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Credit Suisse expects Indonesia to buck the trend with economic and market recovery in 2016
As a result of declining demand for commodities, stagnating foreign investment and slower domestic consumption, the Indonesian economy saw a slower than expected GDP growth of 4.6 percent in 2015E, dragging the benchmark index down by more than 16 percent year-to-date. However, Jahanzeb Naseer, Head of Equity Research for Indonesia at Credit Suisse, believes the Indonesian market will reverse the four-year trend of earning cuts in 2016. “There has been a five year drought in earnings upgrades across Asia and in particular in Indonesia. 2011 was the last year that we saw earnings being upgraded during the year. Markets find it difficult to stage a sustainable performance when earnings are being downgraded.”
“As we enter 2016, earnings growth expectations are the lowest they have been in the past five years. The 12-month forward earnings estimates have been cut by 18 percent this year, the steepest cut since the Global Financial Crisis. Growth expectations for 2016 now stand at 11 percent. We believe this consensus is sufficiently low. Even in a mild economic recovery, earnings could grow at least 15 percent-20 percent, based on the trends that we have seen in past three cycles. We could potentially see earnings upgrades as signs of recovery become more visible, subsequently boosting the stock market’s performance,” Mr. Naseer added.
Macro policies turning from headwinds to tailwinds
There are some initial signs of an improvement in consumption and capex after the government announced seven stimulus packages since September. The government is also moving towards delivering structural reforms such as cutting red tape and inconsistent regulations, and setting a more predictable formula for minimum wages.
According to Credit Suisse, the most productive aspect of these packages, as far as cyclical growth is concerned, is how they help to create space for monetary policy easing and better disbursement for fiscal spending. For the 6-12 month growth outlook, we think the measures to boost purchasing power, ranging from cutting diesel, electricity tariffs for industrial users, and distributing cheap rice, as most helpful for GDP growth. These measures can directly help support real domestic demand as well as allowing a fall in inflation to enable Bank Indonesia to ease its monetary stance.
Credit Suisse forecasts fiscal spending will likely boost GDP by a 20 bps increase, thanks to higher capex spending. This compared to around 200 bps decline in GDP this year versus 2014. Meanwhile, Bank of Indonesia is likely to cut rates by 75 bps, as headline inflation is likely to come down to average under 5 percent next year. Rate cuts are important to drive consumption, as 50 percent of Indonesia's GDP is still driven by consumption.
Positive response from the tax amnesty scheme
The Indonesian government is in the process of proposing a very generous scheme that allows undeclared wealth to be brought into the system with a penalty of 3-6 percent depending on the reporting time. This could be a significant boost to tax revenue, and by implication, government spending as well as asset values. The ministry of finance is confident that the tax amnesty scheme can add about Rp40 trillion of tax revenue, which implies Rp1,300 trillion of declared assets assuming a 3 percent tax rate. Credit Suisse believes the additional money pumped to the economy will have a stronger effect as it will have to be invested somewhere, and the equity market is one of the options.
Significant sector variation amid a narrow recovery in 2016
With the backdrop of a narrow economic recovery in 2016, Credit Suisse expects there will continue to be significant sector variation in performance as it has been in 2015. The bank is overweight on autos, property, telecoms, staples and construction.
- Automotive—end of a long hard road 2015 is likely to see one of the worst volume declines in 4-wheelers in the past decade, with nearly a 20 percent fall in volume. The good news is that the worst seems to be over and we see some green shoots of recovery. There are signs of a recovery on the back of new model launches and an improving economy. Sales volume started to normalize at 80,000-90,000 per month while launch pipeline looks decent. Credit Suisse forecasts 10 percent growth for 2016 on the back of those launches, easing financing and economic recovery.
- Construction—momentum should remain positive The focus of the governments' growth will mainly come from spending and this will be target infrastructure—this sector is in the middle of that. However, it is not cheap because earnings are backward looking with an orderbook and valuations that are forward looking. The catalyst for the sector can be the continued momentum on disbursements for new projects and tenders.
- Telecoms—the new staple Data consumption is proving to be more resilient than any ‘staple’ in a downturn. We like this sector for the first time in nearly 5 years as we are starting to see improvement in the blended average selling price (ASP) as data discounts are being removed. Coupled with consolidation in the industry and the end of the 3G capex cycle, this could lead to sharp improvement in free cash flow.
- Staples—more resilient in a slowdown and beneficiary of government spending Within the consumer space, the staples sector is preferred. If the slowdown continues, this sector will be more resilient. In addition, infrastructure spending and lower interest rates in the later part of the year will benefit them more than retailers.
- Property—beneficiary of a turn in inflation and interest rate cycle The sector is one that should benefit from the upcoming policies that we expect to be launched soon, including easier regulation on loan-to-value ratios and better mortgage terms from banks.
Fundamentally, Credit Suisse believes that interest rates have peaked in Indonesia and this is one of the most interest rate sensitive sectors.
Investors waiting for catalysts
Indonesia’s net foreign buying is now at the lowest level in ten years. International investors have been significantly underweight on Indonesia despite recent market performance and improvement in data. The main concern continues to be the impending rate rise and how the market and the Rupiah may react to that.
“We have not seen the buyer come back and we are unlikely to see investors come back in December for the same reason. This means that if there is an orderly reaction to the rate rise and things do not fall off kilter, there is potential for flows to turn positive,” said Mr. Naseer.