Tuesday 14, March 2017 by Georgina Enzer

Moody's assigns (P)Baa3 rating to Indonesia's US dollar Sukuk offering

Moody's Investors Service has assigned provisional (P)Baa3 senior unsecured debt ratings to the proposed US dollar-denominated trust certificates to be issued by the Government of Indonesia's (Baa3 positive) through Perusahaan Penerbit SBSN Indonesia III ("PPSI III") under its existing trust certificate issuance programme, which was recently enlarged to $15 billion from $10 billion previously.

The payment obligations associated with these certificates are direct obligations of the Government of Indonesia.

In Moody's opinion, the payment obligations represented by the securities to be issued by PPSI III are ranked pari passu with other senior, unsecured debt issuances of the Government of Indonesia. As such, Moody's (P)Baa3 rating to the proposed Sukuk issuance is in line with the Government of Indonesia's Baa3 issuer rating given that any direct government obligation whose repayment is handled by the Government of Indonesia receives a rating equivalent to that of the government.

Moody's expects to remove the provisional status of the rating upon the closing of the proposed issuance and a review of its final terms.

Moody's also notes that its Sukuk rating does not express an opinion on the structure's compliance with Shari'ah law.

RATINGS RATIONALE

Indonesia's Baa3 government bond rating incorporates the country's low debt levels, narrow fiscal deficits, and healthy growth as compared to similarly rated emerging market peers. Indonesia also benefits from the large scale of the economy and a stable -- if shallow -- banking system that poses limited contingent risks to the sovereign.

The narrow revenue base is a key credit constraint that hampers the government's ability to support economic growth given its commitment to the statutory deficit ceiling of 3 per cent of GDP. Other credit challenges include weak rule of law and control of corruption according to the Worldwide Governance Indicators, as well as a shallow domestic capital market, which contributes to Indonesia's reliance on external funding.

The positive outlook on Indonesia's sovereign rating reflects emerging signs of a reduction in structural constraints, including its level of external vulnerability and the strength of its institutions.

The balance of payments has strengthened despite low commodity prices and bouts of volatility in capital flows over the past two years. The current account narrowed to 1.8 per cent of GDP in 2016 from over three per cent as recently as 2014 as the goods trade balance reverted to a surplus starting in 2015. Along with healthy foreign direct investment (FDI) inflows, these policies contributed to a build-up of gross international reserves to $116.4 billion as of end-2016 up from $105.9 billion a year ago which provide a large buffer against volatility in capital flows.

These developments are partly the result of a shift in monetary policy towards preserving macroeconomic stability, away from a focus on short-term growth and a revision in fuel subsidies. The Indonesian government has also pursued structural economic, fiscal and regulatory reforms, although these reforms have not yet provided a significant boost to private sector investment. Moreover, the government has demonstrated fiscal discipline against the backdrop of continued revenue pressure from lower oil and gas prices in recent years.

An upgrade would result from progress in reducing external vulnerabilities and improving institutional strength. This assessment would be supported by a reduction in the government's reliance on external debt, or tangible evidence that reforms foster investment, competitiveness or sustained increases in revenues.

A downgrade is unlikely given the positive outlook. We could revise the outlook to stable if the nascent institutional strengthening is on hold or reversing, there is a lack of improvement in revenue performance, the growth outlook weakens relative to peers, and fiscal, debt, or balance of payments metrics weaken significantly.

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