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Will Indonesia Replace India in the BRICs?

As India fails to deliver on its promise of growth, a smaller Asian country Indonesia, finds itself in a position to lure investors away from the third largest economy in the region with higher stock market returns, better fiscal management and lower inflation.

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“Indonesia looks like it has hit the sweet spot, whereas India is nursing a headache from its latest boom,” says Frederic Neumann, Co-Head of Asian Economic Research at HSBC.

While the two economies aren’t similar in terms of size, with India’s population of 1.2 billion and Indonesia’s at 240 million, the countries share many similarities, leading to comparisons. Both have a burgeoning consumer base and are democracies with an investment grade rating.

India’s economy has hit a rough spot with the slowest pace of growth in three years with the government unable to deliver on economic reforms. On the other hand, Indonesia has won favor with investors over the past few years.

That’s leading Neumann and others to call for Indonesia to be included in the lineup of top global emerging markets. “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,“ says Neumann.

On the other hand, India, according to Goldman Sachs’ Jim O’Neill, the man who coined the term in 2001, is the BRIC that has disappointed. Late last year O'Neill said that India’s poor record on productivity, foreign direct investment (FDI) and policy reform had made it the most disappointing among the four biggest developing economies – Brazil, Russia, India and China.

For example, India’s fiscal deficit target of 5.1 percent is wider than those of its BRIC peers. Its forecast deficit is more than four times Brazil's estimated 2012 budget gap of 1.2 percent of output.

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“It is difficult to see how India can turn around in the short term. It could in the next couple of years, but that is an eternity from investors’ point of view, ” says Neumann.

He adds that investors have already voted with their feet taking money out of India. The latest evidence of this was in the month of April when offshore investors withdrew some $403 million out of Indian equities and bonds, according to Reuters data.

While it is difficult to estimate how much of India’s loss has been Indonesia’s gain, market watchers say many investors have been increasingly looking at Indonesia as an alternative to India.

“To a large extent investor interest has moved to Indonesia,” Robert Prior-Wandesford, Director, 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.”

While the Bombay Stock Exchange’s Sensex was the worst performing major global index in 2011 falling almost 25 percent, the Jakarta Composite Index gained over three percent.

Besides delivering better returns, Indonesia is also catching up with India when it comes to economic growth. India’s gross domestic product (GDP) is expected to expand at just under 7 percent in the current fiscal year, which began April 1, while Indonesia is expected to deliver 6 to 7 percent growth over the next couple of years, say analysts.

Even on trade, Indonesia scores over India. According to brokerage CLSA’s latest forecast Indonesia’s current account deficit in 2012 will be just 0.8 percent of GDP, while India’s will come in at around 3.9 percent.

Rajeev Malik, Senior Economist at CLSA, says in Indonesia’s case, net Foreign Direct Investment (FDI) will offset the current account deficit. In India's case, he points out, an estimated net FDI inflow of $15-20 billion will be well short of the current account deficit.

“They are doing better although they are not as big an economy as India,” he says.

Credit Suisse’s Wandesford says Indonesia reminds him of India three to four years ago, when there was a huge euphoria over the growth opportunity it offered foreign investors and companies. “In 2005-2008 India could do no wrong, now it is Indonesia.”

India, which was awarded an investment grade rating by Standard and Poor’s in 2007 is now under threat of losing it, with the ratings agency last month downgrading its credit outlook to negative. By contrast, both Fitch and Moody’s upgraded Indonesia to investment grade in December and January, respectively.

Size Matters

But despite the growing pessimism around India, most experts feel that it is not time yet to write off a country of a billion-plus people, if on nothing else than its sheer size.

Some argue that while there is a case for Indonesia to join the BRICs, it shouldn’t be at the cost of India as they both have different comparative advantages. While one is a commodity economy, the other is a services oriented one and an investor, for example, can’t completely replicate his menu of Indian stocks in Indonesia, say analysts.

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

By CNBC's Gauri Bhatia

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