Indonesia’s Elections and Their Potential Impact on the Stock Market

Indonesia’s voters head to the polls on Wednesday to choose a new president, succeeding the popular Joko Widodo (Jokowi) who is term-limited. Three candidates are vying for the top job:

• Defense Minister Prabowo Subianto: Known for his strong military background, Subianto is seen as the frontrunner. He’s drawn controversy by choosing Jokowi’s son, Gibran Rakabuming Raka, as his running mate, raising concerns about nepotism.
• Former Central Java Governor Ganjar Pranowo: Representing the ruling party, Pranowo is known for his progressive policies and focus on social programs. He enjoys strong support among younger voters.
• Former Jakarta Governor Anies Baswedan: A popular figure in the capital, Baswedan is seen as a moderate reformer. He’s critical of Jokowi’s signature infrastructure projects and proposes a different approach to economic development.

The election is expected to be close, with each candidate offering a distinct vision for Indonesia’s future. The outcome will have significant implications for the world’s third-largest democracy and the most populous Muslim-majority nation.

Indonesia’s upcoming election holds global significance, exceeding what many might anticipate. Analyst Marko Papic of Clocktower Group emphasizes its importance, stating, “Only three elections truly matter this year: Taiwan, already concluded, Indonesia, and the US.” This critical role stems from Indonesia’s decades-long success in navigating a delicate geopolitical and economic tightrope.

Papic aptly describes their strategy as a “promiscuous foreign policy,” highlighting their ability to maintain cordial relations with both the US and China. This approach has been crucial for their economic stability and regional influence, and it’s a strategy that financial markets are eager to see continue.

Indonesia’s adept approach to balancing relationships with global powers has resulted in a healthy fiscal position, according to Eurasia Group. However, the incoming president faces pressing challenges. They must:

• Continue pro-business reforms: These reforms have attracted significant foreign investment, including projects drawn away from China. Continued progress is crucial for sustained economic growth.
• Navigate commodity export risks: A potential slowdown in China, a major importer of Indonesian commodities, could pose significant risks. Diversifying the economy and mitigating this dependence will be essential.

Discreetly, Indonesia has emerged as a darling of emerging-market investors over the past generation. As the chart reveals, Indonesian stocks have significantly outperformed expectations over the past 20 years. When asked about the top performers, many would likely cite the US and India as leaders. However, surprisingly, Indonesia claims the third spot, surpassing established markets like Taiwan and South Korea. Naturally, any change in leadership raises concerns among investors about whether this impressive trajectory can be sustained.

In the aftermath of the devastating Asian Financial Crisis of 1997, Indonesia embarked on a transformative journey. Through bold reforms, they halved poverty to under 10%, achieving remarkable progress before the COVID-19 pandemic delivered a fresh blow to global competitiveness.

Indonesia also shed its “Fragile Five” label, once assigned by Morgan Stanley and Deutsche Bank due to its reliance on foreign investment. This resilience underscored its economic potential.

Now, as the successful 20-year development plan approaches its 2025 conclusion, Indonesia stands poised for a new chapter.

Indonesia, the fourth-largest economy in East Asia after China, Japan, and South Korea, has successfully diversified away from its reliance on oil exports. During the oil boom of the 1970s, oil exports accounted for over 60% of the country’s domestic revenue. However, Indonesia has since built a robust manufacturing sector, reducing its dependence on this volatile commodity.

This diversification proved crucial when the Asian financial crisis struck in 1997, initially triggered by Thailand’s real estate issues. Indonesia’s resilience during this turbulent period is a testament to its successful economic transformation.

The Asian financial crisis exposed vulnerabilities in Indonesia’s banking sector, characterized by high non-performing loans and short-term debt. While Bank Indonesia’s initial response worsened the bad debt issue and necessitated the closure of 16 banks, it ultimately led to a significant restructuring and recovery.

Today, the Indonesian banking sector is a pillar of the Jakarta stock exchange, the largest sector by market capitalization. Since 2005, the country has enjoyed robust economic growth, outperforming many regional peers.

Indonesia’s response to the Asian Financial Crisis has paid off handsomely in the stock market. While initially tracking the broader emerging-markets index after the crisis, Indonesian stocks have diverged significantly since 2004.

This divergence coincides with the implementation of policies aimed at strengthening institutions, reducing bureaucracy, and promoting transparency. These reforms have fostered long-term investor confidence and fueled impressive market growth.

Can Indonesia maintain its impressive economic trajectory? While it outperformed most developing markets after the Global Financial Crisis, growth has stagnated in recent years. This raises concerns about the “middle-income trap,” where progress stalls. Like other nations, the new government faces the challenge of gradually reversing emergency policies implemented during the pandemic.

Economist Kunal Kumar Kundu of Societe Generale highlights the government’s focus on fiscal consolidation. This means prioritizing a budget surplus and reducing the deficit, potentially limiting public spending as a driver of growth.

A key decision for the next president will be navigating the fiscal deficit cap of 3%. While this rule was temporarily suspended during the COVID-19 pandemic, experts like Udith Sikand and Tom Miller of Gavekal Research argue that the consequences were not detrimental.

Despite exceeding the deficit cap, foreign investment remained stable, with foreign ownership of public debt dropping to around 15% without significant effects on bond yields. Additionally, Indonesia maintained consistent economic growth of around 5% and kept inflation within the target range throughout most of President Jokowi’s term.

Jesse Kuri of BCA Research believes Indonesia’s unique circumstances will likely preserve its balanced approach between China and the US. While this may limit the potential for explosive economic growth, it also reassures investors about stability and minimizes concerns of a shift towards authoritarianism or populism.

Several factors contribute to this stability, including Indonesia’s vast size and diverse population, existing institutional checks on centralized power, an ongoing generational leadership transition, and the influence of established business interests. These elements collectively make it unlikely for another dictatorship to emerge, but also restrict the political capital available for pursuing aggressive market reforms.

Indonesia is brimming with ambition. In just 21 years, the nation will celebrate a century of independence. Embracing this milestone, the new 20-year development plan, “2045 Golden Indonesia Vision,” aims to propel the country into the ranks of the world’s five largest economies by then. However, achieving this ambitious goal (currently sitting at 16th according to the World Bank) presents a significant challenge for the new leader selected by over 204 million eligible voters.