MARC has assigned a foreign currency sovereign rating of ‘AA-’ with a stable outlook to the Republic of Indonesia based on the rating agency’s national rating scale. The government of Indonesia (GoI) has no debt rated by MARC. The country ceiling applies to ringgit-denominated issuances by entities domiciled in Indonesia to reflect the transfer and convertibility (T&C) risk in ringgit-denominated debt issuances by foreign issuers. The rating is based solely on an analysis of information in the public domain.

The rating reflects Indonesia’s macroeconomic conditions which are characterised by its resilient economic growth with low volatility, proactive monetary policy management and stable banking system. The rating is moderated by Indonesia’s vulnerability to capital flows, relatively high political risks and relatively difficult environment to do a business.

Supporting Indonesia’s favourable outlook is its resilient economic growth thanks to stable economic policies, particularly its credible commitment to fiscal prudence and a rules-based monetary policy framework. Strong domestic demand, which helped maintain Indonesia’s economic growth momentum even during the depths of the Great Recession of 2008-2009, is a strong plus point. Its growth volatility is also among the lowest in the region. MARC believes that continued efforts at reform, as well as sustained investment in infrastructure and industry, will keep Indonesia on its positive growth trajectory over the medium term.

Indonesia’s overall level of inflation has been persistently higher than its regional peers. While it appears that the economy has adjusted to an elevated rate of inflation and expectations appear to be well-anchored to a higher but steady inflation rate, there are economic costs. Notwithstanding this, we believe that Indonesia’s monetary policy framework should be able to keep prices stable and as such, inflation risks should be well contained. The Bank Indonesia (BI) has been proactive in reacting to changes in inflationary expectations. The bout of interest-rate hikes in 2013, for example, eased inflation, current account (CA) and rupiah (IDR) pressures, helping to stabilise the Indonesian economy. Going forward, we expect a gradual lowering of the inflation target to bring the inflation rate more in line with neighbouring countries.

In the 15 years since the Asian Financial Crisis (AFC) in 1997-1998, Indonesia’s banking sector has made a notable recovery. Banking sector regulation and supervision have substantially improved, leading to a stable and generally well-capitalised banking system with well-contained risks. Loan impairments have been on the decline generally, while return on assets (ROA) and net interest margins (NIM) remain relatively high. We do not think there is a build-up of excessive leverage in the economy. We believe that ongoing improvements in supervision and regulation, prudent banking management and the authorities’ quick and timely responses to financial stress will ensure continued stability of the banking system.

We think that one of the concerns of the Indonesian economy is its external exposure. The CA turned negative in 2012 mainly due to lower average prices of oil and gas. Indonesia also suffers from strong outflows of income, which in 2013 was boosted by the relatively poor performance of the rupiah. The concern of possible outflows is also compounded by Indonesia’s elevated level of foreign ownership of government securities, the highest in the region. We view that the large share of public debt denominated in foreign currency and deficits in the CA balance are points of vulnerability and a potential source of instability, with ramifications for market interest rates and the rupiah.

Political risks have somewhat abated after the conclusion of the closest and most bitterly fought presidential election in Indonesia's history. The victory of Jakarta Governor Joko "Jokowi" Widodo by just over six percentage points in the July 9 election brings promises of major reforms. There are concerns, however, that Jokowi may be overwhelmed by former president Megawati Sukarnoputri, the chief of the party that supports him, as he acknowledged that 20% of his cabinet will likely be based on deals made with other parties that backed him.

While Indonesia remains a popular investment destination for foreign investors, it remains a relatively difficult place to do business. More improvements are needed in its infrastructure; the country also scores in the lower half of global rankings on many governance indicators, and has a relatively poor record on corruption. The reform process is ongoing, but results have been slow in coming, prompting Jokowi to promise to simplify life for investors by unravelling complicated regulations, beefing up Indonesia's threadbare infrastructure and sacking non-performing ministers. 

The stable outlook reflects MARC’s expectations that Indonesia’s macro-policy stance will remain unchanged. We also base our stable outlook on expectations that structural reform measures will continue and that there will be sustained investment in infrastructure and industry.

Contacts:
Quah Boon Huat, +603-2082 2231/ boonhuat@marc.com.my;
Afiq Akmal Mohamad, +603-2082 2274/ afiq@marc.com.my;
Nor Zahidi Alias, +603-2082 2277/ zahidi@marc.com.my.