Prabowo Debt Plan Stirs Indonesia Credit Rating Worries

Indonesian presidential candidate Prabowo Subianto gestures to supporters after registering at the Election Commission for the July 9 election in Jakarta on May 20, 2014. Prabowo views the nation’s economy as ‘underleveraged’ and would raise its debt-to-gross domestic product ratio to 50 percent from 24 percent now, according to Hashim Djojohadikusumo, his brother and economic adviser. (Reuters Photo)

Presidential contender Prabowo Subianto’s pledge to spur economic growth by doubling the rate of borrowing risks raising Indonesia’s chance of default.

Prabowo sees Southeast Asia’s largest economy as “underleveraged” and would raise its debt-to-gross domestic product ratio toward 50 percent, compared with the current 24 percent, Hashim Djojohadikusumo, his brother and economic adviser, said in a June 6 seminar in Jakarta. The plan includes raising $300 billion from the capital markets over five years to achieve a 10 percent growth rate, Hashim said.

Indonesia has a 0.5 percent chance of defaulting within a year, more than ten times higher than Malaysia or the Philippines, even though its liability ratio is half that of its Southeast Asian peers, Bloomberg’s risk model shows. The last time Indonesia had debt exceeding 50 percent of GDP was 2005, when it was rated five levels lower by Moody’s Investors Service and the assessment of financial and political strength showed a 1.5 percent chance of non-payment.

“Increasing spending won’t immediately translate to growth, so that could cause a downgrade in credit rating before the situation turns around,” Handy Yunianto, Jakarta-based head of fixed-income research at Mandiri Sekuritas, a unit of the nation’s largest lender, said in a June 11 phone interview. “That could end up being costlier for us.”

Slowing growth

Prabowo’s plan comes after economic expansion slowed to 5.21 percent last quarter from a year earlier, the least since 2009. That’s the fourth period in a row of growth below 6 percent. The fastest expansion Indonesia has seen in data going back to 2000 is 7.2 percent in the final three months of 2004.

Bank Indonesia raised its benchmark interest rate by 1.75 percentage points to 7.5 percent from June to November last year. The most-aggressive tightening cycle since 2005 was aimed at putting the economy on a more viable footing, in response to a record current-account deficit, surging inflation and outflows from emerging markets.

The rate increases helped stem a plunge in the rupiah, which lost 21 percent in 2013. The currency has rebounded 3.2 percent to 11,788 per dollar this year. The yield on the country’s benchmark 10-year bond surged 3.26 percentage points to 8.45 percent in 2013 and has since fallen to 8.04 percent. That compares with 4.19 percent for similar-maturity Philippine notes and 4.06 percent for Malaysian paper.

Foreign inflows

Indonesia’s yield advantage has helped lure Rp 70.83 trillion ($6 billion) of foreign inflows into its local-currency securities this year, finance ministry data show.

“From a rating perspective, it isn’t just the level of growth that counts but also its sustainability,” Thomas Rookmaaker, an analyst at Fitch Ratings in Hong Kong, said in an interview on Thursday. “The Indonesian authorities’ choice for stability over growth since the summer of 2013 has helped the country overcome market pressures and led to a renewed surge in foreign portfolio investments in 2014.”

Prabowo attracted 41 percent support in a Deutsche Bank survey of 3,300 voters in 27 cities across Indonesia released June 9, which had a margin of error of 2 percent. Frontrunner Joko Widodo, known locally as Jokowi, garnered 50 percent. The presidential election will be held on July 9.

Joko expects economic growth of less than 6 percent in the next one to two years and plans to sell new bonds only to fund spending that has a “multiplier effect,” such as infrastructure, education and health, according to his mission statement posted on the election commission’s website.

Debt rules

As governor of Jakarta since 2012, he has restarted a monorail project, broken ground on a commuter rail system that had been delayed for decades and dismissed senior officials, citing poor performance. The Jakarta Composite index of shares surged 3.2 percent when his candidacy was announced on March 14.

“The market may not be happy with an aggressive debt management style,” said Hakan Aksoy, a fund manager at Pioneer Investments, which oversees 179 billion euros ($242 billion) globally, referring to Prabowo’s plan. “Jokowi is the market- friendly candidate” and the expectation is that he will introduce reforms, he said in a June 11 interview from London.

Indonesia’s government is required to keep the budget deficit from exceeding 3 percent of GDP and the debt-to-GDP ratio at 60 percent or less, according to a 2003 law. Prabowo pledged to cut the budget shortfall to 1 percent of GDP and erase foreign borrowings by 2019, according to a statement submitted to the election commission.

‘Limited capacity’

“There is relatively limited capacity for the government to borrow money,” Takahira Ogawa, director of sovereign ratings at Standard & Poor’s in Singapore, said in a phone interview on Thursday.
President Susilo Bambang Yudhoyono’s administration reduced the external debt-to-foreign reserves ratio to 7.1 percent at the end of 2013, from 21.6 percent when he took power in 2004, finance ministry data show. That helped the country regain its investment-grade status from Fitch in December 2011 and from Moody’s in January 2012. S&P still assigns the country its highest junk level.

Indonesia’s chance of defaulting is based on Bloomberg’s default-risk model, which takes into account a government’s ability to pay its debt, external finances, economic expansion and political risk. Thailand’s probability is 0.07 percent, that for the Philippines is 0.04 percent and Malaysia’s is 0.03 percent.

Macro-risk profile

The cost of insuring Indonesian debt against non-payment using five-year credit-default swaps has fallen 90 basis points this year to 144, according to CMA. That compares with declines of 30 basis points to 85 for the Philippines, 25 basis points to 85 in Malaysia, and 15 basis points to 114 for Thailand.

Indonesia “shouldn’t take on more leverage just because it can,” Gundy Cahyadi, an economist at DBS Group Holdings in Singapore, said in a June 10 interview. “Public debt as a whole isn’t such a big concern for Indonesia, especially since it has been coming down in the past decade or so. Continuing this trend is critical to continue improving Indonesia’s macro-risk profile.”

Bloomberg