Indonesia: Overheating concerns tarnish country’s investment-grade allure


Matthew Turner
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Indonesia’s growth miracle is expected to continue into 2013, but policy mismanagement and inflationary concerns pose risks to its credit profile.

Increasing inflationary pressure and a lax monetary policy response has raised the spectre of economic overheating in Indonesia, though this prospect does not immediately threaten the country’s investment-grade credit rating, ECR analysts say.

Indeed, the sovereign’s rise in the rankings was cut short last year, after analysts participating in the ECR survey lowered their assessment of the country’s risk profile by 2.9 points, leading to Indonesia’s position in the ECR rankings falling by six places to 64.


The sovereign’s increased risk perception was underpinned by increased concerns in the rupiah’s stability and the deterioration in the country’s current accounts, which have in turn raised doubts about the sustainability of the country’s growth path.

ECR analysts lowered the country’s currency stability and economic growth indicators by 0.4 last year, while the country’s government finances and bank stability scores dipped by 0.2 points during the same period.

Indonesia’s ECR score hit rock-bottom in the aftermath of the Asian financial crisis. The sovereign’s position fell by more than 20 places in the ECR rankings, leaving it in the lower echelons of ECR’s tier-five category – with a global rank of just 115.

Clearly, Indonesia’s position in the rankings today speaks of a vastly different story to the conditions felt in the economy more than 10 years ago.

And although Indonesia’s efforts to boost economic growth and investment after the 1998 crisis were well received by ECR economists, recent events are raising concerns about theviability of Indonesia’s economic model and pose higher risks to foreign trade and investment counterparties, reckon analysts.


Overheating concerns

The rupiah depreciated considerably throughout the year – from around Rp9,000 per $1 at end-2011 to Rp9,600 per $1 – which meant the currency was one of the worst-performing currencies during the past year, owing to a marginal deteriorating in the country’s fiscal position and export growth.

As a result of the currency’s devaluation, headline consumer price inflation rose to 5.3% in February 2013. This almost over-ran the ceiling of the central bank’s 3.5% to 5.5% target range and left inflation reaching a two-year high.

Meanwhile, core inflation is forecast to rise to 5% this year, from 4.3% in 2012. Analysts anticipate that rising inflation could put pressure on the Bank Indonesia to hike interest rates in 2013.

Christian de Guzman, analyst at Moody’s and one of ECR’s expert contributors, attributes the recent hike in inflation to the weakness of the rupiah. “The central bank doesn’t have the most solid record in anchoring inflation expectations amongst central banks in the region,” he says. “So it is important for Bank Indonesia to be more pro-active about declaring its tolerance for inflation.”

Indeed, Moody’s cites sustained loss of inflation control and monetary control as credit negative, and a reason that could push down the rating.

Policy mismanagement

Meanwhile, the country’s current account has deteriorated moderately, shrinking to 1.8% of real GDP in 2012 from a deficit of only 0.3% of GDP in 2011.

However, Moody’s claims a large shock to the country’s fiscal, debt and foreign currency reserve position would be needed to weigh negatively on the country’s credit rating – with policy mismanagement posing the most likely source of a weaker fiscal position.

De Guzman recognizes that a poor policy environment remains a threat to Indonesia’s credit profile over the long-term. “[The policy environment] is more of a concern over a longer time horizon,” he says.

“We see the recent rise in policy and regulatory risk as a function of the upcoming elections. There is a fair degree of positioning and politicking, with some policymakers seen as trying to burnish their nationalist credentials.”

Capital Economics agree. It states: “There is no guarantee that things will improve once president [Susilo Bambang] Yudhoyono’s final term ends in 2014. Indeed, most of the leading presidential candidates are widely seen as throwbacks to the Suharto era. In short, there is a chance that Indonesia could take a backward step over the next few years.”

ECR analysts have recognized the deteriorating policy environment, lowering the country’s regulatory and policy environment indicator by 0.3 points to 4.3 (out of 10). However, corruption remains the most substantial risk to the country’s credit profile, according to ECR analysts, with a score of only 3.2 points.

This artice was originally published by Euromoney Country Risk. To discover more, resister for a free trial at Euromoney Country Risk