Fitch Rating and Our Opportunity Iwan Ungsi, Singapore

06 January, 2012 | Source: The Jakarta Post

After 14 years of improvement, the investment grade for Indonesia has finally been reinstated. Fitch, an international credit rating agency based in New York and London, rates Indonesia’s long-term foreign and local currency issue default rating at triple-B-minus, with a stable outlook. This assignment regains the nation’s position prior to the Asian financial crisis in 1997.

How does the rating exactly affect us and our journey as a developing country? Can we be easily satisfied and be proud about this rating? Exploring the answers to these questions in further detail may provide us with a clear insight to the outcome of this rating for our country.

A previous study by Ferri, Liu, and Stiglitz (1999) points out that the credit rating agency plays a significant role in the financial market. Changes in ratings from these rating agencies in the downgrading or upgrading of sovereign debt below or above investment grade may bring dramatic impacts to a country’s investment activities, as these ratings to directly affect the pool of investors.

According to Fitch’s current sovereign rating history list, Indonesia’s sovereign rating ranked at the same level as India’s, one notch above Portugal’s and even more surprisingly, higher than some European countries that recently struggled in the debt crisis.

Conversely, rating changes revisited due to the recent global financial crisis in some countries may spark a strong adverse reaction from the countries in question. One such example is the recent downgrading of the US’ investment grade based on the future outlook of the US’ sovereign credit rating. US President Barack Obama felt it necessary to clarify the change in ranking by quoting famously: “the United States of America will always be a triple ‘A’ country”.

Indonesia gained its recent investment upgrade ranking due its success in managing its debt-to-GDP ratio from 100 percent, as an outcome of the 1997 Asian financial crisis, to an impressive reduction 26 percent.

On Fitch’s website a full explanation is given to how sovereign ratings are derived, and most importantly, how the established basis, criteria and methodologies are continuously evaluated and updated. These ratings are widely used in financial sector practices, commonly known as investment grade ratings ranging from AAA to BBB and from BB to D.

Bankers, investors and other financial players frequently take into account sovereign (corporate) debt ratings when considering cross border investment decisions. The increase in the sovereign rating tends to reduce the country’s risk exposure, signifying a decrease in borrowing costs as well, not only for the government but also for those elements of the private sector interested in investing. This explains how the upgrade in rating is usually followed by an increase in the amount of capital inflows for both portfolio and foreign direct investment and vice versa.

A quantitative work conducted by Graciela Kaminsky and Sergio Smuckler (2002) shows impacts of changes in sovereign ratings on a country’s risk and stock market. It is also noted in this study that a sovereign rating upgrade will reduce a country’s risk of investment and financial market rallies.

Conversely, a downgrade will increase a country’s risk and create a downturn in the stock market.

In the last decade or so, Indonesia endured the consequences of a downgraded ranking. Losing its investment upgrade in December 1997, its rating dropped and hit a low B minus in April 1998, before bouncing back gradually in 2003. The country had limited opportunities to fully showcase its true investment potential to the international community because of its high investment risk.

Now that Indonesia has passed the investment grade threshold, its chances to enhance the economy are wide open. Trade minister and chairman of the Indonesian Investment Board Gita Wirjawan says the rating upgrade will boost the country’s FDI figures by at least 1 percent of GDP, equivalent to US$9 billion, from the previous level. (The Jakarta Post, Dec. 17, 2011)

Better international perceptions may offer excellent momentum and should be optimized to support further growth of the country’s economy. However, the real challenge is how to maintain the international perception and transform it into a game changer, utilizing it to tackle the foremost constraint of developing countries: a lack of capital needed to support growth. Simultaneously, with our new regulation on tax holidays and the recently passed bill on land acquisition, the investment grade will lure more capital for infrastructure development.

In parallel, at the micro level, the investment grade will also provide better options for banking and financial institutions to access various sources of capital. Banks will be able to cut their cost of funds and lower their interest rates, and as a result, support further lending in business and investment activities.

But one must constantly remember and should not remain complacent in achieving Indonesia’s ultimate goal. We need to remain resilient in resolving our country’s fundamental problems.

Awarding the recent investment grade to Indonesia, Fitch restated the urgency to resolve the country’s long-standing structural weaknesses, namely overburdened infrastructure and corruption. As Charles Kenny (2006) and many other scholars stated, both are intrinsically connected. These scholars were able to correlate the impacts of Indonesia’s corruption to be inversely linked to the poor quality of Indonesia’s infrastructure.

Full and bold commitments are needed from all stakeholders in order to resolve our country’s problems, not only to conform to further upgrading from the credit rating agency, but most importantly, to accomplish social welfare and present better living to all Indonesians.

We are doing better, but we are still far from what we should be able to achieve.

 

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