Five political risks to watch in Indonesia
By Sara Webb
JAKARTA, Feb 1 (Reuters) - Indonesia's improved economic outlook prompted a sovereign ratings upgrade by Fitch last week to one notch below investment grade, but the risk that reforms are stifled by powerful vested interests may hit markets.
Sovereign 5-year credit default swaps for Indonesia IDGV5YUSAC=R are trading at a spread of 184.00 basis points, compared to a weighted average of 134.40 for the Thomson Reuters Emerging Asia Index. Indonesia's spread has narrowed below the Philippines' sovereign CDS spread of 184.75, implying it is now seen as a lower default risk than the Philippines.
Following is a summary of key Indonesia risks to watch:
* GOVERNMENT EFFECTIVENESS IN DRIVING REFORM
President Susilo Bambang Yudhoyono, returned to a second term after a decisive election win last July, is widely regarded as a progressive, market-friendly reformer. Many investors hoped that his second term would see a faster pace of reform, and hopes were raised when he announced a cabinet in October that included top technocrats Sri Mulyani Indrawati and Mari Pangestu in the key economic posts, with a new presidential delivery unit headed by Kuntoro Mangkusubroto and another technocrat, Boediono, as vice president. But so far, the evidence suggests his second term will, like the first, move slowly in implementing reform.
Controversy over the bailout of a small bank last year may also damage reform prospects. Parliament is investigating the rescue of Bank Century, which had been backed by Indrawati and Boediono, and some lawmakers are calling for one or both of them to be replaced. So far Yudhoyono has given the pair his backing, and their supporters say the controversy is being exploited by Indonesia's corrupt old guard to try to halt reforms that could weaken their privileges. How the struggle plays out will be crucial in determining the pace of reforms. [ID:nJAK477288]
What to watch:
-- Will Boediono and Indrawati keep their jobs? If not, and particularly if they are replaced by politicians linked to the old business elites, it will be a strong signal that reform prospects are evaporating. That would spark some capital outflow, hitting stocks .JKSE, the rupiah IDRX= and bond prices in the short-run, and also make Indonesia less attractive to long-term investors. However, healthy fundamentals and a large and growing domestic consumer base would still provide reasons to invest in Indonesia even if reform prospects are dimming. [ID:nJAK527883]
-- Will Yudhoyono become embroiled in the scandal? Local media have reported that among the bank's depositors were several wealthy businessmen who later donated money to his re-election campaign. The president denies wrongdoing and there seems no immediate likelihood he will be impeached. If that changes, Indonesian assets are likely to face a sharp sell-off.
* CORRUPTION AND GOVERNANCE
Corruption has emerged as a defining issue at the start of Yudhoyono's second term, with popular anger mounting over a power struggle between the respected Corruption Eradication Commission (KPK) and the attorney-general's office and police. The KPK has made significant progress in investigating corrupt officials, but this has stirred powerful opposition. Yudhoyono has vowed to back the anti-corruption drive but has so far appeared very cautious about taking more decisive action. [ID:nnJAK470187]
What to watch:
-- Pace of reform of Indonesia's civil service, police and courts. Yudhoyono's cautious response to the power struggle over the KPK suggests he will move much more slowly than markets had hoped, confirming his reputation for preferring gradual change to bold, sweeping reform. Investors betting on more decisive reform during Yudhoyono's second term have had to adjust expectations.
-- Investor perceptions of progress in tackling corruption. In Transparency International's 2009 Corruption Perceptions Index, Indonesia's ranking improved to 111th out of 180 countries from 126th the previous year. But recent events may cause investors to re-evaluate their optimism. Markets would not see much immediate impact, but longer-term investment would suffer.
* HOT MONEY AND CAPITAL CONTROLS
The rupiah was Asia's best-performing currency in 2009 with a gain of 17 percent against the dollar, threatening Indonesia's export competitiveness. Memories are also still raw of the 1998 Asian crisis, widely blamed in Indonesia on foreign "hot money" suddenly being yanked from the country. The central bank says it will keep intervening to stem the rupiah's gains. [ID:nJAK346407]
Late last year the senior deputy governor said Bank Indonesia was studying the possibility of curbing foreign ownership of its short-term debt, sparking speculation about tighter capital controls. With Indonesia attracting increasing interest from foreign investors -- and with the Fitch upgrade likely to give inflows a further boost -- the country may decide it has to impose controls to protect exports and tame hot money.
What to watch:
-- Data on exports and speculative inflows. If problems seem likely, expect controls to be tightened. Draconian measures which send investors fleeing to the exits are unlikely -- measures would be aimed at directing flows, rather than halting them, so any negative impact on asset prices would be relatively muted. But the issue can still spook markets -- the rupiah suffered its biggest one-day sell-off in nine months last November due to mixed signals on capital controls. [ID:nHKG263506]
* SECURITY
Suicide bombings at two luxury hotels in Jakarta last July were the first major terror attacks in Indonesia since 2005 and raised concerns that the threat from militants was again on the rise. The killing of Noordin Mohammad Top and other key figures -- including the man who recruited the two suicide bombers for the attacks in July -- may significantly reduce that threat. Analysts warn, however, that other dangerous militants remain at large and further attacks cannot be ruled out.
What to watch:
-- Ability of militants to regroup and launch more attacks. Particularly if remaining militants are able to establish firm enough links with al Qaeda to secure sustained funding, expertise and recruits, the threat may be far from over. But Indonesia's markets have proven highly resilient to bomb attacks. Unless there is a significant and sustained deterioration in security, any sell-off would be small and short-term. [ID:nSP545301]
* OVER-RELIANCE ON YUDHOYONO
Many analysts worry that Indonesia's recent progress towards greater political and economic stability has been very reliant on the personal popularity and power of Yudhoyono. If anything were to happen to him, much of Indonesia's recent gains could unravel. He has no obvious successor with the support base and drive to continue the reform process. And if popular anger over corruption and the Bank Century issue significantly undermine his popularity, the perception among investors that Indonesia's political stability has greatly improved would be threatened.
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