Indonesia
Investment Opportunity of a Lifetime?
Over the last three years, the collapse in local share
prices and the depreciation of the Rupiah have shrunk the total capitalization
of Indonesia’s stock market to a paltry US$ 30 billion.
Telkom, the leading phone operator, sports the largest market value, at $3.2 billion. But the fifth-largest company (Indosat, the other major phone operator) sells for less than $900 million – a small cap investment by US standards. All in all, only ten Indonesian companies have a market value in excess of $500 million, and a mere thirty-five are worth more than $100 million.
To make matters worse, most of these companies are closely held, either by family interests or by the government and its restructuring agency (IBRA), so that the total float available to outside investors in the Indonesian stock market probably falls below $10 billion.
Yet, Indonesia is far from the small, inconsequential country depicted by its stock market. It offers a potentially lucrative domestic market of two hundred million people; it is rich in many natural resources; and it benefits from a competent and disciplined labor force. On each visit, I am impressed by results that can be obtained from Indonesian labor by good management. In my experience, for example, the quality of service in Indonesia’s best hotels stands two heads above that of equivalent, better known hotels in the region.
In addition, as the largest Muslim country in the world but one with a tradition of moderation and religious tolerance, Indonesia has considerable geopolitical importance. For this reason, I believe that it will enjoy continued support from the world’s leading powers in its efforts to transform itself to a democracy and to open its economy. Symptomatically, even as the country was recently coming under severe international criticism for its government’s handling of the Timor situation, an arm of the World Bank was pledging almost $5 billion in aid for Indonesia, which will help fund its projected 2001 budget deficit.
Obviously, for liquidity reasons, investing in Indonesia is not yet practical for everyone, and there are well-publicized risks. But one should not systematically ignore smaller investments, when an exceptional potential outweighs the apparent risks.
Economic Schizophrenia
Recent economic statistics and corporate releases, as well as the information gathered on my recent visit, confirm my impressions of six months ago: there are two distinct Indonesian economies.
The large conglomerates that used to control the economy thanks to their close links to banks and privileged connections to the Suharto clan now seem completely paralyzed. For many, their assets have been placed under the control of IBRA (the government’s restructuring agency) and no one knows who really makes the corporate decisions or who will control the companies a year from now. The conglomerates’ credit has all but dried up, as have their investments, and these largest of Indonesian companies languish in a sort of catatonic state.
In sharp contrast, the country’s smaller companies, managed by private entrepreneurs that never benefited from either easy credit or government favors, are thriving. Debts have been paid down, cash balances have built up, profit margins have been restored to levels that are the envy of businesses throughout the region, and their owners view 15% to 20% growth rates in revenues as merely “moderate.”
International manufacturing companies also report great satisfaction with their Indonesian operations -- even those, like Clipsal and Yue Yuen Industrial (two Tocqueville portfolio companies), which source most of their production from China.
For example, according to Yue Yuen, the world’s largest manufacturer of branded shoes (Nike, Adidas, Reebok, Timberland, Rockport, etc.), the efficiencies of a common language and culture and a generally higher educational level normally make production in China easier to organize and to manage. Yet, with wages about half of those in China and a labor force that is both conscientious and productive, Indonesia has become quite attractive as a manufacturing base, even more so than Vietnam. Not surprisingly, the volume of Indonesia’s manufactured exports is up almost 30% this year – in good part from Japanese and Korean firms based in trade-free processing zones (exports to neighboring countries are up 45%). Exports by domestic manufacturing companies are still being constrained by the limited availability of trade financing.
The Consumer Is Back
The new prosperity of Indonesia’s entrepreneurial sector and the rising profits of foreign manufacturers have allowed minimum wages to be raised, offsetting much of the deterioration of spending power since 1997. As a result, consumption has been stronger than is obvious from the official statistics. Remember that, as in much of Asia, a significant portion of Indonesia’s retailing is done through street stands and “hole in the wall” shops that escape the government’s statistical (and tax) collection efforts.
It is not only the luxury malls catering to the expatriates and the ultra-rich that are prospering again. Ramayana (one of Indonesia’s most successful retailers, which caters to the lowest-end mass market) has been busy opening new stores and the company’s second quarter sales were almost 48% above last year’s corresponding period. Armed with ample cash reserves, it has aggressive plans to open more stores in outer-island cities where other retailers seldom venture yet, and it feels comfortable with estimates of 20% growth for the next several years. Matahari, another retailer that caters to the country’s middle class consumers (an estimated 32% of the population in the main cities), saw first-half revenue increase by almost 20% over last year’s on a same-store basis, and 26% in total.
Automobile sales in the first eight months were 4½ times those in last year’s same period. Even if this reflects the delivery of backlogged orders, the recovery is impressive. When asked who buys all these cars, Astra International, one of our portfolio companies and the country’s largest automobile dealer with a 50% market share, answers: “small entrepreneurs.” Meanwhile, sales of motorcycles doubled in the same interval, also indicating that the recovery in consumption is not just a richest-class phenomenon.
Another of our portfolio companies, Unilever Indonesia, is on track to increase sales by almost 20% this year, and one supplier of packaging for it and other manufacturers of similar products confirms that “sales are strong across the board.”
Tempo Scan Pacific, also a portfolio company that sells multivitamins and other over-the-counter pharmaceuticals, has seen first-half sales grow at a “moderate rate of 20%” (their adjective).
AC Nielsen regularly polls all kinds and sizes of retail outlets in 11 major cities: it reports that consumer purchases are almost back to pre-crisis levels in volume, after rising 20% over the last 15 months.
What’s Going On Here?
With all this, why do government reports tally the growth of household spending at less than 3% this year, while most forecasters predict only 3%-4% growth for Indonesia’s GDP this year and next?
One reason is a marked slowdown, this year, in the agriculture sector, which still employs almost 40% of Indonesia’s labor force. Estimating the income and spending of farming populations is an iffy exercise even in the best statistically equipped countries. Nevertheless, it is a fact that farming and fishing, which enjoyed prosperity amid the economic crisis as their export value surged, have recently been struggling. Not only have the international prices for their commodities been weak, but also large tracts of plantations and farms have not been properly maintained after being looted or occupied by villagers in some of the more restive regions.
It is possible, therefore, that the revival of consumption from depressed levels in the large cities is being accompanied by a slowdown of consumption in the agricultural areas, where it had remained exceptionally strong throughout the crisis.
Capital Roadblocks
Another brake on economic expansion has been lackluster investment.
Conglomerates, one of the largest sources of capital spending in the past, are facing an uncertain future, burdened as they are by huge debts and complicated negotiations with the government’s restructuring agency. This being said, many of these conglomerates are also large exporters, and their owners -- or prospective owners, if a settlement is reached with IBRA -- are not keen to repatriate export earnings that could be subjected to threats of confiscation during the restructuring negotiations. Often, they prefer to leave some proceeds on deposit abroad: as one economist notes, “most signs point out to large under-invoicing of export receipts through 1999.” To finance essential expenditures, these conglomerates then use offshore deposits as collateral for borrowing domestically from their foreign banks. In such a way the conglomerates’ owners do not increase their visible domestic net worth and, with them their politically vulnerability.
The result of such machinations, however, is that less capital is available for investment in the Indonesian economy than would be warranted by the economy’s export performance. Despite a current account surplus that is estimated to reach 6.5% of GDP, the country’s foreign exchange reserves are lower than when President Wahid took office a year ago.
One ray of light is the recovery in official export figures for manufactured goods this year (+30% in dollars), as it may well indicate a greater willingness to repatriate export proceeds for local investment.
Many non-conglomerate businesses can finance capital expenditures from internal cash flows, which have been strong. But increased sales also mean increased working capital needs for inventories and receivables, so that these smaller companies’ growth, though high, may still have been held back by lack of borrowing ability. Foreign banks have been actively pursuing new business, but mostly from the larger enterprises, while domestic banks, due to capital constraints, will not be in a position to lend until their own restructurings are completed.
There, too, however, things are being sorted out: more aggressive lending is likely to resurface by next spring, and told by local bankers that they will likely focus on small and medium-sized enterprises to a greater degree than at any time before.
As for oil and mining companies, another important source of investment capital in the past, they have adopted a wait-and-see attitude in anticipation of the implementation of the new law that will give greater autonomy to the provinces. This law is supposed to take effect in January, but the implementation guidelines have not yet been published, and negotiations about them between the central and regional governments are still in an early stage. Positioning for these negotiations, regional authorities are clamoring for more revenue from, or even joint-ownership of, their “national” resources.
Although not overly worried, the foreign mining companies are mostly lobbying through inaction, taking the attitude that they hold exploitation contracts and that this is not their problem. For example, Inco Indonesia, one of our portfolio companies and arguably one of the best corporate citizens among the country’s natural resource companies, has taken a somewhat rigid and legalistic stance, even stating its willingness to go to international arbitration if necessary.
Inco’s example is symptomatic of the current, somewhat folkloric gesturing by all parties involved or potentially involved in autonomy/independence negotiations. Three provincial governors in the resource-rich and people-poor island of Sulawesi have accused Inco of relatively vague environmental violations, which the company vehemently and credibly denies – especially since it has no operation in two of the three provinces.
However, the figures used by the governors to substantiate their claim for more revenues indicate the true size of the problem. They state that Inco earned $49 million in this year’s first half, while the local governments made less than $600,000 from land rent and royalty payments. Starting in January, these governments will share in some of the central government’s revenues and, from Inco’s point of view, that’s how their claims should be settled, since Inco itself has a valid legal contract with the central government. However, one cannot fail to notice that doubling the local governments’ take would have dented Inco’s admittedly high first-half profits by only one or two percent. Though the company has given no indication to that effect, it seems to me that they would happily pay that price (in one form or another) for a clear, unalterable, legally solid and dutifully enforced permission to continue operations without further annoyance.
Another type of claim arises from former owners of the land now occupied by mining companies, who ask for additional “expropriation” compensation. Newmont Mining (a holding of other Tocqueville accounts) argues that it paid five times the “market rate” to 400 landowners between 1989 and 1994 – but that was under the Suharto regime… Nevertheless, additional compensation, if agreed, would barely make a dent in one year’s profit from Newmont’s Indonesian mining operations, in my opinion.
Other foreign investors that had reported “imminent” investment projects last year have kept them on hold, as they see no major cost in waiting. French retailer Carrefour seems the exception, and I keep seeing more of its supermarkets in Indonesia -- as in the rest of Asia.
As a result of all the factors described above, foreign direct investment last year was down almost 90% from its 1997 peak -- to just $3.6 billion. From that level, a 17% year-to-year improvement in the first half of 2000 may not seem much, but it should be welcome as a sign of life for a segment of the economy that had been considered moribund until a few months ago.
Altogether, there is an ample supply of investment capital ready to come into the country as soon as some legal and political visibility has been restored. Meanwhile, we should not overlook the fact that, despite the lukewarm official investment figures, domestic cement shipments in the second quarter were almost 15% higher than a year ago – 22% in the Jakarta region and in Sumatra.
Living On a Budget
In the current environment, there is little room for either monetary or fiscal stimulus. The large government debt prohibits pump priming the economy with new spending on any scale, and the vulnerable Rupiah precludes monetary ease. Nevertheless, the new economic team, under the supervision of vice-president Megawati, has come up with what is generally considered to be a credible budget – aiming for a 1.8% surplus before interest expense on the large national debt.
Under this budget, 77% of the increase in spending will come from interest payments, subsidies and, importantly, from the new transfers to regional governments under the autonomy law (42%). The bank-restructuring program will also cause expenditures equal to 26% of the total government budget, but the government hopes to finance much of this through asset sales.
Doubtless, there will be some slippage in many of these planned expenditures. On the other hand, the budget assumes oil prices of only $22/barrel vs. the current $34-plus. According to a leading broker, a $1 increase in the price of the oil barrel adds $150 million to Indonesia’s budgetary revenues. A $29 average price for oil could thus add more than $1 billion to state coffers in 2001, hopefully more than covering any slippage on the $33 billion in forecasted expenditures.
In addition, there could be some additional, favorable surprises on the revenue front, as a number of leading economists are beginning to suspect that the growth rate of the Indonesian economy, especially in the cities, is currently quite a bit higher than the 4% assumed by the Government’s budget.
Democracy Is Messy
Last year’s general excitement over Indonesia’s peaceful transition to a democratically elected government has given way to what could be characterized as the trauma of sudden democracy.
One of the most striking signs of instant change is the incredible freedom of speech that this transition has brought about. During my first two visits, I found the press, though not as servile as in some other autocratic countries, clearly careful not to offend the ruler and his entourage. Now, the country’s media are basking in an orgy of free speech. Academics, journalists, and foreign diplomats all acknowledged this, and many stressed that the local media (in Bahasa Indonesia), is even more aggressive in its criticism of almost everybody than the press in Jakarta.
People who used to lower their voices to discuss politically sensitive subjects in public places now criticize aloud, not only the past ruler, but also the current president, leading political figures and even the army and the police.
Note that Indonesia has traditionally been a complex country, where a plot is suspected behind every political development and the rumor mills are rife with conspiracy theories. This game used to be played mostly among the cognoscenti in the major cities, but now it has become soap opera material for all to read or watch on TV.
One may question whether the Indonesian population was ready for this tidal wave of free speech, and its sudden exposure to the complexities of political life.
Outside of a small intelligentsia, years of dictatorial rule and of struggle to make ends meet had not created a very politically savvy electorate. Most Indonesians (including much of the educated middle class), while rejoicing at the new freedom of speech, clearly remain mostly concerned about the material challenges of daily life. This is particularly true because wage increases have lagged behind the devaluation-induced increase in the cost of living, so that consumers are only now beginning to realize that the worst of the great crisis may be over.
In a way, the explosion of information about political infighting and the delayed economic recovery due to the political transition may explain the bouts of restlessness periodically erupting among the population. Unrealistic earlier expectations about the material benefits that would immediately accrue with the fall of Suharto stand in sharp contrast with the slow pace of change since that momentous event. And frustration, occasionally, needs to be vented.
This is aggravated by the new habit of washing the political dirty laundry in public. Accusations of improprieties, sometimes outlandish and undocumented, are brought daily about everybody against everybody, from the President down to the lowliest politician. The populace, which had never seen so much wrongdoing publicly exposed, may well begin to feel that the new order is not much different from the old order. In fact, it may seem worse, since security in daily life has worsened in the big cities – partly because of the economic crisis, but also because the military’s adoption of a lower profile is overwhelming the police force with new responsibilities.
Independence Dreams Are Just That
The same impatience is evident in the provinces whose politicians, once promised more money and power, want even more of it and want it now. In many of the outer provinces, Java (the most populated and most developed island) is often perceived as another colonial power, which merely replaced older colonial powers in exploiting the local resources for its own benefit. It is easy for provincial politicians to put pressure on Jakarta during the autonomy negotiations by playing on the “nationalistic” feelings and unrealistic expectations of the local population.
Most provinces, however, do not have the management infrastructure or the qualified labor force to exploit their natural resources on their own. In fact, there are questions on how well inexperienced local cadres will manage the additional revenues allocated to them under the new autonomy law. Moreover, beyond the ownership of their local natural resources, and with sparse and ill-trained populations, they would likely remain dependent on Java for much of their needs in other essential products, as well as in financial and logistical services. As one medium-sized company stated to me: “If they become independent, which is highly unlikely, we’ll just export to them.”
In fact, a quick calculation shows that if all the outer provinces became independent, an ensemble made up of Java, Sumatra and Bali would remain the region’s economic powerhouse. Perhaps an even more dynamic one than now: the dynamic forces of emerging economies are often dulled by the ownership of rich natural resources that can only be efficiently exploited by foreign operators. The tendency is to use royalties and other passive revenues from such resources as a sort of national welfare system, which lessens the urgency to develop new skills and other sources of income. We find it somewhat ironic that one of the first acts of East Timor as it gains independence, is to demand that Australia share with it the revenues from a disputed oil field.
Tiptoeing Executive, Bolder Institutions
All this being said, and despite the appearances created by western reporting, Indonesia’s political situation is improving, though in typical Indonesian manner -- under the surface and in somewhat mysterious ways.
Foreign observers who show impatience at Indonesia’s “slow” progress in the barely twelve months since its first democratic election, should try and imagine how long it would have taken the United States, for example, to solve the banking crisis of the 1990s while absorbing the aftershocks of a momentous political revolution and having to re-create much of the country’s legal, financial and political infrastructure from scratch.
Of course, it is not easy to strengthen the legal system and to boldly fight corruption in a country where almost every politician has been part of the old system. A full overhaul may take a generation or more. But progress can still be made: local observers across the political spectrum were impressed by the open process of questioning and debating in Parliament that led to the recent nomination of an entirely new body of Supreme Court judges. The revamping of the Supreme Court is generally viewed as a first requisite to restoring some credibility to Indonesia’s legal system.
While the often puzzling and apparently directionless leadership of President Wahid has irritated many, including former ardent supporters, he can take credit for guiding the country past several dangerous but necessary hurdles over his first twelve months in office.
But more importantly, the Parliament has established its democratic credibility, and a stable political order is emerging behind the scenes. In particular, Vice President Megawati seems to have rebuilt her bridges with the army and with various Muslim factions that had opposed her nomination as president (even though her party had gathered the largest popular vote in the general election). Just as importantly, though she has adopted a characteristically low profile, she remains immensely popular, she has surrounded herself with respected young technocrats, and she seems to be much more active in the management of government than is reported in the western media.
Altogether, I am increasingly confident that, after President Wahid’s tenure, a stable transition can be effected and an effective coalition government can drive Indonesia through the next steps of its political and economic revival.
Investments on Sale
Nomura Securities estimates that the (non-bank) companies in its Indonesian Universe increased their operating profits by 33% in the first half of 2000, vs. the comparable year-ago period. Even so, with stock prices only 15% above their all-time lows, the overall market is selling at 7.5 times this year’s estimated earnings.
Over the last 2 years, companies have re-built the equity side of their balance sheet and re-paid debt, to the point where the percentage of total debt (long and short) to equity of many companies is now in the low double digits, while many have more cash than total debt.
Meanwhile, the overall return on equity, excluding a few troubled conglomerates, has risen from 11% to around 20% (excluding foreign exchange gains and losses). According to Credit Lyonnais, this return now makes Indonesian companies the most profitable in Asia after those in Taiwan, thanks to the high profit margins prevailing in Indonesia.
Yet, even improving corporate fundamentals have not prevented the Indonesian stock market from continuing its slide and the currency has recently been under pressure as well, in a very thin foreign exchange market. Indonesia has a minimal weight in major global or Asian stock indexes and, as is typical with indexing, that weight has diminished along with the decline of the country’s stock market. There is now little incentive for international money managers who measure themselves against popular benchmarks to even bother with the country’s investment opportunities.
As a result, many quality Indonesian companies are selling at multiples of cash flow and earnings in the 3x to 6x range – in spite of very plausible prospective growth rates of 15% to 20% -- perhaps more.
For example, retailer Matahari is selling at 8 times estimated 2000 earnings per share, or less than a third of its growth rate. Indosat and PT Inco Indonesia are selling at Enterprise Value / EBITDA ratios of about 4x and 3x respectively. Tempo Scan, with cash exceeding total debt, has a price/earnings of only 5.2x.
It would be foolish to argue that Indonesia does not face daunting challenges in the next few years. However, when looked at more closely, most of the current problems seem unlikely to be fatal to either the country or its economy, while financial prices seem to be anticipating the worst.
François Sicart
Telkom, the leading phone operator, sports the largest market value, at $3.2 billion. But the fifth-largest company (Indosat, the other major phone operator) sells for less than $900 million – a small cap investment by US standards. All in all, only ten Indonesian companies have a market value in excess of $500 million, and a mere thirty-five are worth more than $100 million.
To make matters worse, most of these companies are closely held, either by family interests or by the government and its restructuring agency (IBRA), so that the total float available to outside investors in the Indonesian stock market probably falls below $10 billion.
Yet, Indonesia is far from the small, inconsequential country depicted by its stock market. It offers a potentially lucrative domestic market of two hundred million people; it is rich in many natural resources; and it benefits from a competent and disciplined labor force. On each visit, I am impressed by results that can be obtained from Indonesian labor by good management. In my experience, for example, the quality of service in Indonesia’s best hotels stands two heads above that of equivalent, better known hotels in the region.
In addition, as the largest Muslim country in the world but one with a tradition of moderation and religious tolerance, Indonesia has considerable geopolitical importance. For this reason, I believe that it will enjoy continued support from the world’s leading powers in its efforts to transform itself to a democracy and to open its economy. Symptomatically, even as the country was recently coming under severe international criticism for its government’s handling of the Timor situation, an arm of the World Bank was pledging almost $5 billion in aid for Indonesia, which will help fund its projected 2001 budget deficit.
Obviously, for liquidity reasons, investing in Indonesia is not yet practical for everyone, and there are well-publicized risks. But one should not systematically ignore smaller investments, when an exceptional potential outweighs the apparent risks.
Economic Schizophrenia
Recent economic statistics and corporate releases, as well as the information gathered on my recent visit, confirm my impressions of six months ago: there are two distinct Indonesian economies.
The large conglomerates that used to control the economy thanks to their close links to banks and privileged connections to the Suharto clan now seem completely paralyzed. For many, their assets have been placed under the control of IBRA (the government’s restructuring agency) and no one knows who really makes the corporate decisions or who will control the companies a year from now. The conglomerates’ credit has all but dried up, as have their investments, and these largest of Indonesian companies languish in a sort of catatonic state.
In sharp contrast, the country’s smaller companies, managed by private entrepreneurs that never benefited from either easy credit or government favors, are thriving. Debts have been paid down, cash balances have built up, profit margins have been restored to levels that are the envy of businesses throughout the region, and their owners view 15% to 20% growth rates in revenues as merely “moderate.”
International manufacturing companies also report great satisfaction with their Indonesian operations -- even those, like Clipsal and Yue Yuen Industrial (two Tocqueville portfolio companies), which source most of their production from China.
For example, according to Yue Yuen, the world’s largest manufacturer of branded shoes (Nike, Adidas, Reebok, Timberland, Rockport, etc.), the efficiencies of a common language and culture and a generally higher educational level normally make production in China easier to organize and to manage. Yet, with wages about half of those in China and a labor force that is both conscientious and productive, Indonesia has become quite attractive as a manufacturing base, even more so than Vietnam. Not surprisingly, the volume of Indonesia’s manufactured exports is up almost 30% this year – in good part from Japanese and Korean firms based in trade-free processing zones (exports to neighboring countries are up 45%). Exports by domestic manufacturing companies are still being constrained by the limited availability of trade financing.
The Consumer Is Back
The new prosperity of Indonesia’s entrepreneurial sector and the rising profits of foreign manufacturers have allowed minimum wages to be raised, offsetting much of the deterioration of spending power since 1997. As a result, consumption has been stronger than is obvious from the official statistics. Remember that, as in much of Asia, a significant portion of Indonesia’s retailing is done through street stands and “hole in the wall” shops that escape the government’s statistical (and tax) collection efforts.
It is not only the luxury malls catering to the expatriates and the ultra-rich that are prospering again. Ramayana (one of Indonesia’s most successful retailers, which caters to the lowest-end mass market) has been busy opening new stores and the company’s second quarter sales were almost 48% above last year’s corresponding period. Armed with ample cash reserves, it has aggressive plans to open more stores in outer-island cities where other retailers seldom venture yet, and it feels comfortable with estimates of 20% growth for the next several years. Matahari, another retailer that caters to the country’s middle class consumers (an estimated 32% of the population in the main cities), saw first-half revenue increase by almost 20% over last year’s on a same-store basis, and 26% in total.
Automobile sales in the first eight months were 4½ times those in last year’s same period. Even if this reflects the delivery of backlogged orders, the recovery is impressive. When asked who buys all these cars, Astra International, one of our portfolio companies and the country’s largest automobile dealer with a 50% market share, answers: “small entrepreneurs.” Meanwhile, sales of motorcycles doubled in the same interval, also indicating that the recovery in consumption is not just a richest-class phenomenon.
Another of our portfolio companies, Unilever Indonesia, is on track to increase sales by almost 20% this year, and one supplier of packaging for it and other manufacturers of similar products confirms that “sales are strong across the board.”
Tempo Scan Pacific, also a portfolio company that sells multivitamins and other over-the-counter pharmaceuticals, has seen first-half sales grow at a “moderate rate of 20%” (their adjective).
AC Nielsen regularly polls all kinds and sizes of retail outlets in 11 major cities: it reports that consumer purchases are almost back to pre-crisis levels in volume, after rising 20% over the last 15 months.
What’s Going On Here?
With all this, why do government reports tally the growth of household spending at less than 3% this year, while most forecasters predict only 3%-4% growth for Indonesia’s GDP this year and next?
One reason is a marked slowdown, this year, in the agriculture sector, which still employs almost 40% of Indonesia’s labor force. Estimating the income and spending of farming populations is an iffy exercise even in the best statistically equipped countries. Nevertheless, it is a fact that farming and fishing, which enjoyed prosperity amid the economic crisis as their export value surged, have recently been struggling. Not only have the international prices for their commodities been weak, but also large tracts of plantations and farms have not been properly maintained after being looted or occupied by villagers in some of the more restive regions.
It is possible, therefore, that the revival of consumption from depressed levels in the large cities is being accompanied by a slowdown of consumption in the agricultural areas, where it had remained exceptionally strong throughout the crisis.
Capital Roadblocks
Another brake on economic expansion has been lackluster investment.
Conglomerates, one of the largest sources of capital spending in the past, are facing an uncertain future, burdened as they are by huge debts and complicated negotiations with the government’s restructuring agency. This being said, many of these conglomerates are also large exporters, and their owners -- or prospective owners, if a settlement is reached with IBRA -- are not keen to repatriate export earnings that could be subjected to threats of confiscation during the restructuring negotiations. Often, they prefer to leave some proceeds on deposit abroad: as one economist notes, “most signs point out to large under-invoicing of export receipts through 1999.” To finance essential expenditures, these conglomerates then use offshore deposits as collateral for borrowing domestically from their foreign banks. In such a way the conglomerates’ owners do not increase their visible domestic net worth and, with them their politically vulnerability.
The result of such machinations, however, is that less capital is available for investment in the Indonesian economy than would be warranted by the economy’s export performance. Despite a current account surplus that is estimated to reach 6.5% of GDP, the country’s foreign exchange reserves are lower than when President Wahid took office a year ago.
One ray of light is the recovery in official export figures for manufactured goods this year (+30% in dollars), as it may well indicate a greater willingness to repatriate export proceeds for local investment.
Many non-conglomerate businesses can finance capital expenditures from internal cash flows, which have been strong. But increased sales also mean increased working capital needs for inventories and receivables, so that these smaller companies’ growth, though high, may still have been held back by lack of borrowing ability. Foreign banks have been actively pursuing new business, but mostly from the larger enterprises, while domestic banks, due to capital constraints, will not be in a position to lend until their own restructurings are completed.
There, too, however, things are being sorted out: more aggressive lending is likely to resurface by next spring, and told by local bankers that they will likely focus on small and medium-sized enterprises to a greater degree than at any time before.
As for oil and mining companies, another important source of investment capital in the past, they have adopted a wait-and-see attitude in anticipation of the implementation of the new law that will give greater autonomy to the provinces. This law is supposed to take effect in January, but the implementation guidelines have not yet been published, and negotiations about them between the central and regional governments are still in an early stage. Positioning for these negotiations, regional authorities are clamoring for more revenue from, or even joint-ownership of, their “national” resources.
Although not overly worried, the foreign mining companies are mostly lobbying through inaction, taking the attitude that they hold exploitation contracts and that this is not their problem. For example, Inco Indonesia, one of our portfolio companies and arguably one of the best corporate citizens among the country’s natural resource companies, has taken a somewhat rigid and legalistic stance, even stating its willingness to go to international arbitration if necessary.
Inco’s example is symptomatic of the current, somewhat folkloric gesturing by all parties involved or potentially involved in autonomy/independence negotiations. Three provincial governors in the resource-rich and people-poor island of Sulawesi have accused Inco of relatively vague environmental violations, which the company vehemently and credibly denies – especially since it has no operation in two of the three provinces.
However, the figures used by the governors to substantiate their claim for more revenues indicate the true size of the problem. They state that Inco earned $49 million in this year’s first half, while the local governments made less than $600,000 from land rent and royalty payments. Starting in January, these governments will share in some of the central government’s revenues and, from Inco’s point of view, that’s how their claims should be settled, since Inco itself has a valid legal contract with the central government. However, one cannot fail to notice that doubling the local governments’ take would have dented Inco’s admittedly high first-half profits by only one or two percent. Though the company has given no indication to that effect, it seems to me that they would happily pay that price (in one form or another) for a clear, unalterable, legally solid and dutifully enforced permission to continue operations without further annoyance.
Another type of claim arises from former owners of the land now occupied by mining companies, who ask for additional “expropriation” compensation. Newmont Mining (a holding of other Tocqueville accounts) argues that it paid five times the “market rate” to 400 landowners between 1989 and 1994 – but that was under the Suharto regime… Nevertheless, additional compensation, if agreed, would barely make a dent in one year’s profit from Newmont’s Indonesian mining operations, in my opinion.
Other foreign investors that had reported “imminent” investment projects last year have kept them on hold, as they see no major cost in waiting. French retailer Carrefour seems the exception, and I keep seeing more of its supermarkets in Indonesia -- as in the rest of Asia.
As a result of all the factors described above, foreign direct investment last year was down almost 90% from its 1997 peak -- to just $3.6 billion. From that level, a 17% year-to-year improvement in the first half of 2000 may not seem much, but it should be welcome as a sign of life for a segment of the economy that had been considered moribund until a few months ago.
Altogether, there is an ample supply of investment capital ready to come into the country as soon as some legal and political visibility has been restored. Meanwhile, we should not overlook the fact that, despite the lukewarm official investment figures, domestic cement shipments in the second quarter were almost 15% higher than a year ago – 22% in the Jakarta region and in Sumatra.
Living On a Budget
In the current environment, there is little room for either monetary or fiscal stimulus. The large government debt prohibits pump priming the economy with new spending on any scale, and the vulnerable Rupiah precludes monetary ease. Nevertheless, the new economic team, under the supervision of vice-president Megawati, has come up with what is generally considered to be a credible budget – aiming for a 1.8% surplus before interest expense on the large national debt.
Under this budget, 77% of the increase in spending will come from interest payments, subsidies and, importantly, from the new transfers to regional governments under the autonomy law (42%). The bank-restructuring program will also cause expenditures equal to 26% of the total government budget, but the government hopes to finance much of this through asset sales.
Doubtless, there will be some slippage in many of these planned expenditures. On the other hand, the budget assumes oil prices of only $22/barrel vs. the current $34-plus. According to a leading broker, a $1 increase in the price of the oil barrel adds $150 million to Indonesia’s budgetary revenues. A $29 average price for oil could thus add more than $1 billion to state coffers in 2001, hopefully more than covering any slippage on the $33 billion in forecasted expenditures.
In addition, there could be some additional, favorable surprises on the revenue front, as a number of leading economists are beginning to suspect that the growth rate of the Indonesian economy, especially in the cities, is currently quite a bit higher than the 4% assumed by the Government’s budget.
Democracy Is Messy
Last year’s general excitement over Indonesia’s peaceful transition to a democratically elected government has given way to what could be characterized as the trauma of sudden democracy.
One of the most striking signs of instant change is the incredible freedom of speech that this transition has brought about. During my first two visits, I found the press, though not as servile as in some other autocratic countries, clearly careful not to offend the ruler and his entourage. Now, the country’s media are basking in an orgy of free speech. Academics, journalists, and foreign diplomats all acknowledged this, and many stressed that the local media (in Bahasa Indonesia), is even more aggressive in its criticism of almost everybody than the press in Jakarta.
People who used to lower their voices to discuss politically sensitive subjects in public places now criticize aloud, not only the past ruler, but also the current president, leading political figures and even the army and the police.
Note that Indonesia has traditionally been a complex country, where a plot is suspected behind every political development and the rumor mills are rife with conspiracy theories. This game used to be played mostly among the cognoscenti in the major cities, but now it has become soap opera material for all to read or watch on TV.
One may question whether the Indonesian population was ready for this tidal wave of free speech, and its sudden exposure to the complexities of political life.
Outside of a small intelligentsia, years of dictatorial rule and of struggle to make ends meet had not created a very politically savvy electorate. Most Indonesians (including much of the educated middle class), while rejoicing at the new freedom of speech, clearly remain mostly concerned about the material challenges of daily life. This is particularly true because wage increases have lagged behind the devaluation-induced increase in the cost of living, so that consumers are only now beginning to realize that the worst of the great crisis may be over.
In a way, the explosion of information about political infighting and the delayed economic recovery due to the political transition may explain the bouts of restlessness periodically erupting among the population. Unrealistic earlier expectations about the material benefits that would immediately accrue with the fall of Suharto stand in sharp contrast with the slow pace of change since that momentous event. And frustration, occasionally, needs to be vented.
This is aggravated by the new habit of washing the political dirty laundry in public. Accusations of improprieties, sometimes outlandish and undocumented, are brought daily about everybody against everybody, from the President down to the lowliest politician. The populace, which had never seen so much wrongdoing publicly exposed, may well begin to feel that the new order is not much different from the old order. In fact, it may seem worse, since security in daily life has worsened in the big cities – partly because of the economic crisis, but also because the military’s adoption of a lower profile is overwhelming the police force with new responsibilities.
Independence Dreams Are Just That
The same impatience is evident in the provinces whose politicians, once promised more money and power, want even more of it and want it now. In many of the outer provinces, Java (the most populated and most developed island) is often perceived as another colonial power, which merely replaced older colonial powers in exploiting the local resources for its own benefit. It is easy for provincial politicians to put pressure on Jakarta during the autonomy negotiations by playing on the “nationalistic” feelings and unrealistic expectations of the local population.
Most provinces, however, do not have the management infrastructure or the qualified labor force to exploit their natural resources on their own. In fact, there are questions on how well inexperienced local cadres will manage the additional revenues allocated to them under the new autonomy law. Moreover, beyond the ownership of their local natural resources, and with sparse and ill-trained populations, they would likely remain dependent on Java for much of their needs in other essential products, as well as in financial and logistical services. As one medium-sized company stated to me: “If they become independent, which is highly unlikely, we’ll just export to them.”
In fact, a quick calculation shows that if all the outer provinces became independent, an ensemble made up of Java, Sumatra and Bali would remain the region’s economic powerhouse. Perhaps an even more dynamic one than now: the dynamic forces of emerging economies are often dulled by the ownership of rich natural resources that can only be efficiently exploited by foreign operators. The tendency is to use royalties and other passive revenues from such resources as a sort of national welfare system, which lessens the urgency to develop new skills and other sources of income. We find it somewhat ironic that one of the first acts of East Timor as it gains independence, is to demand that Australia share with it the revenues from a disputed oil field.
Tiptoeing Executive, Bolder Institutions
All this being said, and despite the appearances created by western reporting, Indonesia’s political situation is improving, though in typical Indonesian manner -- under the surface and in somewhat mysterious ways.
Foreign observers who show impatience at Indonesia’s “slow” progress in the barely twelve months since its first democratic election, should try and imagine how long it would have taken the United States, for example, to solve the banking crisis of the 1990s while absorbing the aftershocks of a momentous political revolution and having to re-create much of the country’s legal, financial and political infrastructure from scratch.
Of course, it is not easy to strengthen the legal system and to boldly fight corruption in a country where almost every politician has been part of the old system. A full overhaul may take a generation or more. But progress can still be made: local observers across the political spectrum were impressed by the open process of questioning and debating in Parliament that led to the recent nomination of an entirely new body of Supreme Court judges. The revamping of the Supreme Court is generally viewed as a first requisite to restoring some credibility to Indonesia’s legal system.
While the often puzzling and apparently directionless leadership of President Wahid has irritated many, including former ardent supporters, he can take credit for guiding the country past several dangerous but necessary hurdles over his first twelve months in office.
But more importantly, the Parliament has established its democratic credibility, and a stable political order is emerging behind the scenes. In particular, Vice President Megawati seems to have rebuilt her bridges with the army and with various Muslim factions that had opposed her nomination as president (even though her party had gathered the largest popular vote in the general election). Just as importantly, though she has adopted a characteristically low profile, she remains immensely popular, she has surrounded herself with respected young technocrats, and she seems to be much more active in the management of government than is reported in the western media.
Altogether, I am increasingly confident that, after President Wahid’s tenure, a stable transition can be effected and an effective coalition government can drive Indonesia through the next steps of its political and economic revival.
Investments on Sale
Nomura Securities estimates that the (non-bank) companies in its Indonesian Universe increased their operating profits by 33% in the first half of 2000, vs. the comparable year-ago period. Even so, with stock prices only 15% above their all-time lows, the overall market is selling at 7.5 times this year’s estimated earnings.
Over the last 2 years, companies have re-built the equity side of their balance sheet and re-paid debt, to the point where the percentage of total debt (long and short) to equity of many companies is now in the low double digits, while many have more cash than total debt.
Meanwhile, the overall return on equity, excluding a few troubled conglomerates, has risen from 11% to around 20% (excluding foreign exchange gains and losses). According to Credit Lyonnais, this return now makes Indonesian companies the most profitable in Asia after those in Taiwan, thanks to the high profit margins prevailing in Indonesia.
Yet, even improving corporate fundamentals have not prevented the Indonesian stock market from continuing its slide and the currency has recently been under pressure as well, in a very thin foreign exchange market. Indonesia has a minimal weight in major global or Asian stock indexes and, as is typical with indexing, that weight has diminished along with the decline of the country’s stock market. There is now little incentive for international money managers who measure themselves against popular benchmarks to even bother with the country’s investment opportunities.
As a result, many quality Indonesian companies are selling at multiples of cash flow and earnings in the 3x to 6x range – in spite of very plausible prospective growth rates of 15% to 20% -- perhaps more.
For example, retailer Matahari is selling at 8 times estimated 2000 earnings per share, or less than a third of its growth rate. Indosat and PT Inco Indonesia are selling at Enterprise Value / EBITDA ratios of about 4x and 3x respectively. Tempo Scan, with cash exceeding total debt, has a price/earnings of only 5.2x.
It would be foolish to argue that Indonesia does not face daunting challenges in the next few years. However, when looked at more closely, most of the current problems seem unlikely to be fatal to either the country or its economy, while financial prices seem to be anticipating the worst.
François Sicart
Jakarta – October 10, 2000
©Tocqueville Asset Management L.P.
The information contained herein has been obtained from sources believed reliable, but is not necessarily complete and cannot be guaranteed. Tocqueville Asset Management L.P. and Tocqueville Finance S.A., their affiliates and their officers, directors, employees, advisors or members of their families as well as the clients for whom they manage portfolios; 1) May have positions in securities or options of issuers mentioned herein and may make purchases or sales of the securities or options while this publication is in circulation; 2) May hold directorships in corporations discussed in this publication. Affiliates of Tocqueville Asset Management L.P. and Tocqueville Finance S.A. may, in the last three years, have been manager or co-manager in a public offering of securities of issuers discussed in this publication.
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