Public Information Notice

On July 13, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Indonesia.¹

Background

Indonesia entered the current global crisis with strong initial conditions. Aided by a generally favorable global economic climate that prevailed prior to the recent crisis, Indonesia’s fundamentals were strengthened through sound macroeconomic policy implementation, including prudent debt management and developing a sound financial sector. Economic growth averaged about 6 percent since 2005, fiscal performance was strong, the current account was in surplus, both public and external debt dropped to about 30 percent of GDP, and international reserves rose to a relatively comfortable level.

Notwithstanding the initial impact of the global crisis, the economy has rebounded in 2009. During the last quarter of 2008, various factors—falling commodity prices, liquidity problems in some segments of the banking sector, default by a private sector conglomerate on its obligations, and general global risk aversion—led to a sharp deterioration in market conditions. However, with relatively strong corporate and banking sector balance sheet positions, high capitalization and profitability of the banking system, and a series of mitigating policy measures, the economy was able to absorb the impact of the crisis. These factors, combined with the stronger than expected recovery in Q1 of 2009, have boosted domestic and foreign investor confidence.

The economy’s resilience to the weak global conditions was evident in the stronger than expected GDP growth in Q1 of 2009 that was supported by particularly strong consumption, as private consumption benefited from a large election-related spending stimulus. External accounts also improved in Q1 as the current account was positive from a non-oil trade surplus and the financial account registered a surplus due to demand for sovereign debt securities. CPI inflation has decelerated rapidly since October 2008 reflecting the weaker economic conditions as well as falling commodity prices.

Macroeconomic policy responses have kept appropriate pace with the evolving economic conditions. Bank Indonesia has been on a monetary-easing cycle since December 2008, consistent with lower inflationary pressures and slowing domestic demand. The policy rate has been cut by 275 basis points to 6¾ percent. A fiscal stimulus package of about 1.4 percent of GDP was announced in February 2009. The fiscal space for the stimulus was made possible by solid performance over several years that has resulted in a decline in public debt. Moreover, the flexible exchange rate has served well as an external shock absorber.

Banking and corporate sector indicators are generally robust, and have proved resilient to the crisis. Financial soundness indicators improved in 2008—profitability rose and the capital base strengthened further. Coming from a period of rapid credit growth in the last two years, and in light of the uncertain economic climate, credit expansion has decelerated on a monthly basis since December 2008. Indonesian companies have over time reduced their vulnerabilities, including lowering leverage ratios, raising profitability, and reducing their exposure to external liabilities.

Executive Board Assessment

Executive Directors welcomed the resilience of the Indonesian economy, which owed much to strong initial fundamentals and appropriate policy responses. Private consumption, supported by the fiscal stimulus package, has kept growth positive and among the highest in the region. The financial sector has recovered from the adverse initial impact of the global turmoil, and investor sentiment has improved in recent months. Nevertheless, Directors noted that, although the economic outlook for 2009 remains positive, another round of global risk aversion could adversely affect external liquidity, demand, and growth prospects for Indonesia. It will therefore be important that the authorities strive to achieve the appropriate policy mix, and promptly adjust it as needed, to preserve macroeconomic and financial stability.

Directors welcomed the fiscal stimulus plan for 2009 and underscored that timely and efficient implementation of the spending program, especially on infrastructure, would be critical to sustaining the economic recovery. They considered it appropriate to maintain some of the stimulus in 2010, given the available fiscal space. While some Directors pointed to financing and capacity constraints, most saw room for a somewhat higher fiscal deficit than currently planned, noting that such a level remains consistent with continued debt consolidation over the medium term, an indication of the authorities’ record of fiscal prudence.

Directors commended the authorities for the progress in fiscal reforms toward a consolidated Treasury Single Account, simplified budget execution procedures, and strengthened cash management. They encouraged the authorities to build on the momentum of past reform efforts to enhance budget flexibility and improve public resource management. Further strengthening tax administration and lowering energy subsidies would help create fiscal space for priority infrastructure and social expenditures.

Directors generally considered that the monetary policy easing since December 2008 was timely and appropriate in the face of decelerating inflation and weakening investment. Going forward, they supported a more cautious stance, given ample liquidity in the banking system, long lags in monetary transmission, and the risk of a reversal of capital flows. Directors encouraged the authorities to continue to strengthen the monetary policy framework. Strong commitment to the medium-term inflation targets, as well as publication of inflation forecasts, would help guide inflation expectations and enhance policy credibility.

Directors stressed that exchange rate flexibility has served the country well in recent months, and remains an important shock absorber. They noted the staff’s assessment that the current level of the real effective exchange rate is broadly in line with fundamentals, and that reserves are at a comfortable level. Most Directors considered it prudent nevertheless to build larger reserve buffers gradually over the medium term to preserve investor confidence in the event that global risk aversion deteriorates. Some others believed that the current level of reserves and the various contingency arrangements should provide an adequate cushion.

Directors welcomed the robustness of the banking sector, with banks recording strong capital positions and improved profitability. The crisis management measures recently introduced by Bank Indonesia have helped alleviate liquidity pressures and restore market confidence. Directors looked forward to early parliamentary approval of the Financial Safety Net law, which would help strengthen the legal framework for bank resolution. They emphasized the importance of a further strengthening of the early warning systems, and of continued close supervision of banks, particularly small and medium-sized banks exposed to liquidity risk. Directors looked forward to the forthcoming Financial Sector Assessment Program (FSAP) to help identify priorities for further financial sector reform.