Following Bank Indonesia’s recent unexpected move to lower interest rates, almost all global investors we spoke with recently were concerned about weakness in the rupiah (IDR), down nearly 7% ytd, making it the worst performing currency in the region (exhibit 1).
Exhibit 1: USD Performance Relative to Other Currencies
Source: Bloomberg, Bahana
These concerns are not unfounded particularly as Indonesia’s private external debt has reached in excess of $160 billion USD (exhibit 2), up 13.5% y-y, surpassing the government’s external debt of $134 billion USD (exhibit 3). Note that some 31% or $50 billion USD of these private external debts are short-term, which could cause difficulties for SMEs in servicing their debt repayments. This, coupled with high dependency for many SMEs in their procurements of USD-linked raw materials, could mean rising NPLs particularly for smaller banks going forward.
Exhibit 2: Private External Debt, 2005 - 11M14
Source: Bank Indonesia
Exhibit 3: Public External Debt, 2005 - 11M14
Source: Bank Indonesia
All of the fund managers we talked to have the view that the Fed will be on target to raise rates in June/July 2015, particularly as the unemployment rate has reached 5.5%, a level low even by historical standards. This suggests that the Fed would be raising rates sooner rather than later.
Meanwhile, there are continued political pressures on the ground to get BI to further cut rates by 50-75bps in an effort to support Jokowi’s ambitious infrastructure-related projects. Hence, investors are concerned about the IDR amid possible lower local rates ahead.
At this stage, a decoupling between equity and currency markets (exhibit 4) is unhealthy in our view. For the JCI, our sensitivity analysis shows that with every 1% IDR depreciation against the USD, market EPS growth will fall by 0.8%. This suggests that the recent JCI record highs are not accompanied by market EPS growth.
Exhibit 4: Currency & Equity Markets, September 2014 - March 2015
Source: Bloomberg, Bahana
Against this backdrop, we believe either the IDR would have to strengthen ahead or the index would have to fall. That said, we cut our market rating to Neutral, although we keep our 2015 index target of 5,800, which we expect to rise in line with our market EPS growth of around 10%.
Currently, we advise investors to adopt a defensive stance in staples, telcos and infrastructure plays, which are relatively immune to IDR gyrations. While USD counters may benefit from a weak IDR, we think policy risks (higher royalties) and unexciting commodity prices remain challenging ahead.
