## _cr1681

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### Macroeconomic impact, recent developments, and outlook
- 2015 performance and indicators:
  - Real GDP growth: estimated 4.7 percent (y/y) in 2015 (staff); authorities report 4.8 percent for 2015 as a whole; Q4 2015 expanded by 5.0 percent (y/y) and authorities report Q4 2015 at 5.04 percent (yoy).
  - Headline inflation: 3.4 percent at end-2015 (staff); authorities report inflation at 3.35 percent (yoy) for Q4 2015; headline inflation rose to 4.1 percent (y/y) in January 2016; core inflation was 3.6 percent (y/y) in January 2016 and reported 3.95 percent (yoy) for Q4 2015 by authorities.
  - Current account deficit (CAD): estimated 2.0 percent of GDP in 2015 (staff); authorities report 2.04 percent of GDP for 2015; staff notes CA improved to about 2 percent of GDP in 2015 from 3.1 percent in 2014.
  - Gross international reserves: US$105.9 billion (or 7.4 months of imports) at end-2015; authorities also report US$105.9 billion as of end-2015 (7.45 months of imports) and US$102.1 billion in January 2016.
  - Rupiah: depreciated by about 10 percent relative to the U.S. dollar in 2015 (staff); market exchange rate: Rp 13,788 per U.S. dollar as of December 31, 2015 (Appendix V).
  - Government bond yields: rose by about 100 basis points in 2015.
  - Government international bond issuance: US$3.5 billion placed in December 2015.
  - Central government deficit: estimated 2.8 percent of GDP in 2015 (staff); authorities report 2.53 percent of GDP (preliminary).
  - Public debt: 27.5 percent of GDP in 2015 (staff estimate); authorities report public debt 27 percent of GDP by end-2015.
  - External debt: 36½ percent of GDP in 2015.
  - Foreign ownership of rupiah-denominated government bonds: 38.2 percent as of end 2015.

- Near-term projections (2016) and medium-term outlook:
  - Real GDP growth: projected 4.9 percent in 2016 (staff baseline); authorities expect 5.2–5.6 percent in 2016.
  - Inflation: projected to remain within Bank Indonesia’s target band; risks from El Niño-driven food prices and further subsidy cuts noted.
  - Current account deficit: projected to increase to around 2½ percent of GDP in 2016 (staff); balance of payments projected to return to a small surplus.
  - Central government revenue: staff baseline projects decline to 12.1 percent of GDP in 2016.
  - Medium-term growth: expected to reach 6 percent by 2020 with strong infrastructure investment and structural reforms (staff).
  - General government debt-to-GDP: projected to increase to about 30 percent of GDP by 2020 under the baseline (staff).

- Risks and contingency:
  - Main risks tilted to the downside and external: volatile global financial conditions, poor market liquidity, capital outflows, a U.S. dollar surge, deeper slowdown in EM trading partners (notably China).
  - Contingency financing in place: about US$77 billion (Chiang Mai Initiative Multilateralization and bilateral swap arrangements).
  - Staff external position assessment: CA gap range -0.7 percent to 1.3 percent of GDP; REER gap range -6.5 percent to 3.5 percent.

### Fiscal policy, revenue mobilization, and public investment
- 2015 fiscal developments and composition:
  - Central government deficit: estimated 2.8 percent of GDP in 2015 (staff); authorities report 2.53 percent of GDP.
  - Government revenues: decreased by 1.7 percentage points to 13 percent of GDP in 2015.
  - Capital spending: expanded by 0.8 percentage points of GDP to 2.5 percent of GDP in 2015 (including local transfers for infrastructure).
  - Energy subsidies: reduced by about 2 percentage points of GDP in 2015 through fuel subsidy reform.
  - Universal health insurance launched in 2014; fiscal impact to date described as small.

- Staff recommendations and targets:
  - Strengthen fiscal strategy with enhanced revenue mobilization within a medium-term fiscal framework.
  - Medium-term target: increase non-oil-and-gas tax-to-GDP by 2-3 percentage points over the medium term, pace to account for cyclical position.
  - 2016 budget: revise early in the year based on 2015 outturns; consider early revenue-raising actions including increases in excises on fuel, tobacco, and vehicles (estimated to raise an additional 0.6 percent of GDP).
    - Combined with savings from rationalizing lower-priority spending, these measures could reduce the general government deficit to 2.5 percent of GDP while maintaining 2015 priority expenditures.
  - Revenue mobilization strategy to combine tax administration improvements and tax policy reforms:
    - Tax administration: focus on risk, target high-potential segments, ensure tax withholding (particularly employers), use external information for audits, advance VAT e-invoicing, implement risk-based compliance strategies by tax type and taxpayer size.
    - Tax policy: broaden the tax base by rationalizing exemptions (paving way to raise VAT rate over the medium term), rationalize income taxes (unify rates and rationalize incentives), and strengthen property taxes.
  - Staff cautioned against relying largely on the tax amnesty bill for 2016 revenue plans due to uncertainty about approval and revenue impact.

- Infrastructure investment and fiscal risks:
  - Authorities’ medium-term investment program: US$480 billion during 2015−2019 (authorities).
  - Financing: two-thirds from public sector (around 30 percent central government, 11 percent local governments, 22 percent SOEs); remainder from private sector (mainly PPPs).
  - Staff: align implementation pace with capacity constraints, minimize tax exemptions, strengthen public investment financial management, SOE governance, and local government capacity; consider fiscal and macro spillovers (interest rates, current account).

### Monetary policy, exchange rate management, and reserves
- 2015–early 2016 policy actions:
  - BI policy rate: kept unchanged since February 2015 until gradual unwinding; reported at 7.50 percent at end-2015 (Appendix V); in January 2016 reduced by 25 bps to 7.25 percent (staff section); by February 18 authorities report BI reduced the policy interest rate by 25 bps to 7 percent and reduced reserve requirement by 100 bps to 6.5 percent.
  - Primary reserve requirement in rupiah: reduced by 50 basis points to 7.5 percent (effective in December per staff); authorities cut rupiah primary reserve requirement by 50bps in January and 100bps in February 2016 in their account.
  - Monetary stance: staff notes an estimated negative output gap of about 0.4 percent of GDP and supports gradual, cautious unwinding of the tightening cycle.
  - FX and reserves: allow flexible exchange rate and market-determined government bond yields; international reserves US$105.9 billion at end-2015 (119 percent of IMF reserve adequacy metric).

- Staff recommendations:
  - Implement gradual unwinding of the tightening cycle cautiously; remain vigilant to external pressures and inflation resurgence.
  - Maintain policy flexibility: allow flexible exchange rates and market-determined government bond yields, with modest use of international reserves to ensure orderly markets.
  - Continue money market deepening, including introducing reserve requirement averaging to reduce banks’ precautionary reserves.
  - Support development of collateralized interbank market (Global Master Repurchase Agreement launched by OJK in January 2016 noted as positive).

### Financial sector, corporate vulnerabilities, and supervisory reforms
- Banking system metrics and vulnerabilities:
  - Regulatory capital ratio: near 19 percent (staff, end-2014 18.7 percent in Box 2); authorities report 21.2 percent (December 2015).
  - Return on assets (ROA): 2.7 percent (staff, end-2014); corporate ROA fell from 19 percent in mid-2012 to around 13½ percent as of September 2015 (Box 3).
  - NPLs: 2.1 percent (end-2014, Box 2); NPLs started to creep up to 2.6 percent of total loans in September (staff); authorities report NPLs at 2.5 percent (December 2015).
  - Special mention loans: jumped to 5.7 percent (August 2015).
  - Total liquidity gap of banks facing shortages estimated at Rp 14 trillion (0.34 percent of total funding) (Box 2).
  - Specific provisions to NPLs rebounded to 51 percent of total loans in Q3:2015, from 47 percent in 2014 (Box 2).

- Corporate sector exposures and risks:
  - Corporate debt relative to GDP: overall around 32 percent (Box 3); corporate FX debt (including FX debt to domestic banks) around US$160 billion or 20 percent of GDP as of June 2015 (Box 3).
  - Interest coverage ratio below 1.5 for a third of the resource sector (Box 3).
  - Under staff’s adverse scenario, median default probability could rise to some 1/2 of the maximum registered during the Lehman crisis; the 95th percentile estimate close to the maximum during the global financial crisis (Box 3).

- Institutional and regulatory reforms:
  - Supervisory responsibilities moved from BI to OJK in 2014; BI retained macroprudential regulatory responsibilities.
  - Need to align financial sector legislation to new institutional arrangements; draft FSSN bill submitted to Parliament (staff) and expected in Q1:2016 (authorities’ account).
  - OJK developing consolidated supervision and risk-based supervision frameworks; BI progressing with Basel III implementation and LCR adoption.
  - BI issued FX hedging regulations requiring corporates starting in 2015:Q4 to hedge a gradually rising share of foreign liabilities falling due and limit external borrowing to investment grade firms.

- Staff recommendations to safeguard stability:
  - Monitor banking and corporate sectors closely; accompany loan restructuring with stronger supervision.
  - Review corporate resolution framework (including bankruptcy regime) and grant LPS additional powers and instruments to resolve small banks.
  - Early approval of the FSSN bill and coordinated legal revisions across BI, LPS, and OJK.

### Structural reforms, diversification, and competitiveness
- Need and priorities:
  - With the end of the commodity super-cycle, new growth drivers required: manufacturing, agriculture, tourism, and services.
  - Structural impediments: large infrastructure gap, complex regulations, protectionist tendencies, rigid labor markets, and shallow financial markets.

- Reforms and measures enacted:
  - Land Acquisition Law (2015): mandatory time limits (maximum two years) on land acquisition for public projects; private procurement by proxy allowed; simplification of permit documentation and reduced processing times.
  - PPP and SOE frameworks strengthened: PPP unit created in 2014; equity injection to selected SOEs and PT SMI amounting to 0.6 percent of GDP in 2015; expanded PPP modalities including availability-based and hybrid PPPs; VGF budgeted.
  - Foreign ownership eased in select sectors (e.g., seaport facility cap increased to 50 percent; 100 percent foreign ownership allowed for power plants >10 MWV).
  - Trade facilitation and SEZ administrative easing; investment permitting streamlined via BKPM One-Stop Service.
  - Labor market: minimum wage formula introduced (Minimum Wage t+1 = Minimum Wage t × (1+National Inflation Rate t + National GDP Growth Rate t)); some rigid regulations removed.
  - Energy sector: electricity subsidies phased out for most consumers; automatic tariff indexation for industrial/business and large residential consumers; new Geothermal Law and feed-in tariffs for projects ≦10 MW.

- Staff recommendations:
  - Follow policy packages with additional measures to reduce excessive regulation, pursue bold supply-side reforms and trade liberalization, and deepen financial markets.
  - Minimize tax exemptions while expanding infrastructure spending; strengthen public investment management and SOE governance; build local government capacity.

### Empirical findings and balance sheet analysis (preserved figures)
- Box 1 (Commodity price impacts):
  - Commodities sector share: just under 10 percent of GDP; major commodities comprise about half of all merchandise exports.
  - Decline in commodity terms of trade over past three years (around 8 percent) may have led to about one percentage point reduction in GDP growth.
  - Fiscal impact in 2015: decline in oil and gas revenues 1.8 percentage points of GDP not fully offset by lower LPG and electricity subsidy spending 0.5 percentage point of GDP.
  - Further decrease in oil and gas prices by 10 percent would raise the fiscal deficit by just under 0.1 percentage point of GDP in 2016.
  - Capital stock estimated to have declined by a cumulative 0.7 percentage point over the past three years due to the terms of trade shock.

- Box 2 (Banking system soundness):
  - Using end-2014 data: regulatory capital ratio 18.7 percent and ROA 2.7 percent.
  - NPL ratio 2.1 percent and liquid assets relative to short-term liabilities 33 percent.
  - Special mention loans surged from 4.2 percent in end-2014 to 5.7 percent in August 2015.
  - Stylized simulation: if real GDP growth moderated from 4.7 percent in t = –1 to 2 percent in t = 0,1,2,3 and rupiah depreciation accelerated from 7.4 percent in t = –1 to 15 percent in t = 0,1,2,3, a stylized bank’s NPL ratio would rise by 1½ percentage points at the end of the simulation period.
  - Total liquidity gap of banks facing liquidity shortages estimated at Rp 14 trillion (0.34 percent of total funding).
  - Specific provisions to NPLs rebounded to 51 percent of total loans in Q3:2015, from 47 percent in 2014.

- Box 3 (Corporate vulnerabilities):
  - Corporate debt relative to GDP around 32 percent.
  - Liability-to-asset ratio less than 50 percent as of June 2015.
  - Corporate ROA fell from 19 percent in mid-2012 to around 13½ percent as of September 2015.
  - FX debt of corporates amounted to around US$160 billion or 20 percent of GDP as of June 2015 (doubling from 2010).
  - Under staff’s adverse scenario, corporate distress could reach high levels: median default probability would rise to some 1/2 of the maximum registered during the Lehman crisis; the 95th percentile estimate very close to the maximum during the global financial crisis.

### Risk Assessment Matrix — selected global and domestic risks and policy responses
- Global risks (likelihood, impacts, recommended responses):
  - Tighter/volatile global financial conditions: Relative likelihood Medium; impacts High on capital inflows, BOP, financing, and financial/corporate sectors; recommended responses include maintaining exchange rate and market-determined bond yields, preserving sound fiscal position, using contingent financing, and combining monetary tightening with targeted measures.
  - Surge in the U.S. dollar: Relative likelihood Medium; impacts High on capital outflows and FX mismatches; recommended responses similar to above and heightened corporate monitoring and hedging.
  - Significant China slowdown: Relative likelihood Low short term/Medium thereafter; impacts High on exports, fiscal balance, and corporate/financial sectors; recommended responses include exchange rate flexibility, possible fiscal tightening if accompanied by market volatility, and accelerating infrastructure and structural reforms.
  - Persistently lower energy prices: Relative likelihood High into the medium term; impacts Medium on fiscal position; recommended responses include upfront revenue reforms to raise non-oil revenues and accelerate structural reforms.

- Domestic risks (likelihood, impacts, recommended responses):
  - Sharper-than-expected growth slowdown: Relative likelihood Medium; impacts Medium on investment, NPLs, and corporate costs; recommended responses include easing monetary policy if inflation anchored, accelerating infrastructure spending and structural reforms, and timely supervisory actions.
  - Failure of a major corporate group with large FX and leverage: Relative likelihood Medium; impacts Medium on confidence and banking system; recommended responses include close monitoring, expeditious corporate debt restructuring, and ensuring crisis management measures and clear regulatory communications.

### Institutional and statistical capacity
- Data and statistics:
  - National accounts: QGDP by activity and expenditure at 2010 prices; BPS and BI, with STA TA, expect to finalize annual nonfinancial accounts for 2010 during 2016 and quarterly financial flows and stocks starting Q1:2015 in 2017.
  - Government finance statistics: central government budget data available with one-month lag; subnational data only with two-year lag; authorities started compiling quarterly general government data in late 2015 with STA TA.
  - Monetary and financial statistics: BI compiles good quality monetary statistics and expanded OFC survey coverage since January 2015; BI reports core and encouraged FSIs quarterly starting Q4:2011.
  - Balance of payments and external sector: IIP data compiled and published though FDI compilation methods need improvement; external debt statistics improved with EDIS.
  - SDDS subscriber since September 1996; Table of Common Indicators provided with latest observations as of early 2016 (selected entries include exchange rates 1/5/16; international reserve assets 11/15; consumer price index 12/15; GDP/GNP 9/15).

- Governance and reform coordination:
  - Authorities committed to continuing structural reforms, improving investment climate, streamlining regulations (including at local government level), reviewing negative investment list, and exploring participation in regional trading arrangements (including TPP).

*Italic source: IMF staff report excerpts and associated appendices as presented in the document.*

### 1. Macroeconomic Impact of Commodity Price Decline _________________________________________ 20

### 1. Macroeconomic Impact of Commodity Price Decline

### Background and context
- Indonesia navigated commodity price shocks, tightening financial conditions, and global market turbulence with broadly appropriate macroeconomic policies.
- Economic fundamentals improved in 2015 despite a less supportive external environment.
- Structural strengths cited: young demographics, rich natural resources, low public debt, large domestic market, participatory and stable political system.
- Headline vulnerabilities:
  - Exposure to lower commodity prices, weaker China growth, and U.S. monetary policy normalization.
  - Effects transmitted via commodity price, trade, and financial channels.
  - Government revenues, particularly from oil, have dropped significantly.
  - FDI and portfolio inflows slowed; corporate performance weakened; non-performing loans (NPLs) creeping up after increases in foreign currency leverage.

### Recent developments, outlook, and key macroeconomic indicators
- 2015 performance:
  - Real GDP growth: estimated 4.7 percent (y/y) in 2015 (down from 5.1 percent in 2014).
  - Headline inflation: 3.4 percent at end-2015.
  - Current account deficit (CAD): estimated 2.0 percent of GDP in 2015.
  - Oil imports reduced by almost 2 percent of GDP from 2014 levels due to lower oil prices.
  - Gross international reserves: US$105.9 billion (or 7.4 months of imports of goods and services) at end-2015; reserves at 119 percent of the IMF’s reserve adequacy metric.
  - Rupiah: depreciated by about 10 percent relative to the U.S. dollar but broadly stable in nominal effective terms.
  - Government bond yields: rose by about 100 basis points in 2015.
  - Government international bond issuance: US$3.5 billion placed in December 2015.

- Near-term projections (2016):
  - Real GDP growth: projected to increase moderately to 4.9 percent in 2016.
  - Growth drivers: domestic demand, government and SOE capital spending in H1, private investment later conditional on reform momentum; private consumption aided by lower fuel prices but constrained by reduced rural commodity income and electricity subsidy cuts.
  - Inflation: projected to remain within Bank Indonesia’s target band; core inflation stable; upward pressure risks from El Niño-driven food prices and further subsidy cuts.
  - Current account deficit: projected to increase to around 2½ percent of GDP in 2016; balance of payments projected to return to a small surplus.
  - Staff baseline for 2016 projects central government revenue decline to 12.1 percent of GDP (down almost one percentage point of GDP from 2015).

- Medium-term outlook:
  - Growth: expected to reach 6 percent by 2020 with strong infrastructure investment and structural reforms.
  - CAD: would remain near 2½ percent of GDP on account of higher investment-related imports and expanding domestic demand.
  - FDI and portfolio inflows: expected to remain supportive; international reserves expected to remain around six months of imports.
  - General government debt-to-GDP: projected to increase to about 30 percent of GDP by 2020 under the baseline.
  - Public debt: 27.5 percent of GDP in 2015 (noted historical decline from near 90 percent in 2000).
  - External debt: 36½ percent of GDP in 2015 (about half public).

- Risks and contingencies:
  - Main risks tilted to the downside and external: volatile global financial conditions, poor market liquidity, capital outflows, U.S. dollar surge affecting FX-denominated corporate debt, deeper slowdown in EM trading partners (notably China).
  - Domestic risks: slow progress on investment-enabling structural reforms, public investment project delays, continued declines in government revenue.
  - Contingency financing in place: about US$77 billion (Chiang Mai Initiative Multilateralization and bilateral swap arrangements).

- External position assessment:
  - 2015 external position assessed broadly consistent with medium-term fundamentals and desirable policies.
  - Staff estimate current account (CA) gap: -0.7 percent to 1.3 percent of GDP; REER gap range: -6.5 percent to 3.5 percent.

### Macro-financial linkages and systemic vulnerabilities
- Transmission channels in adverse scenarios:
  - Heightened risk aversion could cause sudden stops in capital flows.
  - Corporates may increase borrowing from domestic banks, migrating risk to the banking sector and raising net exposure.
  - Corporate sector faces higher refinancing and default risk.
- Policy response capacity:
  - Economy expected to withstand an adverse BOP shock with policy mix: tighter aggregate demand management, continued exchange rate flexibility, market-determined government bond yields, and judicious FX intervention to prevent disorderly conditions.

### Policy discussions — Fiscal policy and reforms: creating fiscal space for priority spending
- Fiscal strategy:
  - Authorities aim to create fiscal space via revenue mobilization and energy subsidy reform to fund infrastructure and social programs.
  - Energy subsidy reform in 2015 eliminated gasoline subsidies and rationalized diesel and electricity subsidies, reducing energy subsidies by about 2 percentage points of GDP in 2015.
  - Universal health insurance launched in 2014; fiscal impact so far small.

- 2015 fiscal developments:
  - Central government deficit: estimated 2.8 percent of GDP in 2015; general government deficit projected at the same level and close to the statutory limit.
  - Government revenues: decreased by 1.7 percentage points to 13 percent of GDP in 2015.
  - Non-oil-and-gas tax ratio: remained similar to 2014 despite one-off tax collections.
  - Capital spending (including local transfers for infrastructure): expanded by 0.8 percentage points of GDP to 2.5 percent of GDP in 2015.
  - About half of 2015 government bond issuance financed by nonresident investors.

- 2016 outlook under current policies:
  - Central government revenue projected to decline to 12.1 percent of GDP.
  - To keep deficits under the legal limit, spending would need to be curtailed even after anticipated subsidy savings of 0.4 percent from better targeting of electricity subsidies and lower oil prices.
  - Staff baseline implies some rollback of priority spending expansion from 2015.
  - Medium-term baseline: general government deficit near statutory limit; capital spending at general government would reach only 4 percent of GDP by 2020 (well below authorities’ objectives and regional average of 8 percent).

- Staff recommendations and policy priorities:
  - Strengthen fiscal strategy with enhanced revenue mobilization within a medium-term fiscal framework.
  - Medium-term fiscal framework target: increase non-oil-and-gas tax-to-GDP by 2-3 percentage points over the medium term, with policies to achieve this; pace should account for cyclical position.
  - 2016 budget: adjust the approved budget early in the year based on actual 2015 revenue; consider early revenue-raising actions including increases in excises on fuel, tobacco, and vehicles (estimated to raise an additional 0.6 percent of GDP).
    - Combined with savings from rationalizing lower-priority spending, these measures could reduce the general government deficit to 2.5 percent of GDP and secure space to maintain priority expenditures at 2015 levels.
  - Revenue mobilization strategy should combine tax administration improvements and tax policy reforms:
    - Tax administration: adapt reforms to focus on risk, target high-potential segments, ensure tax withholding (particularly employers), use priority external information for audits, advance VAT e-invoicing to enable risk-based audits, and implement risk-based compliance strategies by tax type and taxpayer size.
    - Tax policy: broaden the tax base by rationalizing exemptions (paving way to raise VAT rate over the medium term), rationalize income taxes (unify rates and rationalize incentives), and strengthen property taxes.
    - Staff cautioned against relying largely on the tax amnesty bill for 2016 revenue plans due to uncertainty about approval and revenue impact.
  - Infrastructure investment:
    - Authorities’ plan could significantly improve productivity and crowd-in private investment via PPPs and a Committee for Accelerated Infrastructure Delivery.
    - Progress made in project planning and selection, but implementation pace should align with capacity constraints (including local governments).
    - Need to consider fiscal risks and macroeconomic spillovers (interest rates, current account).
    - Minimize granting of tax exemptions; complement expanded infrastructure spending with improved public investment financial management, stronger SOE governance, and greater local government capacity.

*Source: IMF staff summary — “Macroeconomic Impact of Commodity Price Decline” (Indonesia Article IV consultation materials).*

### 16.      Subsidy reform. The fuel subsidy reform has been very successful and can serve as a model

### _cr1681 - 16.      Subsidy reform. The fuel subsidy reform has been very successful and can serve as a model

### Subsidy reform — findings and recommendations
- The fuel subsidy reform has been very successful and can serve as a model for other countries.
- Authorities plan to continue reforms through improved targeting of subsidized electricity rates in 2016.
- Recommendation: introduce a transparent pricing formula that ensures timely adjustments of fuel prices to changes in international oil prices and the exchange rate.
- Continued shift from general price-based subsidies to well-targeted subsidies, focusing in 2016 on:
  - enhanced targeted support for farmers and fishermen, and
  - conditional cash transfers.

### Authorities’ views on fiscal policy, revenue, and public investment
- Authorities concurred with staff on the need to revise the budget and improve the composition of public spending, but differed on actions needed to mobilize revenue.
- The 2016 budget revision is planned earlier in the year, after reviewing tax collections in 2015.
- Authorities aim to increase fiscal space for infrastructure investment, viewing it as a key driver of growth; however, they acknowledge limitations in available financing and expect implementation to be steady and gradual.
- Relevant public agencies have started developing the legal framework to support infrastructure development, including issuing implementing regulations of the land acquisition law to facilitate public investment.
- On revenue mobilization, authorities attribute Indonesia’s low tax-to-GDP ratio mainly to tax administration and compliance problems, including a complex VAT refund system and the strict bank secrecy rule preventing access to taxpayers’ financial data.
- Authorities view staff’s proposal to raise excise taxes as requiring a large increase, especially for selected excises, to boost revenue in the short run.
- Authorities believe Indonesia will need to enhance the menu of tax incentives to promote FDI, in line with other ASEAN countries.
- Financing policies: high reliance on market financing is being reduced with alternative instruments, including financing from bilateral and multilateral sources.

### Monetary policy and foreign exchange management — developments and staff position
- 2015 developments:
  - Financial volatility increased in the first nine months of 2015, early months due to slowdown of EMs growth and external uncertainty, August–September due to renminbi depreciation and Shanghai stock market turbulence.
  - In October, markets recovered and were broadly stable thereafter.
  - Bank Indonesia (BI) kept the policy rate unchanged since February 2015; policy rate was 175 basis points higher at year-end compared to mid-2013.
  - Despite capital outflows, declines in international reserves were moderate compared to the taper tantrum episode.
  - BI promoted money market deepening, introduced new instruments for liquidity management, and reduced its presence in the interbank FX swap market.
- Monetary policy stance and recent actions:
  - Estimated negative output gap of about 0.4 percent of GDP.
  - BI began gradually unwinding its tightening cycle.
  - Effective in December, BI reduced the primary reserve requirement in rupiah by 50 basis points to 7.5 percent.
  - In January, the policy rate was reduced by 25 bps to 7.25 percent.
  - Deposit and lending rates were similarly reduced; with the decline in inflation, real interest rates have turned positive in real terms.
- Staff recommendations:
  - Gradual unwinding of the tightening cycle is appropriate but should be implemented very cautiously; authorities should remain vigilant and ready to respond if external pressures resume or inflation reemerges.
  - Maintain policy flexibility: allow flexible exchange rates and market-determined government bond yields, with modest use of international reserves to ensure orderly markets.
  - Continue money market deepening, including introducing reserve requirement averaging to reduce banks’ precautionary reserves.
  - Launch of the Global Master Repurchase Agreement by OJK in January 2016 is a positive development to develop the collateralized interbank market.

### Financial and corporate sector — soundness, vulnerabilities, and policy advice
- Banking sector recent performance:
  - Banking system broadly sound but with pockets of rising vulnerability.
  - Capital adequacy ratio near 19 percent.
  - Return on assets of 2.7 percent.
  - Some medium and smaller banks vulnerable to liquidity shocks due to higher reliance on short maturity deposits.
  - Profitability showing signs of weakening; NPLs started to creep up to 2.6 percent of total loans in September.
  - Special mention loans jumped to 5.7 percent.
  - Staff analysis suggests continued subdued growth and rupiah depreciation would push NPLs higher.
- Institutional and regulatory developments:
  - Bank supervision and regulation moved from BI to OJK in 2014; BI retained macroprudential regulatory responsibilities.
  - Need to align financial sector legislation to new institutional arrangements; gaps exist in emergency liquidity assistance and bank resolution frameworks, including inadequate resolution tools for the deposit insurance agency and lack of legal protection for supervisors.
  - Authorities submitted draft FSSN bill to Parliament to clarify frameworks, mandates, and provide more tools for resolving systemic banks.
- Supervision and regulation progress:
  - OJK developing a framework for consolidated supervision of banks and non-banks and upgrading risk-based supervision, including AML/CFT, supported by Fund technical assistance.
  - BI progressing with Basel III implementation; Liquidity Coverage Ratio (LCR) requirements are being adopted; counter-cyclical capital buffer introduced.
  - In July 2015, OJK introduced policies to facilitate loan restructuring for banks with relatively strong risk management capacity.
  - BI unwound part of macroprudential tightening (2012–13 measures) for banks with NPL ratios below 5 percent.
- Corporate sector risks:
  - Corporate sector remains relatively strong compared to EM peers but risks are increasing.
  - Corporate FX debt (including FX debt to domestic banks) reached around 20 percent of GDP as of June 2015, double the level seen in 2010, and concentrated in the commodity and a few non-tradable sectors.
  - Rising refinancing risk as maturing FX debt securities are set to peak; some corporates face higher default risk and difficulty meeting interest expenses.
  - BI’s FX hedging regulations require corporates starting in 2015:Q4 to hedge a gradually rising share of foreign liabilities falling due and limit external borrowing to investment grade firms.
- AML/CFT:
  - Indonesia was removed from FATF’s monitoring process in late 2015 in recognition of significant AML/CFT improvements.
  - PPATK is working on a national risk assessment.
- Staff recommendations to safeguard financial stability:
  - Monitor banking and corporate sectors closely; accompanying loan restructuring measures with stronger supervision to ensure adequate implementation.
  - Review corporate resolution framework (including bankruptcy regime) to ensure capacity to deal with large and systemically connected conglomerates.
  - Continue progress on Basel III; expand customer due diligence measures following AML/CFT improvements.
  - Early approval of the FSSN bill is critical, followed by simultaneous, closely coordinated revisions of the laws of BI, the Deposit Insurance Corporation (LPS), and OJK to ensure legal consistency with new institutional arrangements.
  - Grant LPS additional powers and instruments to resolve small banks.
- Authorities’ views:
  - Authorities generally agreed with staff views and recommendations.
  - Banking sector considered strong; asset quality worsened somewhat but remains manageable.
  - OJK is monitoring NPL restructuring closely.
  - Authorities place strong emphasis on strengthening financial stability architecture and are monitoring corporate debt, expressing confidence risks can be managed.

### Structural reform priorities — diversification and competitiveness
- Macro-critical need:
  - With the end of the commodity super-cycle, Indonesia needs new drivers of growth: manufacturing, agriculture, tourism, and other services.
  - Structural impediments to address include a large infrastructure gap, complex and burdensome regulations, protectionist tendencies, rigid labor markets, and shallow financial markets.
  - Investment climate is weak, complicated by numerous permits from different government levels and restrictive FDI regulations (negative investment list).
- Recent reforms and measures:
  - Policy packages since August targeted reducing excessive regulatory burden, facilitating trade, and initial labor market improvements.
  - Implementing regulations for new land acquisition legislation issued to address historical investment impediments.
  - Energy subsidy reforms were combined with institutional changes to facilitate private participation in energy provision.
  - Authorities indicated intent to review the negative investment list and consider participation in regional trading arrangements, including the Trans Pacific Partnership (TPP).
- Staff recommendations:
  - Investment climate: follow policy packages with additional measures to reduce excessive regulation; pursue bold supply-side reforms and trade liberalization to increase investment and attract FDI.
  - Labor market and human capital: introduce flexibility to rigid labor practices (easing complex restrictions on wage setting and hiring/layoff procedures); reduce skill gaps and strengthen vocational training and links with firms to capitalize on demographic trends and foster inclusive growth.
  - Financial deepening: deepen capital markets (including corporate bond markets), strengthen long-term institutional investors, and develop a range of funding instruments and investment options while keeping the financial sector open to foreign participation.

*International Monetary Fund — Selected chapter excerpt*

### 32.      Authorities’ views:

### _cr1681 - 32.      Authorities’ views:

### Authorities’ commitment and reform agenda
- Strong commitment to continuing structural reforms to establish new drivers of growth and encourage investment.
- Reforms prepared comprehensively to cover fiscal issues (revenue, spending, and financing) and actions to enhance productivity and competitiveness.
- Diversification of the economy away from longstanding reliance on natural resources is part of the reform agenda.
- Long-term policies are being developed while actions are implemented to help the economy navigate the current global setting.
- Most targeted regulations have been streamlined, though authorities recognize it may take time for impacts to fully materialize.
- Ongoing efforts to enhance the investment environment and streamline regulations, particularly at the local government level.
- Intention to open new sectors of the economy to FDI and review Indonesia’s participation in regional trading arrangements, including the Trans Pacific Partnership (TPP).

- Provincial minimum wages rose by 30 percent of average in 2013 and in Jakarta by 44 percent.

### Macroeconomic performance and outlook
Findings:
- Despite a weaker external environment in 2015, macroeconomic performance was satisfactory, underpinned by sound macroeconomic management.
- Economic growth remained among the highest in EMs in 2015.
- Inflation fell sharply to within the official target band and has remained well anchored.
- Current account deficit narrowed in 2015.
- Economic fundamentals improved, supported by young demographics, low public debt, large domestic markets, natural resource endowment, and participatory and stable political system.

Risks and near-term outlook:
- Near-term outlook remains positive; in 2016 economic growth is expected to recover moderately, inflation to remain low, and the current account deficit to remain manageable.
- Elevated downside risks, mainly from adverse external developments.
- External risks: reliance on external financing (susceptible to funding reversals), further fall in commodity prices, tighter global financial conditions, larger decline in trading partners’ growth (notably China).
- Domestic risks: delays in structural reforms and in infrastructure spending could dampen growth.
- Combination of external and domestic factors could exacerbate strains on corporates and banks.

### Fiscal policy, revenues, and medium-term framework
Findings:
- Fiscal strategy is appropriate but important challenges emerged in 2015.
- Actions to create fiscal space through revenue mobilization and reform of subsidies achieved significant successes, including a historic subsidy reform and expansion of priority spending.
- Government revenues underperformed significantly in 2015, mainly due to the fiscal impact of lower commodity prices, offsetting much of the gains from subsidy reform.
- Authorities reduced the level of spending to comply with the deficit ceiling of the fiscal rule.

Recommendations:
- Consider adopting a medium-term fiscal framework with key objectives and actions.
- Adjust revenue and expenditure levels of the 2016 budget to be more consistent with 2015 actual outturns.
- Given Indonesia’s low tax ratio and ambitious development goals, there is space to increase the tax-to-GDP ratio by 2‒3 percentage points of GDP over the medium term to allow for priority spending while rebuilding fiscal buffers.
- Increasing the tax burden should be gradual and take into account the cyclical position of the economy.

Revenue mobilization actions:
- Immediate need to reinvigorate policies to mobilize government revenues, with actions framed in a medium-term plan.
- Short-run: increase excises on selected products, including tobacco, fuel, and cars.
- Medium-term: tax reform to broaden the tax base and increase the VAT rate; tax administration should adopt a risk-based approach.
- Collections from a planned tax amnesty are very uncertain; if they underperform, authorities may be forced to reverse some gains in increasing public investment achieved in 2015.

### Monetary policy, exchange rate, and market-determined yields
- Unwinding of monetary policy tightening should be gradual and cautious.
- Tight monetary policy bias in 2015 helped anchor inflation and support the external position.
- Recent decline in inflation and emergence of a small negative output gap support BI’s decisions to ease monetary policy and reduce reserve requirements.
- Financial market indicators were relatively stable since October 2015, including after the increase in the U.S. Federal Funds rate and higher financial volatility in China.
- Further monetary easing should be carefully considered and paced, taking into account inflationary and external developments.
- Maintaining flexible exchange rates and market-determined government bond yields is critical to navigate volatile external financial conditions.
- Authorities have allowed the exchange rate to reflect market forces with judicious foreign currency interventions to ensure orderly market functioning.
- Allowing government bond yields to be market determined has ensured financing of the budget deficit during turbulent conditions.

### Corporate sector and banking vulnerabilities
Corporate vulnerabilities (summary):
- Corporate sector vulnerabilities rising but manageable; need close monitoring and contingency plans.
- Lower corporate performance follows a period of rapid increase in foreign currency leverage, although from low levels.
- Profitability remains high relative to EM peers, but some corporates are under higher stress.
- Authorities have promoted hedging of foreign currency risk and are monitoring the situation closely.

Banking sector soundness (summary):
- Overall, banking sector appears sound although there are pockets of vulnerabilities.
- Financial soundness indicators, including capital and profitability, remain relatively strong.
- Profitability has started to weaken and small banks face higher liquidity risks.
- Banking sector expected to weather slower growth but authorities should remain vigilant for spillovers from adverse external developments and corporate strains on banks.
- Completing plans to strengthen the financial stability architecture remains a top priority.
- Early approval of the FSSN bill will address critical gaps in bank resolution and enhance financial stability; subsequent coordinated legislative alignment across financial agencies is needed.

Boxed empirical findings and metrics (preserved exactly as in source):
- Box 1 (Commodity price decline impacts):
  - Indonesia’s key traded commodity prices rose by 40 percent over a decade, then dropped sharply since 2011.
  - Commodities sector share: just under 10 percent of GDP; major commodities comprise about half of all merchandise exports.
  - Decline in commodity terms of trade over the past three years (around 8 percent) may have led to about one percentage point reduction in GDP growth.
  - Average decline in fixed investment growth is about double that of consumption.
  - Current account balance improved by around ½ percent of GDP during 2014‒15 owing to import contraction.
  - Fiscal impact of lower oil prices was negative in 2015: decline in oil and gas revenues (1.8 percentage points of GDP) not fully offset by lower spending for LPG and electricity subsidies (0.5 percentage point of GDP).
  - Further decrease in oil and gas prices by 10 percent would raise the fiscal deficit by just under 0.1 percentage point of GDP in 2016.
  - Capital stock estimated to have declined by a cumulative 0.7 percentage point over the past three years as a result of the terms of trade shock.

- Box 2 (Banking system soundness):
  - Using end-2014 data: regulatory capital ratio of 18.7 percent and return on assets (ROA) of 2.7 percent.
  - NPL ratio of 2.1 percent and liquid assets relative to short-term liabilities of 33 percent.
  - Special mention loans surged from 4.2 percent in end-2014 to 5.7 percent in August 2015.
  - Simulation example: if real GDP growth moderated from 4.7 percent in t = –1 to 2 percent in t = 0, 1, 2, 3 and rupiah depreciation accelerated from 7.4 percent in t = –1 to 15 percent in t = 0, 1, 2, 3 a stylized bank’s NPL ratio would rise by 1½ percentage points at the end of the simulation period.
  - Total liquidity gap of banks facing liquidity shortages estimated at Rp 14 trillion (0.34 percent of total funding).
  - Specific provisions to NPLs rebounded to 51 percent of total loans in Q3:2015, from 47 percent in 2014 (Table 8).

- Box 3 (Corporate sector vulnerabilities):
  - Overall corporate debt relative to GDP around 32 percent (compared with around 70 percent on average for peers).
  - Liability-to-asset ratio less than 50 percent as of June 2015.
  - Return on assets (ROA) fell from 19 percent in mid-2012 to is around 13½ percent as of September 2015.
  - FX debt of corporates (including FX debt to domestic banks) amounted to around US$ 160 billion or 20 percent of GDP as of June 2015, doubling from 2010.
  - Interest coverage ratio below 1.5 for a third of the resource sector.
  - Risks to monitor: FX exposure (some FX debt unhedged), refinancing risk (maturing FX debt securities likely to peak this year, concentrated in March), default risk (resource sector and telecommunications under most pressure).
  - Under staff’s adverse scenario, corporate distress could reach high levels: the median default probability would rise to some 1/2 of the maximum registered during the Lehman crisis; the 95th percentile estimate is very close to the maximum during the global financial crisis.

### Structural reforms and competitiveness
- Finding: Finding new drivers of growth and diversifying away from commodities require better infrastructure and structural reforms to improve competitiveness and the productivity of investment.
- Policy packages since August 2015 signal a new direction aimed at revamping the business climate and addressing excessive burden of multiple layers of regulations.
- Authorities need to build on these actions and push forward with reforms, including revision of the negative investment list and leveraging regional trading arrangements.

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

*IMF staff report excerpts: “Authorities’ views” and related sections (excerpted)._*

### Box 4. Indonesia: Balance Sheet Analysis (BSA) of the Economy

### Box 4. Indonesia: Balance Sheet Analysis (BSA) of the Economy

### Methodology and data sources
- The BSA matrix presents a snapshot of outstanding gross and net balance sheet positions (stocks) of different sectors in the Indonesian economy and is used to study balance sheet exposures and vulnerabilities in individual sectors, as well as cross-sectoral linkages.
- The BSA for Indonesia is based on outstanding amounts (stocks) and uses the following statistics as source data:
  - monetary and financial statistics (MFS) using standardized report forms (SRFs) (covering the financial sector),
  - international investment position (IIP) (covering the external sector),
  - government finance statistics (GFS) (covering the government sector).
- From-whom-to-whom information in the datasets is used to populate the matrix for nonbank financial institutions (NBFIs) and the nonfinancial sectors (households—HHs and nonfinancial corporations—NFCs).

### Overall external funding and scale
- Reflecting the openness of its economy, overall external funding in Indonesia accounts for the largest share of total inter-sectoral net credit.
- This share is stable at about 33 percent of total allocated liabilities in the 2014 BSA, corresponding to about 60 percent of GDP.

### Key vulnerabilities identified
- Two key vulnerabilities for Indonesia are highlighted: NFCs and banks.
- NFCs:
  - NFCs rely heavily on funding from abroad.
  - Net external funding for NFCs is close to 60 percent of GDP.
  - NFCs are exposed to foreign currency risk and to funding risk.
- Banks:
  - Banks in Indonesia are mostly exposed to NFCs.
  - The large bank exposure to NFCs may be a source of vulnerability if NFC balance sheets are adversely affected.
  - A shock to the balance sheet of NFCs may significantly increase the level of nonperforming loans (NPLs).

### Network map representation (end-2007 vs end-2014)
- The figure compares the network map representation of the Indonesian BSA as of end-2007 and end-2014.
- Visualization dimensions and interpretation:
  - Arrows represent the flow of funds from creditor to debtor.
  - Arrow thickness indicates the size of the link relative to total allocated assets.
  - Node size represents the size of the net imbalance between funds borrowed and lent within a sector.
  - Node color represents whether a sector is a net debtor (red) or creditor (green).
- Main findings from the intertemporal comparison:
  - (i) Net creditors in 2007 remained net creditors in 2014.
  - (ii) Gross exposures (thickness of the arrows) and net exposures (size of the nodes) have overall become larger in the period.
  - (iii) The largest exposure for both periods concerns the NFC sector borrowing from the ROW.

### Implications for risk monitoring
- Given:
  - NFCs’ large net external funding (close to 60 percent of GDP),
  - the prominence of external funding (about 33 percent of total allocated liabilities, ~60 percent of GDP),
  - and banks’ concentrated exposure to NFCs,
- Policymakers and supervisors should monitor:
  - foreign currency mismatches in NFC balance sheets,
  - funding rollover risks for NFCs,
  - bank asset quality metrics (including NPLs) with attention to contagion from NFC stress.

*Prepared by Elena Loukoianova and Giovanni Ugazio (STA).*

### Appendix I. Indonesia—Risk Assessment Matrix 1/

### _cr1681 - Appendix I. Indonesia—Risk Assessment Matrix 1/

### Global risks: likelihoods, impacts, and recommended policy responses
- Tighter or more volatile global financial conditions
  - Relative likelihood: Medium
  - Expected impacts:
    - High: Portfolio and other capital inflows could be curtailed by weaker investor appetite for EM assets.
    - High: Tighter funding conditions put additional pressure on the balance of payments (BOP), government financing, and the financial and corporate sectors.
    - High: Bank funding could become constrained, raising domestic borrowing costs; rollover risks for corporate external debt are high.
    - Medium: Severe pinch in credit growth or spike in lending rates could hit corporate and household balance sheets (including property) and reinforce negative growth dynamics.
  - Recommended policy responses:
    - Maintain exchange rate and market-determined bond yields.
    - Preserve a sound fiscal position to boost investor confidence; allow automatic stabilizers in an extreme slowdown and use contingent financing if market access is restricted.
    - Combine monetary policy tightening with targeted measures to alleviate funding pressures in segments of the banking system and preserve financial stability.
- Surge in the U.S. dollar
  - Relative likelihood: Medium
  - Expected impacts:
    - High: Capital outflows accompanied by a more persistent and disorderly exchange rate adjustment could disrupt financial asset prices and tighten domestic financial conditions.
    - Medium: Adverse financial spillovers from balance sheet mismatches could intensify corporate vulnerabilities given rising foreign currency borrowing.
  - Recommended policy responses:
    - Similar response as for tighter global financial conditions.
    - Heightened monitoring of corporate sector vulnerabilities and encourage hedging of corporate external debt.
    - Maintain vigilance on exchange rate pass-through to inflation.
- Significant China slowdown (corporate distress → shadow bank propagation → deleveraging)
  - Relative likelihood: Low in the short term/Medium thereafter
  - Expected impacts:
    - High: Lower export volumes and prices (particularly commodities) could widen the current account deficit, pressuring FX reserves and the exchange rate.
    - High: Fiscal balance would deteriorate on weaker resource revenues; financial sector exposed to losses from loans to the commodity sector and broader slowdown.
    - High: Corporate profits decline; corporate balance sheets suffer from incomplete hedging of external borrowing.
  - Recommended policy responses:
    - Maintain exchange rate flexibility to reduce the current account deficit and limit FX reserve losses.
    - Consider more stringent fiscal measures if EM slowdown is accompanied by protracted financial market volatility restricting funding.
    - Accelerate infrastructure spending and structural reforms to boost productivity, non-resource employment, and export diversification.
- Persistently lower energy prices (supply-driven, gradual reversal)
  - Relative likelihood: High into the medium term
  - Expected impacts:
    - Medium: Fiscal position weakens on lower oil-related revenues; adverse spillovers to growth if public investment space is curbed.
  - Recommended policy responses:
    - Implement upfront revenue reforms to raise non-oil revenues.
    - Accelerate structural reforms to boost private investment and productivity.

### Domestic risks: likelihoods, impacts, and recommended policy responses
- Sharper-than-expected growth slowdown (sluggish capital budget execution; weak investment climate)
  - Relative likelihood: Medium
  - Expected impacts:
    - Medium: Slower investment, reduced capital inflows, higher bank NPLs, increased country risk premium, higher corporate external borrowing costs; layoffs weakening domestic demand.
  - Recommended policy responses:
    - If inflation is well anchored, ease monetary policy.
    - Accelerate infrastructure spending and structural reforms to trade and investment regime to boost productivity, non-resource employment, and export diversification.
    - Timely, well-coordinated supervisory actions to preserve banking soundness and close monitoring of at-risk corporate borrowers.
- Failure of a major corporate group with large FX and broader leverage (triggered by sharp rupiah depreciation and commodity weakness)
  - Relative likelihood: Medium
  - Expected impacts:
    - Medium: Destabilized confidence, higher NPLs, increased country risk premium, banking system knock-on effects, layoffs and weaker domestic demand.
  - Recommended policy responses:
    - Monitor closely corporate borrowers with high leverage and large FX exposures.
    - Undertake expeditious corporate debt restructuring and timely, well-coordinated supervisory actions to preserve banking system soundness.
    - Ensure crisis management measures are fully implemented and enforced, with clear communications among regulators and with market.

*The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. "Low" indicates probability below 10 percent, "medium" between 10 and 30 percent, and "high" between 30 and 50 percent.*

### Indonesia — External sector: foreign asset and liability position and trajectory
- Background stock positions (end June 2015):
  - NIIP: -48 percent of GDP (compared to -47 percent of GDP at end 2014).
  - Components as percent of GDP: reserves (+12), net FDI (-27), net equities and portfolio debt (-22), other investment (-11).
  - Gross external liabilities: -74 percent of GDP (up from 72 percent of GDP at end 2013).
  - Gross external debt: 36½ percent of GDP; about 5 percent of GDP denominated in rupiah as of June 2015.
- Assessment and risks:
  - Level and composition indicate external position is sustainable, but non-resident holdings of rupiah debt could be affected by global volatility.
  - Public external debt may increase if government relies more on external financing (including multilateral loans) for infrastructure; SOE borrowing may also rise.
  - Growth in private external debt expected to slow owing mainly to tightening global financial conditions (except SOE borrowing for infrastructure).
- Overall Assessment for 2015:
  - External position assessed to be broadly consistent with medium-term fundamentals and desirable policies.
  - Policy actions since mid 2013 (monetary tightening, fuel subsidy reform, exchange rate and bond yield flexibility) helped improve external position.
  - External financing appears sustainable but could be affected by domestic or external shocks.
- Potential policy responses:
  - Monetary policy should focus on containing inflation within Bank Indonesia’s target band.
  - Fiscal policy: aim for a small primary deficit over the medium term, led by reforms to increase the tax take, while providing space for health spending and increased infrastructure spending.
  - Maintain exchange rate flexibility and market-determined interest rates to facilitate adjustment.
  - Ease trade and investment restrictions, deepen financial markets, and improve labor markets to promote growth and competitiveness.

### Current account (CA)
- Background:
  - CA deficit estimated to improve to about 2 percent of GDP in 2015 from 3.1 percent in 2014, mainly from import compression and sharply lower oil prices.
  - In 2015, oil and gas trade balance expected to be about -1 percent of GDP; non-oil and gas trade balance expected to be about 2.5 percent of GDP.
- Assessment:
  - EBA CA results suggest a gap of 0.3 percent of GDP for 2015 (based on estimated cyclically-adjusted CA balance of -1.2 percent of GDP and a norm of -1.5 percent of GDP), smaller than -1.9 percent for 2014.
  - Staff believes underlying cyclically-adjusted CA balance is around -1.5 percent of GDP for 2015.
  - Staff adjusted the mid-point of the norm to -1.8 percent of GDP; taking uncertainties and investment needs into account, staff believes a norm of -0.8 to -2.8 percent of GDP is appropriate.
  - This implies a CA gap range of about -0.7 to 1.3 percent of GDP for 2015.

### Real exchange rate (REER)
- Background:
  - Compared to the 2014 average, the REER appreciated by 3 percent in 2015 due to temporary inflation increase related to reduction in domestic fuel price subsidies.
- Assessment:
  - EBA level and index REER results suggest the REER gap is about -6 percent.
  - Staff assesses REER gap in the range of -6.5 percent to 3.5 percent in 2015.

### Capital and financial accounts: flows and policy measures
- Background:
  - Gross external financing requirement expected to be about 9 percent of GDP in 2015, with amortization at about 7 percent of GDP.
  - Net FDI and new borrowing projected at 1.4 percent and 7.8 percent of GDP, respectively.
- Assessment:
  - Net and gross financial flows appear sustainable but could dissipate or reverse under large domestic or external shocks.
  - Continued policies to strengthen fiscal position, keep inflation in check, and ease supply bottlenecks would help sustain capital inflows.

### FX intervention and reserves level
- Background:
  - More flexible exchange rate policy framework since mid-2013; floating regime better facilitates market adjustments.
  - As of end-2015, reserves were US$105.9 billion (equal to 119 percent of IMF’s reserve adequacy metric—assuming a floating exchange rate—and about 7¼ months of prospective imports of goods and services).
  - Authorities have contingencies and swap lines amounting to about US$70 billion.
- Assessment:
  - Volatile capital flows could cause reserves to decline significantly.
  - Current level of reserves should be sufficient to absorb most shocks; predetermined drains manageable.
  - Intervention should aim primarily at smoothing volatility while allowing the exchange rate to adjust to external shocks.

### Technical notes (selected)
- EBA commodity terms of trade gap estimate for Indonesia has not fully reflected rising share of oil in commodity imports; a recent sharp oil price decline implies a slightly larger improvement (about 0.3 percent of GDP) in the current account than the EBA implies.
- Adjusting for this 0.3 percent of GDP commodity terms of trade change, staff estimates the cyclically adjusted CA norm at -1.8 percent of GDP, with a range of +/- 1 percent to reflect uncertainty.

### Debt Sustainability Analysis — External debt
- Key findings:
  - External debt-to-GDP ratio has increased but remains moderate.
  - External debt as share of GDP: 33 percent at end-2014; estimated 36½ percent at end-2015.
  - Main drivers: rise in general government borrowing (internationally issued bonds and nonresident holdings of domestic bonds) and private external borrowing (loans and debt securities, including SOEs).
  - Outlook under baseline:
    - Debt stabilizes at 36½ percent of GDP at end-2016, then declines to 33¾ percent by end-2020, reflecting favorable real GDP growth and slower nonbank private sector debt buildup.
    - Real growth projected to average about 5½ percent over the medium term and 6 percent in the longer run.
  - Sensitivities:
    - External sustainability robust to interest rate and GDP shocks but more sensitive to current account and exchange rate shocks.
    - A one standard deviation deterioration in the current account would raise external debt-to-GDP to 39 percent by 2020.
    - A 30 percent exchange rate depreciation would raise external debt-to-GDP to about 51½ percent in 2016, declining to 48 percent by 2020.
- Risks:
  - Public external debt may increase if reliance on external financing for infrastructure rises.
  - Growth in private external debt expected to slow, except for SOE borrowing.

### Debt Sustainability Analysis — Public debt
- Key findings:
  - General government debt declined from 87 percent of GDP in 2000 to 25 percent of GDP in 2014, anchored by fiscal rule capping deficit at 3 percent of GDP.
  - Estimated public debt to GDP in 2015: 27.5 percent (from 24.7 percent in 2014), reflecting larger primary deficit, SOE recapitalization (around 0.6 percent of GDP), and exchange rate depreciation.
  - Foreign currency denominated debt has fallen to less than half of total public sector debt as rupiah bond issuance grew.
  - Nonresidents hold about 60 percent of general government debt; foreign ownership of rupiah-denominated government bonds rose from about 20 percent in 2009 to 38.2 percent as of end 2015.
- Baseline projections and financing needs:
  - Baseline assumes general government deficit remains constant at 2.8 percent of GDP over the medium term, implying a primary deficit of around 1 percent of GDP through 2020.
  - Favorable debt dynamics with negative interest rate-growth differential (about 4 percent) limit debt increase; debt expected to reach 31 percent by 2020.
  - Gross financing needs expected to remain at 5 percent of GDP over the medium term.
- Stress-test results and risks:
  - Standard stress tests suggest debt ratio remains low under shocks (higher than baseline by about 1 percentage point of GDP in 2020 under revenue, exchange rate, growth, and interest shocks).
  - Fiscal risks from expanding balance sheets of key state corporations require careful management.
  - Pertamina and PLN had combined total liabilities equivalent to 9.4 percent of GDP at end-2013.
  - Lower world oil prices will affect Pertamina’s upstream revenue.

*Source: IMF staff assessment and related appendices as presented in the document.*

### Appendix IV. Indonesia—Structural Reforms

### Appendix IV. Indonesia—Structural Reforms

### Overview
- The government implemented a set of reforms in 2015 to address supply-side bottlenecks and revamp the investment environment.
- A number of regulations were eased and clarified, including those regarding PPPs and land procurement.

### Land Acquisition Procedures
- A revised land acquisition law came into effect in 2015:
  - Mandatory time limits (i.e., a maximum of two years) were placed on the acquisition of land for public projects.
  - The law clarified that ongoing projects would be subject to this new law, which can force relevant parties to sell their property for public infrastructure projects with fair compensation.
- Other deregulation measures:
  - The private sector is also allowed to procure land for PPP projects on behalf of the government.
  - If a SOE becomes a government-contracted agency, funding for land procurement can be sourced from the SOE’s budget or a relevant cooperating developer.
  - The document requirements for permit have been simplified.
  - Processing time for permit issuance has been reduced.
- Note on prior law: Previously, infrastructure projects that had acquired three-quarters of the required land were subject to the old 1960 law, and those whose land-acquisition process was less than 75 percent complete had to start again if entities wanted to acquire land under the new law.
- Direct land procurement by a private entity has been allowed:
  - A private entity can obtain an authority/proxy in land procurement from a relevant government institution or SOE and act as a proxy.
  - With the authority/proxy mandate, a private entity can carry out compensation payment as well as all the preceding stages (i.e., preparation, consultations, valuation, and negotiation).

### Public-Private Partnership (PPP)
- Institutional framework and role of SOEs strengthened:
  - A PPP unit (Directorate of Government Support and Infrastructure Financing Management) was created in 2014 at the Ministry of Finance, in charge of feasibility studies and transaction of PPP projects.
  - Equity injection was made to selected major infrastructure SOEs and PT SMI (state-owned infrastructure financing facility) amounting to 0.6 percent of GDP in 2015. PT SMI is envisaged to become an infrastructure bank.
  - Incentives were provided to the SOEs to revalue their assets to current market prices.
  - A direct lending scheme of international financial institutions (IFIs) is allowed, under a sovereign guarantee.
- Types of PPPs expanded:
  - PPP modality can now be used for social infrastructure projects, including facilities for education, sports, art, tourism, and health, public housing, as well as for commercial facilities.
  - In addition to user-pay PPPs, availability-based PPPs (i.e., when the source of payment is the government) and hybrid PPPs (a mix of the user-pay and availability-based PPPs) are allowed.
- Other deregulation for PPPs:
  - In addition to a tender mechanism, a direct appointment of concessionaire is allowed under certain conditions.
  - Bundling of projects is allowed to accommodate projects that extend beyond the boundary of one agency or local government.
  - In addition to acting as a concessionaire, a SOE can act as a government contracted agency.
  - Private sector and IFIs are allowed to support the preparation of PPP projects.
- Budget execution and support strengthened:
  - Advance procurement for new projects was initiated so projects planned for the 2016 budget year could already be put out for bid for 2015.
  - A Budget Realization Evaluation and Monitoring Committee was set up to identify and take action to remove bottlenecks facing priority infrastructure projects.
  - Viability gap funding (VGF) has been budgeted to ensure commercial viability of projects that are important but are not commercially viable.

### Foreign Ownership and Investment Procedures
- Restrictions on foreign ownership eased:
  - Seaport facility foreign ownership limit increased to 50 percent from 49 percent.
  - 100 percent foreign ownership for a power plant (greater than 10 MWV) has been allowed, compared with previous 95 percent.
- Investment procedures and permitting time curtailed:
  - Investment process streamlined through a one-stop service at the Indonesia Investment Coordinating Board (BKPM).
  - Construction permit regulations have been streamlined.
  - Processing time of investment permits has been cut (i.e., the mining and geothermal sectors, and mineral and coal mining license extension).
  - Obtaining land certificate has been made easier through deregulating notary’s profession.
  - Regulations on SMEs’ business activities on unused land were clarified.

### Trade Facilitation
- Import procedures reduced for selected products, including sugar, rice for industry, horticulture products, textile products, steel, and raw materials for medical products.
- Trade requirements eased regarding the registered importer (IT), the national standard verification certificate for imported products (SPB-SNI), the labeling of Bahasa Indonesia language, and identification numbers for an importer.
- Export license requirements eased for timber, rice, nonpharmaceutical precursors, palm oil, and minerals.
- Administrative procedures for Special Economic Zone (SEZ) eased:
  - Processing period for investment permits reduced from 8 days to 3 hours for firms that invest more than IDR 100 billion or employ more than 1,000 people.
  - Tax incentives such as exemption from VAT on immediate goods and postponement of import duty payments were provided.

### Labor Market
- To increase predictability, a minimum wage formula for provinces was established and some rigid labor market regulations were removed:
  - Removed requirements include the need to hire ten local employees for every foreign employee; need to obtain work permit for non-resident commissioners or directors and for foreign workers attending meetings or providing training.
  - Nonetheless, sectoral minimum wage setting is allowed; the government can allow a minimum wage setting outside the formula for certain sectors.
- Minimum wage formula:
  - Minimum Wage t+1 = Minimum Wage t × (1+National Inflation Rate t + National GDP Growth Rate t)

### Energy Sector
- Sector governance improved:
  - The government reduced the fiscal burden of energy subsidies by eliminating electricity subsidies for all but the poorest categories of consumers.
  - Measures include: (i) the subsidy was phased out for industrial, business and large residential consumers; (ii) automatic indexation of tariff was adopted to ensure a full cost recovery for industrial/business and large residential consumers; and (iii) reforms were initiated to improve the performance of SOEs in the energy sector.
  - PLN is required to improve metrics relating to its electricity distribution performance; and regularly report performance on these standards.
- Markets for private participation enabled:
  - Licensing for 10 electricity projects was delegated to BKPM.
  - Licensing steps and time were reduced for setting up independent power producer (IPP) projects.
  - Greater private participation enabled by permitting electricity wheeling and power trade activities.
  - Government signaled intent to enhance the domestic supply of gas by creating a market place.
  - A systemic and time-bound process was stipulated for managing expiring production sharing contracts (PSCs); and market rules were established for utilization of compressed natural gas (CNG) for land transport.
- Regulatory environment improved to increase access to clean energy and energy efficiency:
  - Key constraints in the geothermal sector were addressed.
  - Tariff incentives were provided to develop new forms of renewable energy.
  - A market for key energy efficiency services was established.
  - New Geothermal Law issued, which streamlines licensing and tendering of geothermal projects; and a new geothermal pricing regime was established using bidding under a regional ceiling price, by which PLN shall purchase the power from those plants and build the transmission required for geothermal power plants.
  - A feed-in tariff for biomass and biogas projects ≦10 MW and requires PLN to purchase this power; and a feed-in tariff for hydro projects ≦10 MW and requires PLN to purchase this power.

*Appendix IV. Indonesia—Structural Reforms*

### Appendix V. Indonesia—Response to Recent IMF Policy Advice

### Appendix V. Indonesia—Response to Recent IMF Policy Advice

### Monetary and Exchange Rate Policies
- Main Fund recommendation: Maintain the relatively tight monetary stance, with adjustments conditional on reductions in inflation and external pressures.
  - Authorities’ response:
    - Bank Indonesia (BI) has held its policy rate since February 2015, keeping the BI rate at 7.5 percent at end 2015, which was 175 bps higher than in mid 2013.
    - This stance helped lower inflation back within the BI target band by end 2015 and provided a bulwark against external pressures on the rupiah.
    - With economic growth slowing in 2015, accompanied by a narrowing of the current account deficit, BI reduced the primary reserve requirement in rupiah by 50 bps effective in December 2015 to ease liquidity conditions.
    - Policy communications have been clear.
- Main Fund recommendation: Continue flexibility in the exchange rate and government bond yields, limiting intervention to smoothing volatility and ensuring orderly market conditions.
  - Authorities’ response:
    - The exchange rate and yields on government securities were allowed to move freely, and orderly market conditions were maintained.
    - International reserve declines have been more moderate over the past year compared to the taper tantrum.
- Main Fund recommendation: Continue money market deepening efforts to strengthen monetary transmission and liquidity management.
  - Authorities’ response:
    - BI has reduced structural excess liquidity over the course of 2015, introduced new instruments for liquidity management and lengthened tenors, and reduced its presence in FX swap operations, which has encouraged interbank activity.
    - The financial services agency (OJK) launched in January 2016 the Global Master Repurchase Agreement for interbank collateralized lending.

### Fiscal Policy
- Main Fund recommendation: Keep the overall deficit around 2 percent of GDP in 2015, to reduce vulnerability to funding pressures.
  - Authorities’ response:
    - The fiscal deficit in 2015 was 2.8 percent of GDP, higher than the revised budget target (1.9 percent of GDP) and that recommended by staff.
    - Shortfall drivers: underperformance relative to budget of non-oil and gas tax revenues, driven by lower commodity prices and import related taxes.
    - Funding remained manageable through frontloading of bond issuances and greater use of multilateral loans.
- Main Fund recommendation: Anchor credibility of the revised budget by upfront revenue measures and adjustments to capital spending targets in line with absorptive capacity.
  - Authorities’ response:
    - No significant new revenue measures were introduced in 2015; focus was on tax administration to raise compliance, increase registered taxpayers and improve IT systems.
    - Capital budget absorption improved strongly in H2:2015 after transitional delays related to the new administration.
- Main Fund recommendation: Continue phasing out energy subsidies to raise fiscal space for growth-critical spending.
  - Authorities’ response:
    - Following the landmark fuel pricing reform in January 2015, usage of non-subsidized fuel products was expanded during the year.
    - Electricity subsidies were reduced through market-based pricing for more users and better targeting.

### Financial and Corporate Sector
- Main Fund recommendation: Monitor closely banks’ liquidity buffers and corporate risks related to offshore foreign currency borrowing.
  - Authorities’ response:
    - OJK is implementing a liquidity coverage ratio (LCR) in 2016.
    - BI issued regulations on hedging of corporate external borrowing, with quarterly reporting by corporates in place in 2015, and full effect from 2015:Q4.
    - BI and OJK continue to develop tools to ensure systemic stability, including for stress testing with Fund TA.
- Main Fund recommendation: Enhance consolidated/group-wide supervision to ensure resilience among financial conglomerates.
  - Authorities’ response:
    - OJK has identified and mapped out a set of important financial conglomerates, and issued regulations for minimum group-level capital.
- Main Fund recommendation: Close crisis management gaps in the financial stability framework by expeditious passage of the draft Financial System Safety Net (FSSN) law, followed by revision of related regulatory laws.
  - Authorities’ response:
    - A draft FSSN law is in discussion with Parliament, with passage expected in Q1:2016.
    - Following this, laws related to regulatory agencies (e.g., central bank) and the banking industry would be taken up.

### Fund Relations (selected institutional facts and figures)
- Membership Status: Joined February 21, 1967; Article VIII.
- Quota: 2,079.30 SDR Millions (100.00 percent of Quota).
- Fund holdings of currency: 1,933.80 SDR Millions (93.00 percent of Quota).
- Reserve position in Fund: 145.50 SDR Millions (7.00 percent of Quota).
- Net cumulative allocation (SDR Department): 1,980.44 SDR Millions (100.00 percent of Allocation).
- Holdings (SDR Department): 1,761.00 SDR Millions (88.92 percent of Allocation).
- Outstanding Purchases and Loans: None.
- Recent financial arrangements history (approval dates and amounts approved):
  - EFF 02/04/00–12/31/03 Amount Approved 3,638.00 SDR Millions; Amount Drawn 3,638.00 SDR Millions.
  - EFF 08/25/98–02/04/00 Amount Approved 5,383.10 SDR Millions; Amount Drawn 3,797.70 SDR Millions.
  - Stand by 11/05/97–08/25/98 Amount Approved 8,338.24 SDR Millions; Amount Drawn 3,669.12 SDR Millions.
- Projected Payments to Fund (SDR millions; based on existing use of resources and present holdings of SDRs): Charges/Interest 0.14 each year for 2016–2020; Total 0.14 each year for 2016–2020.
- Exchange arrangements:
  - The rupiah has had a de jure free floating exchange arrangement since August 14, 1997; current de facto arrangement is floating.
  - Market exchange rate: Rp 13,788 per U.S. dollar as of December 31, 2015.
  - Indonesia has accepted the obligations of Article VIII, Sections 2, 3, and 4, and maintains an exchange system free of restrictions on payments and transfers for current international transactions.

### World Bank—IMF Collaboration (key joint areas)
- Budget Reforms:
  - World Bank support through GFMRAP, trust funds, and DPLs for treasury operations, medium-term expenditure framework, performance budgeting, and budget oversight.
  - Indonesia’s Ministry of Finance launched SPAN in April 2015 (financial management information system supported by GFMRAP).
  - IMF complemented with TA on subsidy reform and social safety nets.
- Taxation Issues:
  - Fund mission on tax policy and administration in September 2014.
  - Bank provides TA to DG Tax and DPL support for tax policy and administration reforms.
- Asset-Liability Management:
  - Joint efforts to improve asset-liability management at Treasury and Debt Management Office and at BI.
- Crisis Preparedness:
  - World Bank supported crisis prevention and management framework (including 2010 FSAP and crisis simulation exercises); IMF supported legal framework review via TA and surveillance dialogue.
- Financial Sector:
  - Bank supporting reforms for stability, diversification, and inclusion; IMF focused on banking regulation and supervision, placed a resident advisor at OJK in January 2015, and provided recent TA on monetary operations, transmission, macroprudential policy, and bank stress testing.
  - Joint World Bank-IMF FSAP completed in 2010; Bank to provide TA on nonbank financial sector FSAP recommendations.
- Statistics:
  - World Bank STATCAP-CERDAS program launched in 2011 for capacity building at the statistics agency.
  - IMF provided TA on government finance statistics, monetary and financial statistics, and sectoral balance sheets.
- Macroeconomics:
  - IMF leads on macro surveillance, Article IV missions, and updates the Debt Sustainability Analysis with World Bank inputs.
  - Bank assists Ministry of Finance Fiscal Policy Office on macroeconomic monitoring and forecasting.

### Joint Managerial Action Plan, 2015–16 (selected elements)
- Mutual information sharing and coordination of work programs; sample items:
  - Indonesia Economic Quarterly (launched April 2012; latest issue December 2015).
  - Coordination of a follow-up FSAP starting in 2016 (Provisional Timing of Missions: Mid 2016; Expected Delivery Date (Tentative) 2016−2017).
- IMF work program for next 12 months (as listed):
  - 2015 Article IV consultation — December 2015 (Board discussion will take place in February 2016).
  - 2016 staff visit — Mid 2016.
  - 2016 Article IV consultation — Late 2016.
  - Ongoing technical assistance: Financial deepening and market development; Tax policy and revenue administration; Statistical policies; Consolidated supervision (resident advisor).

### Relations with the Asian Development Bank (ADB) — selected data
- ADB loans to Indonesia have totaled US$31.5 billion since 1969 (through the last quarter of 2015).
- The ADB approved a total of US$1.4 billion in loans to Indonesia in 2015.
- Cumulative lending shares by sector (As of December 2015, selected entries):
  - Public sector management: 107 loans, US$5,795.46 million, 18.94 percent.
  - Energy: 81 loans, US$4,416.29 million, 14.43 percent.
  - Agriculture and natural resources: 273 loans, US$4,299.40 million, 14.05 percent.
  - Finance: 66 loans, US$4,111.43 million, 13.44 percent.
- Table 1 (selected annual figures, in millions of U.S. dollars):
  - Loan approvals 2015: 1,375.0.
  - Loan disbursements 2015: 1.401.8.

### Statistical Issues — data adequacy and improvements
- General: Indonesia’s macroeconomic statistics are broadly adequate to conduct effective surveillance.
- National accounts:
  - BPS disseminates annual and quarterly GDP (QGDP) by economic activity and expenditure components at current prices and in volume terms at 2010 prices regularly.
  - QGDP estimates are based on a limited set of indirect indicators.
  - Some sectors are strongly seasonal; seasonally adjusted data are prepared but not published.
  - BPS and BI, with STA TA, expect to finalize annual nonfinancial accounts, financial flows, and stocks for the year 2010 during 2016, and quarterly financial flows and stocks starting from Q1:2015 in 2017.
- Price statistics:
  - In October 2013, BPS released the new Producer Price Index (PPI) with 2010 base; PPI published quarterly.
  - BPS expanded mining sample to include oil and natural gas extraction, coal, and gold; work to expand PPI to include 15 service industries has started or completed.
  - BI has begun work to expand the residential property price index to include resales; planned release later in 2016.
- Government finance statistics:
  - Weaknesses in classification, coverage, and timeliness; central government budget data available with one-month lag; subnational data available only with a lag of two years.
  - Ministry of Finance committed to keep fiscal statistics requirements at the forefront of fiscal reforms.
  - Indonesia reported general government data covering 2008 onwards to STA in 2014.
  - In late 2015, with STA TA, authorities started to compile quarterly general government data based on estimates of local government data; these data are yet to be published on MOF’s website.
- Monetary and financial statistics (MFS) and FSIs:
  - BI compiles good quality monetary statistics using SRFs on a timely basis.
  - BI expanded OFC survey coverage; since January 2015 includes finance companies, insurance companies, pension funds, PT Pegadaian, and Eximbank.
  - OFC data reported monthly.
  - BI compiles and reports to STA 11 core and 12 encouraged FSIs for deposit takers; two encouraged FSIs for OFCs; three encouraged FSIs for the real estate sector; reported quarterly starting Q4:2011.
  - STA recommended exploring FSIs for nonfinancial corporations and households.
- Balance of payments (BOP) and external sector:
  - Trade data have improved; free trade zones and bonded warehouse transactions captured.
  - 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.
  - Annual and quarterly IIP data are compiled and published, but underlying data are weak for FDI.
  - External debt statistics improved with External Debt Information System (EDIS) in 2002 and initiative to publish monthly indicators.
  - Reconciliation of financial transactions with changes in IIP is performed except for direct investment.
- Data Standards and Quality:
  - Subscriber to the Special Data Dissemination Standard (SDDS) since September 1996, observing most SDDS requirements.
  - Indonesia uses SDDS flexibility options for timeliness and periodicity of labor market categories and for general government operations.
  - Data ROSC completed in 2005.
- Table of Common Indicators Required for Surveillance (as of January 5, 2016) — selected entries and dates:
  - Exchange rates: Latest Observation 1/5/16; Date Received 1/5/16; Frequency D.
  - International reserve assets and reserve liabilities of the monetary authorities: Latest Observation 11/15; Date Received 1/16; Frequency M.
  - Reserve/base money: Latest Observation 11/15; Date Received 12/15; Frequency W/M.
  - Consumer price index: Latest Observation 12/15; Date Received 1/16; Frequency M.
  - Revenue, expenditure, balance and composition of financing—central government: Latest Observation 12/15; Date Received 1/16; Frequency M; Frequency of Publication Mid-year.
  - External current account balance: Latest Observation 9/15; Date Received 12/15; Frequency Q.
  - GDP/GNP: Latest Observation 9/15; Date Received 12/15; Frequency Q.
  - Gross external debt: Latest Observation 9/15; Date Received 12/15; Frequency Q.
  - International investment position: Latest Observation 9/15; Date Received 12/15; Frequency Q.

*Source: IMF staff report excerpt — Appendix V. Indonesia—Response to Recent IMF Policy Advice (as provided in the content unit).*

### 1.      Recent Developments

### Recent Developments

### Macroeconomic performance and outlook
- Real GDP in Q4 2015 expanded by 5.0 percent (y/y), led by domestic demand, with higher public-sector investment and public consumption; private consumption continued steady growth.
- Real GDP growth for 2015 as a whole is estimated at 4.8 percent (4.7 percent in the staff report).
- Q4 2015 GDP growth also reported as 5.04 percent (yoy) in the authorities’ account, reflecting recovery momentum since Q3 2015 driven by investment and infrastructure implementation.
- Headline inflation rose to 4.1 percent (y/y) in January 2016 on higher food prices; core inflation continued to slow to 3.6 percent (y/y).
- Authorities report inflation at 3.35 percent (yoy) for Q4 2015, within the government’s inflation target of 4±1 percent for the year; core inflation at 3.95 percent (yoy) noted as lowest in last 10 years.
- Central government deficit in 2015 based on preliminary data was about 2½ percent of GDP (staff report estimate 2.8 percent); authorities report the government budget deficit in 2015 was 2.53 percent of GDP.
- Public debt was 27 percent of GDP by end-2015.
- Current account deficit for 2015 is estimated at 2.1 percent of GDP (2.0 percent in the staff report); authorities report current account deficit fell to 2.04 percent of GDP from 3.10 percent of GDP in 2014.
- In January 2016 a small trade surplus was recorded, mainly driven by lower oil and gas imports; reserves fell to US$102.1 billion due to government external debt repayments.
- Authorities report international reserves continued to be sufficient at US$105.9 billion as of end-2015, equivalent to 7.45 months of imports and official debt repayments.
- Outlook: authorities expect growth to pick up to the 5.2-5.6 percent range in 2016, supported by strong consumption and investment, better business climate, and realization of government infrastructure projects.
- Outlook on inflation for 2016: expected to stay within the 4±1 percent target, aided by anchored inflation expectations and lower fuel prices.
- 2016 fiscal deficit expected to be well below the statutory ceiling of 3 percent of GDP as stipulated in the budget law.
- Balance of payments expected to remain strong with a larger overall surplus; current account deficit expected to be slightly wider than 2015 but sustainable.

### Foreign direct investment regime changes
- On February 11 changes to the negative investment list of FDI:
  - Caps on foreign ownership on 35 industries were removed (examples: toll roads, tourism-related services, e-commerce).
  - Majority foreign ownership for selected sectors now allowed (examples: warehousing, telecommunication networks and services, healthcare facilities).
  - 20 sectors that were closed were partially opened (example: land transport).
  - FDI restricted in 19 sectors to protect small- and medium sized enterprises (examples: small value construction, coral reef harvesting, plantations up to 25 hectares).
- Authorities view these changes as further progress in the reform agenda.

### Monetary policy, exchange rate, and financial markets
- On February 18, Bank Indonesia reduced the policy interest rate by 25 basis points (bps), to 7 percent, and reduced reserve requirement by 100 bps, to 6.5 percent.
- Authorities had earlier lowered the BI rate by 25bps each in both January and February 2016; rupiah denominated primary reserve requirement was cut by 50bps in January and 100bps in February.
- Since end-2015 (as of February 18), the rupiah appreciated by 2.1 percent with respect to the U.S. dollar; equity prices have risen by 4 percent; yield on 10-year government bonds fell by 69 bps.
- Monetary policy objective: use policy rate to achieve inflation target, maintain exchange rate in line with fundamentals, and calibrate macroprudential policy to foster macroeconomic development.
- Exchange rate policy: allow exchange rate to move flexibly as a shock absorber; EBA assessment affirmed external position and exchange rate broadly consistent with medium-term fundamentals.
- Bank Indonesia kept interest rate at 7.50 percent for most of 2015, contributing to headline inflation within the 4±1 percent target.

### Fiscal policy and reforms
- Fiscal strategy: create fiscal space prudently via a medium-term fiscal framework with short-term and long-term strategies.
  - Short-term: provide fiscal stimulus to maintain purchasing power and improve business climate amid global uncertainties.
  - Long-term: create sustainable and equitable growth through budget reform in revenue, spending and financing.
- Fiscal deficit target: maintain within statutory limit of 3 percent of GDP.
- Expenditure reforms:
  - Implemented bold reforms to rationalize and substantially reduce energy subsidies.
  - Shift from general price-based subsidies to well-targeted subsidies expected to continue in 2016, focusing on farmers, fisher folk, and conditional cash transfers for the poor.
  - Fiscal space to be used for larger capital spending in economic and social infrastructure; 22 priority infrastructure projects initiated, mostly in power and transportation, and projects in education and healthcare.
  - Global bond issued with front loaded strategy to accelerate capital expenditure in 2016; some projects auctioned in first two months of 2016.
- Revenue mobilization:
  - Need to reduce reliance on natural resource revenue and shift burden to tax or non-oil revenue due to falling commodity prices.
  - Challenges in tax administration and compliance cited: complex VAT refund system and strict bank secrecy rule preventing access to taxpayers’ financial data.
  - Authorities focusing on improving tax administration by improving compliance, simplifying tax and integrating tax facilities; aim to broaden tax base and implement policies such as tax amnesty.
  - Authorities prefer these measures over large short-run excise tax increases; remain open to alternative revenue-enhancing measures and will review policy alternatives. Government plans to submit a 2016 budget revision.
- Financing:
  - Reduce high reliance on market financing and convert to alternative financing from more concessional bilateral and multilateral sources.

### Financial and corporate sector resilience and reforms
- Banking system metrics:
  - Capital adequacy ratio reached 21.2 percent (December 2015).
  - Non-performing loans at 2.5 percent.
  - Credit growth accelerated from 9.8 percent (yoy) in the previous month to 10.45 percent (yoy).
- Authorities implementing international standards such as Basel III; stress tests on the corporate sector conducted and corporate interconnectedness mapped.
- Measures to mitigate external vulnerabilities: regulation to mitigate currency risk, liquidity risk and overleverage risk including hedging and liquidity requirements; regulation to be fully implemented in 2016.
- Macroprudential adjustments to support growth:
  - Revisions of Loan to Deposit Ratio Reserve Requirement (LDR-RR), Loan to Value (LTV) ratio for mortgage loans, and revision of down payment regulation for automotive loans.
- Financial Sector Safety Net (FSSN) bill:
  - Significant progress; consensus on identifying systemic institutions ex-ante and updating the list periodically.
  - FSSN law expected to incorporate a modern safety net and clarify rule and policy responsibility of each institution.
  - FSSN bill is top priority and hoped to be completed this year.
  - Planned reviews of laws on Bank Indonesia (BI), Depository Insurance Corporation (LPS) and Financial Service Authority (OJK) to harmonize laws.
- Crisis management protocol exists as a forum to assess financial stability, conducted by Bank Indonesia, OJK, Minister of Finance, and LPS.

### Structural reforms and infrastructure investment
- Business climate and competitiveness reforms:
  - One Stop Service (PTSP) program launched January 2015 streamlined investment permit applications; processing time for full business permit shortened from an average of 260 days to 90 days.
  - Implementation of Land Acquisition Law with maximum number of days for land acquisition applied successfully to projects such as Trans Sumatra Toll Road and Palembang−Indralaya Road.
  - Policy packages since August 2015 streamlined regulations, improved logistics, reduced cost of doing business, cut red tape, and eliminated some VAT for the transport industry.
  - 10th policy package includes updated negative list opening new sectors to FDI.
  - Authorities will consider staff suggestion to minimize tax exemptions while accounting for investment promotion in neighboring countries.
- Infrastructure investment program:
  - Medium-term investment program amounting to US$480 billion during the 2015−2019 period.
  - Expected financing: two-thirds from public sector (around 30 percent from central government, 11 percent from local governments, and 22 percent from state-owned enterprises); remainder from private sector mainly through public-private partnerships (PPPs).
- Structural reform strategy: address structural bottlenecks, diversify growth engines, and raise potential growth; authorities recognize full impact will take time but recent leading indicators and investment trends show pickup starting Q4 2015.

### Policy priorities and commitments
- Authorities emphasize maintaining macroeconomic stability while pursuing stronger and sustainable growth.
- Commitments include:
  - Continued structural reform agenda to enhance productivity and potential output.
  - Fiscal prudence combined with targeted stimulus and improved fiscal space.
  - Careful calibration of monetary policy to ensure macroeconomic stability.
  - Strengthening financial sector safety net regulation and crisis management frameworks.
  - Strengthened coordination and communication between Government and Bank Indonesia to ensure mutually reinforcing policies.

*Statement by Marzunisham Omar, Executive Director for Indonesia and Diah Handayani, Advisor to Executive Director, February 24, 2016*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1681.pdf_