Since the global financial crisis hit in late 2007, portfolio investors worldwide have cast a wider net, looking for capital gains in a world where economic growth is far from certain. In their search for markets that have shown resilience, many have turned to the countries of South-east Asia.
Although in the past, a crisis elsewhere could hurt the region’s export-dependent economies, these countries are increasingly trading with each other and are less reliant on Europeans and Americans to buy their cars, televisions, computers and other goods. Asian consumers can increasingly afford these products, and in no country in the ASEAN trading bloc are there more of these newly middle-class consumers than in Indonesia.
The consumer demand narrative has pushed stocks in Indonesia to new heights. At this point many have noted that the market’s valuations seem a little high, and a drop in value would be no surprise. Beyond short-term performance, however, it appears that Indonesia now has a chance to strengthen its capital markets’ offerings, by broadening the options available, fostering a bigger roster of investors and smoothing operations at the country’s exchanges.
AIMING HIGHER: Both in terms of size (as measured by equity market capitalisation as a percentage of GDP) and liquidity, the Indonesia Stock Exchange (IDX) has lagged the development of other markets in the region. Increasing activity on the country’s capital markets could bring substantial benefits, not least by providing domestic companies with access to alternative sources of finance to supplement the banking sector.
For this reason, the IDX has turned to the Asian Development Bank (ADB) to create a plan for market development. The goal is to attain more liquid capital markets, improve market supervision, and increase the resources and capacity of the regulators, with the aim of providing greater investor protection. Working together, the two organisations came up with some ambitious targets in 2009, which included boosting market capitalisation by 50%; increasing the non-bank financial institutions’ share of total financial sector assets to 25-28% by 2012; and doubling the number of individual holders of market securities, equities and government bonds, including through mutual funds.
The ADB has also worked alongside the IDX and the Capital Market and Financial Institution Supervisory Agency (known by its Indonesian acronym, Bapepam) to develop the 2010-14 master plan, which identifies multiple reforms and capacity-boosting plans, sorting them into five main goals, each with several strategies for realisation (see analysis).
STATUS UPGRADE: While the institutional and regulatory changes that are being developed and carried out are important, the most high-profile event for the capital markets in 2011 was the ratings upgrade for the country. Global ratings agency Fitch raised Indonesia’s sovereign debt to investment grade in December 2011. Moody’s and Standard & Poor’s, which currently rate the country’s sovereign bonds one notch below investment grade, are expected to follow suit in 2012, particularly since their current ratings are accompanied by positive outlooks.
Receiving investment grade could have a profound effect on the Indonesian economy in 2012 and beyond. The upgrade has underscored positive investor sentiment and provided a reason for the stock market rally to continue. An extended rally would make Indonesia more than just the flavour of the month among emerging markets followers in New York, London or Hong Kong; it would keep the country at the forefront of those investors’ minds for long enough to make the argument that Indonesia should be counted among the BRIC countries of Brazil, Russia, India and China, as the largest and most important developing economies in the world.
With the fourth-biggest population, investment-grade debt and, if all goes according to plan, an infrastructure building surge, the case could certainly be made. Merely having a debate about whether or not Indonesia belongs in the same category as the BRIC countries is itself a good sign for the nation’s capital markets.
SIZE & SCOPE: Capital markets activity began a century ago in Indonesia, established when Jakarta was known as Batavia and the Dutch were the ruling power. Trading stopped several times during the First and Second World Wars and during the transition to independence. The market reopened in 1951 but was largely inactive until 1977. Activity picked up in 1989, when a second bourse was established in Surabaya, a port city at the eastern end of Java that is now the second-largest in the country. This exchange focused on bonds and derivatives. The two were merged in 2007.
The resulting exchange, now called the IDX, is still considered shallow and small for a country its size. The bourse hosts the trading of 423 equities and 719 bonds and sukuks, a type of hybrid security that is sharia-compliant. The list of the biggest and blue-chip stocks is dominated by commodity, financial and manufacturing firms, along with a telecommunications company, a familiar mix in many resource-rich countries. There are 128 licensed brokers.
Market capitalisation surged in 2010 to Rp3247.1trn ($389.7bn), up 62.1% from Rp2019.4trn ($242.3bn) in 2009. This figure increased slightly in the first half of the year, ending the second quarter at Rp3498.1trn ($419.8bn). As of the end of September 2011, market capitalisation stood at Rp3210.8trn ($385.3bn). The average daily value of stocks traded saw a major gain in 2010 – an average of Rp4.8trn ($576m) changed hands daily, against Rp4.05trn ($486m) in 2009. By the third quarter of 2011, this figure had risen to Rp5.9trn ($703.8m).
DEBT: Growth in the bond market is the responsibility of the Government Debt Management Office, whose brief includes fostering a deeper and wider bond market, both primary and secondary, and promoting domestic participation in order to lessen the country’s reliance on foreign investment.
Sovereign debt has been issued on a regular basis since 2002 after a hiatus caused by the Asian financial crisis several years earlier. Debt denominated in foreign currency was at about 15% of the total outstanding as of late summer 2011. Contributing to this, a dollar-denominated sale in January 2010 raised $2bn in 10-year debt, with an annual interest rate of 5.875% – about 2.3% higher than the yield at the time for US Treasury bills, the standard against which bond prices worldwide are measured. Corporate debt issuers are more likely to tap international markets if they are qualified to do so, as typically the cost of issuing and the yields are lower (see analysis).
A MARKET HIGH: The benchmark stock index is the IDX Composite Index. The measure hit an historic high on December 9, 2010, reaching 3786.097, a notable moment for Indonesia’s post-crisis development. It pushed on and in July 2011 it passed the psychological barrier of 4000 points. After surging close to 4200 points later in the month, the market has cooled somewhat, and as of late September was trading around the 3900-point level.
The top stocks are a list dominated by financial services, energy, commodities and manufacturing companies. Three banks are among the top-10 largest shares by market capitalisation, including Bank Mandiri, the country’s largest lender; Bank Rakyat Indonesia, another sector leader with strength in microfinance; and Bank Central Asia, which is the largest privately owned lender in the country.
While the exact number fluctuates daily, overall approximately two-thirds of free-floating shares on the IDX are owned by foreigners. This reflects not only the international view of Indonesia as a major economic force in the future, but also a relative lack of sophistication on the part of Indonesian investors.
Indeed, the majority of citizens are too poor to participate in the stock market, but for the millions of Indonesians moving into the middle class – the people whose daily consumption habits and economic outlooks form the global investment backbone for Indonesia – the market’s leaders say it is time to start paying closer attention. To this end, the IDX has been building capital market information centres across the archipelago, which are facilities aimed at introducing the concept of stock market investing to a wider portion of the population. This move has could also help coax brokers to move beyond Java when looking for customers. In each centre two brokers are promoted to potential clients, and the brokers that send representatives receive financial assistance from the IDX to help defray the costs of travel and recruitment. As Michael Tjoajadi, the president director at Schroder Investment Management Indonesia, the country’s largest mutual fund, told OBG, “Educating the public about the types of investment instruments available will be vital to the growth of the asset management industry. Second-tier cities will be the focus for companies like us as we attempt grow our domestic market by increasing the number of retail clients that we have. Maintaining and developing relationships with commercial banks will be a key factor in order to further penetrate those markets,”
LACK OF INSTITUTIONAL INVESTORS: What is missing in the community of domestic investors is a strong institutional presence. Indonesia has pension funds, asset managers, mutual funds and insurance companies, but these investors are not playing the role they commonly do in developed capital markets. Typically these actors are the biggest shareholders in any market, and often are a source of price stability. They buy and hold large blocks of shares, and as they are conservative by nature, aiming for capital preservation before capital gains, they tend to gravitate toward the blue-chip stocks. They are unlikely to trade frequently, or based on rumours or emotional reactions as individuals and day traders sometimes do. This approach is good for the country’s future pensioners and insurance claimants, as they have the security that the capital they may want to access will be deployed more deliberately.
For the markets in general, the benefit is a check against volatility from price swings and sentiment-based trading. It is a particularly important role on exchanges that do not use a market-maker system, in which brokers are assigned stocks that they are required to “make a market” in, meaning they must step in to buy or sell when bids and offers do not line up – another way to tamp down volatility. Institutional investors can also play an important role in building a bond market, as their large pools of cash and conservative orientation make them a natural fit to buy big stakes in bonds.
However, Indonesia lacks the market dynamics and legal framework to enlist these market participants in this way. Pension funds are not organised. There are few incentive schemes to encourage Indonesians to put savings into funds, which can be an important tool in an immature economy to build liquidity for an exchange, as well as to encourage savings and investment. IDX officials have said they are working on reforms to leverage the potential power of institutional investors, which would likely require legal changes in addition to regulatory ones.
INITIAL PUBLIC OFFERINGS: Indonesia suffers no shortage of initial public offerings (IPOs) – a listing confers prestige and is a path to a lower cost of funds elsewhere, whether from bonds or increased access to foreign-currency debt markets. A total of 23 new stocks hit the market in 2010, according to the IDX. Many state-owned firms have also floated a minority stake on the exchange, and in the past these companies have been seen as a potential source of new listings – there are about 20 listed now, but more than 100 of these companies in total.
Still, most IPOs are small, with sales worth about $30m-40m. Companies are selling just a small portion of their equity – often about 20% of the total. Larger share sales are associated with a potential loss of corporate control. For now, most share buyers for IPOs are coming from abroad, including emerging-market funds. Because these deals are small, a stake in an IPO worth $40m is not enough to make an impact in a fund’s performance, even for the smaller funds, which might have $50m to $200m in assets under management.
In the country’s small but growing bond market, secondary trading is not the focus, although some activity goes through the IDX. In some cases, secondary trading in the most active issues is restricted, such as the short-term instruments called SBIs, which are the Indonesian equivalent of a US Treasury bill. These are often the vehicle of choice for investors looking to make short-term bets on the rupiah and the overall Indonesian economy without having to trade currencies. Because there is so much activity, and as Indonesia’s history has taught its economic players to fear heavy inflows and outflows of hot money from foreign investors, SBIs and other short-term instruments come with a mandatory hold period before they can be traded. In the case of SBIs, that period is one month (see analysis).
REGULATION: The market regulator, Bapepam, was established in 1976 as part of a larger effort at the time to revive the country’s dormant capital markets. It has been working in recent years to adopt global best practices and implement reforms to boost the role of capital markets in the country.
For example, Bapepam has been pushing for Indonesian accounting standards to converge with international financial reporting standards (IFRS). This could strengthen investor confidence by ensuring that listed companies make high-quality financial information available to potential investors.
Officials from the regulatory agency have publicly stated that both listed and unlisted businesses will be required to fully implement IFRS in their financial reports by January 2012. Companies that are publicly traded and fail to comply with the new standards will be either fined or will face administrative sanctions. In its most recent Article IV staff report for Indonesia, published in October 2011, the IMF said that transitioning to IFRS is a “positive move” for the development of the country’s capital markets and could diversify funding sources.
Bapepam has also issued a regulation that will require every investor who trades Indonesian securities via a local broker to acquire a Single Investor Identification (SID). This identity will then be used for the trading process in the stock exchange, from the order entry through to settlement. The SID is expected to facilitate monitoring of the market by Bapepam and reduce the possibility of market manipulation. Investors must comply with the new rule, which was issued in December 2010, by February 2012. As of late 2011, about 80-85% of investors had a SID, according to Nurhaida, the chairman of Bapepam.
DERIVATIVES: As part of its ongoing development efforts, the IDX and others in the capital markets sector are promoting derivatives trading. Options are limited at this point, as is investor appetite for them. Derivatives are commonly misunderstood as complex tools for speculation and are sometimes associated with the global financial crisis.
However, concepts such as hedging on commodities prices and currency values are a natural need for many Indonesian firms, and many companies have shown that they understand this. Large crude palm oil businesses, for example, often dispatch a trader to Kuala Lumpur to manage a hedging strategy for palm oil futures on its bourse, Bursa Malaysia.
Two derivatives exchanges have set up in Indonesia in recent years, the Jakarta Futures Exchange (JFX) and the Indonesia Commodity and Derivatives Exchange (ICDX), perhaps in response to demand from Indonesian companies for more local hedging options. The JFX was established in 1999, but trading only began in 2011, as the exchange – which at present operates as non-profit organisation – did not get the financial and technical support that it had hoped for. Trading is limited, with just two contracts available, but the plan is to introduce them for commodities such as cocoa, rubber and plywood, and then expand further into finance-based derivatives. The exchange’s five-year aim is to demutualise, incorporate and sell shares on the IDX.
One of the challenges has been overcoming inaccurate perceptions about derivatives, said Arifin Lumban Gaol, the JFX’s president. “There is a perception issue that has to be overcome in regards to hedging products. They are often viewed as gambling, when in fact they offer companies an opportunity to mitigate their risk in the event that major swings in commodity prices should occur.”
The JFX is in direct competition with the ICDX, which was licensed in 2009 and has 12 founding shareholders, each of which hold an 8.33% stake in the bourse. Owners include physical commodity businesses, futures brokerage houses and strategic technology providers. The ICDX market is in many respects similar to that of the JFX. Because Indonesia is a commodity-rich country, and is affected by commodity futures trading, it would like to host most of the trading within the region, meaning contracts for indigenous resources such as crude palm oil, tin, coal, natural gas, cocoa and coffee. The ICDX would not aim to compete with giant global commodity exchanges, but instead to provide the main outlet for these deals within the South-east Asian region.
REGIONAL ROLES: The big attraction is crude palm oil futures. Indonesia is the world’s biggest producer of crude palm oil, and companies with exposure to the fluctuating price of the commodity generally hedge that risk with futures contracts. But Bursa Malaysia has become the market with the most activity in palm futures, and several large-scale Indonesian traders do their buying and selling there.
The ICDX’s main task is a head-to-head competition with the neighbouring exchange. The benefit to Indonesia would be less currency risk and increased transparency on prices. “It is a natural selection for Indonesian companies, who are already trading in Malaysia, to repatriate themselves because their contracts are in rupiah,’’ said Megain Widjaja, the CEO of the ICDX. “Therefore, they will want to avoid additional risk as a result of being exposed to currency fluctuations.” The ICDX is not regulated by Bapepam but by the Commodities Futures Trading Agency.
OUTLOOK: No matter whether the stock market rally tails off in 2012 or if it continues to be foreign investors who comprise the bulk of activity, Indonesia’s capital markets are increasing in size and visibility. The momentum is in the right direction, and it will be the job of the government, regulators and market executives to, at the very least, stay out of the path of progress. A mature capital market will come about faster if they are able to play a constructive role, pushing for reforms, new participants and transparency, all of which would help the market to cope with a potential influx of interest.
If Indonesia can overcome the familiar public sector challenges, the country’s sovereign debt ratings upgrade and plans for an infrastructure expansion programme in the coming years are almost certain to attract more investors to the capital markets – selling bonds to build roads, establishing investment funds, and hedging on currency and other risks.
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