Public Information Notice: IMF Concludes Article IV Consultation with Indonesia

April 13, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On March 25, 1999 , the Executive Board concluded the 1999 Article IV consultation with Indonesia.1


Prior to mid-1997, Indonesia had experienced 25 years of sustained economic progress, during which income per capita had trebled and the number of people in poverty had fallen sharply. However, structural weaknesses had intensified over the years, leaving the economy vulnerable when hit by the regional financial crisis. In particular, the corporate sector had borrowed very heavily abroad, usually without hedging foreign currency exposure; the banking system had been poorly supervised, with widespread violations of legal lending limits; and microeconomic policies had been compromised by poor governance.

Sustained pressure on the rupiah in the wake of the flotation of the Thai baht in July 1997 imposed severe stress on the economy. In November, the authorities reached agreement with the Fund on an economic adjustment program that was supported by a large official external financing package. Key elements of the program included monetary policy tightening, strengthening of the banking system, and a set of structural reform measures to enhance efficiency and transparency in the corporate sector. However, uneven program implementation and increasing political uncertainty in the ensuing months led to intensified capital outflows and a precipitous decline in the value of the rupiah. The political disturbances in May 1998, which culminated in the resignation of President Suharto, were accompanied by further economic disruption and further sharp depreciation of the rupiah.

In late-June 1998, the new Indonesian government reached agreement with the Fund on a new stabilization package intended to restore macroeconomic stability, rebuild the distribution system, strengthen the social safety net, and address the deteriorating condition of the financial system. Monetary policy focussed on reducing inflation and facilitating an appreciation of the overly depreciated exchange rate. The fiscal stance was eased to permit greater social expenditure and help stimulate economic activity. The program achieved important results in terms of restoring macroeconomic stability, although output during the 1998/99 fiscal year [The Indonesian fiscal year runs from April 1 through March 30.] was down 16 percent on the previous year’s level, with the decline in investment especially marked, and the inflation rate was about 66 percent. Real wages fell sharply and surveys indicated that the share of the population below the poverty line rose.

The authorities’ macroeconomic framework for 1999/2000 envisages that the economy should soon bottom out, that real GDP for the year would be broadly unchanged, and the external position should strengthen, with foreign reserves expected to increase to around $29 billion (five months of imports of goods and services). Prudent monetary policy should lay the basis for average inflation of some 15-20 percent for the year. The budget deficit is projected at nearly 6 percent of GDP to help promote recovery, with increased provisions for targeted social safety net outlays; the bulk of this deficit will, as in 1998/99, be financed through external borrowing from multilateral and bilateral donors.

IMF financial support to Indonesia at the beginning of the Asian crisis took the form of a three-year Stand-by Arrangement, approved by the Executive Board in November 1997, in an amount of SDR 7.3 billion. In July 1998, this amount was increased by SDR 1 billion. In August 1998, the Executive Board agreed to convert the undrawn amount of SDR 4.7 billion into an Extended Arrangement, which gave Indonesia more favorable repayment conditions. On March 25, 1999, the Executive Board approved an increase in the amount to be made available by a further SDR 0.7 billion. Total purchases by Indonesia now amount to SDR 6.8 billion (about US$9.3 billion), with a further SDR 2.2 billion (about US$3 billion) available between now and November 2000.

Executive Board Assessment

Executive Directors expressed satisfaction with the continued progress in implementing the program, while noting that recent political and security developments underscored the fragility of the current situation. Directors welcomed the announcement on March 13, 1999, of a major program of private bank recapitalization and closures, and the agreement reached with the Fund staff on strengthening macroeconomic and structural policies. However, recent export performance has been disappointing, there has been renewed volatility of the rupiah within a more depreciated range, inflation rose in December through February, and progress in corporaterestructuring has been limited. These developments are all a reminder of the considerable risks that could lie ahead. Moreover, Directors noted that the recent incidents of social unrest and the uncertainties related to the upcoming elections had also affected confidence.

Directors supported the proposed tightening of the monetary stance, which should help to consolidate the program’s stabilization gains. They endorsed the efforts of the authorities in recent days to bring base money down substantially through vigorous open market operations, thereby offsetting the upsurge in liquidity that had occurred prior to the finalization of the bank restructuring package. Directors agreed that monetary policy should remain cautious in 1999/2000, and that the monetary stance should not be eased prematurely—before there were clear signs of improving confidence and lower inflation. However, concern was expressed about the inadequate availability of credit to the export sector. Directors were also concerned about the continuing negative spreads between the borrowing and lending rates of banks, which further underscored the urgent need for bank restructuring.

Directors expressed concern that fiscal stimulus had been slow to develop over the past year. This was due principally to delays in finalizing spending programs and improving their execution, as well as slower than anticipated disbursements of external financing. They considered that the size of the 1999/2000 budget deficit was appropriate to impart a larger stimulus to the economy than was achieved in 1998/99. Directors noted that the budget is projected to be fully financed without recourse to domestic bank financing, but cautioned that the budgetary framework needed to retain the flexibility to respond both to evolving circumstances—including the possibility of shortfalls in external financing—and the need to maintain long-term sustainability.

Directors welcomed the planned expansion of well-targeted social spending in 1999/2000. They urged the authorities to ensure that spending goals on health, education, and employment generation were fully met, consistent with the overall deficit target, in order to limit the social impact of the crisis. Directors noted that this would require timely agreement with multilateral and bilateral donors on the transparent administration and monitoring of social safety net programs. On labor issues, they welcomed Indonesia’s adoption of four of the International Labor Organization’s seven core labor standards, and encouraged it to subscribe to the other three, as well as to improve compliance with the standards already adopted.

Directors stressed that the large bank restructuring costs pointed to the urgency of intensifying asset recoveries from large corporate debtors and reversing the declining budgetary revenue effort. In this connection, they strongly urged the removal of the recently granted income tax holidays—for up to eight years to newly established corporations in 22 industrial sectors—in accordance with the recommendations of the Fund’s Fiscal Affairs Department of earlier this month, and called for efforts to strengthen tax and customs administration.

Directors welcomed the commitments that had been made by Japan, the World Bank, and the Asian Development Bank to fill the external financing gap in 1999/2000. They supported the further augmentation of the Fund-supported program, which they believed had helped to catalyze these resources, while noting that the relatively low level of disbursements from other multilateral institutions raised serious issues of burden sharing. Directors stressed the importance ofavoiding delays in the disbursement of official external financing, especially in the next few months when private capital inflows are not expected. They noted that discussions are also ongoing with the London Club (on public debt) and on a second interbank exchange offer on private debt. In light of the financing assurances, Directors saw scope for the exchange rate of the rupiah, which is market determined, to appreciate significantly if economic and security conditions stabilize.

Directors stressed that successful bank and corporate restructuring were crucial to improve governance and sustain medium-term recovery. However, both were still at an early stage, and Directors urged that the processes be accelerated. They noted that the private bank recapitalization program will retain an important element of private ownership and management in Indonesia’s banking system. Directors emphasized the particular importance of periodic checks of the soundness of the banking system, the successful restoration of which also depended critically upon the restructuring of the state banks and their early privatization. They stated that state bank recapitalization should be undertaken only after restructuring was completed, and emphasized that sound and transparent restructuring of the state banks was critical to the success of the overall Indonesian economic stabilization and reform program.

Directors emphasized that the Indonesian Bank Restructuring Agency (IBRA) is central to banking system reform, especially for asset recovery. They stressed that the agency must be fully independent to provide assurances that the public costs of bank restructuring are being minimized. Directors underlined the importance of the Asset Management Unit’s developing asset management procedures at an early date, and stressed that it should remain fully independent and be provided with adequate resources. Strong political leadership and external monitoring will be required to assure that this process is successful.

Directors urged the authorities to accelerate corporate debt restructuring under the Jakarta Initiative and take effective measures to counter growing debtor resistance. In this regard, they stated that the bankruptcy law must be applied as envisaged, in a manner consistent with international practice. Directors pressed for early implementation of legislation aimed at improving governance, including in the judiciary, which has already been sent to Parliament, and strengthening of the Commercial Court. They said that state banks and IBRA should aggressively pursue loan collection from their largest borrowers, and quickly initiate bankruptcy filings against recalcitrant debtors. Directors expressed disappointment at the delays in privatization. While recognizing that in part this reflected weak market conditions, they urged the authorities to accelerate the privatization process, including by improving the regulatory and legislative framework.

Directors recognized that the authorities were trying to reorient the economic, financial, and government structure to broaden participation by weaker economic groups and regions. They strongly supported the authorities’ commitments in this regard to respect existing ownership rights, move cautiously to avoid any loss of macroeconomic control, and consult with international institutions before implementing new initiatives. Consolidation of the new competition law and the first phase of fiscal decentralization would be the task of the successor government, and Directors observed that this would need to be an early and essential part of theFund’s dialogue with that government. In the meantime, they cautioned that, based on experience in other countries, devolution of revenue should be commensurate with expenditure responsibilities, and that a loss of overall macroeconomic control had to be avoided.

Directors concluded that the macroeconomic situation in Indonesia would remain difficult until the political transition was further advanced. Firm implementation of the program and the expected continued strong financial support of the international community should allow for the restoration of positive real growth from late this year. They underscored the importance of ensuring transparency in program implementation, especially with regard to corporate and bank restructuring, and the need to avoid political interference in these processes. Directors also stated that policy continuity after the elections and a clear political will for reform will be crucial to unleash new confidence in the adjustment program and to strengthen the country’s medium-term growth prospects and its external position. Overall, Directors were satisfied that policies and developments continue to evolve as best as possible in a manner consistent with setting the stage for economic recovery, against a background of difficult and unsettled domestic conditions.

Indonesia: Selected Economic Indicators, 1996/97-1999/2000 1/
GDP: $113 billion (1998/99)
Population: 203 million (1998)
Quota: SDR 2,079.3 million

1996/97 1997/98 1998/99 1999/2000
Est. Proj.

Growth and inflation (percent change)
Real GDP growth 8.2 2.0 -16 -2 to 1
CPI inflation (end-period) 5.3 39.1 45 10 to 13
CPI inflation (period average) 5.2 12.9 66 15 to 20
Savings and investment (in percent of GDP)

National savings 26.7 26.0 18.9 17.6
Private savings 19.9 20.6 18.6 19.0
Domestic investment 30.0 27.1 14.0 15.5
Private investment 24.3 20.8 9.5 10.3
Central government operations (in percent of GDP) 2/

Revenue and grants 15.1 15.4 13.5 11.2
Oil/gas revenue 3.6 4.4 3.8 1.7
Non-oil/gas revenue 11.4 11.0 9.7 8.4
Expenditure and net lending 3/ 13.9 16.5 17.1 17.0
Overall balance 1.2 -1.1 -3.6 -5.8
Money and credit (annual percent change) 4/

Credit to the private sector 23.8 14.1 4 12
Broad money 26.7 10.4 37 18
Base money 16.5 70.8 21 14
Overnight JIBOR rate (percent; end-period) 16.5 47.1 34.4
Balance of payments ($ billion)

Current account balance -8.1 -1.7 5.5 3.4
(In percent of GDP) -3.4 -0.9 4.8 2.0
Trade balance 1.2 8.8 17.2 17.4
Exports f.o.b. 52.0 56.2 52.2 54.5
o/w: non-oil/gas exports 39.3 45.9 45.1 47.4
Imports f.o.b. 50.9 47.4 34.9 37.1
Capital account 14.1 -11.6 -3.0 -1.4
Direct investment 6.5 1.8 0.9 0.5
Overall balance 6.1 -13.3 2.5 2.0
Foreign reserves and debt ($ billion)

Gross official foreign assets 26.6 16.4 25.7 28.6
Of which: Liquid reserves 25.8 10.7 20.3 22.6
(In months of imports) 5.1 2.2 5.7 6.0
Total external debt 127.4 138.0 139.8 143
(In percent of GDP) 54.5 74.8 123.8 86
Exchange rate (Rp/US$; end period) 2,403 10,200 8,700
Nominal effective exchange rate (1990=100) 5/ 90.3 24.4 25.2
Real effective exchange rate (1990=100) 5/ 108.2 39.2 58.0

Sources: Data provided by the Indonesian authorities; and IMF staff estimates.

1Fiscal year starts on April 1.
2IMF program format: differs from Indonesian budget presentation.
3Includes interest costs of bank restructuring less privatization proceeds in 1998/99 and 1999/2000.
4Foreign currency stocks measured at constant exchange rates.
5End-period; 1998/99 estimate is for February 1999.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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