Fitch Affirms Indonesia’s BBB-/Stable Outlook Investment Grade Status

Key to the positive assessment is that Indonesian authorities choose macroeconomic stability over higher economic growth. Amid global shocks (the winding down of the US Federal Reserve’s quantitative easing program), the central bank of Indonesia (Bank Indonesia) has raised its key interest rate (BI rate) by 175 basis points to 7.50 percent between June and November 2013. In combination with a more flexible exchange rate, this has succeeded in bringing inflation back within the central bank’s target range of 3.5 to 5.5 percent (inflation accelerated sharply after June 2013 when the government introduced higher prices for subsidized fuels). Credit growth also slowed due to Bank Indonesia’s monetary policy, while the institution's foreign exchange reserves managed to rise to USD $112 billion by the end of October 2014.

Such prudent fiscal policy implementation also contributed to slowing economic growth in Indonesia. Over the past decade, Indonesia recorded real GDP growth at an average of 5.8 percent (year-on-year). However, the country’s GDP growth is expected to slide to 5.1 percent (y/y) in 2014. Still, this figure is relatively high (and less volatile) compared to the country’s regional peers. Fitch Ratings expects that Indonesia’s GDP growth will recover in 2015 (to 5.4 percent y/y) and 2016 (5.9 percent y/y).

Regarding Indonesia’s current account balance, Fitch Ratings only detects a modest improvement in 2014 as the country’s exports remain weak (amid weak commodity prices, while the sharply depreciated rupiah exchange rate failed to trigger a major strengthening in exports). Weaker commodity exports are also caused by Indonesia’s ban on exports of mineral ore (implemented in January 2014). Export performance of the non-oil & gas sector has been solid, showing a surplus for most of 2014. Fitch ratings expects that the current account deficit will improve slightly to 3.2 percent of GDP in 2014, and to 2.9 percent in 2015. The credit rating agency warns that this wide current account deficit makes Indonesia vulnerable to external shocks, particularly in the eyes of global investors. As such, a global shock (for example looming rising US interest rates) can result in relatively strong capital outflows. One remedy would be to establish a stronger dependence on manufacturing exports as well as to foster sustained strong foreign direct investment (FDI) inflows. This would facilitate structural higher GDP growth in the future.

Fitch Ratings is also positive about the peaceful change to the Joko Widodo-led government in October 2014. This shows that the democratic foundations of Indonesia have strengthened in the post-Suharto era. However, as the President is facing a large opposition in parliament (the Prabowo Subianto-led Merah-Putih coalition) this could hamper far-reaching reforms (including frustrating improvement of the investment climate).

Several improvements to strengthen the investment climate in Indonesia are advised by Fitch Ratings. These include clearing infrastructure bottlenecks, limiting bureaucratic troubles, and ensuring that minimum wage growth is in line with the country's productivity growth.

Fitch Ratings is positive about a subsidized fuel price hike (which had been confirmed by the Indonesian government but may be postponed after the global oil price has declined sharply in recent weeks) as this would create fiscal space for heightened public infrastructure spending and would curb the current account deficit. Moreover, such a move would increase foreign confidence in the fiscal fundamentals of the country.

Compared to other ‘BBB’ category countries, Indonesia has a safe government debt burden of 26 percent of GDP, triggered by adherence to local law that the government’s fiscal deficit may not exceed 3 percent of GDP. Meanwhile, the banking system of Indonesia is strong (well-capitalized and has good asset quality) with a low gross NPL ratio of 2.2 percent.

Several factors that could lead to an improved credit rating in the future are: reduce the country's dependency on commodity exports (thus making the country less vulnerable to global commodity price volatility), increase FDI inflows, and implement structural reforms that would ease infrastructure bottlenecks (thus allowing for improved future GDP growth).

Key Findings:

• Fitch Ratings affirms Indonesia’s Sovereign Credit Rating at BBB-/stable outlook (investment grade status) on the back of prudent fiscal/monetary policies pursued by Bank Indonesia and the government

• The wide current account deficit of Indonesia makes the country vulnerable to external shocks

• Indonesia’s peaceful transition to the Joko Widodo administration in October is evidence of strong democratic foundations. However, large opposition in parliament may jeopardize far-reaching reforms

• Fitch Ratings advises Indonesia to reduce its traditional reliance on commodity exports and improve the nation’s infrastructure network

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