Monday, Sep 28, 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.
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 .