29/3/2018/Fitch Ratings
Attendees at Fitch Ratings’ Indonesia Credit Briefing held in Jakarta on 22 March were generally optimistic about the outlook for Indonesia’s economy – particularly prospects for the government’s aggressive infrastructure drive. Domestic political turbulence was seen as the biggest threat by 62% of the 243 investors, analysts and business community members that attended. Polling results also suggested unease over external vulnerabilities amid rising US interest rates.
Finance Minister Sri Mulyani Indrawati spoke of the government’s infrastructure push, emphasising the various funding channels being used to support projects. The government has limited fiscal space to increase direct infrastructure spending, in part because the central government’s revenue-to-GDP ratio is among the lowest of Fitch-rated sovereigns, at under 13% in 2017 according to Fitch’s definition. Local governments, state-owned enterprises (SOE) and private investors will be relied on to fill the financing gap. To this end, the government has increased financing options for infrastructure projects, which now include komodo bonds.
SOEs are likely to leverage up to finance capex, which could add to the government’s contingent liabilities. The Finance Minister emphasised that Indonesia has strived to be transparent in reporting and tracking its contingent liabilities. Moreover, it has set a maximum guarantee limit at 6% of GDP for 2018-2021, although the Ministry of Finance can raise that if needed.
The Finance Minister also outlined the government’s strategy for raising the revenue ratio, including tax policy measures, as well as steps to address weaknesses in administration and IT systems that undermine tax compliance and collection efficiency. She expressed hope that the revenue ratio can be raised by at least 1% of GDP per year through 2020. Most of the attendees (73%) expected the revenue ratio to increase over the next two years.
Attendees’ concerns over domestic turbulence most likely reflect upcoming local elections in June and the presidential elections in 2019. Religious tensions dominated last year’s gubernatorial election in Jakarta and could become prominent in other elections, although so far such pressure remains muted. We also see some risk that reform momentum will weaken in the election run-up, with the partial roll-back of fuel subsidy reform in recent months perhaps evidence of this. However, the government appears committed to a long-term reform agenda. Moreover, we do not expect pre-election spending to push the fiscal deficit above the 3.0% of GDP ceiling set by Indonesia’s fiscal rules, even if there is some slippage from the 2.2% target set for 2018.
US interest rate increases were seen as the second-highest risk to Indonesia’s economy and more than half of attendees believed vulnerability to external shocks is the biggest risk facing the country’s credit market. Depreciation in the Indonesian rupiah since the start of the year, while not dramatic, may have contributed to these views.
Fitch believes Indonesia’s underlying resilience to potential external pressure has increased due to the policy focus on stability in the previous few years. A more flexible exchange-rate policy has helped build-up foreign-exchange buffers, while more disciplined monetary policy has limited capital outflows during challenging periods. Macro-prudential measures have also curbed increases in corporate external debt. These policies were key to our decision to upgrade Indonesia’s sovereign rating to ‘BBB’, from ‘BBB-‘ in December 2017.
That said, capital account openness, a high share of non-resident ownership in the government bond market and significant commodity dependence leaves Indonesia’s financial markets vulnerable to bouts of volatility from external pressures.
Watch our exclusive interview with Finance Minister Sri Mulyani Indrawati
