Outgrowing a catchy moniker, Indonesia is fragile no more

Catchy phrases are convenient ways to label similar economies, but Indonesia and India have proved they are no longer in 'The Fragile Five'

PUBLISHED : Thursday, 20 March, 2014, 11:04am
UPDATED : Friday, 21 March, 2014, 5:24am

Emerging markets are a rich picking ground for investment bank analysts with a penchant for developing pet theories they can apply to diverse groupings of economies that start to share some similarities and on which they can slap a catchy marketing label. But things can change fast in emerging markets.

BRICS is a case in point. Coined in 2001 as BRIC, it initially grouped Brazil, Russia, India and China and then had South Africa added later when that country began to fit the bill.

The short-lived and not quite so catchy MIST lumped together Mexico, Indonesia, South Korea and Turkey until it became clear that MINT sounded better and Korea could be ejected in favour of Nigeria.

Now we have "The Fragile Five", a little less catchy but a convenient moniker to apply to a group of economies that for a while last summer all suffered from balance of payments weakness that was a focal point for investor anxiety as a bout of indiscriminate risk aversion struck emerging markets.

Unlike many other countries, Indonesia has been getting its economic house in order

Two Asian economies - Indonesia and India - were in the group, but fast forward just seven months and it's hard to see why they should be.

To be fair, throughout last summer they were more than just fragile, and sentiment towards both - and particularly India - defined the dramatic deterioration in investor perceptions of emerging economies.

Between May and August last year, India's rupee fell a whopping 28 per cent against the US dollar, while Indonesia's rupiah sank some 20 per cent.

But the currencies, bond and equity markets of India and Indonesia have not only proved remarkably resilient to the renewed deterioration in sentiment towards emerging markets in January - they have rallied in spite of it.

Indonesian stocks are up 10 per cent this month alone in the face of mounting concerns about China's economy and the escalating East-West geopolitical standoff over Ukraine.

Even Indian equities are up 2.5 per cent, despite considerable uncertainty about the outcome of May's crucial parliamentary election. The rupee has barely budged against the US dollar this year, in stark contrast to the Russian rouble, which is the second-worst-performing major emerging market currency.

The improvement in sentiment towards Indonesia is the most conspicuous though - and the most important, given that its bonds account for 8 per cent of JP Morgan's benchmark emerging market government bond index.

The rupiah has risen 7 per cent against the US dollar this year - the world's best-performing currency. According to new research from Bank of America Merrill Lynch, foreign holdings of local currency debt in Indonesia increased in the first two months of this year, compared with falls in Turkey, Hungary and Russia.

The yield on Indonesian 10-year local currency bonds is now below 8 per cent, having shot up to 9 per cent last summer after the US Federal Reserve signalled its plans to start scaling back, or "tapering", its asset purchases.

This is an important development, for a number of reasons.

First, it shows that emerging markets are a diverse asset class and that investors are again distinguishing between countries.

Second, it suggests that fear of a systemic crisis in emerging markets is misplaced and that sentiment can be fickle.

Third, and perhaps most reassuringly, it indicates that the credibility of the policymaking regime and economic fundamentals matter to markets.

Unlike many other countries, Indonesia has been getting its economic house in order.

Its central bank took the bull by the horns last year by raising interest rates by 175 basis points at a time when many other central banks, notably Turkey's - and India's, before Raghuram Rajan assumed the governorship in September - were dithering.

This has helped nearly halve Indonesia's current account deficit from about 4 per cent of gross domestic product as recently as the third quarter of last year.

The government's policies have also contributed to the much-needed rebalancing of Indonesia's economy.

Fuel prices were raised in June, for the first time since 2008, by a gigantic 44 per cent in an effort to curb the current account deficit and boost confidence in the rupiah.

All this is taking its toll on domestic demand - but not excessively so. Indonesia's economy expanded by a robust 5.7 per cent in the fourth quarter of last year, led by exports. While inflation remains high, at nearly 8 per cent, it is coming down, allowing the central bank to keep interest rates on hold for the time being.

Political uncertainty, however, is a concern, with parliamentary elections next month and the presidential poll in July. Protectionist and nationalist sentiment is rising, but Joko Widodo, the popular governor of Jakarta who is expected to win the presidency, seems to be winning the support of foreign investors.

Jokowi, as he is affectionately known, is being described as the "Narendra Modi of Indonesia", in reference to India's popular opposition prime ministerial candidate, whose pro-growth agenda and reformist rhetoric are perceived favourably by markets.

While Indonesia still faces many economic and political challenges, it is far less fragile than it was last summer.

Nicholas Spiro is the managing director of Spiro Sovereign Strategy