## _cr07272

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### Executive Summary — Background and Policy Discussions
- Growth and stability:
  - The economy has been growing at about 6 percent over the past year.
  - Growth is expected to continue at the same pace for the rest of the year and pick up modestly over the medium term, driven mainly by domestic demand and a significant increase in investment, especially in infrastructure.
  - Current account remains in surplus; international reserves have risen to all time high.
  - Bank and corporate balance sheets have strengthened; public debt-to-GDP ratio continues to trend down.
- Monetary and exchange rate:
  - Inflation reached a six-month low in May; annual inflation declined to 6 percent in May.
  - Bank Indonesia (BI) has cut the policy rate by 425 basis points since May last year and signaled further rate cuts for 2007.
  - Indonesia’s strengthening fundamentals and yield differentials have recently attracted significant, though volatile, portfolio inflows, resulting in appreciation pressures on the rupiah.
- Fiscal and financial sector:
  - Fiscal policy targets 1.7–1.8 percent of GDP deficits for 2007 and 2008 to further reduce public debt while providing space for infrastructure spending.
  - Need to strengthen the nonbank financial sector and long-term financing; several prudential regulations have been eased to encourage banks to lend.
- Structural reforms:
  - Successful implementation (reducing infrastructure bottlenecks, passage of tax law in parliament, modification of labor regulations) would help attract investment, create jobs and raise productivity, accelerating growth and reducing poverty.

### Economic and Financial Backdrop — Recent Developments (selected)
- Growth and external:
  - Growth reached 5½ percent in 2006; staff projects growth at 6 percent in 2007.
  - External current account surplus projected to decline from 2¾ percent of GDP in 2006 to 2 percent in 2007.
  - Non-oil and gas export value growth assumed to slow to 15 percent in 2007 (compared with 22 percent growth y/y in the first quarter).
- Credit and banking:
  - Credit growth reached 17½ percent y/y in April; credit to businesses now outpacing consumer credit.
  - Banking indicators strengthened: improved profitability, well capitalized system, private banks’ NPLs remain low; state banks’ NPLs remain high but recent restructurings cut them significantly.
- Prices and policy rates:
  - Inflation stabilized at around 6 percent.
  - BI lowered its policy rate 425 bps since May 2006; real interest rates measured against core inflation are now slightly less than 3 percent below the historical (2000–07) average of 3½ percent.
- Reserves and markets:
  - Reserves covered 154 percent of short-term debt and 5 months of imports at end-2006.
  - Exchange rate appreciated by 3 percent in May vis-à-vis the U.S. dollar (some reversal in early June).
  - Debt ratios continue to decline; external debt projected at 31 percent of GDP at end-2007.

### Medium-Term Outlook and Risks
- Baseline projections and requirements:
  - Potential output growth could rise to about 6½–7 percent with productivity gains and increased investment.
  - Achieving higher potential requires investment growth of about 12 percent per annum, assuming current productivity pace is maintained.
  - Authorities’ official medium-term target: 7½ percent.
- Financial intermediation and capital markets:
  - Private sector credit expected to expand faster than nominal GDP; capital markets to gain importance supporting nonbank financial development.
- Risks:
  - Volatile portfolio inflows risk competitiveness erosion and sudden reversals.
  - Loosening prudential regulations could reverse financial stability gains.
  - Above-average inflation remains a concern for macroeconomic volatility and medium-term competitiveness.
- Staff policy emphasis:
  - Maintain focus on structural reforms, infrastructure investment, strengthening financial intermediation, and cautious monetary easing to meet 2008 inflation target.

### BOX 2 — Update of Contingent Claims (CCA) Analysis for Indonesia
- Market-implied credit risk:
  - Markets price historically low default probability for banks and the sovereign.
  - Estimated average default probabilities of banks declined in 2007; state banks’ estimated default probability remained elevated through remainder of 2006 due to volatility in one state-owned bank’s shares.
  - Distribution of risks improved in 2007; default probabilities for riskier banks declined more than the system average.
- Sovereign CCA:
  - Sovereign default probability increased somewhat in late February 2007 along with CDS spreads but remained at historically low level.
- Banking sector indicators:
  - Profitability picked up with credit growth; loan-to-deposit ratio, credit growth (y/y), net interest margin, and return on assets exhibited recovery through Jan-07.
  - State banks' NPLs declining; Capital/Asset ratios remain healthy.
- Investment context:
  - Investment rates picked up but remain low compared with regional peers; FDI inflows likewise lag regional comparators.

### Stress Test Analysis — Impact of Adverse Macro Shocks on Banks (BOX 3)
- Summary finding:
  - Sufficient capital and relatively low outstanding credit should enable Indonesian banks to withstand moderate macroeconomic shocks.
- Setup:
  - Tests on 15 largest banks (68 percent of assets) using BI’s internal risk model; Tier 1 ratio preferred metric.
  - A bank with Tier 1 of 4 percent is seriously undercapitalized; 6 percent is low but acceptable.
  - Macro shock scenario (Scenario A): loss of confidence triggering capital outflows, exchange rate depreciation, lower growth, and higher inflation and interest rates.
- Results (selected figures):
  - Initial Values (December 2006): Number of banks with Tier 1 <4%: 0; <6%: 3; Average Tier 1 Ratio 8.2; Average CAR ratio 19.4
  - Alternative Macro scenario (end 2008): Number of banks with Tier 1 <4%: 2; <6%: 5; Average Tier 1 Ratio 7.6; Average CAR ratio 18.3
  - Stress by risk type (Average Tier 1 Ratio / Average CAR ratio):
    - Credit Risk1/: 7.4 / 17.9 (Number <4%: 2; <6%: 5)
    - Interest Rate Risk2/: 7.6 / 18.4 (Number <4%: 1; <6%: 4)
    - Exchange Rate Risk3/: 8.4 / 19.8 (Number <4%: 0; <6%: 3)
  - Liquidity: only four banks in group (18 percent of assets) have less than 25 percent liquid assets; overall liquidity should not be a problem.
- Additional vulnerabilities:
  - Exposure to credit risk limited by low share of loans to total assets but could increase if lending boosts succeed.
  - Low maturity mismatches and high share of government bonds at floating rates limit interest rate risk.
  - Small net open positions limit exchange rate risk.

  Footnotes:
  - 1/ 33 percent of loans in each classification were downgraded.
  - 2/ 350 basis point increase in interest rates.
  - 3/ 40 percent depreciation of the bilateral exchange rate with the U.S. dollar.
  - 4/ Alternative scenario assumes tightening global liquidity triggering capital outflows, exchange rate depreciation, higher inflation; policy response includes higher domestic interest rates and FX intervention (Scenario A, Annex I).

### Dealing with Capital Inflows — Staff Analysis and Recommendations
- Observations:
  - Appreciation pressures intensified in May as portfolio inflows surged around mid-April.
  - BI intervened at times; net reserve purchases dominated in 2006–07 though there were extended periods without direct intervention and reserve sales in mid-2006 during outflows.
  - Sterilization cost estimated at about 0.1 percent of GDP for each US$10 billion in reserves.
- Valuation uncertainty:
  - ERER at end May 2006 estimated rupiah around 12 percent below fundamentals; other approaches gave +1½ percent overvalued and 16 percent undervalued; considerable uncertainty exists.
- Policy recommendations:
  - Monetary and exchange rate response should include:
    - allowing further appreciation;
    - possible intervention to limit excessively large exchange rate movements;
    - further interest rate cuts provided appreciation improves the inflation outlook.
  - Support export performance through structural measures to enhance the business climate.
  - Deepen financial markets to limit volatility impact and provide hedging instruments.
- Authorities’ views:
  - BI broadly agreed current exchange rate policy is appropriate: flexible exchange rate and commitment to inflation targeting.
  - BI concerned about “hot money” flows; emphasizes significant reserve levels to reduce vulnerability despite sterilization cost concerns.

### Inflation Outlook, Monetary Policy Guidance, and Box 5 Recommendations
- Inflation developments:
  - Rising rice prices pushed headline inflation modestly in early 2007; annual inflation declined to 6 percent in May.
  - Near-term outlook positive; recent exchange rate appreciation contributes to the favorable outlook.
  - Risk: excessive focus on near-term outlook could lead to rapid rate cuts, possibly worsening the 2008 inflation outlook.
- Staff recommendations:
  - Shift monetary policy focus toward meeting 2008 target of 5±1 percent.
  - 2007 target of 6±1 percent will be met; 2008 target remains within reach assuming limited additional rate cuts.
  - Additional rate cuts should be determined by forecast inflation for 2008 relative to the target; BI should be cautious given transmission lags.
  - Further appreciation could create room for lower rates.
- Box 5 — Improving inflation-targeting framework (key recommendations):
  - Transparency and communication:
    - Clarify inflation target and emphasize targets beyond the current year to better anchor expectations.
    - Consider publishing explicit inflation forecasts after more forecasting experience.
    - Align BI public communication with official position; be less specific on future interest rates or credit growth targets; place less emphasis on growth.
  - Monetary operations framework:
    - BI intends to change the policy rate to the overnight interbank rate (from 1-month SBI) to develop the short end of the yield curve.
    - Key conditions: stable overnight rate, improved liquidity forecasting/management, required reserve averaging, development of interbank market including repos.
    - Progress toward implementing the treasury single account (TSA) would facilitate liquidity forecasting and management.

### Investment Climate, Structural Reforms, and Authorities’ Intentions
- Investment climate constraints:
  - Cross-country surveys: investment climate "still compares poorly."
  - Specific impediments:
    - "Strict labor legislation" with high severance payments restricting firms’ adaptability.
    - "A difficult legal and regulatory environment" compared with the region.
- Investment Law (passed in March):
  - Provisions: equal treatment to domestic and foreign investors; longer work permits for expatriates; extended land lease durations; explicit entitlement to repatriate and transfer funds in foreign exchange; disputes can be settled through international arbitrage; Minister of Finance may issue regulations to provide tax incentives.
  - Next steps: complete implementing regulations expeditiously; package of measures to improve investment climate and support SMEs presented in June.
- Progress on structural reforms:
  - Fiscal reforms: restructuring tax agency; modernizing medium taxpayers’ offices; approval in June of key tax law on administrative procedures; strengthening budget process and transparency.
  - Labor reform progress slow; legislative reform set aside due to union opposition; authorities trying to modify regulations to limit severance payments; plan to link severance reform to well-managed pension funds for limited unemployment benefits.
  - SOEs: plan to develop new strategy and revive privatization agenda (planned sale of 30 percent stake in state bank BNI).
- IMF staff appraisal (selected):
  - Achievements: strong growth, declining inflation, reduced balance sheet vulnerabilities, progress building macroeconomic institutions.
  - Key challenges: sustain growth in 6–7 percent range requires stronger financial intermediation, more infrastructure investment, improved investment climate.
  - Capital inflows: modest current account surplus projected to move into deficit over time; portfolio inflows volatile and have caused price swings in shallow asset markets.
  - Policy mix recommended to manage inflows: allow further rupiah appreciation, intervene to limit excessive movements, and consider interest rate cuts if appreciation improves inflation outlook.
  - Financial sector policy: reconsider recent relaxation of prudential regulations; avoid moral suasion to direct lending; promote capital markets and longer-term financing; develop strategy for state banks and confirm date for FSAP.
  - Fiscal policy: appropriate stance; do not go beyond 1.7–1.8 percent deficits envisaged for 2007–2008; aim to lower public debt to about 30 percent of GDP by 2009; create space via improved tax administration, new tax measures, streamlining expenditures and more flexible energy prices.
  - Structural reforms: accelerate reforms, focus on labor regulation modification and facilitating PPPs in infrastructure with adequate preparation and assessment.

### Key Statistics and Projections (selected exact figures)
- Real GDP growth (percent): 2005 5.7; 2006 5.5; 2007 6.0; 2008 6.3; 2009 6.5; 2012 6.7
- CPI inflation (end period): 2005 17.1; 2006 6.6; 2007 6.3; 2008 5.5; 2009 4.0; 2012 3.0
- Gross investment (percent of GDP): 2005 23.5; 2006 22.6; 2007 22.5; 2008 24.3; 2009 25.9; 2012 31.8
- Gross national saving (percent of GDP): 2005 23.6; 2006 25.3; 2007 24.4; 2008 25.8; 2009 26.9; 2012 30.4
- Current account balance (percent of GDP): 2005 0.1; 2006 2.7; 2007 1.9; 2008 1.5; 2009 1.0; 2012 -1.4
- Central government balance (percent of GDP): 2005 -0.3; 2006 -1.0; 2007 -1.8; 2008 -1.8; 2009 -1.5; 2012 -0.6
- Central government debt (percent of GDP): 2005 45.6; 2006 38.6; 2007 35.7; 2008 33.9; 2009 31.9; 2012 26.1
- Reserve assets (end period, US$ billions): 2006 42.6; 2007 55.0; 2008 61.8
- Reserve coverage: reserves covered 154 percent of short-term debt and 5 months of imports at end-2006.
- Banking system metrics (Mar-07): Capital adequacy ratio 22.1; NPLs 6.0 percent of total loans; Return on assets 2.7 percent.
- External debt trends: external debt declined from "over 150 percent of GDP in 1998" to "around 37 percent in 2006"; external debt projections (percent of GDP): 2006 36.6; 2007 31.2; 2008 28.6; 2009 26.2; 2012 19.3.
- Selected balance of payments flows (percent of GDP or levels as presented):
  - Direct Investment, net: -1.5 -5.3 3.3 2.8 4.0
  - Portfolio Investment, net: 4.4 4.2 4.1 8.1 8.1 8.1
  - Overall Balance (III+IV): 4.1 -0.3 12.9 12.4 6.8
  - Reserve assets position (eop): 36.3 34.7 42.6 55.0 61.8
- Monetary aggregates (end-period, in trillions of rupiah / US$ billions reported):
  - Broad money (M2): 1,000.2 1,148.8 1,151.8 1,209.7 1,249.1 1,341.4 1,582.8
  - Net international reserves (BI; US$ billions): 24.4 24.8 30.5 34.0 36.5 39.2 55.0
- Fiscal central government (levels in trillions of rupiah; Act./Est./Proj. where shown):
  - Revenues and grants: 495.4 634.0 723.0 665.0 720.6
  - Expenditure and net lending: 503.8 667.5 763.6 731.1 796.0
  - Overall balance: -8.4 -33.5 -40.6 -66.1 -75.4
  - Revenues and grants (percent of GDP): 17.8 19.0 20.5 17.7 17.1
  - Expenditure and net lending (percent of GDP): 18.1 20.0 21.6 19.5 18.9

### Annex I — Alternative Scenarios and Debt Sustainability (summary)
- Scenario A — Tightening of global liquidity:
  - Shock: net outflow of portfolio capital around US$10 billion during 2008.
  - Policy response: BI increases policy rate by around 300bps relative to baseline.
  - Projections: Reserves decline to around 150 percent of short-term debt in 2008; exchange rate depreciates about 15 percent; GDP growth declines to 4.8 percent; inflation rises to 7 percent.
- Scenario B — Lack of progress on structural agenda:
  - Policy response: authorities relax fiscal and monetary policies to support growth.
  - Projections: Output growth falls to 5.0 percent over medium term; central government deficit increases to 3.2 percent of GDP in 2008; inflation increases to a little under 7 percent (outside BI’s 2008 target).
- Scenario C — Global growth slowdown:
  - Shock: global growth declines just over 2 percentage points in 2008; commodity prices decline; exports fall.
  - Policy response: interest rates unchanged.
  - Projections: GDP growth reduced; inflation around 6.3 percent (outside BI’s 2008 target); current account surplus narrows; reserves accumulation slows.
- Debt sustainability (public debt):
  - Public sector debt ratio declined from 65 percent of GDP at end-2002 to an estimated 39 percent at end-2006.
  - Baseline projection: public sector debt expected to decline to around 26 percent of GDP by 2012 under assumptions including real GDP growth rebound to 6–7 percent and primary surplus averaging around 0.2 percent of GDP.
  - Sensitivity: One-time 30 percent real depreciation or a 10 percent increase in contingent liabilities immediately raises the debt ratio by around 10 percentage points of GDP, impact falling to 7–8 percentage points by 2012.
- External debt stress tests:
  - One-time 30 percent real depreciation in 2006 raises external debt to 51.4 percent of GDP in 2006, declining to 34.2 percent by 2011.
  - Combined shock and various bound-tests produce elevated external debt paths but baseline remains sustainable absent large exchange rate shocks.

### Operational and Institutional Notes
- It is recommended that the next Article IV consultation take place on the standard 12-month cycle.
- IMF relations and Fund data (as of May 31, 2007): Quota 2,079.30; Fund holdings of currency 1,933.80; Reserve position in Fund 145.50; SDR net cumulative allocation 238.96.
- Exchange arrangements: rupiah floated since August 14, 1997; market exchange rate Rp 9,080 per U.S. dollar on June 26, 2007.
- Statistical issues: Indonesia subscribes to SDDS since September 1996; recommendations include improving FDI compilation, expanding monetary statistics coverage to mutual funds, reconciling BI and customs trade data, and developing supply and use tables and updated national accounts.

*Source: IMF staff report content as presented in the supplied PDF extract (_cr07272).*

### Executive Summary ......................................................................................................

### Executive Summary

### Background
- Macroeconomic policies have been geared successfully towards promoting stability while supporting growth.
- The economy has been growing at about 6 percent over the past year, fuelled by a recovery in domestic demand and strong export performance. Bank and corporate balance sheets have strengthened while the public debt-to-GDP ratio continues to trend down. The current account remains in surplus and international reserves have risen.
- Growth is expected to continue at the same pace for the rest of the year and pick up modestly over the medium term, driven mainly by domestic demand. This assumes a significant increase in investment, especially in infrastructure.
- Inflation reached a six-month low in May allowing Bank Indonesia (BI) to continue its easing stance. The policy rate has been reduced by 425 basis points since the easing cycle began in May last year.
- Indonesia’s strengthening fundamentals and yield differentials have recently attracted significant, though volatile, portfolio inflows, resulting in appreciation pressures on the rupiah.

### Policy Discussions
- On policies to address the portfolio inflows, staff and authorities agreed that allowing the rupiah to appreciate while intervening to avoid disruptive changes in the exchange rate would be the best way to deal with the capital influx. Appreciation would help to dampen inflation further and allow BI to cut interest rates, in turn helping to moderate capital inflows and ease concerns about a sudden reversal.
- Monetary policy discussions focused on the need to exercise caution in reducing interest rates to ensure that the inflation target for 2008 is met.
- Fiscal policy, targeting 1.7–1.8 percent of GDP deficits for 2007 and 2008, is appropriately geared to further reducing the public debt burden, while providing space for some additional spending on infrastructure, a major bottleneck to sustainable growth.
- Staff and authorities agreed on the need to strengthen the nonbank financial sector and long-term financing. Several prudential regulations have been eased to encourage banks to lend. BI believes strong risk management practices at banks will help to limit risks, but they plan to review the changes next year. Staff believe such measures send the wrong signals to banks and supervisors.
- Successful implementation of the new structural reform agenda, including reducing infrastructure bottlenecks, passage of the tax law currently in parliament and modification of labor regulations, would help attract investment, create jobs and raise productivity, thus accelerating growth, reducing poverty, and supporting stability.

### Introduction — Key Context
- Indonesia’s economic performance has been strong since the last Article IV consultation. Supported by sound policies and a favorable external environment, output has grown by about 6 percent, inflation has stabilized, and international reserves have risen to an all time high. The government, banking, and corporate sectors continued to reduce balance sheet vulnerabilities. Rising reserves enabled Indonesia to complete the early repayment of its remaining obligations to the Fund in October last year, thus ending post-program monitoring.
- Despite these successes, the benefits of growth have yet to be felt across society. While the official unemployment rate dipped below 10 percent in 2007, formal sector employment opportunities remain limited. Meanwhile, higher prices for some household staples pushed the poverty rate back up to 18 percent in 2006, reversing the improvements of the previous three years.
- The authorities’ focus is therefore on accelerating economic growth to improve social conditions. Key elements of their medium-term strategy include policies to strengthen financial intermediation, improve the business climate, and increase infrastructure investment. Some measures face bureaucratic and political resistance, driven in part by vested interests and ambivalence toward foreign investment. As the 2009 elections approach, the authorities will also need to resist pressures to achieve quick results through interventionist policies.
- Volatile portfolio inflows pose additional challenges, including minimizing the erosion of competitiveness in labor-intensive manufacturing from real exchange rate appreciation and avoiding new external vulnerabilities from a sudden reversal of inflows. A slowdown in domestic credit growth in 2006 has triggered pressure on the central bank and state-owned banks to accelerate lending. Recent loosening of prudential regulations in response to such pressures could risk reversing some gains in financial sector stability.

### Economic and Financial Backdrop — Recent Developments
- Growth and activity:
  - Growth reached 5½ percent in 2006. Staff projects growth at 6 percent in 2007—the pace maintained since Q3 2006—with some shift from external to domestic demand.
  - The external current account surplus is projected to decline from 2¾ percent of GDP in 2006 to 2 percent in 2007. This assumes a slowdown in non-oil and gas export value growth to 15 percent in 2007 (compared with 22 percent growth y/y in the first quarter).
- Credit and banking:
  - Credit growth reached 17½ percent y/y in April. Credit to businesses is now outpacing consumer credit.
  - Banking sector indicators strengthened: the profitability of banks improved with BI’s rate cuts and widening net interest margins. The system is well capitalized and private banks’ nonperforming loans (NPLs) remain low. State banks still have a high share of NPLs, although recent restructurings cut this significantly.
- Prices and policy rates:
  - Inflation has stabilized at around 6 percent.
  - Bank Indonesia has lowered its policy rate 425 bps since May 2006 as inflation moved toward its end-2007 target range of 5–7 percent.
- Fiscal stance:
  - The central government deficit increased modestly to 1.0 percent of GDP in 2006, as budget execution improved toward the end of the year.
  - The central government fiscal impulse was fully offset by the accumulation of regional government deposits, reflecting limited implementation capacity at the regional level.
- External and market indicators:
  - Equity and bond markets have been buoyant since late 2005, with portfolio capital inflows surging in April–May 2007.
  - After volatility, the exchange rate appreciated by 3 percent in May vis-à-vis the U.S. dollar, with some reversal in early June.
  - Foreign exchange reserves have continued to accumulate; reserves covered 154 percent of short-term debt and 5 months of imports at end-2006.
  - Debt ratios continue to decline, with external debt projected at 31 percent of GDP at end 2007.

### Medium-Term Outlook and Risks
- Growth prospects and requirements:
  - Growth is projected to pick up further, driven by domestic demand. Productivity gains and increased investment could raise potential output growth to about 6½–7 percent.
  - Achieving this requires growth in investment of about 12 percent per annum, assuming the current pace of overall productivity growth is broadly maintained.
  - The authorities’ official medium-term target is 7½ percent.
- Financial intermediation:
  - Private sector credit is expected to expand faster than nominal GDP, reflecting continued financial deepening and remonetization, supported by declining inflation and interest rates, and growing demand for financial services.
  - Capital markets should continue to gain in importance, supporting nonbank financial development.
- Risks highlighted:
  - The projection depends on continued progress improving the investment climate and infrastructure, attracting FDI, and greater regional integration.
  - Volatile portfolio inflows risk competitiveness erosion and sudden reversals; loosening prudential regulations could reverse financial stability gains.
  - Above-average inflation remains a concern for macroeconomic volatility and medium-term competitiveness.

*Source: Executive Summary, _cr07272 - Executive Summary*

### BOX 2. UPDATE OF CONTINGENT CLAIMS (CCA) ANALYSIS FOR INDONESIA

### BOX 2. UPDATE OF CONTINGENT CLAIMS (CCA) ANALYSIS FOR INDONESIA

### Market-implied credit risk: banks and sovereign
- Markets continue to price in a historically low probability of default for banks and the sovereign.
- Estimated average default probabilities of banks declined in 2007.
  - The global equity market sell-off in May 2006 raised default probabilities for all banks, but this effect disappeared toward the end of 2006, in particular for private banks.
  - State banks’ estimated default probability remained elevated through the remainder of 2006 due to a surge in volatility of the shares of one state-owned bank related to market perceptions of possible management and nonperforming loan problems.
  - Other state banks showed a decline in default probabilities similar to that of private banks.
- Distribution of risks in the banking system improved in 2007.
  - Risks are more evenly distributed across banks, as estimated default probabilities for riskier banks have declined more than for the banking system on average.
  - The low perception of bank credit risk by the market may be driven not only by expected improvements in bank performance, but also by expectations that the authorities would bail out state banks.
- CCA analysis for the sovereign confirms the improving outlook for sovereign credit risk.
  - Default probability of the sovereign increased somewhat in late February 2007, along with CDS spreads, but remained at a historically low level.

### Banking sector indicators and dynamics
- Profitability and credit:
  - Profitability has recently picked up along with credit growth.
  - Loan to deposit ratio, credit growth (y/y), net interest margin, and return on assets all exhibited recovery trends through Jan-07 in the reported series.
- Nonperforming loans and capital:
  - State banks' NPLs are declining.
  - Capital/Asset ratios remain healthy.
- External investment context:
  - Investment (in percent of GDP) series show Indonesia compared with Korea, Philippines, Thailand, Vietnam for 2002–2006.
  - Foreign Direct Investment inflows (in percent of GDP) for 2002–2006 show Indonesia lagging regional comparators.
  - Summary: Investment rates have picked up, but still remain low in a regional comparison; as does foreign direct investment.

### Medium-term macroeconomic framework (2005–12) — selected projections and levels
- Real GDP growth: 2005 5.7; 2006 5.5; 2007 6.0; 2008 6.3; 2009 6.5; 2012 6.7
- Domestic demand: 2005 5.3; 2006 3.3; 2007 5.2; 2008 7.5; 2009 7.7; 2012 9.4
- Net exports (contribution to GDP growth): 2005 1/1.1; 2006 1.4; 2007 1.3; 2008 -0.3; 2009 -0.4; 2012 -2.1
- CPI inflation (end period): 2005 17.1; 2006 6.6; 2007 6.3; 2008 5.5; 2009 4.0; 2012 3.0
- Gross investment (in percent of GDP): 2005 23.5; 2006 22.6; 2007 22.5; 2008 24.3; 2009 25.9; 2012 31.8
- Gross national saving (in percent of GDP): 2005 23.6; 2006 25.3; 2007 24.4; 2008 25.8; 2009 26.9; 2012 30.4
- Current account balance (in percent of GDP): 2005 0.1; 2006 2.7; 2007 1.9; 2008 1.5; 2009 1.0; 2012 -1.4
- Central government balance (in percent of GDP): 2005 -0.3; 2006 -1.0; 2007 -1.8; 2008 -1.8; 2009 -1.5; 2012 -0.6
- Central government debt (in percent of GDP): 2005 45.6; 2006 38.6; 2007 35.7; 2008 33.9; 2009 31.9; 2012 26.1
- Staff note: Public debt could fall to about 26 percent of GDP in 2012 if overall deficits remain modest (gradually declining to 0.6 percent by 2012), consistent with current policies.
- Inflation target: Inflation is projected to decline to 3 percent in the medium term in line with BI’s target; this requires that BI remains committed to achieving its targets.

### Risks to the medium-term baseline and scenarios
- Main risks: external shocks and possible domestic policy slippages.
- External shocks:
  - A capital account shock or a global growth slowdown would lead to a temporary slowdown in activity.
  - Factors limiting impact: diversity of exports (regionally and by product), limited external debt exposure, and adequate reserve levels.
  - Resilience of banking system: stress tests show the banking system is sufficiently strong to weather a moderate adverse external shock; a financial sector safety net is now largely in place.
  - Appropriate policy response includes: allowing exchange rate depreciation while using reserves to cushion capital outflows and avoid extreme exchange rate movements; raising interest rates as needed to limit the impact on inflation.
- Domestic policy slippages:
  - Slippages in monetary policy or doubts about debt sustainability could lead to capital outflows.
  - Lack of progress in structural reforms or infrastructure investment could create bottlenecks limiting investment and potential growth.
  - Growing nationalist sentiment toward foreign investment in natural resources could impede investment growth.
  - Pressures to boost bank lending could lead to deterioration in supervisory standards and increased financial sector vulnerabilities, with adverse medium-term growth effects if banking difficulties arise.
- Upside scenario:
  - Growth could be higher than baseline if structural reforms are accelerated, notably a breakthrough to a more flexible labor regime unlocking higher growth potential in labor-intensive sectors such as textiles and footwear.
- Annex I: medium-term impact of three adverse shock scenarios described: (1) loss in global risk appetite triggering emerging market capital outflows; (2) domestic policy slippages; (3) slowdown in global growth.

### BOX 3 — Stress test analysis: impact of adverse macro shocks on banks
- Summary finding: Sufficient capital and the relatively low level of outstanding credit should enable Indonesian banks to withstand moderate macroeconomic shocks.
- Capitalization and metrics:
  - At end-2006 the banking system was well capitalized as measured by the capital adequacy ratio (CAR) and by the ratio of Tier 1 capital to total assets (leverage ratio).
  - Tier 1 ratio is preferred since reported CARs are high due to large holdings of zero risk weighted assets, notably government bonds.
- Stress test setup:
  - Tests performed on the 15 largest banks (accounting for 68 percent of banking sector assets) using BI’s internal risk model.
  - Impact assessed based on Tier 1 ratio: a bank with a ratio of 4 percent is considered seriously under capitalized, while a ratio of 6 percent is low but acceptable.
  - Macro shock scenario: loss of confidence triggering capital outflows, exchange rate depreciation, lower growth, and higher inflation and interest rates (see Scenario A, Annex I).
- Results:
  - The largest Indonesian banks should be able to resist this adverse shock without major problems.
  - Some smaller banks of the group (accounting for 6 percent of assets) would exhibit a material decline in their CAR and Tier 1 ratios.
  - Liquidity: only four banks in the group (18 percent of banking system assets) have less than 25 percent liquid assets; overall liquidity should not be a problem.
  - Negative feedbacks from banking sector to macroeconomy should be limited: largest banks could continue to provide credit though credit growth should slow; smaller banks with materially declining capital ratios would see much sharper declines in new lending.
- Additional vulnerability findings:
  - Exposure to credit risk is limited by the low share of loans to total assets, but exposure and risk could increase substantially if efforts to boost lending were successful.
  - Generally low maturity mismatches and the high share of government bonds at floating rates limit interest rate risk.
  - Small net open positions limit exposure to exchange rate risk.
- Stress test table (15 largest banks, in percent unless otherwise noted):
  - Initial Values (December 2006): Number of banks with Tier 1 capital ratio below 4 percent: 0; below 6 percent: 3; Average Tier 1 Ratio 8.2; Average CAR ratio 19.4
  - Alternative Macro scenario (end 2008): Number of banks with Tier 1 <4%: 2; <6%: 5; Average Tier 1 Ratio 7.6; Average CAR ratio 18.3
  - Stress Tests for Vulnerabilities to:
    - Credit Risk1/: Number <4%: 2; <6%: 5; Average Tier 1 Ratio 7.4; Average CAR ratio 17.9
    - Interest Rate Risk2/: Number <4%: 1; <6%: 4; Average Tier 1 Ratio 7.6; Average CAR ratio 18.4
    - Exchange Rate Risk3/: Number <4%: 0; <6%: 3; Average Tier 1 Ratio 8.4; Average CAR ratio 19.8
  - Footnotes:
    - 1/ 33 percent of loans in each classification were downgraded.
    - 2/ 350 basis point increase in interest rates.
    - 3/ 40 percent depreciation of the bilateral exchange rate with the U.S. dollar.
    - 4/ The alternative scenario assumes a tightening of global liquidity conditions triggering capital outflows, exchange rate depreciation, and higher inflation. The policy response includes higher domestic interest rates and FX intervention (see Scenario A in Annex I).

### Dealing with capital inflows — staff analysis and recommendations
- Background observations:
  - Appreciation pressures on the rupiah intensified during May (portfolio capital inflows increased significantly around mid-April).
  - Foreign exchange reserve accumulation moderated appreciation as BI purchased net external debt disbursements and some oil revenues automatically, and intervened directly in the market mostly at times of increased capital flows.
  - Net purchases have dominated in 2006–07, though there were extended periods without direct intervention and BI sold reserves in mid-2006 in response to portfolio outflows.
- Staff discussion points:
  - Valuation of the rupiah: Evidence is far from conclusive; ERER methodology at end May 2006 estimated rupiah around 12 percent below level justified by fundamentals; macroeconomic balances and external sustainability approaches estimated rupiah 1½ percent overvalued and 16 percent undervalued, respectively. Considerable uncertainty exists given possible structural changes.
  - A primarily market-determined exchange rate supports the inflation-targeting framework; attempts to target a specific exchange rate could create one-way bets and trigger speculative inflows.
  - Reserve adequacy: Reserve levels are broadly sufficient by standard indicators; modest further accumulation warranted but sterilization cost is relevant (currently estimated at about 0.1 percent of GDP for each US$10 billion in reserves).
- Staff recommendations to address appreciation pressures:
  - Monetary and exchange rate policy response should include:
    - allowing further appreciation;
    - possible intervention to limit excessively large exchange rate movements;
    - further interest rate cuts provided that appreciation improves the inflation outlook.
  - Support export performance through structural measures to enhance the business climate.
  - Deepen financial markets to limit the impact of volatile portfolio flows on domestic asset prices and the exchange rate and to provide a broader range of financial instruments (including hedging).
- Authorities’ views:
  - BI officials broadly agreed with staff that current exchange rate policy remains appropriate.
    - Flexible exchange rate: commitment to inflation-targeting regime and to a market-determined exchange rate.
    - Current real exchange rate level viewed by BI as consistent with improved fundamentals; some appreciation or depreciation would not pose a significant problem.
  - Authorities expressed concern over “hot money” flows (portfolio holdings of foreign investors) which raise the size of potential capital outflows.
    - Short-term investments, particularly central bank paper, seen as speculative and potentially disruptive if unwound.
    - BI officials emphasize need for significant reserve levels to reduce vulnerability to “hot money” outflows and would welcome some additional accumulation but remain concerned about potential sterilization costs.

*Source: _cr07272 - BOX 2. UPDATE OF CONTINGENT CLAIMS (CCA) ANALYSIS FOR INDONESIA*

### 16.      Inflation remains on-track to meet the end-2007 inflation target of 6±1 percent

### 16.      Inflation remains on-track to meet the end-2007 inflation target of 6±1 percent

### Inflation developments and near-term outlook
- Rising rice prices pushed up headline inflation modestly in early 2007, but prices have begun to decline in line with normal seasonal patterns, and administered prices have remained stable.
- Annual inflation declined to 6 percent in May.
- The near-term inflation outlook is positive with no signs of immediate price pressures.
- Recent exchange rate appreciation contributes to the positive short-term outlook.
- Bank Indonesia (BI) is signaling further rate cuts for 2007.
- Risk: Too much focus on the favorable near-term outlook carries the risk of rapid rate cuts, possibly worsening the inflation outlook for 2008.

### Staff recommendations for monetary policy
- Staff recommended shifting the focus of monetary policy toward meeting the 2008 target.
- Staff’s conditional inflation forecasts indicate:
  - The 2007 target of 6±1 percent will be met.
  - The 2008 target of 5±1 percent remains within reach, assuming limited additional rate cuts.
- Real interest rates are now slightly less than 3 percent (measured against core inflation) below the historical (2000–07) average of 3½ percent, suggesting the current stance might already be slightly expansionary.
- Additional rate cuts should be determined by forecast inflation for 2008 relative to the target.
- With current and projected 2008 inflation above the midpoint of the 2008 target range, BI should be cautious in cutting rates and take into account the significant lags in the monetary transmission mechanism.
- Further appreciation of the rupiah could create room for lower rates.
- Reducing macroeconomic volatility remains a key objective; monetary policy should:
  - Continue to reduce inflation to international levels.
  - Avoid sharp policy reversals (example cited: 2005 when concerns about excessively loose policies led to a loss of confidence and exchange rate depreciation).
- Further strengthening the credibility of the inflation targeting regime could contribute to lower macroeconomic volatility; staff made several recommendations in that regard, including on the planned change in the maturity of the policy rate (see Box 5).

### The authorities’ views on inflation and policy intentions
- BI officials broadly agreed with staff but were slightly more optimistic regarding room for further rate cuts.
- BI emphasized continued commitment to the inflation-targeting framework and to meeting the 2007 and 2008 targets.
- BI considers high food prices as the key risk to the inflation outlook but remains confident it can meet the 2007 target range.
- While BI recognized meeting the 2008 target will be more difficult, officials believe the target remains achievable, even with additional rate cuts, in light of recent rupiah appreciation.

### Box 5 — Further improving the effectiveness of the inflation-targeting framework (summary of key recommendations)
- Transparency and Communication
  - Clarity of the inflation target: Most private sector analysts project 2008 inflation slightly above the official target range, suggesting either limited communication or limited credibility; stronger emphasis on inflation targets beyond the current year could help anchor expectations.
  - Monetary policy and inflation reports: Explicit discussion of risks to the inflation outlook and past inflation performance could improve credibility and predictability; consideration could be given to publishing explicit inflation forecasts after more experience with the forecasting framework.
  - BI’s public communication should be aligned with the official position, be less specific on future interest rates or credit growth targets, and place less emphasis on growth.
  - Authorities’ view: BI officials noted improvements in the Monetary Policy Report and are considering publishing quantitative inflation forecasts.
- Framework for Monetary Operations
  - BI intends to change the monetary policy rate to the overnight interbank rate but has yet to announce a firm date.
  - Current framework: BI uses the 1-month SBI rate as the policy rate, while participation in the overnight market is limited and rates are volatile; the new framework would facilitate development of the short end of the yield curve.
  - Key conditions for changing the policy rate:
    - A stable overnight rate is needed; BI must exert sufficient control over the new policy rate, requiring progress in liquidity forecasting and management; introducing required reserve averaging could help stabilize the rate.
    - Development of the interbank market, including repos, is important to ensure the interbank market reflects liquidity conditions and contributes to stabilizing the interbank rate.
  - Authorities’ view: BI officials concurred on the need to strengthen the overnight interbank market and highlighted ongoing work including efforts to develop the repo market; progress toward implementing the treasury single account (TSA) would facilitate liquidity forecasting and management.

*Source: _cr07272 - 16.      Inflation remains on-track to meet the end-2007 inflation target of 6±1 percent*

### 32.      The investment climate still compares poorly in cross-country surveys. In

### _cr07272 - 32.      The investment climate still compares poorly in cross-country surveys. In

### Investment climate: assessment and constraints
- The investment climate "still compares poorly in cross-country surveys."
- Specific impediments cited:
  - "Strict labor legislation" that is "among the least competitive in the region" with "high severance payments making layoffs very costly and restricting the ability of firms to adapt to shifts in market demand."
  - "A difficult legal and regulatory environment" that compares poorly within the region.
- Recent legal improvement:
  - "The Investment Law was passed in March." Provisions include:
    - "equal treatment to domestic and foreign investors,"
    - "allows for longer work permits for expatriates,"
    - "extends the number of years for which land can be leased,"
    - explicit entitlement "to repatriate and transfer funds in foreign exchange,"
    - "disputes between the government and investors can be settled through international arbitrage,"
    - allows the "Minister of Finance to issue regulations to provide various tax incentives."
- Next steps announced:
  - "Complete the implementing regulations relating to the Investment Law expeditiously."
  - "A package of specific measures to improve the investment climate and support small and medium enterprises ... was presented in June."

### Progress on structural reforms
- Fiscal reforms: main achievements
  - "(i) restructuring the tax agency and modernizing the medium taxpayers’ offices;"
  - "(ii) approval in June of the most important of a package of tax laws before Parliament relating to administrative procedures, that should both enhance collection and improve the business climate;"
  - "(iii) strengthening the budget process and transparency, involving a reorganization of the MOF, as well as a simplification of budget execution procedures."
- Other structural actions:
  - "The Investment Law was passed in March." (See provisions above.)
  - Labor market reform progress is slow; legislative reform "has been set aside because of opposition by unions," though authorities "are trying to modify regulations to limit severance payments."
  - State-owned enterprises (SOEs): authorities "indicated their intention to develop a new strategy for SOEs, including a revival of the privatization agenda," including "the planned sale of a 30 percent stake in the state bank BNI."

### The Authorities’ views and policy intentions
- Structural reform intentions and specific plans:
  - Fiscal reforms:
    - "the issuance of government regulations necessary for the establishment of a treasury single account;"
    - "more regular monitoring of regional governments and public enterprise operations;"
    - "introducing a statement of fiscal risks and a medium-term fiscal framework."
  - Investment climate:
    - "complete the implementing regulations relating to the Investment Law expeditiously."
    - Implement "a package of specific measures to improve the investment climate and support small and medium enterprises."
  - Labor reform:
    - "would continue, albeit without comprehensive legislative reforms."
    - Plans to "link the reforms on severance payments to using well-managed pension funds to provide limited benefits to workers in case of unemployment."
  - SOEs:
    - "intend to develop a new strategy for SOEs, including a revival of the privatization agenda," e.g., "planned sale of a 30 percent stake in the state bank BNI."

### IMF staff appraisal: achievements and key challenges
- Achievements (paragraph 35):
  - "Since the last Article IV consultation, Indonesia has seen strong growth, as well as declining inflation and balance sheet vulnerabilities."
  - "Progress has also been made in building macroeconomic institutions, especially in the fiscal area."
  - Caveat: "continued high poverty and unemployment have tended to devalue the gains toward stability in the eyes of much of the population."
- Key challenges (paragraph 36):
  - To sustain growth "at least in the 6–7 percent range necessary to alleviate poverty and unemployment" the following are needed:
    - "stronger financial intermediation, especially better availability of long-term financing,"
    - "additional investment in infrastructure,"
    - "an improved investment climate."
  - Increased integration in the global economy can "increase risks," enhancing need for "continued sound macroeconomic policies."
- Declining vulnerabilities (paragraph 37):
  - Improved fundamentals: "lower debt and higher reserves" have increased resilience.
  - "The banking system is well capitalized, profitability has improved, and stress tests suggest it is capable of withstanding reasonable adverse shocks."
  - Warning: "the recent flurry in corporate external debt issuance suggests that private sector borrowing needs to be monitored closely."
- Capital inflows and external stability (paragraph 38):
  - Current account context: "a relatively small current account surplus, which is projected to move into deficit over time, and relatively modest net capital inflows (at least so far)."
  - Risks: "portfolio inflows have been volatile and have led to significant price swings in Indonesia’s shallow asset markets."
  - Policy mix to manage surges in inflows: "allowing further rupiah appreciation, intervention to limit excessive exchange rate movements, and additional interest rate cuts, provided that appreciation improves the inflation outlook."
- Exchange rate and competitiveness (paragraph 39):
  - REER measures "suggest a modest undervaluation, as reflected in the current account surplus."
  - "Performance of manufacturing exports has been modest relative to trading partners, as high commodity prices have strengthened the real exchange rate."
  - Conclusion: "some appreciation could take place without jeopardizing the external position" and focus should remain on "structural measures to enhance competitiveness."
- Monetary policy (paragraphs 40–41):
  - With the "2007 inflation target well within reach, monetary policy should now focus on achieving the 2008 target."
  - "BI needs to exercise caution and allow time for past rate cuts to affect the real economy."
  - "Further improvements in transparency and communication could bolster confidence"; BI should avoid sending "mixed signals about policy priorities."
- Financial sector policy (paragraph 42):
  - Concern: "recent relaxation of prudential regulations to encourage lending" departs from international standards and "risk having an adverse signaling effect on supervisors and banks alike."
  - Recommended shifts:
    - Reconsider the appropriateness of the relaxation measures "as soon as possible."
    - Avoid "moral suasion to encourage banks to lend to specific sectors" to prevent credit misallocation.
    - Promote "development of capital markets and instruments of longer-term financing" to preserve financial soundness.
    - Develop "a strategy on the future role of state banks" and confirm a date for the FSAP.
- Fiscal policy recommendations (paragraphs 43–44):
  - Fiscal stance: "appropriate."
  - Deficit guidance: Do not go beyond "the 1.7–1.8 percent deficits currently envisaged" for 2007–2008.
  - Debt objective: "lowering public debt to about 30 percent of GDP by 2009 remains appropriate."
  - Suggested measures to create space for priority spending:
    - "Further improvements in tax administration,"
    - "some new tax measures,"
    - "streamlining of expenditures, including through greater flexibility of energy prices."
  - Support for ongoing fiscal structural reforms: "the recent adoption of a key tax reform bill should improve revenue collection and contribute to improving the investment climate."
  - Staff "supports the planned introduction of a fiscal risk statement and the medium-term fiscal framework in the 2008 budget."
- Structural reform recommendations (paragraph 45):
  - Accelerate structural reforms to "entrench the recovery in growth."
  - Focus on:
    - "modifications in labor regulations to alleviate the burden of severance payments on employment generation,"
    - "facilitating public private partnerships in infrastructure (in addition to more budgetary spending) while ensuring that they are adequately prepared and assessed."

### Selected key statistics and projections (as presented)
- Real GDP (percent change): 2002 4.5; 2003 4.8; 2004 5.0; 2005 5.7; 2006 5.5; 2007 6.0; 2008 6.3
- Domestic demand: 2002 2.4; 2003 6.0; 2004 5.4; 2005 5.3; 2006 3.3; 2007 5.2; 2008 7.5
- Gross fixed investment: 2002 4.7; 2003 0.6; 2004 14.7; 2005 10.8; 2006 2.9; 2007 9.0; 2008 11.9
- Consumer prices (end period): 2002 9.9; 2003 5.2; 2004 6.4; 2005 17.1; 2006 6.6; 2007 6.3; 2008 5.5
- Central government revenue (in percent of GDP): 2002 16.5; 2003 16.7; 2004 17.8; 2005 17.8; 2006 19.0; 2007 17.7; 2008 17.1
- Central government expenditure (in percent of GDP): 2002 18.0; 2003 18.7; 2004 19.1; 2005 18.1; 2006 20.0; 2007 19.5; 2008 18.9
- Central government balance (in percent of GDP): 2002 -1.6; 2003 -2.0; 2004 -1.4; 2005 -0.3; 2006 -1.0; 2007 -1.8; 2008 -1.8
- Central government debt (in percent of GDP): 2002 65.4; 2003 58.3; 2004 55.2; 2005 45.6; 2006 38.6; 2007 35.7; 2008 33.9
- Current account balance (billions of US$): 2002 7.8; 2003 8.1; 2004 1.6; 2005 0.3; 2006 9.9; 2007 8.0; 2008 6.8
- Gross reserves (end period, in billions of US dollars): 2002 32.0; 2003 36.3; 2004 36.3; 2005 34.7; 2006 42.6; 2007 55.0; 2008 61.8
- Total external debt (in billions of US dollars): 2002 131.3; 2003 135.4; 2004 137.4; 2005 133.8; 2006 133.4; 2007 130.5; 2008 132.1
- Unemployment rate: 2001 8.1; 2002 9.1; 2003 9.5; 2004 9.9; 2005 10.3; 2006 10.3
- Poverty: Population under poverty line (in percent): 2001 18.4; 2002 18.2; 2003 17.4; 2004 16.7; 2005 16.0; 2006 17.8

### Operational recommendation
- "It is recommended that the next Article IV consultation take place on the standard 12-month cycle."

*IMF staff report content as presented in the source document.*

### 1. Direct Investment, net-1.55.33.32.84.0

### 1. Direct Investment, net-1.55.33.32.84.0

### External Financial Flows: Direct, Portfolio, and Other Investment
- Direct Investment, net: -1.5 - 5.3 3.3 2.8 4.0
- Portfolio Investment, net: 4.4 4.2 4.1 8.1 8.1 8.1
- Other Investment (total): -0.3 -10.4 -4.7 -6.8 -12.3
  - Non-financial Public Sector: -2.7 -0.8 -2.2 -1.7 -2.1
  - Banking Sector: 0.4 -1.3 0.4 1.1 1.2
  - Corporate Sector: 0.1 1.0 -0.8 1.1 1.2
  - Other 1/: 1.8 -9.3 -2.1 -7.3 -12.5
- III. Total (I+II): 4.1 -0.3 12.9 12.4 6.8
- IV. Errors and Omissions: -3.1 -0.2 3.0 0.0 0.0
- V. Overall Balance (III+IV): 1.0 -0.5 15.9 12.4 6.8
- VI. Reserves and Related Items: -1.0 0.5 -15.9 -12.4 -6.8
  - Changes in Reserve Assets: 0.0 1.6 -7.9 -12.4 -6.8
    - Of which: Transactions: 0.9 1.6 -7.9 -12.4 -6.8
  - Use of Fund Credit and Loans: -1.0 -1.1 -8.0 0.0 0.0
    - Purchases: 0.0 0.0 0.0 0.0 0.0
    - Repurchases: -1.0 -1.1 -8.0 0.0 0.0

- Memorandum items:
  - Reserve Assets Position (eop): 36.3 34.7 42.6 55.0 61.8
  - in months of imports of goods and services: 4.8 4.4 4.8 5.7 5.8
  - in percent of short-term debt: 137 103 154 188 198
  - Current account (percent of GDP): 0.6 10.1 2.7 1.9 1.5
  - Non-oil and gas exports, volume growth: 0.4 16.7 13.4 16.0 10.1
  - Non-oil and gas imports, volume growth: 9.9 27.9 5.5 11.1 13.3

- 1/ Includes unrecorded capital flows and exceptional financing.
- Sources: Bank Indonesia, Fund staff estimates.

### Policy-relevant findings from balance of payments and reserves
- Overall Balance turns from 1.0 to 15.9 then moderates to 6.8 across the period shown.
- Reserve Assets Position (eop) rises from 36.3 to 61.8 over the horizon displayed.
- Current account remains positive in the periods reported (e.g., 0.6, 10.1, 2.7, 1.9, 1.5 percent of GDP).

---

### Monetary Survey (Table 5 highlights)

### Levels and composition (end-period, in trillions of rupiah, unless otherwise indicated)
- Net foreign assets (in US$ billions): 193.1 218.2 262.6 274.2 293.0 309.2 420.1
  - (in US$ billions reported separately): 27.6 31.2 37.5 39.2 41.9 44.2 60.0
- Net domestic assets: 807.0 930.6 889.2 935.5 956.2 1,032.1 1,162.7
- Net claims on government: 499.0 501.8 483.1 491.0 492.7 505.3 551.9
- Claims on business sector: 587.6 703.4 704.2 729.3 758.6 804.3 937.4
- Broad money (M2): 1,000.2 1,148.8 1,151.8 1,209.7 1,249.1 1,341.4 1,582.8
- Rupiah M2: 897.9 1,014.3 1,010.9 1,073.4 1,116.4 1,198.1 1,413.8
- Currency in circulation: 109.3 124.3 112.6 123.8 130.0 151.0 178.2
- Deposits (total): 788.7 890.0 898.3 949.6 986.5 1,047.1 1,235.6
- Foreign exchange deposits: 102.2 134.5 140.9 136.3 132.7 143.2 169.0

### Bank of Indonesia (selected)
- Net international reserves: 170.8 173.9 213.5 237.8 255.2 274.7 385.1
- Base money: 199.4 243.2 233.9 247.7 257.8 297.1 350.0
- NIR of BI (in billions of US$): 24.4 24.8 30.5 34.0 36.5 39.2 55.0
- Money multiplier (rupiah M2): 4.5 4.2 4.3 4.3 4.3 4.0 4.0

### Annual percentage change (selected)
- Broad money: 7.3 14.9 17.0 17.3 14.7 16.8 18.0
- Rupiah broad money: 10.0 13.0 14.7 16.3 16.5 18.1 18.0
- Base money: 20.4 21.9 26.5 24.9 14.9 22.2 17.8
- Private sector claims: 30.4 19.7 15.6 11.8 9.0 14.4 16.5

- Sources: Bank Indonesia; and Fund staff estimates.
- Notes provided on valuation, reclassification from May 2004, and velocity calculations.

---

### Central Government Operations (Table 6 highlights)

### Levels (in trillions of rupiah; Act./Est./Proj. shown)
- Revenues and grants: 495.4 634.0 723.0 665.0 720.6
  - Oil and gas revenues: 138.7 201.3 181.1 162.8 176.1
  - Non-oil and gas revenues: 355.4 430.9 539.2 499.7 543.4
  - Tax revenues: 311.8 365.9 468.2 428.7 481.3
  - Nontax revenues 1/: 43.6 65.0 71.0 71.0 62.1
  - Grants: 1.3 1.9 2.7 2.5 1.1
- Expenditure and net lending: 503.8 667.5 763.6 731.1 796.0
  - Central government expenditure: 369.0 440.4 504.7 474.4 540.6
  - Current expenditure: 306.6 338.1 380.2 354.3 397.1
    - Personnel: 55.6 72.9 101.2 93.1 112.6
    - Subsidies: 120.7 107.4 103.0 95.3 114.4
      - of which fuel subsidies: 95.7 64.2 61.8 50.8 64.5
    - Interest: 67.7 79.0 85.1 83.1 77.4
      - External 2/: 24.2 24.1 26.7 24.1 23.7
      - Domestic: 43.5 54.9 58.4 59.1 53.7
  - Development expenditure 3/: 62.4 102.3 124.5 120.1 143.5
  - Transfers to regions: 150.5 226.4 258.9 256.7 255.4
- Overall balance: -8.4 -33.5 -40.6 -66.1 -75.4
- Financing: 8.5 33.5 40.6 66.1 75.4
  - Domestic: -17.4 34.4 36.8 69.1 84.1
    - Bank financing: -16.2 15.8 13.1 13.0 0.0
    - Net issuance of government securities: -2.1 17.5 22.2 56.0 83.3
    - Recovery of bank assets: 6.1 2.7 1.5 0.0 0.0
    - Privatization of nonfinancial assets: 0.0 0.4 2.0 2.1 2.8
    - Other 4/: -5.2 -2.0 -2.0 -2.0 -2.0
  - External: 25.9 -0.9 3.8 -3.0 -8.7

### Ratios (in percent of GDP)
- Revenues and grants: 17.8 19.0 20.5 17.7 17.1
  - Oil and gas revenues: 5.0 6.0 5.1 4.3 4.2
  - Non-oil and gas revenues: 12.8 12.9 15.3 13.3 12.9
  - Tax revenues: 11.2 11.0 13.3 11.4 11.4
  - Nontax revenues 1/: 1.6 1.9 2.0 1.9 1.5
- Expenditure and net lending: 18.1 20.0 21.6 19.5 18.9
  - Current expenditure: 11.0 10.1 10.8 9.4 9.4
  - Development expenditure 3/: 2.2 3.1 3.5 3.2 3.4
- Overall balance: 3/ -0.3 -1.0 -1.1 -1.8 -1.8
- Financing: 0.3 1.0 1.1 1.8 1.8
- Memorandum:
  - Primary balance: 2.1 1.4 1.3 0.5 0.0
  - General government balance: 0.3 -0.1 ... -1.4 -2.0
  - Non-oil primary balance: -2.9 -4.7 -3.9 -3.9 -4.1
  - Crude oil price (US $ per barrel): 51.8 63.9 63.0 60.3 64.3
  - Oil production (mbpd): 0.999 0.956 1.000 0.956 0.956

- 1/ From 2004 onwards, deposit insurance premia are treated as nontax revenues.
- 2/ Interest on a due basis (Paris Club moratoria is shown as a financing item)
- 3/ From 2005 onwards, comprises capital spending and social assistance spending.
- 4/ Includes capitalization of deposit insurance company in 2005.
- Sources: Data provided by the Indonesian authorities; and Fund staff estimates.

---

### Key Economic and Market Indicators (Latest observations and trends)

### Real economy, prices, financial markets (latest observations)
- Real GDP growth (in percent): 4.8 5.0 5.7 5.5 6.0 (Mar-07)
- CPI inflation (in percent): 5.2 6.4 17.1 6.6 6.0 (May-07)
- Short-term (ST) interest rate (in percent): 8.3 7.4 12.8 9.8 8.5 (Jun-07)
- EMBI secondary market spread (bps, end of period): 341 237 171 151 (Jun-07)
- Exchange rate NC/US$ (end of period): 8,425 9,285 9,830 8,990 9,080 (Jun-07)

### External sector and reserves
- Current account balance (percent of GDP): 3.5 0.6 0.1 2.7 ... (Dec-06)
- Net FDI inflows (percent of GDP): -0.3 -0.6 1.8 0.9 ... (Dec-06)
- Exports (percentage change of US$ value, GNFS): 5.3 19.7 20.7 15.1 ... (Dec-06)
- Real effective exchange rate (End, Jan. 2000=100): 119.8 109.2 124.6 134.5 140.1 (May-06)
- Gross international reserves (GIR) in US$ billion: 36.3 36.3 34.7 42.6 50.8 (Jun-07)
- GIR in percent of ST debt at remaining maturity (RM): 134.5 137.4 103.0 153.7 ... (Dec-06)
- Total gross external debt (ED) in percent of GDP: 57.7 53.5 46.6 36.6 ... (Dec-06)
  - o/w ST external debt (original maturity, in percent of total ED): 1.7 3.0 5.9 5.3 ... (Dec-06)
  - ED of domestic private sector (in percent of total ED): 40.2 41.0 43.8 50.0 ... (Dec-06)
  - ED to foreign official sector (in percent of total ED): 57.8 55.3 51.5 44.5 ... (Dec-06)
- Gross external financing requirement (in US$ billion) 2/: 19.8 22.1 24.3 19.2 ... (Dec-06)

### Public sector and financial sector indicators (latest)
- Public sector overall balance (percent of GDP): -2.0 -1.4 -0.3 -1.0 ... (Dec-06)
- Primary balance (percent of GDP): 1.6 1.3 2.1 1.4 ... (Dec-06)
- Public sector gross debt (PSGD, in percent of GDP): 58.3 55.2 45.6 38.6 ... (Dec-06)
- Capital adequacy ratio (in percent): 19.4 19.4 19.3 21.3 22.1 (Mar-07)
- NPLs in percent of total loans: 6.8 4.5 7.6 6.1 6.0 (Mar-07)
- Return on assets (in percent): 2.6 3.5 2.6 2.6 2.7 (Mar-07)
- Credit to private sector (percent change): 22.1 30.4 19.7 12.8 17.4 (Apr-07)

- Notes on definitions provided in source footnotes.

---

### Medium-Term Macroeconomic Framework (Table 8 highlights, 2005–12 projections)

### Growth and demand (percent change and contributions)
- Real GDP (percent change): 5.7 5.5 6.0 6.3 6.5 6.7 6.7 6.7
- Domestic demand: 5.3 3.3 5.2 7.5 7.7 8.7 9.3 9.4
  - Private consumption: 4.0 3.2 4.6 4.6 5.3 5.7 6.7 6.7
  - Gross fixed investment: 10.8 2.9 9.0 11.9 11.8 12.6 11.5 11.7
  - Change in stocks 1/: -0.4 -0.3 -0.8 0.7 0.4 0.1 1.1 1.3
  - Net exports 1/: 1.1 1.4 1.3 -0.3 -0.4 -0.3 -1.8 -2.1
  - Statistical discrepancy 1/: -0.3 1.1 0.0 0.0 0.0 0.0 0.0 0.0

### Saving and investment (percent of GDP)
- Gross investment 2/: 23.5 22.6 22.5 24.3 25.9 27.3 29.5 31.8
- Gross national saving: 23.6 25.3 24.4 25.8 26.9 27.6 28.9 30.4
- Foreign saving: -0.1 -2.7 -1.9 -1.5 -1.0 -0.3 0.5 1.4

### Prices (12-month percent change)
- Consumer prices (end period): 17.1 6.6 6.3 5.5 4.0 3.0 3.0 3.0
- Consumer prices (period average): 10.5 13.1 6.2 5.4 4.9 3.2 3.0 3.0

### Public finances (percent of GDP; projections)
- Central government revenue: 17.8 19.0 17.7 17.1 17.0 17.1 16.9 16.6
- Central government expenditure: 18.1 20.0 19.5 18.9 18.5 18.2 17.7 17.2
- Central government balance: -0.3 -1.0 -1.8 -1.8 -1.5 -1.1 -0.8 -0.6
- Primary balance: 2.1 1.4 0.5 0.0 0.1 0.2 0.2 0.3
- Central government debt: 45.6 38.6 35.7 33.9 31.9 30.0 28.1 26.1

### Balance of Payments (US$ billions, selected)
- Oil and gas (net): 4.2 6.8 6.4 4.3 3.9 4.5 3.0 1.6
- Non-oil exports (f.o.b): 66.8 80.6 92.5 100.8 109.4 119.1 130.3 142.5
- Non-oil imports (f.o.b): -53.4 -57.7 -68.7 -75.7 -84.0 -95.8 -108.8 -123.8
- Current account balance: 0.3 9.9 8.0 6.8 5.0 1.6 -3.3 -9.7
- Direct foreign investment: 5.3 3.3 2.8 4.0 4.9 6.2 6.6 7.8
- Overall balance: -0.5 15.9 12.4 6.8 7.0 6.4 7.3 8.0

### Gross reserves (end period)
- In billions of US dollars: 34.7 42.6 55.0 61.8 68.8 75.2 82.5 90.5
- In months of imports: 4.4 4.8 5.7 5.8 5.8 5.7 5.6 5.5
- As a percent of short-term debt (remaining maturity): 103.0 153.7 187.8 197.8 209.2 216.4 224.5 232.7

### External and memorandum items
- Total external debt (US$ billions): 133.8 133.4 130.5 132.1 133.1 132.8 131.7 129.4
- Total external debt (percent of GDP): 46.6 36.6 31.2 28.6 26.2 23.9 21.5 19.3
- Oil production (000 bcpd): 999 956 956 956 1,004 1,104 1,104 1,104
- Indonesian oil price (US$/bbl): 51.8 63.9 63.0 60.3 64.3 64.1 63.8 63.3
- Nominal GDP (US$ billions): 287 364 418 462 507 556 612 672

- Sources: Data provided by the Indonesian authorities; and Fund staff estimates.
- Notes on contributions, computation, and short-term debt in footnotes.

---

### Progress on the Government’s Structural Policy Agenda (Table 9 summary)

### Key areas and status
- New Investment Law: Approved by Parliament (March 2007). Regulation including a “negative list” under preparation.
- Improve customs: Customs Law approved by Parliament in October 2006; simplification of procedures ongoing.
- Modifications to the Labor Law: Stalled after labor protests; government preparing regulations to change severance pay.
- Facilitate resolution of non-performing loans at state-owned banks: Presidential decree allowing haircuts issued (October 2006); oversight committee established (February 2007).
- Financial Safety Net: Gradual shift from blanket guarantee to limited deposit insurance completed (March 2007).
- Development of securities markets: Primary dealer system for government securities introduced (December 2006). First T-Bill issuance in June 2007.
- Infrastructure PPP framework and risk management unit: Risk Management Unit (RMU) set up at MoF and PPP framework in place.
- Fiscal reforms — Tax Laws (Tax Administration; Income Tax; VAT): Law on General Tax Rules and Procedures approved (June 2007). Other laws submitted to Parliament and expected to be passed later this year.
- Improving tax administration: New organizational structure for headquarters; modernization of medium tax payer office completed; work ongoing on small taxpayer offices, audits, and VAT streamlining.
- Reorganization of MoF: Fiscal policy office, debt unit, and directorates for monitoring regional governments and public enterprises have been set up.
- Treasury reforms: Regulations to implement State Treasury Law under discussion between MoF and BI; outstanding issues include BI-MoF negotiations on remuneration of treasury deposits and coordination of BI and treasury operations, and consolidation of government funds under treasury oversight.
- Budget reforms: MTFF and a fiscal risk statement to be introduced with the 2008 budget; procurement procedures being reviewed.

---

### Appendix I: Medium-Term Outlook Under Alternative Assumptions and Debt Sustainability

### I. Alternative Scenarios (summary)
- Scenario A — Tightening of global liquidity conditions:
  - Shock: Widening of bond spreads and a net outflow of portfolio capital of around US$10 billion during 2008.
  - Policy response: BI assumed to increase the policy rate by around 300bps relative to the baseline.
  - Projections: Reserves decline to around 150 percent of short-term debt in 2008; exchange rate depreciates by about 15 percent; GDP growth declines to 4.8 percent; inflation rises to 7 percent; current account surplus higher than baseline.

- Scenario B — Lack of progress on structural agenda:
  - Policy response: Authorities assumed to relax fiscal and monetary policies to support growth.
  - Projections: Output growth gradually falls back to 5.0 percent over the medium term; overall central government deficit increases to 3.2 percent of GDP in 2008; public debt ratio still declines; interest rates lower than baseline; inflation increases to a little under 7 percent (outside BI’s target range for 2008).

- Scenario C — Global growth slowdown:
  - Shock: Global economic growth declines by just over 2 percentage points relative to baseline in 2008; oil and other commodity prices decline; value and volume of Indonesian exports decline; spreads increase modestly.
  - Policy response: Interest rates unchanged relative to baseline.
  - Projections: GDP growth reduced by lower exports and domestic multiplier effects; with exchange rate depreciation, inflation around 6.3 percent (outside BI’s target range for 2008); current account surplus narrows; reserves accumulation slows.

### II. Debt Sustainability Analysis Under the Baseline

A. Public Debt
- Historical decline: Public sector debt ratio declined from 65 percent of GDP at end-2002 to an estimated 39 percent at end-2006.
  - Drivers: Fiscal consolidation, declining interest rates, and growth in real GDP.
  - Share of debt held by foreign creditors declined to less than 50 percent.
- Baseline projection: Public sector debt expected to decline to around 26 percent of GDP by 2012.
  - Underlying assumptions for 2007-12 baseline:
    1. Real GDP growth rebounds to 6-7 percent.
    2. Primary surplus averages around 0.2 percent of GDP.
    3. Average nominal interest rates on public debt gradually decline to around 3 percent by the end of the period.
- Sensitivity analysis:
  - A one-time 30 percent real depreciation of the exchange rate or a 10 percent increase in contingent liabilities immediately raises the debt ratio by around 10 percentage points of GDP, with the impact falling to 7–8 percentage points by 2012.
  - Other macroeconomic shocks have a more limited impact.

B. External Debt
- (Content on external debt begins after this point in the source; available text ends here.)

*Source: IMF staff compilation from the provided PDF content.*

### 4.      Indonesia’s external debt has also declined steadily since the crisis, from over 150

### _cr07272 - 4.      Indonesia’s external debt has also declined steadily since the crisis, from over 150

### External debt trends and historical levels
- External debt declined from "over 150 percent of GDP in 1998" to "around 37 percent in 2006".
- External debt as a percentage of exports declined from "288 percent" in 1998 to "116 percent" in 2006.
- External debt projections (external debt in percent of GDP, Table 2 projections):
  - 2006: "36.6"
  - 2007: "31.2"
  - 2008: "28.6"
  - 2009: "26.2"
  - 2010: "23.9"
  - 2011: "21.5"
  - 2012: "19.3"
- External debt-to-exports ratio (in percent):
  - 2002: "200.1"
  - 2003: "195.8"
  - 2004: "166.0"
  - 2005: "134.0"
  - 2006: "116.0"
  - 2007: "104.5"
  - 2008: "98.5"
  - 2009: "92.4"
  - 2010: "85.0"
  - 2011: "78.4"
  - 2012: "71.5"

### Baseline sustainability assessment and drivers
- Under the baseline scenario, external debt dynamics are sustainable, with the debt-to-GDP ratio declining to "less than 20 percent by 2012".
- Main factors driving favorable dynamics:
  - "(1) real GDP growth projected to increase to 6-7 percent over the medium term;"
  - "(2) a projected positive growth- interest rate differential;"
  - "(3) an expected increase in non-debt-creating capital inflows."
- Public sector debt (gross central government debt) projections (Table 1, public sector debt in percent of GDP):
  - 2006: "38.6"
  - 2007: "35.7"
  - 2008: "33.9"
  - 2009: "31.9"
  - 2010: "30.0"
  - 2011: "28.1"
  - 2012: "26.1"
- Key macroeconomic and fiscal baseline assumptions (selected):
  - Real GDP growth (in percent): 2006 "5.5", 2007 "6.0", 2008 "6.3", 2009 "6.5", 2010 "6.7", 2011 "6.7", 2012 "6.7".
  - Primary deficit (percent of GDP): 2006 "-1.4", 2007 "-0.5", 2008 "0.0", 2009 "-0.1", 2010 "-0.2", 2011 "-0.2", 2012 "-0.3".
  - Gross external financing need (in billions of US dollars): 2006 "18.9", 2007 "14.9", 2008 "17.9", 2009 "21.8", 2010 "26.8", 2011 "33.5", 2012 "41.8".
  - Net non-debt creating capital inflows (negative, percent of GDP): 2006 "-0.8", 2007 "-1.0", 2008 "-1.1", 2009 "-1.1", 2010 "-1.2", 2011 "-1.3", 2012 "-1.4".
  - Net foreign direct investment, equity (percent of GDP): 2006 "0.8", 2007 "0.5", 2008 "0.5", 2009 "0.6", 2010 "0.6", 2011 "0.8", 2012 "0.9".

### Vulnerabilities: stress tests and shocks
- External debt sustainability is most vulnerable to exchange rate shocks:
  - "A one-time 30 percent real exchange rate depreciation would raise the debt ratio by around 20 percentage points in 2007, with the impact declining to around 15 percentage points over the baseline by 2012."
- Bound-test and scenario results for external debt (selected outcomes, Table 2 and figures):
  - Historical scenario vs baseline external debt levels (in percent of GDP): Historical "0" baseline "19" (chart labels indicate baseline external debt around "19" percent in projections).
  - Combined shock (permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account) shows elevated external debt levels relative to baseline (figures indicate combined shock values above baseline; table B4 shows combined shock external debt projections: 2006 "32.7", 2007 "31.5", 2008 "30.5", 2009 "29.3", 2010 "28.0", 2011 "26.5").
  - One-time 30 percent real depreciation in 2006 (B5): external debt projections in percent of GDP: 2006 "51.4", 2007 "48.6", 2008 "45.8", 2009 "42.4", 2010 "38.5", 2011 "34.2".
  - Ten-year stress-test scenarios (selected):
    - B1 (nominal interest rate at baseline plus one-half standard deviation): external debt projections include 2006 "31.4", 2007 "29.0", 2008 "26.8", 2009 "24.5", 2010 "22.3", 2011 "20.1".
    - B2 (real GDP growth at baseline minus one-half standard deviation): 2006 "32.2", 2007 "30.5", 2008 "29.0", 2009 "27.3", 2010 "25.4", 2011 "23.3".
    - B3 (non-interest current account at baseline minus one-half standard deviations): 2006 "33.1", 2007 "32.1", 2008 "31.4", 2009 "30.5", 2010 "29.6", 2011 "28.7".
    - B5 (one-time 30 percent real depreciation in 2006) increases external debt sharply to "51.4" in 2006 and remains elevated through 2011 ("34.2").
- Automatic debt dynamics and contributors (Table 2, selected entries):
  - Automatic debt dynamics (percent of GDP contribution): 2006 "-8.6", 2007 "-3.5", 2008 "-2.0", 2009 "-1.7", 2010 "-1.5", 2011 "-1.4", 2012 "-1.3".
  - Contribution from nominal interest rate: 2006 "1.3", 2007 "1.1", 2008 "1.0", 2009 "0.9", 2010 "0.8", 2011 "0.7", 2012 "0.7".
  - Contribution from real GDP growth: 2006 "-2.0", 2007 "-1.9", 2008 "-1.8", 2009 "-1.7", 2010 "-1.6", 2011 "-1.5", 2012 "-1.3".
  - Contribution from price and exchange rate changes: 2006 "-7.9", 2007 "-2.8", 2008 "-1.2", 2009 "-0.9", 2010 "-0.7", 2011 "-0.7", 2012 "-0.6".

### Public sector debt dynamics (selected metrics)
- Public sector debt-to-GDP (Table 1 actuals and projections):
  - 2002: "65.4"
  - 2003: "58.3"
  - 2004: "55.2"
  - 2005: "45.6"
  - 2006: "38.6"
  - 2007: "35.7"
  - 2008: "33.9"
  - 2009: "31.9"
  - 2010: "30.0"
  - 2011: "28.1"
  - 2012: "26.1"
- Foreign-currency denominated share of public sector debt (percent of GDP, selected):
  - 2002: "29.8"
  - 2003: "27.6"
  - 2004: "28.1"
  - 2005: "23.3"
  - 2006: "17.8"
  - 2007: "16.5"
  - 2008: "14.8"
  - 2009: "13.1"
  - 2010: "11.5"
  - 2011: "10.2"
  - 2012: "9.2"
- Change in public sector debt (percent of GDP): 2006 "-7.0", 2007 "-2.9", 2008 "-1.8", 2009 "-2.0", 2010 "-1.9", 2011 "-1.9", 2012 "-2.0".
- Debt-stabilizing primary balance (Table 1 entries indicate implied balances; for baseline public sector debt the table reports "Debt-stabilizing primary balance 9/": baseline public sector debt and related entries are provided in Table 1).

### Additional projection details and data notes
- Gross financing need definitions and levels:
  - Gross financing need (percent of GDP) (Table 1): 2006 "3.4", 2007 "4.0", 2008 "3.9", 2009 "3.4", 2010 "2.8", 2011 "2.3", 2012 "1.7".
  - Gross financing need (in billions of U.S. dollars): 2006 "0.0" (table lists zeros for years 2002–2012 in the extract provided).
- Key assumptions and definitions are stated in footnotes:
  - Exchange rate shock definition: "One-time real depreciation of 30 percent occurs in 2007" (figures and footnotes also reference 2006 in some tables).
  - Formulas for automatic debt dynamics and contributions are provided in footnotes (see footnotes 1–6 in tables).
- Data sources cited in the text and figures: "CEIC Database and Fund staff estimates"; "International Monetary Fund, Country desk data, and staff estimates."

*INTERNATIONAL MONETARY FUND — Staff report for the 2007 Article IV Consultation — Informational Annexes; Prepared by Asia and Pacific Department; June 26, 2007*

### ANNEX I. INDONESIA: FUND RELATIONS

### ANNEX I. INDONESIA: FUND RELATIONS (As of May 31, 2007)

### I. Membership
- Status: Joined February 21, 1967; Article VIII

### II. General Resources Account
- SDR Millions / Percent of Quota
  - Quota                                                                                          2,079.30100.00
  - Fund holdings of currency 1933.8093.00
  - Reserve position in Fund 145.507.00

### III. SDR Department
- SDR Millions / Percent of Allocation
  - Net cumulative allocation 238.96100.00
  - Holdings    9.053.79

### IV. Outstanding Purchases and Loans
- None

### V. Financial Arrangements
- Type — Approval Date — Expiration Date — Amount Approved (SDR Millions) — Amount Drawn (SDR Millions)
  - EFF Feb. 04, 2000 Dec. 31, 2003 3,638.00 3,638.00 
  - EFF Aug. 25, 1998 Feb. 04, 2000 5,383.10 3,797.70 
  - Stand-by Nov. 05, 1997 Aug. 25, 1998 8,338.24 3,669.12

### VI. Projected Payments to Fund (expectations basis)
- (SDR Millions; based on existing use of resources and present holdings of SDRs)
  - Forthcoming 2007 2008 2009 2010 2011 — Principal
  - Charges/Interest                                      4.93
  - 9.819.80         9.81         9.81
  - Total 4.939.819.80 9.81 9.81

### VII. Exchange Arrangements
- The rupiah has floated since August 14, 1997.
- The market exchange rate was Rp 9,080 per U.S. dollar on June 26, 2007.
- Indonesia has accepted the obligations of Article VIII, Sections 2, 3, and 4, and maintains an exchange system free of restrictions on payments and transfers for current international transactions.

### VIII. Article IV Consultation
- The last Article IV consultation report (IMF Country Report No. 06/319) was discussed by the Executive Board on July 31, 2006.

---

### World Bank Relations (Annex II — selected highlights as of June 18, 2007)
- CAS and strategic focus
  - The World Bank’s CAS for Indonesia was extended by one year to FY08 (from July 2007 to June 2008) to coincide with Indonesia’s scheduled graduation from IDA funding.
  - CAS addresses: (i) a weak investment climate and (ii) the lack of quality service delivery to the poor; governance is the overarching focus.
  - Greater emphasis on natural disaster management within the CAS; recalibration toward more program lending (Development Policy Lending and Infrastructure DPL) is supported.
- Engagement highlights: improving investment climate
  - DPL program, targeted projects, large AAA program, and IFC interventions support policy and institutional reforms for higher growth.
  - Actions include enhanced financial sector competitiveness, streamlined business start-up/trade/customs procedures, improved tax administration, SME promotion, and infrastructure dialogue including PPP and NBFI strategy.
- Making service delivery responsive to the poor
  - Support for education (ECD to tertiary), development of RENSTRA, Provincial Health Projects (PHPs), CDD approaches in WSS, GEG program, PNPM, Conditional Cash Transfer Program.
  - DPL program includes a new policy pillar supporting teacher certification, program assessments, and multi-year coverage of community spending.
- Governance
  - Governance positioned at core of Bank work; DPL/GFMRAP designed to improve public administration and public financial management.
  - Use of Public Expenditure Reviews, trust-funded programs for corruption prevention and civil service reform, and a CDD portfolio.
  - Multi-donor Decentralization Support Facility (DSF) to improve decentralization and donor effectiveness.
- Program for the Recovery of Aceh and Nias
  - Bank mobilized an Aceh reconstruction program: Bank grant resources US$25 million from IBRD net income leveraged to mobilize significant donor support.
  - Bank has mobilized over US$660 million (commitment) for reconstruction, including the Multi-Donor Fund (MDF) with 15 donors (in the amount of some US$547 million in grants).
  - Multi-donor Java Reconstruction Fund (JRF) established at government request, primarily supporting housing reconstruction with total value of pledge US$79 million.
  - Disaster Management is an important component of the Bank’s country strategy.
- New Lending Operations (as of March 2007)
  - Active portfolio: 31 projects with a total net commitment of US$2.6 billion.
  - In FY07, 6 projects likely to be delivered with total lending volume at US$1.2 billion.
  - A third Development Policy Loan (DPL3) was approved for a loan amount of US$600 million in December 2006 (financial support from Japan and AsDB).
  - Other FY07 approvals include Strategic Roads Infrastructure (US$208 million), FEATA (US$92 million), KDP additional financing (US$123 million), UPP additional financing (US$136 million), Better Employment and Redeployment (BERMUTU)(US$86 million), 5 Aceh and Nias MDF projects (US$197 million), and 3 projects under JRF (US$67 million).
- Analytic and Advisory Activities (AAA)
  - AAA organized around five “breakthrough” themes: (1) investment climate, (2) reducing poverty, (3) improving decentralized service delivery, (4) improving governance, and (5) progress and constraints in the recovery of Aceh and Nias.
  - In FY07, as of end-April, 7 reports were delivered and more expected by end of June (including Poverty Assessment, Public Expenditure Reviews and NBFI Study).

### Asian Development Bank Relations (Annex III — as of June 20, 2007)
- Cumulative and 2006 activity
  - Asian Development Bank (ADB) cumulative loans to Indonesia exceeded $21.5 billion at end-December 2006.
  - In 2006, the ADB approved a total of $784.8 million or 10.2 percent of the total loans approved by the institution for the year.
  - Financing covered programs to strengthen macroeconomic management, governance, investment climate, and accelerate infrastructure development; project loans included aquaculture, madrasah education, infrastructure project development facility, and a $75 million loan through ADB’s private sector window for the South Sumatra to West Java (SSWJ) Phase II Gas Pipeline project (part of a larger $652.5 million project).
  - ADB arranged a $125 million B loan from commercial lenders for the SSWJ Project.
  - ADB approved a $10 million grant to Indonesia following the Central Java and Yogyakarta earthquake.
  - ADB supported post-tsunami reconstruction in Aceh and Nias through Earthquake and Tsunami Emergency Support Project (grant-financed).
- Country Strategy and Program (CSP) 2006–09
  - CSP aims: higher pro-poor sustainable growth and enhanced social development; key thematic focus on governance and capacity development.
  - Five engagement areas: improved infrastructure and services, deepened financial sector, improved decentralization, accelerated MDG achievement, strengthened environment and natural resources management.
- Technical Assistance (TA)
  - Between 1967 and 2006, ADB provided 484 Technical Assistance grants to Indonesia amounting to $247.5 million (8.2 percent of the total number of TA grants approved during this period).
  - In 2006, seven TA grants amounting to $7.1 million were approved, representing 2.9 percent of total TA grants approved by ADB during the year.
- Loan approvals and disbursements (table data as presented)
  - Loan approvals      1997      1998 1999 2000 2001 2002 2003      2004          2005 2006
    - 1,108.8  1,836.01,020.0800.0500.0767.2261.6 225.0    1,145.69784.8
  - Loan disbursement
    - 676.6  1,079.01,329.4748.4686.01,000.5442.9 593.5    1,014.99    1,025.88
- Cumulative lending by sector (as of December 31, 2006)
  - Social infrastructure: 41 loans, 3,225.415.0
  - Agriculture and natural resources: 101 loans, 4,189.919.5
  - Energy: 32 loans, 3,856.117.9
  - Transport and communication: 33 loans, 2,713.912.6
  - Finance: 17 loans, 3,261.115.2
  - Multisector: 35 loans, 2,372.111.0
  - Industry: 14 loans, 665.73.1
  - Others: 8 loans, 1,229.25.7
  - Total: 285 loans, 21,513.3100.0

### Statistical Issues (Annex IV)
- SDDS subscription and observance
  - Indonesia has been a subscriber to the Special Data Dissemination Standard (SDDS) since September 1996, observing most of the SDDS requirements.
  - Exceptions include the currency composition in the reserve template in the first quarter of 2007, 2005 general government operation data, and timeliness in the production index data due to short delays.
  - Indonesia’s macroeconomic statistics and statistical base are broadly adequate to conduct effective surveillance.
- Real sector data issues and staff recommendations
  - Annual national accounts data are based on a 2000 base year.
  - Quarterly GDP data published timely for both expenditure and production sides, but estimates rely on a limited set of indirect indicators of uncertain quality.
  - Seasonally adjusted data are prepared but not published; no survey of nonfinancial services is conducted.
  - Economic census undertaken every 10 years, not updated in intervening periods; household budget survey does not cover higher income households.
  - There are inconsistencies with Bank Indonesia (BI) in imports and exports; and possibly with the Ministry of Finance (MoF) regarding local government figures.
  - The five-yearly input-output tables remove the statistical discrepancy, but there are large discrepancies in intervening years.
  - Staff recommended:
    - (i) development of a system to continuously update the census of businesses;
    - (ii) introduction of comprehensive annual establishment surveys for nonfinancial services industries;
    - (iii) publication of annual GDP estimates, including a time series of at least 20 years;
    - (iv) development of a set of annual supply and use tables (SUTS) starting from 2000;
    - (v) expedited conversion to the 1993 System of National Accounts; and
    - (vi) enhancing the convergence exercise on trade data with BI.
- Labor market data
  - Labor market data, including wages and employment, are available (with some delay) through the annual labor market survey (Sakernas) published by the Bureau of Statistics.
  - Data also available on minimum and maximum wages for the formal sector; quarterly industrial wages available with some delay.
- Public finance data
  - Government finance data suffer from weaknesses in classification, coverage, and timeliness.
  - Central government data were available until recently with a one-month lag; subnational government data available only with a lag of two years, with variable quality.
  - Decentralization has shifted substantial resources to subnational governments, compounding budget and accounting system problems.
  - Significant reforms are underway, including planned adoption of advanced accounting and statistical standards, introduction of best practice budget management processes, and development of computerized financial management information systems.

*Source: ANNEX I. INDONESIA: FUND RELATIONS (As of May 31, 2007) and subsequent annexes included in the supplied content.*

### 5.      Against this background, the MoF and the Ministry of Home Affairs are committed to

### _cr07272 - 5.      Against this background, the MoF and the Ministry of Home Affairs are committed to

### Fiscal statistics and public-sector accounting
- Authorities committed to keeping fiscal statistics requirements at the forefront of ongoing fiscal reforms to make better statistical monitoring a deliverable of current efforts.
- One-month reporting lag for central government lengthened significantly, but temporarily, in the course of 2007 as a new treasury system was put in place; this should reverse as the reform is fully implemented.
- Coverage and timeliness of public debt statistics is generally adequate; however, only limited information on contingent liabilities is available.
- New expenditure classification introduced in the 2005 budget is generally consistent with the Government Finance Statistics Manual 2001 (GFSM 2001) on functional codes and classification, although the data are compiled on a cash basis.
- Authorities have committed to full adoption of the GFSM 2001 standards.

Short-term Fund staff recommendations:
- Establishment of a register of all extrabudgetary units to improve the coverage of central government activity.
- Inclusion of the economic codes consistent with the GFSM 2001 in the chart of account to ensure that general government units report in a statistically meaningful way all transactions and balances over which they exert control.

Medium-term priorities:
- Seize the opportunity offered by the two new subnational fiscal reform efforts3 to simultaneously establish the underlying reporting arrangements to obtain timely preliminary data for local government statistics.
- Develop GFSM 2001 operating statements, statements of sources and uses of cash, and partial balance sheets, all of which should be published on the MoF websites to facilitate the adoption of a full accrual accounting basis for all budget transactions.

### Monetary accounts and monetary statistics
- Good quality monetary statistics are compiled by the BI on a timely basis.
- With STA assistance, BI developed an integrated database from which alternative presentations of monetary statistics can be drawn to meet the needs of BI and the Fund.
- Coverage expansion needed to include mutual funds (REKSA DANA), which report data to BAPEPAM—an agency that supervises some nonbank financial institutions.
- BI is developing institutional data-sharing arrangements to access the register of—and data on—mutual funds.

STA recommendations to strengthen monetary statistics:
- Collection of source data on mutual funds in a format that meets statistical requirements.
- Expansion of the coverage of the monetary statistics to include mutual funds.
- Harmonization of the reported interbank positions between the BI and commercial banks.

### Balance of payments statistics
- Trade data are affected by shortcomings: customs sources are generally reliable, but coverage of merchandise trade flows is insufficient.
- When the online reporting system for exports and imports was introduced in 2004, the historical series were reconstructed only as far back as 2003; therefore, prior to 2003, balance of payments statistics are not entirely consistent with the national accounts estimates.
- Data on services suffer from outdated surveys and weak methodologies.
- BI adjusts customs data to cover exports and imports of Batam and other bonded zones.
- Adjustments are also made to data on compensation of employees and workers remittances to cover professional workers, legal workers not reported to the Ministry of Manpower, and illegal workers.

Capital and financial account weaknesses:
- Methodological basis for FDI compilation needs substantial improvement.
- Inflows currently calculated based on loan disbursements to companies with foreign equity and application of a fixed ratio to loan disbursements data to estimate equity inflows.
- BI surveys to collect FDI data have a low response rate; the directory of enterprises requires enhancement in coverage.
- Recording of trade credits and assets data for portfolio investment and other investment transactions need improvement.
- Errors and omissions item has been significant and appears related to methodology used for unrecorded assets in the financial account.
- Financial transactions data have not been reconciled with changes in the International Investment Position (IIP).

BI measures planned or proposed:
- Established a working group to reconcile differences between BI and customs data.
- Planning to collect and publish data on goods imported for processing, goods procured in ports by carriers, and transactions with the oil and gas sector.
- Planning to collect and publish data on direct investment abroad, portfolio investment assets, other investment assets, and trade credits.

### International Investment Position and external debt statistics
- An annual IIP is compiled, but underlying data are weak in several areas, notably for FDI.
- External debt statistics improved considerably with the introduction of an External Debt Information System (EDIS) in 2002.
- EDIS records external debt of government and over 800 other entities that report to the BI on a monthly basis.
- Data generated for public sector external debt and debt service, as well as those for private banks, are considered reliable.
- Improvements still needed for private corporate sector data, particularly:
  - Distinguishing between scheduled and actual debt service.
  - Estimating the accumulation/reduction of private sector payments arrears.
  - Estimating rescheduling and debt reductions received by the private sector from external creditors.

### Table of Common Indicators Required for Surveillance (As of June 19, 2007) — selected entries and frequency/quality notes
- Exchange Rates: Date of latest observation 6/19/07; Date received 6/19/07; Frequency of Data D; Frequency of Reporting D; Frequency of publication W/M.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation 6/18/07; Date received 6/19/07; Frequency of Data D; Frequency of Reporting D; Frequency of publication W/M.
- Reserve/Base Money: Date of latest observation 6/14/07; Date received 6/15/07; Frequency of Data D; Frequency of Reporting D; Frequency of publication W/M.
- Broad Money: Date of latest observation 4/07; Date received 6/07; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- Central Bank Balance Sheet: Date of latest observation 4/07; Date received 6/07; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- Consolidated Balance Sheet of the Banking System: Date of latest observation 4/07; Date received 6/07; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- Consumer Price Index: Date of latest observation 5/07; Date received 6/07; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of latest observation 3/07; Date received 5/07; Frequency of Data M; Frequency of Reporting M; Frequency of publication ...
- External Current Account Balance: Date of latest observation 1/07; Date received 6/07; Frequency of Data Q; Frequency of Reporting Q; Frequency of publication Q.
- Exports and Imports of Goods and Services: Date of latest observation 05/07; Date received 6/07; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
- GDP/GNP: Date of latest observation 2007Q1; Date received 6/07; Frequency of Data Q; Frequency of Reporting Q; Frequency of publication Q.
- Gross External Debt: Date of latest observation 2007Q1; Date received 3/06; Frequency of Data Q; Frequency of Reporting Q; Frequency of publication A.

Quality assessment footnotes (as provided):
- Footnote 7: Reflects the assessment provided in the data ROSC (published on July 28, 2005, and based on the findings of the mission that took place during March 28-April 11, 2005) for the dataset corresponding to the variable in each row. Assessment codes: O (fully observed); LO (largely observed); LNO (largely not observed); NO (not observed); NA (not available).
- Footnote 8: Same as footnote 7, except referring to international standards concerning source data, assessment of source data, statistical techniques, assessment and validation of intermediate data and statistical outputs, and revision studies.

### IMF Staff Representative statement (July 18, 2007) — key updates
- Inflation: CPI inflation declined to 5.8 percent y/y in June (compared with 6.0 percent in May). Core inflation eased to 5.4 percent.
- Monetary policy: Bank Indonesia cut its policy interest rate by another 25 bps to 8.25 percent at its July 5 Board meeting.
- Growth indicators: Latest short-term indicators suggest expansion at an annual rate of about 6 percent, in line with staff projections.
- Trade: Exports continue to perform well; trade surplus narrowed slightly as a result of rising imports in recent months, in particular non-oil and gas exports.
- Exchange rate and capital flows:
  - Rupiah weakened in June to about 9,000 Rp/US$, reversing some appreciation observed in May.
  - Strong portfolio inflows during April/May subsided in June; foreign investors reduced positions in fixed income securities while moderate inflows into the stock market continued; the stock market continues to reach new highs.
- Poverty: Latest estimate indicates a decline to 16.6 percent as of March 2007 (compared to 17.8 percent in March 2006); rate remains higher than in 2005 (16.0 percent).
- Fiscal structural reforms:
  - Parliament passed on June 19 amendments to the Law on General Tax Rules and Procedure; amended law will take effect as of 1 January 2008 and improves legal certainty and balance between taxpayers’ rights and tax agency’s powers, making the appeal process less onerous to the taxpayer.
  - Two more tax law amendments (VAT and income tax) are scheduled for deliberation by Parliament during the remainder of the year and are expected to also take effect by 2008.

*Source: IMF staff report content provided in the supplied PDF extract.*

### 6.      The government is in the process of finalizing a set of implementing regulations

### 6.      The government is in the process of finalizing a set of implementing regulations

### Status of implementing regulations and investment framework
- The government is finalizing a set of implementing regulations for the investment law.
- A negative list relating to foreign investment has already been issued.
- The negative list:
  - "retains a broadly open investment regime and clarifies existing ownership limits, which were previously opaque."
  - Leaves "the vast majority of business sectors" open or "even more so" than previously.
  - Limits foreign ownership in "only a handful of sectors" to lower levels.
- Reaction and government outreach:
  - The negative list "has raised some concerns in the foreign business community."
  - "In recent days the authorities have been meeting with concerned investors to explain the rationale for the list, and to address concerns about how it will be applied."

### Relevant macroeconomic context and indicators cited in the document
- Growth and inflation:
  - Economic growth reached 5½ percent in 2006.
  - Staff projects growth at 6 percent in 2007.
  - Inflation "has stabilized at around 6 percent."
  - Bank Indonesia (BI) has "lower[ed] its policy rate more than 400 basis points since May 2006."
  - Inflation rate remains on track to end 2007 inside its target range of 5–7 percent.
- Labor and poverty:
  - "The official unemployment rate dipped below 10 percent in 2007."
  - Poverty rate fell back to 16.6 percent in March 2007, having increased to 17.8 percent a year earlier.
- External balance and fiscal position:
  - The external current account surplus is projected to decline "from 2¾ percent of GDP to 2 percent in 2007."
  - The central government deficit increased modestly to 1.0 percent of GDP in 2006.
  - For 2007, staff projects a deficit at "about 1.8 percent of GDP."

### Executive Board policy observations and recommendations relevant to investment climate and implementation
- On exchange rate and capital flows:
  - Directors emphasized that possible future surges in inflows should be addressed through:
    - "allowing further rupiah appreciation,"
    - "intervention to limit excessive exchange rate movements," and
    - "additional interest rate cuts, provided that exchange rate appreciation improves the inflation outlook."
  - Directors welcomed "a modest further increase in reserves."
- On structural and regulatory reforms:
  - Directors endorsed the flexible exchange rate policy and the current macroeconomic policy mix, while underscoring "continued focus on structural reforms" to enhance external competitiveness.
  - Directors "commended the authorities on the passage of the investment law" and encouraged the authorities to:
    - "focus on increased infrastructure spending, both through direct budget spending to the extent possible and by facilitating public-private partnerships in infrastructure,"
    - "alleviate the burden of severance payments on employment generation."
- On financial sector policy and prudential standards:
  - Directors commended BI for its cautious monetary stance but cautioned:
    - Recent relaxation in prudential regulations to encourage lending "could risk sending an adverse signal to supervisors and banks alike" and they "encouraged BI to reconsider the measures as soon as possible."
    - They warned that "moral suasion to encourage banks to lend to specific sectors could result in credit misallocation."
    - Recommended steps to "promote the development of capital markets and longer-term financing instruments" and called for "a strategy on the future role of state banks."
    - Encouraged the authorities to undertake a Financial Sector Assessment Program.
- On fiscal policy:
  - Directors "supported the authorities’ fiscal stance" and considered the modest relaxation in deficit targets for 2007 and 2008 appropriate to allow additional development spending.
  - Directors cautioned that authorities "should not go beyond the deficit levels currently envisaged for 2007–08" because of potential negative consequences of higher debt financing.
  - Recommended further measures including "improvements in tax administration, some new tax measures, and the streamlining of expenditures, including through greater flexibility of energy prices," and strengthening "the implementation capacity of local government."

*Source: Public Information Notice (PIN) No. 07/91 — IMF Executive Board Concludes 2007 Article IV Consultation with Indonesia (July 31, 2007).*

### 5.8 percent in June 2007. In the external side, a robust growth in exports, together with large

### 5.8 percent in June 2007. In the external side, a robust growth in exports, together with large

### External position and outlook
- Exports grew robustly and there was a large surge of capital inflows that:
  - significantly improved the surplus of the balance of payments,
  - strengthened the Rupiah,
  - bolstered international reserves.
- Remaining debt to the IMF totaled US$7.6 billion in June and October 2006; authorities expedited servicing, resulting in Indonesia's early completion of its Post-Program Monitoring.
- At the end of June 2007, international reserves reached US$50.9 billion.
- For 2007, projections:
  - current account surplus projected at US$8.9 billion,
  - financial account surpluses projected at US$4.9 billion,
  - overall balance of position projected to record a surplus of US$13.4 billion,
  - increase in international reserves projected to US$56.2 billion.
- Exchange rate outlook and risks:
  - Rupiah exchange rate expected to remain stable and appropriate relative to fundamentals.
  - Authorities recognize risks from external shocks (capital account shock, global growth slowdown) and from reversals of short-term portfolio flows under fully free capital mobility.
  - Recommended mitigations include intervention to limit excessive exchange rate movements, allowing further Rupiah appreciation, and appropriate adjustments in interest rate.
- Growth and macro outlook:
  - Annual GDP growth projected to achieve 6.3 percent in 2007.
  - Growth expected around 6.7 percent in 2008.
  - Unemployment expected to decline to 8-9 percent in 2008.
  - Poverty expected in the range of 15-16.8 percent in 2008.
  - Inflation forecasts:
    - 2007: within target range of 6±1 percent,
    - 2008: within target range of 5±1 percent.
- Overall expectation: expanding balance of payments surplus, increasing international reserves, and stable Rupiah to underpin stronger and more balanced economic growth in 2007 and 2008.

### Fiscal policies and reforms
- Fiscal stance:
  - Fiscal policy designed to support higher growth while ensuring fiscal sustainability.
  - Expenditure focus on health, education, infrastructure, energy projects, and natural disaster mitigation.
- 2007 budget revisions:
  - Central government deficit revised from initial target of 1.1 percent to 1.6 percent of GDP for 2007.
  - Budget deficit financed by domestic sources, mainly through bond issuance; foreign sources expected from program loans.
  - Public debt to GDP ratio expected to decline further to around 36 percent by end-2007.
- 2008 budget:
  - Expected deficit around 1.7 percent of GDP, consistent with declining public debt path and growth target of 6.7 percent.
- Revenue and tax administration reforms:
  - Commitments to strengthen tax administration, improve tax services, and modernize supporting functions.
  - Simplification of procedures and facilities for exports and imports, and harmonizing import duty tariffs.
  - Deliberations over the tax reform package expected to be concluded by the parliament by the end of this year.
  - General Administrative Rules for Taxation recently passed by parliament.
  - Income Tax and Value Added Tax for Goods and Services, and Sales Tax on Luxury Items bills under parliamentary review.
  - Approved bill designed to balance taxpayer rights and tax authority powers; revised law provides mechanisms for appeals and suspends obligation to pay disputed taxes until court ruling.
- Expenditure-side and budget execution:
  - Progress in addressing budget execution obstacles via streamlined procedures and improved capacity of local government.
- Public financial management reforms:
  - Publication of ROSCs - Fiscal Transparency Module for Indonesia in September 2006.
  - Pursuit of cash management reform by implementing a Treasury Single Account (TSA).
  - Budget reform via unified budget since 2005.
  - Establishing Medium Term Expenditure Framework (MTEF), improving revenue projections, and forward estimates of government expenditures and transfers to local government.
- Governance and bureaucracy reforms:
  - Government Regulation Number 8/2006 on Government Agencies' Performance and Financial Reporting.
  - Law Number 7/2006 ratifying UN Convention Against Corruption, 2003.
  - Bureaucracy reform focused on improving public service at the Ministry of Finance (including Tax Office, Custom Office, Treasury Office) and designing a remuneration system consistent with level, risk and competency.
  - Establishment of Risk Management Unit in the Ministry of Finance.

### Monetary and exchange rate policies
- Monetary policy framework:
  - Bank Indonesia (BI) committed to achieving medium-term inflation target of low inflation under an inflation targeting framework.
  - Inflation targets:
    - 2007: 6±1 percent,
    - 2008: 5±1 percent.
  - BI sets interest rate policy in line with underlying macroeconomic conditions to maintain price stability.
- Operational improvements:
  - Strengthening monetary policy operational framework and infrastructure to enhance effectiveness of open market operations.
  - Efforts to enrich monetary instruments and improve liquidity forecasting and management.
  - Progress toward implementing Treasury Single Account (TSA) to facilitate central bank liquidity management.
- Communication and transparency:
  - Continued policy communication via press releases, monthly, quarterly and annual economic reports, and outreach programs.
  - Improvements in the Monetary Policy Report, including more forward-looking discussion and more detailed treatment of risks; publication of quantitative inflation forecasts under consideration.
- Coordination:
  - Strengthened coordination between monetary and fiscal policy, including a joint team for monitoring and controlling inflation.
- Exchange rate policy:
  - Authorities committed to a flexible exchange rate regime; movements mainly determined by market mechanisms.
  - Interventions confined to smoothing abrupt movements without targeting a specific exchange rate level.
  - Adequate accumulation of international reserves viewed as necessary to safeguard external stability and reduce vulnerability to "hot money" outflows.

### Structural reforms and investment climate
- Investment law and policy package:
  - Parliamentary approval of the Investment Law in March 2007.
  - Key features: equal legal status for local and international investors, strengthened investor protection and property rights, simplified immigration procedures, dispute resolution using international laws, and tax incentives.
  - Recent policy package addresses investment climate, acceleration of infrastructure development, empowerment of SMEs, and financial sector development.
- Investment climate measures:
  - Simplification of procedures for granting investment approval and establishing a new company.
  - Revocation of unfriendly regional regulations.
  - Strengthening investment service institutions, synchronizing regional and central regulations, improving custom and tax services, and protecting taxpayer rights.
  - Plans to introduce tax incentives for listed companies to boost domestic capital market.
- Infrastructure acceleration:
  - Focus on regulatory reform, institutional developments (including establishment of a non-bank financial institution for infrastructure), and improvement in management of infrastructure development.
  - Measures to accelerate land acquisition process for public infrastructure.
- SME empowerment:
  - Objectives: enhance SME productivity by improving access to financial resources, developing entrepreneurship and human resources, and promoting markets for SMEs.
- Labor reform:
  - Consideration of a new scheme transferring severance payment obligations to pension funds to reduce costs for employers and compromise between employers' and workers' interests.

### Financial sector development and reforms
- Banking sector performance and indicators:
  - Banks remained well capitalized and profitable; capital adequacy ratio rose to over 20 percent.
  - Net interest margin remained at about 0.5 percent.
  - Non-performing loans around 6.6 percent of credit outstanding.
  - Lending growth:
    - Loans outstanding increased by 14.1 percent in 2006,
    - Accelerated to 15.8 percent (y.o.y) for the first five months of 2007,
    - Compared to growths of 24.7 percent and 22.7 percent in 2004 and 2005, respectively.
- Credit slowdown diagnosis:
  - Authorities view credit slowdown as involving both supply and demand factors.
  - Demand-side factors include lack of demand associated with overall investment condition and financing needs from creditworthy borrowers.
  - Substitution effect: businesses seeking non-bank financing indicated by increased new IPOs and new corporate bond issuance.
  - Supply-side responses include encouraging lending from banks with strong risk management while retaining prudential practices.
- Banking consolidation and supervision:
  - Measures to reinforce banking industry consolidation under the Indonesian Banking Architecture: incentives for merger and consolidation, new regulation on corporate governance of banks, and bank risk-management certification.
  - Implementation progress on Basel II via risk-based supervision.
- Infrastructure improvements:
  - Operationalization of the Credit Information Bureau covering borrowers of commercial banks, credit unions, and non-bank financial institutions; staff suggested inclusion of utility companies though creation of a reliable unified consumers database is challenging.
  - Consideration of transforming a state-owned bank into a new development bank to facilitate long-term financing.
- Financial stability and safety nets:
  - Establishment of the Financial Sector Stability Forum for discussing government and central bank roles in crisis management.
  - Drafting of a bill on a financial safety-net program and a blueprint for an Indonesian Financial System Architecture (IFSA).
  - Progress on settlement of non-performing loans of state-owned banks and treatment of ailing insurance companies.
  - Strengthening capacity of the Deposit Insurance Corporation.
  - Efforts to diversify financing sources via capital market and non-bank financial institutions: facilitation of bond repo market development and preparation of regulatory framework for Islamic capital markets, including Shukuk.

### Conclusion and policy direction
- Indonesia has regained strong momentum with high growth and sound macroeconomic stability attributed to sound macroeconomic policies and continued reforms.
- Authorities emphasize need for further broad-based reforms to secure high and sustainable medium-term growth.
- Policy goals:
  - Enhance international competitiveness through improvements in efficiency and economic productivity.
  - Promote private sector-led growth to reduce unemployment and poverty.
- Transparency commitment:
  - Indonesian authorities remain committed to transparency and consent to publication of all staff reports, with necessary deletions of market sensitive information.

*IMF staff report content as provided.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07272.pdf_