The new fiscal flu infecting Indonesia’s financial market

(News Terupdate) - The performances of regional stock markets over the past few days have been volatile to say the least, impacted by the so-called European PIIGS (Portugal, Ireland, Italy, Greece and Spain) group, which caught the fiscal flu — as seen in their ballooning budget deficits (see table for details).

This is well above the recommended threshold level of 3 percent, and it is worth pointing out that the sub-prime problem in Europe started in Southern Europe, with Spain.

All financial markets’ eyes are now focused on the sovereign debt problems faced by the PIIGS group, particularly since the debt to GDP ratios of Greece and Italy have reached 113 percent and 115 percent.
Some analysts have argued that the GDP of these countries are small, with Greece at US$343 billion, smaller than Indonesia’s $500 billion. However, this situation should not be taken lightly, because European countries’ economies are interwoven in a single currency. Note that PIIGS countries’ GDP of $4,317 billion constitute around one-third of the Eurozone’s total economy.

Some have also argued that industrial production in the PIIGS group has shown a recovery, with November 2009 figures for Greece, Italy and Spain reaching -6 percent, -8 percent, and 4 percent. This was up from October’s -9 percent, -12 percent, and -13 percent.

However, because the improvement was a result of the government’s fiscal stimulus, unemployment rates in the PIIGS areas continued to deteriorate (see table for details), which is a cause of concern.

Now, the question would be the impact of this situation on Indonesia’s financial markets, which we believe would occur more through the global economic recovery story, adversely affecting commodity prices. Coupled with concerns about the China bubble (resulting in the Chinese government’s holding back spending) this could mean commodity prices remain unexciting for the next two to three months.

This is likely to weaken both Indonesia’s currency and equity markets in our view. As money is taken out of the Indonesian stock market, the Indonesian rupiah is likely to weaken. Thus far we have seen the currency depreciating more than 2 percent from around the Rp 9,150 level in the beginning of the year to Rp 9,400 at present. Going forward, on the back of the PIIGS group’s fiscal problems, we expect global risk premium, including Indonesia’s, to remain at elevated levels for awhile. And this is bad news for equity markets in general. In Indonesia, this coupled with the deteriorating political landscape could mean profit taking in the stock market in the short-term.

It is also worth highlighting that global Credit Default Swap (CDS) has risen in general. However, we expect minimal impact on the Indonesian bond market. While Indonesia’s CDS has risen from 193 to 216 at present, we expect continued foreign interest as our bond yields provide substantial spreads relative to the rest of the region.

Back to the local equity market, with 32 percent of the total Jakarta Composite Index market capitalization in commodity-related stocks, we expect both the equity and currency markets to be feeling under the weather in the short-term, impacted by the latest financial flu from PIGS.

Posted in: Update News