Indonesian Strategy:S&P keeps junk rating,our take

Event

    S&P has announced that after a detailed review, it has elected to maintainIndonesia’s sub-investment-grade sovereign credit rating (one notch below),dashing widespread expectations that an upgrade was imminent. We discusshow we believe the degree of dismay over the decision is unjustified, andindeed that it is arguable now would have been an odd time to upgrade.

    Impact

    Indonesian policymakers have reacted with surprise and indignation to S&P’sdecision, with Indonesia’s finance minister Bambang Brodjonegoro beingquoted by the Jakarta Post as saying that “S&P is not important” and thatinvestors would respond positively to Indonesia’s economy “with or without abunch of analysts anointing it to be so anyway”. S&P’s concerns about a lackof revenue mobilisation were also said to be old news, and hence that S&P“never analyses anything and is just repeating the same things”. Thesesentiments have also been echoed by a number of global debt investors.

    We concur that a rating upgrade would have had limited consequences,although we doubt sentiments to the effect that an S&P rating upgrade wasirrelevant would have been expressed had the rating indeed been upgraded.

    In our view, rating agencies seldom tell the market anything it does notalready know, and the limited reaction in the forex, bond, and equity marketsto S&P’s decision seems to be confirming that assessment. We note thatIndonesia’s 10-yr bond yields troughed at 5.2% in 2012 when all three majorrating agencies rated the bonds sub investment grade, but rose as high as9.8% last year despite both Moody’s and Fitch having already upgraded.

    We are nevertheless much less surprised by S&P’s decision than many. Wehighlight that there is more to sovereign debt analysis than a country’s fixedin-time debt-to-GDP ratio, which remains at a relatively low 31.3% of GDP,and highlight that Indonesia has now already started down the well-troddenpath of a commodity-dependent EM experiencing a significant increase infiscal deficits and government debt ratios in the wake of a commodity bust.

    In particular, we highlight that (1) Indonesia’s debt-to-GDP ratio has alreadystarted to trend up, from a trough of 23.3% in 2011 to 31.3% by 1Q16A; (2)Indonesia’s tax-to-GDP ratio remains very low, at 11% (i.e. government debtis c3x taxes), while government efforts to mobilise additional fiscal resourceshave largely failed to date; (3) debt servicing ratios are much higher onaccount of relatively high interest rates; and (4) Indonesia’s fiscal deficit israpidly climbing, reaching 4.9% of GDP in 1Q16A, and if the fiscal deficit capis abolished, could quickly rise further to 5