RATING ACTION COMMENTARY
Fitch Affirms Indonesia at 'BBB'; Outlook Stable
Wed 14 Dec, 2022 - 5:21 AM ET
Fitch Ratings - Hong Kong - 14 Dec 2022: Fitch Ratings has affirmed Indonesia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Low Public Debt; Weak Revenue: Indonesia's rating balances a favourable medium-term growth outlook and low government debt/GDP ratio against weak government revenue and lagging structural features, such as governance indicators, compared with 'BBB' category peers.
Growth Slowing in 2023: Like other sovereigns, Indonesia faces increased yields and a strong US dollar, but as a commodity exporter it is better positioned than many peers to weather the adverse conditions. Strong export performance and a recent domestic recovery from the pandemic support our GDP growth forecast of 5.2% for 2022.
Domestic and external demand are weakening going into 2023, as the domestic rebound should start to fade, higher interest rates will bite, and prices of many commodities wane. We forecast growth to slow to 4.8% in 2023, but there is some upside from the tourism rebound and spending on presidential elections scheduled for February 2024.
Strong Medium-Term Outlook: Fitch forecasts growth to accelerate again to 5.6% in 2024, well above the 'BBB' category median of 3.5%. Investment should receive a boost over the medium term from the implementation of structural reforms over the past two years, including the Omnibus Law on Job Creation. In the near term, investment may, nonetheless, be affected by some policy uncertainty from the elections. The impact on investment and tourism of a controversial amendment of the criminal code in December is still uncertain.
Focus on Infrastructure Development: Infrastructure spending is likely to continue under the next administration, including on the construction of the new capital in East Kalimantan, although the next president may have different priorities. The Indonesia Investment Authority, set up in February 2021, is intended to finance infrastructure development over the next few years from a combination of public and foreign official and private funds, including through disinvestment of government assets, such as toll roads. This may help finance more infrastructure over time, as it is gradually starting its activities.
Fiscal Consolidation to Continue: We expect the fiscal deficit to narrow to 3.4% of GDP in 2022, from 4.6% in 2021, following a strong revenue performance, partly from high commodity-related proceeds. We expect a further narrowing of the deficit to 2.9% of GDP in 2023, as the government is likely to follow through on its statements throughout the pandemic that it will reinstate its budget deficit ceiling of below 3% of GDP. This is below the 3.6% 'BBB' category median and would make Indonesia one of the first governments in Asia-Pacific to return to pre-pandemic fiscal deficit levels.
The government also plans to discontinue monetary debt financing in 2023, although parliament is in the process of discussing a draft law that may formalise the central bank's bond-buying role in times of crisis.
Gradual Decline in Public Debt: In our baseline scenario, government debt will gradually fall from 41.1% of GDP in 2023, which compares well with the 'BBB' category median of 55.6%. However, interest payments are high at 15.0% of our estimated government revenues in 2023 as Indonesia's revenue/GDP ratio, forecast at 14.4%, is the lowest among 'BBB' category sovereigns. The government took steps to enhance revenue, including raising the VAT rate. A hike in administered fuel prices of around 30% in September should in 2023 help reduce the subsidy bill, estimated by the government at 1.6% of GDP.
Strengthened Balance of Payments: We expect the current account to turn into a deficit of 0.8% of GDP in 2023, after two years of small surpluses from pandemic-related import contraction and high commodity prices. A widening of the current account deficit to pre-pandemic levels and a return of the strong dependence on portfolio flows to finance the deficit is less likely to occur in the next few years.
Down-Streaming Gathers Pace: We expect FDI to gradually pick up, including in the electric vehicle sector, which will likely imply increased manufacturing exports and a further increase in down-streaming activities, adding more value to Indonesia's commodity exports. Balance of payments vulnerabilities could be reduced over the medium term, if these developments lead structurally to higher manufacturing exports and FDI inflows, and lower current account deficits.
Shrinking Foreign Reserve Buffers: A strong US dollar and Bank Indonesia's (BI) foreign-exchange interventions caused its reserves to fall by USD10.9 billion since the end of 2021 to USD134.0 billion in November 2022, which equals 5.0 months of current account payments ('BBB' median: 5.5 months). Indonesia's external liquidity, measured by the ratio of the country's liquid external assets to its liquid external liabilities, is weaker than peer medians, according to Fitch's calculations, while it exhibits a higher sovereign external debt ratio.
Further Monetary Policy Tightening: Inflation appears to have peaked at 6.0% in September after the administered fuel price increase, but we expect BI to retain a tightening bias, given our assumption of continued US dollar strength with further Fed policy rate hikes in the pipeline. We forecast BI will raise its policy rate by a further 50bp to a terminal rate of 5.75% in early 2023, after hiking by a cumulative 175bp in 2H22. This should help bringing inflation towards the inflation target range of 3% +/- 1% by end-2023.
ESG - Governance: Indonesia has an ESG Relevance Score (RS) of '5' and '5[+]' for Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model.
Indonesia has a medium WBGI ranking at 49th reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a high level of corruption.
Fitch Ratings - Hong Kong - 14 Dec 2022: Fitch Ratings has affirmed Indonesia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Low Public Debt; Weak Revenue: Indonesia's rating balances a favourable medium-term growth outlook and low government debt/GDP ratio against weak government revenue and lagging structural features, such as governance indicators, compared with 'BBB' category peers.
Growth Slowing in 2023: Like other sovereigns, Indonesia faces increased yields and a strong US dollar, but as a commodity exporter it is better positioned than many peers to weather the adverse conditions. Strong export performance and a recent domestic recovery from the pandemic support our GDP growth forecast of 5.2% for 2022.
Domestic and external demand are weakening going into 2023, as the domestic rebound should start to fade, higher interest rates will bite, and prices of many commodities wane. We forecast growth to slow to 4.8% in 2023, but there is some upside from the tourism rebound and spending on presidential elections scheduled for February 2024.
Strong Medium-Term Outlook: Fitch forecasts growth to accelerate again to 5.6% in 2024, well above the 'BBB' category median of 3.5%. Investment should receive a boost over the medium term from the implementation of structural reforms over the past two years, including the Omnibus Law on Job Creation. In the near term, investment may, nonetheless, be affected by some policy uncertainty from the elections. The impact on investment and tourism of a controversial amendment of the criminal code in December is still uncertain.
Focus on Infrastructure Development: Infrastructure spending is likely to continue under the next administration, including on the construction of the new capital in East Kalimantan, although the next president may have different priorities. The Indonesia Investment Authority, set up in February 2021, is intended to finance infrastructure development over the next few years from a combination of public and foreign official and private funds, including through disinvestment of government assets, such as toll roads. This may help finance more infrastructure over time, as it is gradually starting its activities.
Fiscal Consolidation to Continue: We expect the fiscal deficit to narrow to 3.4% of GDP in 2022, from 4.6% in 2021, following a strong revenue performance, partly from high commodity-related proceeds. We expect a further narrowing of the deficit to 2.9% of GDP in 2023, as the government is likely to follow through on its statements throughout the pandemic that it will reinstate its budget deficit ceiling of below 3% of GDP. This is below the 3.6% 'BBB' category median and would make Indonesia one of the first governments in Asia-Pacific to return to pre-pandemic fiscal deficit levels.
The government also plans to discontinue monetary debt financing in 2023, although parliament is in the process of discussing a draft law that may formalise the central bank's bond-buying role in times of crisis.
Gradual Decline in Public Debt: In our baseline scenario, government debt will gradually fall from 41.1% of GDP in 2023, which compares well with the 'BBB' category median of 55.6%. However, interest payments are high at 15.0% of our estimated government revenues in 2023 as Indonesia's revenue/GDP ratio, forecast at 14.4%, is the lowest among 'BBB' category sovereigns. The government took steps to enhance revenue, including raising the VAT rate. A hike in administered fuel prices of around 30% in September should in 2023 help reduce the subsidy bill, estimated by the government at 1.6% of GDP.
Strengthened Balance of Payments: We expect the current account to turn into a deficit of 0.8% of GDP in 2023, after two years of small surpluses from pandemic-related import contraction and high commodity prices. A widening of the current account deficit to pre-pandemic levels and a return of the strong dependence on portfolio flows to finance the deficit is less likely to occur in the next few years.
Down-Streaming Gathers Pace: We expect FDI to gradually pick up, including in the electric vehicle sector, which will likely imply increased manufacturing exports and a further increase in down-streaming activities, adding more value to Indonesia's commodity exports. Balance of payments vulnerabilities could be reduced over the medium term, if these developments lead structurally to higher manufacturing exports and FDI inflows, and lower current account deficits.
Shrinking Foreign Reserve Buffers: A strong US dollar and Bank Indonesia's (BI) foreign-exchange interventions caused its reserves to fall by USD10.9 billion since the end of 2021 to USD134.0 billion in November 2022, which equals 5.0 months of current account payments ('BBB' median: 5.5 months). Indonesia's external liquidity, measured by the ratio of the country's liquid external assets to its liquid external liabilities, is weaker than peer medians, according to Fitch's calculations, while it exhibits a higher sovereign external debt ratio.
Further Monetary Policy Tightening: Inflation appears to have peaked at 6.0% in September after the administered fuel price increase, but we expect BI to retain a tightening bias, given our assumption of continued US dollar strength with further Fed policy rate hikes in the pipeline. We forecast BI will raise its policy rate by a further 50bp to a terminal rate of 5.75% in early 2023, after hiking by a cumulative 175bp in 2H22. This should help bringing inflation towards the inflation target range of 3% +/- 1% by end-2023.
ESG - Governance: Indonesia has an ESG Relevance Score (RS) of '5' and '5[+]' for Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model.
Indonesia has a medium WBGI ranking at 49th reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a high level of corruption.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- External Finances: A sustained decline in foreign-exchange reserve buffers, resulting, for example, from outflows stemming from a deterioration in investor confidence or large foreign-exchange interventions.
- Macroeconomic: A weakening of the policy framework that could undermine macroeconomic stability, for instance, resulting from continued monetary financing of the deficit in the next few years.
- Public Finances: A material increase in the overall public debt burden closer to the level of 'BBB' category peers, for example, resulting from failure to reduce the fiscal deficit to pre-crisis levels or accumulation of debt by publicly owned entities.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Public Finances: A marked improvement in the government revenue ratio in the next few years closer to the level of 'BBB' category peers, including from better tax compliance or a broader tax base, which would strengthen public finance flexibility.
- External Finances: A material reduction in external vulnerabilities, for instance, through a sustained increase in foreign-exchange reserves, a further decline in the dependence on portfolio flows or lower exposure to commodity price volatility.
- Structural: Significant improvement of structural indicators, such as governance standards, closer to those of 'BBB' category peers.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit
https://www.fitchratings.com/site/re/10111579.
