While Indonesia's sovereign debt rating was promoted to investment grade by Fitch Ratings in 2011, followed by Moody's Investors Service in 2012, S&P - known for being the most conservative one among the top credit rating agencies - has failed to follow suit so far. This is unfortunate for Indonesia, Southeast Asia's largest economy, as it blocks additional capital inflows into the nation. It is assumed that investment into Indonesia - through portfolio investments (stocks and bonds) as well as direct investment - would rise if S&P had given the investment grade status. Such an upgrade would also positively affect Indonesia's borrowing costs. In fact, Indonesia needs such additional inflows in order to overcome the budget deficit and current account deficit.

Indonesian government officials were surprised to learn S&P's decision to keep Indonesia's sovereign debt rating in the junk level category. For example, Finance Minister Bambang Brodjonegoro said it is remarkable that several other emerging markets fall within S&P's investment grade category while these countries have lower gross domestic product (GDP) ratios and run bigger deficits compared to Indonesia. On the other hand, Brodjonegoro acknowledged that there is also a positive side to the story. Whereas several emerging countries were downgraded by S&P over the past year amid severe global economic uncertainties, Indonesia's rating remained stable.

S&P mentioned several reasons that led to its decision to leave Indonesia's credit rating and outlook unchanged. Firstly, it detects structural problems in Indonesia's fiscal performance. The credit rating agency stated that Indonesia needs to enhance its fiscal performance (and credibility) in order to have a chance of becoming a member of its investment grade club. A good example of Indonesia's weak fiscal credibility is the rising discrepancy between the government's tax revenue targets and tax revenue realization in recent years (this discrepancy is the key reason why there occurs a major budget deficit as tax is the main source for state income).

The table below shows that in the period 2011 - 2015 the difference between tax revenue targets and tax revenue realization surged drastically in Indonesia. This situation is caused by overly ambitious (in other words unrealistic) tax collection targets in combination with sluggish reforms at the nation's tax office. The number of Indonesian tax officials is too little to monitor all tax matters, the organizational structure is weak, while there remains a high degree of corruption at this institution. This situation allows for weak tax compliance in Indonesia as well as the nation's low tax-to-GDP ratio (around 12 percent).

Indonesia's Tax Collection Target and Realization 2008-2016

   2008  2009  2010  2011  2012  2013  2014  2015  2016
(in IDR trillion)
 534.5  597.5  661.4  878.7  885.0  995.2 1,072.4 1,294.3 1,360.1
(in IDR trillion)
 607.4  563.2  650.0  872.6  835.3  916.3  985.1 1,055.6 1,160.0¹
(in IDR trillion)
  72.9   34.3   11.4    6.1   49.7   78.9   87.2  238.6  200.1¹

green color indicates that tax revenue realization met the target set in the State Budget; red color indicates that tax revenue realization failed to meet the target
indicates forecast
Sources: Direktorat Jenderal Pajak & Nota Keuangan

The tax shortfall in 2016 is estimated at IDR 200 trillion (approx. USD $14.8 billion), a figure that could rise if the Tax Amnesty Bill is not implemented this year, or, if the fruits of the bill - when implemented - turn out to be disappointing. Lower-than-estimated tax revenue is key reason why the government expects to see a wider-than-initially-estimated budget deficit at 2.48 percent of GDP - or IDR 313 trillion (approx. USD $23 billion) - in 2016. The government mainly uses (additional) rupiah-denominated bonds to plug this deficit. However, in order to attract enough investor appetite, coupons have to be relatively high.

Secondly, S&P also mentioned that the decline in Indonesia's corporate credit quality was a reason for the agency not to promote Indonesia to investment grade status (yet). Since late-2014 Indonesia's corporate credit quality fell amid falling commodity prices, hence triggering companies' slowing revenue growth and falling cash flows, while debt servicing requirements remained high.

At IDR 3,279 trillion - equivalent to 27 percent of GDP (in April 2016) - Indonesia's total public debt is low. However, with the revenue account showing a negative balance it implies that the Indonesian government needs to borrow (thus raising loans and interest obligations), hence further widening the revenue deficit. With bond yields higher than the economy's nominal growth rate, there emerges the so-called 'debt trap' threat.

The Indonesian government therefore has plenty of homework to do. Boosting tax collection by introducing structural reforms in this sector would be the medicine for various "illnesses" that affect the country presently. This will not be an easy task, however.

Credit Rating Indonesia:

     Standard & Poor's        Fitch Ratings            Moody's
Rating Outlook Rating Outlook Rating Outlook
Indonesia BB+ Positive BBB- Stable Baa3 Stable

Source: Standard & Poor's