As one of the emerging markets' Fragile Five, Indonesia finds itself saddled with a current account deficit, a fiscal deficit, and negative market sentiment. While it's far too early to sound the "all-clear," we're seeing indications that Indonesia is making progress toward graduating from the Fragile Five.
Year-to-date, the market has been positively surprised by economic data that Indonesia has reported. Real GDP growth for the fourth quarter came in at 5.7%, with full-year GDP reported at 5.8%. While year-over-year investment growth declined from nearly 10% in 2012 to 4.2% in 2013, consumption was more resilient than expected at 5.3% and exports grew at 7.4% year over year. Indonesia also moved from a trade deficit in the third quarter of 2013 to a surplus in the fourth quarter. Today, we saw additional data pointing to stabilization, with the current account deficit now below 2%.
IHS forecasts a slight decline of GDP growth to 5.0% in 2014, but against the backdrop of an improving current account deficit, flattish inflation, abating currency depreciation, and increasing foreign reserves, discussions about interest rate cuts have begun, albeit still not likely until the second half of 2014. Consensus expectations are that GDP growth bottoms out in 2014 before returning to more normalized 6% year-over-year levels, which would be a positive backdrop for Indonesian rupiah appreciation. Year-to-date, the rupiah is one of a select few EM currencies that have appreciated.
While the other Fragile Five countries continued to tighten in January, Indonesia has been on pause since November. Currency depreciation helped achieve a trade surplus, and the government has used other measures to support the rupiah, such as lower loan-to-deposit ratios, higher reserves, and swaps. A transition from tightening to easing without significant adverse impacts on growth and inflation would certainly be a positive for the Indonesia economy. More broadly, it could boost EM sentiment.
Indonesia holds legislative elections in April and presidential ones in July, with the presidential installation in October. Stalled reform initiatives probably won't pick up prior to October, although we believe increased discussion and optimism around these topics are likely. Indonesia recently announced a delay in its raw mineral export ban and an increase in allowed foreign direct investment in ports and airports. Both are positive steps toward much-needed larger reforms.
Indonesia is not out of the woods yet, but we are encouraged by its recent progress. Upcoming elections and potential monetary easing could provide key near-term catalysts. Indonesia represents 2.4% of the MSCI Emerging Markets Index, and we have been underweight in our portfolios. However, if we identify bottom-up opportunities, we are increasingly comfortable about moving closer to an equal weight in Indonesia.