It was 20-year ago today (well almost) that Indonesia lost its investment grade rating from Standard & Poor’s.
Much has changed since then. The current iPhone has more processing power than the world’s fastest super computer in 1997.
But Moore’s law has vastly outpaced Standard & Poor’s law over the interim period and it has taken Indonesia 20 years to get back to the credit status it held when the Asian financial crisis struck.
In 1997, the global rating agencies were under huge pressure and enormous fire from investors for being slow to react to the crisis, which was engulfing Asia. Indeed, S&P only made its move two months after the country had been forced to turn to the IMF for financial help (to the eventual tune of $40 billion).
Company after company was collapsing under the weight of their dollar-denominated debts after the rupiah went into freefall and the country’s crony capitalist economy buckled. Most notable was the implosion of Asia Pulp & Paper, which went under with $13.4 billion of debt in February 2001.
The sovereign itself had hits its absolute ratings nadir in March 1999 when S&P assigned it a selective default rating.
Yet if the agencies were accused of being too slow on the downside, S&P has also been under fire for being too tardy on the upside, since Indonesia attained full investment grade status from Fitch in 2011 and Moody’s in 2012.
The timing of its move to upgrade Indonesia back to BBB- on Friday also surprised a number of market participants. As recently as March this year, Craig Michaels, S&P’s director of sovereign and public finance ratings, had said the agency was not convinced of the need for an upgrade.
In addition, the country has engendered plenty of negative headlines in recent months in those parts of the world, which are worried about rising Islamic fundamentalism. Earlier this month, Jakarta’s governor, Basuki Tjahaja Purnama, was sentenced to a two-year jail term for breaching the country’s blasphemy laws.
Ahok, as he is better known, is an ally of president, Joko Widodo. But if ever the country’s secularist forces needed positive affirmation from one of Indonesia’s geopolitical allies, then the US rating agency provided it.
Yuniar Restanto, head of debt capital markets at PT Indo Premier Sekuritas, believes the upgrade has come at just the right time.
"It's happened when global attention is focused on Indonesia because of the Jakarta governor's election," he told FinanceAsia. "We expect this positive news will counter all the negative news relating to political issues."
Balancing the books
But the upgrade is also testament to the Jokowi government’s economic programme under Finance Minister Sri Mulyani Indrawati. And S&P has undoubtedly helped underpin that reform momentum by holding off its upgrade until the oil subsidy was removed (2015), the commodities cycle turned positive (2016) and the government took greater steps to improve its revenue collection (2016 and 2017).
For example, last year’s tax amnesty generated $11 billion in revenue, which is being used to boost infrastructure spending.
Analysts also say the repeal of the country’s 1983 domestic bank secrecy laws will close another chapter on the crony capitalist economy. Giving tax inspectors access to domestic bank accounts should help further boost tax as a percentage of GDP from its lowly 10.4% level in 2016.
In its ratings release, S&P said it expects “better revenue collection to result from the data collected during the just-concluded tax amnesty.”
It also expects “increased control over fiscal spending with subsidy reforms being extended to electricity subsidies in 2017.”
Gioshia Ralie, Citi's head of corporate and investment banking in Indonesia said the “move demonstrates how S&P is now comfortable with the government's ability and commitment to balance revenues and expenditure, keeping the budget deficit capped at 3%".
Bond and equity markets gain
Financial markets reacted positively to news of the upgrade on Friday.
In the domestic bond market, benchmark 10-year government treasuries tightened from a yield of 7.12% to 7.105%.
In the international bond market, Citi’s Ralie noted a “50 cent move across high yield and a 15bp tightening all along the sovereign curve.”
Jim Veneau, AXA IM's head of Asian fixed income, commented that investment grade status marks an important validation for the sovereign.
“It’s symbolically and technically important,” he stated. “There’s a larger eligible investor base now. In fact, the sovereign upgrade should give a bit of a boost to the entire corporate bond market.”
Robby Winarta, Credit Suisse's head of Indonesian coverage, agreed that, “the recent ratings upgrade will benefit the Indonesian sovereign and quasi-sovereign offshore borrowing costs.”
However, like many fixed income analysts, he also believes that since, “the upgrade had been expected by the market for some time, it was priced into secondary yields.”
A clutch of Indonesian corporates are expected to tap the international bond market over the coming week and the level of demand they attract will be a key indicator of how much momentum still remains at a time when spreads are already at historically tight levels.
Analysts note a similar pattern in the domestic equity market.
On Friday, the upgrade provided a new shot in the arm for the Jakarta Composite Index, which closed up 2.59% at 5,791.88.
Year to date, the index is up 9.35%, but UBS cautions that it is trading one standard deviation above its five-year average of 15 times forward earnings. On Friday it was at 17.86 times.
On the other hand, DBS said the move could “lure further foreign funds into the equity markets” as the country is now at less risk of an outflow when the Federal Reserve raises interest rates.
“It may well mean that Bank Indonesia does not need to move its repo reference rates up in the exact same quantum to stave off capital flight,” it concluded in a note to clients. “With that, we think there's a case for Indonesia’s interest rates to stay low well into 2018.”
With its new roster of low triple B ratings, Indonesia is now rated the same level as India on Baa3/BBB-/BBB-, but one notch lower than the Philippines Baa2/BBB/BBB- ratings.
It shows that while it has come a long way since the Asian financial crisis, Indonesia still has further to go if it is to achieve the same standing the rating agencies accorded shortly before the crisis when it was two notches higher than India (then Ba2/BB+) and two to three notches about the Philippines (Ba2/BB).
