Market Update Bancassurance July 2020

Article / 23 July 2020

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Entering Q3-2020 several countries have exercised lockdown easing and started reopening their economy. What is the impact on economy? Is there still risk for the second wave

Lockdown easing in multiple countries starts to give positive impact in economy, shown by improvements in manufacture activities, retail sales, and also workforce data in many countries. This drives market optimism that global economy can gradually recover, inline with the views of various international institutions that projected the economy can recover gradually in the second semester of 2020 and in 2021 if Covid-19 can be handled and economy is reopened. 

On the other had we still need to pay attention to the risk second wave of Covid outbreak. Rising Covid-19 cases has the risk to hinder the process of economy opening that will negatively affect recovery process. OECD projected that Covid second wave will affect economic recovery in 2021. In its analysis, OECD projected US economy will grow 4.1% in 2021 under no second wave scenario. But if the second wave happens, US economy is projected to only grow 1.9% in 2021

Nevertheless, it is possible to reopen the economy and at the same time prevent further Covid outbreak. North Asian countries such as China, South Korea, Taiwan, and also European Union region have successfully eased lockdown and keep Covid-19 case low, so that economic recovery can happen in ‘new normal’ phase. People’s self-discipline to prevent Covid-19 and the government capability to exercise 3T (Test, Track, Treat) will be the key to the success of the transition to ‘new normal’ period. 

How about Indonesia, what is your view on Indonesia economic recovery potential?

Q3-2020 is the transition phase from Large Scale Social Restriction (PSBB) period towards new normal, where PSBB will be relaxed and economy will be opened gradually while still implementing health protocol. From the economic perspective, this is a positive thing because PSBB easing will support economic activity. As what has happened in other countries, economic data improvements are expected to start to happen in this phase, such as the increase in manufacture sector activities, retail sales, and labor absorption. The improvements will also driven by stimulus issued by the government. Indonesian government have prepared IDR695 billion worth of Covid-19 stimulus fund, in which the largest fund of IDR203 billion is allocated for social assistance. We think the majority of this fund will be disbursed in the second semester of 2020, which will support purchasing power and recovery process in the second half of this year. 

On the other hand, the increase of Covid-19 case is the main risk factor we need to monitor. As mentioned before, second wave can affect economic recovery process. This is a difficult factor to project since it depends on the people’s behavior and the government’s capability. Therefore during the transition period in Q3-2020 we think the economy has the potential to show signs of recovery, although the overall economic growth is likely to remain weak. This condition will be followed by a stronger growth in Q4-2020 onwards after Indonesia passes through transition period and has adapted with new normal condition. 

The government issued large stimulus to support the economy, this spending will increase government debt. Any comment on the increase of Indonesia debt level? 

Covid-19 pandemic is an extraordinary event that has never happened before and has huge impact on the economy. According to IMF, the economic crisis caused by Covid-19 has the potential to become the worst economic crisis since 1930. Therefore not only Indonesia, many countries also issued their largest fiscal stimulus in history as a bolster as well as to push the economy. The idea is that by giving stimulus, over time economic activity will increase – consumption as well as production – so that state income would increase and the burden of debt would gradually decrease. 

In the short term, the stimulus will increase Indonesia debt level. However in our view Indonesia debt rate is still at safe level. Before Covid-19 pandemic, Indonesia debt rate was 30% of GDP. With stimulus and the impact of Covid-19, Indonesia debt rate is projected to increase to 37%-38% of GDP. Although significantly increases, Indonesia debt rate is still one of the lowest. As comparison, IMF projected debt level of countries in the Emerging Asia region to rise from 54% of GDP to 65% of GDP due to Covid stimulus.

Bank Indonesia and the government agreed on burden sharing scheme to fund Covid-19 stimulus. What impact does this policy have on the market? 

Basically, the purpose of burden sharing scheme is to help the government’s Covid-19 stimulus funding by sharing state debt interest burden with Bank Indonesia (BI). This is a positive thing because the government can issue Government bonds to fund the debt with lower interest – because BI takes part in paying for the interest – and to ensure BI is available as standby buyer of new government bond issuance. This policy also has the potential to give positive sentiment to bond market since it can reduce government bond supply to the market – supported by BI who absorbs new government bonds issuance – thus bond market stability is maintained.

Previously, there was concern in the market that with this policy the government can issue debt without control, and also about BI’s capability to bear the debt burden. But within the agreed final scheme, those concerns can be put aside because the government stated that this is only a one-off policy and BI analysis shows that its capital is strong enough for burden sharing. Therefore, we view that this policy is likely to be welcomed by the market.

So far bond market shows resilient performance. Does bond market still have attractive prospect in the future? 

We think Indonesia bond market still offers attractive potential. This view is supported by some factors:

• Global yield hunt. Easy monetary and fiscal policy in global level pushes global bond yields to very low level, close to 0% or even negative. This condition will encourage global investors to look for investment instruments with more attractive yield. 
  
• Indonesia has attractive bond yields rate. Indonesia is a country with ‘Investment Grade’ credit rating that offers the highest government bond yield, with 10-year bond yield of around 7%. ‘Investment Grade’ status and high yields will potentially attract foreign investors. 
  
• Interest rate decline trend. So far in 2020 BI has cut its interest rate three times to 4.25% as of June. In our view there’s still room for BI to cut interest rate, supported by low inflation and stable exchange rate. This condition is conducive for bond market. 
  
• Burden sharing scheme between BI and the government has the potential to lower the pressure of government bond issuance in the market. 
  

How about stock market, JCI is currently underperform compared to stock markets in the region. Is there any potential in stock market? 

With the current JCI level, stock market offers attractive potential to investors with long term investment horizon. We think the market has not priced-in the potential of economic and earnings recovery in 2021. At the end of June 2020, JCI recorded -22.1% year-to-date performance, inline with market expectation of 22% earnings contraction estimated by the market consensus. This indicates current JCI level has priced-in this year’s downturn. However we think that the market hasn’t priced-in potential recovery in 2021. Market consensus projects that earning could grow 24% in 2021. From this perspective, current JCI level remains attractive for investors with longer investment horizon. 

Any suggestion for investors who are still contemplating whether equity or bond is more attractive at this point? 

Each investor has different investment needs and risk tolerance, and therefore asset class selection should be based on those criteria. As mentioned before, both equity and bond market have attractive upside potential. The main difference of the two will be the volatility. due to its underlying characteristics and current economic condition, equity tends to have higher volatility compared to the more stable bonds. Therefore, for investors who prioritize stability, bonds can be the more suitable option, while for investors with long term investment horizon, who look for more aggressive upside potential, and can tolerate higher volatility can consider equity as an option.

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