Ratings On Indonesia Raised To #BBB-/A-3# On Reduced Fiscal Outlook Stable

Stocks and Financial Services Press Releases Friday May 19, 2017 17:46
S&P Global Ratings--19 May--S&P Global Ratings

On May 19, 2017, S&P Global Ratings raised its long-term sovereign credit ratings on the Republic of Indonesia to 'BBB-' from 'BB+'. The outlook is stable. We also raised our short-term sovereign credit ratings on Indonesia to 'A-3' from 'B' and our ASEAN regional scale long-term rating to 'axA-' from 'axBBB+'. In addition, we affirmed the short-term ASEAN regional scale rating at 'axA-2'.


We raised the ratings to reflect our assessment of reduced risks to Indonesia's fiscal metrics. We believe the government's increased focus on realistic budgeting has reduced the likelihood that a shortfall in future revenue would widen the general government deficit significantly beyond what we expect now. This also reduces the risk of a rising net general government debt ratio and debt servicing burden. Instead, we now anticipate that net debt will remain at the moderate levels of below 30% of GDP.

The government's new focus on realistic budgeting has lowered the risks that budget deficits will widen significantly when government revenue disappoints. Generating revenue from Indonesia's tax system has been a structural challenge confronting successive Indonesian governments. The ratio of general government revenue to GDP in Indonesia is the second lowest of all 67 investment-grade sovereigns, higher only than that of the Emirate of Sharjah. This leads to high interest burdens as a share of revenues, despite Indonesia's relatively low government debt stock (see: Sovereign Risk Indicators, an interactive version is available at www.spratings.com/sri).

Partly due to weaker commodity prices, tax receipts have been well below initial budget projections at least for the past three years. This had left the government having to cut spending toward the later part of the fiscal year (which runs from January to December) in order to keep the budget deficit within the legal ceiling of 3% of GDP. The 3% cap on the budget deficit written in Indonesia's State Finances Law 17 of 2003 has kept Indonesian governments focused on the fiscal balance. Consequently, the general government deficit in the five years to the end of 2016 averaged a modest 2.2%of GDP despite a sometimes challenging external environment.

In 2017, the government is projecting tax receipts that are lower than projections in the 2016 budget. Although this still represented an increase of more than 15% over realized tax collection a year earlier, the increase is significantly lower than those of earlier years. We expect this cautious stance toward budgeting fiscal revenue to persist over the next few years.

At the same time, we expect better revenue collection to result from the data collected during the just-concluded tax amnesty. We also expect increased control over fiscal spending with subsidy reforms being extended to electricity subsidies from 2017. These developments should ensure that the fiscal deficit remains below 2.5% of GDP over the next three to four years despite the government's intention to expand its infrastructure program to address the existing shortfall in infrastructure and basic services. Together with the greater focus on realistic budgeting, we believe that this will contain the risk of fiscal slippage leading to larger fiscal deficits than what we currently project. Despite the broader vulnerabilities of the economy to external shocks, we consider strong public finances a cornerstone of our investment-grade rating on Indonesia.

We also forecast a stable general government debt ratio over the next few years, reflecting the relatively stable projected fiscal balance. In some recent years, general government debt had increased significantly more than the size of the budget deficit. In the five years to 2016, for instance, the average increase was 3.2% of GDP annually. This was due to the impact of the depreciation of the Indonesian rupiah during this period on the size of the government's foreign currency debts as measured in local currency terms. More than 40% of government debt is denominated in foreign currencies at the end of 2016. We expect the change in government debt to be more in line with the fiscal deficit over the next few years, given our relatively stable outlook for the rupiah exchange rate. We project net general government debt to remain well below 30% of GDP. On top of this relatively moderate debt burden, we expect limited contingent liabilities facing the government over the next few years. That said, Indonesia continues to display an elevated interest burden relative to revenues, a reflection of the aforementioned difficulties of boosting tax revenues. We now consider the fiscal factors to be a rating strength, while institutional, monetary, and external factors are considered neutral.

Indonesia has exhibited effective policymaking in recent years to promote sustainable public finances and balanced economic growth. Political and policy institutions in Indonesia are generally stable and free of challenges to their legitimacy.

The Indonesian society is generally cohesive despite the expanse of the country over many islands. News and information generally flow freely in Indonesia, with key policy and other changes well publicized and debated. Indonesia publishes timely economic, fiscal, and financial statistics in great detail. At the same time, Indonesia continues to trail many similarly rated sovereigns in perceptions regarding governance issues, such as control of corruption. We believe this has stunted growth-enhancing, inward foreign direct investment.

We believe economic and financial policy settings have become more predictable recently. The government has built a political coalition with a parliamentary majority. Despite the government having a greater number of political parties, it has managed to appoint individuals who are generally viewed as competent to the key economic ministerial positions.

Bank Indonesia, the central bank, has been an important institution in Indonesia's ability to sustain economic growth and attenuate economic or financial shocks. Over the past decade or so, inflation in the country has been broadly in line with those of its major trading partners. The central bank has had significant operational independence to pursue its monetary policy target since July 2005, when it formally adopted the Inflation Targeting Framework. It relies increasingly on market-based instruments in implementing monetary policy in a financial system that has grown steadily in recent years. Monetary flexibility has been augmented in recent years by the increasing flexibility of the rupiah, a floating currency.

Indonesia's external debt burden has risen over the past five years. External debts amount to a little above one-third of GDP at the end of 2016. The country's current account receipts (CAR), however, are small in relation to the size of the economy and have fallen relative to economic output over the past five years. Partly reflecting this decline, total external debt--net of liquid assets held by the public and financial sectors--has risen to just below annual CAR in 2016 from less than half in 2011.

The greater flexibility of the rupiah since 2013 should benefit the external metrics over the next three to five years. The current account has narrowed with the rupiah depreciation since 2013. At the same time, the rupiah flexibility has allowed the central bank to increase its foreign exchange reserves. Together with policy measures to discourage short-term external borrowing, gross external financing needs (current account payments plus short-term external debt) have declined to 94% of CAR in 2016 from almost 100% in 2014. We expect this external liquidity ratio to continue to decline (in other words, improve) in the next three years. This should go some way toward mitigating the risk of marked deterioration in the cost of external financing that we believe Indonesia continues to face in times of volatility in international financial markets.

The main weakness remains the economic risks facing the country, where the economy is still considered lower middle-income and, as a commodity exporter and capital importer, subject to external shocks. A key rating constraint is Indonesia's GDP per capita, which we estimate at US$3,800 in 2017. We estimate the trend growth rate of GDP per capita to be slightly above 4% per year.

Growth of the Indonesian economy is largely dependent on domestic demand in recent years while exports have diminished in importance due to the decline in commodity prices. Improved global demand and stabilizing prices, however, have contributed to a strong rebound in exports early in 2017.


The stable outlook reflects our view that the policy environment and economic conditions will keep external and fiscal metrics close to current levels over the next one to two years. We could raise the long-term ratings if external and fiscal balances significantly outperform our current expectations.

Conversely, downward pressure on the rating could emerge if we expect trade and fiscal balances over the next three to five years to be materially worse than our current projections. Indications of pressure on the rating are net general government debt and budget deficits surpassing 30% and 3% of GDP, respectively, in a sustained way; or external liquidity (gross financing requirements as a percentage of current account receipts and foreign exchange reserves) consistently surpassing 100%, which could be triggered by another negative terms of trade shock.

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