## HARNESSING INDONESIA'S DEMOGRAPHIC DIVIDEND: OPPORTUNITIES AND CHALLENGES (cr1833)

## Source details

**Canonical URL:** [HARNESSING INDONESIA'S DEMOGRAPHIC DIVIDEND: OPPORTUNITIES AND CHALLENGES (cr1833)](https://www.imf.org/-/media/files/publications/cr/2018/cr1833.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2018/cr1833.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2018/cr1833.pdf.json)

---

### A. Demographic trends and macroeconomic implications
- Population and location
  - Population grew at 1.3 percent per year on average during 2000−16, reaching around 260 million in 2016.
  - About 57 percent of the population lives in Java island, which has the lowest population growth (1.1 percent).
  - Urban population grew at 3 percent per year during 2000−16; rural population declined by 0.2 percent.
  - About 55 percent of the population lives in urban areas.
  - Total population projected to rise to 296 million by 2030.
- Fertility and longevity
  - Fertility rate: 2.4 children per woman; projected to remain above the replacement rate of 2.1 children per woman until 2030.
  - Marked improvement in life expectancy contributes to population rise.
- Working-age population and growth impact
  - Share of working-age population (15 to 64 years old) grew by 1.6 percent or 2.5 million people per year during 2000−16.
  - Working-age share: 67 percent of total population in 2016; projected to peak at about 70 percent in 2031.
  - Estimated growth impact (production function approach, baseline assumptions listed):
    - Demographic trends expected to increase annual real GDP growth by close to 1 percentage point of GDP during 2020−2050.
    - During 2020−2050, demographic trends expected to increase Indonesia’s annual per capita GDP growth by close to an additional 0.2 percentage points of GDP.
  - Methodological notes: relies on production function with capital and labor inputs; baseline assumes unchanged total factor productivity growth, unchanged age- and gender-specific labor force participation rates, and constant capital-to-effective-labor ratio.
- Aging risks
  - Aging projected to start impacting in less than 15 years; old-age dependency ratio projected to increase from 15 to 20 within 11 years.
  - At the working-age share peak (projected in 2031), Indonesia projected to have 32 percent of the U.S. per capita income.
  - Workforce aging estimated to reduce real GDP growth by 0.1 percent per year during 2020−50 via declines in total factor productivity growth.
  - Projected increase of age-related spending (pension and health) is less than 1 percent of GDP from 2015 to 2050; current coverage limited and future expansions would raise spending pressure.

### B. Labor market, human capital, and gender
- Labor market indicators and structure
  - Average unemployment rate: 5.6 percent; youth (15−24 years old) unemployment: 19.4 percent.
  - Informal employment: 58 percent.
  - Fresh graduates, particularly with tertiary education, face difficulty finding jobs.
  - Geographical variation: overall unemployment highest in Java island, ranging from 8.9 percent in West Java to 2.7 percent in Yogyakarta; lowest in Bali at 1.9 percent.
- Gender disparities
  - Female labor force participation rate improved from 48 percent in 2005 to 51 percent in 2017.
  - Male labor force participation rate: 83 percent.
  - About a third of women have part-time jobs compared to less than 20 percent of men.
  - Most female workers operate in services (52 percent) and in agriculture (32 percent).
- Human capital and skills
  - Quality of education remains low with skill shortages; under-qualified workers fill many positions.
  - International assessments show weaknesses in mathematics, science and literacy; significant regional disparities with eastern Indonesia lagging.

### C. Policy implications to maximize the demographic dividend
- Core objective: raise productivity and create sufficient quality jobs for the growing working-age population.
- Priority policy actions
  - Invest in human capital early: education and health care to improve workforce productivity.
  - Broaden access to health services, improve workforce training, and promote innovation via higher R&D to mitigate negative productivity impacts of aging.
  - Facilitate development of globally competitive labor-intensive sectors by streamlining regulations, nontariff measures and FDI restrictions to absorb rising labor supply.
  - Enhance revenue mobilization to create fiscal space for higher spending on education and health; maintain strong fiscal anchor: current deficit ceiling of 3 percent of GDP.
  - Labor market reforms to promote female labor force participation, including expanding availability of childcare facilities and promoting flexible employment.
  - Implement structural reforms early in the demographic transition to speed up the transition and increase benefits from the demographic dividend.

---

### 4. The government has prioritized several infrastructure projects

### A. Overview of priority projects and status
- 247 priority infrastructure projects selected, total cost US$323 billion (32 percent of GDP), to be implemented in 2015−22.
- Project list highlights:
  - construct 3,650 km of roads;
  - construct 3,258 km of railways;
  - 24 new seaports;
  - 15 new airports;
  - develop power plants with total capacity of 35 GW;
  - 33 new dams;
  - new oil refineries of 600,000 barrels per day.
- Project status: 4 completed; 131 being constructed; 112 being prepared.
- KPPIP coordinates 37 projects (including 12 oil refineries, one electricity program, 74 roads, and 23 rail roads).

### B. Financing and fiscal implications
- Expected financing sources:
  - Private sector: 18 percent of GDP;
  - State-owned enterprises (SOEs): 10 percent of GDP;
  - Remaining share implicit from public budgets and other sources to total US$323 billion.
- Fiscal spending developments:
  - Central government capital spending and transfers to local governments for infrastructure rose by 1 percentage point of GDP between 2014 and 2017.
  - Funds allocated for infrastructure in the 2018 budget about 6 percent higher than in the 2017 revised budget.
  - Government injected capital to SOEs amounting to 0.6 percent of GDP in 2015−16.
- Government guarantees:
  - Government guarantees for infrastructure investment stood at 2.8 percent of GDP in March 2017.
  - Maximum guarantee limit: 6 percent of GDP during 2017−20.

### C. Institutional, regulatory, and market-deepening actions
- Land acquisition and institutional reforms
  - Maximum time for land acquisition shortened to around 400 days from 518 days.
  - Revised regulations allow revocation of land rights in public interest; businesses can acquire land on behalf of authorities and be reimbursed later.
  - State Asset Management Agency (LMAN) established to facilitate financing of land acquisitions and integrate acquisitions for national strategic projects.
  - Land acquisition completed for Trans-Sumatra toll road and Java North Line Double track rail project.
- FDI and ownership liberalization
  - Negative Investment List (DNI) eased: foreign ownership limit for toll road operators, telecommunications, and testing companies rose to 100 percent from 95 percent.
  - Foreign ownership limit of distribution and warehousing increased to 87 percent from 33 percent.
- PPP and support measures
  - PPP unit established; Viability Gap Fund covers up to 49 percent of construction cost; Availability Payment scheme used.
  - PPPs launched include Palapa Ring Broadband (US$0.6 million, Availability-Payment), Umbulan Water (US$0.3 million, Viability Gap Fund), Central Java Power Plant (US$3 billion), and three toll roads (US$2.2 billion).
- Market-deepening recommendations
  - Enhance regulations on structured products, clarify risk allocation between SPVs and issuers.
  - Explore ABS (e.g., Jagorawi toll roads IDR2 trillion precedent), infrastructure bonds, IDR-linked global bonds.
  - Consider Limited Concession Schemes (LCS) to monetize operational assets.
  - Expand institutional investor base (insurance firms, social security funds, private pension funds) with stronger regulatory/supervisory framework.

### D. Risks, vulnerabilities, and recommended safeguards
- Current concerns
  - Heavy reliance on SOEs may crowd out private investment and hinder sustainable development.
  - Investor concerns: lack of transparency in procurement, perceived preferential assignment to SOEs, uncertain legal/regulatory framework, land acquisition risks.
- Recommended prioritization and risk management
  - Finance infrastructure with revenue from a medium-term revenue strategy (MTRS) to limit buildup of external debt.
  - Pace infrastructure development in line with available financing and absorptive capacity.
  - Prioritize projects with larger impact on production capacity.
  - Monitor SOE financial performance, including domestic and external debt.
  - Shift financing burden to private sector via PPPs and FDI where feasible.
  - Carefully design and monitor government guarantees to avoid rising contingent liabilities.
  - Clarify PPP contracts: rights, responsibilities, risk allocation, and change mechanisms.

---

### 16. A comprehensive and properly sequenced package of fiscal and structural reforms

### A. Reform strategy and complementarities
- Priority areas given limited fiscal space:
  - reform product markets to promote entry and reduce state control;
  - streamline complex regulations;
  - foster financial deepening and inclusion.
- Revenue gains from tax reforms would create fiscal space for infrastructure, education and health.
- Complementarities:
  - Product market reforms promote private participation in infrastructure.
  - Stronger property rights improve access to credit.
  - Financial inclusion (e.g., student loans) expands education opportunities.
  - Financial deepening mobilizes financing for infrastructure; infrastructure improves education access in remote areas.

### B. GIMF model calibration and fiscal multipliers (Indonesia)
- Tax increases: multipliers on output in the first year from a 1 percent of GDP permanent rise in revenue due to higher taxes:
  - consumption taxes: –0.2 percent,
  - labor taxes: –0.3 percent,
  - corporate taxes: –0.5 percent.
- Dynamics of tax impacts:
  - Negative impact from higher consumption taxes declines to nearly zero after 10 years.
  - Negative impact from higher labor taxes rises to 0.5 percent in the second year and remains at that level for the following eight years.
  - Negative impact from higher corporate taxes increases gradually over time to 1.5 percent after 10 years.
- Infrastructure investment multiplier:
  - 1 percent of GDP permanent increase in infrastructure investment yields multiplier on output: 1 percent in the first year, rising to over 2 percent in 10 years.
- Social transfers:
  - Targeted transfers to the poor: 0.15 percent in the first year from a 1 percent of GDP permanent rise.
  - Untargeted general transfers: 0.05 percent in the first year.
  - Medium-term impact slightly negative as taxes are raised or spending cut to keep fiscal deficit unchanged.
- Other structural reforms modeled via assumed impacts on TFP based on literature.

### C. Reform scenario design and expenditure composition
- Scenario components
  - Higher spending in infrastructure and targeted transfers financed mainly by higher consumption taxes;
  - Reduced barriers to trade and FDI;
  - Structural reforms to product and labor markets.
- Revenue composition
  - About 2 percentage points of GDP of extra revenue from an MTRS would come from consumption taxes (VAT and excises on fuel, vehicles, and plastic bags).
  - The other 1 percentage point of GDP would come from taxes with larger negative multipliers.
- Expenditure allocation of the extra revenue
  - infrastructure: 1.3 percentage points of GDP;
  - targeted transfers in education, health and social programs: 1.5 percentage points of GDP.
- Assumed structural measures
  - 10 percent reduction in the OECD’s product market regulations (PMI) over 5 years to BRICS-average level;
  - rationalize SOEs, remove FDI and trade restrictions, ease entry barriers and administrative burdens, accompanying legal and regulatory reforms.
- Timing: initial gains from infrastructure and lower trade/FDI restrictions; education and labor-market effects materialize later.

### D. Projected macroeconomic impacts (illustrative reform scenario)
- Real GDP growth (selected entries; baseline then reform scenario)
  - Baseline real GDP growth: 2015: 4.8; 2016: 5.0; 2017: 5.1; 2018: 5.3; 2019: 5.5; 2020: 5.6; 2021: 5.6; 2022: 5.6
  - Reform scenario real GDP growth: 2018: 5.4; 2019: 5.7; 2020: 5.9; 2021: 6.2; 2022: 6.5
  - Reform raises potential real GDP growth gradually to 6.5 percent by 2022, 0.9 percentage point higher than baseline.
- Contributions by 2022 relative to baseline
  - higher private investment: 0.5 percentage point;
  - employment growth: 0.2 percentage point;
  - gains in TFP from regulatory reforms: 0.1 percentage point in 2020−21 and 0.2 percentage point in 2022.
- Macrostability under reform scenario
  - Inflation: baseline 2018: 3.6; reform 2018: 3.8; reform 2019: 4.1; reform 2020: 4.0; reform 2021: 3.7; reform 2022: 3.8.
  - Current account deficit/GDP: baseline 2018: -1.9; reform 2018: -2.0; reform 2019: -2.0; reform 2020: -2.2; reform 2021: -2.3; reform 2022: -2.3.
  - Fiscal position: with MTRS, fiscal deficit contained at around 2.2 percent and government debt below 30 percent of GDP in the medium term.

### E. Key fiscal and sectoral statistics (selected series, percent of GDP or rates as presented)
- General government revenue: 2015: 14.9; 2016: 14.3; 2017: 13.8; 2018: 14.0; 2019: 13.9; 2020: 13.9; 2021: 13.9; 2022: 13.9
- Central government revenues and grants: 2015: 13.1; 2016: 12.5; 2017: 12.0; 2018: 12.2; 2019: 12.1; 2020: 12.1; 2021: 12.1; 2022: 12.1
- Tax revenues (central): 2015: 10.8; 2016: 10.4; 2017: 9.8; 2018: 10.0; 2019: 10.0; 2020: 10.0; 2021: 10.0; 2022: 10.0
- Non-oil and gas revenues: 2015: 11.9; 2016: 11.8; 2017: 11.2; 2018: 11.3; 2019: 11.3; 2020: 11.4; 2021: 11.4; 2022: 11.4
- General government expenditure: 2015: 17.5; 2016: 16.8; 2017: 16.5; 2018: 16.5; 2019: 16.4; 2020: 16.4; 2021: 16.4; 2022: 16.4
- Infrastructure spending: 2015: 2.2; 2016: 2.2; 2017: 2.7; 2018: 2.8; 2019: 2.6; 2020: 2.5; 2021: 2.5; 2022: 2.5
- Education spending: 2015: 3.5; 2016: 3.3; 2017: 3.3; 2018: 3.3; 2019: 3.3; 2020: 3.3; 2021: 3.3; 2022: 3.3
- Health spending: 2015: 1.3; 2016: 1.5; 2017: 1.5; 2018: 1.5; 2019: 1.5; 2020: 1.5; 2021: 1.5; 2022: 1.5
- Social assistance: 2015: 1.5; 2016: 1.7; 2017: 1.7; 2018: 1.7; 2019: 1.7; 2020: 1.7; 2021: 1.7; 2022: 1.7
- General government deficit: 2015: -2.6; 2016: -2.5; 2017: -2.7; 2018: -2.5; 2019: -2.5; 2020: -2.5; 2021: -2.5; 2022: -2.5
- General government debt: 2015: 26.8; 2016: 28.3; 2017: 29.1; 2018: 29.6; 2019: 30.2; 2020: 30.2; 2021: 30.4; 2022: 30.5

### F. Conclusion on reform package
- Structural reforms on infrastructure, regulations, and human capital can lift inclusive potential growth.
- Constraints include large infrastructure gap, low institutional quality, and inadequate human capital.
- Illustrative reform scenario shows potential growth could rise to 6.5 percent in the medium term, around 1 percentage point higher than the baseline.
- Clear communication of reforms would help boost confidence in the economy.

---

### 5. Access to the formal financial system

### A. Access levels, financial deepening, and inclusion
- Account ownership and targets
  - About 36 percent of adults had a transaction account with a formal financial institution in 2014, up from 20 percent in 2011 (Global Findex).
  - Peer average among other EMs in East Asia and Pacific: 53 percent.
  - SNKI target: reach 75 percent of adults with a transaction account by end-2019.
- Financial system size and structure
  - Aggregate assets of financial institutions: 72 percent of GDP; banks account for about 80 percent of aggregate assets.
  - Pension funds outstanding assets under management: about 2 percent of GDP (end-2015).
  - Insurance companies: below 8 percent of GDP (end-2015).
- Capital markets and short-term funding
  - Daily average volume of unsecured interbank market: IDR11.8 trillion in 2016 (less than 0.1 percent of GDP).
  - Overnight accounted for about 60 percent of interbank market activity in 2016.
  - Outstanding domestic debt securities: 16 percent of GDP (end-2015); stock market capitalization: 41 percent of GDP (end-2015).
  - Government bond market in 2016: outstanding government bonds about 22 percent of GDP; nearly three-quarters denominated in rupiah.
  - Corporate bond market: less than 3 percent of GDP.
  - Corporate bond issuances: IDR116 billion in 2016 (up from IDR58 billion in 2013).
  - IPO activity: 16 firms a year on average during 2014−16; total listed firms increased to 555.

### B. Inefficiencies and policy measures
- High net interest margins (NIMs) driven by:
  - Small banking system size, weaknesses in legal and institutional environment, high market power, operational inefficiencies.
- Policy measures taken but with limited effect:
  - Caps on deposit rates; moral suasion; minimum lending exposure quotas to MSMEs—these have not reduced NIMs and impeded monetary policy effectiveness.
- Recommended priorities (FSAP and IMF 2017)
  - Strengthen credit culture and infrastructure (online movable collateral registry; credit registry; operationalize credit bureaus).
  - Upgrade supervisory and regulatory frameworks; consider formal amendment of the OJK law to reduce silo structures.
  - Establish a liquid benchmark yield curve; maintain regular T-bill issuances.
  - Promote long-term financing with new financial instruments; expand domestic investor base.
  - Eliminate interest rate caps to improve monetary transmission.

### C. Digital financial services (DFS), FinTech, and agent networks
- DFS and agent coverage
  - Agents present in all provinces and in 99 percent of the districts.
  - LKD agents: cash-in, cash-out, bill payments, transfers.
  - LP agents: can open basic bank accounts and conduct transactions.
  - At end-2016, 23 banks offering LP services to around 3.7 million customers.
- FinTech developments and oversight
  - FinTech sector attracted around US$15 billion in investments in 2016.
  - BI established a FinTech office; OJK established an internal cross-departmental group; OJK issued a regulation on Peer-to-Peer lending.
  - BI issued regulation in December 2016 on FinTech players in the payments system.
- Operational risks and priorities
  - Operational risks from weak communications infrastructure in remote areas may affect agent/customer confidence—engage telecom regulator and payment system operators to enhance reliability.
  - Launch nationwide campaigns to raise awareness on DFS.
  - Review KUR program effectiveness and potential fiscal costs; KUR total loans reached IDR53 trillion in August 2017.

### D. Market development and investor base expansion
- Actions to deepen markets and mobilize long-term financing:
  - Use SOE bonds and structured products cautiously to avoid concentration risks.
  - Develop FX and derivatives markets to help market participants manage risk.
  - Encourage domestic institutional investor growth (improve financial literacy, IPO distribution, tax framework).
  - Note: withholding tax rate of foreign investors is 20 percent (peers range 0 to 15 percent).

---

### Trade patterns, export composition, and GVC participation

### A. Recent trade patterns and destinations
- Commodities and destinations
  - Global share of palm oil exports rose from 28.1 percent to 54.5 percent; coal almost tripled from 6.7 percent to 19.5 percent.
  - China replaced Japan as Indonesia’s top export destination between 2000 and 2016.
    - China’s share of total exports: 4½ percent in 2000 to 11½ percent in 2016.
    - Japan’s share: 23¼ percent in 2000 to 11 percent in 2016.
    - United States’ share: 13.7 percent in 2000 versus 11.2 percent in 2016.
  - In 2016, China sourced 26 percent of its coal imports and 62 percent of its palm oil imports from Indonesia.
  - Coal and palm oil accounted for 41 percent of Indonesia’s total exports to China in 2016.
- Bilateral trade with China
  - Indonesia ran a bilateral trade deficit with China: small deficit since 2008, widening to 1.9 percent of GDP in 2016.
  - Shift to deficit concentrated in manufacturing sectors (machinery and transport equipment, textiles); resource-based sectors maintained a surplus.

### B. Export composition, comparative advantage, and complexity
- Comparative advantage and sophistication
  - Indonesia maintained RCA > 1 in mineral fuels and low technology industries throughout 2000–16.
  - RCA for mineral fuels increased in 2013–16; RCA for low technology industries remained stable.
  - RCA in high technology industries declined gradually in 2000–16.
  - Export sophistication improved but remained low compared with peers.
  - Economic Complexity Index (ECI): in 2015 Indonesia ranked 57th out of 108 countries; ECI decreased in 2000–16 while most comparators increased.
- Diversification and concentration
  - Product diversification improved since 2011; mid-range among comparators.
  - Export destinations: moved from moderate concentration to unconcentrated; one-third of products exported to top three destinations in 2016 versus one half in 2000.

### C. Trade policy, tariffs, NTMs, and GVC participation
- Tariffs and NTMs
  - Average applied MFN tariff: 6.9 percent in 2016 (down from 9.5 percent in 2006).
  - Average bound tariff rate: 37 percent in 2016; gap between bound and applied: 30 percentage points (G20 developing average: 20 percentage points).
  - Share of tariff lines subject to NTMs on import side: 42 percent in 2009 to 51 percent in 2015.
  - On export side: 4 percent in 2009 to 10 percent in 2015.
  - Global Trade Alert: Indonesia introduced more NTMs than other G20 countries since 2008.
- GVC participation
  - Participation increased slightly since 2000 but remains below Asian comparators.
  - Increase mainly from forward participation; backward participation declined.
  - Domestic sources dominated value added in exports (88 percent) and final demand (77.9 percent) in 2011.
  - China’s shares in Indonesia’s exports, final demand, and import value added increased.

### D. Constraints and policy recommendations
- Constraints to higher GVC integration: tariffs, infrastructure, access to trade finance, regulatory environment, business environment, labor skills, transportation, economic complexity.
- Recommended reforms
  - Streamline NTMs and shift controls from border to post-border.
  - Pursue bilateral and regional trade agreements to open markets and attract GVC-linked investment.
  - Improve investment climate: infrastructure, regulations, and labor skills.
  - Strengthen competitiveness in higher-technology products to improve economic complexity and move up the value chain.

*Italic: Content derived from the supplied "cr1833" PDF (IMF staff analysis and associated chapters provided).*

### References ____________________________________________________________________________ 10

### HARNESSING INDONESIA'S DEMOGRAPHIC DIVIDEND: OPPORTUNITIES AND CHALLENGES

### A. Demographic Trends in Indonesia
- Indonesia’s population grew at 1.3 percent per year on average during 2000−16, reaching around 260 million in 2016.
- About 57 percent of the population lives in Java island, which has the lowest population growth (1.1 percent).
- Fertility rate is currently at 2.4 children per woman and is projected to remain above the replacement rate of 2.1 children per woman until 2030.
- Total population is projected to rise to 296 million by 2030, helped by a marked improvement in life expectancy.
- Urban population grew at 3 percent per year during 2000−16, while rural population declined by 0.2 percent.
- About 55 percent of the population lives in urban areas.

### B. Tailwinds from Demographic Dynamics
- Infant mortality declined from 41.1 infant per 1,000 live births in 2000 to 22.8 in 2016.
- The share of working-age population (persons 15 to 64 years old) grew by 1.6 percent or 2.5 million people per year during 2000−16.
- Working-age share: 67 percent of total population in 2016; projected to peak at about 70 percent in 2031.
- Estimated growth impact:
  - Demographic trends are expected to increase annual real GDP growth by close to 1 percentage point of GDP during the period 2020−2050.
  - During 2020−2050, demographic trends are expected to increase Indonesia’s annual per capita GDP growth by close to an additional 0.2 percentage points of GDP.
- Methodological notes:
  - Estimates rely on a production function approach with capital and labor as inputs and follow IMF (2017) and related literature.
  - Baseline assumptions include unchanged total factor productivity growth, unchanged age- and gender-specific labor force participation rates, and constant capital-to-effective-labor ratio.

### C. Challenges Ahead
- Labor market:
  - Average unemployment rate is 5.6 percent; youth (15−24 years old) unemployment is 19.4 percent.
  - Informal employment remains high at 58 percent.
  - Fresh graduates, particularly those with tertiary education, face difficulty finding jobs.
  - Geographical variation: overall unemployment highest in Java island, ranging from 8.9 percent in West Java to 2.7 percent in Yogyakarta; lowest in Bali at 1.9 percent.
- Gender disparities:
  - Female labor force participation rate improved from 48 percent in 2005 to 51 percent in 2017.
  - Male labor force participation rate is 83 percent.
  - About a third of women have part-time jobs compared to less than 20 percent of men.
  - Most female workers operate in services (52 percent) and in agriculture (32 percent).
- Human capital and skills:
  - Quality of education remains low with skill shortages; under-qualified workers fill many positions.
  - International assessments reveal weaknesses in mathematics, science and literacy; significant regional disparities with eastern Indonesia lagging.
- Aging risks:
  - Aging projected to start impacting in less than 15 years; Indonesia’s old-age dependency ratio is projected to increase from 15 to 20 within 11 years.
  - At the share-of-working-age peak (projected in 2031), Indonesia is projected to have 32 percent of the U.S. per capita income.
  - Workforce aging is estimated to reduce real GDP growth by 0.1 percent per year during 2020−50 via declines in total factor productivity growth.
  - Projected increase of age-related spending (pension and health spending) is less than 1 percent of GDP from 2015 to 2050, though current coverage is limited and future expansions would raise spending pressure.

### D. Implications for Policies
- Core objective: maximize the demographic dividend by raising productivity and creating sufficient quality jobs for the growing working-age population.
- Key policy priorities:
  - Invest in human capital early: education and health care to improve workforce productivity.
  - Broaden access to health services, improve workforce training, and promote innovation via higher R&D to mitigate negative productivity impacts of aging.
  - Facilitate development of globally competitive labor-intensive sectors by streamlining regulations, nontariff measures and FDI restrictions to absorb rising labor supply.
  - Enhance revenue mobilization to create fiscal space for higher spending on education and health and to support structural reforms.
  - Maintain strong fiscal anchor: current deficit ceiling of 3 percent of GDP.
  - Labor market reforms to promote labor force participation of women, including expanding availability of childcare facilities and promoting flexible employment.
  - Implement structural reforms early in the demographic transition to speed up the transition and increase benefits from the demographic dividend.

*Source: HARNESSING INDONESIA'S DEMOGRAPHIC DIVIDEND: OPPORTUNITIES AND CHALLENGES (IMF content provided).*

### References

### References

### Key bibliographic entries
- Aiyar, S., C. Ebeke, and X. Shao, 2016, “The Impact of Workforce Aging on European Productivity,” IMF Working Paper No. 16/238 (Washington: International Monetary Fund).
- Allen, Emma R., 2016, “Analysis of Trends and Challenges in The Indonesian Labor Markets,” ADB Papers on Indonesia No. 16 (Manila: Asian Development Bank).
- Amaglobeli, D., and W. Shi, 2016, “How to Assess Fiscal Implications of Demographic Shifts: A Granular Approach,” IMF Fiscal Policy Paper, How-to-Note No. 16/02 (Washington: International Monetary Fund).
- Feyrer, J., 2007, “Demographics and Productivity,” Review of Economics and Statistics, Vol. 89 Issue 1, pp. 100–09.
- International Monetary Fund, 2017, Regional Economic Outlook, April 2017: Asia and Pacific—Preparing for Choppy Seas, World Economic and Financial Surveys (Washington).
- International Monetary Fund, 2015, Regional Economic Outlook, April 2015: Sub-Saharan Africa—Navigating Headwinds, World Economic and Financial Surveys (Washington).
- International Monetary Fund, 2017, Fiscal Monitor: Tackling Inequality, October 2017, World Economic and Financial Surveys (Washington).
- Jin, Hui, 2017, “Deepening the Growth-Enhancing Fiscal Strategy,” in Indonesia: Selected Issues, IMF Country Report No. 17/48 (Washington: International Monetary Fund).
- World Bank, 2016, Indonesia’s Rising Divide (Washington).
- World Bank, 2018, Doing Business 2018: Reforming to Create Jobs (Washington).

### Summary of substantive findings and policy recommendations (from the Indonesia chapters included with the references)
- Rationale and Medium-Term Revenue Strategy (MTRS)
  - Indonesia’s general government revenue is around 12 percent of GDP.
  - An MTRS should increase revenue by at least 3 percent of GDP over the medium term to finance priority expenditure within Indonesia’s fiscal rules.
  - Most revenue gains should come from tax policy reforms (income and VAT), complemented by tax administration improvements and introducing excise taxes on vehicles and fuel products.
  - Recommended uses of additional revenue: infrastructure, health, education, social safety nets, and improved spending efficiency (Jin 2017).

- Near-term actions
  - Introduce excise taxes on vehicles and fuel to raise additional revenue of about 1 percent of GDP to partly finance the authorities’ infrastructure plan, including the 247 priority projects.

- Near-term revenue and equity subset
  - Revenue-side priorities: remove exemptions in income taxes and VAT, lower VAT and corporate income tax (CIT) thresholds, simplify VAT policy and administration, enhance tax administration overall.
  - These measures could deliver additional revenue of 0.5−1 percent of GDP in the near term.
  - Expenditure-side priorities: expand most effective and targeted social programs to reduce inequality.

- Tax policy distortions identified
  - Distortions across capital asset types: differences between tax depreciation and economic depreciation, especially equipment associated with information technology.
  - Distortions across source of financing: deductibility of interest expenses but not returns to equity for CIT calculation.
  - Distortions across firm size: lower CIT rates for firms below certain size measures (profits, turnover, or employees).
  - Distortions across business formality: higher taxes and social security contributions on formal businesses while enforcement is weak on informal businesses.

- Potential growth gains
  - Reducing tax-induced distortions to the level of top performing countries in the same income group could increase real GDP growth by 1.3 percentage points in the long run for emerging market economies like Indonesia.

- Indonesia-specific tax system distortions
  - CIT exemptions and lower-rate regimes:
    - Statutory CIT rate: 25 percent.
    - 1 percent presumptive tax on gross revenue for small and medium enterprises below an annual turnover of IDR 4.8 billion (USD 355,100).
    - Rate reduction of 50 percent for taxable income corresponding to gross turnover up to IDR 4.8 billion of medium-sized enterprises with an annual turnover below IDR 50 billion.
    - Reduced rate of 20 percent for publicly listed companies.
  - VAT issues:
    - Statutory VAT rate: 10 percent.
    - Long list of VAT exemptions including: mining (unprocessed products), staple goods (agriculture), tourism (hotels and restaurants), transportation, employment services, banking and insurance, art and entertainment services, education, medical and social services; capital goods; agricultural, plantation, and forestry products; electricity (excluding that supplied to households with consumption above 6,600 Watts); distributed piped water; cattle, poultry, and seeds; weapons for the army; educational books; ships, trains, aircrafts and their spare parts; and low-cost housing.
    - VAT threshold for mandatory registration: IDR 4.8 billion (same as the CIT threshold for the 1 percent turnover tax), covering only 50,000 firms compared to over 400,000 firms previously registered under a threshold of IDR 600 million.
  - Behavioral consequences:
    - The 1 percent presumptive turnover tax incentivizes firms to stay below IDR 4.8 billion, discouraging growth.
    - The high VAT threshold and many exemptions break the VAT chain and compromise VAT efficiency and neutrality.
    - Complexity increases DGT resource allocation to managing exemptions instead of risk-based audits.

- Recommended tax policy reforms
  - VAT:
    - Reduce the VAT threshold of IDR 4.8 billion (e.g., to previous threshold of IDR 600 million) to broaden the tax base.
    - Remove unnecessary VAT exemptions on both final and intermediate consumptions to strengthen VAT chain integrity.
  - CIT:
    - Limit the 1 percent presumptive tax to truly small and new firms (e.g., below IDR 600 million) with a phase-out period of a few years for special treatment.
    - Unify remaining CIT rates at 25 percent or slightly lower to level the playing field across firms and encourage growth.

- Tax administration reforms
  - Simplify and strengthen tax administration, particularly VAT.
  - Remove VAT exemptions to simplify administration.
  - Subject VAT refunds to risk-based audits instead of auditing almost every refund request to improve DGT focus and collection efficiency.
  - World Bank Doing Business indicators:
    - Indonesia improved to rank 72 in 2018 from 106 two years earlier, with notable improvements in resolving insolvency (36), enforcing contracts (26), protecting minority investors (26), starting a business (23), and getting electricity (23).
    - Paying taxes ranking improved only from 115th to 114th.
    - For a typical medium-sized company: number of tax payments reduced from 54 to 43 (peer average 19); 18 hours spent to comply with VAT refunds (peer average 12 hours); 47.7 weeks to receive VAT refunds (peer average 27.9 weeks).
    - Indonesian VAT taxpayers must itemize each transaction in returns; DGT audits almost every taxpayer who requests a VAT refund rather than using risk-based approach.

- Fiscal distributive role and inequality
  - Indonesia’s income Gini coefficient: 39.5 in 2013.
  - Mobility during 1993−2007: 37 percent of the poorest 20 percent families remained in the poorest quintile; 56 percent of the richest 20 percent families remained in the richest quintile.
  - Gaps in access to social services and infrastructure:
    - Health insurance coverage around 50 percent across income groups.
    - Only 28 percent of villages in poor regions of Maluku and Papua have health centers (national average 38 percent).
    - For villages without health centers, the closest health center is 24 kilometers away (national average 6 kilometers).
  - Current equity-enhancing programs are small:
    - PKH, RASKIN and BSM together spend 0.3 percent of GDP.
    - Expanding these programs with additional revenue of 0.5−1 percent of GDP from structural tax reforms would strongly boost equity.
  - Tax system distributional effects:
    - VAT is only slightly regressive due to staple food exemptions.
    - Excise taxes are notably progressive.
    - Personal income tax is progressive.
    - Overall tax system is generally equity-neutral; increasing taxes to finance equity-enhancing expenditure would reduce inequality.

- Revenue potential and sequencing
  - Estimated revenue potential from structural tax reforms: 0.5 percent to 1 percent of GDP in the next couple of years.
  - Lowering the VAT threshold and removing distortionary VAT exemptions are prerequisites for raising VAT rate from 10 percent to a higher rate (e.g., 12 percent) without amplifying distortions.
  - With full implementation of the growth-enhancing fiscal strategy, Indonesia would gain resources for moving beyond middle-income status.

### Representative evidence and external findings cited
- IMF (2014): multiplier on output of increasing infrastructure investment by 1 percentage point of GDP ranges between 1 percent and 1.3 percent in the first year, rising to over 2 percent in 10 years.
- Barnes (2014): benchmark reduction in product market regulation (PMR) index could increase TFP by around 2 percent of GDP over 5 years; a 10 percent reduction in PMR could yield TFP gains of 1.7 percent for BRICS and 1.3 percent for OECD.
- Gal and Hijzen (2016): product market reforms increase capital, output, and employment—after two years, capital +4 percent, output +3 percent, employment +1 percent.
- Bouis and others (2016): major reductions in entry barriers yield large increases in output and labor productivity over five years; effects become statistically significant two to three years after reform.
- Dabla-Norris and others (2016): trade and FDI liberalization and labor market reforms can significantly boost TFP in EMEs with small short-term costs and sizable medium-term benefits.
- Coady and Dizioli (2017): expanding education helps reduce income inequality, especially in EMEs.

*Italic: Content derived from the supplied "cr1833 - References" PDF and associated Indonesia chapters contained therein.*

### 4.      The government has prioritized several infrastructure projects.

### 4.      The government has prioritized several infrastructure projects.

### Overview of priority projects
- The government has selected 247 priority infrastructure projects, with a total cost of US$323 billion (32 percent of GDP), to be implemented in 2015−22.
- The plan centers on improving logistics, power generation, water and sanitation, and oil refineries, and includes:
  - constructing 3,650 km of roads;
  - constructing 3,258 km of railways;
  - 24 new seaports;
  - 15 new airports;
  - developing power plants with total capacity of 35 GW;
  - 33 new dams;
  - new oil refineries of 600,000 barrels per day.
- Project status: out of 247 projects, four have been completed; 131 are being constructed; and 112 are being prepared.

### Financing and fiscal implications
- Expected financing sources:
  - Private sector: 18 percent of GDP;
  - State-owned enterprises (SOEs): 10 percent of GDP;
  - Remaining share implicit from public budgets and other sources to total US$323 billion.
- Fiscal spending developments:
  - Central government’s capital spending and transfers to local governments for infrastructure have risen by 1 percentage point of GDP between 2014 and 2017.
  - Funds allocated for infrastructure investment in the 2018 budget is about 6 percent higher than in the 2017 revised budget.
  - Government injected capital to SOEs amounting to 0.6 percent of GDP in 2015−16.
- Government guarantees:
  - Government guarantees for infrastructure investment (credit, business viability, and PPP guarantees) stood at 2.8 percent of GDP in March 2017.
  - The maximum guarantee limit is 6 percent of GDP during 2017−20.

### Institutional and regulatory improvements
- Coordination and delivery:
  - Committee for Acceleration of Priority Infrastructure Delivery (KPPIP) established to coordinate priority projects and commission/amend feasibility studies; KPPIP coordinates 37 of these projects, including 12 oil refineries, one electricity program, 74 roads, and 23 rail roads.
  - Investment Coordinating Board (BKPM)’s one-stop service helps expedite investment approvals.
- Land acquisition reforms:
  - Maximum time for land acquisition shortened to around 400 days from 518 days.
  - Revised regulations allow for revocation of land rights in public interest and enable businesses to acquire land on behalf of the authorities and be reimbursed later.
  - State Asset Management Agency (LMAN) established to facilitate financing of land acquisitions, integrate land acquisitions for national strategic projects, and carry over unused budget into the following year.
  - Land acquisition completed for Trans-Sumatra toll road and Java North Line Double track rail project.
- FDI and ownership liberalization:
  - Negative Investment List (DNI) eased: foreign ownership limit for toll road operators, telecommunications, and testing companies rose to 100 percent from 95 percent.
  - Foreign ownership limit of distribution and warehousing increased to 87 percent from 33 percent.
- PPP framework and support:
  - PPP unit established and financial support schemes improved, including Viability Gap Fund (covering up to 49 percent of the construction cost) and Availability Payment scheme (annuity payment during the concession period).
  - Several PPPs launched, including:
    - Palapa Ring Broadband project (US$0.6 million, supported by Availability-Payment scheme);
    - Umbulan Water project (US$0.3 million, supported by the Viability Gap Fund);
    - Central Java Power Plant (US$3 billion);
    - three toll roads (US$2.2 billion).

### Risks, vulnerabilities, and policy recommendations to protect macrofinancial stability
- Current concerns and vulnerabilities:
  - Government reliance on SOEs to jumpstart infrastructure investment due to limited fiscal space and low private sector participation may crowd out private investment and hinder sustainable development.
  - Investors concerned with lack of transparency in procurement and perceived preferential assignment of commercially attractive projects to SOEs.
  - Investors concerned about uncertain legal/regulatory framework, particularly regarding policy continuity and land acquisition, given long-term capital-intensive nature of projects.
- Recommended prioritization and pacing:
  - Priority should be given to financing infrastructure development with revenue from a medium-term revenue strategy (MTRS) to allow steady funding and limit buildup of external debt.
  - Infrastructure development should be paced in line with available financing and the economy’s absorptive capacity; a measured pace would help preserve macrofinancial stability.
  - Projects with larger impact on production capacity should be prioritized.
- SOE and PPP risk management:
  - Monitor financial performance of SOEs, including domestic and external debt, as SOEs in the infrastructure sector have continued to leverage.
  - Ensure proper balance between SOEs and the private sector to prevent crowding out private investment; shift financing burden to the private sector through PPPs and FDI where feasible.
  - Proper design of PPP contracts is important—clarify respective rights and responsibilities, risk allocation, and mechanisms for dealing with changes.
  - Avoid overemphasis on equity aspects that may undermine feasibility studies.
  - Government guarantees for infrastructure development need careful design and monitoring to avoid a potential increase in contingent liabilities.

### Attracting private sector financing: regulatory and market-deepening actions
- Structured products and securitization:
  - Regulations on structured products should be enhanced, including clarifying risk allocation between special purpose vehicles (SPVs) and issuers.
  - Build on the successful issuance of asset-backed securities (ABS) for the Jagorawi toll roads (IDR2 trillion); further explore ABS, especially for toll roads and power plants with more predictable cash flows.
  - Develop infrastructure investment schemes (e.g., project finance, infrastructure bonds, or IDR-linked global bonds) with thorough assessment of potential fiscal risks.
- Limited concession schemes (LCS):
  - Explore LCS to offer concession to the private sector for infrastructure assets already operational and generating cash flows, to free financial resources, increase management efficiency, and adopt private-sector know-how.
- Institutional investors and market infrastructure:
  - Expand the institutional investor base (e.g., insurance firms, social security funds, private pension funds) supported by a stronger regulatory and supervisory framework to allow better asset and liability management.

*Source: cr1833 - 4.      The government has prioritized several infrastructure projects.*

### 16.      A comprehensive and properly sequenced package of fiscal and structural reforms

### 16.      A comprehensive and properly sequenced package of fiscal and structural reforms

### Overview
- A comprehensive and properly sequenced package of fiscal and structural reforms would be self-reinforcing.
- Given limited fiscal space, priority should be on:
  - reforming product markets to promote entry and reduce state control,
  - streamlining complex regulations,
  - fostering financial deepening and inclusion.
- An increase in revenue from tax reforms would create fiscal space for development spending on infrastructure, education and health.

### Complementarities between reforms
- Product market reforms (including relaxing FDI and network industry regulations) can promote private participation in infrastructure.
- Stronger property rights through regulatory reforms can improve access to credit.
- Financial inclusion (such as student loans) can expand education opportunities.
- Financial deepening can help mobilize financing for infrastructure; infrastructure development can improve education access in remote areas.

### GIMF model and fiscal multipliers
- The IMF’s Global Integrated Monetary and Fiscal (GIMF) model is used to estimate macroeconomic effects of fiscal reforms in Indonesia. GIMF is a multicountry general equilibrium model with detailed fiscal policy specification.
- Main GIMF-calibrated properties for Indonesia:
  - Tax increases: multipliers on output in the first year from a 1 percent of GDP permanent rise in revenue due to higher taxes:
    - consumption taxes: –0.2 percent,
    - labor taxes: –0.3 percent,
    - corporate taxes: –0.5 percent.
  - Dynamics of tax impacts:
    - negative impact from higher consumption taxes declines to nearly zero after 10 years;
    - negative impact from higher labor taxes rises to 0.5 percent in the second year and remains at that level for the following eight years;
    - negative impact from higher corporate taxes increases gradually over time to 1.5 percent after 10 years.
  - Infrastructure investment: multiplier on output from a 1 percent of GDP permanent increase in infrastructure investment is 1 percent in the first year, rising to over 2 percent in 10 years. Medium-term rise driven by increased private investment as higher public capital raises private capital productivity.
  - Social transfers: multipliers on output from a 1 percent of GDP permanent rise in social transfers:
    - targeted transfers to the poor: 0.15 percent in the first year,
    - untargeted general transfers: 0.05 percent in the first year;
    - medium-term impact slightly negative as taxes are raised or spending cut to keep fiscal deficit unchanged.
  - Other structural reforms: cannot be estimated directly in GIMF and are modeled via estimated impacts on TFP based on previous studies.

### Reform scenario design
- Components:
  - Higher spending in infrastructure and targeted transfers financed mainly by higher consumption taxes.
  - Reduced barriers to trade and FDI.
  - Structural reforms to product and labor markets.
- Revenue composition:
  - About 2 percentage points of GDP of extra revenue from a medium-term revenue strategy (MTRS) would come from consumption taxes (VAT and excises on fuel, vehicles, and plastic bags).
  - The other 1 percentage point of GDP would come from taxes with larger negative multipliers.
- Expenditure allocation of the extra revenue:
  - infrastructure: 1.3 percentage points of GDP,
  - targeted transfers in education, health and social programs: 1.5 percentage points of GDP.
- Other structural reforms (assumed):
  - 10 percent reduction in the OECD’s product market regulations (PMI) over 5 years, to a level comparable to the average of the BRICS economies.
  - rationalizing the role of SOEs through enhanced governance and reduced price controls;
  - removing FDI and trade restrictions;
  - easing entry barriers and administrative burdens to businesses;
  - accompanying legal and regulatory framework reforms.
- Timing: effects on education and labor markets take longer to realize; initial gains driven by infrastructure and lower trade/FDI restrictions.

### Projected macroeconomic impacts (Illustrative reform scenario)
- Potential real GDP growth:
  - Would increase gradually to 6.5 percent by 2022, 0.9 percentage point higher than the baseline scenario.
  - Initial years: most gains from public and private investment due to fiscal reforms and improved efficiency.
  - Outer years: gains in TFP from other structural reforms play a bigger role.
  - Higher infrastructure investment and lower trade and FDI regulations would be main growth drivers in the first two years, raising potential growth by 0.2−0.3 percentage point initially.
  - By 2022, additional contributions relative to baseline:
    - higher private investment: 0.5 percentage point,
    - employment growth: 0.2 percentage point,
    - gains in TFP from regulatory reforms: 0.1 percentage point in 2020−21 and 0.2 percentage point in 2022.
  - Long-term TFP gains would grow further via enhanced competition, improved labor skills, and greater integration with global value chains.

- Macroeconomic stability assumptions under reform scenario:
  - Inflation: would rise to around 4 percent (y/y) in the initial years due to demand stimulus and higher consumption taxes, then moderate due to tighter monetary stance, stronger domestic competition and expanded production capacity.
  - Current account deficit: would widen to around 2.3 percent of GDP due to higher public and private investment-related imports, partly offset by higher exports from enhanced competitiveness.
  - Fiscal position: with a medium-term revenue strategy, fiscal deficit contained at around 2.2 percent and government debt below 30 percent of GDP in the medium term.

### Key statistics from baseline and reform scenario (selected series, percent of GDP or rates as presented)
- General government revenue: 2015: 14.9; 2016: 14.3; 2017: 13.8; 2018: 14.0; 2019: 13.9; 2020: 13.9; 2021: 13.9; 2022: 13.9
- Central government revenues and grants: 2015: 13.1; 2016: 12.5; 2017: 12.0; 2018: 12.2; 2019: 12.1; 2020: 12.1; 2021: 12.1; 2022: 12.1
- Tax revenues (central): 2015: 10.8; 2016: 10.4; 2017: 9.8; 2018: 10.0; 2019: 10.0; 2020: 10.0; 2021: 10.0; 2022: 10.0
- Non-oil and gas revenues: 2015: 11.9; 2016: 11.8; 2017: 11.2; 2018: 11.3; 2019: 11.3; 2020: 11.4; 2021: 11.4; 2022: 11.4
- General government expenditure: 2015: 17.5; 2016: 16.8; 2017: 16.5; 2018: 16.5; 2019: 16.4; 2020: 16.4; 2021: 16.4; 2022: 16.4
- Infrastructure spending: 2015: 2.2; 2016: 2.2; 2017: 2.7; 2018: 2.8; 2019: 2.6; 2020: 2.5; 2021: 2.5; 2022: 2.5
- Education spending: 2015: 3.5; 2016: 3.3; 2017: 3.3; 2018: 3.3; 2019: 3.3; 2020: 3.3; 2021: 3.3; 2022: 3.3
- Health spending: 2015: 1.3; 2016: 1.5; 2017: 1.5; 2018: 1.5; 2019: 1.5; 2020: 1.5; 2021: 1.5; 2022: 1.5
- Social assistance: 2015: 1.5; 2016: 1.7; 2017: 1.7; 2018: 1.7; 2019: 1.7; 2020: 1.7; 2021: 1.7; 2022: 1.7
- General government deficit: 2015: -2.6; 2016: -2.5; 2017: -2.7; 2018: -2.5; 2019: -2.5; 2020: -2.5; 2021: -2.5; 2022: -2.5
- General government debt: 2015: 26.8; 2016: 28.3; 2017: 29.1; 2018: 29.6; 2019: 30.2; 2020: 30.2; 2021: 30.4; 2022: 30.5
- Real GDP growth (baseline then reform scenario entries): 2015: 4.8; 2016: 5.0; 2017: 5.1; 2018: 5.3; 2019: 5.5; 2020: 5.6; 2021: 5.6; 2022: 5.6 (baseline) and 2018: 5.4; 2019: 5.7; 2020: 5.9; 2021: 6.2; 2022: 6.5 (reform scenario)
- Inflation: 2015: 3.4; 2016: 3.0; 2017: 3.7; 2018: 3.6; 2019: 3.8; 2020: 3.7; 2021: 3.5; 2022: 3.6 (baseline) and 2018: 3.8; 2019: 4.1; 2020: 4.0; 2021: 3.7; 2022: 3.8 (reform scenario)
- Current account deficit/GDP: 2015: -2.0; 2016: -1.8; 2017: 4.7; 2018: -1.9; 2019: -1.8; 2020: -1.9; 2021: -2.0; 2022: -2.0 (baseline) and 2018: -2.0; 2019: -2.0; 2020: -2.2; 2021: -2.3; 2022: -2.3 (reform scenario)

### Conclusion
- Indonesia can achieve stronger inclusive potential growth with structural reforms on infrastructure, regulations, and human capital.
- Constraints: large infrastructure gap, low institutional quality, inadequate human capital.
- An illustrative reform scenario including fiscal and structural reforms shows potential growth could rise to 6.5 percent in the medium term, around 1 percentage point higher than the baseline.
- Clear communication of reforms will help boost confidence in the economy.

### Financial deepening and inclusion (summary points from continuation)
- Promoting financial deepening and inclusion is crucial to increase resilience to external shocks; authorities issued a national strategy for financial inclusion in 2016 and are preparing a national strategy for financial market development.
- Financial system characteristics:
  - Aggregate assets of financial institutions amounted to 72 percent of GDP; banks account for about 80 percent of aggregate assets.
  - Outstanding assets under management of pension funds: about 2 percent of GDP (end-2015).
  - Insurance companies: below 8 percent of GDP (end-2015).
- Short-term funding markets:
  - Daily average volume of the unsecured interbank market was IDR11.8 trillion in 2016 (less than 0.1 percent of GDP).
  - Overnight accounted for about 60 percent of interbank market activity in 2016.
  - Main liquidity providers in interbank rupiah market are state-owned banks.
- Capital markets:
  - At end-2015, outstanding domestic debt securities: 16 percent of GDP; stock market capitalization: 41 percent of GDP (below peer median of 60 percent and 49 percent).
  - Foreign investors hold about 39 percent of government securities denominated in local currency.
  - Government bond market in 2016: outstanding government bonds about 22 percent of GDP; nearly three-quarters denominated in rupiah.
  - Corporate bond market: less than 3 percent of GDP (two-thirds by financial institutions, rest mainly SOEs).
  - Corporate bond issuances: IDR116 billion in 2016 (up from IDR58 billion in 2013).
  - IPO activity: 16 firms a year on average during 2014−16; total listed firms increased to 555 (small compared to peers: 4,073 in India; 806 in Malaysia).

*Source: cr1833 - 16.      A comprehensive and properly sequenced package of fiscal and structural reforms (PDF).*

### 5.      Access to the formal financial system

### 5.      Access to the formal financial system

### Access levels and challenges
- About 36 percent of adults had a transaction account with a formal financial institution in 2014, up from 20 percent in 2011, per the Global Findex database.
- Account ownership in Indonesia remains low compared to the average among other EMs in the East Asia and Pacific region (53 percent).
- Indonesia’s unique geographical challenges constrain access despite recent improvements.

### Inefficient bank intermediation and its effects
- Net interest margins (NIMs) are structurally higher in Indonesia than in many other EMs, reflecting inefficient bank intermediation.
- Contributing factors to high NIMs:
  - Small size of the banking system.
  - Weaknesses in the legal and institutional environment.
  - High market power.
  - Operational inefficiencies (World Bank, 2017).
- Adverse implications due to inefficiencies in Indonesia’s bank-centric system:
  - Reduced savings mobilization.
  - Weaker credit intermediation.
  - Hindered financial inclusion.
- Current policy measures to address high NIMs have included:
  - Caps on deposit rates.
  - Moral suasion to induce banks to lower lending rates to single digit levels, particularly for the corporate and mortgage segments.
  - Requirements for all banks to meet minimum lending exposure quotas to micro, small and medium-sized enterprises.
- These measures have not reduced NIMs and have also hindered the effectiveness of monetary policy operations.

### National strategies and recent progress on financial deepening and inclusion
- High-level institutional arrangements:
  - A national council for financial inclusion (chaired by the President) adopted the National Strategy for Financial Inclusion (SNKI) in 2016.
  - A high-level joint forum is preparing a national strategy for financial market development covering three pillars and seven elements to develop six financial markets through phases 2017−19, 2020−22, and 2023−24.
- Money and FX market reforms and instruments:
  - In August 2016, BI introduced a regular 7-day reverse repo operation with a fixed rate, full allotment, and the attached rate as the main policy rate.
  - The interest rate corridor was narrowed to 150 basis points from 250 basis points.
  - In July 2017, BI launched a partial reserve requirement (RR) averaging of 1.5 percent, out the 6.5 percent current primary RR ratio, over a two-week period, allowing the floor of the RR ratio to be at 5 percent on a given day.
  - BI stopped issuing the 3-month tenor securities; regular 3-month T-bills issuances are planned by the Ministry of Finance (MOF).
  - Issuance of T-bills has risen, providing more instruments at the short end of the yield curve.
  - OJK launched the Global Master Repurchase Agreement to develop the repo market; BI offers seminars and workshops on the trading of repo operations.
  - FX market development measures include an overhauled FX regulatory framework, introduction of the Indonesian version of the International Swap and Derivatives Association contract, and allowance of call spread options as hedging instruments.
  - Currently, 74 out of 103 conventional banks have signed the Global Master Repurchase Agreement, and 55 banks engage in repo transactions.
- Capital market coordination and infrastructure:
  - Cross-agency coordination and private sector consultation occur through the Capital Market Infrastructure Development Program Team and the Bond Market Development Program Team.
  - Achievements include a capital market data warehouse and implementation of Single Investor Identification for government bonds.
  - Initiatives under implementation include infrastructure for third party repo and establishment of a bond electronic trading platform.
- National Strategy for Financial Inclusion (SNKI) details:
  - SNKI has five pillars: financial education, public property rights, expansion of financial products, distribution of government transfers, and consumer protection.
  - SNKI is supported by three foundations: conducive policies and regulations, supportive IT infrastructure, and effective coordination and implementation.
  - Targets an ambitious goal to reach 75 percent of adults with a transaction account by end-2019.
- Programs to expand MSME access:
  - The “People’s Business Loan” (KUR) program (established 2007) provides subsidized, partial credit guarantees covering 70 percent of the loss and interest subsidies to participating banks to lend to MSMEs at capped interest rates.
  - Total loans supported by KUR reached IDR53 trillion in August 2017.

### Digital financial services (DFS) and FinTech developments
- DFS definition in Indonesia: tailored financial services and products delivered through channels other than traditional bank branches.
- Regulatory changes have allowed e-money issuers (banks and nonbanks) to engage Layanan Keuangan Digital (LKD, digital financial services) agents and allowed banks to provide basic bank accounts and other financial services via Laku Pandai (LP, branchless banking) agents.
- Agent coverage:
  - Agents are present in all provinces and in 99 percent of the districts in the country.
  - LKD agents provide cash-in, cash-out, bill payments and transfers.
  - LP agents can offer the same services and facilitate opening basic bank accounts and conduct transactions.
  - At end-2016, 23 banks were offering LP services to around 3.7 million customers.
- FinTech expansion and oversight:
  - The FinTech sector attracted around US$15 billion in investments in 2016.
  - BI established a FinTech office and OJK established an internal cross-departmental group to promote sustainable growth of FinTech and mitigate risks.
  - OJK issued a regulation on Peer-to-Peer lending and proposals to establish a FinTech incubator.
  - BI issued regulation in December 2016 on FinTech players in the payments system.

### Key priorities and policy recommendations for successful implementation
- Prioritization and sequencing:
  - Effective prioritization and sequencing of strategic actions are essential to improve fundamentals without raising undue stability risks.
  - Key recommended priorities (as per FSAP (IMF, 2017)):
    - (i) strengthening credit culture;
    - (ii) upgrading supervisory and regulatory framework along with financial market development;
    - (iii) establishing a liquid benchmark yield curve;
    - (iv) promoting long-term financing with new financial instruments;
    - (v) expanding the domestic investor base.
- Strengthening credit culture and infrastructure:
  - Transition to an online movable collateral registry (2013) greatly increased registrations and facilitated financing:
    - Since its launch, the registry has facilitated over US$30 billion in financing for more than 200,000 small-scale businesses.
    - Total of 19.3 million registrations of corporates, MSMEs, and consumers in the three years since the launch, compared to only three million registrations in total during the ten years of the previous manual system.
  - Introduction of a credit registry and licensing of private credit bureaus were positive steps; efforts should be stepped up to operationalize credit bureaus.
  - Indonesian insolvency and creditor rights (ICR) legislation improved over pre-2004 laws, but out-of-court restructuring remains preferred due to costs of formal procedures; further improvements to ICR regimes would improve recovery rates and access to credit, particularly for MSMEs.
- Supervisory and regulatory evolution:
  - OJK established the Integrated Supervisory and Regulatory Department to reduce silo structures internally and bring coordination under the authority of the Chairman.
  - Formal amendment of the OJK law is recommended to tackle silo structures, strengthen financial oversight and enforcement of prudential regulations, including with respect to financial conglomerates (IMF, 2017).
  - Other priorities include eliminating interest rate caps to improve monetary transmission.
  - Portfolio exposure targets (minimum MSME exposure targets and minimum investment requirements on government bonds and infrastructure-related SOE bonds on nonbank financial institutions) should be reviewed.
- Financial innovation and stability:
  - BI and OJK should step up oversight of DFS and FinTech and expand collaboration to monitor safety, efficiency and reliability.
  - Operational risks from weak communication infrastructure in remote and rural areas may affect agent and customer confidence in DFS; authorities should engage the telecom regulator and payment system operators to enhance operational reliability.
  - Consider launching a nationwide campaign, in partnership with financial institutions, to spread awareness on DFS.
  - Review the effectiveness of the KUR program, including potential fiscal costs and whether it is achieving increased lending to new borrowers (IMF, 2017).
- Developing a liquid benchmark yield curve:
  - MOF observes good practices in issuance program and auctions; perceived liquidity for 5, 10, 15, and 20-year maturities is reasonable, but liquidity is thin in shorter segments.
  - Further improvements to consider:
    - (i) the gradual move to further reserve averaging already planned;
    - (ii) the gradual consolidation of BI liquidity management instruments to support the move to the mid-corridor system;
    - (iii) the maintenance of regular issuances of T-bills to avoid competition between BI instruments and T-bills on the same maturities.
- Mobilizing private long-term financing and product introduction:
  - Government has issued SOE bonds and structured products (e.g., asset backed securities) to fund infrastructure projects in addition to traditional bank funding.
  - Important to ensure new products do not compromise prudential standards or create undue concentration risks to infrastructure-related instruments or SOE debt on financial institutions’ balance sheets.
  - Development of FX and derivatives markets is important to support bond and stock market development by allowing market participants to manage existing risk exposures.
- Enlarging the domestic investor base:
  - Paucity of domestic institutional investors constrains capital market development and creates vulnerabilities.
  - Institutional investors can provide market liquidity, act as market stabilizers, intermediate large national savings domestically, and mitigate reliance on foreign funding.
  - Measures to encourage greater domestic participation:
    - Improve financial literacy and IPO distribution to enhance retail investor participation.
    - Improve tax framework for financial products and hedging instruments (World Bank, 2017).
    - Note: The withholding tax rate of foreign investors is 20 percent, while ranging from 0 to 15 percent in its peers.

*Source: cr1833 - 5.      Access to the formal financial system (IMF chapter).*

### 5.6 percent of GDP in 2000 to 0.7 percent of GDP in 2016). The global share of palm oil exports

### cr1833 - 5.6 percent of GDP in 2000 to 0.7 percent of GDP in 2016). The global share of palm oil exports

### Trade patterns and main destinations
- The global share of palm oil exports almost doubled from 28.1 percent to 54.5 percent and that of coal almost tripled from 6.7 percent to 19.5 percent.
- China replaced Japan as Indonesia’s top export destination between 2000 and 2016.
  - China’s share in Indonesia’s total exports increased from 4½ percent in 2000 to 11½ percent in 2016.
  - Japan’s share fell from 23¼ percent in 2000 to 11 percent in 2016.
  - The United States’ share remained broadly stable: 13.7 percent in 2000 versus 11.2 percent in 2016.
- In 2016:
  - China became the top destination for Indonesia’s coal and base metal exports, and the number two destination for oil and palm oil exports.
  - China sourced 26 percent of its coal imports and 62 percent of its palm oil imports from Indonesia.
  - Coal and palm oil accounted for 41 percent of Indonesia’s total exports to China in 2016.
- Despite rising exports, Indonesia ran a bilateral trade deficit with China:
  - The bilateral surplus turned into a small deficit in 2008, widening to 1.9 percent of GDP in 2016.
  - The shift to deficit occurred in manufacturing sectors such as machinery and transport equipment, and textiles, while resource-based sectors maintained a surplus.
- Regional integration effects:
  - As of September 2017, Indonesia was part of seven regional and two bilateral FTAs.
  - Counterparts of these FTAs accounted for 60 percent of Indonesia’s exports and 70 percent of its imports in 2016.
  - The share of Indonesia’s exports to other ASEAN countries rose from 17.5 percent in 2000 to 20.7 percent in 2016.

### Composition of exports and comparative advantage
- Non-commodity exports:
  - Shares of key non-commodity exports, such as electrical appliances and textiles, in total exports declined in 2000–16 due to increased competition from neighboring countries (e.g., Bangladesh, Vietnam, and China).
- Revealed Comparative Advantage (RCA):
  - Indonesia has maintained RCA > 1 in mineral fuels and low technology industries throughout 2000–16.
  - RCA for mineral fuels increased in 2013–16; RCA for low technology industries remained stable.
  - RCA in high technology industries declined gradually in 2000–16.
  - RCAs in medium-low and medium-high technology industries remained below one and stable.
  - China and Vietnam gained comparative advantage in high technology industries over this period.
- Export sophistication and economic complexity:
  - Export sophistication improved but remained low compared with peers in 2000−16; Indonesia surpassed Philippines but lagged China, Malaysia, Thailand, and non-Asian large emerging economies.
  - Economic Complexity Index (ECI):
    - Indonesia has low economic complexity.
    - In 2015, Indonesia ranked the 57th out of 108 countries by the Economic Complexity Observatory.
    - While most comparators increased ECI in 2000–16, Indonesia’s ECI decreased.
    - Indonesia’s ECI was lower than India, Philippines, and Vietnam despite higher per capita income.

### Trade policy, tariffs, and non-tariff measures (NTMs)
- Tariffs:
  - Indonesia’s average applied most-favored-nation (MFN) tariff rate was 6.9 percent in 2016, down from 9.5 percent in 2006.
  - Indonesia’s average bound tariff rate was 37 percent in 2016.
  - The difference between bound and applied tariff rates was 30 percentage points, higher than the average of 20 percentage points among G20 developing countries.
  - Indonesia offers additional tariff reductions for economies in FTAs.
- Services trade restrictiveness:
  - Most of Indonesia’s OECD services trade restrictiveness measures were higher than the average G20 countries, with large gaps in distribution services, maritime transport, and legal services.
- Non-tariff measures:
  - Share of tariff lines subject to NTMs on the import side grew from 42 percent in 2009 to 51 percent in 2015.
  - On the export side, the share of tariff lines subject to NTMs grew from 4 percent in 2009 to 10 percent in 2015.
  - World Bank Temporary Trade Barriers data indicate import restrictions decreased in 2004–05 but then increased sharply after the global financial crisis and remain higher than pre-crisis levels.
  - Global Trade Alert data show Indonesia introduced more NTMs than other G20 countries since 2008.

### Diversification and market concentration
- Product and destination diversification (Herfindahl concentration index, SITC-Rev3):
  - Indonesia’s export products became more diversified since 2011; product diversification stood in the middle among comparators.
  - Within the region: similar product diversification as India and Vietnam; more diversified than the Philippines and Malaysia; less diversified than China and Thailand.
  - Export destinations improved: Indonesia moved from moderate concentration to unconcentrated category; one-third of products exported to top three destinations in 2016 versus one half in 2000.

### Participation in Global Value Chains (GVCs)
- GVC participation trends:
  - Indonesia’s participation in GVCs increased slightly since 2000 but remains below Asian comparators.
  - The increase came mainly from forward participation (domestically produced intermediate goods used in third countries).
  - Backward participation (foreign value added in domestic exports) declined over time, likely influenced by complex regulations including NTMs.
  - Indonesia’s share in global value added remained in the middle of its comparators.
- Origin of value added (2011 data):
  - Domestic sources dominated value added in exports (88 percent) and final demand (77.9 percent).
  - China’s shares in Indonesia’s exports, final demand, and import value added increased; shares of the United States, Japan, Singapore, Germany, and Australia fell.
- Determinants of GVC participation (literature):
  - Include tariffs, infrastructure, access to trade finance, regulatory environment, business environment, labor skills, transportation, and economic complexity.
- Constraints and reforms to improve GVC integration:
  - Indonesia’s investment environment (regulatory quality, labor skills, infrastructure) is relatively weak compared with most comparators.
  - Despite relatively low tariffs and partial FDI liberalization, trade barriers and FDI restrictions have contributed to low GVC integration.
  - Planned policy actions include streamlining NTMs, shifting controls from border to post-border, and opening to trade through bilateral and regional trade agreements.
  - Enhancing the investment climate—improving infrastructure, regulations, and labor skills—would strengthen links with GVCs and competitiveness.

### Conclusion and policy recommendations
- Key conclusions:
  - Indonesia has become more integrated globally through FTAs and has improved export diversification and destinations.
  - Comparative advantage remains concentrated in mineral fuels and low technology industries; economic complexity is low.
  - Participation in GVCs is low compared with Asian comparators.
- Policy recommendations to strengthen export competitiveness and move up the value chain:
  - Strengthen competitiveness in higher technology products.
  - Improve economic complexity.
  - Enhance participation in GVCs by improving the investment environment, including infrastructure, regulations, and labor skills.
  - Streamline NTMs and shift controls from border to post-border.
  - Pursue bilateral and regional trade agreements to open markets and attract GVC-linked investment.
- Expected outcome:
  - By pursuing reforms in these areas, Indonesia would be better positioned to enhance living standards and transition from a basic commodity exporter subject to global price swings, low value added, and limited employment growth.

*Source: IMF staff analysis as presented in the provided content.*

### References

### References

### Scholarly articles and working papers
- Balassa, B., 1965, “Trade Liberalization and “Revealed” Comparative Advantage,” The Manchester School, Vol. 33, pp. 99–123.
- Blanchard, E., 2013, “What Global Fragmentation Means for the WTO: Article XXIV, Behind-the-Border Concessions, and A New Case for WTO Limits on Investment Incentives,” WTO Working Paper ERSD-2013–03 (Geneva: World Trade Organization).
- Cheng, K., S. Rehman, D. Seneviratne, and S. Zhang, 2015, “Reaping the Benefits from Global Value Chains,” IMF Working Paper No. 15/204 (Washington: International Monetary Fund).
- De Backer, K. and S. Miroudot (2013), “Mapping Global Value Chains,” OECD Trade Policy Papers, No. 159 (Paris: Organisation for Economic Co-operation and Development).
- Ding, X., and M. Hadzi-Vaskov, 2017, “Composition of Trade in Latin America and the Caribbean,” IMF Working Paper No. 17/42 (Washington: International Monetary Fund).
- Hatzichronoglou, T., 1997, “Revision of the High-Technology Sector and Product Classification,” OECD Science, Technology and Industry Working Papers, No. 1997/02 (Paris: Organisation for Economic Co-operation and Development).
- Hausmann, R., J. Hwang, and D. Rodrik, 2007, “What You Export Matters,” Journal of Economic Growth, Vol. 12, pp. 1–25.
- Hidalgo, C. A., and R. Hausmann, 2009, “The Building Blocks of Economic Complexity,” Proceedings of the National Academy of Sciences, Vol. 106, pp. 10570–10575.
- Hummels, D., and Schaur, G., 2012, “Time as a Trade Barrier,” NBER Working Paper No. 17758 (Cambridge, Massachusetts: National Bureau for Economic Research).
- Simoes, A. J. G, and C. A. Hidalgo, 2011, “The Economic Complexity Observatory: An Analytical Tool for Understanding the Dynamics of Economic Development,” Workshops at the Twenty-Fifth AAAI Conference on Artificial Intelligence, 2011.

### Country- and region-specific studies
- Marks, S., 2015, “The ASEAN-China Free Trade Agreement: Political Economy in Indonesia,” Bulletin of Indonesian Economic Studies, Vol. 51, No. 2.
- Marks, S., 2017, “Non-tariff Trade Regulations in Indonesia: Nominal and Effective Rates of Protection,” Bulletin of Indonesian Economic Studies (March).
- Pangestu, M., S. Rahardja, and L. Ing, 2015, “Fifth Years of Trade Policy in Indonesia: New World Trade, Old Treatments,” Bulletin of Indonesian Economic Studies, Vol. 51, No. 2.
- Ding, X., and M. Hadzi-Vaskov, 2017, “Composition of Trade in Latin America and the Caribbean,” IMF Working Paper No. 17/42 (Washington: International Monetary Fund).

### Institutional reports and datasets
- OECD, 2003, Science, Technology and Industry Scoreboard.
- Office of the United States Trade Representative (USTR), 2017, 2017 National Trade Estimate Report on Foreign Trade Barriers. Available via the Internet: https://ustr.gov/sites/default/files/files/reports/2017/NTE/2017%20NTE.pdf.
- World Trade Organization, 2013, Trade Policy Review—Indonesia.
- _______________, 2014, “The Rise of Global Value Chains,” World Trade Report (Geneva).
- WTO-OECD, 2013, Global Review of Aid for Trade.

*cr1833 - References*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1833.pdf_