As the Indonesian government substitutes bilateral and multilateral borrowing with bond issuance to cover its budget deficit, the sovereign rating becomes more important. The obvious benefit is cheaper borrowing costs. But the sovereign rating has a wider impact than just for the government. Indonesia deserves an investment grade rating now, with stable economic performance, much improved macroeconomic management and especially fiscal prudence.
A special note is the economic resilience in the face of the global crisis in 2008. Despite some pullback recently, the still massive foreign presence in the equity and government bond market is a testament to this.
Sovereign rating measures the ability and willingness of the issuing country to repay its loans. As most countries issue in their own currency as well as some other foreign currencies so there are also ratings for domestic and foreign currencies. In terms of methodology, most rating agencies look at macroeconomic indicators, the fiscal situation and the balance of payments.
Macroeconomic factors that matter are mainly growth and inflation. Fiscal variables include the government’s debt including contingent liabilities assumed by the government, the revenue stream, primary balance and overall deficit including the ease of its financing. Relevant balance of payment factors include exports and current account performance, reserve accumulation and how much extra reserves are available after taking into account current debt and interest liabilities.
The first role of sovereign rating is determining the coupon that the issuing country must pay. The second is its role as a ceiling to all other issuers in each country and the third is delineating countries into investment grade and speculative grade with its attendant consequences.
The first role is similar to the situation in the corporate bond market. For the second role, it is important to note that the government in most cases is the strongest entity in the entire economy.
This is simply because it has the power to increase revenue, say by raising taxes, to fulfill its obligations. This is not necessarily the case, however, for foreign currency bonds.
The third role also comes from the corporate bond market practice. It is a common market practice that issuers and bonds are distinguished into what is called investment grade and speculative grade.
Standard and Poors currently rates Indonesia at BB with positive outlook. Fitch in early 2010 upgraded Indonesia’s sovereign rating to BB+ with stable outlook. The main rationales were our resilience during the 2008-2009 global financial turmoil, continued decline in government debt to GDP ratio, the rise in international reserves and prudent economic policies. The main criticisms were delays in phasing out energy subsidies and shallow capital market.
On Jan. 17 Moody’s raised Indonesia’s rating to Ba1 which is one step below investment grade. The main reasons were sustained growth potential, fiscal prudence, the large domestic market that is immune to global uncertainties and the declining government debt burden. Further upgrades hinge on stable inflation, sound bank supervision, sustained foreign direct investment inflows and development of the domestic financial market.
Looking at several variables that make up the sovereign rating we can find that Indonesia’s score in most cases looks as good as countries with a better rating. For example in the Standard and Poors list, countries that are close to our ratings at BB include Egypt (BB+), Colombia (BB+), Morocco (BBB-), India (BBB-) and Brazil (BBB-). Our estimated GDP growth for 2010, for example, is higher than all these countries except Brazil and India. Our savings and investment ratios to GDP are the highest among them, with one exception, namely Morocco.
In terms of debt Indonesia’s net debt (debt minus the government’s financial resources) as a percentage of GDP at 24.5 percent is the lowest compared to the five in our comparison set. Also our fiscal deficit is the lowest.
In the balance of payments analysis, Indonesia’s current account as a percentage of GDP at 25.7 percent is larger than that of Colombia’s and Brazil’s. In terms of reserves divided by monthly imports and outflow to pay for foreign services (labor, profit repatriation, etc.) at 4.7 months is the lowest compared to these five countries.
The question now is why are we not rated higher?
The main obstacle is weak institution mainly in the governance aspect. Corruption is still perceived to be widespread making foreign direct investment challenging and creating uncertainty in policy implementation and outcome.
Although it is not yet ideal, the platform for improvement in governance is actually in place. The main change in the political scenery since 1998 is the distribution of power. Based on this governance progress is happening albeit in a noisy environment and sometimes slow manner. To name a couple: Many corrupt officials have been put in jail by the anticorruption commission, there is a widely perceived independent Constitutional Court, there is balance of power between the executive and legislative branches.
Additionally the government budget, monetary policy and banking supervision are basically beyond political intervention, and most state-owned enterprises are also beyond the influence of political interests.
It is unfortunate that the hard work that goes into good economic policy making is tainted by the behavior of a few corrupt officials. This is our challenge.
The writer is an economics lecturer at the University of Indonesia.
