## _cr08299 — Executive Summary

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### Background and outlook
- Growth and drivers:
  - Growth expected to remain at over 6 percent in 2008 on favorable resource sector activity and increased investment.
  - Growth in 2007 was 6.3 percent, driven by domestic demand; poverty and unemployment were 15.4 percent and 8.5 percent, respectively.
  - Staff projection: Real GDP growth of 6.1 percent in 2008, with some weakening in the second half of 2008; 2009: 6.3; 2010: 6.5; 2013: 6.7.
- Inflation and monetary stance:
  - Headline inflation accelerated to 11.0 percent at end-June; core inflation reached 8.7 percent at end-May.
  - Headline inflation expected to reach 12 percent at end-2008; CPI inflation (end period): 2006: 6.6; 2007: 6.6; 2008: 12.0; 2009: 7.5; 2010: 6.5.
  - BI tightened monetary policy (hiked three times since May by a total of 75 basis points); overnight rates increased by about 400 basis points from the average level in December 2007.
  - Real policy interest rate calculated on the basis of core inflation is currently around zero; mission suggestion: bring real rates to at least a neutral 2–3 percent (authorities: neutral around 1½ percent).
- External and reserves:
  - NEER depreciated about 11.5 percent since mid-2007 by end-June; Indonesia accumulated US$14 billion of reserves in 2007.
  - Reserves increased by $2.5 billion with respect to end-2007 as BI slowed accumulation in early 2008; end-period gross reserves projection: 2008: 63.4 (US$ billion); 2009: 69.7.
  - Current account recorded a surplus of 2.5 percent of GDP in 2007; current account balance (percent of GDP): 2006: 3.0; 2007: 2.5; 2008: 2.0; 2009: 0.8; 2010: 0.3; 2013: -1.2.
- Fiscal position and subsidies:
  - Fiscal deficit contained to 1.2 percent of GDP in 2007; central government balance (percent of GDP): 2006: -1.0; 2007: -1.2; 2008 (Proj.): -1.9.
  - Government raised subsidized fuel prices by 29 percent in May 2008.
  - Energy subsidies: 3 percent of GDP in 2007 and about 5 percent of GDP in 2008; staff update projects energy subsidies to reach 5.7 percent of GDP in 2008.
  - May 24 fuel price increase yielded a positive budget impact of about 0.6 percent of GDP; part used for cash compensation to 19 million households through December 2008; remainder (0.3 percent of GDP) to contain fiscal deficit.

### Key findings on macroeconomic background and projections
- Growth and demand:
  - Real GDP growth (percent change): 2006: 5.5; 2007: 6.3; 2008: 6.1; 2009: 6.3; 2010: 6.5.
  - Domestic demand: 2006: 3.2; 2007: 4.2; 2008: 6.8; 2009: 6.7; 2010: 6.8.
  - Net exports contribution (percentage points): 2006: 1.1; 2007: 0.4; 2008: 0.3; 2009: 0.4; 2010: 0.4.
- Saving, investment, and external balances:
  - Gross investment (percent of GDP): 2006: 23.4; 2007: 22.5; 2008: 23.6; 2009: 24.5; 2010: 25.4; 2013: 28.5.
  - Gross national saving (percent of GDP): 2006: 26.4; 2007: 25.0; 2008: 25.6; 2009: 25.3; 2010: 25.7; 2013: 27.3.
  - Current account balance (percent of GDP): 2006: 3.0; 2007: 2.5; 2008: 2.0; 2009: 0.8; 2010: 0.3; 2013: -1.2.
- Prices and money:
  - Consumer prices (end period): 2005: 17.1; 2006: 6.6; 2007: 6.6; 2008 (Proj.): 12.0; 2009 (Proj.): 7.5.
  - Rupiah M2 (end-period percent change): 2005–2008: 13.0; 18.1; 19.1; 18.5...
  - Private sector credit (end-period percent change): 2005–2008: 19.0; 14.9; 23.3; 24.2...
- Fiscal projections (selected):
  - Central government revenue (percent of GDP): 2006: 19.0; 2007: 17.8; 2008: 20.4; 2009: 20.1.
  - Central government expenditure (percent of GDP): 2006: 19.9; 2007: 19.1; 2008: 22.4; 2009: 22.2.
  - Central government debt (percent of GDP): 2006: 39.0; 2007: 35.0; 2008: 31.2; 2009: 29.4; 2010: 27.9; 2013: 25.2.

### Financial sector resilience and vulnerabilities
- Soundness indicators:
  - Banking sector profitability increased and gross NPLs declined to 4 percent (May/Mar-08 observations: NPLs 4.1; 3.8).
  - CAR and Tier 1 ratios for the largest 15 banks are 18% and 15%, respectively; capital adequacy ratio (in percent) observations: 19.3; 21.3; 19.3; 20.5 (Mar-08).
  - Loan-to-deposit ratio: 71 percent; private sector credit equivalent to about 25 percent of GDP.
- Credit growth and risks:
  - Private sector credit growth around almost 30 percent; credit to private sector (percent change) latest observations: 19.7; 12.8; 25.7; 29.8 (Apr-08).
  - Rapid acceleration in consumer credit and foreign currency credit flagged as potential vulnerability.
- Market stress and contagion:
  - Sovereign bond market stress in March: bond yields spiked by about 300 basis points since end-February; some auctions failed to attract targeted demand.
  - Government raised $2.2 billion in an external bond issue in June.
  - Evidence (Box 1): global VIX shocks spill over into Indonesian markets within 2–3 days, largest impact on equities; Indonesian markets relatively sensitive within Asia.
- Stress-test results (Box 4):
  - Under extreme adverse scenario, average Tier 1 and CAR ratios fell by 2.6 percentage points each.
  - Under the adverse test scenarios, one bank’s Tier 1 would fall below 4 percent; two banks’ CAR would fall below 8 percent.
  - Sensitivity thresholds to push one bank below tier thresholds:
    - Credit risk (share of loans downgraded one category): 24% → Tier 1 below 4%.
    - Interest rate risk (rise in policy rate): +1000 bps → Tier 1 below 4%.
    - Exchange rate risk (Rp depreciation): 29.7% → Tier 1 below 4%.
    - Market risk (change in price of government bonds): -21% → Tier 1 below 4%.

### Policy discussions and recommendations
- Monetary and exchange rate policy:
  - Staff recommendation: tighten monetary policy and support through some exchange rate appreciation to put inflation back on a downward path.
  - Staff recommendation: interest rates need to be brought promptly to a more neutral 2–3 percent in real terms (based on a 2009 inflation projection of about 7½ percent).
  - Authorities’ view: neutral real rate around 1½ percent; prefer a more gradual tightening.
  - Communication: publish inflation forecasts beyond the current year; discuss monetary policy decisions explicitly in reference to multi-year forecasts; consider revising 2009 and 2010 targets (4.5±1 and 4.0±1, respectively) toward a medium-term objective around 3 percent.
  - FX operations: support for recycling official foreign exchange receipts from oil exports to provide liquidity; staff suggested a more automatic mechanism for recycling to enhance liquidity and FX market development but cautioned against sustained reserve decline.
- Fiscal and subsidies:
  - Fiscal stance consistent with continued reduction in public debt, but high energy subsidies limit scope for priority spending.
  - Staff suggested introducing automatic adjustments of fuel prices (or ad-hoc adjustments as second best) to improve spending composition and protect fiscal space.
  - Mission proposal: reintroduce automatic fuel price adjustments to achieve goal of eliminating fuel subsidies over the medium term; authorities view automatic adjustments as politically not feasible now and consider alternative measures (capping purchases, gradual price increases for certain users, replacing kerosene with LPG).
  - Accompanying social measures: cash transfers to the poor to cushion fuel price impacts; cash transfers should replace tax incentives and trade measures used to limit food price increases.
- Financial sector policy:
  - Monitor private sector credit growth and loan approval standards closely; do not loosen prudential regulations beyond international standards.
  - Ensure capital standards are not lowered through partial Basel II implementation; offset potential reductions with higher capital for operational risk or increased provisioning.
  - Finalize review of the financial safety net and set a date for participation in the FSAP.

### Downside external risks and adverse macro scenario
- Key downside risks:
  - Financial contagion and investor sentiment: increased global risk aversion, deleveraging, and repricing of risk could trigger capital outflows; Indonesian markets remain relatively sensitive to short-term shocks.
  - Commodity price reversal: a sharp fall in commodity prices could undermine export revenue and FDI, pressure the rupiah, and trigger capital outflows; conversely, lower food and oil prices would ease inflation and reduce subsidies.
- Adverse scenario assumptions and projected impacts:
  - Scenario: global growth slows by 1 percentage point in 2009; major export commodity prices fall by 20 percent (oil price to $100 per barrel); surge in risk aversion and capital outflows.
  - Policy response assumed: BI raises policy rate by around 200 bps relative to baseline; BI intervenes in FX market; fiscal policy contains deficit via cuts in capital expenditures.
  - Projected effects under adverse scenario:
    - GDP growth: about 5 percent (about 1 percent below baseline).
    - Exchange rate: depreciates by around 15 percent.
    - Inflation (end-period): 8.5 percent (versus 7.5 percent baseline).
    - Bond yields: rise by 200 bps.
    - Equity prices: fall by 30 percent.
    - Current account: surplus narrows by 0.3 percentage points.
    - Reserves: slowdown in reserve accumulation.
    - Fiscal impact: deterioration of fiscal deficit by around 0.2 percentage points of GDP.

### Fiscal impacts and subsidy details
- Baseline fiscal impact estimates:
  - Baseline estimate: 0.1 percent of GDP fiscal effect; increases to about 0.2 percent of GDP in the following fiscal year.
  - A 10 percent increase in consumption of subsidized products would raise the annual subsidy cost by 0.3 percent of GDP.
  - Energy subsidies in 2008 remain large: about 5 percent of GDP in 2008.
  - As long as consumption remains contained, energy subsidies are not a threat to fiscal sustainability, although they affect the quality of spending.
- Public finance reforms and cash management:
  - Cash management regulations approved July 2007; outstanding issues impede establishment of a Single Treasury Account (TSA); recommendation to create a TSA.
  - Progress on tax administration reforms (small taxpayers offices) and publication of a fiscal risk statement in the 2008 budget.
  - Improvements needed: monitoring of SOEs; reporting of quasi-fiscal and extra-budgetary activities; monitoring contingent liabilities.

### Data, compilation, and statistical weaknesses
- Capital and financial account:
  - FDI data require substantial improvement; currently calculated based on loan disbursements using a fixed ratio to estimate equity inflows.
  - BI surveys to collect FDI data have low response rates; coverage of enterprise directory should be improved.
  - Other weaknesses: recording of trade credits; asset data for portfolio and other investment; unreconciled financial transactions with changes in IIP; magnitude of errors and omissions significant.
- BI proposed measures:
  - Establish working group to reconcile BI and customs data.
  - Collect and publish data on goods imported for processing, goods procured in ports by carriers, transactions with oil and gas sector, direct investment abroad, portfolio investment assets, other investment assets, and trade credits.
  - External Debt Information System (EDIS) introduced in 2002 improved external debt statistics for government and reporting entities; remaining improvements needed for private corporate sector data.

### Balance of payments and monetary survey highlights (selected numeric series)
- Balance of Payments — Other investment (2006–13, US$ billions) sequence (total other investment): 3.8, 5.9, 11.1, 7.1, 4.6, 2.1, 0.3, 4.1.
- Reserve assets position (eop, US$ billions): 42.6, 56.9, 63.4, 69.7, 77.8, 84.6, 92.2, 99.4 (2006–13 memoranda).
- Monetary Survey (selected levels, trillions rupiah):
  - Broad money (M2): 1,187.3; 1,382.3; 1,373.4; 1,450.8; 1,508.9; 1,634.1; 1,936.4.
  - Net foreign assets (rupiah terms): 301.0; 402.9; 440.1; 482.9; 499.1; 491.5; 558.5.
  - Private sector claims (level): 728.4; 837.2; 843.9; 908.4; 959.1; 1,032.5; 1,282.5.
- Selected vulnerability indicators (latest observations):
  - Real GDP growth: 5.7 (2005), 5.5 (2006), 6.3 (2007), 6.3 (2008, Mar-08).
  - CPI inflation: 17.1 (2005), 6.6 (2006), 6.6 (2007), 11.0 (2008, Jun-08).
  - Short-term interest rate: 12.8 (2005), 9.8 (2006), 8.0 (2007), 8.8 (2008, Jul-08).
  - EMBI secondary market spread (bps, end of period): 269; 153; 275; 381 (Jun-08).
  - Gross international reserves (US$ billion): 34.7; 42.6; 56.9; 59.5 (Jun-08).

### Debt sustainability and public/external debt trajectories
- Public sector debt:
  - Declined from 58.3 percent of GDP in 2003 to 35.0 percent in 2007; projected 2008: 31.2; 2009: 29.4; 2010: 27.9; 2013: 25.2.
  - Public sector debt-to-revenue ratio projected to decline from 196 percent to 138 percent over 2007–13.
  - Debt-stabilizing shocks sensitivity: one-time 30 percent real depreciation → ~8 percentage points of GDP increase in public debt ratio by 2013; 10 percent increase in contingent liabilities → 8 percentage points increase.
- External debt:
  - External debt (percent of GDP) historical and baseline: 2003: 57.7; 2004: 53.3; 2005: 45.7; 2006: 35.5; 2007: 31.7; 2008: 28.3; 2009: 25.5; 2013: 17.6.
  - External debt sustainability most vulnerable to exchange rate shocks: one-time 30 percent real depreciation raises debt ratio by around 16 percentage points in 2009 (impact declining toward 2013).

### Structural reforms, World Bank relations, and institutional priorities
- Structural reform priorities:
  - Improve investment climate, accelerate infrastructure spending and PPPs, improve fiscal transparency and public financial management, and continue tax administration reforms.
  - Labor market reform likely delayed until after the 2009 general elections; recommendation to improve labor market flexibility.
- World Bank engagement (Annex II highlights):
  - CAS extended to FY08 to coincide with graduation from IDA; CPS under preparation for second half of 2008.
  - Active portfolio: 25 projects with net commitment $2.7 billion and undisbursed $1.7 billion; FY08 approvals included Fourth DPL ($600 million), Infrastructure DPL ($200 million), BERMUTU ($86 million), Urban and Rural Community Empowerment ($409 million), GEF Geothermal ($4 million).
  - AAA program organized around five breakthrough themes: investment climate, reducing poverty, decentralized service delivery, governance, and recovery of Aceh and Nias.

### Staff appraisal and Executive Board recommendations (selected)
- Macroeconomic outlook: Indonesia has shown resilience; downside risks predominate (weaker Asia, commodity price slumps).
- Monetary policy: continued tightening needed; strengthen inflation-targeting framework; publish forecasts; consider adjusting 2009–10 targets.
- Exchange rate policy: flexible regime appropriate; manage FX sales to avoid perceptions of targeting; consider additional reserve accumulation over medium term.
- Fiscal policy: automatic or ad-hoc fuel price adjustments advised to protect fiscal space; continue public finance reforms.
- Financial sector: monitor rapid credit growth; adhere to prudential regulations; support gradual Basel II implementation; pursue FSAP participation.

*Source: IMF staff report (content unit _cr08299).*

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

### Executive Summary

### Background and outlook
- Indonesia’s growth performance remains strong despite the deteriorating global environment; growth is expected to remain at over 6 percent in 2008 on favorable resource sector activity and increased investment.
- Inflation developments:
  - While inflation remained within the target range at end-2007, it has accelerated since and is expected to reach 12 percent at the end of the year, reflecting large increases in food and fuel prices, as well as demand pressures.
  - Headline inflation accelerated to 11.0 percent at end-June, while core inflation reached 8.7 percent at end-May.
- Monetary policy response:
  - Bank Indonesia (BI) has started to tighten monetary policy (by 75 basis points since May).
  - The real policy interest rate calculated on the basis of core inflation has been declining over the year and is currently around zero.
  - Overnight rates have increased by about 400 basis points from the average level in December 2007 in line with the implementation of the change in the monetary operations framework.
- Fiscal and subsidies:
  - The government raised subsidized fuel prices by 29 percent in May, the first time since 2005.
  - Energy subsidies remain sizeable: 3 percent of GDP in 2007 and 5 percent of GDP in 2008.
  - Fiscal deficit was contained to 1.2 percent of GDP in 2007.
- External and exchange rate position:
  - The nominal effective exchange rate (NEER) depreciated further (by 10 percent) in 2007 as Indonesia accumulated US$14 billion of reserves; in 2008 the NEER has remained stable and BI has slowed the accumulation of reserves.
  - The current account recorded a surplus of 2.5 percent of GDP in 2007 supported by gains in the price of major commodity exports.
- Social indicators and reform context:
  - Growth in 2007 was 6.3 percent, driven by domestic demand; poverty and unemployment were 15.4 percent and 8.5 percent, respectively.
  - Progress on structural reforms: passage of the investment law and a key tax law; other reforms (VAT and income tax laws) not yet passed by parliament; labor market reform likely delayed until after the 2009 general elections.

### Key findings on the economic background
- Growth and demand:
  - Growth of 6.3 percent in 2007 driven by robust private consumption and rebound in investment, including a strong rise in foreign direct investment.
  - Growth momentum maintained in Q1 2008 despite deterioration in consumer confidence.
- Inflation and drivers:
  - Headline inflation reached 9 percent at end-April (before the May fuel price adjustment), well above BI’s 4–6 percent target range for end-2008.
  - Part of the uptick owes to the fuel price adjustment in late May; high food prices and demand pressures have been important contributors.
- Monetary stance and liquidity:
  - BI lowered interest rates to 8 percent and then held them unchanged since late 2007, before hiking three times since May by a total of 75 basis points.
  - Bank liquidity has been tightened in 2008; the real policy interest rate on core inflation is around zero.
- Exchange rate and external position:
  - The real exchange rate remains moderately undervalued.
  - Despite NEER depreciation in 2007, Indonesia accumulated US$14 billion of reserves.
  - Some episodes of capital outflows have occurred, but overall external position is generally strong.
- Fiscal performance:
  - Energy subsidies rose to 3 percent of GDP in 2007 (almost a third of total current spending).
  - Revenue performance was buoyant with across-the-board surge in non-oil and gas revenue.
  - Budget execution improved, notably in development expenditure.
- Financial sector resilience and vulnerabilities:
  - Financial soundness indicators improved: banking sector profitability increased and gross NPLs declined to 4 percent amid strong private credit growth.
  - Private sector credit growth around almost 30 percent.
  - Several factors limited transmission of global shocks: reserves exceed 150 percent of short-term external debt; low exposure to structured credit and derivatives; ample domestic liquidity; relatively low reliance on external financing.
  - Government bond market stress in March: bond yields spiked by about 300 basis points since end-February; some bond auctions failed to attract targeted demand.
  - The government raised $2.2 billion in an external bond issue in June.

### Policy discussions and recommendations
- Monetary and exchange rate policy:
  - Staff and the authorities agree that monetary tightening, supported by some exchange rate appreciation, is warranted to put inflation back on a downward path.
  - Staff recommendation: interest rates need to be brought promptly to a more neutral 2–3 percent in real terms to limit second-round effects of the fuel price increase.
  - Authorities’ view: this can be achieved by somewhat smaller rate increases.
  - With the 2008 inflation target to be missed, effective communication and a credible commitment to medium-term inflation objectives are important to anchor expectations.
  - The new policy of increased reselling of official foreign exchange receipts from oil exports should support the rupiah and help dampen inflation; staff suggested a more automatic mechanism for recycling official reserves to enhance liquidity and foreign exchange market development.
  - The rupiah is seen as moderately undervalued.
- Fiscal policy and fuel subsidies:
  - Fiscal stance consistent with continued reduction in the public debt burden, but high energy subsidies could further reduce the scope for spending on priority areas.
  - Staff suggested introducing automatic adjustments of fuel prices (or, as second best, ad-hoc adjustments) to improve the composition of spending.
  - Authorities noted that further price increases may not be feasible ahead of the 2009 elections and are considering options to limit the consumption of subsidized fuel.
- Financial sector policies:
  - Focus on maintaining stability and soundness of the financial system.
  - Private sector credit growth and standards for new loan approval should be closely monitored.
  - Prudential regulations should not be loosened further.
  - Stress-test analysis and monitoring of contingent liabilities are important given some increase in estimated default probabilities for parts of the banking system.

*Source: Executive Summary, IMF staff report._cr08299*

### 11.      Notwithstanding the weakening external environment, Indonesia’s growth is

### _cr08299 - 11.      Notwithstanding the weakening external environment, Indonesia’s growth is

### Growth outlook and medium-term framework
- Staff projection: Real GDP growth of 6.1 percent in 2008, with some weakening in the second half of 2008 due to higher domestic fuel prices, tighter monetary policy, and expected global slowdown.  
- Investment: Expected to remain strong, supported by rapid credit growth, a booming resource sector, and some improvement in the investment climate.  
- Comparative resilience: Indonesia is relatively better sheltered than many emerging markets from a U.S. slowdown due to high commodity prices in the WEO baseline, healthy demand from other emerging countries, a diversified export base, and lower trade exposure (including indirect links) to the U.S.  
- Trade surpluses: Expected to continue but decline over time because of higher reliance on imported oil and higher non-oil imports aligned with stronger private investment.

Key macroeconomic projections (percentage change; percent of GDP where indicated)
- Real GDP growth: 2006: 5.5; 2007: 6.3; 2008: 6.1; 2009: 6.3; 2010: 6.5; 2013: 6.7
- Domestic demand: 2006: 3.2; 2007: 4.2; 2008: 6.8; 2009: 6.7; 2010: 6.8; 2013: 8.0
- Net exports (contribution to GDP growth, percentage points): 2006: 1.1; 2007: 0.4; 2008: 0.3; 2009: 0.4; 2010: 0.4; 2013: -0.5
- CPI inflation (end period): 2006: 6.6; 2007: 6.6; 2008: 12.0; 2009: 7.5; 2010: 6.5; 2013: 5.0
- Gross investment (percent of GDP): 2006: 23.4; 2007: 22.5; 2008: 23.6; 2009: 24.5; 2010: 25.4; 2013: 28.5
- Gross national saving (percent of GDP): 2006: 26.4; 2007: 25.0; 2008: 25.6; 2009: 25.3; 2010: 25.7; 2013: 27.3
- Current account balance (percent of GDP): 2006: 3.0; 2007: 2.5; 2008: 2.0; 2009: 0.8; 2010: 0.3; 2013: -1.2
- Central government balance (percent of GDP): 2006: -1.0; 2007: -1.2; 2008: -1.9; 2009: -2.1; 2010: -1.8; 2013: -1.9
- Central government debt (percent of GDP): 2006: 39.0; 2007: 35.0; 2008: 31.2; 2009: 29.4; 2010: 27.9; 2013: 25.2

### Downside external risks and shock scenarios
- Financial contagion and investor sentiment: Increased global risk aversion, substantial deleveraging and repricing of risk could trigger capital outflows from high-beta and more volatile emerging markets; staff analysis indicates Indonesian financial markets remain relatively sensitive to short-term shocks to risk aversion (see Box 1).  
- Commodity price reversal: A sharp reversal of the rise in commodity prices poses downside risks because commodities account for more than half of total exports; declines would undermine export revenue, profits and valuations of commodity producers, could trigger capital outflows, pressure the rupiah, and reverse recent FDI increases to these sectors. Conversely, declines in food and oil prices would ease inflationary pressures and reduce budget subsidies.  
- Adverse shock scenario (referenced): Medium-term impact explored assuming a stronger global slowdown, a sharp drop in commodity prices, and a surge in risk aversion (details in accompanying Selected Issues Paper).

### Inflation developments and monetary policy response
- Inflation path: Headline inflation expected to reach 12 percent by end-2008, reflecting the fuel price adjustment, high food prices, and demand pressures.  
- Inflation drivers:
  - Food prices: Accounted for 49 percent of y/y inflation as of June, while the CPI weight for food is 36 percent.
  - Fuel: The 29 percent fuel price adjustment significantly raised headline inflation.
  - Rupiah weakness and strong domestic demand also contributed to rising inflation.
- Output gap and demand: Economy growing at fastest pace in 10 years; capacity utilization increased and unemployment declined. Real interest rates have been falling since late 2006, contributing to credit growth and domestic demand.
- Policy tightening:
  - Mission suggestion: Real interest rates need to be brought to at least a neutral 2–3 percent (based on a 2009 inflation projection of about 7½ percent) and achieved soon to help anchor expectations.
  - Authorities’ view: Neutral real rate around 1½ percent and a more gradual tightening approach.
  - Both sides: Extent and pace of tightening should depend on domestic economic performance, commodity prices, and exchange rate evolution.
- Monetary operations: Bank Indonesia (BI) moved the operational target from the 1 month SBI rate to the overnight interbank rate on June 9; transition prepared via fine-tuning operations and variable rate SBI auctions, stabilizing the overnight rate.

### Exchange rate, reserves, and FX market operations
- Rupiah: By end-June, nominal effective rupiah depreciation about 11.5 percent since mid-2007, pushing up imported inflation; it has remained quite stable in 2008.  
- Reserve accumulation and recycling: Higher oil prices boosted oil-related revenues and reserve accumulation; since early 2008 BI slowed the pace of accumulation—reserves increased by $2.5 billion with respect to the level at end-2007. BI has been “recycling” official foreign exchange receipts to provide liquidity to the FX market. Staff supported recycling policy but cautioned against a steady and prolonged decline in reserves. Current reserve levels described as comfortable; medium-term higher reserves could reduce vulnerabilities and borrowing costs.  
- Valuation assessment: Model-based estimates suggest the rupiah may be modestly undervalued in real effective terms—about 0 to 15 percent depending on methodology (see Box 2). Staff suggested a moderately stronger rupiah would align with fundamentals and help support external balance and inflation objectives.  
- Suggested transparency measure: Consider an automatic mechanism for “recycling” foreign exchange receipts similar to Mexico’s approach, where part of realized reserve accumulation in one quarter is sold in subsequent quarters.

### Communication, transparency, and inflation-targeting recommendations
- Inflation forecasts: Recommended publishing inflation forecasts beyond the current year and discussing monetary policy decisions explicitly in reference to those forecasts and targets beyond the current year. Public statements on specific future interest rate levels and credit growth targets could be less specific.  
- Targets: No recommendation to change the 2008 target given short time remaining; instead provide a forecast and explain deviation. Consider revising 2009 and 2010 targets (4.5±1 and 4.0±1, respectively) to a more realistic yet ambitious path toward an unchanged medium-term inflation objective around 3 percent. Revisions should be used to guide expectations in the absence of official multi-year forecasts; BI should emphasize medium-term objectives and measures to achieve them. BI broadly agreed and reiterated commitment to the medium-term objective.

### Financial market spillovers (Box 1)
- Evidence: Global shocks to risk aversion (VIX) spill over into Indonesian financial markets within 2–3 days, with largest impacts on equities. Within Asia, Indonesia’s markets are relatively sensitive to short-term spillovers; compared to Turkey, South Africa, Brazil, Indonesian markets appear somewhat more stable, but could still be significantly affected by episodes of flight from emerging market assets.  
- Data and methods: Based on daily data January 2006–February 2008; impulse responses from VARs with 2 lags and generalized impulses robust to ordering of shocks.

### Exchange rate assessment (Box 2)
- REER developments: REER recovered since the Asian crisis, most appreciated level in 10 years in mid-2007; real depreciation around 9 percent from May 2007 to April 2008 despite improving terms of trade.  
- Equilibrium estimates: Two of three CGER methodologies imply rupiah modestly undervalued in range 0–15 percent. MB approach: fairly valued with CA norm -0.5 percent of GDP vs underlying CA -0.1 percent of GDP. ERER and external sustainability approaches suggest undervaluation of 13 and 15 percent respectively. Caution urged due to sample assumptions.  
- Exports and competitiveness: Export market share dipped slightly in 2007 and remains slightly below 2000 level (by 0.03 percentage points); competitiveness challenges persist, reflected in low ranking in investment climate surveys.  
- Medium-term outlook: Modest current account surplus projected to narrow and eventually give way to a small deficit consistent with development level and stronger domestic demand; large improvement in NFA position limits risks to external sustainability.

### Fiscal policy and fuel subsidies
- Fiscal stance: Overall fiscal performance strong; staff foresees central government overall fiscal deficit limited to -1.9 percent of GDP for 2008, reducing public debt to below 32 percent at end-2008 and consistent with 30–35 percent of GDP target for end-2009. Government expects a slightly lower deficit of -1.8 percent of GDP than in the revised budget (-2.1 percent of GDP) due to lower consumption of subsidized domestic fuel. Local/regional governments expected to accumulate small surpluses in 2008.  
- Subsidy burden: High energy subsidies likely to account for over one third of central government discretionary spending in 2008; government introduced a 10 percent cut on discretionary spending compared to original 2008 budget.  
- Mitigating measures: May 24 fuel price increase yielded a positive budget impact of about 0.6 percent of GDP and reduced smuggling incentives. Part of the fiscal space used for a cash compensation scheme to protect the poor and remainder (0.3 percent of GDP) to contain the fiscal deficit. Cash payments disbursed monthly to 19 million households through December 2008; rice distribution program expanded. Tax incentives and trade measures introduced to limit food price increases, including reduced import duties on rice, wheat, and soybeans, and VAT exemptions.

Box 3 (impact of oil prices on budget) — key points
- Market concerns: Surging international oil prices raised market concerns about budget impact and sustainability of energy subsidies, contributing to government bond sell-off and widening of CDS and EMBI spreads.  
- Net fiscal effect: Considering oil-related revenues and expenditures together, net effect on the budget is relatively small. Oil-related expenditures include fuel and electricity subsidies to Pertamina and PLN and transfers to regions (many transfers based on budgeted not actual oil prices, adjusting only in next budget year). Oil-related revenues include royalties, income tax, profit sharing, and dividends from Pertamina (often paid based on previous year’s profits, delaying budget impact by one year unless advance dividends requested).  
- Preliminary estimate: The initial combined effect of a $10/barrel oil price increase on the fiscal deficit is currently estimated at about [text truncated in source].

*Italic: Source: IMF staff report (content unit _cr08299 - 11. Notwithstanding the weakening external environment, Indonesia’s growth is).*

### 0.1 percent of GDP. This increases to about 0.2 percent of GDP in the following fiscal year.

### _cr08299 - 0.1 percent of GDP. This increases to about 0.2 percent of GDP in the following fiscal year.

### Fiscal impact of energy subsidies
- Baseline estimate: 0.1 percent of GDP. This increases to about 0.2 percent of GDP in the following fiscal year.
- Energy subsidies in 2008 remain large: about 5 percent of GDP in 2008.
- A 10 percent increase in the consumption of subsidized products would raise the annual subsidy cost by 0.3 percent of GDP.
- Overall assessment: as long as consumption remains contained, energy subsidies are not a threat to fiscal sustainability, although they do affect the quality of spending.

### Determinants of subsidized fuel consumption
- Subsidized fuel consumption tends to increase with the gap relative to the international price, likely due to smuggling and shifts from non-subsidized to subsidized fuels.
- The above estimates assume fuel consumption broadly in line with past trends.
- Policy measures under consideration by the authorities to contain subsidized fuel consumption:
  - Capping purchases of subsidized fuels to certain amounts.
  - Gradual price increases for certain users, such as private cars.
  - Replacing heavily subsidized kerosene by more economical LPG as the main cooking fuel through supplying the population with free LPG-using stoves.

### Policy responses on fuel pricing
- Mission proposal: reintroduce automatic fuel price adjustments to achieve the government’s goal of eliminating fuel subsidies over the medium term; automatic adjustments would protect the fiscal position and depoliticize price adjustments.
- Authorities’ view: automatic adjustments are politically not feasible at this point.
- Alternative: further ad-hoc adjustments would help reduce subsidies, albeit a second best alternative to an automatic adjustment mechanism.
- Accompanying social measures: accompanying cash transfers to the poor are used to cushion the social impact of fuel price increases; cash transfers should also replace tax incentives and trade measures introduced to limit food price increases.

### Public finance reforms
- Ongoing reforms aim at strengthening revenue collection and public financial management, and improving the investment climate by making the tax system more business-friendly.
- Comprehensive tax administration reforms, including the roll-out of the small taxpayers offices, are generating important gains in revenue and the investment climate.
- Progress is being made towards establishing a treasury single account, though completion depends on resolving issues with BI including remuneration of government deposits.
- Improvements in fiscal transparency include the publication of a fiscal risk statement in the 2008 budget.

### Financial sector policies and vulnerabilities
- Indonesia has remained relatively insulated from the global crisis to date, but local markets are vulnerable to higher funding costs, spikes in volatility, and declining risk appetite.
- Financing pressures have increased for corporates with access to foreign markets; domestic financing has partly offset this, but rising policy interest rates and high government bond yields indicate domestic financing conditions are likely to tighten.
- Exchange rate volatility has remained subdued, but loss of confidence could exert downward pressure on the rupiah.
- Private sector credit growth needs close monitoring:
  - Loan to deposit ratio: 71 percent.
  - Private sector credit equivalent to about 25 percent of GDP.
  - Rapid acceleration in bank lending, particularly consumer credit and credit in foreign currency, could become a source of vulnerability.
- Prudential regulatory changes aimed to stimulate credit growth included lowering risk weights on loans to SMEs and corporate bonds, while establishing caps on corporate bond holdings; credit concentration limits were raised above international standards.
- Policy guidance: prudential regulations should not be loosened beyond international standards; standards for new loan approval need close monitoring, especially for foreign currency credit and consumer credit.

### Stress testing and banking system resilience (Box 4)
- Banking system capitalization and liquidity:
  - CAR and Tier 1 ratios for the largest 15 banks are 18% and 15%, respectively.
  - Tier 1 ratio below 4 percent is considered seriously undercapitalized.
  - Liquidity is relatively high.
- Coverage: largest 15 banks represent nearly 70 percent in total assets and were subject to stress tests.
- Adverse macro scenario results:
  - Under the extreme adverse scenario, average Tier 1 and CAR ratios of the banks fell both by 2.6 percentage points each.
  - Most banks would absorb the shock, but one bank would see its Tier 1 capital ratio dip below 4 percent, and two banks would experience a drop in the CAR below the 8 percent threshold.
- Sensitivity thresholds (shock needed for one bank to fall below respective capital ratio):
  - Credit risk (share of loans downgraded one category): 24% leads to Tier 1 below 4%.
  - Interest rate risk (rise in policy rate): +1000 bps for Tier 1 below 4%.
  - Exchange rate risk (Rp depreciation): 29.7% for Tier 1 below 4%.
  - Market risk (change in price of government bonds): -21% for Tier 1 below 4%.
- Overall conclusion: the banking system should be able to sustain significant stress due to low loan-to-deposit ratio, large share of floating-rate securities, small net open exchange rate position, strong profitability, and high capital cushion; however, credit quality needs close monitoring given rapid credit growth.

### Regulatory and institutional reforms for financial stability
- Authorities plan a gradual transition to Basel II between 2008 and 2010, with differentiated pace across banks.
- Most needed regulations for Pillar I expected to be completed in the year of the report; emphasis needed on implementation of Pillar 2 (day-to-day risk-based supervision and risk management).
- Concern: reduction in capital requirements for certain assets under the gradual Basel II approach could lower capital standards; offsetting measures recommended include higher capital requirements for operational risk or increased loan provisioning.
- Review of the financial safety net underway:
  - Draft financial safety net law is being discussed between the government and BI in the context of the Financial Stability Forum.
  - Assessment of the LOLR framework to ensure consistency with international best practice.
  - Importance of clear responsibilities but retaining sufficient flexibility in the framework.
- Authorities have signaled intention to participate in an FSAP but have not committed to timing.

### Staff appraisal and recommendations
- Macroeconomic outlook:
  - Indonesia’s economy has shown resilience amid global turmoil; sound macroeconomic policies improved fundamentals.
  - Growth expected to remain strong, though downside risks predominate, particularly from weakening in growth in Asia and slumping commodity prices.
- Monetary policy:
  - Continued monetary tightening is needed to limit second-round inflation effects; BI has started hiking interest rates.
  - Real interest rates are now negative and low by cross-country comparison.
  - Efforts should continue to strengthen the inflation targeting framework; publish inflation forecasts and consider adjusting the 2009–10 targets.
- Exchange rate policy:
  - Policy is generally appropriate; real exchange rate likely somewhat undervalued.
  - Increased reselling of oil receipts should strengthen the currency; foreign exchange sales should be managed to avoid perceptions of exchange rate targeting and avoid sustained reserve decreases.
  - Some additional reserve accumulation over the medium-term could reduce vulnerabilities.
- Fiscal policy:
  - Fiscal stance consistent with substantial reduction of public debt burden, but energy subsidies present a major challenge.
  - Recent fuel price increase was important; introduction of an automatic fuel price adjustment mechanism, or ad-hoc fuel price adjustments, would help protect fiscal space for capital and social expenditures.
  - Because of subsidy uncertainties, little scope exists for deploying fiscal policy in the event of a downturn despite a fundamentally sound position.
  - Continued support for public finance reform agenda.
- Financial sector policy recommendations:
  - Focus on maintaining stability and soundness of the financial system given rapid credit growth.
  - Avoid loosening prudential regulations beyond international standards.
  - Ensure capital standards are not lowered as a result of partial Basel II implementation.
  - Finalize review of the financial safety net and set a date for the FSAP.

*Source: Extract from IMF staff report content unit _cr08299.*

### introduction of a mechanism for automatic

### _cr08299 - introduction of a mechanism for automatic

### Energy pricing and subsidies
- Domestic fuel prices were raised by 29 percent in May 2008.
- Prices remain the lowest in the region (at about 30–70 percent of international spot prices depending on the fuel product).
- The recent fuel price adjustment alleviates pressures on the budget but due to rising oil prices, energy subsidies continue to squeeze priority spending.
- Recommendation: introduction of a mechanism for automatic adjustments of energy prices and reduce untargeted energy subsidies to improve fiscal space.

### Treasury and cash management
- Cash management regulations were approved in July 2007.
- Outstanding issues continue to impede the establishment of a Single Treasury Account (TSA).
- Recommendation: Create a Single Treasury Account to ensure better fiscal management.

### Fiscal policy and fiscal risk management
- No new revenue measures were introduced (a tax policy package has been under discussion in parliament since 2005).
- A statement of fiscal risks and a medium-term fiscal framework were introduced in the 2008 budget.
- Improvements are needed to better assess fiscal risks, including:
  - monitoring of SOEs,
  - reporting of quasi-fiscal and extra-budgetary activities,
  - monitoring contingent liabilities.

### Financial sector developments and recommendations
- BI should reconsider the appropriateness of the relaxation in prudential regulations to encourage lending.
  - There has been no reversal of previous regulation.
- A deeper non-bank financial sector could be a significant source of long-term financing.
- The Sharia Banking Bill was approved by parliament on April.
- Efforts to develop the government securities market included:
  - reintroduction of T-bills auction,
  - a decree on the Dealer System.
- The latest policy package includes various measures in support of financial sector development.
- Recommendation: A strategy on the future role of state banks is needed.
- Recommendation: The authorities should participate in an FSAP.
  - An explicit strategy has not yet been developed.
  - The authorities have agreed in principle to participate in an FSAP, but have yet to commit to a date.

### Structural reforms and investment climate
- Focus on increased infrastructure spending, including by facilitating public-private partnerships, and improve business climate.
- Investment has picked up over the past year.
- The government revised its negative list (indicating sectors with limitations on foreign investment) at end-2007. The list improves clarity for foreign investors.
- Recommendation: Improve flexibility in the labor market.
  - No progress has been made on this area.

### Key macroeconomic indicators and projections (selected)
- Nominal GDP (2007): 3,801 trillions rupiah or 433 billions U.S. dollar
- GDP per capita (2007): 1,925 U.S. dollar
- Unemployment rate (2008): 8.5
- FDI (2007, net): 1,2 U.S. billions dollar
- Public debt (2007, gross): 35 percent of GDP
- Foreign public debt (2007): 14.4 percent of GDP
- Poverty headcount ratio at national poverty line (2008): 15.4 percent of population

- Selected growth and demand (Real GDP, percent change):
  - 2005: 5.7
  - 2006: 5.5
  - 2007: 6.3
  - 2008: 6.1
  - 2009: 6.3
- Domestic demand:
  - 2005: 5.3
  - 2006: 3.2
  - 2007: 4.2
  - 2008: 6.8
  - 2009: 6.7
- Components:
  - Private consumption (2005–2009): 4.0; 3.2; 5.0; 5.1; 5.1
  - Gross fixed investment (2005–2009): 10.8; 2.5; 9.2; 11.0; 10.4
  - Change in stocks 1/ (2005–2009): -0.4; -0.3; -1.5; 0.1; 0.0
  - Net exports 1/ (2005–2009): 1.1; 1.1; 0.4; 0.3; 0.4
  - Statistical discrepancy 1/ (2005–2009): -0.3; 1.5; 2.2; -0.2; 0.0

- Saving and investment (in percent of GDP):
  - Gross investment 2/ (2005–2009): 23.5; 23.4; 22.5; 23.6; 24.5
  - Gross national saving (2005–2009): 23.6; 26.4; 25.0; 25.6; 25.3
  - Foreign saving (external current account balance) (2005–2009): -0.1; -3.0; -2.5; -2.0; -0.8

- Prices (12-month percent change):
  - Consumer prices (end period) (2005–2009): 17.1; 6.6; 6.6; 12.0; 7.5
  - Consumer prices (period average) (2005–2009): 10.5; 13.1; 6.4; 10.6; 8.7

- Public finances (in percent of GDP):
  - Central government revenue (2005–2009): 17.8; 19.0; 17.8; 20.4; 20.1
  - Central government expenditure (2005–2009): 18.1; 19.9; 19.1; 22.4; 22.2
  - Central government balance (2005–2009): -0.3; -1.0; -1.2; -1.9; -2.1
  - Primary balance (2005–2009): 2.1; 1.4; 0.8; 0.2; -0.2
  - Central government debt (2005–2009): 45.6; 39.0; 35.0; 31.2; 29.4

- Money and credit (12-month percent change; end of period):
  - Rupiah M2 (2005–2008): 13.0; 18.1; 19.1; 18.5...
  - Base money (2005–2008): 21.9; 22.2; 27.8; 18.3...
  - Private sector credit (2005–2008): 19.0; 14.9; 23.3; 24.2...
  - One-month SBI rate (period average) (2005–2008): 9.1; 11.8; 8.6; 8.9...

- Balance of Payments (in billions of US$):
  - Oil and gas (net) (2005–2009): 4.2; 6.8; 6.0; 2.7; -0.1
  - Non-oil exports (f.o.b) (2005–2009): 66.8; 80.6; 93.1; 109.9; 113.4
  - Non-oil imports (f.o.b) (2005–2009): -53.4; -57.7; -66.1; -78.7; -83.6
  - Current account balance (2005–2009): 0.3; 10.8; 11.0; 9.8; 4.2
  - Foreign direct investment (2005–2009): 5.3; 2.2; 1.8; 2.7; 3.4
  - Overall balance (2005–2009): -0.5; 14.5; 13.2; 6.2; 6.4

- Gross reserves:
  - In billions of U.S. dollars (end period) (2005–2009): 34.7; 42.6; 56.9; 63.4; 69.7
  - In months of imports (2005–2009): 4.4; 4.7; 5.1; 5.1; 5.3
  - As a percent of short-term debt 3/ (2005–2009): 103.0; 147.8; 159.9; 213.4; 246.9

- Total external debt:
  - In billions of U.S. dollars (2005–2009): 133.8; 129.5; 137.4; 140.8; 143.4
  - In percent of GDP (2005–2009): 46.6; 35.5; 31.7; 28.3; 25.5

- Net International Investment Position:
  - In billions of U.S. dollars (2005–2006): -127; -139.........
  - In percent of GDP (2005–2006): -44; -38.........

- Exchange rate (period average):
  - Rupiah per US$ (2005–2007): 9,705; 9,165; 9,141......
  - Nominal effective exchange rate (Jan. 2000=100) (2005–2007): 79.3; 83.7; 80.9......

- Memorandum items:
  - Oil production (000bcpd) (2005–2009): 999; 956; 899; 927; 955
  - Indonesian oil price (US$/bbl) (2005–2009): 51.8; 63.9; 70.7; 116.1; 124.6
  - Nominal GDP (in trillions of Rupiah) (2005–2009): 2,785; 3,339; 3,957; 4,642; 5,366
  - Nominal GDP (in billions of US$) (2005–2009): 287; 364; 433; 500; 565

- Table note definitions:
  - 1/ Contribution to GDP growth (percentage points).
  - 2/ Includes changes in stocks. Computed on real basis.
  - 3/ Short-term debt on a remaining maturity basis.

### Social indicators (selected, 2002–2007)
- Elementary school net enrollment ratio, % of relevant aged group (2002–2007): 96.1; 96.4; 96.8; 97.1; 97.4; 97.6
- Population > 10 yr old not completed primary school (%) (2002–2006): 24.1; 21.9; 15.3; 21.5; 20.8...
- Population > 10 yr old finished primary and Junior high school (%) (2002–2006): 49.2; 50.1; 52.0; 49.4; 49.2...
- Population > 10 yr old finished high school (%) (2002–2006): 19.5; 19.6; 23.7; 21.3; 22.6...
- Adult literacy rate (2002–2006): 90.7; 90.9; 91.5; 91.9; 92.4; 92.5
- Life expectancy rate (2002–2006): 66.5; 66.2; 68.6; 67.8; 68.2; 69.1
- Fertility rate, births per woman (2002–2006): 2.4; 2.4; 2.3; 2.3; 2.2...
- Children < 5 yr old that have good nutrition (%) (2002–2005): 71.9; 69.6; 74.4; 91.2......
- Children < 5 yr old that had been immunized (%, measles) (2002–2006): 72.0; 72.0; 77.2; 72.5; 78.2...
- Household with access to piped water (%) (2002–2006): 19.7; 18.9; 20.4; 22.1; 22.8...
- Household with electricity (%) (2002–2004 and 2006): 87.6; 87.9; 89.0...90.6...
- Number of people under poverty line (million) (2002–2007): 38.4; 37.3; 36.1; 35.1; 39.3; 37.2
- Population under poverty line (%) (2002–2007): 18.2; 17.4; 16.7; 16.0; 17.8; 16.6
- Gini Coefficient (2002–2007): 0.34; 0.32; 0.33; 0.33; 0.36; 0.36
- Total labor force (millions) (2002–2007): 99; 101; 100; 104; 106; 106
- Labor participation rate (2002–2007): 67.8; 65.7; 67.6; 66.8; 66.2; 67.0
- Unemployment rate (2002–2007): 9.1; 9.5; 9.9; 11.2; 10.3; 9.1

*Source: IMF staff summary of the content unit.*

### 3. Other investment-3.8-5.9-11.1-7.1-4.6-2.10.34.1

### 3. Other investment-3.8-5.9-11.1-7.1-4.6-2.10.34.1

### Balance of Payments: Other investment components and overall balances (2006–13, in billions of U.S. dollars)
- Other investment (total row sequence): 3.8, 5.9, 11.1, 7.1, 4.6, 2.1, 0.3, 4.1
- Nonfinancial public sector (row sequence): -2.5, -2.4, -1.0, -1.7, -1.0, -1.1, -1.3, -1.2
  - Disbursements: 3.6, 4.0, 5.3, 4.5, 4.3, 4.1, 3.8, 3.8
  - Repayments: -6.1, -6.4, -6.3, -6.2, -5.3, -5.2, -5.1, -5.0
- Banking sector (row sequence): 0.4, 0.1, 0.0, 0.1, 0.2, 0.2, 0.2, 0.2
  - Disbursements: 1.5, 1.1, 1.0, 1.2, 1.4, 1.5, 1.6, 1.7
  - Repayments: -1.1, -1.0, -1.0, -1.1, -1.2, -1.3, -1.4, -1.4
- Corporate sector (row sequence): -0.8, 1.1, -0.4, 0.5, 0.1, -0.2, -0.6, -0.9
  - Disbursements: 6.0, 8.1, 7.6, 8.1, 8.7, 9.2, 9.9, 10.5
  - Repayments: -6.8, -7.0, -8.1, -7.6, -8.5, -9.4, -10.4, -11.4
- Other 1/ (row sequence): -0.9, -4.8, -9.6, -6.0, -4.0, -1.0, 1.9, 6.0

- III. Total (I+II): 13.8, 13.8, 6.4, 6.3, 8.1, 6.9, 7.5, 7.2
- IV. Errors and omissions: 0.7, -1.2, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0
- V. Overall balance (III+IV): 14.5, 12.5, 6.4, 6.3, 8.1, 6.9, 7.5, 7.2
- VI. Reserves and related items: -14.5, -12.5, -6.4, -6.3, -8.1, -6.9, -7.5, -7.2
  - Changes in reserve assets: -6.9, -12.5, -6.4, -6.3, -8.1, -6.9, -7.5, -7.2

Memorandum items:
- Reserve assets position (eop): 42.6, 56.9, 63.4, 69.7, 77.8, 84.6, 92.2, 99.4
- in months of imports of goods and services: 4.7, 5.0, 5.1, 5.3, 5.6, 5.7, 5.8, 6.0
- in percent of short-term debt: 148, 150, 213, 247, 282, 334, 361, 213
- Current account (percent of GDP): 3.0, 2.5, 2.0, 0.7, 0.3, -0.5, -0.9, -1.4

Sources noted in table: Data provided by the Bank Indonesia; and Fund staff estimates.
1/ Includes unrecorded capital flows and exceptional financing.

### Monetary Survey (December 2005 to December 2008; end of period, in trillions of rupiah unless otherwise indicated)
Key levels (selected):
- Net foreign assets (in rupiah terms): 301.0, 402.9, 440.1, 482.9, 499.1, 491.5, 558.5
  - (in billions of U.S. dollars): 33.4, 44.8, 48.9, 53.7, 55.5, 54.6, 62.1
- Net domestic assets: 886.3, 979.4, 933.3, 967.9, 1,009.9, 1,142.6, 1,377.9
- Net claims on government: 496.4, 501.8, 443.6, 426.6, 435.9, 493.2, 493.5
- Claims on business sector: 728.4, 837.2, 843.9, 908.4, 959.1, 1,032.5, 1,282.5
  - Rupiah claims: 615.6, 689.1, 691.6, 744.1, 787.9, 839.1, 1,085.1
  - Foreign exchange claims: 112.8, 148.1, 152.4, 164.3, 171.2, 193.4, 197.3
- Other items (net): -338.6, -359.7, -354.3, -367.1, -385.2, -383.1, -398.1
- Broad money (M2): 1,187.3, 1,382.3, 1,373.4, 1,450.8, 1,508.9, 1,634.1, 1,936.4
  - Rupiah M2: 1,014.3, 1,198.1, 1,190.7, 1,239.4, 1,295.3, 1,427.3, 1,691.3
  - Currency in circulation: 124.3, 151.0, 129.6, 146.7, 160.3, 183.4, 217.4
  - Deposits (level): 890.0, 1,047.1, 1,061.1, 1,092.7, 1,135.0, 1,243.9, 1,473.9
  - Foreign exchange deposits: 173.0, 184.1, 182.7, 211.4, 213.6, 206.8, 245.1

Bank Indonesia (selected):
- Net international reserves: 223.6, 353.2, 393.1, 424.7, 434.0, 458.8, 556.8
- Base money: 243.2, 297.1, 272.2, 289.7, 310.3, 379.6, 449.0
  - Currency in circulation: 124.3, 151.0, 129.6, 146.7, 160.3, 183.4, 217.4
  - DMBs: 118.5, 146.0, 142.4, 142.7, 149.6, 195.8, 231.4

Memorandum items:
- NIR of BI (in billions of US$): 24.8, 39.2, 43.7, 47.2, 48.2, 51.0, 61.9
- Money multiplier (rupiah M2): 4.2, 4.0, 4.4, 4.3, 4.2, 3.8, 3.8
- Base money velocity: 12.5, 11.8, 13.5, 13.3, 13.3, 11.0, 10.3
- Rupiah broad money velocity: 3.0, 2.9, 3.1, 3.1, 3.2, 2.9, 2.7

Annual percentage change (selected):
- Broad money (constant exchange rate): 15.3, 16.4, 14.3, 16.4, 14.0, 18.2, 18.5
- Rupiah broad money: 13.0, 18.0, 16.8, 15.9, 13.6, 19.1, 18.5
- Base money: 21.9, 22.2, 20.1, 17.9, 12.7, 27.8, 18.3
- Private sector claims: 19.0, 14.9, 14.2, 19.4, 20.2, 23.3, 24.2

Notes in table: All foreign currency denominated components are valued at a constant exchange rate.

### Central Government Operations (Selected, percent of GDP, 2005–08)
- Revenues and grants (series): 17.9, 19.0, 4.1, 18.0, 17.8, 5.5, 18.1, 20.0, 20.4 (table lists various columns)
- Oil and gas revenues (selected): 5.0, 6.0, 0.6, 3.8, 4.3, 1.3, 3.7, 5.3, 6.4
- Non-oil and gas revenues: 12.8, 12.9, 3.5, 14.2, 13.5, 4.2, 14.4, 14.6, 14.0
  - Tax revenues: 11.2, 11.0, 3.2, 11.9, 11.3, 3.8, 12.8, 12.4, 11.9
  - Nontax revenues 1/: 1.6, 1.9, 0.3, 2.3, 2.2, 0.3, 1.6, 2.2, 2.0
- Expenditure and net lending: 18.2, 19.9, 3.9, 19.6, 19.1, 4.1, 19.8, 22.1, 22.4
  - Current expenditure: 11.1, 10.1, 1.7, 9.9, 9.7, 2.2, 9.6, 11.8, 12.5
    - Personnel: 2.0, 2.2, 0.7, 2.6, 2.3, 0.7, 3.0, 2.3, 2.3
    - Subsidies: 4.4, 3.2, 0.3, 2.8, 3.8, 0.8, 2.3, 5.2, 6.0
      - Of which: Energy subsidies: 3.4, 1.9, 0.2, 1.5, 3.0, 0.8, 1.8, 4.2, 5.0
    - Interest 2/: 2.4, 2.4, 0.6, 2.3, 2.0, 0.5, 2.1, 2.1, 2.1
  - Development expenditure 3/: 2.3, 3.1, 0.3, 3.0, 2.9, 0.4, 3.8, 3.8, 3.5
  - Transfers to regions: 5.4, 6.8, 1.8, 6.6, 6.4, 1.5, 6.5, 6.5, 6.4
- Overall balance: -0.3, -1.0, 0.3, -1.6, -1.2, 1.4, -1.7, -2.1, -1.9
- Financing (selected): 0.3, 1.0, -0.3, 1.6, 1.2, -1.4, 1.7, 2.1, 1.9
  - Domestic financing: -0.6, 1.0, -0.3, 1.6, 1.5, -1.8, 1.5, 1.8, 1.3
    - Bank financing: -0.6, 0.5, -0.9, 0.3, 0.4, -2.1, 0.0, -0.3, 0.0
    - Net issuance of government securities: -0.1, 0.5, 0.6, 1.3, 1.1, 0.3, 1.6, 2.1, 1.3

Memorandum items:
- Primary balance: 2.1, 1.4, 0.9, 0.6, 0.8, 1.9, 0.4, 0.0, 0.2
- General government balance: 0.3, -0.2, ..., -1.2, -1.2, ..., -1.7
- Non-oil primary balance: -2.9, -4.6, 0.3, -3.1, -3.5, 0.6, -3.3, -5.3, -6.3
- Public debt to GDP: 45.8, 39.0, ..., 35.5, 35.0, ..., 34.0, ..., 31.2

Notes: From 2004 onward, deposit insurance premia treated as nontax revenues; interest on a due basis; development expenditure from 2005 onward comprises capital spending and social assistance spending.

### Selected Vulnerability Indicators (latest observations as indicated)
- Real GDP growth (in percent): 5.7 (2005), 5.5 (2006), 6.3 (2007), 6.3 (2008, Mar-08)
- CPI inflation (in percent): 17.1 (2005), 6.6 (2006), 6.6 (2007), 11.0 (2008, Jun-08)
- Short-term interest rate (in percent): 12.8 (2005), 9.8 (2006), 8.0 (2007), 8.8 (2008, Jul-08)
- EMBI secondary market spread (bps, end of period): 269, 153, 275, 381 (Jun-08)
- Exchange rate NC/US$ (end of period): 9,830, 8,990, 9,395, 9,220 (Jun-08)

External sector snapshots:
- Current account balance (percent of GDP): 0.1 (2005), 2.7 (2006), 1.9 (2007), 2.8 (2008, Mar-08)
- Net FDI inflows (percent of GDP): 1.8, 0.9, 0.7, 1.5 (Mar-08)
- Exports (percentage change of US$ value, GNFS): 20.7, 15.1, 8.6, 28.2 (Mar-08)
- Gross international reserves (GIR) in US$ billion: 34.7, 42.6, 56.9, 59.5 (Jun-08)
- GIR in percent of ST debt at remaining maturity: 103.0, 153.7, 187.8, ... (Dec-07)
- Total gross external debt (in percent of GDP): 46.6, 36.6, 31.2, ... (Dec-07)
- Current account deficit plus amortization (gross external financing requirement, in US$ billion): 24.3, 19.2, 15.3, ... (Dec-07)

Financial sector indicators (latest observations):
- Capital adequacy ratio (in percent): 19.3, 21.3, 19.3, 20.5 (Mar-08)
- NPLs in percent of total loans: 7.6, 6.1, 4.1, 3.8 (Mar-08)
- Provisions in percent of NPLs: 82.2, 99.7, 120.5, 122.4 (Mar-08)
- Return on assets (in percent): 2.6, 2.6, 2.8, 2.7 (Mar-08)
- FX deposits (in percent of total deposits): 13.1, 15.5, 15.6, 16.5 (Apr-08)
- Credit to private sector (percent change): 19.7, 12.8, 25.7, 29.8 (Apr-08)

### Medium-Term Macroeconomic Framework (2007–13, selected projections)
Real economy:
- Real GDP (percent change): 6.3 (2007 Act.), 6.1 (2008 Act.), 6.3 (2009), 6.5 (2010), 6.7 (2011), 6.7 (2012), 6.7 (2013)
- Domestic demand: 4.2, 6.8, 6.7, 6.8, 7.2, 7.5, 8.0
  - Private consumption: 5.0, 5.1, 5.1, 5.5, 6.0, 6.3, 6.7
  - Gross fixed investment: 9.2, 11.0, 10.4, 10.1, 10.4, 10.7, 11.1
- Net exports: 0.4, 0.3, 0.4, 0.4, 0.3, 0.0, -0.5
- Gross investment (percent of GDP): 22.5, 23.6, 24.5, 25.4, 26.3, 27.3, 28.5
- Gross national saving (percent of GDP): 25.0, 25.6, 25.3, 25.7, 25.9, 26.6, 27.3
- Foreign saving (external current account balance): -2.5, -2.0, -0.8, -0.3, 0.4, 0.6, 1.2

Prices:
- Consumer prices (end period): 6.6, 12.0, 7.5, 6.5, 5.6, 5.1, 5.0
- Consumer prices (period average): 6.4, 10.6, 8.7, 7.0, 6.0, 5.3, 5.0

Public finances (percent of GDP):
- Central government revenue: 17.8, 20.4, 20.1, 19.9, 19.3, 18.8, 18.3
- Central government expenditure: 19.1, 22.4, 22.2, 21.7, 21.2, 20.8, 20.3
- Central government balance: -1.2, -1.9, -2.1, -1.8, -1.9, -1.9, -1.9
- Primary balance: 0.8, 0.2, -0.2, 0.0, -0.1, -0.1, -0.1
- Central government debt: 35.0, 31.2, 29.4, 27.9, 26.8, 26.0, 25.2

Balance of payments (in billions of U.S. dollars):
- Oil and gas (net): 6.0, 2.7, -0.1, 0.0, -3.2, -5.9, -10.0
- Non-oil exports (f.o.b): 93.1, 109.9, 113.4, 117.5, 123.8, 132.2, 141.1
- Non-oil imports (f.o.b): -66.1, -78.7, -83.6, -88.6, -94.9, -102.2, -110.0
- Current account balance: 11.0, 9.8, 4.2, 1.7, -2.4, -4.8, -9.9
- Direct foreign investment: 1.8, 2.7, 3.4, 4.0, 4.5, 5.2, 5.7
- Overall balance: 13.2, 6.2, 6.4, 7.9, 7.7, 9.4, 9.2

Gross reserves (end period, US$ billion):
- 56.9, 63.4, 69.7, 77.8, 84.6, 92.2, 99.4
- In months of imports: 5.1, 5.1, 5.3, 5.6, 5.7, 5.8, 6.0
- As a percent of short-term debt 2/: 159.9, 213.4, 246.9, 282.1, 334.3, 360.9, 213.5

Total external debt (selected):
- In billions of U.S. dollars: 137.4, 140.8, 143.4, 145.4, 146.4, 146.0, 144.4
- In percent of GDP: 31.7, 28.3, 25.5, 23.6, 21.6, 19.6, 17.6

Memorandum:
- Oil production (000 bcpd): 899, 927, 955, 1,031, 1,021, 1,031, 1,010
- Indonesian oil price (US$/bbl): 70.7, 116.1, 124.6, 123.1, 123.1, 123.1, 123.4
- Nominal GDP (in billions of U.S. dollars): 433, 500, 565, 620, 681, 748, 822

### Adverse Macro Scenario (Annex summary)
Scenario premise:
- Sharper global growth slowdown and a fall in commodity prices, higher risk aversion, and capital outflows.

Macro shocks (assumptions):
- Global growth slows by 1 percentage point relative to the WEO baseline for 2009.
- Major export commodity prices, including oil, fall by 20 percent relative to the baseline (resulting in an oil price of $100 per barrel).
- Trigger: increased risk aversion and market sell-off in Indonesian equity and bond markets, as well as the rupiah.

Policy response (assumptions):
- BI increases the policy rate by around 200 bps relative to the baseline to stem capital outflow, stabilize the exchange rate, and limit inflationary impact.
- BI intervenes in the foreign exchange market to cushion capital outflows.
- Fiscal policy contains the deficit through some cuts in capital expenditures.

Projected effects under the adverse scenario:
- GDP growth: about 5 percent (about 1 percent below the baseline).
- Exchange rate: depreciates by around 15 percent.
- Inflation (end-period): picks up to 8.5 percent (versus 7.5 percent in the baseline).
- Bond yields: rise by 200 bps in line with policy interest rates.
- Equity prices: fall by 30 percent.
- Current account: surplus narrows by 0.3 percentage points due to lower export receipts.
- Reserves: slowdown in reserve accumulation due to capital outflows.
- Fiscal impact: deterioration of the fiscal deficit by around 0.2 percentage points of GDP due to declining revenue and higher interest cost, partially offset by lower energy subsidies and cuts in capital expenditure.

Figure referenced: "Figure 1. Alternative Scenarios" shows comparisons for Real GDP Growth, Inflation (end-period), Net Portfolio Inflows/GDP, Overall Fiscal Balance/GDP, Current Account/GDP, and Reserves (in terms of short-term debt) between Baseline and Alternative scenarios for 2006–10.

### Debt sustainability and outlook
- The annex frames an adverse macro scenario to analyze impacts on public sector debt and external debt sustainability, highlighting the roles of weaker external demand, commodity price declines, capital outflows, exchange rate depreciation, higher policy rates, and fiscal pressures on debt dynamics.

*Sources: Data provided by the Bank Indonesia; and Fund staff estimates.*

### 1.      The public sector debt ratio has declined steadily from 58 percent of GDP at

### _cr08299 - 1.      The public sector debt ratio has declined steadily from 58 percent of GDP at

### Public sector debt: historical path and drivers
- Public sector debt ratio declined from 58 percent of GDP at end-2003 to an estimated 35 percent at end-2007.
- Factors cited for the decline:
  - government’s fiscal consolidation policy;
  - declining interest rates;
  - high real GDP growth rates.
- The share of debt held by foreign creditors (mostly multilateral institutions) has declined to less than 50 percent.
- Trend expected to continue as authorities increasingly tap the domestic bond market.

### Baseline projections for public sector debt (2008–13) and key assumptions
- Under the baseline scenario, public sector debt is expected to decline to around 25 percent of GDP by 2013.
- Public sector debt-to-revenue ratio projected to decline from 196 percent to 138 percent over the 2007–13 period.
- Key assumptions underlying baseline projections for 2008–13:
  - real GDP growth averages 6.5 percent;
  - the primary surplus averages 0.1 percent of GDP;
  - average nominal interest rates on public debt increase slightly to 7.9 percent by the end of the period.

### Sensitivity of public debt trajectory to shocks
- The trajectory of the debt ratio is most sensitive to changes in interest rates, exchange rates, or contingent liabilities.
- Specific shock impacts (eventual effect on the debt ratio by 2013):
  - increasing average real interest rates by half of the historical standard deviation → 8 percentage points of GDP increase;
  - a one-time 30 percent real depreciation of the exchange rate → 8 percentage points of GDP increase;
  - a 10 percent increase in contingent liabilities → 8 percentage points of GDP increase.
- Other macroeconomic shocks have a more limited impact.

### Public sector debt numerical highlights (selected rows from Table 1, 2003–13; in percent of GDP unless otherwise indicated)
- Baseline: Public sector debt
  - 2003: 58.3
  - 2004: 55.2
  - 2005: 45.8
  - 2006: 39.0
  - 2007: 35.0
  - 2008: 31.2
  - 2009: 29.4
  - 2010: 27.9
  - 2011: 26.8
  - 2012: 26.0
  - 2013: 25.2
- Debt-stabilizing foreign-currency denominated primary (o/w foreign-currency denominated) — selected:
  - 2003: 27.6
  - 2004: 28.1
  - 2005: 23.4
  - 2006: 18.2
  - 2007: 16.5
  - 2013: 8.1
- Change in public sector debt (year-on-year)
  - 2003: -7.1
  - 2004: -3.1
  - 2005: -9.3
  - 2006: -6.8
  - 2007: -4.0
  - 2008: -3.8
  - 2009: -1.8
  - 2010: -1.5
  - 2011: -1.1
  - 2012: -0.9
  - 2013: -0.7
- Identified debt-creating flows (4+7+12)
  - 2003: -20.3
  - 2004: -2.7
  - 2005: -6.1
  - 2006: -8.1
  - 2007: -2.5
  - 2008: -3.3
  - 2009: -2.2
  - 2010: -1.8
  - 2011: -1.3
  - 2012: -1.0
  - 2013: -0.9
- Primary deficit (line 4)
  - 2003: -1.6
  - 2004: -1.3
  - 2005: -2.1
  - 2006: -1.4
  - 2007: -0.8
  - 2008: -0.2
  - 2009: 0.2
  - 2010: 0.0
  - 2011: 0.1
  - 2012: 0.1
  - 2013: 0.1
- Revenue and grants (line 5)
  - 2003: 16.7
  - 2004: 17.8
  - 2005: 17.9
  - 2006: 18.9
  - 2007: 17.8
  - 2008: 20.4
  - 2009: 20.1
  - 2010: 19.9
  - 2011: 19.3
  - 2012: 18.8
  - 2013: 18.3
- Automatic debt dynamics (line 7)
  - 2003: -17.0
  - 2004: -0.6
  - 2005: -3.9
  - 2006: -6.8
  - 2007: -1.7
  - 2008: -3.1
  - 2009: -2.4
  - 2010: -1.8
  - 2011: -1.4
  - 2012: -1.1
  - 2013: -1.0
- Contribution from interest rate/growth differential (line 8)
  - 2003: -15.7
  - 2004: -3.2
  - 2005: -5.4
  - 2006: -5.0
  - 2007: -2.4
  - 2008: -3.1
  - 2009: -2.4
  - 2010: -1.8
  - 2011: -1.4
  - 2012: -1.1
  - 2013: -1.0
- Public sector debt-to-revenue ratio (line)
  - 2003: 349.0
  - 2004: 310.5
  - 2005: 256.5
  - 2006: 205.8
  - 2007: 196.2
  - 2008: 152.5
  - 2009: 146.3
  - 2010: 139.9
  - 2011: 138.8
  - 2012: 137.7
  - 2013: 137.7
- Gross financing need (in percent of GDP)
  - 2003: 8.3
  - 2004: 4.5
  - 2005: 2.4
  - 2006: 3.5
  - 2007: 3.7
  - 2008: 3.8
  - 2009: 3.8
  - 2010: 3.3
  - 2011: 3.3
  - 2012: 3.1
  - 2013: 2.9
- Key macro/fiscal assumptions (Real GDP growth, in percent)
  - 2003: 4.8
  - 2004: 5.0
  - 2005: 5.7
  - 2006: 5.5
  - 2007: 6.3
  - 2008: 6.1
  - 2009: 6.3
  - 2010: 6.5
  - 2011: 6.7
  - 2012: 6.7
  - 2013: 6.7
  - Baseline average for projections listed separately as 6.5 (key assumption above).

### Alternative scenarios and bound tests (public debt)
- A.1 No policy change (constant primary balance) in 2005–09: Public debt path includes 31.2, 27.7, 25.5, 23.6, 22.0, 20.5 and associated primary balance -0.7.
- A.2 Scenario with key variables at their historical averages: selected values include 31.8, 28.0, 24.3, 20.8, 17.5, 14.5 and primary balance -1.0.
- B1. Real interest rate at historical average plus one standard deviation: values (selected) 32.7, 32.3, 32.1, 32.3, 32.7, 33.3 and impact 0.5.
- B2. Real GDP growth at historical average minus one standard deviation: selected values 31.6, 30.3, 29.4, 29.1, 29.1, 29.4 and impact -0.7.
- B3. Primary balance at historical average minus one standard deviation: selected values 31.6, 30.2, 29.1, 28.4, 27.9, 27.6 and impact -0.9.
- B4. Combination of B1–B3 using 1/4 standard deviation shocks: values 32.3, 31.5, 30.9, 30.7, 30.8, 30.9 and impact -0.2.
- B5. One time 30 percent real depreciation in 2006: values 40.9, 38.5, 36.6, 35.2, 34.0, 33.0 and impact -1.1.
- B6. 10 percent of GDP increase in other debt-creating flows in 2006: values 41.2, 38.7, 36.8, 35.4, 34.2, 33.2 and impact -1.1.

### External debt: historical path and drivers
- External debt declined from over 150 percent of GDP in 1998 to around 32 percent in 2007.
- External debt as a percentage of exports declined from 288 percent to 105 percent over the same period.

### Baseline projections and drivers for external debt (2008–13)
- External debt to GDP ratio declines to around 18 percent by 2013 under the baseline scenario.
- Main factors driving favorable dynamics:
  - real GDP growth projected to increase to 6–7 percent over the medium term;
  - a projected positive growth-interest rate differential;
  - an expected increase in non-debt-creating capital inflows.
- The favorable trend may be reversed if these positive developments do not occur.

### Sensitivity of external debt to 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 16 percentage points in 2009, with the impact declining to around 11 percentage points over the baseline by 2013.

### External debt numerical highlights (selected rows from Table 2, 2003–13)
- Baseline: External debt (percent of GDP)
  - 2003: 57.7
  - 2004: 53.3
  - 2005: 45.7
  - 2006: 35.5
  - 2007: 31.7
  - 2008: 28.3
  - 2009: 25.5
  - 2010: 23.6
  - 2011: 21.6
  - 2012: 19.6
  - 2013: 17.6
- Change in external debt (line 2)
  - 2003: -9.5
  - 2004: -4.3
  - 2005: -7.6
  - 2006: -10.2
  - 2007: -3.8
  - 2008: -3.4
  - 2009: -2.8
  - 2010: -1.9
  - 2011: -2.0
  - 2012: -2.0
  - 2013: -2.0
- Identified external debt-creating flows (3)
  - 2003: -15.8
  - 2004: -6.9
  - 2005: -7.0
  - 2006: -13.6
  - 2007: -9.2
  - 2008: -4.8
  - 2009: -3.5
  - 2010: -3.0
  - 2011: -2.4
  - 2012: -2.1
  - 2013: -1.5
- Current account deficit, excluding interest payments (line 4)
  - 2003: -5.0
  - 2004: -2.0
  - 2005: -1.8
  - 2006: -4.3
  - 2007: -3.6
  - 2008: -2.7
  - 2009: -1.4
  - 2010: -0.8
  - 2011: -0.1
  - 2012: 0.3
  - 2013: 0.8
- Exports (line 6)
  - 2003: 29.4
  - 2004: 32.2
  - 2005: 35.0
  - 2006: 31.6
  - 2007: 30.1
  - 2008: 31.7
  - 2009: 29.1
  - 2010: 27.6
  - 2011: 26.1
  - 2012: 25.0
  - 2013: 23.8
- External debt-to-exports ratio (in percent)
  - 2003: 195.8
  - 2004: 165.5
  - 2005: 130.8
  - 2006: 112.6
  - 2007: 105.3
  - 2008: 89.3
  - 2009: 87.6
  - 2010: 85.3
  - 2011: 82.8
  - 2012: 78.4
  - 2013: 74.1
- Gross external financing need (in billions of U.S. dollars; line)
  - 2003: 19.0
  - 2004: 21.8
  - 2005: 24.0
  - 2006: 17.3
  - 2007: 13.0
  - 2008: 24.4
  - 2009: 21.9
  - 2010: 23.2
  - 2011: 27.0
  - 2012: 27.5
  - 2013: 32.1
- Gross external financing need (in percent of GDP)
  - 2003: 8.1
  - 2004: 8.5
  - 2005: 8.4
  - 2006: 4.8
  - 2007: 3.0
  - 2008: 4.9
  - 2009: 3.9
  - 2010: 3.8
  - 2011: 4.0
  - 2012: 3.7
  - 2013: 3.9

*Source: INTERNATIONAL MONETARY FUND, Staff Report for the 2008 Article IV Consultation—Informational Annex (July 11, 2008).*

### ANNEX II. INDONESIA: WORLD BANK RELATIONS

### ANNEX II. INDONESIA: WORLD BANK RELATIONS

### Indonesia Country Assistance Strategy (CAS)
- CAS 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 two fundamental problems impeding rapid poverty reduction: (i) a weak investment climate and (ii) the lack of quality service delivery to the poor; both arise from weak governance.
- CAS emphasizes natural disaster management due to expansion of the Bank program and redeployment to post-disaster efforts (notably Aceh and Yogyakarta/Central Java).
- Given a good track record of reform, continued financing need, solid macroeconomic indicators, and improved creditworthiness, CAS supports government request to recalibrate assistance toward more program lending (the on-going Development Policy Lending (DPL) series and the Infrastructure DPL).
- A new Country Partnership Strategy (CPS) reflecting transition from IDA to middle income country status is under preparation and expected to go to the Board in second half of 2008.
- The CPS will focus on improving Indonesia’s institutions at central and sub-national levels through six core areas: private sector development, infrastructure, poverty reduction, education, climate change and natural resource management, and disaster mitigation and recovery.

### World Bank Engagement: Selected Highlights

- Improving the Climate for High Quality Investment:
  - DPL program, targeted projects, a large AAA program, and IFC interventions support policy and institutional reforms for higher growth.
  - Reforms supported by DPLs have helped consolidate macroeconomic stability; enhanced competitiveness of the financial sector; streamlined procedures for business start-up, trade, and customs; improved tax administration; and promoted SMEs.
  - Dialogue on infrastructure provision addresses a key growth constraint; TA addresses regulatory reforms, new legislation, risk management, and PPP.
  - A strategy to mobilize long-term private financing through NBFIs has been developed; a project establishing infrastructure and guarantee funds is under preparation.
  - IFC complements Bank work including local financing of infrastructure, business licensing, and SME development.
  - Bank Group activities focus on rural investment climate with projects on water management, agricultural services, agribusiness, land titling, irrigation, and coral reef protection.

- Making Service Delivery Responsive to the Poor:
  - Bank supports improvements in quality and equitable access to education, water and sanitation (WSS), and health services by strengthening capacity and systems and changing service management and delivery.
  - Education support spans early childhood development (ECD) to tertiary education; Bank supported an education sector review and a comprehensive national medium-term strategy (RENSTRA).
  - Provincial Health Projects (PHPs) clarify roles of different levels of government and strengthen district health administrations’ capacities; focus areas include maternal and child health, and nutrition.
  - CDD approaches in WSS and the GEG program aim to improve sanitary and health environments.
  - Bank is involved in the Government’s National Program of Community Empowerment (PNPM) and a Conditional Cash Transfer Program.
  - Several service delivery efforts are supported by a service delivery policy pillar within the DPL program.

- Addressing the Core Issue of Governance:
  - Governance is positioned as the most critical cross-sectoral issue and is central to the Bank’s program.
  - DPL program and the Government Financial Management and Revenue Administration Program (GFMRAP) aim to improve public administration, particularly public financial management.
  - Targeted interventions—Public Expenditure Reviews, trust funded programs on corruption prevention and civil service reform, and a relatively large CDD portfolio—are resulting in progress toward strengthening accountability, functional streamlining, and modernization of processes at national, subnational, and community levels.
  - The multi-donor Decentralization Support Facility (DSF) supports improved decentralization and donor effectiveness.

- Program for the Recovery of Aceh and Nias:
  - Bank is deeply engaged in recovery with focus on post-tsunami reconstruction, institution building, analytical support, and monitoring of progress.
  - Bank mobilized an Aceh reconstruction program substantial in scope and objectives and played a vital role in reconstruction management and international coordination.
  - In partnership with the Netherlands, the Bank established a multi-donor office in Banda Aceh for donor coordination.
  - The community-based housing approach deployed under the MDF housing project in Aceh was indicated by the Government as the model for housing reconstruction in Yogyakarta and Central Java after the May 2006 earthquake.
  - At government request, the Bank established the Multi-donor Java reconstruction Fund (JRF) primarily supporting housing reconstruction with total value of pledge US$79 million.
  - Disaster Management has become an important component of the Bank’s country strategy given Indonesia’s geographic location and vulnerability to natural disasters.

- New Lending Operations (as of June 2008):
  - Active portfolio: 25 projects with a total net commitment of $2.7 billion and an undisbursed balance of $1.7 billion.
  - In FY07, in addition to the development policy loan, 7 projects were delivered for a total lending volume of $1.2 billion.
  - For FY08, $1.3 billion was approved, including:
    - Fourth DPL ($600 million)
    - Infrastructure DPL ($200 million)
    - BERMUTU education project ($86 million)
    - Urban and Rural Community Empowerment projects ($409 million)
    - GEF Geothermal project ($4 million)
  - For FY09, two development policy loans and projects in urban water, dams, roads, community empowerment, education, youth employment, public finance management, and infrastructure financing are expected to be delivered.

### Analytic and Advisory Activities (AAA)
- AAA program organized around five “breakthrough” themes:
  1. investment climate
  2. reducing poverty
  3. improving decentralized service delivery
  4. improving governance
  5. progress and constraints in the recovery of Aceh and Nias
- “Flagship reports,” stand-alone policy notes and think pieces, and day-to-day informal dialogue between Bank staff and government counterparts support GOI in making informed policy choices and shaping supporting Bank programs.

*For questions relating to this annex, contact Bill Wallace, at (+62-21) 5299-3000 or Preeti Ahuja at 202 473-1657.*

### 10.      For the capital and financial account, the methodological basis for the compilation of

### _cr08299 - 10.      For the capital and financial account, the methodological basis for the compilation of

### Capital and financial account: methodological weaknesses
- FDI data require substantial improvement: inflows are currently calculated based on loan disbursements to companies that have foreign equity using a fixed ratio to estimate equity inflows.
- BI surveys to collect FDI data have a low response rate and the coverage of the directory of enterprises should be improved.
- Other areas needing improvement:
  - Recording of trade credits.
  - Asset data for portfolio investment and other investment transactions.
- The magnitude of the errors and omissions item has been significant and appears related to the methodology used, for instance, for unrecorded assets in the financial account.
- Financial transactions data have not been reconciled with changes in the International Investment Position (IIP).

### BI proposed measures to address weaknesses
- Establishment of a working group to reconcile differences between BI and customs data (trade-related).
- Plans to collect and publish data on:
  - Goods imported for processing.
  - Goods procured in ports by carriers.
  - Transactions with the oil and gas sector.
- On the financial account, BI plans to collect and publish data on:
  - Direct investment abroad.
  - Portfolio investment assets.
  - Other investment assets.
  - Trade credits.
- Objective: address shortcomings in the recording of private financial flows.

### International Investment Position (IIP) and external debt statistics
- An annual IIP is compiled, but underlying data are weak in several areas, notably for FDI.
- External debt statistics improved 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.
  - The system generates data for public sector external debt and debt service, as well as those for private banks, that are considered reliable.
- Remaining improvements needed for private corporate sector data:
  - 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.

### Recent economic developments (IMF staff update)
- High-frequency indicators suggest activity remains firm despite the rise in domestic fuel prices in May:
  - Motor vehicle sales rose by 38 percent (y/y) in June.
  - Motorcycle sales rose by 46 percent in June.
  - Exports grew by nearly 30 percent (y/y) in nominal terms.
  - GDP growth in the second quarter is expected to have remained above 6 percent.
- Financial market movements:
  - Ten-year government bond yields declined by 175 basis points from the highs in mid-June.
  - Foreign ownership of SBI and SUN increased by nearly $5 billion since mid-June, contributing to an appreciation of the rupiah of around 2 percent against the dollar.
- Fiscal projections and budget:
  - The 2008 fiscal deficit is expected to be 1.9 percent of GDP, slightly below the revised budget.
  - Energy subsidies projected to reach 5.7 percent of GDP (compared to 4.2 percent of GDP in previous projections).
  - Draft 2009 budget envisages a lower fiscal deficit of 1.5 percent of GDP, with tax revenues expected to improve by 0.4 percentage points of GDP.
  - Draft budget includes contingencies to protect the budget if oil prices reach $160 p.b.

### IMF Public Information Notice — macro context and assessment
- Growth and labor:
  - Growth of 6.3 percent in 2007, highest in a decade.
  - Poverty at 15.4 percent and unemployment at 8.5 percent.
- Inflation and monetary policy:
  - Headline inflation accelerated to 11.0 percent at end-June.
  - Core inflation reached 8.7 percent at end-May.
  - BI hiked rates three times since May by a total of 75 basis points after lowering them earlier; the real policy interest rate calculated on the basis of core inflation is currently around zero.
- External position:
  - NEER depreciated by 10 percent in 2007; Indonesia accumulated US$14 billion of reserves in 2007.
  - In 2008 BI slowed reserve accumulation and the NEER remained stable.
  - Current account recorded a surplus of 2.5 percent of GDP in 2007.
- Fiscal performance:
  - Energy subsidies rose to 3 percent of GDP in 2007 (almost a third of total current spending).
  - Fiscal deficit contained to 1.2 percent of GDP in 2007.
- Financial sector:
  - Gross non-performing loans (NPLs) declined to 4 percent.
  - Stock market index about 6 percent above end-June 2007.
  - Since end-February, EMBI and CDS spreads widened and government bond market came under stress.
- Executive Board views and recommendations:
  - Further monetary tightening likely needed to bring inflation down.
  - Strengthen inflation targeting framework: effective communication, publication of inflation forecasts, strong commitment to medium-term targets.
  - Flexible exchange rate policy appropriate; caution urged in reselling oil receipts to avoid perceptions of exchange rate targeting.
  - Consider additional reserve accumulation over the medium term to reduce vulnerabilities.
  - Move toward an automatic fuel price adjustment mechanism; in the interim, further ad-hoc adjustments could reduce subsidy costs.
  - Continue public finance reforms and complete pending tax system and tax administration reforms.
  - Consider participating in the Extractive Industries Transparency Initiative to enhance fiscal transparency.
  - Monitor rapid credit growth and adhere strictly to prudential regulations; support planned gradual transition to Basel II.
  - Early participation in the Financial Sector Assessment Program (FSAP) encouraged.
  - Continue structural reforms to improve the business climate and accelerate infrastructure development.

### Key statistics and projections (selected, as presented)
- Real GDP (percent change):
  - 2005: 5.7
  - 2006: 5.5
  - 2007: 6.3
  - 2008: 6.1 (Proj.)
  - 2009: 6.3 (Proj.)
- Consumer prices (end period):
  - 2005: 17.1
  - 2006: 6.6
  - 2007: 6.6
  - 2008: 12.0 (Proj.)
  - 2009: 7.5 (Proj.)
- Central government balance (in percent of GDP):
  - 2005: -0.3
  - 2006: -1.0
  - 2007: -1.2
  - 2008: -1.9 (Proj.)
  - 2009: -2.1 (Proj.)
- Energy subsidies:
  - Projected to reach 5.7 percent of GDP in 2008 (staff update).
  - Energy subsidies were 3 percent of GDP in 2007.
- Foreign ownership of SBI and SUN increased by nearly $5 billion since mid-June (staff update).
- Reserves:
  - End-period gross reserves (US$ billions): 2005: 34.7; 2006: 42.6; 2007: 56.9; 2008: 63.4 (Proj.); 2009: 69.7 (Proj.).
- Current account balance:
  - 2007: surplus of 2.5 percent of GDP.
- Poverty and unemployment:
  - Poverty: 15.4 percent.
  - Unemployment: 8.5 percent.

*Source: IMF staff report and Public Information Notice, August 1 and August 12, 2008 excerpts as provided in the supplied content.*

### 1.             On behalf of the Indonesian authorities, we would like to express our appreciation

### On behalf of the Indonesian authorities, we would like to express our appreciation

### Recent updates and outlook
- 2007 performance:
  - Economy grew at a record high of 6.3 percent.
  - Inflation remained within the target range of 5-7 percent.
  - Growth was broad based with substantial acceleration of investment and buoyant consumer demand.
  - Government budget deficit was well contained at 1.3 percent of GDP.
  - Debt-GDP ratio fell to around 30 percent by the end of 2007.
  - Balance of payments recorded significant surpluses.
  - International reserves were US$ 59.5 billion at end-June 2008, equivalent to 5.1 months of imports and external public debt services.
- 2008–2009 outlook and risks:
  - Growth projected to around 6 percent for 2008 and return to 6.3 percent in 2009.
  - Authorities expect inflationary pressures to ease and return into the range of 6½ -7½ percent in 2009 following monetary tightening and on-going fiscal and structural measures.
  - High commodity prices expected to remain a key driver of exports.
  - Rapid credit expansion and improved investment climate expected to boost domestic consumption and investment.
  - Balance of payments expected to remain strong, supporting exchange rate stability.
  - Immediate policy challenges identified: containing inflation and managing the fiscal impact of high oil prices.

### Fiscal policies and reforms
- 2008 revised budget objectives:
  - Safeguard fiscal position from escalating fuel subsidies while creating fiscal space for growth.
  - Fiscal reforms have increased tax and non-tax revenues and dividends from SOE’s.
  - Expenditures of government agencies and line ministries were cut by as much as 10 percent.
  - Energy saving program introduced; efficiency improvements in Pertamina and PLN.
  - Policy retained for food subsidies for the poor.
  - Steps taken to accelerate transfer from highly subsidized kerosene to less subsidized LPG.
- Fuel price reform:
  - Domestic fuel prices were raised in May 2008 to maintain budget credibility and create fiscal space for priority spending on infrastructure and social programs.
  - Targeted cash transfer program re-implemented to cushion impact on vulnerable groups.
  - Authorities see gradual elimination of fuel subsidies as desirable long-term but politically not feasible in the short run given next year’s election.
  - Government considering introducing a mechanism for limiting consumption of subsidized fuels during transition to market prices.
- Fiscal projections:
  - Government is confident the deficit for fiscal year 2008 can be contained at 1.9 percent of GDP, lower than that approved in the revised budget.
  - 2009 budget expected to be prudent with a deficit around 1.5-2.0 percent of GDP, consistent with a declining path of public debt and growth target of 6.0-6.4 percent.
- Public financial management reforms:
  - Comprehensive tax administration reforms: establishing small taxpayer offices; modernizing tax and customs administrations with IT; bureaucracy reform in tax offices and customs.
  - National single windows system in customs introduced; provision of fast track facilities for compliant importers/exporters.
  - Progress towards implementation of a treasury single account.
  - Government started to publish a fiscal risk statement in the 2008 budget document.

### Monetary and exchange rate policies
- Monetary policy stance and actions:
  - Bank Indonesia (BI) shifted to tightening mode and raised its policy rate by 75 bps from 8 to 8¾ percent since May 2008.
  - Major sources of inflation in 2008: increases in domestic fuel and food prices, plus domestic demand and inflation expectations from second-round effects.
  - BI intends to stand ready to adjust its policy interest rate to bring down inflation toward the designated target range in 2009.
  - BI shares staff view not to revise the inflation target for 2008, but intends to make a public statement on the missed target.
- Monetary operations and framework improvements:
  - Since June 2008, operational target changed from 1 month Bank Indonesia Certificate (SBI) rate to the overnight inter-bank rate.
  - New instruments launched: fine tune operations (FTOs); narrowing implicit standing facility; progressive improvements in liquidity projections and management.
  - With the new framework, the interbank interest rate has increased by 400 bps since December 2007.
  - BI has revamped communications and transparency: press releases; publication of monthly, quarterly and annual economic reports; seminars and discussion programs.
- Exchange rate policy:
  - Authorities committed to a flexible exchange rate regime; movements mainly determined through market mechanisms.
  - Interventions confined to smoothing abrupt movements without targeting a specific level.
  - Recent recycling of official foreign exchange receipts aimed to limit exchange rate volatility when supply is limited.
  - Authorities have noted staff suggestion to adopt an automatic mechanism for recycling foreign exchange receipts but view a rule-based intervention as not appropriate under current market conditions.

### Financial sector issues
- System soundness and resilience:
  - Financial soundness indicators show the banking system has performed favorably: strong credit growth, well-capitalized, and liquid.
  - Loan quality continued to improve with NPL falling to 4% in May 2008.
  - Authorities’ stress-test confirms bank capital is generally strong enough to withstand simultaneous shocks: interest rate increase, exchange rate depreciation, fall in government bond prices, and rising NPLs.
  - Non-bank financial institutions and capital markets continued to grow amidst global market pressures.
  - Authorities remain vigilant over rapid growth of consumer loans and will monitor closely.
- Institutional strengthening and regulation:
  - BI facilitating merger process for banking consolidation program, particularly for systematically important banks.
  - Steps to accelerate development of financial markets and instruments.
  - Authorities planning to gradually implement Basel II in 2008 with a differentiated pace across banks.
  - Banks required to be fully compliant with good corporate governance (GCG), including disclosure of their GCG in public reports.
  - Central bank requires banks to enhance transparency of their banking products to the public.
- Crisis management and legal framework:
  - Draft Financial Safety Net Act as a legal basis for bank resolution is being prepared.
  - Authorities preparing a financial crisis management protocol outlining procedures and responsibilities of agencies.
  - Coordination among financial agencies to be improved by strengthening the role of the Financial Stability Forum.

### Structural reforms
- Investment climate and policy package:
  - Reforms to improve investment climate remain top priority.
  - Following June 2007 economic policy package, business perceptions and investment growth have improved.
  - New policy package issued to accelerate: investment climate improvements, infrastructure development, empowerment of small medium enterprises, and financial sector development.
  - Other policies address natural resource management, environment, agriculture sector, labor and transmigrations, energy supply, upgrading infrastructure, and preparations toward ASEAN economic integration.

### Conclusion and commitments
- Assessment and commitments:
  - Indonesian economy has shown strong performance: high growth and sound macroeconomic stability despite global environment.
  - Performance attributed to sound macroeconomic policies and continued reforms; authorities stress need for further broad based reforms for high quality and sustainable medium-term growth.
  - Authorities underscore vigilance and readiness to adjust economic policy mix to ensure macroeconomic stability.
  - Authorities remain committed to transparency and consent to publication of staff reports, with necessary deletions of market sensitive information.

*Provided by the Indonesian authorities in response to the 2007 Article IV Consultation staff report.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08299.pdf_