- Elections in India and Indonesia have created intense expectations for reform.
- However, several major hurdles face both countries.
- We have a somewhat more bullish outlook for India, but believe that changes can lead to opportunities in both countries.
By Jack Deino
In both India and Indonesia, leaders are facing intense pressure from markets and investors to initiate reforms that are real rather than merely cosmetic. Our outlook is somewhat more bullish for India, but we believe change can lead to opportunity in both countries.
Hurdles to reform
The recent election of Prime Minister Narendra Modi in India brings to power a strong government with a solid mandate for reform. However, Mr. Modi's Bharatiya Janata Party (BJP) doesn't control a majority in the upper house of parliament, which is required for many reforms, nor does it control most local governments, which must approve implementation of some reforms on the state level. India's fiscal deficit, already quite large, is under the microscope of diverse constituents, making it difficult to fund infrastructure projects even if they're approved through a streamlined approval process. Labor reform is necessary to provide jobs for about 10 million citizens entering the labor force annually. But it's unpopular.
In Indonesia, if frontrunner and market favorite, Joko Widodo, wins the upcoming election, a fractious parliament will likely challenge attempts to implement important reforms. Mr. Widodo's Indonesian Democratic Party of Struggle (PDI-P) fell short of a decisive victory in the April legislative election.
Both countries also face daunting challenges in light of reduced, more selective flows to emerging markets, serious infrastructure-related bottlenecks, massive corruption, and unsustainable, poorly structured subsidies for food, fertilizer and various fuels that could increase pending the Iraqi conflict's impact on energy prices.
Outlook for investors
While both India and Indonesia appear attractive from a local currency perspective, India looks slightly more so, in our opinion. Both the Reserve Bank of India (RBI) and Bank Indonesia (BI) have taken concrete measures to reduce structural imbalances. On the hard currency front, we see both markets as pretty fully valued from a corporate and sovereign perspective. India has no hard-currency sovereign debt and only quasi-sovereign, bank and corporate debt outstanding.
For investors, India looks attractive, in our view, given that it is not a constituent of the JPMorgan GBI-EM Global Diversified Index, and therefore has very little foreign participation at about 3%.1 We expect further volatility for Indian depository receipts around elections and as seasonal factors generate an increase in the closely watched current account deficit. But we believe the Indian rupee should remain stable as foreign flows stabilize while the RBI takes measures to rebuild foreign reserves and maintain a competitive currency, which now looks slightly overvalued. Given the risks of an El Niño-induced drought impacting food price inflation, we anticipate the RBI maintaining a neutral policy stance, despite RBI Governor Raghuram Rajan's assertion that the glidepath to lower inflation he's mapped out is achievable.
Meanwhile, Indonesia is in the JPMorgan GBI-EM Global Diversified Index and already has sizable foreign participation at approximately 35%.1 Given that most investors overwhelmingly favor Mr. Widodo and the Indonesian race is still quite fluid with five televised debates to come, we see some degree of risk that many investors would cut positions across asset classes in Indonesia if Mr. Widodo's rival, Subianto Prabowo, wins the election. Mr. Prabowo has mentioned that if he wins, he may consider increasing Indonesia's ratio of sovereign debt to gross domestic product (GDP) from about 24% to approximately 50% in an effort to spur growth in the "underlevered" Indonesian economy.
1 Source: EM Markets: EM Macro Daily - Globalizing Local Currency Rates, Goldman Sachs Global Macro Research, June 25, 2014
JPMorgan GBI-EM Global Diversified Index is a version of the benchmark index for emerging market local currency bonds issued by emerging market governments.
The performance of an investment concentrated in issuers of India or Indonesia is expected to be closely tied to conditions within those countries and to be more volatile than more geographically diversified investments.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
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