## _cr10284

## Source details

**Canonical URL:** [_cr10284](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10284.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10284.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10284.pdf.json)

---

### Executive summary: context, outlook, and key challenges
- Authorities successfully steered the economy out of the crisis with appropriate policy responses while lowering public debt.
- Key challenges:
  - Maintain the appropriate policy mix in a volatile external environment.
  - Foster sustained high growth.
  - Enhance financial sector resilience and development based on FSAP findings.
- Growth projections:
  - 2010: 6 percent.
  - Medium term: 7 percent as infrastructure development takes hold.
- Inflation:
  - Likely higher than in 2009 but still within Bank Indonesia’s (BI’s) target range.
- Near-term risk:
  - A sustained increase in global risk aversion could trigger capital outflows and dampen growth momentum.
- Medium-term risks:
  - Stronger external demand could boost growth.
  - Delays in implementing the planned infrastructure program are a downside risk.

### Managing capital flows, exchange rate, and reserves
- Challenge: Attaining the appropriate policy mix to manage volatile capital inflows.
- Exchange rate:
  - Broadly in equilibrium.
  - Continued flexibility in both directions is an important policy tool.
- Reserves and sterilization:
  - About US$15 billion accumulation in 2009 and US$12 billion through April 2010; reserves dropped by about US$4 billion to US$74½ billion in May and recovered by nearly US$2 billion in June.
  - Mounting sterilization costs are a concern.
  - Need to address nonmarketable government securities on BI’s balance sheet; making them marketable would expand BI’s operational toolkit.
- Policy measures:
  - Package announced on June 16 could help improve monetary operations and lower volatility of short-term capital flows.
  - One-month holding period on SBIs introduced on June 16; could deter short-term inflows but may raise SBI yields and complicate cash management.

### Monetary policy: stance, inflation expectations, and guidance
- Current stance:
  - Bank Indonesia’s holding stance is appropriate for now; BI policy rate unchanged since September 2009 at 6½ percent after easing policy by 300 bps during the crisis.
- Inflation outlook and expectations:
  - 2009 average inflation: 2.8 percent (y/y).
  - Average annual inflation through June 2010: 4 percent.
  - BI’s inflation target ranges cited: 3½−5½ percent and 4−6 percent (for 2010 projection); staff emphasize 4−6 percent target range repeatedly.
  - Inflation expectations for 2011: 5.9 percent (June Consensus Survey forecasts), at the top end of the target range.
- Policy guidance:
  - Signaling a proactive stance is needed to anchor inflation expectations in the target range.
  - Unwinding monetary accommodation may need to start in the second half of 2010 (estimated Taylor rule indicates unwinding may need to start in H2 2010).
  - Administrative measures to fuel credit growth should be avoided; staff advise against linking reserve requirements to each bank’s LDR.
- Money market and liquidity operations:
  - BI widened corridor between overnight deposit facility (FASBI) rate and overnight BI repo rate by 100 bps to 5.5 percent to 7.5 percent.
  - BI shifted SBI maturities from one-month to 3- and 6-month tenors, plans for 9- and 12-month tenors; one-month holding period for SBIs introduced on June 16.
  - Staff support measures to develop the money market, encourage interbank trading, and manage market rates close to the policy rate.

### Financial sector stability: FSAP findings and reform priorities
- FSAP confirms sustained progress in financial sector stability and identifies further reform priorities.
- System resilience:
  - Banking system has a large capital buffer and ample liquidity.
  - Banking capital adequacy ratio (CAR) at end-2009: 17½ percent (regulatory minimum 8 percent; BI informal target 12 percent).
  - Banks were profitable in 2009 and expected to improve further as growth picks up.
- Vulnerabilities from stress tests:
  - Extreme macro shock (economy contracts by 5 percent): TD—one third of banks undercapitalized (CAR < 8 percent); BU—three out of eight participating banks undercapitalized.
  - A 10 percentage point hike in interest rates would cause a 2½−3 percentage point drop in system-wide CAR; about one out of five banks could become undercapitalized.
  - Liquidity shocks: about one out of five large and medium banks would run out of liquidity after a five-day deposit run.
  - Concentration risk: if ten largest borrowers default for some large banks, five large banks would become undercapitalized and one insolvent.
  - Exchange rate shocks: negligible impact; a 50 percent depreciation would reduce system-wide CAR by 0.1 percentage point.
- FSAP reform priorities and recommended actions:
  - Strengthen legal and governance framework; adopt the revised Financial System Safety Net Law.
  - Introduce a legally mandated prompt corrective action regime.
  - Strengthen enforcement of creditors’ rights.
  - Bolster coordination of macro and micro prudential supervision; consider BI assuming a financial stability mandate or ensure careful management if supervision is transferred.
  - Secure BI’s financial independence by strengthening BI’s balance sheet (including making nonmarketable government securities marketable).
  - Develop deeper capital markets: strengthen legal and accounting standards, encourage state-owned enterprises to list domestically, expand institutional investor base (pension funds).

### Fiscal policy: stance, risks, and reform priorities
- 2010 budget and deficit:
  - Indonesia’s 2010 budget is modestly expansionary; budget envisages deficit expansion to 2.1 percent of GDP (staff estimate of 2010 deficit could be 1.9 percent of GDP due to underspending).
  - Net fiscal impulse in 2010: 0.3 percent of GDP.
  - Public debt in 2009: about 29 percent of GDP; public debt likely to remain below 30 percent of GDP.
  - Financing risks in 2010 are very low; two-thirds of financing need already met.
  - Fiscal consolidation planned from 2011 with a fiscal target of 1.7 percent of GDP (stimulus withdrawal of 0.2 percent of GDP relative to 2010).
- Recommended fiscal reforms to create space for infrastructure:
  - Phase out energy subsidies; expand transfer programs and social services for the poor.
    - Increase in the electricity tariff by 10 percent from July noted (small fiscal impact: 0.1 percent of GDP compared with budgeted subsidy of 3.2 percent of GDP).
    - Postponement of administered fuel price increase in 2010 is a setback and could increase fiscal vulnerabilities.
  - Improve budget execution and coordination with line ministries.
  - Broaden the tax base and improve tax administration to raise revenue ratios (current level noted as one of the lowest in the G-20).
  - Improve arrears collection, taxpayer registration, and audit functions.

### Recent macro-financial developments and salient statistics
- Growth and demand:
  - Real GDP growth in Q1 2010: 5.7 percent (y/y).
  - 2009 growth: 4½ percent.
  - Shift in 2010 from consumption to investment; annual credit growth in June 2010: 18½ percent.
  - Real GDP series (2007–11): 6.3, 6.1, 4.5, 6.0, 6.2.
  - Medium-term framework projections (2008–15): 6.1 (2008), 4.5 (2009), 6.0 (2010), 6.2 (2011), 6.5 (2012), 6.7 (2013), 7.0 (2014), 7.0 (2015).
- Inflation and monetary aggregates:
  - 2009 average inflation: 2.8 percent (y/y); average annual inflation through June 2010: 4 percent.
  - CPI inflation (end period and period average): 2009 end-period: 2.8; 2009 period average: 4.8.
  - Inflation outlook revisions: staff revised 2010 annual average to 5 percent (up by ¼ percentage point) and year-end to 6 percent.
  - Rupiah M2 (end-period annual percent change) 2009: 13.9.
  - Base money (end-period) 2009: 17.2.
  - Total credit (end-period) 2009: 10.1; credit growth in 2009: 10 percent.
- Capital flows and external position:
  - Net portfolio and other foreign capital flows positive since Q3 2009; surge in Q1 2010.
  - Foreign direct investment in Q1 2010: US$2½ billion.
  - Rp/US$ exchange rate appreciated nearly 35 percent from the trough in March 2009 through April 2010.
  - May capital outflows during European crisis: US$5¾ billion (about US$5 billion were SBIs).
  - Government’s US$2 billion 10-year global bond issued in January ended with a 6 percent yield.
  - Sovereign rating moves: Fitch upgrade to BB+ in January; S&P and Moody’s upgraded to two notches below investment grade.
- Financial soundness and market indicators:
  - Banking CAR at end-2009: 17½ percent; Mar-10 CAR: 19.3 (Table 5).
  - Gross NPL ratio in 2009: 3.2 percent of total loans; June 2010 industry average NPL around 3.3 percent.
  - One-month SBI period average rates: 2007: 8.6; 2008: 9.1; 2009: 7.4.
  - Nominal GDP (2009): "Rp 5,613 trillion or US$539 billion".
  - GDP per capita (2009): "US$2,330".
  - Unemployment rate (2009): "7.9".
  - Poverty headcount ratio at national poverty line (2009): "14.1 percent of population".
  - Gross investment (percent of GDP) 2009: 31.1; gross national saving 2009: 30.0.
  - Central government revenue (percent of GDP) 2009: 15.5; central government expenditure 2009: 17.1.
  - Central government debt (percent of GDP) 2009: 28.6.

### Debt sustainability—public and external
- Public debt:
  - Debt ratio fell to a record-low level of 29 percent in 2009.
  - Baseline projection: public debt fall to about 27 percent of GDP in 2010; decline to 23 percent of GDP by 2015 under gradual fiscal consolidation.
  - Stress tests:
    - Fiscal contingent liabilities amounting to 10 percent of GDP could raise public sector debt to 32 percent of GDP by 2015.
    - Currency depreciation of 30 percent would raise the debt ratio to about 29 percent of GDP by 2015.
    - An increase in real interest rates would raise the debt ratio to 26 percent by 2015.
  - Stochastic simulation: maximum likely debt level ~35 percent of GDP in the 95 percent confidence interval under macroeconomic and oil price shocks.
- External debt and external sustainability:
  - External debt projected to decline to 27 percent of GDP by end-2010 and to 20 percent of GDP by 2015.
  - External debt dynamics are resilient to a range of standardized shocks; largest vulnerability is a one-time 30 percent real depreciation.
    - A one-time 30 percent real depreciation in 2009 would raise the external debt ratio by 14 percentage points in 2011 and by 11 percentage points over baseline by 2015.
  - Baseline macro assumptions (selected):
    - Real GDP growth series: 5.7 5.5 6.3 6.0 4.5 6.0 6.2 6.5 6.7 7.0 7.0.
    - Nominal external interest rate (percent): 3.5 3.7 3.4 3.2 2.6 2.3 2.2 2.6 3.2 3.4 3.3.
  - Gross external financing need (percent of GDP) series indicates levels around 7.8–11.6 percent in selected years; projected gross external financing need in billions of U.S. dollars shows rising levels through the projection horizon.

### Capital inflows and policy response (Appendix I)
- Inflows composition and vulnerabilities:
  - Inflows primarily via portfolio flows rather than banking sector; not directly contributing to credit growth.
  - Equity market valuations have risen sharply; potential asset price pressures.
- Policy instruments and trade-offs (country experience 2006–2010 summarized):
  - Options discussed include foreign exchange intervention, monetary easing/tightening, fiscal tightening, prudential measures (e.g., higher reserve requirements on FX liabilities), limits on FX exposure, liberalization of residents’ outward investments, taxes on portfolio inflows, bans on foreign purchase of central bank bills, and minimum maturity requirements for inflows.
  - Trade-offs highlighted: sterilization costs, potential reputational effects, market dislocations, administrative complexity, and risk of disintermediation.
- Operational context:
  - Indonesia strengthened reporting requirements for foreign ownership of fixed income investments effective January 1, 2010.

### ADB relations, technical assistance, and data issues
- ADB engagement:
  - As of end-December 2009, ADB cumulative loans to Indonesia: $25.7 billion.
  - 2009 ADB approvals: $2,184 million.
  - ADB Country Partnership Strategy for 2011−2015 aligned with RPJM 2010−2014; core areas: transport, energy, financial sector, natural resource management, water supply and sanitation, and education.
- Statistical and data quality issues and recommendations:
  - National accounts: need for better indirect indicators, business census updates, establishment surveys for nonfinancial services, publication of longer time series, development of supply and use tables.
  - Government finance statistics: weaknesses in classification, coverage, timeliness; need for register of extrabudgetary units and GFSM 2001 operating statements; commitment to adopt GFSM 2001 standards.
  - Monetary statistics: good quality compiled by BI; recommendation to expand coverage to include mutual funds.
  - Balance of payments: shortcomings in trade coverage and FDI methodology; need improved recording of trade credits, portfolio transactions, and reconciliation with IIP.
  - Data dissemination: subscriber to SDDS since September 1996.

### Authorities’ views and staff appraisal
- Authorities broadly agree with staff growth outlook; government considers medium-term growth of about 7¾ percent feasible with infrastructure program implementation.
- Authorities agreed on exchange rate flexibility, making nonmarketable government securities marketable, and one-month SBI holding period to curb volatility.
- Staff appraisal:
  - Indonesia showed resilience during shifts in external conditions; appropriate policy responses, strong balance sheets, and low external demand dependence helped.
  - Main priorities: appropriate policy mix amid volatile external conditions, enhancing financial sector resilience and development per FSAP, and fiscal reforms to support medium-term investment and growth.
  - Continue exchange rate flexibility, strengthen BI balance sheet to lower sterilization costs, signal monetary readiness to anchor inflation expectations, avoid administrative credit-growth measures, and implement FSAP and fiscal reforms.

*Italic: Source — IMF staff report content in the provided PDF chapter.*

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

### EXECUTIVE SUMMARY

### Context
- Authorities successfully steered the economy out of the crisis with appropriate policy responses while lowering public debt.
- Key challenges:
  - Maintain the appropriate policy mix in a volatile external environment.
  - Foster sustained high growth.
  - Enhance financial sector resilience and development based on FSAP findings.

### Outlook and risks
- Growth projections:
  - 2010: 6 percent.
  - Medium term: 7 percent as infrastructure development takes hold.
- Inflation:
  - Likely higher than in 2009 but still within Bank Indonesia’s (BI’s) target range.
- Near-term risks:
  - A sustained increase in global risk aversion could trigger capital outflows and dampen growth momentum.
- Medium-term risks:
  - Stronger external demand could boost growth.
  - Delays in implementing the planned infrastructure program are a downside risk.

### Managing capital flows
- Challenge: Attaining the appropriate policy mix to manage volatile capital inflows.
- Exchange rate:
  - Broadly in equilibrium.
  - Continued flexibility in both directions is an important policy tool.
- Sterilization costs:
  - Rising sterilization costs are a concern.
  - Need to strengthen BI’s balance sheet and operational toolkit.
- Policy action:
  - The package of measures announced on June 16 could help improve monetary operations and lower volatility of short-term capital flows.

### Monetary policy: key findings and guidance
- Current stance:
  - Bank Indonesia’s holding stance is appropriate for now.
- Inflation expectations:
  - Expectations for 2011 are at the top end of the target range.
  - Several risk factors could push expectations higher.
- Policy guidance:
  - Signaling a proactive stance is needed to anchor inflation expectations in the target range.
  - Unwinding monetary accommodation may need to start in the second half of 2010.
- Administrative measures:
  - Administrative measures to fuel credit growth should be avoided as they could conflict with banks’ prudential policies and risk management practices.

### Financial sector stability (FSAP findings)
- FSAP confirms sustained progress in financial sector stability and identifies further reform priorities.
- Vulnerabilities:
  - Some banks are vulnerable to credit and liquidity risks.
- Recommended actions:
  - Address vulnerabilities through enhanced regulations.
  - Strengthen the legal framework.
  - Bolster coordination of macro and micro prudential supervision.
  - Develop a deeper capital market to deliver a more diverse funding base.

### Fiscal policy
- Budget execution:
  - Better budget execution is critical for a more effective fiscal policy.
- Reforms to create fiscal space for infrastructure:
  - Phase out energy subsidies.
  - Expand transfer programs and social services for the poor.
  - Increase non-commodity based revenues.

### Recent macro-financial developments and salient statistics
- Growth and demand:
  - Real GDP growth in Q1 of 2010: 5.7 percent (y/y).
  - 2009 growth: 4½ percent.
  - Shift in 2010 from consumption to investment; annual credit growth in June 2010: 18½ percent.
- Inflation:
  - 2009 average inflation: 2.8 percent (y/y).
  - Average annual inflation through June 2010: 4 percent.
  - BI’s inflation target range cited: 3½−5½ percent (for context) and elsewhere 4−6 percent for 2010 projection.
- Capital flows and external position:
  - Net portfolio and other foreign capital flows positive since Q3 of 2009; surge in Q1 2010.
  - Foreign direct investment in Q1 2010: US$2½ billion.
  - Reserves: about US$15 billion accumulation in 2009 and US$12 billion through April 2010; reserves dropped by about US$4 billion to US$74½ billion in May and recovered by nearly US$2 billion in June.
  - Rp/US$ exchange rate appreciated nearly 35 percent from the trough in March 2009 through April 2010.
  - May capital outflows during European crisis: US$5¾ billion (about US$5 billion were SBIs).
- Market developments:
  - Government’s US$2 billion 10-year global bond issued in January ended with a 6 percent yield, about 575 bps lower than a similar issue in March 2009 and 278 bps higher than comparable U.S. treasuries.
  - Sovereign rating moves: Fitch upgrade to BB+ in January; S&P and Moody’s upgraded to two notches below investment grade.
- Monetary operations and instruments:
  - BI policy rate unchanged since September 2009 at 6½ percent after easing policy by 300 bps during the crisis.
  - BI widened corridor between overnight deposit facility (FASBI) rate and overnight BI repo rate by 100 bps to 5.5 percent to 7.5 percent, respectively.
  - BI shifted SBI maturities from one-month to 3- and 6-month tenors and from weekly to monthly auctions; plans to introduce 9- and 12-month tenor SBIs later in the year.
  - One-month holding period for SBIs introduced on June 16 for primary and secondary market purchases by domestic or foreign investors.
- Fiscal stance:
  - Fiscal stimulus in 2009: 1.1 percent of GDP.
  - Primary surplus in 2009: 0.1 percent of GDP.
  - Public debt in 2009: about 29 percent of GDP.
- Financial soundness:
  - Banking capital adequacy ratio (CAR) at end-2009: 17½ percent (regulatory minimum 8 percent; BI informal target 12 percent).
  - Gross NPL ratio broadly unchanged at 3.2 percent of total loans in 2009.
  - Credit growth in 2009: 10 percent.

*IMF staff executive summary*

### 13.      Risks to the outlook are broadly balanced. Direct spillovers from the European

### 13.      Risks to the outlook are broadly balanced. Direct spillovers from the European

### Risks to the outlook
- Direct spillovers from the European crisis are likely to be limited given low dependence of Indonesian banks on foreign funding and modest trade exposure to the region.
- Near-term risk: an increase in global risk aversion could trigger capital outflows and squeeze liquidity, dampening growth momentum.
- Medium-term upside: sustained and stronger external recovery combined with larger foreign direct investment, as the investment climate improves, could further boost growth potential.
- Downside risk: weak implementation of the government’s infrastructure development program could reduce growth.
- Inflationary risks in 2010/11 arise from rising commodity prices and supply-side constraints.

### Authorities’ views on outlook
- Broad agreement with the growth outlook; authorities remain cautious about global economic conditions and spillovers to Indonesia.
- Government considers medium-term growth of about 7¾ percent as feasible with implementation of its infrastructure program to expand capacity and boost productivity.
- Authorities noted recent signing of a decree easing foreign investment restrictions in over 40 industries, including healthcare and agriculture, likely to increase foreign investment.

### Managing volatile capital flows (Policy discussion)
- Recent growth and ratings upgrades have made Indonesia an attractive investment destination, posing policy challenges due to volatile inflows.
- Authorities’ policy response: exchange rate flexibility supplemented by modest reserve accumulation to reduce short-term exchange rate volatility; a one-month holding period on all SBI holdings has been introduced.
- Concerns: continued large inflows could exert upward pressure on the rupiah, weaken competitiveness, and increase sterilization costs; risk of sudden reversal given short-term nature of inflows.

Key staff assessments and recommendations:
- Exchange rate flexibility
  - Exchange rate flexibility has helped absorb external shocks during the 2008/09 global financial crisis and should remain a significant policy response to volatile capital flows.
  - Staff assessment: the current exchange rate level is broadly in equilibrium (Box 1), allowing room for some further appreciation in response to continued capital inflows.
  - Sustained appreciation could affect competitiveness; removing supply constraints (developing infrastructure and improving the investment climate) would help ease the stress.
  - Anecdotal evidence: some industries (e.g., footwear and garments) are relocating to Indonesia from other Asian countries due to relatively lower labor costs.
- Reserve buffers and sterilization costs
  - Further modest strengthening of reserve buffers may be justified given Indonesia’s sensitivity to global risk aversion, evidenced even as recently as 2008/09, despite some standard metrics indicating adequacy of the current reserve level (Appendix I).
  - Mounting sterilization costs are a concern.
  - Need to address the long-standing issue of nonmarketable government securities on BI’s balance sheet; making this debt marketable would expand BI’s operational toolkit for liquidity management and secure a firmer financial footing for BI, better aligning its incentive structure with its mandate.
  - Footnote: The notional amount of nonmarketable and noninterest earning government securities on BI’s balance sheet is roughly equal to the outstanding amount of SBI’s issued to drain liquidity. If a portion of these securities were replaced by interest bearing marketable instruments, BI could sell them to replace maturing SBI’s to drain liquidity, without incurring losses.
- One-month holding period on SBIs
  - Could be effective in deterring short-term inflows since offshore investors cannot use onshore banks to invest in SBIs to circumvent the regulation.
  - If effective, less BI intervention may be needed to stem rupiah appreciation, lowering sterilization costs.
  - Risks: rolling over the existing stock of SBIs could become more costly as SBI yields rise to compensate for lower liquidity, potentially increasing overall sterilization costs.
  - Short-term complications: may complicate cash management for banks and longer-term investors, given relatively weak repo and interbank market trading.

### Authorities’ views on capital flow measures
- Authorities agreed with staff analysis, including addressing supply constraints to relieve potential competitiveness pressures from rupiah appreciation.
- Authorities agreed that making nonmarketable government securities marketable could improve monetary management; discussions between the government and BI are underway.
- On the one-month holding period requirement for SBIs, authorities noted it was meant to curb volatility, applies equally to domestic and foreign investors, and therefore should not adversely affect foreign investor sentiment.

### Box 1 — Indonesia: Exchange Rate Assessment (summary)
- Indonesia’s REER fell nearly 20 percent from its peak in August 2008, before turning around in February 2009 to surpass pre-crisis levels by April 2010.
- Strong real appreciation accompanied a marked pick up in imports after the crisis; exports also performed remarkably reflecting booming commodity prices and volumes.
- Evidence of some sluggish manufacturing sectors (e.g., textiles, electric machinery, furniture, paper) suggesting some competitiveness erosion; other manufacturing sectors growing robustly (e.g., road vehicles, industrial machinery).
- CGER methodologies (different approaches) suggest the exchange rate is close to equilibrium:
  - External stability (ES) approach: points to a 9 percent undervaluation, with a gap of 1.3 percentage points of GDP between the NFA-stabilizing CA (−2.4) and the underlying CA (−1.1). Result reflects a baseline projection with a yet-to-materialize pick up in real GDP growth (averaging 7 percent over the medium term, against an average of 5.5 percent for the period 2003−07).
  - Macroeconomic balance (MB) approach: points to an overvaluation of 5 percent, resulting from a gap of 0.9 percentage points of GDP between the underlying CA (−1.1) and the CA norm (−0.2).
  - Equilibrium real exchange rate (ERER) approach: suggests convergence to zero misalignment in 2010 under the projected path.
- Overall: close-to-equilibrium CGER estimates and a positive but weakening trade balance and current account suggest no clear evidence of misalignment at this point.

### Monetary policy: managing inflation expectations
- BI has signaled intent to maintain current stance until inflation climbs outside the 4−6 percent target range.
- Some tightening implemented through the increase in reserve requirements announced last year.
- Immediate need to raise interest rates is mitigated by the rupiah appreciation and the delay in administered price increases (the 10 percent electricity tariff hike from July is likely to have only a relatively small inflationary impact).
- BI’s holding stance is appropriate for now, but proactive signaling is necessary to anchor inflation expectations within the 4−6 percent target range.
  - Inflation expectations for 2010 are well within the 4−6 percent target range.
  - Inflation expectations for 2011 are at the top end of the range (5.9 percent, June Consensus Survey forecasts).
  - Risk factors that could push expectations higher: narrowing output gap, recovering credit growth, excess liquidity, commodity price fluctuations, and potential administered price hikes.
- Given limited scope for a countercyclical fiscal policy response, near-term burden falls on monetary policy.
- Based on current inflation and growth projections, an estimated Taylor rule indicates unwinding may need to start in the second half of 2010, broadly consistent with market expectations.
- Continued efforts by BI to communicate its strategy to anchor inflation expectations will help lower Indonesia’s term premium and boost medium-term growth potential.

Staff advice on money market and credit measures:
- Supported recent measures to develop the money market to encourage interbank trading and enhance BI’s liquidity management.
  - A lower FASBI rate gives banks an incentive to trade in the interbank market rather than park cash in BI deposits when short-term investments in SBIs are constrained.
  - Managing market interest rates close to the policy rate is needed to maintain policy credibility.
  - For planned issuance of the 12-month SBI from September, close coordination with the government (which also issues one-year treasuries) will be necessary to manage the yield curve.
- Advised against introducing administrative measures to boost credit growth (e.g., linking reserve requirements to each bank’s loan-to-deposit ratio (LDR)).
  - Staff view: credit growth is gaining momentum in line with the economic recovery cycle and recent sharp rise in credit approvals foreshadows stronger credit growth; changing RR linked to LDR could conflict with sound prudential policies and banks’ credit risk management.
  - Authorities’ view: BI disagreed with staff that credit momentum is picking up sharply, attributing recent increases to low base effects and fearing credit growth could slow again; they favor symmetric incentives to achieve an appropriate LDR to facilitate better financial intermediation.
  - Footnote: A similar measure existed previously; at that time banks met a higher RR only if their LDR fell below the threshold.

### FSAP and financial sector stability
- Significant progress over the last decade in bank regulation and supervision: stricter loan classification and provisioning, tightened related-party lending limits, higher capital adequacy requirement, tightened foreign exchange open position limits, increased transparency and corporate governance, enhanced on- and off-site supervision, fit-and-proper tests, individual bank risk assessments, enhanced consolidated supervision, and progressive movement toward Basel II.
- FSAP findings: overall resilience of the banking sector
  - Banking system has a large capital buffer and ample liquidity.
  - Banks were profitable in 2009 despite the economic slowdown and expected to improve further as growth picks up.
  - Stress testing: only under extreme shocks some banks become vulnerable to liquidity shocks and a few large banks susceptible to concentration risk. Exchange rate and contagion risks were not major concerns.
- FSAP reform priorities:
  - Strengthen legal and governance framework, coordination of macro-micro prudential supervision and crisis management, secure BI’s financial independence, and develop capital markets.
  - Legal framework: adopt the revised Financial System Safety Net Law to clarify responsibilities of BI, Financial Services Authority (OJK), LPS, and Ministry of Finance; introduce a legally mandated prompt corrective action regime; strengthen enforcement of creditors’ rights.
  - Supervisory coordination: ensure coordination of macro-micro prudential supervision; consider BI assuming a financial stability mandate given macro oversight expertise; ensure BI has full and timely access to supervisory information; if bank supervision is transferred out of BI, manage carefully to avoid losing capacity.
  - Capital market development: strengthen legal and accounting standards (including augmenting the Capital Markets Law); encourage state-owned enterprises to list on the domestic exchange; expand institutional investor base by supporting pension fund industry development.
  - Strengthen BI’s balance sheet to increase financial independence and enhance monetary management (see paragraphs on nonmarketable government securities).

### Box 2 — Banking sector stress test results (summary)
- Stress tests applied scenario and sensitivity analyses using top-down (TD) and bottom-up (BU) approaches.
- Findings:
  - Extreme macroeconomic shock (economy contracts by 5 percent): in TD, a third of banks become undercapitalized with CARs falling below the 8 percent regulatory minimum; in BU, three out of eight participating banks become undercapitalized when accounting for profit projections and banks’ own models. Non-performing loans would increase significantly. State-owned banks are most vulnerable; small banks weather stress better.
  - Market shocks: banks most vulnerable to interest rate shocks. A 10 percentage point hike in interest rates would cause a 2½−3 percentage point drop in system-wide CAR, with close to one out of five banks becoming undercapitalized. Domestic private banks are most vulnerable, with one quarter reporting CAR below 8 percent, followed by state-owned banks. Vulnerability linked to short-term funding: over 90 percent of deposits have maturities of less than one month and at call.
  - Liquidity shocks: some second-tier large and medium-sized banks vulnerable; about one out of five of these banks would run out of liquidity at the end of a five-day deposit run. Illiquid banks have high loan-to-deposit ratios, averaging 89 percent vs. 74 percent for the group that stays liquid.
  - Concentration risk: a few large banks vulnerable to concentration; if their ten largest borrowers default, five large banks would become undercapitalized, and one would become insolvent. Single borrower-lending limit of 30 percent noted for state-owned enterprises.
  - Exchange rate and contagion risks: negligible. A 50 percent depreciation would reduce system-wide CAR by only 0.1 percentage point. Interbank exposures limited; only four small banks at risk of becoming undercapitalized if one of their large borrowers fails.
- Policy implications: apply international best practices in asset classification and provisioning; introduce regulations and enhance supervision of interest rate risk; enact the financial safety net law to deal with unexpected shocks timely and effectively.

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

### 26.      Authorities’ views: The authorities were in broad agreement with the main

### _cr10284 - 26.      Authorities’ views: The authorities were in broad agreement with the main

### Authorities’ views on financial sector reform
- Broad agreement with the main conclusions of the FSAP.
- Authorities are preparing an action plan to address key priorities and requested IMF technical assistance in a number of areas to build capacity and guide reforms.
- Three pieces of legislation are under consideration to reform the legal and governance framework of the financial system:
  - creation of the OJK,
  - the Financial Safety Net law,
  - revising the BI Act in the area of appointment of BI’s top management.
- Authorities recognized the importance of coordination between micro and macro prudential supervision and noted that the FSAP’s recommendation will be considered in the current policy debate on the OJK.
- Government and BI recognize the need for capital market development and welcomed further guidance on setting priorities.

### Fiscal policy: supporting sustained growth — framework and outlook
- Indonesia’s 2010 budget is modestly expansionary but consistent with macroeconomic stability.
- 2010 budget envisages a deficit expansion to 2.1 percent of GDP.
  - The bulk of the expansion stems from implementation of the second round of corporate tax cuts planned before the crisis: Rp 30 trillion or 0.5 percent of GDP.
- Staff estimates that the deficit could be slightly lower (1.9 percent of GDP) largely based on the historical pattern of under spending.
- Net fiscal impulse in 2010 amounts to only 0.3 percent of GDP; public debt is likely to remain below 30 percent of GDP and risks are manageable under all adverse scenarios.
- Financing risks in 2010 are very low, given that two-thirds of the financing need has already been met.
- Fiscal consolidation is planned from 2011 with a fiscal target of 1.7 percent of GDP, implying a stimulus withdrawal of 0.2 percent of GDP relative to 2010.

### Fiscal policy: specific findings and recommended reforms
- Key priorities to support sustained high growth:
  - Improve both the quality and quantity of publicly provided infrastructure services to alleviate supply-side bottlenecks (noted low international ranking for infrastructure).
  - Create fiscal space for more capital spending, especially for the power sector and inter-island connectivity.
  - Phase out energy subsidies, combined with expanding transfer programs and social services for the poor, to create fiscal space for public investment with little impact on fiscal sustainability.
    - Increase in the electricity tariff by 10 percent from July is a step in the right direction, despite its small fiscal impact (0.1 percent of GDP compared with the budgeted subsidy of 3.2 percent of GDP).
    - Postponement of the increase in administered fuel prices in 2010 is a setback to subsidy reforms; delaying subsidy reforms could increase fiscal vulnerabilities over the medium term.
  - Implement sustained fiscal reforms to improve the quality and efficiency of fiscal institutions:
    - Improved budget execution, including better coordination with line ministries.
    - Broaden the tax base and improve tax administration to raise tax revenue ratios from the current level (noted as one of the lowest in the G-20).
    - Improve arrears collection, taxpayer registration, and audit functions.

### Box 3 — Administered price adjustments and inflation volatility: findings
- Inflation level and volatility have been higher in Indonesia than some peer countries.
  - Indonesia’s consumer price inflation has averaged 12 percent since 1997 and 8½ percent since the formal adoption of inflation targeting in July 2005.
  - By comparison, some Asian comparators have averaged about 3−6 percent inflation since July 2005, while Mexico and Brazil have averaged about 4−5 percent inflation in this period.
- Indonesia’s inflation volatility has been sharply higher than peers and is highly correlated with administered price adjustments; recent price-hike episodes in 2005 and 2008 saw volatility spike significantly.
- Energy price adjustments and core inflation are highly correlated because of second-round effects.
- Dispersion of inflation survey forecasts (Consensus Forecasts) shows Indonesia has the highest standard deviation among forecasts for one-year ahead inflation.
- Ad hoc administered price adjustments create uncertainty over inflationary expectations, complicating monetary policy and undermining policy credibility; this leads to a higher inflationary risk premium and can raise borrowing costs and reduce growth.

### Staff appraisal — macroeconomic and policy priorities
- Indonesia showed resilience during shifts in external conditions: strong balance sheets, relatively low dependence on external demand, and appropriate policy responses helped support domestic demand through the crisis.
  - Indonesia was the only country in the G-20 to lower its public debt-to-GDP ratio in 2009.
  - Large portfolio inflows from the second half of 2009; some pullout in May (market turbulence) but inflows have since returned.
- Main policy challenges:
  - Achieve appropriate policy mix amid volatile external conditions while supporting sustained high growth.
  - Volatile capital flows complicate monetary management and timing of removal of policy accommodation.
  - Enhancing financial sector resilience and development based on the FSAP findings is a top priority.
  - Fiscal reforms are necessary to support medium-term investment and growth.
- On capital flows and monetary policy:
  - Allowing rupiah appreciation and modest international reserve accumulation has worked well; continued exchange rate flexibility in both directions remains important.
  - Rising sterilization costs are a concern; making the nonmarketable government bonds in BI’s balance sheet marketable would help expand BI’s operational toolkit.
  - Recent measures introduced by BI could improve monetary management and help lower volatility in short-term capital flows.
- BI stance and inflation expectations:
  - BI’s holding stance is appropriate for now, but signaling readiness to respond to inflationary pressures is necessary to anchor expectations within the target range of 4−6 percent.
  - Expectations for 2011 are at the top end of the target range.
  - Taking into account an estimated Taylor rule, unwinding may need to start in the second half of 2010, broadly consistent with market expectations.
  - Continued effective communication of a proactive stance would signal BI’s commitment to lower inflation and reduce its volatility to trading partner levels.
  - Avoid administrative measures to fuel credit growth to avert conflicts with banks’ prudential policies and risk management practices.
- Financial sector priorities from the FSAP:
  - Some banks remain vulnerable to credit and liquidity risks.
  - Need to improve coordination of macro and micro prudential supervision and develop a crisis management framework for quick resolution of problem banks, including adoption of the Financial Safety Net law.
  - Address weaknesses in the legal mandate for supervision and governance structures in financial institutions.
  - Strengthen enforcement of creditors’ rights and develop a deeper capital market to improve financial intermediation and diversify funding for long-term investment.
- Fiscal reform priorities reiterated:
  - Improved budget execution of development spending.
  - Increase non-commodity based revenues.
  - Phase out energy subsidies while expanding transfer programs and social services for the poor to create fiscal space for infrastructure development.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10284.pdf*

### 36.      It is proposed that the next Article IV consultation take place on the standard

### It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

### Macroeconomic developments and outlook
- GDP growth:
  - "Real GDP (percent change)" series (2007–11): 6.3, 6.1, 4.5, 6.0, 6.2.
  - Projections in medium-term framework (2008–15): 6.1 (2008), 4.5 (2009), 6.0 (2010), 6.2 (2011), 6.5 (2012), 6.7 (2013), 7.0 (2014), 7.0 (2015).
  - Contributions: Domestic demand and net exports shown as components of GDP growth; domestic demand supportive of recovery.
- External sector and trade:
  - Non-oil and gas exports (f.o.b.) (2009–11): 99.1, 121.6, 127.2.
  - Main exports (percent of total, 2009): mineral fuels (30), manufactured goods (16), machinery and transport equipment (15).
  - Current account balance (percent of GDP): 2009: 0.1; projections: 2010: 0.6, 2011: 0.8 (Table 6 shows further projected deficits in later years).
  - Indonesia recorded a current account surplus in some series: "Current account balance 10.5, 0.1, 10.6, 5.8, 0.2" (Table 1, in billions of U.S. dollars).
- Prices and inflation:
  - CPI inflation (end period and period average): 2009 end-period: 2.8; 2009 period average: 4.8.
  - Medium-term projected consumer prices (end period): 2010: 5.7; 2011: 5.6; later years decline to 3.6 by 2015 (Table 6).
- Public finances:
  - Central government balance (percent of GDP): 2009: -1.6; 2010 (proj.): -1.9; 2011 (proj.): -1.7.
  - Central government debt (percent of GDP): 2009: 28.6; 2010 (proj.): 27.0; medium-term declines toward 23.3 by 2015 (Table 6).
  - Primary balance (percent of GDP): 2009: 0.1; 2010 (proj.): -0.2; 2011 (proj.): -0.1.
- Reserves and external position:
  - Gross reserves (end period, US$ billions): 2009: 66.1; 2010 (outturn/proj. varies by table) e.g., Table 1: 66.1; Table 6 projects reserves rising to 104.9 by 2015.
  - Gross reserves in months of imports: 2009: 5.5; 2010 proj.: 5.6; Table 1 shows 2009 value 5.5 months.

### Business activity and high-frequency indicators
- Retail sales, cement sales, industrial production, motor vehicle and motorcycle sales, and consumer confidence all show rebounds or upward trends in the period through mid-2010 (Figures indicate year-on-year growth and 3-month moving averages).
- Specific indicators cited:
  - Industrial production surged since the start of last year (figure series; index base 2000=100 shown).
  - Consumer confidence index above 100 indicates optimism; series shows values between 70 and 120 in 2008–2010.

### Inflation and monetary developments
- Inflation trajectory:
  - Inflation decelerated starting October 2008, driven by declines in food and commodity prices and slower domestic demand.
  - CPI series plotted: Headline and Core year-on-year inflation from Jan-2007 to Jul-2010.
- Monetary aggregates and credit:
  - Rupiah M2 (end-period annual percent change): 2009: 13.9 (Table 1).
  - Base money (end-period): 2009: 17.2 (Table 1).
  - Total credit (end-period): 2009: 10.1 (Table 1); credit growth declined during the crisis but started to recover as money growth rose.
- Interest rates and central bank operations:
  - One-month SBI rate (period average) series: 2007: 8.6; 2008: 9.1; 2009: 7.4 (Table 1).
  - Interest rate series (SBI 1-month, Bank Indonesia rate, JJIBOR O/N) plotted Jan-2007 to Jul-2010.
  - After providing liquidity during the crisis, Bank Indonesia increased draining operations; OMO outstanding series in trillions rupiah shown.
  - Real short-term interest rates are near the top of the estimated neutral window (real SBI 1-month series shown).

### Financial market performance
- Equity and bond markets:
  - Stock market surged past pre-crisis levels; sovereign external debt spreads and local currency debt yields have recovered toward pre-crisis levels (figures shown).
  - Government bond yields (10-year) series plotted with Indonesia compared to regional peers.
  - CDS five-year spreads presented for regional countries.
- Capital flows:
  - Net foreign buying series for SBIs, SUNs, and stocks plotted (in millions of U.S. dollars) showing foreign demand for SUNs steady despite outflows from SBIs during the European debt crisis.
- Exchange rate flexibility and reserves:
  - Exchange rate indices (national currency/U.S. dollar, Jan. 2, 2007 = 100) show Indonesia’s high degree of exchange rate flexibility during crisis and post-crisis amid increases in foreign exchange reserves.

### Banking sector indicators
- Profitability and margins:
  - Net interest margin and return on assets series plotted; banks lowered retail lending rates only slightly, supporting high interest margin.
- Asset quality and capital:
  - NPLs (nonperforming loans) in percent of total loans: 2009: 3.2 (Table 5); NPL series show declines from earlier peaks.
  - Loan loss reserve coverage: high and described as "ample" (series and percentages plotted).
  - Capital adequacy ratio: Mar-10: 19.3 (Table 5); capital asset ratios have improved recently.
- Default probabilities:
  - Default probabilities for banks (75th percentile) fell in line with recovery in the stock market; series compared regionally.

### Corporate sector indicators
- Credit and balance sheets:
  - Bank credit growth: large corporates and SMEs series show pickup in investment credit growth; working capital credit remained sluggish.
  - Sector distribution of credit shifted toward infrastructure-related sectors (manufacturing, construction, transportation, communications).
  - Balance sheet indicators: ST debt/total debt, quick ratio, debt/equity series show corporate balance sheets relatively liquid in aggregate.
- Corporate debt markets and risk:
  - Domestic corporate bond issuance picked up (new issuance and outstanding series in billions rupiah through Bapepam).
  - Default probabilities for corporates (75th percentile) declined with surge in equity market; regional comparisons shown.

### Key statistics and memoranda (selected exact figures from tables and text)
- Nominal GDP (2009): "Rp 5,613 trillion or US$539 billion".
- GDP per capita (2009): "US$2,330".
- Unemployment rate (2009): "7.9".
- Poverty headcount ratio at national poverty line (2009): "14.1 percent of population".
- Main macro aggregates (Table 1, selected):
  - Gross investment (percent of GDP): 2009: 31.1.
  - Gross national saving (percent of GDP): 2009: 30.0.
  - Foreign saving (external current account balance) (percent of GDP): 2009: -2.0.
  - Consumer prices (end period): 2009: 2.8; period average: 4.8.
  - Central government revenue (percent of GDP): 2009: 15.5; central government expenditure: 2009: 17.1.
  - Central government debt (percent of GDP): 2009: 28.6.
- Balance of payments (Table 2, selected, in billions of U.S. dollars):
  - Current account (2009): 0.1.
  - Exports, f.o.b. (2009): 139.6.
  - Imports, f.o.b. (2009): -116.7.
  - Direct investment, net (2009): 3.4.
  - Overall balance (2009): -1.9; Reserves position (end-period, 2009): 66.1 US$ billion.
- Monetary survey (Table 3, end-period, in trillions of rupiah):
  - Broad money (2009): 1,895.8.
  - Rupiah M2 (2009): 1,614.9 (component of broad money).
  - Base money (2009): 499.0.
  - Total credit outstanding (2009): 1,408.7.
- Central government operations (Table 4, selected):
  - Revenues and grants (2009): 871 (trillions of rupiah).
  - Expenditure and net lending (2009): 957 (trillions of rupiah).
  - Overall balance (percent of GDP) 2009: -0.1 (Table 5 summary lists -1.6 for 2009 in other presentations; see tables for consistent series).
- Selected vulnerability indicators (Table 5, latest observations):
  - Real GDP growth (latest observation): 5.7.
  - CPI inflation (latest): 17.1 (2005?), series shows 6.6, 5.6, 11.1, 2.8, 5.7 (check table for year alignment).
  - Gross international reserves (GIR) in US$ billion (May-10): 74.6.
  - Gross external financing requirement (US$ billion, projected): 45.0 (Table 5 memorandum).
  - Public sector gross debt (percent of GDP) (proj.): 27.0.

*Sources: CEIC Data Co., Ltd.; Bloomberg L.P.; Country authorities; Bank Indonesia; Data provided by the Indonesian authorities; Fund staff estimates; IMF staff calculations and estimates.*

### APPENDIX I: INDONESIA—CAPITAL INFLOWS AND POLICY RESPONSE

### APPENDIX I: INDONESIA—CAPITAL INFLOWS AND POLICY RESPONSE

### Capital inflows, reserves, and market implications
- Indonesia’s strong growth trajectory and high interest rate environment attracted capital inflows over the last few quarters; rapidity of inflows raises susceptibility to sharp outflows when investor risk appetite declines (example: sharp outflows in May amid concerns about the European debt situation).
- Policy response to inflows:
  - Allowed sharp rupiah appreciation, with real appreciation far exceeding that of regional peers.
  - Reserve accumulation increased: stock of net international reserves at US$75 billion in May 2010 compared with US$57 billion as of June 2009.
  - Standard metrics of reserve adequacy (as of end-2009): gross reserves as a percent of short-term debt at remaining maturity at about 200 percent; coverage of imports of goods and services at 5.5 months; coverage of M2 at 28 percent.
  - Staff note: some scope remains for incremental reserve accumulation given vulnerability to shifts in external sentiment (e.g., sharp loss of reserves during the 2008 crisis).
  - Operational measure: introduction of a one-month holding period on all BI certificates (SBIs) expected to reduce short-term volatility in capital flows.
- Capital inflows composition and asset prices:
  - Inflows have come primarily through portfolio flows rather than the banking sector and are not directly contributing to credit growth.
  - Equity market valuation levels have risen sharply; while having little impact on the wider economy so far, this could signal building asset price pressures.
- Staff analysis: periods of capital inflows coupled with reserve accumulation and excess liquidity may contribute to asset boom/bust cycles.

### Policy trade-offs and operational measures to manage inflows (summary of Table I.1)
- General observation: any mix of policy measures to deal with continued inflows involves trade offs.
- Measures considered and key pros/cons/considerations (country examples indicate operational experience, 2006–2010):
  - Foreign exchange intervention
    - Many examples: China, Thailand, Taiwan POC, Malaysia, Philippines, Russia, Turkey.
    - Pros: Indonesia has some scope to expand reserve cushion.
    - Cons: Sterilization costs can erode central bank capital; limiting rupiah appreciation could cause buildup of a bubble/one-way bet; less appreciation would push forward need for monetary tightening.
  - Monetary easing
    - Examples: Russia, Turkey, Poland, Czech Republic, Hungary, Serbia.
    - Pros: Lowering rates would decrease OMO costs.
    - Cons: May erode credibility and raise LT borrowing costs.
  - Fiscal tightening
    - Pros: Lower domestic issuance might lower onshore interest rates.
    - Cons: Limited room for fiscal tightening; interest rate response uncertain.
  - Restrictions on mortgage lending
    - Examples: Hong Kong SAR, Korea, Singapore, China.
    - Cons/Considerations: Maybe not so relevant for Indonesia given relatively subdued credit growth; affects only real estate transactions.
  - Higher reserve requirement on FX liabilities than on local currency liabilities
    - Examples: Thailand (2006–2008), Croatia, Romania.
    - Pros: Prudential measures are not capital controls and do not result in negative investor sentiment; does not require additional administrative resources and can be administered within existing reserve requirement framework.
    - Cons: Inflows to Indonesia are through portfolio investment rather than banks; may lead to disintermediation via offshore borrowing by nonfinancial private sector or through institutions not subject to reserve requirements.
    - Operational note: Thailand applied an effective unremunerated reserve requirement of 55 percent to increases in banks’ foreign liabilities until 2009.
  - Limits to direct and indirect FX exposure
    - Examples: Korea (2010), Romania.
    - Pros: Prudential measures are not capital controls and do not always involve negative investor sentiment.
    - Indonesia specifics: already has FX NOP limits of 20 percent of regulatory capital, and banks maintain even smaller ratios; FX loans have fallen to 15–16 percent of total loans.
    - Cons/Considerations: Inflows are portfolio-driven and may lead to disintermediation.
  - Liberalization of controls on residents' outward investments
    - Examples: Thailand, China.
    - Pros: Viewed as improving the investment environment.
    - Considerations: Preconditions for liberalization must be in place (e.g., prudential ratios for exchange rate risk management).
  - Tax on portfolio inflows
    - Examples: Brazil (2 percent tax on portfolio inflows imposed in October 2009), Thailand (2006); discussed by Russia.
    - Pros: Some studies show such taxes might modestly lengthen maturity of inflows.
    - Cons: Could reverse positive sentiment, raise local currency borrowing costs, create market dislocations or misreporting as investors attempt to go around regulations; requires effective tax collection and imposes additional burden on financial intermediaries; rate should be carefully calibrated to avoid collapse of stock exchange; may be circumvented if not broad based.
  - Ban on foreigners buying central bank bills
    - Example: Iceland currently.
    - Pros/Considerations: Relatively easy to administer; affects only a relatively minor segment of investments.
    - Cons: Creating a wedge between SBIs and SUNs might further impede deepening of the yield curve; additional provisions needed to minimize circumvention.
  - Minimum maturity requirements for certain types of inflows
    - Examples: Thailand, Colombia.
    - Cons: Distorts investment decisions, destroys secondary market liquidity, may raise cost of borrowing; administratively cumbersome and requires cooperation of securities depository, banks and brokers.
  - Other bans on foreign access
    - Example: Taiwan POC barred access to time deposit accounts for foreign investors.
    - Considerations: Local banks need to participate in administration; compliance needs monitoring.
- Administrative / operational context:
  - Indonesia has a reporting regime for foreign ownership of fixed income investments administered through onshore custodians.
  - Reporting requirements were strengthened effective January 1, 2010 such that nonresident investors are required to periodically supply verified documentation to be granted the lower withholding tax specified under double taxation treaty agreements.

*Italic: APPENDIX I: Indonesia—Capital Inflows and Policy Response (source content provided).*

---

### APPENDIX II: INDONESIA—PUBLIC AND EXTERNAL DEBT SUSTAINABILITY IN THE BASELINE SCENARIO

### A. Public Debt — key findings and projections
- Recent debt dynamics and drivers:
  - Public sector debt is low and declining despite the global shock in 2009.
  - Debt ratio fell to a record-low level of 29 percent in 2009 owing to prudent fiscal management, which led to primary fiscal surpluses averaging almost 1.6 percent of GDP per year in the last decade and a modest fiscal stimulus in response to the global shock in 2009.
  - Reduced inflation, lower interest rates, and high real GDP growth contributed to debt consolidation.
  - Foreign-currency debt (mostly due to multilateral institutions) has fallen markedly to less than half of total debt as the improved fiscal position facilitated government access to the domestic capital market.
- Baseline projections:
  - Public debt is likely to fall to about 27 percent of GDP in 2010, reflecting rupiah appreciation and robust economic growth.
  - Medium term: gradual fiscal consolidation starting in 2011 (based on subsidy reduction and tax administration reforms) and continued strong economic growth will support a further decline in public debt to 23 percent of GDP by 2015.
  - Strategy implication: ensure a primary balance near zero while accommodating extra resources for development spending.
- Debt sustainability and stress tests:
  - Public debt is sustainable and robust to macroeconomic and oil price shocks; standard stress tests suggest debt ratio likely to remain modest under shocks from contingent liabilities, sharp exchange rate movements, and higher interest rates.
  - Specific stress-test outcomes:
    - Fiscal contingent liabilities amounting to 10 percent of GDP could raise the public sector debt to 32 percent of GDP by 2015.
    - Currency depreciation of 30 percent would raise the debt ratio to about 29 percent of GDP by 2015.
    - An increase in real interest rates would raise the debt ratio to 26 percent by 2015.
  - Stochastic simulations: maximum likely debt level under macroeconomic and oil price shocks is relatively moderate at about 35 percent of GDP in the 95 percent confidence interval.

### B. External Debt — key findings and projections
- Recent trend:
  - External debt continues on a steady downward trend after a temporary spike in 2009.
  - The sharp nominal depreciation of late 2008 and early 2009 temporarily led to an increase in the external debt-to-GDP ratio from 30 percent to 32 percent.
  - Strong growth and the rapid turnaround in the exchange rate are reversing this increase, with the ratio projected to reach 27 percent of GDP as early as end 2010.
- Baseline projections and drivers:
  - External debt projected to continue on a declining path over the medium-term, reaching 20 percent of GDP by 2015.
  - Factors expected to more than offset a weakening current account balance (projected to reach -1 percent of GDP by 2015):
    - (i) sustained high real GDP growth in the range of 6.5−7.0 percent per year;
    - (ii) increasing non-debt creating (i.e., FDI) flows;
    - (iii) some further real appreciation.
  - Medium-term non-interest current account balance projected at -0.4 percent of GDP, remaining comfortably above the debt-stabilizing level (−2.5 percent of GDP).

*Italic: APPENDIX II: Indonesia—Public and External Debt Sustainability in the Baseline Scenario (source content provided).*

### 6.      External sustainability is robust to most shocks. The external debt ratio is expected

### 6.      External sustainability is robust to most shocks.

### Summary findings
- The external debt ratio is expected to follow a declining path and remain at manageable levels under all standardized-shock scenarios presented.
- A one-time 30 percent real exchange rate depreciation would have the largest impact, raising the debt ratio by 14 percentage points in 2011, and 11 percentage points over the baseline by 2015.
- Individual shocks analyzed include: interest rate shock, growth shock, noninterest current account shock, combined shock, and a 30 percent real depreciation shock.

### Scenario results and shock impacts
- One-time real depreciation shock:
  - 30 percent real depreciation in 2009 defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
  - Impact on external debt ratio: +14 percentage points in 2011; +11 percentage points over baseline by 2015.
- Interest rate shock (figure box values):
  - Baseline:     3.5
  - Scenario:    4.0
  - Historical:   3.5
- Growth shock (figure box values):
  - Baseline:     5.3
  - Scenario:    4.5
- Noninterest current account shock (figure box values):
  - Baseline:     0.1
  - Scenario:   -1.4
  - Historical:   4.9
- Combined shock (figure box value): 31
- Gross financing need under baseline (figure box): 21

### Key statistics from the External Debt Sustainability Framework (Table II.2)
- Baseline: External debt series (in percent of GDP): 46.5 35.8 32.0 32.0 32.0 27.3 25.7 24.3 22.9 21.6 20.4 -2.5
- Change in external debt (in percent of GDP): -6.9 -10.6 -3.9 -1.7 1.7 -4.8 -1.6 -1.4 -1.4 -1.3 -1.2
- Identified external debt-creating flows (in percent of GDP): -7.1 -14.0 -9.5 -5.7 -4.1 -2.9 -2.5 -2.0 -1.6 -1.6 -1.5
- Current account deficit, excluding interest payments (in percent of GDP): -1.8 -4.3 -3.5 -0.9 -2.7 -1.4 -0.6 -0.1 0.2 0.3 0.4
- Exports (in percent of GDP): 35.0 31.6 30.2 30.3 24.7 23.4 22.1 21.0 20.1 19.4 18.6
- Imports (in percent of GDP): 32.0 26.1 -21.7 -21.8 -17.0 -16.8 -15.8 -15.0 -14.3 -13.9 -13.3
- Net nondebt creating capital inflows (negative, in percent of GDP): -1.6 -1.0 -1.5 -0.7 -0.5 -0.6 -1.0 -1.1 -1.1 -1.1 -1.2
- Automatic debt dynamics (in percent of GDP): -3.7 -8.7 -4.6 -4.1 -0.8 -0.9 -1.0 -0.9 -0.8 -0.8 -0.7
- External debt-to-exports ratio (in percent): 133.0 113.5 105.9 100.1 129.7 116.6 116.1 115.9 114.1 111.6 110.0
- Gross external financing need (in billions of U.S. dollars): 26.7 32.8 33.6 59.1 47.2 54.0 66.5 78.4 88.8 99.0 109.0
- Gross external financing need (in percent of GDP): 9.3 9.0 7.8 11.6 8.8 7.8 8.7 9.3 9.6 9.7 9.6

### Baseline macroeconomic assumptions underlying the external baseline
- Real GDP growth (in percent): 5.7 5.5 6.3 6.0 4.5 6.0 6.2 6.5 6.7 7.0 7.0
- GDP deflator in U.S. dollars (change in percent): 5.2 20.8 11.6 11.6 0.9 20.5 4.1 3.5 3.4 3.5 3.4
- Nominal external interest rate (in percent): 3.5 3.7 3.4 3.2 2.6 2.3 2.2 2.6 3.2 3.4 3.3
- Growth of exports (U.S. dollar terms, in percent): 20.7 15.1 13.4 18.7 -14.0 20.8 4.6 4.4 5.7 6.8 6.0
- Growth of imports (U.S. dollar terms, in percent): 28.0 4.1 -198.3 18.9 -17.7 26.3 4.2 4.1 5.7 7.1 6.3
- Current account balance, excluding interest payments (in percent of GDP): 1.8 4.3 3.5 0.9 2.7 1.4 0.6 0.1 -0.2 -0.3 -0.4
- Net non-debt creating capital inflows (in percent of GDP): 1.6 1.0 1.5 0.7 0.5 0.6 1.0 1.1 1.1 1.1 1.2

### Robustness and policy implications (implied by scenarios)
- External debt dynamics are resilient to a range of standardized shocks; the largest vulnerability is an abrupt large real depreciation.
- Monitoring and managing exchange rate risks and contingent liabilities is important given the size of the impact from a 30 percent real depreciation.
- Maintaining favorable growth and current account dynamics supports a declining external debt path and manageable gross external financing needs.

*Sources: International Monetary Fund; Country desk data; and staff estimates.*

### ANNEX III: INDONESIA—RELATIONS WITH THE ASIAN DEVELOPMENT BANK

### ANNEX III: INDONESIA—RELATIONS WITH THE ASIAN DEVELOPMENT BANK

### ADB operations and recent approvals
- As of end-December 2009, Asian Development Bank (ADB) cumulative loans to Indonesia reached $25.7 billion.
- In 2009, the ADB approved a total of $2,184 million or 16.5 percent of the total loans approved by the institution for the year.
- More than 90 percent of the loans approved in 2009 were provided through four policy-based operations.
  - Two loans in 2009 supported the Government’s efforts to mitigate the effects of the global economic crisis.
  - Two loans in 2009 supported the Government’s medium-term reform agenda in capital market development, investment climate, public financial management, and poverty alleviation.

### Country Partnership Strategy and sector priorities
- ADB is preparing a Country Partnership Strategy with the Government of Indonesia to cover the period 2011−2015.
- The strategy will be aligned with the Government’s medium-term development plan (RPJM) for 2010−2014.
- Anticipated core areas of assistance: transport, energy, financial sector, natural resource management, water supply and sanitation, and education—consistent with ADB’s Long-Term Strategic Framework.
- Cross-cutting emphases: good governance, gender equality, environmental sustainability, regional cooperation.
- Special emphasis: assist the Government to implement its Climate Change action plan.

### Technical Assistance (TA)
- Between 1967 and 2009, ADB provided 504 Technical Assistance grants to Indonesia amounting to $282.9 million.
- TA grants were financed from ADB’s Technical Assistance Special Fund, the Japan Special Fund, and other sources.
- Measured by cumulative TA approvals, Indonesia is the second largest recipient of TA support from the ADB.

### Sovereign and Nonsovereign Loan Approvals and Disbursements (annual figures)
- Loan approvals by year (in millions of U.S. dollars):
  - 2004: 225.0
  - 2005: 1,145.69
  - 2006: 784.8
  - 2007: 1,187.1
  - 2008: 1,085
  - 2009: 2,184.2
- Loan disbursements by year (in millions of U.S. dollars):
  - 2004: 593.5
  - 2005: 1,014.99
  - 2006: 1,025.88
  - 2007: 1,136.3
  - 2008: 949.6
  - 2009: 739.3

### Cumulative lending to Indonesia by sector (As of December 31, 2009)
- Total: 303 loans; $25,707.54 million; 100.00 percent
- Agriculture and Natural Resources: 99 loans; $4,047.00 million; 15.74 percent
- Education: 32 loans; $2,222.35 million; 8.64 percent
- Energy: 31 loans; $3,781.05 million; 14. 71 percent
- Finance: 20 loans; $3,526.10 million; 13. 72 percent
- Health and Social Protection: 13 loans; $1,068.30 million; 4.16 percent
- Industry and Trade: 12 loans; $645.70 million; 2.51 percent
- Public Sector Management: 16 loans; $4,167.22 million; 16.21 percent
- Multisector: 16 loans; $1,586.22 million; 6.17 percent
- Transport and ICT: 33 loans; $2,713.86 million; 10.56 percent
- Water Supply and Other Municipal Infrastructure and Services: 31 loans; $1,949.74 million; 7.58 percent

### Statistical issues for surveillance (summary)
- General: Indonesia’s macroeconomic statistics are broadly adequate to conduct effective surveillance.
- National accounts:
  - Quarterly GDP data are published in a timely manner for both expenditure and production sides.
  - Annual national accounts have 2000 as the base year.
  - Estimates rely on a limited set of indirect indicators of uncertain quality.
  - Seasonally adjusted data are prepared but not published.
  - No survey of nonfinancial services is prepared.
  - Fund recommendations (selected):
    - development of a system to continuously update the census of businesses;
    - introduction of comprehensive annual establishment surveys for nonfinancial services industries;
    - publication of annual GDP estimates, including a time series of at least 20 years;
    - development of a set of annual supply and use tables (SUTS) starting from 2000;
    - enhancing the convergence exercise on trade data between Bank Indonesia (BI) and Ministry of Finance (MoF).
- Price statistics: broadly adequate for surveillance.
- Government finance statistics:
  - Data suffer from weaknesses in classification, coverage, and timeliness.
  - Central government budget data available with a one-month lag; subnational government data available only with a lag of two years and variable quality.
  - Recent decentralization has shifted substantial resources to subnational governments, compounding problems.
  - Progress underway: adoption of advanced accounting and statistical standards; introduction of best practice budget management processes; development of computerized financial management information systems.
  - Coverage and timeliness of public debt statistics generally adequate.
  - New expenditure classification introduced in the 2005 budget is generally consistent with GFSM 2001 on functional codes and classification, although data are compiled on a cash basis.
  - Authorities committed to adopting GFSM 2001 standards.
  - Fund staff short-term recommendations (selected):
    - establishment of a register of all extrabudgetary units;
    - inclusion of economic codes consistent with GFSM 2001 in the chart of accounts so general government units report all transactions and balances over which they exert control.
  - Medium-term priorities:
    - establish reporting arrangements to obtain timely preliminary data for local government statistics;
    - develop GFSM 2001 operating statements, statements of sources and uses of cash, and partial balance sheets for publication on the MoF websites.
  - A system has been set up to allow automatic conversion of budget files to GFSM 2001 data; these data are yet to be published on the MoF website.
- Monetary statistics:
  - Good quality monetary statistics are compiled by BI on a timely basis.
  - With STA assistance, BI developed an integrated database enabling alternative presentations of monetary statistics.
  - STA recommended expansion of coverage to include mutual funds.
  - Additional challenges include timely revisions of published banking sector data after supervisory verification.
- Balance of payments:
  - Trade data have shortcomings: customs sources used by BI are generally reliable, but coverage of merchandise trade flows is insufficient.
  - When the online reporting system for exports and imports was introduced in 2004, the historical series were reconstructed only as far back as 2003, so prior to 2003 BOP statistics are not entirely consistent with national accounts estimates.
  - Exports and imports volume data, and trade deflators, are incorrectly computed as aggregate indexes that do not weight sub-category volumes by economic value.
  - FDI data methodology needs substantial improvement:
    - inflows are calculated based on loan disbursements to companies with foreign equity using a fixed ratio to estimate equity inflows;
    - BI surveys to collect FDI data have low response rates and directory coverage should be improved.
  - Other needed improvements: recording of trade credits; asset data for portfolio and other investment transactions.
  - Errors and omissions have been significant at times and appear related to methodology for unrecorded assets in the financial account.
  - Financial transactions data have not been reconciled with changes in the International Investment Position (IIP).
  - Annual IIP is compiled, but underlying data are weak, notably for FDI; published IIP data should include a higher degree of disaggregation.
  - External debt statistics improved with introduction of an External Debt Information System (EDIS) in 2002 and recent initiative to publish monthly indicators.
  - Further improvements needed for private corporate sector components: distinguishing scheduled versus actual debt service; estimating accumulation/reduction of private sector payment arrears; estimating rescheduling and debt reductions received by the private sector from external creditors.

### Data standards and reporting
- Subscriber to the Special Data Dissemination Standard (SDDS) since September 1996, observing most of the SDDS requirements.
- Data ROSC completed in 2005.

### IMF staff update (information available after staff report; Aug 27, 2010)
- Q2 2010: economic recovery continued with 6.2 percent annual real GDP growth.
  - Private consumption continues to drive growth; investment (including rebounding FDI inflows) contributed significantly.
  - Credit growth continued; July showed an increase of 19½ percent (y/y).
  - Net exports contribution declined somewhat due to acceleration of investment-related imports but remained positive.
  - Balance of payments surplus narrowed in Q2 2010 primarily due to slowdown in portfolio inflows linked to European debt crisis turbulence and a marginally weaker current account amid strong imports.
  - These developments are consistent with the projections for 2010 in the staff report.
- Inflation outlook revised upward for 2010:
  - Annual average: 5 percent (revised up by ¼ percentage point).
  - Year-end: 6 percent—the upper end of Bank Indonesia’s (BI) target range.
  - Headline inflation rose to 6¼ percent in July.
  - Core inflation increased in July to near 4 percent.
  - BI’s August policy statement signaled some concern over price pressures.
- Market sentiment and capital flows:
  - During July and August (2010), the rupiah traded at about Rp 9,000 per U.S. dollar.
  - Local government debt yields continued to fall despite the uptick in inflation.
  - Net foreign purchases of BI certificates (SBIs) kept pace with those of government notes at US$2 billion since the beginning of July, indicating continued appetite for SBIs despite the one-month holding period requirement announced on June 16.

*Prepared by ADB staff; statistical and IMF staff updates as of June 9, 2010 and August 27, 2010 respectively.*

### 4.      The government revised down its estimate for the overall 2010 budget deficit to

### _cr10284 - 4.      The government revised down its estimate for the overall 2010 budget deficit to

### Fiscal outlook and government budget
- Government revised down its estimate for the overall 2010 budget deficit to 1½ percent of GDP from 2 percent, largely reflecting higher projected revenue and slower capital spending.
- The preliminary 2011 budget framework released on August 17 projects an overall deficit of 1¾ percent of GDP, reflecting a planned increase in capital spending and improved revenue collections (in line with staff projections).
- Fiscal indicators and selected public finance figures (as reported):
  - Central government revenue: 17.9 (2007), 19.8 (2008), 15.1 (2009), 15.4 (2010 proj.), 15.4 (2011 proj.)
  - Central government expenditure: 19.1 (2007), 19.9 (2008), 16.7 (2009), 16.8 (2010 proj.), 17.2 (2011 proj.)
  - Central government balance: -1.2 (2007), -0.1 (2008), -1.6 (2009), -1.5 (2010 proj.), -1.7 (2011 proj.)
  - Primary balance: 0.8 (2007), 1.7 (2008), 0.1 (2009), 0.1 (2010 proj.), -0.1 (2011 proj.)
  - Central government debt: 36.9 (2007), 33.2 (2008), 28.6 (2009), 26.7 (2010 proj.), 26.3 (2011 proj.)
- Executive Directors endorsed the overall fiscal stance for 2010 and recommended:
  - Reducing energy subsidies to create fiscal space for infrastructure spending and transfer programs for the poor.
  - Better budget execution to strengthen fiscal policy effectiveness.
  - Efforts to expand the tax base and raise revenue ratios.

### Growth, demand, and external sector
- Recent growth and outlook:
  - Real GDP: 6.3 (2007), 6.1 (2008), 4.5 (2009), 6.0 (2010 proj.), 6.2 (2011 proj.)
  - Private consumption: 5.0 (2007), 5.3 (2008), 4.9 (2009), 5.3 (2010 proj.), 5.5 (2011 proj.)
  - Gross fixed investment: 9.4 (2007), 11.9 (2008), 3.3 (2009), 7.9 (2010 proj.), 8.2 (2011 proj.)
  - Net exports contribution to GDP growth: 0.6 (2007), 0.7 (2008), 1.2 (2009), 0.5 (2010 proj.), 0.6 (2011 proj.)
- Saving and investment (percent of GDP):
  - Gross investment: 25.0 (2007), 27.7 (2008), 31.1 (2009), 31.9 (2010 proj.), 32.6 (2011 proj.)
  - Gross national saving: 27.4 (2007), 27.7 (2008), 33.0 (2009), 32.8 (2010 proj.), 32.7 (2011 proj.)
- Balance of payments and trade (billions of U.S. dollars):
  - Non-oil exports (f.o.b): 93.1 (2007), 107.9 (2008), 99.1 (2009), 123.3 (2010 proj.), 129.2 (2011 proj.)
  - Non-oil imports (f.o.b): -66.1 (2007), -92.8 (2008), -72.2 (2009), -94.7 (2010 proj.), -103.7 (2011 proj.)
  - Current account balance: 10.5 (2007), 0.1 (2008), 10.6 (2009), 6.4 (2010 proj.), 0.5 (2011 proj.)
  - Overall balance: 12.7 (2007), -1.9 (2008), 12.4 (2009), 16.4 (2010 proj.), 7.5 (2011 proj.)
- Gross reserves:
  - In billions of U.S. dollars (end period): 54.1 (2007), 52.1 (2008), 66.1 (2009), 82.5 (2010 proj.), 90.0 (2011 proj.)
  - In months of imports: 4.5 (2007), 5.6 (2008), 5.5 (2009), 6.3 (2010 proj.), 6.3 (2011 proj.)
  - As a percent of short-term debt: 157.4 (2007), 141.5 (2008), 203.7 (2009), 226.4 (2010 proj.), 223.5 (2011 proj.)
- Total external debt:
  - In billions of U.S. dollars: 137.4 (2007), 149.7 (2008), 172.8 (2009), 187.7 (2010 proj.), 195.5 (2011 proj.)
  - In percent of GDP: 31.8 (2007), 29.3 (2008), 32.0 (2009), 27.0 (2010 proj.), 25.2 (2011 proj.)

### Inflation and monetary policy
- Inflation developments:
  - Inflation decelerated to 2.8 percent in 2009 (year-on-year) and was increasing slightly in 2010.
  - Consumer prices (end period): 5.6 (2007), 11.1 (2008), 2.8 (2009), 5.9 (2010 proj.), 5.8 (2011 proj.)
  - Headline inflation lifted to 6.2 percent (y/y) in July 2010; core inflation held at 4.2 percent (y/y).
  - Bank Indonesia’s inflation target range: 5–6 percent in 2010 (authorities’ stated target).
- Bank Indonesia (BI) policy stance and measures:
  - BI left the policy rate unchanged since September 2009 after easing by 300 bps during the crisis; policy rate remained at a historic low of 6½ percent.
  - BI widened its policy rate corridor by 100 basis points to 5.5 percent to 7.5 percent.
  - BI shifted the maturity structure of SBIs from one month to 3- and 6-months, plans to introduce 9- and 12-month bills later in the year.
  - A one-month holding period on SBIs across the board was introduced to help reduce money market volatility.
  - Additional measures introduced in mid-June 2010 included: requiring a minimum 1-month holding of SBIs, introducing 9- and 12-month SBIs, doubling the interest margin to 100 bps from the policy rate on overnight borrowings and deposits with the central bank, and creating a term-deposit facility.
  - One-month SBI rate (period average): 8.6 (2007), 9.1 (2008), 7.4 (2009).
- Executive Directors’ monetary recommendations:
  - Maintain exchange rate flexibility to manage capital flow volatility.
  - Support the one-month holding period for BI certificates to reduce short-term volatility.
  - Gradually convert nonmarketable government bonds in BI’s balance sheet to marketable bonds to lower sterilization costs and expand BI’s operational toolkit.
  - Signal readiness to respond to rising inflationary pressures to anchor inflation expectations within the 4–6 percent target range.
  - Caution against administrative measures to fuel credit growth.

### Capital flows, exchange rate, and reserves management
- Capital flows and market reactions:
  - Capital flows were buoyant, driven in part by ratings upgrades; large portfolio inflows into government bonds and SBIs.
  - Volatility increased in May following the European crisis, with about US$5.75 billion of capital outflows—mostly SBIs—inflows have since returned.
  - In the first four months of 2010 foreign inflows caused the rupiah to surge by more than 4 percent and reserves to reach nearly USD79 billion.
  - Subsequent sell-off amounted to USD5.7 billion in a month, putting pressure on the rupiah (weakened nearly 2 percent) and causing reserves to drop by USD4 billion.
- Policy tools to manage inflows and volatility aimed to reduce attractiveness of short-term carry trades and encourage longer-term investment.

### Financial sector resilience and supervision
- Banking sector performance and indicators:
  - Banks maintained high capital adequacy ratios and remained profitable.
  - Gross nonperforming loans increased but the ratio remained low at 3.2 percent (general mention) and around 3.3 percent (June 2010 industry average NPL).
  - Credit growth: 10 percent in 2009 and 19½ percent growth in the year to July (2010); loan growth reported back to pre-crisis level of 18 percent in recent months.
  - Industry’s average CAR reached 17.4 percent in June 2010.
  - Over 50 percent of banks’ financial products are in the form of Micro, Small and Medium Enterprises (MSME) loans.
- Executive Directors and authorities’ actions and recommendations:
  - Commended steps to strengthen financial sector resilience in line with FSAP recommendations, including enactment of the Financial System Safety Net Law, introducing a prompt corrective action regime, and enforcement of creditors’ rights.
  - Emphasized proper coordination of macro- and micro-prudential supervision and development of capital markets to diversify funding.

### Executive Board assessment and medium-term priorities
- Directors commended Indonesia’s policy performance during the global financial crisis and noted opportunities to sustain or accelerate growth given favorable public debt dynamics, sovereign ratings upgrades, and higher global risk appetite.
- Key medium-term priorities and recommendations:
  - Maintain an appropriate policy mix in a volatile external environment.
  - Improve public infrastructure and the business climate to raise growth potential.
  - Address potential competitiveness pressures from rupiah appreciation by removing supply constraints.
  - Continue fiscal reforms, including subsidy reform and revenue mobilization, to support sustained high growth.
  - Reduce sterilization costs and expand BI’s operational toolkit through bond market development.

*Public Information Notice (PIN) No. 10/130 — IMF Executive Board Concludes 2010 Article IV Consultation with Indonesia; September 16, 2010.*

### 10. As monetary policy in Indonesia remains to face challenges from distorted transmission

### 10. As monetary policy in Indonesia remains to face challenges from distorted transmission

### Monetary policy and Inflation Targeting Framework (ITF)
- ITF has anchored inflation expectations and prevented excessive CPI pressures despite:
  - distorted transmission mechanism of sticky downward bank interest rates;
  - prevailing supply side constraints.
- Bank Indonesia’s (BI) liquidity management and money supply control have been effective in containing demand-pull inflationary pressures.
- Authorities’ challenges and responses:
  - Implement appropriate policy mix and improve effectiveness of communication in the ITF.
  - Improve cross-institutional coordination and reinforce industrial structure.
  - Established the Inflation Monitoring and Control Team at central and regional government levels to intensify coordination and communication.
- Ongoing structural constraints prioritized by authorities:
  - high cost of banking fund;
  - excess liquidity in financial market;
  - lack of adequate infrastructure;
  - inefficiency of distribution channels;
  - imperfect market structure.
- Policy emphasis:
  - strengthen economic institutions;
  - accelerate infrastructure development to expand production capacity and economic capacity in general.

### External vulnerabilities and reserves management
- Capital flow risks:
  - Open capital account and recent massive foreign capital inflows increase vulnerability to sudden reversal or capital flight.
- Foreign exchange reserves:
  - Reserves increased around USD 18 billion since September 2008.
  - A large sell-off in foreign holdings could rapidly reduce reserves if BI defends the Rupiah.
  - Importance of a deep reserves cushion to stem excessive currency volatility.
- BI balance sheet concerns:
  - BI incurs growing costs paying relatively high domestic interest rates compared to low earnings on reserve assets.
  - Government and BI discussions initiated to make non-marketable government securities held by BI sellable to the market to improve monetary management and strengthen BI’s balance sheet.

### Fiscal policy: stimulus, consolidation, and revenue measures
- 2009 fiscal stimulus:
  - Substantial stimulus involving tax relief and measures to safeguard public purchasing power.
  - 77 percent of the stimulus package allocated to tax savings and tax subsidies for business; remaining delivered through infrastructure spending.
  - Size of package around 1.3 percent of GDP.
  - Package increased the 2009 budget deficit by 1.6 percent of GDP above the original target of 1 percent of GDP.
- 2010 fiscal stance:
  - Magnitude of 2010 fiscal stimulus lowered to 0.8 percent of GDP while maintaining countercyclical policy.
  - Stimulus primarily tax incentives (corporate income tax cut of 5 percent for listed companies and 3 percent for non–listed companies; abolition of luxury tax for some high-tech industries).
  - Shortfall of tax revenues expected to be offset by better collection efforts owing to improved administration and taxpayer compliance.
  - Authorities prioritize raising tax revenue ratios by broadening the tax base and improving tax administration effectiveness.
- Energy price reforms:
  - Authorities acknowledge importance for fiscal sustainability and downside risks of delay.
  - Favor gradual approach due to vulnerability of purchasing power for corporate and households.
  - July 2010: electricity subsidy reduction via tariff increases around 10 to 15 percent on average (18 percent maximum) excluding small customers.
  - Administered fuel price adjusted when world oil price deviates more than 10 percent from the assumption.
  - Authorities remain committed to undertake fuel price reforms as conditions allow.
- Fiscal outcomes and financing:
  - Government reduced projected budget deficit to 1.5 percent of GDP.
  - To finance lower deficit, government cut plan on spending the 2009 financing surplus and decreased bond issuance.
  - Debt to GDP ratio recorded 26 percent.
  - By early August 2010, government sold IDR132 trillions of conventional and sharia bonds and USD2 billion global bonds.
  - Projected 2011 budget deficit: 1.7 percent of GDP (slightly higher than 2010).

### Banking policy and financial sector resilience
- Post-1997/1998 reforms greatly strengthened the financial system.
- Banking sector:
  - Represents 80 percent of overall financial sector assets.
  - FSAP stress test results suggest resilience to various shock scenarios and robust condition to support higher economic growth.
- BI policy measures:
  - Focused on improving banking industry resilience and strengthening intermediation.
  - Macroprudential adjustments to reduce pro-cyclicality of bank lending by linking reserve requirement to banks’ Loan to Deposit Ratio (LDR).
  - LDR-linked reserve requirement has been implemented for years and revised to incorporate an automatic brake when credit growth is relatively high.
- Regulatory and supervisory progress:
  - Authorities active in G-20, FSB, and BCBS; committed to implement internationally agreed rules and robust supervision.
  - Joint IMF-WB FSAP conducted for the first time in Indonesia; authorities prepared action plans to respond to FSAP findings.
  - Priorities include bolstering compliance in the banking sector and with Basel Core Principles (BCP).
- Crisis management and supervisory architecture:
  - Minister of Finance, BI Governor, and Chairman of Deposit Insurance Company signed an MOU to clarify roles and responsibilities of financial safety net participants.
  - Authorities committed to adopt the revised Financial System Net Law (draft submitted for Parliamentary approval).
  - Re-embarked initiative to integrate bank and other financial institution supervision, including capital market supervision, into a new unified supervisory body.
  - Process underway to define macro-micro supervisory responsibilities between the central bank and a newly proposed agency.
  - Central bank to continue analysis of macro-prudential regulation tailored to Indonesia; comprehensive central bank role in macro-prudential surveillance to prevent systemic risks is recognized.

### Final remarks and outlook
- Authorities overcame 2009 challenges with achievements in macroeconomic and financial stability while continuing structural reforms.
- Looking forward:
  - Global recovery, persistently strong domestic demand, and rising capital inflows present challenges in implementing appropriate policy mix amid wide-ranging global uncertainty.
  - Authorities welcome a strengthened relationship with the Fund to help address challenges and achieve a prosperous future.

*IMF Staff Country Report content unit: 10. As monetary policy in Indonesia remains to face challenges from distorted transmission*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10284.pdf_