Is Indonesia gaining on India?
Indonesia has a good case, on paper, to replace India in BRICS. But like India, it too is afflicted by macroeconomic imbalances
byV. Anantha Nageswaran
Lately, there is justifiable talk of Indonesia replacing India in the Brazil, Russia, India, China and South Africa, or BRICS, table. Based on the ease of doing business, Indonesia should pip India to the BRICS community. Indonesia is slightly ahead of India in the overall business ranking (128 vs 132 for India). The good thing for Indonesia is that it has improved its position from 130 to 128 whereas India’s rank remained unchanged at 132. The biggest area of improvement for Indonesia is the availability of electricity whereas, ironically, that is the biggest area in need of improvement for India. Indonesia’s ranking on electricity availability improved by 11 whereas India’s ranking worsened by six. Further, after 2008, India has done poorly in terms of gross domestic product (GDP) growth rate and Indonesia has done exceptionally well compared with its own history. However, the risk is that things get tougher for Indonesia in the years ahead.
Much as Bare Talk disagrees with the worldview of Jim O’Neill, the coiner of the expression BRIC, it would like to acknowledge the serendipitously good timing of the launch of the BRIC concept. It was 2002. India was trying to break out of its growth and stock market slump that had lasted some eight years. Brazil had a new president and asset prices were exceedingly cheap. China had a change of leadership at the top. Finally, loose monetary policies in the US and elsewhere in the Western world were expected to push money into emerging markets. Hence, a case of great timing. Nearly 10 years after the concept was launched, it is difficult to state if BRICS countries will fulfil their promise. India is facing several headwinds and the country is likely to be stuck in low-growth equilibrium for quite some time. That is the optimistic scenario. China, Brazil and Russia have their own challenges too. BRICS has to be scrapped. The world might well go through a period of vacuum without any clear leadership and the probability that the US reasserts itself must be considered higher than the mantle falling on China. Other countries in the BRICS club do not even stand a chance. Clearly, now is not the time to do a BRICS recomposition. Indonesia must await its turn and, in this column, we examine why.
Indonesia has a currency that is substantially overpriced in real terms compared with what it was 10 years ago. The Indonesian rupiah has appreciated in real terms against the currencies of its trading partners. Just in case one wondered if there could be a calculation error, the Indonesian current account deficit (CAD) should set such suspicions right. Indonesia’s current account balance has plunged into deficit. This is what the eroding competitiveness of a currency does. Despite its strength in commodities, that is what happened to Australia’s CAD. Its currency strength pushed its CAD to nearly 5% of its GDP. Indonesia too, with its bountiful supply of coal, has not managed to cash in on the boom in the demand for coal from China and India.
Of course, CAD is not just about the absence of an export boom. It is also about domestic overheating. The rise in the Indonesian economic growth rate in recent years is nicely correlated with the acceleration in the rate of growth of bank credit. Its bank credit is still growing at a rate of over 20% per annum. For an economy growing at a nominal rate of 10% of GDP, the growth in credit is too rapid. These numbers mean that, while the credit train ride might be exhilarating, its end will not be pretty. A hard economic landing is possible not only because of the domestic credit indigestion but also because the chance of global risk appetite waning sharply in 2013 is rather high. In fact, that should be the baseline scenario.
Indonesian and Philippine bonds have performed very well in the last few years. In fact, the yield on the 10-year sovereign bonds of both the countries is barely above 5%. While both countries have improved their fiscal fundamentals unlike India, there is a compelling case to be made that these yield levels reflect investors’ desperation for nominal yield in a world of zero interest rates. Valuations in Indonesia stocks, by any measure and based on any stock index, are rich. The fact is borne out whether one looks at price/earnings, price/sales or price/free cash flows.
As we have seen repeatedly in the last two decades, asset prices get ahead of fundamentals when global financial conditions are ultra-easy as they are now.
However, five years after the last global crisis, it is time for a tumble for global financial assets in 2013. Investors brush aside bad economic data to propel stocks (in the case of the US) and currencies (in the case of Europe and Australia) higher. This is what they did in 2007, only to turn tail in 2008. To sum up, Indonesia enters 2013 with imbalances, an overvalued exchange rate and expensive stock markets.
V. Anantha Nageswaran is the cofounder of Aavishkaar Venture Fund and Takshashila Institution.