Credit Suisse Asia Equity Focus Indonesia strategy -Correction triggered by inflation fears

With yesterday's 4.6% decline in the Jakarta Composite Index (JCI), the Indonesia market has corrected by approximately 7% in the last two trading days. Inflation in December 2010 hit a 20-month high of 7%. As the core inflation rate of 4.28% is still below Bank Indonesia's 5% target threshold, the central bank left its policy rate unchanged at 6.5% at its most recent meeting on 6 January, triggering inflation fears. The central bank downplayed the inflation risk, maintaining that rising price pressure was due to soaring food prices which can be addressed by improving supply. Our economist is projecting an average Consumer Price Index of 6% for the year and a 100 basis point rate hike to 7.5% by end-2011.

Based on the events of 2005 and 2008, when the equity market lost ground in the three months after inflation spiked above 7%, the JCI could remain under pressure in the near term. The next central bank meeting is on 4 February. However, the correction, led by foreign investors who turned net sellers (net foreign selling of USD 190 m between 6 January and 7 January versus net foreign buying of USD 160 m between 3 January and 5 January), has led to an improvement in the market valuation to a P/E 2011 of 13.8x, although it is still at a premium to its 10-year historical average of 12.3x.

We believe the current sell-down provides a window of opportunity for investors to buy into our preferred consumer and infrastructure-related sectors for the multi-year growth story. Our TOP PICKS are Indofood (INDF IJ, BUY), Indosat (ISAT IJ, BUY) and United Tractors (UNTR IJ, BUY). Although rising inflation could adversely affect consumer demand through reduced purchasing power, spending on noodles consumption and telecommunications tends to be non-discretionary and form a low proportion of overall household spending; we therefore expect them to remain resilient. Premised on its vertically integrated business model, Indofood should also benefit from higher crude palm oil and flour prices through its wheat mill and agribusiness subsidiaries. For United Tractors, higher interest rates could impact demand for heavy machinery due to higher financing costs, but we believe this should be offset by earnings growth at its coal contracting subsidiary, which is well positioned to benefit from rising coal prices. We maintain our end-2011 JCI target of 4,300. In the medium term, we see two major developments as having a positive impact on the market. Firstly, the passage and implementation of the land acquisition reform bill could expedite the land acquisition process and herald more infrastructure investments. Secondly, an upgrade in Indonesia's sovereign credit rating on its strengthening debt and foreign currency reserve position could potentially drive more foreign investment into the market. For a more detailed report on Indonesia, please refer to the RWA published on 7 January 2011.