Indonesia has made significant strides towards building the political institutions necessary for the country to achieve investment-grade status, according to Standard & Poor’s. But, unfortunately for more sanguine investors and the country’s policymakers, it is not there yet.
"Generally, investment-grade sovereigns are in charge of their own fate, meaning they are able to absorb exogenous shocks by drawing on entrenched economic, political, and institutional strengths," S&P credit analyst Agost Benard said in a statement yesterday.
"Based on our criteria, the strength, predictability, and transparency of a country's political institutions are among the key considerations in assessing a sovereign. Indonesia has advanced much in this area over the past decade, although it still has some way to go," he said.
Benard's remarks follow a recently published S&P paper titled: How far, or close, is Indonesia to an investment-grade rating?
Indonesia’s foreign currency debt is rated BB (with a positive outlook) by S&P, which is two notches below investment grade.
At the beginning of this month, rival agency Moody’s assigned a positive outlook to Indonesia’s foreign currency debt, which it rates Ba2 (equal to the S&P rating).
“The positive outlook on the BB credit rating on Indonesia signifies the improving trend in the government's credit standing, which means Indonesia's reaching investment grade is possible, although not ineluctable," said Benard.
He pointed positively to the success of the presidential and parliamentary elections in 2009 which demonstrated a “smoothly functioning electoral process and presaged policy continuity on economic and fiscal management”. But, he warned that Indonesia's institutions and bureaucracy are still evolving and are weaker than those of most BBB- rated sovereigns.
“As systems for checks and balances develop and as the country's legal framework becomes more predictable, these political factors are likely to become less of a binding constraint on the sovereign rating,” he said.
However, there are other obstacles – notably linked to the country’s economic structure and growth prospects.
"Labour market inflexibility, inadequate power and infrastructure, legal uncertainty, corruption, bureaucratic obstacles, and inconsistent policies and rules between different levels of government combine for a difficult business environment," said Benard.
Indonesia also relies too heavily on external borrowing, caused by its shallow domestic capital markets and low savings rate.
Although the government is making an effort to lower the reliance on foreign funding and to shift the borrowing mix gradually towards local currency, “it will take time for this to translate into lower vulnerability”, said Benard.
"Indonesia's credit rating [is] firmly on an upward path, but there is no set timeframe, nor is there a prescribed recipe of reforms or improvements needed before investment-grade status is reached," he added.
For more than a decade, Indonesia has moved gradually towards political and macroeconomic stability. An important element has been a steady reduction of its public and external debt burden, which was a legacy of the 1998 Asian financial crisis.
The continued effectiveness of reforms, the government's response to any further external shocks, and changes in debt ratios, given the current policy stance and growth expectations, will determine its success in becoming an investment-grade country.