Jokowi victory could see Modi-style market rally in Indonesia but challenges remain whoever wins

8th July 2014


The Indonesia election does not promise a swift economic turnaround regardless of who wins this week’s election says fund manager Schroders in a note issued this week.

Craig Botham, Schroders emerging markets economist says: “In one corner, we have the plucky newcomer Joko “Jokowi” Widodo, governor of Jakarta, and in the other a formidable veteran slugger in the form of Prabowo Prabowo, businessman, politician, and former Lieutenant General.

“Of course, Indonesia is not the only large Asian democracy with an election this year, and many investors are hoping Indonesia repeats India’s recent experience, with a considerable market rally during and post the election.”

“Any analogy with India’s election should place Jokowi in the role of Modi insofar as he is regarded as investors’ favourite on the back of his record in infrastructure investment as governor of Jakarta and his generally market friendly stance. By contrast, Prabowo is regarded as a more populist and controversial candidate.”

Botham says that a reflection of these differing perceptions can be found in investor intentions. A survey conducted by Deutsche Bank showed 87% of 70 institutional investors interviewed said the election would affect their investment decisions. Some 72% said they would buy Indonesian assets in the event of a Jokowi victory, while 56% would sell if Prabowo won.

“It seems then that for a market rally to occur, Jokowi would need to win. Unfortunately for markets, Jokowi’s lead over Prabowo has narrowed to just 6 percentage points, down from a 13 point lead in May, and from much greater highs last year.


“Surprisingly however, the market has if anything rallied, rather than weakened as Jokowi’s chances have slimmed. Perhaps investors are choosing to turn a blind eye to the polls and assuming a Jokowi victory. If so, this is risky; disappointment seems increasingly likely.”

Botham says that whoever wins the election, they will have to tackle Indonesia’s fiscal and current account deficits. The current account reached a nadir of -3.8% in the third quarter of last year (on a 12 month rolling basis) but has improved since to a deficit of 3.2%. Unfortunately, more recent trade data suggests deterioration even from this very modest improvement.

He adds: “Indonesia’s weak external performance probably stems chiefly from structural issues, particularly its reliance on commodity exports (non-food commodities accounted for 62% of exports in 2013).

“The recent ban on a range of metal ores has not helped; exports of nickel, copper ore, and bauxite are now negligible. It should be noted that both candidates have pledged to keep this ban in place, so there seems little prospect of relief post-elections.”

“However, mineral shipments, excluding coal, accounted for just 3.6% of total exports in 2013. Meanwhile, coal exports (13% of total exports in 2013) are struggling and will likely continue to do so in the face of lower Chinese demand, excess supply from producing countries, and a government cap on production to support price levels.

Botham says that the main issue is structural, not cyclical. “As with many commodity exporters, the country has experienced a Dutch Disease problem; under-development of other industry leading to high import dependence, overreliance on commodity exports and the consequent decline of manufacturing. While the export ban aims to address this by forcing the construction of domestic processing capacity, it will take several years to have any effect. The country also has significant fuel price subsidies which do much to explain its fiscal weakness.”


Fuel subsidies need to go

Indonesia faces a challenge in terms of fuel subsidies given its budget deficit.

Botham says: “After a mid-year budget revision, the targeted budget deficit will be 2.4% of GDP, an increase of 0.7 percentage points. Both fuel and electricity subsidies were increased, and partly funded by cuts  to the budgets for both current and capital expenditure. The reduction of infrastructure spending to finance an inefficient, consumption-boosting subsidy exemplifies poor fiscal management. Given the legal requirement that the fiscal deficit not exceed 3% of GDP, the fuel subsidy is not a sustainable policy measure, and will probably result in further infrastructure cuts if not reduced or scrapped.

“From what we have seen of the candidates’ manifestos so far, only Jokowi has said he would reduce the fuel subsidy through reductions over the next four to five years (with the savings to be spent on infrastructure), by contrast Prabowo would maintain the current subsidies but attempt to prevent the rich benefitting through taxation.

“A fuel subsidy not only increases the risk of fiscal slippage, it also, by increasing demand for imported oil, worsens the current account and reduces incentives for greater energy efficiency. Consequently, cutting the subsidy will ease pressure on Indonesia’s twin deficits immediately. Furthermore, if the savings are spent on infrastructure investment, as Jokowi plans, the longer term picture for the country’s balance sheet also improves.

“Overall, it is difficult to be overly optimistic about the elections in Indonesia. Not only is there a vanishingly small margin of voter preference between the two candidates, but also a similar narrowing in their policy stances. The position on fuel subsidies notwithstanding, Jokowi has been forced to move closer to Prabowo by his diminishing lead in the polls, hinting at barriers to foreign investment to protect domestic firms. We can hope this nationalism is not genuine, but it is not a promising sign. Arguably there is less of a case for a large market rally in the event of a Jokowi win than there was following Modi’s victory – but that doesn’t mean it won’t happen.”


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