Fitch Ratings has affirmed Indonesia' Long-Term Foreign-Currency Issuer Default Rating at 'BBB' with a stable outlook. The agency also forecasted the GDP growth to recover gradually to 5.3 percent in 2021 and 6.0 percent in 2022 - Photo by Finance Ministry Office

JAKARTA (TheInsiderStories) – Fitch Ratings has affirmed Indonesia’ Long-Term Foreign-Currency Issuer Default Rating at ‘BBB’ with a stable outlook. The agency also forecasted the GDP growth to recover gradually to 5.3 percent in 2021 and 6.0 percent in 2022, from a contraction of 2.1 percent in 2020 induced by the COVID-19 pandemic.

It said, the country’ rating balances a favorable medium-term growth outlook and a still low, but rising, government debt to GDP ratio against a high dependence on external financing, low government revenue and lagging structural features compared with ‘BBB’ category peers, such as governance indicators and GDP per capita. The recovery is being supported by government stimulus spending and net exports, including from improved commodity prices.

“We expect growth momentum to be further supported in the near term by fiscal relief measures and infrastructure spending. Growth, nonetheless, remains subject to significant downside risk from weak domestic demand, including consumption of services, as COVID-19 infections continue to spread,” said the report.

The authorities started their vaccination program in January and aim to reach herd immunity by first quarter (1Q) of 2022, an optimistic target in Fitch’ view. Over the medium term, they expect growth to receive a boost from implementation of the Omnibus Law on Job Creation, which aims to alleviate several long-standing barriers to investment.

Government spending remains focused on alleviating the impact of the health crisis, with 4.2 percent of GDP allocated in 2021 for health and relief measures to support households and businesses, after 3.8 percent of GDP was disbursed in 2020. Infrastructure development remains a key medium-term priority for the government, but its investment capacity may be constrained by rising interest payments (18 percent of revenue in 2020), constitutionally mandated spending on health and education, and the possible need for further capital support to state-owned enterprises.

A newly established “sovereign wealth fund”, the Indonesia Investment Authority, is intended to help finance infrastructure development over the next few years from a combination of government and private-sector funds, including through disinvestment of government assets, such as toll roads.

“We expect the fiscal deficit to narrow only marginally to 5.6 percent in 2021 from 6.1 percent in 2020, broadly in line with the government’ target. Fiscal consolidation should speed up from 2022, once the impact of the pandemic abates, given broad support across the political spectrum for prudent fiscal policies and Indonesia’s track record of low debt accumulation compared with its peers,” wrote Fitch.

As known, the government aims to adhere to its temporarily suspended 3 percent deficit ceiling again by 2023. In their view, consolidation is likely to come from the phasing out of relief policies and spending rationalization, rather than from revenue measures. They expect the revenue ratio to pick up gradually to 12.3 percent of GDP in 2021 and 12.8 percent in 2022 as the economy recovers, from 12.1 percent in 2020, the lowest in the ‘BBB’ category.

Nonetheless, the authorities face financing challenges, which are being alleviated by having the central bank purchase government bonds in the primary market. The challenges are exacerbated, in Fitch’ view, by Indonesia’ low revenue ratio and strong dependence on foreign financing of the debt. Around 39 percent of government debt is denominated in foreign-currency, while non-residents held 25 perent of local-currency government debt in January, albeit down from 39 percent in December 2019.

Investor inflows into local-currency government debt have remained muted since the large outflows of around US$9 billion in March 2020. Monetary financing of the deficit has helped to reduce the government’ interest costs, freeing up resources for relief measures, but has also raised questions about Indonesia’s policy approach over the medium term.

Repeated central bank financing would raise the potential for government interference in monetary policymaking, risk fiscal dominance, and could undermine investor confidence, which would weaken the credit profile. Bank Indonesia (BI) has announced that in 2021, it will only stand by to purchase bonds in the primary market as the buyer of last-resort and will not repeat its more elaborate “burden sharing” arrangement of 2020.

The central bank has so far this year taken up 0.4 percent of GDP in primary market purchases and plans to adhere to a maximum share per auction of 25 percent for conventional domestic bonds and 30 percent for shariah bonds. While, the parliament dropped a draft law late last year to expand BI’ mandate to monetize debt.

In Fitch’ view, passage of such a law would negatively affect Indonesia’ credit profile. The Bank has also responded to the pandemic by cutting its policy rates by 150 basis points in total since early 2020, easing macro-prudential policies and providing ample liquidity to the banking system.

“We expect BI to keep its policy rates unchanged through 2021, as an improved current account position, including from the rise in commodity prices, should help offset pressures from rising US yields in the near term. We expect BI to start a tightening cycle in 2022, when inflation picks up with a rise in economic activity,” said Fitch.

BI’ foreign-exchange buffers strengthened to $138.8 billion by end-February 2021 from $121.0 billion at end-March 2020, and covered 8.2 months of current account payments at end-2020 (‘BBB’ median: 5.0 months), after the current account deficit narrowed to 0.4 percent of GDP from 2.7 percent in 2019.

“However, we expect the deficit to widen to 1.9 percent in 2021, as growth accelerates and imports rise,” the report stated.

Fitch rated, Indonesia remains more vulnerable than many of its peers to shifts in investor confidence towards emerging markets, for instance from a further rise in global bond yields. The country remains more dependent on commodity exports and portfolio flows, while external debt ratios are higher than peer medians and external liquidity, measured by the ratio of the country’ liquid external assets to its liquid external liabilities, is weaker.

The Indonesian economy is less developed on a number of structural metrics than many of its peers. Indonesia’s relatively low basic human development is indicated by its ranking on the United Nations Human Development Index (43rd percentile versus the ‘BBB’ median of 68th percentile), while average per capita GDP also remains low, at $3,884, compared with the median of $10,471 for peers in the ‘BBB’ rating range. These structural metrics could improve over time with successful reform implementation.

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