Indonesia's credit quality uptrends are moderating: S&P
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The credit quality of bond issuers in Indonesia has improved steadily across sectors in the past three years, but further uptrend may be losing momentum due to delay of structural reforms, said Standard & Poor's Ratings Services.
In a report titled "Credit Quality Improvements Across Indonesia Into 2014 Are Slowing Down”, the rating company highlights persisting regulatory risks in the days ahead of the 2014 presidential election.
"We believe the election will offer the different political parties incentives to float new economic policies or regulations," said Standard & Poor's credit analyst Xavier Jean Jean said. "The general political consensus is that Indonesia should increase the added value in its products."
"We could see new policies to restrict exports on a broader range of unprocessed products besides minerals, reduce import quotas or increase tariffs of semi-finished goods to encourage their production domestically. These could disrupt supply chains, increase costs, and weaken competitive advantages in targeted sectors," he added.
The report noted that the delay of structural reforms, especially rationalisation of the country's energy subsidy regime, is a constraint in sovereign credit quality. At the same time, debt metrics are likely to continue improving as fiscal deficits stay low, nominal GDP growth high, and external liquidity strong.
"A sovereign upgrade is then a question of weighing these two trends against each other," said Standard & Poor's sovereign credit analyst, Agost Benard, the primary analyst for Indonesia.
High nominal GDP growth should also support asset quality in the Indonesian banking sector. However, Standard & Poor's believes the improvement in loan quality will likely moderate in the next 12-18 months as reported non-performing loans are already close to historical lows. In addition, Indonesia's low per capita income and weaknesses in the country's payment culture and legal infrastructure remain key structural risks for the sector.
The credit outlook into 2014 differs across the corporate sector. The credit outlook for domestic services and manufacturing sectors is generally stable to positive, but competition is intensifying as the result of Indonesia's favorable domestic growth prospects.
"Companies will need to spend increasingly more to keep their market share, and operating margins will be more difficult to maintain,” said Jean. "This could reduce free operating cash flows and limit further improvements in credit quality across domestic-focused sectors."
Standard & Poor's does not consider the slide in the Indonesian rupiah over the past 12 months as a major risk to the credit quality of the corporate sector into 2014. The larger Indonesian companies have repaired their balance sheets since 2008 and possess more equity cushion. Nevertheless, foreign exchange risks are building up in the real estate, media, and telecommunications sectors, following a surge in dollar-denominated bond issuances over the past 12 months.
"The confidence-sensitive nature of the Indonesian rupiah is also a constraining rating factor for the sovereign, given the still-high external leverage of the country as a whole," Benard said.
