By: Russell E. Hoss, CFA, Portfolio Manager of EuroPac Asia Small Companies Fund (EPASX)
Back in 2001 when tech weary investors first started noticing the allure of the emerging markets, Goldman Sachs analyst Jim O'Neill coined the acronym BRIC to collectively refer to Brazil, Russia, India and China, then considered the top tier of the emerging economies. The BRIC countries became a symbol of the shift in economic power from the G7 countries to the developing world. For much of the first decade of the 21st Century, the BRICs lived up to their billing. They largely led the world in GDP growth and delivered rock solid returns to those wise enough to invest early. (See our current analysis of Latin American rail in our latest Global Investor Newsletter).
Over the years, with investors continuously seeking the next wave in emerging markets, other clever acronyms came and went, but none caught on quite like the BRIC. In the investment world nothing is static, and at Euro Pacific Capital we feel it's time for a change. But the BRICs don't need to be abandoned, just expanded. In particular, it needs another I as in Indonesia. In other words, we think the BRIC bloc should now be the BRIIC bloc. For a variety of reasons, Indonesia has earned the right to be considered as a premiere destination for emerging market investment.
Most investors don't realize that Indonesia is the 4th most populous country in the world, with more people than Brazil or Russia, two other charter nations in the BRIC club. They also may be unfamiliar with Indonesia's enormous under developed natural resources, including oil/gas, coal, tin, gold, wood and rubber. Indonesia's economy is well-balanced, with a large consumption component and limited reliance on exports to the developed world. Impressively, retail sales in Indonesia doubled from 2009 to 2012 (yes, doubled in three years) which we attribute to an improving labor market, favorable demographics, strong growth in wages and high consumer confidence. Meanwhile, developed markets struggle with high unemployment, an aging workforce, stagnant wages, and low consumer confidence. It's no wonder retail sales in the US and Europe, struggling to grow 1% per year, create a stark contrast to Indonesia.
While Indonesia's economy is still small relative to the other BRICs (roughly half the size of Brazil and Russia), it does have an economic growth rate that puts it well into the mix. According to the IMF, for the 17 year period between 1990 and 2007, Indonesia grew at an annual rate of 7.54%. While this is less than China (13.3%) and India (7.6%), it is more than Brazil (6.1%) or Russia (4.92%). The country is the largest economy in Southeast Asia and is a member of the G-20 group of the world's major economies.
In the past two months, while the rating agencies were busy downgrading most European countries and financial institutions, Fitch and Moody's actually upgraded Indonesia's sovereign debt ratings to investment grade, the first time Indonesia has achieved such a rating since the 1997 Asian Financial Crisis.
The upgrades demonstrate the strength of the underlying economic fundamentals in Indonesia, which we believe will support asset prices. With debt to GDP at 27%, GDP growth forecast of approximately +6% and inflation running at the lower end of the central bank target of +4-6%, Indonesia's economy is one of the strongest in the world. Indonesia also has large foreign exchange reserves (US$110b), a strong banking system, government bond yields near all time lows, consumer confidence near all time highs, and retail sales/industrial production at 20-year highs.
The contrast with the United States and Europe could not be more pronounced.
Investment grade sovereign debt ratings should result in lower cost of capital, which supports growth in the public and private sectors. After under spending on infrastructure for much of the past 15 years, Indonesia needs significant development. We expect such spending to accelerate and broaden, as the government recognizes the positive correlation between proper infrastructure and economic growth. Additionally, we anticipate that a strong corporate bond market will partially offset the likely slowdown in credit availability from European banks.
Indonesia still has many risks, including corporate governance, a complex political environment (it is a country comprised of more than 17,000 islands around 300 distinct native ethnicities), inefficient subsidies and sluggish policy responses to economic developments. However, we consider the Fitch and Moody's sovereign debt upgrades indicative of Indonesia's progress since the Asian Financial Crisis of 1997 and its emergence as an important global economy.
While the G7 countries celebrate 1-2% GDP growth (partially reflective of massive quantitative easing), the Indonesian economy appears well positioned to continue its impressive fundamental growth with little fanfare. At some point, global investors will begin to focus on the many opportunities emerging from one of the strongest economies in the world. We think it's high time to add another I in the BRICs. As we all know, better bricks make better houses.
Russell Hoss, CFA is Portfolio Manager of EuroPac Asia Small Companies Fund (EPASX). Opinions expressed are those of the writer and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff. Russell Hoss is not affiliated with Euro Pacific Capital.
Carefully consider the risks and special considerations associated with investing in the fund. You may lose money by investing in the fund. Foreign investments also present risks due to currency fluctuations, economic and political factors, lower liquidity, government regulations, differences in securities regulations and accounting standards, possible changes in taxation, limited public information and other factors. The risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies. In considering this investment, please also keep in mind that, due to the limited focus of this fund, the fund is more susceptible to market volatility because smaller companies may not have the management experience, financial resources, product diversification and competitive strengths of larger companies. Additionally, smaller company stocks tend to be sold less often and in smaller amounts than larger company stocks. More information about these risks and others can be found in the fund's prospectus.
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