## cr1748 ## Source details **Canonical URL:** [cr1748](https://www.imf.org/-/media/files/publications/cr/2017/cr1748.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr1748.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr1748.pdf.json) --- ### Capital inflows to Indonesia since the Global Financial Crisis (GFC) - Definitions and scope: - Capital inflows defined as net acquisition of domestic assets by nonresidents. - Analysis period emphasis: post-GFC developments through 2016:Q3; prepared by Yinqiu Lu. - Volumes and composition (2010:Q1–2016:Q3 and related comparisons): - Average inflows increased from 3¼ percent of GDP in 2005–09 to 4½ percent of GDP in 2010:Q1–2016:Q3. - Composition (2010:Q1–2016:Q3): FDI = 52 percent of total cumulative inflows; portfolio inflows = 40 percent of total cumulative inflows. - Government bonds accounted for 83 percent of total cumulative portfolio inflows and averaged 1.5 percent of GDP in 2010:Q1–2016:Q3. - Estimated that 60 percent of inflows to government bonds went to rupiah-denominated government bonds in 2010:Q1–2016:Q3. - Total cumulative inflows to LCY government bonds reached US$52 billion in 2010:Q1–2016:Q3. - Time patterns and global drivers: - Liquidity from systemic economies’ unconventional monetary policies produced global search-for-yield and large EMDE inflows, especially portfolio inflows. - Indonesia’s inflows increased, peaked in late 2014, then declined yet remained relatively high in 2015:Q1–2016:Q3, contrasting many EMDEs that declined in 2013−16. - Portfolio flows show clear risk-on/risk-off patterns with major reversals at: late 2011 (euro area sovereign debt crisis), 2013 (taper tantrum), and 2015 (renminbi reform). - LCY government bond inflows and returns (2016 specifics): - Inflows to LCY government bonds: about US$9.5 billion in January–September 2016. - Total annual returns of bonds reached 40 percent in U.S. dollar term at end-September 2016. - Estimated capital reversal from LCY government bonds: US$2.2 billion in October 1–November 30, 2016; yield of 10-year bonds up by 100 basis points during that episode. - After the reversal, inflows gradually resumed accompanied by a decline of bond yields. - Other investment and banking links: - Other investment inflows turned positive (four-quarter rolling) since early 2008 due to cross-border bank lending pickup, but recent external deleveraging reversed those inflows. - Correlations and investor behavior: - Low-frequency correlations (2010:Q1–2016:Q3): generally low correlations across inflow types; low positive correlations suggest limited herding; low negative correlations indicate limited substitution across inflow types. - High-frequency data: high correlation between equity and LCY government bond inflows during shocks (e.g., taper tantrum, 2015 renminbi reform) with both declining or reversing. ### Foreign liabilities, external debt, currency composition, and off-balance exposures - Aggregate levels and changes: - Foreign liabilities rose from 55 percent of GDP in 2009 to 67 percent of GDP at end-2015. - External debt to GDP increased from 29¾ percent at end-2009 to 35¾ percent at end-September 2016. - Share of public debt decreased from 57½ percent to 50 percent over the same period. - About 60 percent of the increase in external debt was due to private sector borrowing. - Sector and intra-company structure: - External debt of nonfinancial corporate sector stood at 6 percent of GDP. - At end-September 2016, one third of private sector external debt was intra-company (US$50 billion, 5.5 percent of GDP); debt from parent companies accounted for 78 percent of such intra-company debt. - Two-thirds of intra-company loans concentrated in nonfinancial corporates; this large share reduces rollover risk. - Currency and LCY bond holdings: - About 18 percent of Indonesia’s external debt denominated in rupiah at end-September 2016, up from 10 percent at end-2009. - Share of rupiah-denominated public debt doubled from 16¼ percent at end-2009 to 32¾ percent at end-September 2016. - Five-fold increase in nominal value of foreign holdings of LCY government bonds and a doubling of the foreign share from end-2009 to end-2015. - Derivatives and off-balance exposures: - Foreign investors gain exposure via TRS and CLN backed by LCY government bonds, potentially expanding foreign exposure beyond official cash-bond reporting. - Annual CLN issuance averaged US$1.2 billion in 2011–15, about 15 percent of the increase in foreign holding of cash bonds. - Information gaps: volume of TRSs and CLNs issued by local subsidiaries of global banks not fully observable. ### High-frequency drivers of LCY government bond inflows (GARCH results, Jan 1, 2010–Oct 31, 2016) - Mean-equation selected coefficients (statistical significance preserved): - C: 105.6 (Standard Error 25.44; z-Statistic 4.15; p value 0.00) - Inflows(-1): 0.2 (Standard Error 0.03; z-Statistic 8.08; p value 0.00) - Inflows(-2): 0.1 (Standard Error 0.02; z-Statistic 4.29; p value 0.00) - NDF3M(-2)-NDF3M(-5): -0.3 (Standard Error 0.02; z-Statistic -15.79; p value 0.00) - YIELD5Y(-2)-JIBOR3M(-2): 3.2 (Standard Error 1.90; z-Statistic 1.69; p value 0.09) - LOG(VIX(-2)): -29.5 (Standard Error 8.69; z-Statistic -3.39; p value 0.00) - Variance-equation highlights: - C_var: 314.0 (Standard Error 79.79; z-Statistic 3.94; p value 0.00) - RESID(-1)^2: 0.0 (Standard Error 0.01; z-Statistic 8.77; p value 0.00) - GARCH(-1): 0.4 (Standard Error 0.01; z-Statistic 37.50; p value 0.00) - GARCH(-2): -0.4 (Standard Error 0.01; z-Statistic -35.40; p value 0.00) - GARCH(-3): 0.9 (Standard Error 0.01; z-Statistic 71.92; p value 0.00) - Model fit: - R-squared: 0.188; Adjusted R-squared: 0.185. - Interpretation: - Expectations of rupiah appreciation (NDF movements) associated with more foreign purchases. - Wider bond yield–interbank spread (YIELD5Y - JIBOR3M) encourages foreign participation. - Higher LOG(VIX) (global risk aversion) reduces foreign exposure. - Strong short-term persistence (momentum) in foreign inflows for up to two days (Inflows(-1) and Inflows(-2) significant). ### Implications and policy recommendations on capital inflows - Benefits: - Enabled financing of Indonesia’s current account and fiscal deficits since late 2011. - FDI provided long-term, stable capital and technology/management transfer; portfolio inflows facilitated external borrowing in domestic currency. - Risks: - Volatility and wave-like nature of inflows, especially portfolio flows, transmit global shocks and can pressure exchange, equity, and bond markets. - Recommendations: - Structural reforms to attract more FDI (less volatile) — recent partial FDI liberalization is welcomed. - Increase domestic savings, including public saving, to reduce reliance on foreign capital; strengthen revenue collection post commodity-boom. - Deepen domestic capital markets to absorb surges and sudden stops; address narrow investor base and low market liquidity in government bond markets. ### Fiscal stance, growth-enhancing fiscal strategy, and medium-term targets - Near-term and medium-term fiscal stance: - Support for a slightly larger fiscal deficit of about 2¾ percent of GDP in 2016 based on modest fiscal space. - Medium-term deficit target of 2¼ percent of GDP would provide a countercyclical buffer of ¾ percent of GDP under the fiscal rule. - Growth-enhancing fiscal strategy design: - Proposed increase in revenue and expenditure each by about 3 percentage points of GDP over the medium term, with revenue mobilization slightly greater than expenditure expansion to generate the countercyclical buffer. - Expected impact: - Menu of policy options summarized expected to increase potential growth to 6 percent by 2021. ### Priority spending areas and quantitative expenditure entries (selected, percent of GDP) - Infrastructure: - Increase investment expenditure toward 5 percent of GDP; selected expenditure entry: Infrastructure = 1.3 percent of GDP increase. - Total infrastructure spending was 2.5 percent of GDP in 2015 vs EM Asia average 5.1 percent of GDP. - Government’s infrastructure investment plan for 2015−19: US$480 billion; about 30 percent executed through central government. - Starting in 2017, 20 percent of central government transfers via DAU and revenue sharing will be earmarked to infrastructure. - Health: - Implement universal health coverage to 100 percent by 2019; baseline: about 60 percent covered in 2016. - Public health spending to reach 2.1 percent of GDP in 2021 — 0.6 percentage points of GDP above baseline. - Selected expenditure entry: Health = 0.6 percent of GDP increase. - Education: - Increase education spending toward EM average (4.8 percent of GDP); selected expenditure entry: Education = 0.8 percent of GDP increase. - Social assistance and other: - Social Assistance: 0.1 percent of GDP increase (consolidation and better targeting). - Other expenditure: -0.1 percent of GDP (cut nonpriority expenditure). ### Revenue measures and quantitative revenue entries (selected, percent of GDP) - Total revenue policy: 3.0 percent of GDP (aggregate of measures). - VAT reform: - Current statutory VAT rate: 10 percent. - Revenue losses from VAT exemption of final consumption: about 0.8 percent of GDP. - Cascading tax on intermediary consumption: about 0.9 percent of GDP. - Reform scenario: increasing VAT rate in stages to 15 percent (maximum in current legislation) while removing exemptions could increase VAT revenue by at least 1.8 percentage points of GDP. - Selected revenue entry: Value-added tax = 1.8 percent of GDP. - Excise taxes: - Vehicle excise (rebase): could generate additional revenue up to 1 percentage point of GDP. - Environmental fuel tax: Rp 1,000/liter for gasoline and Rp 500/liter for diesel could generate an estimated 0.3 percent of GDP. - Selected revenue entry: Excise taxes = 1.0 percent of GDP (vehicle and tobacco excise increases and environmental tax). - Property tax: - Current recurrent property tax revenue: about 0.6 percent of GDP. - Potential medium-term increase: about 0.2 percentage points of GDP by increasing maximum municipal rate and improved administration. - Selected revenue entry: Property tax = 0.2 percent of GDP. - Corporate Income Tax (CIT) and PIT: - Current statutory CIT rate: 25 percent. - Current top PIT rate: 30 percent for income over 15 times GDP per capita. - Policy options include consolidating preferential regimes, broadening PIT base combined with a modestly lower top rate (example: lower top PIT threshold to 7 times GDP per capita while lowering top rate slightly), and revenue-neutral CIT base consolidation. ### Revenue administration and tax policy implementation priorities - Revenue administration reforms: three components — improve tax collection efficiency; strengthen business environment; strengthen tax administration institution (DGT). - Immediate administrative actions include: - Segment taxpayers and target compliance strategies. - Expand specific-issue audits (numerical example: specific-issue audits could comprise at least 50 percent of all audits in one year). - Use external data matching, pilot risk-based case selection, and move expansification programs to targeted campaigns. - Revise VAT return complexity and refund procedures. - Caution on creating a semi-autonomous revenue agency (SARA): - Risks and transition costs of SARA could outweigh benefits; recommend incremental DGT strengthening and management/ministerial performance agreements instead. - Prioritization: - Near-term: improve quality of spending, raise revenues via higher excises, start phased move to risk-based tax administration, prepare to upgrade key tax laws. ### Tax policy: international taxation, BEPS, treaties, and specific measures - Worldwide vs territorial regime: - Indonesia operates a worldwide system with foreign tax credits. - Assessment: "On the whole, there does not thus appear to be a strong case for Indonesia to switch from a worldwide to a territorial system." - Bilateral tax treaties: - Indonesia has 66 treaty partners. - With more than half of treaty partners, FDI is less than US$100 million. - Strategic suggestions: set reasonable domestic parameters; consider participation exemption/reduced WHT for participating dividends; use one model treaty; include EoI provisions; use TIEAs where full treaties are not merited. - BEPS commitments and priorities: - Indonesia endorsed BEPS 2015 Final Reports and committed to the four BEPS minimum standards (Actions 5, 6, 13, 14). - Prioritized BEPS actions: strengthen CFC rules (Action 3); limit interest deduction erosion (Action 4); address PE avoidance in the digital economy (Action 7); implement CbC reporting (Action 13). - CFC and interest-deduction policy specifics: - Current thin capitalization rule (effective 2016): debt-to-equity ratio limit 4:1 (MOF Regulation 169/PMK.010/2015). - ORBIS simulations: 4:1 affects 3.8 percent of MNEs; lowering to 2:1 affects 10.1 percent. - Recommendation: augment thin-cap rule with earnings-stripping rule (e.g., restrict net interest deductibility to at most 30 percent of EBITDA); simulations show EBITDA-based limits affect far more firms (30 percent of EBITDA affects 39.7 percent; 20 percent affects 50.7 percent; 10 percent affects 64.3 percent). - Digital economy and PE: - Formed a team on taxation of e-commerce (June 2016); Indonesia has investigated internet-based companies and asserted intention to tax advertising income of internet enterprises. - Recommended adopting expanded PE definitions and anti-fragmentation measures consistent with BEPS Action 7; consider using the MLI to update existing treaties. - Transfer pricing administration: - Upgrade DGT regulation PER-32/PJ/2011 to a Ministry of Finance regulation (PMK) and consider establishing a specialized transfer pricing unit. ### Country-by-Country (CbC) reporting, AEOI/CRS, and Exchange of Information (EoI) - CbC reporting: - Legislative provisions for the Master File, Local File, and CbC report drafted and expected to be finalized by end-2016. - CbC reporting threshold: companies with annual turnover of at least Rp 11 trillion (about US$824 million). - EoI and CRS commitments: - Indonesia signed the Convention on Mutual Administrative Assistance in Tax Matters (November 2011; effective May 2015) and is a signatory of the Multilateral Competent Authority Agreement (MCAA) as of June 2015. - Indonesia committed to implement the CRS for Automatic Exchange of Information (AEOI). - Domestic primary legislation considered in place to enable submission of first CRS reports on September 2018; secondary legislation and operational measures remain to be completed as of December 2016. - Gaps and operational constraints: - Global Forum (2014) peer review: domestic laws largely in place but access to bank and securities account information requires additional approvals from Bank Indonesia or the Financial Services Authority and currently demands specific account identifiers—this is not aligned with international standards that require only taxpayer identification. - Institutional actions: - Dispute resolution team created in 2016 to handle MAP and APAs; Minister of Finance designated competent authority and delegated to Director of Tax Regulation II of the DGT. ### Social assistance programs: coverage, performance, and reform priorities - Key programs and 2016 figures (selected): - PBI-JKN (Jamkesmas → JKN-PBI): covers over 92 million individuals in 2016; 2016 cost: Rp 25.5 trillion. - Rastra (Raskin → Rastra): 2016 target: 15.5 million households; 2016 expenditure: Rp 22.5 trillion. - PIP (BSM → PIP): 2016 target: 19 million students; 2016 budget: Rp 14 trillion. - BLSM (BLT → BLSM): targeted poorest 25 percent; 2015 disbursed budget: Rp 14.6 trillion; monthly payments of Rp 150,000 per tranche. - PKH: 2016 scale-up target: reach 6 million families; 2016 budget: Rp 9 trillion. - Performance highlights and issues: - PBI-JKN: targeting relatively good but slightly worsened; beneficiaries often unaware of benefits; recommendation to increase outreach and merge monitoring with JKN system. - Rastra: least well targeted; only 57 percent of beneficiaries in poorest 40 percent; households receive only 4 kilograms/month on average (11 kilograms less than promised); recommend UDB-based allocations, stronger last-mile oversight, and e-voucher pilot evaluation. - PIP: improved targeting and positive welfare/education impacts; recommendations to address institutional fragmentation, update benefit levels, and strengthen beneficiary support. - BLSM: effective in poverty protection during fuel price increases; no evidence of adverse labor supply effects; targeting relatively better among similar-sized programs but inclusion/exclusion errors persist. - PKH: significant positive impacts on health and education indicators; inclusion errors low and exclusion errors high; scale-up requires strengthening IT/HR, MIS updating, timely verification and disbursement. - System-wide gaps and reforms: - Coverage gaps for old age, disability, ECED, and scalable livelihood support. - Recommendation to operationalize and automate Crisis Monitoring and Response System (CMRS) and develop response protocols to activate programs without budgetary/parliamentary delays. - Move away from universal subsidies toward targeted programs using the UDB; standardize monitoring, grievance mechanisms, and cross-ministerial coordination. ### Investment trends, drivers, firm-level evidence, and policy implications - Aggregate and sectoral investment trends: - Investment rose by around 10 percentage points of GDP since early 2000s and now accounts for more than a third of output; private investment ≈ 90 percent of total investment. - Private investment slowed markedly since 2014, weakness intensified into 2016:H1 with little recovery into Q3:2016; capital expenditure of SOEs doubled in 2016 and expected to rise by around 35 percent in 2017. - Commodity-sector investment surged to 2013 and then stalled; manufacturing investment contracted. - Structural constraints to investment: - Weak infrastructure (electricity, roads), high regulatory compliance costs, rigid labor market and skills gaps, weak integration into global value chains, and restrictive FDI regulations prior to 2015 reforms. - Example impacts: weak road conditions and blackouts accounted for 4½ percent and almost 6 percent of total annual sales, respectively; ownership of electricity generators for backup >60 percent in 2014. - Firm-level empirical evidence (sample: 370 listed corporates, 2007−15; sample size 2,722 observations) - Investment positively and significantly related to cash flows (EBITA) and to changes in debt. - No significant relationship found with effective interest rate payments or Tobin Q. - Interaction effects: cash flow × rupiah volatility = -0.16*** (p-value (0.00)); cash flow × VIX = -0.07*** (p-value (0.00)); cash flow × stock price volatility = -0,37*** (p-value (0.00)). - Panel R-sq ranged 0.34–0.40 across specifications. - Policy implications from empirical results: - Maintain macroeconomic stability and reduce rupiah volatility to support investment. - Improve access to debt finance (deepen corporate bond markets; strengthen bank asset quality and liquidity). - Reduce transmission of international financial volatility to domestic firms. - Address structural impediments: accelerate infrastructure, reduce regulatory burdens, and reform labor markets and skills training to improve cash flows and investment recovery. *Italic: INDONESIA — INTERNATIONAL MONETARY FUND (cr1748; excerpts and analysis as provided).* ### 1. EMDEs: Capital Inflows ______________________________________________________________ 6 ### 1. EMDEs: Capital Inflows ### A. Introduction - Capital inflows are defined as net acquisition of domestic assets by nonresidents. - The paper analyzes developments in capital inflows to Indonesia since the global financial crisis (GFC), focusing on trends, new features of Indonesia’s external positions, and main drivers for capital inflows. - Prepared by Yinqiu Lu. ### B. Developments of Capital Inflows - Capital inflows to Indonesia have increased since the GFC: - Average volume increased from 3¼ percent of GDP in 2005–09 to 4½ percent of GDP in 2010:Q1–2016:Q3. - Global drivers: - Liquidity released from systemic economies’ unconventional monetary policies led to a global search for yields and large capital inflows to EMDEs, especially portfolio inflows. - Time patterns: - Many EMDEs experienced a steady decline in capital inflows during 2013−16, but Indonesia’s inflows increased, peaked in late 2014, then declined yet remained relatively high in 2015:Q1–2016:Q3. - Role in financing: - Increasing capital inflows helped finance Indonesia’s current account and fiscal deficits after the commodity super-cycle ended in 2011. - Composition (2010:Q1–2016:Q3): - FDI accounted for 52 percent of total cumulative inflows. - Portfolio inflows accounted for 40 percent of total cumulative inflows. - These ratios have broadly remained stable since 2005. - Other investment: - Other investment inflows became positive (in four quarter rolling terms) since early 2008 due to a pickup in cross-border bank lending to the private sector; recent external deleveraging led to a reversal of other investment inflows. ### C. Portfolio Inflows and Instrument Composition - Portfolio inflows are highly influenced by global market sentiment and exhibit a risk-on / risk-off pattern: - Main reversals correspond to the euro area sovereign debt crisis (late 2011), the 2013 taper tantrum, and the 2015 renminbi reform. - Instrument breakdown and preferences: - Government bonds accounted for 83 percent of total cumulative portfolio inflows and averaged 1.5 percent of GDP in 2010:Q1–2016:Q3. - Corporate bonds are the second most popular instrument, but foreign purchases of corporate bonds have recently declined, paralleling declines in cross-border bank lending. - Inflows to central bank bills (SBIs) were affected by Bank Indonesia’s capital flow management measures: - Minimum holding period of SBIs extended to 6 months in May 2011 (from one month imposed in July 2010). - The minimum holding period was reduced to one month in September 2013 and later to one week in September 2015. - When the minimum holding period was extended, foreign investors sold off SBIs. - Equity inflows: relatively small in volume and volatile. ### D. Local Currency Government Bonds (LCY) Inflows - LCY vs hard currency: - It is estimated that 60 percent of the inflows to government bonds went to rupiah-denominated government bonds in 2010:Q1–2016:Q3. - Cumulative amount: - Total cumulative inflows to LCY government bonds reached US$52 billion in 2010:Q1–2016:Q3. - 2016 developments: - Inflows to LCY government bonds were strong in the first three quarters of 2016, reaching about US$9.5 billion in January–September 2016. - Drivers included a favorable global financial environment, attractive bond yields, and some speculative inflows related to the tax amnesty program. - Inflation-adjusted yield of Indonesia LCY government bonds was high compared with other countries. - Total annual returns of bonds reached 40 percent in U.S. dollar term at end-September 2016, driven by high yields, positive valuation, and rupiah appreciation versus the U.S. dollar. - Volatility and reversals: - Returns from exchange rate movements have been volatile and often correlated with valuation returns, indicating foreign investors’ role in influencing bond yields. - Inflows reversed in October 2016 as foreign investors likely took profits, with reversal accelerating following the U.S. election. - Estimated capital reversal from LCY government bonds reached US$2.2 billion in October 1–November 30, 2016 with the yield of 10-year bonds up by 100 basis points. - After the reversal, capital inflows gradually resumed accompanied by a decline of bond yields. ### E. Correlations, Herding, and Episodes of Shock - Low-frequency (quarterly balance of payments) correlations (2010:Q1–2016:Q3) suggest: - Correlations among key types of capital inflows are generally low. - Low positive correlations point to a small likelihood of foreign investors’ herding behavior during shocks. - Low negative correlations indicate limited scope for one type of inflows to compensate for a decline in another type. - The negative correlation between FDI debt inflows and debt outflows reflects recurrent short-term intra-company trade credit recorded as debt inflows and debt outflows in the same quarter. - Correlation between FDI and private sector bond inflows is relatively high, suggesting common underlying drivers (e.g., economic outlook or commodity prices). - Correlation between public bond inflows and public other investment inflows was almost zero, indicating limited substitution between these government borrowing types. - High-frequency observations: - High-frequency data point to a high correlation between equity and LCY government bond inflows during shocks. - During the taper tantrum and 2015 renminbi reform, both equity and bond inflows to Indonesia declined or reversed as foreign investors reduced exposures to EMs. ### F. Developments of Foreign Liabilities and External Debt - The landscape of capital inflows has changed Indonesia’s external liabilities and debt positions. - While capital inflows financed current account and fiscal deficits since late 2011, they introduced challenges due to volatility and tendency to come in waves, particularly portfolio inflows. - The recent external deleveraging of the private sector has led to a reversal in other investment inflows. _Italic: Content derived from "CAPITAL INFLOWS TO INDONESIA SINCE THE GLOBAL FINANCIAL CRISIS" (Prepared by Yinqiu Lu) in the IMF chapter provided._ ### 11. Capital inflows to Indonesia since the ### 11. Capital inflows to Indonesia since the ### Overview: trends in foreign liabilities and inflows - Indonesia’s foreign liabilities rose from 55 percent of GDP in 2009 to 67 percent of GDP at end-2015. - Increases in FDI and portfolio liabilities were the main drivers for the overall increase in foreign liabilities; their total share in foreign liabilities increased by 9 percentage points over 2010–15. - At one-half of total capital inflows in Indonesia, FDI flows have acted as a long-term stable source of capital as well as a source of new technology and management practices. ### Investor base and portfolio composition - The investor base shifted towards investors from Europe and the United States; within a larger pie of portfolio claims, investors from the United States and European financial centers (such as Luxembourg, Netherlands, Ireland, and United Kingdom) saw their shares increase. - The share of Singaporean portfolio investors declined, but Singapore investors still dominated short-term portfolio debt claims with a share of 65 percent. - About half of the holders of LCY government bonds are central banks, foreign governments, and mutual funds. - A relatively high share of foreign investors are benchmark-driven EM funds. ### External debt levels and sector composition - External debt to GDP ratio increased from 29¾ percent at end-2009 to 35¾ percent at end-September 2016. - The share of public debt decreased from 57½ percent to 50 percent over the same period. - About 60 percent of the increase in external debt was due to private sector borrowing. - Within the private sector, the external debt of nonfinancial corporate sector stood at 6 percent of GDP. ### Intra-company debt and rollover risk - At end-September 2016, one third of private sector external debt was from either parent or affiliated companies (US$50 billion, 5.5 percent of GDP), with debt from parent companies accounting for 78 percent of such debt. - The share of intra-company loans in external debt was highest among nonfinancial corporate (two-thirds). - This large share of intra-company loans reduces the rollover risk. ### Currency composition and foreign holdings of LCY bonds - About 18 percent of Indonesia’s external debt was denominated in rupiah at end-September 2016, up from 10 percent at end-2009. - Five-fold increase in the nominal value of foreign holdings of LCY government bonds and a doubling of the foreign share from end-2009 to end-2015. - The share of rupiah-denominated public debt doubled from 16¼ percent at end-2009 to 32¾ percent at end-September 2016. - Foreign ownership as a share of foreign reserves is relatively high compared with peers. ### Use of derivatives and off-balance exposure - Foreign investors also use derivatives (Total return swaps (TRS) and credit linked notes (CLN)) backed by LCY government bonds to gain exposure without holding cash bonds. - When local subsidiaries of global investment banks sell TRSs and CLNs to foreign investors, total foreign exposure to LCY bonds could be larger than official reporting because local subsidiaries are considered residents. - Volume of annual CLN issuance averaged at US$1.2 billion in 2011–15, roughly 15 percent of the increase in foreign holding of cash bonds. - Information about the volume of TRSs is difficult to gather; there is no information about the volume of CLNs issued by local subsidiaries of global investment banks. ### Drivers of capital inflows — panel analysis (2009–15, quarterly; 34 countries) - Analysis based on a panel of 34 countries with country fixed effects; coefficients applied to Indonesia-specific and global factors to derive portions of capital inflows explained by each factor (source: Hannan, 2017). - Main findings: - Cyclical factors are significant: growth and interest differences between Indonesia and the United States account for an important portion of capital inflows. - Global risk aversion is important: more global risk aversion leads to low inflows, especially for portfolio debt inflows. - The estimation does not fully capture large fluctuations (for example, the taper tantrum) likely due to large temporary shifts in market expectations and limitations of quarterly regression data. - Table 2 (panel regression results) indicates various coefficients and significance levels for drivers such as growth differential, interest rate differential, reserves, institutional quality, income per capita, global risk aversion (log), global liquidity (growth), and others (observations = 809 for most specifications; number of groups = 34; country fixed effects = YES). ### Drivers of capital inflows — high-frequency (GARCH) analysis for LCY government bonds - Daily data sample: January 1, 2010 to October 31, 2016. - GARCH model specification: - Mean equation models capital inflows to LCY government bonds with autoregressive terms and exogenous regressors. - Conditional variance equation includes GARCH and ARCH terms to model volatility. - Explanatory variables selected for foreign investors’ returns: - Change of the 3-month NDF rate to represent expected movement of the rupiah against the U.S. dollar (hypothesis: more appreciated forward exchange rate persuades foreign investors to purchase more bonds). - Difference between the five-year government bond yield and 3-month JIBOR rate (YIELD5Y - JIBOR3M); hypothesis: a wider spread supports foreign participation. - VIX indicator to capture global financial conditions and perceived risks; higher market volatility should reduce foreign interest. - Lags of explanatory variables used to reduce endogeneity; bond auction date dummy included but not statistically significant. - GARCH estimation results (Table 3) — selected coefficients (mean equation): - C: 105.6 (Standard Error 25.44; z-Statistic 4.15; p value 0.00) - Inflows(-1): 0.2 (Standard Error 0.03; z-Statistic 8.08; p value 0.00) - Inflows(-2): 0.1 (Standard Error 0.02; z-Statistic 4.29; p value 0.00) - NDF3M(-2)-NDF3M(-5): -0.3 (Standard Error 0.02; z-Statistic -15.79; p value 0.00) - YIELD5Y(-2)-JIBOR3M(-2): 3.2 (Standard Error 1.90; z-Statistic 1.69; p value 0.09) - LOG(VIX(-2)): -29.5 (Standard Error 8.69; z-Statistic -3.39; p value 0.00) - Variance equation highlights: - C_var: 314.0 (Standard Error 79.79; z-Statistic 3.94; p value 0.00) - RESID(-1)^2: 0.0 (Standard Error 0.01; z-Statistic 8.77; p value 0.00) - GARCH(-1): 0.4 (Standard Error 0.01; z-Statistic 37.50; p value 0.00) - GARCH(-2): -0.4 (Standard Error 0.01; z-Statistic -35.40; p value 0.00) - GARCH(-3): 0.9 (Standard Error 0.01; z-Statistic 71.92; p value 0.00) - R-squared: 0.188; Adjusted R-squared: 0.185. - Interpretation: expectations of rupiah appreciation are associated with more foreign purchases; wider bond yield–interbank spread encourages more foreign participation; increased global risk aversion reduces foreign exposure; foreign capital inflows exhibit strong persistence (momentum) for up to two days. ### Conclusions and policy recommendations - Benefits of capital inflows: - Enabled financing of current account and budget deficits. - FDI provided long-term, stable capital plus technology and management practices. - Portfolio inflows to LCY government bonds allowed external borrowing in domestic currency at reasonable rates. - Other investment flows complemented domestic banking to supply credit for trade and investment. - Risks and vulnerabilities: - Capital inflows arrive in waves and can transmit global shocks; Indonesia experienced episodes of reversal or sharp declines since the GFC, during which exchange, equity, and bond markets came under pressure. - Resilience improvements: - Improved policy framework (subsidy reform, more flexible exchange rate policy) helped manage risks. - Current account deficit adjusted to the commodity down-cycle; external position broadly consistent with medium-term fundamentals and desirable policy settings. - Current low inflation provided room to adjust macroeconomic policies if needed. - Reserves are adequate to prevent disorderly market conditions. - Further actions recommended: - Structural reforms to attract more FDI inflows, as FDI is less volatile than other capital inflows; the recently partially liberalized FDI regime is a welcome step. - Increase domestic savings, including public sector saving, to reduce reliance on foreign capital; this requires strengthening revenue collection in the post commodity-boom area. - Deepen the domestic capital market to accommodate surges and sudden stops in capital inflows, addressing narrow investor base and low market liquidity that make the government bond market susceptible to heightened market volatility. *Source: Hannan (2017) and IMF staff analysis (chapter on capital inflows to Indonesia).* ### 2. Although there is modest fiscal space in the near term, a countercyclical buffer within ### 2. Although there is modest fiscal space in the near term, a countercyclical buffer within the rule is desired in the medium term. ### Near-term fiscal stance and medium-term target - Findings: - Indonesia’s low debt and deficit levels, small gross financing needs, and other macro indicators suggest modest fiscal space in the near term. - This supports a slightly larger fiscal deficit of about 2¾ percent of GDP in 2016. - In the medium term, aiming for a deficit target of 2¼ percent of GDP would provide a countercyclical buffer of ¾ percent of GDP under the fiscal rule, and boost the economy’s resilience to shocks. - Fiscal strategy design: - The proposed growth-enhancing fiscal strategy would increase revenue and expenditure each by about 3 percentage points of GDP over the medium term. - Revenue mobilization is slightly greater than expenditure expansion, to generate the countercyclical buffer. ### Growth-enhancing fiscal reforms: focus and rationale - Core areas to expand and improve efficiency: - Infrastructure - Health - Education - Rationale: - IMF (2015a) menu: encourage labor supply; enhance investment in physical capital; support human capital development; increase total factor productivity and promote technological progress. - For emerging economies, priority policies include protecting/increasing public capital stock, more efficient public infrastructure, access to education for disadvantaged groups, and expanded basic healthcare access. ### Infrastructure: gaps, execution, and PFM reforms - Findings and statistics: - Total infrastructure spending was 2.5 percent of GDP in 2015, compared to the EM Asia average of 5.1 percent of GDP. - Indonesia’s access to infrastructure is particularly low in electricity, road transportation, and health facilities. - Government’s infrastructure investment plan for 2015−19 is US$480 billion; only about 30 percent will be executed through the central government. - Starting in 2017, 20 percent of the central government transfers to regions via general allocation fund (DAU) and revenue sharing will be earmarked to infrastructure. - Efficiency gap: 56 percent gap between Indonesia and the most efficient countries with comparable public capital stock per capita; averages: emerging market economies 41 percent, emerging and developing Asia 50 percent, all countries 41 percent. - Policy recommendations to improve execution and efficiency: - Streamline the annual budget process. - Develop a multi-year pipeline of high-quality projects by investing in project development. - Encourage use of multi-year contracting and carry-overs, both at the central and local levels. - Improve timeliness and content of information flow to SNGs on special purpose grants (DAK) and line ministry’s own investment plans. - Develop a wide-ranging capacity building plan in the PFM area for SNGs, jointly by Ministry of Finance (MOF) and Ministry of Home Affairs (MOHA). - Simplify and reduce the reporting burden of SNGs. - Coordinate the five central agencies with mandates on public investment (MOF, MOHA, BAPPENAS, KPPIP, TEPRA) more closely and develop a Single Window monitoring system for line ministry and SNG public investments; later integrate PPP and SOE project monitoring. ### Health: coverage expansion and financing implications - Findings and commitments: - Health spending is low in Indonesia compared to peers. - Authorities committed to expand the coverage of public health insurance to 100 percent by 2019. - At present, about 60 percent of the population is covered. - The bottom one third of the population (the poorest 92 million) are included with waivers of health insurance premium (government subsidizes the premium for the poor). - The uncovered 40 percent of the population are self-employed middle-income individuals, who have reportedly purchased private health insurance. - Fiscal implications and projections: - Based on Thailand’s experience with universal health coverage, the share of public spending in total health care spending could rise from 40 percent now to 60 percent over the medium term. - The ratio of public health spending to GDP would reach 2.1 percent of GDP in 2021—0.6 percentage points of GDP above the baseline. - Policy options: - Increase public spending on health infrastructure. - Open up the health sector to the private sector and foreign investors. - Ensure central government legal requirement to allocate at least 5 percent of its budget expenditure on health is supported by outcome-focused fiscal planning. ### Education: efficiency first, then expansion - Findings: - Indonesia’s public education spending is lower than the average level in EM Asia. - Central government legally required to allocate at least 20 percent of its budget expenditure on education, but much of increases are spent on teachers’ compensation (notably through certification programs) without strong links to outcomes. - Policy recommendations: - Review teachers’ compensation system to identify inefficiencies. - Strengthen link between compensation and educational outcomes. - After improving efficiency, expand spending from general primary and secondary education to early childhood, vocational, and tertiary education. ### International experience and benchmarks - Examples: - Malaysia: maintained health and education expenditure at steady levels of 1.5 percent and 5 percent of GDP, respectively; Indonesia’s 2015 spending levels were health 1.3 percent and education 3.5 percent of GDP. - Chile: during fiscal consolidation in the late 1970s, increased public spending on primary and secondary education and primary health care. ### Fiscal space and revenue mobilization constraints - Findings: - General government revenue has trailed behind peers, with the gap widening after 2008. - Sharp decline in oil-and-gas revenue accounted for majority of shortfall; non-oil revenue in percent of GDP remains weak around its 2004 level. - Indonesia’s public expenditures in growth-enhancing areas are below peers due to constrained revenue mobilization capacity. - Indonesia’s C-efficiency ratio is about 0.6 (collects 60 percent of total VAT revenue compared to benchmark taxing all consumption at uniform 10 percent). - CIT productivity (ratio of CIT revenue in percent of GDP to top CIT rate) is low. - Policy implications: - Significant potential to mobilize major non-oil tax revenue by streamlining exemptions, removing differentiated tax rates, and improving tax administration. ### Tax policy reform priorities - Principles: - Increase revenue from the most “growth-friendly” taxes: property tax (least mobile base), indirect taxes (VAT, excise), labor income tax, corporate income tax. - Property tax is growth-friendly but administratively challenging—less suitable for short-term gains. - Indirect taxes (VAT and excise) are growth-friendly and easier to administer—suitable for near- to medium-term revenue gains. ### Value-Added Tax (VAT) reform - Findings and statistics: - Present statutory VAT rate is 10 percent. - Many exemptions on intermediate inputs cause cascading effects. - Revenue losses from VAT exemption of final consumption are about 0.8 percent of GDP. - Cascading tax collected on intermediary consumption is about 0.9 percent of GDP. - Reform scenario: - Any VAT rate increase should be accompanied by removal of exemptions on both intermediate and final consumption. - Example: increasing the VAT rate in stages to 15 percent (maximum allowed in current legislation) while removing exemptions could increase VAT revenue by at least 1.8 percentage points of GDP in the near to medium term. - Administrative improvements: - Simplify complex VAT return that currently requires itemization of transactions that can amount to millions between taxpayers each month. - Shorten and streamline refund procedures (regular taxpayers are audited prior to receiving a refund payment; delays from refunds related to about 2,000 bonded zones and 600 bonded warehouses). ### Excise tax reforms - Near-term revenue potential and measures: - Vehicle tax: rebase from ad valorem Sales Tax on Luxury Goods (STLG) to an excise on motor vehicles based on CO2 emissions; could generate additional revenue up to 1 percentage point of GDP. - Tobacco excise: streamline and increase rates; current 13-tier specific rates could be simplified; Indonesia has high smoking prevalence but tax burden below regional average. - Environmental (fuel) taxes: introduce environmental tax; an environmental tax of Rp 1,000/liter for gasoline and Rp 500/liter for diesel would generate an estimated 0.3 percent of GDP of new revenue and support Indonesia’s Paris Agreement pledge to lower greenhouse gases by 29 percent below “business-as-usual” levels by 2030. ### Corporate Income Tax (CIT) and international taxation - Findings: - Current statutory CIT rate is 25 percent. - Numerous preferential low-rate regimes exist: - 1 percent tax on gross revenue for SMEs below an annual turnover of Rp 4.8 billion. - Rate reduction of 50 percent up to taxable income corresponding to gross turnover of Rp 4.8 billion for medium-sized enterprises up to an annual turnover of Rp 50 billion. - Reduced rate of 20 percent for publicly listed companies. - Policy recommendations: - Consolidate regimes for companies above the SME threshold of Rp 4.8 billion and apply a single and modestly lower CIT rate in a revenue-neutral manner. - Strengthen anti-avoidance measures (permanent establishment, transfer pricing, thin capitalization, controlled foreign corporations). - Implement G20/OECD BEPS project outcomes, adapted to Indonesia’s capacity and circumstances (careful, phased implementation). _International Monetary Fund_ ### 20. Property tax could be gradually increased while the administration capacity is ### 20. Property tax could be gradually increased while the administration capacity is ### Property tax: findings and recommendations - Recurrent property tax in the form of “land and building tax” has been decentralized; the central government sets the maximum rate municipalities may adopt. - Current rates range between 0.1−0.3 percent of the assessed value. - Total revenue from property tax was only about 0.6 percent of GDP in recent years, compared to the worldwide average of 1 percent of GDP. - Potential to increase revenue by about 0.2 percentage points of GDP in the medium term by increasing the maximum rate set by the central government. - As capacity to register and assess property values is strengthened over the medium term, additional property tax could gradually replace: - the central-government transaction tax of 2.5 percent of property transaction values, and - local government stamp duties of 5 percent of property transaction values. ### Personal Income Tax (PIT): findings and recommendation - The top PIT rate is 30 percent for income over 15 times GDP per capita. - The top-rate threshold is high compared to peers: OECD (3.8), Singapore (4.9) and Malaysia (3.1). - Policy recommendation: consider a revenue-neutral change that broadens the base of the top PIT rate by lowering the threshold to 7 times GDP per capita (about half of current), while lowering the top rate slightly, thereby broadening the tax base for the top 3 percent of the income distribution. ### Revenue administration reform: three components - Three critical components to pursue: 1. Improve tax collection efficiency. 2. Strengthen the business environment. 3. Strengthen the institution of tax administration. #### Improve tax collection efficiency: four suggested reforms - Develop strategies to boost compliance for a few major taxes: - Segment taxpayers; for each segment: (1) identify and rank main compliance risks; (2) develop treatments for mitigating risks; (3) provide performance criteria and indicators to measure impacts. - Short-term focus: VAT and employer withholding of personal income tax, targeting large taxpayers and top-end medium taxpayers in major centers. - Extended audit coverage through more specific-issue audits based on risk: - Specific-issue audits focus on a limited number of issues and can be completed faster than comprehensive audits, allowing greater coverage. - Numerical target example: specific-issue audits could comprise at least 50 percent of all audits conducted in one year. - Use external information for data matching and pilot risk-based case selection: - Prioritize two or three high priorities for exchange of information targeting highest risk areas (examples: payments of investment income to individuals from financial institutions; real property purchases from property registers; automobile registrations from the motor vehicle department). - Use matched data to pilot more targeted case selection. - Move the Extensification program toward a targeted campaign: - Focus on a few high-risk sectors in the informal economy and on increasing registration and filing of registrants with significant tax potential. - Use project-based approaches targeting sectors and individuals that pose the highest risk to tax collection. #### Strengthen the business environment: suggested reforms - Conduct a comprehensive review of tax legislation and regulations to remove ambiguities and inconsistencies that create uncertainty for taxpayers and investors. - Expand the number of taxpayers eligible to receive VAT refunds without a prior audit: - Revisit criteria for ‘golden’ and ‘low risk’ taxpayers so more taxpayers could receive refunds without an audit. - Issue enhanced guidance on audit techniques and technical issues and implement a process ensuring consistent application: - Introduce an up-skilling program focused initially on auditors and make it mandatory for auditors to follow published guidance. #### Strengthen the institution of tax administration: suggested reforms - Strengthen the Directorate General of Taxes (DGT) through incremental reforms and consider management and ministerial performance agreements: - Consider making the Director General subject to a performance agreement with a small set of performance measures based on tax administration results and taxpayer satisfaction (performance measures should not include or give undue weight to a revenue collection target). - Establish a consultative forum with business representatives to discuss areas of concern in tax administration. - Put in place a strong reform-management team and establish a comprehensive tax revenue strategy comprising short- and medium-term actions on tax policy and administration. - Explore avenues to grant the DGT additional management and administrative flexibility to facilitate modernization. #### Caution on creating a semi-autonomous revenue agency (SARA) - The revenue administration reform bill envisions a SARA, but: - No “one-size fits all” arrangement for tax administration exists. - Risks of establishing SARA appear to outweigh potential benefits in the current context. - Structural institutional change would lead to considerable transition costs (staff separation, new systems) that could overwhelm other reform efforts while revenues are already significantly below levels needed to support growth-enhancing spending priorities. ### Growth and equity: balancing revenue and expenditure reforms - The recommended mix of revenue and expenditure reforms aims to promote growth while maintaining or improving equity. - Revenue-side considerations: - Raising property tax could be highly progressive. - Reliance on increasing indirect taxes (VAT and excise) tends to be regressive. - Increasing the more progressive PIT could have a negative impact on growth. - Expenditure-side measures to offset regressivity: - Increase expenditure on public health and education to provide more equitable access for the poor, promoting both growth and equity. - Social assistance reforms: - Current social assistance programs lack coverage and adequacy; many poor and vulnerable households do not receive all eligible benefits. - Authorities intend to replace general price subsides, including energy subsidies, with more targeted cash transfers. - An integrated database for social assistance (PBDT) has been developed covering the bottom 45 percent of the income distribution. - Medium-term consideration: introduction of a means-tested Guaranteed Minimum Income program once administrative capacity is developed. ### Prioritization and implementation of the strategy - Implementation in stages; not all reforms should be simultaneous. - Near-term priorities: - Improve quality of spending. - Raise revenues through higher excises (tobacco excise, environmental tax on fuel products, etc.). - Start phased move to a risk-based tax administration regime. - Prepare to upgrade key tax laws. - The revenue strategy is central to enabling growth-enhancing expenditure policy; design of the revenue strategy could begin immediately to set the stage for gradual expenditure expansion over the medium term. - Expected impact: - The menu of policy options summarized in Table 2 are expected to increase potential growth to 6 percent by 2021. - Selected entries from Table 2 (In percent of GDP): - Total revenue policy: 3.0 - Value-added tax: 1.8 — Increase rate from 10 percent to 15 percent while removing exemptions. - Excise taxes: 1.0 — Increase vehicle and tobacco excise rates and impose environmental tax on fuel. - Personal income tax: 0.0 — Remove exemptions and lower top rate in a revenue-neutral manner. - Corporate income tax: 0.0 — Remove exemptions and lower statutory rate in a revenue-neutral manner. - Property tax: 0.2 — Increase rate and gradually replace transaction tax with recurrent property tax. - Total expenditure policy: 2/2.7 - Health: 0.6 — Implement universal health coverage while improving efficiency. - Education: 0.8 — Increase education expenditure toward EM average (4.8 percent of GDP) while improving efficiency. - Social Assistance: 0.1 — Consolidate poorly-targeted programs. - Infrastructure: 1.3 — Increase investment expenditure toward 5 percent of GDP while improving efficiency. - Other expenditure: -0.1 — Cut nonpriority expenditure. - Note: 2/ Positive sign means more expenditure. 1/ Positive sign means more revenue. *International Monetary Fund (excerpt from the Indonesia country report content provided).* ### 10. Indonesia operates a "worldwide" tax system, in which its resident taxpayers are ### 10. Indonesia operates a "worldwide" tax system, in which its resident taxpayers are ### Worldwide versus territorial regime: considerations and findings - Indonesia currently operates a "worldwide" tax system: resident taxpayers are subject to income tax on both domestic and foreign-source income; foreign tax credit (FTC) is provided for income taxes paid abroad. - The government is considering switching to a "territorial" system that would exempt foreign earnings from domestic taxation. - Practical design notes on territorial systems: - Best practice territoriality typically exempts only participating dividends received by resident corporations. - Portfolio dividends and all foreign income received by individuals normally continue to be taxed on a worldwide basis to discourage offshore passive investment and to ensure fairness and progressivity. - Income other than dividends (including interest and royalties) that is deductible in the source jurisdiction should always be taxed on a worldwide basis. - These features limit simplification benefits because FTCs must still be tracked for income other than participating dividends. - Repatriation incentives and tax-rate interactions: - Territoriality can reduce disincentives to repatriate foreign earnings; the U.S. example of more than US$2 trillion in un-repatriated earnings illustrates the potential shortcoming of worldwide systems with high domestic CIT rates. - The disincentive to repatriate depends critically on the domestic/foreign CIT rate differential. Ireland has a worldwide system but its low tax rate of 12.5 percent effectively functions as territoriality. - Indonesia's CIT rate, at 25 percent, "should not produce excessive distortions such as in the U.S. system." - Revenue and investment implications: - Territoriality is likely to reduce revenues and, relative to a worldwide system, can encourage outbound investment. - Repeal of repatriation taxes can increase tax rate differentials and exacerbate incentives to shift income from high-tax to low-tax jurisdictions. - Under territoriality, controlled foreign corporation (CFC) rules need to be strengthened to distinguish active (exempt) from passive (taxed) foreign income. - Overall assessment: - "On the whole, there does not thus appear to be a strong case for Indonesia to switch from a worldwide to a territorial system." ### Bilateral tax treaties: scope, risks, and strategy - Characteristics and trade-offs: - Bilateral tax treaties aim at alleviating double-taxation and favor the principle of residence over source taxation. - The main trade-off in entering treaties is reducing the domestic tax base (mainly via lower cross-border withholding tax (WHT) rates) in hopes of attracting greater foreign investment. - Empirical evidence on whether treaties stimulate FDI is mixed; some evidence indicates treaties stimulate FDI particularly in middle-income countries. - Indonesia-specific treaty observations: - Indonesia has 66 bilateral treaty partners. - With more than half of its treaty partners, Indonesia has less than US$100 million in FDI (inbound or outbound). - Few of Indonesia’s tax treaties reduce its domestic-law cross-border WHT rate of 20 percent to less than 10 percent. - Suggested strategic elements for treaty policy: - (i) Set reasonable parameters in domestic law so countries without a treaty are not discouraged from investing; definitions of source, residence, and permanent establishments should accord with international norms. - (ii) Consider offering a participation exemption or reduced WHT for cross-border participating dividends, similar to domestic corporations. - (iii) Use one model treaty to negotiate with all countries; set minimum reserve values (e.g., for WHT rates) below which the government will not negotiate. - (iv) All treaties should include provisions for exchange of information (EoI); for non-treaty countries, EoI can be provided by the OECD/G-20 Convention on Mutual Administrative Assistance in Tax Matters. - Where mutual economic relations do not merit a bilateral double tax agreement, consider tax information exchange agreements (TIEAs). ### BEPS commitments, priorities, and implementation issues - Indonesia has endorsed the BEPS Action Plan agreements as reflected in BEPS 2015 Final Reports. - Existing domestic instruments relevant to BEPS: - Indonesia already has CFC rules, transfer pricing "arm's length principle" regulations, requirements for related-party documentation, and anti-avoidance measures (e.g., thin capitalization). - Key implementation questions: - (i) Which BEPS recommendations are relevant and best for net capital-importing countries?; - (ii) Is there sufficient institutional capacity to implement them?; - (iii) If not, what capacity-strengthening measures are needed? - Countries may also implement anti-avoidance measures not covered by BEPS (e.g., capital gains taxation of indirect offshore asset sales). - BEPS action items prioritized for Indonesia: - Strengthening CFC rules (Action 3). - Limiting base erosion via interest deductions (Action 4). - Addressing artificial avoidance of permanent establishment (PE) status, especially in the digital economy (Action 7). - As a G-20 country, Indonesia committed to implementing the four BEPS "minimum standards": countering harmful tax practices (Action 5), preventing "treaty-shopping" (Action 6), implementing country-by-country (CbC) reporting (Action 13), and improving dispute resolution effectiveness (Action 14). ### CFC rules: current limits and recommended tightening - Purpose: - CFC rules allow the resident jurisdiction to attribute income earned by foreign subsidiaries to resident shareholders to combat profit shifting and deferral. - Current limitations: - Indonesia's current CFC rules are limited to corporate shareholdings and can be avoided with interposed foreign trusts and foreign partnerships. - Without strong anti-fragmentation rules, ownership can be fragmented among group members or affiliated companies to fall below domestic control tests. - Recommended broadening aligned with BEPS Action 3: - Widen scope to capture indirect ownership and tighten anti-fragmentation rules. - Three suggested control tests: - Test 1: Capture situations where five or fewer Indonesian residents have at least 50 percent associate-inclusive control interests in a foreign company (control interests include indirect ownership). - Test 2: Capture individuals with at least 40 percent associate-inclusive control interests (direct and indirect), unless another person has a higher interest (assumed controller). - Test 3: If five or fewer Indonesian residents either alone or together with associates control the foreign company—de facto controllers—it will be classified as a CFC (e.g., evidence of email messages or directions from residents controlling the CFC and directors following directions). ### Interest deductions, thin capitalization, and earnings stripping - Background and risk: - Excess debt and interest deductions are common BEPS techniques because interest is deductible while dividends typically are not under standard CIT. - Allocating debt to affiliates in high-tax countries and equity to affiliates in low-tax countries reduces multinational groups' overall tax liabilities. - In 2014 more than one-third of all inward direct investment in Indonesia was financed by debt (Table 1). - Current Indonesian rule: - In September 2015 Indonesia introduced a "thin capitalization" rule (MOF Regulation 169/PMK.010/2015) restricting interest deductibility for companies with more than a 4:1 debt-to-equity ratio. Debt includes both short-term and long-term debts as well as interest-bearing trade payable; both related party loans and loans from independent lenders are included. The regulation became effective in 2016. - Effectiveness analysis (ORBIS database simulations): - The current debt-to-equity ratio of 4:1 affects only 3.8 percent of MNEs. - Halving the ratio to 2:1 would constrain only 10.1 percent of the MNEs. - By contrast, restricting net interest deductibility to specific net interest-to-EBITDA ratios would affect far more firms: - 30 percent of EBITDA: would affect 39.7 percent of firms. - 20 percent of EBITDA: would affect 50.7 percent of firms. - 10 percent of EBITDA: would affect 64.3 percent of firms. - Recommendation: - Augment the current thin capitalization rule with an “earnings stripping” rule consistent with BEPS Action 4, denying deductibility of interest expense in excess of a percentage of EBITDA. Consider restricting net interest deductibility to at most 30 percent of EBITDA. ### Digital economy, permanent establishment (PE) definitions, and anti-fragmentation - Digital economy challenge: - The digital economy challenges PE concepts designed for "brick-and-mortar" environments. Indonesia formed a team to focus on taxation of e-commerce (June 2016) and has investigated internet-based companies; reports indicate Indonesia has asserted intention to tax advertising income of internet enterprises. - BEPS Action 1 addresses digital economy issues, and BEPS Action 7 concerns avoidance of PE status. - Recommended PE reforms: - Consider modifying the definition of a PE in domestic law and tax treaties to address techniques used to avoid PE status. - Adopt an expanded PE definition to lower the PE threshold for "commissionaire arrangements" and include anti-fragmentation measures consistent with BEPS Action 7. - Incorporate the new PE definition from BEPS Action 7 in future tax treaties and the revised income tax law. - If Indonesia joins the Multilateral Instrument (MLI), consider implementing BEPS Action 7 in existing treaties through the MLI. ### Transfer pricing administration and capacity building - Legal framework and guidance: - Indonesia is strengthening its legal framework for transfer pricing adjustments by upgrading DGT regulation PER-32/PJ/2011 into a Ministry of Finance regulation (PMK). - BEPS Actions 8–10 guidance focuses on valuation of intangible assets and transfer pricing risk analysis. - Administrative recommendation: - To more effectively administer transfer pricing rules, the DGT should consider establishing a specialized transfer pricing unit. - Current practice: most transfer pricing queries arise during regular tax audits and are addressed by regular audit teams. - Rationale: transfer pricing analysis is highly specialized; specialist auditors could better analyze related-party documents, select taxpayers for audit, train regular audit teams, and build capacity. ### BEPS minimum standards, harmful tax practices, and treaty-shopping - BEPS Action 5 (countering harmful tax practices): - Requires elimination of certain preferential regimes and transparency about regimes granted via individual resolutions through sharing information (including unilateral APAs and private PE rulings). - Special attention is on preferential IP regimes ("IP boxes"); Indonesia does not offer preferential IP regimes and has joined the Forum on Harmful Tax Practices. - Where necessary, existing IP regimes will need amendment and transparency will be achieved through compulsory spontaneous exchanges of information. - BEPS Action 6 (preventing treaty-shopping): - Treaty-shopping occurs when an investor from Country A invests in Country B via an entity in Country C to exploit C–B treaty benefits and reduce WHT (illustrative hypothetical structure described). - Indonesia’s tax treaties generally provide weak protections against treaty shopping, with exceptions (India, Hong Kong SAR, United States). - Current measure: Indonesia uses a “beneficiary ownership” (BO) test limited to conduits and nominees; interposed entity structures may satisfy BO while not satisfying a principal or specific purpose test. - Indonesia has required certification of domicile (Form DG-1 or DG-2) for each cross-border transaction, imposing a significant compliance burden; where treaties do not authorize this, it can strain relationships. - Recommendations: - Consider implementing BEPS Action 6 by including a principle or specific purpose test in all future treaties and treaty revisions. - Require Form DG-1/2 only once a year to reduce compliance burden. - If joining the MLI, implement BEPS Action 6 for existing treaties through the MLI. *Source: IMF staff report text (chapter excerpt provided).* ### 32. One of the most significant BEPS Project measures has been adoption of CbC reporting ### 32. One of the most significant BEPS Project measures has been adoption of CbC reporting ### Country-by-Country (CbC) Reporting and BEPS Action 13 - CbC requires MNE parent companies to submit detailed documentation on their global operations broken down by country. - Purpose: help tax administrations improve the efficiency and effectiveness of assessing transfer pricing and other BEPS-related risks. - Legislative provisions governing the three-tier CbC process—the Master File, the Local File and the CbC report—have been drafted by the Ministry of Finance and are expected to be finalized by the end of 2016. - CbC reporting requirements are limited to companies with annual turnover of at least Rp 11 trillion (about US$824 million). - Notes on the three-tier files (as provided in the source): - Master file will contain a high-level information on global MNE business operations and transfer pricing policies; it will be available to all relevant country tax administrations. - Local file will require more transactional transfer pricing documentation in each country. - CbC reports should be filed in the jurisdiction of tax residence of the ultimate parent entity and shared between jurisdictions through automatic exchange of information. ### Dispute Resolution: MAP and APAs - A dispute resolution team was created in 2016 to deal with mutual agreement procedures (MAP) and APAs. - Purpose: enable the Indonesian competent authorities and their staff to specialize in tax treaty dispute resolution. - MAP provides opportunities to settle disputes where tax treaties are not effective, and is usually engaged when there is a case of genuine double taxation that needs to be resolved. - Policy impact: Seeking to resolve MAP cases provides businesses with confidence that double taxation can be avoided. - Institutional detail (as provided in the source): - The Minister of Finance is the designated competent authority, delegated to the Director of Tax Regulation II of the DGT. ### Exchange of Information (EoI) for Tax Purposes - Context: With increasing economic integration, exchange of information for tax administration purposes has become more prominent and necessary to combat international tax evasion and promote compliance. - Indonesia is well-advanced in building architecture for exchange of information. - Global Forum peer review findings (Global Forum, 2014): - Domestic legislative provisions are largely in place. - Phase 2 peer review suggested bringing Indonesian laws to access bank information and information on securities accounts held by custodians into line with international standards. - Current limitation: Indonesian competent authorities can only obtain information directly where the information is available from the tax administration database. - Where information needs to be collected from a bank or about securities account, additional approval is necessary from Bank Indonesia or the Financial Services Authority. - To obtain such approval, the name of the taxpayer holding the bank or securities account, or in the case of securities account, the account number must be provided—this is not in accordance with international standards, which only require that the taxpayer be “identified” (Global Forum, 2014). ### Commitments to the Common Reporting Standard (CRS) and Automatic Exchange of Information (AEOI) - Key steps taken: - Indonesia committed to implement the common reporting standard (CRS) for Automatic Exchange of Information (AEOI). - Indonesia signed the multilateral Convention on Mutual Administrative Assistance in Tax Matters (the Convention) in November 2011; the Convention is effective from May 2015. - As of June 2015, Indonesia is a signatory of the Multilateral Competent Authority Agreement (MCAA)—an administrative agreement between competent authorities that provides the modalities for AEOI. - Domestic legislation status (as of December 2016): - Indonesia’s primary legislation is considered to be in place to enable submission of first CRS reports on September 2018. - Other requirements, such as secondary legislation, will need to be addressed. - Note on CRS monitoring: - The Global Forum monitors the CRS implementation of all committed jurisdictions. ### Cross-cutting implications for tax administration and business - Expected outcomes from CbC and EoI implementation: - Improved ability of tax administrations to assess transfer pricing and BEPS-related risks. - Greater transparency and international cooperation in tax matters through legal and administrative frameworks (Convention, MCAA, CRS). - Remaining legal and operational gaps to align fully with international standards, particularly access to bank and securities account information without requiring account identifiers in advance. *INDONESIA — INTERNATIONAL MONETARY FUND (cr1748).* ### 12. This section briefly describes the main five social assistance programs with references ### 12. This section briefly describes the main five social assistance programs with references ### Overview and expenditure/coverage trends - Table 1 summarizes Central Government Expenditure of main social assistance programs, 2004-16 (In trillions of rupiah). Key program expenditures reported: - Jamkesmas/JKN-PBI: --, 3.00, 4.40, 4.76, 7.30, 19.90, 25.50 - Raskin/Rastra: 4.80, 5.30, 12.10, 13.92, 20.92, 18.10, 22.50 - BLT/BLSM: --, 18.60, 13.90, --, --, 6.20, -- - BSM/PIP: --, --, 1.20, 3.60, 5.40, 6.60, 14.00 - PKH: --, --, 0.94, 1.12, 1.90, 5.20, 9.00 - Table 2 summarizes Target Beneficiaries of main programs, 2004-16 (In millions of households and individuals 1/). Key targeted beneficiary figures reported: - Jamkesmas/JKN-PBI (Ind): --, 60, 76.4, 76.4, 86.4, 92.2 - Raskin/Rastra (HH): 8.5, 10.8, 19.1, 17.5, 17.5, 15.5, 15.5 - BLT/BLSM (HH): --, 17.1, 19, ----, 15.5, -- - BSM/PIP (Ind): ----, 4.6, 5.8, 9.5, 11.2, 19.2 - PKH (HH): ----, 0.7, 2.0, 0.8, 1.5, 12.8, 6 - Sources for the tables: For 2004-10, 2012 Indonesia Social Assistance Public Expenditure Review; and for 2011-16, revised Budget from Ministry of Finance, Financial Note and BAPPENAS. ### Penerima Bantuan Luran—Jaminan Kesehatan Nasional—PBI-JKN (PBI) - Key facts and coverage: - PBI is a health insurance fee waiver, previously known as Jamkesmas. - Managed by The Ministry of Health and BPJS Health. - Covers over 92 million individuals (approximately one-third of the population) in 2016. - 2016 cost: Rp 25.5 trillion. - Targeting performance: - Targeting outcomes are “relatively good but appear to have slightly worsened.” - Reasons for worsening: coverage expansion; initial quota generation method vs. locally-based identification in 2012; beneficiary list issues during Jamkesmas merge into JKN-PBI in early 2014; beneficiaries often unaware of benefit extent. - Implementation and reform recommendations: - Increase outreach, facilitation and beneficiary support to improve utilization. - Promote greater dissemination of information to beneficiaries about the scope of PBI-JKN health care coverage and standards of practice. - Merge PBI monitoring of the healthcare service sector with that of the JKN system. ### Beras Sejahtera—Rastra (formerly Raskin) - Key facts and coverage: - Implemented by the Ministry of Social Affairs and Bulog, the State Logistics agency. - 2016 target: 15.5 households; 2016 expenditures: Rp 22.5 trillion. - Performance and issues: - “Rastra remains the least well targeted of any Indonesia’s SA programs.” - Survey estimates: 28.6 million households (just over 40 percent of the total population) are receiving Rastra, with only 57 percent of beneficiaries being in the poorest 40 percent. - Actual per-household receipts: households are receiving only 4 kilograms per household per month, 11 kilograms less than households should be receiving. - Problems: dilution of benefits due to village-level re-allocation to non-poor households; missing rice; hidden financing burdens; lack of clarity on responsibilities and financing at the “last mile”; remote households receive a lower per-kilogram benefit than promised. - Reform recommendations: - Base allocations exclusively on the UDB and monitor allocations and ‘last-mile’ rice delivery with stronger oversight. - Continue experimenting with different delivery modalities: in-kind, in cash, or a monetized transfer to be spent only on Rastra rice or other staple goods. - Implement and closely monitor the planned e-voucher reform initiative (E-Warong) in 44 cities in early 2017; evaluate closely as it scales up. ### Program Indonesia Pintar—PIP (formerly BSM) - Key facts and coverage: - Scholarship program for poor students implemented by the Ministry of Education and The Ministry of Religious affairs. - 2016 target: 19 million students; 2016 budget: Rp 14 trillion. - Targeting and impacts: - PIP has matured and begun demonstrating full potential; contributes to welfare of poor and near-poor households and to universal basic education goals. - 2015 targeting outcomes improved over 2013 BSM: incidence for poorest decile decreased from 22 percent to 20 percent; vulnerable increased from 42 percent to 47 percent; non-poor decreased from 18 percent to 14 percent. - Exclusion and inclusion errors declined but exclusion errors remain high, possibly due to low program uptake or procedural requirements (KPS or KKS card). - Reform recommendations: - Focus on continuous and coordinated monitoring, evaluation, and improvements in delivery. - Address institutional fragmentation between the two implementing Ministries. - Update benefit levels more frequently to keep transfers relevant. - Strengthen outreach to poor students approaching senior secondary or university levels; develop beneficiary support modules for senior secondary and university level drop-outs. ### Bantuan Langsung Sementara Masyarakat—BLSM (formerly BLT) - Key facts and coverage: - Unconditional Cash Transfer implemented by the Ministry of Social Affairs. - Targeted the poorest 25 percent of households (15.8 million in 2015). - Payment design: monthly payments of Rp 150,000 for seven and six months respectively for each tranche. - Total budget disbursed in 2015: Rp 14.6 trillion. - Impacts and evidence: - Effective in preventing an increase in poverty due to increased fuel prices; the poverty rate fell by about 1 percentage point during the BLT UCT implementation. - No evidence that UCT or CCT affects labor supply or generates dependency; BLT transfer comprised about 15 percent of household monthly expenditure. - Targeting performance: - BLSM shows better targeting outcomes compared with similarly sized programs. - In 2013 incidence to target group (poorest 25 percent) is around 45 percent; similar in 2014 BLSM round. ### Program Keluarga Harapan—PKH - Key facts and coverage: - PKH is Indonesia’s CCT program implemented by the Ministry of Social Affairs. - 2016 scale-up target: reach 6 million families in all districts at a budget of Rp 9 trillion. - Impacts: - PKH has generated significant and positive impacts in welfare, health, education and nutrition-seeking behavior. - Midline evaluation impacts: prenatal care (at least four visits) increased by 9 percentage points; newborn delivery at a facility or attended by a professional increased by 5 percentage points; post-natal care improved by almost 10 percentage points; immunizations increased by 3 percentage points; growth monitoring check-ups increased by 22 percentage points. - Targeting performance: - Relatively well targeted. 2014 distribution of benefits: poorest 10 percent received over one third of benefits; bottom 20 percent received over half; bottom 30 percent received over two-thirds. - PKH’s use of UDB-based beneficiary identification and verification with two-way dynamic updating contributed to better targeting. - Program is small and focused on the poorest 10 percent: inclusion errors very low; exclusion errors very high. - Reform recommendations for scale up: - Strengthen institutional capacity, IT and HR systems, and capacity of affiliated service providers (requires higher level coordination). - Enhance core functions: timely verification of beneficiaries’ status and conditionality fulfillment; regular MIS updating; adjustment of benefit levels and timely disbursements; determine local capacity for distributing benefits; remediate local supply inadequacies in health and education; improve program socialization. ### Looking Ahead: gaps, system-wide reforms, and crisis response - Coverage gaps and program fragmentation: - Not all household risks are covered: old age and disability programs (ASLUT and ASODKB) exist but are low in coverage. - No social assistance program to foster poor household low-cost access to early child hood education and development services (ECED). - Active support for livelihood and labor market activation exists in scattered programs (e.g., Sustainable Livelihoods initiative P2B launched in 2015) across many Ministries; effectiveness and scalability unclear. - Actionable reform: evaluate, consolidate where appropriate, and promote scale up of existing programs. - Crisis Monitoring and Response System (CMRS): - Indonesia’s nascent CMRS should be fully operational and automatically activated as part of the social safety net when needed. - A functioning monitoring system exists but depends on timely, high quality data across several agencies. - Response protocols are needed so programs can be automatically funded, activated, and implemented without delays from budgetary and parliamentary procedures. - System-wide recommendations to improve social protection: - Some programs will need higher budget allocation and reforms targeted at: - increased coverage (PKH); - increased benefit levels (PKH and PIP); - revised delivery system (Rastra); - standardized systems for monitoring and evaluation, grievance redress, socialization and feedback (all programs). - Tying programs together requires more cross-ministerial coordination and standardized use of the UDB toward a more dynamic and open targeting system. - Continue moving social assistance spending away from universal subsidies toward targeted programs; consider expansion or integration of existing smaller programs as well as creation of new programs to cover risks such as disability, old age, inadequate skills, stunting, and lack of access to early child hood education. *Source: cr1748 - 12. This section briefly describes the main five social assistance programs with references* ### 1. Total investment in the global and ### 1. Total investment in the global and ### B. Overview of Investment Trends in Indonesia - Total investment in the global and regional economies has slowed over the past several years, driven by private investment; global investment slowed into 2016, well below levels prior to the Global Financial Crisis (GFC). - Private investment accounts for around 90 percent of total investment (IMF, 2015b). - In Indonesia: - Investment has risen relative to GDP by around 10 percentage points since the early 2000s and now accounts for more than a third of output. - Private investment constitutes around 90 percent of total investment. - During the commodity boom in 2011–12, investment contributed to as much as half of economic growth. - Private investment has markedly slowed since 2014, with weakness intensifying into 2016:H1; high frequency indicators showed little recovery into Q3:2016, with early signs of stabilization in Q4:2016. - Slowdown in private investment is more distinct in Indonesia than EM peers. - Public sector investment has picked up following 2015 reforms: - Central government increasingly channels investment through local governments and encourages SOEs to ramp up capital spending. - Capital expenditure of SOEs doubled in 2016, and is expected to rise by around 35 percent in 2017. - Most spending is centered on energy, mining and exploration, and transportation. ### C. Cyclical Factors - Dependence on commodity sector since 2010: - Commodity-sector investment surged during the commodity boom until 2013 and accounted for half of annual realized investment during that period. - Investment growth in Kalimantan and Sumatera reflected the commodity-driven surge. - Post-super-cycle slowdown: - Investment growth in the commodity sector stalled; manufacturing investment contracted. - Commodity price fall produced supply glut and slack capacity utilization; some mining firms closed or reduced employees and faced debt-servicing difficulties in 2015. - Manufacturing investment slowed markedly since 2014 due to weak economic activity, slump in selling prices, and tighter borrowing conditions (e.g., weak rupiah). - Many manufacturing firms operated on existing facilities rather than launching new projects. - Cash flow constraints: - Cash buffers are important due to corporates’ reliance on internal cash flows amid limited financial deepening. - Cash flows (EBITA) showed a sharp decline in non-commodity manufacturing; commodity sector showed a similar but lesser trend and recent partial recovery. - Despite falling cash flows since 2011, Indonesia’s corporate profitability remains the highest among EM peers. - Macrofinancial linkages: - Corporate borrowing from banks and overseas slowed as corporates consolidated and deleveraged, particularly foreign currency denominated debt. - Tepid credit demand was a main driver of weak credit growth; firms also faced tightened financial conditions from reduced cash flows and tightened lending standards in some banks. - Banks became more cautious amid weak activity, increased NPLs, and tighter liquidity due to slowing deposit growth. ### D. Structural Factors - Manufacturing investment constrained by high fixed costs and structural impediments: - Shift-share analysis suggests manufacturing and utilities investment lag national investment trend; commodity and domestic consumption-related industries exceeded it. - High-cost structural factors include weak infrastructure, uncertain investment climate, and low labor productivity driven by rigid labor markets and labor skill gaps. - Government actions and outcomes: - Government delivered 14 economic policy packages since August 2015 aimed at enhancing the investment climate through deregulation, cutting bureaucracy, one-stop shops, and rationalizing permit and license procedures. - The FDI regime was partially liberalized in May 2016 (most significant move since 2007), removing foreign ownership caps on 35 industries and allowing majority foreign ownership for selected sectors, while limiting access to some sectors to protect SMEs. - World Bank Doing Business ranking improved by 18 positions to 91 position in 2016; authorities aim to improve it to within the top 40 in the near future. - Remaining structural bottlenecks: - Inadequate infrastructure, particularly logistics and energy: - Underdeveloped infrastructure is the most important barrier to manufacturing investment and the third most important in services. - Weak road conditions and blackouts accounted for 4½ percent and almost 6 percent of total annual sales, respectively; ownership of electricity generators for back-up power reached more than 60 percent in 2014. - Weak investment climate with high regulatory compliance costs: - Inconsistent regulations across government layers, burdensome local regulations (nontariff trade barriers, local content requirements, license regulations), and concerns about policy continuity and transparency. - FDI regime exhibits frequent and uncertain changes; 2016 revision strengthened protection for domestic corporates in some areas, potentially undermining investor confidence. - Rigid labor market and skills gap: - Indonesia has one of the most rigid labor markets among EM peers, including high severance pay and complex dismissal procedures. - Rigid practices led to proliferation of short-term contracts, hampering workplace skills accumulation; labor productivity gains lag global trends and EM peers. ### E. Weak External Linkages - FDI regime modernization since August 2015 aims to improve external linkages; prior to reforms, FDI regulations had become more restrictive, especially in the primary sector, with rigid foreign equity and experienced foreign personnel restrictions. - Exports and imports lag global trends and regional peers; exports decelerated since 2011: - Commodity exports (coal, crude, palm oil) account for more than half of total exports. - Weak growth in manufacturing exports reflects structural constraints. - Indonesia’s share of the world market for manufactured goods fell to 0.6 percent in 2013 from 1.2 percent in 1995. - Weak integration into global value chains and low services contribution: - Foreign value-added share of gross exports declined since the Asian financial crisis; latest available data show foreign value relative to gross exports around 12 percent, versus 30−40 percent in Malaysia, Thailand, and China. - Low foreign value contribution aligns with restrictive FDI regulations in services (e.g., hiring experienced foreign personnel), which hampers services that rely on qualified personnel. - Services’ contribution to industry is weak across industries (mining, food, chemicals), indicating room to strengthen services to boost competitiveness and investment. ### F. Drivers for Private Investment in Indonesia (Empirical Analysis) - Hypothesis: Investment driven by firm-level factors (cash flows, access to finance) and affected by macro-level factors (macroeconomic instability, international financial volatility, policy uncertainty); structural bottlenecks that raise fixed costs and undermine earnings also matter. - Data and model: - Firm-level panel fixed effects model based on Magud and Sosa (IMF, 2015b). - Sample: firm-level data of 370 listed Indonesian corporates for 2007−15; macro variables include rupiah volatility (3 months), stock index volatility, and VIX. - Model specification (symbols explained in text): I/K, CF (EBITA), ∆Debt, Int (effective interest rate), Q (Tobin’s Q), FX vol (rupiah volatility 3 months), VIX, Stock vol; includes time and firm fixed effects. - Empirical conclusions (Table 1): - Firm-level factors: - Investment has a positive and statistically significant relationship with cash flows, implying reduced cash flows during downturns or commodity cycles dampen investment. - Investment has a positive and statistically significant relationship with changes in debt, suggesting improving access to debt finance could support investment. - No significant relationship found with effective interest rate payments or Tobin Q, implying access to debt finance matters more than interest cost or equity valuation for investment dynamics. - Macro-level interaction results (cash flow × macro variables): - Cash flow * rupiah volatility: coefficient -0.16*** (p-values shown as (0.00)), indicating rupiah volatility (macro instability) negatively interacts with cash flows to reduce investment. - Cash flow * VIX: coefficient -0.07*** (p-values (0.00)), indicating international financial volatility can weaken investment via cash flows. - Cash flow * stock price volatility: coefficient -0,37*** (p-values (0.00)) — (note: table uses a comma in the coefficient as presented). - Table 1 summary statistics and estimated coefficients (as reported): - Panel 1–4 coefficients for key variables: - Cash flow: 0.65*** (Panel 1), 3.03*** (Panel 2), 1.02*** (Panel 3), 7.83*** (Panel 4) with p-values (0.00) respectively. - Changes in debt: 0.39***, 0.39***, 0.31***, 0.35*** with p-values (0.00). - Lagged effective interest rate: -2.46, -2.44, -1.86, -2.20 with p-values (0.93), (0.93), (0.94), (0.94). - Tobin Q: 0.00 across panels with p-values (0.97). - Interaction terms: Cash flow*rupiah volatility -0.16*** (0.00); Cash flow*VIX -0.07*** (0.00); Cash flow*stock price volatility -0,37*** (0.00). - Sample size: 2,722. - R-sq: 0.34, 0.34, 0.40, 0.36 across panels. - Note: 1/ Includes constant. Significance at *p <0.10, **p <0.05,***p <0.01. - Policy implications from empirical results: - Maintaining macroeconomic stability and reducing rupiah volatility is positive for investment. - Reducing international financial volatility exposure (or its transmission) can support investment, given corporates’ reliance on external borrowing and foreign currency debt. - Strengthening policy certainty could support investment by lowering stock price volatility and expected-earnings uncertainty. - Improving access to debt finance (e.g., deepening corporate bond markets, strengthening bank asset quality and liquidity) could support investment. - Addressing costly structural impediments (accelerating infrastructure, reducing regulatory compliance costs, enhancing labor productivity) would help support investment growth by improving cash flows. ### G. Conclusion - Empirical analysis confirms private investment in Indonesia is driven by firm-level cash flows and access to finance and is negatively affected by macro instability, international financial volatility, and policy uncertainty via effects on cash flows. - High-cost structural impediments that undermine corporate cash flows — weak infrastructure, regulatory burdens, and labor market rigidities/skills gaps — are important constraints; addressing these can support investment recovery. *INDONESIA INTERNATIONAL MONETARY FUND* ### 20. Investment in Indonesia has also slowed more than in peer countries, with particular ### 20. Investment in Indonesia has also slowed more than in peer countries, with particular ### Causes of the investment slowdown - Sluggish commodity prices and soft economic activity have weakened corporate cash flows and limited internal financial space for investment. - External financing such as bank loans or foreign bonds has decelerated, partly because of weak investment sentiment and partly because some banks have tightened lending standards. - Structural factors have hampered investment over the years, particularly in manufacturing, including: - limited infrastructure, - the business climate, - low labor productivity, - weakened linkages with global value chains. ### Outlook for private investment - With a pickup in commodity prices and economic growth, private investment is expected to gradually recover. - It is essential to address structural constraints and maintain stable macroeconomic conditions in order to sustain and expand the growth of investment. ### Policy recommendations and reform priorities - Deepen structural reforms to support competitiveness and productivity growth to bolster private investment by lowering the cost of capital. - Financial deepening to improve access to finance, such as domestic corporate bond markets, and continue to strengthen the financial system to support investment. - Accelerate infrastructure development to reduce logistics and energy-related costs and stimulate investment, especially in manufacturing. - Strengthen inter-agency coordination to streamline complex regulations and assure policy and regulatory consistency to alleviate costly factors. - Open new sectors of the economy to investment, particularly the primary and services sectors. - Close labor skill gaps through improved education to strengthen competitiveness and productivity and help sustain investment growth. *Source: IMF country chapter text.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1748.pdf_