Deutsche Bank Indonesia strategy : This too shall pass

Near-term distraction 
Concerns over inflation and the perception that Bank Indonesia is behind the curve have led to a significant 25-30% pullback in big caps. Regional trade, moving away from inflation to disinflation countries and emerging to developed markets, may have also exacerbated the market sentiment. As such, nuances on the nature of inflation, i.e. weather-related with no scenario of runaway inflation, gets washed out. So, unless inflation peaks or BI acts to quell such concerns, the negative sentiment may linger, contrary to fundamentals.

Fundamentals remain intact; reiterating our 4,500 12-month index target
Importantly, earnings impact from this inflation is limited, if any. Not only are the cost pressures relatively contained, there are significant drivers to cushion earnings, e.g. 3-4% job growth from the surge in investments and 10-15% wage increases. Indeed the structural growth outlook, as the economy definitively breaks away from its lost decade, far outweighs the near-term headwinds.

Relatively stable rupiah amid outflow 
Recent selldowns have taken out some US$700m from foreign holdings in equity, or almost 20% of the entire inflow last year. In fixed income related, outflow of c.US$1.2bn amounted to c.10% of the entire FY10 inflow amount. However, the rupiah has held up relatively well, thanks to the hefty buildup in FX reserves last year, which reached US$96.2bn, up US$30bn and much more than the collective inflow in bonds and equity of US$16bn.

Reasons why we remain bullish on Indonesia
Inflation unlikely to spiral out of control – no material earnings risk
Rate hike unlikely to derail growth – no credit crunch expected
Real economy is definitively picking up
Stable/strong rupiah outlook
Political noises may rise but not boil over
Commodity up-cycle sustains
Higher oil price unlikely to derail macro stability
Post 25-30% pullback, valuations are more compelling

As such we believe the market weakness would be short-lived and as inflation peaks, market will start to focus on its strong fundamental. Inflation is front-loaded, as ¾ of FY10 inflation was in 2H10; we expect easing in 2H11. Our stock pick criteria; 1) companies with exposure to credit, and its food chain, 2) pricing power amidst rising purchasing power and 3) high barrier to entry on rising investments. Refer to adjacent
table for our top picks

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