(Bloomberg) -- Indonesia successfully overcame its Fragile Five days and survived a risky money-printing exercise to become a key emerging market for investors. Now its status as a fund favorite is under threat from an upcoming presidential election.
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As the Feb. 14 vote draws near, some rupiah bondholders see the risk of a relaxation of the fiscal discipline that had underpinned a 10% gain in the notes last year. T. Rowe Price is underweight on Indonesian securities while Pictet Asset Management has reduced its holdings of 10-year sovereign debt.
There’s a lot at stake for whoever wins the election as foreign inflows helped shrink the budget deficit to a 12-year low and are pivotal to the nation’s ambitions of becoming a global battery manufacturing hub. A continued influx of overseas money would also help Indonesia beat back the challenge posed by India — another high yielder whose growing influence over the world economy is making it a firm favorite in investor portfolios.
“We’re expecting a bit more of a more expansionary fiscal posture,” said Leonard Kwan, a portfolio manager at T. Rowe in Hong Kong. “They’ve had a really good run in terms of responsible, pragmatic management. But maybe they haven’t yet fully delivered on the potential growth for Indonesia. The new government may try a little bit more in that direction.”
Global funds snapped up more than $5 billion of Indonesian sovereign securities in 2023, the biggest annual haul since 2019, according to official data. The inflows came on the heels of a marked improvement in the nation’s metrics over the years: the fiscal deficit fell back below 3% by end-2022, a year earlier than authorities targeted, and the trade balance has been in surplus since May 2020.
A lot of the progress was sparked by reforms initiated during President Joko Widodo’s decade in power. Indonesia undertook a widespread crackdown on corruption and launched a tax amnesty program that unearthed hundreds of billions of dollars in previously undisclosed assets. The positive sentiment propelled the rupiah to a 1% gain last year — a performance that beat most of its Asian peers.
But some market watchers warn that the good times may not last.
“Under Jokowi there has been progress on opening up the economy to foreign investors and on improving regulation and it’s not clear that the next administration will continue this trend,” said Jon Harrison, managing director for emerging-market macro strategy at GlobalData TS Lombard in London. “While there could be relatively safe investments in green transition, we are inclined to reduce exposure ahead of the election.”
As the polling day draws near, investors are scrutinizing the respective candidates’ policies more closely.
Prabowo Subianto, who’s leading the race to succeed Jokowi, has campaigned on the premise that Indonesia can run up debt to as much as 50% of gross domestic product, well above the 38% recorded in 2023. A key advisor in his campaign team has since said the candidate will keep debt at just 30% of GDP.
Prabowo’s key election promise is to give free lunches to 83 million beneficiaries estimated to cost 300 trillion rupiah ($19 billion) a year — almost the size of the nation’s 2023 budget deficit. Bank of America expects the pledges of more social assistance programs and protectionist policies to widen the fiscal shortfall to 2.5% to 3% of GDP from 1.65% last year.
Anies Baswedan, a former governor of Jakarta, has vowed to review Widodo’s industrial policies, including a push to make the nation a downstream commodities powerhouse, and wants to reduce its heavy reliance on China, Indonesia’s biggest source of foreign capital. Similarly, Ganjar Pranowo, who’s trailing in opinion polls, plans to reassess labor laws that are a key legacy of the Jokowi administration.
If none of the candidates wins at least 50% of the votes, a runoff will take place in June. That might lead to more populist programs and a looser fiscal policy.
Some others think the concerns are overdone. Ashmore Group Plc, the top holder of 10-year rupiah debt, is looking past any volatility to focus on the nation’s fundamentals and the bonds’ attractive carry, said head of research Gustavo Medeiros. M&G Investments is increasing its exposure to Indonesian equities, and favors the consumer, financial and commodity sectors.
“The incoming administration is likely to continue, or even enhance, the economic trends established over the past decade,” said Vikas Pershad, Asian equities portfolio manager at M&G in Singapore. “Consequently, we do not anticipate significant shifts in the macroeconomic landscape that would affect investment in Indonesia.”
But the market appears to be pricing in some risk as the race heats up, with the 10-year government bond yield having climbed 12 basis points since the start of the year to around 6.60%.
For the local-currency notes, “you probably want some sort of insurance in the short term due to election risk because I don’t think it’s particularly giving you much cushion in terms of a risk premium,” said Sabrina Jacobs, senior client portfolio manager for emerging-market fixed income at Pictet.
--With assistance from Marcus Wong and Claire Jiao.
(Updates with Ashmore’s comments in 14th paragraph)
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