Room for growth on Indonesia's stock exchange

Already one of the fastest-growing major capital exchanges in the world, Indonesia’s equity and bond markets saw increased activity in late 2016 and early 2017 after a lacklustre performance in 2015. The recent resurgence is based on the country’s strong economic fundamentals and aided by short-term trends which saw a recovery in commodity prices, increased government infrastructure spending and improved liquidity due to the government’s tax amnesty programme.

REGISTERING RAPID GROWTH: Consequently, the Indonesia Stock Exchange (IDX) continues to grow more quickly than the majority of markets in developed and developing economies – not just in Asia, but around the world. Through the first 10 months of 2017, the Jakarta Composite Index (JCI) – the IDX market benchmark – expanded by 13.39%, making it the one of the best performing major indices in the world behind South Korea (24.52%), Hong Kong (28.39%), India (24.74%), the Philippines (22.29%) and Singapore (17.12%).

The JCI performed even more favourably in the decade to 2017, with growth of 232.63%, ranking it first by a wide margin over the next-best-performing indexes of the Philippines (180.47%), Thailand (153.20%) and India (140.90%), and well above more mature markets such as the S&P500 in the US (81.57%), Hong Kong (41.48%) and Shanghai (26.83%).

Indonesia also outperformed global and regional indexes as measured by MSCI (formerly Morgan Stanley Capital International) from January 2008 to October 2017. Over this period the MSCI Indonesia index rose from the benchmark of 100 to 180.37, well above the MSCI ASEAN index of 109.25, MSCI World (128.20), MSCI Emerging Markets (89.92) and MSCI BRIC (73.31).

In terms of products, government bonds continue to dominate, raising a total of Rp485trn ($36.6bn) in 2016 alongside Rp115trn ($8.7bn) in corporate bonds. This far outweighs equity-based funding, in which rights issuances were valued at Rp61.9trn ($4.7bn), along with Rp12.11trn ($912.8m) in initial public offerings (IPOs) and Rp1.1trn ($82.9m) in warrants. These trends continued through to the third quarter 2017, during which government bonds accounted for 73% of total funds raised, corporate bonds brought in another 18% and equities supplied 9%.

GAINING MOMENTUM: IDX experienced its first boom in the late 1980s following the easing of regulations in 1987-88. At that time IDX was known as the Jakarta Stock Exchange and it operated alongside a second bourse, the Surabaya Stock Exchange in the eastern region. Growth continued over the next decade until the 1997-98 Asian financial crisis shook the region, after which the Jakarta Stock Exchange was privatised and underwent a period of modernisation. In 2007 it merged with the Surabaya Stock Exchange to become IDX. The consolidation resulted in a major upturn in capital market activity. These gains were interrupted by the 2007-08 global economic downturn, but the market rebounded quickly and has been on a relatively stable upward trajectory ever since. The number of listed companies reached 543 as of May 2017, and market capitalisation continues to grow.

The stock market benefitted from repatriated funds that flowed into the country between July 2016 and March 2017 as a result of the government’s tax amnesty programme. IDX hit a new high of 5900 points in July 2017 and exceeded 6000 points on October 25, 2017. This represents a substantial increase from 2015, when the JCI averaged 4910.7 points.

GROWTH DRIVERS: There are numerous reasons for this recent growth spurt, chief among them being improved performance of the national economy compared to 2015 and 2016, as well as optimism related to increased government infrastructure spending and the aforementioned tax amnesty programme.

Another positive development that helped bolster the financial markets in the first half of 2017 was the upgrade to the country’s credit rating by Standard & Poor’s. The agency’s decision to increase Indonesia’s rating from junk status to the investment grade “BBB-” in May 2017 was received positively by the market, with the JCI spiking 3.2% upon the announcement to a high of 5825.2 points before receding slightly to close at 5645.45 points for the day. The move by Standard & Poor’s put Indonesia’s credit rating in line with other international rating agencies, including Moody’s, which increased the country’s rating to investment-grade “Baa3” in January 2012, and Fitch, which granted a “BBB-” rating in December 2011.

Boosted by the news, the JCI grew from around 5400 points in March 2017 to 6060 by November In turn, market capitalisation reached an all-time high of Rp6708trn ($505.6bn) in November 2017, up from Rp5750trn ($433.2bn) in 2016 and Rp4800trn ($361.8bn) in 2010. Average daily equity trading stood at Rp7.3trn ($550.3m) as of October 2017, up 2.5% from the beginning of the year.

BOURSE BREAKDOWN: As of mid-2017 financial services businesses accounted for 41% of market capitalisation in the top-20 companies. Infrastructure, utilities and transportation firms accounted for another 19% of capitalisation, followed by basic industry and chemicals (11%), miscellaneous industry (10%), property and real estate (10%), mining (7%) and agriculture (3%).

Although volatility has stabilised over the past few years and the JCI has fared largely well since the 2007-08 global financial crisis, internal factors, such as upcoming elections in 2018 and 2019, could induce swings in the market. External factors may also have an impact, with global macroeconomic and political trends having an effect on currency exchange rates relative to the dollar. Global economic forces have impacted local markets several times in the past, sometimes with distressing results, for example, the international economic downturns in 2007 and again in 2013, both of which had a cooling effect on the market as foreign investors pulled funds from IDX.

BONDING EXPERIENCE: The fixed-income segment has proved to be an attractive market for investors looking for more stable investment tools. For the government and its large portfolio of state-owned enterprises (SOEs), the bond market has traditionally been the go-to choice for capital financing. Corporate, government, municipal, retail and sharia-compliant bonds (sukuk) are often viewed as less risky investment vehicles by many institutional and retail investors; equities can offer greater profitability but are also more susceptible to fluctuations in growth and value.

Increased infrastructure expenditure is driving demand within the fixed-income segment, with interest being shown in both project and securitisation bonds. As of October 2017, 111 entities in Indonesia had outstanding bonds worth a total of Rp2407trn ($181.4bn). Average daily trading of corporate bonds through to October 2017 stood at Rp1.3trn ($97.9m), while daily government bond trading averaged Rp16.5trn ($1.2bn).

SOEs issuing debt also enjoy the benefit of a government-mandated minimum investment for major funds managed by state entities, such as government insurance and pension funds. In such cases, 30% of their portfolio value must comprise government or SOE investment. There are roughly 120 SOE companies operating in the country and hundreds more subsidiaries, giving investors plenty of choice for bond opportunities with minimal risk. Excluding the effects of the 1997-98 Asian financial crisis, default on “AAA” and “AA” SOE securities has been largely non-existent, in part due to strong state backing.

Government-issued debt has expanded in value each year since 2009, when government bonds raised Rp95trn ($7.2bn), with the value on pace to top Rp500trn ($37.7bn) in 2017. This figure is expected to rise further as the state seeks financing for its massive infrastructure programme. The trend has some concerned, however; these ongoing government issuances of new debt in the fixed-income segment could produce a crowding effect, which in turn could affect institutions not only in the bond market, but also in the stock market where there is less liquidity to go around. As a result, financing could become more difficult for the private sector, which would then have to raise coupon rates or face potential difficulties in refinancing debt due to decreased liquidity in the market.

CHANGE ON THE HORIZON: Despite strong baseline fundamentals supporting the growth of the sector, a level of uncertainty has crept into the market environment due to impending regulatory changes. The first change that could impact markets is the conclusion of the terms of the initial nine-member board of the Financial Service Authority (OJK). These positions comprise a chairman, deputy chairman, two commissioners assigned by the Ministry of Finance and Bank Indonesia (BI) as their representatives, and another five commissioners overseeing different specialities, namely banking, non-banking, capital markets, education and consumer protection, and auditing.

In July 2017 Wimboh Santoso, former president-commissioner of state lender Bank Mandiri, was elected as the chairman of the board of commissioners for the 2017-22 period, replacing Muliaman Hadad. With new commissioners having taken over the same month, the board will set its own priorities and seek to quell the perception by some in the securities sector that the regulator has been inefficient in its oversight of the market. Concerns voiced within the industry have cited an overabundance of fees, as well as a convoluted regulatory environment when the Ministry of Finance, OJK and BI enforce overlapping policies. While some of these concerns are the result of growing pains as the new OJK establishes itself and sector players adjust to the current environment, regulated companies are now largely concerned with how the new commissioners will interpret and implement policy, and how consistent it will be with the existing regulatory system.

EXPANDING ACCESS: As part of the government’s financial inclusion efforts, regulators are also moving to open up the capital markets to the public, introducing new products and easing trading restrictions in some areas. Changes are being made by the OJK and IDX on a more targeted level, with various measures being implemented to help spur participation from companies looking to secure funding through the exchange. In February 2017 IDX loosened several rules governing securities that can be traded though its margin facilities, increasing the number of such securities to 180, compared to the previous list of 65.

Brokers were also given the freedom to set limits on clients’ financing ratios to be able to take certain actions (such as margin call or forced sell) as long as the broker’s policy is more stringent than the implementation of risk management demanded by the regulation. Additionally, the single maximum limit applicable to all customers regarding the value of margin financing by a broker was abolished, and other adjustments were made related to brokers’ operations in order to provide margin facilities to customers more efficiently.

While the OJK and IDX are moving to boost trading and increase market capitalisation, many of their recent efforts have generally been more focused on growing financial inclusion for the public at large, rather than attracting institutional investors that are drawn to more sophisticated products.

“It is important to increase financial literacy as there are many Indonesians that still lack an understanding about investment,” Aldo Tjahaja, president-director of Victoria Investama, told OBG. “Increasing the level of education in financial services will not only improve their knowledge, but also help improving the welfare of the Indonesian people as a whole.”

This strategy is largely due to the fact that Indonesian capital markets remain relatively underutilised compared to the size of the economy and population. Consequently, current growth strategies are focused on building up a larger base of investors and companies before addressing more sophisticated and often riskier investment tools. “The introduction of new products would not significantly affect the market because trading is not especially active right now,” Ahmad Mikail, economist and manager of credit ratings agency PEFINDO, told OBG. “There are tight regulations for institutional investors to follow, so they can’t hedge, for example. If you want to boost products like derivatives, you would first need to loosen regulation.”

PUBLIC OFFERINGS: New entrants have arrived to IDX each year through IPOs, and 2017 has been a strong year, with 27 companies added to the exchange by the end of October. Many firms in the past preferred to obtain funding through bond issuances or bank loans, but going public is becoming more popular as market capitalisation increases and, with it, the potential to raise greater sums faster than via bonds or loans.

In 2016 the exchange established six Go Public information centres located in different regions across the country in a bid to promote and educate smaller companies on the benefits of listing.

Meanwhile, the IDX Incubator was founded in early 2017 to help create and develop early-stage companies by supporting them with the necessary financial and technical services. This is done in conjunction with private companies and institutions, such as universities and agencies. Support includes business guidance and other training, mentorship programmes, funding access and basic business amenity infrastructure.

STATE OF PLAY: Results from these efforts may take time to materialise, and equities in Indonesia remain relatively underdeveloped in the meantime, with IPOs accounting for just 1% of funding raised through capital markets in the first six months of 2017. Institutional investors have displayed a clear preference for fixed-income securities and smaller businesses largely continue to turn to other means to raise money. One obstacle for small and medium-sized enterprises looking to list are the limitations placed on large institutional investors, such as pension funds, by mandating investment assets be rated “AA” or above. This policy places a significant portion of products outside the acceptable range.

Speed is another reason many companies – particularly smaller firms starting out – turn to banks rather than the stock exchange to obtain financing. With these businesses often racing to capture market share for their products before other domestic or foreign competitors step in, bank loans provide a quick and simple source of financing compared to a stock issuance, which takes far longer and is less reliable. Thus, even though the number of small businesses continues to grow, many struggle to expand once they move past the start-up phase. Maintaining the necessary funding is difficult due to the relatively small pool of individual investors willing to invest in uncertain IPOs. As a result, the development plan for many of the new operations is to create a viable business in hopes of attracting a larger, well-financed institution to acquire them.

Taking these factors into account, funding acquired through bank loans far exceeds that raised through capital markets. Outstanding loans from investment banks and operational banks were valued at Rp1123trn ($84.6bn) and Rp2033trn ($153.2bn), respectively, in the first half of 2017, compared to Rp346.28trn ($26.2bn) raised through capital markets.

INTERNATIONAL AMNESTY: One key initiative to increase government tax revenues and boost liquidity in domestic capital markets was the tax amnesty programme overseen by the current minister of finance and former managing director of the World Bank, Sri Mulyani Indrawati. Launched in 2016 the amnesty programme sought to recoup some of the unreported income of eligible taxpayers by offering drastically reduced tax rates and an amnesty from penalties for reporting income and assets held offshore or unreported domestically. The programme was set up as a three-stage system that rewarded taxpayers for declaring previously unreported assets and gave additional incentives for moving them back onshore. For example, if a taxpayer declared their assets prior to September 31, 2016 a tax rate of 4% was applied, which would be further reduced to 2% if the funds were repatriated within a three-year window. The longer a taxpayer waited, the higher the tax rates became, with the rate rising to 6% by December 31, 2016 (3% if also repatriated), and to 10% if reported by March 31, 2017 (5% if repatriated). Repatriated money declared under the programme must also stay onshore for a minimum of three years, which will presumably offer a shot of liquidity into a range of financial instruments.

Some Rp4854trn ($365.9bn) in assets was declared during the nine months that the programme was offered, according to the Ministry of Finance. The figure was in line with government projections. The majority of these newly noted assets – Rp3676trn ($277bn) – were located domestically. Another Rp1031trn ($77.7bn) in overseas assets was declared, with Rp147trn ($11.1bn) repatriated. Singapore was the most popular overseas home for reported funds, with Rp643.2trn ($48.5bn) in assets declared and Rp78.69trn ($5.9bn) repatriated. Reported funds placed in the Caribbean tax havens of the British Virgin Islands and the Cayman Islands totalled Rp72.57trn ($5.5bn), of which Rp2.49trn ($187.7m) was repatriated, and Rp52.54trn ($4bn), of which Rp16.51trn ($1.2bn) was repatriated, respectively. A substantial amount of funds also came from Hong Kong: Rp38.39trn ($2.9bn) reported and Rp14.05trn ($1.1bn) repatriated.

Much of these have been channelled into fixed-income products such as government and SOE-issued bonds, but this liquidity is also expected to boost capital inflows into equities over time.

RESULTS: Tax revenue received from the inflow, however, was only 80% of what the government had expected. This discrepancy was due to a number of factors, such as assets declared in tax-sheltered countries or the reporting of non-cash assets. The government initially set its sights on drawing in Rp165trn ($12.4bn) from the programme and it realised Rp134.4trn ($10.1bn). Despite the shortfall, the amnesty programme has proven to be one of the most successful initiatives of its type in history, with Indonesia recording newly declared assets amounting to 23% of GDP and tax revenue of 0.76% of GDP. This compares favourably to efforts carried out previously in other countries. Chile’s amnesty programme in 2015, for example, saw the value of declared assets reach 8% of GDP and brought in 0.62% of GDP in tax revenue.

Another result of the tax amnesty programme is the reorganisation of companies and other entities through the implementation of technical IPOs, which are licensed by the OJK rather than being listed on IDX. Those who have brought funds back onshore are still able to shield some of their wealth with this type of offering, which can include mergers as well as spin-offs. Technical IPOs are not traditional first-time offerings, but a structural reorganisation of existing assets or operations. One of the most important aspects of this arrangement is that once the technical IPO is sold, it is subject to a 0.1% transaction tax rate (0.5% if the founder is the seller), rather than the 30% capital gains rate that would be charged to a privately held company.

A POPULAR PRODUCT: A relatively new product on the Indonesian market, which is likely benefitting from the government’s tax amnesty policy and has thus been generating a lot of investor interest, is exchange-traded funds (ETF). The rapidly growing segment operates similar to mutual funds, with investors now able to buy and sell them directly rather than having to go through an intermediary, as was the case in the past. The first two ETFs to hit the market – the Asian Bond Fund-Indonesia Bond Index Fund and the Premier ETF LQ-45 Fund – did so in December 2007. Since then the number of ETF offerings has steadily increased, with nine products in total available by the end of 2016.

The total value of ETFs traded in 2016 reached Rp28.3bn ($2.1m), according to IDX data, compared to Rp15.01bn ($1.1m) the previous year. Over the same period, the volume of products traded more than doubled, from 22.2m to 54m. Seeking to tap into this growing demand, three more ETFs were launched in 2017, first by Bank Negara Indonesia, followed by two from Bank Central Asia, which listed its first ETF in 2016.

SECURING THE FUTURE: Securitisation bonds, which raise capital based on future revenue projections, are relatively new in Indonesia and were introduced in order to help the development of large infrastructure projects. Government-owned toll road operators, for instance, are able to leverage their underlying assets and future projected cash inflows for up-front financing needed to build or improve the required infrastructure (see Transport chapter).

The securitisation model generally works with the company issuing a trust-like investment structure that is backed by future revenue of an asset, with investors being rewarded with a certain rate of return, expected at 8-9% over a five-year period. The model has an added bonus of paving the way for selling off SOE assets to private companies, which is a process championed by the current administration.

With extra sources of financing needed to support the government’s infrastructure programme, it has turned to new forms of funding like securitisation (see Infrastructure chapter). Seeking to capitalise on the ratings boost from Standard & Poor’s, President Joko Widodo announced plans in July 2017 to raise an additional $10bn for infrastructure projects from the capital markets. “We can’t just sit back and wait for people to come because competition to attract capital flows is ferocious,” Thomas Lembong, chairman of Indonesia Investment Coordinating Board, told local press in June 2017. “Everything from toll roads to power plants to airports to ports should be securitised to capital markets.”

State-owned power corporation Perusahaan Listrik Negara (PLN), with its large capital expenditure plans and wide customer base, is also a prime candidate for securitisation bonds. “This is an opportunity for foreign investors to see a coupon rate,” PEFINDO’s Mikail told OBG. “The government won’t allow large companies such as PLN to fail, so the risk is almost the same as the government’s sovereign risk at ‘AAA’. This gives a coupon spread of 150 basis points, although there is still some exchange-rate risk.” By offering securitisation bonds, the government is hoping to draw in large institutional investors such as Canada Pension Plan and Japan’s Government Pension Investment Fund.

ISLAMIC FINANCE: The world’s most populous Muslim-majority country, Indonesia also has the largest potential captive market for Islamic financial products, which already attract a strong following in nearby Malaysia. To date there has been only limited success in sharia-compliant products, especially for large corporations, due to their disadvantages in terms of risk and funding compared to traditional products. According to the Asian Development Bank, sukuk accounted for 13% of all bond value at the end of March 2017, leaving traditional bonds with the dominant share of the market.

As of the first quarter of 2017, outstanding central government sukuk were valued at $21bn, a 34.4% year-on-year (y-o-y) increase. Outstanding central bank sukuk were worth $900m, up 74.4% on the same quarter in 2016, while outstanding corporate sukuk were also valued at $900m, up 28.4% y-o-y.

In addition to sukuk, the Malaysian and Indonesian stock markets also signed a memorandum of understanding in 2016 to create a joint World Sharia Stock Market Centre for retail investors to trade Islamic bonds and equities. Due to the challenges of regulatory harmonisation, the project is being developed incrementally. The first step is the creation of a joint website where both markets are able to distribute their data onto a single platform. According to IDX, the website is expected to be in place by early 2018.

The next and more complicated step will be to connect both of these stock markets in order to create an online sharia trading system for financial products.

OUTLOOK: Indonesia’s large yet underserved population, along with solid economic growth prospects, will continue to provide fertile ground for further expansion of the capital markets. However, while the number of companies going public increased in 2017 and will likely continue to do so in the coming years, these moves are not expected to move the needle significantly in terms of overall market capitalisation in the near term. This is because the number of large, high-value companies present on IDX is not expected to increase substantially, and numerous small-scale listings will have a less significant impact on market value as each of these firms brings relatively smaller amounts of capital into the system.

Even with new incentives and regulations being put in place to encourage a greater number of listings and liquidity in the financial markets, perhaps the single most important factor that will drive future growth is the organic economic development of the country, in particular the benefits from an expanding middle class. While increasing rapidly, the country’s per capita GDP still lags behind global middle-class income levels. In the longer term, government efforts to expand financial inclusion could lead to a spike in new investment, ultimately creating a more attractive listing destination for new and secondary offerings.

Politics and continuity are also a concern for both foreign and domestic players, with a round of local elections in 2017 leading to the unseating of the incumbent governor of Jakarta. There will be another series of elections in 2018 that includes key positions in Java, where more than half the country’s population lives. The Java voting bloc could prove crucial to President Widodo’s re-election efforts in 2019. Some commentators argue that the upcoming election should not affect the Indonesian market, with IDX reports noting that the 2014 presidential race had minimal impact on the JCI, while global market turbulence in the following year had more of an effect. Nevertheless, investors, both within the country and internationally, will be keeping a close eye on the outcome of these elections.