Moody’s decision to upgrade Indonesia’s sovereign rating to investment grade earlier this year will benefit the country’s companies gradually as they remain constrained by more company- or industry-specific issues.
While immediate rating implications from the sovereign upgrade have been moderate, we expect the wider environment for corporations to improve in the medium to longer term. For example, Indonesian corporations will, over time, benefit from cheaper and more diverse funding opportunities, more foreign direct investment, and a more stable and predictable operating environment.
Foreign direct investment (FDI) in the country is increasing, attracted by the economy’s large consumer base, low labour costs and profitable commodity sector, and despite a poor record of infrastructure development and an uncertain regulatory environment.
As the exhibit below shows, FDI hit a record of more than $18 billion in 2011, even though global economic growth was slowing. FDI, as well as domestic investment, has also been increasingly broad-based, with more manufacturing and a larger share of investments now outside the main island of Java.
Investor confidence to rise
In addition, improved sovereign strength — as a result of the upgrade — will boost investor confidence in Indonesian companies when compared with those in non-investment-grade countries.
In the aftermath of the 1997 Asian financial crisis, most Indonesian companies improved their governance, internal controls and treasury policies with respect to liquidity and the currency. As a result, they were less affected during the more recent global financial turmoil of 2008-2009.
The improved investor confidence will in turn encourage Indonesian companies to tap the capital markets.
The sovereign upgrade also comes at a propitious time for Indonesian companies with foreign currency earnings, as offshore rates are low and investor interest in Indonesia may be spurred by the upgrade to investment grade. This development will encourage some bond issuance as companies lock-in long-term funding at the low rates. Cikarang Listrindo, Berau Coal and Alam Sutera have all been bond issuers in recent months.
Risks and uncertainties remain
At the same time, Indonesia remains an emerging market with ongoing issues regarding corporate governance, regulation and corruption.
Some positive steps, such as more stringent stock exchange listing requirements and a stronger risk and regulatory framework for the financial sector, have improved transparency and disclosure, but not eliminated the risks.
Moreover, Indonesian companies remain largely family-controlled businesses which tend to have less transparent operations and disclosures. Of the Moody’s-rated Indonesian companies, 20 of the 22 non-government-related issuers have concentrated family ownership structures.
Furthermore, Indonesia’s average real GDP growth of 5.3% since 2001 has not been accompanied by commensurate improvements in the country’s infrastructure. According to the World Economic Forum, its quality of infrastructure remains one of the worst in the G-20.[1]
This deficit in infrastructure is reflected in the high cost of intra-island transport, the limited throughput of key facilities, such as airports and ports, and the relatively poor quality of electricity supply.
The medium-term outlook for public investment has improved as a result of procedural reforms, such as the Land Acquisition Bill passed by the country’s legislature in late 2011, and the identification of key projects under an over-arching master plan.
Nevertheless, material improvements to Indonesia’s capital stock over the next year are unlikely, and policymakers need to ensure that growth does not significantly surpass potential to avoid overheating pressures.
Reforms Must Continue
In addition, while we do not expect a significant shift from Indonesia’s current policy stance, the elections in 2014 introduce a degree of uncertainty in relation to the continuity of the reform agenda. Indonesia's recently announced rules restricting foreign ownership of new mines indicate traces of continued protectionism, while similar rules relating to the single ownership of banks onshore were also proposed last year.
The liberalisation of the wide subsidy framework, especially for gasoline, has seemingly stalled on political concerns. Uncertainties are particularly acute at the sub-sovereign level as local governments continue to hold broad licensing and regulatory powers.
Moreover, the limitations on domestic banks to raise funds in foreign currencies, particularly in US dollars, constrain their ability to offer foreign currency loans. The growth in foreign currency loans has significantly outpaced growth in deposits in recent years, with banks’ average foreign currency loan-to-deposit ratio having now surpassed its pre-crisis level as shown below.
Increasing FC loan-to-deposit ratios (LDR) may constrain Indonesian banks' FC lending
Looking ahead, we expect corporate demand for foreign currency loans to continue, but banks may tighten supply as they increasingly face the risk of a funding mismatch. Consequently, Indonesian companies could be forced to find alternative sources of funds, including accessing banks outside the country, or issuing debt themselves.
Lastly, we note that the potential for ratings uplift for Indonesian companies — following the sovereign upgrade — varies by sector due to a range of factors, including competition, regulation, size and scale.
The oil and gas and utility companies have already benefitted, given their strategic importance and government links.
We expect some issuers in the telecommunication and media, mining and real estate industries to gain from the sovereign upgrade in the medium term, while it may take longer for the benefits to trickle down to rated issuers in the agriculture and cement industries.
Nidhi Dhruv, the author of this article, is an analyst with Moody’s Corporate Finance Group in Singapore. She covers a portfolio of telecom companies in Southeast Asia as well as Indian corporations. She is also a member of Moody’s Hybrid Capital team and the regional coordinator for hybrid issuances in Asia-Pacific.
1 According to the World Economic Forum’s Global Competitiveness Report 2011-12, only India, Russia, Brazil, and Argentina have lower scores among the G-20 countries in terms of quality of overall infrastructure.
