Indonesia is a phoenix rising

Indonesia has tremendous investment potential, according to a recent report by Nomura, but policymakers must be wary of complacency.

Indonesia's progress towards regaining its appeal to investors, lost during the Asian crisis more than a decade ago, has been well-acknowledged by analysts and officially endorsed by rating agencies. Increasingly, too, the risks for investors are weighted on the upside, if key institutional reforms are put in place.

In an exhaustive report published on June 7, Nomura identified six top investment opportunities, assuming that the country delivers regular annual GDP growth rates of 7 percent. Its positive outlook is predicated on Indonesia's "abundant natural gifts", including a youthful and more affluent population, rich natural resources, a burgeoning democratic political structure and the fact that the archipelago is situated in the right region - Asia.

The bank's inaugural study coincides with its own commitment to build out an equity platform in the country.

Already, Indonesia has built up record foreign exchange reserves, attracted higher levels of foreign direct investment and can boast average annual economic growth of 5.7 percent during the past five years. Its credit rating is now just one notch below investment grade.

According to Nomura, Indonesia is a "phoenix rising". In the bank's base case, "the current momentum will be augmented by incremental reforms and progress on infrastructure development", to enable Indonesia to deliver GDP growth averaging 7 percent during the next five years.

At that rate of expansion, capital inflows could push the rupiah as high as 7,400 against the US dollar by the end of 2014, from around 8,500 today, according to Nomura's analysts. The sovereign credit default swap spread could also narrow even further. Natural resources should continue to attract investment, especially as the government intends to promote downstream manufacturing and processing, and progress towards infrastructure development, with official spending estimates of $220 billion between 2010 and 2014, offering plenty of opportunities. Meanwhile, discretionary consumer stocks will benefit as the country's middle class triples in size to 150 million in 2014, which will also highlight the under-penetrated banking sector.

Nomura also identifies "10 signposts" that, if passed, could lead to further progress. Several are related to infrastructure formation.

These include: the passage of the land acquisition bill and its related regulations, realisation of the planned pick-up in public-sector infrastructure investment, successful pilot public-private partnership projects, and a move to market pricing in the power industry

Regulatory changes include labour market reforms, where Nomura looks for a reduction of severance pay mitigated by more effective worker protection, such as unemployment benefits, re-establishing minimum wages simply as a safety net for low-wage earners, and an improved framework for skills development. In the oil and gas sector, it hopes for regulatory certainty, investment incentives and improved governance to help boost exploration.

The financial industry needs further development, and a sign of that happening would be a cutback in public ownership; and the services sector needs to be opened up to domestic and international competition, especially to enhance quality and productivity in education and health. Nomura will also be watching with approval for the removal of "wasteful fiscal subsidies on food and energy", and the reallocation of resources to productive human and physical capital investment.

The bank echoes investors' insistence that there should be strong, consistent political backing for the anti-corruption agency (KPK) and, of course, looks for a pro-reform coalition to emerge from the 2014 elections to allow Indonesia to maintain its momentum.

But, it is politics and commitment to institutional reform that could scupper Indonesia's full admission to the Bric club of countries apparently destined to advance.

Nomura warns that the "fundamental institutional reforms (of the electoral system and judiciary, among others) required to realise the economy's full potential are likely to be slow-moving and dominated by imperatives for stability and consensus building during the rest of President Yudhoyono's administration".

Complacency might be tempting if economic growth is delivered, but it is not a sensible policy option. Indonesia is vulnerable to volatile commodity prices, choked by poor physical infrastructure, susceptible to political instability and always threatened by natural disasters.

On the other hand, the bank points out that a "more evolutionary approach to reform, based on consensus building... may be the more judicious and sustainable way to build on past gains", bearing in mind the country's diversity and the brief period of its democracy.

Source : http://www.intellasia.net