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Where Big Is Beautiful
Investors used to favor small, flexible Asian markets. But their tastes are shifting to the major blockbusters including, possibly, Indonesia
May 1, 2006 issue - It's a scene familiar to moviegoers: as fires burn, bombs explode and shrapnel flies, the ash-smeared hero marches on, undaunted and unafraid. Much like Indonesia's stock market. In the face of leadership upheavals, civil rebellions and financial turmoil that would rattle its neighbors, the Jakarta Stock Exchange has stood out as one of the hottest in all of Asia. Behind that surprising performance lies a major shift in the way foreign investors watch emerging markets.
For most of the past two decades, investors have favored plotlines involving small, flexible countries, often with a technological flair: Thailand, Malaysia, Taiwan. Now smaller countries have been left behind as tastes shift to the major blockbusters. In Asia, that means China, India and now, possibly, Indonesia. These are big, sprawling acts, with large workforces that multinationals can tap, and vast domestic consumer markets. Furthermore, a wealth of natural resources―once viewed as a kind of curse, a source of easy money that sapped a nation's will to produce and excel―is now seen as a competitive advantage, benefiting countries from Brazil to Russia. Indonesia is the only Asian economy that is blessed in both respects: the world's fourth most populous nation, with 240 million people, it also has vast untapped oil reserves, coal, palm oil and nickel.
And so our hero rises amid the chaos. Since the Bali bombings of October 2002, the Indonesia market has risen 400 percent, and it now trades at a premium to fellow members of the Association of Southeast Asian Nations like Malaysia or Thailand, despite the fact that its economy is growing no faster and more precariously. In recent years GNP growth has averaged 4.5 percent, following the new trend line for the region's once high-flying economies, brought to earth by the Asian financial crisis of 1997-98. Meanwhile, Indonesia's inflation and balance of payments have often looked shaky, triggering a mini-collapse of the rupiah a few months ago.
The market continues to climb in part because of the "base effect." It's always easy to grow from a small base, and Indonesia's market is still recovering from a more than 90 percent plunge in dollar terms during the crisis years. Now that it has surpassed its smaller neighbors, however, the conclusion seems clear: investors are just more bullish on big countries in Asia.
No matter that Indonesia has so far missed out on its own potential. A messy transition to democracy since the 1998 collapse of the Suharto regime has resulted in a general sense of policy drift. Little has been done to combat the "three L's"―local regulations, legal uncertainty and labor rigidity―that famously constrain the economy. During the transition, Indonesia has been rising in global surveys of the most corrupt and difficult countries in which to do business. With foreign companies reluctant to invest in a country where property rights are opaque and labor laws are burdensome, Indonesia's oil production has been in decline for a decade. Once a net exporter, it had to import oil last year, making it a major casualty rather than a big beneficiary of the surge in crude-oil prices.
However, there is now reason to believe that the faith shown by investors may not be misplaced. For one, Indonesia at last has a government that has some pretensions of an economic vision. President Susilo Bambang Yudhoyono took office in 2004 and has begun to act decisively in the last year, putting economic policy in the hands of technocrats, who in turn are working on policy packages designed to improve the investment climate.
They are trying to resolve old contractual disputes in critical economic sectors, including oil and gas, as a signal of welcome to foreign investors. And they are pushing labor-market reform, including plans to ease the requirement that employers pay severance to workers equal to two months' compensation for every year they spend on the job. This proposal has run into predictable resistance, but the widespread view in Jakarta is that Indonesia cannot follow the "French example" and that such reform will pass soon enough.
To be sure, the Indonesian president needs to expend a lot of political capital to gain any meaningful traction for reform. And there is still so much to be done: Indonesia has weak human capital due to a lousy education system―which is why it has no world-class companies. And it has a low value-added manufacturing sector that is being squeezed by both China and Vietnam. These factors limit Indonesia's long-term appeal. However, as Russia has shown, in a commodity-led bull market, all it takes is some basic economic reform and a modicum of stability to usher in boom times. It could be a thrilling emerging market story, while it lasts.
Sharma is a co-head of global emerging markets at Morgan Stanley Investment Management
© 2006 MSNBC.com
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