Indonesia seems to be flavour of the month, particularly in terms of bond investments. Debt instruments issued in the country were already proving very popular, even before Standard & Poor's upgraded the country's foreign-currency rating to BB from BB- on March 12, its highest rating in 12 years.

Foreign holdings of Indonesian bonds rose to Rp127.76 trillion ($14 billion) on March 12, up from Rp125.06 trillion on March 5, Rp108 trillion at the end of last year and Rp87.6 trillion at the end of 2008, according to the finance ministry.

Hence, foreign investors bought nearly Rp20 trillion worth of bonds in 2010 to March 12, around the same amount as they purchased during the whole of 2009, says Johan Sidik, a Jakarta-based investment specialist at Fortis Investments.

Moreover, foreign holdings of Indonesian Treasury bills rose to Rp66.03 trillion on March 13, up 8.8% from Rp60.7 trillion on March 9, he tells AsianInvestor.

S&P's upgrade was expected and had been priced in to a degree, since Fitch had upgraded Indonesia's rating from BB- to BB+ in January, agree analysts and portfolio managers.

The main reasons for the upgrade were steadily improving debt metrics (net general government debt fell to 26% of GDP in 2009, half the level of five years ago) and growing foreign exchange reserves accompanied by cautious fiscal management, says Sidik.

The upgrade also seems to have had a positive effect for asset classes other than debt. Foreign investors recorded net buying of Rp2.78 trillion of equities between March 1 and 15 on the Jakarta exchange, compared to net sales in February of Rp2 trillion and net purchases of Rp430.2 billion in January.

In addition to the rating upgrade, exports and domestic sales posted higher than expected growth in January to February, providing momentum for earnings upgrades for listed companies in Jakarta, says Sidik.

As for currency, immediately after the upgrade, the rupiah rose from 9,160 to 9,152 against the US dollar, thereby gaining almost 3% in the year to March 13.

Moreover, Indonesia's five-year credit default swaps on March 12 narrowed to 154/159 basis points from 158/163bp in the morning. And 10-year government bonds advanced, driving yields to the lowest level since May 2007. The yield on the 11% note due November 2020 dropped 43bp to 9.22%, according to the Inter-dealer Market Association, supported by domestic and foreign buying. The price climbed 3.0658% to 111.8998.

Looking ahead, the effect of the upgrade will be positive, given the greater level of confidence among foreign and institutional investors, adds Sidik. The combination of a lower risk premium and a historically low domestic lending-rate amid benign inflation momentum relative to the region should offer a better real return for investors, boosting both buying interest and risk appetite for Indonesian assets.

More importantly, adds Sidik, government will have improved external financing for the 2010 budget deficit (2.1% of GDP) in the form of Islamic bonds, Samurai bonds and US dollar bonds.

Other fund managers are also positive on the country's prospects. "Indonesia will continue to benefit from sustained domestic demand from a large and growing population, which was relatively unaffected by the financial crisis," says Dhananjay Phadnis, a portfolio manager at Fidelity International.

"In fact, a rebound in prices of agricultural and other commodities will lead to an increase in disposable incomes," he tells AsianInvestor. "[The country] also has a healthy trade surplus and sizeable foreign exchange reserves, giving it room for further fiscal and monetary policy stimulus."

Bhaskar Laxminarayan, chief investment officer for Asia at Swiss private bank Pictet, says that during the recent turmoil, Indonesia proved resilient and exhibited lower economic volatility, posting positive quarterly real GDP growth. "This was achieved through a greater dependence on domestic consumption that looks sustainable given demographics, employment and disposable income trends," he says.

The upgrade is only likely to improve the investment outlook for Indonesia, adds Laxminarayan. Flow benefits have improved following the upgrade, he says, and will have a positive impact over the medium to long term.

Meanwhile, there is a strong likelihood of a further rating upgrade in 2010, say fund managers, but there are a number of obstacles to overcome if the country is to achieve investment-grade status.

Fitch rates Indonesia one notch below investment grade and S&P puts it two notches below. Once investment grade is achieved, Sidik expects an 80-100bp rally in the yield for Indonesian bonds, as a result of narrowing CDS spreads (reflecting lower risk for Indonesia) and increasing foreign inflows.

As for obstacles to an upgrade, one of the main concerns is the ongoing turmoil over the government's bailout of Bank Century in 2008, say analysts and fund managers.

They also note other potential issues. "Investors will need to closely monitor corporate earnings growth and compare it against market expectations," says Fidelity's Phadnis. "There are also concerns that healthy economic growth and rising inflation could lead to less accommodative monetary policy. This will also have implications for the rupiah."