Fitch Revises Indonesia's Outlook to Positive - The Indonesia Today

Fitch Ratings has on Thursday (February 24) revised Indonesia's outlooks to positive from stable. Its ratings have been affirmed at Long-term foreign and local currency Issuer Default (IDR) 'BB+', Short-term foreign currency IDR 'B' and Country Ceiling 'BBB-'.

"The positive outlook reflects Fitch's view that Indonesia's favourable macroeconomic prospects are likely to see the credit profile strengthen further over the next twelve to eighteen months, despite near-term risks from inflation and potentially volatile capital flows," said Andrew Colquhoun, Senior Director and Head of Asia-Pacific Sovereign Ratings at Fitch. "Faster progress in tackling long-standing weaknesses in economic and credit fundamentals including the low tax take, infrastructure deficiencies and corruption, would further support the case for an upgrade."

Indonesia's economy grew 6.1% in 2010 after a mild slowdown to 4.6% in 2009, consolidating the five-year average at 5.7% pa, well ahead of the 'BB' and 'BBB' range medians (each 3.6% pa). Growth is being driven by domestic demand, supported by a pick-up in the investment rate to 32.5% of GDP in 2010, up from 24.9% in 2007.





Indonesia's growth has not been accompanied by the emergence of potentially risky external imbalances - rising savings rates have largely matched rising investment, and the economy has run a modest current account surplus since 1998. Moreover, investment is well-diversified across the industrial and service sectors as well as the traditionally-important mining industry.

Indonesia needs faster growth to narrow the income differential with rated peers; average income of USD3,000 in 2010 compares poorly with the 'BB' median of USD5,400 and the 'BBB' median of USD7,700.

Inflation poses a near-term risk to economic prospects. CPI inflation of 7% at end-2010 exceeded Bank Indonesia's (BI) target range of 4%-6%. BI hiked its key policy rate in February to 6.75% from 6.5% and signalled its willingness to act more firmly to contain inflation expectations, while citing the role of food prices (36% of the basket and up 17.7% to end-December).

However, Indonesia has a history of higher and more volatile inflation than rated peers, while BI's focus on its inflation target has been tempered by caution over attracting excessive capital inflows. Fitch expects inflation will average 6.5% over 2011, but a more severe inflation shock than the agency expects that is sufficient to damage economic and financial stability would weaken the case for positive rating action.

Indonesia's gross government debt to GDP ratio fell again to 26% of GDP by end-2010, well below the 'BB' median of 41% and the 'BBB' median of 37%. The budget deficit came in at 0.6% in 2010, extending a run of low deficits below 2% since 2002 that has contributed to the debt ratio reduction.

The low revenue take (just 16% of GDP in 2010) continues to weigh on the ratings, although even the debt/revenue ratio is projected to drop from 163% at end-2010 to nearer the projected 'BBB' median of 126% by 2012. Nonetheless, low revenues diminish fiscal flexibility and constrain resources available for public investment, all of which weigh on the ratings.

Official foreign reserves rose to a record USD96.2bn by end-2010, worth some seven months of imports and up 46% on the end-2009 figure. FDI inflows were also strong in 2010 at USD9.8bn (1.4% of GDP). A long run of current account surpluses has helped take Indonesia's net external debt down to the 'BB' median of 9% of GDP.

Strengthening external liquidity supports the ratings, although portfolio capital inflows were a strong USD14bn in 2010, and any reversal in the event of a shift in investor sentiment could undo some of the improvement.

Long-standing weaknesses in economic and credit fundamentals including deficiencies in physical infrastructure and a high reported prevalence of corruption weigh on the ratings. Faster progress in tackling these would help secure Indonesia's prospects for sustained growth and would support the ratings. Indonesia's steady consolidation as a democracy leaves political stability as a rating strength relative to the 'BB' category.