Reform Implementation to Determine India & Indonesia's Sovereign Credit Trajectories

Moody's Investors Service says that how recently elected leaders in India and Indonesia implement their pledges to improve infrastructure and governance will determine the respective credit trajectory of each sovereign, both rated Baa3.

According to Moody's, India and Indonesia's growth will continue to outperform similarly rated peers, and macroeconomic policy vigilance is likely to contain inflation and balance of payments pressures in the near term.

If policies also address Indonesia's exposure to external volatility and India's weak fiscal and banking metrics, their respective credit profiles would improve.

These conclusions are contained in the rating agency's report titled India and Indonesia - Peer Comparison: Reform Implementation to Determine Credit Trajectories.

The report notes that India and Indonesia's Baa3 sovereign ratings reflect shared credit strengths of robust economic size and growth, and similar credit challenges of weak governance and infrastructure. But the two sovereign's credit profiles also have important differences. India's fiscal metrics are weaker than Indonesia's, and contribute to inflation and high domestic capital costs.

Indonesia: More vulnerable to global trends

Indonesia is more vulnerable to global trends. The Southeast Asian nation's vulnerability stems from the larger proportion of commodities in its exports, its higher share of non-resident financing of government debt, and its shallower domestic capital market.

The report compares India and Indonesia's credit profiles based on Economic Strength, Institutional Strength, Fiscal Strength and Susceptibility to Event Risk, which are the four main analytic factors in Moody's Sovereign Bond Rating Methodology.

Relative to their Baa3 rated peers, both have robust economies, although India's is much larger than Indonesia's, and has grown faster on average over the last decade. Favorable savings levels, investment rates, and demographics are likely to keep both countries' growth stronger than most Moody's rated peers.

Although Indonesia scores lower on institutional strength, both India and Indonesia face common challenges such as regulatory complexity and weak social and physical infrastructure compared to peers.

Moody's says the evolution of each sovereign's credit profile will hinge on whether its leaders are able to implement policies that facilitate infrastructure development and strengthen the private sector's operating environment.

India's fiscal position is weaker than most similarly rated sovereigns, while Indonesia's is stronger than most peers. Indonesia's track record of fiscal prudence and low government deficit and debt ratios are a credit strength whereas India's high government debt and deficits constrain its creditworthiness.

Moderate susceptibility to event risk

Each sovereign has a moderate susceptibility to event risk, the sources of risk differ. The Indonesian government is more exposed to external volatility because about 45% of its debt is in foreign currency, compared to about 6% for India. Lower global commodity prices have subdued Indonesia's near term growth outlook, whereas they support India's growth and balance of payments.

On the other hand, India's banking system is weaker than Indonesia's, and will pose sovereign risks over the medium-term if bank asset quality and capitalization levels do not improve.

Moody's positive outlook on India's rating incorporates the reduction in inflation and the balance of payments pressures over the last year, recent measures to address constraints on investment, including the passage of related bills in parliament, and its expectation that India's strong growth will improve its fiscal ratios over the rating horizon.

Moody's stable outlook on Indonesia's rating reflects its view that although lower global commodity prices and possible international financial volatility pose near term challenges, policy vigilance will limit their negative sovereign credit impact and that policy efforts to revive investment will keep growth at relatively robust levels.

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