What's the Catch, Indonesia?

Around the Curve

What's the Catch, Indonesia?

Three market concerns about Indonesia, and why we think they are likely overstated.

From where we stand today, there are a handful of emerging markets (EMs) where 10-year local-currency bonds yield 8-9%: Brazil, Indonesia, Mexico, Russia, South Africa, and Turkey. Mexico and Turkey are still dealing with inflationary pressures which forced their central banks to tighten policy in 2018. Brazil and South Africa are under new leadership that has yet to address fiscal sustainability issues. Russia continues to face sanctions risk.

Meanwhile, Indonesia exhibits below target inflation, a solid investment grade profile, and few geopolitical headlines. So what’s the catch with Indonesia? Is there a price anomaly in the bonds or are we missing something?

Below, we offer three market concerns that we think are likely overstated.

1) The current account (c/a) is unsustainable

Yes, the c/a has widened from -1.7% to -2.7% and is no longer fully covered by foreign direct investment. However, there is scope for the c/a to narrow from here. The government’s efforts to slow down infrastructure investments are finally showing through in the data with capital goods imports slowing (Chart 1). The services balance is likely to respond with a lag to the weakening in the exchange rate (Chart 2). Exports suffered from weaker China demand and lower commodity prices, both of which are likely to reverse this year. A narrower c/a could easily be financed by inflows into the local debt market.


Charts 1 and 2: Source: Haver Analytics, 12/31/2018. Past performance is no guarantee of future results.  This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

2) External debt remains a concern

2018 was a year where Federal Reserve quantitative tightening put EM external liabilities under a microscope. While Indonesia does not share the vulnerabilities of a Turkey or Argentina, its underdeveloped capital markets have led local corporates to borrow in international dollar markets despite often being recipients of rupiah revenues. As the rupiah started to weaken, these corporations rushed to hedge their exposure which created a snowball effect in the currency. Proactive policy reaction in the form of rate hikes and the provision of a dollar hedge program should help ease these pressures. It is also worth noting that reserve coverage ratios for Indonesia, although worse than some regional neighbors, look reasonable on an EM basis (Chart 3).1


Source: Haver Analytics, 12/31/2018. Past performance is no guarantee of future results.  This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

1 External Vulnerability Ratio: Short-term External Debt + Currently Maturing Long-Term External Debt + Total Nonresident Deposits Over One Year)/Official Foreign Exchange Reserves (%)


3) Politics are going to be pivotal

Indonesia is a relatively young democracy and April will be the first time in recent history when presidential and parliamentary elections will be held at the same time. Ever since the Jakarta elections of 2017, religious issues have played a greater role in domestic politics. While this will surely make for scary headlines in one of the most ethnically and religiously diverse countries in the world, we think the incumbent Jokowi is very likely to be reelected. His ability to deliver economic growth and improve government service has translated to still-high approval ratings. Investors would welcome a second Jokowi term given his commitment to reforms, as evidenced by the country’s ability to gain in the World Bank’s ease of doing business surveys, rising from a rank of 120th in the world to 73rd.

Like any emerging market, there are certainly risks to investing in Indonesia, but both the currency and rates may have overshot at this point. An improvement in the current account, a better hedged external liability profile for corporates, and uneventful political outcomes could lead to better asset returns in 2019.



Current account refers to the net flow of goods, services, income and transfer payments into and out of a country.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

External liabilities refers to a country's creditors outside the country, including holdings of a country's bonds by entities outside that country.


Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:

This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) (“Legg Mason”). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client’s professional advisers.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.