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Standard & Poor’s Ratings Services has raised its long-term foreign and local currency ratings on Indonesia by one notch, reflecting good fiscal performance backed by the growing stability in economic conditions. The foreign currency rating was raised to ‘B’ from ‘B-‘ and the local currency rating to ‘B+’ from ‘B’. The short-term foreign currency rating was also raised one notch to ‘B’, the same level as the short-term local currency rating.
Continued fiscal adjustment spurred the upgrade, with Indonesia’s government generating primary surpluses of 2.5-3.5% in the past few years. “Despite general and presidential election scheduled for next year, the government has shown its commitment to reducing central government fiscal deficits to less than 1.5%, from 1.8% of GDP this year, and has budgeted a primary surplus about 2% in 2004,” says Takahira Ogawa, Standard & Poor’s credit analyst and director in the Asia-Pacific Sovereign Ratings Group.

Stable rupiah foreign exchange rates and increases in foreign investment in bank and corporate assets are improving international liquidity in Indonesia, despite the government’s decision not to extend the IMF program after the end of this year and intermittent terrorist attacks. Since the government will not be able to seek a fourth Paris Club rescheduling without an IMF programme, the risk of default to commercial creditors is reduced.

The ratings on the Republic of Indonesia are constrained by political uncertainty. “Although in terms of recent political history, there is relative political stability, Indonesia’s democracy is still in its infancy, and there remains the risk of disruptions that could adversely affect key economic policies, undermine the government’s new and existing loan commitments, or lead to a widening of the financing gap,” says Ogawa. “In this regard, next year’s general and presidential elections are important not only to judge the course of democracy in Indonesia, but also political stability in the country.”

Indonesia is also still suffering from heavy public indebtedness. The public sector’s total net debt burden peaked at about 97% of GDP in 2000, but is expected to drop to 77% by the end of 2003. Nevertheless, Indonesia remains vulnerable to trends in exchange rates and other variables. The public sector’s net external debt burden has stabilized at about 75% of current account receipts since 2001. The expiration of the consolidation period of Paris Club 3 at the end of 2003 generates an onerous amortisation profile, however, with US$6bn-US$6.5bn of principle due between 2004 and 2008. “Well-planned funding programmes in 2005 and 2006 will be required to meet US$500mn and US$900mn of debts falling due to private creditors, respectively,” Ogawa claims.

The stable outlook balances Standard & Poor’s expectation that the government will continue its fiscal consolidation against the risk that political or external developments will cause investor confidence to wane and jeopardize the government’s funding plans. Going forward, the general government primary budget surpluses of about 2% of GDP, combined with small divestment proceeds, will be central to Indonesia’s debt-management strategy. “Further improvement in the government’s fiscal position, together with the progress in structural reform, such as judicial and governance reform and a relatively smooth electoral process, Indonesia’s creditworthiness could improve faster than most of its peers,” adds Ogawa. However, institutional weaknesses often hinder policy coordination and timely response to political and external shocks. If the government draws back from fiscal consolidation because of political paralysis or by failure of economic policy, the ratings could be at risk.