JP Morgan - Indonesia Market Strategy

Indonesia: Election momentum

Issues over the last 12 months
The combination of the reversal in commodity prices and strong imports during 2HFY08 moved the current account into a deficit, bringing unwelcome memories of the crisis, by pressuring the currency and bringing macroeconomic stability under the scanner. Bank Indonesia has cut the policy rate by 225bps since November, and rates in the economy are still declining. Based on a healthy recovery in the Balance of Payments
position, the currency has recovered significantly over the last 2 months. The April 9th parliamentary election went off smoothly, with quick counts pointing to a lead position for president SBY’s Partai Democrat, strengthening his bid for re-election in July.

Outlook
The reassurance of increasing foreign reserves and a surprise return to a current account surplus in 1QFY09 should offset any renewed pressures from global risk aversion on the Rupiah. While growth is still a concern, Indonesia’s large domestic demand base, and its lack of reliance on external capital flows mean that the economy is slated to grow in FY09 (J.P. Morgan estimate: 3.5%). In April, upwards revisions to earnings have matched downgrades for the first time since October, suggesting expectations have declined adequately. 1Q results were largely healthy – with strong performance from some large caps opening up the possibility of upward revisions to earnings in coming weeks, which should be supportive of further upside to equities. We see lending rates in the economy still remaining somewhat sticky, and funding costs are likely to decline further over the next couple of quarters. We believe that markets are now discounting the likelihood of the presidential election being completed in a single round (i.e. a simple majority) and if the elections were to go to a second round run-off - it may prompt a corrective move.

Recommendations
Our preferred stock among banks has been Bank Rakyat, BRI’s 1Q results stood out among the banks, addressing several recent concerns, as we see it as the one of the main channels for stimulus initiatives later in the year. We believe that Astra International is well positioned for investors looking to play an eventual recovery, and possibly offers the possibility of PE expansion during a recovery. We recommend Indofood as a potential beneficiary from consumer purchasing power and prospects could receive a boost from the recovery underway in palm oil prices. We have recently downgraded Unilever Indonesia to an underweight, believing that its strengths are well captured in the price and as defensives rotate out of fashion, it is likely to underperform.