Indonesia was one of the most severely hit emerging markets because Southeast Asia’s largest economy faced a number of financial difficulties, most notably the current account deficit (which hit a record high in the second quarter of 2013 at USD $9.9 billion or 4.4 percent of GDP), inflation (accelerating to nearly 9 percent year-on-year after the government raised prices of subsidized fuels in June 2013), and a sharply depreciating rupiah exchange rate (falling more than 21 percent against the US dollar during 2013). This unstable financial context made international investors highly concerned about their Indonesian assets and led to total foreign net selling of Indonesian stocks worth IDR 18.9 trillion (USD $1.6 billion) in 2013. As a result, Indonesia’s benchmark stock index (known as the Jakarta Composite Index or IHSG) experienced a major correction. In late May 2013, it hit a record high at over 5,200 points but after Bernanke's speech, the index immediately plunged (ending the year 18 percent lower than its peak in late May). Similarly, the rupiah exchange rate lost investors’ confidence and weakened accordingly. As the market reacts faster than ‘reality’, capital outflows were limited when the Federal Reserve finally really started to wind down its quantitative easing program in December 2013; most of the money had already been withdrawn in the months ahead of the tapering.

Cautious Optimism at the Start of 2014

How did the Jakarta Composite Index perform so far in 2014? In the first five weeks of 2014, the index has risen 4.5 percent to 4,466 on Friday (07/02). Total foreign net buying amounted to IDR 2.6 trillion (USD $215 million) in this same period. The announcement of further Federal Reserve tapering in late January 2014 (down to USD $65 billion per month), did not seem to have a negative impact, providing further evidence that the market has already reacted toward the Federal Reserve’s tapering issue. However, the risk of further capital outflows remains when interest rates in the USA are raised (currently these are still close to zero).

The return of foreign capital inflows into Indonesia’s stock market and the government's global bond issuance in January being oversubscribed 4.4 times are obviously signs of restored foreign confidence. Moreover, the Indonesian government and central bank (Bank Indonesia) have done their homework regarding safeguarding financial stability, thus fostering investors’ confidence. Through fiscal policy packages and monetary policy, both institutions have managed to ease the country’s wide current account deficit to a near-sustainable level of 3.5 percent of GDP by the end of 2013. In the last three months of 2013, the country in fact posted a trade surplus. However, this surplus - particularly the USD $1.52 billion trade surplus in December 2013 - was mainly caused by exports of raw minerals ahead of the implementation of the ban on unprocessed minerals (effective from 12 January 2014); miners were quickly exporting as much raw material as possible (although a last-minute revision to the ban made the continuation of exports - under specific conditions - possible). But as these exports are now seriously restrained it will impact negatively on the country’s trade balance and raises doubts whether Indonesia can continue to record a series of trade surpluses into this year. Both Bank Indonesia and Finance Minister Chatib Basri remain confident, however, that the country’s current account deficit can be lowered to the range of 2.5 to 3.0 percent in 2014. Generally, a deficit below the 3 percent mark is considered as a sustainable level.

Inflation has also started to ease although remains high at 8.22 percent (year on year) in January 2014. The shock that was caused by higher subsidized fuel prices in June 2013 and which led to high monthly inflation rates in the months of June, July and August has been under control since September 2013. As usual, January inflation was still high (at 1.07 percent) amid a peak of the rainy season resulting in disruptions to distribution networks. Therefore, starting from February, Indonesia’s inflation should ease more markedly and may reach between 5 and 6 percent by the end of 2014, which is near the central bank’s target of 4.5 percent plus or minus one percent.

On the downside, these efforts of the government and Bank Indonesia (which also includes a higher interest rate environment) have brought about a slowdown of economic growth. A few days ago, Statistics Indonesia announced that Indonesia’s economy expanded 5.78 percent in 2013, thus slowing from a 6.23 percent growth pace in 2012. Meanwhile, the rupiah exchange rate has not been able to gain strength yet as reduced US dollar liquidity results in a strengthening US dollar against emerging market currencies.

Legislative and Presidential Elections in 2014

Apart from the (gradually improving) financial indicators, there remains one big question mark this year, and that is the legislative and presidential elections, scheduled for April and July 2014. Due to the undemocratic culture in the country’s political institutions it is difficult for an intelligent and integer person to join the presidential race. Money-politics, status and nepotism are still the key elements in Indonesian politics today although a glimmer of hope was seen when Joko Widodo and Ahok were chosen to govern Jakarta in 2012. Both these men differ significantly from the traditional Indonesian leaders and try to change the inefficient bureaucratic tradition that has lingered on for so long. Joko Widodo (known as Jokowi) is now by far the most popular presidential candidate in the eyes of Indonesians. Foreigners also seem to respect his new and down-to-earth style of leadership. However, it remains unknown whether he will participate in the election. It is highly likely that the market will respond more positive to the election of a new type of leader, such as Jokowi or Gita Wirjawan, than the older generation of politicians, such as Aburizal Bakrie (running for the Golkar party) and Prabowo Subianto (Gerindra party), both of whose names have been linked to corruption scandals or even human rights violations.