In Emerging Markets, Don’t Forget Indonesia

When thinking about the Emerging Markets growth story, most focus on the larger nations—like the so-named BRIC (Brazil, Russia, India and China)—primarily because they are indeed more populous with larger output. And for the past few years, larger emerging markets have overall been bright spots in the global economy. But smaller, less heralded nations also play a role in the emerging markets growth story.

Indonesia is one such example. Its GDP growth rate is twice America’s, and its population exceeds Brazil’s or Russia’s. What’s more, Indonesia has embarked on impressive pro-growth reforms in recent years. To start, the country’s pro-reform president, Susilo Bambang Yudhoyono, handily won re-election in 2009. The country has gradually lowered tax rates to stimulate growth and has incentivized capital investment with a five-year tax holiday. A new long-term plan will accelerate infrastructure investment (estimated to grow 24% in 2012), and a new law updates their very rickety eminent domain laws, paving the way for more economic growth. And free trade agreements with neighbors like China, India, South Korea and Australia have contributed to booming export growth (+40% y/y in Q2 2011 alone).

Geography and demographics are also key advantages. Asia is the world’s fastest-growing region, and Indonesia’s geography provides easy access to ocean trade. The country’s labor pool is Asia’s second largest and offers the lowest cost—attractive to multinational firms looking to lower labor costs. And the country should have a sustainably productive workforce—the population over 65 is under 6% of the total, median age is 27 and the birth rate is twice Japan’s or Europe’s.

The country’s monetary policy is also fueling growth. Credit is expanding at a faster rate than most Emerging Market countries, helping drive consumer spending. Indonesia recently dropped the rate it pays banks on funds deposited at the central bank—incentivizing banks to make loans rather than holding on to capital. Add to that the country has made progress in reducing corruption and controlling inflation. With per capita GDP at just half Thailand’s and one-third Malaysia’s, Indonesia has huge growth potential.

Heading into 2011, in our view sentiment on Emerging Markets stocks had gotten a bit ahead of itself. But the overall choppy market this year—choppier still for Emerging Markets—has shaken out a lot of that optimism—a positive for stocks overall going forward. Keep in mind, too, Indonesia’s growing capital markets remain fairly small—therefore it’s likely difficult for individual investors to diversify well through individual securities. But if Indonesia continues on its current path, it could become a regional contender.