Research Update:

Rating On Indonesia Affirmed At 'BB+/B' And 'axBBB+/axA-2'; Outlook Remains Stable

Primary Credit Analyst: Takahira Ogawa, Singapore (65) 6239-6342; takahira.ogawa@standardandpoors.com Secondary Contact: Agost Benard, Singapore (65) 6239-6347; agost.benard@standardandpoors.com

Table Of Contents
Overview Rating Action Rationale Outlook Key Statistics Related Criteria Ratings List

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Research Update:

Rating On Indonesia Affirmed At 'BB+/B' And 'axBBB+/axA-2'; Outlook Remains Stable

Overview
The rating on Indonesia balances institutional, economic, and external constraints with a moderately strong fiscal and economic growth profile. We are affirming our 'BB+' long-term and 'B' short-term sovereign credit ratings on Indonesia. We are also affirming our 'axBBB+' long-term and 'axA-2' short-term ASEAN regional scale rating on Indonesia. The stable outlook reflects our view that the moderately weak institution, low GDP per capita, and external vulnerability are generally balanced against favorable fiscal and debt metrics and the country's moderately strong growth prospects.

Rating Action
On April 28, 2014, Standard & Poor's Ratings Services affirmed its 'BB+' long-term and 'B' short-term sovereign credit ratings on the Republic of Indonesia. The outlook remains stable. At the same time, Standard & Poor's affirmed its 'axBBB+' long-term and 'axA-2' short-term ASEAN regional scale ratings on Indonesia. Our transfer and convertibility risk assessment on Indonesia is unchanged at 'BBB-'.

Rationale
The sovereign credit rating on Indonesia reflects the economy's low per capita income, its developing structural and institutional foundations, a relatively weak policy environment, and rising external leverage. These rating constraints are weighed against the country's well-entrenched cautious fiscal management, modest general government debt and interest burden, and moderately strong economic growth rate. Indonesia's low per capita GDP at a projected US$3,315 for 2014 is one of the negative factors for the sovereign ratings. We believe Indonesia has limited ability at this income level to ensure policy flexibility to deal with changing economic conditions. The income level also provides the government with less room to maneuver when maintaining creditworthiness would require unpopular polices. The country's annual average 4.4% real GDP per capita growth in the past decade is respectable. However, the growth started from a low base. The depreciation of the Indonesian rupiah against the U.S. dollar also hurts dollar-denominated per capita GDP. We expect it would take four to five years to improve the economic score of the country, if the trend growth rate continues and without a significant depreciation in the rupiah.

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Research Update: Rating On Indonesia Affirmed At 'BB+/B' And 'axBBB+/axA-2'; Outlook Remains Stable

In our view, Indonesia's broad economic and fiscal policy stance will continue. We don't expect the outcome of the presidential election in July 2014 to have a significant impact on the government's prudent fiscal policy. However, the level of success of the next administration in improving the governance as well as legal and regulatory issues is important for the sovereign ratings on Indonesia. Numerous recent industry and trade policy measures aimed at promoting downstream processing and boosting local participation have raised regulatory uncertainty or created market distortions. Reform initiatives have stalled in some key areas, such as labor markets and the judiciary. These factors are constraining Indonesia's critical infrastructure investment and growth potential. Indonesia's external vulnerability persists. The country has weathered downward pressure on its currency through market-based approaches. The general government's net external debt, as a percentage of current account receipts (CAR), stands at only about 7% in 2013. However, net external private sector debts were 44% of CAR in December 2013. Indonesia's external leverage is rising from a moderate level, and it is much larger than most similarly rated peers', with its narrow net external debt at a projected 73% of CAR in 2014. The country's rising external debts are a result of a growing economy with relatively small and shallow domestic financial and capital markets. Outstanding domestic debt securities were just 14% of GDP, with corporate debts under 3% of GDP as of the end of 2013. Indonesia still faces the risk of market deterioration, especially with larger external indebtedness and a current account deficit trend of about 2% of GDP in the medium term. The direction of flow of funds could change to net outflow from net inflow. The government's small fiscal deficits and low debt levels are supporting factors for the sovereign ratings. Indonesia has a longstanding law that limits the central government fiscal deficit to 3% of GDP. Overall budget deficits have averaged just 1.1% of GDP annually for the past 10 years. However, this was partly because of the recurrent underspending of its planned capital spending. In our view, a reduction in the subsidy burden--still the largest expenditure in the budget at 27% of total expenditure--and the progressive deepening of domestic capital markets could redirect public funds to education or infrastructure projects, both of which could improve growth prospects. The government plans to further raise domestic fuel prices, following the increase in June 2013. However, we think the chance of a further increase is slim before the next administration takes office. Standard & Poor's forecasts net general government debt to decline to 23% of GDP in 2015 (from a peak of 110% of GDP in 1999), which is low compared with similarly rated peers'. Consistent primary surpluses, supported by high nominal GDP growth, contributed to this downward trend. The interest burden of about 8% of general government revenue poses a moderate constraint on discretionary spending. Standard & Poor's expects government debt ratios to

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Research Update: Rating On Indonesia Affirmed At 'BB+/B' And 'axBBB+/axA-2'; Outlook Remains Stable

improve further with continued cautious fiscal management, which in turn would improve the sustainability of public debt. The local currency rating on Indonesia reflects our view that the sovereign's monetary and fiscal flexibility does not yet match that usually found in sovereigns in higher rating categories. This is because of the combination of a narrow revenue base, significant infrastructure needs, inflexible subsidy regimes, and inflation. It also reflects a high share of nonresident holdings of local currency debt, consistently at 30%-34% of total outstanding. The transfer and convertibility risk assessment on Indonesia is 'BBB-'. Standard & Poor's believes the likelihood of the sovereign restricting access to foreign exchange needed by Indonesia-based non-sovereign issuers for debt service is slightly lower than the likelihood of the sovereign defaulting on its foreign currency obligations. The Indonesian corporate sector relies on international financial markets for long-term financing because of the still-shallow domestic financial markets.

Outlook
The stable outlook reflects our view that the moderately weak governance and effectiveness of the government's policies, low GDP per capita, and external vulnerability are generally balanced against a conservative fiscal policy, favorable debt trajectory, and the country's moderately strong growth prospects. We may raise the ratings if the next government's policies, such as subsidy reform, would reduce Indonesia's fiscal vulnerabilities, improve its balance sheet, reduce the external debt burden, or boost economic growth prospects. Conversely, we may lower the ratings if the government fails to respond to fiscal or external pressures with timely and adequate policies, or if policies endanger strong growth prospects or the positive fiscal and debt trajectories.

Key Statistics
Table 1

Republic of Indonesia Selected Indicators

--Fiscal year ending Dec. 31-2007 Nominal GDP (US$ bil.) GDP per capita (US$) 432 2008 510 2009 540 2010 709 2011 846 2012 877 2013e 868 2014f 838 2015f 981 2016f 1,100 2017f 1,204

1,871

2,178

2,272

2,947

3,470

3,551

3,475

3,315

3,836

4,256

4,608

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Research Update: Rating On Indonesia Affirmed At 'BB+/B' And 'axBBB+/axA-2'; Outlook Remains Stable

Table 1

Republic of Indonesia Selected Indicators (cont.)

Real GDP growth (%) Real GDP per capita growth (%) Change in general government debt/GDP (%) General government balance/GDP (%) General government debt/GDP (%) Net general government debt/GDP (%) 6.3 6.0 4.6 6.2 6.5 6.3 5.8 5.6 5.8 6.0 6.2

4.8

4.5

3.2

4.8

5.1

4.9

4.5

4.4

4.6

4.8

5.1

2.2

5.0

(0.8)

1.3

1.8

2.0

4.4

1.3

2.1

1.7

1.3

(0.3)

(0.1)

(1.6)

(0.7)

(1.1)

(1.9)

(2.3)

(2.2)

(2.0)

(1.6)

(1.2)

35.2

33.1

28.4

26.0

24.4

24.0

26.2

25.5

25.0

24.0

22.7

33.2

29.2

26.0

23.7

22.1

22.3

24.2

23.6

23.3

22.5

21.4

General 9.9 government interest expenditure/revenues (%) Oth dc claims on resident non-govt. sector/GDP (%) CPI growth (%) Gross external financing needs/CARs +usable reserves (%) Current account balance/GDP (%) Current account balance/CARs (%) Narrow net external debt/CARs (%) 27.0

9.0

11.0

8.9

7.7

7.5

7.9

8.7

8.3

8.0

7.6

28.2

27.3

29.4

31.9

35.3

38.7

42.5

46.2

49.7

52.4

6.4

9.8

4.8

5.1

5.4

4.3

7.0

6.3

5.3

5.5

5.6

94.7

107.5

84.1

85.3

82.8

88.4

91.3

100.3

99.8

99.6

98.6

2.4

0.0

2.0

0.7

0.2

(2.7)

(3.3)

(3.0)

(2.3)

(2.3)

(2.3)

7.8

0.1

7.8

2.9

0.8

(10.9)

(13.1)

(11.3)

(8.6)

(8.4)

(8.2)

59.8

47.5

50.6

37.3

33.0

42.8

69.8

73.1

63.6

56.4

49.4

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Research Update: Rating On Indonesia Affirmed At 'BB+/B' And 'axBBB+/axA-2'; Outlook Remains Stable

Table 1

Republic of Indonesia Selected Indicators (cont.)

Net 126.1 external liabilities/CARs (%) 93.2 157.5 165.0 142.6 163.2 199.7 216.7 193.6 180.2 170.0

Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private-sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. CARs--Current account receipts. The data and ratios above result from S&P's own calculations, drawing on national as well as international sources, reflecting S&P's independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Related Criteria
Sovereign Government Rating Methodology And Assumptions, June 24, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009 Understanding National Rating Scales, April 14, 2005

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision. After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts. The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook.

Ratings List
Ratings Affirmed Indonesia (Republic of)

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Research Update: Rating On Indonesia Affirmed At 'BB+/B' And 'axBBB+/axA-2'; Outlook Remains Stable

Bank Indonesia Sovereign Credit Rating ASEAN Regional Scale Indonesia (Republic of) Senior Unsecured Perusahaan Penerbit SBSN Indonesia I Senior Unsecured Perusahaan Penerbit SBSN Indonesia II Senior Unsecured Perusahaan Penerbit SBSN Indonesia III Senior Unsecured

BB+/Stable/B axBBB+/--/axA-2

BB+

BB+

BB+

BB+

Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com and at www.spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.

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