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.
Economic resilience remains Indonesia’s biggest rating support. Thanks to fundamentals, its economic performance continued to improve in 2016 against a backdrop of weak global growth, heightened global policy uncertainty, as well as international financial market volatility. Real gross domestic product (GDP) expanded 5.0% in 2016, and the government expects growth to improve slightly to 5.1% in 2017. Domestic demand, which also expanded 5.0% in 2016, continues to be an important growth driver. Importantly, this continues to contribute toward Indonesia’s low GDP growth volatility (2011-2016: 0.6%). Meanwhile, prices remained stable in 2016. Inflation averaged 3.5%, compared to an average of 5.8% over the 2011-2015 period. With the central bank intent on maintaining macroeconomic stability, inflation should remain within the official target band of 3.0%-5.0%. Downside risks to economic outlook, mainly external in nature, include policy uncertainties in the US, tighter global financial conditions, and lower commodity prices.
Another rating support is low government debt (2016: 27.9% of GDP), thanks to strict rules capping the fiscal deficit at 3% of GDP and debt at 60% of GDP. If there is a need, there is ample room to increase public debt to finance key national programmes. Foreign currency-denominated debt as a percentage of public sector gross debt is on a downtrend, which is credit positive. In 2016, it settled at 40.3%, more than six percentage points lower than at end-2013. Bilateral and multilateral external loans used to make up about three quarters of total foreign currency-denominated debt. By 2016, their proportion had fallen to 50.3% while that of foreign currency-denominated government securities rose to 49.7%. And with foreign investors now holding about 37% (2016) of rupiah-denominated government securities, there is material external exposure. Meanwhile, rising contingent liabilities related to borrowings by state-owned enterprises (SOE) and public-private partnerships (PPP) to fund infrastructure projects could pose risks.
While the banking sector remains stable with high capitalisation and profitability, non-performing loans (NPL) are a rating concern. After bottoming out at 1.7% in 2013, the sector’s NPL ratio rose to 2.9% in 2016, mainly due to manufacturing, trade and mining sector loans. In January 2017, it reached 3.1%. Due to rising NPLs and low credit demand, credit growth slowed in 2016. Tighter lending standards due to higher NPLs at medium-sized banks have also contributed to the slowdown. In 2016, the monthly average growth pace of loans extended by commercial and rural banks slowed to 7.9% from 10.5% in 2015. If the credit growth slowdown continues, bank profitability will likely be pressured. While corporate debt in Indonesia is relatively low at around 32% of GDP, risks remain elevated due to, among other things, the fact that around two-thirds of debt exposures are denominated in foreign currency.
Even though Indonesia’s economic fundamentals remain sound, its external vulnerability is a rating concern. Its external position, while broadly consistent with its medium-term fundamentals, is not strong. At end-2016, its net international investment position (NIIP) reached a significant -34.4% of GDP, though it should be noted that this is an improvement from -43.8% at end-2015. Indonesia is highly reliant on foreign portfolio investment inflows to finance its current account (CA) deficits. The negative NIIP is due mostly to net portfolio inflows to finance, amongst others, government debt as the fiscal balance remains in deficit. Due to this reliance, the economy is vulnerable to, for example, monetary policy normalisation in the US and other events that impact global capital flows. That said, Indonesia’s sound monetary policies and macro-prudential policy mix should somewhat mitigate its vulnerability to shifts in investor sentiment. In addition, its stock of foreign exchange reserves (end-2016: USD116.4 billion) is deemed sufficient to buffer most external shocks.
Weak institutions are also a rating constraint. Indonesia scores poorly in all the components of the World Bank’s World Governance Indicators, namely political stability and absence of violence/terrorism, voice and accountability, government effectiveness, regulatory quality, rule of law, and control of corruption. Weak government monitoring, law enforcement and bureaucratic hurdles, for example, encourage low tax compliance, with the resulting fiscal implications. Due to low tax compliance, Indonesia’s actual tax-GDP ratio is about four to five percentage points lower than its ‘potential’. Weak institutions also affect the other side of the fiscal coin – public spending. Slow fiscal disbursements, for example, have time and time again held back economic growth in Indonesia.
Indonesia’s stable outlook reflects MARC’s view that Indonesia's sovereign credit profile will remain resilient in the face of downside risks that include policy uncertainties in the US, a further slowdown in China and tighter global financial conditions. The stable outlook is further supported by the government’s continued commitment to its reform efforts, a gradually improving global economy and a stable oil outlook.
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May 11, 2017