Public Information Notice No.  10/130

Public Information Notice: IMF Executive Board Concludes 2010 Article IV Consultation with Indonesia

September 16, 2010

On August 27, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Indonesia.¹

Background

Indonesia’s growth in 2009 was 4½ percent, the third highest in the G-20 group of countries, and the pace is accelerating in 2010. Several factors contributed to this resilience during the crisis, including strong initial conditions, which resulted from prudent macroeconomic management, greater dependence on domestic demand, a diversified export base, and appropriate policy responses to support domestic demand. High frequency indicators for both consumption and investment indicate strong growth momentum in 2010. Inflation decelerated to 2.8 percent in 2009 (year-on-year) but is increasing slightly in 2010.

Capital flows into Indonesia have been buoyant, driven in part by ratings upgrades. Both push and pull factors have attracted large portfolio inflows, particularly into government bonds and short-term Bank Indonesia certificates (SBIs). While volatility increased in May following the European crisis, with about US$5.75 billion of capital outflows—mostly SBIs—inflows have since returned. Meanwhile, the stock market, the rupiah exchange rate, and the level of international reserves are at or above pre-crisis levels.

Bank Indonesia (BI) has left the policy rate unchanged since September 2009. After easing the policy rate by 300 bps during the crisis, BI has left the rate at a historic low of 6½ percent. Meanwhile, to enhance its liquidity management, BI recently introduced a series of measures. In particular, to discourage the use of SBIs for short-term cash management, BI has been shifting the maturity structure of SBIs from one month to 3- and 6-months, and it plans to introduce 9- and 12-month bills later this year. In addition, to encourage interbank market development, BI widened its policy rate corridor by 100 basis points to 5.5 percent to 7.5 percent. A one-month holding period on SBIs across the board was also introduced to help reduce money market volatility.

Fiscal support during the crisis was modest by international standards. Despite having room for undertaking countercyclical fiscal measures, owing to consistent prudent fiscal management in previous years, Indonesia’s fiscal stimulus was about 1.1 percent of GDP or half the average stimulus in the G-20 group. In fact, Indonesia had a primary surplus of 0.1 percent of GDP in 2009, and public debt declined to about 29 percent of GDP—the only country in the G-20 with declining debt in 2009.

The financial and corporate sectors were resilient to the crisis. Banks maintained high capital adequacy ratios and remained profitable despite the difficult operating environment. Although gross nonperforming loans increased, the ratio of nonperforming loans to total loans remained low at 3.2 percent. Banking sector liquidity improved throughout the year. Credit growth was 10 percent in 2009 and is gaining momentum in 2010, with 19½ percent growth in the year to July. Corporate balance sheets were relatively more liquid than other Asian economies. Corporate bond issuance declined during the crisis, but large corporations have returned to local debt markets since mid-2009.

The Article IV consultation also included discussions on the findings of the recently concluded joint IMF/World Bank Financial Sector Assessment Program (FSAP).

Executive Board Assessment

Executive Directors commended the Indonesian authorities for their impressive policy performance which successfully steered the economy through the global financial crisis. Its favorable public debt dynamics, sovereign ratings upgrades and higher global risk appetite provide an opportunity for Indonesia to sustain, and even accelerate, economic growth and development. Going forward, maintaining an appropriate policy mix is an important challenge in the current volatile external environment. Over the medium term, efforts should continue to improve public infrastructure and the business climate.

Directors considered that maintaining exchange rate flexibility is an important part of the toolkit to manage the volatility of capital flows. They supported the introduction of a one-month holding period for Bank Indonesia (BI) certificates to help thwart short˗term volatility. Directors encouraged the authorities to address potential competitiveness pressures from further rupiah appreciation by removing supply constraints. To lower sterilization costs, Directors recommended the gradual conversion of the nonmarketable government bonds in BI’s balance sheet to marketable bonds, thereby also expanding BI’s operational toolkit.

Directors considered BI’s current monetary policy stance to be appropriate given that core inflation is within the target range. Looking ahead, they advised that BI should signal its readiness to respond to rising inflationary pressures to anchor inflation expectations within the 4–6 percent target range. Continued effective communication of a proactive policy would also signal BI’s commitment to lower the level and volatility of inflation in line with trading partners. Directors generally cautioned against introducing administrative measures to fuel credit growth.

Directors commended Indonesia’s progress over the last decade in improving financial stability. They welcomed the steps being taken by the authorities to further strengthen the resilience of the financial sector in line with the recommendations of the recent FSAP, including enactment of the Financial System Safety Net Law, introducing a prompt corrective action regime to deal with problem banks, and enforcement of creditors’ rights. Proper coordination of macro and micro prudential supervision and developing capital markets to diversify the funding base are also important.

Directors endorsed the overall fiscal stance for 2010 and noted that further fiscal reforms will be necessary to support sustained high growth. Specifically, reducing energy subsidies would create additional fiscal space for much needed infrastructure spending and transfer programs for the poor, with little impact on debt sustainability. They stressed the importance of better budget execution for strengthening fiscal policy effectiveness and of efforts to expand the tax base and raise revenue ratios.