Investors Like Indonesia, But Risks Linger

MarketsETF Trends

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The iShares MSCI Indonesia ETF (NYSEArca: EIDO) and the VanEck Vectors Indonesia Index ETF (NYSEArca: IDX) have both tumbled this year, losing an average of about 6.5%. However, investors remain enthusiastic about Southeast Asia's largest economy while acknowledging some lingering risks.

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Improving domestic consumption, government capital spending and further structural reforms, along with potentially loose monetary policies, could help support the Indonesian market.

“Attendees at Fitch Ratings' Indonesia Credit Briefing held in Jakarta on 22 March were generally optimistic about the outlook for Indonesia's economy - particularly prospects for the government's aggressive infrastructure drive,” said Fitch Ratings in a recent note. “Domestic political turbulence was seen as the biggest threat by 62% of the 243 investors, analysts and business community members that attended. Polling results also suggested unease over external vulnerabilities amid rising US interest rates.”

The MSCI Indonesia Investable Market Index

The $540.4 million EIDO tracks the MSCI Indonesia Investable Market Index and holds 86 stocks. That ETF allocates 38.3% of its weight to financial services stocks, more than double its second-largest sector weight. Consumer staples and consumer discretionary stocks combine for 26.6% of the fund's roster.

“The government has limited fiscal space to increase direct infrastructure spending, in part because the central government's revenue-to-GDP ratio is among the lowest of Fitch-rated sovereigns, at under 13% in 2017 according to Fitch's definition. Local governments, state-owned enterprises (SOE) and private investors will be relied on to fill the financing gap. To this end, the government has increased financing options for infrastructure projects, which now include komodo bonds,” according to Fitch.

Related - Emerging Markets Recovery: Resilient Despite Tariff Concerns

Emerging markets are enjoying improved fundamentals thanks to corporate earnings improving as economic growth rebounds and strengthening currencies against the U.S. dollar on the back of improved economic outlooks. Investors would do well to not simply focus on the weak dollar or supposedly compelling valuations on emerging markets stocks.

“US interest rate increases were seen as the second-highest risk to Indonesia's economy and more than half of attendees believed vulnerability to external shocks is the biggest risk facing the country's credit market,” according to Fitch. “Depreciation in the Indonesian rupiah since the start of the year, while not dramatic, may have contributed to these views.”

The Federal Reserve has raised rates once this year and could proceed with up to three more rate hikes before the end of 2018.

For more information on the developing economies, visit our emerging markets category.

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