Statement by IMF Staff at the Conclusion of the 2006 Article IV Consultation Discussions with Indonesia

Press Release No. 06/106
May 19, 2006

Mr. Stephen Schwartz, Senior Resident Representative of the IMF in Indonesia, made the following statement in Jakarta today:

"An IMF mission led by Mr. Milan Zavadjil, Assistant Director in the Asia and Pacific Department, is completing a two-week visit to Jakarta today to conduct the 2006 Article IV Consultation discussions. The team exchanged views with the government on the economic outlook, policy priorities, and progress in implementing the government's economic agenda. Based on these discussions, the team will prepare a staff report, scheduled to be presented to the IMF's Executive Board in late July.

"Over the past six months, sound macroeconomic management has contributed to a strong rise in financial markets and a substantial increase in international reserves to over $43 billion at present. Nevertheless, as previously anticipated, economic growth has slowed in recent quarters, to 4.6 percent (year-on-year) in the first quarter of 2006. The slowdown largely reflects the impact of necessary policy adjustments in the second half of last year, notably the increase in domestic fuel prices and the tightening of monetary conditions in response to rising international oil prices and interest rates. The fuel price increase has enabled the government to reorient spending plans toward higher priority social areas, and Bank Indonesia's monetary policy has succeeded in containing inflationary pressures.

"The mission supports the government's efforts to sustain near-term growth momentum through increased budgetary spending, including in the context of the cash transfer scheme for low income families. The government's plans to raise the deficit target in the 2006 revised budget is appropriate, as are efforts to address recent shortfalls in spending to bring expenditures up toward budgeted levels. These plans are consistent with the government's strategy to reduce the public debt-to-GDP level to around 30 percent by 2009.

"Monthly inflation rates are trending down, and inflation is projected to decline to the lower end of Bank Indonesia's 7-9 percent target range at end-year. The mission therefore supports Bank Indonesia's cautious easing of interest rates, in the context of its inflation targeting framework. Following the significant run-up in the stock and bond markets of recent months, in the past several days Indonesia's markets have been affected by the volatility in global financial conditions. Such volatility poses an additional challenge to monetary policy, and reinforces the merits of Bank Indonesia's cautious approach.

"The mission projects annual GDP growth to reach 5.2 percent for 2006. This is based on an expected recovery of domestic demand during the second half of the year as interest rates are eased and the adjustment to higher fuel prices winds down. The anticipated recovery is dependent on a continuation of a favorable external environment. Nevertheless, there are important risks to the outlook stemming from further increases in international oil prices, a tightening of global financial conditions, and slower than projected government spending. Continued flexible policy management will be needed to limit the economy's vulnerability to such risks.

"To reach Indonesia's potential growth rate of 6-7 percent per annum in coming years, the government has recognized the importance of sustained implementation of its agenda of structural reforms to enhance the investment climate. In this regard, the mission welcomes the authorities' recent Investment Climate Policy Package, and its emphasis on policy implementation. Efforts to enhance infrastructure investment, improve tax administration and customs procedures, and foster greater labor market flexibility are key components of the strategy to strengthen investor confidence and attract new domestic and foreign investment.

"The mission is also encouraged by the authorities' efforts to ensure the continued health of the financial system. An important near-term policy priority is to address the problem of high NPLs in the state-owned banks, and to strengthen governance in the state bank sector."



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