## 1idnea2019002

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---

### Exchange Rate and Trade Balance: Recent Trends
- Key headline:
  - A 10 percent depreciation in the exchange rate is associated with a rise in the goods net-exports of up to 1.6 percent of GDP.
- Recent movements and stylized facts:
  - Rupiah depreciated by about 6 percent in real effective terms after the tightening of global financing conditions in 2018.
  - Imports surged by approximately 20 percent (value) and 8 percent (volume) year-on-year in 2018.
  - Exports grew in value by 7 percent in 2018.
- Evidence of disconnect between exchange rate and fundamentals:
  - Correlation between ToT and NEER: 2011–2014: 0.67; 2015–2018: -0.32.
  - Correlation between IRD and NEER: 2011–2014: -0.65; 2015–2018: 0.49.
  - Estimated standard deviation of PPI-based REER and NEER (2010:Q1–2018:Q4) is strictly above the standard deviation of the terms of trade index by approximately 4 standard deviations.
- Implications from the literature:
  - High and “excess volatility” of nominal and real exchange rates associated with limited pass-through to trade and consumer prices.
  - Reasons: nature of shocks (international asset demand/financial shocks), price-setting behavior (local currency pricing, pricing-to-market), home-bias in consumption, deep integration in global value chains.

### Data and Empirical Methodology
- Data sources and scope:
  - Sectoral monthly trade value and volume data from Statistics Indonesia (BPS) at SITC (revision four).
  - Real effective exchange rate data from BIS.
  - Monthly commodity price index from the IMF (weighted average of 68 global commodity prices; normalized to 100 at year 2016 prices).
  - Global value chain data from OECD Trade in Value database.
- Estimation approach:
  - Focus on six- and twelve-month cumulative changes.
  - Sector-level pass-through equation conditions on quarterly time effects (ρq).
  - Import-price specification includes asymmetric exchange rate and commodity-price components:
    - ∆mpt = βi+ ∆ect+ + βi− ∆ect− + γi+ ∆cct+ + γi− ∆cct− + ρq + εi,ct.
  - Aggregate pass-throughs obtained by share-weighted aggregation of sector-wise coefficients.
- Estimation sample period: 2011–2018.

### Pass-Through Results — Import Prices
- Aggregate 6-month pass-throughs (Table 1 summary):
  - A 10 percent appreciation is associated with an import price decrease of 5.7 percent (aggregate coefficient shown as -0.57***).
  - A 10 percent commodity price increase is associated with an import price increase of 4.6 percent (aggregate coefficient shown as 0.46***).
- Aggregate 12-month pass-throughs:
  - A 10 percent appreciation associated with an import price decrease of 7 percent (aggregate coefficient shown as -0.70***).
  - Commodity price pass-through at 12 months shown as 0.60***.
- Asymmetric aggregate effects (sector-weighted):
  - Appreciation/commodity price increase: exchange rate PT for appreciation -0.80*; commodity PT for commodity price increase -1.01***; other reported values 0.33, 0.58***.
  - Depreciation/commodity price decrease: -0.31**, -0.43**, 0.53***, 0.70**.
- Directional and sector-specific findings:
  - Trade prices more responsive to exchange rate shocks than to commodity price shocks on average.
  - Import-price pass-through higher than export-price pass-through (exports in U.S. dollars).
  - Appreciations linked to stronger import price changes; depreciations linked to stronger export price changes.
  - Sectoral heterogeneity and aggregation bias risk:
    - Largest importing sector (machinery and transport equipment) share: 31.7% of imports; six-month exchange rate pass-through coefficient = -0.04.
    - Other top importing sectors average coefficient about -0.6 at six months.
    - Twelve-month horizon shows increased pass-through sensitivity for many sectors (example: machinery and transport equipment sensitivity increases to 0.06 at 12 months).

### Pass-Through Results — Export Prices and Volumes
- Export price pass-throughs:
  - A 10 percent increase in exchange rate (commodity-prices) is associated with increasing export prices (in foreign currency) by 4 percent (2 percent) at the six-month horizon.
  - The same 10 percent increase is associated with increasing export prices by 1.5 percent (3 percent) over the twelve-month horizon.
  - Export price pass-through coefficients generally lower than import price pass-through coefficients.
  - Depreciations and commodity-price declines associated with higher export pass-throughs than appreciations and commodity price increases.
  - Largest exporting sector shows insignificant exchange rate pass-throughs but significant commodity-price pass-throughs (on average 4 percent increase to a 10 percent increase in commodity prices).
- Volume responses:
  - Six-month quantity adjustment is strong with aggregate elasticities close to one for both imports and exports.
  - Import quantities adjust one-on-one to changes in import prices over all horizons.
  - Export quantity response strong at six months but weaker over time.
  - Commodity-intensive sectors (e.g., mineral fuels) are more inelastic to price changes.

### Implications for the Current Account
- Combining aggregate price and volume pass-throughs with trade shares:
  - A 10 percent depreciation is associated with a rise in goods net exports of 1.3 percent of GDP over a 6-month horizon.
  - A 10 percent depreciation is associated with a rise in goods net exports of 1.6 percent of GDP over a 12-month horizon.
- Benchmarks:
  - Bussiere and others (2013) find pass-through coefficients between 0.5 to 0.7 (up to two quarters) for Indonesia.
  - IMF (2015) estimates average effect of a 10 percent depreciation on net-exports to be 1.5 percent of GDP across a set of 23 advanced and 37 emerging/developing economies.

### Nature of Shock, Asymmetry, and GVC Transmission
- Decomposition by type of exchange rate shock (six-month aggregate import/export price pass-throughs):
  - Financial market fluctuations: Imports -0.15; Exports 0.36.
  - Residual fluctuations: Imports -0.64 **; Exports 0.44 *.
  - Pass-through of residual fluctuations higher than that induced by financial market volatility, especially for imports.
- Role of global value chains (GVC):
  - As of 2016, 14 percent of Indonesian exports have foreign value-added content.
  - Share of intermediate goods imports used for re-exports is 20 percent, on average in Indonesia.
  - Export pass-throughs sensitive to share of foreign value-added: lower backward linkages → higher export pass-throughs.
  - Import price pass-throughs vary with share of imports used for re-exports: high re-export shares → lower pass-through.
  - Tight GVC linkages weaken pass-through.

### Summary Conclusions on Pass-Through
- Trade prices adjust less than fully to exchange rate and commodity price shocks; volumes adjust strongly and rapidly.
- Incomplete price adjustment concentrated in top import/export sectors over shorter horizons.
- Pass-through effects vary substantially across sectors; appreciations have stronger pass-through effects than depreciations.
- Pass-through is weaker when exchange rate changes derive from financial market perturbations and when sectors are tightly connected in GVCs.

*Italic: Prepared by Manasa Patnam (SPR); estimation sample period is between 2011–2018; significance notation: *** 1% level, ** 5% level, * 10% level.*

### Growth-at-Risk (GaR) — Key Points and Results
- Predictors and indices:
  - GaR analysis uses a country-specific Financial Condition Index (FCI) and Macrofinancial Vulnerability Index (MVI).
  - Both indices were at a neutral level at end-2018.
- Conditional central tendency:
  - Conditional on two neutral indices, the 2019 GDP growth rate is most likely to be 5.2 percent.
- GaR statistics for 2019:
  - GaR at 5 percent: 2.7 percent (a 5 percent chance that real GDP in 2019 will grow by at most 2.7 percent).
  - Probability of a recession is less than 1 percent in 2019.
  - Interquartile interval of the GDP forecast at end-2019: 3.9 to 5.3 percent.
  - Mode: 5.2 percent.
  - Median: 4.5 percent.
- Partitioned variable groups used:
  - Financial conditions: Real long-term interest rates; Term spread; Sovereign spreads; Corporate spreads; CEMBI market cap; Equity returns; Change in foreign exchange rate; VIX.
  - Macrofinancial vulnerability: Credit growth; Credit gap; NPL ratios; External debt to GDP; Current account balance to GDP; House price growth.
  - External condition: China’s GDP growth.
- Methodology:
  - Quantile regressions for horizons h ∈ {4,8,12} quarters and quantiles τ ∈ {10,25,50,75,90}.
  - Conditional quantiles fitted with a t-skew distribution characterized by five parameters (location/mode, degree of freedom, scale/variance (sigma), kurtosis, skewness) to derive the conditional CDF and Growth-at-Risk measures.

### Financial Condition Index (FCI) and Macrofinancial Vulnerability Index (MVI)
- FCI:
  - Constructed via PCA extracting the first principal component from eight financial variables.
  - Normalized to zero mean and standard deviation of one over 2001–2018.
  - Historical episodes: Global Financial Crisis, 2013 taper tantrum, 2015 global stock market episode.
  - As of end-2018, financial conditions tightened to a neutral level; expected to loosen a bit in 2019:Q1.
- MVI:
  - First principal component from slow-moving credit aggregates and sectoral indicators.
  - Normalized to zero mean and standard deviation of one over 2001–2018.
  - Two most important variables: current account deficits and the credit gap.
  - End-2018 assessment: vulnerabilities broadly contained but turned slightly positive due to wider current account deficits and increased corporate external debt.

### Empirical Findings on Predictability
- Tighter financial conditions negatively correlated with near-term economic activity; as they revert, medium-term boost to growth expected.
- Elevated macrofinancial vulnerability associated with weaker growth across horizons; potential shock amplification larger over medium term.
- Relationships vary across forecasting horizons and quantiles.

### Financial and Macro Variables Used (selected)
- Financial variables:
  - Change in Long-Term Real Interest Rate (percentage point change in 10-year government bond yield, adjusted for inflation).
  - Term Spreads: 10-year minus 1-year government bond yields.
  - Sovereign Spreads: 10-year Indonesia government bonds minus 10-year U.S. government bonds.
  - Corporate Spreads: commercial banks’ lending rates for corporate working capital minus interbank interest rate.
  - CEMBI market cap, Equity Returns (local currency), Exchange Rate Movements (change in U.S. dollar per national currency), VIX.
- Macrofinancial variables:
  - Credit Growth (yoy), Credit Gap, NPL Ratio, External Debt to GDP, Current Account Deficits to GDP, House Price growth.
- Growth series:
  - Real GDP Growth for Indonesia and Real GDP Growth for China.

*Source: IMF staff estimates and analysis as presented in the chapter “4. Financial conditions serve as a useful predictor for downside risks to GDP growth.”*

### Monetary Policy Press Releases and Market Rates — Main Findings
- Press releases do not have a significant impact on market rates once policy rate decisions are accounted for.
- Monetary policy surprises:
  - Unanticipated policy changes have a significant impact on short-end money market maturities but do not propagate along the entire yield curve.
  - No significant impact of press releases on bond yields and the exchange rate.
- Alternative full-sample regressions (Appendix II) support the finding that press releases have no significant independent impact on market rates.
- Monetary policy reports (MPR) similarly show no significant contemporaneous impact on market rates.

### Key Statistics on Press Releases (selected coefficients and significance)
- Unanticipated policy change coefficients:
  - 1-week: 1.369 *** (0.357)
  - 2-week: 1.000 *** (0.19)
  - 3-week: 1.195 *** (0.252)
  - 1-month: 0.469 *** (0.17)
  - 1-year: 0.540 *** (0.21)
  - 5-year: 0.285 (0.175)
  - 10-year: 0.133 (0.113)
  - Exchange rate: -0.008 (0.096)
- Anticipated policy change coefficients (selected):
  - 1-month: 0.203 (0.221) *
- Observations per column: mostly 135; some columns 126, 138, 141.
- R-squared examples: 0.079 (1-week), 0.213 (2-week), 0.246 (3-week), 0.001 (exchange rate).

### MPR Impact (selected)
- Overnight coefficient in restricted-sample regressions: 0.759 *** (0.1)
- 1-year coefficient: 0.327 ** (0.144)
- 10-year coefficient: 0.063 (0.081)
- Surprise dummy * Overnight interaction (selected):
  - 1-year: -0.439 *** (0.106)
- Unanticipated policy change (selected):
  - 1-week: 1.008 *** (0.147)
  - 2-week: 1.201 *** (0.246)

### Methods and Identification (Appendix III summary)
- Monetary policy surprise decomposition:
  - Δit = (it − Et-1 it) + (Et-1 it − it−1) = Δi_u + Δi_a.
- Baseline OLS specification with robust standard errors:
  - Δm_t = α0 + α_u Δi_u + α_a Δi_a + α_c Controls + ε_t.
- Identification of press release impact via interaction of overnight rate with surprise dummy.
- Robustness: regress absolute changes in market rates |Δm_t| on dummies for MP and MPR releases in full sample.

### Policy Implications and Recommendations on Monetary Transmission
- Evidence of weak transmission from policy-rate changes to broader yield curve, bond yields, and exchange rate.
- Recommendations:
  - Improve clarity of monetary policy communication to enhance effectiveness.
  - Deepen financial markets to support monetary policy transmission.
  - Financial deepening reforms include:
    - Improving liquidity and activity in the money market beyond one month of maturity.
    - Increasing issuance of short-term government securities.

### Broader Contextual Figures (selected)
- Economic growth in Indonesia around 5 percent.
- A Medium-Term Revenue Strategy (MTRS) could raise revenues by up to 5 percent of GDP in the medium term:
  - 1.5 percent of GDP from tax administration reforms.
  - 3.5 percent of GDP from tax policy reforms.
- Achieving the SDGs estimated to require additional spending of about 5½ percent of GDP per year in education, health, and infrastructure.

*Source: IMF staff analysis as presented in the chapter "Monetary policy press releases appear not to have a significant impact on market rates" (content unit 1idnea2019002).*

### Medium-Term Revenue Strategy (MTRS) — Operational Approach and Major Reforms
- Operational approach:
  - MTRS requires careful prioritization, sequencing and phasing; buy-in and stakeholder support essential.
- Key reform pillars:
  - Tax policy reforms to remove exemptions, streamline regimes, broaden base and increase rates in least distortionary manner.
  - Tax administration reforms to improve compliance and efficiency.
  - Use other instruments (expenditure policy) for social/industrial objectives rather than special tax treatments.

### VAT Reforms (selected)
- Remove certain exemptions (mining, agriculture, tourism, domestic transportation, employment services, fee-based financial services, art, entertainment, electricity, water); keep “standard exemptions” for margin-based financial services, education, health care.
  - Revenue impact: modest gain of about 0.2 percent of GDP.
- Reduce the registration threshold (current multiple of per capita PPP GDP ≈ 30).
- Replace STLG with VAT and a vehicle excise:
  - STLG raised 0.15 percent of GDP in 2015 (90 percent from vehicles).
  - Vehicle excise revenue expected: about 0.6 percent of GDP.
- Increase standard VAT rate by 2 percentage points after exemptions removed and threshold reduced.

### Excise and Fuel Excises
- Introduce fuel excises (example benchmark: around IDR 3,000 per liter for gasoline).
  - Revenue impact: can raise 0.5 percent of GDP.
  - Feasibility: feasible after fuel subsidies phased out.
  - Distributional concern: potentially large negative impact on the poor; strengthen social safety net.

### Corporate Income Tax (CIT) Reforms
- Replace special regimes with a single corporate income tax (except shipping); abolish final withholding schemes and high-discount rules.
  - Expected fiscal impact: revenue neutral; potential to lower headline CIT rate.
- Reduce SME regime threshold; align with VAT threshold and set at IDR 600 million.
- Introduce alternative minimum tax (AMT) based on turnover with a 10-year carry-forward period.
  - AMT expected to raise revenues but may introduce complexity.
- Continue strengthening international taxation measures (transfer pricing, anti-avoidance).

### Personal Income Tax (PIT)
- Broaden PIT base, strengthen progressivity:
  - Base on individual income instead of family income.
  - Could raise an additional 0.3 percent of GDP by end of reform.
  - Trade-offs: lower efficiency, higher tax burden on middle class, improved equity.

### Property Tax
- Current revenues: 0.3 percent of GDP; assessment values below market value; municipal rate cap 0.3 percent of assessed value.
- Reform package:
  - Increase maximum recurrent land and building tax rate from 0.3 percent to 1 percent.
  - Reduce property transaction tax from 5 to 2 percent gradually.
  - Expected revenue impact: around 0.3 percent of GDP by local governments.

### Tax Administration Reform Program
- Objective: raise 1.5 percent of GDP via compliance improvement programs (CIPs) targeting VAT, employer withholding, UHWI and HWI.
- Five initiatives:
  - Strengthen audit workforce; national audit taskforce over next two years.
  - Build data matching capacity; invest in whole-of-government access to high-leverage data sets.
  - National deployment of compliance risk management (CRM).
  - Reassign staff to risk-based compliance and extensification.
  - Leverage Tax Amnesty and AEOI intelligence.
- Institutional reforms:
  - Autonomy and budget flexibility for DGT while remaining in Ministry of Finance.
  - Organizational alignment, integrity measures, IT improvements and a new core tax administration system.

### Complementary Reforms and Use of Revenue
- Complementary reforms in expenditure policy and public financial management required.
- Primary objective: raise revenues for priority spending including SDGs.
- Evidence: countries with tax-to-GDP below 15 percent grow significantly slower than those above the tipping point.
- Use of additional revenues options:
  - Invest in priority areas with growth near potential and stable environment.
  - If economy overheats or external financing volatile: lower fiscal deficit, repay SOE obligations, or reduce SOE infrastructure spending.

### Expected Revenue Impacts (illustrative totals)
- Total MTRS revenue potential: around 5 percent of GDP over five years.
- Tax policy total: 3.5
  - VAT total: 1.8
    - Remove exemptions: 0.2
    - Reduce registration threshold: 0.2
    - Replace STLG with VAT and vehicle excise: 0.6
    - Increase standard rate by 2 percentage points: 0.8
  - Excise taxes total: 0.5 (fuel excises: 0.5)
  - CIT total: 0.4
    - Reduce SME threshold: 0.1
    - Introduce AMT: 0.3
  - PIT total: 0.4
  - Property tax total: 0.3
  - Tax administration total: 1.5

### Sequencing, Phasing, and Action Plan
- Four reform categories with sequencing:
  - Immediate (Year 1): public information campaign; improving tax administration; streamlining existing taxes.
  - Streamlining reforms: Year 1–Year 3.
  - Expanding tax base: Year 2–Year 5.
  - Increasing tax rates or introducing new taxes: Year 4–Year 5 (fuel excises only after subsidy removal; VAT rate increase after exemptions removed and threshold lowered).
- Near-term actions:
  - Launch CIPs; national audit taskforce; data improvement pilot; deploy CRM nationally; revise VAT law; repeal STLG and prepare vehicle excise; review CIT regimes.
- Institutional prerequisites: DGT autonomy, budget flexibility, IT system launch, workforce improvements.

### Social Safety Net, Sequencing, and Political Economy
- Strengthening social safety net mitigates adverse impacts of VAT increases and fuel excises and helps build public support.
- Sequencing and phasing must reflect social impacts and implementation challenges; MTRS should not be implemented in one step.
- Recommended immediate focus: public communication campaign; stakeholder engagement; build consensus using past whole-of-government campaign experience.

### Strategic Considerations and Conclusions
- Government revenues are very low in Indonesia; MTRS can raise around 5 percent of GDP over five years and improve tax system, productivity, and growth.
- Reforms require prioritization, sequencing, phasing, and complementary expenditure reforms to translate revenues into higher inclusive growth.
- Decisions should adapt as social and economic conditions change; authorities should refine the strategy and action plan over time.
- Note: the decision to reduce SME turnover tax to 0.5 percent runs contrary to MTRS recommendations and may need reconsideration due to not aligning with best practice.

*Source: 1idnea2019002 — IMF PDF chapter content.*

### References _______________________________________________________________________________ 15

### EXCHANGE RATE AND TRADE DYNAMICS IN INDONESIA: CONNECTING THE DOTS

### A. Exchange Rate and Trade Balance: Recent Trends
- Key headline:
  - A 10 percent depreciation in the exchange rate is associated with a rise in the goods net-exports of up to 1.6 percent of GDP.
- Recent movements and stylized facts:
  - Following the tightening of global financing conditions in 2018, the rupiah depreciated by about 6 percent in real effective terms.
  - During the same period, imports surged both in value and volume terms by approximately 20 percent and 8 percent year-on-year respectively.
  - Exports grew in value by 7 percent in 2018.
- Evidence of disconnect between exchange rate and fundamentals:
  - Correlation between ToT and NEER:
    - 2011–2014: 0.67
    - 2015–2018: -0.32
  - Correlation between IRD (Indonesia-U.S. interest rate differential, in bps) and NEER:
    - 2011–2014: -0.65
    - 2015–2018: 0.49
  - The estimated standard deviation of both the PPI-based REER and NEER index (2010:Q1–2018:Q4) is strictly above the standard deviation of the terms of trade index by approximately 4 standard deviations.
- Implications from the literature (summarized findings):
  - High and “excess volatility” of nominal and real exchange rates is associated with limited pass-through of exchange rate changes to trade and consumer prices.
  - Reasons for limited pass-through include:
    - Nature of shocks: international asset demand/financial shocks can generate large exchange rate fluctuations with small effects on real economy due to financial frictions.
    - Transmission mechanisms: price-setting behavior (local currency pricing, pricing-to-market), home-bias in consumption, and deep integration in global value chains.

### B. Data and Empirical Methodology
- Data sources and scope:
  - Sectoral monthly trade value and volume data from Statistics Indonesia (BPS) at the SITC (revision four) sectoral classification.
  - Real effective exchange rate data from BIS.
  - Monthly commodity price index from the IMF (weighted average of 68 global commodity prices representing energy, agriculture, fertilizers, metals; normalized to 100 at year 2016 prices).
  - Global value chain data from OECD Trade in Value database.
- Estimation approach:
  - Focus on six- and twelve-month cumulative changes to mitigate nominal price rigidity biases.
  - Sector-level pass-through equation conditions on quarterly time effects (ρq) to capture unobserved time-varying factors.
  - Specification for import prices (mp, in local currency, deflated by CPI) includes asymmetric exchange rate pass-through components:
    - ∆mpt = βi+ ∆ect+ + βi− ∆ect− + γi+ ∆cct+ + γi− ∆cct− + ρq + εi,ct
    - e denotes log of real effective exchange rate; c denotes log of commodity price index; subscripts ct denote cumulative 6- or 12-month changes; sector aggregation uses sector shares si.
  - Aggregate pass-throughs obtained by share-weighted aggregation of sector-wise coefficients.

### C. Results — Pass-Through, Asymmetries, and Sector Heterogeneity
- Aggregate and horizon results for import-price pass-throughs (summary from Table 1):
  - 6-month horizon:
    - A 10 percent increase in exchange rate (appreciation) is associated with an import price decrease of 5.7 percent (aggregate coefficient shown as -0.57***).
    - A 10 percent increase in commodity prices is associated with an import price increase of 4.6 percent (aggregate coefficient shown as 0.46***).
  - 12-month horizon:
    - A 10 percent increase in exchange rate (appreciation) is associated with an import price decrease of 7 percent (aggregate coefficient shown as -0.70***).
    - Commodity price pass-through at 12 months shown as 0.60***.
  - Asymmetric aggregate effects (aggregated from sector-wise differentiated effects):
    - + (Appreciation/commodity price increase): -0.80* (exchange rate PT for appreciation), -1.01*** (commodity PT for commodity price increase), 0.33, 0.58***
    - - (Depreciation/commodity price decrease): -0.31**, -0.43**, 0.53***, 0.70**
- Notable directional and sector-specific findings:
  - Trade prices are on average more responsive to exchange rate shocks than to commodity price shocks.
  - Exchange rate pass-through coefficient of import prices is higher than that of export prices (exports expressed in U.S. dollars).
  - Pass-throughs vary by shock direction:
    - Appreciations linked to stronger import price changes.
    - Depreciations linked to stronger export price changes.
  - Significant sectoral heterogeneity and aggregation bias risk:
    - Largest importing sector (machinery and transport equipment) share: 31.7% of imports; six-month exchange rate pass-through coefficient = -0.04 (very low sensitivity).
    - Other top importing sectors have significantly higher pass-throughs (average coefficient about -0.6 across those sectors).
    - Twelve-month horizon shows general increase in pass-through sensitivity for sectors, e.g., machinery and transport equipment sensitivity increases to 0.06 (described as 6 percent following a 10 percent exchange rate change).
- Interpretation:
  - Import prices adjust well to exchange rate fluctuations but adjustments are stronger for appreciation episodes and exhibit delayed effects (larger pass-throughs at 12 months vs 6 months).
  - Heterogeneity likely driven by sectoral characteristics: extent of global value chain integration, invoicing currency, and sector-specific delivery/pricing lags.

_Italic: Prepared by Manasa Patnam (SPR); estimation sample period is between 2011–2018; significance notation: *** 1% level, ** 5% level, * 10% level._

### 13.      The price sensitivity of export prices to exchange rate shocks is generally lower than of

### 13.      The price sensitivity of export prices to exchange rate shocks is generally lower than of

### Pass-through of exchange rate and commodity-price shocks to export prices
- A 10 percent increase in exchange rate (commodity-prices) is associated with increasing export prices (in foreign currency) by 4 percent (2 percent) at the six-month horizon.
- The same 10 percent increase is associated with increasing export prices by 1.5 percent (3 percent) over the twelve-month horizon.
- Export price pass-through coefficients are generally lower than import price pass-through coefficients; one explanation is exporters setting prices in a dominant currency (mostly the dollar), limiting frequent price adjustments.
- Considerable asymmetry and heterogeneity across sectors and by type of shock:
  - Depreciations and commodity-price declines are associated with higher pass-throughs compared to appreciations and commodity price increases.
  - The largest exporting sector shows insignificant pass-throughs for exchange rate changes but significant pass-through effects for commodity price changes (on average 4 percent increase to a 10 percent increase in commodity prices).

### Estimation and aggregate bias
- Pooled specification that aggregates all sectors yields aggregate import and export pass-through coefficients of -1.65 and 0.06, respectively.
- Pooled (aggregate) estimates are significantly downward biased due to substantial heterogeneity in sectoral shares and sector-specific volume responses to price changes.
- Downward bias suggests presence of sectors with large price changes but relatively more elastic volumes.

### Volume responses to price changes
- For both imports and exports, the six-month adjustment to quantities is strong with aggregate elasticities close to one.
- Import quantities adjust one-on-one to changes in import prices over all horizons.
- For exports, the quantity response is strong over the six-month horizon but weaker over time.
- Commodity-intensive sectors (e.g., mineral fuels) are more inelastic to price changes.

### Implications for the current account
- Combining aggregate price and volume pass-through estimates with import and export shares:
  - A 10 percent depreciation in the exchange rate is associated with a rise in goods net exports of, on average, 1.3 percent of GDP over a 6-month horizon.
  - A 10 percent depreciation is associated with a rise in goods net exports of, on average, 1.6 percent of GDP over a 12-month horizon.
- These results are similar to benchmarks: Bussiere and others (2013) find import and export price pass-through coefficients to range between 0.5 to 0.7 (for up-to two quarters) for Indonesia; IMF (2015) estimates average effect of a 10 percent depreciation on net-exports to be 1.5 percent of GDP across a set of 23 advanced and 37 emerging/developing economies.

### Nature of the shock and pass-through asymmetry
- Pass-through effects of trade prices are weaker when exchange rate fluctuations are driven by international financial market perturbations.
- Six-month aggregate import and export price pass-throughs decomposed by type of exchange rate shock:
  - Financial market fluctuations: Imports -0.15; Exports 0.36.
  - Residual fluctuations: Imports -0.64 **; Exports 0.44 *.
- Pass-through of residual fluctuations to import/export prices is higher than that induced by financial market volatility, especially for imports.
- Conceptual explanations include exchange rate movements driven by expectations/speculators unrelated to trade fundamentals.

### Transmission mechanisms: role of global value chains (GVC)
- Indonesia has sizable forward and backward GVC linkages:
  - As of 2016, 14 percent of Indonesian exports have foreign value-added content.
  - Share of intermediate goods imports used for re-exports is 20 percent, on average in Indonesia.
- Sectoral variation findings:
  - Export pass-throughs are very sensitive to the share of foreign value-added embodied in the sector’s exports: sectors with lower backward linkages (less dependence on imported intermediates) are more likely to have high exchange rate pass-through effects on export prices.
  - Import price pass-throughs vary with the share of imports used for re-exports: sectors with high re-export shares experience lower price pass-through effects of exchange rate shocks.
  - Tight GVC linkages (higher re-import and re-export intensity) weaken pass-through.

### Summary conclusions
- Trade prices adjust less than fully to exchange rate and commodity price shocks; volumes adjust strongly and almost instantaneously to price changes.
- Exchange rate fluctuations can have a significant impact on the current account via net-exports through price and quantity adjustments.
- Incomplete adjustment of trade prices is concentrated in the top import/export sectors over shorter horizons.
- Pass-through effects vary substantially across sectors; appreciations have stronger pass-through effects than depreciations (asymmetry).
- Pass-through is weaker when exchange rate changes derive from financial market perturbations and when sectors are more tightly connected in GVCs.

### Growth-at-Risk (GaR) — key points (brief)
- Macrofinancial conditions and vulnerabilities are useful predictors of downside risks to GDP growth.
- For Indonesia, a GaR analysis using a country-specific financial condition Index and macrofinancial vulnerability index shows both indices were at a neutral level at end-2018.
- Conditional on two neutral indices, the 2019 GDP growth rate is most likely to be 5.2 percent.
- GaR partitions used for Indonesia:
  - Financial conditions (Real long-term interest rates; Term spread; Sovereign spreads; Corporate spreads; CEMBI market cap; Equity returns; Change in foreign exchange rate; VIX)
  - Macrofinancial vulnerability (Credit growth; Credit gap; NPL ratios in the banking system; Ratio of external debt to GDP; Ratio of currency account balance to GDP; House price growth)
  - External condition (China’s GDP growth)

*INDONESIA  INTERNATIONAL MONETARY FUND*

### 4. Financial conditions serve as a useful predictor for downside risks to GDP growth

### 4. Financial conditions serve as a useful predictor for downside risks to GDP growth

### Financial Condition Index (FCI): construction and role
- FCI constructed using principal component analysis (PCA) by extracting the first principal component from a collection of eight financial variables.
- Both domestic and external financial conditions (e.g., sovereign spreads and VIX) play an important role in explaining future GDP growth in Indonesia.
- Historical episodes captured by the FCI include:
  - Global Financial Crisis: sharp tightening in the FCI.
  - Taper tantrum in 2013: noticeable tightening.
  - Global stock market episode in 2015: noticeable tightening.
- The FCI is normalized to have zero mean and a standard deviation of one over 2001–2018.

### Recent financial conditions and near-term outlook
- As of end-2018, financial conditions in Indonesia tightened to a neutral level.
  - Drivers of the tightening: worsening external financial conditions and global trade tensions; partly contributed by Bank Indonesia’s policy rate hikes in response to 2018 global market turbulence and EM sell-off.
- Expectations for 2019:Q1
  - Financial conditions expected to loosen a bit in 2019:Q1 based on growing optimism about U.S.-China trade negotiations and expectations that major central banks would take a more patient approach to monetary policy normalization.
  - Conclusion: financial conditions would continue to be supportive of growth in the near term for Indonesia.

### Macrofinancial Vulnerability Index (MVI)
- MVI captures credit boom-bust cycles and macrofinancial imbalances in the housing market and external sector in Indonesia.
- MVI constructed as the first principal component from a list of slow-moving credit aggregates and sectoral indicators; it summarizes the level of systemic risk in Indonesia.
- The two most important variables explaining MVI: current account deficits and the credit gap.
- The MVI is normalized to have zero mean and a standard deviation of one over 2001–2018.

### Current assessment of vulnerabilities (end-2018)
- Macrofinancial vulnerability is broadly contained as of end-2018:
  - Indonesia’s external debt is described as moderate and sustainable.
  - Credit cycle moved out of a prolonged downturn with credit gap closing.
  - Banking system remains broadly sound with large capital buffers, strong profitability, and asset quality improvement.
- However, vulnerability turned slightly positive because:
  - Current account deficits widened.
  - Corporate external debt increased.
- Risk note: Vulnerability can be elevated further if credit, especially to the corporate sector, grows rapidly without reins.

### Empirical relationships: quantile regressions and horizons
- Method: Quantile regressions estimate relationships between explanatory variables (financial conditions, macrofinancial vulnerability partition, external factor) and quantiles of future GDP growth rates.
- Horizons considered: h ∈ {4,8,12} (quarters ahead).
- Quantiles estimated: τ ∈ {10,25,50,75,90}.
- Key empirical findings:
  - Tighter financial conditions are negatively correlated with economic activity in the near term; as financial conditions revert to their historical average, they tend to boost growth over the medium term.
  - Elevated macrofinancial vulnerability is associated with weaker growth regardless of horizon; the impact of potential shock amplification is larger over the medium term.
- Interpretation: relationships vary over the forecasting horizon and differ across quantiles in Indonesia.

### Growth-at-Risk (GaR) results and 2019 projections
- Baseline 2019 GDP growth rate most likely to be 5.2 percent, given neutral financial conditions and macrofinancial vulnerability.
- Distribution construction:
  - The distribution of 4-quarter ahead GDP growth is derived by fitting a t-skew distribution to predicted values of the conditional quantile regressions.
  - The predicted growth mode for one-year ahead closely tracks realized growth, especially since the global financial crisis.
- Key statistics reported for 2019:
  - GaR at 5 percent is 2.7 percent (implying a 5 percent chance that real GDP in 2019 will grow by at most 2.7 percent).
  - Probability of a recession is less than 1 percent in 2019.
  - Interquartile interval of the GDP forecast at end-2019: 3.9 to 5.3 percent.
  - Mode: 5.2 percent.
  - Median: 4.5 percent.

### Methodology: parametric estimation of future growth distribution
- Conditional quantile specification:
  - y_{t+h} = α_τ + ∑_{i∈I} β_{i,τ} X_{i,t} + ε_{i,t,τ}, for horizons h ∈ {4,8,12} and τ ∈ {10,25,50,75,90}.
  - Interpretation: quantile regression at the 10th percentile estimates relationships when GDP growth is relatively weak; at the 90th percentile when growth is strong.
  - Advantages: best unbiased linear estimator for conditional quantile under standard assumptions; robust to outliers; known asymptotic properties.
- Parametric t-skew fit:
  - Conditional quantiles are used as sufficient statistics to describe the conditional CDF; a Student t-skew distribution is fit to represent fatter tails.
  - The t-skew distribution characterized by five parameters: location/mode, degree of freedom, scale/variance (sigma), kurtosis, and skewness.
  - Estimation steps:
    - Degrees of freedom computed directly; mean parameter retrieved from OLS fit with same specification as quantile regressions.
    - Sigma, skew, and kurtosis estimated by minimizing the squared deviations between t-skew quantiles and conditional quantiles from regressions (explicit minimization program described).
  - Once parameters are estimated, fitted t-skew cdf and pdf are derived, allowing estimation of Growth-at-Risk.

### Data variables used (selected)
- Financial variables include:
  - Change in Long-Term Real Interest Rate: Percentage point change in the 10-year government bond yield, adjusted for inflation.
  - Term Spreads: Yield on 10-year government bonds minus yield on 1-year government bonds.
  - Sovereign Spreads: Yield on 10-year Indonesia government bonds minus yield on 10-year U.S. government bonds.
  - Corporate Spreads: Commercial banks’ lending rates for corporate working capital minus interbank interest rate.
  - CEMBI market cap: Market capitalization of Indonesia corporate debt securities in CEMBI.
  - Equity Returns (local currency): Log difference of the Jakarta stock market index.
  - Exchange Rate Movements: Change in U.S. dollar per national currency exchange rate.
  - CBOE Volatility Index (VIX): Measure of expected price fluctuations in the S&P 500 Index options over the next 30 days.
- Macrofinancial and sectoral variables include:
  - Credit Growth: Year-on-year growth rate of loans to private sectors.
  - Credit Gap: difference between the credit-to-GDP ratio and its long-term trend, estimated with one-sided HP filter.
  - NPL Ratio: Ratio of nonperforming loans to total loans in the banking system.
  - External Debt to GDP: Ratio of external debts to GDP.
  - Current Account Deficits (relative to GDP): Ratio of current account deficits to GDP.
  - House Price growth: Year-on-year growth rate of residential property price index.
- Growth series:
  - Real GDP Growth for Indonesia: Percent change in GDP at constant prices for Indonesia.
  - Real GDP Growth for China: Percent change in GDP at constant prices for China.

*Source: IMF staff estimates and analysis as presented in the chapter “4. Financial conditions serve as a useful predictor for downside risks to GDP growth.”*

### 9.      Monetary policy press releases appear not to have a significant impact on market rates

### 9. Monetary policy press releases appear not to have a significant impact on market rates

### Main empirical findings on press releases and market rates
- Press releases do not have a significant impact on market rates once policy rate decisions are accounted for.
- Monetary policy surprises (unanticipated policy rate changes) have a significant impact on short-end money market maturities but do not propagate along the entire yield curve.
- There is no significant impact of press releases on bond yields and the exchange rate.
- An alternative estimation approach (Appendix II), regressing the absolute change in market rates on a dummy for press releases in the full sample, supports the finding that press releases have no significant independent impact on market rates.
- Even though press releases and monetary policy reports show no contemporaneous significant impact on market rates, they may still serve other functions over time (for example, increasing clarity on the policy framework without moving market rates contemporaneously).

Key statistics from Table 2 (Press Release impact on market rates)
- Unanticipated policy change coefficients (selected maturities):
  - 1-week: 1.369 *** (0.357)
  - 2-week: 1.000 *** (0.19)
  - 3-week: 1.195 *** (0.252)
  - 1-month: 0.469 *** (0.17)
  - 1-year: 0.540 *** (0.21)
  - 5-year: 0.285 (0.175)
  - 10-year: 0.133 (0.113)
  - Exchange rate: -0.008 (0.096)
- Anticipated policy change coefficients (selected maturities):
  - 1-week: 0.442 (0.376)
  - 2-week: 0.334 (0.224)
  - 3-week: 0.505 (0.258)
  - 1-month: 0.203 (0.221) *
  - Exchange rate: -0.115 (20.736)
- Observations (per column): mostly 135; some maturities: 126, 138, 141.
- R-squared (selected): 0.079 (1-week), 0.213 (2-week), 0.246 (3-week), 0.075 (1-month), 0.050 (1-year), 0.029 (5-year), 0.013 (10-year), 0.001 (exchange rate), 0.027 (other).

Alternative approach (Appendix II) — Press Release and MPR dummies (selected)
- Press Release Dummy on Overnight interbank: -0.051 (0.052)
- MPR Release Dummy on Overnight interbank: 0.002 (0.076)
- Policy Rate Change on Overnight interbank: -0.401 (0.233)
- Macroeconomic releases dummy on Overnight interbank: -0.042 (0.038)
- Observations: 2,703 (full-sample regressions)
- R-squared (selected): 0.0009 (1-week), 0.0023 (2-week), 0.0027 (3-week), 0.0011 (1-month), 0.0040 (1-year), 0.0008 (5-year), 0.0017 (10-year), 0.0006 (exchange rate), 0.0002 (other)

### Findings on monetary policy reports (MPR)
- Monetary policy reports do not appear to have a significant impact on financial markets.
- Comparing restricted sample (days of MPR release) and full sample, there is no significant difference in the propagation coefficient from the short end of the yield curve to other maturities, suggesting MPRs have no significant impact on market rates.
- The alternative estimation approach (Appendix II) regressing absolute market-rate changes on a dummy for MPR release in the full sample also shows no significant impact.

Key statistics from Table 3 (MPR impact on market rates)
- Overnight coefficient in restricted-sample regressions: 0.759 *** (0.1)
- 1-year coefficient: 0.327 ** (0.144)
- 10-year coefficient: 0.063 (0.081)
- Surprise dummy coefficients (selected):
  - 1-year: -0.046 ** (0.018)
  - 5-year: -0.051 (0.034)
- Surprise dummy * Overnight (interaction) (selected):
  - 1-year: -0.439 *** (0.106)
  - 5-year: -0.095 (0.178)
- Unanticipated policy change (selected):
  - 1-week: 1.008 *** (0.147)
  - 2-week: 1.201 *** (0.246)
  - 3-week: 0.466 *** (0.171)
- Anticipated policy change (selected):
  - 1-week: 0.301 ** (0.141)
  - 2-week: 0.479 ** (0.208)
  - 3-week: 0.214 (0.227)
- Observations: mostly 135; some columns 122.
- R-squared (selected): 0.725 (1-week interbank), 0.422 (2-week), 0.083 (3-week), 0.078 (1-month), 0.046 (1-year), 0.026 (5-year), 0.026 (10-year), 0.052 (exchange rate)

### Methods and identification (Appendix III summary)
- Predictability of monetary policy: monetary policy surprise defined as the difference between BI’s rate decision (it) and analysts’ anticipated rate (Et-1 it). The change in the policy rate is decomposed into unanticipated and anticipated components:
  - Δit = (it − Et-1 it) + (Et-1 it − it−1) = Δi_u + Δi_a
- Efficacy of monetary policy: ordinary least squares with robust standard errors. Dependent variables: market rates (money market, bond yields, exchange rate). Independent variables: anticipated and unanticipated policy rate changes; controls include global factors (changes in U.S. Fed rates, 1-month money market rate, 10-year government bond yield) and country risk (EMBI and CDS for Indonesia).
  - Baseline specification: Δm_t = α0 + α_u Δi_u + α_a Δi_a + α_c Controls + ε_t
- Isolating press release impact: interact the short-end overnight rate with a dummy for policy-rate surprise to detect shifts attributable to press-release content when there is no surprise.
  - Specification: Δm_t = α0 + overnight + surprise + overnight*surprise + α_u Δi_u + α_a Δi_a + α_c Controls + ε_t
- Impact of monetary policy reports: compare coefficients from restricted sample (days of MPR release) and full sample to test whether α_r,c and α_f,c differ significantly.
- Robustness check: regress absolute changes in market rates |Δm_t| on dummies for MP and MPR releases and other controls in the full sample.

### Policy implications and recommendations
- The analysis indicates a weak transmission of monetary policy from policy-rate changes to the broader yield curve and to bond yields and the exchange rate.
- Policy recommendations to strengthen the effectiveness of monetary policy and its communication:
  - Improve the clarity of monetary policy communication to enhance its effectiveness.
  - Deepen financial markets to support monetary policy transmission and the impact of communication.
  - Key financial deepening reforms include:
    - Improving liquidity and activity in the money market beyond one month of maturity.
    - Increasing the issuance of short-term government securities.

### Broader contextual findings (from adjoining chapter material)
- Monetary policy transparency in Indonesia has improved over time; predictability is somewhat higher than peers, but clarity of communication appears to have weakened.
- Growth and revenue context (selected figures):
  - Economic growth in Indonesia has remained at a healthy level of about 5 percent.
  - A Medium-Term Revenue Strategy (MTRS) could raise revenues by up to 5 percent of GDP in the medium term, with 1.5 percent of GDP from tax administration reforms and 3.5 percent of GDP from tax policy reforms.
  - Achieving the United Nations’ Sustainable Development Goals (SDGs) in Indonesia is estimated to require additional spending of about 5½ percent of GDP per year in education, health, and infrastructure.

*Source: IMF staff analysis as presented in the chapter "Monetary policy press releases appear not to have a significant impact on market rates" (content unit 1idnea2019002).*

### 4.      The operationalization of the MRTS requires careful prioritization, sequencing and

### 1idnea2019002 - 4.      The operationalization of the MRTS requires careful prioritization, sequencing and

### Operational approach
- The MRTS requires careful prioritization, sequencing and phasing, taking into account economic and social considerations as well as implementation challenges.
- The complexity and interdependence of the MTRS reforms and the importance of buy-in and support by stakeholders require a well sequenced and phased approach to reap the benefits of the MTRS while mitigating any adverse social impacts.

### Key MTRS Reforms — overview
- The MTRS centers on tax policy reforms to remove certain exemptions, streamline tax regimes, and broaden base and increase rates in the least distortionary manner.
- Tax administration reforms aim to improve compliance and the efficiency of tax filing and collection.
- Beyond revenue mobilization, the MTRS is intended to improve economic efficiency, equity and ease of tax administration and compliance.
- Special tax treatments for social objectives or industrial policies should be accommodated through other instruments (for example, expenditure policy).

### VAT
- Remove certain exemptions:
  - Exemptions for mining, agriculture (including plantation and forestry products), tourism, domestic transportation, employment services, fee-based financial services, art, entertainment, electricity, and water would be eliminated.
  - A short list of “standard exemptions” would remain (margin-based financial services, education, and health care).
  - Revenue impact: a modest revenue gain at about 0.2 percent of GDP.
  - Expected effects: improved efficiency, administration and compliance; equity impact likely mixed; part of revenue gain should be used to strengthen the social safety net.
- Reduce the registration threshold:
  - Indonesia’s VAT threshold as a multiple of per capita PPP GDP is about 30 (compared with around or below 5 in most other economies).
  - Lowering the VAT registration threshold would have similar impacts as removing exemptions; the impact on equity is unclear.
- Replace the sales tax on luxury goods (STLG) with VAT and a vehicle excise:
  - STLG raised only 0.15 percent of GDP in 2015—ninety percent of which came from vehicles—and has been subject to severe erosion.
  - Recommendation: repeal STLG; subject goods to normal VAT rate; vehicles subject to a specific excise based on engine size, adjusted yearly for inflation; expand coverage to currently exempt vehicles (pick-ups and trucks).
  - Expected revenue from vehicle excise: about 0.6 percent of GDP.
  - Expected benefits: improved efficiency (address environmental externalities), equity (burden mostly on the rich based on car ownership), and administration and compliance.
- Increase the standard VAT rate by 2 percentage points:
  - Scope to gradually raise the standard VAT rate by 2 percentage points after exemptions removed and registration threshold reduced.
  - Trade-offs: substantial revenues versus some distortionary impact and potentially significant adverse impact on the poor; mitigation via strengthened social safety net.

### Excise
- Introduce fuel excises:
  - Fuel excises internalize externality costs (global warming, local air pollution, traffic congestion and accidents, noise, road damage).
  - Example benchmark: around IDR 3,000 per liter for gasoline (to levels close to ASEAN averages).
  - Revenue impact: can raise 0.5 percent of GDP.
  - Feasibility: easy to administer under current capacity and scalable; only feasible after fuel subsidies are phased out.
  - Distributional concern: potentially large negative impact on the poor; strengthening social safety net is critical.

### Corporate Income Tax (CIT)
- Current issues:
  - Discrimination between firms due to sector-based final tax regimes, generous presumptive taxation of SMEs, preferential treatment of selected businesses, and many selective discretionary incentives.
  - Result: uneven playing field, misallocation of capital and labor, lower productivity.
  - Tax alignment with PIT recommended to avoid arbitrage between capital and labor income.
- Replace special regimes with a single corporate income tax:
  - A single uniform CIT rate should be imposed on all corporate income, except shipping.
  - Abolish final withholding schemes on deemed profits, remove the 50 percent discount on CIT rate for medium-sized businesses, and make corporations no longer eligible for the small business regime even if turnover is below SME threshold.
  - Phase out discretionary tax incentives in CIT.
  - Expected fiscal impact: reform is expected to be revenue neutral; additional revenues could be used to lower the headline CIT rate.
  - Expected benefits: improved efficiency, equity, and administration and compliance.
- Reduce the threshold of the SME regime:
  - Current SME gross turnover threshold is exceptionally high; many medium-sized businesses are subject to the 0.5 percent final tax on turnover.
  - Problems: discourages firm growth, creates horizontal inequities, and sacrifices revenues.
  - New threshold under the MTRS would be aligned with the VAT threshold and set at IDR 600 million.
  - A small business regime would remain for very small non-incorporated firms with limited bookkeeping ability.
  - Expected effect: improved fairness of tax burden; efficiency implications unclear.
- Introduce an alternative minimum tax (AMT):
  - AMT would be based on a tax on turnover; corporations pay the maximum of ordinary CIT liability or AMT.
  - Mitigation: accompany AMT with a generous “carry-forward” period of 10 years; difference between AMT payments and regular CIT would be creditable against future CIT liabilities.
  - Benefits: could raise considerable revenues and smooth volatility; drawbacks: may introduce inefficiencies and increase complexity of administration and compliance.
- Improving international taxation:
  - Indonesia has adopted measures to comply with minimum international standards on base erosion, profit shifting and AEOI, and implemented controlled foreign corporation legislation and restrictions on interest deductibility.
  - Further strengthening is underway (transfer pricing, provisions against treaty shopping, permanent establishment definition, general anti-avoidance rule).
  - Impact of these initiatives is expected to be small and should not be overestimated.

### Personal Income Tax (PIT)
- Broaden PIT base and strengthen progressivity:
  - Current system: relatively high basic exemption threshold and rate structure yield relatively low PIT burden for the middle class.
  - Restructure to be based on individual income instead of family income.
  - Gradually more people would enter the PIT (holding the basic exemption constant as nominal incomes rise); reduce income level at which top rate of 30 percent applies.
  - Revenue impact: could raise an additional 0.3 percent of GDP by the end of the reform.
  - Trade-offs: lower efficiency with higher tax burden on the middle class but improved equity via stronger progressivity.

### Property Tax
- Current situation:
  - Revenues from property taxes are 0.3 percent of GDP and are low.
  - Assessment values are considerably below market value.
  - Law caps municipal rates at 0.3 percent of assessed value.
- Reform package:
  - Increase maximum allowable rate of the recurrent land and building tax from 0.3 percent to 1 percent.
  - Develop an accurate property register and an efficient valuation system.
  - Gradually reduce maximum allowable rate of the property transaction tax (stamp duty) from 5 to 2 percent.
  - Expected revenue impact: could raise around 0.3 percent of GDP by local governments and allow the central government to reduce transfers to local governments.
  - Expected benefits: increased efficiency (replace distortionary transaction tax with less distortionary property tax), improved equity (a wealth tax); limited effect on administration and compliance given existing property tax.

### Tax Administration
- Current challenges:
  - Taxpayer compliance is low and, in some areas, declining.
  - DGT (Directorate General of Taxes) needs capacity strengthening to collect more revenues, increase workforce productivity, and reduce taxpayers’ compliance costs.
- Five initiatives to support compliance improvement programs (CIPs) targeting VAT, employer withholding, UHWI and HWI to raise 1.5 percent of GDP in revenues:
  - Strengthening the audit workforce:
    - Audit numbers low by international standards; increase staff and enhance skills and support tools.
    - Establish a national audit taskforce to supply trained auditors to all regions over the next two years.
  - Building a data matching capacity:
    - Invest in high-quality data and whole-of-government access to high leverage data sets.
  - National deployment of compliance risk management (CRM):
    - Scale CRM beyond the first generation pilot in 16 district tax offices to support improved taxpayer compliance.
  - Increasing efficiency of support and supervision:
    - Reassign staff from low-risk refunds and low revenue extensification work to risk-based compliance management and extensification on taxpayers with significant potential.
  - Leveraging the tax amnesty and AEOI intelligence:
    - Develop a plan to exploit revenue benefits of the Tax Amnesty and data from the OECD’s common reporting standard and AEOI; credible enforcement following amnesty is critical.
- Institutional reforms to sustain gains and improve DGT productivity:
  - Autonomy and budget flexibility: provide additional flexibility in managing and organizing workforce while keeping DGT within the Ministry of Finance.
  - Organization: align organizational reform with international practices to curb corruption and enhance staff productivity; strengthen integrity measures and publicize Code of Conduct consequences.
  - Information technology (IT): prioritize IT improvements; combine the planned new core tax administration system with redesign and simplification of core processes (registration, filing, payment).

### Complementary Reforms
- Complementary reforms in expenditure policy and public financial management are required for MTRS to enhance inclusive growth and welfare.
- Primary objective of the MTRS: raise revenues for priority spending, including meeting spending needs to achieve the SDGs.
- Evidence cited: countries with a tax-to-GDP ratio below 15 percent tend to grow significantly slower than countries above this tipping point.
- Additional revenues will only lead to higher growth if spent efficiently; MTRS should be accompanied by reforms to improve spending efficiency, particularly in energy subsidies, education, and public investment management.
- Note: Energy subsidies are very inefficient; fuel excises can only be introduced after subsidies are eliminated.

*Source: 1idnea2019002 — IMF PDF chapter content.*

### 23.      Strengthening social safety net can improve social welfare and help build consensus

### 23.      Strengthening social safety net can improve social welfare and help build consensus

### Social safety net and public support
- Some MTRS reforms will adversely affect the wellbeing of the poor—examples cited include the increase in VAT rate and the introduction of fuel excises—and a well-functioning social safety net would help mitigate the impact.
- Strengthening the social safety net would help build public support for the reforms.

### Sequencing and phasing of MTRS reforms
- The MTRS is comprehensive and ambitious and should not be implemented in one step; sequencing and phasing must reflect economic and social impacts and implementation challenges.
- MTRS reforms are categorized into four groups:
  - Tax administration reforms: designed to better enforce existing laws, improve compliance and efficiency, mostly under direct control of the Ministry of Finance; revisions to the General Tax Provisions and Procedures Law (RUU KUP) are needed to provide more autonomy and budget flexibility for DGT.
  - Tax reforms that streamline existing taxes: improve functioning of existing taxes, improve efficiency, equity and administration/compliance; may face resistance and require law revisions.
  - Tax reforms that expand the base of existing taxes: broaden the tax base; could have negative impacts on efficiency, equity or administration/compliance; lowering VAT and SME turnover thresholds should occur after exemptions are removed and CIT is streamlined; may require extensive consultations and law revisions.
  - Tax reforms that increase rates or introduce new taxes: raise substantial revenues but tend to hurt efficiency or equity; most challenging; fuel excises only after fuel subsidies removed; VAT rate increase after exemptions removed and threshold lowered; strong social safety net needed before increases.
- Recommended immediate focus:
  - Public information campaign, improving tax administration, streamlining existing taxes.
  - Preparations for streamlining reforms could be implemented from 2020.
  - Tax reforms that expand the base could be implemented starting in 2021 or 2022.
  - Tax reforms that increase rates or introduce new taxes in 2023.

### Illustrative revenue timing (as described)
- The narrative cites an illustrative scenario of annual revenue gains by reform category across 2020–2024, with sequencing:
  - Tax administration (earliest)
  - Streamlining existing taxes
  - Expanding the tax base of existing taxes
  - Increasing tax rates of existing taxes or introducing new taxes (latest)

### Action plan and near-term measures
- An action plan with detailed steps and timelines is recommended to operationalize the MTRS.
- Building public support:
  - Implement a public communication campaign immediately to build consensus; engage and consult key stakeholders; communicate urgency, rationale, and content of the MTRS; build on the whole-of-government communication campaign used during the tax amnesty.
- Improving tax administration:
  - Launch CIPs (in VAT, employer withholding obligation, professional/high income/wealthy persons, and ultra-high wealth individuals).
  - Implement supporting initiatives: establish a national audit improvement taskforce; initiate a data improvement pilot; deploy CRM nationally; better target extensification; keep amnesty participants in the system and compliant.
  - Institutional reforms: enhance staff integrity and HR management; allow more autonomy for DGT; improve organization of DGT; approve budget flexibility for DGT; complete initial IT preparations (local office data cleansing teams commence operations; high priority data sets available).
- Streamlining existing taxes (near term actions):
  - Review VAT exemptions and prepare for their removal: phase out from January 2019.
  - Revise the VAT law.
  - Abolish the STLG and prepare proposal for phasing in vehicle excise; introduce vehicle excise.
  - Review current CIT regimes and estimate the revenue neutral CIT rate for a single CIT; revise the CIT law.

### Expected revenue and fiscal impacts
- The MTRS can help raise substantial revenues—around 5 percent of GDP over five years—to meet priority spending needs and streamline the tax system to improve productivity and boost growth.
- Table highlights (Indonesia: Key Tax Policy and Administration Reforms) — revenue impacts and qualitative effects:
  - Tax policy total: 3.5
  - VAT total: 1.8
    - Remove certain exemptions: 0.2 (effects: ↑ on administration/compliance; equity shows “-”)
    - Reduce the registration threshold: 0.2 (effects: -/↑ on efficiency; -/↓ on equity; ↑ on administration/compliance)
    - Replace STLG with VAT and vehicle excise: 0.6 (effects: ↑ on efficiency; ↑ on equity; ↑ on administration/compliance)
    - Increase in the standard rate by 2 percentage points: 0.8 (effects: ↓ on efficiency; ↓ on equity; - on administration/compliance)
  - Excise taxes total: 0.5
    - Introduce new excises on fuel: 0.5 (effects: ↑ on revenues; ↓ on equity; - on administration/compliance)
  - Corporate income tax (CIT) total: 0.4
    - Replace special regimes with one single corporate income tax: 0.0 (effects: ↑ on efficiency; ↑ on equity; ↑ on administration/compliance)
    - Reduce the threshold of the SME regime: 0.1 (effects: -/↓ on efficiency; ↑ on equity; - on administration/compliance)
    - Introduce alternative minimum tax: 0.3 (effects: ↓ on efficiency; - on equity; ↓ on administration/compliance)
    - Improve international taxation: 0.0 (effects: -; -; -)
  - Personal income tax (PIT) total: 0.4
    - Broaden PIT base by including the middle class and strengthen progressivity: 0.4 (effects: ↓ on efficiency; ↑ on equity; - on administration/compliance)
  - Property tax with higher rate total: 0.3
    - Reducing property transaction tax and increasing property tax: 0.3 (effects: ↑ on efficiency; ↑ on equity; - on administration/compliance)
  - Tax administration total: 1.5 (effects: ↑ on efficiency; ↑ on equity; ↑ on administration/compliance)
    - Launch CIPs for VAT, employer WHT, UHWI and Wealthy Indonesians; strengthen audit workforce; build powerful data matching capacity; national deployment of CRM; increase efficiency of support and supervision; leverage tax amnesty and AEOI intelligence; institutional reforms: autonomy and budget flexibility, organization, IT.
- Table 3 sequencing overview (timelines):
  - Improving tax administration: Year 1-Year 5
  - Streamlining existing taxes: Year 1-Year 3
  - Expanding the tax base of existing taxes: Year 2-Year 5
  - Increasing tax rates or introducing new taxes: Year 4-Year 5

### Conclusions and strategic considerations
- Government revenues are very low in Indonesia and the tax system has various distortions.
- The MTRS can raise around 5 percent of GDP over five years and improve the tax system, productivity, and growth, but requires prioritization, sequencing, and phasing mindful of economic and social impacts and implementation challenges.
- Ongoing administration reforms are consistent with the MTRS (development of CRM, automatic exchange of information including lifting bank secrecy, acceleration of VAT refund, and an IT plan).
- The decision to reduce the SME turnover tax from 1 percent to 0.5 percent ran contrary to MTRS recommendations and may need reconsideration; the lower turnover tax of 0.5 percent is limited to 3, 4, and 7 years—depending on the establishment type of the SMEs—after which they will have to file the standard CIT, which could be burdensome for small SMEs and is not consistent with best practice.
- Expanding zero-rated VAT on some service exports (already adopted) and lowering CIT (under discussion) may be justifiable on their own but would weaken overall revenues; additional tax incentives need careful evaluation of revenue and productivity impacts.
- Use of additional revenues should balance short-term macro stability and long-term spending needs:
  - With growth at around potential, low inflation, stable external environment, and large spending needs, additional revenues could be used for investments in priority areas.
  - If the economy overheats or external financing becomes volatile, additional revenues could lower the fiscal deficit, repay SOE obligations for past infrastructure spending, or reduce infrastructure spending through SOEs and the private sector to bring spending onto the budget.
- The reform strategy should adapt as social and economic conditions change; authorities should continue to refine and revise the strategy and action plan as circumstances change.

*Source: 1idnea2019002 — "23.      Strengthening social safety net can improve social welfare and help build consensus".*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1idnea2019002.pdf_