Today, global credit rating agency Standard & Poor’s announced that it affirmed Indonesia’s BB+ credit rating but changed the outlook from stable to positive citing that enhanced policy effectiveness and predictability resulted in expanded fiscal and reserve buffers and improved the country’s external resilience. S&P further stated that there is a possibility that Indonesia may be raised to investment grade within a period of 12 months provided that the government achieves its objective of improving the quality of expenditure. Key for this positive assessment is that Indonesian President Joko Widodo finally scrapped a large chunk of costly fuel subsidies at the start of the year, hence opening room for more productive government spending (for example for infrastructure or social development). However, in the first quarter of 2015 we have not seen much of this productive government spending as the country continuous to be plagued by bureaucracy and weak coordination among ministries and government agencies. Moreover, the House of Representatives (DPR) needed until February 2015 to approve the revised 2015 State Budget, hence delaying government spending. As such, slowing economic growth continued in Q1-2015.

S&P’s upgrade to positive offset the negative impact of weak manufacturing data from China, one of Indonesia’s largest trading partners. A preliminary HSBC Purchasing Managers’ Index indicated a score of 49.1 for May, below analysts’ estimates (a score below 50 indicates contraction).

Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) appreciated 0.14 percent to IDR 13,150 per US dollar on Thursday (21/05).

Indonesian Rupiah versus US Dollar (JISDOR):

| Source: Bank Indonesia

Bank Indonesia decided not to alter its key interest rate (BI rate) at its May policy meeting - as inflationary pressures are mounting and the rupiah remains vulnerable amid bullish US dollar momentum ahead of further monetary tightening in the USA - but instead relaxed its macro-prudential policy to make it easier to loan by revising the LDR-RR regulation, LTV policy for mortgage loans and down payments for automotive loans in a move to enhance liquidity and boosting credit expansion in the banking sector. Although this move could potentially create a credit bubble, few analysts see this happening as loan demand in Indonesia may not be as robust currently. Indonesians have become more cautious amid the country’s slowing economic growth (moreover interest rates remain relatively high). When we take a look at car sales, motorcycle sales and cement sales in the first quarter of 2015 (all these sales are important data to measure people’s purchasing power, consumer confidence and property development) we see sharply declining growth numbers: not because people cannot afford it, but more likely because they are more cautious now seeing mostly negative news headlines. Indonesian President Widodo has seen his popularity decline in recent months as he has been unable (yet) to achieve his ambitious targets (which include accelerated economic growth and the start of many government-led infrastructure projects).

At only 20 percent of GDP, household debt is still low in Indonesia (in Malaysia, for example, this figure stands at about 80 percent). Although on the one hand this low figure implies that there is ample room for growth for lending in Indonesia (and can lead to a bubble when rapid credit expansion is followed by a contraction), it is highly unlikely that this figure will rise rapidly as most Indonesians do not have bank accounts. In 2014 around 36 percent of the Indonesian population (aged over 15 years) had a bank account and only 13 percent borrowed money from a financial institution. These data indicate that Indonesians are not too eager to take up bank loans. Moreover, Indonesian businesses also tend to hold back on spending and investment amid the economic slowdown and further weakening rupiah.

Although Indonesia’s current account deficit (CAD) improved to USD $3.8 billion, or 1.8 percent of GDP, in the first quarter of 2015 this deficit remains a problem. The CAD is expected to widen in the second and third quarters of 2015 as more imports are needed for the Ramadan and Idul Fitri celebrations. These (seasonal) festivities always trigger increased consumer spending (and inflation and imports grow accordingly). Moreover, the government is expected to push for the start of various infrastructure projects starting in Q2-2015 (which was previously blocked by the late approval of the revised state budget by the House of Representatives). These infrastructure projects need a considerable amount of imported materials and therefore put more pressure on the CAD. The central bank expects to see a CAD in the range of 2.5-3.0 percent of GDP in 2015.

By keeping its interest rate environment relatively high, the CAD can be curbed. This is important as those countries that are plagued by CADs are more vulnerable to capital outflows in times of economic turmoil or shocks. Higher US interest rates (expected in September 2015 considering the latest Federal Reserve minutes and US macroeconomic data) is such a looming shock that can cause severe capital outflows from emerging economies, particularly those that have CADs.