The Impact Of Terrorism On Indonesia: A Foreign Investment Perspective
A publication in partnership with Watson Wentworth
In the second week of January 2016, Indonesia, the world’s largest Muslim-majority country and one of ASEAN’s leading economies, was hit by a terrorist attack that resulted in at least seven deaths. The attacks came in the form of explosions and gunfire and were directed at a shopping mall and a nearby Starbucks café in Jakarta. An avalanche of questions rushed through the minds of investors when the news were spread across the world via major publications like the Financial Times and Bloomberg. Most importantly, capital allocators were naturally wondering how these events will impact on their investments and assets.
This article aims to provide you with an analysis of how [the recent] terror attacks impacted Indonesia from an economic and financial perspective. The analysis will be conducted from the point of view of a foreign [conservative] investor (defined as the group of capital allocators that do not have direct access to information or do have limited access to information regarding the severity of economic, social and political events within the country), that judges risk as permanent loss of capital.
I will look at certain signals that ought to suggest the impact of terrorism on the world’s largest Muslim-majority: the behaviour of the stock market taken as a response from the community of traders and investors, the financial health of specific industries, such as tourism, after the attacks and to glue everything, the article will look into the past and see what history can teach us about dealing with acts of terror from an economic point of view. The conclusion will offer a brief overview of the real issues that foreign investors need to consider when investing in Indonesia.
The Indeks Harga Saham Gabungan (IHSG) and terrorism
The IHSG is the Indonesian abbreviation for the Indonesian Stock Exchange or Jakarta Composite Index. It is the international benchmark for how the Indonesian equity markets are performing and includes nine major industries (market sectors) such as: agriculture, mining, chemicals, miscellaneous industrials, consumer goods, property and real estate, infrastructure, utilities and transportation, finance and trade, services and investments. A quick run on the Equity Market Screener offered by the Financial Times can reveal that roughly 500 companies are listed on the IHSG.
After the terrorist attacks, the Jakarta Composite Index was reported to have dropped 1.8% but closed down at just 0.5%, making a 1.3% recovering by the end of the trading day. At the same time, the Rupiah feel by 0.5%. Let us take a step back and question: what does this really mean? It means that investors, mainly institutions, funds and wealth management offices instantly valued the totality of companies listed on the JCI to worth 1.8% less immediately after attacks than the amount they valued before the attacks; but somehow miraculously, by the end of the trading day, the index was worth 1.3% more. This clearly irrational move has its roots in two reasons.
Firstly, most of the market participants are making the parallel between the index and the country’s economic performance (measured as GDP or GNP). They regard them as being interconnected or as two reflections of the same entity. Some do so because they are believers of the efficient market theory and others do so as a result of the language used by mass media, consultancy reports and the financial jargon. How many times have you read that, say S&P 500 is down 0.5% and that investor X from fund Y is worrying about the US economy (in general) or about major US industries that express the same business cycles for centuries?
Justifiably, certain industries will be hit harder than others as a result of terrorism. For example, tourists might be deterred to visit countries or regions that have been affected by violent expressions of extreme ideologies. Consequently, the private transport sectors, such as airlines, the leisure and luxury goods and services markets, including hotel chains, restaurants and shopping centres might make a loss as a result. However, what the market up-and-down movement suggested was that the world of investment made a short-sighted statement that it fears for its capital allocated across the country. How can this be?
In fact, as the study conducted by Elroy Dimson, Paul Marsh and Mike Staunton (The Triumph of the Optimists: 101 Years of Global Investment Returns, 2002) from the London Business School suggests, there is a negative relationship between the economic growth, measured as GDP, and stock returns. In other words the higher the GDP growth rate the lower the returns of the stock exchanges – most likely because the majority of the companies were overvalued. Also, Paul Marson, the ex-CIO at Lombard Odier, an independent Swiss private bank, examined the drivers of return in developing countries over the period from 1976-2005 and found no correlation between GDP growth and stock market returns (The Economist, Buttonwood’s Notebook: The Growth Illusion, 2009).
Don’t get the point made wrong: there were, are and will be companies affected by terror attacks. However, as a foreign investor that lacks the clear picture of the legal, cultural and political of landscape of Indonesia, either as an institution or a private individual, you should make individual assessments of each business you have invested in and decide based on each case whether the company was affected or not and if yes by how much will the business quality and operations decline for the next 5 to 10 years.
Therefore, the second reason for the IHSG movements is rooted in the lack of emotional management that is present not only in the financial services industry but in the majority of human beings. Making the difference between our feelings, their causes and the decision to act or not on them can make or break the road towards successful investment. We can thus make the point that the Indonesian economy’s performance is not necessarily related to the performance of its major index and that the sudden volatility in its valuation should be taken just as an emotional response to the acts of terror and not as a clear stand of the real value of the companies listed on it.
Indonesia’s GDP Map
Above I briefly touched on the fact that certain industries are more likely to be affected by such events. However, let us dig deeper. According to a report conducted in March 2015 by the Organisation for Economic Co-operation and Development (OECD), the Indonesian economy ‘performed exceptionally well over the decade following the Asian Crisis on the back of the prudent macroeconomic framework and solid policy reforms’. Most of this growth was domestically driven by household consumption and good labour market conditions. However, on top of this landscape, Indonesia has consolidated its external sectors by focusing on improving its main source of external capital – commodity exports. Furthermore, since 1995, the rate of unemployment has been stable and fluctuated between the lowest 5.9% in 2014 to an almost double rate of 10.5% in 2005.
Additionally, a force that is eating from Indonesia’s economic performance is its raging inflation which colours a spectrum from 17.1% in 2005 to 3.8% in 2011 (in January 2016, based on data from Tradingeconomics, the inflation was no more than 4.14%). The impact of high inflation and drop in commodity prices (driven by business demands plus human psychological biases) have seen the country’s GDP fall from 6.4% in 2010 to 4.7% at the end of 2015.
Against the above landscape of macroeconomic factors, Indonesia’s GDP sources are three big sectors: Industrial, Services and Agriculture. The Industrial sector is the biggest of all, accounting for almost 50% of Indonesia’s GDP: mining and manufacturing are the powerhouses of this sector and of Indonesian economy. The country is well known for its main mining and manufacturing products, such as coal, gold, footwear, paper products, furniture and textile products. A statistical review for the world’s energy review in 2015, released by BP, the oil and gas giant, puts Indonesia as the third coal producer in 2014 with a capacity of producing the equivalent of 281.7 Mt of oil.
More importantly for our subject, the global authority on the economic and social contribution of travel and tourism, The World Travel & Tourism Council (WTTC) identified that tourism and travel, as a sector, in Indonesia has been steadily growing since 2011 and contributed to 9.3% of the country’s total GDP in 2015. Terrorist attacks are likely to impact this market more than any other economic sector. For example, after the recent attacks, Starbucks has closed its 50 outlets in the city for the day, an action which obviously caused financial losses. However, the losses were temporary and unimportant in the medium and long-term.
Investors should look at the impact of unusual events, like terrorism, on each individual business within the industry of their operation. A careful analysis of how the management is handling the situation and the attitude of the company towards these tragic events will be more important than monetized losses which can be and will be covered by future profits. It is true that in the short term, at least, tourism in Jakarta will likely follow the path of tourism in Paris: will slow-down. However, as we will see later, history teaches us that short-term views are irrelevant to investment decisions.
One thing to always look to understand is that such events are not hurting the reputation of a country’s economic health nor the image of a particular business or city – they are damaging the people’s trust in the country’s government’s ability to protect its citizens and foreigners.
Consequently, we cannot make the assumption that terrorist actions have a meaningful impact on the country’s economy. It is more likely that the drop in coal prices and the slow in demand for goods are slowing down Indonesia’s economic performance more than any other event. As foreign investors, we should be conservative in our capital allocation and shift our portfolio allocation in a country’s equity markets or other assets based on how strong is the economic moat (goodwill) of the particular asset.
A Recent History of Terror in Indonesia
The purpose of this section is to show that this is not the first time when the country is experiences such events, unfortunately. Also, it has the aim to suggest that spontaneous terrorist attacks have meaningless impact on the economic performance of the country even in short and medium term.
According to a ‘Timeline of terror’ published by the Financial Times on January 14, 2016, Indonesia has been hit by car bomb that exploded in the basement parking lot of the Jakarta stock exchange and killed 15 people in 2000 and by a co-ordinated bombings launched by al-Qaeda and Jemaah Islamiyah that resulted in 18 deaths in the same year, two years later; in 2002, it was hit by the death of over 200 people caused by bombed nightclubs packed with tourists; in 2005, Indonesia saw 22 people being killed and more than 40 injured by two bomb blasts in Central Sulawesi; four years in the future, in 2009, suicide bombing attacks at JW Marriott and Ritz-Carlton Hotels in Jakarta killed 7 people; in 2015 three major events shacked Indonesia again: the investigation of two former pilots who were believed to have been radicalized by ISIS, the Bangkok bomb attack that led to 20 deaths and the Christmas and New Year’s Eve bombing alarming period during which nine individuals were arrested; and in 2016, the Jakarta explosions.
None of these events led to an economic or business slowdown. Equity markets were more volatile immediately after the episodes were mediatized but as we established above we cannot take the market reaction as meaningful in short-term – remember the words of Ben Graham from The Intelligent Investor: ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine’. Therefore, investors should look at what value their assets create as opposed to how their prices are impacted by uncontrollable events.
Moreover, the human mind focuses a lot more on negative happenings – this leads to cognitive biases that are disrupted by the apparent randomness of these attacks. For example, we are prone to expect that peace and prosperity will continue in to the future simply because it did so for a number of years and we have grown comfortable with the way things were. However, because we are bad at taking accurate decisions when faced with change, our emotions are overwhelming our faculty of reason and this is expressed through market volatility, news portraying the situation more negative than it really is and absurdly pessimistic predictions of the future: we turn from absolute optimists into complete pessimists in a matter of minutes. Therefore, before clicking the sell button or panicking about the future of your investments, look back and see that the world is always moving on from whatever the past presents.
Conclusion: The Real Issues
Here are some real issues foreign investors need to consider when allocating capital in Indonesia:
- The corrupt political system;
- The country’s dependence on demand for commodities;
- Indonesia’s attitude towards foreign trade and free markets;
- The people’s perception of local culture impacting on the business operations;
- The legal protection enjoyed by investors in case of fraud;
- Shareholders’ rights;
- The three economic forces: long-term debt cycle, short-term debt cycle and the productivity line;
- The Debt to GDP ratios (both public and private debt);
- The regulation of the targeted industry;
- And the ability to sell the asset when in need to do so.
These considerations are more important in making an investment decision than terror attacks.