Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey : Indonesia—Moving in a New Direction

March 19, 2015

  • Significant steps bolster Indonesia’s resiliency to shocks
  • Fuel subsidy reforms make room for growth-enhancing spending
  • Policies aim to raise growth potential and entrench macroeconomic stability

Sound macroeconomic management and exchange rate flexibility over the past 18 months have bolstered Indonesia’s policy credibility and its resiliency to shocks, say IMF economists.

Processing nickel in Sulawesi, Indonesia.  Policymakers seek to hasten the economy’s move from commodity–supported growth (photo: Corbis/Yusuf Ahmad)

Processing nickel in Sulawesi, Indonesia. Policymakers seek to hasten the economy’s move from commodity–supported growth (photo: Corbis/Yusuf Ahmad)


The country’s macroeconomic fundamentals, and reserve buffers have also been strengthened through a clearer policy framework, and better policy coordination, they add.

In their annual assessment of the state of Indonesia’s economy, the economists note that Indonesia has taken strong policy actions in the face of an end to quantitative easing by the U.S. Federal Reserve and headwinds posed by falling commodity prices.

Markets have responded favorably, notes the report, as evidenced by large portfolio inflows in 2014, supported by global push factors.

5¼ percent growth expected this year

The near-term outlook is broadly positive, despite soft demand for commodity exports and global uncertainties.

Led by an expected pickup in public investment, growth should reach around 5¼ percent this year. Inflation should return to within Bank Indonesia’s target band of 3–5 percent by end 2015, given the current monetary stance and lower fuel prices.

The current account deficit should narrow slightly, with a smaller oil import bill offsetting lower nonoil commodity exports, while foreign reserves should remain adequate.

Risks from the outside

But risks remain, mostly emanating from outside of the country. Most relevant to Indonesia would be a deeper­than-expected slowdown in emerging market trading partners and surges in global financial market volatility.

These risks could exacerbate potential vulnerabilities in the banking and corporate sectors. Slower or narrower reforms than envisaged in the report’s current baseline might also affect the pace of growth.

A new growth model

The 2014 Article IV consultation, which concluded in March, found Indonesia in transition to a new growth model. Given the commodity down-cycle, policymakers seek to hasten the economy’s move from commodity-supported to more competitiveness-driven growth.

Over the past five years, the contribution of the commodity sector to GDP has declined by around five percentage points, with demand slowing in several important markets, notably China. More recently, manufacturing exports have emerged as a bright spot, supported by foreign direct investment, and the rupiah’s adjustment. But, given the global outlook, more needs to be done to develop new growth drivers, say the report’s authors.

Under focused reforms, more infrastructure investment, and a stable macroeconomic setting, growth is expected to rise to 6 percent by 2018. From the government’s perspective, it seeks to chart a course to even higher growth over the medium term, mindful of the need to preserve macro-financial stability, and strengthen the external position.

Attention has been placed on easing longstanding supply bottlenecks through a reform strategy that aims to raise potential growth. As a first step, decisive actions were taken soon after the new government took office in October 2014 to remove most fuel subsidies with a view to freeing up space in the government budget for more social and infrastructure spending.

IMF staff and Indonesian authorities on way ahead

In keeping with these objectives, current policy settings appear balanced and appropriately focused. In this context, IMF staff and the authorities broadly agreed on the following:

• Sound fiscal policy is a key anchor to growth and stability objectives. Despite recent energy subsidy reforms, budgetary pressures could re-emerge without new revenue measures, given declining oil and gas revenues. Larger nonoil tax revenues would help sustain increases in development expenditure, and help maintain a strong fiscal position, with moderate deficit reduction also enhancing resilience to shocks.

• Prudent debt management—a hallmark of Indonesia over the past 15 years—will need to underpin the government’s strategy for ramping up infrastructure investment, which is targeted at 8-9 percent of GDP a year through the end of the decade. Here, financing support is expected from both domestic and external borrowing, with some off budget, which will need to be managed closely to avoid undue fiscal risks.

• A relatively tight monetary stance has kept inflation in check in the face of earlier fuel price increases, and bolstered external inflows. Exchange rate and bond yield flexibility have helped Indonesia manage several episodes of heightened volatility facing a number of emerging markets since mid–2013. Further progress in improving monetary operations, and deepening money markets are expected to improve the effectiveness of monetary transmission.

• Financial and corporate sector vulnerabilities appear manageable, but require close watch given the growth slowdown. The banking system remains generally sound, with system stability better ensured by steps to strengthen frameworks for macroprudential policy and crisis management. The corporate sector warrants careful monitoring, supported by recent actions to contain risks tied to external borrowing.

Reforms for growth and stability

Still, more can be done to support growth and ensure stability, with structural reforms to play a larger role going forward, says the report. The aim should be to ease supply bottlenecks and improve the investment climate, with a view to expanding the export base, say the authors.

Upfront actions would send an important signal to potential investors, with staff urging focus on a stable trade and investment regime, human resource development and labor market flexibility, and financial market deepening.

Reforms in these areas could boost potential growth and create more jobs for Indonesia’s youthful population, while helping contain macroeconomic imbalances, all with a view to moving quickly to higher-income status, and reducing inequality.