This is the ninth in a series of articles that makes a fundamental macroeconomic sectoral flow analysis of the economies of key countries across the globe. The purpose of the review is to see if the local stock market is worth investing in via exchange traded funds (ETFs). These funds are available to all investors, even for non-residents or those not able to trade in the stock market of that country directly.
In this article, we examine Indonesia from a sectoral flow analysis perspective to see if the private sector, containing the local stock market, is getting the support it needs from the government and external sectors to continue its march upward. Details of the methodology employed to analyze these opportunities are available in the sectoral analysis section found later in this article.
The magic formula for success is:
P = G + X
And you can read more about that below.
Which Countries Are Doing Well?
The first port of call is the ETF page at Seeking Alpha and a look at country ETFs and how they are performing.
One notices from the list the following items:
Latin American countries head the list; what are they doing right?
No European countries head the list.
Only three "developed" countries are near the top of the list: New Zealand, Canada, and Australia; what do they have in common?
The U.S. is green and showing promise, though far down the list. Why?
Mexico, a Latin American country, is near the bottom. Why? What is it doing wrong?
All these questions and more will be addressed in forthcoming articles on a country-by-country basis from top to bottom. Most countries on the list are in the red and are of no further interest, though we could learn from them what to avoid, as could their governments and politicians. But, as investors, we will leave that to them.
Since starting this series of articles, Indonesia has fallen from ninth to thirteenth place but still shows a 20% growth rate over the last twelve months.
One can find the Market Vectors Indonesia Index (NYSEARCA: IDX) near the top of the SA ETF list, and the current fiscal situation is as follows:
The near-term government budget picture is shown in the chart below.
The chart shows that the government sector is net adding to the private sector but that this trend has been in growing
The long-term government budget picture is shown in the chart below:
The chart shows that the government sector, in common with almost all nations, has been net adding to the private sector for decades.
Indonesia's budget has a distinct ten-year rhyme to it. It appears that every ten years there is a rise and fall in the net add to the private sector. Judging from the existing pattern the net add from the government sector will continue and is reaching a peak that will go on for at least a few more years yet.
The low term government budget picture shows a government aware of its role of providing the medium of exchange into a growing economy. One exception is the late 1990's where one sees that for some years the government was running budget surpluses. The was an extraction of money out of the private sector helping it to shrink and decline into the Asian economic crisis of 1997.
One blot on the horizon though is the financial involvement of the World Bank extending loans for "development". Indonesia is a sovereign nation with an infinite supply of its currency unit; it did not need a loan from anybody as it can finance itself. The core of the 1997 Asian Financial crisis, mentioned above, was sovereign debt dominated in a foreign currency where one was short that currency.
"WASHINGTON, May 31, 2016-The World Bank's Board of Executive Directors today approved the first Indonesia Fiscal Reform Development Policy Loan to boost revenue collection and improve the quality of spending, key elements to accelerating growth, reducing poverty and sharing prosperity more widely in South East Asia's biggest economy.
The $400 million budget financing will support the Government of Indonesia's policy and institutional reforms to improve revenue collection and spending. Relative to its regional and emerging market peers, Indonesia has one of the lowest revenue-to-GDP (13.1 percent in 2015) and tax-to-GDP (10.8 percent) ratios. It is estimated that Indonesia collects less than half of its potential tax revenue.
As a result, public spending has been insufficient to support Indonesia's development plans, with expenditure accounting for only 16.9 percent of GDP in 2014, compared to an average of 28 percent for middle-income countries in Asia. Inadequate budgeting for key investments has led to a large infrastructure deficit, which impedes growth potential, and to under spending on health-care and social assistance programs, which increases vulnerability to poverty."
The American World Bank loan money will be spent on "help" from American companies providing consulting services on tax collection. That is, how one can better shrink one's economy by draining it of funds. One benefit will be that the international credit rating will improve and that is good news for holders of Indonesian sovereign bonds.
Indonesia may well benefit from the China led Silk Road infrastructure proposal that would add much productive infrastructure to the economy and be worth billions enduring for decades.
IDX has fallen about 5% in the last three months probably timing with the beginning of the World Bank loan conditions and "advice" taking effect, helping to contract and complicate an otherwise vibrant and free economy. (free from regulation and excessive tax collection)
A sovereign government that is the monopoly issuer of its currency has a responsibility to provide a steady supply of fresh money into the economy to allow for an ever expanding number of transactions to take place. If there is too little currency in circulation then deflation results, if there is too much in circulation then inflation results. The level of money can be controlled by government spending and taxation.
This then begs the question that if you are net spending over decades why tax at all? One simply needs to spend the difference required and leave the rest of the cash in the private sector.
When such a government chooses to provide this fresh money via a government bond issue a bond "debt" develops to bondholders, and one can watch this debt grow year by year. It is better for a government to simply spend this additional money into the economy by way of a citizens' community dividend by providing more education, health, and infrastructure to the community that it serves. The spend is simply the gap between taxes and government spending. This method of increasing the amount of currency in circulation is less stressful on a population that might otherwise wring its hands over the level of "debt" thus accumulated.
If every country in the world repaid its national debt, there would be no money in circulation and the balances at the Treasury would be returned to zero. This is a simple fact of accounting and mathematics.
Another consideration to issuing the currency in this debt free way is that it releases the government from the opinions and suggestions of private sovereign bond rating agencies forever calling for surpluses and "balanced budgets" that only work to contract the economy to maintain the desired bond rating. With their recommended contractionary government budgetary policy setting the only way the money supply and the economy can grow is from net inflows from the external sector.
Another plus for Indonesia is foreign trade. The near term can be seen in the chart below.
The chart shows that the balance of trade is positive and net adding to the private sector.
The long term balance of trade picture is shown below:
The chart shows that Indonesia has had a consistently strong positive balance of trade for decades and that the trend is beginning to swing back to the strong position that it had in prior decades before the GFC.
Foreign Direct Investment
The chart below shows the near term flow situation.
The chart indicates that there are net inflows adding to the private sector in Indonesia.
The influx of foreign direct investment has been strong in the longer term as well as the chart below shows.
Sectoral Analysis Methodology
Each nation state is composed of three essential components:
The private sector
The government sector
The external sector
The private sector comprises the people, business and community, and, most importantly for investors, the stock market. For the stock market to move upward, this sector needs to be growing. This sector by itself is an engine for growth and innovation. However, only it needs income from one or both of the other two sectors to grow.
The government sector comprises the government with its judicial, legislative and regulatory power. The key for the stock market is that this sector can be both a source of funds to the private sector through spending and also a drain on funds through taxes. The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine.
The external sector is trade with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance. One should note that a negative trade balance also means that a country has traded currency, that is in infinite supply, for real resources that have a finite supply.
For the stock market in the private sector to prosper and keep moving upward, income is required to be put into the flow. Otherwise, the sector can only circulate existing funds, or is being drained of funds and is in decline.
The ideal situation is that the private sector has a net inflow of funds and is constantly growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.
This relationship can be expressed by the following formula:
Private Sector [P] = Government Sector [G ]+ External Sector [X]
For the best investing outcome, one looks for countries where the government sector and external sector are both net adding to the private sector and causing the local stock market index to rise with the receipt of additional funds.
Indonesia is a buy. The government sector is net adding to the private sector and just about always has. There appears to be a ten-year pattern of government spending in Indonesia, and we appear to be in the peak phase of the current cycle expansion that can last for more years yet.
The only factor that makes me uneasy about the government sector is the recent loan from the World Bank and the "advice" and "help" that is tied to the loan. The loan funds are to be spent overseas and will be buying advice on tax collection which is the method by which money is drained out of the private sector. This does not appear to be a good investment for anyone except the lender.
In addition to this, the local economy is further supported by a positive balance of trade and foreign direct investment flows further net adding to the circular flow of income that will lift the local stock market index.
One must remember that these positive external flows have been maintained and for the most part have grown despite the "great recession" since the GFC in 2008. When the rest of world begins to come out of its neo-liberal induced monetary economic coma one can expect that growth and prosperity in Indonesia will further accelerate and grow.
The rest of the world can learn from Indonesia that consistent net adding to the economy by way of positive inflows from the government sector and external sector is not unsurprisingly the secret to sustained growth and prosperity over the long term.
Many countries do not enjoy the trade situation that Indonesia has and can at best hope to have a balanced external trade sector. This makes the role of the government sector all the more important in sustaining growth by maintaining aggregate demand through full employment.
One can get investment access to Indonesia via these ETF funds:
Aberdeen Indonesia Fund Inc (NYSEMKT: IF)
DB X-TRACKERS DBX MSCI INDONESIA ETF (LON: XMID)
HSBC ETFS PLC HSBC MSCI INDONESIA UCITS ETF (LON: HIDR)
MULTI UNITS FRANCE LYXOR ETF MSCI INDONESIA (LON: INDL)
MULTI UNITS FRANCE LYXOR ETF MSCI INDONESIA $ (LON: INDO)
In the next article, we will take a look at Australia.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.