INDONESIA - 2015

MARC has affirmed Indonesia’s foreign currency sovereign rating of AA- with a stable outlook based on MARC’s national rating scale. The rating reflects MARC’s opinion of the sovereign’s ability to meet its foreign currency obligations in full and on time. The government of Indonesia has no debt rated by MARC. The rating also serves as a country ceiling for ringgit-denominated debt issued locally by issuers domiciled in Indonesia. Transfer and convertibility (T&C) risks are reflected in the country ceiling. The analysis is based solely on information available in the public domain.

Indonesia’s AA- rating is supported by its resilient economic growth prospects, which are supported by its large domestic demand base and growing middle class, as well as manageable and sustainable public debt. The rating also takes into account Indonesia’s banking system which will likely face tougher times ahead, rising external vulnerability, weak institutions and poor business environment.

Economic strength remains Indonesia’s biggest rating support, despite growth having slackened to its slowest pace in five years. In 2014, gross domestic product (GDP) growth moderated to 5.0% from the 5.8% average growth pace achieved during the 2010-2014 period. The government has revised downwards its growth target for 2015 to a still optimistic 5.2% from 5.8% previously. However, Indonesia continues to hold enormous promise. It is the largest economy in Southeast Asia. Its population is relatively young, the third youngest in East Asia, and around 10 years younger than in most major advanced countries. Indonesia’s rising working-age population and low dependency ratio have helped power GDP growth. Apart from China and India, the growth of the consuming class in Indonesia is already stronger than in any economy of the world. Continued structural reform efforts by the new government under the reformist new president are expected to keep Indonesia on a positive and respectable growth trajectory over the medium term.

Another rating support is Indonesia’s manageable and sustainable public debt. At 26.1% of GDP (end-2014), it is much lower than the median of other emerging market economies. Contingent liabilities also appear manageable and unlikely to pose a threat to public debt sustainability. At end-2013, the debt of non-financial state-owned enterprises was moderately low at 5% of GDP. According to stress test results, the general government debt-to-GDP ratio will likely remain modest under shocks from contingent liabilities, sharp exchange rate movements, slower economic growth, and higher interest rates. However, Indonesia’s fiscal deficits remain persistent (2014: 2.3% of GDP), with budgetary pressures coming from rising energy subsidies and weak revenue collections. Over the 2011-2014 period, for example, energy subsidies averaged 3.5% of GDP a year. Subsidy rationalisation has started. To relieve fiscal pressures further, Indonesia needs to improve its tax take. If not, there could be heightened fiscal risks going forward because of expected increases in public spending on health and pensions over the medium to long term.

Even though the banking system remains stable, it is expected to face tougher times ahead, and as such is a rating concern. Thanks to financial sector reforms, gone are the days of capital deficiency, weak compliance and governance. The banking sector, now stronger with larger domestic deposit bases, meets Basel III’s capital ratio standards. As at end-June 2014, the sector’s regulatory capital to risk-weighted assets stood at 18.9%, while regulatory Tier-1 capital to risk-weighted assets stood at 17.7%. It remains profitable and appears generally robust with low loan impairments at the aggregate level. The latest data show overall non-performing loans (NPL) to total gross loans standing at 2.5% in April 2015. However, aggregate asset quality going forward is expected to drop on account of slowing economic growth and recent market volatilities that have caused the rupiah to fall significantly. Commodity exporters, who took on debt in anticipation of continued high demand for their products and high prices, have been hit by lethargic demand and a swift decline of prices.

External weaknesses continue to be a rating constraint. Indonesia’s current account balance remains in deficit territory, though there have been improvements. Over the 2Q2014-1Q2015 period, the deficit narrowed from -3.9% to -1.8% of GDP. At the same time, Indonesia has managed to chalk up six consecutive quarters of balance of payments surpluses. While these indicate falling annual external financing requirements, it remains dependent on external financing. The problem is, Indonesia has always been vulnerable to international capital volatility, and its external vulnerability has been accentuated by rising international financial market uncertainty. Its external sustainability is sensitive to both current account and exchange rate shocks, and the falling rupiah is a major concern. Also of concern is Indonesia’s gross external debt. While still at a moderate level (end-June 2015: 34.4% of GDP), it is nearly three times the size of the country’s official reserves. Indonesia’s official reserve assets at end-2014 were, according to the International Monetary Fund (IMF), sufficient to deal with most shocks. By end-August 2015, it had fallen 5.9%, and any further falls would increase concerns further.

Weak institutions and a poor business environment are also rating constraints for Indonesia. It was ranked 107th out of 175 countries in Transparency International’s Corruption Perception Index 2014. It also did poorly in the World Bank’s World Governance Indicators (2014 update), with percentile rankings in all six indicators below 50. And as expected, it is ranked very low at number 114 in the World Bank’s Ease of Doing Business 2015 report. President Jokowi has been vocal about wanting to return Indonesia to 7% growth. Making this difficult to achieve is the resistance he faces in his reform efforts. This is because not only does he head a minority coalition in the national parliament, he is also an outsider to the political establishment. For Indonesia to reach its economic potential, it is probably not too much to say that the success of governance reforms may turn out to be the deciding factor.

Indonesia’s stable outlook reflects MARC’s assumptions that there will be some successes in the government’s reform efforts to improve institutions and the business environment, as well as other economic, political and social reforms. We also assume effective implementation of infrastructure development plans to improve logistics in Indonesia, which are expected to attract foreign direct investment (FDI) inflows over the medium term. Other assumptions include the global economy continuing to improve without undergoing any major crises, and the oil outlook remaining stable.

Major Rating Factors

Strengths

• Large economy with a growing middle class; and
• Manageable and sustainable public debt.

Challenges

• Tougher times ahead for the banking system;
• Rising external vulnerability; and
• Weak institutions and poor business environment.