Rating the debtors

Credit Rating Indonesia Ltd., which was set up early this year, is expected to begin operating soon after the recent issuance of two regulations on the role, function and operational mechanism of rating institutions in the capital market. Credit rating and research has indeed become a much-needed service in the capital market due to the increasing popularity of debt instruments as a source of fresh funds for investments.

One may argue that demand for rating is not so urgent yet because domestic investors have never experienced actual credit losses on debt securities. But since the cumulative amount of rupiah bonds issued through the Jakarta Stock Exchange has exceeded Rp 5.05 trillion (US$2.3 billion), not including another Rp 500 billion to be floated by the State Electricity Company later this month, a credit rating agency is really needed to help investors to manage the risks of their investments in bonds and to promote a bond secondary market, which is virtually non- existent at the moment.

Judging from the tough requirements imposed by the Capital Market Supervisory Agency (Bapepam) on the credit rating agency, we feel assured that Credit Rating Indonesia Ltd., locally known by its acronym, "Pefindo", will likely be able to provide credit assessment with the quality, reliability and credibility needed both by debtors and investors.

Bapepam has ruled that a credit rating agency must be objective, independent and professional in its credit assessment and must make the method of its assessment transparent. Obviously, a credit rating agency must have the freedom to express its opinion on the issuers of debt instruments. Within the Indonesian business scheme of things, such independence is very crucial. Past experiences have shown that the political connections of a company often blunt the professional judgment of bankers or auditors.

Transparency also is vital for enabling issuers of debt instruments to know exactly how their credibility is assessed. Investors, too, should understand how the rating system operates in order to be able to understand and consequently to react appropriately to the rating agency's opinions.

A note of caution is in order here. Investors should be informed that a rating is an opinion which measures the risk that a given issuer of debt instruments may default on the payment of the principal or interest over the life of the rated instruments. Ratings serve as a form of protection for the investors, but the ratings should not be mistaken for a guarantee against losses. What is sure is that the ratings will be greatly helpful for investors in managing potential risks.

We reckon that Pefindo, which is owned jointly by several state banks, pension funds, the Jakarta and Surabaya stock exchanges and a securities company, will cooperate with a foreign credit rating agency for at least the first few years to improve the skills of its staff and to establish its credibility among foreign investors.

For sure, Pefindo will contribute to the development of a better credit information system in Indonesia. Investors will be helped to better manage their investment risks. The ratings will also help issuers of debt instruments to attract more investors and will secure them better access to cheaper capital and lower borrowing costs.