Indonesia Plagued by Capital Outflows as Investors Leave Emerging Markets

Indonesia Investments

After several years of significant foreign capital inflows into Indonesia, a sharp contrast has been visible in recent weeks. Global panic that followed in the days after Ben Bernanke announced that the Federal Reserve intends to withdraw its quantitative easing program in 2014 (if economic recovery of the USA continues), hit Indonesia hard. It triggered a massive capital outflow from the country's stock exchange (IDX) as well as from government securities (Surat Berharga Negara, or SBN).

However, in May - prior to Bernanke's speech - foreign concerns about the state of the Indonesian economy had already resulted in capital outflows.

Before June 2013, market sentiments were mostly fuelled by optimism. Foreign ownership of SBNs rose to IDR 302.9 trillion (about USD $30 billion). Furthermore, in the first four months of 2013, foreign net buying of Indonesian stocks at the stock exchange amounted to IDR 19.5 trillion (about USD $2 billion). Lastly, foreign direct investment reached IDR 65.5 trillion (about USD $6.7 billion) in Q1-2013. These three figures indicated high foreign confidence in Indonesia's economy.

Starting in late May, a reversal of the above trend has occurred. Foreign ownership of SBNs fell to IDR 285.7 trillion at the end of last week (from IDR 302.9 trillion on 31 May). Moreover, foreigners recorded net selling of about IDR 20 trillion in June, thus evaporating foreign net buying this year. Indonesia's main stock index (IHSG) has suffered significant losses in the last month. Today, the IHSG fell to 4,418.87, significantly below its record high of 5,214 on 20 May 2013.

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Obviously, this large capital outflow is not only due to the Federal Reserve's announced policy change as some financial and macroeconomic indicators of Indonesia had already shown weakening trends before the announcement of Bernanke. However, with the threat of a stop to the Fed's quantitative easing program next year, it has caused widespread panic and asset dumping in emerging markets (including Indonesia).

The country's IDR rupiah has been one of the worst performing Asian currencies against the US dollar (and Indonesia's central bank has sold quite some of its foreign exchange reserves to limit the rupiah's fall this year). Year to date, the currency lost 3.1 percent against the US dollar. One important reason that the rupiah has been weakening is because of Indonesia's ongoing trade deficit. Indonesia has rarely posted a trade deficit throughout its history, but this situation reversed last year as imports (oil in particularly) surpassed the country's exports. Expensive oil imports had to be made as domestic demand for fuel has risen rapidly. This increased fuel demand was partly government sponsored as it provides cheap fuel through subsidies (although the price of subsidized fuel has been increased last Saturday in order to relieve the government's budget deficit). However, high yet temporary inflation - up to 7.3 percent - is expected as a result of this measure. To support the rupiah, Indonesia's central bank (Bank Indonesia) raised its benchmark interest rate by 25 basis points to 6.0 percent on 13 June 2013.

Lastly, GDP growth in Q1-2013 was disappointing at 6.02 percent and it will take hard work to realize the government's GDP growth target of 6.3 percent for full-year 2013.

Various analysts believe that this period of capital outflows from Indonesia (amid global panic) is only a temporary hiccup as the country's fundamentals and potential remain strong.

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