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Indonesia
– The Long March Back to Investment Grade?
By
Scott B. MacDonald
Before the 1997-98 Asian financial crisis Indonesia
was rated Baa3/BBB. It was regarded as a stable investment
grade credit, based on the country’s relative political
stability, strong export base, and competent fiscal
management. The Asian financial crisis, however, left
Indonesia in a state of shock. Political stability was
shown to be fleeting as the longstanding Suharto regime
fell and successor governments wrestled with new democratic
procedures and institutions. Political Islam rediscovered
its voice. Long dormant regional loyalties resurfaced
to challenge Jakarta’s central power. And, the
economy took a sharp downward plunge that has taken
several years to recover. Indonesia’s sovereign
ratings reflected this descent, falling to B3/CCC+.
Although tough challenges remain, Indonesia is turning
the corner and the long climb back to investment grade
has begun. On May 21, Standard & Poor's recognized
this and upgraded Indonesia to B-, with a stable outlook.
In June, Moody’s put Indonesia’s B3 ratings
on review for an upgrade.
How has Indonesia’s progress been marked? Consider
the following:
-
Inflation
was down to 9% in 2002. Since year-end 2003, it has
fallen further to 7.54% in April. If the government
maintains a tight monetary policy, inflation could
fall below 9% in 2003.
-
The
budget deficit has been reduced from 6% of GDP in
1998 to 1.8% in 2003 and less than 1% is projected
for 2004.
-
The
burden of Indonesia’s public debt (which is half
domestic and half foreign) as a percentage of GDP
will fall below 70% of GDP by year-end 2003.
Despite
ongoing political and social unrest on a number of fronts,
the democratic experiment continues. Since the fall of
Suharto in 1997, the country has seen three different
civilian leaders, all assuming office by constitutional
means and supported by the public.
As
a result of these improving prospects Indonesia’s
ability to return to the international bond market for
financing have improved. Indeed, Indonesia's finance
ministry at the end of April announced it may issue
international bonds next year for the first time since
the 1997-98 Asian crisis as part of an effort to end
its reliance on the International Monetary Fund. "We
are studying possibilities to issue international bonds,"
Finance Minister Boediono was quoted as saying by Dow
Jones Newswire. The country wants to end its IMF program
at the end of this year. Without an IMF economic reform
program in place, the country's international creditors
are unlikely to agree to further debt restructuring.
Indonesia will need to refinance about US$3 billion
in debt coming due next year through a combination of
international and local bonds if it ends the IMF program.
Yet, Indonesia faces a number of challenges, which have
the potential to slow ratings upgrades. These include:
-
The
tourist sector is still in difficulty. Islamic radicalism
and terrorism as well as SARS, is putting a dent into
tourism. In 2002, tourism earned the country $4.3
billion from 5.03 million tourists, 20% down from
2001. Bali is still suffering from the bombing.
-
Oil
prices vulnerability: as long as oil prices do not
drop significantly the financing gap is manageable.
-
Institutional weakness: The process of democratization
is hardly over and the country’s political institutions
remain weak. Corruption remains a problem. The central
government’s authority is being challenged by
new regional governments, which have recently been
given greater autonomy as part of the decentralization
process. As S&P noted: “Indonesia’s
institutional weaknesses can often hinder policy coordination
and could undermine a timely response to political
and external shocks.”
-
Related
to the weakness of central authority is the ongoing
problem of separatist movements in Aceh and Irian
Jaya. In 2003, negotiations between the local independence
movement, the GAM, and the government broke down.
Clearly Acehese aspirations for an independent country
carved out of northern Sumatra have little appeal
in Jakarta, which has already felt the loss of East
Timor and is threatened by separatist groups in Irian
Jaya. Although the war is popular in Indonesia and
is helping Megawati in opinion polls, the conflict
does have a cost – both on the fiscal side and
in terms of Indonesia’s image as a place to invest.
-
2004
is a pivotal year – elections and debt coming
due.
-
Maintaining
positive relations with the IMF and other donors.
There is growing political pressure on the government
to end the IMF program by year-end 2003. President
Megawati would stand a greater chance of reelection
if she can demonstrate that her administration has
made progress on the economic front and regained independence
vis-à-vis outside influences.
Indonesia
has some tough challenges ahead. Moving back to an investment
grade rating will be a multi-year process, with ongoing
concerns over policy slippage, terrorist threats and potentially
volatile international market conditions. In the short-term,
the focus on the war in Aceh could obscure ongoing efforts
to reform the economy – even past August 2003 when
parliament ends and electoral politics come into play.
Along these lines, it is encouraging that the government
went ahead in June 2003 with the privatization of PT Bank
Mandiri, which was heavily oversubscribed. Following that
success, the Indonesian Bank Restructuring Agency (IBRA)
signaled that it was moving ahead with the sale of about
20 percent of PT Bank Danamon and PT Bank Niaga. Indonesia
remains a pivotal country on many fronts. Sustained economic
reform and growth could be a major positive for its large
population as well as the rest of Asia. Reflecting this,
the long path back to investment grade will be closely
watched by investors.
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