UPDATE 2-Moody's ups Indonesia's rating, still junk status

* Rating is still two notches below investment grade

* Moody's says outlook on the rating is stable

* Rupiah, bond prices jump on the news

* Indonesia benefits from political stability

JAKARTA, Sept 16 - Moody's Investors Service raised Indonesia's sovereign rating by one notch to Ba2 on improving economic prospects for Southeast Asia's biggest economy, sparking a jump in the rupiah and bond prices.

Moody's analyst Aninda Mitra said Indonesia's economy could weather global uncertainties better than other sovereigns in the Ba-rating category and compared with its regional peers.

He said management of the economy was improving and the appropriate policy stance was expected to persist in the foreseeable future.

"These developments highlight the growing credibility and predictability of government policies, and are expected to ensure macro-economic stability," he said.

Despite the move, Indonesia's rating is still two notches below investment grade and only one above the Philippines. It is also still several notches below neighbours Singapore, Malaysia and Thailand, all of which are investment grade.

"It will likely need at least two years for the country to achieve an investment grade rating," said economist Anton Gunawan of Bank Danamon. "This will require significant progress."

The rupiah, Asia's best performing currency this year, jumped 1.8 percent to 9,710/dollar on the news, bringing its gains this year to 13 percent.

The yield on the most actively traded 5-year debt slipped seven basis points to 9.23 percent, while the 10-year yield dropped 8 basis points to 9.92 percent, traders said. The country's credit default swap also narrowed by 15 bps to 170/180, traders said.

Indonesia, long regarded as a laggard in the region, is back on many investor radar screens thanks to its economic resilience and political stability under President Susilo Bambang Yudhoyono.

Its economy is one of the few in Asia expected to grow this year because it is less dependent on exports than its neighbours. The World Bank this week revised up its growth forecast to 4.3 percent in 2009 from 3-4 percent, citing resilient consumption.

STRONGER REFORMS NEEDED

Yudhoyono's resounding re-election in July has also reassured many investors, who expect the former general to continue his programme of reforms.

Analysts, however, said Indonesia would need stronger reforms to achieve an investment grade rating after suffering badly during the Asian financial crisis of 1997-1998.

Moody's said the outlook on the rating was stable. Its sovereign rating for Indonesia is now at the same level as Fitch Ratings but one notch above that of Standard & Poor's Ratings Services.

"In my opinion, they're late in upgrading the ratings," said Michael Tjoajadi, president director of Schroders Investment Management in Jakarta, referring to Moody's.

"Indonesia is better than what many expected. Indonesia is improving."

Others said they saw scope for a further drop in bond yields.

"There is room for yields on rupiah bonds rather than on the U.S. dollar bonds to go down further after the upgrade," said Handy Yunianto, debt market analyst at Mandiri Sekuritas, adding the upgrade had not come as a surprise.

"It's already been priced in by the market. If you see our CDS (credit default swap), for example it's now at 200 basis points. And the yield on our global bonds is down to 5 to 6 percent, compared with 11 to 12 percent when our government issued the bonds" earlier this year, he said.