JAKARTA (TheInsiderStories) – Fitch forecasts economic activity in Indonesia will contract by 2 percent in 2020, largely attributable to the impact of the coronavirus. The contraction is exacerbated by the effects of social-distancing measures on consumption and investment, a temporary deterioration in terms of trade and the sudden stop in foreign tourism inflows.
The strong, broad-based impact of the pandemic on economic activity was illustrated by the 5.3 percent contraction in second quarter (2Q) of 20, which we had largely anticipated in our projections. Fitch forecasts a rebound to 6.6 percent growth in 2021, partly driven by a low-base effect, and expects growth momentum to continue at 5.5 percent in 2022, supported in part by the government’s renewed focus on infrastructure development.
“Our forecasts are subject to considerable risks, in particular due to a continued spread of COVID-19 within Indonesia. The government has responded swiftly to the crisis with a broad range of relief measures to support households and companies, including small and medium-sized enterprises,” said Fitch.
Total coronavirus-related government support amounted to Rp695 trillion (US$47.93 billion), or 4.4 percent of GDP, and included direct cash transfers, provision of basic foods, guarantees and tax incentives. The authorities have also taken some exceptional, temporary measures, which include a three-year suspension of a self-imposed deficit ceiling of 3 percent of GDP and direct central bank financing of the deficit.
In Fitch’ view, prudent fiscal policy in past years has provided headroom for the relief measures. Fiscal deficits were well below the ceiling over the past decade, illustrating support for prudent fiscal policy across the political spectrum. It stated,
“We believe the government is likely to resume adhering to the 3 percent of GDP’ deficit ceiling by 2023, in line with its stated intention.”
The agency rated, higher government spending and lower revenue due to the slowdown should cause the fiscal deficit to rise to around 6.0 percent in 2020 from 2.2 percent in 2019. Fitch expect, the deficit to narrow to 5.0 percent in 2021 and 3.5 percent in 2022, as most of the pandemic-related expenditure should be temporary.
“We forecast general government debt to rise to 36.7 percent of GDP in 2020 from 30.6 percent of GDP in 2019, and to peak at 39.1 percent of GDP in 2022. Both the debt burden and its increase this year (6 percent of GDP) are still significantly smaller than the ‘BBB’ category median of 51.7 percent (9.5 percent of GDP higher than in 2019),” the report stated.
The government debt burden, when measured as a ratio against general government revenue, is however higher than that of peers, at 307.7 percent in 2020 (BBB median: 138.3 percent), according to Fitch. The government is working to improve tax compliance, which should over time improve the revenue ratio, the lowest among ‘BBB’ category peers at 11.9 percent in 2020.
However, a gradual reduction in corporate tax rates between 2021 and 2023, from 25 to 20 percent, is likely to offset some of the revenue gains from other measures in the short run before any potential medium-term gains materialize through higher investment. The low revenue base exacerbates the challenges of financing the large pandemic-related expenditure.
The authorities have responded to the higher spending needs by implementing a “burden sharing” scheme in which Bank Indonesia will purchase government bonds in the primary market and bear part of the interest costs of additional debt issuance. The scheme will help reduce the government’ direct interest costs, and is unlikely to generate inflationary pressures in this year’s environment of demand compression.
However, the scheme raises questions about Indonesia’ policy approach over the medium term. In particular, if central bank financing were to be sought repeatedly, beyond 2020, it would raise the potential for government interference in monetary policymaking, and could undermine investor confidence.
This may be mitigated by Indonesia’s generally disciplined monetary policy stance of the past few years, which reinforces our belief the scheme will be one-off, driven by the unusual circumstances of the pandemic, as the authorities have asserted. Indonesia’ dependence on foreign portfolio financing and commodity exports leaves it vulnerable to renewed bouts of external risk aversion and other shocks.
External liquidity, measured by the ratio of the country’ liquid external assets to its liquid external liabilities, is also weaker than that of ‘BBB’ peers. Sharp portfolio outflows and central bank intervention caused a drop in foreign-exchange reserves by $10.7 billion to $121.0 billion at end-March 2020.
Stabilization of the global financial environment and issuance of foreign-currency government bonds since then have facilitated BI rebuilding its reserves to $135.1 billion by end-July, covering 7.1 months of current account payments, well above the ‘BBB’ median of 4.9 months.
“We forecast these reserve buffers will be supported by a narrowing of the current account deficit to 1.8 percent of GDP in 2020 from 2.7 percent in 2019, in light of the compression in domestic demand and a recovery in Indonesia’s terms of trade since April,” rated by Fitch.
BI has provided liquidity to the banking system in response to the pandemic and cut its policy rate by a total of 100 basis points since February 2020 to 4.0 percent.
“We expect BI to keep the rate unchanged, provided the economy does not deteriorate further, given its apparent desire to prevent volatility of the rupiah. Fitch considers the sovereign’ exposure to banking-sector risks limited. Private credit represents only 36.4 percent of GDP and the banking sector’s capital-adequacy ratio remained strong at 22.1 percent in May 2020,” said the report.
The government is continuing to press ahead with its structural reform efforts, although in recent months the policy focus has been on the immediate crisis at hand. Parliament’ discussion of the Omnibus Laws on Job Creation is likely to be completed in the next few months.
Fitch understands the draft law contains a number of long-awaited amendments to regulations related to the business environment and reportedly aims to simplify the regulatory framework, ease land acquisition, reduce the number of items on the negative investment list, and ensure greater labour market flexibility.
In Fitch’ view, the reforms have the potential to lift economic growth and foreign direct investment over the medium term, depending on the details and implementation. While, Indonesia’ ranking for Ease of Doing Business has significantly improved in recent years, but at the 60th percentile, it is still below the ‘BBB’ median of the 71st percentile.
Social-distancing measures appear to have slightly delayed, but not fully derailed, the government’ ambitious plans for infrastructure development over the next few years, which include construction of a proposed new capital in East Kalimantan. Infrastructure development was already a key policy aim during the first term of President Joko Widodo, when progress was made on a number of projects, including an underground metro system in Jakarta.
State-owned enterprises (SOE) play an important role in these plans and have been raising the leverage on their balance sheets considerably since mid-2017. The gross combined debt of SOEs increased to 7.3 percent of GDP in March 2020 from 4.7 percent, two years earlier. This trend is likely to continue in the next few years and could test the ability of the government’ risk-monitoring framework to contain vulnerabilities.
Indonesian economy is less developed on a number of structural metrics than many of its peers. Indonesia’ relatively low basic human development is indicated by its ranking on the United Nations Human Development Index (41st percentile versus the BBB median of 67th percentile), while average per capita GDP also remains low, at $4,000, compared with the ‘BBB’ range median of $9,878.
With various data, Fitch has affirmed Indonesia‘ Long-Term Foreign-Currency Issuer Default Rating at ‘BBB’ with a Stable Outlook. The countries’ rating balances a favorable medium-term growth outlook and a low government debt to GDP ratio against a high dependence on external financing, low government revenue, and lagging structural features.
Edited by Editorial Staff, Email: email@example.com