Indonesia Upgrade Soon, But IDR Remains Hostage To Risk Appetite

by Win Thin

Moody’s put Indonesia’s rating on review for possible upgrade.  This is a stronger statement than the June move to positive outlook on the Ba2 rating (equivalent to BB), and we think an upgrade will be seen soon.  Indeed, the agencies are really behind the curve as our own sovereign ratings model has Indonesia at BBB+/Baa1/BBB+ compared to actual ratings of BB/Ba2/BB+.  Fitch’s BB+ is the closest to our view amongst the three major US agencies, but all should be moved upward.  Earlier this year, Japan Credit Rating Agency raised Indonesia’s foreign currency debt rating to investment grade BBB-.  While JCRA moves usually don’t garner much attention, we think it is important given rising Japan investor interest in Indonesia. 

We note that high yields and a policy rate of 6.5% coupled with strong economic fundamentals have made Indonesia one of the top investment destinations this past year, especially with the rest of Asia offering such low yields.  That is slowly shifting as more and more Asian central banks hike rates, but Indonesia is starting off with a high yield advantage.  While Indonesian officials have been quite dovish, market is looking for the first hike in Q1 of 25 bp.  Recent inflation data supports the need for tightening, as November inflation came in at 6.3% y/y vs. 5.7% y/y in October.  This is right near the cycle high of 6.4% y/y in August, and core CPI edged higher to 4.3% y/y from 4.2% y/y in October.  The economy avoided recession and has been growing close to 6% so far in 2010 and so the output gap remains quite low.

IDR softened with the rest of EM in recent weeks, but we believe fundamentals remain strong and so the rupiah should do well when risk appetite returns.  USD/IDR was unable to break the 200-day moving average this week around 9045, but the near-term outlook depends greatly on what the ECB delivers tomorrow.  EM currencies are firmer today along with peripheral bonds, but optimism is hanging on the belief that the ECB will deliver some measures to address the euro zone crisis.  We are of the belief that any potential ECB actions tomorrow can only address the liquidity issues.  It cannot do anything about the solvency issue, which is at the root of the euro zone crisis and will have to be addressed by the politicians.  While we are positive on EM longer-term, we think further near-term IDR losses are likely on ECB disappointment.