MARC has affirmed Indonesia’s foreign currency sovereign rating of AA- with a stable outlook based on its 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.

Economic resilience continues to be the biggest rating support. In 2017, economic growth performance improved on the back of higher domestic demand. Indonesia’s large population, a growing middle class and rapid urbanisation continue to fuel domestic demand. There was also growth support from the recovery in commodity prices, as well as the surge in gross fixed capital investment, which expanded 6.2% from 4.5% previously. Improving global trade, which saw exports growing 9.1%, also helped. Meanwhile, the pace of inflation remains benign due in part to structural shifts that have helped shore up Indonesia’s monetary policy credibility. Over the medium term, economic growth will likely come in the 5.0%-5.5% range.

Another rating support is Indonesia’s historically prudent and conservative fiscal and debt management policies. With the focus on keeping aggregate fiscal discipline, the momentum of the rise of fiscal deficit has moderated and stabilised, though it remains close to the legal deficit ceiling of 3.0% of gross domestic product (GDP). Meanwhile, government debt stood at a moderate 29.0% of GDP in 2017, well below the 60% legal threshold. Indonesia’s government debt dynamics are deemed robust to both standard shocks and stress tests. Over the medium term, government debt will likely increase modestly to around 30% of GDP on the back of infrastructure development spending.

Indonesia’s dependence on external financing, which keeps it vulnerable to external risk factors, is a rating concern. This is amply illustrated by its net international investment position of -33.5% of GDP as of end-2017. With the fiscal and corporate sectors heavily dependent on non-resident financing, a shock coming from a sudden large reversal of capital inflows triggered by, for example, global financial volatility or rising geopolitical concerns, could be amplified with significant ramifications for economic, fiscal and financial sector stability. Notwithstanding these concerns, it should be noted that its external position remains sustainable and improving fundamentals have helped increase its ability to weather external storms thus far.

Indonesia’s narrow tax base is another rating concern. Less than 10% of the population, approximately 15% of the total number of employed workers, are obligated to file annual income tax returns. While the percentage of registered employed workers (as a share of total employed) has continued to rise, the percentage of those obligated to file tax returns has trended downwards. On top of that, tax buoyancy has continued to weaken. In 2017, Indonesia's GDP growth accelerated by 5.1%, while domestic tax revenue realisation grew only 4.3%, about half of what the authorities had expected. It reflects in part weak tax compliance and the tax authorities' declining capability to tap Indonesia’s tax potential.

Governance and institutional issues continue to be rating constraints in Indonesia. For example, among other things, the effectiveness of tax efforts can be affected by factors such as corruption and voice and accountability. Indonesia currently ranks lowly (2018: 114) in terms of ease of paying taxes in the World Bank’s Doing Business report. Not surprisingly, Indonesia’s tax-to-GDP ratio is about four to five percentage points lower than its ‘potential’ due to low tax compliance. In terms of ease of doing business, corruption is also a major impediment. In 2017, the country was ranked at number 96 in Transparency International’s Corruption Perceptions Index report.

Indonesia’s stable outlook reflects MARC’s view that the island archipelago's sovereign credit profile will remain resilient in the face of downside risks that include escalation in geopolitical conflicts, a potential US-China trade war, a potential hard landing of its major trading partner China, as well as tighter global financial conditions. We assume the government remains committed to its reform efforts amidst a gradually improving global economy and commodity market.

Contacts:
Quah Boon Huat, +603-2717 2931/ boonhuat@marc.com.my;
Nor Zahidi Alias, +603-2717 2936/ zahidi@marc.com.my.