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Can Indonesia ETFs Bounceback?

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Like many other emerging economies, concerns over Southeast Asia's largest economy – Indonesia – have been growing since the beginning of the year as the nation is grappling with internal and external economic issues. Already facing the pain from a weak currency, slowing growth and widening current account deficits, the country is now perturbed by rising inflation rates as well.

The nation’s inflation rose to its highest level in July in four years, thanks to a fuel price rise in late June and higher food prices during Ramadan (Read: Emerging Market ETFs Tumble on Global Worries). Inflation was as high as 8.6% in July, up from 5.9% in June.

Indonesian Issues in Detail

The Indonesian currency, the rupiah, which lost strength in the near past mainly due to the outflow of foreign funds from the nation’s investable securities following taper talks, began to depreciate further with higher-than-expected inflation in the second quarter of 2013. With another round of inflationary pressure in the cards due to higher fuel prices, the rupiah will surely take a downturn in the coming days (Read: Indonesia ETFs Slide as Rupiah Tumbles).

In such a scenario, the Indonesian Central Bank may resort to the age-old formula of raising interest rates to counter inflation and save the Rupiah, but at the price of slower economic growth. Notably, the central bank had already hiked the benchmark interest rate at its previous two meetings by a total of 75 basis points (Read: Can You Fight Inflation With This Real Return ETF?).

Economic growth slowed down to 5.81% in second-quarter 2013 from 6.03% growth recorded in the first quarter marking the fourth successive quarter of sluggish growth.

Some stringent government restrictions, nationalist-friendly, ahead of the next year's general election have been thwarting foreign direct investments to the country and thus slowing the country’s winning momentum. These measures include levying of a tax on raw materials, tapering of import quotas for some goods, compelling foreign miners to slash their stakes in local mining companies.

As a result, exports contracted 8.6% sequentially in June 2013 while import growth shrunk, though less harshly, by 6.4%, leading to a bigger trade deficit. As of June end, the trade deficit was US$0.8 billion, up from US$0.5 billion recorded at May’s end. Also, continued slowdown in China, one of the largest markets for Indonesian exports, hit the nation’s export profile badly.

World Bank Trims Indonesian Growth Forecast

Last month, the World Bank cut its 2013 growth forecast for Indonesia to 5.9% from the prior projection of 6.2% (March 2013) keeping in view the muted internal demand resulting in a choppy outlook on investment, weaker export-competitiveness and softer commodity prices.

Per the World Bank, Indonesia faces budgetary weakness as it generates lower revenues and pays higher subsides. This combination has resulted in mounting pressure on public debt.  In its quarterly economic outlook, the World Bank also hinted at heightened inflationary pressures in Indonesia.

Inflation for Indonesia is now expected at 7.2% for 2013 and 6.7% for 2014, as per the World Bank. In March 2013, the organization forecasted 5.5% of inflation for 2013 and 5.2% for 2014. As for the current account deficit, the World Bank now expects it to be 2.7% of GDP in 2013 (down from 2.5% projected in March) and 2.1% in 2014.

Indonesia ETF Impact

Quite expectedly, owing to such shocks, Indonesia ETFs have been suffering in the last six months. Three ETFs iShares MSCI Indonesia Investable Market Index Fund (EIDO - Free Report) , Market Vectors Indonesia Index ETF (IDX - Free Report) and Market Vectors Indonesia Small Cap ETF lost about 10%, 8.9% and 3.1% respectively in the period. Needless to say, returns from all three ETFs underperformed SPY (up 12%) in the past six months.

The most popular Indonesia ETF, EIDO has $475 million in AUM with a tilt towards large caps and charges investors 60 basis points a year in fees. IDX – the oldest Indonesian ETF – amassed around $301 million charging investors 57 basis points a year while IDXJ, which focuses on small cap stocks, has assets around $6.4 million with an expense ratio of 61 bps. All three funds currently sport a Zacks ETF Rank #3 (Hold).

Bottom Line

The recent downfall in Indonesia’s economic indicators might offer an attractive valuation and a good entry point to the country’s ETFs for risk- tolerant investors. In fact, the least popular among the three, IDXJ, fetched an impressive return of about 30% in the first quarter of 2013 (Read: Can Anything Stop These Soaring Southeast Asia ETFs?).

Even though the estimates are on a declining trail, Indonesia still remains a strong growth vehicle in the global map as the latest projections for the nation are still quite high when compared to many of its Western as well as Eastern counterparts (see more ETFs in the Zacks ETF Center).

Despite some weakness, the Indonesia ETFs still shed lower than some of its contenders including Philippines (EPHE), India (INDY), Brazil (EWZ), Chile (ECH) and Turkey (TUR) ETFs in the broader emerging market space. Considering these, the Indonesia ETF outlook – at least over the long term – isn’t as grim as one might think.

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