0/03/2013 @ 10:22fm 4 875 views
Why The Worst Is Yet To Come For Indonesia's Epic Bubble Economy
The archipelago nation of Indonesia is part of the emerging markets bubble that I have been warning about in recent years (read my EM bubble report). The emerging markets bubble started inflating in 2009 as China embarked on an aggressive credit-driven construction and infrastructure boom that led to a surge in demand for raw materials, many of which are exported by emerging market nations. The growing commodities export boom bolstered the fortunes of EM nations, which piqued the interest of investors who were looking to diversify away from hard-hit Western economies.
Ultra-low interest rates in ailing developed economies combined with the Federal Reserve's multi-trillion dollar QE programs led to a $4 trillion tsunami of "hot money" flowing into emerging market assets in the four years after the Great Recession ended.
A global carry trade developed in which investors borrowed cheaply from the U.S. and Japan, and plowed the proceeds into higher-yielding EM assets, especially bonds, while earning the difference or the "spread." The surge of liquidity into emerging market assets created a bond bubble, which helped to push borrowing costs to abnormally low levels for such fast-growing economies, which in turn enabled a government-driven infrastructure spending boom, explosive credit growth, and property bubbles across the emerging world.
Massive capital inflows into Indonesia after the 2008 Credit Crunch contributed to a nearly 50 percent rise in the rupiah currency's exchange rate against the U.S. dollar, and pushed the country's 10-year government bond yields down to record lows of 5 percent from their 10 to 15 percent pre-Crisis range. In just two years, foreign holdings of Indonesian local currency government bonds rose from 14 percent to 34 percent, while the country's external debt nearly doubled:
Foreign direct investment (net inflows, current dollars) more than tripled:
Source: IndexMundi.com
During this time, Indonesian equities quintupled:
The surging rupiah caused Bank Indonesia, the country's central bank, to cut their benchmark interest rate from 12.75 percent to just 5.75 percent to stem export-harming currency appreciation:
Indonesia's Growth Is Fueled By A Credit Bubble
Record low interest rates have fueled an epic credit and consumption boom in Indonesia, which is no small matter given the fact that domestic consumer spending accounts for nearly 60 percent of the country's overall $878 billion economy. For the past half-decade, Indonesia's annual GDP growth rate has averaged about 6 percent – the fastest in Southeast Asia – thanks largely to their consumer spending boom.
According to Moody's, Indonesia's compound credit loan growth rate has been over 22% for the past six years, while non-mortgage consumer credit nearly tripled in the last five years. During this time, credit card use has greatly proliferated, with the number of credit cards jumping by 60 percent, while the actual value of transactions almost tripled. Fears of a consumer debt crisis forced Bank Indonesia to limit the number of credit cards a single person is allowed to hold, while barring Indonesians who earn less than $330 (USD) a month from being issued credit cards.
The chart of loans to Indonesia's private sector provides a graphical view of Indonesia's credit bubble:
Domestic credit to Indonesia's private sector as a percentage of GDP shows that leverage has been increasing as well:
With such rapid consumer credit growth, it's unsurprising to see a concomitant rise in consumer spending:
Automobile registrations have more than tripled since 2004:
International automakers including Nissan, Toyota and General Motors have taken notice of Indonesia's automobile boom, and committed up to $2 billion to expand their manufacturing operations in the country in the next few years. Cheap financing has also been fueling a surge in motorbike sales, an indicator of domestic consumption, which grew 13.9 percent in August from a year earlier, after growing 21.3 percent in July. Retail sales that have been growing at an annual rate of 10 to 15 percent in recent years have attracted numerous Western consumer brands like L'Oreal, Unilever and Nestle that are seeking to cash in on Indonesia's spending boom.
Indonesia Also Has A Property Bubble
Cheap credit and property bubbles go hand in hand, and Indonesia's bubble economy is no exception. Though data for all Indonesian property markets are scarce, property markets in Jakarta and Bali are becoming frothy, especially at the higher end of the market. Jakarta condominium prices rose between 11 and 17 percent on average between the first half of 2012 and 2013, after rising by more than 50 percent since late 2008. Luxury real estate prices in Jakarta soared by 38 percent in 2012, while luxury properties in Bali rose by 20 percent – the strongest price increases of all global luxury housing markets. A small two-room apartment on the outskirts of Jakarta can cost nearly $80,000 USD (RM253,373), making housing unaffordable for many ordinary Indonesians.
The surge in real estate activity spurred a 70 percent rally in Indonesian property shares in the first five months of 2013 (though they have sold off since then). Even Indonesia's central bank has become worried about a property and credit bubble, causing them to issue new rules to curb speculation, including mandating a minimum 40 percent down payment for the purchase of a second house or apartment (bigger than 70 m²).
Bank Indonesia has plenty to worry about when it comes to a mortgage bubble: from June 2012 to May 2013, outstanding loans for apartment purchases nearly doubled from IDR 6.56 trillion (USD $659.3 million) to IDR 11.42 trillion (USD $1.15 billion). In July, the Bali branch of Bank Indonesia gave a warning that it was "on alert" for a possible bursting of the island's property bubble. Indonesian property boom apologists cite soaring incomes and economic growth as a justification for the rise of property prices, but the problem with their logic is that the country's economic growth itself is being buoyed by a credit-driven bubble.
Indonesia's Bubble Is A Derivative Of China's Bubble
While domestic consumption accounts for nearly two-thirds of Indonesia's economy, raw materials account for much of the other third. Unfortunately, this part of Indonesia's economy is also experiencing a bubble due to its reliance upon exports to China. In recent years, China has been building countless empty "ghost cities" and other wildly ambitious infrastructure projects for the sake of boosting economic growth, much of which is funded by a teetering multi-trillion dollar debt bubble. Indonesia provides a good portion of China's coal needs, which have boosted the country's exports:
The popping of China's bubble will hit Indonesia's export sector very hard (Australia's as well), and the recent decline of the country's exports due to China's slowdown is a preview of what is ahead. The fading of Indonesia's export boom has already contributed to the country's record trade deficit:
Indonesia's growing trade deficit and this past summer's taper scare caused a panic in the country's financial markets that pushed the rupiah currency down 13 percent, their stock market down 25 percent, and sent yields on their 10 year government bond to nearly 9 percent from 5 percent in just a few months. Though Indonesian financial markets have recovered slightly on the Fed's taper delay, this doesn't mean that the country is out of the woods – relief rallies are very common after violent market routs. Indonesia and other EM financial markets' extreme sensitivity to U.S. monetary policy only serves to reinforce the assertion that the emerging markets bubble is driven by speculative "hot money."
From a technical analysis standpoint, the Jakarta Stock Price Index (JCI) broke below its five year old rising trendline, which is hardly a positive sign and may indicate more declines ahead. The relief rally of the past month simply took the index back to its former trendline, which is now a resistance level. After breaking below important trendlines, markets often rally back up to those levels before embarking on their next leg down. Taper fears are likely to flare up again soon, which could be a catalyst for another decline. (However, if the index can break back above the trendline, the bearish signal would be invalidated.)
The weak rupiah has caused Indonesia's inflation rate to roughly double since the start of 2013, which forced their central bank to raise its benchmark interest rate from 5.75 percent to 7.25 percent. (The chart below is the U.S. dollar to rupiah exchange rate)
My primary concern is that rising interest rates across the Indonesian yield curve will eventually pop the country's property and credit bubbles – after all, it was record-low interest rates that caused them in the first place (just like the U.S.' bubble from 2003-2007). The strong possibility of an Indonesian credit downgrade in the near future is another bearish catalyst to be mindful of.
As I've said before (pre-EM panic), I expect the ultimate popping of the emerging markets bubble to cause another crisis that is similar to the 1997 Asian Financial Crisis, and there is a strong chance that it will be even worse this time due to the fact that more countries are involved (Latin America, China, and Africa), and because the global economy is in a far more precarious state now than it was in the booming late-1990s.
In the coming weeks, I will be publishing more reports on other countries that I consider to be part of the emerging markets bubble. Please follow me on Twitter and Facebook to keep up with the latest bubble news and my related commentary.
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