## _cr12277 (selected sections from 2012 ARTICLE IV REPORT INDONESIA) ## Source details **Canonical URL:** [_cr12277 (selected sections from 2012 ARTICLE IV REPORT INDONESIA)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12277.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12277.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12277.pdf.json) --- ### Global spillovers, risks, and transmission channels - Key findings - Financial shocks have a larger impact on Indonesian growth than shocks to external growth or commodity prices. - A one standard deviation decline in global growth (equivalent to 0.6 percentage points) would reduce Indonesian growth by 0.2 percentage points within a year. - An increase in the VIX by one standard deviation (8 points) would result in lower Indonesian growth of about 0.3 percentage points. - Higher oil prices (used here as a proxy for commodity prices in general) support growth because Indonesia is a commodity exporter. - Transmission channels and magnitudes - Trade channel - A one standard deviation decline in global growth would lower real exports of goods and services by about 8 percent. - Chinese GDP growth has about one-fifth the impact of global growth on exports controlling for commodity prices. - Financial channel - A one standard deviation (8 point) rise in the VIX lowers portfolio and other capital flows by about $1.5 billion. - Contagion can occur through foreign investor retreat from local capital markets, especially the bond market where foreign presence is large in Indonesia. - Commodity channel - As a commodity exporter, Indonesia benefits from higher commodity prices; commodity-price shocks can have supportive effects on growth. - Quantitative evidence and model specification - Analysis uses a Bayesian Vector Autoregression ordered: VIX, external GDP growth, global oil price, net portfolio and other capital flows, exports, and domestic GDP growth. - Impulse responses show negative accumulated responses of output growth to VIX and global output shocks; large negative capital inflow responses to VIX shocks; and reductions in real exports to global/China output shocks. - Policy implications - Safeguard against rapid portfolio outflows and elevated foreign participation in local currency debt markets. - Strengthen market liquidity and foreign exchange market functioning to mitigate sudden investor retrenchment. - Prepare for China slowdown effects via fiscal buffers, public investment, and maintaining cost competitiveness. ### China’s growth pattern and implications for Indonesia - China-driven commodity demand and Indonesia’s exports - Indonesia accounted for 30 percent of China's coal imports. - China accounted for 20 percent of Indonesia's palm oil exports. - Palm oil and rubber exports to China have grown materially (values shown in source charts). - Macrofinancial model estimates (extended Global Projection Model estimated with Bayesian techniques) - A 1 percentage point increase in the spread leads to a 0.15 percent change in the output gap, compared to 0.13 percent for the policy rate. - Inflation drivers: about 40 percent of the dynamics accounted for by domestic supply and another quarter by global prices. - A 1 percent reduction in the output gap decelerates inflation by 0.26 percent. - Second-round effects: a 1 percentage point increase in the difference in headline from core leading to a 0.45 percentage point increase in core inflation. - Interest volatility (GARCH(1,1) JIBOR volatility controlling for policy rate) negatively impacts the output gap. - Policy implication - Scope exists to reduce inflationary pressures by lowering the spread between money market and policy rates rather than hiking the policy rate itself. ### Liquidity, monetary operations, and market rates - Liquidity and market operations - Liquidity built up despite numerous instruments; Bank Indonesia’s outright purchases of government securities rose sharply (negative is liquidity injection in source charts). - Declining yields accompanied excess liquidity. - Long-term inflation expectations are persistently higher than in other inflation targeting ASEAN countries. - Policy transmission and market structure - Pass-through of policy rate to lending rates is weaker relative to Thailand and Philippines. - Volatility of 1-Month money market rates has risen. - Recommendations for Bank Indonesia (BI) - Reiterate operational target: keep the overnight money market rate broadly in line with the policy rate. - Rationalize open market instruments and refrain from intervening in the secondary market for government paper except in extreme dysfunction. - Ensure foreign exchange and rupiah operations are predictable and supportive of market making. - Improve infrastructure and legal basis for the interbank repo market to address segmentation. ### Exchange rate flexibility, reserves, and external position - Assessment and projections - Indonesia’s external position appears moderately stronger than implied by medium-term fundamentals and desirable policies. - Preliminary model: the real effective exchange rate is moderately undervalued by 0 − 10 percent. - Medium-term structural current account balance: should be a deficit of 2 percent of GDP, compared with the 0.2 percent surplus recorded in 2011. - The current account is expected to turn into a small deficit of around 2 percent in 2012 and in the medium term. - Reserves are well above standard metrics and the IMF’s composite adequacy metric; in the middle of the range among regional peers. - Policy implications - Increase exchange rate flexibility, combined with judicious use of reserves, to address market tensions and smooth sharp, temporary supply–demand mismatches. - More explicit public statement prioritizing domestic price stability over exchange rate considerations would be helpful. ### Investment, macroeconomic volatility, and financial depth - Investment drivers and constraints - Rising investment has driven recent robust growth; much recent investment concentrated in the mining sector. - Public investment ratio remains among the lowest in the region; infrastructure needs are pressing. - Empirical determinants of investment - Investment negatively correlated with interest rate volatility, exchange rate volatility, and the real lending rate; positively correlated with terms of trade improvements. - Interest rate volatility became more important post-2005; coefficient nearly doubled in post-2005 regressions. - Firm-level evidence: investment sensitive to internal cash positions; local currency bond market is thin relative to regional peers. - Policy implication - Reduce interest and exchange rate volatility and deepen capital markets (particularly the local currency bond market) to support sustained investment growth. ### Monetary policy stance, liquidity, and credit (recent developments) - Monetary and liquidity stance - BI widened operational corridor to a non-symmetric corridor (-200bps and +100bps from the policy rate); lower end increased by 25bps recently. - Money market rates have risen 30−50 basis points; lower bound increased by 25 bps. - BI uses dual intervention: FX market intervention and purchases of government bonds in the secondary market (used as reverse repo instrument). - Credit and banking indicators - Credit growth: 26 percent year-on-year; decompositions show investment credit growth 29.1%, working capital 28.2%, consumption credit 19.6%; total credit growth reported as 25.6% in source. - Banking system: capital adequacy ratio above 8 percent; gross non-performing loan below 5 percent. - Macroprudential measures - Loan-to-Value (LTV) ratio for automotive and mortgage credit adopted. - BI confident prudential tools and drawdown of excess liquidity can control financial risks while ensuring sufficient credit. ### Fiscal policy, subsidies, and budget execution - 2012 and 2013 fiscal stance and execution - 2012 deficit expected to rise to 1.8 percent of GDP (up from 1.1 percent in 2011); budget ceiling 2.2 percent of GDP. - Postponed energy price adjustments in 2012 boost energy subsidies to 3.5 percent of GDP, compared with 2.6 percent of GDP allocated to all development spending. - Capital spending: only 80 percent of budgeted amount executed in 2011; in H1 2012 only 19 percent of budgeted capital spending disbursed. - Draft 2013 budget assumes real GDP growth of 6.8 percent and CPI inflation of 4.9 percent; overall deficit target 1.6 percent of GDP. - Draft budget proposes capital spending increase by 14.9% from 2012 allocation. - Under current WEO oil price projections and staff baseline, projected energy subsidy bill to reach 3 percent of GDP in 2013. - Policy recommendations on fiscal policy - If external risks materialize, sizable and prolonged slowdown should be addressed by the budget given limited scope for further monetary easing; additional discretionary spending—especially capital spending—preferred. - Other avenues for fiscal stimulus include direct cash transfers. - Increase fiscal flexibility: consider moving from a hard 3 percent deficit ceiling to a rule allowing intracyclical variation so long as the ceiling is not breached over the cycle. - Replace costly and inefficient energy subsidies with direct cash transfers to vulnerable groups to create fiscal room for infrastructure, health, and education. ### Public–private partnerships (PPPs) and infrastructure financing - Implementation and risks - PPP program constrained by weak project selection and preparation at local government level. - Government guarantee fund for PPPs has low current capital; potential budget involvement beyond the fund poses fiscal risks. - Land acquisition law approved in late-2011 could help unlock constraints; administrative regulations and further land reforms remain needed. - Policy implication - Monitor fiscal risks from PPP guarantees and provide room in the budget for further capital infusions to the guarantee fund over the medium term. ### Financial sector stability, supervision, and reforms - Banking sector health and risks - Banking system asset quality satisfactory; banks profitable and well capitalized with capital to risk weighted asset ratio at 16 percent (staff text) and Jun-12: 17.5 percent in table. - Rapid loan growth could affect loan quality and capital ratios; SME lending and property market developments require monitoring. - Stress tests: larger banks have sufficient buffers for severe shocks; several smaller banks could see capital declines below 8 percent. - Banks expected to meet Basel III capital requirements; some borderline banks may require special attention and capital raising. - Institutional reforms and gaps - Passage of Financial Services Authority (OJK) law to transfer regulation and supervision to new entity, to be completed by end-2013 (source sections note full operational date end-2014 in other sections). - High level forum for coordinating financial stability established; MOU among entities finalized; draft FSSN law under preparation. - Gaps to address: maintain oversight during OJK transition; clarify roles for BI and OJK in macroprudential policy; define solvency in FSSN law; operational safety net not yet in place. - AML/CFT - FATF warned in June 2012 that Indonesia had not made sufficient progress on AML/CFT deficiencies, focusing on incomplete CFT legislative framework. - Draft CFT law expected to be discussed by parliament in September; prompt passage could prevent potential sanctions/blacklisting. ### Labor markets, social protection, and inclusiveness - Labor market and social indicators - 45 percent of population under 25; average age of working population currently 30−34. - Percentage living under $1.25 per day declined from 48 percent to 18 percent during 1999−2010. - Youth unemployment rates among the highest in the region; much employment in informal sector. - Social indicators weak: infant and maternal mortality among highest in the region; public investment in health and education very low. - Social security reform - National Social Security System (SJSN) Law (2004) to create five programs; BPJS Law (2011) requires transforming current schemes into BPJS Health and BPJS Employment by 2015. - Implementation challenges: setting benefits and contribution rates, registering all workers, collection of contributions from informal sector. - Structural implication - Address rising income inequality, increase infrastructure investment, and invest in human capital to achieve more inclusive growth. ### Public and external debt sustainability (APPENDIX II) - Public debt recent developments and projections - Public sector debt fell to 24.5 percent of GDP in 2011. - Baseline projection: public debt projected to fall to about 23.5 percent of GDP in 2012 and to 17.6 percent of GDP by 2017 (selected series list 2017: 17.6). - Debt-stabilizing primary balance (percent of GDP): -1.4. - Public debt time series (public debt in percent of GDP) - 2005: 46.3; 2006: 39.0; 2007: 35.1; 2008: 33.2; 2009: 28.6; 2010: 26.9; 2011: 24.5; 2012 (projection): 23.5; 2013: 21.5; 2014: 20.1; 2015: 19.1; 2016: 18.3; 2017: 17.6. - Stress tests and sensitivities - Fiscal contingent liabilities amounting to 10 percent of GDP could raise public sector debt to 24.5 percent of GDP by 2017. - Currency depreciation of 30 percent would raise the debt ratio to about 21.5 percent of GDP. - An increase in real interest rates would raise the debt ratio to 21 percent by 2017. - External debt and projections - External debt trended downward; projected about 26 percent of GDP by 2012 and 18.6 percent by 2017 (selected series list 2017: 18.6). - Selected external debt series (percent of GDP): 2005: 47.1; 2008: 30.4; 2011: 26.6; 2012 (projection): 26.1; 2017: 18.6. - External stress-test results - A one-time 30 percent real exchange rate depreciation would raise the external debt ratio by 10 percentage points in 2012, and by 4 percentage points over the baseline by 2017. - Key macro assumptions underlying baseline - Real GDP growth: 2011: 6.5; 2012: 6.0; 2013: 6.3; 2014: 6.5; 2015: 6.6; 2016: 6.7; 2017: 6.8. - Nominal external interest rate (percent): 2011: 1.9; 2012–2014: 1.7; 2015: 1.6; 2016: 2.3; 2017: 2.1. - Current account balance, excluding interest payments (percent of GDP): 2011: 0.7; 2012: -1.5; 2013: -1.6; 2017: -2.5. - Debt-stabilizing noninterest current account (percent of GDP): -3.6. ### Recent data, 2013 budget proposal, and selected statistics - Summary statistics and growth projections (selected) - Nominal GDP (2011): Rp 7,427 trillion or US$846 billion. - GDP per capita (2011): US$3,509. - Real GDP (percent change): 2008: 6.0; 2009: 4.6; 2010: 6.2; 2011: 6.5; 2012 (Proj.): 6.0; 2013 (Proj.): 6.3. - Domestic demand (percent change): 2012 (Proj.): 7.7; 2013 (Proj.): 6.7. - Unemployment rate (Feb. 2012): 6.3 percent. - Poverty headcount ratio at national poverty line (2011): 12.5 percent of population. - Prices, exchange rates, and reserves - Consumer prices (end period, 12-month percent change): 2011: 3.8; 2012 (Proj.): 5.0; 2013 (Proj.): 5.1. - Rupiah per U.S. dollar (period average): 2011: 8,774. - Real effective exchange rate (end period; 2005=100): 2011: 124.7; Jul-12: 122.9. - Gross reserves (end period, US$ billions): 2011: 110.1; 2012 (Proj.): 107.8; 2013 (Proj.): 110.3; international reserve in July 2012: $106.6 billion (authorities’ statement). - Balance of payments (selected) - Current account balance (percent of GDP): 2008: 0.0; 2009: -2.0; 2010: -0.7; 2011: -0.2; 2012 (Proj.): 1.9; 2013 (Proj.): 2.0 (note table conventions vary; another table shows current account in US$ billions with 2012: -17.3 and 2013: -20.2). - Foreign direct investment (US$ billions): 2011: 18.9; 2012 (Proj.): 21.4; 2013 (Proj.): 21.5. - Financial sector indicators (latest observations) - Capital to risk-weighted assets (Jun-12): 17.5 percent. - Nonperforming loans (Jun-12): 2.2 percent. - FX deposits (May-12): 14.3 percent of total deposits. - FX loans (May-12): 15.8 percent of total loans. - Total credit outstanding (annual percent change, May-12): 26.1. ### Risk Assessment Matrix — main risks and recommended responses - Strong intensification of the Euro-area crisis - Likelihood: Medium. - Expected impact: Medium. - Key risks: global risk aversion, capital outflows, weaker global growth reducing exports and FDIs. - Recommended responses: flexible exchange rate, FX intervention as needed, BI liquidity provision, emergency liquidity support for viable banks, fiscal stimulus if downside risk persists. - China’s hard landing - Likelihood: Medium. - Expected impact: High. - Key risks: sharp fall in commodity prices and demand, lower export earnings, investment, and FDI in commodity sectors. - Recommended responses: fiscal stimulus preferred; less scope to reduce policy rates. - Inflation surprise (food price spike) - Likelihood: Low. - Expected impact: Medium. - Key risks: bond market sell-off, yield spike, weaker rupiah. - Recommended responses: improve food import policy, BI to tighten monetary stance, eliminate supply bottlenecks. - Small bank failure - Likelihood: Low. - Expected impact: Medium. - Key risks: damage to consumer and investor confidence if resolution is messy. - Recommended responses: effective supervision during OJK transition, prompt passage of financial safety net law, emergency protocols, contingency plans for recapitalization or intervention. ### World Bank–IMF collaboration (ANNEX II) - Coordination areas and joint programs - Joint focus on budget and treasury reform, taxation, asset liability management, financial sector monitoring and reform, statistics, and macroeconomics. - Specific programs include GFMRAP support, PINTAR tax administration reform (approved 2009), joint FSAP follow-up, and statistical capacity programs launched in 2010. - Coordination mechanisms - Keep each other informed about ongoing work; requests for inputs; periodic meetings. - Joint products and missions include asset liability management (December 2010) and ongoing joint work programs. ### Staff appraisal — key assessments and policy recommendations - Macroeconomic position - Indonesia in a strong position to navigate global uncertainties: reliance on domestic demand, healthy corporate and financial sector balance sheets, and a marked reduction in public debt. - Key policy recommendations (selected) - Monetary policy: normalize liquidity to arrest incipient inflation and financial sector risks; rely on traditional monetary policy tools rather than sector-targeted prudential measures; expedite review of monetary policy framework to guide market expectations. - Financial sector reforms: address gaps during OJK transition; maintain oversight; adopt amended FSSN law promptly; formulate emergency protocols and contingency plans. - Exchange rate and external liquidity: continue exchange rate flexibility; monitor FX market liquidity; be ready to intervene in thin and volatile markets. - Fiscal policy: continue fiscal reforms to improve composition and execution; replace energy subsidies with targeted cash transfers; improve budget execution; consider fiscal space for increased capital spending as debt continues to decline. - Structural reforms: persist with labor market, business climate, social security, infrastructure, and financial deepening reforms to increase productivity and equity. ### Conclusion - Authorities recognize the challenges to ensure higher, sustained, and inclusive growth and will continue to monitor the economic situation closely and stand ready to ensure macroeconomic and financial stability, acknowledging staff advice and continuing engagement with the Fund. *Source: Selected sections from the 2012 ARTICLE IV REPORT INDONESIA (content unit _cr12277).* ### 1. Global Spillovers to Indonesia: Risks and Transmission Channels ______________________________9 ### Global Spillovers to Indonesia: Risks and Transmission Channels ### Key summary findings - Staff analysis suggests financial shocks have a larger impact on Indonesian growth than shocks to external growth or commodity prices. - A one standard deviation decline in global growth (equivalent to 0.6 percentage points) would reduce Indonesian growth by 0.2 percentage points within a year. - An increase in the VIX by one standard deviation (8 points) would result in lower Indonesian growth of about 0.3 percentage points. - Higher oil prices (used here as a proxy for commodity prices in general) support growth because Indonesia is a commodity exporter. ### Transmission channels and magnitudes - Trade channel - A one standard deviation decline in global growth would lower real exports of goods and services by about 8 percent. - Chinese GDP growth has about one-fifth the impact of global growth on exports controlling for commodity prices. - Financial channel - A one standard deviation (8 point) rise in the VIX lowers portfolio and other capital flows by about $1.5 billion. - The financial system has only limited exposure to Europe and little reliance on foreign wholesale funding, but contagion can occur through foreign investor retreat from local capital markets, especially the bond market where foreign presence is large in Indonesia. - Commodity channel - Indonesia, as a commodity exporter, benefits from higher commodity prices; thus commodity-price shocks can have supportive effects on growth. ### Quantitative evidence and model specification - The analysis uses a Bayesian Vector Autoregression ordered as follows: VIX, external GDP growth, global oil price, net portfolio and other capital flows, exports, and domestic GDP growth. - Impulse response evidence presented shows: - Accumulated response of output growth to one standard deviation shocks (figures indicate negative responses to VIX and global output shocks). - Accumulated response of capital inflows to one standard deviation shock to the VIX Index (figures indicate large negative capital inflow responses). - Accumulated response of real exports to one standard deviation shocks from global output growth and China output growth (figures indicate reductions). ### Policy implications and considerations - Understanding that the financial channel (global risk aversion) has a relatively large effect on Indonesian growth suggests policy focus on: - Safeguarding against rapid portfolio outflows and elevated foreign participation in local currency debt markets. - Measures to strengthen market liquidity and foreign exchange market functioning to mitigate sudden investor retrenchment. - The trade and commodity channels imply exposure to a China slowdown: - A slowdown in China could significantly affect Indonesia through reduced commodity demand and lower export volumes. - The magnitude of the effect depends on how much investment and export volumes adjust; increased public investment or sustained cost competitiveness could mitigate impacts. *Source: Box 1, “Global Spillovers to Indonesia: Risks and Transmission Channels,” from the IMF staff report excerpt.* ### Box 2. China’s Growth Pattern: Implications for Indonesia (concluded) ### Box 2. China’s Growth Pattern: Implications for Indonesia (concluded) ### China-driven commodity demand and Indonesia’s exports - China’s demand contributed to increases in global commodity prices and Indonesia’s export growth (index 2005=100 shown for Oil, Gas, Rubber products, Palm oil, Coal). - Share of commodity exports, especially coal, palm oils, and rubber has increased; Indonesia: Exports by Sector shown in percent of GDP. - Indonesia is now the largest exporter of coal to China and the world: - "Indonesia accounted for 30 percent of China's coal imports, the largest exporter of coal to China." - Palm oil and rubber exports to China have grown: - "China accounted for 20 percent of Indonesia's palm oil exports." - China: Palm Oil Imports and Rubber Imports Value series indicate growing import values from Indonesia (values shown in billions of U.S. dollars in the source charts). ### Lending conditions, policy rate, and macroeffects - Empirical model: extended Global Projection Model (GPM) for Indonesia estimated with Bayesian techniques to decompose domestic and global shocks and macrofinancial transmission. - Key model estimates: - "A 1 percentage point increase in the spread leads to a 0.15 percent change in the output gap, compared to 0.13 percent for the policy rate." - Inflation drivers: "about 40 percent of the dynamics accounted for by domestic supply and another quarter by global prices." - "A 1 percent reduction in the output gap decelerates inflation by 0.26 percent." - Second-round effects: "a 1 percentage point increase in the difference in headline from core leading to a 0.45 percentage point increase in core inflation." - Interest volatility and output: - A GARCH(1,1) measure of JIBOR volatility (controlling for policy rate) has a negative impact on the output gap. - Implication: scope exists to reduce inflationary pressures by lowering the spread between money market and policy rates rather than hiking the policy rate itself. ### Liquidity, monetary operations, and market rates - Liquidity built up despite use of numerous instruments; Bank Indonesia’s outright purchases of government securities rose sharply (negative is liquidity injection, in trillions of rupiah in source charts). - Ownership of government securities: Bank and Other Domestic, Foreign, and Bank Indonesia shares shown (percent of total outstanding). - Yield and expectations: - Declining yields accompanied excess liquidity. - Long-term inflation expectations are persistently higher than in other inflation targeting ASEAN countries (1-year and 10-year series shown). - Policy transmission: - Pass-through of policy rate to lending rates is weaker relative to Thailand and Philippines (pass-through by months following policy rate change shown in source charts). - Volatility of 1-Month money market rates has risen (standard deviations series shown). ### Exchange rate flexibility, reserves, and external position - External position and reserve adequacy: - "Indonesia’s external position appears moderately stronger than implied by medium-term fundamentals and desirable policies." - Preliminary model estimates: "the real effective exchange rate is moderately undervalued by 0 − 10 percent." - Medium-term structural current account balance: "should be a deficit of 2 percent of GDP, compared with the 0.2 percent surplus recorded in 2011." - "The current account is expected to turn into a small deficit of around 2 percent in 2012 and in the medium term." - Current levels of reserves are "well above all standard metrics and the IMF’s composite adequacy metric" and "in the middle of the range among regional peers." - Note: "Estimates of both CGER and EBA methodologies refer to REER values as of March 2012. Until June 2012, the REER has moved by less than 1 percent." - Policy implications: - Increased exchange rate flexibility, combined with judicious use of reserves, would help address market tensions and smooth sharp, temporary supply–demand mismatches. - A more explicit public statement prioritizing domestic price stability over exchange rate considerations would be helpful. ### Strengthening the monetary policy framework and Bank Indonesia’s operations - Recommendations to improve policy clarity and transmission: - Reiterate that the operational target is to keep the overnight money market rate broadly in line with the policy rate. - Rationalize open market instruments and refrain from intervening in the secondary market for government paper, except in cases of extreme market dysfunction. - Ensure BI’s foreign exchange and rupiah operations are predictable and supportive of market making. - Improve infrastructure and legal basis for the interbank repo market to address rupiah money market segmentation. - Balance sheet and governance: - Consider swapping part of BI’s holdings of nonmarketable, non-interest-bearing government debt for higher yielding securities to address balance sheet concerns; recognize that a swap could only postpone recapitalization needs depending on future interest rates. - Consider a comprehensive reform of BI’s financial relationship with the government covering cost-sharing of reserve accumulation, taxation, and dividend distribution to permanently strengthen BI’s balance sheet and limit scope for political interference. ### Investment, macroeconomic volatility, and financial depth - Investment dynamics: - Rising investment has been a key driver of recent robust growth; strong recent investment focused on the booming mining sector. - Public investment ratio remains among the lowest in the region; infrastructure needs are pressing. - Empirical determinants of investment (aggregate and firm-level): - Investment is negatively correlated with interest rate volatility, exchange rate volatility, and the real lending rate; positively correlated with improvements in the terms of trade. - Interest rate volatility has become a more important factor post-2005, with the magnitude of its coefficient nearly doubling in regression estimates for the post-2005 period. - Firm-level regressions: interest rate volatility negatively affects investment; responsiveness to interest rate volatility increased in the more recent sample. - Firms’ investment decisions are highly affected by internal cash positions, indicating underdeveloped financial markets and a thin local currency bond market relative to regional peers. - Policy implication: reducing volatility of interest and exchange rates and deepening capital markets (particularly the local currency bond market) would support sustained investment growth. *2012 ARTICLE IV REPORT INDONESIA, INTERNATIONAL MONETARY FUND* ### 14. The authorities are committed to exchange rate flexibility to reflect fundamentals, ### _cr12277 - 14. The authorities are committed to exchange rate flexibility to reflect fundamentals, ### Exchange rate policy and monetary stance - Authorities committed to exchange rate flexibility to reflect fundamentals; interventions are limited to smoothing sharp fluctuations. - Tensions in the foreign exchange market in May were labeled anomalous; Bank Indonesia (BI) acted quickly to restore order. - BI is confident that a mix of prudential tools, combined with the drawdown of excess liquidity already achieved, would help meet near-term objectives: control potential financial risks, ensure sufficient credit to sectors that enhance domestic productive capacity, and help meet the inflation target. - Recent prudential steps by BI include limits on consumer lending and on mortgages for high value residential property. ### Credit, banking system, and prudential measures - The rise in overall credit growth was mostly for investment financing; this is expected to ease supply-related inflationary pressures and underpin sustained economic growth. - Continued improvements in banking system efficiency would allow credit growth to continue with little increase in risks, provided prudential tools curb excessive credit to specific sectors. - BI has placed some prudential limits on consumer lending and on mortgages for high value residential property. ### Monetary policy framework development - Authorities initiated a review of the monetary policy framework with the objective of eventually announcing a fully articulated and internally coherent revised framework. - A key plank would include macroprudential policies to allow a greater mix of tools to balance multiple objectives (financial stability, inflation, growth in productive capacity). - Prudential policies could help redirect credit across sectors while interest rates target aggregate credit conditions appropriate for growth and inflation objectives. - Authorities recognize the need to flesh out and communicate the evolving policy framework to minimize market volatility while retaining low inflation. ### Financial market structure and implications - Authorities underscored the link between interest and exchange rate volatility and inadequate financial market development. - Large foreign participation in central bank bills had been associated with excessive volatility; authorities replaced bills with nontradable bank deposit facilities. - Money supply and credit are very low in Indonesia in international comparison; other capital markets are relatively thinner (see Figure 4 in source). ### Fiscal policy: stance, flexibility, and buffers - The 2012 budget embodies a moderate stimulus considered appropriate given the downturn in external demand, but expenditure composition is “not ideal.” - 2012 deficit expected to rise to 1.8 percent of GDP, up from 1.1 percent in 2011, and still under the budget ceiling of 2.2 percent of GDP. - Proposed upward adjustment of subsidized energy prices was postponed by parliament unless oil prices exceed a revised higher threshold. - Postponement will boost energy subsidies to 3.5 percent of GDP, compared with 2.6 percent of GDP in total allocated to all of development spending. - Under-spending on other items, including public investment, will likely limit the impact on overall expenditure growth; budgeted cash payments to compensate for fuel price increases will provide some savings if a price adjustment is not implemented. - If external risks materialize, any sizable and prolonged slowdown should be addressed by the budget given limited scope for further monetary easing; additional discretionary spending—especially capital spending—would be the preferred channel. - Other avenues for injecting fiscal stimulus, given expenditure execution constraints, include direct cash transfers. - Government secured $5 billion contingent financing from the World Bank and bilateral partners. - Government cash balances are over 2 percent of GDP. - Government’s gross financing requirement for 2012 is around 3 percent of GDP. ### Fiscal rules and flexibility recommendations - Increasing fiscal flexibility is a priority; fiscal policy historically has not been countercyclical in Indonesia. - Given the sharp fall in public debt over the past decade, staff suggest considering moving from a hard 3 percent deficit ceiling to a rule that allows intracyclical variation so long as the ceiling is not breached over the cycle. - Authorities’ view: budget includes provisions allowing government to ask parliament for speedy authorization to modify and increase spending if growth and unemployment indicators deteriorate; scope exists to expedite some infrastructure investment, particularly in east Indonesia. - Authorities emphasized room to increase fiscal flexibility within the existing 3 percent of GDP legal limit by reducing expenditure rigidities and increasing revenues; priority remains addressing energy subsidies and raising tax intake, particularly from the natural resource sector. ### Financial sector stability, supervision, and reforms - The banking sector is sound but warrants continued monitoring; corporate and financial sector balance sheets have strengthened. - Banking system asset quality remains satisfactory; banks are profitable and well capitalized, with the capital to risk weighted asset ratio at 16 percent. - Rapid loan growth could adversely impact loan quality and capital ratios; lending to SMEs with limited credit histories and property market developments require close monitoring. - Recent stress tests analyzing spillovers from Europe show larger banks have sufficient buffers to withstand severe shocks, but several smaller banks could see capital declines below 8 percent. - Banks in Indonesia are expected to meet Basel III capital requirements, though a number of borderline banks may require special attention and will need to consider ways to increase capital soon. - Important recent steps to strengthen financial stability: - Passage of the Financial Services Authority (OJK) law, with the objective of gradually transferring regulation and supervision of banking, insurance, capital markets, pension funds, and other financial institutions to the new entity, to be completed by end-2013. - Establishment of a high level forum for coordinating financial stability. - Finalization of a Memorandum of Understanding (MOU) among entities responsible for financial stability. - Drafting of a revised Financial System Safety Net (FSSN) law. - Gaps to address for smooth transition: - Maintain proper oversight of supervisory and regulatory functions during OJK transition. - Clarify or amend provisions (e.g., define roles/responsibilities for BI and OJK in macroprudential policy; define solvency in the FSSN law). - Operational safety net is not yet in place; MOU does not specify roles and responsibilities of each agency during normal or crisis times. ### AML/CFT and legislative timetable - In June 2012, the Financial Action Task Force (FATF) warned Indonesia had not made sufficient progress in addressing identified AML/CFT deficiencies, focusing on an incomplete CFT legislative framework. - A draft CFT law was expected to be discussed by parliament in September; prompt passage could prevent potential AML/CFT-related sanctions and blacklisting. - Authorities plan to dispute the FATF conclusions while expecting the CFT law adoption as scheduled; a temporary government decree with broadly the same features as the FSSN law could be promulgated in a crisis if the law is not yet in place. ### Medium-term outlook and inclusive growth - Growth could exceed the recent high of 6.5 percent with the right policies and broadly favorable global conditions over the medium term. - Indonesia benefits from a demographic dividend; investment-to-GDP has recovered to mid-1990s levels; low public debt provides room for increasing social and infrastructure spending. - Emergence of modest current account deficits over the medium term is consistent with the demographic profile and higher investment needs; prospects for strong FDI to finance deficits are enhanced by strong macroeconomic fundamentals. - Achieving improved growth outcomes requires further initiatives: address rising income inequality, increase infrastructure investment, and invest more in human capital. - Demographics and social indicators: - 45 percent of the population is under 25. - Average age of the working population is currently 30−34. - The demographic dividend will crest in the next decade; by 2035, Indonesia will have an aging ratio close to that of Japan in the early 1990s. - Social indicators are weak: infant and maternal mortality among the highest in the region; public investment in health and education very low in international comparison (see Figure 6). - Authorities’ economic Master Plan (unveiled 2011) aims to transform Indonesia into one of the 10 largest economies by 2025; plan targets investments of $468 billion over 2011−15, of which nearly half will be in infrastructure. ### Income inequality, infrastructure, and education (Box 6 findings) - Despite robust growth and significant reduction in absolute poverty, income inequality has risen during recent decades. - Percentage living under $1.25 per day declined from 48 percent to 18 percent during 1999−2010. - Latest rural and urban Gini indexes are higher than in 1999; income share of the richest quintile has risen while that of the lowest quintile has fallen. - Infrastructure is a defining constraint: Indonesia lags regionally in both quantity and quality of infrastructure (communication, power, roads). - Regression results from a cross-country study indicate infrastructure and education spending have a significant positive impact on income equality. - Infrastructure and income distribution may have two-way causality; indexes enter regressions with one lag to address endogeneity. - Results also reinforce the importance of increasing the share of formal sector employment—in particular, industrial employment—to improve income distribution. _Italic: Source: 2012 ARTICLE IV REPORT INDONESIA (selected section)._ ### 33. Fiscal reforms to increase capital investment remain a priority. Budget execution still ### Fiscal reforms to increase capital investment remain a priority. Budget execution still ### Capital spending and budget execution - Capital spending is increasing in absolute terms, but only 80 percent of the budgeted amount was executed in 2011, with about half disbursed only in the last two months of the year. - Measures to improve capital execution have not fully delivered: in the first half of 2012, only 19 percent of budgeted capital spending was disbursed, a pattern broadly similar to previous years. - Recent government steps to improve infrastructure project implementation: - New procurement regulation adopted. - Budget preparation and payment processes streamlined. - Remaining bottlenecks: - Project development and preparation still significant constraints. ### Public–private partnerships (PPPs) and infrastructure financing - Government schemes to facilitate infrastructure investment have had limited success but are seen as promising if fiscal risks are monitored. - Constraints and risks: - PPP program held back by weaknesses in project selection and preparation, especially at the local government level. - A government guarantee fund for PPPs has been set up to ring fence fiscal risks, but: - The fund has current low capital. - Continued potential involvement of the budget to provide guarantees beyond the scope of the fund poses fiscal risks. - The budget would need to provide room for further capital infusions into the fund over the medium term. - Land as a constraint for private infrastructure: - Land acquisition law approved in late-2011 could help unlock the bottleneck now that the presidential decree on its implementation has been issued. - Administrative regulations still need to be finalized and further land reforms are required to ensure that land titles are clear. ### Fiscal space, debt, and deficit policy - Debt trajectory: - Under the current baseline, public debt is projected to decrease to 17.6 percent of GDP by 2017. - Policy implication: - As debt continues to decline, there may be scope to increase the deficit to allow for greater social and investment spending. - Due to constraints in expenditure execution, existing deficit ceilings have not become binding yet; near-term focus should remain on improving execution. ### Authorities’ views on spending execution and deficit ceilings - Authorities agree spending execution, particularly investment, remains a challenge but are hopeful about recent initiatives. - Indonesia’s decentralized fiscal structure imposes significant coordination challenges. - Despite limited improvements in execution rates, the absolute volume of investment spending has been increasing significantly due to reforms. - Additional measures to streamline procurement were about to be adopted to further ease bottlenecks. - On PPPs: - Authorities acknowledged weak progress despite seven years of effort, but cited one major successful example as a model to accelerate future projects. - On deficit ceilings: - Authorities viewed considerations to increase the deficit ceiling as relevant only at a later date—once the composition of current spending and execution of capital spending improved and deficit ceilings became binding. - Reducing energy subsidies (recognized in the authorities’ roadmap) was highlighted as an important means to increase social and investment spending in the medium term. ### Deepening financial markets - Rationale: - Financial deepening is key to mobilizing domestic savings for private and public investment and to providing a greater range of financial products. - Current constraints: - Low bank credit partly reflects aversion to debt since the 1998 financial crisis; many firms finance investment through retained earnings. - Anecdotal evidence suggests a significant proportion of resident savings are intermediated offshore. - Contractual savings sector weak due to low formal employment and lack of enforcement of pension requirements. - Insurance and investment funds have grown from a small base and do not contribute significantly to domestic long-term savings. - Recommended priorities and sequencing: - Facilitate development of money and secondary government bond markets to provide better benchmarks for long-term financing and promote market-making. - Expand supply of long-term savings via growth of pension and mutual fund industries, dependent on design of expanded social insurance schemes. - Improve business climate to increase demand for credit from firms outside the resource sector. - Authorities’ views: - Authorities are extremely keen to develop and deepen financial markets and welcomed Fund technical assistance; sequencing of reforms is the key challenge. ### Labor markets and social protection - Labor market findings: - On the surface, Indonesia compares well in creating employment relative to population growth. - Youth unemployment rates are among the highest in the region and much employment is in the informal sector, masking underemployment. - Indonesia’s labor laws are relatively rigid in international comparison; reform could help create greater formal and youth employment. - Improved public spending on infrastructure, health, and education would better equip the young for the formal labor market. - Social protection structure and reforms: - Current system: targeted cash transfer program and contributory social insurance for civil servants and formal sector employees; evasion is high and coverage is very low. - National Social Security System (SJSN) Law (approved in 2004) will create five social security programs: health insurance, employment injury, pension, old-age savings, and death benefits; aims to cover entire population including informal sector. - Social Security Administrative Body (BPJS) Law passed in 2011 requires establishment by transforming current insurance schemes into: - BPJS Health (managing the health fund). - BPJS Employment (managing the other four funds). - Transformations required to take place by 2015. - Implementation challenges: - Benefits and contribution rates need to be determined; inappropriate settings could create substantial contingent liability for the state. - All formal and informal sector workers must be registered and assigned identification numbers. - Collection of contributions, especially for informal sector workers, remains unclear. - Authorities’ views: - Authorities committed to implementing social security reforms, emphasizing that benefits and contribution rates must ensure fiscal soundness and that the reform timetable allows gradual rollout to address implementation challenges. ### Business climate and recent policy measures - Competitiveness and constraints: - Indonesia improved in the World Economic Forum’s Global Competitiveness index to 46th, supported by a strong macroeconomic environment (23rd, up from 89th in 2007). - Weaknesses remain in infrastructure, institutions, and security. - World Bank Doing Business survey rankings less favorable; constraints include access to electricity, resolving insolvency, and contract enforcement. - Mining sector concerns about stability and predictability of the tax regime; 2010 FSAP noted weaknesses in legal and governance framework, including lack of creditor rights. - Recent trade and investment measures affecting investor sentiment (five broad categories): - (i) export restrictions and taxes on raw resources; - (ii) tighter import licensing requirements, quantitative limitations, and pre-shipment inspections; - (iii) requirements for majority stake divestment by foreign mining companies; - (iv) point of entry restrictions on some imports; - (v) single ownership limits on commercial banks. - Features and implications of measures: - Many measures contain exceptions that limit economic impact (e.g., mining divestment regulation does not apply to existing companies). - Coordination appeared lacking; some measures had unintended consequences (e.g., increasing on-shore mineral processing would require substantial increase in electricity generation), leading to postponements or amendments. - Authorities’ views: - Authorities acknowledged communication challenges around motivations for initiatives. - Emphasized aim to increase value added and create jobs while respecting sanctity of contracts and external commitments. - Banking regulation aimed at improving corporate governance and did not limit acquisition of domestic banks by strong foreign banks. - Domestic policy coordination challenges in a diverse democracy influenced some initiatives; authorities were working to ensure external commitments, such as under the WTO, continued to be respected. ### Staff appraisal — key assessments and policy recommendations - Macroeconomic position: - Indonesia is in a strong position to navigate global macroeconomic uncertainties, supported by reliance on domestic demand, healthy corporate and financial sector balance sheets, and an exemplary reduction in public debt over the past decade. - Recently weakening external current account is a natural consequence of movement toward long-term equilibrium. - Risks and policy uncertainties: - Risk perceptions remain elevated; reserves declined by nearly 15 percent from the August 2011 peak and inflation expectations have picked up sharply. - Easy monetary conditions amplified capital outflows; delayed adjustments to subsidized fuel prices suppressed inflation recovery. - Transition to a unified financial supervisor could raise vulnerabilities if effective FSSN legislation is delayed. - Trade and investment measures have led to questioning of commitment to an open regime. - Monetary policy recommendations: - Bank Indonesia encouraged to normalize liquidity to arrest incipient inflation and financial sector risks and to bolster resiliency to global risk aversion. - Rely on traditional monetary policy tools rather than prudential measures targeted at specific sectors. - Expedite review of the monetary policy framework to better guide market expectations and support financial market deepening. - Financial sector reform recommendations: - Address gaps and inconsistencies during planned reforms; maintain proper oversight during OJK transition via close coordination. - Adopt an amended FSSN law reflecting previous Fund recommendations as soon as possible to provide a sound legal framework for systemic crisis management. - Exchange rate and external liquidity: - Continue exchange rate flexibility; the exchange rate is moderately undervalued from a medium-term perspective. - Pay close attention to foreign exchange market liquidity conditions to avoid damaging market confidence. - Fiscal policy and structural reforms: - Continue fiscal reforms to improve composition and execution of spending. - Replace costly and inefficient energy subsidies with direct cash transfers to the vulnerable to create fiscal room for infrastructure, health, and education and to enhance equity. - Continue reforms to streamline and expedite budget execution processes. - Trade and investment openness: - Maintain an open foreign trade and investment regime while pursuing value-added objectives through coordinated industrial policy, investment in human capital, reducing business costs, and deepening financial markets. - Structural priorities: - Persevere with structural reforms (labor market, business climate, social security) to increase growth and make it more equitable; the authorities’ economic master plan is well targeted at growth constraints. *2012 ARTICLE IV REPORT INDONESIA* ### 57. It is recommended that the next Article IV consultation take place on the standard ### _cr12277 - 57. It is recommended that the next Article IV consultation take place on the standard ### Summary statistics and growth projections - Nominal GDP (2011): Rp 7,427 trillion or US$846 billion - GDP per capita (2011): US$3,509 - Real GDP (percent change): 2008: 6.0, 2009: 4.6, 2010: 6.2, 2011: 6.5, 2012 (Proj.): 6.0, 2013 (Proj.): 6.3 - Domestic demand (percent change): 2008: 7.6, 2009: 5.2, 2010: 5.9, 2011: 6.2, 2012 (Proj.): 7.7, 2013 (Proj.): 6.7 - Private consumption (percent change): 2008: 5.3, 2009: 4.9, 2010: 4.7, 2011: 4.7, 2012 (Proj.): 4.9, 2013 (Proj.): 4.9 - Gross fixed investment (percent change): 2008: 11.9, 2009: 3.3, 2010: 8.5, 2011: 8.8, 2012 (Proj.): 11.0, 2013 (Proj.): 10.0 - Change in stocks (contribution to GDP growth, percentage points): 2008: 0.1, 2009: -0.2, 2010: 0.6, 2011: 0.5, 2012 (Proj.): 0.8, 2013 (Proj.): 0.1 - Net exports (contribution to GDP growth, percentage points): 2008: 0.7, 2009: 1.2, 2010: 0.9, 2011: 1.5, 2012 (Proj.): -1.8, 2013 (Proj.): -0.4 - Main exports (percent of total, 2011): Oil and gas (16.0), coal (13.4), palm oil (9.7), process rubber (7.0), other manufactured goods - Unemployment rate (Feb. 2012): 6.3 percent - Poverty headcount ratio at national poverty line (2011): 12.5 percent of population ### Prices, inflation, and exchange rates - Consumer prices (end period, 12-month percent change): 2008: 11.1, 2009: 2.8, 2010: 7.0, 2011: 3.8, 2012 (Proj.): 5.0, 2013 (Proj.): 5.1 - Consumer prices (period average, 12-month percent change): 2008: 9.8, 2009: 4.8, 2010: 5.1, 2011: 5.4, 2012 (Proj.): 4.4, 2013 (Proj.): 5.0 - Rupiah per U.S. dollar (period average): 2008: 9,697; 2009: 10,406; 2010: 9,086; 2011: 8,774 - Real effective exchange rate (end period; 2005=100): Jul-12 observations include 110.1 (2008), 109.9 (2009), 124.4 (2010), 124.7 (2011), 122.9 (Jul-12) ### Public finances and budget - Central government revenue (percent of GDP): 2008: 19.8, 2009: 15.1, 2010: 15.8, 2011: 16.1, 2012 (Proj.): 16.3, 2013 (Proj.): 16.0 - Central government expenditure (percent of GDP): 2008: 19.9, 2009: 16.7, 2010: 16.4, 2011: 17.3, 2012 (Proj.): 18.1, 2013 (Proj.): 17.7 - Central government balance (percent of GDP): 2008: -0.1, 2009: -1.6, 2010: -0.6, 2011: -1.1, 2012 (Proj.): -1.8, 2013 (Proj.): -1.8 - Primary balance (percent of GDP): 2008: 1.7, 2009: 0.1, 2010: 0.8, 2011: 0.1, 2012 (Proj.): -0.5, 2013 (Proj.): -0.5 - Central government debt (percent of GDP): 2008: 33.2, 2009: 28.6, 2010: 26.9, 2011: 24.5, 2012 (Proj.): 23.5, 2013 (Proj.): 21.5 - Budgetary figures (trillions of rupiah, selected 2012 staff projections): Revenues and grants: 1,344.5; Central government expenditure: 1,050.4; Overall balance (% of GDP): -2.2 (2012 proposed budget shows -1.5; revised/proj. -2.2) ### Monetary aggregates and credit - Rupiah M2 (12-month percent change; end period): 2008: 12.7, 2009: 13.8, 2010: 16.5, 2011: 17.4 - Base money (12-month percent change; end period): 2008: -9.2, 2009: 16.7, 2010: 28.9, 2011: 18.3 - Private sector credit (12-month percent change; end period): 2008: 30.7, 2009: 8.1, 2010: 22.1, 2011: 25.8 - One-month interbank rate (period average): 2008: 9.1, 2009: 7.4, 2010: 6.4, 2011: 6.2 - Key market indicators (latest observations): Short-term interest rate (One-month JIBOR) Jul-12: 4.5 percent; Ten-year government bond yield Jul-12: 5.7 percent; Indonesia EMBI spread (bps, end of period) Jul-12: 237 ### Balance of payments, reserves, and external sector - Current account balance (percent of GDP): 2008: 0.0, 2009: -2.0, 2010: -0.7, 2011: -0.2, 2012 (Proj.): 1.9, 2013 (Proj.): 2.0 (Table 1 shows values in US$ billions: Current account 2008: 0.1, 2009: 10.6, 2010: 5.1, 2011: 1.7, 2012 (Proj.): -17.3, 2013 (Proj.): -20.2 — note differing table conventions) - Goods, net (trade balance, US$ billions): 2008: 22.9, 2009: 30.9, 2010: 30.6, 2011: 33.9, 2012 (Mar-12 Apr-12 May-12 entries reflect monthly variations) - Non-oil exports (f.o.b., US$ billions): 2008: 107.9, 2009: 99.0, 2010: 129.4, 2011: 162.7, 2012 (Proj.): 159.6, 2013 (Proj.): 167.2 - Non-oil imports (f.o.b., US$ billions): 2008: -92.8, 2009: -73.5, 2010: -102.0, 2011: -127.9, 2012 (Proj.): -143.5, 2013 (Proj.): -154.6 - Oil and gas (net, US$ billions): 2008: -23.9, 2009: -15.2, 2010: -25.4, 2011: -38.7, 2012 (Proj.): -41.2, 2013 (Proj.): -40.7 - Foreign direct investment (US$ billions): 2008: 9.3, 2009: 4.9, 2010: 13.8, 2011: 18.9, 2012 (Proj.): 21.4, 2013 (Proj.): 21.5 - Gross reserves (end period, US$ billions): 2008: 51.6, 2009: 66.1, 2010: 96.2, 2011: 110.1, 2012 (Proj.): 107.8, 2013 (Proj.): 110.3 - Reserves in months of imports: 2008: 5.7, 2009: 5.2, 2010: 5.9, 2011: 6.7, 2012 (Proj.): 5.9, 2013 (Proj.): 5.7 - Total external debt (US$ billions): 2008: 155.1, 2009: 172.9, 2010: 202.4, 2011: 225.4, 2012 (Proj.): 233.2, 2013 (Proj.): 247.9 - Total external debt (percent of GDP): 2008: 30.4, 2009: 32.1, 2010: 28.6, 2011: 26.6, 2012 (Proj.): 25.7, 2013 (Proj.): 23.9 ### Financial sector and vulnerabilities - Capital to risk-weighted assets (in percent): Jun-12: 17.5 - Nonperforming loans (NPLs in percent of total loans): Jun-12: 2.2 - FX deposits (percent of total deposits): May-12: 14.3 - FX loans (percent of total loans): May-12: 15.8 - Government debt held by financial sector (percent of total FS assets): May-12: 7.1 - Total credit outstanding (annual percent change): May-12: 26.1 ### Medium-term projections (2012–17, selected) - Real GDP (percent change): 2012: 6.0, 2013: 6.3, 2014: 6.5, 2015: 6.6, 2016: 6.7, 2017: 6.8 - Gross investment (percent of GDP): 2012: 34.2, 2013: 35.2, 2014: 36.2, 2015: 37.4, 2016: 38.9, 2017: 40.3 - Gross national saving (percent of GDP): 2012: 33.3, 2013: 33.0, 2014: 33.3, 2015: 34.1, 2016: 35.2, 2017: 36.3 - Central government debt (percent of GDP): 2012: 23.5, 2013: 21.5, 2014: 20.1, 2015: 19.1, 2016: 18.3, 2017: 17.6 - Consumer prices (end period, 12-month percent change): 2012: 5.1, 2013: 4.8, 2014: 4.5, 2015: 4.2, 2016: 4.0, 2017: 4.0 - Nominal GDP (US$ billions) projected: 2012: 906, 2013: 1,036, 2014: 1,222, 2015: 1,412, 2016: 1,634, 2017: 1,896 ### Fiscal and monetary policy recommendations (from risk responses and tables) - Exchange rate policy: - Allow the exchange rate to move flexibly to absorb shocks, while not shying away from foreign exchange intervention in thin and volatile markets. - BI to be ready to ensure ample liquidity in both foreign exchange and rupiah markets. - Monetary policy: - BI should tighten monetary stance in the event of an inflation surprise (food price spike). - There is limited scope to reduce policy rates from current low levels in response to external shocks; fiscal stimulus preferred where room exists. - Financial stability and bank resolution: - Emergency liquidity support should be available for viable banks. - Close coordination by relevant agencies to ensure effective supervision during OJK transition. - Prompt passage of the financial safety net law is needed; emergency protocols and contingency plans for recapitalization or intervention should be formulated. - Fiscal policy: - Fiscal stimulus could be used if downside risk on growth is persistent. - Improved food import policy and policies to eliminate supply bottlenecks to mitigate food-price-driven inflation. - External shock preparedness: - BI to ensure ample liquidity; emergency liquidity support for viable banks. - Authorities should allow flexible exchange rates and stand ready to intervene when markets are thin and volatile. ### Risk Assessment Matrix — main risks, likelihood, expected impact, and recommended responses - Strong intensification of the Euro-area crisis - Likelihood: Medium - Expected impact: Medium - Key risks: global risk aversion, capital outflows, weaker global growth reducing exports and FDIs - Recommended responses: flexible exchange rate, FX intervention as needed, BI liquidity provision, emergency liquidity support for viable banks, fiscal stimulus if downside risk persists - China’s hard landing - Likelihood: Medium - Expected impact: High - Key risks: sharp fall in commodity prices and demand, lower export earnings, investment, and FDI in commodity sectors - Recommended responses: fiscal stimulus preferred; less scope to reduce policy rates - Inflation surprise (food price spike) - Likelihood: Low - Expected impact: Medium - Key risks: bond market sell-off, yield spike, weaker rupiah - Recommended responses: improve food import policy, BI to tighten monetary stance, eliminate supply bottlenecks - Small bank failure - Likelihood: Low - Expected impact: Medium - Key risks: damage to consumer and investor confidence if resolution is messy - Recommended responses: effective supervision during OJK transition, prompt passage of financial safety net law, emergency protocols, contingency plans for recapitalization or intervention *Sources: Data provided by the Indonesian authorities; and Fund staff estimates.* ### APPENDIX II: INDONESIA—PUBLIC AND EXTERNAL DEBT SUSTAINABILITY ### APPENDIX II: INDONESIA—PUBLIC AND EXTERNAL DEBT SUSTAINABILITY ### Public Debt: recent developments and baseline projections - Public sector debt has been declining as a share of GDP since 2000 and fell to a record-low level of 24.5 percent in 2011. - Drivers of the decline: prudent fiscal management, low fiscal deficits over the last decade, lower interest rates, high real GDP growth, and reduced share of foreign-currency debt (now less than half of total debt). - Baseline projections: - Public debt is projected to fall to about 23.5 percent of GDP in 2012. - Public debt is projected to decline to 18 percent of GDP by 2017. - Strategy accommodates extra resources for development spending and targets a small primary deficit of around 0.8 percent of GDP in the medium term. - Stress-test results and shock sensitivity: - Fiscal contingent liabilities amounting to 10 percent of GDP could raise public sector debt to 24.5 percent of GDP by 2017 (the 2011 level). - Currency depreciation of 30 percent would raise the debt ratio to about 21.5 percent of GDP. - An increase in real interest rates would raise the debt ratio to 21 percent by 2017. - Other macroeconomic shocks have even more limited impact; overall public debt judged sustainable and robust to macroeconomic and oil price shocks. - Selected public sector debt time series (public debt in percent of GDP): - 2005: 46.3 - 2006: 39.0 - 2007: 35.1 - 2008: 33.2 - 2009: 28.6 - 2010: 26.9 - 2011: 24.5 - 2012 (projection): 23.5 - 2013: 21.5 - 2014: 20.1 - 2015: 19.1 - 2016: 18.3 - 2017: 17.6 - Debt-stabilizing primary balance (percent of GDP): -1.4 ### Public debt dynamics and fiscal arithmetic (key flows and indicators) - Change in public sector debt (percent of GDP): series from 2005 to 2017 includes values such as -9.5 (2005), -2.4 (2011), -0.9 (2012), and -0.7 (2017). - Identified debt-creating flows (percent of GDP): e.g., -8.8 (2005), -2.7 (2011), -1.6 (2012), -0.3 (2017). - Primary deficit (percent of GDP): historical and projected values include -0.5 (2011), 0.1 (2012), 0.5 (2013), 0.6 (2014), 0.8 (2015–2017). - Revenue and grants (percent of GDP): 17.8 (2011), 18.1 (2012), 17.8 (2013), 17.6 (2014), 17.5 (2015–2017). - Primary (noninterest) expenditure (percent of GDP): 17.3 (2011), 18.2 (2012), 18.3 (2013), 18.2 (2014), 18.3 (2015), 18.2 (2016), 18.3 (2017). - Gross financing need (percent of GDP): 2.7 (2011), 3.6 (2012), 4.2 (2013), 3.6 (2014), 3.6 (2015), 2.8 (2016), 2.7 (2017). ### External Debt: recent developments and baseline projections - External debt trended downward after a temporary increase in 2009 (nominal depreciation late 2008 / early 2009 raised external debt-to-GDP from 30 percent to 32 percent). - Baseline projections: - External debt projected to reach about 26 percent of GDP by 2012. - External debt projected to decline to 19 percent of GDP by 2017. - Factors expected to offset a weakening current account: - Sustained high real GDP growth in the range of 6−7 percent per year. - Increasing non-debt-creating (i.e., FDI) flows. - Some further real appreciation. - Current account and sustainability: - The medium-term noninterest current account balance is projected at -2.5 percent of GDP and would remain above the debt-stabilizing level of -3.6 percent of GDP. - Stress-test results and shock sensitivity: - External sustainability is robust to most shocks. - A one-time 30 percent real exchange rate depreciation would have the largest impact: raising the debt ratio by 10 percentage points in 2012, and by 4 percentage points over the baseline by 2017. - Selected external debt time series (external debt in percent of GDP): - 2005: 47.1 - 2006: 36.4 - 2007: 32.7 - 2008: 30.4 - 2009: 32.1 - 2010: 28.6 - 2011: 26.6 - 2012 (projection): 26.1 - 2013: 24.5 - 2014: 22.3 - 2015: 20.8 - 2016: 19.6 - 2017: 18.6 - Debt-stabilizing noninterest current account (percent of GDP): -3.6 ### External debt dynamics and key indicators - Change in external debt (percent of GDP): -7.3 (2005), -2.0 (2011), -0.5 (2012), -1.6 (2013), -1.2 (2016), -1.0 (2017). - Identified external debt-creating flows (percent of GDP): -7.2 (2005), -3.0 (2011), -1.2 (2012), -0.9 (2013), 0.4 (2017). - Current account deficit, excluding interest payments (percent of GDP): historical and projected values include -0.7 (2011), 1.5 (2012), 1.6 (2013), 2.5 (2017) — note these figures reflect the table entries for "Current account deficit, excluding interest payments" and the projected path of the current account. - Exports and imports (percent of GDP): exports 26.1 (2011), 24.4 (2012), 22.3 (2013), 15.2 (2017); imports 23.4 (2011), 24.1 (2012), 22.5 (2013), 16.7 (2017). - External debt-to-exports ratio (in percent): 101.9 (2011), 106.8 (2012), 109.9 (2013), 121.7 (2017). - Gross external financing need (in percent of GDP): 8.6 (2011), 11.3 (2012), 10.6 (2013), 9.2 (2017). ### Key macroeconomic assumptions underlying the baseline - Real GDP growth (in percent): 6.5 (2011); 6.0 (2012); 6.3 (2013); 6.5 (2014); 6.6 (2015); 6.7 (2016); 6.8 (2017). - GDP deflator in U.S. dollars (change in percent): 12.3 (2011); 0.6 (2012); 6.8 (2013); 10.7 (2014); 8.3 (2015); 8.4 (2016); 8.6 (2017). - Nominal external interest rate (in percent): 1.9 (2011); 1.7 (2012–2014); 1.6 (2015); 2.3 (2016); 2.1 (2017). - Current account balance, excluding interest payments (percent of GDP): 0.7 (2011); -1.5 (2012); -1.6 (2013); -2.5 (2017). - Net nondebt creating capital inflows (percent of GDP): 1.3 (2011); 1.6 (2012); 1.4 (2013); 1.3 (2017). *Source: IMF staff estimates and tables in APPENDIX II: INDONESIA—PUBLIC AND EXTERNAL DEBT SUSTAINABILITY.* ### ANNEX II: WORLD BANK-IMF COLLABORATION ### ANNEX II: WORLD BANK-IMF COLLABORATION ### Background - The working relationship between the IMF and the World Bank in Indonesia is acknowledged by both sides to be very strong with joint working programs in many areas and close coordination through frequent meetings between resident offices and with headquarters missions, including the Article IV consultation. ### Key Areas with Joint Programs - Budget - The reform agenda for budget and treasury remains a high priority for both institutions. - The strategic framework for joint work is built into joint Bank/Fund budget missions. - Current Bank support is being provided through the GFMRAP program, trust funds, and DPLs, with elements in support of: - (a) efficient treasury operations, including accounting reforms, improved in˗year budget disbursement, and regulatory reform; - (b) improved linkages between planning and budget preparation through the implementation of a medium-term expenditure framework, performance budgeting, and the enhancement of budget flexibility at the service delivery level; - (c) improved capacity for budget oversight through systems and organizational reform. - Taxation - Taxation is a priority for the Fund and the Bank with improving tax revenues an important issue for both macroeconomic security and the investment climate. - The Fund has a longstanding program of support for the tax department in Indonesia, recently focused on tax policy and donor coordination. - The Bank support for tax administration reform is largely executed through the comprehensive Program for Indonesian Tax Administration Reform (PINTAR), which was approved in 2009, and trust funds. - Participants generally anticipate that the current division of labor will continue. - Asset Liability Management - The Bank and Fund have been leading an effort to improve asset liability management, including at the Treasury and Debt Management Office of the Ministry of Finance and Bank Indonesia. - The Bank and Fund team will continue to work together as needed. - Financial Sector - The Bank has focused on broad monitoring of the financial sector with special emphasis on issues important for the investment climate (as part of Development Policy Loan programs). - Most recently, through its Financial Sector and Investment Climate Reform and Modernization Development Policy Loan, the Bank is supporting implementation of reforms aimed at maintaining stability, increasing diversification, and enhancing financial sector inclusion in Indonesia. - The Fund has concentrated on the banking system per se, with emphasis on bank regulation and supervision. - A joint Bank/Fund FSAP was completed in 2010 and some recommendations have been followed through by the authorities. - The Bank is to provide technical assistance to implement select FSAP recommendations concerning nonbank financial sector. - Statistics - The Bank has a major program with the statistics agency launched in 2010 focusing on improvements in key statistical series, executed through an institution-wide approach including IT and personal/institutional reforms. - A quick-wins program is being introduced while longer-term reforms play out. - The Fund indicated it is prepared to continue to assist in the area of government finance statistics. - Macroeconomics - The Fund continues to take the lead in macroeconomic areas, with the Article IV and other missions, staff reports, and policy notes on issues including the stance of fiscal, monetary, and exchange rate policies, the credibility and effectiveness of monetary policy, macrofinancial linkages, and global impacts on Indonesia. - The Bank has taken on a larger role in macroeconomic monitoring, public policy dialogue, and capacity building, requiring close coordination with the Fund. - The Bank team has been assisting the Ministry of Finance, Fiscal Policy Office, to improve capacity for macroeconomic monitoring, forecasting, and evidence-based macroeconomic and fiscal policy analysis. ### Coordination and Continuing Work - These threads of work are expected to be continued by both parties, with regular meeting(s) to explore ways to improve synergies. - Coordination mechanisms include: - keeping each other informed about ongoing work; - requests to each other in areas of interest; and - periodic meetings. - Issues being addressed include: - For the Fund: the impact of structurally high inflation rates and associated higher volatility on real interest rates. - For the Bank: the link between macro/fiscal policy and real economic outcomes including growth and poverty, resource-sector fiscal revenues, and longstanding problems in the implementation and effectiveness of government spending. ### Indonesia: JMAP Implementation (selected entries) - Mutual Information on Relevant Work Programs - Bank work program - Indonesia Economic Quarterly — Launched in April and July 2012; next issues due September and December 2012. - World Bank follow up work related to WB/IMF Financial System Assessment Program missions (October 2009 and February/March 2010) — Ongoing. - Development of the first in a new Development Policy Loan series—Institutional, Tax Administration, Social and Investment (INSTANSI)—plus a Financial Sector and Investment Climate Reform and Modernization (FIRM) Development Policy Loan and a Connectivity Development Policy Loan — November 2012. - IMF work program - 2011 Article IV mission — July 2011; Board discussion took place in October 2011. - Tax administration technical assistance — July 2011 — Ongoing. - 2012 staff visit — January 2012. - 2012 Article IV mission — July 2012; Board discussion expected in September 2012. - Requests for Work Program Inputs - Fund request to Bank - Assessment of economic developments and structural policies — Ongoing. - Information sharing — Ongoing. - Bank request to Fund - Assessment of macroeconomic developments and policies — Ongoing. - Information sharing — Ongoing. - Government Financial Statistics training — June 2011. - Agreement on Joint Point Products and Missions - Joint work program: Asset liability management — December 2010. *Source: ANNEX II: WORLD BANK-IMF COLLABORATION (content unit _cr12277).* ### 1. The latest data are in line with the staff’s projections. Domestic demand indicators ### 1. The latest data are in line with the staff’s projections. Domestic demand indicators ### Recent developments and indicators - Domestic demand indicators remain strong. - Consumer confidence continues to hold up. - Cement sales continue to hold up. - Motor vehicle sales continue to hold up. - Strength in domestic demand is supported by robust credit conditions. ### Financial market developments and risks - Concerns about the widening current account deficit have put some pressure on financial markets in recent weeks. - The rupiah weakened by 0.8 percent during August 22−29. - Equities and bond prices have drifted down moderately. *Source: _cr12277 - 1. The latest data are in line with the staff’s projections. Domestic demand indicators* ### 2. The government has submitted its initial 2013 budget proposal to parliament. The ### _cr12277 - 2. The government has submitted its initial 2013 budget proposal to parliament. The ### 2013 budget proposal and fiscal stance - Draft budget assumes real GDP growth of 6.8 percent and CPI inflation of 4.9 percent (y/y) in 2013. - Overall deficit target in the draft budget: 1.6 percent of GDP (slightly lower than staff projection of 1.8 percent of GDP). - Authorities expect revenues to grow by 12 percent relative to the 2012 revised budget. - Draft budget proposes to increase capital spending by 15 percent over 2012 (budget allocation for capital spending in 2013 will increase by 14.9% from the 2012 allocation). - Provisions for a modest hike in subsidized electricity prices; no plans to raise subsidized domestic fuel prices. - Under current WEO oil price projections and the staff’s baseline macroeconomic assumptions, projected energy subsidy bill to reach 3 percent of GDP in 2013 (broadly unchanged from the staff report and consistent with the authorities’ own estimates). - In 2012, energy subsidies are projected to boost energy subsidies to 3.5 percent of GDP if postponed price adjustment is maintained (compared with 2.6 percent of GDP allocated to all development spending). ### Macroeconomic performance and outlook - 2011 growth: 6.5 percent (highest in over a decade). - Projected growth: 6 percent for 2012 before picking up again in 2013. - Staff report projection for 2013 growth: 6.3 percent. - Domestic demand contributors: investment grew at 20 percent (Q2, year-on-year) in 2012. - Inventories have built up significantly and are expected to level out. ### Inflation developments - Headline CPI: bottomed at 3.7 percent (year-on-year) in January; rose to 4.6 percent in July. - Inflation expected to end 2012 at 5 percent (within authorities’ target range of 4.5±1 percent). - Draft budget assumes CPI inflation of 4.9 percent in 2013. - BI July 2012 Consensus Forecast: inflation expectation for 2012 revised to 4.6% and for 2013 to 5.2% (revised down from 4.8% and 5.5% in June 2012). - BI notes Selected Issue Paper finding that 40 percent of inflation dynamic in Indonesia is attributable to domestic supply condition. ### Monetary policy and liquidity - Excess bank liquidity and rapid credit growth warrant continued vigilance and a tightening bias for monetary policy (as noted by Executive Directors). - BI adopted a policy mix since mid-2010 consisting of: interest rate response, exchange rate policy, capital flow management, macroprudential policy, and monetary policy communication and coordination. - BI widened its operational corridor from 200bps around the policy rate to a non-symmetric corridor (-200bps and +100bps from the policy rate); lower end increased by 25bps recently. - Money market rates have risen 30−50 basis points; BI increased the lower bound of its interest rate policy corridor by 25 bps. - Credit growth: 26 percent year-on-year (robust pace; decomposition by June 2012: investment credit growth 29.1%; working capital credit 28.2%; consumption credit 19.6%; total credit growth some 25.6% or 25.6% as stated). - Banking system indicators: capital adequacy ratio above 8 percent; gross non-performing loan below 5 percent. - BI uses dual intervention strategy: intervening in FX market and purchasing government bonds in the secondary market; bonds used as reverse repo instrument in open market operations. ### Financial sector reform and stability - Authorities established a Financial Services Authority (OJK) to be fully operational by end-2014. - Established a high level forum for coordinating financial stability; finalized a Memorandum of Understanding among all entities responsible for financial stability. - Passage of an effective financial system safety net (FSSN) legislation remains outstanding; draft FSSN law submitted to parliament. - Transition of supervisory functions: OJK to handle regulation and supervision of microprudential aspects; BI to handle macroprudential issues (amendments to BI Act proposed). - Macroprudential measures adopted: Loan-to-Value (LTV) ratio for automotive and mortgage credit. - Authorities improving AML/CFT regime; draft bill on Counter Financing Terrorism included in national Legislation Program 2010–2014 and recently updated. ### External sector, exchange rate, and reserves - Rupiah and equity markets under pressure in spring 2012 with sharp outflows; BI increased foreign exchange sales and allowed faster depreciation to stabilize markets. - Current account expected to record a deficit of 1.9 percent of GDP in 2012, funded mostly by strong foreign direct investment inflows. - Directors welcomed authorities’ commitment to exchange rate flexibility and recommended intervention only within a well defined strategy to limit short-run volatility. - Staff assessment: exchange rate is moderately undervalued. - Gross reserves (end period): 110.1 (2011), 107.8 (2012), 110.3 (2013) in billions of U.S. dollars as presented in the Selected Economic Indicators table; international reserve in July 2012 stood at $106.6 billion (authorities’ statement). - Reserves in months of imports: 6.7 (2011), 5.9 (2012), 5.7 (2013) as in the Selected Economic Indicators table. ### Structural reforms and investment agenda - Authorities emphasize strengthening domestic economy: enhancing competitiveness, accelerating infrastructure development (MP3EI 2011–2025), strengthening food security, electrification ratio and energy conversion, human resource development, and poverty alleviation (MP3KI 2012–2025). - Budget allocation for capital spending in 2013 will focus on energy security, food security and domestic interconnectivity. - Interdepartmental committee established to coordinate MP3EI implementation; promotion of PPP and Indonesia Infrastructure Guarantee Fund to mobilize private participation. - Viability Gap Fund near completion to provide cash to companies to defray construction costs for PPP projects (funded by remaining over budget (SAL)). - Authorities note some recent trade and investment measures intended to support downstreaming of industries and will proceed cautiously while preserving external commitments. ### Executive Directors' assessment and policy recommendations - Commended authorities for sound economic management and strong economic performance. - Noted elevated downside risks but affirmed ample buffers to allow countercyclical policy responses if needed. - Recommended: - Continued vigilance on excess liquidity and rapid credit growth; tightening bias for monetary policy. - Strengthen monetary policy communications to better inform market expectations. - Careful implementation of financial regulation and oversight initiatives to minimize transitional risks. - Move quickly to address remaining gaps in AML/CFT regime. - Limit official intervention in FX market to a well defined strategy to limit short-run volatility. - Advance fiscal reforms: improve budget execution, reorient spending toward social sectors and infrastructure, replace energy subsidies with targeted cash transfers to the vulnerable, and boost revenue collections. - Deeper structural reforms to increase productivity and competitiveness: invest in human capital, reduce cost of doing business, deepen financial markets, labor market reforms, and address infrastructure and supply bottlenecks. ### Selected economic indicators (as presented) - Real GDP (percent change): 2008 6.0; 2009 4.6; 2010 6.2; 2011 6.5; 2012 6.0; 2013 6.3. - Consumer prices (end period): 2008 11.1; 2009 2.8; 2010 7.0; 2011 3.8; 2012 5.0; 2013 5.1. - Central government balance (in percent of GDP): 2008 -0.1; 2009 -1.6; 2010 -0.6; 2011 -1.1; 2012 -1.8; 2013 -1.8. - Central government debt (in percent of GDP): 2008 33.2; 2009 28.6; 2010 26.9; 2011 24.5; 2012 23.5; 2013 21.5. - Current account balance (in billions of U.S. dollars): 2008 0.1; 2009 10.6; 2010 5.1; 2011 1.7; 2012 -17.3; 2013 -20.2. - Foreign direct investment (in billions of U.S. dollars): 2008 9.3; 2009 4.9; 2010 13.8; 2011 18.9; 2012 21.4; 2013 21.5. - Gross reserves (in billions of U.S. dollars, end period): 2008 51.6; 2009 66.1; 2010 96.2; 2011 110.1; 2012 107.8; 2013 110.3. - Nominal GDP (in billions of U.S. dollars): 2008 510; 2009 539; 2010 708; 2011 846; 2012 906; 2013 1,036. - Indonesian oil price (US$/bbl): 2008 97.0; 2009 61.6; 2010 79.4; 2011 111.5; 2012 107.2; 2013 101.5. - Oil production (thousands of barrels per day): 2008 976; 2009 949; 2010 945; 2011 907; 2012 895; 2013 890. *Source: IMF staff report and Public Information Notice (PIN) No. 12/112, September 25, 2012.* ### Conclusion ### _cr12277 - Conclusion ### Key messages - In summary, Indonesian authorities recognize the challenges they face in their effort to ensure higher, sustained and inclusive growth. They will continue to monitor the economic situation closely and stand ready to ensure that macroeconomic and financial stability are well maintained. In that regard, they acknowledge the staff’s advice on such issues, and look forward to a continued fruitful engagement with the Fund. *Source: _cr12277 - Conclusion* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12277.pdf_