Indonesia information technology report q3 2013

BMI Industry ViewBMI View: The Indonesian IT market is forecast to be one of the outperforming markets globally in the medium term on the back of strong economic growth and an emerging m

Q3 2013 www.businessmonitor.com

INDONESIA

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2017

Report Q3 2013

INCLUDES 5-YEAR FORECASTS TO 2017

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: May 2013

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BMI Industry View 7

SWOT 9

IT 9

Wireline 11

Political 13

Economic 15

Business Environment 17

Industry Forecast 18

Table: Indonesia IT Industry - Historical Data And Forecasts (IDRmn) 18

Broadband 22

Table: Internet - Historical Data And Forecasts, 2010-2017 22

Macroeconomic Forecasts 24

Macroeconomic Forecast 24

Industry Risk Reward Ratings 33

Industry Risk/Reward Ratings 33

Table: Asia Pacific IT Risk/Reward Ratings - Q3 2013 36

Market Overview 37

Hardware 37

Software 44

IT Services 47

Industry Trends And Developments 51

Regulatory Development 55

Table: Key Ministers And Departments 55

Company Profile 59

Hewlett-Packard 59

Oracle Corp 66

Table: Oracle: Selected Acquisitions 67

IBM 73

Table: IBM Acquisitions, 2012 (Total Value, US$3.964bn) 75

Sigma 79

Regional Overview 82

Demographic Forecast 87

Demographic Outlook 87

Table: Indonesia's Population By Age Group, 1990-2020 ('000) 88

Table: Indonesia's Population By Age Group, 1990-2020 (% of total) 89

Table: Indonesia's Key Population Ratios, 1990-2020 90

Table: Indonesia's Rural And Urban Population, 1990-2020 90

Methodology 91

Methodology 91

IT Industry 91

IT Ratings - Methodology 92

Table: IT Business Environment Indicators 93

Weighting 94

Table: Weighting Of Components 94

Sources 94

BMI Industry View

BMI View: The Indonesian IT market is forecast to be one of the outperforming markets globally in the

medium term on the back of strong economic growth and an emerging middle class Spending is expected to reach IDR64.6trn in 2013, up 16.3% from 2012 The retail market will be a major driver of growth, with

PC penetration estimated at below 10% in 2012, meaning significant growth potential from first-time buyers and upgrades/personal devices Continued strength in government spending will also support expansion of the market, boosting long-term growth potential.

Headline Expenditure Projections

Computer Hardware Sales: IDR45.9trn in 2013 to IDR65.4trn in 2017, at a CAGR of 10.4% in local

currency terms Rising incomes and the growing affordability of devices, combined with credit

availability, will increase sales in the consumer segment

Software sales: IDR7.8trn in 2013 to IDR13.0trn in 2017, a CAGR of 15.1% in local currency terms.

Windows 8 sales will boost spending in 2013, although progress will depend on the success in bringingdown illegal software use

IT Services Sales: IDR11.0trn in 2013 to IDR17.2trn in 2017, with a CAGR of 13.1% in local currency

terms Forecast unchanged, with a key growth area being cloud services, which could be worth more thanIDR12.1trn by 2017

Risk/Reward Ratings: Indonesia's score was 47.5 out of 100.0 Indonesia remained in ninth position in our

latest RRR table, below the Philippines but ahead of Thailand

Key Trends & Developments

The tablet market is expected to experience rapid growth in 2013 as a wide range of low-cost based tablets hit the market Consumers have shown a clear preference for mobile computing devices,including netbooks and notebooks, but tablet adoption failed to take off prior to 2012 due the high price ofdevices, putting them out of reach for the majority of consumers Higher specification devices are nowbecoming available at affordable prices, and, with PC penetration at under 10% in 2012, there is a largeopportunity for tablets to be adopted as a first device, with consumers skipping ownership of a desktop or

Android-notebook BMI believes OEMs from China, as well as local brands such as S Nexian will be the main

beneficiaries of demand for low-cost devices However, global vendors such as Acer have stated their

intentions to target mid- and low-specification devices at the market in order to achieve growth

Although the consumer story in Indonesia means the retail hardware market is set to remain the dominanttheme in the Indonesian IT market, there are also opportunities for vendors to generate sales to the publicand enterprise sectors An active approach by the government to encourage IT development, led by theNational ICT Council, should stimulate spending through a series of infrastructure and education initiatives.Meanwhile, according to government data, IT penetration in enterprises is low, particularly in the SMEsegment, representing a huge potential market Modernisation is driving spending on applications such asCRM, ERP and financial management in key sectors such as financial services, telecoms, utilities,

government, retail and manufacturing

IT

SWOT Analysis

Strengths ■ Large potential market

■ The market may be entering a faster growth stage It is forecast to grow quicker thanmost other Association of South East Asian Nations (ASEAN) markets over theforecast period due to its underdeveloped nature

Weaknesses ■ Computer penetration is among the lowest in South East Asia, estimated at only 9%

in 2012

■ Underdeveloped telecommunications infrastructure due to years of governmentcontrol and slow progress in deregulation

■ Lack of government support, and there is still no unified ICT ministry

■ History of recent political instability

■ High piracy rate continues to be a drag on the software market, with one of thehighest piracy rates in the region as of 2011

Opportunities ■ Some positive trends: computer ownership and internet access are on the rise, and

the government is showing signs of taking intellectual property more seriously

■ Strong demand for tablets and low-cost laptops from a youthful population andbooming economic performance

■ Per capita IT spending to increase rapidly as the middle class increases in size

■ Opportunities exist in services such as system integration, support systems, training,professional services, outsourcing and internet services

■ Computer sales are predicted to grow faster than almost anywhere else in the ASEANover the next few years, although from a lower base

SWOT Analysis - Continued

Threats ■ Continuing lack of government action to support increased PC penetration and

internet access, or drive ICT sector development

■ The global economic slowdown may hit key demand segments

Wireline SWOT

Strengths ■ Fixed-wireless offers a balance between fixed line and mobile at affordable prices and

has experienced strong demand, helping to boost overall fixed-line subscriber figures

in an otherwise slowing market

■ Increased competition in the fixed-wireless market following the award of nationwidelicences to Bakrie Telecom and Smart Telecom

Weaknesses ■ Lack of competition in the fixed-line market with Telkom dominating with an

80%-plus market share

■ Low teledensity rates, especially in the fixed-line sector

■ Limited available capital via loans could hinder further progress of the broadbandmarket

■ Poor fixed-line infrastructure means limited internet accessibility in rural areas

Opportunities ■ Plenty of opportunities for broadband growth, with a higher number of operators

awarding contracts to the likes of Nokia Siemens Networks and Ericsson

■ Submarine cable projects are on the rise, connecting Indonesia to regional peers such

as Hong Kong and then onwards to Singapore and Vietnam

■ Solid economic outlook led by domestic demand should aid growth of the telecomsindustry

Wireline SWOT - Continued

Threats ■ Uneven development between urban and regional areas could be further

exaggerated, with current broadband contracts centring on the larger islands of Javaand Sumatra

■ The cost of PCs and tariffs could place internet and broadband services out of thereach for the majority of Indonesians

■ Growing preference in the consumer segment for mobile broadband solutions

SWOT Analysis

Strengths ■ Indonesia managed a successful transition to democracy in 2004 In addition, the

2009 parliamentary and presidential elections passed peacefully, signalling theconsolidation of the democratic process Following 2009, the government showedfurther signs of improvement in both efficacy and engagement, but progress hasstagnated since 2012

■ The military's role in politics has gradually been reduced The prospects of a militarycoup - which seemed a real possibility in the late 1990s and early 2000s - havediminished substantially As the military's role in politics continues to wane,Indonesia's political stability should likewise improve

Weaknesses ■ Indonesia's domestic political scene is characterised by a proliferation of minority

parties, and formal and informal coalitions are necessary to govern and legislate.Moreover, the efficiency of state institutions is encumbered by bureaucracy andcorruption Prospects for reform are beset with numerous challenges, such as thelong-running practice of politicians promising government positions to campaignsupporters

■ The country was impacted by separatist rebellion and ethnic violence in the late1990s and early 2000s, which took great efforts to bring to heel In the event of a neweconomic crisis, calls for regional secession could re-emerge

Opportunities ■ President Susilo Bambang Yudhoyono's Democratic Party had a strong showing in

the 2009 parliamentary elections Coupled with a strong mandate following his election in the same year, the implementation of policies in the legislature shouldbecome less problematic

re-■ Indonesia's status as the world's most populous Muslim country leaves it wellpositioned to speak out on global Islamic issues and act as a bridge between theMiddle East and the Asia Pacific region

SWOT Analysis - Continued

Threats ■ Regional militant group Jemaah Islamiah poses a lingering threat to security in

Indonesia Jemaah Islamiah is blamed for a series of attacks, including the Balibombings of October 2002 and the Jakarta bombings of July 2009

■ The fact that Indonesia subsidises basic goods means that when the governmentraises prices, there is a risk of public unrest, or at least a political backlash

Additionally, Indonesia's population is extremely young, with more than 50% ofIndonesians younger than 30 Younger populations have historically been a predictor

of political instability

SWOT Analysis

Strengths ■ Indonesia's strategic location between the Indian and Pacific Oceans and its

adjacency to major east-west trade routes make it an important economy in theregion Indonesia is also resource-rich and is the world's largest producer of palm oil

■ Indonesia has a low cost and large supply of available labour resources Its labourforce, the fourth largest in the world, is also one of the world's youngest

Weaknesses ■ Indonesia's economy is not growing fast enough to reduce unemployment, with the

rate still relatively high at 6.2% as of August 2012 Many are forced to work in theinformal sector Of particular concern is the youth unemployment rate, which is fivetimes the overall rate

■ Indonesia's physical infrastructure is considered sub-standard The archipelagicnature of the country makes it difficult to weave national infrastructure together.Despite an ambitious infrastructure revitalisation plan, the country currently comparesunfavourably with its Association of Southeast Asian Nations peers

Opportunities ■ Indonesia could attract much-needed foreign investment by strengthening its

business environment, particularly through reform of its unreliable legal system

■ Indonesia stands to benefit from the rise of Islamic financing, having adopted newlegislation in early 2008 designed to tap into this rapidly expanding sphere With anoverall market share of only 3%, growth prospects for Islamic banking in the world'slargest Muslim country are enormous

Threats ■ Production at Indonesia's ageing oil fields has been in decline since the mid-1990s

The country has therefore become a net importer of crude oil in recent years, puttingdownward pressure on its current account position Furthermore, rising oil priceshave begun to pressure Indonesia's current account, where it typically runs a healthysurplus The resumption of the Cepu field in late 2009 may help to alleviate

Indonesia's dependence on foreign oil

SWOT Analysis - Continued

■ Indonesia is perceived as one of Asia's riskier destinations This leaves the economyvulnerable to sudden capital outflows at times of risk aversion, which can lead tosharp swings in the currency

Business Environment

SWOT Analysis

Strengths ■ Indonesia is South East Asia's largest economy with a nominal GDP of US$880bn and

is the world's fourth most populous country with more than 240mn people It thusoffers investors a vast home market in which to do business

■ As a member of the Association of South East Asian Nations' Free Trade Area,Indonesia is committed to lowering tariff and non-tariff barriers to trade

Weaknesses ■ Corruption remains a major problem Indonesia ranked 118th out of 174 countries

surveyed in Transparency International's 2012 Corruption Perceptions Index, where alow ranking denotes a higher degree of corruption

■ Indonesia's excessive bureaucracy makes it a difficult place to do business AmongAsian economies, Indonesia has the longest period to start a business Labour lawsare also considered excessive

Opportunities ■ President Susilo Bambang Yudhoyono's administration has gradually been reforming

the business environment, particularly by strengthening the legal system and fightingcorruption If sustained, this would boost investor interest in Indonesia However,reform has been slow, and divisions within the government could curb progressahead of 2014 elections

■ Indonesia has been amending its debt and banking regulations, with the aim ofattracting Islamic financial activities Over the past five years, Islamic banking growthhas averaged more than 65%

Threats ■ Recent high-level business disputes between the government and foreign investors

demonstrate that even after investments are up-and-running, there is still scope forlegal problems or obstacles posed by legal wrangling

Industry Forecast

Table: Indonesia IT Industry - Historical Data And Forecasts (IDRmn)

2010 2011 2012e 2013f 2014f 2015f 2016f 2017f

IT market value 40,532,778 46,570,952 55,574,624 64,638,860 71,968,907 79,630,698 88,607,844 95,572,420 o/w Hardware 28,676,941 33,694,084 39,847,005 45,925,910 50,666,110 55,542,412 61,228,020 65,419,322

- PC 23,228,322 27,359,596 32,674,544 38,026,654 41,951,539 46,100,202 50,819,257 54,298,037

- Servers 2,580,925 3,032,468 3,586,230 4,133,332 4,559,950 4,998,817 5,510,522 5,887,739 o/w Software 4,863,933 5,215,947 6,446,656 7,756,663 8,924,144 10,192,729 11,696,235 12,997,849 o/w Services 6,991,904 7,660,922 9,280,962 10,956,287 12,378,652 13,895,557 15,683,588 17,155,249

IT market, % of GDP 0.63 0.63 0.67 0.70 0.70 0.69 0.69 0.67

e/f = BMI estimate/forecast Source: BMI

BMI forecasts the Indonesian IT market to be a regional and global outperformer over the duration of our

forecast period to 2017 We forecast a compound annual growth rate (CAGR) of 11.5% over 2013-2017,with Indonesia's IT market reaching a total value of IDR95.57trn by 2017 In the immediate future, ITspending is forecast to increase to IDR64.6trn in 2013, up from IDR55.6bn in 2012 Some fundamentaldrivers, including rising computer penetration and growing affordability, should ensure that the marketremains firmly in positive growth territory

Market Trends

Our forecast for the Indonesian IT market has been

downgraded earlier in 2013 in response to a weaker

global outlook negatively impacting the Indonesian

economy Even after the downgrade, we are still

forecasting strong growth of 16.3% in 2013, albeit a

slowdown from 19.3% growth in local currency

terms in 2012 Indonesia will still be one of the

region's fastest-growing IT markets in 2013,

consolidating a strong performance in most market

segments during 2012

There are strong fundamentals in the Indonesian

market Real GDP growth is forecast to reach 6.1%

in 2013, with private final consumption expected to

increase by 5.5% in real terms Meanwhile, PC

penetration is below 10%, giving this huge market

unrivalled long-term growth potential as incomes

rise to levels where large parts of the emerging middle class can afford their first household computingdevice

Although PC penetration is relatively low across Indonesia, there are differences across the country ICTpenetration remains heavily concentrated in the capital Jakarta and its surrounding area Regions beyondJakarta offer greater first-time PC buying potential, but, with a strong middle class emerging around thecapital, there is a large mobile computing device opportunity Vendor focus will shift to thinner and lighterlaptops with more features and longer battery life, and to other form factors such as tablets

The government's masterplan to lift Indonesia into the ranks of the world's top 10 economies by 2025,should fuel ICT investments Spending in some key IT verticals, such as financial services and banking, will

be central to growth in enterprise IT spending However, there is also great potential in currently

underpenetrated sectors such as manufacturing Business IT investment should remain buoyant in line withthe general economy Adoption of cloud computing services by enterprises will also increase, with the value

of the market potentially increasing to IDR12.1trn by the end of BMI's five-year forecast period 2013-2017.

Industry Trends - IT Market

2010-2017

e/f = BMI estimate/forecast Source: BMI

Meanwhile, government infrastructure investments should also provide a boost to the business

sector Government IT spending is expected to increase, however, and continue to account for around 25%

of the IT market, while the government is also encouraging state companies to use more IT

The enterprise market will also boost spending on IT products and services Private enterprises, particularlySMEs, will provide a large part of PC sales, while ERP and other e-business applications are also findingincreasing popularity in the SME market The SME sector of 42.2mn companies will drive demand forbasic hardware and applications as enterprises look to enhance productivity through automating inventory,accounting and other functions Around 30-35mn Indonesian companies are estimated to lack any IT-basedsolutions IT services for this segment will be dominated by basic services such as system integration,support systems, training, professional services, outsourcing and internet services There is also an

opportunity for cloud computing vendors in the SME market, but this market will only open up as telecomsoperators invest in improving wireless and wireline broadband infrastructure

A more active approach by the government to encourage IT development, including the establishment of theNational ICT Council, headed by President Yudhoyono, should stimulate spending through a series ofinfrastructure and education initiatives The Indonesian government's Master Plan for Acceleration andExpansion for Indonesia Economic Development (MPEEI) states that connectivity between the islands ofthe country is a priority area Major government infrastructure and ICT initiatives, particularly the PalapaRing Project, have been rolled out to create the infrastructure to support IT market growth Cheap computerprogrammes are likely to be favoured as increasing internet penetration and computers in schools

programmes are believed to represent potential demand for up to 25mn units

Segments

Although the consumer segment is relatively small as a proportion of the total market, it is estimated that

be fuelled by lower prices and new entertainment and wireless connectivity features Low-cost tabletsrunning Android, particularly from OEMs in China, are expected to prove particularly popular with

Indonesian consumers The government's plans to establish fixed wireless networks in major cities andencourage WiMAX build-out in rural areas will also be drivers There are also an increasing number of Wi-

Fi 'hotspots' Telecoms operators are increasingly pushing tablets as devices to bundle with wireless datasubscriptions as a means of winning market share and increasing network usage

While the emerging middle class in Indonesia is promoting consumption, a large portion of sales are reliant

on government initiatives to increase penetration It will remain dominated by the lower-price tiers, whichwill account for about 80% of sales The popularity of lower cost netbook computers, which flooded themarket a few years back, has helped to sustain volume sales, but demand for the devices has dropped offsharply - largely replaced by tablets, but also by low-cost and slimline notebooks Computer sales will alsoreceive a boost from programmes to increase computer penetration in education, as the government seeks tomeet its growth targets for this sector

Increased corporate demand for IT products and services will reflect a growing awareness of the value oftechnology in various sectors Despite cutbacks due to the financial crisis, the financial services segmentwill continue to be significant, with spending on regulatory compliance and security, for example, lesssusceptible to cutbacks The market also remains relatively under-penetrated, with IT implementationslargely limited to transactions support Islamic banking also presents strong growth opportunities for thenext few years

Another potential demand driver will be organisations looking for help to utilise efficiencies from cloudcomputing such as SaaS and infrastructure-as-a-service The cloud computing market is currently small in

absolute terms, at less than IDR2bn, but in H111 IT giants such as PT Telkom and Microsoft launched

cloud services in Indonesia and demand should grow as more vendors enter the market

No of internet users/100 inhabitants 10.9 18.0 24.9 29.6 33.2 35.8 37.3 38.8

No of broadband internet subscribers ('000) 2,280 2,736 3,037 3,280 3,444 3,617 3,797 3,987

No of broadband internet subscribers/100 inhabitants 1.0 1.1 1.2 1.3 1.4 1.4 1.5 1.6

e/f = BMI estimate/forecast Source: BMI ITU, Kominfo, operators

Latest data retrieved from the International

Telecommunication Union (ITU) showed a drastic

change in the number of internet users and fixed

broadband subscribers in Indonesia compared to

those previously reported The ITU said there were

about 43.6mn individuals using the internet in the

country at the end of 2011, representing a

penetration rate of 18% This was up from 26.2mn in

2010, equivalent to 11% penetration Previously, we

note that the ITU said there were about 61.0mn

internet users in 2011 No reasons were given for the

change in data Consequently, we had amended our

forecasts and we expect 99.4mn internet users in

Indonesia by end-2017, up from 73.2mn in

end-2013

Current forecasts for Indonesia's broadband market

are based on data from the ITU, which showed that

there were only 2.7mn fixed broadband subscribers

in Indonesia at the end of 2011, up from 2.3mn in 2010 Similarly, there were changes to ITU's historicaldata Previously, it reported 1.9mn fixed broadband users in the country in 2010 We have also based our

Industry Trends - Broadband

Sector

2010-2017

e/f = BMI estimate/forecast Source: BMI, ITU, Kominfo, operators

While the low broadband customer base suggests significant growth potential, we note that development offixed broadband infrastructure in Indonesia is hampered by the country's fragmented geography, especially

in rural regions Consequently, operators are instead turning to mobile broadband technologies to increasecoverage, and consumers are also opting for mobile broadband services in light of more affordable

subscriptions and devices

At the end of 2012, Telkom reported 2.3mn fixed broadband subscribers, up from 1.8mn at end-2011 By

comparison, Telkom reported that it had 11.0mn mobile broadband subscribers and 5.8mn BlackBerry

users at end-2012, up from 5.5mn and 3.2mn respectively at end-2011

WiMAX has been deployed on a limited basis, but operators now seem wary of investing in a technologythat will be superseded by alternatives, primarily LTE The government has effectively put back its plannedlicensing of LTE by two to three years in an effort to coerce the WiMAX operators into committing to

network rollouts, but BMI thinks this will have little effect, even with the sweetener of being allowed to

offer mobile WiMAX Nevertheless, WiMAX seemed the most appropriate solution to delivering speed broadband services across Indonesia's 17,508 islands

high-We expect Indonesia's fixed broadband industry to exhibit a steady growth trajectory with increasingservice adoption mainly in urban cities among businesses and more affluent consumers that require higher-speed connectivity The masses' generally low purchasing power and lack of need for high-speed broadbandspeeds mean that 3G-based mobile broadband services would be suffice in the near-to-medium term, whichwill be to the detriment of Indonesia's fixed broadband market We forecast 4.0mn fixed broadband

subscribers in Indonesia by end-2017, representing a penetration rate of 1.6%, up from 3.3mn in end-2013

Macroeconomic Forecasts

Macroeconomic Forecast

BMI View: Indonesia's growth boom is built on solid foundations and we expect it to continue over the

coming years That said, risks are growing, the most pressing of which is a deterioration in global credit markets that could force up local borrowing costs As such, we forecast real GDP growth of 6.1% this year, versus an estimated 6.2% in 2012 and consensus expectations of 6.3% growth.

Indonesia's economic growth boom since the Asian Financial Crisis has been impressive, with real GDPgrowth averaging 5.4% per annum since the recovery began in 2000 Corporate profits (as measured by thecompanies on the Jakarta Composite Index) have grown by an average annual rate of 22% over this period,even accounting for the 60% peak-to-trough decline seen in the global financial crisis This has allowedIndonesia's GDP (in US dollar terms) to rise faster than any other country in the region (with the exception

of Myanmar) over this period

Remarkable Growth Performance

Nominal GDP Growth In US Dollar Terms, %

Source: BMI, National Statistics Institutes

We expect 2013 to be another good year for Indonesian growth, but caution that a disruption in global creditmarkets poses a large risk to the Indonesian economy, particularly given the recent collapse in the currentaccount We forecast real GDP growth of 6.1% this year, versus an estimated 6.2% in 2012 and consensusexpectations of 6.3% growth We believe that 6%+ can be maintained over the coming years,

notwithstanding the growing risks

What's Behind The Growth Boom?

With commodity-related exports accounting for over 60% of total exports, Indonesia has certainly

benefitted from the commodities boom over recent years However, this by no means entirely explains thecountry's improving economic fortunes in recent years Relative political stability, an improving regulatoryenvironment, sound monetary and fiscal policy (and thus a lack of distortionary bubbles), and supportiveglobal credit markets have all played their part This combination of supportive factors has unlocked privatesector profit potential, resulting in a doubling of private capital spending over the past decade in real terms

Nicely Balanced

Indonesia - Trade Balance Breakdown, IDRmn

Source: BMI, BI

Unlike the growth that we have seen in China over the past decade (the third best performer in terms ofGDP growth in US dollar terms), we believe that Indonesia's growth is sustainable We see few signs ofmajor malinvestment threatening Indonesia's long term growth outlook, and expect relative financial

stability to reign Below we outline Indonesia's growth drivers and identify key risks that could derail this growth.

Commodity Prices: Not The Be All And End All

Indonesia has undoubtedly benefitted from the commodities boom, with commodity-related exports

increasing 30% faster than non-commodity exports since 2005 The weakness in export prices seen in 2012was a clear blow to the economy, with total exports falling 6% over the full year, exposing the current andfiscal accounts and leading to a weakening of the rupiah Commodity imports still make up a relatively lowshare of total imports (at just 30%), so a declining commodity import bill in 2012 offered little respite

While continued declines in commodity export prices pose a risk to Indonesia's growth story, this risk is notcritical The economy held up strongly in 2012, in spite of this external shock, and we believe that thiscould be the case going forward Furthermore, looking at Indonesia's terms of trade chart, we could see

some sort of mean reversion over the coming years following several years of deterioration

A Terms Of Trade Bear Market

Indonesia - Citigroup Terms Of Trade Index

Source: BMI, Citigroup

Political Stability: Not To Be Taken For Granted

A return of political instability is perhaps the largest threat to Indonesia's medium-term economic outlook.President Yudhoyono's Democratic Party (PD)'s prospects ahead of 2014's elections continue to shrinkowing to successive corruption scandals, and the potential for a more populist regime to rise in prominence

is growing Specifically, a large risk comes from a continuation in the resource nationalism that we have

seen over the past 12 months (see 'Trade Policy Casts Shadow Over Commodities Sectors', January 22).

Should this continue, it could undermine opportunities not only in the commodities space but also deterforeign investors from entering other areas of the economy

Reform Agenda: Steady Progress

Indonesia's business environment has improved markedly over recent years, albeit from a very low base.The central and local governments have cut red tape and eased the costs associated with business activity bymaking regulatory practices more efficient According to the World Bank's Doing Business Report 2012

Indonesia, represented by Jakarta, is among the top 50 economies improving the most to close their gapwith the top performers globally, and among the top five within the East Asia and the Pacific region.

To cite a few examples, business start-up times have been cut dramatically over the past five years, as hasthe time dealing with construction permits Tax rates have been reduced, and, just as importantly, onlinesystems for filing taxes have cut the time it takes to pay taxes by more than half The recently-passed landacquisition bill is another step in the right direction The Heritage Foundation's Index of Economic Freedomcorroborated the broad improvement seen in Indonesia's business environment The country's score hasrisen steadily since the GFC, increasing from 53 in 2009 to 57 today, helping the country close the gap withthe world's freest economies

While there is a risk posed by a new national government, we do not expect to see the trend of regulatorypragmatism be reversed anytime soon, with local officials increasingly aware of the positive impact thatthese reforms have had on local tax revenues and economic growth

Fiscal And Monetary Policy: Can Crowding Out Be Kept To A Minimum?

Tax reforms to widen the government's revenue base have been instrumental in boosting revenues overrecent years and allowing the government to lower its debt level Natural resource-related revenues havealso grown strongly thanks to the commodity boom, but their share of total revenues have halved over thelast year, reflecting the structural improvement seen in the tax take On the revenue side, despite the

continued lack of willingness to push through fuel price reforms, total expenditures as a share of GDP haveaveraged a respectable 18% over the past five years, and debt-to-GDP has continued its retreat Indonesia'sfiscal accounts are in pretty good shape, and this will continue to facilitate private investment over thecoming years by keeping crowding out to a minimum

Reasonable Real Rates

Indonesia, China - Real Interest Rates

*Real interest rates calculated as: average of (Bank Base Rate minus CPI) & (Nominal GDP minus 1-Year Lending Rate) Source: BMI, IFS

Prudent monetary policy has also had a large part to play in keeping government bond yields low Interestrates have generally been above Bank Indonesia's base rate over the past decade and the lending rate hasgenerally exceeded nominal GDP growth With the exception of late-2011 when we believe that BI was tooaggressive with its rate cutting policy, they have generally acted prudently While M2 growth has been alittle high over recent years, total credit as a share of GDP had grown only marginally, and is not showingany warning signs as of yet With property bubbles springing up in a number of countries across the region,

we take comfort in the lack of speculative activity going on in the country's real estate market comparedwith its regional peers

No Sign Of Credit Excesses Or Corporate Stress

We believe that prudent monetary and fiscal policy has prevented the build-up of excesses and speculativebubbles that have characterised China's growth story over recent years While we do not dispute that thereare certain excesses in some areas of the economy, on the whole, there are few signs that the capital

spending of recent years has been driven by flawed price signals and prone to widespread losses On the

contrary, the corporate sector is in rude health This contrasts greatly with the situation we see in China atpresent, where a huge credit bubble appears to be in its final stages and evidence of corporate stress isalready clearly showing.

Leading The Pack

Average Return On Assets For Listed Stocks, %

Source: BMI, Bloomberg

Using corporate data from stocks listed on the Jakarta Composite Index, return on assets is showing no sign

of easing The 12% figure is among the highest in the region, almost triple that seen in China Going beyondthis, Indonesian corporates appear to be showing high quality earnings By this we mean that companies areboasting strong cash flows, with operating cash flows exceeding net income by a strong margin Again thiscontrasts with China (as represented by the Shanghai Composite Index), where cash flows have laggedearnings potentially reflecting a rise in receivables and accounting gimmicks inflating earnings

Quality Earnings

Indonesia, China - Average Operating Cash Flows / Earnings For Listed Stocks

Source: BMI, Bloomberg

Uniquely Exposed To Global Risks

Looking at the composition of GDP by expenditure, it appears as though Indonesia is relatively insulatedfrom external forces, with private consumption representing the lion's share of GDP at 55% However, theeconomy is highly exposed to global credit conditions This became abundantly clear in 2009 when theIndonesian rupiah collapsed and local bond yields soared Since then, the external debt position has

strengthened and we are not expecting a perfect storm in global capital markets That said, Indonesia is onceagain at risk from a freeze up in global debt markets The local bond market is increasingly at the mercy ofexternal demand, with foreigners holding 33% of total bonds Regarding external debt, the global reach foryield has pushed the 5-year CDS spread to near record lows of 130 basis points This has come at a timewhen Indonesia's current account deficit is hitting all-time highs, suggesting that any flare-up in global riskaversion could send local interest rates soaring and the currency plunging, both to the detriment of domesticdemand

Below Consensus, But Still Bullish

Growth should continue to perform strongly in comparison with regional peers in 2013 Business

confidence is on the up according to a number of surveys, with the recent CPA Australia-Pacific smallbusiness survey showing Indonesian firms as being by far the most optimistic in the region Likewise,consumer confidence is also booming according to official sources Our infrastructure team holds a brightoutlook for the construction sector thanks in part to continued progress on the public-private partnershipfront We also expect to see a broad-based recovery in exports as the regional growth rebound continuesuntil H213

Confidence Is Up

Indonesia - Business And Consumer Confidence Indices

Source: BMI, Statistik Indonesia

That said, we remain concerned by the unique threat posed by renewed weakness in global credit markets,which could once again undermine the country's growth prospects in the near term As such, the balance ofrisks favours being below consensus in our 2013 real GDP growth forecast, and we are forecasting 6.1%

Industry Risk Reward Ratings

Industry Risk/Reward Ratings

BMI's Asia Pacific IT Risk/Reward Ratings (RRR) compares the potential of a selection of the region's

markets over our forecast period through to 2017 Our Q313 ratings reflect our consideration of the politicaland economic risks, as well as the risks associated specifically with IT intellectual property (IP) rightsprotection and the implementation of state spending projects There were several changes to this quarter'srankings as we have updated our macroeconomic and industry data

Rising to the top is South Korea with an IT Rating score of 72.2, up from 65.2 the previous quarter Thesignificant improvement was due to an increase in the country's Industry Rewards score, which partiallyoffset a decline in its Country Risks score Two key factors form the foundation for the Industry Rewardsupgrade: South Korea's LTE market is one of the most mature in the world and the country houses the two

largest consumer electronics firms - Samsung Electronics and LG Electronics The close working

relationship between telecoms operators and the two manufacturers means that there is a portfolio of mobiledevices to support the 4G service, which in turns allows companies to develop new services such as cloudsolutions to leverage on the high-speed connectivity

Singapore fell to second rank after its IT Rating score decreased from 74.1 to 71.3 due to a combination ofdeclines in its Industry Rewards and Country Risks scores However, Singapore's Country Score of 100 andthe proactive nature of the ICT regulator continue to provide support Due to the lack of natural resources,Singapore relies heavily on technological innovations to attract businesses Besides rolling out 4G and fibrebroadband networks, the country encourages developments such as creating smart districts and exportableenterprise mobility solutions The Infocomm Development Authority also collaborated on an interoperableNFC infrastructure in the country

Hong Kong remained in third position with an IT Rating score of 68.9, down from 72.2 the previous quarter

in light of a decline in its Country Risks score Hong Kong's trade performance thus far has been in linewith our expectations We acknowledge that the uptick in trade could have further room to run However,

we are still convinced that this momentum is likely to be unsustainable and are maintaining our call foreconomic activity to slide towards the latter stages of the year Hong Kong is a well-established financialhub, and IT solutions present an opportunity for companies to reduce operating costs and improve

operational efficiency when carrying out transactions, particularly cross-border trade

Australia fell to fourth position after its IT Rating score decreased from 73.3 to 68.0 Like several of itspeers, the score revision was due to a change in its Country Risks score Although Australia has its

ambitious National Broadband Network, which will vastly improve broadband coverage and speeds

throughout the country, thereby providing a boost to the IT sector, the project is facing an uncertain futurewith the federal elections approaching in September 2013 The opposition government has announced that itwill rely on less of fibre and more on the existing copper networks to save costs and time We believe thatthis is a short-term solution that will materially impact developments in the IT industry

China rose to fifth position with an improvement in its Industry Rewards score offsetting a decline in itsCountry Risk score While our view for a bounce in the Chinese economy has played out, should the newleadership reduce support for loss-making state-dominated industries, this would mean a much weakerH213 and 2014 for China's economy than the consensus currently expects However, our long-term viewthat China will shift its economy away from infrastructure investment and towards consumer services bodeswell for the IT sector The introduction of next generation broadband technologies will also provide thenecessary growth foundation, providing impetus to new IT services and consumer electronics

Malaysia's IT Rating score increased from 52.3 to 56.4, but the country still fell from fifth to sixth position.The country's score revision was due to an improvement in its Industry Rewards score, which mitigate adecline in its Country Risks score Malaysia's Economic Transformation Programme has earmarked areassuch as cloud computing as one of its top 10 strategic technology priorities For the ICT sector, the countryhas identified business opportunities areas such as fixed and mobile services as well as semiconductors andindustrial electronics

India moved up the Risk/Reward Ratings table as we have factored in the country's longer-term growthpotential - the country's IT Rating score increased from 42.1 to 51.6 India's IT market houses some of the

world's largest players - Wipro, Tata Consultancy and Infosys - and we note that companies in the country

are becoming more receptive to engaging the services of professional IT firms to reduce cost and focus ontheir core competency Assuming that the government is able to eventually sort out the chaotic situation inthe telecoms sector, 3G and 4G services could be unshackled, thereby leading to growth in IT services such

as telemedicine and cloud computing, and consumer electronics products such as tablet computers

The Philippines fell to ninth position even though its IT Rating score increased from 43.8 to 49.6 thisquarter The country follows the theme of an increase in Industry Rewards score offsetting a decline inCountry Risks score The Philippines is a well-established player in the business process outsourcing (BPO)

Long Distance Telephone Company agreed to sell its majority stake in BPO unit, SPi, to CVC Capital Partners' Asia Outsourcing Gamma.

There were no changes to the rankings of the last four countries - Indonesia, Thailand, Vietnam and SriLanka - although there were adjustments to their IT Rating scores Indonesia's IT Rating score came in at47.5 One of the most populous country in the world, Indonesia is experiencing strong IT developments inricher areas such as Java, where IT infrastructure is more established Growing urbanisation means thatmedium-tier cities are also becoming investment hotspots, which will lead to demand for IT services Bothconsumer- and business-facing solutions have strong growth opportunities, especially with the governmentkeen to spur developments For example, the Indonesian government is currently in negotiation with

Foxconn Technology Group to set up a manufacturing facility.

Thailand's ICT industry is looking increasingly brighter with the National Broadcasting and

Telecommunications Commission able to implement changes Besides facilitating the launch of 3G

services, which will satisfy pent-up demand from consumers and businesses, the regulator is targeting tokick start the digital TV sector These developments have in turn attracted investments into the country's IT

sector In April 2013, NetApp announced that it is tripling its investment in the country to capitalise on the

rapidly growing datacentre market

Vietnam has pledged to invest US$8.5bn in its ICT sector in the next 10 years The government is also

looking to attract US$5bn worth of foreign investments in the IT sector by 2015, according to Avaya In

April 2013, construction for the Danang Hi-Tech Park, which costs US$278mn and follow the same model

as the US' Silicon Valley and Taiwan's Hsinchui Science Park, was started The project is expected to houseabout 100 businesses, create 25,000 jobs and generate revenue of US$3bn Vietnam's IT Rating score hasincreased from 34.2 to 41.1

Sri Lanka saw its IT Rating score increase from 27.7 to 35.2 due to improvements to its Industry Rewardsand Country Risks scores However, the country continues to lag behind its peers, although telecomsoperators have started to roll out LTE services In January 2013, the Sri Lanka Institute of Information

Technology joined the EMC Academic Alliance programme, which will offer courses on areas such as

cloud computing, backup recovery systems and architecture and big data analytics to students Sri Lankanreal GDP growth came in much stronger than expected in the final quarter of 2012, surging to 6.3% year-on-year from 4.8% in Q312, surpassing consensus expectations for a 5.5% expansion We are holding on toour core view for full-year real GDP growth to remain flat this year, implying a similar 6.4% economicexpansion for 2013 (up from our previous forecast of 5.4%) We are likely to see renewed headline

weakness through H113, before the economy turns up in the second half of the year Looking further ahead,

we still see growth improving from 2014 onwards

Table: Asia Pacific IT Risk/Reward Ratings - Q3 2013

Country Industry Rewards Country Rewards Industry Risks Country Risks IT Rating Ran k Previous Rank

South Korea 70.0 80.0 75.0 65.4 72.2 1 4 Singapore 55.0 100.0 70.0 74.4 71.3 2 1 Hong Kong 55.0 100.0 45.0 77.7 68.9 3 3 Australia 60.0 95.0 45.0 66.9 68.0 4 2 China 76.7 30.0 45.0 55.1 57.5 5 6 Malaysia 58.3 55.0 35.0 67.7 56.4 6 5 India 73.3 15.0 45.0 50.9 51.6 7 8 Philippines 53.3 45.0 42.5 50.9 49.6 8 7 Indonesia 53.3 40.0 35.0 51.4 47.5 9 9 Thailand 58.3 20.0 35.0 62.9 47.0 10 10 Vietnam 51.7 15.0 35.0 53.7 41.1 11 11 Sri Lanka 40.0 15.0 35.0 50.9 35.2 12 12

Average 58.8 50.8 45.2 60.6 55.5

Scores out of 100, with 100 highest The IT Risk/Reward Rating comprises two sub-ratings 'Rewards' and 'Risks' Scores are weighted as follows: 'Rewards': 70%, of which Industry Rewards 65% and Country Rewards 35%; 'Risks': 30%, of which Industry Risks 40% and Country Risks 60% The 'Rewards' rating evaluates the size and growth potential of an IT market in any given state, and country's broader economic/socio-demographic characteristics that impact the industry's development; the 'Risks' rating evaluates industry specific dangers and those emanating from the state's political/

economic profile, based on BMI's proprietary Country Risk Ratings that could affect the realisation of anticipated returns Source: BMI

BMI maintains a positive growth outlook for the IT

hardware market in 2013, with wider economic

performance providing key impetus for growth The

forecast for 2013 comes on the back of a strong 2012

during which the market grew by an even more

impressive 18.3% The Indonesian economy seems

to be enjoying the fruits of political stability under a

government that is liberal, yet sensitive, to the

demands of the market The equation between the

US dollar and the Indonesian rupiah is likely to play

a role as it did in 2012 A weaker dollar translates

into cheaper imports, boosting sales in the local

currency, although the same effect will not be visible

when looked at in terms of US dollar sales

There are a range of factors that combine to underpin

our outlook for the Indonesian hardware market and

make it one of our picks for outperforming growth both regionally and globally The Indonesian promisehinges on the following factors:

■ The sheer size of its economy places Indonesia among the top markets in Asia Pacific, even though PCpenetration remained low in 2012 It is the only country in South East Asia to feature in the G20 For amajor duration since the late 1970s, Indonesia has seen healthy economic growth barring the meltdown in

1997 to a large extent Indonesia, at its present growth rates, is well on the way towards featuring in thetop ten global economies by the year 2025

■ The low PC penetration means there is a large pool of first-time buyers that can be tapped as incomes rise

over the medium term Intel pegs the PC penetration of the country to be as low as 7%, while other

estimates are slightly higher at around 9-10% for 2012 This is still considerably lower than regional

peers such as Malaysia and Thailand as well as even Philippines and Vietnam Given BMI's forecast for

real private final consumption growth to average 6.5% annually 2013-2017, during which time GDP per

Hardware Market (IDRmn)

2010-2017

e/f = BMI estimate/forecast Source: BMI

capita will increase from US$3,595 in 2012 to US$6,031 in 2017, the lack of PC penetration is acompelling business opportunity The modest PC penetration remains centred on metros such as Jakarta,according to estimates, providing a much clearer picture of the market opportunity.

■ Indonesia presents an attractive demographic distribution with more than half the population under 30years of age, as of 2013 The distribution places the segment most receptive to IT in a clear majority,which bodes well for IT hardware vendors over the medium term

The notebook category has been an outperformer in the retail market, and is the largest market in South EastAsia Gfk reports that the combined shipment units for notebooks and tablets in the country grew by an

impressive 37% during 9M12 to 2.76mn units Meanwhile, IDC estimates 3.6mn notebooks were shipped

during the whole of 2012, with sales of a further 1.4mn tablets These numbers are a resounding

endorsement of the health of the market

Notebooks have gained greatest traction in the retail market, where IDC estimates they accounted for 85%

of sales, compared to 35% of units in the enterprise market This difference between retail and corporate

and business users is supported by statements from Chinese equipment vendor Lenovo Lenovo also

contends that notebooks are the main drawers for first time PC users, including students Given the

demographic profile of Indonesia, it is obvious that the most promising customer segment is

overwhelmingly in favour of notebooks Lenovo, in fact, pegs the proportional share of notebooks amongthe retail user's PC purchases at a formidable 85% Recognising the appeal of notebooks in the largelyaspirational segment comprising of the youth, Lenovo offered its IdeaPad products at a very competitiveprice of US$250 in January 2013

Lenovo has good reason to be aggressive in the Indonesian market as the top two slots in notebook sales in

the country in 2012 were occupied by Acer and Asus respectively, according to IDC.

Tablets

Tablets have experienced a sharp uptick in sales in 2012, and are set to grow rapidly in 2013 IDC

estimates a 42% increase in the number of tablet shipments in the country in the year 2012 In that sense,tablets in Indonesia are following in the footsteps of their success globally Tablet uptake in Indonesia was

initially slow, with an Apple-centric market meaning the devices were out of reach for the majority of

consumers However, more affordable devices have seen volumes increase markedly

Statcounter data show that iOS (the operating system on Apple's iPad) and Android respectively accountedfor 2.1% and 3% of PC browsing traffic in March 2013 This is a small share of overall traffic, as would beexpected, but, with Android's share up by 2.4pps and iOS up 1.2pps, they are rising rapidly It is notablethat Android is ahead of iOS, a feature not seen in the vast majority of markets, even with low incomes

Samsung claims to have achieved 50% tablet market share in 2012 through its Galaxy Tab products (as

well as an 80% share of Android smartphones), moving it ahead of Apple

Samsung is well positioned to sell large numbers of tablets, with tablets expected to eventually surpassnotebook volumes However, we believe that low-priced alternatives from Chinese OEMs and local

manufacturers will be the ones to take the tablet truly mass market Key local vendors in the market include

Advan, MITO and Smartfen among others Meanwhile, Indonesia manufacturer S Nexian launched six

new devices in March 2013, including an 8-inch Android tablet The S Nexian device will come with 8GB

to 32GB of storage with a 1,024x768 resolution The device is available for IDR1.5mn (US$155),

approximately 50% of the cost of the Asus Google Nexus 7 and is available subsidised through a

partnership with telecoms operator Indosat, giving the user access to the operators 5,000 Wi-Fi locations

across the country S Nexian is targeting the sale of 250,000 tablets over the course of 2012

The decline in the average price of a tablet sold in Indonesia reflects the focus on the low end of the market.The average price was US$485 in 2012, which was a considerable drop from US$651, as recorded in 2011,according to Gfk Indonesia Acer is targeting the tablet market, and hopes to capture 20% market share in

2013, from around 1% in 9M12 Acer is planning to do so by focusing on low-cost tablets in an effort totarget the emerging middle class in Indonesia IDC states that Acer was not even among the top 10 tabletvendors in 2012, during which over 1.3mn tablets were shipped Acer's success in Indonesia will dependpartly on its ability to reach beyond the largest cities to establish a dealer network that will repair as well assell its devices

Ultrabooks

Despite little traction being gained in 2012, Intel, the key driver behind the ultrabook concept, remains

bullish about it in Indonesia It plans to stick to its guns by employing the more advanced, and thus moreexpensive, Ivy Bridge processor There were suggestions from certain vendors about reverting to the costeffective, but feature limited Sandy Bridge processors; but Intel plans to stick to Ivy Bridge, for its betterendurance Some of the ultrabook models available in Indonesia as of Q412 include Acer Aspire S3, Asus

Zenbook, Dell XPS, HP Folio, Lenovo Ideapad U300, Samsung Series 5 and Toshiba Portege Z series.

While premium pricing of ultrabooks can be a showstopper in a price sensitive market at Indonesia, Intel isconfident economies of scale will make the price more palatable The release of Windows 8 in October

2012 could also provide a boost to adoption of ultrabooks as consumers and businesses upgrade to the new

operating system BMI expects lower cost ultrabooks to become widely available in H213 and 2014 as

vendors risk losing out on volumes to tablet manufacturers Lower cost slimline Ultrabooks (or near

equivilents) have already been seen in Vietnam