Fitch Ratings downgrades Indonesia's outlook to negative, highlights MBG and fiscal risks

JAKARTA - International rating agency Fitch Ratings has downgraded Indonesia's debt rating outlook from stable to negative.

However, the agency still maintains the long-term credit rating in foreign currency (Long Term Foreign Currency Issuer Default Rating/IDR) Indonesia at the BBB level.

This change in outlook reflects the increased uncertainty in the direction of policy and the weakening of the consistency of the policy mix amid the tendency for centralization of decision-making.

"This could weaken medium-term fiscal prospects, undermine investor sentiment, and put pressure on external reserves," Fitch said in a report Wednesday, March 4.

On the other hand, the affirmation of the BBB rating shows recognition of Indonesia's track record in maintaining macroeconomic stability, supporting relatively strong medium-term growth, maintaining the government debt ratio to GDP at a moderate level, and maintaining the adequacy of foreign exchange reserves.

"The strength of this rating is limited by weak revenue collection, high debt service costs, and lagging structural features such as governance indicators compared to other 'BBB' rated countries," he said.

In addition, Fitch expects the government to remain in compliance with the 3 percent fiscal deficit limit and the push to achieve an ambitious growth target of 8 percent and an increase in social spending is considered risky to produce a mix of looser fiscal and monetary policies, which can create pressure on macroeconomic stability.

"The increased risk is exemplified by the inclusion of a review of the State Finance Law by the government in its legislative priorities in 2026," he said.

Fitch explained that a significant relaxation of the fiscal framework, including the deficit limit, was considered to have the potential to reduce policy credibility and increase dependence on central bank financing support.

For 2026, Fitch projects the fiscal deficit to be in the range of 2.9 percent of GDP, slightly above the government's target of 2.7 percent, based on assumptions of more moderate growth and limited short-term impact from tax compliance enhancement efforts.

In addition, social spending is expected to increase, including funding for the free nutritious meal program which is allocated around 1.3 percent of GDP throughout 2025-2029, as well as accelerating spending in the first half of 2026 is also considered to increase the risk of fiscal deviation.

Government revenue is projected at an average of 13.3 percent of GDP in 2026-2027, well below the median for BBB-rated countries of 25.5 percent.

The weakening of tax revenue, the transfer of state-owned enterprise dividends to the new state wealth fund Danantara, and tax return factors are factors that suppress income.

"Continued efforts to strengthen tax compliance should increase revenue, but it is likely not to provide a material increase in the short term, thereby limiting fiscal space," he explained.

Fitch also highlighted the role of Danantara, which was tasked with improving SOEs' efficiency and driving growth through commercial investments outside the state budget.

The fund plans to invest around 26 billion US dollars or equivalent to 1.7 percent of GDP by 2026 for the downstream sectors of minerals, energy, food, and agriculture.

"Uncertainty still exists regarding whether the mandate of the fund can be expanded over time to include quasi-fiscal activities through investments that are used to support government policy priorities, which can reduce fiscal transparency and policy consistency and increase the risk of contingent liabilities for the state," he explained.

The next widespread protests in 2025 highlight public discontent and there is a risk that social tensions could continue, posing a political challenge for the president and the ruling coalition.

"Indonesia's position in the World Bank's governance indicators has deteriorated and is ranked at the 44th percentile on the composite governance score, below the median 'BBB' of 56th percentile. The continued uncertainty surrounding macroeconomic policymaking can further burden the country's governance and institutional strength," he added.

Externally, Fitch expects the current account deficit to widen to 0.8 percent of GDP by 2026 due to weakening net exports and foreign exchange reserves are still considered adequate, equivalent to about five months of current account payments, although the risk of capital outflows remains as investor sentiment is fragile.

Furthermore, Fitch expects inflation to remain within the target of 2.5 percent plus minus 1 percent, and opens the opportunity for two rate cuts to 4.25 percent by the end of 2026.

However, the potential for broader policy easing is considered to make it difficult for the central bank to maintain price and exchange rate stability if capital outflow pressure increases.

"The policy stance that tends to be soft and the potential for expanding its mandate to support growth and job creation can make BI difficult to meet its core objectives in controlling inflation and maintaining exchange rate and financial stability if there is an increase in capital outflow pressures," he said.

Government debt is projected to rise slightly to 41 percent of GDP by 2026, still below the BBB median of 57.3 percent.

"We expect the debt ratio to remain stable in the medium term, reflecting our current baseline assumption that the government will comply with the fiscal deficit limit," he said.

Nevertheless, the interest payment ratio, which is estimated to reach 17 percent of government revenue, is one of the highest in the group.

Going forward, Fitch expects Indonesia's economic growth to remain solid at around 5 percent in 2026-2027, or double the median for BBB countries.

Domestic demand is predicted to remain the main engine of growth, supported by higher public spending, investment and intra-industry, monetary easing, moderate debottlenecking reforms, and downstream programs.

"We believe that the government's target for growth of 8 percent in 2029 will be difficult to achieve without significant structural reforms," he said.