OREANDA-NEWS. November 10, 2015. Fitch Ratings has affirmed Indonesia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BBB-'. The issue ratings on Indonesia's senior unsecured foreign- and local-currency bonds as well as Islamic certificates (sukuk) are also affirmed at 'BBB-'. The Short-Term Foreign-Currency IDR is affirmed at 'F3' and the Country Ceiling at 'BBB'. The Outlooks on the Long-Term IDRs are Stable.

KEY RATING DRIVERS
Fitch's affirmation of Indonesia's sovereign ratings and Outlook balances a moderate general government debt burden and limited sovereign exposure to banking system risks, with weak external balances that contributed to a few recent episodes of relatively strong pressure in Indonesian asset markets.

The slowdown in real GDP growth to 4.7% in each of the past three quarters does not materially weigh on the sovereign credit profile in itself, as this is still well above the 'BBB' category median of 3.1%. However, there does not seem to be much room for macro policies to counter the slowdown, given a budget deficit close to the 3% formal ceiling and monetary policy aimed at potential external market pressures and restraining inflation. The business cycle is likely to slowly bottom out as government capital expenditures are picking up.

The recent wave of reform initiatives by the government is likely to improve business sentiment. The series of announced packages include a number of measures with the potential in the longer run to significantly change the business environment, which can currently be characterised as difficult. For instance, measures related to reduction of red tape and the labour market have the potential to contribute to higher real GDP growth, but the impact will depend on the details of the reforms and the implementation. The reform agenda may signal a structural change from a more nationalistic approach to economic policy of the recent past. Fitch expects annual real GDP growth to pick up to 5.3% in 2016 and 5.5% in 2017 from 4.8% in 2015.

Weak external balances resulting from a relatively strong dependence on commodity exports, low FDI inflows, increased external debt and large foreign ownership of government bonds make Indonesia more vulnerable to weakening investor sentiment toward emerging markets than a number of its peers. However, the external balances look more favourable now than in mid-2013, when the taper tantrum struck, and significantly better than in the run-up to the Asian financial crisis of 1997-98. Foreign exchange reserves are still comfortable at 5.6 months of current external payments, but have fallen by USD14bn to USD101.7bn in the seven months up to September 2015, in part due to the authorities' interventions to reduce volatility in the exchange rate. The outlook for sovereign creditworthiness hinges on the authorities' ability to maintain macroeconomic stability.

Headline inflation is high in Indonesia compared with peers, averaging 6.3% over the past three years. Over the first ten months of 2015, average inflation was 6.8%, well above the formal inflation target range of 4% plus or minus 1pp. However, Fitch expects inflation to come down substantially at the end of the year, given limited inflationary pressures because of a reduction in economic activity and a base effect related to the energy subsidy reform conducted in late 2014.

A moderate general government debt burden of 26.2% of GDP in 2015, compared with the 'BBB' category median of 42.8%, supports the credit profile and helps Indonesia in times of external market pressure. However, the government's revenue intake is exceptionally low at 13.6% of GDP and on a declining trend, implying limited spending power. Only three out of the 110 rated countries exhibit lower government revenues. The impact of greater budgetary devolution is still unclear so far, as local or provincial officials may well know best what is needed in their regions in terms of capital spending, but spending may also be constrained by capacity issues.

The health of the banking system is relatively strong, although the slowing business cycle has put pressure on many corporate and bank balance sheets, causing deferral of private-sector capital expenditures and an increase in non-performing loans to 2.8% of total assets in August 2015 from a low of 1.8% at end-2013. However, the banking sector's capital adequacy is strong and banks' exposure to rupiah depreciation is limited as many banks reportedly have net assets in foreign currency, lowering the chances that the government would have to extend support.

The Indonesian economy is less developed on a number of metrics than many of its peers. Average per capita GDP remains low at USD3,402 in 2015 compared with the 'BBB' range median of USD9,202, while Indonesia's ranking on the United Nations Human Development Index indicates relatively low basic human development. Governance also continues to be weak, as illustrated by a low, although gradually improving score for the World Bank governance indicator (44th percentile versus the 'BBB' median of 52nd percentile).

RATING SENSITIVITIES
The main factors that, individually or collectively, could trigger negative rating action are:
- A sharp and sustained external shock to foreign and/or domestic investors' confidence with the potential to cause external financing difficulties, for example as a result of an undue change in the authorities' monetary policy strategy focussing on stability.
- A rise in the public debt burden, for example caused by breaching the budget deficit ceiling.

The main factors that, individually or collectively, could trigger positive rating action are:
- A strengthening of the external balances, making Indonesia less vulnerable to sudden changes in foreign-investor sentiment, for instance through lower commodity export dependence or structurally higher FDI inflows.
- Evidence that structural reforms or improvements in infrastructure translate into higher sustainable GDP growth in the longer run.

KEY ASSUMPTIONS
- The global economy performs broadly in line with Fitch's Global Economic Outlook, including a gradual slowdown of growth in China to 5.5% by 2017 and average Brent oil price assumptions of USD55 per barrel in 2015 and USD60 in 2016.