Reuters - Asia's best performing stock market this year, Indonesia, is now seeing a string of upgrades in corporate earnings forecasts that could give the rally further momentum and cement its lead in the region.

Jakarta's stock market is basking in the quick turnaround the economy made from last year's currency crisis, helped by a rise in interest rates and an improvement in the country's huge trade deficit. The index has risen 17.5 percent in dollar terms so far in 2014, with the rupiah's rally contributing to those gains.

Analysts are now counting on other factors to drive the market up by a further 10 to 15 percent. Indonesia has presidential elections in April, and the stock market has historically rallied after elections.

Besides, domestic demand is strong and companies catering to the Indonesian middle class are seeing a jump in earnings. Consensus estimates for future business profits are rising.

"Once people could see that Indonesia's macro was improving faster than the other countries that are perceived to be risky, then Indonesia's risk premium vanished pretty quickly. That is what led to the initial sharp rally," said Jahanzeb Naseer, research analyst at Credit Suisse in Jakarta.

"From here on, what will differentiate Indonesia is that it is probably starting an upcycle in earnings. That tends to be a much more sustained period of recovery for markets."

So far, earnings have not been upgraded as fast as stock prices, causing a rapid expansion in Indonesia's price-to-earnings (PE) multiples.

The consensus PE ratio for Indonesia is 26.3 percent above its long-term average, analysts at Nomura estimate, whereas most others in Asia have PEs at or below long term averages.

Indonesia's PE has expanded 5 percent since early December to 13.4, according to Thomson Reuters I/B/E/S. In the same period, Singapore's PE is down 5 percent, India's is down 3 percent, while South Korea's is up a mere 2 percent.

The Jakarta stock market has had a 0.3 percent upward revision in average earnings for the next fiscal year in the past 30 days, the most in Asia, as per Thomson Reuters StarMine.

Analysts now expect earnings per share (EPS) in the next financial year will be up 10 percent, and those earnings upgrades could drive the next leg up in stock prices.

"Most of these EPS forecast improvements came over the course of February when the macro environment was starting to look better," said Mixo Das, a strategist with Nomura.

EXPENSIVE MARKET

The $387 billion Jakarta stock exchange is still 10 percent below record highs hit last May, just before fears of capital outflows from a tightening of U.S. monetary policy dragged emerging markets down, hitting India, Indonesia, Turkey, Brazil and South Africa the hardest.

Both India and Indonesia have bounced back, helped by interest rate rises, import curbs and other measures to contain their current account deficits. The rupiah has rallied nearly 8 percent from lows hit at the end of December.

The rally has made Indonesia one of Asia's most expensive markets, with a price to book ratio (P/B) of 3.5. The Philippines comes closest to that kind of valuation with a P/B ratio of 3.

But the priciness is partly illusory and somewhat curiously comforting, say Credit Suisse analysts.

If Unilever Indonesia, which is 5 percent of the market capitalisation and trades at a price-to-book of 54, is removed from the index, then the average index P/B ratio is down to 2.6, which is more in line with the Asian average.

Secondly, history shows the index tends to rally when the P/B ratio is this high.

Moreover, there is a lot of money riding on the strength of domestic spending in Indonesia, a factor underpinning both the economy and the stock market.

Return on equity for the past 12 months is close to a long-term average of 23 percent, way above peers in the region that offer returns in the teens. That has to do with the high profit margins of Indonesian consumer-oriented businesses, a market that foreign firms have struggled to enter.

"When you have these barriers to entry through high cost of capital, regulation, currency volatility, etc., the players who are entrenched have the ability to deliver very high return on capital," said Samir Mehta, a senior fund manager at J O Hambro Investment Management. JOHIM manages $21 billion globally.

Still, investors know the risks posed by upcoming elections and the economy. The economy could falter if the central bank continues to raise rates. If it doesn't, imports could blow out again, putting pressure on the rupiah through a widening of the current account deficit.

"There are a number of reasons to still be worried," said Naseer. But the odds are that the economy continues to improve, he said.

"That is why you have to be bullish. If you wait for certainty, then you'd probably be buying when everything is already priced in."