Ratings upgrade invigorates Indonesian bond activity

Sovereign bond issuance is set to accelerate in Indonesia, after global ratings agency Standard & Poor’s (S&P) became the last of the big three international ratings agencies to upgrade its sovereign credit rating to investment grade. The country has made notable progress in improved budgeting practices, cutting spending and launching a bold, broadly successful tax amnesty programme which should significantly augment revenue realisation in the years to come. Its balance of payments is also improving, supported by a turnaround in global commodity prices, a falling energy import bill and rising foreign direct investment (FDI). Although high levels of non-performing loans (NPLs) remain a risk, the country’s mid-term outlook remains positive, and bond issuance could rise to support its sizeable infrastructure agenda in the coming years.

FITCH: In December 2011 Fitch Ratings became the first of the big three ratings agencies to upgrade Indonesia’s long-term foreign and local currency issuer default ratings to investment grade, or from “BB+” to “BBB-”, giving both a stable outlook. Fitch reported that the upgrades reflected the country’s strong, resilient economic growth – GDP growth averaged 5.9% from 2007 to 2011, according to World Bank data – supported by a low and declining public debt ratio, improved external liquidity and a prudent macroeconomic policy framework. The agency reaffirmed Indonesia’s “BBB-” credit rating in December 2016 and again in July 2017, upgrading the outlook from stable to positive. This decision was attributed to improvements brought about by the reform drive under way since September 2015 (see Economy chapter), as well as a strong mid-term growth outlook, with Fitch forecasting GDP growth at 5.2% in 2017 and 5.6% in 2018.

BETTER BUDGETING: President Joko Widodo’s administration is expected to use the estimated Rp100trn ($7.5bn) repatriated following the 2016 tax amnesty to boost spending on infrastructure, ranging from new roads and ports, to railways and airports, supporting a government target to boost annual GDP growth to 7%. Realisation of improved tax collection will also help balance the budget against rising infrastructure spending; the 2018 budget put the deficit target at 2.19% of GDP, well below the 3% legal threshold.

Sri Mulyani Indrawati, minister of finance, has won praise from public and private stakeholders for adopting a more realistic approach to public spending and revenue generation, moving in 2016 to slash Rp133.8trn ($10.1bn) of planned expenditure after revenue collection fell below target (see Economy chapter). Fitch reported that a strengthened external balance, improvements to the business environment and maintenance of a sustainable growth rate could trigger a future upgrade, although potential external financing difficulties and increased public debt could push the country’s outlook back to stable.

MOODY’S: Moody’s followed suit in January 2012, upgrading Indonesia’s foreign and local currency bond ratings to “Baa3” from “Ba1”, with a stable outlook. The agency reported that Indonesia’s resilience to large external shocks – according to the World Bank, GDP growth stood at 6% in 2009, against a global contraction of 1.8% – indicated a sustainably high growth trend over the medium term. Moody’s also praised Indonesia for gains in investment and infrastructure development following key reforms to policy and a well-managed financial system.

Like Fitch, Moody’s also reported that improvements in the external payments position, supported by increasingly large FDI inflows, were deciding factors in its ratings upgrade. The Indonesia Investment Coordinating Board (BKPM) reports that FDI inflows rose significantly at the time of these upgrades, growing from Rp148trn ($11.2bn) in 2010 to Rp175.3trn ($13.2bn) in 2011, an increase of 18.4%, rising a further 31.03% in 2012 to end the year at Rp229.7trn ($17.3bn). In February 2017 Moody’s upgraded its credit outlook for Indonesia from stable to positive, while reaffirming its “Baa3” rating, joining Fitch in highlighting the country’s efforts to keep finances under control despite a sharp drop in prices of its primary commodity exports.

COMMODITIES IMPACT: An improved current account balance has also brightened the outlook. Commodity prices began to stabilise in 2016-17, with the World Bank reporting that for the first nine months of 2017 coal prices averaged 50% above the same period in 2016. Similarly, oil and gas prices rose over the period, with crude oil and natural gas prices averaging 25% and 26% higher, respectively. Base metal prices, including copper and nickel, have also improved considerably.

Nevertheless, the crash in global oil prices between 2014 and 2016 brought benefits to Indonesia, enabling the country to end decades of extremely costly fuel subsidies, which were estimated to have reached a value equivalent to 3.7% of GDP in 2012, according to the World Bank. Indonesia has been a net energy importer since 2003, and energy imports rose in the years to 2015, peaking at $45.27bn in 2013, according to Ministry of Trade data. While annual oil and gas export revenues fell by 64.6% between 2012 and 2016, from $36.98bn to $13.1bn, the country’s oil and gas import bill also dropped significantly over the same period, from $42.56bn to $18.74bn. As a result, its energy trade deficit has fallen from a high of $12.63bn in 2013 to $5.63bn in 2016. Subdued oil prices and rising commodity prices have helped the country reduce its current account deficit, with the World Bank reporting it fell from a high of 4% of GDP in 2013 to 1.8% in 2016, and just 0.8% in the fourth quarter of 2016, its lowest level since 2011. Although the deficit rose to 2% of GDP in the second quarter of 2017, the outlook is broadly positive, supported by improved budgeting practices, increased revenue collection, and a low public debt-to-GDP ratio – 27.9% in 2016, against 32.3% in 2007 – which leaves plenty of room for future borrowing.

S&P DELAY: For more than five years following the Moody’s upgrade, S&P was the only major global ratings agency to rate Indonesia’s debt below investment grade, creating an obstacle to increased foreign inflows since some major institutional investors require a country to be rated investment grade by the big three ratings agencies prior to buying its debt. In May 2017, however, S&P announced that it had upgraded Indonesia’s credit rating from “BB+” to “BBB-” with a stable outlook, as a result of more realistic budgeting practices, reduced risk of a widening budget deficit and improved fiscal metrics. This upgrade could prove critical for the country, which has struggled to advance its infrastructure agenda under a public-private partnership model. Sovereign debt is expected to significantly augment infrastructure spending in 2018, supported by the S&P upgrade (see Economy chapter). The Indonesia Stock Exchange jumped by 2.59% immediately following the announcement, and the rupiah appreciated modestly against the US dollar, while rupiah- and dollar-denominated 10-year government bond yields fell from 6.92% to 3.73%.

RISKS: Although local media reports that banks are not expected to increase bond issuance in the near term, a planned Rp597trn ($45bn) sovereign bond issuance is in the works for 2017, against Rp532.4trn ($40.1bn) in 2016, while a number of state-owned enterprises are also turning to international debt markets to finance major infrastructure projects, including a light rapid transit system, ports upgrades and construction of new telecommunications infrastructure.

Nevertheless, the country remains at risk of a future downgrade, particularly as a result of high NPLs in the banking sector. According to data from BMI Research, in the four years to 2017, Indonesia’s NPL ratio was on a consistent uptrend, increasing from 1.8% in December 2013 to a high of 3.1% in May 2017, despite government moves to relax loan restructuring criteria in 2015. Low global commodity prices drove NPL growth during this period, with many large Indonesian banks significantly exposed to corporate loans in the manufacturing, mining and construction sectors.

Furthermore, BMI Research reported that ongoing bank efforts to restructure loans, meant to delay their recognition as delinquent, could obscure the true levels of NPLs in the banking sector. In March 2017 Fitch reaffirmed its negative outlook for Indonesian banks, reporting that asset quality and profitability were under pressure due to elevated NPLs.

Despite these negative indicators, there were signs of a turnaround in 2017, with the Financial Services Authority reporting a NPL ratio of 2.9% in September 2017. This should improve the ratings outlook for the sector, and may help keep ratings stable in 2018.