Economic Stabilization, Reform Key for Indonesia's Sovereign Credit and Rating Over Next 12 Months

Unofficial "quick counts" point to a narrow win for Jakarta Governor Joko Widodo (Jokowi) in Indonesia's presidential election - the official result will be announced on 22 July.

Either candidate's ability to implement and execute policy at the national level has yet to be tested.

The track record of current front-runner Jokowi as Governor of Jakarta offers little guide to his policy priorities at a national level.

In addition, he would have to work with a parliament in which supporters of his election opponent are currently in the majority - although coalitions may prove fluid if Jokowi's victory is established.

The campaign team of his opponent, Prabowo Subianto, raised the issue of higher sovereign borrowing to fund investment.

Impact on credit or ratings

Fitch would wait to see if such a policy was adopted and if so, how it was implemented, before determining any impact on credit or ratings.

The key issue for the sovereign credit and rating over the next six to 12 months is whether the authorities continue to prioritize economic stabilization and sustainability, says Fitch Ratings.

The longer-term focus is likely to shift to the question of the extent to which a new government will pass structural reforms, and whether this will return the country to higher sustainable growth.

Efforts by the government and Bank Indonesia to tighten monetary policy and allow for a more flexible exchange rate are having a positive effect on the external position.

The trade deficit (on a 12-month rolling basis) has declined to US$2.4bn as of May 2014, down from a peak of US$9.1bn in September 2013. Furthermore, foreign reserves are up by 8.3% year-to-date (to US$108bn).

Tightening monetary conditions have also reined in inflation and slowed credit growth, which have fallen to 6.7% yoy and 17.4%, respectively, according to the latest data.

There was little in either candidate's election platform to suggest they might re-direct current economic policy in the short term. Nonetheless, ongoing challenges to stability highlight the importance for the credit profile of economic policy management.

With Fed policy tightening on the horizon, Fitch believes Indonesia's prospects of avoiding a disruptive impact from any turbulence would be bolstered by a clear prioritization of economic stabilisation in the short term.

Indonesia is vulnerable to external pressures owing to the current account flipping into deficit in 2012 (to which loose monetary policy had contributed); relatively high commodity dependence amid weakening prices for Indonesia's key exports; and shallow domestic financial markets.

The effect of the weaker rupiah on the cost of imported fuel has prompted government to revise up its budget deficit projection to 2.4% of GDP from 1.7%. Fitch believes that the assumptions factored in on subsidy spending may not be achievable without a further revision of retail fuel prices.

The risks from increased financial market volatility related to potential Fed tightening remain, in addition to the fiscal impact of rising energy costs.

Beyond the immediate period, lifting Indonesia's trend growth rate will be important for the credit profile. Returning to the growth model of the 2000s is likely to be impossible in an environment of softer prices for the country's key commodity exports.

Fitch believes structural reforms to boost productivity, including improving the business environment by cutting bureaucratic impediments to starting businesses and clearing infrastructure bottlenecks, would support prospects for getting growth back to the pre- 2008 rates above 6% in a sustainable manner.

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