Indonesia’s Emerging-Market Growth Story

by Tony D’Altorio, Investment U Research
Monday, June 20, 2011

Global investors are catching on to the fascinating story of Indonesia. As Asia’s fifth-largest economy and its third most-populous nation – with 240 million people – more than half of that population is under the age of 30. And today, thanks largely to a boom in commodities, Indonesia’s economy is humming right along…

Visitors to Indonesia can easily see the hustle and bustle of the local economy.

The country’s ports are running all out, feeding demand for coal, palm oil and other commodities (mainly from Asia).

And economic growth is expanding far beyond the main island of Java to many of the country’s outer provinces.

The spreading of wealth to rural provinces is creating a burgeoning middle class. So it’s no wonder that businesses of all sorts are springing up all over Indonesia to service these new consumers.

And foreign investors poured a record $16.1 billion into the country last year. That’s twice the level five years ago and nearly four times the amount a decade ago.

This money pouring into the Jakarta stock market led to a 133 percent rise in the market over the past two years, and it continues to outperform other markets in the region.

But will its run, and that of the Indonesian economy, last?

Indonesia’s Sustainable Economic Growth

Many analysts, understandably, still have doubts about investing in Indonesia. The country has been here before.

In the late 1980s and 1990s, the country was an emerging markets favorite among global investors. But that was shattered by the 1997 Asian financial crisis, which saw the country’s banking system plunge into crisis right along with its neighbors. Indonesia defaulted on its debt, and the economy contracted by 13 percent.

Things certainly changed, though. Even during the global recession in 2009, Indonesia’s economy still grew by 4.5 percent, aided by strong domestic demand. Its sovereign bonds were upgraded to one step below investment grade, and an upgrade to investment grade looks almost certain.

Some investors are worried that much of Indonesia’s good fortune today rests too much on one commodity – coal. Indonesia is the world’s biggest exporter of thermal coal.

However, that really shouldn’t be much of a concern. Demand for this commodity remains very high thanks to continued high oil prices, renewed safety concerns about nuclear power and other factors. None of these factors look likely to change in the near future.

Indonesia’s Infrastructure – A Work in Progress

But that’s not to say Indonesia isn’t sorely lacking in some areas. Take infrastructure, for example. Around 40 percent of Indonesians still live without electricity.

The government says it needs $150 billion for roads, bridges, ports, airports and power plants. But Indonesia can only afford a third of that on its current limited state budget.

In particular, transportation is a glaring weakness of the Indonesian economy. Transportation costs account for 14 percent of total costs for manufacturers because of the inefficiencies. This number is poor, and not only when compared to developed countries, but to other developing countries, too.

And help isn’t coming anytime soon, either. The proposed $17-billion Sunda Strait bridge connecting two of the main islands – Java and Sumatra – isn’t expected to be completed until 2025. The delays in building the bridge again emphasize the difficulty of trying to link together a country made up of about 17,000 islands.

What the Indonesian government needs to do is expand its budget. Public debt to gross domestic product for Indonesia is only at 27 percent. That’s an enviable position, especially compared to most countries around the globe, but perhaps it’s too low in the light of the country’s infrastructure needs.

Indonesia’s infrastructure needs point to the fact that it’s very much a work in progress. But one that’s still profitable for investors. Companies directly involved in the build-out of Indonesia’s infrastructure are just one obvious example.

Good investing,

Tony D’Altorio