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 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. The government of Indonesia has no debt rated by MARC.

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, and a weak institutional and business environment.

Economic resilience remains Indonesia’s biggest rating support. The economy did relatively well in 2015 despite falling international oil prices, episodic capital outflows, and turbulent global financial markets. There are a number of key reasons for Indonesia’s economic resilience. It has the world’s fourth largest population and a growing middle class. Urbanization has been rapid. The urban population, as a percentage of the total, increased from 23% in 1981 to 42% in 2000. By 2014, it had risen to 53%. The population is also relatively young, the third youngest in East Asia. Going forward, Indonesia’s demographic dividend is expected to remain a growth driver. Meanwhile, research has shown that Indonesia’s domestic demand is resilient to external influences. Empirical data show that, over a 10-year period, the correlation between domestic final demand and exports was considerably lower in Indonesia than in Malaysia, Thailand and the Philippines. The central bank sees gross domestic product (GDP) growing at between 5.2% and 5.6% in 2016, while the government has set a growth target of 5.3%.

Another rating support is Indonesia’s manageable and sustainable public debt, thanks to a prudent fiscal stance that is anchored by a fiscal rule that caps the general government deficit at 3.0% of GDP a year. In 2015, public sector debt stood at just below 27% of GDP, a far cry from around 95% in 2000. Indonesia’s debt consolidation process over the years was possible primarily because of both low interest rates and high real GDP growth rates. Meanwhile, the proportion of public sector debt exposed to interest rate risk in 2015 stood at just 2.8% of GDP, significantly lower than the 8.3% recorded in 2011. Standard stress tests by the International Monetary Fund (IMF) show that Indonesia’s public debt dynamics remain robust to macroeconomic shocks. This notwithstanding, public sector debt has been edging upwards. The 2.1 percentage point jump in 2015 from 24.7% of GDP in 2014 was due to a larger primary deficit, recapitalisation of state-owned enterprises (SOE), and exchange rate depreciation.

The banking sector is a rating concern because the economic environment remains difficult. This notwithstanding, the sector remains profitable, well capitalised and continues to meet Basel III’s capital ratio standards. End-2015 data show that the system had on average a capital adequacy ratio of 21.3%, the highest in the post-Global Financial Crisis (GFC) period. Credit risk remains the main risk facing Indonesian banks. Besides sluggish growth and rupiah depreciation, the corporate sector has had to contend with low commodity prices and tighter funding conditions. The doubling of foreign currency-denominated (FX) corporate debt, which includes FX debt to domestic banks, to 20% of GDP over the 2010-2015 period is a cause for concern. With global economic and financial uncertainties remaining, this is particularly true in the case of corporates whose FX debts are not completely hedged, and whose balance sheets are not healthy enough to act as adequate buffers against negative macroeconomic shocks.

Indonesia’s external vulnerability, a rating concern, remains elevated as the economy continues to be dependent on external financing against a backdrop of ongoing global uncertainties. It is not surprising that Indonesia’s external sustainability is especially sensitive to exchange rate depreciation. According to the IMF, a 30% depreciation of the rupiah in 2016 could raise Indonesia’s external debt to GDP ratio to about 51.5%. There have, however, been positive developments in Indonesia’s external position. Its current account (CA) balance as a percentage of GDP, after first turning negative in 4Q2011 in the post-GFC period, has been improving. By 2015, the deficit had narrowed to 2.1%. While this positive development means lower annual external financing requirements, Indonesia remains susceptible to volatile capital outflows. In 2015, Indonesia’s financial account balance declined to USD17.1 billion, the second lowest in the post-GFC period, from USD45.0 billion in 2014, due to fleeing capital. The net direct investment balance in that year, for example, fell to USD9.3 billion from USD14.8 billion previously.

Weak institutions and a poor business environment are also rating constraints for Indonesia. While the government is working hard on jump-starting growth and attracting foreign investors, such efforts are being stymied by issues that include weak implementation capacity and poor inter-agency coordination. It continues to face criticism over creeping protectionism and regulatory flip-flops. In the mid-February 2016 move to open the doors wider to foreign investment, for example, the government opened 35 sectors to foreigners but closed 20 others. Jokowi heads a minority coalition in the national parliament, and is an outsider to the political establishment. He will likely continue to have to struggle to get around entrenched vested interests and face resistance in his reform efforts.

Indonesia’s stable outlook reflects MARC’s view that Indonesia's sovereign credit profile will remain resilient in the face of low oil prices, sluggish global demand and turbulent global financial markets that could again result in episodic capital outflows. We assume some successes in the government’s structural reform efforts, a gradually improving global economy, and a stable oil outlook.

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