Will Indonesia Replace India in the BRIC?

The question of whether Indonesia is poised to replace India in the BRIC country group is a question increasingly being posed by foreign investors concerned with high inflation, slowing growth, and the policy paralysis that is hindering investment in India.

Foreign investors pulled out a net $540 million from India in March and April of this year, compared with $13 billion in inflows in January and February. Among the most significant developments from the shift is the direction that the money was headed. A big chunk flowed to Jakarta and other Southeast Asian capitals.

Earlier this month, India announced quarterly GDP growth of 5.3 percent, its lowest quarterly growth in nearly a decade. Inflation in April was 7.23 percent. India’s GDP expanded 8.4 percent in fiscal 2009 to 2010 and fiscal 2010 to 2011. In the most recent fiscal year, it fell to 6.5 percent.

Five global financial services majors, including Morgan Stanley, Standard Chartered, and Citi, have lowered India’s growth prospects to 5.7 to 6.4 percent for the current fiscal year, The Economic Times reported. And Indonesia’s economy is expected to grow 6 to 7 percent in the coming years.

Indonesia’s solid public finances

“Indonesia looks like it has hit the sweet spot, whereas India is nursing a headache from its latest boom,” Frederic Neumann, co-head of Asian economic research at HSBC, said recently. “The term BRICs really misses out on some of the key developments of our time. Indonesia has solid public finances, strong growth, a burgeoning consumer market, and plenty of resources to keep the economy afloat for many years.”

Goldman Sachs’ Jim O’Neill, the man who coined the term BRIC for Brazil, Russia, India, and China in 2001, said this month that India has been “most disappointing of them all.” In a Viewpoint, he said that India holds growth potential, but to unlock it the country must “allow its cherished democracy to actually function and get things done.”

His note added, “[a]s I have also written about a lot in the past year, on many credible measures of productivity, India scores the lowest among the BRICs. On the Goldman Sachs Growth Environment Score (GES), an index of 18 variables relevant for productivity and sustainable growth, India scores 3.9 on a scale of zero to 10. This is much lower than the 4.9 score for Russia and the 5.4 score for both Brazil and China. In addition, India’s fiscal position is much weaker than the others. In fact, the steady increase in India’s fiscal and current account deficits over the past couple of years may place India in line for the kind of ill-treatment that traditional emerging markets can sometimes experience, and that is currently being dished out to the Club Med countries.”

India, Indonesia share similarities

While India and Indonesia are not similar in terms of size, with India’s population at 1.2 billion and Indonesia’s at 240 million, both have a growing consumer base and are democracies with an investment-grade rating.

“To a large extent investor interest has moved to Indonesia,” Robert Prior-Wandesford, director of Asian economics at Credit Suisse told CNBC. “Indonesia’s equity market is hugely better than that of India and in part at the cost of India.” Wandesford said Indonesia reminds him of India three to four years ago, when there was a huge euphoria over the growth opportunity India offered foreign investors and companies. “In 2005-2008 India could do no wrong, now it is Indonesia.”

The Bombay Stock Exchange’s Sensex Index (INDEXBOM:SENSEX) has come down 13 percent in the past year – one of the worst performing major global indices. By contrast, the Jakarta Composite Index (JCI:IND) has fallen about 5 percent in the past year.

The Indian rupee hit a record low of 56.52 to the US dollar in late May, dented by global risk aversion and concerns about India’s economic and fiscal challenges. While it has recovered slightly, most of corporate India expects the currency to weaken to 58 per US dollar in the near term according to a survey of 440 respondents from 220 organizations conducted by ING Vysya.

S&P downgrades India’s credit rating

In a further sign that India’s near-term future remains bleak, Standard & Poor’s, which gave India an investment-grade rating in 2007, scaled down the country’s credit rating outlook in April 2012 to BBB- (one notch above junk) from stable BBB+. S&P warned of a downgrade if there is no improvement in the fiscal situation and political climate.

By contrast S&P in April retained its positive outlook, keeping its BB+ long-term and B short-term sovereign credit ratings for Southeast Asia’s largest economy.

Despite the hype, some investors say that Indonesia and India are different and it cannot be argued that one joins the BRIC group at the expense of the other. Indonesia is a commodity economy while India is a service-oriented economy, and investors cannot replicate the portfolio of Indian stocks in Indonesia. In addition, what’s happened in the past years, especially in India’s case, is a setback, but at the same time, not permanent.

“BRIC investors have a 20-year horizon and India will finally deliver in the long term,” HSBC’s Neumann said.

Securities Disclosure: I, Karan Kumar, hold no direct investment interest in any company mentioned in this article.