## Recent Policy Measures (Through September 2013) — IMF staff report (_cr13362) ## Source details **Canonical URL:** [Recent Policy Measures (Through September 2013) — IMF staff report (_cr13362)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13362.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13362.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13362.pdf.json) --- ### Monetary policy and liquidity management - BI raised policy rate and overnight deposit facility rate starting in June 2013 by a total 150 bps to 7.25 percent and 5.5 percent, respectively. - Introduced tradable central bank rupiah deposits at one- and six-month tenors in September 2013; allowed these to be treated as required reserves. - Shortened minimum holding period for central bank bills (SBIs) from six months to one month from mid September 2013. - BI policy corridor: overnight deposit facility rate noted as 5.5 percent in earlier section and 5.75 percent in other dated measures; overnight lending rate increased to the same level as BI policy rate per staff timeline. ### Exchange rate policy and FX market operations - Commenced biweekly auctions of FX swaps with resident banks in July 2013; from August 2013 allowed banks to pass derivative positions with customers to BI through these swap auctions. - Broadened maturities of U.S. dollar term deposits placed by banks with BI from August 2013. - Relaxed FX purchase rules for exporters who have converted export proceeds (August 2013). - Relaxed regulations in August 2013 on banks' short-term foreign borrowing (cap currently at 30 percent of capital) by exempting certain nonresident demand deposits. - Policy stance: exchange rate and bond yields being allowed to adjust more freely in line with market conditions. ### Macroprudential controls - Tightened loan-to-valuation (LTV) limits on mortgages for second and third residential properties in September 2013. - Raised LTV limits for motor vehicles (date: September 2013). - Raised secondary reserve requirement (RR) in September 2013 from 2.5 percent to 4 percent (fulfilled by banks’ holding of treasury and BI securities), to be phased in by December 2013. - Tightened LDR-linked RR by lowering applicability to banks with LDR in excess of 92 percent (from 100 percent) and with capital adequacy ratio less than 14 percent. ### Fiscal and administrative measures - Increased subsidized petrol price by 44 percent and subsidized diesel price by 22 percent in mid‑June 2013; revised 2013 budget approved a temporary cash compensation scheme for vulnerable groups. - Announced August 2013 temporary deductions and deferred payments of income tax for the rest of 2013 for certain labor-intensive and export-oriented industries. - Eliminated luxury taxes on certain televisions and appliances in August 2013. - Increased biodiesel usage to 10 percent in diesel fuel in August 2013 to reduce oil imports. - Relaxed regulations on bonded zones in August 2013 (simplified licensing; increased allocation for local sale to 50 percent from 25 percent). - Changed import mechanism for beef and horticultural products in September 2013 from strict quotas to price‑reference based stop/start system. - Announced plans in August 2013 to issue a presidential decree guiding regional minimum wage setting in 2014. ### Market operations, liquidity and FX market functioning - Net bond and equity outflows since May 22 to end‑October 2013: US$2.7 billion. - Rupiah depreciation in 2013 to date: 17 percent against the U.S. dollar (most since July). - Wedge between onshore and offshore rates reached as much as 5 percent in mid‑2013 but diminished with greater exchange rate flexibility. - Selected financial snapshot (as presented): - Exchange rate (Rp per US$): End‑2012 9,638; May 22 9,770; Aug. 30 10,920; Oct. 31 11,273. - 10‑year rupiah government debt (in percent): End‑2012 5.19; May 22 5.70; Aug. 30 8.42; Oct. 31 7.47. - Jakarta stock index: End‑2012 4,317; May 22 5,208; Aug. 30 4,195; Oct. 31 4,511. - CDS spreads (bps): End‑2012 136; May 22 142; Aug. 30 278; Oct. 31 196. - Net bond and equity flows (US$ billions): change to October 29, 2013 shown as -2.7 (with earlier 3.4 inflow as presented). --- ### Recent macroeconomic developments and near‑term outlook ### Growth and inflation - Real GDP growth expected to slow to 5‒5½ percent in 2013 and 2014 from 6¼ percent in 2012. - Growth in first half 2013: slightly under 6 percent (y/y). - Headline inflation expected to peak at 9.5 percent (y/y) at end‑2013 before moderating; inflation was 8.4 percent in September 2013, up from 4.3 percent at end‑2012. - Core inflation (less food and fuel) increased to 4.7 percent in September 2013 from 4.0 percent in May 2013. ### External sector and reserves - Current account deficit projected to widen to 3½ percent of GDP in 2013. - Overall BOP: sizable deficit projected in 2013. - Gross reserves: US$96 billion at end‑September 2013; staff expect fall to around US$89 billion at end‑2013 (4.9 months of imports or 155 percent of short‑term debt), compared to US$113 billion at end‑2012 (6.4 months of imports or 206 percent of short‑term debt). - Staff projection and table alternatives also list reserves: Sep 2013: 95.7; 2013 Proj./end period: 96.2; 2014 Proj./end period: 88.7 (tables present multiple reserve series). ### Capital flows and vulnerabilities - Portfolio flows in 2013 so far: equity outflows net 0.1 percent of GDP; bond inflows net 1 percent of GDP (staff estimate for 2013 so far). - Reliance on portfolio flows increases vulnerability to reversals from global risk aversion or unwinding of global monetary accommodation. - Gross external financing requirement (2013 Proj.): US$85.0 billion (Table 3 and debt projections). --- ### External position assessment and policy implications ### Overall assessment (EBA and staff estimates) - External position remains moderately weaker than implied by medium‑term fundamentals and desirable policies. - EBA results for 2012: - Current account norm: −½ to −2½ percent of GDP. - Cyclically adjusted current account balance (CAB): −2.2 percent of GDP. - CAB was 0−2 percentage points weaker than the norm in 2012. - EBA external sustainability: a CAB of −2.7 percent of GDP would stabilize net foreign asset (NFA) position at −38 percent of GDP. - Staff estimate for 2013: - Cyclically adjusted CAB about −3.3 percent of GDP (weaken by a further 0.6 percentage points), about 1−3 percentage points of GDP weaker than implied by medium‑term fundamentals and desired policies. ### Real exchange rate (REER) and depreciation effects - REER, 2012 average: 102; REER norm: 96 to 106. - By September 2013, REER had fallen a further 8½ percent, suggesting possible undervaluation. - Using standard elasticities, depreciation so far in 2013 (if maintained) would improve the CAB by about 1¼ percentage points of GDP over the medium term. - Staff view: macrobalance approach preferred to REER approach given worsening CAB and large residual in REER approach. ### Reserves and contingent financing - Official reserves: End‑December 2012 US$113 billion; End‑July 2013 US$93 billion; staff project US$89 billion at end‑2013. - Projected end‑2013 reserves at low end of recommended 100−150 percent on IMF composite reserve adequacy metric. - Contingent financing: - World Bank DPL with Deferred Drawdown Option approved May 2012 provides US$2 billion through end‑June 2014. - Additional partner financing around US$3 billion possible from ADB, Japan, Australia (at current exchange rates, as presented). - Bilateral swap arrangements: Japan US$12 billion (extended August 2013); China Y 100 billion (agreed October 2013); Korea US$10 billion (agreed October 2013). - CMIM access up to US$11.4 billion under current rules; Indonesia given formal consent to doubling CMIM to US$240 billion. ### Policy stance recommended - Restore stability and reduce vulnerabilities: rebuild policy and financial buffers while clear communicating policy framework. - Take advantage of any delay in UMP tapering to strengthen buffers. - Maintain exchange rate flexibility, limit FX sales to SOEs, strengthen SOE financial risk management and hedging; new regulations in October 2013 expected to help. --- ### Monetary and financial sector — developments, vulnerabilities, and recommendations ### Financial conditions and markets - Credit growth: 20 percent (y/y) in August 2013 (down from 27 percent in mid‑2012); private sector credit in Aug 2013: 22.2 percent annual growth (Table/FSI). - Loan‑to‑deposit ratio (LDR): 89 percent in August 2013, compared to 84 percent a year earlier; projected system‑wide LDR reach 92 percent by end‑2013. - Banking soundness indicators: regulatory capital to risk‑weighted assets Jun 2013: 17.5 percent; Tier‑1: 16.1 percent; NPLs Jun 2013: 1.8 percent. - FX lending at commercial banks Aug 2013: 15.6 percent of total loans; foreign currency deposits Aug 2013: 16.4 percent of total deposits. - Money market: interbank trading thin beyond one‑month tenors; bid‑ask spreads widened (recently > Rp 50 vs average Rp 7 in 2010); spot interbank volumes fell to < US$300 million daily in Aug 2013 from > US$1 billion in 2010. ### Financial sector oversight and crisis preparedness - Transfer of banking supervision from BI to OJK scheduled to complete by beginning of 2014; MOUs being finalized. - Financial System Stability Forum (FKSSK) central to crisis management; FSSN law draft submitted to Parliament but passage not expected before 2014 elections. - Staff recommendations: - Close monitoring of banks and corporates; augment macroprudential oversight and crisis management arrangements. - Fill CMP gaps urgently through interim protocols (likely by presidential decree) if FSSN law delayed. - BI to lead systemic risk monitoring; OJK to implement prudential tools; clear accountability framework required. ### Stress tests and liquidity risks - Systemic liquidity risk assessed low given retail funding base; total liquidity gap of banks facing strains estimated at Rp 9 trillion (0.2 percent of total banking system assets) based on end‑December 2013 data. - FX liquidity gap in a system‑wide shock estimated about US$7.5 billion (5 percent FX deposit outflow shock scenario). - Scenario: net interest margins compress by 60 bps → ROA falls by estimated 0.5 percentage point; capital buffers lower by 0.8 percent of RWA. - If all restructured and special mention loans classified as NPLs, additional provisions ≈ Rp 125 trillion (3 percent of total banking system assets); system wide CAR would fall to 14.2 percent from 17.5 percent; around 5 percent of banks likely to breach 8 percent minimum. ### Staff monetary policy recommendations - Ensure clear nominal anchor focused on bringing headline inflation back within BI’s target band (4.5±1 percent). - Further tighten monetary policy if inflation remains outside target band. - Strengthen monetary transmission and deepen money markets: narrow interest corridor, use OMOs to guide short‑term rates to middle of corridor, introduce tradable OMO instruments, continue IMF TA on secured lending. - Limit FX intervention to smoothing volatility; scale back FX sales to SOEs; communicate clearly to stimulate price discovery and interbank trading. --- ### Fiscal policy, public debt, and medium‑term fiscal priorities ### Recent fiscal developments and 2013 performance - Fuel price increases mid‑June 2013: subsidized petrol up 44 percent; subsidized diesel up 22 percent. - Fiscal deficit revised upward to 2.4 percent of GDP in 2013 from original target of 1.6 percent; 2012 outturn 1.9 percent of GDP. - Temporary cash transfers and assistance equivalent to 0.2 percent of GDP to 15 million households included to garner support for fuel price increase. - Central government revenue (percent of GDP): 2012 16.2; Jan‑Sep 2013: 10.8; 2013 Est.: 16.0; 2014 Budget: 16.0. - Central government expenditure (percent of GDP): 2012 18.1; Jan‑Sep 2013: 12.0; 2013 Est.: 18.5; 2014 Budget: 18.4. - Central government balance (percent of GDP): 2012: -1.9; 2013 Est.: -2.5; 2014 Budget: -2.5. ### Debt trends and projections - Public sector debt record low 24.4 percent at end‑2011; broadly unchanged in 2012. - Baseline projections: public sector debt expected to rise to around 26.8 percent of GDP in 2014; medium‑term decline to around 24.4 percent by 2018. - External debt (percent of GDP) path: 2012: 28.7; 2013: 30.3; 2014: 32.2; 2018: 31.2. - Gross external financing need (US$ billions): 2012: 71.2; 2013: 85.0; 2014: 85.0; 2018: 109.7. - Debt‑stabilizing primary balance (baseline): -0.9 percent of GDP. ### Staff fiscal recommendations - Keep overall deficit capped at 2 percent of GDP in 2013 to bolster credibility (staff view); staff baseline assumed deficit around 2½ percent of GDP in 2013 and 2014. - Pursue moderate fiscal consolidation in 2014 and medium term; staff recommended limiting deficit to 1½ percent of GDP in 2014 (note: final draft 2014 budget targeting deficit 1.7 percent of GDP approved by Parliament in late October 2013). - Rationalize energy subsidy regime and mobilize tax revenues to bring primary deficit into balance and keep debt manageable. - Replace broad energy subsidies with targeted cash transfers per IMF TA recommendations. - Move from fixed subsidized price to fixed subsidy as proposed by MoF. - Strengthen cash and debt management; consolidate line ministry accounts in commercial banks; modalities for replacing nonmarketable government securities on central bank balance sheet to be agreed (nonmarketable securities totaled Rp 234 trillion (2.6 percent of GDP) as of August 2013). ### Medium‑term fiscal priorities - Broaden tax base and mobilize non‑oil tax revenues: potential to raise tax revenues by about 4−5 percentage points of GDP over the medium term by strengthening direct and indirect taxes and mining sector revenues. - Gradually eliminate fuel and electricity subsidies over medium term to create space for social and capital spending. - Improve budget execution, especially for capital spending; capital spending disbursements over past five years were 70−90 percent of amount budgeted. --- ### Structural reforms, labor market, and competitiveness ### Labor market findings and recommendations - Labor market rigidities (high severance pay, strict fixed‑term contract rules, frequent minimum wage adjustments, strict severance and outsourcing limits) hinder efficient labor allocation. - Only one‑third of labor force has formal sector employment; less than 40 percent of workers have full‑time employment (>35 hours/week). - Minimum wage growth outpaced productivity; Jakarta minimum wage increased by average 44 percent in 2013. - Empirical findings (regression evidence): interaction between labor rigidity and initial labor productivity shows high severance pay has adverse effects on efficient labor allocation particularly for countries with lower initial labor productivity. - Table excerpts: R‑squared entries 0.144, 0.200, 0.495, 0.037, 0.165, 0.321; Observations 46 across regressions; significance indicators retained as presented. - Policy recommendations for Indonesia: - Reduce labor market rigidity (reconsider high severance and Manpower Law restrictions). - Align minimum wage growth with productivity growth. - Complement with infrastructure and business climate improvements to support labor reallocation. ### Trade, investment, and structural transformation - Main priority: improve transparency, predictability, and stability of trade and investment regime, move away from ad hoc restrictions (e.g., earlier 2013 quotas on beef and horticultural imports). - Clear transition plan needed for 2014 ban on raw mineral ore exports to avoid current account pressures and encourage on‑shore processing investment. - A less restrictive negative list for foreign investment, improvements in transport, power, logistics would bolster integration and growth. --- ### AML/CFT, data adequacy, and surveillance ### AML/CFT status - February 2013 CFT law criminalized terrorist financing but does not fully address identified deficiencies, notably framework for identifying and freezing terrorist assets. - Indonesia remains on FATF list of jurisdictions that have not made sufficient progress; addressing deficiencies quickly recommended to avoid heightened scrutiny and possible countermeasures. ### Data adequacy for surveillance - National accounts: annual and quarterly GDP timely (base year 2000); revision to base year 2010 in progress with STA TA; publication improvements and establishment of supply and use tables recommended. - Government finance statistics: weaknesses in classification, coverage, timeliness; subnational data lagging; authorities committed to GFSM 2001 adoption; recommendations include register of extrabudgetary units and timely local government reporting. - Monetary and financial statistics: BI compiles timely monetary statistics and FSIs; recommended expansion of OFC coverage and improvements in revisions after supervisory verification. - Balance of payments: trade data improved; significant improvement needed in FDI compilation methodology and IIP underlying data. - Data dissemination: SDDS subscriber since September 1996; uses flexibility options for some labor and general government categories. --- ### Risk Assessment Matrix — selected high‑likelihood/high‑impact risks and recommended responses - Global protracted EME volatility (Likelihood: High; Expected Impact: High) - Policy responses: allow exchange rate flexibility; tighten monetary policy; pursue fiscal consolidation; accelerate structural reforms. - Global/medium term lower than anticipated EM growth or sharp slowdown in China (Likelihood: Medium; Expected Impact: High to Medium/High) - Policy responses: exchange rate flexibility; monetary tightening; fiscal measures as needed; accelerate structural reforms. - Domestic short term government funding shortfalls (Likelihood: Medium; Expected Impact: Medium/High) - Policy responses: tighten fiscal policy; maintain exchange rate and bond yield flexibility; use contingent financing if market access restricted. - Domestic banking system distress from severe funding squeeze (Likelihood: Low/Medium; Expected Impact: Medium) - Policy responses: strengthen lender‑of‑last‑resort/emergency liquidity protocols; coordinate regulators; expedite Financial Safety Net Law or interim protocols. --- *Italic: IMF staff report content unit _cr13362 — selected chapters and staff analysis as provided in the source content.* ### 1. Recent Policy Measures (Through September 2013) ___________________________________________6 ### Recent Policy Measures (Through September 2013) ### Overview of measures since May 2013 - Objective: reduce macroeconomic imbalances, neutralize inflation pressures, maintain financial stability, and contain employment losses. - Measures implemented jointly by the government and Bank Indonesia (BI) span monetary policy and liquidity management, exchange rate and FX market operations, macroprudential controls, fiscal policy, and other administrative measures. ### Monetary Policy and Liquidity Management - BI raised both the policy rate and the overnight deposit facility rate (bottom of interest rate corridor) starting in June 2013 by a total 150 bps to 7.25 percent and 5.5 percent, respectively. - BI introduced tradable central bank rupiah deposits at one- and six-month tenors in September to facilitate interbank money market development, and allowed these instruments to be treated as required reserves. - BI shortened the minimum holding period for central bank bills (SBIs) from six months to one month from mid September to increase their liquidity. ### Exchange Rate Policy and Foreign Exchange Market Operations - Commenced biweekly auctions of foreign exchange (FX) swaps with resident banks in July 2013; allowed derivative positions held by banks with their customers to be passed on to BI through the swap auctions starting August 2013. - Broadened the maturities of U.S. dollar term deposits placed by banks with BI from August. - Relaxed the rules in August on FX purchases by exporters that have converted their export proceeds. - Relaxed regulations in August on banks' short-term foreign borrowing (currently capped at 30 percent of their capital) mainly by exempting demand deposits of nonresidents used for investment activities in Indonesia and demand deposits of nonresidents that contain divestment funds. - Policy stance: exchange rate and bond yields are being allowed to adjust more freely in line with market conditions. ### Macroprudential Controls - Tightened loan-to-valuation (LTV) limits on mortgages for second and third residential properties in September 2013. - Raised LTV limits for motor vehicles. - Raised the secondary reserve requirement (RR) in September (fulfilled by banks’ holding of treasury and BI securities) from 2.5 percent to 4 percent, to be phased in by December 2013. - Tightened the loan-to-deposit ratio (LDR) linked RR by lowering its applicability to banks with an LDR in excess of 92 percent (from 100 percent) and with a capital adequacy ratio of less than 14 percent. ### Fiscal Policy Measures - Increased subsidized petrol price by 44 percent and subsidized diesel price by 22 percent in mid­June 2013; approved in the revised 2013 budget a temporary cash compensation scheme for vulnerable groups. - Announced in August the allowance of temporary deductions and deferred payments of income tax for the rest of 2013 for certain labor-intensive and export-oriented industries. - Eliminated luxury taxes on more common use goods previously classified as luxury items (certain televisions and appliances) in August. - Increased the quantity of biodiesel usage to 10 percent in diesel fuel to reduce oil imports in August. - Relaxed regulations in August on bonded zones through simplification of licensing procedures and increasing the allocation of certain goods for local sale. ### Other Administrative and Structural Measures - Changed the mechanism for importing beef and horticultural products in September 2013, moving away from strict quotas to a system that will halt imports when the domestic price falls below the reference price and allow imports to resume if the domestic price exceeds the reference price. - Expanded the share of sales that industries in bonded zones can derive domestically in August to 50 percent from 25 percent, reversing a 2011 decision to restrict these sales. - Announced plans in August to issue a presidential decree guiding regional minimum wage setting in 2014. ### Recent macroeconomic developments and near-term outlook - Real GDP growth is expected to slow to 5‒5½ percent in 2013 and 2014 from 6¼ percent in 2012. - In the first half of 2013, growth was slightly under 6 percent (y/y). - Headline inflation is expected to peak at 9.5 percent (y/y) at end­2013 before moderating; inflation was 8.4 percent in September 2013, up from 4.3 percent at end­2012. - Core inflation (less food and fuel) increased to 4.7 percent in September from a low of 4.0 percent in May. - The current account deficit is projected to widen to 3½ percent of GDP in 2013. - Overall BOP is projected to show a sizable deficit in 2013; gross reserves were US$96 billion at end-September and are expected to fall to around US$89 billion at end­2013 (4.9 months of imports or 155 percent of short-term debt), compared to US$113 billion at end-2012 (6.4 months of imports or 206 percent of short-term debt). ### Market developments and capital flows (selected indicators) - Since May 22, net bond and equity outflows have totaled US$2.7 billion (to end-October). - The rupiah depreciated by 17 percent against the U.S. dollar so far in 2013, with most of this occurring since July. - Wedge between onshore and offshore rates reached as much as 5 percent in mid­2013 but diminished with greater exchange rate flexibility. - Financial market snapshot (selected changes noted in text table): - Exchange rate (Rp per US$): End‑2012 9,638; May 22 9,770; Aug. 30 10,920; Oct. 31 11,273; Change since May 22: -17.0 -15.4 -3.2 (as presented in the source). - 10‑year rupiah government debt (in percent): End‑2012 5.19; May 22 5.70; Aug. 30 8.42; Oct. 31 7.47; Changes in basis points as presented. - Jakarta stock index: End‑2012 4,317; May 22 5,208; Aug. 30 4,195; Oct. 31 4,511; Changes as presented. - CDS spreads (in basis points): End‑2012 136; May 22 142; Aug. 30 278; Oct. 31 196; Changes as presented. - Net bond and equity flows (in US$ billions): change to October 29, 2013 shown as -2.7 with earlier 3.4 inflow (as presented). ### Risks and prospects - Near-term risks: protracted economic and financial volatility (especially in EMEs), a fiscal policy shock in the United States, deterioration in export demand and commodity prices, and weakening investor sentiment leading to exacerbated external and fiscal imbalances. - Vulnerability indicators point to some elevated risks (see reference to Table 3 and RAM). - Domestic risk: potential bank distress from a sharper-than-envisaged squeeze on liquidity and/or slowdown in economic activity; prolonged inaction on structural reforms could reduce productivity and competitiveness. ### Medium-term baseline assumptions and projections - Medium-term growth expected to average 6 percent, contingent on managing risks, restoring a stable macroeconomic environment, and stepping up structural reforms. - Baseline assumes energy subsidies are phased out by 2018, with some interim savings redirected to larger development spending. - Under the baseline: - Current account deficit would narrow to 2½ percent of GDP in the medium term. - Gross FDI would stay at around 2 percent of GDP. - Reserves would stabilize at around 3½ months of imports and 100−120 percent of short-term debt. ### Authorities' views - Authorities are more optimistic than staff: expect growth to slow less in 2013 and to recover more in 2014 due to more favorable domestic conditions and election year spending (parliamentary and presidential elections slated for mid­2014). - On inflation, authorities expect recent policy tightening and more benign exchange rate pass-through will bring inflation back within BI’s target band (4.5±1 percent) in 2014. - Authorities expect the current account deficit to widen only slightly in 2013 to around 3 percent of GDP and to narrow more in 2014 and over the medium term due to regional and global factors and domestic reforms. *Italic: Source — IMF staff summary of "Recent Policy Measures (Through September 2013)" (document content provided).* ### 9. The external position appears moderately weaker than implied by medium­term ### 9. The external position appears moderately weaker than implied by medium­term fundamentals and desirable policies ### Overall assessment - The external position remains moderately weaker than implied by medium-term fundamentals and desirable policies. - The IMF’s external balances assessment (EBA) methodology results for 2012: - Current account norm: −½ to −2½ percent of GDP. - Cyclically adjusted current account balance (CAB): −2.2 percent of GDP. - CAB was 0−2 percentage points of GDP weaker than the norm in 2012. - The EBA external sustainability approach estimates that a CAB of −2.7 percent of GDP would stabilize Indonesia’s net foreign asset (NFA) position at −38 percent of GDP. - Staff estimate for 2013: - Cyclically adjusted CAB about −3.3 percent of GDP (weaken by a further 0.6 percentage points), about 1−3 percentage points of GDP weaker than implied by medium-term fundamentals and desired policies. ### Drivers of the external position (factors and recent evolution) - Recent deterioration reflects a combination of cyclical and structural forces. - 2012 drivers: - Weak commodity prices, falling oil and gas exports, and strong imports caused CAB to weaken by 3 percentage points to −2.8 percent of GDP. - Widening of the fiscal deficit had relatively limited impact (less than 0.3 percentage points of GDP). - Policy and structural contributions to estimated 2012 Current Account Gap (In percent of GDP): - Cyclically adjusted CA: −2.2 - CA norm: −0.5 to −2.5 - Estimated CA gap: 0 to −2 - Of which: - Partners' fiscal deficits: 1.0 - Domestic capital controls: 0.6 - Partner policies, other: −0.2 - Domestic policies, other: −0.2 - Residual: −2.2 ### Real exchange rate (REER) - EBA REER model suggests 2012 REER was in line with fundamentals and desirable policies. - REER data: - REER, 2012 average: 102 - REER norm: 96 to 106 - Estimated REER gap: (residual and specific contributions shown in source) - By September 2013, the REER had fallen a further 8½ percent, suggesting possible undervaluation. - Using standard elasticities, the depreciation so far in 2013 (if maintained) would improve the CAB by about 1¼ percentage points of GDP over the medium term. - Staff view: macrobalance approach gives a more accurate assessment of Indonesia’s external position than the REER approach given the worsening CAB and large residual in the REER approach. ### Capital account and flows - Staff estimate FDI will remain about 2 percent of GDP over the medium term. - Investor assessments: Indonesia rates highest on market size and the macroeconomic environment but needs improvements in labor markets, business startup procedures, contract enforcement, and infrastructure. - Portfolio flows: - Equity outflows (net) in 2013 so far: 0.1 percent of GDP (small). - Bond inflows (net) in 2013 so far: 1 percent of GDP. - Vulnerabilities: reliance on portfolio flows poses added risks; Indonesia remains vulnerable to slowdown or reversal in capital inflows due to increased global risk aversion, unwinding of global monetary accommodation, or weaker investor sentiment. - Capital flow management measures: introduced in 2010 and partially reversed in August 2013 (reduction in holding period for BI securities). ### Foreign reserves and external assets/liabilities - Official reserves: - End-December 2012: US$113 billion. - End-July 2013: US$93 billion. - Staff project reserves: US$89 billion at end-2013. - Assessment: projected end-2013 reserves at the low end of the recommended range of 100−150 percent on the IMF’s composite reserve adequacy metric. - Net foreign asset position at end-2012: −41 percent of GDP, comprising: - Reserves: +13 percent of GDP. - Net FDI and equities: −34 percent of GDP. - Net debt and other liabilities: −20 percent of GDP. - Outlook: external asset and liability ratios expected to stay fairly constant over the medium term; not viewed as a significant vulnerability given relatively low level of debt and other liabilities. - Projected near-term movements: both external and public debt are projected to rise slightly (as a share of GDP) but remain at relatively low levels. - Debt Sustainability Analysis (Appendix 3) indicates the debt profile is resilient to standard shocks. ### Contingent financing and swaps - World Bank DPL with Deferred Drawdown Option (approved May 2012): - Provides US$2 billion in contingent budget support through end-June 2014, to be accessed in the event of a fiscal financing crisis under government decree-defined circumstances. - Additional partner/parallel financing could come from ADB, Japan, and Australia totaling around US$3 billion (at current exchange rates). - Bilateral swap arrangements (BSAs): - Japan: US$12 billion (extended in August 2013). - China: Y 100 billion (agreed in October 2013). - Korea: US$10 billion (agreed in October 2013). - Chiang Mai Initiative Multilateralization (CMIM): - Under current CMIM agreement (since March 2010), Indonesia can access up to US$11.4 billion. - Note: under the agreement, Indonesia can swap rupiah for U.S. dollars in the amount of its contribution multiplied by its current purchasing multiple (2.5), or up to US$11.4 billion. - Indonesia has given formal consent to doubling the CMIM agreement to US$240 billion. ### Policy issues and recommended stance - Policy focus: restore stability and reduce vulnerabilities in light of external and fiscal imbalances and likely permanent shift in global financing conditions. - Authorities should take advantage of delay in UMP tapering to rebuild policy and financial buffers and improve market perceptions. - Required actions: continued vigilance over macroeconomic imbalances, clear communication of policy framework, firm follow-through on stabilization measures. - Contingent financing and swap arrangements provide important fiscal and reserve buffers. - Past actions: authorities tightened monetary policy and allowed greater exchange rate flexibility (with some lag); subsidized fuel prices were raised with temporary safety nets; gaps remain in financial stability architecture and trade- and investment-creating opportunities have not fully materialized. ### Monetary and exchange rate policies — Recent developments - Financial conditions: - Credit growth: 20 percent (y/y) in August 2013 (down from 27 percent in mid-2012). - Loan-to-deposit ratio (LDR): 89 percent in August 2013, compared to 84 percent a year earlier. - Credit growth expected to slow to 15−20 percent by end-2013 and further in 2014. - Exchange rate and money market developments: - From early 2012 to mid-2013, rupiah steadily weakened against the U.S. dollar as CAB shifted into deficit. - Bank Indonesia (BI) intervened heavily and used moral suasion, creating a wedge between onshore and offshore rates and reducing spot FX market liquidity. - Official reserves fell from US$113 billion at end-December 2012 to US$93 billion at end-July 2013, before stabilizing. - BI projected to reduce interventions and allow rupiah to move more freely; BI also stepped up government bond purchases in response to selling pressures. - Trading in the interbank money market remains thin and segmented, with negligible activity beyond one-month tenors. ### Policy response measures (timeline and instruments) - Since June 2013: - BI policy and overnight deposit facility rates raised by 150 bps to 7.25 percent and 5.75 percent, respectively. - Overnight lending rate increased to same level as BI policy rate; BI policy rate now forms the upper bound of interest corridor. - August–September 2013 measures: - New short-term instruments introduced in August 2013 to aid bank liquidity management. - Holding period on BI bills (SBIs) shortened to one month from six months in September 2013 to increase liquidity and attract foreign inflows. - Additional macroprudential measures on property lending introduced: lower loan-to-valuation ratios for second and third property loans. - Phased increases in secondary and LDR-linked reserve requirements began coming into effect in September 2013. - Foreign exchange swap auctions with resident banks started in July 2013. - BI clarified traders could quote exchange rates freely in the spot market and took steps to increase hedging opportunities. ### Foreign exchange market functioning (Box 3 findings) - FX market characteristics: - Local FX market small and illiquid relative to EM peers; growth in FX transactions involving the rupiah has risen more slowly than most major EM currencies. - Contributing factors: tight restrictions on forward market activity, smaller domestic financial markets, high proportion of commodity exports. - Liquidity and volatility indicators: - Bid-ask spreads widened to more than Rp 50 lately compared to an average of Rp 7 in 2010. - Spot interbank volumes fell from a daily average of over US$1 billion in 2010 to less than US$300 million in August 2013; interbank FX volumes have picked up modestly since August 2013. - Episodes of onshore market illiquidity (notably September 2011, May 2012, May 2013) associated with sharp increases in NDF spreads and reliance on offshore markets. - BI interventions: - Some FX sales by BI appeared directed toward large FX needs of SOEs (e.g., Pertamina and Perusahann Listrik Negara), reducing banks’ ability to act as market makers and depressing spot interbank activity. - Recent improvements since August 2013: - Moral suasion eased, banks able to quote more freely and transact in onshore markets, and overall FX market liquidity gradually increasing. - Potential benefits of deeper FX market: - Could improve foreign investor sentiment and decrease risk premia for rupiah-denominated assets. - Without deeper interbank trading and market making, spreads on rupiah-denominated assets could rise further reflecting increasing liquidity premia. ### Staff’s position and main policy recommendations - Monetary framework: - BI should ensure a clear nominal anchor that focuses on bringing headline inflation back within the target band under the central bank’s inflation targeting framework. - Policy rate hikes and liquidity management measures have been positive; however, monetary transmission remains weak with substantial lags and short-term money market rates still at the low end of BI’s interest rate corridor. - Effective policy rate remains negative in real terms. - Exchange rate policy: - Continued exchange rate flexibility is necessary to facilitate BOP adjustment and absorb external shocks. - Government bonds should remain market determined to attract external inflows and meet official financing needs. - Specific recommendations: - Further tighten monetary policy if projected inflation remains outside the target band; additional tightening could reinforce investor confidence and stabilize capital flows. - Use foreign exchange swap auctions with resident banks and open market operations (OMO) consistent with policy tightening. - Strengthen monetary transmission and deepen money markets: narrow the interest corridor, use OMO more aggressively to guide short-term rates back to the middle of the corridor, introduce tradable OMO instruments, and continue IMF technical assistance to develop secured lending among banks. - Continue to limit FX market intervention to smoothing volatility and communicate clearly to traders to stimulate price discovery and increase interbank trading volumes. - Scale back FX sales to state-owned enterprises (SOEs) to safeguard reserves and improve financial risk management practices at SOEs, including prudent hedging of FX exposures; new regulations issued in October 2013 expected to aid this effort. *Source: IMF staff analysis in the IMF country document (Indonesia) provided in the source content.* ### 16. Authorities’ views. The authorities broadly agreed with staff’s assessment of recent ### 16. Authorities’ views ### Monetary policy and BI views - Authorities broadly agreed with staff’s assessment of recent developments and the near-term outlook for financial conditions. - Emphasized value of clearly communicating policy intentions to anchor market expectations, mitigate inward spillovers, and ensure orderly adjustment of the exchange rate and bond yields. - Bank Indonesia (BI) officials: - Believed further monetary policy tightening might be necessary but future decisions would remain data dependent, taking account of both domestic and external conditions. - Noted that market expectations of UMP tapering in the United States had posed challenges for their policy response. - Reaffirmed commitment to inflation targeting and indicated continued use of a flexible approach, factoring in the slowdown in economic activity and the need to strengthen the monetary transmission mechanism. - Viewed staff recommendations as too narrowly focused on policy rates and noted that indirect instruments would also be used to achieve monetary targets. - Authorities welcomed planned IMF TA on deepening money and FX markets. ### Fiscal policy — recent developments - Fiscal position pressured by rising energy subsidies and lagging revenue growth. - Between 2009 and 2012, energy subsidies rose by 2 percentage points of GDP due to rapidly expanding fuel consumption and rising global crude oil prices. - During the same period, tax revenues grew by only ¾ percentage points of GDP despite rapid increases in household and corporate income and healthy consumption growth. - Public debt levels remained relatively low, anchored by a fiscal rule limiting the general government deficit to no more than 3 percent of GDP a year. ### Budget performance (first half of 2013) - Fiscal performance continued to be affected by excess subsidy costs and weak revenue growth. - Government increased subsidized fuel prices by an average of 33 percent on June 22. - Fiscal deficit revised upward to 2.4 percent of GDP in 2013 from an original target of 1.6 percent of GDP (and against a 2012 outturn of 1.9 percent of GDP) to accommodate fiscal slippages in the first half of year. - To garner political support for the fuel price increase, the larger deficit also accommodated temporary cash transfers and other needed assistance (equivalent to 0.2 percent of GDP) to 15 million households most vulnerable to fuel price increases. ### Staff’s position and recommendations - Staff noted need for fiscal policy to support monetary policy to reduce macroeconomic imbalances and lower external pressures. - Under staff’s baseline, deficit expected to stay around 2½ percent of GDP in both 2013 and 2014. - Staff concerns: moderately countercyclical stance would add pressure on the current account and lead to higher borrowing costs if capital inflows are not supportive. - Staff recommended: - Keep the overall deficit capped at 2 percent of GDP in 2013 to bolster credibility and reduce vulnerability to funding pressures. - Staff welcomed June action to contain fuel subsidies but noted rupiah’s depreciation, high world oil prices, and rising natural gas subsidies were likely to keep total energy subsidy costs at around 3¾ percent of GDP in 2013—the same level as last year. - To contain the deficit, staff urged managing spending and further limiting energy subsidy costs, including for natural gas. - Pursue moderate fiscal consolidation in 2014 and over the medium term, limiting the deficit to 1½ percent of GDP next year. - A final draft of the 2014 budget targeting a deficit of 1.7 percent of GDP was approved by Parliament in late October 2013; staff viewed the budget’s revenue and subsidy assumptions as more optimistic than staff’s. - To achieve necessary deficit reduction in 2014, firm measures would be needed to bolster tax collections and reduce energy subsidies, accompanied by appropriate safety nets. - Near- to medium-term space needed for new social protections coming on stream in 2014 (health care) and 2015 (pensions) and greater infrastructure investment. - Anchor medium-term consolidation by rationalizing the energy subsidy regime and mobilizing tax revenues to bring the primary deficit into balance and keep debt levels manageable. - Staff urged replacing broad energy subsidies with targeted cash transfers in line with IMF TA recommendations. - Staff welcomed MoF proposal to move from a fixed subsidized price for fuel to a fixed subsidy, urging firm measures by 2014. - This approach aligns with G-20 leaders’ commitment to phase out fossil fuel energy subsidies by mid-decade. - More nonoil tax revenue needs to be mobilized through stronger administration, enforcement, and compliance, leveraging the rise in registered taxpayers. - Staff noted the export tax of 20 percent imposed on raw minerals in 2013 has likely led to efficiency losses. - Strengthen cash and debt management, with closer collaboration between MoF and BI to manage official liquidity and borrowing costs. - Under tighter financing conditions, shortening maturity profile of primary auctions has helped maintain demand as investors sought shorter duration. - Line ministry accounts in commercial banks should be consolidated. - MoF and BI should agree on modalities for replacing nonmarketable government securities on the central bank’s balance sheet. - Note: As of August 2013, these securities totaled Rp 234 trillion (2.6 percent of GDP). ### Authorities’ views on fiscal policy - Authorities committed to maintain a prudent fiscal stance and secure access to contingency funds in the event financing conditions worsened sharply. - Based on recent revisions to their macroeconomic outlook, government’s deficit target would be less than 2 percent of GDP in 2014 when the proposed 2014 budget is approved by Parliament in late 2013. - Authorities broadly agreed on the main focus of structural fiscal reforms. - Given slowdown in growth and political constraints, they expect measured changes in 2014 to: - Improve tax administration. - Limit access to subsidized fuel. - Optimize financing from domestic sources through more transparent debt management. - Noted raising subsidized fuel prices would be politically challenging entering an election year, but remained committed to gradual phasing-out of energy subsidies. - Recognized buffer provided by contingent budget support but did not foresee need to use it based on current fiscal outlook. ### Financial and corporate sector issues — banking system - Banking system appears sound as a whole with systemic risk remaining low, but divergence across institutions warrants close watch given rapid credit expansion, recent market turbulence, and incomplete policy buffers. - Shadow banking activity limited, mainly through finance companies which control less than 10 percent of financial system assets. - Financial soundness indicators (FSIs) generally improved in 2012 and compared favorably to major EME and ASEAN peers. - Some smaller banks face liquidity pressures due to reduced access to interbank or wholesale funding, narrow deposit base, and increased funding costs. - Sector weaknesses and a slowing economy could affect asset prices and loan quality. - Property prices have accelerated in past few years, but property lending accounts for less than 15 percent of banks’ total loans, limiting overall system risk. - Concerns remain over composition of banks’ Tier­1 capital and robustness of loan classification and provisioning standards (as raised in the 2010 FSAP). - All three pillars of Basel II have been implemented, although risk-based supervision is nascent. - Implementation of Basel III capital standards slated to begin in 2015, with regulations expected to be issued by end‐2013. ### Corporate sector - Corporate debt levels, including external borrowing, have risen sharply in recent years, but overall leverage ratios still relatively low and profitability remains high, except in the mining sector. - Much newly contracted external debt is either FDI-related or by large SOEs—the latter with government guarantees. - Some corporate borrowing appears to have unhedged FX exposure. - Other potential risks stem from a sustained fall in commodity prices or a sharp rise in oil prices. ### Financial sector oversight and crisis management - Transfer of banking supervision from BI to Otoritas Jasa Keuangan (OJK) scheduled to be completed by beginning of 2014. - BI and OJK formalizing agreements on organizational and human resource issues, data collection and information sharing, and bank regulation, licensing, and supervision. - OJK developing framework for consolidated supervision of financial conglomerates, expected to be introduced in 2014. - BI and OJK finalizing an MOU on macro- and microprudential surveillance and policy to delineate authority and communication channels. - Financial System Stability Forum (FKSSK) plays central role in guiding crisis management responses per MoUs signed in 2012 among MoF, BI, OJK, and LPS. - Crisis management protocols (CMPs), particularly for emergency liquidity provisions and interventions in systemically important financial institutions (SIFIs), are lacking. - A draft Financial System Safety Net (FSSN) law submitted to Parliament addresses these gaps, but its passage is not expected before the 2014 elections. ### Financial deepening - Deepening financial markets expected to mobilize more domestic savings, improve resource allocation, and fund infrastructure and long-term commitments. - BI, with IMF TA support, has a comprehensive strategy for financial market development; immediate priority is to facilitate development of money markets to provide better benchmarks for long-term financing and promote market-making activities. - Another key goal is to expand supply of long-term savings through growth of pension and mutual funds industry, guided by design of expanded social insurance schemes. ### Box 4 — Indonesia: Corporate External Financing (key facts) - Total corporate external debt rose to US$104 billion at end­July 2013 from US$53 billion at end-2008. - About 30 percent of this increase was FDI­related (financed by parent or affiliated companies). - One-third of the increase was incurred by SOEs, mostly Pertamina and Perusahaan Listrik Negara (PLN). - Private sector non­FDI related debt accounted for the remainder. - Excluding FDI­related external debt, resource and utilities sectors accounted for 63 percent of total corporate nonfinancial external debt. - FDI­related debt accounted for about 64 percent of gross external debt disbursed to nonfinancial corporates for the year ending July 2013. - Given relatively short maturity structure, rollover of corporate external debt could be challenging if financial conditions deteriorate sharply. ### Box 5 — Indonesia: Financial Market Deepening (key actions) - Financial market metrics as of end-2012: - Stock market capitalization equivalent to 49 percent of GDP, with free floating stocks accounting for 37 percent of the total. - Outstanding debt securities issued domestically amounted to 15 percent of GDP, with government securities accounting for 85 percent of the total. - Daily foreign exchange turnovers amounted to 0.6 percent of GDP in April 2013, compared to an average of 2.4 percent of GDP among peers. - Recommended three-year action plan comprising modules for money, foreign exchange, and capital markets. - Money market actions: - Increase availability and liquidity of short-tenor treasury bills; promote lending at longer horizons; expand instrument types, including development of the Global Master Repurchase Agreement. - Revise BI’s monetary operations to improve incentives for money market participation, reduce frequency of open market operations, and destigmatize use of BI’s lending facility. - Strengthen institutional arrangements, establish a self-regulatory body and a code of conduct for market participants. - Foreign exchange market actions: - Reduce BI’s presence in FX market, rely more on market-based interventions, and decrease market segmentation from BI’s interactions with public banks. - Employ more flexible reserve requirements to deal with FX market volatility. - Review regulations on derivatives trading to allow rollover and netting; facilitate development of new instruments; enhance monitoring and dissemination of market information. - Capital markets actions: - Ease regulatory frictions such as restrictions on FX forward contracts and pension funds’ collateralized borrowing. - Develop a broader and more diversified domestic investor base by promoting financial inclusion, strengthening governance and institutional framework, and mobilizing funds from contractual savings to finance investment, especially infrastructure. *Source: IMF staff report excerpt (content unit: _cr13362).* ### 26. Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT). In February ### Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) ### AML/CFT status and concerns - In February 2013, a new CFT law was enacted that focused on the criminalization of terrorist financing. - Indonesia remains on the Financial Action Task Force’s (FATF) list of jurisdictions that have not made sufficient progress in addressing strategic shortcomings in their AML/CFT framework. - The February 2013 law does not fully address identified deficiencies, particularly with regard to the framework for identifying and freezing terrorist assets. - These concerns should be addressed quickly to: - protect Indonesia’s financial sector from heightened scrutiny from foreign financial institutions; - avoid possible countermeasures; and - facilitate an exit from the FATF monitoring process. ### Staff’s position — financial stability and crisis management recommendations - Assessment of near-term environment: - The banking and corporate sectors are likely to face a more challenging environment stemming from a slowing economy, rupiah depreciation, and tightening financial conditions. - To strengthen buffers, macroprudential oversight and crisis management arrangements need to be augmented, building on BI’s systemic risk framework put in place in recent years. - Further progress is needed on addressing FSAP recommendations, while plans should be in train for completing an FSAP update by 2015. - Main policy recommendations: - Closely monitor banks’ and corporates’ financial soundness and risk management practices, while continuing to manage carefully the transfer of banking supervision to OJK, with a focus on ensuring the continuity of supervisory activities. - Current macroprudential measures appear adequate, but banks with large restructured loans or heavy exposure to export-related and property sectors need heightened monitoring. - In view of tighter financial conditions and the rupiah’s depreciation, corporate leverage ratios and external borrowing should also be systematically monitored. - Fill gaps in existing CMPs, in the absence of passage of the FSSN law, and revise the BI, OJK, LPS, and banking laws to ensure legal consistency. - Staff argued that interim protocols (likely by presidential decree) governing the provision of emergency liquidity assistance and interventions in SIFIs should be an immediate priority. - While current liquidity pressures reside mainly in smaller banks, clear CMPs coupled with early corrective actions could avoid an amplification of risks. - The FKSSK secretariat should focus on serving as a coordinating body by integrating each member’s CMPs into a mutually supportive framework, but refrain from developing its own surveillance capacity. - Establish a well-functioning macroprudential framework. - BI should take a lead role in systemic risk monitoring and assessment in conducting macroprudential policy and also within the FKSSK. - OJK should drive the implementation of all prudential tools. - A clear accountability framework for making policy decisions and exercising these responsibilities needs to be put in place. - Additional staff advice: - Further efforts should be made to strengthen the AML/CFT regime in line with the FATF’s recommendations. ### Authorities’ views - The authorities were in general agreement with staff’s assessments and recommendations. - Bank Indonesia noted that banks continue to manage potential risks well. - The authorities indicated their desire to see passage of the FSSN law and readiness to amend related financial sector legislation to ensure a comprehensive and coordinated approach to crisis management. ### Medium-term policy priorities — overview - Deep-seated reforms are needed to reduce supply bottlenecks, broaden the export base, bolster employment growth, and improve medium-term growth prospects, with a view to reducing poverty and inequality. - Momentum for reform has increased due to the weak outlook for commodity prices and the need to diversify the economy away from primary resources. - Major actions may be more difficult ahead of the elections in mid­2014, but interim measures could improve the supply response and bolster investor sentiment toward Indonesia. ### Priorities — trade, investment, and labor market reforms - Trade and investment: - Main priority: improve the transparency, predictability, and stability of the trade and investment regime and reorient it toward promoting competition and competitiveness. - The imposition of quotas on beef and horticultural imports earlier in 2013 led to severe market disruptions and food price hikes; staff welcomed a move to put in place less restrictive measures aimed at improving supply conditions. - The scheduled ban on raw (unprocessed) mineral ore exports in 2014 has raised uncertainty; a clear transition plan is needed to avoid adding pressures on the current account and to bolster investor confidence in developing onshore mineral processing facilities. - A less restrictive and more investor-friendly negative list for foreign investment, coupled with improvements in transportation, power supply, and logistics, could bolster regional integration and strengthen growth prospects. - Labor markets: - Removing impediments to employment generation in the formal sector is critical to raising productivity and output growth and providing opportunities for low­wage workers. - Currently, only one-third of the labor force has formal sector employment (defined as employees plus the self-employed assisted by permanent workers); the rest of the labor force comprises the informal sector. - Less than 40 percent of formal and informal sector workers in Indonesia have full-time employment (i.e., work more than 35 hours per week). - Reducing the rigidity of Indonesia’s labor regulations, particularly with respect to severance pay, would improve competitiveness and generate jobs to absorb a large pool of underemployed workers, supported by higher social spending. - Aligning wage increases with productivity growth and redefining the minimum wage as a safety net instrument rather than a tool for collective bargaining would help. ### Structural transformation and labor market issues (Box 6) — key points - Structural transformation has been slow; agriculture employment remains high while the productivity differential between agriculture and manufacturing has been widening. - Agriculture continues to employ over one-third of the labor force. - Manufacturing contributed 24 percent of GDP in 2011 and provided less than 15 percent of the workforce. - A hypothetical labor reallocation to the average of a 46-country sample (24 percent in agriculture, 23 percent in manufacturing, and 53 percent in services), keeping sector productivity unchanged, would raise aggregate labor productivity and income per capita by as much as 13 percent. - Rigid labor market regulations have undermined manufacturing’s capacity to transform output growth into employment, including: - high minimum wage levels relative to average wages; - frequent adjustments to minimum wages; - indexation of most wage contracts to minimum wage increases; - strict regulations on severance payments, limits on fixed-term contracts, and outsourcing restrictions. - Reducing these rigidities and aligning minimum wage increases with productivity growth would help competitiveness, foster formal employment creation, promote gender equality, and enhance macro-social stability. ### Staff appraisal — outlook, risks, and policy priorities - Near-term macroeconomic environment: - Indonesia faces a more challenging macroeconomic environment from slowing growth in major EMEs, falling commodity prices, capital outflows, and tighter funding conditions tied to a prospective exit from extraordinarily easy global monetary conditions. - This reversal, coupled with an accommodative policy stance, has put pressure on Indonesia’s BOP. - Downside risks: - Vulnerable to protracted volatility in EMEs, a disorderly unwinding of UMPs in advanced economies, a more pronounced growth slowdown among major trade partners (including China and India), and further softening in commodity prices. - A deterioration in investor sentiment, prompted by external conditions and policy uncertainty in Indonesia, could intensify macroeconomic pressures and feed back into confidence. - EBA’s REER estimates show the exchange rate to be broadly in line with fundamentals, while debt levels remain relatively low and resilient to standard shocks. - Near-term projections and vulnerabilities: - Growth is projected to slow in 2013 and 2014 on weaker investment and external demand. - Inflation will likely peak by end­2013 before moderating. - The current account deficit is expected to widen further in 2013 and narrow only slightly in 2014. - The projected slowdown in FDI and volatility of portfolio flows will make Indonesia more vulnerable to external shocks in the near term. - Reserve losses have been sizable in the past year but are expected to slow going forward, with capital inflows foreseen to pick up gradually and the flexible exchange rate facilitating adjustment of the current account. - Policy recommendations to consolidate stabilization: - Upfront policy tightening to ease external and fiscal pressures and firm actions over the medium term to reduce supply bottlenecks. - Continued vigilance to consolidate recent stabilization efforts; use any delay in tapering of UMPs to strengthen policy and financial buffers and improve market perceptions. - Reduce the current account deficit to a sustainable level and place inflation firmly within the target band. - Further policy rate hikes by BI may be necessary if BOP or inflation pressures do not subside. - Fiscal policy should support monetary policy while providing adequate space for new social protections and higher capital spending. - Fiscal consolidation targeted at bringing the primary deficit back into balance will require bolstering tax collections and eliminating energy subsidies over the medium term, supported by better prioritizing expenditures. - Maintain flexible exchange and interest rates to manage volatility, encourage capital inflows, and assist in boosting reserve buffers. - Financial stability framework: - Maintain a framework and contingencies for managing systemic risks during the transition in bank supervision to avoid oversight gaps. - Clearly delineate responsibilities for macro- and microprudential surveillance and strengthen the financial stability architecture. - Banks’ asset quality and capital positions are generally sound, but indicators require close watch given rapid credit expansion in recent years, the rise in LDRs, and the recent slowdown in economic activity. - Further efforts should be made to strengthen the AML/CFT regime in line with the FATF’s recommendations. - Broader reforms: - Accelerate infrastructure investment, address labor market rigidities, deepen financial markets, and create a more open trade and investment regime to raise productivity, create new export opportunities, and support higher, more inclusive growth. - Government measures announced in mid­2013 address some shortcomings, but more comprehensive and cohesive actions are needed to bolster investor confidence and achieve potential growth. *International Monetary Fund — Staff report content unit* ### 38. It is recommended that the next Article IV consultation take place on the standard ### It is recommended that the next Article IV consultation take place on the standard 12­month cycle. ### Overview - For 2012, except population data, which are latest estimates. - Nominal GDP (2012): Rp 8,242 trillion or US$879 billion. - Population (2010): 237.6 million. - Main exports (percent of total, 2012): Oil and gas (18.7), coal (13.6), palm oil (8.6), processed rubber (7.1). - GDP per capita (2012): US$3,592. - Unemployment rate (May 2013): 5.8 percent. - Poverty headcount ratio at national poverty line (2012): 12.0 percent of population. ### Recent market developments (Figure 2) - Financial markets partially recovered from the post May 22 sell off, aided by policy tightening in Indonesia and a delay in the tapering of unconventional monetary policies. - Bond inflows from foreign investors led the reversal over the past few months. - Domestic bond yields have fallen lately, but still remain well above pre May 22 levels. - Equity prices, which fell by more than 25 percent in the mid 2013 sell off, have recovered about half of the loss incurred between May and August 2013. - The rupiah began to weaken significantly vis à vis the U.S. dollar in mid 2013, as foreign exchange market intervention by Bank Indonesia (BI) eased up. - After widening sharply between May and August, external spreads have narrowed recently in line with other emerging markets (EMs). ### Emerging markets comparison (Figure 3) - The rupiah has depreciated more than most other currencies vis à vis the U.S. dollar. - Bond yields in Indonesia have increased more than in other EMs. - Sovereign CDS spreads have widened significantly more than most peers. - Equity prices have held up better in Indonesia relative to peers in 2013, but mainly due to large increases in the first half of the year. - Despite the rupiah’s pronounced depreciation, foreign reserves have fallen more in Indonesia than among other EMs. - Higher inflation and reserve declines prompted BI to tighten monetary policy more aggressively. ### Real sector developments (Figure 4) - Growth slowed in 2013:H1, with investment the main factor. - Net exports continued to make a positive contribution, partly reflecting weak investment-related import demand. - Production indicators point to further slowing. - Moderating investment demand visible in tepid cement sales growth. - Consumption growth is slowing; retail sales weakened significantly. - Headline inflation accelerated in 2013 on the impact of June’s fuel price increase and a food price spike at midyear. - Subsidized fuel prices in Indonesia remain low compared to the market based price. ### External sector developments (Figure 5) - The current account balance shifted into a deficit at end-2011 due to deterioration in both the oil and non-oil trade balances, with reserves also coming under pressure. - Exports have slowed more sharply than imports, reflecting weaker commodity prices. - Key commodity export prices unlikely to pick up going into 2014. - Export volumes have shown some signs of recovery, while import growth remains depressed due mainly to raw materials and capital goods. ### Monetary and interest rate developments (Figure 6) - Monetary policy tightened: BI rate and deposit facility rate increased by 150 bps since June 2013. - Overnight money market rates remain close to the bottom of the interest rate corridor, as liquidity conditions have yet to firm significantly. - Real short term rates remain low by most measures. - Broad money and credit growth moderating slowly. - Funding pressures may be rising as loan to deposit ratios continue to increase. - Retail lending and deposit rates have only begun to reflect these pressures, suggesting lags in the monetary transmission mechanism. ### Fiscal developments (Figure 7) - Fiscal deficit has widened since 2010, driven mainly by rising energy subsidies. - Public debt to GDP ratio remains low. - Tax revenue as a share of GDP has stagnated; Indonesia has the lowest tax to GDP ratio among regional peers. - Despite the June 2013 increase in subsidized fuel prices, energy subsidies expected to remain large in 2013. - Fiscal deficit increasing at a faster pace than in recent years. ### Financial and corporate sector soundness (Figure 8) - Banks generally remain well capitalized, though early signs of asset quality deterioration exist. - Corporates remained profitable, but liquidity measures have weakened slightly. - Leverage ratios have shown signs of rising, reflecting a surge in foreign currency debt issues. - Equity valuations declined with the mid 2013 sell off. - Property prices have risen rapidly in recent years, especially in Jakarta. ### Selected economic indicators, 2008–14 (Table 1) — key figures and projections - Real GDP (percent change): 2008: 6.0; 2009: 4.6; 2010: 6.2; 2011: 6.5; 2012: 6.2; 2014: 5.9; H1 2013: 5.4; 2013 Est.: 5.3. - Domestic demand: 2008: 7.6; 2009: 5.2; 2010: 5.4; 2011: 6.1; 2012: 8.2; 2014: 4.9; H1 2013: 5.0; 2013 Est.: 4.9. - Private consumption: 2008: 5.3; 2009: 4.9; 2010: 4.7; 2011: 4.7; 2012: 5.3; 2014: 5.1; H1 2013: 5.2; 2013 Est.: 4.8. - Gross fixed investment: 2008: 11.9; 2009: 3.3; 2010: 8.5; 2011: 8.8; 2012: 9.8; 2014: 5.2; H1 2013: 5.0; 2013 Est.: 4.0. - Gross investment (percent of GDP): 2008: 27.8; 2009: 31.0; 2010: 32.3; 2011: 32.9; 2012: 35.3; 2014: 34.6; 2013 Est.: 33.8. - Gross national saving (percent of GDP): 2008: 27.8; 2009: 33.0; 2010: 33.0; 2011: 33.1; 2012: 32.5; 2014: 31.1; 2013 Est.: 30.6. - Foreign saving (external current account balance): 2008: 0.0; 2009: -2.0; 2010: -0.7; 2011: -0.2; 2012: 2.8; 2014: 3.5; 2013 Est.: 3.2. - Consumer prices (end period): 2008: 11.1; 2009: 2.8; 2010: 7.0; 2011: 3.8; 2012: 4.3; Sep 2013: 8.4; 2014: 9.5; 2013 Est. (period average): 6.0. - Central government revenue (percent of GDP): 2008: 19.8; 2009: 15.1; 2010: 15.8; 2011: 16.1; 2012: 16.2; Jan-Sep 2013: 10.8; 2014 Budget: 16.0; 2013 Est.: 16.0. - Central government expenditure (percent of GDP): 2008: 19.9; 2009: 16.7; 2010: 16.4; 2011: 17.3; 2012: 18.1; Jan-Sep 2013: 12.0; 2014 Budget: 18.4; 2013 Est.: 18.5. - Central government balance (percent of GDP): 2008: -0.1; 2009: -1.6; 2010: -0.6; 2011: -1.1; 2012: -1.9; Jan-Sep 2013: -1.2; 2014: -2.5; 2013 Est.: -2.5. - Central government debt (percent of GDP): 2008: 33.2; 2009: 28.6; 2010: 26.8; 2011: 24.4; 2012: 24.5; 2014: 26.2; 2013 Est.: 26.8. - Rupiah per U.S. dollar (period average): 2008: 9,687; 2009: 10,405; 2010: 9,086; 2011: 8,772; 2012: 9,381; Jan-Oct 2013: 10,172. - Gross reserves (end period, US$ billions): 2008: 51.6; 2009: 66.1; 2010: 96.2; 2011: 110.1; 2012: 112.8; Sep 2013: 95.7; 2014 Proj.: 88.7; 2013 Latest: 79.7. ### Balance of payments (Table 2) — selected items (US$ billions) - Current account: 2008: 0.1; 2009: 10.6; 2010: 5.1; 2011: 1.7; 2012: -24.4; 2013 Est.: -30.4; 2014 Proj.: -27.6. - Exports, f.o.b.: 2008: 139.6; 2009: 119.6; 2010: 158.1; 2011: 200.8; 2012: 188.5; 2013 Est.: 182.1; 2014 Proj.: 189.7. - Non-oil and gas exports (f.o.b.): 2008: 107.9; 2009: 99.0; 2010: 129.4; 2011: 162.7; 2012: 152.9; 2013 Est.: 150.7; 2014 Proj.: 159.8. - Imports, f.o.b.: 2008: -116.7; 2009: -88.7; 2010: -127.4; 2011: -166.0; 2012: -179.9; 2013 Est.: -176.8; 2014 Proj.: -182.0. - Services, net: 2008: -13.0; 2009: -9.7; 2010: -9.3; 2011: -10.6; 2012: -10.3; 2013 Est.: -12.0; 2014 Proj.: -10.8. - Income, net: 2008: -15.2; 2009: -15.1; 2010: -20.8; 2011: -26.7; 2012: -26.7; 2013 Est.: -27.5; 2014 Proj.: -28.4. - Capital and financial account: 2008: -1.8; 2009: 4.9; 2010: 26.6; 2011: 13.6; 2012: 25.1; 2013 Est.: 13.2; 2014 Proj.: 18.6. - Portfolio investment, net: 2008: 1.8; 2009: 10.3; 2010: 13.2; 2011: 3.8; 2012: 9.2; 2013 Est.: 6.9; 2014 Proj.: 7.0. - Overall balance: 2008: -1.9; 2009: 12.5; 2010: 30.3; 2011: 11.9; 2012: 0.2; 2013 Est.: -17.2; 2014 Proj.: -9.0. - Change in reserve assets (- = increase): 2008: 5.3; 2009: -14.5; 2010: -30.1; 2011: -13.9; 2012: -2.7; 2013 Est.: 24.2; 2014 Proj.: 9.0. - Reserve assets position (eop, US$ billions): 2008: 51.6; 2009: 66.1; 2010: 96.2; 2011: 110.1; 2012: 112.8; 2013 Est.: 88.7; 2014 Proj.: 79.7. - Current account (percent of GDP): 2008: 0.0; 2009: 2.0; 2010: 0.7; 2011: 0.2; 2012: -2.8; 2013 Est.: -3.5; 2014 Proj.: -3.2. ### Selected vulnerability indicators (Table 3) - Real GDP growth (in percent): 2013 Proj.: 5.4. - CPI inflation (percent, e.o.p.): 2013 Proj.: 9.5. - Short-term (ST) interest rate (percent, e.o.p.) 1/: Sep 2013: 6.9. - Ten-year government bond yield (percent, e.o.p.): Oct 2013: 7.5. - Indonesia EMBI spread (bps, e.o.p.): Oct 2013: 274. - Exchange rate (rupiah per U.S. dollar, e.o.p.): Oct 2013: 11,273. - Current account balance (percent of GDP): 2013 Proj.: -3.5. - Net FDI inflows (percent of GDP): 2013 Proj.: 1.3. - Gross international reserves (US$ billion): Sep 2013: 95.7. - Gross external financing requirement (US$ billion) 2/: 2013 Proj.: 85.0. - Overall public sector balance (percent of GDP): 2013 Proj.: -2.5. - Primary balance (percent of GDP): 2013 Proj.: -1.1. - Public sector gross debt (percent of GDP): 2013 Proj.: 26.2. - Public sector debt exposed to exchange rate risk (percent of total PSGD): 2013 Proj.: 44.2. - Capital to risk-weighted assets (FS, percent): Jun 2013: 17.5. - Nonperforming loans (percent of total loans): Jun 2013: 1.8. - Foreign currency deposits at commercial banks (percent of total deposits): Aug 2013: 16.4. - Foreign exchange loans at commercial banks (percent of total loans): Aug 2013: 15.6. - Total credit outstanding of banking system (annual percentage change): Aug 2013: 22.2. (Notes from table footnotes retained verbatim: 1/ One-month Jakarta Interbank Offered Rate. 2/ Current account deficit plus amortization of external debt. 3/ Public sector covers central government only. 4/ Overall balance plus debt amortization. 5/ Short-term debt and maturing medium- and long-term debt (domestic debt only). 6/ Debt in foreign currency or linked to the exchange rate (domestic and external), excluding external debt on concessional terms. 8/ From 2010, includes capital charge for operational risk. 7/ Short-term debt and maturing medium- and long-term debt (at variable interest rates for domestic debt). Information on external debt is not available.) ### Medium-term macroeconomic framework, 2010–18 (Table 4) — selected projections - Real GDP (percent change): 2013: 5.4; 2014: 5.3; 2015: 5.8; 2016: 6.0; 2017: 6.0; 2018: 6.0. - Consumer prices (end period): 2013: 9.5; 2014: 6.0; 2015: 5.5; 2016: 5.5; 2017: 5.5; 2018: 5.0. - Current account balance (US$ billions): 2013: 5.1; 2014: 1.7; 2015: -24.4; 2016: -30.4; 2017: -27.6; 2018: -26.5 (table lists long series; users should refer to table for full chronology). - Gross reserves (US$ billions, end period): 2013: 96.2; 2014: 110.1; 2015: 112.8; 2016: 88.7; 2017: 79.7; 2018: 80.9; 2019: 83.5; 2020: 87.5; 2021: 92.7 (table spans beyond 2018). ### Monetary survey (Table 5) — select levels and growth rates (trillions of rupiah, end period) - Bank Indonesia net foreign assets: 2009: 54; 2010: 277; 2011: 495; 2012: 1,056; Mar 2013: 985; Jun 2013: 939; Aug 2013: 977. - Monetary base: 2009: 402; 2010: 518; 2011: 613; 2012: 705; Mar 2013: 665; Jun 2013: 692; Aug 2013: 713. - Broad money (Rupiah M2): 2009: 1,837; 2010: 2,140; 2011: 2,513; 2012: 2,874; Mar 2013: 2,867; Jun 2013: 2,926; Aug 2013: 2,965. - Private sector credit: 2009: 1,409; 2010: 1,684; 2011: 2,111; 2012: 2,581; Mar 2013: 2,620; Jun 2013: 2,798; Aug 2013: 2,894. - Gross international reserves (US$ billions, memorandum): Mar 2013: 104.8; Jun 2013: 98.1; Aug 2013: 93.0. - Annual percentage change (Aug 2013): Broad money: 13.0; Rupiah M2: 10.9; Private sector credit: 20.5. ### Central government operations (Table 6) — summary (trillions of rupiah; percent of GDP) - Revenues and grants (2013 Budget): 1,530; 2013 Revised: 1,502; 2014 Budget: 1,667. - Tax revenues (2013 Budget): 1,193; 2013 Revised: 1,148; 2014 Budget: 1,280. - Oil and gas revenues (2013 Budget): 246; 2013 Revised: 255; 2014 Budget: 290. - Expenditure and net lending (2013 Budget): 1,683; 2013 Revised: 1,726; 2014 Budget: 1,842. - Subsidies (2013 Budget): 317; 2013 Revised: 348; 2014 Budget: 384. - Of which: Energy subsidies (2013 Budget): 95; 2013 Revised: 140; 2014 Budget: 256. - Overall balance (trillions): 2009: -88; 2010: -39; 2011: -84; 2012: -153; 2013 Est.: -153; 2013 Revised: -224; 2014 Budget: -225. - Overall balance (percent of GDP): 2009: -1.6; 2010: -0.6; 2011: -1.1; 2012: -1.9; 2013 Est.: -1.6; 2013 Revised: -2.4; 2014 Budget: -2.5. - Primary balance (percent of GDP, memorandum): 2013 Est.: -0.4; 2014 Budget: -1.2; Staff proj.: -1.1. - Central government debt (percent of GDP, memorandum): 2013 Est.: 26.2. (Notes retained: 1/ Approved by Parliament in October 2013. 2/ Deposit insurance premia are treated as nontax revenues. 3/ Comprises capital spending and social assistance spending. 4/ Non-oil balance calculated as overall balance excluding oil and gas revenue and expenditure, in percent of non-oil GDP.) ### Summary of general government operations, 2005–12 (Table 7) - Revenue (2012): 1,486 (trillions of rupiah). - Taxes (2012): 981. - Taxes on income, profits, and capital gains (2012): 465. - Taxes on goods and services (2012): 433 (VAT and luxury taxes 338). - Grants (2012): 3. - Total expenditure (2012): 1,623. - Expense (2012): 1,255. - Fuel subsidies (2012): 306. - Net incurrence of liabilities (2012): 511. ### Financial soundness indicators, 2008–June 2013 (Table 8) — select ratios (percent) - Regulatory capital to risk-weighted assets: 2008: 17.5; 2009: 17.8; 2010: 16.2; 2011: 16.1; 2012: 17.3; Jun 2013: 17.5. - Regulatory Tier-1 capital to risk-weighted assets: Jun 2013: 16.1. - Nonperforming loans to total gross loans: 2008: 3.2; 2009: 3.3; 2010: 2.5; 2011: 2.1; 2012: 1.8; Jun 2013: 1.8. - (Specific) provisions to nonperforming loans: 2008: 58.8; 2009: 62.3; 2010: 57.1; 2011: 60.7; 2012: 52.0; Jun 2013: 50.1. - Return on assets: 2008: 2.4; 2009: 2.6; 2010: 2.7; 2011: 2.3; 2012: 2.6; Jun 2013: 2.5. - Return on equity: 2008: 25.3; 2009: 26.8; 2010: 25.9; 2011: 20.3; 2012: 21.0; Jun 2013: 19.9. - Liquid assets to total assets: 2008: 25.9; 2009: 28.7; 2010: 27.2; 2011: 26.2; 2012: 25.7; Jun 2013: 24.0. - (Non-interbank) loans to customer deposits: 2008: 79.3; 2009: 77.5; 2010: 80.4; 2011: 84.4; 2012: 93.2; Jun 2013: 96.4. - Foreign currency denominated loans to total loans: 2008: 19.5; 2009: 14.9; 2010: 15.6; 2011: 16.6; 2012: 15.2; Jun 2013: 15.1. - Residential real estate prices (year-on-year): 2008: 2.6; 2009: 2.3; 2010: 2.9; 2011: 5.0; 2012: 6.8; Jun 2013: 12.1. - Residential real estate loans to total loans (Jun 2013): 8.4. *Source: IMF staff estimates and projections; data provided by the Indonesian authorities (excerpts from _cr13362)._* ### Appendix 1. Indonesia—Risk Assessment Matrix 1/ ### Appendix 1. Indonesia—Risk Assessment Matrix 1/ ### Global/short to medium term: Protracted economic and financial volatility, especially in emerging market economies (EMEs) (triggered by prospective exit from UMP) - Likelihood: High: Prospects of higher interest rates in advanced economies could trigger a sustained reversal of capital flows. - Expected Impact: High: Portfolio and FDI inflows could be curtailed by weaker investor appetite, brought on by a further re weighting of EM assets, with tighter funding conditions adding to pressure on the balance of payments (BOP), on government finances, and in the financial sector. - Recommended Policy Responses: - Allow exchange rate flexibility to facilitate BOP adjustment; and tighten monetary policy to help reduce the trade deficit and boost investor confidence. - Pursue fiscal consolidation possibly through tax and subsidy reforms; with government also using contingent financing if market access is restricted. - Accelerate structural reforms to boost productivity and employment in nonresource sectors. ### Global/short term: Financial stress in the euro area reemerges - Likelihood: Medium: Bank sovereign real economy links could intensify on a stalled or incomplete delivery of policy commitments at the national or euro area level or adverse developments in the periphery. - Expected Impact: Medium: Direct trade and financial impact is limited. However, portfolio net inflows could weaken on rising global risk aversion. Weaker global growth would reduce exports and FDI, leading to BOP pressures and reserve losses. - Recommended Policy Responses: - Exchange rate flexibility and monetary policy tightening, as discussed above. ### Global/short term: Fiscal policy shock in the United States - Likelihood: Low - Expected Impact: Medium/High: A sharp increase in global risk aversion associated with a large negative shock could spur capital outflows, drive up local yields, and put downward pressure on the rupiah. The global outlook would also weaken, driving down commodity prices and resulting in BOP pressures. - Recommended Policy Responses: - Exchange rate flexibility and monetary policy tightening, as discussed above. ### Global/short term: Global oil shock triggered by geopolitical events (driving oil prices to US$150 per barrel) - Likelihood: Low - Expected Impact: High: Both fiscal and current account balances would deteriorate immediately. A second round impact could come through weaker global growth and market sentiment. - Recommended Policy Responses: - Increase subsidized fuel prices to help reduce imbalances, with temporary fiscal support to protect those more vulnerable. - Allow exchange rate flexibility to absorb pressure and tighten monetary policy to limit second­round effects on inflation. ### Global/medium term: Lower than anticipated emerging market growth potential - Likelihood: Medium: A deeper than expected slowdown in EMEs due to earlier maturing of the cycle and incomplete structural reforms with spillovers to low income and advanced economies. - Expected Impact: High: Lower demand or prices for commodity exports could widen the current account deficit, adding to BOP pressures and resulting in reserve losses. The fiscal balance would deteriorate on weaker resource revenues and knock on effects to domestic demand, while the financial sector could be exposed to this broader slowdown. - Recommended Policy Responses: - Exchange rate flexibility and monetary policy tightening, as discussed above. - Fiscal measures to contain the budget deficit might be necessary if slowdown in EMEs was accompanied by protracted financial market volatility. ### Global/medium term: Sharp slowdown in growth in China (buildup of excess capacity eventually resulting in large financial and fiscal losses) - Likelihood: Medium: China is one of Indonesia’s largest export markets and sources of FDI, having a major impact on prices of Indonesia’s commodity exports and demand conditions for some of its major trade partners. - Expected Impact: Medium/High: Lower demand or prices for commodity exports could lead to deterioration in the current account. FDI inflows into Indonesia’s resource sector could be curtailed, resulting in increased external vulnerability and possible reserve losses. The fiscal balance would deteriorate. - Recommended Policy Responses: - Exchange rate flexibility and some fiscal consolidation, along with accelerated structural reforms to boost productivity and employment in nonresource sectors. ### Domestic/short term: Government funding shortfalls - Likelihood: Medium: Domestic funding requirements remain large into 2014 and could become problematic if EMEs remain volatile and/or liquidity pressures on domestic banks intensify. - Expected Impact: Medium/High: Limited scope to meet financing shortfall from government deposits. Market confidence could deteriorate rapidly if the policy response is inadequate and domestic yields could spike. - Recommended Policy Responses: - Tighten fiscal policy, while maintaining exchange rate and bond yield flexibility to avoid a market disruption, with government also using external contingent financing if market access is restricted. ### Domestic/short to medium term: Prolonged inaction on key structural reforms undermines business confidence - Likelihood: Medium: Steps in the past few years to restrict foreign mining operations, impose a raw mineral ores ban, and curtail beef and horticultural imports have raised concerns. - Expected Impact: Medium: Negative investor sentiment toward Indonesia could add to undermine competitiveness, impede FDI, and exacerbate BOP pressures, with welfare losses. - Recommended Policy Responses: - Reverse trend toward ad hoc trade and investment restrictions; take firm measures to reduce structural bottlenecks, notably on infrastructure development and labor market flexibility, and improve governance. ### Domestic/short to medium term: Banking system distress by a severe funding squeeze - Likelihood: Low/Medium: Stress could arise from liquidity pressures prompted by sizable capital outflows and/or a sharp economic slowdown. Uncertainty regarding the crisis management framework could complicate the policy response and amplify risks. - Expected Impact: Medium: Severe financial stresses on banks that have higher loan to deposit ratios and lower capital buffers, with a sharp rise in deposit and lending rates, deterioration in asset quality, and reduced profitability. - Recommended Policy Responses: - Ensure proper risk controls at banks, with clear lender of last resort/emergency liquidity protocols in place and close coordination between financial regulators, backed by swift approval by Parliament of the Financial Safety Net Law or stop gap measures. *The relative likelihood definitions: “low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 percent and 30 percent, and “high” a probability of 30 percent or more. The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.* ### 4. Public sector debt has been declining as a share of GDP since 2000 despite the ### 4. Public sector debt has been declining as a share of GDP since 2000 despite the ### Recent debt trends and projections - Public sector debt fell to a record-low level of 24.4 percent at end-2011 and remained broadly unchanged in 2012. - Drivers of debt consolidation: - Prudent fiscal management and low fiscal deficits in the last decade. - Lower interest rates and relatively high growth. - Foreign-currency denominated debt has fallen to less than half of total public sector debt, as improved fiscal position facilitated greater government access to the domestic capital market. - Baseline projections: - Public sector debt is expected to rise to around 26.8 percent of GDP in 2014 due to larger fiscal deficits and financing needs. - Over the medium term, public debt is expected to decline as a share of GDP—to around 24.4 percent by 2018. - Coverage note: Public sector debt does not include debt of state-owned enterprises. Total gross debt of nonfinancial public sector corporations was Rp 262 trillion (3.2 percent of GDP) as of June 2012. ### Debt sustainability and stress tests - Public debt is assessed as sustainable and robust to macroeconomic and oil price shocks. - Standard stress tests suggest the debt ratio is likely to remain modest even under shocks from contingent liabilities, sharp exchange rate movements, and higher interest rates. - Public sector debt-to-revenue ratio (selected years): - 2008: 156.2 - 2009: 173.6 - 2010: 157.9 - 2011: 136.9 - 2012: 136.1 - 2013: 145.1 - 2014: 147.4 - 2015: 147.1 - 2016: 146.1 - 2017: 142.6 - 2018: 136.1 - Debt-stabilizing primary balance (baseline): -0.9 (percent of GDP) ### External debt indicators and projections (selected figures) - Baseline: External debt (percent of GDP) - 2008: 30.4 - 2009: 32.1 - 2010: 28.5 - 2011: 26.6 - 2012: 28.7 - 2013: 30.3 - 2014: 32.2 - 2015: 31.8 - 2016: 31.3 - 2017: 31.2 - 2018: 31.2 - Change in external debt (selected years): - 2008: -2.3 - 2009: 1.7 - 2010: -3.6 - 2011: -1.9 - 2012: 2.1 - 2013: 1.5 - 2014: 1.9 - External debt-to-exports ratio (in percent): - 2008: 100.1 - 2009: 130.2 - 2010: 115.8 - 2011: 101.8 - 2012: 119.3 - 2013: 129.5 - 2014: 128.8 - 2015: 127.0 - 2016: 125.5 - 2017: 125.2 - 2018: 124.3 - Gross external financing need (in billions of U.S. dollars): - 2008: 27.4 - 2009: 18.9 - 2010: 26.5 - 2011: 41.2 - 2012: 71.2 - 2013: 85.0 - 2014: 85.0 - 2015: 87.1 - 2016: 94.2 - 2017: 102.1 - 2018: 109.7 - Gross external financing need (in percent of GDP): - 2008: 5.4 - 2009: 3.5 - 2010: 3.7 - 2011: 4.9 - 2012: 8.1 - 2013: 9.7 - 2014: 9.9 - 2015: 9.3 - 2016: 9.2 - 2017: 9.2 - 2018: 9.1 ### Public sector debt dynamics (Table 3.2 highlights) - Baseline: Public sector debt (percent of GDP) - 2008: 33.2 - 2009: 28.6 - 2010: 26.8 - 2011: 24.4 - 2012: 24.5 - 2013: 26.2 - 2014: 26.8 - 2015: 26.5 - 2016: 26.1 - 2017: 25.4 - 2018: 24.4 - Share foreign-currency denominated (percent of GDP): - 2008: 17.1 - 2009: 13.3 - 2010: 11.9 - 2011: 10.7 - 2012: 10.5 - 2013: 10.4 - 2014: 9.8 - 2015: 10.0 - 2016: 9.0 - 2017: 9.0 - 2018: 7.9 - Change in public sector debt (selected years): - 2008: -1.8 - 2009: -4.6 - 2010: -1.8 - 2011: -2.4 - 2012: 0.1 - 2013: 1.7 - 2014: 0.6 - 2015: -0.4 - 2016: -0.4 - 2017: -0.7 - 2018: -1.0 - Identified debt-creating flows (4+7+12) (selected years): - 2008: -4.5 - 2009: -4.6 - 2010: -3.0 - 2011: -2.8 - 2012: 0.0 - 2013: -0.1 - 2014: -0.2 ### Fiscal framework: current challenges - Fiscal rule: limits the general government deficit to 3 percent of GDP. - Revenues - Tax revenue to GDP ratio averaged 10.9 percent of GDP over the past five years. - Indonesia’s tax collection is constrained by narrow tax base, dependence on commodity sector, and weak administration. - Policy changes in the last decade included decreases in CIT and PIT rates in response to the 2008 downturn, increases in the personal allowance in the PIT system, and introduction of a small-enterprise taxation regime in 2013. - Nearly fourfold increase in registered taxpayers over the past decade, but tax administration remains weak with poor enforcement and low voluntary compliance. - Declining contribution of oil and gas revenues; a US$10 increase in the price of oil would raise projected revenues in 2013 by about 0.3 percentage points to 3.5 percent of GDP. - Expenditures - Total subsidy bill increased from 2.5 percent of GDP in 2009 to 4.2 percent of GDP in 2012; development spending remained at 2.7 percent of GDP. - Almost 90 percent of subsidies remain energy related (post–June 2013 fuel price increase). - Sensitivity of subsidies to external shocks: a 10 percent rise in oil prices or a 10 percent rupiah weakening vis à vis the U.S. dollar would increase energy subsidies by 0.6 percentage points to 4.3 percent of GDP in 2014 (staff estimate). - Capital spending disbursements over the past five years have been 70−90 percent of the amount budgeted. - Indonesia spends 0.5 percent of GDP on household social assistance (World Bank comparison), versus regional average 1.0 percent of GDP and developing countries’ average 1.5 percent of GDP. - Education spending (including personnel costs) has averaged around 3 percent of GDP in the last decade. - Health spending averages around 0.9 percent of GDP. ### Medium-term fiscal priorities and policy recommendations (from Appendix 4) - Fiscal reforms needed to: - Broaden the tax base and mobilize tax revenues from the non-oil and gas sector to expand fiscal space. - Gradually eliminate energy subsidies over the medium term to create space for social and capital spending and reduce budget exposure to external shocks. - Ensure sound budget implementation to improve execution of development expenditures, especially at subnational levels. - Trade-offs and constraints: - Meeting increasing social spending needs over the medium term will require either substantially higher budget revenues or lower spending on other expenditure items. - Development spending has been used as a buffer for revenue shortfalls and subsidy overruns, constraining longer term strategic planning. *Prepared by Lawrence Dwight (SPR) and Dora Benedek (FAD). Source: IMF staff estimates and projections as presented in the chapter.* ### 7. In the medium term, key structural fiscal reforms are needed to ensure fiscal ### 7. In the medium term, key structural fiscal reforms are needed to ensure fiscal sustainability and support economic growth. ### Fiscal policy objective and recommended focus - Reforms should focus on continuing efforts to mobilize revenues, eliminate the energy subsidies, and strengthen budget implementation, in order to: - create additional space for social and infrastructure spending, - reduce Indonesia’s vulnerability to external shocks, - improve the effectiveness of fiscal policy. ### Tax Revenue — findings and reform opportunities - Concerted efforts are needed to raise the tax revenue to GDP ratio by strengthening broad based taxes, reducing exemptions and incentives, and improving tax compliance. - Estimations suggest that over the medium term, Indonesia could raise tax revenues by about 4−5 percentage points of GDP by strengthening both direct and indirect taxes, as well as revenues from the mining sector. - Direct taxes: - Indonesian tax law provides a comprehensive and generally well designed tax regime, but implementation remains a challenge and tax bases need to be broadened. - The base of the CIT has been eroded by use of extensive tax incentives. - The base is not protected by rules against thin capitalization which make it easy to transfer the tax base to other jurisdictions. - The government needs to fully analyze the prevalence and cost of tax expenditures as part of a base broadening strategy. - Indirect taxes: - Revenue productivity is low due to extensive exemptions, leaving room for base broadening as well. - Natural resource taxation: - Indonesia’s natural resource tax regime is in line with international practice and the income tax rates and royalty charges are broadly appropriate. - More could be done to capture rents and minimize disincentives for investment and production. - The high level of export taxes on some minerals discourages production and investment. - Taxpayer base and administration: - Taxpayers comprise a relatively narrow segment of the population, but their share (both for individuals and corporations) has been steadily increasing over the last decade. - The current challenge is to raise the number of tax returns filed by registered taxpayers, increasing compliance. - An increased number of tax returns entails greater administrative burden on the tax authority, which could be alleviated by improving capacity and simplifying administration. ### Energy Subsidies — findings and recommendations - Further reforms to energy subsidies are needed to generate the fiscal space necessary to address near term pressures and allow more productive spending over the longer term. - Projection/trajectory: - In the absence of subsidy reform, but with world oil prices expected to moderate over the projection horizon, energy subsidies are projected to gradually decrease to around 2.8 percent of GDP by 2018, but still remain above the 2010 level as a share of GDP. - Staff’s baseline differs from this number since the medium-term projection incorporates a gradual elimination of fuel and electricity subsidies. - Risks and trends: - Fuel subsidies constitute a substantial fiscal risk to the budget, especially with fuel consumption expected to grow faster than real GDP over the medium term. - Electricity subsidies have almost doubled since 2009 as a share of GDP, despite intermittent price adjustments. - Policy recommendations: - Both fuel and electricity subsidies should be gradually eliminated over the medium term by raising prices to the cost recovery levels. - Cutting energy subsidies would open considerable fiscal space for social and development spending and also eliminate some of the risks to budget execution associated with the current fuel subsidy system. - Some of the savings generated could compensate vulnerable groups through targeted social programs. - The government should also consider tackling the rapid growth in LPG subsidies and move ahead with planned reforms of the electricity subsidy. ### Social Security System — planned expansions and fiscal implications - Legal framework and planned coverage: - The 2004 Sistem Jaminan Sosial Nasional (SJSN) or National Social Security System Law contains provisions both for health and pension insurance. - The law sets out the gradual introduction of a universal health care system that will cover the entire population, including both formal and informal workers. - Contributions and fiscal support: - Formal sector workers will pay a fixed percent payroll tax (the current rate is set at 5 percent); while informal sector workers will be required to pay a fixed monthly contribution (the proposal was Rp 35,000 per month per person). - Contribution of poor and near poor households will be paid by the central government. - The proposed 2014 budget uses a monthly contribution of Rp 19,200 per person for Indonesia’s 86 million poor and near poor, with Rp 25 trillion (0.2 percent of GDP) allocated next year for this purpose. - Implementation risks and uncertainties: - Projected spending on these new protections remains uncertain, in part due to concerns about the capacity of the government to execute them. - The government is responsible for paying contributions for the poor and for covering any gap between contributions and spending of the health fund. - The 5 percent contribution rate may not be sufficient to cover the direct health care costs of formal sector workers and their dependents, posing an additional burden on the budget. - About 75 million individuals that either work in the informal sector or are not covered by the budget are expected to pay the fixed monthly contribution; collection of these contributions will be difficult, especially in the early years of the transition. - Public health spending is likely to grow faster than income and will require development of additional capacity financed by the central government. - Pension provisions: - The SJSN Law also establishes a pension program for salaried workers to be implemented starting in 2015. The contribution rate has not yet been decided. - The introduction of a minimum social pension could help reduce poverty among the elderly. ### Infrastructure Investment — needs, implementation issues, and governance - Need to scale up public investment and improve quality of spending to ensure supply-side bottlenecks do not constrain growth. - Budget execution issues: - Spending is concentrated in the last few months of the fiscal year (typically 50−60 percent of capital spending is disbursed in the last quarter), contributing to low budget execution in public investment. - New procurement regulations were put in place in 2011 to revise spending rules and simplify procurement procedures to speed up disbursements; however, improvements remain to be seen. - Land acquisition: - Slow acquisition of land has affected infrastructure spending; a new land acquisition law enacted in 2012 aims at speeding up this process. - Progress has been made in issuing supporting regulations, including the establishment of financing mechanisms for acquiring land for public projects. - Subnational governance and monitoring: - At the general government level, concerns remain about the accountability of local governments and capacity of the central government to monitor their activities. - The fiscal rule limits the general government deficit to 3 percent of GDP. - Enhanced monitoring of local budgetary developments is needed to allow more accurate planning of the central government’s capital budget. - The system for preparing local budgets needs to be reviewed; delays in central government budget preparation make it difficult for local governments to prepare their own budgets on time. - Budget reporting by local governments is improving, but is still subject to long lags and does not follow the IMF Government Finance Statistics reporting standards. --- ### Appendix 5. Indonesia—Banking Sector Stability ### Financial system structure — key statistics and composition - Despite rapid growth over the past decade, Indonesia’s financial system is small compared with its peers, with total assets at end­2012 accounting for 68 percent of GDP. - Within the financial system, banks dominate, accounting for around four fifths of the financial system’s total assets. - Bank credit to the private sector is small compared with peers, at only 35 percent of GDP at end­June 2013, but up from 22 percent a decade ago. - Cross border intermediation is comparatively large given sizable funds held abroad, particularly in Singapore. - Insurance companies form the largest component of nonbank financial institutions (NBFIs), accounting for slightly more than 10 percent of the financial system’s total assets. - Finance companies conduct some shadow banking activities. - Selected structure metrics (2012): - Depository institutions: 4,330 (in trillions of rupiahs); 77.5 percent of financial system assets. - Commercial banks: 4,263 (in trillions of rupiahs); 76.3 percent of financial system assets. - State-owned banks: 1,535 (in trillions of rupiahs); 27.5 percent of financial system assets. - Regional public banks: 367 (in trillions of rupiahs); 6.6 percent of financial system assets. - Private banks: 1,841 (in trillions of rupiahs); 33.0 percent of financial system assets. - Foreign-controlled private banks: 722 (in trillions of rupiahs); 12.9 percent of financial system assets. - Nondepository institutions: 1,255 (in trillions of rupiahs); 22.5 percent of financial system assets. - Insurance companies: 569 (in trillions of rupiahs); 10.2 percent of financial system assets. - Financial system total: 5,584 (in trillions of rupiahs); 100.0 percent of financial system assets. - In percent of GDP: 67.8 (note: table lists 67.8... and IMF staff estimates). ### Recent banking sector performance — soundness indicators and trends - Overall assessment: The banking sector appears generally sound, although some divergence exists within the system. - Key noteworthy aspects: - Capitalization: - The system wide capital adequacy ratio (CAR) was 17.5 percent at end­June 2013, unchanged from a year earlier. - Capital largely comprises Tier­1 capital, with a system wide Tier 1 CAR at 16.1 percent. - Large private domestic banks generally have lower capital levels. - The quality of capital remains an issue. - Profitability: - Return on assets of Indonesian banks amounted to 2.6 percent in 2012. - Profitability tends to be lower at small private domestic banks, in part due to higher operating costs. - Liquidity: - At end June 2013, the ratio of liquid assets to short term liabilities was 34 percent. - If stable funding such as current and savings deposits were excluded from short term liabilities, the ratio would be well above 100 percent. - Bank liquidity is not evenly distributed; small private domestic banks hold less liquid assets relative to their balance sheets. - Asset quality: - NPLs at end­June 2013 were 1.8 percent of total loans, down from 3.3 percent at end­December 2009. - Loss provisions for impaired loans were about 130 percent of NPLs for the banking system as a whole. - Provisions for NPLs may not be adequate at some regional public banks and small private domestic banks. - Market turbulence and exposure: - The banking sector was relatively insulated from market turbulence arising in May 2013 due to limited direct exposure to securities (only about 10 percent of total earning assets). - Foreign investor holdings of government bonds and free floating stocks (roughly one third and three fifths, respectively) mitigated wealth-effect spillovers to banks. - Credit growth and related risks: - Credit growth has moderated since mid 2012, but recent expansion may pose elevated risks. - Macroprudential measures implemented in 2012 (caps on LTV ratios and minimum down payments for vehicle purchases) slowed recorded growth in housing and auto loans, but growth in multipurpose loans accelerated, suggesting possible circumvention and credit diversion. - Residential property prices in major cities have been rising steadily; prices in the Jakarta area were up 10 percent year on year in June 2013. - Loans for housing purchases and loans to construction companies are about 12 percent of total loans. - Credit growth has outpaced deposit growth, raising loan to deposit ratios (LDRs): - As of end August 2013, the system wide LDR was 89 percent, compared to about 60 percent at end December 2006. - Based on envisaged credit and deposit growth in 2013, the system wide LDR is projected to reach 92 percent by end­2013, with around one­third of all banks expected to have LDRs in excess of 100 percent. - Signs of increasing competition for bank deposits have emerged, with small domestic banks facing reduced access to local interbank funding and foreign banks confronting higher costs to obtain offshore funding. - Selected Financial Soundness Indicators (excerpt, percent): - Regulatory capital to risk-weighted assets: 17.5 (2012), 17.5 (2013:Q2) - Regulatory Tier-1 capital to risk-weighted assets: 16.1 (2013:Q2) - Nonperforming loans to total gross loans: 1.8 (2013:Q2) - Return on assets: 2.6 (2012) - Liquid assets to short-term liabilities: 34.0 (2013:Q2) - Loans to deposits: 96.4 (2013:Q2) - Capital to assets: 12.4 (2013:Q2) ### Risk factors and near-term challenges - The current environment presents a number of challenges to banks, stemming from slowing economic growth, a less accommodative monetary stance, and higher funding costs. - Near-term vulnerabilities: - Banks will likely face heightened funding pressures, which could raise funding costs and/or reduce liquidity buffers, and adversely affect profitability. - Balance sheets could weaken due to deteriorating asset quality and losses stemming from market risk. - Most banks should have adequate capital buffers to withstand such shocks, though vulnerabilities are unevenly distributed across the banking system. *Source: IMF staff report content unit _cr13362 — selected chapters on fiscal reforms, social protections, infrastructure investment, and banking sector stability.* ### 7. Liquidity risks. Systemic liquidity risk remains low since the bulk of banks’ short term ### 7. Liquidity risks ### Liquidity risks — systemic assessment - Systemic liquidity risk remains low since the bulk of banks’ short term liabilities come from relatively stable retail funding, namely current and savings deposits. - Most banks have sufficient high quality liquid assets (cash, securities, and reserves held at BI) to cover a sizable deposit outflow concurrently with a complete withdrawal of short term wholesale funding. - Based on end December 2013 data, the total liquidity gap of banks facing liquidity strains was estimated at Rp 9 trillion (0.2 percent of total banking system assets). - The banking system could face an FX liquidity gap of about US$ 7.5 billion in the event of a system wide shock to FX liabilities, including deposits, other commitments, and contingent liabilities (i.e. a 5 percent FX deposit outflow shock, which would represent the single largest monthly withdrawal in the past decade, simultaneously with an entire drawdown of other FX commitments and contingent liabilities). ### Funding pressures and earnings - More intense competition for deposits and imperfect pass‑through of higher funding costs will likely narrow net interest margins and reduce banks’ profitability. - Scenario: If net interest margins were to compress by 60 bps (i.e., by one‑tenth of the current system wide margin), then: - banks’ return on assets would fall by an estimated 0.5 percentage point; and - their capital buffers would be lower by 0.8 percent of risk weighted assets. - Small domestic banks face more acute funding pressures, implying their net interest margins are likely to be more compressed going forward and potentially eroding their capital buffers more than other banks. ### Credit risks - Lower economic growth, rising interest rates, and sectoral weaknesses could significantly worsen asset quality, especially for banks with sizable restructured and special mention loans. - State owned banks are more vulnerable because their loan portfolios comprise a larger share of restructured loans (2.5 percent compared to 1.8 percent system wide) and special mention loans (5.1 percent compared to 3.7 percent system wide). - While direct exposure to the property sector is limited, higher domestic interest rates and a sharp reversal in property prices could weaken property developers’ and mortgage holders’ ability to service debt, adding to banks’ credit losses. ### Market risks - Banks are increasingly exposed to market risks in an environment of rising interest rates and volatile currency movements, but so far these risks remain manageable. - Interest rate shock sensitivity: - For each 100 bps increase in government treasury yields, mark to market losses would reduce the system wide CAR by an estimated 0.15 percentage point. - Even a 500 bps increase would produce losses the banking system could absorb; such a loss would amount to about 20 percent of total net income on average. - Exchange rate risks: - FX lending accounts for 15 percent of total loans, some of which may not be fully hedged by borrowers. - Direct impact of currency movements on banks’ balance sheets appears minimal given a small system wide net open FX position (4.5 percent of capital at end June 2013). - Exchange rate fluctuations should be monitored closely. ### Capital buffers and stress scenarios - If all current restructured and special mention loans were classified as NPLs, additional provisions would amount to about Rp 125 trillion (3 percent of total banking system assets). - Under that scenario, the system wide CAR as of end‑2013 would fall to 14.2 percent from 17.5 percent as of end‑2012, with around 5 percent of banks likely to breach the minimum capital requirement of 8 percent. - Even after these complete write downs, the banking system as a whole could withstand a further increase in the NPL ratio of 6.8 percentage points to around 9 percent before breaching the minimum capital requirement (based on a very conservative assumption that all new NPLs would be fully provisioned). - Capacity to meet additional credit losses varies across banks, with a number of small private domestic banks potentially exposed to capital shortfalls. - Regulatory sensitivity notes: - Tier‑1 CAR would be 2 percentage points lower if adjusted for specific reserves and unaudited current year’s profits; the ratio would decline further by about 2 percentage points if net interoffice funds of foreign bank branches are excluded. ### Banking sector oversight — framework and gaps - Basel II: All three pillars of Basel II were implemented in 2012; all Indonesian banks use the standardized approach for credit risk under Pillar 1. - Pillar 2: The risk‑based supervisory approach is nascent; BI introduced a risk based rating system covering risk profile, profitability, capital adequacy, and corporate governance as a supervisory tool. - Stress testing: Stress testing based on full‑fledged scenario analysis has not been incorporated into individual banks’ Internal Capital Adequacy Assessment Process or into BI’s systemic risk assessment and supervisory process. - Progress since 2010 FSAP: - BI enhanced the prompt corrective action framework by placing banks under intensive supervision and special surveillance based on qualitative indicators in addition to quantitative indicators such as CARs. - Criteria for initiating the resolution process for unviable banks have become more stringent. - BI revised regulation on the treatment of restructured loans, allowing reclassification by one notch only after a borrower has fulfilled repayment obligations for at least three consecutive periods. - Remaining regulatory weaknesses to address: - Tier‑1 capital still includes items that do not meet certainty, permanence, and loss‑absorbing ability tests. - Asset classification and provisioning regulations have issues: exposures backed by certain collateral (such as guarantees) do not have to be classified as NPLs even if in default, and the uniform asset classification norm and forward looking risk assessment in classifying assets are subject to numerous exemptions. - Potentially distorting regulations: - LDR‑linked reserve requirement (adopted in 2010) imposes surcharges on banks with LDRs falling outside a stipulated range and could encourage banks below the floor to lend more aggressively to avoid higher surcharges. - Currently, the reserve requirement would be 0.1 percentage points higher for each additional LDR (in percentage points) below 78 percent, and 0.2 percentage points higher for each additional LDR above 92 percent (originally, 100 percent). - As of end‑2012, about one quarter of banks (accounting for 42 percent of total banking system assets) had LDRs below 78 percent. - BI regulation issued in 2012 stipulates that banks must allocate 20 percent of their lending to micro, small, and medium size enterprises by 2018; around half of all banks are already in compliance, while others may need to alter business models and risk management practices to contain potential credit risks from a lack of expertise in lending to this sector. _Italic: IMF staff analysis and findings as presented in the source content._ ### 5. This highlights the important role of improving the efficiency of labor allocation in ### _cr13362 - 5. This highlights the important role of improving the efficiency of labor allocation in ### Role of improving labor allocation - Improving the efficiency of labor allocation promotes economic growth in developing countries. - The note focuses on labor market policies as a key factor hindering efficient labor allocation in Indonesia. - Two labor cost measures examined: the legal level of severance pay and the minimum wage. ### Cross-country correlations and patterns - More rigid labor markets are associated with less efficient allocation of labor, particularly for lower income countries. - Observed correlations: - A strong negative correlation between the covariance term and severance pay level for countries with lower initial labor productivity (Figure 6.4). - A weak positive correlation between the covariance term and severance pay level for countries with higher initial labor productivity (Figure 6.5). - Similar pattern for the covariance term and the minimum wage level relative to the average wage (Figures 6.6 and 6.7). ### Regression evidence (Table 6.4) - Regression analysis includes an interaction term between labor market rigidity and initial productivity level; robust standard errors in parentheses. - Main empirical observations: - On average, a negative and statistically significant effect of the severance pay level on the efficiency level of labor allocation is found (column 1), but controlling for the initial aggregate productivity level leads to a statistically insignificant effect (column 2). - Adding the initial aggregate productivity level and its interaction term with the severance pay level leads to a larger negative coefficient estimate on severance pay, with the interaction term being positive and statistically significant (column 3). Interpretation: high severance pay has adverse effects on efficient labor allocation particularly for countries with a lower initial labor productivity level; these adverse effects are diluted for countries with higher initial labor productivity. - A statistically insignificant effect from the initial labor productivity level negates the alternative explanation that the efficiency of labor allocation simply follows the income level. - Results are similar when labor market rigidity is measured by the relative minimum wage level (columns (4)−(6)). - Selected table entries (as presented): - Labor rigidity 4/-0.002 **-0.001-0.022 *** -0.001-0.001-0.022 *** (0.001)(0.001)(0.003)(0.001)(0.001)(0.003) - Initial labor productivity0.034 *-0.0250.046 **-0.025 (0.019)(0.020)(0.019)(0.020) - Labor rigidity × initial labor productivity0.002 ***0.002 *** (0.000)(0.000) - Constant0.136 ***-0.2090.367 *0.106 ***-0.346 *-0.010 (0.031)(0.192)(0.193)(0.034)(0.186)(0.208) - R-squared0.1440.2000.4950.0370.1650.321 - Observations464646464646 - 1/ Significance: * 10 percent; ** 5 percent; *** 1 percent. - 4/ Labor rigidity is measured as severance pay (in weeks of salary) in columns (1)-(3), and minimum wage-average wage ratio in columns (4)-(6). - (3) Dependent variable is covariance term in 2007 scaled by initial aggregate labor productivity in 1996 for columns (1)‐(6). - Sources: World Bank, World Development Indicators; World Bank, Doing Business (2007); International Labor Organization, Wage Report (2008); and IMF staff estimates. ### Policy implications (general) - The effect of labor market policies depends on the level of economic development. - Policies that hinder efficient allocation of labor adopted at an earlier stage of development may deter economic growth more than if adopted later. - Ensuring adequate labor market flexibility should be a top priority for low and middle income countries to promote growth and avoid a middle income trap. ### Implications for Indonesia - Indonesia’s manufacturing sector has experienced a sustained loss in competitiveness over the past decade and has not created enough jobs to facilitate efficient reallocation of labor toward higher productivity sectors. - Reallocation in Indonesia is hindered in part by extremely high hiring and firing costs relative to other countries; the Manpower Law introduced in 2003 is a factor. - The law stipulates an increase in mandated severance pay rates, imposes tighter restrictions on fixed-term contracts and subcontracting, and establishes the minimum wage-setting mechanism at the provincial and district level. - Minimum wages, particularly binding for formal sector jobs predominant in larger scale manufacturing, have risen rapidly over the past decade, outpacing both inflation and productivity growth, and are high relative to average wages (Figure 6.8). - Example: the minimum wage in Jakarta was increased by an average of 44 percent in 2013. - Result: minimum wage indexing to non-minimum wages has contributed to a sharp increase in real unit labor costs in the industrial sector in the past decade. ### Historical trends and recommendations for Indonesia - Changes in the efficiency of labor allocation (covariance term) in Indonesia: - Labor allocation improved across sectors in the early 1990s following deregulation. - Greater allocation toward manufacturing suffered a setback in the run up to and during the Asian financial crisis and after introduction of the Manpower Law. - Recent years show signs of reversing this trend, but sustaining improvement requires broader policy actions. - Recommended policy actions: - Reduce rigidity of labor market regulations (including reconsideration of high severance pay and restrictions introduced by the Manpower Law). - Align minimum wage growth with productivity growth. - Broader policy measures to support labor reallocation toward higher productivity sectors (noting infrastructure and business climate are also important impediments). *Prepared by Asia and Pacific Department; sources include World Bank, World Development Indicators; World Bank, Doing Business (2007); International Labor Organization, Wage Report (2008); and IMF staff estimates.* ### 11.62 percent of the total loans approved by the institution for the year. The sectors with the largest ### _cr13362 - 11.62 percent of the total loans approved by the institution for the year. The sectors with the largest ### ADB lending and technical assistance to Indonesia - Between 1966 and 2012, the ADB provided 527 Technical Assistance (TA) grants to Indonesia amounting to $366.75 million. - TA grants were financed from the ADB’s TA Special Fund, the Japan Special Fund, and other sources. - Measured by cumulative TA approvals, Indonesia is the second largest recipient of TA support from the ADB. - The ADB approved a new Country Partnership Strategy 2012−2014 (CPS) with the Government of Indonesia in May 2012 covering the period 2012−2014. - CPS alignment and objectives: - Aligned with the Government’s medium-term development plan for 2010−2014 and the Masterplan for the Acceleration and Expansion of Indonesia Economic Development 2011−2025. - Guided by the government’s commitment to “pro-poor, pro-job, pro-growth and pro-environment” development. - Two strategic CPS pillars: inclusive growth and environmental sustainability with climate change mitigation and adaptation. - ADB support areas: upgrading infrastructure, improving logistics, enhancing skills, and strengthening local government capacity for public service delivery. ### Sovereign and nonsovereign loan approvals and disbursements (selected annual figures) - Loan approvals: - 2005: 1,145.69 (US$ millions) - 2006: 784.80 (US$ millions) - 2007: 1,187.10 (US$ millions) - 2008: 1,085.00 (US$ millions) - 2009: 2,184.20 (US$ millions) - 2010: 785.00 (US$ millions) - 2011: 580.00 (US$ millions) - 2012: 1,232.75 (US$ millions) - Loan disbursements: - 2005: 1,014.99 (US$ millions) - 2007: 1,025.88 (US$ millions) - 2008: 1,136.30 (US$ millions) - 2009: 949.60 (US$ millions) - 2010: 739.30 (US$ millions) - 2011: 1,079.80 (US$ millions) - 2012: 631.90 (US$ millions) - 2012 alternative row: 862.50 (US$ millions) ### Cumulative lending to Indonesia (As of December 31, 2012) — sectoral shares and amounts - Total: 317 loans; 28,305.29 (US$ millions); 100.00 percent. - Sectoral breakdown (No., US$ millions, Percent): - Agriculture and natural resources: 99; 4,047.00; 14.30 percent - Education: 33; 2,297.35; 8.12 percent - Energy: 32; 3,831.05; 13.53 percent - Finance: 23; 4,226.10; 14.93 percent - Health and social protection: 13; 1,068.30; 3.77 percent - Industry and trade: 12; 645.70; 2.28 percent - Public sector management: 21; 5,324.97; 18.81 percent - Transport and information and communications technology: 35; 3,193.86; 11.28 percent - Water supply and other municipal infrastructure and services: 32; 1,984.74; 7.01 percent - Multisector: 17; 1,686.22; 5.96 percent - Note: "1/ Total may not add up because of rounding." ### Assessment of data adequacy for surveillance (IMF staff summary) - General: Indonesia’s macroeconomic statistics are broadly adequate to conduct effective surveillance. - National accounts: - Annual and quarterly GDP data published timely for both expenditure and production sides, base year 2000. - Estimates rely on a limited set of indirect indicators of uncertain quality; some sectors strongly seasonal. - Seasonally adjusted data are prepared but not published. - No survey of nonfinancial services is prepared. - IMF recommendations: - (i) development of a system to continuously update the census of businesses; - (ii) introduction of comprehensive annual establishment surveys for nonfinancial services industries; - (iii) publication of annual GDP estimates, including a time series of at least 20 years; - (iv) development of a set of annual supply and use tables (SUTS) starting from 2000; - (v) enhancement of the convergence exercise on trade data between Bank Indonesia (BI) and the Ministry of Finance (MOF). - Revision of the base year of national accounts to 2010 is in progress with technical assistance (TA) from STA; GDP estimates based on improved data sources and methodology are expected by 2013. - Price statistics: - Price statistics broadly adequate. - Badan Pusat Statistik (BPS) is developing a producer price index (PPI) with TA from STA to replace the wholesale price index (WPI). - New PPI planned for publication in 2014, covering goods and services. - Government finance statistics: - Weaknesses in classification, coverage, and timeliness. - Central government budget data available with a one-month lag; subnational data available only with a lag of two years. - Decentralization has shifted substantial resources to subnational governments, compounding problems. - Authorities committed to adopting GFSM 2001 standards. - Short-term IMF staff recommendations: - (i) establishment of a register of all extrabudgetary units; - (ii) inclusion of economic codes consistent with GFSM 2001 in the chart of accounts to ensure general government units report all transactions and balances they control. - Medium-term priorities: - (i) establishment of reporting arrangements for timely preliminary data for local government statistics; - (ii) development of a GFSM 2001 operating statement, statements of sources and uses of cash, and partial balance sheets, to be published on the MOF’s website. - 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’s website. - MOF efforts to compile GFS data are being assisted by STA. - Monetary and financial statistics (MFS) and financial soundness indicators (FSIs): - BI compiles good quality monetary statistics on a timely basis. - With STA assistance, BI has compiled and reported monetary data using the Standardized Report Forms (SRFs). - BI has compiled monetary data for other financial corporations (OFCs) comprising only finance companies. - STA recommended expanding OFC coverage to include insurance companies and pension funds and expanding ODCs to include mutual funds. - Challenge: timely revisions of published banking sector data after supervisory verification. - BI compiles and reports FSIs to the IMF: - Initially semiannual; starting Q4:2011 reported quarterly. - FSIs for Indonesia comprise 11 core FSIs, 12 encouraged FSIs for deposit takers, 2 encouraged FSIs for OFCs, and 3 encouraged FSIs for the real estate sector. - A 2011 STA mission recommended BI coordinate to explore compiling FSIs for nonfinancial corporations and households. - Balance of payments (BOP): - Trade data have improved; since 2006 import/export transactions of free trade zones are covered in goods data of BOP statistics. - Capital and financial account: methodological basis for FDI compilation needs substantial improvement. - Inflows currently 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 a low response rate and directory of enterprises coverage needs improvement. - Other needed improvements: recording of trade credits; asset data for portfolio investment and other investment transactions. - Errors and omissions have been large at times, related to under-coverage of assets in the financial account. - Financial transactions data are reconciled with changes in the International Investment Position (IIP), except data on direct investment. - Annual IIP is compiled, but underlying data are weak notably for FDI. - External debt statistics improved with External Debt Information System (EDIS) introduced in 2002 and recent initiative to publish monthly indicators. - Ongoing reconciliation by BI has made the IIP and external debt data fully consistent. - Remaining needs: components of private corporate sector data — distinguishing scheduled vs actual debt service, estimating accumulation/reduction of private sector payments arrears, and estimating reschedulings/debt reductions received by the private sector from external creditors. ### Data standards and dissemination - Subscriber to the Special Data Dissemination Standard (SDDS) since September 1996, observing most SDDS requirements. - Indonesia uses SDDS flexibility options for timeliness of labor market categories (employment, unemployment, and wages/earnings) and general government operations. - Flexibility options also used for periodicity of labor market categories (employment and unemployment). - Data ROSC completed in 2005. ### Table of Common Indicators Required for Surveillance (As of October 31, 2013) — selected entries - Exchange rates: Date of Latest Observation 10/31/13; Date Received 10/31/13; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D. - International reserve assets and reserve liabilities of the monetary authorities: Date of Latest Observation 9/13; Date Received 10/13; Frequency M/M/M. - Reserve/base money: Date of Latest Observation 9/13; Date Received 10/13; Frequency W/M W/M W/M; Data Quality—Methodological Soundness: O, LO, O, O, O; Data Quality—Accuracy and Reliability: LO, O, O, LO, O. - Broad money: Date of Latest Observation 8/13; Date Received 10/13; Frequency M M M. - Central bank balance sheet: Date of Latest Observation 9/13; Date Received 10/13; Frequency M M M. - Consolidated balance sheet of the banking system: Date of Latest Observation 8/13; Date Received 10/13; Frequency M M M. - Interest rates: Date of Latest Observation 10/31/13; Date Received 10/31/13; Frequency D D D. - Consumer price index: Date of Latest Observation 9/13; Date Received 10/13; Frequency M M M. - Revenue, expenditure, balance and composition of financing—central government: Date of Latest Observation 9/13; Date Received 10/13; Frequency M M Mid-year; Data Quality—Methodological Soundness: LNO, LNO, LO, LNO; Data Quality—Accuracy and Reliability: LNO, LO, LO, LO, LNO. - Stocks of central government and central government–guaranteed debt: Date of Latest Observation 6/13; Date Received 8/13; Frequency Q Q Q. - External current account balance: Date of Latest Observation 6/13; Date Received 8/13; Frequency Q Q Q; Data Quality—Methodological Soundness: LO, LO, LO, LO; Data Quality—Accuracy and Reliability: LO, O, LO, O, O. - Exports and imports of goods and services: Date of Latest Observation 8/13; Date Received 10/13; Frequency M M M. - GDP/GNP: Date of Latest Observation 6/13; Date Received 8/13; Frequency Q Q Q; Data Quality—Methodological Soundness: LO, LO, O, LO; Data Quality—Accuracy and Reliability: LO, LO, LO, LO, LNO. - Gross external debt: Date of Latest Observation 6/13; Date Received 8/13; Frequency Q Q Q. - International investment position: Date of Latest Observation 2012; Date Received 10/13; Frequency A A A. ### IMF staff update (Statement by the IMF Staff Representative on Indonesia, November 15, 2013) - Latest data developments: - Real GDP grew 5.6 percent (y/y) in 2013:Q3, down from 5.8 percent in the previous quarter mainly on continued slow investment growth but supportive consumption. - Headline inflation declined to 8.3 percent (y/y) in October from 8.4 percent in September, mostly due to a sharp drop in volatile food prices; core inflation remained at 4.7 percent. - Private sector credit growth was 20.5 percent (y/y) in September, unchanged from August. - Current account deficit was US$8.4 billion in 2013:Q3, compared to US$10.0 billion in the second quarter. - For the first three quarters of 2013, the current account deficit was US$24.3 billion (3.7 percent of GDP on an annualized basis). - Inward foreign direct investment rose to US$5.4 billion in 2013:Q3 from US$4.7 billion in the previous quarter. - Overall balance of payments deficit was broadly unchanged at US$2.6 billion. - Gross international reserves rose to US$97 billion (5.3 months of imports of goods and services) at end October from US$96 billion at end September. - Bank Indonesia policy action: - BI raised its policy rate by 25 bps to 7.5 percent on November 12. - Deposit and lending facility rates were also increased by 25 bps to 5.75 percent and 7.5 percent, respectively. - BI stated the move aimed to further reduce current account pressures and bring inflation back to around its target band of 4.5±1 percent in 2014. *Source: IMF staff report content provided in the source PDF.* ### 3. The government announced a set of policy measures on November 1 aimed at ### _cr13362 - 3. The government announced a set of policy measures on November 1 aimed at ### Policy measures to improve ease of doing business - Streamlined procedures for: - starting up a business - registering ownership rights of land and buildings - receiving building permits - connecting to electricity - making tax payments - contributing to social security program - The government indicated that a plan for implementing the whole set of measures would be in place by February 2014. ### Macroeconomic outlook and projections (staff report summary) - Real GDP: - 2012: 6¼ percent - Growth projected to slow to around 5−5½ percent in 2013 and 2014 - Inflation: - Expected to reach 9½ percent (year-on-year) in 2013 - Expected to ease back to around 6 percent in 2014 - Current account: - Shifted into a deficit in 2012 - Projected to remain above 3 percent of GDP in 2013 and 2014 - Capital flows and reserves: - Foreign direct investment and net portfolio inflows expected to moderate but remain supportive - Despite drawdown in first half of 2013, reserves are expected to remain adequate ### Recent policy actions taken by authorities (staff report summary) - Fiscal: hike in subsidized fuel prices in June to check rise in energy subsidies - Monetary: tightened through a substantial increase in policy rates - Exchange rates and bond yields moved to reflect market conditions for an orderly adjustment - Supply-side measures and contingent financing arrangements put in place to cushion shocks or prolonged market disruptions ### Financial sector assessment (staff report summary) - Banks: - Remain well capitalized and highly profitable - Asset quality has continued to be strong - Loan-to-deposit ratios have continued to rise despite macro-prudential measures to slow credit growth - Supervision and crisis management: - Ongoing transition of bank supervision from Bank Indonesia to Otoritas Jasa Keuangan continues as planned - Gaps remain in crisis management framework; expected to be filled by a financial sector safety net law when approved by parliament - Need to address remaining deficiencies in prevention of money laundering and terrorism financing ### Executive Board Assessment (summing up) - Directors commended authorities’ track record and actions to contain external and fiscal imbalances, reduce inflation, and manage market volatility. - Policy recommendations and views: - Rebuild policy buffers, address emerging vulnerabilities, and step up structural reforms. - Additional monetary tightening might be necessary to facilitate balance-of-payments adjustment and better anchor inflation expectations. - Strengthen monetary transmission mechanism; develop money and foreign exchange markets to improve liquidity management. - Continue exchange rate flexibility to dampen impact of external shocks. - Fiscal policy should support monetary orientation; moderate consolidation appropriate. - Measures should include bolstering tax collection and sustaining energy subsidy reform with well-targeted safety nets. - Open up fiscal space for infrastructure investment to lift longer-term growth prospects. - Implement pending FSAP recommendations, notably regarding quality of banks’ capital. - Avoid oversight gaps in transition to new supervisory architecture; put in place effective crisis management framework. - Reforms to reduce supply bottlenecks, enhance business climate, increase labor market flexibility, and open trade and investment are key. ### Selected economic indicators, 2008–14 (key figures preserved) - Real GDP (percent change): 2008 6.0 4.6 6.2 6.5 6.2 5.4 5.3 - Domestic demand: 2008 7.6 5.2 5.4 6.1 8.2 5.0 4.9 - Private consumption: 5.3 4.9 4.7 4.7 5.3 5.2 4.8 - Gross fixed investment: 11.9 3.3 8.5 8.8 9.8 5.0 4.0 - Change in stocks 1/: 0.1 -0.2 0.1 0.4 1.8 -0.4 -2.0 - Net exports 1/: 0.7 1.2 0.9 1.5 -1.5 1.1 1.2 - Gross investment 2/ (percent of GDP): 27.8 31.0 32.3 32.9 35.3 34.6 33.8 - Gross national saving (percent of GDP): 27.8 33.0 33.0 33.1 32.5 31.1 30.6 - Foreign saving (external current account balance): 0.0 -2.0 -0.7 -0.2 2.8 3.5 3.2 - Consumer prices (end period): 11.1 2.8 7.0 3.8 4.3 9.5 6.0 - Consumer prices (period average): 9.8 4.8 5.1 5.4 4.3 7.2 7.6 - Central government revenue (percent of GDP): 19.8 15.1 15.8 16.1 16.2 16.0 16.0 - Central government expenditure (percent of GDP): 19.9 16.7 16.4 17.3 18.1 18.4 18.5 - Central government balance (percent of GDP): -0.1 -1.6 -0.6 -1.1 -1.9 -2.5 -2.5 - Primary balance (percent of GDP): 1.7 0.1 0.8 0.1 -0.6 -1.1 -0.9 - Central government debt (percent of GDP): 33.2 28.6 26.8 24.4 24.5 26.2 26.8 - Rupiah M2 (12-month percent change; end of period): 12.7 13.8 16.5 17.4 14.4 - Base money (12-month percent change; end of period): -9.2 16.7 28.9 18.3 14.9 - Private sector credit (12-month percent change; end of period): 30.5 7.2 19.6 25.4 22.3 - One-month interbank rate (period average): 9.1 7.4 6.4 6.4 6.2 4.4 - Balance of payments (in billions of U.S. dollars): - Oil and gas (net): 7.8 5.4 3.2 -0.7 -5.2 -10.9 -14.3 - Non-oil and gas exports (f.o.b.): 107.9 99.0 129.4 162.7 152.9 150.7 159.8 - Non-oil and gas imports (f.o.b.): 92.8 73.5 102.0 127.3 139.1 134.4 137.8 - Current account balance: 0.1 10.6 5.1 1.7 -24.4 -30.4 -27.6 - Inward direct investment: 9.3 4.9 13.8 19.2 19.4 16.5 17.1 - Overall balance: -1.9 12.5 30.3 11.9 0.2 -17.2 -9.0 - Gross reserves (end period, in billions of U.S. dollars): 51.6 66.1 96.2 110.1 112.8 88.7 79.7 - Reserves in months of imports: 5.6 5.2 5.9 6.2 6.4 4.9 4.1 - As percent of short-term debt 3/: 175.0 208.7 224.2 235.5 206.4 154.6 131.6 - Total external debt (in billions of U.S. dollars): 155.1 172.9 202.4 225.4 252.4 264.6 277.3 - Total external debt (percent of GDP): 30.4 32.1 28.5 26.6 28.7 30.3 32.2 - Rupiah per U.S. dollar (period average): 9,687 10,405 9,086 8,772 9,381 - Nominal GDP (in trillions of rupiah): 4,949 5,606 6,447 7,423 8,242 9,102 10,123 - Indonesian oil price (in US$ per bbl.): 97.0 61.6 79.4 111.5 112.7 109.4 105.3 - Oil production (thousands of barrels per day): 976 949 945 907 860 830 830 - Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections. ### Statement by Indonesian authorities (Wimboh Santoso and Evie Akbar) — main points - Appreciate candid dialogue; express concern that staff report emphasizes short-term snapshot over broader dynamic. - Emphasize resilience: average GDP growth reaching 6% over last 5 years; solid fundamentals pre-taper concerns. - Note external pressures from tapering concerns and volatile capital flows by end-Q2-13; shifted macro strategy to prioritize stability over expansion. - Policy packages since August 2013 focused on: - narrowing current account deficit - curbing inflation - preserving monetary and foreign exchange stability - promoting investment and maintaining sustainable growth - complementing existing structural reforms - Q3-2013 growth and inflation: - Q3-2013 growth: 5.62% (y-o-y) or 5.83% (y-t-d) - Authorities' 2013 projection range: between the 5.5% – 5.9% level of growth for 2013 - Inflation: reported -0.35% (m-t-m) or 8.40% (y-o-y) in September; 0.09% (m-t-m) or 8.32% (y-o-y) in October; peak of 3.28% (m-t-m) in July 2013 - Authorities foresee inflation in 2014 to be in line with the 2014 target range of 4.5 + 1% - Balance of payments and reserves: - Expect BOP pressure to ease starting Q3-2013; current account deficit targeted around 3% in 2013 and further below 3% in 2014 - Reserves reached $97 billion in October 2013; adequate to cover 5.3 month of imports and government’s external debt service; authorities expect reserves to stay around same level by end of 2013 (higher than staff projection of $88.7 billion) - Authorities pursuing bilateral swap arrangements with regional central banks as second line of defense - Fiscal: - Following energy subsidy adjustment and compensating spending, fiscal deficit set to record at 2.38% of GDP in 2013 - Debt level at 23.7% in June 2013, declining from 33% in 2008 - Financial stability supported by high capital adequacy ratio and low NPLs - Monetary and exchange rate policy: - BI adopted a policy mix: monetary policy, macro-prudential policy, financial deepening, and communication strategy - Policy rate and overnight deposit facility rate raised by 150 bps since June 2013 to 7.25% and 5.5% respectively (as of issuance of staff report) - BI stands ready for further tightening; BI Board of Governors decided to raise the policy rate by 25 bps earlier that week (relative to the report) - Authorities maintain flexible exchange rate and have introduced market instruments including FX Swap transactions and tradable central bank rupiah deposit; introduced new regulation on hedging activities by state-owned companies - Authorities remain vigilant to global uncertainties and the consequences of soft-landing strategy *Italic: IMF Press Release No. 13/503; December 15, 2013 — IMF Executive Board Concludes 2013 Article IV Consultation with Indonesia* ### 13. The authorities have consistently adopted prudent fiscal policy by placing hard-cap on the ### _cr13362 - 13. The authorities have consistently adopted prudent fiscal policy by placing hard-cap on the ### Fiscal policy stance and strategies - Authorities maintain a hard-cap on the deficit i.e. not more than 3% of GDP. - Fiscal deficit was successfully maintained less than 2% of GDP for the last 10 years and the debt to GDP ratio continued to decrease. - For 2013, the authorities have four strategies to keep fiscal position strong: - optimizing the revenue, - increasing the quality of spending, - controlling budget deficit, and - decreasing debt to GDP ratio. - On optimizing the revenue: - carried out tax reforms by enhancing tax payable administration, broadening the tax based and increasing tax compliance, - improved SOEs performance to enhance non-tax revenue. - On improving the quality of spending: - allocating higher budget for capital expenditure, social assistance spending and targeted subsidies. - Debt management objective: - intention to strengthen debt management by reducing the Debt to GDP ratio to 23% in 2013. - 2013 budget revision in response to shocks: - energy subsidy reduced through fuel price hikes of 22.3% for diesel and 44.4% for gasoline in June 2013, - additional budget for social protection and infrastructure, - improvements in efficiencies in line ministries spending. - Fiscal outcome and commitments: - adjustment widened the fiscal deficit to 2.38% of GDP, - authorities commit to maintain solid fiscal position and ensure that the budget deficit remain sound. - Policies to support external adjustment and inflation management: - regulation to increase the portion biodiesel in diesel fuel to reduce oil import, - tax relief to export-oriented industries to encourage export, - regulation to improve the trade system of some volatile foods to manage volatile food prices and lessen inflationary pressure. ### Financial sector policy and resilience - Post-1997/1998 crisis reforms undertaken to restore solvency and improve regulation and supervision, including adoption of Basel Core Principles in Banking Supervision (BCBS). - Capital adequacy regime aligned with Basel II principles and moving forward to implement Basel III. - Stress testing: - stress testing models routinely simulated to assess top down and bottom up resiliency of the financial system, - results published regularly in the financial stability report every six months. - Key financial indicators: - Capital Adequacy Ratio (CAR) recorded at 18%, well above the minimum requirement of 8%, - ratio of NPL arriving at just 1.86% in September 2013, - credit growth starts to moderate, hovering around 20%. - Stress test results indicated resilient banking industry to risks including an economic downturn, interest rate hike, and exchange rate depreciation. - Regulatory and supervisory actions: - addressed a number of regulatory weaknesses identified in the FSAP, including the remaining weakness identified in tier 1 capital framework. - Macroprudential measures: - setting the LTV level for mortgages and down payments on motor vehicle loans, - pursuing supervisory actions and enhancing the liquidity management of banks. - authorities predict these policies would reduce the credit growth to the level of 19%-20% at the end of the year. - Institutional changes and coordination: - BI and OJK signed memorandum of understanding (MOU) to smooth-out the transfer process of banking supervision and strengthen cooperation and coordination, - MOU covers cooperation in formulating policies/regulations for financial industry, executing macro and micro-prudential surveillance, and exchange of data and information access to banking system data. - Crisis management framework: - authorities note importance of Financial Sector Safety Net (FSSN) Law to support effective management of systemic crisis, - stronger coordination among institutions under the Financial System Stability Forum (FKSSK) would complement current framework, - authorities are in the process of amending the BI and banking laws to strengthen the Crisis Management Protocol framework. ### Structural reforms and investment promotion - Authorities emphasize accelerating structural reforms to achieve sustainable medium-term growth and reduce infrastructure bottlenecks. - Investment promotion policy launched in August 2013 to: - streamline process for investment permits, - improve single window service for investment, - revise the regulation of negative investment lists, - resolve problems in strategic investment projects such as power plant, oil, gas, mineral mining and infrastructure projects. - Public investment priorities: - capital expenditure to build seaports, roads, railways, energy and airports to facilitate trade and investments. ### Conclusion and policy stance going forward - Indonesia has navigated turbulence since the 1997 Asian crisis and reiterates unwavering commitment to pursue sustainable growth. - Authorities stand ready to take further measures as warranted. - Longer-term priorities: - preserving macroeconomic and financial stability, - pursuing necessary structural reforms to ensure sustainable growth and improved social welfare. - Relationship with the Fund: - authorities look forward to maintain close and even-handed collaboration with the Fund, - authorities emphasize importance of the Fund having a more balanced assessment and constructive recommendations in its surveillance process. *Source: _cr13362 - 13. The authorities have consistently adopted prudent fiscal policy by placing hard-cap on the* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13362.pdf_