody likes it anymore.

On cement, sales remain largely retail with sack sales representing 80 percent of revenue. The problem here is that the share price is on the high side. Property is actually strategic, given the huge discount to Net Asset Value. But the problem here is one of size, given the small market capitalization and governance issues, where there is considerable related-party transactions when it comes to land purchases.

Anto: Cigarettes used to be more exciting, but for the last ten years stock price movement has been dormant. It went nowhere. The trend is one of consolidation, spurred by government tax policy which favors the larger cigarette producers, squeezing the smaller ones.

Hani: We prefer not to look at sectors, but instead seek smaller companies whose revenues are closely linked with domestic demand or natural resources.

Manggi: What do you see are the issues going forward?

Hani: The biggest limiting factor on the equity side is our small market capitalization. For instance, we have roughly 400 companies that are publicly listed, while in India the number is 4,000 companies. Closer to home, we are also smaller than Thailand, so it is important that we make a greater effort to get more companies listed.

Investors have always been concerned about inflation. But for the first two month of this year, the inflation is lower than the average for the last few years. The relative stability of our currency also helps, so I don't think inflation will go up. If the government goes along with its plan to raise electricity tariffs by 15 percent in July this year, then inflation could rise to 5.7 percent up from 5.2 percent, which is still acceptable.

The government is also trying to address the issue of volatility in the government bond market, by providing a broader variety of instruments. Currently, government bonds carry a relatively complete range of tenures from less than a year to 30 years, covering the whole yield curve. They have also raised Islamic sukuk bonds. The next challenge would be to raise more bonds in different currencies, and to stimulate the retail market by issuing smaller denominations.