Indonesians Too Like Expensive Toilets

The announcement at the end of 2017 by US-based Kohler Co., the manufacturer of high-end kitchen and bathroom fixtures, that it was inaugurating an Indonesian production facility was a matter-of-fact affair. Household-income levels have been spiraling upward; pricey condominiums demand pricey toilets and faucets; the government is working hard to lure foreign direct investment. To celebrate the occasion, the Minister of Industry, Airlangga Hartarto, accepted an invitation to the ribbon-cutting ceremony at the plant, located on the far east side of Jakarta.

The move by Kohler is a harbinger of economic trends in Indonesia. Foreign direct investment in the nation historically centers on key export industries, including coal and palm oil. In contrast, the Kohler plant is producing goods primarily for the domestic market. And while some might suggest that vitreous china is a low value-added product, Kohler executives would argue otherwise. The company’s Indonesian website highlights the benefits of anti-bacterial glaze and touchless technology. Kohler has hired about 1,000 people to work at the facility, in partnership with a nearby vocational school. That increment matters in a nation where about 30% of the work force is tied to agriculture.

Manufacturing is set to be the economic buzzword of choice in Indonesia for the foreseeable future. The National Development Planning Agency (Bappenas) and the Manila-based Asian Development Bank just released a report entitled, “Policies to Support the Development of Indonesia’s Manufacturing Sector.” Despite the deadly title, the publication offers insight on the sort of structural reform that can be achieved to meet economic growth targets over the cycle ahead. There is also a section on Indonesia’s role in the global value chain. International executives who are looking to steer clear of US-China trade friction should take a close look at this material.

Increases in capital investment for manufacturing, whether targeting domestic or international distribution, should have a healthy impact on the Indonesian economy. Assuming policy levers work correctly, some estimate that the nation could reach annual growth targets approaching 7% over the cycle ahead. The World Bank offers a more conservative view of about 5.0%-to-5.5% in each year between now and 2021. In this commentary, we avoid debating the nuances of these numbers. We suggest, however, that cautious analysts will revise their estimates upwards in the second half of 2019.

Economic policy will tread water in Indonesia for the next several months, given the hotly-contested April presidential race. The incumbent Widodo and his rival Prabowo are locked into a replay of the 2014 election. Ostensibly, Widodo is campaigning more aggressively on economic issues than his opponent because of his administration’s mangled record on achieving growth targets. The actual election outcome may not be that important for global investors. Regardless of who wins, foreign companies should expect to see a parade of fiscal incentives later this year, especially since foreign direct investment data for 2018 was oddly weak.

Even though the government aims to amplify the role of manufacturing in the economy, Indonesia is not an also-ran in secondary industries. Manufacturing value added as a component of national output is about 20%, according to World Bank data. That figure hovers some four percentage points above the global average. Indonesia only lacks shine in a regional context. The number in China is 29%. Among ASEAN member states, Thailand delivers 27% and Malaysia registers 22%.

The Kohler decision to set-up a manufacturing plant in Indonesia was a predictable one for a company that already has outposts across Asia. We are still fond of the example. This case study offers unconventional perspective on household income, property development, and domestic demand. And the fact that their Indonesian investment lagged their other commitments in the region underscores the still-fertile character of the market opportunity.

Our Vantage Point: Indonesia is offloading its reputation as primary-industry powerhouse. Further policy shifts favoring the manufacturing sector will become apparent after the April presidential election.

Learn more at the Asian Development Bank.

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Image: The population of Jakarta alone is more than 10 million. Credit: Kellkinel at Can Stock Photo Inc.

How Should Investors Frame Kandy Riots?

Kandy is located in the mountainous interior of Sri Lanka

Some analysts dismiss the ethnic attacks in Sri Lanka last week as a purely domestic affair. Globalists should be less cavalier. The tragedy is a sobering reflection on our collective failures; it also is a jarring reminder of headline-grabbing violence elsewhere in the developing world. The threats and emergencies that sprout from these conflicts have important implications for global business strategies.

Mob violence broke out around the central city of Kandy last week. Longstanding tensions careened out-of-control when a Sinhalese truck driver was killed by a group of Muslim men in a road-rage incident. That confrontation quickly escalated to widespread attacks on the Islamic community. Muslims represent about 10% of the Sri Lankan population, but they control a disproportionate amount of local commerce.

News reports have identified three deaths. As many as 200 Muslim homes and businesses were sacked. Eleven mosques were damaged or destroyed. The government responded by announcing a nationwide state-of-emergency and deploying military units to civilian areas. About 150 provocateurs were arrested. A judiciary board has now been appointed to investigate the breakdown of law and order.

For cross-border investors, the Sri Lankan faultline spotlights three issues that are relevant both here and elsewhere:

Emerging-Market Companies Handle Risk Nimbly

The economic disruption from the Kandy riots will likely have a greater-than-expected impact. Sri Lanka is a trade juggernaut, but its domestic economy is heavily exposed to the volatile tourism industry. Fortunately, local corporations understand this risk because of the nation’s civil-war heritage. Most have diversified activities that backstop domestic stress. As one example, John Keells Holdings, the largest company in Sri Lanka, has reach to marine logistics and information technology, among other verticals.

Social Media Plays Huge Role in Developing World

Amid the Kandy riots, the government ordered a shutdown of Facebook, WhatsApp, Instagram, and Viber to control hate speech and false news. For investors, the action emphasizes the influence of social media in the developing world, in ways that we may not completely understand in mature economies. Consumer brands, including banks, have either skipped through the brick-and-mortar phase of the business lifecycle, or avoided it altogether. Major markets are behind that curve.

Investors Generalize News to Their Detriment

Although some outside observers may think that these now-dissipated riots are a country-wide phenomena, Sri Lanka is not ablaze. The violence has been largely contained to a single region in the middle of the island. We note that the Central Province—where Kandy is located—is materially smaller in population than the Colombo metropolitan area. The dominant economic corridor on the west coast, while not immune to social friction, has largely deflected communal violence since its own flare-up four years ago.

Sri Lanka attracts boutique portfolio and direct investors. The nation benefits heavily from capital flows sourced in the Middle East and Asia. Among Western names, the market opportunity tends to be overlooked in favor of the larger stories, but Sri Lanka does stand comfortably among regional rivals. One reason that stock-market allocators, for instance, have seen comparatively strong returns is because Sri Lankan companies are heavily exposed to the cyclical uptrend in the global economy. The broad MSCI index for the country has gained 5.7% in US dollar terms since the beginning of the year, including the dip provoked by ethnic clashes in Kandy.

Our Vantage Point: Conflict in Sri Lanka, while tragic, also provides a roadmap for investors to manage their exposure to the developing world. We caution about writing off the news as merely a local matter.

Learn more at Al Jazeera.

© 2018 Cranganore Inc. All rights reserved.
Unauthorized use and/or duplication of any material on this site without written permission is prohibited.

Image: The Central Province has a population of about 2.5 million; Kandy is the largest city. Credit: Ziggymars at Can Stock Photo Inc.

Bank Stocks Lure Investors to Colombia

Bogota is a high-altitude capital

The bombings in the northeast city of Barranquilla at the end of January are a savage reminder of the evolving political setting in Colombia. Despite the government’s signature agreement with the Revolutionary Armed Forces of Colombia, commonly called FARC, other terrorist groups continue to operate. In this most recent incident, the National Liberation Army, known as ELN, claimed responsibility for the series of attacks, killing seven police officers and wounding dozens. Cross-border investors are unnerved by these headlines.

Isolated terrorist incidents, albeit tragic, will not derail a strong economic story. In Colombia, GDP growth could reach 2.9% this year, well above the 2.0% or so expected on average in Latin America. Recovering commodity prices are a huge boost, so too are outsized infrastructure outlays. As a testimony to this growth outlook, the Colombian central bank announced that its 25 basis point interest-rate cut at the end of January would be the last for this easing cycle.

Global investors tend to focus on headline political developments in emerging markets in ways that local investors do not. Politically-motivated violence has been a recurring backdrop in Colombia for at least two generations. FARC, for instance, was formed in 1964. The stock market was volatile after the recent Barranquilla bombings, but that actually reflected oil-related trading patterns in Ecopetrol, the largest single stock by capitalization on the Colombia Stock Exchange. The broad-based Colcap Index is otherwise up a dollar-based 11% in the year-to-date period through February 2.

Ecopetrol is the local blue-chip benchmark. Colombia ranks as a top 20 oil exporter; its capacity is similar to the United Kingdom or Azerbaijan. Ecopetrol controls a dominant portion of the domestic business, although it is not a strict monopoly. Among cross-border investors, Ecopetrol is considered a more conservative portfolio holding than Pemex and Petrobras, the Mexican and Brazilian oil giants. If the oil price continues to improve, Ecopetrol’s stock price should also be buoyant.

The real gem in Colombia, however, may be the financial services sector, representing the largest component of the domestic economy at about 20% of GDP. One reason for that largess is that the country runs a mandatory pension-contribution system. The combined market capitalization of the major bank stocks is near one-third of the total stock market, or about twice the size of Ecopetrol.

Global investors should be encouraged by the fundamental story among Colombia banks, the largest of which is Bancolombia. You can scratch the classic emerging-market stereotype of slow-to-innovate financial institutions that are dogged by government regulation. As a group, these banks are altogether different. We see two trends worth watching, both of which should propel bank stocks over time:

Asset Growth. Financial inclusion rates are low. According to the World Bank, only 39% of the Colombian population over 15 years old has a bank account. Compare that to 68% in Brazil and 63% in Chile. As the volume of bank accounts grow, the role of credit in the economy should also expand.

Financial Technology. The major Colombian banks are highly profitable, empowering them to go on a startup acquisition binge, especially among local fintech players. Average return-on-equity among the major banks is close to 15%, compared to about 10% among US banks. The ratio is lower in Europe.

The fintech angle deserves attention. Colombia has the third largest number of fintech companies in the region at 124 firms, compared to 230 in Brazil and 238 in Mexico, according to Finnovista, a venture-development consultant. Take-over expectations may be one reason why valuation levels among some Colombian startup companies are so lofty, in our view. Acquisitions by traditional banks of fintech companies could have a further impact on enterprise innovation.

The dark shadow lingering over the investment story is the May presidential election; there is also a March parliamentary vote. President Santos is constitutionally barred from running again. He is also deeply unpopular. One reason is that many feel the FARC deal is overly generous. Another is ongoing corruption scandals. A prominent case involves bribes paid by the Brazilian construction giant Odebrecht to Colombian officials.

Santos’ weak approval rating opens the door to emerging national politicians. The front runner is Sergio Fajardo, a recent governor of economically-powerful Antioquia Province, where the city of Medellin is located. Yet Fajardo is vulnerable. Provincial debt levels ballooned enormously under his leadership. The opposition is likely to paint him as a fiscal profligate. Adding texture to the race, the former FARC guerilla commander Timochenko is now set to run in the May election.

The political setting could upend interest in the stock market over the next few months, but we are still drawn to the opportunity because of the underlying growth potential. A primary focus is the robust banking sector. We are prepared to look beyond sporadic violence. Local companies can probably manage that risk better than distant analysts.

Our Vantage Point: Global investors may be surprised at the upside potential in Colombian equities in 2018. We expect to see most of those prospective gains in the second half of the year, after investors are more comfortable with now-uncertain election results.

Learn more at The New York Times.

© 2018 Cranganore Inc. All rights reserved.
Unauthorized use and/or duplication of any material on this site without written permission is prohibited.

Image: The capital city of Bogota has a population of about 8 million. Credit: Ostill at Can Stock Photo Inc.