Looking beyond investment grade

Looking beyond investment grade

Winarno Zain, Jakarta | Thu, 02/02/2012 9:48 AM

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Indonesia will be appearing more often on the radar screens of investors around the globe, as the mass media is churning out more and more good news on the Indonesian economy.

Moody’s Investor Service and Fitch Ratings have upgraded Indonesia’s debt rating to investment grade, which means that investors should be less worried about Indonesia as a place to invest. It has taken 14 years for Indonesia to regain its investment-grade status since the Asian crisis in 1997, when its debt rating was degraded to junk bond status.

Standard Chartered Bank’s research department has projected that the Indonesian economy would be the sixth-largest economy in the world in 20 years, surpassing Germany, the UK and France. And the Goldman Sachs Group is expected to soon make a place for the Indonesian economy into the prestigious BRICS grouping of Brazil, Russia, India, China and South Africa.

This exciting news is coming out as Indonesia suffered capital outflows as part of the fallout of the Eurozone debt crisis. Indonesia’s economy emerged unscathed, but the debt crisis in Europe has touched investor’s nerves. The Jakarta Stock Exchange suffered a big blow when a large sell-off of equities by foreign investors led the Jakarta Composite Index to plunge from 4,221 to 3,200 between August and September.

Over the same month period, the nation’s exchange reserves dropped US$10 billion. In comparison, even during 2008 crisis, which was dubbed as the biggest recession since the Great Depression of the 1930s, Indonesia’s exchange reserves dropped only $5 billion between 2007 and 2008. The capital and financial accounts in balance of payments turned from a surplus of $13 billion in the second quarter of 2011 to a deficit of $3.1 billion in the third quarter, a huge reversal of capital flows that could undermine economic stability.

The need for capital inflows is getting more urgent as the balance of payments cannot rely on the growth of current accounts in the medium term. The current account balance, which has been in surplus in recent years, would turn into deficit in the coming months as import growth surpasses export growth. The current account surplus has dropped significantly, from $5.0 billion in first three quarters of 2010 to $2.7 billion in the same period of 2011, a drop of 45 percent.

Sufficiently large current account surpluses might have previously served as a buffer for the negative effects of capital flight and financial accounts surpluses, preventing the balance of payment from moving into deficit. But with current account surpluses rapidly declining, the balance of payments is now entirely dependent on strong capital inflows. So when with the debt rating upgrades and other positive developments underpinning the economy, expectations are high that capital will be flowing back to Indonesia.

Preliminary indications show that this might be the case. The initial response from investors after the ratings upgrade was positive. The government raised Rp 10.5 trillion from selling its bonds and notes, more than the Rp 7.5 trillion it had originally sought to sell.

The government received bids totaling Rp 50 trillion, or almost five times the amount offered. With those sales, foreign holdings of Indonesian government bonds rose 1.5 percent to Rp 226 trillion. But in the equity markets, the JCI fluctuated in January, as investors still focused their attention on the eurozone crisis. The JCI has not moved far from what it was in December 2011.

But unfortunately whether capital inflows will pick up in coming months depends on investor risk perception of the ongoing debt crisis in the eurozone. If the crisis gets worse, investor sentiment could easily turn sour and seek a safe haven for capital, no matter how good our debt rating is.

Domestically, the prospect for a rapid improvement in the investment climate is not so bright. Work on improving infrastructure, bureaucracy and legal certainty are progressing slowly, and this could pose a serious hurdle for rising capital inflows. The irony is that despite a near economic miracle, the country is mired in red tape and corruption. Our roads, ports and airports are hopelessly inadequate for the pace for growth the government would like to sustain in the coming years.

The global economy is being wrought with uncertainties and challenges. A more severe world economic downturn, the still unresolved debt crisis in Europe, and the affect of a potential US-Iran conflict over oil prices, would intensify the fear-factor in investors’ minds. Therefore it is necessary for the government to make some extra efforts to offset these adverse influences to make investors more comfortable in doing businesses in Indonesia.

The government has started to do some homework to improve the investment climate. But unfortunately what constitutes a good investment climate can no longer be defined as improved bureaucracy and infrastructure and legal certainties. Even if the government could improve these areas, let us have no illusions that these would overcome obstacles in attracting investment.

The increasing militancy of labor unions and the inability of the government to deal with industrial conflicts have triggered more and more violent labor strikes all over the country. Similarly, conflicts between local residents and plantation and mining companies have turned into violent riots.

The government’s track record in conflict management is so poor that legal uncertainties and a weak state apparatus ensures that industrial and social conflicts will continue unabated - and that will undermine the investment climate.

Under these circumstances it is possible that prospective investors will reconsider their decisions to invest, while existing investors will possibly start thinking about relocating their investments elsewhere.

The writer is an economist.

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