IMF Executive Board Concludes 2011 Article IV Consultation with IndonesiaPublic Information Notice (PIN) No. 11/128
October 21, 2011
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2011 Article IV Consultation with Indonesia is also available.
On October 7, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Indonesia.1
Continuing the impressive performance during the global financial crisis, Indonesia’s economy expanded 6.1 percent in 2010 and accelerated to 6.5 percent in the first half of 2011. Growth has also become more balanced, with investment adding to consumption and exports as the main engines of growth. In the absence of a significant further deterioration in global conditions, GDP growth is projected to remain robust at about 6−6.5 percent in both 2011 and 2012, increasingly driven by investment, which is offsetting a lower contribution from net exports.
Headline inflation has eased in recent months on softening food prices, but upward pressure on core inflation is expected to continue. At end˗2010, rising food prices had pushed CPI inflation to 7 percent; exceeding Bank Indonesia’s (BI) 4−6 percent target range. Headline inflation started to ease since February 2011, falling to 4.6 percent in July, as good local harvests and increased rice imports helped hold down food prices. Core inflation rose steadily through 2010 and into 2011, reaching 5.2 percent in August 2011. The future path of food prices will play a major role in the evolution of inflation. Nevertheless, a closing output gap, accelerating credit growth and elevated inflation expectations from an anticipated reduction in energy subsidies are projected to push core inflation higher in the second half of this year and into 2012.
The current account surplus has declined, but capital inflows have increased. Exports have been robust, buoyed by higher commodity prices and growing demand from major emerging market partners. Imports are also rising rapidly, in line with strengthening domestic demand. Strong growth prospects, solid macroeconomic fundamentals, and the potential for a ratings upgrade to investment status have continually led to large portfolio inflows, boosting bond and equity prices to all time highs. Foreign direct investment inflows have picked up and become broader based, and should provide greater support for the balance of payments. International reserves have more than doubled from the 2008 level, increasing to $125 billion by end August 2011. The rupiah has appreciated about 5 percent against the dollar from end 2010 to end August 2011, and external debt spreads have narrowed.
Indonesian banks continue to be profitable and are generally well capitalized. In line with the findings of the 2010 Financial Sector Assessment Program (FSAP), capital adequacy ratios remain high at 17.5 percent, and asset quality is satisfactory, with the nonperforming loan ratio at about 3 percent as of March 2011. BI has made progress towards the FSAP recommendation to establish a legally mandated Prompt Correction Action (PCA) mechanism, but the adoption of the Financial System Safety Net (FSSN) law remains outstanding.
Since October 2010, BI has used a wide range of instruments to stem mounting inflationary pressures and strong foreign demand for its sterilization instruments. The central bank raised its policy rate by 25 basis points to 6.75 percent in February 2011, after holding it unchanged at a historical low of 6.5 percent since August 2009. Reserve requirements on both local currency and foreign currency deposits have also been raised. BI has successfully shifted the composition of inflows away from central bank bills (SBI) by extending the holding requirement, lengthening the maturity of issues, and introducing longer maturity nontradable term deposits available only to banks.
The moderate fiscal stimulus provided in 2009 was reduced in 2010. The 2010 central government budget deficit was 0.6 percent of GDP, well below the government’s revised budget deficit target of 2.1 percent, reflecting ongoing problems in implementing spending programs. Public debt to GDP fell to 27 percent, one of the lowest among G20 countries. The overall budget deficit in 2011 is projected to increase slightly to about 1.25 percent of GDP, reflecting higher energy subsidies.
Executive Board Assessment
Executive Directors commended the authorities for cautious policymaking, which has underpinned a strong macroeconomic performance during the global crisis and a favorable growth outlook. Given Indonesia’s strong fundamentals, significant policy buffers, and vigorous domestic demand, Directors agreed that the risks from a deterioration in global economic conditions appear to be manageable. Looking ahead, improved infrastructure, better targeted social spending, and deeper structural reforms will be crucial to lifting the long-term prospects for growth.
While taking note of the authorities’ view that inflation may not be an immediate concern, Directors nonetheless considered that Bank Indonesia should be prepared to tighten monetary policy, in view of high credit growth and a planned reduction in energy subsidies. The timing of such move should, however, be mindful of global developments and the likely impact on capital flows. Directors suggested a combination of policy rate increases, macro-prudential measures, and liquidity absorption to tighten monetary conditions, and encouraged the central bank to focus its communications on its commitment to the inflation target.
To improve the effectiveness of monetary policy, Directors suggested that the central bank’s operational framework be adjusted to link interbank rates to the policy rate more effectively while promoting money market development. Directors also recommended strengthening the central bank’s financial resources by increasing the share of marketable securities in its balance sheet and replenishing its capital base.
Directors agreed that domestic financial conditions are generally sound. They welcomed the authorities’ progress in implementing the recommendations of the 2010 Financial Stability Assessment Program and efforts to reinforce supervisory oversight through a new risk-based bank rating system. In this regard, Directors noted that the adoption of the Financial System Safety Net law remains key to an improved framework for crisis management and resolution.
Directors commended the authorities’ commitment to strong public finances and a prudent fiscal policy. They encouraged the authorities to phase out poorly targeted subsidies with a view to creating room in the 2012 budget for needed infrastructure and other priority expenditures. Noting that implementation constraints still hamper policy flexibility, they called for further improvements in budget execution and public financial management, as well as tax reforms that could create the budgetary space for high-priority social expenditures.
Directors considered that further structural reforms are critical for higher potential growth and the achievement of the authorities’ longer-term development targets. In this regard, they recommended renewed efforts to improve regulation, strengthen governance, and bolster the business climate.