As such, 2013 seemed to become another year of great growth. In the last decade Indonesia's benchmark stock index has shown a remarkable upward trend with the notable exception of 2008 when Indonesia felt the impact of the global economic crisis and experienced a significant correction (-50.6 percent). However, the euphoria waned when Ben Bernanke, Head of the US central bank, speculated in late May 2013 that the Federal Reserve might start to wind down its monthly USD $85 billion bond buying program known as quantitative easing. Previously, this program had given rise to a massive inflow of cheap US dollars into lucrative assets in emerging markets, including Indonesia. Bernanke's announcement immediately triggered panic among investors and the IHSG subsequently lost about 1,000 points between late May and the end of 2013.

Performance of Indonesia's Jakarta Composite Index

    2004   2005   2006   2007   2008
  2009   2010   2011   2012  2013¹
Annual Percentage Growth
+44.6% +16.2% +55.3% +52.1% -50.6% +87.0% +46.1% +3.2% +12.9% -3.3%

Source: Indonesia Stock Exchange (IDX)
¹ up to 24 December 2013

Indonesia's Financial Weaknesses in 2013

In the second half of 2013 there has been much cause for concern in Indonesia. Investors were more eager to pull their money out from Indonesia's capital markets than from other emerging economies as the country shows a number of financial weaknesses. The most influential financial weakness of Indonesia seems to be the wide current account deficit. In the second quarter of 2013 this deficit reached an all-time record of USD $9.8 billion, equivalent to 4.4 percent of the country's gross domestic product (GDP). All market participants agreed that this figure constituted an unsustainable level. The main factor that contributed to this deficit is Indonesia's large trade deficit in the oil & gas sector. The country imports a large portion of expensive oil in order to satisfy domestic demand for fuels. The government itself is partly to blame for this situation as it subsidizes a significant portion of fuel prices, thus spurring fuel demand amid a robustly growing economy. Car sales have risen steeply in recent years reaching record highs due to a rapidly expanding middle class in combination with a low per capita car ownership ratio.

With regard to the trade balance, Indonesia also faces problems in terms of exports. The country is a major commodities exporting country (mainly raw commodities) and amid weak global demand, commodity prices have fallen steeply. As such, there is not much to offset the deficit in the oil & gas sector. The susceptibility of the country to volatile commodity price movements is also one of the reasons why the Indonesian government wants to lessen dependency on raw commodity exports, while increasing value-added revenues. Through the controversial 2009 Mining Law, it intends to ban the export of unprocessed minerals starting from 12 January 2014.

After seeing the current account deficit go to a record high in the second quarter of 2013, the government decided to release a sort of 'economic rescue package', containing various fiscal policies to support exports and limit imports. Although the impact of this package needs more time to be felt, the current account deficit did ease to USD $3.4 billion in the third quarter of 2013 (3.8 percent of GDP). This improvement is expected to continue in the last quarter of 2013 as well as in 2014. Indonesia's central bank (Bank Indonesia) aims to reduce the deficit to below 3 percent of GDP (a sustainable level) in the second half of 2014.

The current account deficit is also a factor behind Indonesia's sharply depreciating rupiah exchange rate. Since the start of 2013, the rupiah (Bank Indonesia's mid-rate) has weakened 26.6 percent to IDR 12,245 per US dollar (from IDR 9,670). Similarly to the IHSG, pressure on the rupiah intensified after Bernanke's announcement in May 2013. Although at first the central bank tried to support the currency by using a significant portion of its foreign exchange reserves, it soon realized that it should let the currency depreciate in line with its fundamentals. After all, the US dollar started to appreciate strongly against almost all emerging market currencies. It is expected that the rupiah will continue its depreciating trend in 2014.

| Source: Bank Indonesia

The last financial weakness that I would like to mention here is inflation. In order to relieve the ballooning state budget as well as trade deficit, the government decided to increase prices of subsidized fuels by an average of 33 percent in June 2013. In combination with rising prices of electricity and a number of badly-managed import quotas, it led to sharply rising inflation between the months of June and August 2013. Year-on-year inflation accelerated to almost 9 percent. Seeing the weak rupiah and high inflation, Bank Indonesia decided to raise its benchmark interest rate (BI rate) gradually between June and November from 5.75 percent to 7.50 percent. Obviously, this policy adjustment comes at the expense of economic growth (which had already been slowing amid global turmoil). Efforts of both the central government and central bank did manage to tackle the inflation problem. Since September 2013, inflation has been limited although still high at 8.37 percent (yoy) in November 2013. By mid-2014, inflation is expected to have eased to the level of 4.5 percent (yoy), which is a normal ratio for Indonesia.

Indonesia's Economic Growth 2009–2013 (annual percentage change)

 Year    Quarter I
   Quarter II    Quarter III    Quarter IV
 2013        6.05        5.83         5.62            -
 2012        6.29        6.36         6.16         6.11
 2011        6.45        6.52         6.49         6.50
 2010        5.99        6.29         5.81         6.81
 2009        4.60         4.37         4.31         4.58

Source: Statistics Indonesia (BPS)

Continued Volatility in 2014?

Technical indicators inform us that the IHSG is now oversold and thus has the potential to rise entering 2014. Two important financial weaknesses - the current account deficit and inflation - are largely under control and showing an improving trend. However, both will need time to reach sustainable levels. The rupiah exchange rate, on the other hand, is expected to continue its downward spiral as the Federal Reserve's tapering issue will translate into a stronger US dollar. Indonesia's declining GDP growth rate from over 6 percent in recent years to 5.62 percent (yoy) in the 3rd quarter of 2013 (and which will probably continue its downward trend) adds to negative market sentiments. In this uncertain context, volatility is expected to continue and it will be interesting to see how the market will respond to the Federal Reserve's actual winding down of the quantitative easing program in the first month of 2014. The largest potential shock, that is when the tapering policy was announced in the second half of December 2013, passed without significant losses on the stock exchange. With the financial context slowly improving and technical indicators pointing to an oversold market, I expect a gradual improvement in the performance of the IHSG in the first quarter of 2014 but its trajectory will be accompanied by volatility.