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For the first time since the 1997 Asian Financial Crisis, Standard and Poor (S&P – a rating agency) adjusted Indonesia’s sovereign bonds rating from junk status to BBB- which signifies adequate ability to repay national debts. The new rating status created a sharp upswing in the Indonesian stock market which hit a record high; rallying as much as 3.2% with the rupiah, also rising by 0.3% against the dollar. S&P’s decision took into account the Indonesian government’s policymaking to prioritise fiscal sustainability among other factors. Such policies have shifted in focus towards a more ‘realistic budgeting’ scheme that involved making effective expenditure and revenue measures — such as cutting the tax revenue budget and the revision of fuel subsidies (See Anticipating Changes to Indonesia’s Fuel Subsidy Policy – Updated) which have helped to stabilise Indonesia’s public finances and could attract a wider pool of investors, therefore, resulting in more fund inflows to Southeast Asia’s largest economy.
Momentum in the Indonesian economy has picked up slightly in the first quarter of 2017 following on from an $11 billion USD tax amnesty programme (See Indonesian Government Banking on Tax Amnesty to Plug Tax Shortfall ) which has offset some of the damage caused by the downturn in global commodity prices; GDP growth is expected to reach 5.1% in 2017. Furthermore, the government’s cutting of public spending to meet the legal deficit cap of 3% of GDP has allowed for a build-up of foreign exchange reserves to a five-year high reaching $123 billion USD. The Indonesian government’s new targeted approach away from short-term growth policies and the preservation of macroeconomic stability have contributed to a narrower current account deficit. However, as reflected by the sudden increase in the rupiah, the currency is still very much volatile as it is vulnerable to external market shocks given the economy’s ongoing reliance on commodities (See The Present Plight of the Indonesian Rupiah).
Despite the latest rating move by S&P, this should be taken with a healthy dose of caution as it remains to be seen if Indonesia can follow through with its plans to improve the investment climate. The country is still plagued by rampant corruption and a shallow banking industry (See Indonesia’s Banking Sector; Under Pressure But Staying Strong); Indonesia also continues to fare worse than comparable peers in important aspects of institutional strength. Nonetheless, the new credit rating is a sign that the country is moving in the right direction. The Indonesian government must focus on implementing its economic policies and instigate its next steps for further reforms, especially in fundamental areas such as the rule of law and increasing the tax base. Only then can Indonesia truly take advantage of the upgrade in status of its sovereign bonds rating.
Throughout 2015 and 2016 the Joko Widodo government issued 14 economic policy packages which were designed as a first-aid kit for the Indonesian economy and focused on deregulation, infrastructure development, and the liberalisation of selected sectors that were previously closed to foreign investors; the Negative Investment List (See Indonesia’s New Negative Investment List; A Big Bang?). The Indonesian government’s decision to cut fuel subsidies has freed up much of a greater proportion of the revised state budget programmes and projects that are in dire need of investment; the country saved up to 100 trillion IDR in 2015 through cutting fuel subsidies. Furthermore, coupled with the appointment of Ms Sri Mulyani as Finance Minister in 2016, investors have increasing confidence in the government’s capacity to execute important reforms. As such, through these reform measures, Indonesia has seen one of the largest inflows of foreign direct investment in the region, rising by 10% in Q3 2016 to 155.3 trillion IDR (See FDI Growth in Indonesia: A Timely Reminder of Long-term Upside).
Reinforcing a positive business climate has no doubt contributed to Indonesia’s positive credit rating outlook. Indonesia will need to demonstrate that it can go beyond the rhetoric and implement all of its desired economic policies. With the release of 14 in total thus far, the government has been able to make some, albeit limited progress. The government has, for example, provided incentives to assist small and medium enterprises (SMEs) through a micro-loan programme (See Indonesia’s 12th Economic Policy Package is Unveiled to the Benefit of SMEs), and have cut interest rates in 2016 to further boost the economy (See Will Bank Indonesia Cut Interest Rates in August?). Still largely ignored, however, are the increasing labour costs (See Labour Pains in Indonesia) and energy prices that are continuing to burden companies and reducing Indonesia’s competitive advantage amongst its regional peers. Rating agencies like S&P will be eager to see the introduction of more policy packages in 2017 to support economic growth and shore up investor confidence through plans to curb bureaucracy and deregulation.
The S&P upgrade also comes off the back of a successful tax amnesty programme that earned the government some $11 billion USD in revenue; contributing to an additional 0.9% of GDP. As the world’s most successful tax amnesty programme, the scheme saw 800,000 people declare more than $330 billion USD — equal to nearly 40% of Indonesia’s GDP — in unreported assets abroad. Not only did the tax amnesty help improve spending in 2016, but it also enabled the government to broaden its tax base; the Finance Minister has set up a special tax reform team to boost collection. For Indonesia to attract greater investment and take advantage of its improved credit rating, the country needs to push through meaningful legislation to reform the tax system.
President Joko Widodo has cited higher tax revenue as the key to boosting infrastructure spending and growth; the tax ratio is currently only at 11% of GDP with aims of increasing it to 15% in 2020. The tax amnesty also exposed the massive scale of uncollected taxes from Indonesian citizens and despite the value of undeclared assets, the tax amnesty has yet failed to meet the desired target in repatriated funds. This has been attributed to a lack of attractive investment instruments in the country compared to that of Singapore and Hong Kong. Furthermore, rising political uncertainty surrounding the imprisonment of the former Governor of Jakarta in April 2017 has polarised the country, and, coupled with external factors such as the surge in the US dollar following on from the US elections See The US Presidential Elections and What it Means for Indonesia) as well as the geopolitical situation in Europe, investors are worried about the volatility of Indonesia’s markets.
With a working population of 110 million people, only 30 million people have registered with their tax office and less than 10 million file a tax return regularly. The tax office, therefore, must concentrate in pursuing tax evaders and implement greater reforms to the tax system that can penetrate the informal sector, which constitutes a substantial and important portion of the labour force (See Indonesia SMEs: Increased Government Support to Overcome Challenges). In doing so, the country can broaden its tax base which would generate significant revenue for infrastructure (See High Stakes for Indonesia's New Infrastructure Push), healthcare (See Indonesia’s Healthcare Industry; Showing Strong Vital Signs), and education (See An Overview of the Indonesian Education System), among others. Progress on the tax amnesty is the stepping stone needed to initiate fiscal reforms and for potentially further credit rating upgrades going forward.
As a foundation of the Joko Widodo government, infrastructure development is integral for a more integrated archipelago amidst an increasingly competitive ASEAN regional landscape. As much as $450 billion USD is required within the next five years for essential infrastructure upgrades with investment rules having been substantially overhauled to make them more attractive for private sector partners (See Indonesian Infrastructure: Tremendous PPP Opportunities). With Indonesia’s recent credit rating upgrade, the country will ideally have wider access to international investors and thus be able to jump-start infrastructure investments across the country.
Furthermore, with a full-suite investment grade (IG) rating, this opens up potential new sources of capital; particularly from investors that only invest in at least IG related assets. This could lead to lowering funding costs and effect ‘quasi-sovereign assets’; this could also mean Indonesia becoming one of the highest-yielding investment grade markets in the world. As such, the Indonesian government is scheduled to issue Yen-dominated government bonds (Samurai bonds) in June 2017 worth $900 million USD in a first public issuance in 30 years. Previously, Indonesia issued Samurai bonds under a private placement scheme whereas this year it changed to a public placement scheme to attract a larger pool of investors. Such an inflow of funds could be redirected to not only accelerate infrastructure-related sectors but also important manufacturing industries.
Indonesia’s credit rating upgrade by S&P demonstrates the growing confidence investors have with Indonesia’s business climate as it strives to be a major economic player on the global stage. The government’s focus on macroeconomic and fiscal policies suggests that institutional reform efforts are improving. As such, the country’s investment in infrastructure development, the revision of fuel subsidies and the Negative Investment List can also serve to reduce Indonesia’s external vulnerability in the long-term. Furthermore, the Indonesian government’s fiscal discipline against the continuous revenue pressure from oil and gas prices (See Will Indonesia Become a Net Importer of Natural Gas by 2020?) has resulted in the budget deficit of just 2.5% of GDP, thereby providing a strong backbone to support the economy.
However, despite the recent strides made, Indonesia needs to remain committed to keeping the deficit under control and stay on course for reforms across all sectors to improve its investment climate. Indonesia continues to fare worse than its emerging market peers in aspects of institutional strength, rule of law, and corruption. Moreover, a shallow banking and capital market sector (See Indonesia’s Capital Market: Growing Beyond Expectations) and a low tax base have had a negative impact on the government’s capabilities to support economic growth. It is therefore imperative that Indonesia enacts further reforms to open new and diverse channels for sustainable government revenue such as incorporating the informal sector into the tax system. In the long-term, this will no doubt impact domestic and external investment in Indonesia in addition to the country’s competitiveness, which will provide a much needed boost to the Jokowi government as presidential elections loom in 2019.
Global Business Guide Indonesia - 9th June 2017
Bourse Name: Bursa Efek Indonesia (IDX)
Main Index: Jakarta Composite Index
Market Capitalisation: 5.6 trillion IDR July, 2016)
Annual Performance: 11.97% (2016)
Record High: 5,523.29 (April 2015)
Number of Issuers: 523 (2015)
Top Stocks by Market Capitalisation: HM Sampoerna, BCA, Telkom, Unilever, BRI, Astra International, Bank Mandiri, Gudang Garam, BNI.
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