* Aberdeen sees govt bonds, consumer stocks drawing cash
* Middle East interest seen in sukuk bonds - hedge fund
* Jakarta stocks rise 1 pct on Thursday
By Charmian Kok
SINGAPORE, Jan 19 (Reuters) - Moody's upgrade of Indonesia's credit status to investment grade is set to spur capital inflows into the country, with fund managers tipping that to mainly benefit government bonds and stocks with exposure to domestic consumption, such as PT Unilever Indonesia Tbk .
Moody's Investors Service on Wednesday became the second credit-ratings agency in just over a month to give Southeast Asia's biggest economy an investment-grade rating, paving the way for more fund managers to allocate money to Indonesia.
Most bond funds can only invest in a country if it has investment-grade ratings from at least two of the three major agencies -- Moody's, Standard & Poor's and Fitch Ratings. Moody's now rates Indonesia Baa3 with a stable outlook.
Flows into the country have steadily picked up since the Fitch upgrade in December. According to fund flows tracker EPFR Global, inflows into Indonesia-focused equity funds were at their highest in the week ended January 11 since the third quarter of 2010.
That is seen accelerating now.
"While many other countries are going in the opposite direction, Indonesia's upgrade should result in further fund inflows," said Peter Elston, head of Asia Pacific strategy and asset allocation at Aberdeen Asset Management.
Aberdeen, which has invested $2.6 billion in Indonesian equities, is overweight on the country's retail firms. Elston expects the sector to benefit from its booming middle class, which Nomura Research projects could expand to more than 150 million people in the next four years.
"The middle class is where you get the real driving force for consumption and the industry is at the point where the middle class is starting to grow very rapidly, making the retailing sector interesting from an investment perspective," Elston said.
His top picks include Unilever Indonesia, PT Bank Permata Tbk, PT Ace Hardware Indonesia Tbk and PT Ramayana Lestari Sentosa Tbk.
Reaction to Moody's upgrade was swift. Indonesian stocks rose, with the benchmark Jakarta's Composite Index gaining 1.1 percent on Thursday.
The yield on Indonesia's benchmark 10-year government bond gained 2 basis points on Thursday, but had dropped 30 basis points the previous day.
With a population of 238 million and swelling investment, Indonesia is set to become one of the world's biggest economies, rebounding from credit-rating downgrades to junk status during the Asian financial crisis of 1997/98, when the 32-year rule of strongman Suharto ended.
Endre Pedersen, executive director of fixed income at Manulife Asset Management, said investors are focused on Indonesia's improving fundamentals, such as inflation which slowed in December for a fourth straight month to the lowest level since March 2010.
"We should see more investors moving to the long end," he said. "The rupiah bond trade may be crowded but BI (Bank Indonesia) has provided relief by stepping in to inject liquidity. That is a positive."
Manulife Asset Management had $3.4 billion invested in Indonesia as of the end of September.
Although the Moody's move will boost interest across Indonesian assets, it is likely to have the most immediate impact on sovereign bonds.
"The upgrades are related to sovereign ratings, so one would expect government bonds to see the most inflows," said Elston at Aberdeen.
S&P is the only other major agency that has not returned the country to investment level. The agency rates the country at the highest non-investment level.
"The interesting area for Indonesia here is the sukuk bonds. For some Middle East buyers who could not invest earlier because it was not investment grade, this is a new thing for them, which is good," said Guan Ong, Principal at Blue Rice Investment Management, a hedge fund that specialises in fixed income.
Ong, previously Chief Investment Officer at Korea Investment Corp, also said he expects a greater amount of funds to flow into Indonesia once S&P lifts its rating on the country.
"That would lift the final barrier (on fund flows and allocation) for those investors who have mandates but are prevented from investing because of the restrictions," he said.
Indonesia stocks gained 3.2 percent last year, outperforming the MSCI Asia Ex-Japan index's 18 percent plunge and after a 46 percent surge in 2010.
According to JPMorgan, bonds returned 7.7 percent last year, following 15.4 percent the year before.
Indonesia is also likely to see further credit ratings upgrades in the next few years, Aberdeen's Elston said, adding the economy's exposure to commodities makes it less susceptible to the slowdown seen in Europe and the United States.
"The economy is less manufacturing-oriented but more focused on primary industries like commodities, which makes it more linked to what's going on in the region than in the Western world. That places Indonesia in a much stronger position," he said. (Additional reporting by Mark Tay; Editing by Muralikumar Anantharaman)