Insights

Global Macro Trends
Volume 3.5 • June 2013

Indonesia: Transitioning Potential Into Reality

Indonesia: Transitioning Potential Into Reality
In a world increasingly starved for growth, we believe Indonesia has several substantial macro tailwinds that will continue to drive its GDP higher – and potentially with lower than average volatility. However, recent economic growth has come at a significant cost, and in our view, the country now needs to address the notable increases in both its fiscal and current account deficits. If the country can successfully address these challenges, then we think Indonesia could represent one of the more compelling opportunities in the global capital markets over the next five to seven years.

KKR Global Macro & Asset Allocation Team Henry H. McVey Head of Global Macro & Asset Allocation +1 (212) 519.1628 henry.mcvey@kkr.com David R. McNellis +1 (212) 519.1629 david.mcnellis@kkr.com Frances B. Lim +1 (212) 519.1630 frances.lim@kkr.com Rebecca J. Ramsey +1 (212) 519.1631 rebecca.ramsey@kkr.com

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Insights: Global Macro Trends

education.7% of total GDP on fuel subsidies to placate an increasingly vocal voting base2. which is taken from a 14th century poem. Indonesia is one of the demographic ‘elite’ countries.’ A key culprit for this conundrum is the country’s fuel subsidy program. which is significant as the OECD is projecting middle class consumers in the region to increase by a staggering 515% to 3. particularly on social services and infrastructure. 3 Ibid. I thought it might make sense to detail some of my impressions from my recent trip. is “Unity in Diversity.5% for Thailand and 13.2. 2 Data as at May 31. 2012 GDP per capita was just $3. and education/training all as attractive markets. Source: MSCI. Factset. Source: Departemen Keuangan. Haver Analytics. Source: Biro Pusat Statistik. To this day. the country is also misdirecting its limited government monies away from the infrastructure. fulfill its long-term potential. suggesting that the government can and probably should spend more. to tackle an agenda that was 100% work-related. and spend time in cities like Surabaya and Medan. 70% of Indonesia’s exports now stay within Asia. it also applies to the country’s rich backdrop of religious. the government now spends 3. IMFWEO. compared to 1. Credit Penetration and Government Leverage Are Still at Attractive Levels Even with a 20% CAGR over the past five years. by visiting existing ports. the marginal return on credit growth is still quite high. Indonesia is now one of the few Asian emerging market (EM) countries with both a fiscal and current account deficit. over the last five years productivity has been 4.596.” Importantly. KKR GMAA calculation. 2012. we believe. this type of policy is extremely shortsighted and has already begun to create significant currency and inflation concerns. but faster growing and more dynamic parts of the country’s economy. return on equity for the Indonesia index of publicly traded companies is around 21. 2013. Despite Strong Growth. Jakarta accounts for 20%+ of GDP growth1). Why? Because we believe it gives an investor a true appreciation for the smaller. healthcare and education initiatives that the country desperately needs to 1 Data as at March 6.4%. this trip too was quite memorable as I left the country with a sound understanding of why Indonesia is becoming such an important linchpin in the meteoric rise of the overall Southeast Asia region in the global economy. as history shows that such misguided spending can often act as a cancer. trailing only China and India. when I touched down in the country’s largest city.6% in a country like Brazil. Given such strong tailwinds. transportation. and as such. Moreover.. gross government leverage as a percentage of GDP fell to just 24% in 2012 from 95% in 2000 (Exhibit 14).5% versus 16.g. 5 Data as at December 31. I trekked to Bukit Lawang in northern Sumatra with my best childhood friend to see orangutans in the rainforest.When I first went to Indonesia in 1995. and I spent the lion’s share of my time in Bali with my wife snorkeling and surfing near the beautiful beaches and then hiking upland in the country’s lush rainforests. 4 Data as at May 31. This viewpoint is not to be under-estimated. the nation’s capital and economic power (e.5 However. we see health and beauty. 2013. But to fully understand what is changing in Indonesia. High Corporate Sector Profitability in Fast Growing Region of the World Indonesian companies are highly profitable. and infrastructure can materially accelerate improvements in the country’s GDP per capita. In our view. Nonetheless. domestic credit to the private sector in Indonesia was just 33% of GDP versus 55% for India and 130% for China in 2012 (Exhibit 13). Within this consumer market. an investor gains a better understanding of how even small improvements in technology. In fact. Indonesia now boasts an economic trajectory that is on pace to become a top-10 economy by 2030. By overspending on fuel subsidies. a few weeks back. Source: Badan Pusat Statistik. I guess there is—indeed—a reason that Indonesia’s national motto. roads and retail outlets in these smaller cities.2 billion by 2030 versus 525 million in 2009. So. leisure. with India being the only other major EM country with this ‘distinction. the tall buildings. However. Indeed. All told. KKR Insights: Global Macro Trends 3 . using both its “unity” of purpose and “diversity” of resources. So as one might imagine.  Overall. ranking among the most lucrative in Asia. What they suggest — and the numbers seem to bear out — is that the country’s average annual productivity is quite strong and likely to remain so. Turkey and Brazil. Given these substantial macro cross-currents. 3/5 the level of China and only 1/3 the level of Brazil (Exhibit 22). My next trip to Indonesia was in 2001. and we look for a further 40% aggregate increase from 2012 to 2017. Potentially more important to investors is that Indonesia’s consumer economy could become the third largest by 2050. destroying both long-term productivity and potential growth. strong profitability represents not only sound execution but is also reflective of the positive macro tailwinds that Indonesia enjoys by being part of the fast-growing Southeast Asian region. Haver Analytics. All told. Meanwhile. After more than a decade of notable discipline surrounding macro-related matters. They are as follows: Favorable Demographics Will Likely Drive Further Increases in GDP per Capita Similar to India. economic success in recent years has come at a significant cost.5% for Malaysia4. cultural and commercial diversity. it remains one of the highlights of my international travels. traffic and crowds were all certainly a shock to my previous memories. This low ratio is important because it means that demand has not been artificially pulled forward. Biro Pusat Statistik. Already. Indonesia’s debt statistics are even more impressive when matched against the backdrop of country’s strong 6% annualized real GDP growth rate (Exhibit 8). Jakarta. Instituto Brasileiro de Geografia e Estatística. There Are Definite Signs of Economic ‘Slippage’ In 2012. though. Indonesia is projected to be the fourth biggest consumer economy in the world by 2030 versus just 18th today (Exhibit 10). our recommendation is that folks need to get out of Jakarta. with 50% or more of its population under the age of 30 (Exhibit 17). In our view. The good news is that the gap is now narrowing as Indonesian GDP per capita (in USD) has compounded at an annual growth rate of 18% between 2005 and 20113. ethnic. 2013. Indonesia’s breadth of offerings is not limited to just geography.

interest rates rising. slightly better than Brazil and India but more difficult than China.2. Indonesia is ranked 128 out of 185 economies. 2. To put this in perspective. 2013. 7 Ibid. in a world where it is increasingly hard to find growth. this ranking could fall further after it was announced that foreigners owning local mines must “sell back” their properties to locals by 2018. which now totals around 3. Indonesia may be forced to make adjustments to its deficits precisely at a time when its cost of capital is now almost certain to rise. And with reasonable productivity. not volume (Exhibit 46).0 4. including services and infrastructure. and it is likely to pressure emerging market currencies and interest rates in the future. palm oil and rubber8. as has been consistently documented in the press. Source: Bloomberg. Hard Place to Do Business According to the World Bank’s Ease of Doing Business Index for 2012. Source: MSCI. Exhibit 1 Indonesian Equities Have Re-rated Since 2004 Indonesia: Forward Price-to-Earnings 18 16 +1 14 12 10 8 6 4 01 02 03 04 05 06 07 08 09 10 11 12 13 Avg. they often portend an imminent ‘adjustment’ period. Unlike many of the larger and higher profile EM countries. we think that Southeast Asia. while its fiscal deficit reached negative 2.0 5. and its resource base is richer in many instances than some higher profile emerging markets like China. India. crude oil.0 91 93 95 97 99 01 03 05 07 09 11 13 +1 Avg. Recent results seem to reflect this view as real 1Q13 GDP fell to 6. 2013. and Brazil. driven largely by declines in the prices of coal. the country can move faster to capitalize on the significant opportunity to leverage its recent ‘commodity dividend’ into other areas of the economy. In 2013. Need to Translate Recent Commodity Economy Into a ‘New’ Services-based Economy In our view. 74% of the increases in exports in 2011 were driven by price. the issues surrounding these deficits have only gotten more challenging. 2013. Importantly. including currency weakness and/or inflation headwinds. The risk of missing this opportunity is significant as the economy still has 35% of total employment related to agriculture. Finally.3 -1 Data as at May 31. Source: Factset Aggregates. corruption remains an ongoing issue in Indonesia that foreign investors must consider carefully. At the moment. Twin deficits are rare in fast growing economies. And with China now shifting its growth priorities towards less capital-intensive growth. Exhibit 2 But Indonesian Equities are No Longer Cheap Indonesia: Trailing Price-to-Book 6. Exacerbating the issue is the country’s large fuel subsidy program. Indonesia has a more balanced economy.0% y/y from 6. Indonesia in particular.7% current account deficit. We also heard repeated concerns from business executives about the growing power of labor and its impact on operating results.2. margins and operating flexibility in particular. its debt load is lower. the competition for capital is now going up. the outlay for its current fuel subsidy program is almost equal in both absolute dollars and as a percentage of GDP to what the government now spends on public healthcare and education programs combined7. we think GDP growth in Indonesia is likely to disappoint in the nearterm. We certainly acknowledge that the government is now in the process of reigning in spending on fuel subsidies.0%6. Indonesia has just 39% of its industry in services versus 56% in India and 68% in Brazil (Exhibit 16).9 Data as at May 31.0 2.0 3.0 0.8% in 4Q2010.S. there is already heightened risk that Indonesia may have already missed its window of opportunity. 11. Finally.Indonesia ran a 2.8 May-13 3. Public valuations are now rich in many instances at a time when significant wage growth is beginning to pressure margins. Given that the Fed may now be finally withdrawing excess liquidity. but – unfortunately – it appears that the monies will be redirected towards other programs that keep its imbalances at notable levels. moreover. driven largely by lower commodity prices and weaker export growth. there are several reasons why some patience and skepticism is required.0 -1 1. And with U. growth should shine bright on both a relative and absolute basis. Factset. In the near-term though. 4 KKR Insights: Global Macro Trends . represents one of the more compelling long-term investment destinations. 8 Data as at May 6.1% versus a mandatory legal limit of 3. and as such. Indonesia’s GDP 6 Ibid.7% of GDP. So what is our bottom line on Indonesia? Simply stated.2 May-13 15.

the speed and – potentially more importantly – the steadiness – of Indonesia’s growth rate is a notable point of distinction. Also. a higher score indicates more restrictions) 3. Source: OECD. Biro Pusat Statistik. private equity investors may need to work harder with the local communities in which they invest to navigate the secular trend towards increasing government intervention. Data as at December 31. Exhibit 4 Its Sovereign Bonds Are Now Too Under Pressure YTD Change in 10-Year Govt Yields (bp) 175 150 125 100 75 50 25 0 -25 -50 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 U. GDP: Consistently Strong In a world of increasing macroeconomic instability.S. despite the fact that exports were actually negative for the first time in eight years (Exhibit 8). 2013.S.5 1. Equally as important. On the private side.5 0. 2013. 2013. for example. see www. 2008.5 3.0 U. Source: Departemen Keuangan. To find out more about the methodology used to calculate the OECD employment protection indicators.Exhibit 3 Exhibit 5 Given the Country’s Imbalances. they should be good partners with strong operational capabilities and industry expertise. but so too is a regional one to be able to compare and contrast both macro and micro influences affecting current investment decisions and business trends across the region.5 2.0 0. the Indonesian Rupiah is Now Beginning to Depreciate Indonesian Rupiah Spot Exchange Rate (USDIDR) 8500 8700 8900 9100 9300 9500 9700 9900 10100 10300 10500 Jan-11 May-11 Weaker Rupiah Large Subsidies and Weak Tax Collection Have Widened Indonesia’s Imbalances Indonesia: Fiscal Balance % of GDP (Left) Indonesia: Government Revenue % GDP (Right) Indonesia: Government Expenditure % GDP (Right) 2 1 0 -1 -2 -3 2010 2000 2002 2004 2008 2006 2012 Turkey 1990 1992 1994 1998 1996 25 20 15 10 5 0 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Data as at June 18. Source: Bloomberg. 2008 (Scale 0-6. Source: Bloomberg. a local presence is likely required. KKR Insights: Global Macro Trends 5 .0 1.2% growth rate.oecd. Data as at June 19. the country maintained a 6.org/employment/protection.0 2. private equity firms should bring more than just their capital base. nationalism and income equality. In 2012. From our vantage point. Brazil Indonesia Greece India Mexico Russia China Data as at June 20. Haver Analytics. Korea Thailand Indonesia Malaysia China Singapore Exhibit 6 Indonesia Has Rigid Employment Policies OECD Employment Protection Index. IMF WEO. given that the cost of capital is now so low relative to history. the story is even more complex.

biro Pusat statistik.9 0.0 2030 IndIa chIna u.6 21. World 4. IndonesIa JaPan russIa GermanY meXIco braZIl France World 12. source: Instituto brasileiro de Geografia e estatística. If there is a shortcoming in GdP composition. source: brookings Institution.1 1. IndIa JaPan GermanY russIa France IndonesIa meXIco u.9 0.0 1. GDP Composition (2012) 60 Brazil 57 56 48 35 28 21 20 9 20 1 3 34 India Indonesia China Relatively Low Volatility for High Single Digit GDP Growth 6 Stdev of Real GDP 2000 to 2012 (%) 5 4 3 2 1 0 0 2 4 Indonesia 6 8 10 Brazil European Union China Laos Korea Cambodia Real GDP vs.285 deV/doc (2010). one can see the stability and breadth of recent economic trends in Exhibits 7 and 8 below.2% in 2012 Indonesia: Real GDP Y/y (%) Statistical Discrepancy Gross Fixed Capital Formation Private Consumption 8 6 4 2 0 -2 -4 00 01 02 03 04 05 06 07 08 09 10 11 12 Net exports a drag to growth for the first time in eight years Net Exports Government Real GDP Fiscal stimulus and strong credit growth off set weak external conditions 9 10 data as at may 6.2 1.0 35. and china national bureau of statistics.5 2..0 4.3 1.7 2. Indonesia’s government contribution to GdP substantially lags that of its peers. 2013. Average Real GDP 2013 to 2018 (%) exhIbIt 10 data as at april 16. …And By 2030 Should House the World’s Fourth Largest Consumption Market ToP 10 CoUnTRIeS: MIDDle ClASS ConSUMPTIon (TRIllIonS of 2005 PPP DollARS) 2009 1 2 3 4 5 6 7 8 u. we would argue that it is the government’s low spending ratio.9 0. exhIbIt 7 exhIbIt 9 Indonesia Has a Relatively Balanced Economy.. Volatility Turkey Singapore 14 Consumption Government Investment -1 -6 Net Exports PPP=purchasing power parity. many emerging markets we visit are either overly reliant on low-end exports and/or high fixed investment.3 3.and over the last 12 years.K. the country has had among the lowest volatility and cyclicality of GdP in the major economies we follow.8 1.0 1. 2013. as one can see in Exhibit 9. KKr Global macro & asset allocation calculation. a major reason for Indonesia’s success is that the economy is not too dependent on one sector or product.7 0. In particular. Real GDP Was 6.K. 2013. by comparison. data as at January 2010.7 exhIbIt 8 Despite the Net Export Drag.5 4. russIa chIna ITalY meXIco braZIl World 4. source: ImF estimates.4 1.9 0.2 1. India central statistical organization. the Indonesian economy has its own vibrant domestic consumption economy. source: biro Pusat statistik. JaPan GermanY France u. data as at June 4.2 0.0 2.8 10. oecd development centre Working Paper no.s.s. PPP = purchasing power parity.3 2020 chIna u. haver analytics.3 1.1 55.4 1.2 1.7 0. 6 KKR InsIGhTs: Global macro Trends .2 1.4 1.s.

Vietnam.000 Rural Indonesia 5. “ We see health and beauty.9 31 7 30 6 26 100 50 100 Data as at 3Q2012. 203 160 135 130 128 124 Exhibit 12 Japan Thailand China Malaysia Singapore Vietnam Brazil Turkey India Indonesia Philippines Mexico 33 33 25 65 56 55 Growth in Smaller Cities Will Outpace Jakarta GDP compound annual growth rate 2002-10 Jakarta Large middleweights cities 5million-10million Midsized middleweights cities 2million-5million Small middleweight cities 150. Brazil and Mexico. the low level of credit gives us comfort that strong underlying GDP trends will not be overshadowed by de-leveraging in any part of the economy. the manufacturing sector has become more formidable as the country transitions from low-end manufacturer (food processing and clothing) to higher value-added products like equipment and machinery. leisure. and education/training all as attractive markets. While it certainly may not feel that way when stuck in one of Jakarta’s well-documented traffic jams.4 5. Source: Bank for International Settlements. Haver Analytics. a lot of the fastest growing parts of the country are smaller cities outside Jakarta where the introduction of basic services like the Internet. transportation.7 Share of GDP 2010 19 6 11 Share of Total Population (%) 4 5 6 109 6.9 5. water infrastructure and public transportation are all helping to drive growth (Exhibit 12). Indonesia has also been able to grow its economy without the use of significant leverage from either the government or private sector. Haver Analytics. Credit Penetration Is Low… 2012 Domestic Credit to Private Sector % GDP U.Exhibit 11 Productivity in Indonesia Is Relatively High Indonesia: Real GDP Y/y (%) Labor Force 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 1961 1964 1967 Productivity Real GDP As these cities become more modern. (2) Population estimates as of May 11. as we mentioned earlier. Respective National Statistical Agencies. Source: United Nations World Population Prospects. “ 7 KKR Insights: Global Macro Trends . Malaysia. Third. we believe it will continue to drive productivity levels higher. in terms of downside protection. including India. which provides an inherently attractive productivity tailwind. These low leverage ratios are hugely important for several reasons.S. there is an ongoing shift from a rural to an urban population. Indonesia’s productivity growth is notably above other emerging market countries. Third.000-2million Other cities <150. Another key attribute of the economy is that Indonesia is blessed with strong productivity (Exhibit 11). no sector of the economy appears to be over-earning by using credit to facilitate strong growth. Importantly. Source: McKinsey Global Institute “The archipelago economy: Unleashing Indonesia’s Potential” dated September 2012.3 5. We link the strong productivity to several things. leverage levels are so low that there is actually the potential to help improve the build-out of key industries like housing.9 5. First. Second. which can serve as an important cornerstone in the trend toward urbanization/GDP per capita. First. Second. Philippines. 2011. Source: Biro Pusat Statistik. One can see this in Exhibits 13 and 14. Exhibit 13 President Suharto 1968-1998 1998 Habibie 1999 Wahid 2001 Megawati President Susilo Bambang Yudhoyono 2004-current 1970 1976 1991 2000 2006 2009 2003 1985 2012 1982 1988 1994 1997 1979 1973 (1) Real GDP as of 2012.8 6.

2013. To be sure. and it is also among the leaders in rubber production. Exhibit 16 …While the Services Sector Is Relatively Small 2012 GDP by Industry (%) Indonesia China India Brazil 47 45 39 26 26 14 17 10 5 Manufacturing. There is also significant opportunity for GDP growth in the country’s services sector. Equally as important. Our trip also left us with the distinct impression that there is a major opportunity to make the country’s remaining agricultural sector more productive. A key reason is that credit penetration is relatively low. 8 KKR Insights: Global Macro Trends . Brazil India Malaysia Vietnam Mexico Philippines Turkey Korea Indonesia China 238 111 107 68 67 55 52 44 42 36 34 24 23 The Agriculture Sector Is Still Relatively Large… Agriculture % Total Employment Vietnam (2009) India (2010) Indonesia (2012) China (2011) Philippines (2012) Turkey (2011) Brazil (2009) 17 25 35 35 32 52 51 Data as at April 16. the country is still a net importer as at 2012. Rice is still the country’s staple crop. the country already has enough internal demand to make it less dependent on the global economy to meet its growth forecast. Indonesia’s services sector is still relatively small at 39% of GDP. So while there is more work to be done in terms of more focused government spending and the need to energize the private sector to do more in partnership with the government on the infrastructure front. India Central Statistical Organization.S. but wages are rising. Haver Analytics. The country is also now the world’s second largest producer of palm oil. and GDP per capita is ticking higher. As a result. pushing heavily for improved farming techniques. Source: IMF WEO. Haver Analytics. the government is starting to do its part. As Exhibits 15 and 16 illustrate. Source: World Bank. India and Brazil all have services sectors that are between 6 to 29 percentage points of GDP higher than Indonesia. Importantly. Construction & Mining Services Indonesia services sector is still relatively small 45 68 56 Agriculture & Livestock Data as at April 15. China and Brazil. we believe the Indonesia GDP growth story is not likely to suffer the same significant slowdown in GDP that we are seeing in India. but just a modest 15% of total GDP. IMF. we think that the long-term outlook for the country makes it an attractive destination for emerging market-oriented growth capital.Exhibit 14 Exhibit 15 …As Is Government Leverage 2012 Gross Government Debt % GDP Japan Singapore U. but given surging demand. Data as at December 2009-2012. the country’s retail and lending segments of the services market are still in their infancy relative to many other emerging market countries. Source: Biro Pusat Statistik. spending is growing. and with low credit penetration and a modest GDP per capita. including fertilizer improvements and more sophisticated seeding. China. agricultural employment accounts for a full 35% of total employment. By comparison. export growth linked to commodities and international trade is likely to disappoint in the near-term. As Exhibit 16 shows. Haver Analytics. China National Bureau of Statistics. 2013.

Philippines Cambodia India Mexico Indonesia Vietnam In aggregate. basketball star michael Jordan When it comes to consumption. exhIbIt 17 exhIbIt 18 The Demographic Dividend Crests in 2036 Working Age Population Indexed: 2000 = 100 Indonesia Indonesia’s working age population will only peak in 2036 China India Brazil 2052 180 160 140 120 100 80 2036 2032 2016 2012 2000 2016 2004 2040 2008 2020 2044 A Young and Growing Population. Indonesia will have the third largest middle class population in the world. they often portend an imminent ‘adjustment’ period. with huge consumption potential. or 18% of the total population today (Exhibit 20). 2012. or 35-45% of the total population by 2030 versus 45 million. China Young and growing population data as at september 26. source: united nations World Population Prospects.Consumption: Demographic Tailwinds Are Favorable Some people want it to happen. source: united nations World Population Prospects. some wish it would happen. haver analytics. behind only china and India (Exhibit 21). Indonesia’s working population is not likely to peak until 2036. Indeed. as Exhibit 17 shows. this trend is likely to gain momentum because. Indonesia’s middle class is expected to grow to 95-125 million people. 2012. others make it happen. and if one has the time and patience to look out to 2050. Indonesia has a pretty good balance between savings and consumption. as we show on Exhibit 18. “ source: hsbc report “consumer in 2050” dated october 2012. Indonesia has not only a young population but also a growing one. Fourth Largest in the World Total Population Growth 2030 vs 2010 (%) 50 40 30 20 10 0 -10 -20 20 30 40 50 60 70 Percent of Population Under Age 30 (%) Hong Kong Spain Germany Japan Russia Australia Singapore Turkey Brazil U. Importantly. which is already the largest part of the Indonesian economy at 56%. 2060 2048 2056 2052 2028 2032 2036 2024 KKR InsIGhTs: Global macro Trends 9 . which needs to encourage savers to spend. there is no question that Indonesia is in the michael Jordan “make it happen” category. “ Twin deficits are rare in fast growing EM economies. and unlike a country like china. and as such.S. haver analytics. exhIbIt 19 The Current Middle Class Is Only About 45 Million… 200 150 100 50 0 Turkey Saudi Arabia Colombia Malaysia Argentina Mexico Egypt Brazil Peru Pakistan Thailand Poland Indonesia Russia Philippines China India 2011: Size of Middle Class Population (millions) China’s middle class is estimated at 300-400 million data as at september 26.

596 2017 5. 51. we expect the trend towards rising GDP per capita to maintain strong momentum over the next five to seven years. 2013.9% CAGR Indonesia Estimate 7. 2012 quoting Deputy Finance Minister Mahendra Siregar. reaching 57% percent over the next five to seven years.000 3. Data as at April 16. Haver Analytics. “ 10 30 20 10 0 2000 1980 2004 1960 1992 1988 1984 1996 1964 1968 1972 1976 2008 2012 Data as at March 18. IMF.000 1. urbanization is only around 51-52% of the total population (Exhibit 23). At the moment. 2013. the Indonesia story is really about staying the course. KKR Insights: Global Macro Trends . So unlike the “catch-up” in urbanization that some are forecasting in India or the rebalancing that some are forecasting in China. Indonesia Will Have the Third Largest Middle Class Among Emerging Markets 800 700 600 500 400 300 200 100 0 Pakistan Turkey Thailand Brazil Egypt Indonesia Saudi Arabia Argentina Colombia Malaysia Mexico Poland Russia Philippines China India Peru Third largest middle income population among emerging markets 2050: Size of Middle Class Population (millions) Given its strong demographic profile and shifting economic drivers. Source: Biro Pusat Statistik.Exhibit 20 Exhibit 22 …But it Is Growing Rapidly Indonesia: Population (millions) Middle Class Population Total Population GDP per Capita Should Grow by 40%.000 2.8 51.4% Annually. 517 2000 1982 2006 2009 1988 1994 1970 1979 1973 1976 1991 2012 85 31.000 280 5. or 7.7 2016 2003 2015 2020 2018 1985 1997 14. Exhibit 23 Urbanization Moving in Sync with China Urban Population % of Total 90 80 70 60 50 40 Indonesia China India Brazil Source: HSBC report “Consumer in 2050” dated October 2012. Over the Next Five Years Indonesia: GDP per Capita (US$) 6.136 245 Middle class is 18% total population 45 Middle class is 35-45% total population 95-125 2012 2030 0 Source: Article by Asosiasi Pengusaha Indonesia dated October 8. Source: World Bank.000 4. We believe this can easily continue to increase on an annual basis by 70-80 bps. Haver Analytics.5 “ The long-term outlook for the country makes it a highly attractive destination for emerging market-oriented growth capital. Exhibit 21 By 2050.000 1998.4% CAGR 2012 3. including steadily lifting GDP per capita via urbanization efforts in many of its smaller cities.

education spending in Indonesia is still well below many of its emerging market peers on a per capita basis. China National Bureau of Statistics.0% of GDP 6. Education and Training One of the great ironies of visiting an emerging market like Indonesia these days is that. To remain competitive as well as to drive further long-term economic growth. IMF. down from 8.478 India China Brazil Data as at April 16.0 1.0 4. First. Probably more important though. 2013. it just needs to focus on two goals.000 0 2002 2006 2010 1990 1982 1986 1994 1998 1970 1978 1974 2014 2018 6. 9 Data as at March 31. Our research shows that Indonesia faces multiple issues in the area of higher education.0 2. we spend time in this section highlighting macro-related trends that we think may benefit certain micro-related sectors. Source: World Bank. GDP per Capita Can Still Move Higher GDP per Capita (US$) Indonesia 14. including infrastructure. Public Spending on Education Is Just 3% of GDP… Public Spending on Education % GDP 7. To be sure. education. At the moment. both of which we think are achievable.6 5. Haver Analytics. 2013. many of the industries we view favorably are in the consumer part of the economy. KKR Insights: Global Macro Trends 11 .076 3. Importantly. India Central Statistical Organization.000 4. including education and training.3 Government spending on education is just 3. our base view is that demographic trends. Banco Central do Brasil. Biro Pusat Statistik. economic and social nuances to which one must pay attention. 2010.543 11. and healthcare.8 Industry: Focus on Middle Class Beneficiaries As part of our trip to Indonesia. Not surprisingly. Rather.000 8.596 1. OECD.3 3. As we show in Exhibit 25. but we do believe that one can make reasonable assumptions – often using historical comparisons – to forecast which sectors are likely to be the star performers. no one knows exactly how a doubling of the country’s middle class will exactly play out over the next decade.000 6.9%. after talking with leading executives across a variety of sectors in Jakarta. our strong view is that Indonesia needs to immediately invest much more aggressively in higher-level education and vocational industry training initiatives. healthcare. we strongly feel that the unemployment rate understates what we think is a large and growing issue: the ability of many businesses to find local workers with the required technical expertise to compete in an increasingly competitive economy.0 0.3 5. Please note. there is still a shortage of skilled laborers in many sectors of the economy. though – as we discuss below – every country has political. despite its booming labor force growth.000 12. as we look ahead. Source: Biro Pusat Statistik. Second.0 3. the unemployment rate in Indonesia is just 5. to us is that only 7% of adults complete post-secondary education (Exhibit 26). retail. and housing/ financial services.7 3.0 2.6 5.000 2. To this end.0 3. Importantly. including the sizeable increase in the country’s middle class through 2030. this viewpoint is consistent with our approach to other leading emerging economies. it should execute on building out basic goods and services.9 However. however.0 6.Exhibit 24 ment. the country should then allow its demographic forces to help drive its economy away from more traditional agriculture and commodities toward more services and value-added exports. the country does not need to rely on a lot of external macro forces to be successful. Overall. Fundaçâo Instituto. that we address the Indonesian infrastructure opportunity in our savings and investment section. are likely to make Indonesia one of the most compelling consumer growth stories in the global economy. we spent time talking with leading executives and senior government officials about which sectors would benefit from the ongoing changes we are seeing in the country’s demographic profile.000 10. Source: UNESCO. given that it includes a large degree of government involve- UNESCO statistics as at December 31. Exhibit 25 Given Current Urbanization Trends in Indonesia.0 5. except China per OECD 2008 estimate.5% five years ago.

against this backdrop. data as at december 31. however. which should help to improve the levels of spending and healthcare services throughout the country.200. because there is no real regulation of pricing and quality of services. unesco Global education digest 2010. not cyclical. We also heard on our trip that more foreign healthcare doctors and providers may gain access to the country over the next three to five years.2007 Number of Vocational Students (Left) Share of Vocational Students to Total Secondary Students (Right) 1.700. 2011. source: newhouse and suryadarma.S. we think that healthcare demand can grow materially faster than GdP per capita over the next 5-10 years. More Students Have Enrolled in Vocational Training Vocational School Enrolment 1992 .000 1. one alternative that an increasing number of affluent Indonesians are choosing is to send their kids to the united states or europe for higher education. as more citizens enter the ‘formal’ workforce through increased urbanization. healthcare spending. publishing. moreover. Indeed. This statement is actually not that radical. this approach clearly does not address how the country will deal with the 50 million or more middle class Indonesians who are eager to improve their standing in the global workforce. including facilities. 16 14 9 7 France Chile Mexico Brazil Indonesia source: JPmorgan education in brazil report dated February24. as Exhibit 28 shows. 2009 (based on susenas).000 1. the opportunity for quality private companies to build a loyal following over time is significant. Importantly. given that Indonesia allocates among the lowest amount of money as a percentage of GdP to healthcare.000 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 38 36 34 32 30 28 26 24 22 20 18 Share of vocational students to total secondary students (%) 25 20 15 10 5 0 U. we expect healthcare as a percentage of GdP to increase meaningfully over time too. Key to our thinking is that GdP per capita in Indonesia is historically at a level where we typically see private sector practices start to emerge and take share from crowded government-run facilities. .100.600. education and technology.400.300. which can help to expedite certain aspects of this growth. “ 12 KKR InsIGhTs: Global macro Trends Healthcare Without question. “ The greatest ‘wildcard’ surrounding the question of the country’s growth trajectory is whether the current administration—and its successor government in 2014—has the nearterm courage to make the right long-term decisions that address some of the country’s structural shortcomings. should benefit smartly. which compares unfavorably with brazil and Turkey and even India.000 1.exhIbIt 26 exhIbIt 27 …and Higher Education Is Lacking % Adults Completing Post Secondary Education 40 35 30 23 38 Of Late.000 1. and one that is likely to be a major opportunity for private capital. healthcare spending as a percentage of GdP is less than 1%.000 Number of vocational students 1.000 1. after our most recent trip to Indonesia. we think that it is linked to the fact that more students are beginning to again embrace vocational programs (Exhibit 27). we view the trend towards greater participation in higher education and vocational training as secular.500. 2009. particularly with scale providers. If there is an encouraging trend.

1 4.1 1. Environmental and Social Statistics .6 2.5 70.2 4.© OECD 2011. Separately.2 1.0 8.2 2. Japan Korea China KKR Insights: Global Macro Trends 13 .9 4.1 4. Data as at April 17.4 6. our base view is that as wealth accumulates.000 people 137 103 6 2 Indonesia 9 7 India 30 24 30 28 17 20 23 18 Brazil U.2 2.8 1. Source: World Bank.4 8.000 People) Physicians (per 10.6 17.7 2.9 2.html Data is 2009 or latest available year. June 2012).3 86. we also expect overall healthcare volumes to increase.4 72.ilo.1 5. U.S.0 8.0 6. Importantly though. the Indonesian government’s shift towards more of a decentralized structure since 2001 likely means that the private sector may become more influential sooner in the process than in other EM countries.1 4.5 1.9 1.8 1. Japan Brazil Korea China India U. we expect to see similar momentum in Indonesia in the coming years. National statistical offices. Haver Analytics.0 2.K. http://laborsta. Looking ahead.0 0.ISBN 978-92-64-111509 . Haver Analytics. 38 18 20 21 Mexico Data as of 2011. Source: Organization for Economic Co-operation and Development (OECD).3 4.3 2. a growing percentage of the urban population will migrate towards private clinics and hospitals. Exhibit 29 …As We Now Expect the Informal Economy To Begin to Shrink More Quickly Informal Employment as a Share of NonAgricultural Employment.1 9.1 68.0 0.6 6. Factbook 2011: Economic.1 Exhibit 31 Indonesia’s Healthcare Spending Is Among the Lowest in Emerging Markets Public & Private Expenditure on Health Care % GDP Public Private 9.0 5.6 6.Exhibit 28 Exhibit 30 Health Care Spending Should Rise… 2011: Public Health Care Spending % GDP 9.4 2.4 4.0 7. 2013.1 6.org/informal_economy_E.4 1.0 1.0 3.000 People) Just 6 beds and 2 physicians per 10. which should create opportunity for scale players in the healthcare supply industries.4 1. Latest available data per respective country as per the World Bank.9 8. Most Recent Year (%) Nepal India Pakistan Indonesia Philippines Vietnam Sri Lanka Thailand China 32.4 83.9 3.S.0 4.6 42.4 3.0 7.6 78.3 3.1 8.9 Turkey Mexico Indonesia Source: International Labour Organization (ILO): Statistical update on employment in the informal economy (Geneva.0 3.0 4.2 Healthcare Facilities and Services Are Deficient Hospital Beds (per 10. Source: World Bank. including testing and preventative practices. This trend is playing out nicely in almost all the emerging markets we visit. and as such.3 9.K.2 62. U.

Specifically. of which mortgage penetration is just 5% of GDP (Exhibit 34). Euromonitor. filling the shopping basket” dated March 10. Housing and Financial Services As a former financial services analyst. the overall retail market in Indonesia is largely unsaturated. while there is a state-run component to part of the banking sector. http:// www.6% in 2011 (Exhibit 35). I always view the banking sector as the ‘life blood’ of any economy. margins are strong and growth is enviable. one can see in Exhibit 33 that it is also quite immature. Kearney Global Retail Development Index. particularly when there are generational shifts in private company ownership or industry leaders  with management teams who are eager to consolidate a greater proportion of their industries. total insurance penetration remains relatively low by global standards in Indonesia. Indonesia’s convenience stores.Retail/Restaurants/QSR In theory. Euromonitor. 70 60 50 40 30 20 10 0 Mexico Source: JPMorgan “Indonesia Retailers: Organizing the shelf. Indonesia has been able to grow its economy without the use of leverage from either the government or private sector. Source: The 2011 A. we think private equity currently represents a more elegant way to access retail trends.K. bakeries and snackfoods all represent interesting private equity investment opportunities. In other developing markets. But as one can see in Exhibit 32. Exhibit 32 Exhibit 33 Services as a Percentage of GDP Are Still Small as the Basic Retail Segment Is Far From Fully Developed Breakdown in Grocery Retailing Modern Traditional The Indonesian Market Is Still Young and Far From Saturated The 2011 Global Retail Development Index: Market Saturation (0=saturated. our view is that local QSRs (quick service restaurants). The good news for Indonesia – which was confirmed on our visit – is that the banks are in great shape.S. Separately. 2013. by comparison. food and other sundry goods to shoppers. 2013. Looking at the details. “ 10 Source: JPMorgan “Indonesia Retailers: Organizing the shelf. sales comprise around 10% of total retail sales10. Measured by gross premiums written as a percentage of GDP. All told In fact. And if we use Indonesia’s grocery retailing as a proxy for overall retailing. credit losses are low.7% overall. penetration is only 1. compared with the world average of 6. Turkey Brazil Vietnam China Indonesia Kuwait “ Importantly. 14 KKR Insights: Global Macro Trends Malaysia India South Korea Malaysia U. it pales in comparison to what we see in many of the larger emerging economies. 100=not saturated) 86 75 58 47 29 24 16 12 14 Indonesia 25 Philippines 42 Thailand 53 71 76 84 88 Singapore U. Overall.atkearney.T. hypermarket stores and department stores only represent around 2-4% of total retail sales. a thriving consumer benefits companies that sell clothes. Moreover.com Against this backdrop. . credit penetration in total in Indonesia is just 32% of GDP. filling the shopping basket” dated March 10.

Haver Analytics.00% from 12.75% in 2005… Bank Indonesia Policy Rate (%) Jakarta Interbank Rate (JIBOR) 3-Month (%) 16 111 73 69 67 38 Germany 80 32 Malaysia 74 111 63 16 Sweden China U. 84 14 12 10 8 6 4 2 05 06 07 08 09 10 11 12 13 B3 B2 Feb-12 4.5 07 08 09 10 11 12 Global Indonesia Global Indonesia 5 0 04 Life Insurance Pentration Non-Life Insurance Pentration 05 06 13 *Insurance penetration defined as gross insurance premiums written as a percentage of GDP. Data as at January 31.00 5. Exhibit 35 …As Is Insurance Penetration FY11 Insurance Penetration in Indonesia 3. Source: World Insurance in 2011.5 1.S.2 Nov-09 5.1% 0.68 Dec-05 12. Source: Respective national statistical agencies. 2013.75 Ba3 Ba2 Moody's Upgrade to Baa3 27 5 Indonesia 32 10 Mexico 45 5 Turkey 47 4 India 35 20 Poland 55 7 Brazil 32 Korea 42 France Data as at 2012 or latest available.25 Oct-05 14. Source: Bank Indonesia.8% 2.1 Oct-08 38. Bloomberg.Exhibit 34 Exhibit 36 Credit Penetration Is Low… Credit to Private Sector % GDP Mortgages % GDP Other Credit % GDP Interest Rates Are Now At 6.25 B1 6. 2013.6% 25 20 15 10 Aug-06 9. Haver Analytics. Data as at June 13. Source: Bank Indonesia. Swiss Re Sigma. Which Remains Strong at 23% Indonesia: Credit Growth Y/y (%) 40 35 30 Jan-13 23. KKR Insights: Global Macro Trends 15 .8% Exhibit 37 …Fueling Credit Growth.

5 2. Data as at March 6.4 75 6. Banco Central do Brasil. Haver Analytics. Not Too Many Loans Deposits as a % of GDP Indonesia India 180 160 140 120 100 80 60 40 20 0 04 05 06 07 08 09 10 11 12 13 No growth in deposits as a % of GDP 89 63 36 168 145 China Brazil Singapore “ The recent trend towards increased government intervention is certainly worthy of investor attention. our conversations with senior executives in the financial services industry lead us to believe that credit growth is now finally percolating among a broader base of consumers. it is that the banking system’s loan-to-deposit ratio is moving up rather quickly (Exhibit 39). Source: World Bank. trade finance and other lending vehicles are all worthy of consideration. . “ 16 KKR Insights: Global Macro Trends Data as at January 31.Exhibit 38 Exhibit 39 The Loan Loss Ratio Appears to Be Structurally Much Better Since the Asian Financial Crisis 2012 Indonesia: Bank Nonperfoming Loans to Total Gross Loans (%) 34. 55 50 03 Jan-03 53. when I was in Surabaya. many of which would be similar to a standard western-style dwelling.1 Jan-13 83.5 7.1 70 65 60 Jan-07 60. we think insurance. Consistent with this view.0 3. 2013. may represent valuable assets for investors looking to participate in the Indonesian growth story that we are forecasting. If there is an issue.8 4. One sharp executive with whom we spoke believed that lack of government spending on real investments was part of the problem. though we view the financial services system positively. the community I visited was more the exception than the rule (and we saw plenty of shanty huts to confirm this viewpoint). Exhibit 40 Indonesia Suffers From Too Few Deposits. 2013.3 2. Haver Analytics. Haver Analytics.0 Loan-to-Deposit Ratio Has Risen to 84% From 54% Over the Past 10 Years Indonesia: Loan-to-Deposit Ratio (%) 90 85 80 Jan-10 72. but it certainly provided me with a window on why I think housing and mortgage-related activity can be a more meaningful part of the economy. I visited a large community development of maybe 60-70 three and four bedroom houses being built with compelling amenities. including subsidies.1 4. Overall. Instituto Brasileiro de Geografia e Estatística. Singapore Department of Statistics.9 6.8 04 05 06 07 08 09 10 11 12 13 However.9 24. Monetary Authority of Singapore.1 2. 2013. and we think the publicly traded banks. For private investors. Biro Pusat Statistik. People’s Bank of China. India Central Statistical Organization. Source: Bank Indonesia. while expensive.6 Data as at April 17. as wages grow and urbanization begins to further accelerate. We tend to concur with this logic.4 31. our research shows that housing is still a small part of the market that is starting to grow nicely. Reserve Bank of India. Key to his thinking is that capital that traditionally might flow through the banking system via consumer deposits to help finance productive long-term investments was currently being misallocated towards more consumption-oriented programs. payments. Source: Bank Indonesia. China National Bureau of Statistics. No doubt. particularly as the country’s deposit-to-GDP ratio is now the lowest in the Asia (Exhibit 40). For example.2 3.

5% in 201111. recent trends have continued into 2013. 2013. with both countries disappointing badly again in 1Q13. 17 . exhIbIt 41 exhIbIt 42 …Due to the Large Informal Sector 45 40 Government Revenue % GDP 35 Turkey 30 25 20 15 10 20 30 40 50 60 70 80 Informal Jobs % Total Employment (%) 90 Thailand Indonesia Philippines India Vietnam Brazil data as at april 16. unfortunately. central statistics office. also.S.org/ informal_economy_e. poor macroeconomic choices have left these countries with slower than expected growth but higher than expected inflation. Key to our thinking is what we are seeing unfold in both India and brazil. a tax is levied. source: Instituto brasileiro de Geografia e estatística. so that it can fund more social programs and infrastructure. Turkey Vietnam China Singapore Brazil Germany Norway Saudi Arabia data as at april 16. low unemployment. similar to Indonesia. as Indonesia becomes more developed. Importantly. both of these countries have incredible demographic backdrops. so what should happen? We believe that the government needs to do more to expand its base of eligible employees. KKR InsIGhTs: Global macro Trends Spain Japan U. source: ImF Weo estimates for 2013. politician or regulator with whom we spoke indicated that the current fiscal policies. The major issue. Indonesia’s tax revenue base at 15-17% of GdP definitely appears low versus other countries. our experience however. with a strong economy. ralph Waldo emerson Given that the country must try to absorb an additional 50 million ‘new’ middle-classers between now and 2030. many people feel that this is not a situation that will quickly spiral out of control. Indeed. source: “statistical update on employment in the informal economy” by International labour organization (Ilo) department of statistics dated June 2012. the informal sector of the economy in Indonesia is outsized. suggests a more cautious approach to these issues is likely warranted. were detrimental to the long-term health of the country. the absolute base of tax revenues should grow commensurately. Put another way (and contrary to what ralph Waldo emerson suggested). the recent trend towards increased government intervention is certainly worthy of investor attention.2% versus a peak of 6. as one can see in Exhibit 42. there are clearly significant opportunities for the government to help ensure that Indonesia’s GdP-per-capita story maintains its current momentum. is that in both instances the government over-stimulated economic growth via short-term fuel subsidies and one-off social spending after the 2008 Great recession. however. some of the headwinds created by such a large informal economy could start to dissipate. almost every business leader. sound familiar? last year in fact. while India grew 6. a way to accomplish this without massively raising taxes is to expand the taxable base of ‘qualified’ individuals. India.1% in 2007.The Role of Government in the Economy: More and Less Required For every benefit you receive. as we show in Exhibit 41. 2013. and a small deficit in absolute terms. a tax is actually not necessarily levied. which dents the country’s ability to properly capture tax revenues. however. haver analytics. given that the government by law can’t have more than a 3% fiscal deficit. including a small tax base and outsized subsidies. and ImF Weo estimates for 2013. http://laborsta. it appears that Indonesia is actually one of the few countries where for every benefit one receives. as GdP per capita continues to increase. so where do we go from here? our base view is that. the government also needs to address the small size of its tax revenue base. 2013. also.html.9% year over year versus a peak of 6. we believe. while government support of labor is 11 data as at may 29. there is no longer a catalyst for action the way there has been in the past during periods of economic strife. brazil grew just 0.ilo. beyond the fuel subsidy issue that we have already flagged. Revenue Collection as a Percent of GDP is Extremely Low… 60 55 Government Expenditure % GDP 50 45 40 35 30 25 20 15 10 10 20 30 40 Government Revenue % GDP 50 60 India Indonesia Government revenues are extremely low Revenue = Expenses Line Interestingly. In particular.

According to work done by my colleague Frances Lim.important in any developing country. Indonesia has a strong trade business. including coal. Source: Bank Indonesia. in our view. The country is rich in key natural resources. This strategic positioning is significant. 2013. “ Demographic trends. Haver Analytics. Haver Analytics. Another key insight we learned during our trip is that multinational firms are increasingly viewing Indonesia as not only a destination for product but also as a hub for their Southeast Asian businesses. 2013. there is a growing risk that the government may overstep its boundaries. growth in the export economy in Indonesia has been too reliant on higher commodity prices. palm oil and rubber. gas. driving up the country’s cost of capital and driving out the foreign direct investment that is necessary to fund many of its growth initiatives. Source: Bank Indonesia. while about twothirds of imports come from non-commodity related items (Exhibits 43 and 44). a full 74% of the total export increase in 2011 came from price. more than 60% of the country’s imports are non-commodity related. including the sizeable increase in the country’s middle class through 2030. Exhibit 44 …While One Third of Indonesia’s Imports Are Commodity Related Indonesia: Import Composition (% Total) Commodity Related Other Exports and Imports: Period of Transition From almost any vantage point. two-thirds of the total exports come from commodity related sources. are likely to make Indonesia one of the most compelling consumer growth stories in the global economy. not volume (Exhibit 46). “ 18 KKR Insights: Global Macro Trends . Two-Thirds of Indonesia’s Exports Are Commodity Related… Indonesia: Export Composition (% Total) Commodity Related Products Other 67 70 65 60 55 50 45 40 35 30 25 20 62 53 47 38 63 63 62 64 63 However. not on productivity gains in the sector. copper. By comparison. and is likely to further accelerate foreign direct investment into important areas like manufacturing. oil. One can also see from this chart that 2012 is actually not that much of an outlier. Exhibit 43 70 60 50 40 30 20 34 66 67 65 67 71 68 64 67 33 35 33 29 32 36 33 2005 2006 2007 2008 2009 2010 2011 2012 Data as at May 27. 37 37 38 36 33 37 2005 2006 2007 2008 2009 2010 2011 2012 Data as at May 01. This total is significant as commodity exports represent 60-70% of total export volume (Exhibit 43). All told. with machinery and transport equipment accounting for nearly half of that total (Exhibit 44).

exhIbIt 45 Indonesia’s Exports Have Been Commodity Dependent… 15% 10% 5% 0% -5% -10% -15% -20% 2012 Commodity Trade Balance (% of GDP) In our humble opinion. source: bank Indonesia.1 0 -1 -2 -3 -4 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 Jun-01 -3. volumes rose 3. veg oils & fats Beverages & tobacco Mineral fuels & lubricants All Commodities data as at may 9. Indonesia has not moved fast enough yet to leverage its recent success in commodities to further buttress the other parts of its economy. haver analytics. source: bank Indonesia. biro Pusat statistik. this segment accounted for 15% of FdI (Exhibit 48). all told. In fact. Malaysia Thailand exhIbIt 46 Foreign Direct Investment Remains Strong… Indonesia: Trailing 12 Months Foreign Direct Investment % of GDP 3 2 1 In 2011. 2013. KKR InsIGhTs: Global macro Trends 19 . The good news is that there are signs that the situation is turning more positive. data as at may 30. many parts of its export economy are now feeling the pinch. at the end of 2012. 74% due to price appreciation …But Export Growth Has Primarily Been From Price Appreciation Indonesia: Exports Growth Y/y (%) Volume Impact 50 40 30 20 10 0 -10 -20 -30 -40 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 In 2012. ImF. That’s the bad news (Exhibit 46). ceIc data. This trend is particularly acute with foreign corporations in the areas of transportation equipment and machinery.1 data as at 1Q2013. with china slowing and coal and palm oil prices having fallen by 20% or so. If it can. haver analytics. now. source: morgan stanley research. we think the export-related manufacturing story in Indonesia is sustainable. we heard first hand during our last china visit that manufacturers are now consistently seeing parts of their value-chain being transferred to Java from southern china. in 2012 exports were actually negative.6% but prices fell 4. International investors have clearly taken note of this trend. as foreign direct investment has ballooned in recent months.9 Mar-13 2. looking ahead. though our thinking is that the country should do even more to diversify its export economy.7% Price Impact Exports Value Y/y Mar-06 2. 2013. and we actually have confidence that the government and private sectors are working together to build momentum in the manufacturing export sector. then it will be one of the few emerging market countries with not only a broad-based consumer economy but also one that can compete actively in a global trade market in one of the fastest growing regions in the world. Interestingly. exhIbIt 47 Korea Hong Kong Singapore Philippines Indonesia Taiwan India China Food & live animals Crude materials Animal.

Data as at December 31. Source: Bank Indonesia.9 6.3 0. “Indonesia Infrastructure: A US$250bn Opportunity” dated May 11. Communication Mining & Quarrying Manufacturing India China Indonesia 10% 8% 6% 4% 2% 0% Data as at March 31.8 2.2 2. more comparable to the current 6-8% in India and nearly 10% in China.7 5. But one does not need to be a macro person to know Indonesia lacks in infrastructure.5 0. 12 Data as at May 11.9 4.5 10. 2012. in the emerging markets. “Indonesia Infrastructure: A US$250bn Opportunity” dated May 11.0 1.2 5. This is not ‘new’ news. sustainable growth. 2011 by Deyi Tan. 2011 by Deyi Tan.7% 17.0 11.3 1.4 19.9 8.1 20. the key to investment is usually the infrastructure part of the investment spend.0 27.6 3.3 58.7 0.6 0.3 1. If a country doesn’t save enough.9 1. was when multiple executives with whom we spoke told of pumping water to their homes in Jakarta.2 12. reminded us of the infrastructure challenges the country faces. Storage.9 5.2 3. 20 KKR Insights: Global Macro Trends .9%   Data as at May 11.9 7.7 1.0 3. according to the Public Works Ministry (Exhibit 49).9 48.9% 19. 2013. f = Morgan Stanley Research forecasts.4 1.9 2. In the years prior to the Asian Financial Crisis.3 34.4 1.7 3. Exhibit 50 …But Estimates Are For It to Increase From Here 2008e 2009e 2010f 2012f 2014f 2013f 2015f 24.7 8.6 9. f = Morgan Stanley Research forecasts.2 0.3% 65.3 1.7 7.0 3.9 4.9 1. 2011. Source: Morgan Stanley Research. 2005 2006 2007 2008 2009 2010 2011 2012 Savings and Investment: More Infrastructure Needed An important piece of any macro puzzle we review when doing country-level research is the relationship between savings and investment.1 4.6 40.4 1.1 5.3% 32.2 0.7 21.4 13. this is an area where Indonesia has chronically underspent.6 0.7 16. e = Morgan Stanley Research estimates.9 3.1 0. it usually can’t afford to spend enough on the investment required to drive long-term.8 18.6% 22.. 2011.6 10.2 8. however.3 4.5 15.6 2.4 0. as it was still not provided to them by the government. A ‘quick’ trip in from the Jakarta airport.Exhibit 48 Exhibit 49 …Particularly In Manufacturing Indonesia: 2012 Foreign Direct Investment Breakdown (%Total) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 04 05 06 07 08 09 10 11 12 44 63 34 35 25 32 36 42 46 Infrastructure Spending Lagging Even India. which is usually filled with gobs of traffic and several random phone disconnections. Importantly. Infrastructure spend (% of GDP) 12% Other Financial Intermediation Wholesale & Retail Transportation.. Though it is now changing.1 0.7 9. Indonesia was spending 7%.7 6.4 11.7 2.0% 30.7 0. In fact.1 11. infrastructure spending has been tracking at only 3-4% of GDP12.9 2011f US$B 20102015 CAGR 22. What did surprise us. Source: Morgan Stanley Research.8 69. e = Morgan Stanley Research estimates. Source: CEIC Data and Morgan Stanley Research.0 2.7 1.3 13.1% Electricity Telecom Roads Railways Airports Seaports Water Total As a % GDP 5.

has not happened.12.000 $1.000 $6. The government’s medium-term plan.S. the country will spend $250 billion over the fiveyear period ending in 201513. specifically. That is the good news. data as at april 16. a trend that has been exacerbated by a more decentralized government structure that has made it harder to get things done.000 $7. Indonesia was ruled by the dutch from 1826 to 1949 and as history has demonstrated. and it is now aggressively making changes to improve the situation. execution between the government and private sector has been disappointing. source: ImF Weo estimates for the year 2013. is that a lot of the private sector capital went into higher return mining investments and less into basic infrastructure services required to meet the needs of the country’s booming middle class. 16 19 14 17 47 High gross national savings should support investment 36 The bad news is that—to date—almost all infrastructure plans are well behind schedule. 2013. 13 Ibid. up from 4% in 2010.S.000 $5. as we mentioned above. 2013. KKR InsIGhTs: Global macro Trends 21 . There are also some historical ‘quirks’ worth considering.000 $0 India Indonesia China Brazil U. exhIbIt 52 …But Investment per Capita Still Lags Behind Brazil and China 2013 Estimated Investment Per Capita US$ $8.000 $4. second. If correct. Interestingly. with electricity and roads accounting for over 50% of the total incremental increase (Exhibit 50). government revenues are light relative to many economies.S. similar to brazil. 2013. source: ImF Weo april 2012. which called for 70% of the $150 billion allocation to be invested in infrastructure from 2010-2014 to come from the private sector.000 $3. also. as Exhibits 53 and 54 show. source: ImF Weo estimates for the year 2013. What has happened though. as we mentioned earlier. dutch-occupied countries enjoyed much less infrastructure build-out than those overseen by countries like the united Kingdom. Third. according to an optimistic report by the global investment bank morgan stanley. the lack of infrastructure investment is not linked to either a low savings rate or lack of external capital. Germany 30 40 50 60 Singapore Saudi Arabia data as at april 16.000 $2. Indonesia has a varied terrain that has historically prevented it from making sweeping cross-country (or even cross island) investments. 2013 Estimated Gross National Savings % GDP estimates for 2013. exhIbIt 53 35 32 data as at april 16. including more government funding and greater economic incentives for the private sector. The Public Works ministry acknowledged that its Private Partnership Plan (PPP) has not worked. Indonesia actually has both. 2000-2013 CAGR 13% 2000-2013 CAGR 17% 1980 1990 2000 2013 2000-2013 CAGR 19% 2000-2013 CAGR 1% A High Savings Rate Is Needed to Support Investment… 2000-2013 CAGR 10% 50 2013 Estimated Investment % GDP 45 40 35 30 25 20 15 10 0 10 20 Turkey Investment running ahead of savings Savings = Investment Line China Indonesia India Mexico Japan Brazil U. then annual infrastructure spending would rise to around 6% of GdP. so the government contribution to infrastructure spending has been limited.exhIbIt 51 China Leads the World in Both Rate of Savings and Investment % of GDP 2013 Estimated Gross National Savings % of GDP 2013 Estimated Investment % of GDP 60 50 50 40 30 30 20 10 0 China India Indonesia Brazil U.

its external foreign debt relative to its reserves is second to only Korea in the Asian markets. and the government’s sense of urgency is now heightened. Singapore Department of Statistics. 60% 55% Indonesia Total East Asia* Data as at 1Q2013 or latest available. Source: Bloomberg. we believe that the equity story is far from over (Exhibit 56). These initiatives will certainly not happen overnight. Source: Bank Indonesia. Exacerbating the issue is that Indonesia has only around $100 billion in reserves14. but we believe that expectations are now more realistic. return targets are more reasonable. General Statistics Office of Vietnam. However. the government has been revamping its strategy for working with the private sector. Bank of Thailand. and our discussions in Jakarta with a variety of infrastructure folks leads us to believe that expectations have been lowered to a much more appropriate level. Currency and Inflation Outlook: A Potential Near-Term Achilles Heel? As investor interest in Indonesia has grown. 2013. Until recently. Malaysia. Central Bank of the Philippines. Thailand.Exhibit 54 Exhibit 55 …But Foreign Direct Investment Is Needed Too LTM Inward Direct Investment US$: Indexed 1Q07=100 500 450 400 350 300 250 200 150 100 50 0 Sep-10 Sep-08 Sep-09 Jan-08 Jan-09 Sep-12 Jan-10 Jan-12 May-11 Jan-07 May-10 May-08 May-09 May-07 Sep-07 May-12 Jan-13 Sep-11 Jan-11 Indonesia Philippines Thailand Myanmar Malaysia Singapore Vietnam Cambodia Indonesian Market Cap Percentage of GDP Has Slowly Converged With Asian Average Market Cap % of GDP 120% 100% 80% 60% 40% 20% 0% 2003 2005 2007 2009 2011 2013 3/31/2013. Indonesia Market Cap Percentage of GDP Is Above China and Vietnam. Data as at March 31. as we show in Exhibit 55. Indonesia relies heavily on foreign investors to cover its fiscal deficit (Exhibit 57). Source: IMF. 14 Data as at March 31. high profitability and powerful demographics. Source: Bloomberg. 2013. However. and Singapore. IMF. roads. *GDP-weighted average of China. International Monetary Fund. Indonesia. This re-rating makes sense. this dependence was not really an issue. Vietnam. our conversations with both the government and private sectors lead us to believe that we are close to a bottom in terms of missed infrastructure execution. IMF. Asian Development Bank. S. Malaysia Department of Statistics. Taiwan. Monetary Authority of Singapore. In particular. as tightening cycles occur in areas like the United States or Europe. Korea. Haver Analytics. Philippines. 22 KKR Insights: Global Macro Trends . its capital markets have developed considerably. we see increased private sector interest in allocating capital towards shipping. Haver Analytics. tolls and power. 7 8 9 Data as at March 31. 2013. Moreover. In recent weeks. As we show in Exhibit 58. Bank Negara Malaysia. particularly if the government can reign in its deficits. its market capitalization as a percentage of GDP is now much more on par with the average of its Asian peers. Haver Analytics. the story is more complicated. given the country’s strong growth. then Indonesia could face some serious headwinds. Exhibit 56 Looking ahead. On the fixed income side. But Far Below Many Other Asian Peers Market Cap. Haver Analytics. % of GDP (3/31/13) 1 2 3 4 5 6 Singapore Taiwan Malaysia Thailand Korea Philippines Indonesia China Vietnam 224% 173% 149% 119% 95% 95% 55% 37% 30% Capital Markets.

Indonesia is likely going to feel some notable impact from the country’s reduction in its fuel subsidy over time. KKR Insights: Global Macro Trends 23 . by comparison. respectively. both debt spreads and equity trading multiples in Indonesia are quite rich relative to both history and their peer group. bringing headline inflation to mid-8% territory15. there is still a lot of running room for Indonesia to grow its market capitalization as a percentage of GDP. First. In China. which differentiates it from many of other large EM markets. Asia Development Bank AsiaBondsOnline http:// asianbondsonline. denting consumption on the margin.500/litre to Rp6. Exhibit 59 The Financial Markets in Indonesia Have Room to Grow 250 2012 Corporate Debt % GDP 2012 Gross Government Debt % GDP 200 2011 Market Cap % GDP Data as of April 30. and the ‘tapering’ of Quantitative Easing in the U. Source: Indonesia Directorate General of Debt Management. in our view. particularly at a time when the United States begins to raise rates.e. and given that GDP growth is likely to remain strong over the coming five to seven years. And in the financial arena. Source: World Bank. we remain optimistic for two important reasons. in early June. Bank of Thailand. Foreign Ownership of Government Debt Securities (% Total) 40 35 30 25 20 15 10 5 0 03 04 05 06 07 08 09 10 11 12 13 14 Indonesia Malaysia Thailand Looking ahead. its subsidy/inflation issues. the country decided not to issue bonds at certain maturities because there was a lack of investor demand at rates the government deemed acceptable.500/litre and Rp5. Indonesia is actually overweight consumer stocks. a reduction in the fuel subsidy may also act like a tightening. and we would not be surprised to see the country struggle a little in terms of raising capital and/or see some renewed pressure on its currency.S. a rising percentage of GDP in a rising GDP environment). with a 22-44% increase adding 290 bps. 2013. Data as at March 19.. As we show in Exhibit 59. interest rates are moving in line with the U. Exhibit 58 150 …and the Short-term External Debt Load Is High 2011 Short Term External Debt / FX Reserves (%) Korea Indonesia Mexico Malaysia India Thailand China Brazil Philippines 8 11 14 26 25 31 31 34 42 100 50 0 Vietnam Thailand Singapore Indonesia Malaysia China Source: World Bank. there is the potential to succeed both ways (i. Indonesia’s liquid capital markets are actually reflective of the economy. consumer stocks are less than three percent of the composite index. Third..S.. Haver Analytics. 15 Retail prices for gasoline and diesel to be hiked from Rp4. Source: Morgan Stanley “Indonesia Economics: Retail Fuel Price Hike – What If?” by Deyi Tan dated May 23. though they have corrected somewhat in recent weeks. Second.org. 2013. large state-run companies dominate the index. In the case of a country like Brazil. First. Second. which often leads to lower returns and lack of focus on burgeoning consumer trends. by comparison. the Indonesian capital markets face several issues through which investors should work. are likely to increase the volatility of its capital markets. Longer-term though.500/litre. every 10% rise in retail fuel price would add 80 bps to headline inflation. as we believe that ultimately it is a fuel price increase that may cause inflation to rise. we believe Indonesia actually has well-run banks that are not overly swayed by government influences. Already. This represents increases of 44% and 22%. Bank Negara Malaysia. and on the verge of causing a tightening cycle. everything needs to continue to go right for it to persist in maintaining such premium valuations. Haver Analytics. History shows – time and time again – that capital flows into the emerging markets can reverse quite quickly. we think the country’s upcoming election.Exhibit 57 There is High Foreign Ownership of Indonesian Bonds. we think that the size of the overall Indonesian capital markets still has significant potential for appreciation. In our view. So. as an example. Not surprisingly.adb. According to the investment bank Morgan Stanley. In fact. one can see that in Exhibit 60. 2013.

9% 2. and transportation/logistics all are expected to grow meaningfully above global GDP for the next five to 10 years and represent interesting long-term investment opportunities for both public and private investors. To do so however. there is now greater implied risk in both the funding and currency markets than there has been for the past several years.5% 3.9% 5.7% 11. similar to what we have seen recently in other emerging markets like China. In many instances.Exhibit 60 Compared to Global Peers.3% 11.9% 1. Against this backdrop.8% 2.4% 6.9% 21. Factset. the Indonesian Market Is Heavily Overweight Financials and Consumer Discretionary.2% Data as of March 31.3% 7. MSCI EM 8.0% 13. continues to increase at the substantial rate we and others are forecasting (Exhibit 22). Importantly.6% 1.1% -5. it immediately needs to make the necessary investments in infrastructure and education that keep productivity above wage growth. Summary From almost any vantage point.5% 3. in a world increasingly starved for growth.8% 6.9% 34. India and Brazil. 24 KKR Insights: Global Macro Trends . and Underweight IT.6% 4.7% 9.3% 14. However.1% -2.6% 12. the next ten years may not be as easy as the past ten.9% 1. which is currently around $3.5% -11. healthcare/wellness.0% 10.8% % Index Weight MSCI EM 7.S.6% MSCI AC World 11.5% 2.3% 3. Indonesia should also ensure that GDP-per-capita. industries like education.6% Indonesia % Over/(Under) Weight vs.1% 4.2% 10.9% 9.1% -2. if the country continues to run with strong growth using a twin deficit strategy.1% 10.5% 10. and there is increasing risk that Indonesia missteps. In addition. it is poor decision-making at the government level – often to curry favor with certain private sector influences – that may slow economic growth and earnings trajectories. Indonesia has emerged as a rising global economic power. Indonesia has some substantial macro tailwinds that will continue to drive its GDP higher – and potentially with lower than average volatility. may be closer to ending its powerful run of Quantitative Easing.3% 2.0% 7.600.8% 0. then this country could represent one of the more compelling opportunities in the global capital markets over the next five to seven years.7% -6.7% -6. it needs to work even harder to effectively transition the economy into high value-added industries and services in the formal economy from agriculture and other parts of the informal economy. Source: MSCI.4% 11.3% -7. If it can do these things. which could add pressure to an already high inflation backdrop.2% vs.9% 6. Energy and Industrials     Consumer Discretionary Consumer Staples Energy Financials Healthcare Industrials Info Tech Materials Telecommunication Services Utilities MSCI Indonesia 16.5% 4. And given that the U.9% 1. 2013.5% -14. In particular. then we believe the currency will need to adjust downward.6% 27.4% 7. MSCI AC World 5.

KKR Insights: Global Macro Trends 25 .

26 KKR Insights: Global Macro Trends .

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