Indonesian President Joko Widodo, Vice President Ma'ruf Amin and their new cabinet member - Photo by President Office

JAKARTA (TheInsiderStories) – Indonesia’ (Baa2 stable) credit profile is supported by the economy’ large size, low fiscal deficits and modest debt burden. These features are balanced by a weak revenue base that constrains debt affordability, a reliance on external market funding, and a degree of economic concentration that leaves the economy vulnerable to commodity cycles.

We expect GDP growth will slow to just under 5 percent in 2020, as global growth remains tepid and as Chinese demand for commodities could soften on the back of the coronavirus outbreak. Nevertheless, even with a slowdown in growth, Indonesia’ economy continues to outpace most Baa-rated sovereigns, allowing increases in average incomes.

At 12.4 percent of GDP in 2019, government revenue remains significantly below the median for Baa peers of 27.6 percent, and the lowest of all investment-grade sovereigns. Weak revenue also weighs on debt affordability.

These constraints are balanced by fiscal discipline, anchored by very strong adherence to a statutory deficit ceiling of 3.0 percent of GDP. Low deficits have kept the government’s debt burden at around 30 percent of GDP in 2019, below the Baa median of 47.3 percent.

On the external front, the current account deficit (CAD) was stood at 2.7 percent in 2019, wider than a low of 1.6 percent recorded in 2017. Still, external buffers are sufficient to withstand a degree of shock. Pressure on the rupiah and turns in investor sentiment have eroded foreign reserves in the past, but levels have recovered to close to their peak following a prolonged period of currency depreciation in 2018.

The stable outlook reflects balanced risks and takes into consideration a relatively slow pace of reform momentum. We expects that reforms aimed at reducing a number of structural economic and fiscal constraints will continue, albeit at a gradual pace, similar to the relatively slow progress achieved in the last few years.

On Feb. 10, Moody’s Investors Service affirmed Indonesia‘ local and foreign currency long-term issuer ratings at Baa2 and maintained the stable outlook. The local and foreign currency senior unsecured ratings, the medium term notes (MTN), and shelf program ratings were also affirmed at Baa2 and (P)Baa2, respectively.

The affirmation of the rating is underpinned by a number of credit
strengths – including Indonesia’ robust and stable growth rates and a low government debt burden, preserved by consistent fiscal discipline and emphasis on macroeconomic stability – as well as persistent credit challenges.

These comprise a very weak revenue base that constrains debt
affordability, the government’ reliance on external market funding that exposes its balance sheet and the economy to changes in foreign investor sentiment, and an economic structure that remains vulnerable to commodity cycles.

Its expects that reforms aimed at reducing a number of
structural economic and fiscal constraints will continue, albeit at a
gradual pace, similar to the relatively slow progress achieved in the
last few years.

With a nominal GDP of just over $1.0 trillion and a population of more  than 260 million, Indonesia is among the largest and most populous  countries in Moody’s rated universe. This, coupled with a robust pace of population growth, supports the economy’s shock-absorption capacity.

Through trade and capital flows shocks, GDP growth tends to fluctuate within a narrow range of around 4.9 – 5.2 percent year-on-year. Growth slowed slightly to 5.0 percent in 2019, as the pace of investments moderated, and growth in exports (in nominal dollar terms) dipped into negative territory.

Indonesia maintains a low government debt burden and moderate CAD underpinned by a prudent policy framework and an emphasis on maintaining macro stability. These credit strengths are balanced by a very narrow revenue base and a material proportion of foreign currency-denominated government borrowing that raises the sovereign’ vulnerability to financing shocks.

Moreover, external buffers are sufficient to withstand some degree of shock. Pressure on the Rupiah and turns in investor sentiment have eroded foreign reserves in the past, although following a prolonged episode of currency depreciation in 2018, levels
have now recovered close to peak levels.

Moody’s External Vulnerability Index–which measures reserve adequacy against a sudden stop in capital–has climbed over the past year, but at 51 percent in 2020 denotes strong reserve adequacy. These fiscal and external features contrast with a number of persistent credit challenges that leave the sovereign vulnerable to financing shocks.

The stable outlook reflects balanced risks and takes into consideration a relatively slow pace of reform momentum. Upside risk relates to possibly stronger reform impetus than Moody’s currently assumes that raises investment growth and boosts trade flows, as well as an increase in revenues.

Conversely, downside risks relate to possible prolonged delays to reforms that directly or indirectly result in a persistent erosion in the revenue base and/or a marked slowdown in potential growth. While, environmental risks are a material consideration for Indonesia’ credit profile.

Coastal flooding and rising sea levels are a particular source of risk, with widespread implications, including for agricultural production, damage to infrastructure and property, and food security.

Over time, indications that fiscal policy measures can durably and significantly raise government revenue would put upward pressure on the rating. Higher revenue would enhance fiscal flexibility and provide more direct financial means for the government to address large social and physical infrastructure spending needs.

An upgrade would also likely result from indications that Indonesia’
growth potential is strengthening, towards rates commensurate with the country’ population growth and income levels, including through a deepening of financial markets and improved competitiveness.

Beside, downward pressure would likely arise if evidence indicates that the gradual strengthening of Indonesia’s policy framework and institutions stalls or reverses and there were a meaningful deterioration in the external position such as from prolonged currency depreciation or capital  outflows, which would also have ramifications for debt affordability.

by Anushka Shah, Moody’s Vice President and Senior Analyst.