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Indonesia’s economy grew a higher-than-expected 6.4% year-on-year in the second quarter of this year, thanks to high commodity prices, strong consumer spending and robust exports. This is slightly higher than Indonesia’s 2007 GDP growth of 6.3%.

The figures will give a boost to President Susilo Bambang Yudhoyono as he unveils the government’s 2009 budget today. Ministers say this will include a 55% cent increase in funds for poverty alleviation programs and a significant expansion of the education budget that is mandated to be 20% of the total budget.

John Aglionby of the Financial Times reports that exports accounted for 30% of growth in the second quarter, far lower than in neighboring countries, while consumer spending represented 60.3 per cent. Sri Mulyani Indrawati, Indonesia’s chief economics minister, was upbeat. “The growth momentum is very strong and the upward trend on employment and poverty reduction is healthy,” she told the Financial Times. “The main worry is inflation. It will be a couple of months before the central bank and we get it down to single digits again.”

This would be a great story except that market valuations are high with the stock market trading at 3.5 times book, 12.2 times cash flow and eighteen times annualized earnings based on S&P data.

Indonesia has been urged by the OECD to overhaul its rigid labor laws, remove foreign investment and ownership restrictions and cut its fuel price subsidies.

Despite a 30% increase in fuel prices in May, the Indonesian government is expected to spend one-fifth of its government budget on fuel subsidies this year. The country’s central bank was also advised to act “resolutely” and “preemptively” to raise rates and combat inflation, which hit a 21-month high of more than 11% in June.

The close-ended Indonesian Fund (NYSEMKT:IF) has been beaten down a bit but still is trading at the high end of the 30 countries tracked by Chartwell ETF. However, while a year ago it traded at a 13% premium, it is now at a 13% discount to net asset value. The fund's largest holding is Indonesian Telecom at 17% of total assets.


Source: Indonesia Fund Pullback Based on Valuations, Not Growth