Fitch Upgrades Indonesia's Sovereign Credit Rating to BBB/Stable

In a statement that was released by Fitch Ratings on Wednesday (20/12) the credit rating agency cited the following key rating drivers:

• Macroeconomic policies, conducted by the central bank (Bank Indonesia) and the government, consistently aim at maintaining financial and fiscal stability. As a result, Indonesia's resilience to external shocks has steadily strengthened over the past couple of years, hence the country managed to limit capital outflows in times of global economic and political turmoil.
• Bank Indonesia has been allowing a more flexible exchange rate policy since mid-2013 and this has helped its foreign exchange reserves to grow to USD $126 billion (at end-November 2017), reaching seven months of current account payments, compared with the 'BBB' median of six months.
• Macro-prudential measures have also managed to curb a sharp rise in corporate external debt, while financial deepening has coincided with improved market stability.
• The Indonesian government has been setting more realistic assumptions in recent annual state budgets.
• Indonesia's gross domestic product (GDP) growth remains strong when compared with BBB peers. While the BBB median is 3.2 percent of annual GDP growth over the past five years, Indonesia averages 5.1 percent growth over that period. Fitch expects Indonesia's GDP growth to accelerate to 5.4 percent (y/y) in 2018 and 5.5 percent (y/y) in 2019, from an estimated 5.1 percent (y/y) in 2017. Accelerating growth is supported by the global pick-up in trade, stabilizing commodity prices and rising investment (on the back of rising public infrastructure spending, lower borrowing costs and structural reform implementation).
• Indonesia has a low general-government debt burden of 28.5 percent of GDP in 2017, compared with the 'BBB' median of 41.1 percent. Indonesia's low public debt is due to the self-imposed budget-deficit ceiling of 3 percent of GDP, which has helped maintain investor confidence in Indonesia in times of market turbulence. The government's 2018 budget deficit target is set at 2.2 percent of GDP (hence another conservative approach). Fitch Ratings expects the figure to rise to 2.7 percent of GDP but to remain withing the 3 percent ceiling.

Nevertheless, Fitch Ratings sees several external and domestic challenges that can impact negatively on Indonesia.

• US Federal Reserve's policy normalization could trigger market pressure in emerging markets, including Indonesia.
• Indonesia's dependence on commodities remains relatively high.
• Both Indonesia's net and gross external debt (at 166 percent of current account receipts) remain elevated compared with the 'BBB' median of 130 percent.
• Indonesia is about to enter the political years of 2018 (regional elections) and 2019 (legislative and presidential elections), hence there exists the possibility that the focus will shift to political matters and distract authorities from economic policy-making as well as from the reform agenda. This could undermine domestic and foreign market sentiment.
• The government's revenue intake is very low (particularly due to structurally weak tax revenue realization). Among Fitch-rated sovereigns, only four countries have lower government revenue as a percentage of GDP. This undermines the ability of the government to invest in infrastructure projects, hence increase the reliance on state-owned enterprises (SOE) to address the large infrastructure deficit. Hence, non-financial SOE debt of 4.5 percent of GDP (as of July 2017) is likely to increase substantially in the coming few years, raising the state's contingent liabilities.
• A structural weakness of the Indonesian economy us that average per capita GDP is low at USD $3,780, compared with the 'BBB' median of USD $11,173.
• Another structural weakness is that governance remains weak, as reflected by a low World Bank governance indicator score in the 45th percentile (albeit improving from a ranking of 42 in the preceding edition).

Fitch Ratings emphasizes that it is important for the government to keep up its good work in recent years. The government's reform drive is improving a still-challenging business environment in Indonesia. Deregulation has sharply improved Indonesia's position in the World Bank's Ease of Doing Business ranking. In the latest edition Indonesia ranked 72nd (out of 190 countries), a rise of 37 places in two years.

The improving investment and business climate of Indonesia contribute to stronger external finances, with foreign direct investment (FDI) picking up in recent quarters. In fact, Fitch Ratings expects net FDI to cover the country's current account deficit over the next few years.

Fitch Ratings sees few risks for the sovereign's exposure to the banking sector. Private credit represents only 37 percent of GDP and Indonesia's banking sector's capital adequacy ratio (CAR) remains strong at 23.2 percent in October 2017. Meanwhile, banks' non-performing, special mention and restructured loan ratios stabilized in 2017. Risks that built up in the previous credit cycle led to deferral of private-sector capital expenditure and a rise in gross non-performing loans (NPL) to 3.0 percent of total assets (per October 2017), from a low of 1.8 percent at end-2013.

Credit Ratings Indonesia:

	Standard & Poor's		Fitch Ratings		Moody's
	Rating	Outlook	Rating	Outlook	Rating	Outlook
Indonesia	BBB-	Stable	BBB	Stable	Baa3	Positive

^{Various sources}

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