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IMFSurvey Magazine: Countries & Regions

Indonesia’s Choice of Policy Mix Critical to Ongoing Growth

A woman looks at headscarves in the central textile market, Jakarta, Indonesia, where domestic demand has fueled rebound (photo: Reuters/Enny Nuraheni)

ECONOMIC HEALTH CHECK

Indonesia’s Choice of Policy Mix Critical to Ongoing Growth

IMF Survey online

July 28, 2009

  • Indonesian domestic demand fuelling strong rebound
  • IMF backs maintaining fiscal stimulus and cautious monetary policy
  • Exchange rate flexibility — an important shock absorber

Indonesia remains one of the few bright spots in the generally bleak, global economic landscape, but Jakarta’s choice of policy mix will be key to continued growth, says the International Monetary Fund.

In its annual assessment of Asia’s third most populous country, the IMF called on Indonesian authorities to balance a cautious monetary policy with improved execution of its budget plans.

“Although the economic outlook for 2009 remains positive, another round of global risk aversion could adversely affect external liquidity, demand, and growth prospects for Indonesia,” it said in a report drawn up following consultations with the Indonesian authorities which ended on June 5th.

“It will therefore be important that the authorities strive to achieve the appropriate policy mix, and promptly adjust it as needed to preserve macroeconomic and financial stability,” it added.

Domestic demand fuels growth

Although Indonesia was hit by the global fall in demand following the economic downturn, unlike many of its more export-dependent neighbors, it has managed to skirt the recession, helped by strong domestic demand (which makes up about two-thirds of the economy) and a government fiscal stimulus package of about 1.4 percent of GDP, announced earlier this year.

While the tax cuts mandated by the stimulus program have been implemented, there have been delays in capital spending plans — delays which, the Fund warns, could blunt the program’s effectiveness. “Timely and efficient implementation of the spending program, especially on infrastructure, would be critical to sustaining the economic recovery,” it says.

Given the low levels of public debt, the Fund suggests it would be appropriate to maintain some of the stimulus into 2010.

“The fiscal space is available to invest in infrastructure areas, such as transportation and water systems, and for strengthening the social safety net; without jeopardizing debt sustainability,” said head of the Indonesian team for the IMF, Thomas Rumbaugh.

Cautious monetary policy

While maintaining some fiscal stimulus is important for supporting growth, the report recommends a cautious monetary stance. Inflationary pressures remain low and year-to-date credit growth has been flat, but the IMF believes there is now enough monetary stimulus in the system. It warns of the dangers of overstimulating the economy and introducing inflationary pressures.

The Indonesian Rupiah has been one of the strongest performers among Asian currencies this year and the IMF report says exchange rate flexibility remains an important shock absorber. “The current level of the real effective exchange rate is broadly in line with fundamentals,” it says.

After India and China, Indonesia is currently the third fastest growing economy in the Group of Twenty (G20) industrialized and developing economies. The $512 billion economy expanded 4.4 percent in the first quarter from a year earlier and last month, the IMF revised its 2009 forecast for the country to 3-4 percent from 2.5 percent.

Stronger fundamentals

Indonesia enjoyed stronger fundamentals going into the economic crisis, than many of its neighbors. After the 1997-98 Asian economic crisis, authorities of this vast archipelago implemented wide-ranging economic and financial reforms, including a rapid reduction in public and external debt, strengthening of corporate and banking sector balance sheets and reducing bank vulnerabilities through higher capitalization and better supervision.

The country’s rebound has also been attributed to the quick policy response by the government and Bank Indonesia and the recent presidential elections that analysts say testifies to Indonesia’s maturity as a thriving democracy.

“The dividends from Indonesia’s reforms to date are clear in terms of its macroeconomic and financial stability, as well as solid economic growth,” said Rumbaugh.

“Now is the time to advance the reform momentum and continue Indonesia’s development as one of the leading economies in Asia and the world.”

Comments on this article should be sent to imfsurvey@imf.org


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