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Indonesia: Staff Report for the 2017 Article IV Consultation

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2018
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Context

1. The Indonesian economy continues to perform well. Economic growth has stabilized at near 5 percent, inflation has moderated, the current account deficit is manageable, and systemic risks are contained.1 The current favorable external environment, characterized by a pickup in global growth, supportive financial conditions, and a partial recovery of commodity prices, provides a window of opportunity to push forward the government’s reform agenda, while addressing vulnerabilities and risks, including the reliance on external financing.

2. Against this backdrop, the country is in a favorable position to address its socioeconomic challenges. The government’s objective to achieve higher sustainable and inclusive growth will help create jobs for the young and growing population. Indonesia’s working age population is growing rapidly, at 1.6 percent or 2.5 million people per year (Box 1), which could increase further youth unemployment (19.4 percent in 2016).2 In addition to faster economic growth, reaping the benefits of the demographic dividend requires diversifying the economy away from agriculture and towards industry and services, which have larger elasticities of employment growth to output growth.

Indonesia: Okun Coefficients and Share of Employment 1/

Sources: Indonesian authorities; and IMF staff estimates.

1/ The Okun coefficient is the elasticity of employment growth to RealGDP growth.

3. Discussions focused on policies to boost potential growth in the medium term as well as on the appropriate policy mix in the near term. Increasing potential growth requires a self-reinforcing fiscal-structural reform package that mobilizes revenues to finance development spending (infrastructure, education, health, and targeted transfers), and supports structural reforms to the product, labor, and financial markets. The near-term policy mix, given the slightly negative output gap, slow credit growth, and downside risks, should protect growth while preserving stability.

4. The authorities’ policies have been broadly in line with past policy advice. Monetary policy easing in 2017 was appropriate given cyclical considerations and moderate inflation, and there has been further progress with monetary operations reforms. The authorities are taking steps to implement the 2017 FSAP recommendations and progress has already been made in some areas. On the fiscal front, there have been efforts to rebalance the budget away from untargeted subsidies towards social and infrastructure spending. However, the progress in implementing a medium-term revenue strategy has been slow, and the authorities are focusing on tax administration reforms using the information gathered from the tax amnesty implemented in 2016–17.

Recent Developments, Outlook, and Risks

A. Recent Developments

5. Real GDP growth picked up slightly to 5.1 percent (y/y) in Q3:2017 from 5 percent in 2016 and H1:2017, led by stronger export and fixed investment growth. Private consumption growth remained stable at 5 percent, while government consumption and public investment growth increased. The output gap is estimated at around −0.5 percent of GDP.

6. The credit cycle downturn has continued, with credit growth slowing to 7.7 percent (y/y) in September 2017 and a negative credit-to-GDP gap, reflecting both weaker demand and banks’ tighter lending standards.

7. Inflation fell to 3.3 percent (y/y) in November, or to the lower half of the official target band (4±1 percent), due to the slightly negative output gap, stable food prices, and well-anchored inflation expectations, which more than offset the increase in electricity prices earlier in the year due to improved targeting of subsidies. Core inflation has remained stable at around 3 percent.

8. The fiscal deficit is projected to increase in 2017 to near the statutory ceiling of 3 percent of GDP due to modest tax revenue growth. Despite robust oil and gas revenue, total revenue grew by 4.4 percent (y/y) through October, less than envisaged in the original budget (16.7 percent, y/y). A revised budget was submitted in July 2017, with higher spending on subsidies and investment, and a larger fiscal deficit of 2.9 percent of GDP (2.4 percent in the original budget). However, expenditure restraint in H2:2017 has helped contain the fiscal deficit to around 2.7 percent of GDP, despite revenue shortages of 0.8 percent of GDP. The fiscal stance is projected to be neutral in 2017, with the cyclically adjusted primary balance remaining broadly unchanged.

9. The current account (CA) deficit fell to 1.5 percent of GDP in Q1-Q3:2017 from 1.8 percent in 2016 due to higher exports, led by coal and palm oil. Portfolio inflows, mainly into local currency government bonds, have been robust. The balance of payments (BOP) has remained in surplus, and international reserves reached US$126 billion (8 months of imports) in November 2017. The rupiah has depreciated by 0.1 percent in nominal effective terms in the first 10 months of 2017, but it has appreciated by 2.1 percent in real effective terms due to the inflation differential.

B. Outlook and Risks

10. The economy is expected to improve in the near term. Real GDP growth is projected at 5.1 percent in 2017 and 5.3 percent in 2018, led by a pickup in investment and credit, and higher commodity prices. Infrastructure investment is also expected to increase, although less than planned by the authorities. Inflation is projected at 3.3 percent in 2017 and 3.6 percent in 2018, within the official target range (4±1 percent in 2017 and 3.5±1 percent in 2018), due to stable food and administered prices, and a slightly negative output gap. The CA deficit is projected to remain contained at 1.7 percent of GDP in 2017 and 1.9 percent in 2018 due to firmer commodity prices and robust exports, with the BOP remaining in surplus.

11. The medium-term outlook is favorable. Real GDP growth is projected at 5.6 percent over the medium term due to robust domestic demand, with the output gap closing in 2020. These projections include smaller increases in infrastructure investment than planned by the authorities and do not include major tax reforms. Inflation is expected to remain within the target band. Improved bank balance sheets and sustained economic growth would lead to a gradual pickup in credit growth to 12 percent by 2020, with the credit gap also closing in 2020.

12. Risks to the outlook remain tilted to the downside (Appendix I). The main risks are external, including a reversal in capital inflows (triggered by global financial volatility or uncertainty around U.S. monetary and fiscal policies), lower growth in China, and geopolitical tensions. The impact of these shocks could be amplified by the fiscal and corporate sectors’ heavy reliance on nonresident financing (61 percent and 33 percent of total debt, respectively). On the upside, global growth and commodity prices could be stronger than expected. Domestic risks include tax revenue shortfalls, larger fiscal financing needs due to higher interest rates, political uncertainty in the run-up to the 2019 presidential elections, and natural disasters.

13. Systemic financial risks are contained, but some critical vulnerabilities remain. FSAP stress tests find that banks are broadly resilient to severe external shocks. The banking system remains sound with high capital, ample liquidity, and strong profitability. Banks have been repairing their balance sheets, but problem loans, including NPLs, special mention and restructured loans, remain elevated at over 10 percent of total loans due to legacy effects from the fall in commodity prices and the slight economic slack. Banks are also exposed to potential systemic financial risk given their exposure to the corporate sector, which is vulnerable to FX and external rollover risks.

Problem Loans

(In percent of total loans)

Sources: Financial Services Authority (OJK); and IMF staff estimates.

Loan-to-GDP Gap1/

(In percent of GDP)

Sources: Bank Indonesia: CEIC Data Co., Ltd.; and IMF staff estimates.

1/ The gap is the difference between the loan to GDP ratio and its long run trend which is estimated from an one-sided HP filter with 400,000 as a smoothing parameter.

C. External Sector Assessment

14. Indonesia’s external position is assessed as broadly consistent with fundamentals and desirable policies, while external debt remains sustainable. Preliminary estimates indicate that the CA deficit remains close to the estimated CA norm (Appendix II).3 The level and composition of the net international investment position indicate that Indonesia’s external position is sustainable. External debt remained moderate at 34.4 percent of GDP in September 2017. External financing appears sustainable, although it could be affected by domestic and external volatility (Appendix III). International reserves, projected at US$127.6 billion or 134 percent of the IMF’s reserve adequacy metric at end-2017, would be sufficient to address most shocks.

Authorities’ Views

15. The authorities broadly agreed with the macroeconomic outlook and risks. They remain committed to maintaining macrofinancial stability. Growth is projected to strengthen in 2018 led by strong investment growth and higher commodity prices. Private investment would pick up as banks clean their balance sheets and some infrastructure projects are completed. Private consumption growth is expected to remain stable due to robust consumer confidence and higher non-cash transfers to low income households. Inflation is expected to remain contained on stable food and administered prices, while core inflation continues to be under control. The external position would remain resilient, with low CA deficits and high reserve buffers. Structural reforms would accelerate medium-term growth above 5.5 percent.

16. The authorities broadly concurred with the external sector assessment, but expressed some concerns with the level of the CA norm. They agreed with the assessment that the external position remains broadly consistent with fundamentals and desired policies, but expressed doubts about the IMF EBA methodology to estimate the CA norm (−1.3 percent of GDP in 2017). They disagree with some indicators used in the EBA model to measure country risk (those of the International Country Risk Guide). Therefore, the CA norm resulting from the EBA model does not reflect Indonesia’s needs of higher CA deficits to finance investment on infrastructure and critical structural reforms. They encourage the IMF to always consider country specific factors when estimating the CA norm, noting that the EBA model is based in a multilaterally consistent approach.

Policies to Boost Potential Growth and Safeguard Macrofinancial Stability

17. Boosting potential growth requires a comprehensive, self-reinforcing, and properly sequenced fiscal-structural reform package. As fiscal space is constrained, the near-term priority should be on structural reforms with low fiscal costs, such as reforming product markets to promote entry and reduce state control, easing complex regulations, and fostering financial deepening and inclusion. Gains in growth from these reforms, along with a medium-term revenue strategy (MTRS), would create additional fiscal space for further structural reforms and development spending on infrastructure, education and health, where policy gaps remain large. Complementarities between reforms should also be exploited.

A. Fiscal and Other Structural Policies to Boost Potential Growth

Fiscal Policy to Create Space for Investment and Structural Reforms

18. In the context of declining tax revenues in recent years, the authorities have improved the quality of public spending.

  • a. Following the decline in oil and gas revenue amounting to 2 percent of GDP since 2014, the government has aimed to mobilize revenues by strengthening tax administration. It implemented a tax amnesty in July 2016–March 2017 with mixed results. Amnesty revenues, at 1.1 percent of GDP, exceeded market expectations, but other non-oil and gas revenue fell, likely impacted by the suspension of audits for amnesty participants. Despite these efforts, non-oil and gas tax revenues have declined by 0.5 percent of GDP since 2014.

  • b. In response, the government has rebalanced spending to priority sectors and improved efficiency. While total public spending has fallen by 2 percent of GDP since 2014, capital spending has risen by 1 percent of GDP. The targeting of electricity subsidies to low-income households has been improved, and performance criteria for transfers to local governments have been adopted. Efficiency savings on education spending are to be channeled to a trust fund to finance future education needs. However, some reforms have been delayed, such as the application of fully automatic formula-based fuel and electricity pricing mechanisms. The prices of low octane gasoline and electricity have not been adjusted since H1:2017.

19. The authorities are also aiming to strengthen tax administration with the data from the tax amnesty. Although asset repatriation during the amnesty was modest at 1.2 percent of GDP, assets declared totaled 40 percent of GDP. The authorities plan to use this data to improve tax compliance, assisted by the International Automatic Exchange of Information initiative. To help these efforts, the authorities passed a law that will give tax officials direct access to bank accounts owned by both Indonesian citizens and foreigners starting in 2018. The authorities are also developing a proposal for a MTRS to raise additional revenue, which they expect to finalize by March 2018.

Staff Position

20. Indonesia has some fiscal space. Despite small gross financing needs and low debt, fiscal space is constrained by weak revenues, a fiscal deficit near the statutory ceiling, and the large reliance on external financing. Shallow domestic financial markets and an open capital account render the economy vulnerable to capital flow volatility. Adhering to the statutory 3 percent of GDP deficit ceiling is critical to maintain fiscal discipline and protect investor confidence.

21. Early implementation of a MTRS to finance growth-enhancing priority spending and structural reforms is critical. The MTRS should aim to raise revenue by at least 3 percentage points of GDP in the medium term, which would allow the government to expand spending on infrastructure, health, and education, and support critical structural reforms. This can be achieved by frontloading tax policy reforms, improving tax administration, removing exemptions in VAT, CIT, and PIT, introducing excise taxes on vehicles and fuel, and raising the VAT rate to 12 percent from 10 percent. The MTRS should also aim to lower poverty and inequality. Although some tax measures included in the MTRS could be regressive, their impact on poverty and inequality is expected to be modest.4 Much of the incidence of poverty and inequality in Indonesia is associated with unequal access to social services and infrastructure. Thus, the potential adverse effects from taxes could be more than offset by the increased provision of social services and infrastructure, and higher targeted social spending in education, health, and social programs.

Indonesia: Policy Options in the Reform Scenario(In percent of GDP)
Estimated Fiscal
Policy OptionsImpact by 2022Details of the Policy
Total revenue measures 1/3.0
Value-added tax1.0Remove exemptions, lower VAT registration threshold, and increase rate from 10 percent to 12 percent.
Excise taxes1.0Introduce fuel excise tax and convert the current luxury goods sales tax on vehicles to a vehicle excise tax.
Corporate income tax0.5Remove exemptions and unify tax rates, impose alternative minimum tax to fight profit shifting
Personal income tax0.3Lower threshold for the top rate.
Property tax0.2Increase rate and gradually replace transaction tax with recurrent property tax.
Total expenditure measures 2/2.7
Infrastructure1.3Increase investment expenditure toward 5 percent of GDP while improving efficiency.
Education0.8Increase education expenditure toward EM average (4.8 percent of GDP) while improving efficiency.
Health0.6Implement universal health coverage while improving efficiency.
Social Assistance0.1Consolidate poorly-targeted programs.
Other expenditure-0.1Cut nonpriority expenditure.

Positive sign means more revenue. This includes both tax policy and administration reforms.

Positive sign means more expenditure. This includes both expenditure policy and public financial management reforms.

Positive sign means more revenue. This includes both tax policy and administration reforms.

Positive sign means more expenditure. This includes both expenditure policy and public financial management reforms.

22. As adopting a MTRS will take time, the authorities should focus on implementing its short-term action items to arrest the fall in the tax-to-GDP ratio. As a subset of the MTRS, the government could introduce excises on fuel, vehicles, sugary drinks, and plastic bags, reduce the VAT threshold, streamline tax administration, and lower compliance costs. These actions would protect the environment, improve the business climate, level the playing field, and encourage innovation, e.g., by shifting tax incentives to new rather than existing firms. They would also pave the way for future reforms such as raising the VAT rate, which can be used to support costlier structural reforms and expand priority spending, including social programs to lower poverty and inequality.

Authorities’ Views

23. The authorities agreed with the need to implement a comprehensive MTRS to create fiscal space for priority spending. They concurred that fiscal space is constrained due to the lower oil and gas revenues and a fiscal deficit near the statutory ceiling. The authorities are working on a proposal for a MTRS with the objective of raising tax revenue by at least 3 percent of GDP in five years based on both tax policy and tax administration reforms, which is expected to be finalized by March 2018. Higher excises on sugary drinks and plastic bags are currently under examination, as part of comprehensive tax reform efforts to optimize revenue. The extra revenue would be used to finance spending on infrastructure, health, education, and structural reforms.

Structural Reforms to Promote Investment and Employment

24. Public infrastructure investment has grown (Box 2). The authorities have increased public infrastructure spending by 1 percent of GDP between 2014 and 2017, and improved the institutional framework by establishing the Committee for Acceleration of Priority Infrastructure Delivery (KPPIP) and expediting land acquisition procedures. However, the narrow fiscal space has constrained public investment, and the authorities are aiming to raise infrastructure investment through SOEs and PPPs. They have selected 247 priority projects, with a total cost of US$323 billion (32 percent of GDP), to be implemented between 2015 and 2022. Most of the cost is expected to be borne by the private sector (18 percent of GDP) and SOEs (10 percent of GDP). The government is piloting various forms of financing, including banks loans to and bond issuances by SOEs and project securitization.5

25. The authorities have been implementing reforms to improve the business environment. They have adopted 16 economic packages since 2015 to streamline regulations and strengthen productivity and competitiveness (Appendix IV). The FDI regime was partially liberalized, including on logistics, tourism, and agriculture, and the setting of the minimum wage was made clearer. A single submission system is being introduced to simplify business registration, covering the licenses of both central and local governments. A national single window system to automate export and import permits has been introduced in more than 21 ports. The authorities are also planning to streamline non-tariff measures (NTMs), gradually shifting control from border to post border, and open to trade through bilateral and regional trade agreements. These efforts have led to a notable rise in Indonesia’s World Bank’s Doing Business ranking from the 106th position in 2016 to the 72nd position in 2018, with gains in most areas.

Indonesia: Ease of Doing Business Rank 1/

(Highest = 1: Lowest = 190)

Source: World Bank Doing Business Report.

1/ These indicators should be interpreted with caution due to a limited number of respondents, a limited geographical coverage, and standardized assumptions on business constraints and information availability.

26. The authorities have articulated a financial development strategy. A high-level joint forum for financial deepening and the National Council for financial inclusion were created to promote interagency coordination. The authorities are preparing an ambitious national strategy for financial market development, including detailed multi-year strategic initiatives. BI has implemented measures to develop the money and FX markets to enhance monetary policy transmission (e.g., the reserve requirement averaging and the adoption of the Global Master Repurchase Agreement). The introduction of a credit registry and the recent licensing of private credit bureaus are positive steps to strengthen the credit culture. The increasing use of digital financial services (DFS) can help overcome geographical barriers to financial inclusion.6

27. Notwithstanding these efforts, challenges remain. Growth remains constrained by a large infrastructure gap, low institutional quality, inadequate human capital, and shallow financial markets. Coordination among line ministries has improved, which has helped avoid conflicting regulations, but challenges remain in the coordination between central and local governments. Large state control through SOEs and entry barriers have discouraged private investment and undermined competition. Trade barriers and FDI restrictions have contributed to low integration with global value chains compared to ASEAN peers.7 The weak credit culture has hampered financial deepening.

Staff Position

28. Infrastructure development should continue, but vulnerabilities and risks need to be carefully managed to protect macrofinancial stability:

  • The increase in infrastructure spending should be paced in line with available financing and the economy’s absorptive capacity. Given shallow domestic financial markets and constrained fiscal space, the level of infrastructure investment planned would require a significant rise in corporate external debt, including by SOEs, with potential spillovers to the financial system. A more measured pace of infrastructure development would help preserve stability, while sound risk management would help mitigate fiscal risks from contingent liabilities.

  • Priority should be given to financing infrastructure development with additional revenues from the MTRS. This would allow for steady funding for infrastructure investment, while protecting stability and limiting the buildup of corporate external debt.

  • Private sector participation, including FDI, should be encouraged. This would accelerate infrastructure investment, lower contingent liabilities from SOE debt, improve efficiency, and allow transfers of knowhow. Achieving this goal requires ensuring transparent, competitive bidding processes, expediting concessions for brownfield projects, and regulatory certainty. Financing through asset backed securities can be further explored, including in the areas of toll roads and power plants, where successful operations have been completed. Government guarantees for infrastructure development (credit, business viability, and PPP guarantees), which remained small at 2.8 percent of GDP in March 2017 (Box 2), need to be carefully designed and monitored to avoid a potential increase in future contingent liabilities.

29. Rationalizing the role of SOEs would reduce fiscal risks and foster competition. Indonesia has 118 SOEs spread across 13 sectors. In 2016, total SOE assets amounted to 51 percent of GDP and total SOE liabilities to 33 percent of GDP. Limiting the role of SOEs to strategically relevant and commercially viable areas would lower fiscal support needs, strengthen financial oversight, and attract private investment, including FDI. This could begin in the energy sector, where two SOEs dominate and large investment is needed. The authorities should also ensure cost recovery in Pertamina and PLN by adjusting regulated fuel and electricity prices with an automatic formula. Reducing barriers to entry could foster market-based incentives and improve SOE governance and efficiency. The plan to create holding companies of SOEs should be carefully reviewed. While it may enhance efficiency, it may also increase the monopolistic power of SOEs.

Framework far Reviewing the Status of Public Enterprises

Source: IMF, Fiscal Affairs Department, 2016. How to improve the Financial Oversight of Public Corporations, Fiscal Policy Paper.

30. Deregulation efforts should be targeted to areas with the greatest economic gains:

  • Easing regulations on state control, antitrust exemptions, and barriers in the network sector (electricity and transport) would foster competition. Streamlining NTMs and easing FDI restrictions would strengthen links with global value chains and competitiveness. Greater ministerial coordination would avoid conflicting regulations. The recent presidential decree to strengthen the coordination of economic policies through all coordinating ministries is a welcome first step.

  • A regional government coordination forum, anchored by a national policy direction, would help improve coordination. Introducing merits and competition factors into fiscal transfers to local governments and capacity building would enhance accountability and coordination.

Enacted Regulations During 1998–2017

(Number of regulations; as of April 2017)

Source: Ministry of National Development Planning.

31. Improving education and easing labor market regulations would support employment. The labor market has underperformed, with high youth unemployment (30 percent); high informal employment (58 percent); and low female labor participation (55 percent).

  • Labor markets. Streamlining stringent job protection, including administrative dismissal procedures and severance payments, while improving vocational training and job placement services, would promote youth employment and reduce the use of short-term contracts. Active labor market policies, including job placement services and vocational training, would help labor mobility. However, these programs should tackle well identified labor market failures and be subject to careful ex-post evaluations. Adopting a more open immigration policy for skilled labor, and improving the quality of domestic education, can lower skill mismatches, especially in professional services. Female labor force participation can be enhanced by providing flexible work arrangements and subsidizing childcare subject to careful cost-benefit analysis.

  • Education. Strengthening the link between compensation and performance in the education sector would improve the efficiency of spending and the quality of education. Savings from these measures and additional resources could be directed to ensure more equitable access to quality education, especially in rural areas. Improved access to student loans would increase enrollment in higher education. The monitoring framework on the local government’s budget spending and schools’ performance should also be improved.

Government Education Spending and Outcome 1/

Sources: World Bank; and IMF staff estimates.

1/ Latest data available.

32. Stronger regulatory and supervisory frameworks would promote financial deepening and inclusion, and support infrastructure development. Progress developing a strategy for capital market development is commendable, and reflects high-level political support and enhanced inter-agency coordination. Continued efforts are needed to build a liquid yield curve and introduce new interest rate and FX hedging instruments. The supervisory and regulatory framework should evolve in line with financial market development. Portfolio exposure targets, including minimum MSME exposure targets and the minimum investment requirement on government bonds and infrastructure-related SOE bonds on nonbank financial institutions, should be reviewed. Improving the insolvency and creditor rights regimes would raise participation in the corporate bond market and financial access for MSMEs. The authorities should review the effectiveness of the People’s Business Loan (KUR) program, including its fiscal costs and whether it has achieved its objective.8

33. An illustrative scenario that includes fiscal and other structural reforms shows that potential growth could rise to 6.5 percent in the medium term (Appendix V). Staff’s reform scenario includes a MTRS that raises additional revenue by 3 percent of GDP, which is used to expand public spending in infrastructure, education, and health. It also includes structural reforms to the product and labor markets, reduced trade and FDI restrictions, and lower state control in the economy. Initially, potential growth rises due to a pickup in infrastructure investment and lower trade and FDI restrictions, which catalyzes private investment and employment growth. Over the medium term, structural reforms to the product and labor markets lead to gains in total factor productivity, which combined with additional investment in infrastructure and private investment, raise potential growth to 6.5 percent by 2022. Inflation increases in the near term due to the demand stimulus and higher taxes, but moderates after due to a tighter monetary stance, stronger domestic competition and expanded production capacity. The CA deficit widens due to higher investment-related imports, partly offset by higher exports due to enhanced competitiveness.

Indonesia: Illustrative Effects of Fiscal and Other Structural Reforms 1/
BaselineReform Scenario
2015201620172018201920202021202220182019202020212022
General government revenue14.914.313.814.013.913.913.913.914.515.115.616.216.9
Central government revenues and grants13.112.512.012.212.112.112.112.112.713.213.714.314.9
Of which : tax revenues10.810.49.810.010.010.010.010.010.511.011.612.212.8
Oil and gas revenues1.10.70.90.90.80.70.70.60.90.80.70.70.6
Non-oil and gas revenues11.911.811.211.311.311.411.411.411.812.413.013.614.2
Tax revenues10.310.19.59.69.79.79.79.810.110.711.312.012.6
Income tax4.85.14.44.44.44.54.54.64.64.85.05.25.4
VAT3.73.33.43.63.53.53.53.53.73.94.14.34.5
Excise1.31.21.21.31.31.31.31.31.51.71.92.12.3
Other0.60.50.50.50.40.40.40.40.40.40.40.40.4
Nontax revenues1.51.71.71.71.71.71.71.71.71.71.71.71.7
Local government revenue net of transfer1.81.81.81.81.81.81.81.81.81.91.92.02.0
General government expenditure17.516.816.516.516.416.416.416.417.017.518.018.519.1
Health1.31.51.51.51.51.51.51.51.61.71.92.02.1
Education3.53.33.33.33.33.33.33.33.53.63.83.94.1
Social assistance1.51.71.71.71.71.71.71.71.71.71.71.81.8
Infrastructure2.22.22.72.82.62.52.52.52.93.23.43.63.8
Other expenditure8.98.17.37.37.37.47.37.37.37.27.27.27.2
General government deficit-2.6-2.5-2.7-2.5-2.5-2.5-2.5-2.5-2.5-2.4-2.3-2.2-2.2
General government debt26.828.329.129.630.230.230.430.529.630.130.029.929.7
Real GDP growth4.85.05.15.35.55.65.65.65.45.75.96.26.5
Inflation3.43.03.33.63.83.73.53.63.84.14.03.73.8
Current account deficit/GDP-2.0-1.8-1.7-1.9-1.8-1.9-2.0-2.0-2.0-2.0-2.2-2.3-2.3
Source: World Bank; Indonesian authorities; and IMF staff estimates.

The estimated impact of the reforms included in the staff’s active scenario are based on Nozaki and Shin, 2015, “Infrastructure Development in Indonesia,” IMF Country Report No. 16/82; Dabla-Norris and others, 2015, “Structural Reforms and Productivity Growth in Emerging Market and Developoing Economies,” IMF Working Paper No. 16/15); Bouis, Duval and Eugster, 2016, “Producer Market Deregulation and Growth: New Country-Industry-Level Evidence,” IMF Working Paper No. 16/114; Gal and Hijzen, 2016, “The short-term impact of produt market reforms: A cross-country firm-level analysis.”; Chapter 3, Time for a supply-side boost? Macroeconomic effects of labor and product market reforms in advanced economies, IMF World Economic Outlook, April 2016.

Source: World Bank; Indonesian authorities; and IMF staff estimates.

The estimated impact of the reforms included in the staff’s active scenario are based on Nozaki and Shin, 2015, “Infrastructure Development in Indonesia,” IMF Country Report No. 16/82; Dabla-Norris and others, 2015, “Structural Reforms and Productivity Growth in Emerging Market and Developoing Economies,” IMF Working Paper No. 16/15); Bouis, Duval and Eugster, 2016, “Producer Market Deregulation and Growth: New Country-Industry-Level Evidence,” IMF Working Paper No. 16/114; Gal and Hijzen, 2016, “The short-term impact of produt market reforms: A cross-country firm-level analysis.”; Chapter 3, Time for a supply-side boost? Macroeconomic effects of labor and product market reforms in advanced economies, IMF World Economic Outlook, April 2016.

Authorities’ Views

34. The authorities broadly agreed that the macroeconomic implications and fiscal risks of the infrastructure plan should be closely monitored. They noted the progress made in upgrading infrastructure, with SOEs playing a key role on advancing projects that had been stalled for years. Going forward, they have an ambitious infrastructure development plan, and are seeking private sector and SOE participation. They agree that infrastructure development should be paced in line with available financing and the economy’s absorptive capacity, and are exploring alternative financing instruments that could mitigate risks, including by enhancing equity instead of debt financing. They also conveyed that the financial deepening program has progressed to support the need of infrastructure financing, and concurred with the need to closely monitor SOEs and PPPs to mitigate fiscal risks from contingent liabilities.

35. The authorities have been implementing growth-enhancing structural reforms. They highlighted their past efforts to streamline regulations, reform education and health, and open to FDI, which have led to a significant improvement in the World Bank’s Doing Business ranking. On trade policy, they want to harmonize NTMs with their ASEAN neighbors to reinvigorate trade. They are also considering labor market reforms to increase flexibility and align wage growth with productivity growth. Understanding the importance of these reforms, the authorities will continue to strive for the agenda to be achieved by taking concrete and prudent necessary steps.

B. Near-Term Policy Mix—Supporting Growth While Preserving Stability

36. The near-term policy mix should support growth while preserving stability given the slight economic slack, slow credit growth and downside risks. Fiscal adjustment should be more gradual than planned in the 2018 budget, monetary policy should continue focusing on price stability and supporting growth, and financial policies should safeguard financial stability.

Fiscal Policy

37. The 2018 budget targets a reduction in the fiscal deficit to 2.2 percent of GDP. Total revenues are projected at 12.8 percent of GDP, 0.8 percentage points above the projected outturn in 2017. The increase in revenue would be fully driven by a rise in income tax revenue of more than 1 percent of GDP as tax compliance improves with the data from the tax amnesty, which could prove optimistic. Total budgeted expenditure is projected to be 0.3 percent of GDP higher than the projected outturn in 2017, led by higher current and capital spending, partly offset by lower transfers to local governments.

38. The public sector’s reliance on nonresident financing stabilized in 2017, although at a high level. Public debt is moderate at 29 percent of GDP, but the share of public debt held by nonresidents remained high at 61 percent in September 2017, broadly unchanged from 2016. The high reliance on nonresident financing makes public debt vulnerable to exchange rate and capital flow volatility. However, government bond yields have been relatively resilient in recent episodes of high global financial volatility. For example, 10-year bond yields increased only from 7.2 percent to 7.9 percent between October and December 2016 when global financial volatility spiked following the U.S. presidential elections, and have since declined to 6.5 percent in November 2017.

Staff Position

39. The authorities should aim for a gradual adjustment in 2018 to balance stability and cyclical considerations. Indonesia has some fiscal space, allowing for a slower than planned pace of adjustment. If revenues continue to surprise on the downside, adhering to the fiscal deficit target of 2.2 percent of GDP would require cutting expenditure, which would weaken domestic demand and limit resources for investment in infrastructure and critical structural reforms. Given the slightly negative output gap, a more gradual fiscal adjustment (a deficit target of up to 2.5 percent of GDP) would be more appropriate to protect growth while gradually lowering the primary deficit and rebuilding fiscal buffers. The resulting fiscal stance would be less contractionary than in the budget plan, with the cyclically adjusted primary balance rising by 0.2 percent of GDP. The deficit should not exceed 2.5 percent of GDP to preserve market confidence in the fiscal rule. Within the budget envelope, there is still scope to continue rebalancing away from untargeted subsidies towards more support for social spending, public investment, and structural reforms. Limiting the issuance of FX denominated government bonds and lowering the primary deficit as revenues increase with a MTRS would help moderate the reliance on nonresident financing.

Authorities’ Views

40. The authorities broadly agreed that fiscal adjustment should be gradual in 2018. Fiscal policy will continue supporting growth through spending on infrastructure, health, education, and social transfers as envisaged in the budget. But it will not be used to stimulate aggregate demand beyond the budget plan. The authorities recognized a potential risk of revenue shortfalls in 2017, but they have already anticipated them to keep the budget deficit at a level well below the deficit ceiling. They believe that revenue and expenditure will be less volatile going forward, as the one-off shocks to revenue since 2014 will taper off, including those from the 2014-15 fall in commodity prices, the 2015-16 special tax on SOE asset reevaluation, and the 2016-17 tax amnesty. They also indicated that with the spirit of a better targeted mechanism for energy subsidies, they will keep monitoring energy prices and ensure the protection of the poor from hikes in energy prices.

Monetary and Exchange Rate Policies

41. Bank Indonesia (BI) recently eased monetary policy. BI cut the policy rate by 50 basis points to 4.25 percent in August-September 2017, after cutting it by 150 basis points in 2016 and then holding it unchanged for 10 months. These actions were motivated by the moderate inflation outlook, the slightly negative output gap, slow credit growth, and lower external pressures. The rupiah has depreciated by 0.3 percent against the U.S. dollar in the first 11 months of 2017, and international reserves have risen by US$9.6 billion, due to higher foreign currency proceeds from international bond issuances, tax revenues, and oil and gas export receipts, and BI’s FX intervention aimed at stabilizing the rupiah in line with its fundamental value.

42. There has been further progress with the reform of monetary operations. The interbank rate has moved closer to the policy rate since August 2016, when the policy rate was changed to the 7-day reverse repo rate and the interest rate corridor was narrowed. In July 2017, BI launched a partial reserve requirement (RR) averaging of 1.5 percent, out of the 6.5 percent current primary RR ratio, over a two-week period, allowing the floor of the RR ratio to be at 5 percent on any given day. This reform has benefited small banks with potential shortage of liquidity. BI has also moved to a variable-rate auction for its securities to encourage price discovery in the money markets. Issuance of T-bills has risen, providing more instruments at the short end of the yield curve.

Staff Position

43. The current stance of monetary policy is broadly appropriate. Recent monetary policy easing is adequate, given moderate inflation, the slightly negative output gap, and lower external pressures. With the real policy rate (1 percent) below the estimated neutral real rate (1¾ percent), monetary policy is sufficiently accommodative to support growth while maintaining price stability. Given external uncertainty, monetary policy should stay on hold in the immediate future, while BI assesses the pass-through of its recent actions.

44. There is room to further strengthen monetary transmission. Although the interbank rate has moved closer to the policy rate, market interest rates have been slow to adapt, particularly lending rates. Structural factors affecting the transmission include limited bank competition; distortionary interest rate caps; a weak credit culture; and low efficiency in the banking sector. Policy priorities include eliminating interest rate caps; limiting issuances of BI securities at the short end and minimizing overlap with MOF instruments; and improving banks’ asset quality through faster restructuring.

Monetary Policy and Interbank Rates

(In percent)

Sources: CEIC Data Co., Ltd.; and IMF staff estimates.

45. Exchange rate flexibility is critical to adjust to shocks. BI should allow the exchange rate to move freely in line with market forces, with FX intervention limited to preventing disorderly market conditions.

Authorities’ Views

46. The authorities broadly concurred with the assessment of the monetary stance and reform priorities. The current monetary policy stance is appropriate given the moderate inflation outlook and slightly negative output gap. Going forward, BI will continue to remain vigilant and formulate monetary policy in line with economic developments. The implementation of the RR averaging has been smooth and has helped small banks with potential shortage of liquidity. Large banks with ample liquidity have not made use of the extra degree of flexibility. BI plans to gradually increase the RR averaging from 1.5 percent to the total RR by 2021, based on review of the liquidity conditions and progress in financial market deepening. The authorities broadly agreed with the reform priorities to further strengthen monetary transmission.

47. The authorities reiterated their commitment to exchange rate flexibility. BI continues to maintain a flexible exchange rate policy and to ensure the rupiah is in line with its fundamental value. BI will not shy away to intervene in the FX market in the case of excessive volatility of the rupiah exchange rate and misalignment of the rupiah exchange rate that may induce risks to the attainment of the inflation target.

Financial and Corporate Sector Issues—Enhancing the Supervisory Framework

48. Financial soundness indicators point to a sound, liquid, and profitable banking sector. The banking system is well capitalized with a capital adequacy ratio of 23.2 percent. Profitability is strong, and system-wide liquidity remains ample. However, banks are exposed to corporate sector vulnerabilities and financial soundness varies across banks. The FSAP’s stress tests show that, under the most severe stress scenario, banks experience credit losses, particularly from corporate exposures, but high capital buffers and strong profitability help to absorb most of these losses, and many but mostly smaller banks are vulnerable to liquidity shocks, including FX liquidity shortfalls, due to their reliance on short-term deposits and limited access to the money market. NPLs have stabilized at slightly below 3 percent due to improved corporate performance and household debt service capacity, but special-mention loans and restructured loans remain elevated. BI’s simulations suggest that the impact of the recent expiration of the Financial Services Authority’s (OJK’s) relaxation on loan restructuring criteria would be limited: the system-wide capital adequacy ratio would fall by less than ½ percentage points under the worst-case scenario.9

49. The authorities have been strengthening financial oversight and crisis management. Basel III standards and a new insurance law have been adopted, and supervisory practices are improving. The authorities have made active use of macroprudential tools and introduced a countercyclical capital buffer, currently set at zero in line with credit developments. Most implementing regulations for the crisis management law have also been issued, including those regarding recovery plans for domestic systemically important banks, resolution framework for both systemic and non-systemic banks, and rules for write-off and haircut of remaining assets from the Bank Restructuring Program. However, the implementing regulation regarding a levy for the Bank Restructuring Program is still under discussion.

50. The authorities are taking early actions in response to the findings of the 2017 FSAP. They broadly agree with the key recommendations of the FSAP and are considering how to take them forward, recognizing that some recommendations are for the medium term (Box 3). That said, the draft bill amendment of the BI law that is being prepared and will be included in the 2015-2019 National Legislation Program includes a financial stability and macroprudential mandate. An amendment to the OJK law is also included in that Program. BI and OJK have been improving their stress test framework and established a framework for a joint stress test and data sharing. To advance on the recommendation to reduce silos in financial oversight, which ultimately requires changes to the OJK law, OJK brought internal coordination directly under the authority of the Chairman. The authorities conducted several joint crisis simulation exercises. BI and OJK also issued regulations to implement risk-based AML/CFT supervision.

51. The corporate sector has reduced leverage but some sectors remain vulnerable to FX and external rollover risks. Profitability has improved on cost-cutting efforts, and external debt has moderated. However, NPLs in commodity-related corporates are high (e.g. 8 percent in the mining sector), due to legacy effects from low commodity prices and banks’ risk management, as well as the weak credit culture. With FX debt accounting for 45 percent of total corporate debt, corporates are exposed to exchange rate volatility while facing larger rollover needs next year. These could have spillovers to the banking sector, as 71 percent of bank loans are extended to the corporate sector.

52. The corporate prudential FX regulation has helped moderate risks from corporate external debt. This regulation requires hedging at least 25 percent of net FX liabilities of corporates with external debt maturing within six months, maintaining the short-term liquidity ratio (FX assets to FX liabilities maturing within three months) above 70 percent, and having a credit rating of no less than BB- or equivalent to borrow externally. The regulation was adopted in 2015 in response to the rapid increase in corporate external debt as well as regulatory and supervisory gaps, which has the potential to disrupt the financial system through spillovers to the banking sector. Since the introduction of this measure, corporate foreign debt has stabilized.

Corporate Borrowing and Leverage

(In percent of four quarters rolling GDP; otherwise noted)

Sources: Bloomberg L.P.; BIS Database; CEIC data Co. Ltd ; and IMF staff estimates.

Indonesia: Corporate Return on Assets

(In percent)

Sources: Bloomberg LP. and IMF staff estimates.

1/ In percent of assets.

Staff Position

53. Efforts should continue to strengthen financial oversight and crisis management in line with the FSAP recommendations (Table 11). OJK should tackle its silo structure in its law amendment and strengthen the enforcement of prudential regulations, including on credit risk management and supervision on financial conglomerates. The authorities should continue to monitor closely restructured and special mention loans, and enforce proper loan classification to avoid evergreening. Restructuring of commodity-related legacy NPLs should be accelerated, taking advantage of the improved credit information. Legal protection of supervisors and officials of all agencies involved in financial oversight and crisis management should be enhanced to ensure timely actions. Consideration should to be given to the emergency liquidity assistance (ELA) eligibility criteria to allow extending emergency lending to banks that are assessed by OJK as viable even if its capital is temporary below minimum requirements. The ELA framework should also enable BI, in situations where it is not satisfied with a bank’s solvency and viability, or with collaterals, to request an indemnity from the government subject to appropriate safeguards. The authorities need to consider allowing for the use of public funding in limited circumstances justified by systemic preconditions for use and processes for recovery from the banking industry. A liquidity coverage ratio requirement by significant currencies could be adopted to contain FX liquidity risks.

Table 1.Indonesia: Selected Economic Indicators, 2013–18
Nominal GDP (2016): Rp 12,407 trillion or US$ 932 billion
Population (2016): 258.7 million
Main exports (percent of total, 2016): Coal (10.1), palm oil (9.9), oil and gas (9.1), textile & textile products (8.2)
GDP per capita (2016): US$3,604
Unemployment rate (August 2016): 5.6 percent
Poverty headcount ratio at national poverty line (2016): 10.9 percent of population
2013201420152016201720172018
Prel.Latest outturnProj.
Real GDP (percent change)5.65.04.95.05.15.0Q1-Q35.3
Domestic demand4.75.04.24.64.74.5Q1-Q35.1
Of which:
Private consumption 1/5.55.34.85.05.05.0Q1-Q35.0
Government consumption6.71.25.3−0.12.11.3Q1-Q32.0
Gross fixed investment5.04.45.04.56.05.8Q1-Q36.2
Change in stocks 2/−0.60.5−0.60.3−0.2−0.3Q1-Q30.0
Net exports 2/0.6−0.21.00.10.70.8Q1-Q30.3
Saving and investment (in percent of GDP)
Gross investment 3/33.834.634.234.334.034.1
Gross national saving30.731.532.132.532.432.3
Prices (12-month percent change)
Consumer prices (end period)8.18.43.43.03.33.3Nov.3.6
Consumer prices (period average)6.46.46.43.53.83.8Jan.-Nov.3.4
Public finances (in percent of GDP)
Central government revenue15.114.713.112.512.08.1Jan.-Sept.12.2
Central government expenditure17.316.815.715.014.710.1Jan.-Sept.14.7
Of which : Energy subsidies3.23.21.00.90.70.4Jan.-Sept.0.7
Central government balance−2.2−2.1−2.6−2.5−2.7−2.0Jan.-Sept.−2.5
Primary balance−1.0−0.9−1.2−1.0−1.0−0.8Jan.-Sept.−0.9
Central government debt24.824.727.428.329.029.5
Money and credit (12-month percent change; end of period)
Rupiah M29.413.59.011.712.09.8Jul.
Base money16.711.63.04.69.87.2Jul.
Private Sector Credit20.011.810.37.78.67.5Sept.10.3
One-month interbank rate (period average)5.87.57.26.9
Balance of payments (in billions of U.S. dollars, unless otherwise indicated)
Current account balance−29.1−27.5−17.5−16.8−16.9−11.5Q1-Q3−20.4
In percent of GDP−3.2−3.1−2.0−1.8−1.7−1.5Q1-Q3−1.9
Trade balance5.87.014.015.418.415.8Q1-Q314.8
Of which : Oil and gas (net)−9.7−11.8−5.7−4.8−6.9−5.0Q1-Q3−7.6
Inward direct investment18.821.816.63.823.816.8Q1-Q326.6
Overall balance−7.315.2−1.112.111.310.6Q1-Q37.3
Terms of trade, percent change (excluding oil)−2.5−3.3−14.6−0.26.52.7
Gross reserves
In billions of U.S. dollars (end period)99.4111.9105.9116.4127.6126.5Oct.135.0
In months of prospective imports of goods and services5.98.18.07.98.07.9Oct.7.9
As a percent of short-term debt 4/177189191213226224Oct.234
Total external debt 5/
In billions of U.S. dollars266.1293.3310.7318.8345.4335.4Q2359.3
In percent of GDP29.032.936.134.234.033.0Q232.8
Exchange rate
Rupiah per U.S. dollar (period average)10,41411,86213,39113,30613,382Jan.- Dec.
Rupiah per U.S. dollar (end of period)12,17112,43513,78813,47313,579Dec. 18
Memorandum items:
Jakarta Stock Exchange (12-month percentage change, composite index)−1.022.3−12.115.315.5Dec. 18 (ytd)
Oil production (thousands of barrels per day)830794800820815800
Nominal GDP (in trillions of rupiah)9,54610,57011,53212,40713,60414,852
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.

Includes NPISH consumption.

Contribution to GDP growth (percentage points).

Includes changes in stocks.

Short-term debt on a remaining maturity basis.

Public and private external debt.

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

Includes NPISH consumption.

Contribution to GDP growth (percentage points).

Includes changes in stocks.

Short-term debt on a remaining maturity basis.

Public and private external debt.

Table 2.Indonesia: Selected Vulnerability Indicators, 2013–17
20132014201520162017Observation
Proj. or latest
Key economic and market indicators
Real GDP growth (in percent)5.65.04.95.05.1Proj.
CPI inflation (in percent, end of period, e.o.p.)8.18.43.43.03.3Proj.
Short-term (ST) interest rate (in percent, e.o.p.) 1/7.66.68.67.04.8Nov. 2017
Ten-year government bond yield (in percent, e.o.p.)8.57.88.76.86.5Nov. 2017
Indonesia EMBI spread (basis points (bps), e.o.p.)292266329195168Nov. 2017
Exchange rate (rupiah per U.S. dollar, e.o.p.)12,17112,43513,78813,47313,579
External sector
Current account balance (in percent of GDP)−3.2−3.1−2.0−1.8−1.7Proj.
Net FDI inflows (in percent of GDP)1.31.71.21.72.0Proj.
Exports of goods and nonfactor services (GNFS) (percentage change, in US$ terms)−2.8−3.0−13.8−2.112.3Proj.
Real effective exchange rate (e.o.p.; 2010=100)83.592.491.594.294.1Sept. 2017
Gross international reserves (in US$ billion)99.4111.9105.9116.4127.6Proj.
In percent of ST debt at remaining maturity (RM)176.6188.8190.9212.9225.8Proj.
Total gross external debt (in percent of exports of GNFS)129.8147.5181.3190.0183.3Proj.
Gross external financing requirement (in US$ billion) 2/83.883.876.872.371.6Proj.
Public sector (PS) 3/
Overall balance (in percent of GDP)−2.2−2.1−2.6−2.5−2.7Proj.
Primary balance (in percent of GDP)−1.0−0.9−1.2−1.0−1.0Proj.
Gross PS financing requirement (in percent of GDP) 4/4.04.44.24.23.7Proj.
Public sector gross debt (PSGD) (in percent of GDP)24.824.727.428.329.0Proj.
Of which : Exposed to rollover risk (in percent of total PSGD) 5/7.07.67.57.07.4Proj.
Exposed to exchange rate risk (in percent of total PSGD) 6/46.743.444.542.639.0Proj.
Exposed to interest rate risk (in percent of total PSGD) 7/5.24.02.82.01.3Proj.
Financial sector (FS)
Capital to risk-weighted assets (in percent) 8/18.119.621.422.923.2Q3
Nonperforming loans (in percent of total loans)1.82.22.52.92.9Q3
Foreign currency deposits at commercial banks (in percent of total deposits)17.015.916.514.513.7Jul. 2017
Foreign currency loans at commercial banks (in percent of total loans)16.515.714.313.313.0Q2
Government debt held by financial system (percent of total financial system assets)5.96.07.58.48.1Sept. 2017
Private sector credit of banking system (annual percentage change)20.011.810.37.77.5Sept. 2017
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.

One-month Jakarta Interbank offered rate.

Defined as current account deficit, plus amortization on medium- and long-term debt and short-term debt at end of previous period.

Public sector covers central government only.

Overall balance plus debt amortization.

Short-term debt and maturing medium - and long-term debt.

Debt in foreign currency or linked to the exchange rate.

Government securities at variable interest rates.

Includes capital charge for operational risk.

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

One-month Jakarta Interbank offered rate.

Defined as current account deficit, plus amortization on medium- and long-term debt and short-term debt at end of previous period.

Public sector covers central government only.

Overall balance plus debt amortization.

Short-term debt and maturing medium - and long-term debt.

Debt in foreign currency or linked to the exchange rate.

Government securities at variable interest rates.

Includes capital charge for operational risk.

Table 3.Indonesia: Balance of Payments, 2013–18(In billions of U.S. dollar, unless otherwise indicated)
201320142015201620172018
Prel.Proj.
Current account−29.1−27.5−17.5−16.8−16.9−20.4
Goods, net (trade balance)5.87.014.015.418.414.8
Exports, f.o.b.182.1175.3149.1144.4164.5173.2
Oil and gas33.628.817.212.914.916.4
Non-oil and gas 1/148.5146.5131.9131.6149.5156.8
Of which : Manufacturing109.3115.4104.8105.9118.8124.7
Palm oil16.517.515.414.418.417.4
Rubber products9.37.05.85.57.56.1
Other manufacturing83.591.083.586.093.0101.2
Mining30.421.819.518.222.524.1
Imports, f.o.b.−176.3−168.3−135.1−129.0−146.1−158.4
Oil and gas−43.3−40.6−22.9−17.7−21.8−24.0
Non-oil and gas−133.0−127.7−112.2−111.3−124.2−134.4
Services, net−12.1−10.0−8.7−7.0−7.6−6.9
Income, net−27.1−29.7−28.4−29.7−31.8−32.5
Current transfers, net4.25.25.54.44.14.3
Capital and financial account22.044.916.928.928.227.7
Capital account0.00.00.00.00.00.0
Financial account21.944.916.828.628.227.7
Direct investment, net 2/12.214.710.716.120.521.0
Abroad, net−6.6−7.1−5.912.2−3.4−5.6
In Indonesia (FDI), net18.821.816.63.823.826.6
Portfolio investment, net10.926.116.219.019.58.3
Assets, net−1.32.6−1.32.2−1.9−2.0
Liabilities12.123.517.516.821.410.3
Equity securities−1.93.3−1.51.3−1.90.7
Debt securities14.020.219.015.523.39.6
Other investment−0.84.3−10.1−6.5−11.8−1.6
Assets−3.4−3.4−11.82.5−12.3−3.3
Public sector0.00.00.0−0.30.00.0
Private sector−3.4−3.4−11.82.8−12.3−3.3
Liabilities2.67.71.7−9.00.51.7
Public sector−1.4−4.2−0.2−3.3−1.3−1.2
Private sector4.011.91.9−5.71.82.9
Total−7.117.4−0.711.811.37.3
Errors and omissions−0.2−2.2−0.40.30.00.0
Overall balance−7.315.2−1.112.411.37.3
Valuation changes−6.1−2.8−4.8−1.90.00.0
Change in reserve assets (- = increase)13.4−12.55.9−10.4−11.3−7.3
Memorandum items:
Reserve assets position (eop)99.4111.9105.9116.4127.6135.0
In months of prospective imports of goods and services5.98.18.07.98.07.9
In percent of short-term (ST) debt at remaining maturity (RM)177189191213226234
In percent of ST debt at RM plus the current account deficit119146147163166170
Current account (- deficit, percent of GDP)−3.2−3.1−2.0−1.8−1.7−1.9
Non-oil and gas exports, volume growth4.84.50.0−1.011.34.8
Non-oil and gas imports, volume growth−1.2−1.00.95.26.66.2
Terms of trade, percent change (excluding oil)−2.5−3.3−14.6−0.26.52.7
Terms of trade, percent change (including oil)−3.1−2.4−2.53.12.60.5
Gross external financing requirement (in US$ billion) 3/83.8 #83.876.872.371.676.9
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.

Includes “other exports” category.

FDI developments in 2016 reflected some one-off transactions associated with the tax amnesty program.

Defined as current account deficit, plus amortization on medium- and long-term debt and short-term debt at end of previous period.

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

Includes “other exports” category.

FDI developments in 2016 reflected some one-off transactions associated with the tax amnesty program.

Defined as current account deficit, plus amortization on medium- and long-term debt and short-term debt at end of previous period.

Table 4.Indonesia: Medium-Term Macroeconomic Framework, 2015–22
20152016201720182019202020212022
Est.Proj.Proj.Proj.Proj.Proj.
Real GDP (percent change)4.95.05.15.35.55.65.65.6
Domestic demand4.24.64.75.15.35.45.55.5
Of which:
Private consumption 1/4.85.05.05.05.25.25.35.3
Government Consumption5.3−0.12.12.03.84.24.14.0
Gross fixed investment5.04.56.06.26.26.36.46.3
Net exports 2/1.00.10.70.30.30.30.30.3
Output gap0.3−0.1−0.5−0.4−0.10.00.00.0
Prices (12-month percent change)
Consumer prices (end period)3.43.03.33.63.83.73.53.6
Consumer prices (period average)6.43.53.83.43.73.73.63.6
Public finances (in percent of GDP)
General government revenue14.914.313.814.013.913.913.913.9
General government expenditure17.516.816.516.516.416.416.416.4
General government balance−2.6−2.5−2.7−2.5−2.5−2.5−2.5−2.5
General government primary balance−1.2−1.0−1.0−0.9−0.8−0.8−0.9−0.9
General government debt27.428.329.029.529.930.230.330.4
Balance of payments (in billions of U.S. dollars)
Current account balance−17.5−16.8−16.9−20.4−21.9−25.4−28.1−32.0
In percent of GDP−2.0−1.8−1.7−1.9−1.8−1.9−2.0−2.0
Trade balance14.015.418.414.814.714.613.713.8
In percent of GDP1.61.71.81.31.21.11.00.9
Of which : Oil and gas (net)−5.7−4.8−6.9−7.6−7.1−7.3−7.3−7.6
Service balance (in percent of GDP)−1.0−0.8−0.7−0.6−0.6−0.6−0.5−0.5
Overall balance−1.112.111.37.39.47.910.011.2
Gross reserves
In billions of U.S. dollars (end period)105.9116.4127.6135.0144.4152.3162.3173.4
In months of prospective imports8.07.98.07.97.87.67.57.5
As a percent of short-term debt 3/190.9212.9225.8234.3245.5256.2270.6286.9
Total external debt
In billions of U.S. dollars310.7318.8345.4359.3374.4389.0405.5423.3
In percent of GDP36.134.234.032.831.429.828.326.6
Credit
Private Sector Credit10.37.78.610.311.212.312.312.3
Credit-to-GDP gap 4/0.9−0.3−1.0−0.7−0.40.00.10.3
Memorandum items:
Oil production (thousands of barrels per day)800820815800740710710710
Indonesian oil price (period average, in U.S. dollars per barrel)49.240.249.555.953.752.351.851.6
Nominal GDP (in trillions of rupiah)11,53212,40713,60414,85216,24517,79419,46921,296
Nominal GDP (in billions of U.S. dollars)861932
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.

Includes NPISH consumption.

Contribution to GDP growth.

Short-term debt on a remaining maturity basis.

Follows the guidance of the Basel Committee on Banking Supervision.

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

Includes NPISH consumption.

Contribution to GDP growth.

Short-term debt on a remaining maturity basis.

Follows the guidance of the Basel Committee on Banking Supervision.

Table 5.Indonesia: Summary of Central Government Operations, 2014–18(In trillions of rupiah)
20142015201620172018
Proj. Revised BudgetProj.Budget
Revenues and grants1,5501,5081,5561,6371,7361,8161,895
Of which: tax revenues1,1471,2401,2851,3381,4731,4861,618
Oil and gas revenues30412881118114135118
Tax revenues87503646425238
Nontax revenues217784572728280
Non-oil and gas revenues1,2411,3681,4661,5181,6191,6801,775
Tax revenues1,0591,1911,2491,2921,4311,4331,580
Income tax459553630593742650817
Of which : tax amnesty114212100
VAT409424412469476530542
Other192214207231213253221
Nontax revenues182177217226188247195
Grants51291311
Expenditure and net lending1,7771,8081,8642,0002,1332,1892,221
Current expenditure9588719351,0471,1031,1621,194
Personnel244281305340340369366
Subsidies392186174171169168156
Of which : energy subsidies342119107929010695
Fuel240614443455247
Electricity102586349455448
Interest133156183221219242239
Other189248273315374384433
Development expenditure245314219197264260260
Capital spending147217169139206179179
Social assistance spending 1/98975058588181
Transfers to local governments574623710756766766766
Of which : transfers for infrastructure 2/3239101232239230230
Overall balance−227−300−308−363−397−373−326
Financing227300308363397373326
Net issuance of government securities274367408436467451415
Rupiah bond issuance353408440572641
External bond issuance86871098681
Amortization−165−128−140−223−271
Program loan (gross issuance)18553513−6−6
SOE recapitalization and land acquisition−60−91−60−60−66−66
Other−63−45−27−4−7
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.

Some social assistance spending was reclassified to other expenditure in 2016.

Special purpose transfers (DAK) for physical infrastructure and Village Fund transfers. Starting 2017, 25 percent of general transfer and revenue sharing is included.

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

Some social assistance spending was reclassified to other expenditure in 2016.

Special purpose transfers (DAK) for physical infrastructure and Village Fund transfers. Starting 2017, 25 percent of general transfer and revenue sharing is included.

Table 6.Indonesia: Summary of Central Government Operations, 2014–18(In percent of GDP, unless otherwise indicated)
20142015201620172018
Proj.Revised BudgetProj.Budget
Revenues and grants14.713.112.512.012.812.212.8
Of which: tax revenues10.910.810.49.810.810.010.9
Oil and gas revenues2.91.10.70.90.80.90.8
Tax revenues0.80.40.30.30.30.40.3
Nontax revenues2.10.70.40.50.50.60.5
Non-oil and gas revenues11.711.911.811.211.911.312.0
Tax revenues10.010.310.19.510.59.610.6
Income tax4.34.85.14.45.54.45.5
Of which: tax amnesty0.90.20.0
VAT3.93.73.33.43.53.63.6
Other1.81.91.71.71.61.71.5
Nontax revenues1.71.51.71.71.41.71.3
Grants0.00.10.10.00.00.00.0
Expenditure and net lending16.815.715.014.715.714.715.0
Current expenditure9.17.67.57.78.17.88.0
Personnel2.32.42.52.52.52.52.5
Subsidies3.71.61.41.31.21.11.1
Of which : energy subsidies3.21.00.90.70.70.70.6
Fuel2.30.50.40.30.30.30.3
Electricity1.00.50.50.40.30.40.3
Interest1.31.41.51.61.61.61.6
Other1.82.12.22.32.82.62.9
Development expenditure2.32.71.81.41.91.81.8
Capital spending1.41.91.41.01.51.21.2
Social assistance spending 1/0.90.80.40.40.40.50.5
Transfers to local governments5.45.45.75.65.65.25.2
Of which : transfers for infrastructure 2/0.30.30.81.71.81.51.5
Overall balance−2.1−2.6−2.5−2.7−2.9−2.5−2.2
Financing2.12.62.52.72.92.52.2
Memorandum items:
Net issuance of government securities (in trillions of rupiah)274367408436467451415
SOE recapitalization and land acquisition (in trillions of rupiah)659160606666
Primary balance (percent of GDP)−0.9−1.2−1.0−1.0−1.3−0.9−0.6
Cyclically-adjusted primary balance (percent of GDP)−1.0−1.3−1.0−1.0−0.8
Capital spending and transfers (percent of GDP) 3/1.72.22.22.73.32.82.8
General government debt (percent of GDP)24.727.428.329.029.5
Indonesian crude oil price (US$ per barrel)96.549.240.249.545.055.948.0
Oil production (thousands of barrels per day)794800820815815800800
Nominal GDP (in trillions of rupiah)10,57011,53212,40713,60413,60414,85214,852
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.

Some social assistance spending was reclassified to other expenditure in 2016.

Special purpose transfers (DAK) for physical infrastructure and Village Fund transfers. Starting 2017, 25 percent of general transfer and

Sum of capital spending and transfers for infrastructure.

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

Some social assistance spending was reclassified to other expenditure in 2016.

Special purpose transfers (DAK) for physical infrastructure and Village Fund transfers. Starting 2017, 25 percent of general transfer and

Sum of capital spending and transfers for infrastructure.

Table 7.Indonesia: Summary of General Government Operations, 2014–18
20142015201620172018
Proj.Proj.
(In trillions of rupiah)
Total revenue and grants1,7401,7151,7781,8812,082
Taxes1,2741,3791,4341,5011,664
Taxes on income, profits, and capital gains546602666638703
Taxes on goods and services527568556638716
VAT and luxury taxes409424412469530
Excise118145144169186
Taxes on international trade and transactions4435354043
Taxes not elsewhere classified157173176185202
Grants512911
Other revenue461324335379417
Total expenditure1,9672,0152,0872,2432,455
Expense1,6421,6051,6451,7981,930
Of which :
Compensation of employees564631681752819
Purchases/use of goods and services177233260301368
Interest133156183221242
Energy subsidies34211910792106
Social benefit1101126882109
Net acquisition of nonfinancial assets324410442446525
Net lending/borrowing−227−300−308−363−373
Net acquisition of financial assets3582895763
Of which : policy lending33500
Net incurrence of liabilities262382397419436
(In percent of GDP)
Total revenue and grants16.514.914.313.814.0
Taxes12.012.011.611.011.2
Taxes on income, profits, and capital gains5.25.25.44.74.7
Taxes on goods and services5.04.94.54.74.8
VAT and luxury taxes3.93.73.33.43.6
Excise1.11.31.21.21.3
Taxes on international trade and transactions0.40.30.30.30.3
Taxes not elsewhere classified1.51.51.41.41.4
Grants0.00.10.10.00.0
Other revenue4.42.82.72.82.8
Total expenditure18.617.516.816.516.5
Expense15.513.913.313.213.0
Of which :
Compensation of employees5.35.55.55.55.5
Purchases/use of goods and services1.72.02.12.22.5
Interest1.31.41.51.61.6
Energy subsidies3.21.00.90.70.7
Social benefit1.01.00.60.60.7
Net acquisition of nonfinancial assets3.13.63.63.33.5
Net lending/borrowing−2.1−2.6−2.5−2.7−2.5
Net acquisition of financial assets0.30.70.70.40.4
Of which : policy lending0.00.00.00.00.0
Net incurrence of liabilities2.53.33.23.12.9
Memorandum items:
General government debt (In percent of GDP)24.727.428.329.029.5
Nominal GDP (In trillions of rupiah)10,57011,53212,40713,60414,852
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.
Sources: Data provided by the Indonesian authorities; and IMF staff estimates and projections.
Table 8.Indonesia: Monetary Survey, 2013–17(In trillions of rupiah, unless otherwise indicated, end of period)
20132014201520162017
Est.
Bank Indonesia
Net foreign assets1,1661,3491,3851,4401,641
Net domestic assets−343−431−439−450−555
Monetary base8239189469901,086
Monetary survey
Net foreign assets1,0081,1081,1391,2131,523
Net domestic assets2,7233,0723,4103,7924,028
Net claims on central government493625571632566
Claims on other nonfinancial public sector211241224305370
Private sector credit3,0983,4653,8224,1164,471
Other items, net−1,079−1,258−1,208−1,262−1,379
Broad money 1/3,7304,1734,5494,8635,355
Rupiah M23,1443,5683,8894,3454,866
Currency in circulation400529587613683
Deposits2,7443,1153,4203,8374,297
Foreign currency deposits564592646647669
Annual percentage change:
Broad money12.811.99.06.910.1
Rupiah M29.413.59.011.712.0
Monetary base16.711.63.04.69.8
Private sector credit20.011.810.37.78.6
Memorandum items:
Money multiplier (rupiah M2)3.83.94.14.44.5
Base money velocity 2/11.611.512.212.512.5
Rupiah M2 velocity 2/3.03.03.02.92.8
Credit by borrower (annual percentage change)
Corporate25.812.111.810.3
Non-corporate17.010.98.48.3
Credit by sector (annual percentage change)
Agriculture23.919.119.820.0
Mining22.811.7−8.0−13.7
Manufacturing29.314.014.311.9
Services23.09.59.38.8
Household14.111.89.19.3
Sources: Bank Indonesia; and IMF, International Financial Statistics; and staff projections.

Includes securities classified as broad money.

Calculated using end-period quarterly GDP, annualized.

Sources: Bank Indonesia; and IMF, International Financial Statistics; and staff projections.

Includes securities classified as broad money.

Calculated using end-period quarterly GDP, annualized.

Table 9.Indonesia: Financial Soundness Indicators, 2013–17(In percent; unless otherwise indicated)
20132014201520162017
Latest observation
Depository institutions
Capital adequacy
Regulatory capital to risk-weighted assets18.119.621.422.923.2Q3
Core Tier-1 capital to risk-weighted assets16.418.019.021.221.5Q3
Capital to assets12.512.813.614.414.9Q3
Large exposures to capital0.81.00.40.50.4Q3
Asset quality
Nonperforming loans to total gross loans1.72.12.42.92.9Q2
Nonperforming loans, net of provisions to capital4.65.55.95.76.1Q2
Specific provisions to nonperforming loans50.946.851.557.852.8Q2
Earning and profitability
Return on assets3.12.72.22.12.4Q2
Return on equity24.521.317.314.516.0Q2
Interest margin to gross income68.869.070.368.068.6Q2
Trading income to gross income3.22.72.81.23.9Q2
Noninterest expenses to gross income49.250.350.046.649.0Q2
Personnel expenses to noninterest expenses41.340.440.741.841.5Q2
Liquidity and funding
Liquid assets to total assets23.522.923.922.423.3Q2
Liquid assets to short-term liabilities30.533.335.032.633.9Q2
Non-interbank loans to customer deposits99.699.2100.796.395.2Q2
Sensitivity to market risk
Net open position in foreign exchange to capital1.72.40.91.81.9Q2
Foreign currency denominated loans to total loans16.515.714.313.313.0Q2
Foreign currency denominated liabilities to total liabilities24.422.924.120.919.6Q2
Gross asset position in financial derivatives to capital4.22.42.51.41.1Q2
Gross liability position in financial derivatives to capital4.92.63.31.51.0Q2
Nonfinancial corporates
Leverage
Total liabilities to total assets46.848.544.544.143.7Q3
Profitability 1/
Return on assets14.814.113.913.714.6Q3
Liquidity 1/
Current assets to current liabilities249.0280.1261.7220.8214.5Q3
Liquid assets to current liabilities171.8204.7125.2113.7137.0Q3
Debt servicing capacity
Companies with negative equity (in percent of total assets)5.75.42.62.30.7Q3
Companies with financial distress (in percent of total debt) 2/5.05.54.55.14.2Q3
Households
Household debt (in percent of GDP)17.017.116.817.016.9Q1
Real estate markets
Residential real estate prices (year-on-year percentage change)11.56.34.62.43.3Q3
Residential real estate loans to total loans8.08.28.28.38.3Q2
Commercial real estate loans to total loans6.36.87.48.58.3Q2
Sources: Bloomberg Data LP.; IMF, Financial Soundness Indicators; Bank for International Settlements; CEIC Data Co. Ltd.; and IMF staff estimates.

Based on capitalization-weighted average of listed companies.

Companies with financial distress are those with earnings before interest, tax, depreciation and amortization (EBIT) less than interest payments.

Sources: Bloomberg Data LP.; IMF, Financial Soundness Indicators; Bank for International Settlements; CEIC Data Co. Ltd.; and IMF staff estimates.

Based on capitalization-weighted average of listed companies.

Companies with financial distress are those with earnings before interest, tax, depreciation and amortization (EBIT) less than interest payments.

Table 10.Indonesia: Key Poverty and Social Indicators
Population261.9millions(2017)
Life expectancy at birth, total69.1years(2015)
Mortality rate, under 527.2per 1,000 live births(2015)
Secondary school enrollment:
Total85.8percent(2015)
Female86.0percent(2015)
Male85.7percent(2015)
GINI index39.3(2017)
Income share held by highest 20%47.4percent(2013)
Income share held by lowest 20%7.2percent(2013)
Poverty rate11.0percent(2017)
CO2 emissions1.9metric tons per capita(2013)
Population with access to improved water87.4percent(2015)
Population with access to sanitation60.8percent(2015)
Human development index0.69(2015)
Rank113
Gender inequality index0.47(2015)
Rank105
Sources: World Bank; Badan Pusat Statistik; and United Nations Development Programme.
Sources: World Bank; Badan Pusat Statistik; and United Nations Development Programme.
Table 11.Indonesia: Key FSAP Recommendations
Key RecommendationsTime
Institutional and legal arrangements
Revise OJK Law to give primacy to objective of safeguarding stability, BI Law to include a financial stability and macroprudential policy mandate focused on systemic risk of the financial system, with access to data; and LPS Law to focus objectives on the maintenance of financial stability, continuity of critical functions, protection of insured deposits, and minimization of resolution costs.Medium term (MT)
Amend the Insurance Law to specify policyholder protection as principal objective of OJK.MT
Strengthen legal protection of supervisors and officials of all agencies involved in financial oversight and crisis management in line with global standards.MT
Systemic risk monitoring and prudential policy
Strengthen BI’s capacity for systemic risk analysis and macroprudential stress tests, and OJK’s capacity for regulatory stress tests; OJK should do bottom-up stress tests for D-SIBs regularly.Near term (NT)
Introduce a foreign currency liquidity coverage ratio.NT
Financial sector oversight
Reduce OJK’s silo structure, including by revising the OJK Law to remove the responsibilities of individual Commissioners for the supervision of specific sectors.MT
Strengthen the banking supervisory approach and continue enhancing supervisory practices for financial conglomerates.NT
Further strengthen the enforcement of credit and risk management regulations.MT
Revise the insurance supervisory framework (three strikes-approach) to allow prompt actions.MT
Governance of financial conglomerates
Strengthen corporate governance practices within the financial system, including the Board of Commissioners’ oversight roles and responsibilities.MT
Introduce legal provisions for licensed non-operating financial holding companies.MT
Crisis management and resolution, and safety nets
Revise the PPKSK Law to clarify the role of the KSSK as solely a coordination body; limit the involvement of the President to approving public funding.MT
Adjust the emergency liquidity assistance framework to ensure it is effective.NT
Amend the relevant laws to ensure that resolution powers can be exercised over financial conglomerates.MT
Develop resolution options and implementation guidelines for banks, and resolvability assessment and resolution planning frameworks for D-SIBs.NT
Financial integrity
Integrate key ML/TF risks in the priorities and operations of relevant agencies.NT
Finalize and implement risk-based AML/CFT supervisory tools.NT
Financial deepening and inclusion
Develop an integrated roadmap for promoting financial deepening and inclusion.MT
Enhance bond yield curve by consolidating debt issuance and improving secondary markets.MT

54. The corporate prudential FX regulation can be further improved by extending its coverage to all corporate FX liabilities. This regulation is assessed as a residency-based capital flow management measure (CFM) by the IMF’s Institutional View and as a macroprudential measure (MPM) because it applies only to FX liabilities of corporates with external debt, while it is intended to mitigate a buildup of systemic risk. Going forward, this regulation should be periodically reviewed and could be revisited as steps are taken to strengthen regulation and supervision to address systemic financial risks.

Authorities’ Views

55. The authorities broadly agreed with the reform priorities on supervision and risk management. They are committed to take further steps to strengthen the financial sector. These include strengthening and clarifying the roles and objectives of statutory authorities by amending the laws of BI, OJK, and Indonesian Deposit Insurance Corporation (LPS) as well as efforts to advance financial market deepening and promote further financial inclusion. Several changes are already underway to strengthen the legal and supervisory framework.

56. The authorities are of the view that the corporate prudential FX regulation should not be seen as a CFM nor a CFM/MPM, but plan to do a cost-benefit analysis of extending its coverage. The regulation is aimed to ensure macrofinancial stability through the adoption of prudential principles on corporate foreign borrowing. This regulation is not targeted to limit capital flows, and therefore it should be categorized as “other policies.” The authorities encouraged staff to continue deepening understanding on this policy area by exhaustively drawing on country experiences, including Indonesia’s experience, in mitigating corporate sector risks.

Staff Appraisal

57. The Indonesian economy continues to perform well. Economic growth has stabilized at near 5 percent, inflation has moderated, the CA deficit remains manageable, and systemic risks are contained. The economic outlook is positive, with a continuation of recent trends and a gradual pickup in growth over the medium term. Risks remain tilted to the downside and are mainly external. The public and corporate sectors continue to rely heavily to external financing, leaving Indonesia vulnerable to a reversal in capital inflows. Indonesia’s external position in 2017 continues to be assessed as broadly consistent with fundamentals and desirable policies.

58. Achieving higher potential growth would help create jobs for the young and growing labor force. The policy priority should be a self-reinforcing fiscal-structural reform package that mobilizes revenues to finance development spending (infrastructure, education, health, and targeted transfers), and supports structural reforms to the product, labor, and financial markets.

59. The government has rebalanced public spending to priority sectors and improved efficiency. The targeting of fuel and electricity subsidies to low-income households has been improved, and performance criteria for transfers to local governments have been adopted. However, the implementation of a fully automatic pricing mechanism for fuel and electricity has been delayed.

60. Early implementation of a MTRS to finance growth-enhancing priority spending and structural reforms is critical. The MTRS should also aim to lower poverty and inequality, and should include frontloaded tax policy reforms and gradual gains from tax administration reform by removing exemptions in VAT, CIT, and PIT; introducing excise taxes on vehicles and fuel, raising the VAT rate, improving compliance, and streamlining the VAT refund process. As adopting a MTRS will take time, the short-term action items should be implemented to arrest the fall in revenue.

61. Infrastructure development should be paced in line with available financing and the economy’s absorptive capacity. Priority should be given to financing infrastructure development with revenue from the MTRS and encouraging private sector participation, including FDI. This would limit the buildup of corporate external debt, including by SOEs, and the potential adverse spillovers to the domestic financial system. Infrastructure development should also be accompanied by sound risk management to mitigate fiscal risks from contingent liabilities from SOE debt and PPPs.

62. Efforts to streamline regulations should target areas with the largest potential gains for the economy, such as reducing state control, antitrust exemptions, and barriers in the network sector. Avoiding conflicting regulations requires greater coordination among ministries and regional governments under a national policy direction. Rationalizing non-tariff measures and FDI restrictions would support linkages with global value chains and competitiveness.

63. Improving education and easing labor market regulations would support employment. Ensuring more equitable access to quality education requires improving the efficiency of education spending and the quality of education. Promoting employment and reducing the use of short-term contracts requires streamlining stringent job protection, while improving vocational training and job placement services. Enhancing productivity and female labor participation requires a more open immigration policy for skilled labor, flexible work arrangements, and affordable childcare.

64. Financial deepening with appropriate prudential standards would support infrastructure development. The recent progress developing a national strategy for capital market development reflects high-level political support and enhanced inter-agency coordination. Improving the insolvency and creditor rights regimes would raise participation in the corporate bond market and financial access for MSMEs. The corporate prudential FX regulation can be further improved by extending its coverage to all corporate FX liabilities.

65. The near-term policy mix should support growth while preserving stability. Monetary policy should continue focusing on price stability and supporting growth. The current monetary stance is appropriate; BI should stay on hold in the immediate future and assess the pass-through of its recent actions. BI should also allow the exchange rate to move freely in line with market forces, with FX intervention limited to preventing disorderly market conditions. Fiscal adjustment should be gradual in 2018 to protect growth and rebuild fiscal buffers.

66. Efforts should continue to strengthen financial oversight and crisis management, and implement the FSAP recommendations. The authorities have made progress in strengthening the frameworks for financial oversight and crisis management and resolution in recent years. The FSAP identified several areas where further improvement is needed, including clarification of institutional mandates, improving supervision of financial institutions and financial conglomerates, adopting a more rigorous approach to credit risk, and reconsidering some elements of the new crisis management framework, including the ELA framework.

67. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Box 1.Demographic Dividend: Opportunities and Challenges

Indonesia has the fourth largest population in the world (260 million), with a median age of 28 years. Population growth averaged 1.3 percent per year in 2000-16, but it fell to 1.1 percent in 2016 due to a lower fertility rate. At the same time, the working age population (15-64 years old) grew by 1.6 percent or 2.5 million people per year in 2000-16, reaching 67 percent of total population in 2016. Urbanization has also been rapid.

Indonesia: Demographic Indicators
2000200520102016 1/
Population growth (percent)1.41.41.31.1
Working age (15-64 years old)2.11.61.41.2
Rural−0.7−0.1−0.3−0.4
Urban4.33.12.92.5
In percent of total
Working age (15-64 years old)64.665.366.257.2
Rural58.054.150.145.5
Urban42.045.949.954.5
Population <30 years old58.055.753.751.9
Total population (million)211.5226.7242.5261.1
Life expectancy at birth, total (years)66.267.268.169.1
Fertility rate, total (births per woman)2.52.52.52.4
Source: World Bank; Health Nutrition and Population Statistics; and BPS.

or latest available data.

Source: World Bank; Health Nutrition and Population Statistics; and BPS.

or latest available data.

The share of working age population is projected to peak at 70 percent in 2030, providing a sizable demographic dividend to the economy. Working age population is projected to continue growing faster than overall population until 2030, and slightly slower than that after, with the share of working age population remaining above current levels until 2050.1/ Thus, Indonesia has a window of opportunity to take advantage of its demographic dividend and try to get rich before getting old.

Fertility, Population Growth and Life Expectancy

(In percent left scale)

Source: IMF staff estimates based on United Nations 2015 (medium fertility scenario)

The demographic dividend also poses challenges. The economy will need to accelerate job creation to absorb the new labor force entrants and lower youth unemployment (15-29 years old), which remains significantly higher than in other age groups likely due to stringent labor regulations, low education quality, and skill mismatches. Addressing youth unemployment and reaping the benefits of the demographic dividend will require implementing structural reforms to accelerate growth and diversify the economy away from agriculture and towards industry and services, which have higher elasticities of employment growth to output growth.

Unemployment Rates by Age Group

(In percent of labor force)

Sources: CEIC Data Co. Ltd; and IMF staff estimates.

1/ Arslanalp and Lee (2017) project that Indonesia’s demographic classification will change to late dividend by 2030 (a shrinking working age population share over the subsequent 15 years) from early dividend in 2015 (an increasing working-age population share over the subsequent 15 years).

Box 2.Strengthening Institutions and Funding for Infrastructure

The authorities have made infrastructure development a priority. They have increased public capital spending, recapitalized SOEs to boost infrastructure investment, and improved the institutional framework by creating the Committee for Acceleration of Priority Infrastructure Delivery (KPPIP) and accelerating land acquisition procedures. The authorities have selected 247 National Strategic Projects with a cost of 32 percent of GDP to be implemented during 2015-22. KPPIP coordinates 37 of these projects, including 12 oil refineries, one electricity program, 74 roads, and 23 rail roads.

Funding Allocation Plan for 247 Projects

(In percent of GDP)

Sources: The Committee for Acceleration of Priority Infrastructure Delivery (KPPIP): and IMF staff estimates.

Progress has already been made on infrastructure development:

  • Government and SOE infrastructure spending has increased. Central government capital spending and transfers to local governments for infrastructure rose by 1 percent of GDP between 2014 and 2017. The government also injected capital to SOEs by 0.6 percent of GDP in 2015-16 to support their infrastructure investment. SOEs are slowly leveraging to finance infrastructure projects, including by issuing domestic and external bonds. The government has also committed guarantees for infrastructure investment (credit, business viability, and PPP guarantees), which reached 2.8 percent of GDP in March 2017, below the maximum limit of 6 percent of GDP for 2017-20.

  • The institutional framework has improved. KPPIP was created to accelerate and coordinate the priority projects. The land acquisition process has been streamlined, with the maximum time needed to acquire land shortened to 400 days from 518 days. The State Asset Management Agency has made this process more flexible by unifying land acquisitions for the National Strategic Projects under one agency.

  • The authorities are making efforts to attract private sector participation. The government is providing guarantees to ensure acceptable market returns for the private sector to finance infrastructure projects, including through the Viability Gap Fund (covering up to 49 percent of the construction cost) and Availability Payment (annuity payment scheme during the concession period). The authorities are also aiming to mobilize debt and equity financing and develop the regulatory framework for new financing instruments, including structured products (e.g. asset backed securities) and infrastructure bonds.

  • The Negative Investment List has been revised to attract FDI to infrastructure development. For instance, the foreign ownership limit for toll road operators, telecommunications, and testing companies has been increased to 100 percent from 95 percent; and the foreign ownership limit for distribution and warehousing has been raised to 87 percent from 33 percent.

  • Out of 247 National Strategic Projects, four have been completed; 131 are under construction; and 112 are under preparation. The construction of the light rail transit in Jakarta has been fast-tracked, and land acquisition has been accelerated. For instance, land acquisition for the Java North Line Double Track Rail project took less than 2 years to complete.

  • Several PPP projects are under way: Umbulan Water (US$0.3 million) supported by the Viability Funding Gap; Palapa fiber-optic supported by the Availability Payment scheme (US$0.6 million); Central Java Power Plant (US$3.0 billion); and three toll roads (US$2.2 billion).

Box 3.Implementation of the 2017 FSAP Key Recommendations

The authorities are taking early steps to implement some of the key FSAP recommendations, although others, such as changes to laws, will take time to implement. Progress has been achieved in the following areas:

  • A draft bill amending the BI law is now under preparation and is included in the 2015-19 National Legislation Program. It will set out a financial stability and macroprudential mandate for BI. The legislation program also includes an initiative to amend the OJK law, regarding the primacy of objectives and authority over non-operating financial holding companies. Also, the authorities acknowledge the importance of insurance policyholder protection and plan to propose, after consultations with Parliament, an amendment of the Insurance Law to specify policyholder protection as principal objective of OJK.

  • BI and OJK are improving their stress test frameworks and have established a framework for a joint stress test and data sharing.

  • To advance on the recommendation to reduce silos in financial oversight, which ultimately requires changes to the OJK law, OJK has established a new Integrated Supervisory and Regulatory Department which brings internal coordination directly under the authority of the Chairman as an interim solution.

  • OJK has started an initiative to strengthen its banking supervision by re-evaluating data quality, methodology, and business process used in on-site and off-site supervision, and optimize the IT system to support the integrated supervision.

  • OJK has issued a new regulation in 2017 related to the imposition of administrative sanctions in the form of revocation of business licenses to insurance companies in specific circumstances, such as drastic deterioration of financial condition.

  • In the area of crisis management and resolution, the authorities have focused on the promulgation of several regulations under the PPKSK Law, including regulations regarding recovery planning for domestic systemically important banks, resolution framework for both systemic and non-systemic banks, and write-off and haircut of remaining assets from the Bank Restructuring Program. The authorities have also conducted a series of join crisis simulation exercises.

  • BI and OJK have issued regulations to implement risk-based AML/CFT supervision.

Figure 1.Indonesia: Macro-Financial Developments

Figure 2.Indonesia: Recent Market Developments

Figure 3.Indonesia: Real Sector

Figure 4.Indonesia: External Sector

Figure 5.Indonesia: Fiscal Sector

Figure 6.Indonesia: Monetary Sector and Bank Liquidity Developments

Figure 7.Selected Emerging Market Economies: Financial Soundness Indicators, 2017:Q2 1/

1/ Or latest available data.

Figure 8.Financial Soundness Indicators by Size of Commercial Banks

Appendix I. Risk Assessment Matrix 1/
Source of RisksRelative LikelihoodExpected ImpactsRecommended Policy Responses
GlobalTighter global financial conditions. Fed normalization and tapering by ECB increase global rates and term premia, strengthen the U.S. dollar and the euro vis-à-vis the other currencies, and correct market valuations. Adjustments could be disruptive if there are policy surprises. Higher debt service and refinancing risks could stress leveraged firms, households, and vulnerable sovereigns, including through capital account pressures.HighMediumMaintain exchange rate flexibility and market-determined bond yields. Preserve a sound fiscal position, while allowing automatic stabilizers to work. Tighten monetary policy and support banks facing funding pressures to preserve financial stability and avoid negative feedback loops with capital outflows. Closely monitor corporate sector vulnerabilities. Maintain vigilance on exchange rate pass-through to inflation. Access contingent external financing if needed.
Capital inflows decline due to weaker investor appetite for emerging market (EM) assets, creating funding pressures for the current account (CA) deficit. Tighter external financial conditions put pressure on the balance sheets of the public, financial, and corporate sectors. Bank funding becomes constrained, leading to a crunch in domestic credit growth and higher domestic borrowing costs. Rollover risks rise for the public, financial, and corporate sectors, and the balance sheet of households (including property) weaken. Economic growth falls, reinforced by asset price corrections and lower confidence. The rupiah depreciates and imports decline, reducing the CA deficit.
Significant China slowdown. Efforts to rein in financial risks expose vulnerabilities and reduce near-term growth. Over the medium term, ambitious growth targets lead to unsustainable policies and higher financial imbalances. A sharp slowdown leads to lower commodity prices, global financial market volatility, and lower global growth.MediumHighMaintain exchange rate flexibility to help reduce the current account deficit and limit FX reserve losses. More stringent fiscal measures to contain the budget deficit might be necessary if the slowdown in EMs were accompanied by protracted financial market volatility that restricts funding. Accelerate infrastructure spending and structural reforms to boost productivity and employment in non-resource sectors, and export diversification.
Lower export volume and prices (particularly those of commodities) could widen the current account deficit, putting pressure on FX reserves and the exchange rate. The fiscal balance would deteriorate on weaker oil and gas revenues and knock-on effects to domestic demand, with the financial sector exposed to losses from loans to the commodity sector and a broader economic slowdown. Corporate profits would decline from weak commodity related activities.
Retreat from cross-border integration lead to reduced global and regional policy collaboration with negative effects on trade, capital and labor flows, and growth.MediumLow-MediumResist protectionism and deepen regional trade integration. Seek new opportunities to enhance position in global value chains. Strengthen domestic drivers of growth by enhancing infrastructure and implementing structural reforms.
Exports and capital inflows decline, putting pressure on the exchange rate and foreign reserves. The balance sheets of the public, financial, and corporate sectors weaken, and domestic financial conditions tighten. Domestic credit growth slows and borrowing costs rise.
Stronger global growth and commodity prices. The global recovery strengthens more than expected, leading to higher commodity prices due to robust demand.LowMediumIn addition to increasing public investment and other priority spending, use the extra fiscal space to rebuild fiscal buffers and support costly structural reforms. Remain vigilant to overheating risks, and adjust policies as needed.
The fiscal position strengthens due to higher oil and gas revenues, increasing the fiscal space for public investment and other expenditure, with positive spillovers to growth. Private investment and exports also pick up, especially in commodity-related sectors, boosting growth.
DomesticRevenue shortfalls or larger financing needs due to higher interest rates, constrain fiscal space, with adverse spillovers to growth. Large ad-hoc cuts in public spending are taken to keep the budget deficit below the statutory ceiling.MediumMediumImplement growth-friendly revenue reforms to raise collections, and prioritize spending in growth-critical areas. Accelerate structural reforms to the trade and investment regime to boost productivity, private investment, and exports. Ease monetary policy if necessary, provide support to banks in need to preserve financial stability, and monitor corporate borrowers at risk.
The fiscal impulse becomes negative, resulting in a growth slowdown that can damage investor confidence, curb capital inflows, raise bank NPLs, increase the country risk premium, and raise costs for corporate external borrowing. Corporate are forced to reduce costs by laying off workers, which further weaken domestic demand.
Natural disasters, disrupt economic activity and affect sentiment, resulting in higher fiscal expenditure.MediumLowImplement revenue enhancing reforms and prioritize expenditure to the affected region. If the economy slows significantly, ease monetary policy, provide support to banks, and monitor corporate borrowers at risk.
Economic activity in the affected regions is disrupted and business sentiment suffers. Economic growth slows leading to a decline in portfolio inflows. Fiscal expenditure increases to provide disaster relief and for reconstruction.
Appendix II. External Sector Report
IndonesiaOverall Assessment
Foreign asset and liability position and trajectoryBackground. At end-June 2017, Indonesia’s net international investment position (NIIP) stood at -35¾ percent of GDP, compared to -43¾ percent of GDP at end-2015 (and -39¼ percent at end-2012). The less negative net liability position was largely due to the disclosure of external financial assets held by residents under the tax amnesty program. At end-June 2017, gross external assets stood at 32½ percent of GDP (close to 40 percent being reserve assets) and gross external liabilities at 68¼ percent of GDP. Indonesia’s gross external debt was moderate at 34¼ percent of GDP at end-June 2017, with 19½ percent of external debt denominated in rupiah. About one-third of government’s external debt (at 17 percent of GDP at end-June 2017) was denominated in rupiah.

Assessment. The level and composition of the NIIP and gross external debt indicate that Indonesia’s external position is sustainable, but nonresident holdings of rupiah denominated government bonds, with a 38 percent share of the total stock (or 6 percent of GDP) at end-October 2017, could be affected by global financial volatility. Staff projections for the current account suggest that the NIIP position as a percent of GDP will strengthen over the medium term.
Overall Assessment

The external position of Indonesia in 2017 was assessed to be broadly consistent with medium-term fundamentals and desirable policies. The recovery of commodity prices and external demand and relatively low projected world oil prices should help to contain the current account deficit. External financing appears sustainable, although the large share of foreign portfolio holdings makes the economy vulnerable to external shocks.

Potential Policy Responses

Continued flexibility of the exchange rate and market-determined bond yields would continue to underpin external stability, supported by monetary policy focused on containing inflation within Bank Indonesia’s target band. The fiscal position should be strengthened by accelerating tax reforms to boost investor confidence, keeping the fiscal deficit within the statutory limit. While expanding the safety-net could lead to a widening in the CA deficit over the medium term, pro-competitive structural policies, particularly easing non-tariff trade barriers and FDI restrictions would bolster exports and external competitiveness, helping contain the CA deficit, and continuing infrastructure investment and strengthening human capital (including through job placement services, vocational training, and better education) can help ease supply bottlenecks. Deepening financial markets would help to strengthen resilience to external shocks.
Current accountBackground. Indonesia’s current account deficit is projected at 1.7 percent of GDP in 2017, an improvement from the peak of 3.2 percent in 2013, as the economy has adjusted to the low commodity prices. Exports and imports started to pick up in Q4: 2016, as commodity prices bottomed out. Over the medium term, a moderate increase in the current account deficit is expected from a rise in capital goods and raw material imports tied to infrastructure investment and a pickup in domestic demand. A gradual increase in manufacturing exports, stronger demand from trading partners, and relatively low projected world oil prices should help limit the current account deficit.

Assessment. The EBA CA model suggests a gap of -0.1 percent for 2017, consistent with an estimated cyclically-adjusted CA balance of -1.4 percent of GDP and a norm of -1.3 percent of GDP. Taking uncertainties around the estimates into account, staff assesses that a norm of -2.3 percent to -0.3 percent of GDP is appropriate.1/ This suggests that the CA gap range of about -1.1 percent to 0.9 percent of GDP for 2017. Domestic policy gaps, including in social spending and policy gaps in partner countries (particularly fiscal) are largely offset by other distortions not captured by the model.
Real exchange rateBackground. Compared to the 2016 average, the average REER appreciated by 2.1 percent in the first ten months of 2017, due to relatively higher inflation rate than its trading partners, as the average NEER remained broadly the same.

Assessment. EBA index and level REER results point to an REER gap of about 0.5 percent to 3.9 percent for 2017, respectively, in line with staff’s REER gap assessment in the range of -4.5 percent to 5.5 percent (based on the CA assessment and estimated elasticities).
Capital and financial accounts: flows and policy measuresBackground. In 2017: Q1–Q3, net capital and financial account inflows (3.1 percent of GDP) have been sustained by net FDI inflows (1.9 percent of GDP) and net portfolio inflows (2.5 percent of GDP), while net other investment inflows were at -1.3 percent.

Assessment. Net and gross financial flows have been steady since the global financial crisis despite some short periods of volatility. The narrower current account deficit and strengthened policy framework, including exchange rate flexibility since mid-2013 have also helped reduce capital flow volatility. Continued strong policies focused on strengthening the fiscal position, keeping inflation in check, and easing supply bottlenecks would help sustain capital inflows in the medium term.
FX intervention and reserves levelBackground. Since mid-2013, Indonesia has had a more flexible exchange rate policy framework. Its floating regime has better facilitated adjustments in exchange rates to market conditions. At end-November 2017, reserves were US$126 billion (equal to 12% percent of GDP, about 133 percent of IMF’s reserve adequacy metric, and about 8 months of prospective imports of goods and services) compared to US$116.4 billion at end-2016. In addition, contingencies and swap lines amounting to about US$81% billion are in place.

Assessment. Volatile capital flows could cause reserves to decline significantly. While the composite metric may not adequately account for commodity price volatility, the current level of reserves (US$126 billion at end-November) should be sufficient to absorb most shocks, with predetermined drains also manageable. Intervention should aim primarily at preventing disorderly market conditions, while allowing the exchange rate to adjust to external shocks.
Technical Background Notes1/ A range of +/- 1 percent is added to reflect the fact that the EBA-regression estimates are subject to normal uncertainty.
Appendix III. Debt Sustainability Analysis

Indonesia’s external debt remains moderate and sustainable, supported by robust real GDP growth and high nondebt generating capital inflows. Public debt is also moderate and sustainable. However, potentially weaker-than-expected revenue, contingent liabilities from state-owned enterprises (SOEs) and public-private partnerships (PPPs) should be carefully monitored. Reliance on foreign investors remains sizable, which could leave Indonesia susceptible to capital flow reversals.

External Debt Sustainability

Indonesia’s external debt has stabilized at a moderate level after steady increases in recent years. External debt reached 34¼ percent of GDP in 2016, down from 36 percent in 2015, reflecting a decline in external debt of the nonbank private sector. General government external debt has been stable, including internationally issued bonds and holdings of domestic bonds by nonresidents. These trends are projected to continue, with external debt declining to 34 percent of GDP at end-2017 (Figure 1 and Table 1).

Figure 1.Indonesia: External Debt and Debt Service

Table 1.Indonesia: External Debt Sustainability Framework, 2012–2022(In percent of GDP, unless otherwise indicated)
ActualProjections
20122013201420152016201720182019202020212022Debt-stabilizing non-interest current account 6/
1Baseline: External debt27.520.032.936.134.234.032.331.429.323.326.6−3.9
2Change in external debt2.21.53.33.2−1.9−0.2−1.2−1.4−1.5−1.5−1.7
3Identified external debt-creating flows (4+8+9)0.11.31.51.6−2,3−1.3−1.3−1.3−1.7−1.6−1.5
4Current account deficit, excluding Interest payments2.12.62.41.10.00.70.90.30.91.01.1
5Deficit in balance of goods and services−0.2−0.7−0.30.60.91.10.70.60.50.50.4
6Exports23.022.422.319.918.018.513.317.917.717.216.7
7Imports−23.2−23.0−22.7−19.3−17.1−17.5−17.6−17.3−17.1−16.7−16.3
8Net nondebt creating capital inflows (negative)−1.7−1.1−2.0−1.1−1.9−1.8−2.0−2.0−2.1−2.1−2.1
9Automatic debt dynamics 1/−0.30.31.21.5−1.3−0.7−0.7−0.6−0.6−0.6−0.5
10Contribution from nominal interest rate0.60.60.70.30.90.31.01.01.01.00.9
11Contribution from real GDP growth−1.5−1.5−1.5−1.7−1.7−1.6−1.7−1.7−1.6−1.5−1.4
12Contribution from price and exchange rate changes 2/0.51.32.02.3−1.1
13Residual, including change in gross foreign assets [2-3] 3/2.1−0.22.41.60.91.50.60.40.20.1−0.2
External debt-to-exports ratio (in percent]119.6129.8147.5181.3190.0183.3179.5175.1168.9165.1159.0
Gross external financing need (in billions of U.S. dollars] 4/71.283.883.376.872.371.676.979.584.287.592.0
In percent of GDP7.79.19.48.97.87.07.06.76.56.15.8
Scenario with key variables at their historical averages 5/10-Year10-Year34.032.030.328.426.725.1−2.8
HistoricalStandard
Key Macroeconomic Assumptions Underlying BaselineAverageDeviation
Real GDP growth (in percent]6.05.65.04.95.05.80.95.15.35.55.65.65.6
GDP deflator in U.S. dollars (change in percent)−2.9−5.5−7.4−7.83.13.510.33.82.33.33.44.05.3
Nominal external interest rate (in percent]2.32.02.42.62.82.80.73.03.23.43.63.63.6
Growth of exports (U.S. dollar terms, in percent)−0.9−2.8−3.0−13.8−2.15.015.712.36.26.87.86.68.4
Growth of imports (U.S. dollar terms, in percent]12.7−0.8−4.5−17.8−4.07.020.111.58.37.28.37.18.8
Current account balance, excluding interest payments−2.1−2.6−2.4−1.1−0.9−0.12.0−0.7−0.9−0.8−0.9−1.0−1.1
Net nondebt creating capital inflows1.71.12.01.11.91.30.51.82.02.02.12.12.1

Derived as [r - g - r[1+g] + ea[1+r]]/[1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency], and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g] + ea(1+r]]/(1+g+r+gr] times previous period debt stock, r increases with an appreciating domestic currency [e > 0] and rising inflation (based on GDP deflator].

For projection, line includes the impart of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP] remain at their levels of the last projection year.

Derived as [r - g - r[1+g] + ea[1+r]]/[1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency], and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g] + ea(1+r]]/(1+g+r+gr] times previous period debt stock, r increases with an appreciating domestic currency [e > 0] and rising inflation (based on GDP deflator].

For projection, line includes the impart of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP] remain at their levels of the last projection year.

External debt is projected to gradually decline in the medium term. In the baseline scenario, external debt would decline to 26.6 percent in 2022 reflecting strong real GDP growth and higher nondebt creating capital inflows to finance the current account deficits. Public and private external debt are expected to decline as external borrowing by the public sector is tightly regulated by an inter-ministerial committee and the domestic financial market develops.

External debt sustainability is robust to interest rate and GDP shocks, but is more sensitive to current account and exchange rate shocks (Figure 2). A widening of the current account deficit from current levels would cause external debt to rise moderately (a one standard deviation shock would increase external debt to 31 percent of GDP by 2022). Exchange rate depreciation would have the largest impact—a 30 percent depreciation in 2018 would raise external debt to 46 percent of GDP in 2018 followed by a gradual decline to 37 percent of GDP by 2022.

Figure 2.Indonesia: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data; and staff estimates.

1/ Shaded areas represent actual data, Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown,

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead,

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2018

Public Debt Sustainability

Indonesia’s public sector debt remains moderate. General government debt has declined steadily from 87 percent of GDP in 2000 to 28 percent in 2016, owing to a prudent fiscal stance, which has been anchored by a fiscal rule since 2003. This rule caps the general government deficit at 3 percent of GDP and debt at 60 percent. The debt dynamics have been also favorable, with strong real GDP growth and moderate real interest rates. In 2017, public debt is projected to rise to 29 percent of GDP, reflecting a slightly larger primary deficit than in the past but still within the fiscal rule. At the same time, foreign-currency denominated debt has fallen to less than half of total public sector debt, as issuance in the domestic rupiah bond market has grown. However, dependence on foreign investors remains sizable, with nonresidents holding 61 percent of general government debt. Moreover, the share of foreign ownership of rupiah-denominated government bonds rose from 20 percent in 2009 to 40 percent in September 2017.

Public sector debt is expected to increase modestly over the medium term (Figure 3). The baseline scenario envisages the general government deficit to remain at 2.5 percent of GDP over the medium term, resulting in a primary deficit of 0.9 percent of GDP. Favorable debt dynamics, with a negative interest rate-growth differential (-0.9 percent over the medium term), would limit the increase in the debt-to-GDP ratio, which is expected to reach 30% percent by 2022. Gross financing needs are also expected to remain moderate at around 4.4 percent of GDP over the medium term.

Figure 3.Indonesia: Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as general government.

2/ Based on available data.

3/ EMBIG.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r - π(1 + g) - g + ae(1 + r)]/(1 + g + π +gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a - share of fa reign-currency denominated debt: and e - nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1 + g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1 + r).

8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flaws) remain at the level of the last projection year.

Public debt dynamics are robust to both standard shocks and stress tests (Figures 4 and 5). Even under the most severe scenario with a combined macro-fiscal shock, total government debt would stabilize at 36 percent of GDP or 258 percent of revenue by 2022, with gross financing needs staying below 6 percent of GDP. Nevertheless, fiscal risks arising from potentially weaker-than-expected revenue and expanding balance sheets of SOEs and PPPs, will need to be managed carefully.

Figure 4.Indonesia: Public DSA—Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Figure 5.Indonesia: Public DSA—Stress Tests

Source: IMF staff.

Appendix IV. The Authorities’ Economic Policy Packages

The authorities have issued 16 economic policy packages since September 2015. These packages aim to improve competitiveness and boost exports and investment by harmonizing regulations, simplifying bureaucratic processes, and ensuring law enforceability.

Progress has been made in several areas. About 215 regulations have been revised to lower administrative burdens for businesses and reduce trade barriers; a transparent minimum wage formula has been adopted; the land acquisition process has been simplified; a 3-hour one-stop service has been launched; and a single submission system linked to local government regulations is being introduced. These reforms have led to a notable raise in Indonesia’s ranking in the World Bank’s Doing Business from the 114th position in 2015 to the 72nd position in 2017.

The authorities’ have adopted a more holistic approach in recent policy packages, with clear communication and strong coordination with local governments.

  • Earlier packages entailed ad-hoc or general measures rather than specific measures to address bottlenecks in each sector. The most recent packages, however, have adopted a more strategic, thematic, and holistic approach. For example, the 14th package intends to create a roadmap for the e-commerce industry; the 15th package aims to improve logistics; and the 16th package seeks to create a single submission system.

  • The authorities have improved their communication strategy, providing diagnostics of critical constraints in selected sectors and clarifying policy objectives and targets.

  • The authorities are also strengthening coordination with local governments. The impact of earlier packages was limited due to bottlenecks in the regional governments due to concerns about their revenue streams or lack of capacity. More recently, the government has focused on standardizing regulations and strengthening capacity, cooperation and coordination with local governments.

The authorities are committed to continue improving the business climate. They will make a comprehensive review of the key issues in the major sectors of the economy, address underlying bottlenecks, and continue to strengthen coordination with regional governments.

Key measures in the 16 economic policy packages:

Deregulation

The authorities have revised 215 regulations, including 50 regulations at the Presidential Level and 165 regulations at the Ministerial/Institutional level. Deregulation efforts have centered on reducing administrative burdens for corporates, lowering barriers to trade, and easing legal barriers that protect existing businesses.

The FDI regime has been partially liberalized. To support infrastructure development, the foreign ownership limit for toll road operators, telecommunications, and testing companies has risen to 100 percent from 95 percent; and that for distribution and warehousing to 87 percent from 33 percent. Other measures include allowing for partnership with SMEs; introducing a grandfathering clause protecting existing foreign investor from potentially tighter protection in the future; and strengthening coordination with ministries, agencies, and regional governments.

Foreign Ownership Limit(In percent)
BeforeAfter
Cold storage33100
Toll road operator, telecommunication, testing company95100
Distribution, warehousing3387
Consultancy for construction5567
Telecommunication provider with integrated services5567
Restaurants, bars51100
Rharmaceutical raw materials manufacturing85100
Sports center, film processing lab, crumb rubber49100
Professional training, golf course management, air transport support service, travel bureau4967
Source: Data provided by the Indonesian authorities.
Source: Data provided by the Indonesian authorities.

Investment Certainty

The setting of the minimum wage has been made more transparent and predictable. Since 2016, the increases in the minimum wage is set by a formula that aligns it with inflation and real GDP growth. This formula has already been applied in major provinces, improving certainty for investors compared with past practices. For instance, the minimum wage rose by 40 percent in Jakarta in 2013, which significantly undermined business confidence in the region.

The land acquisition process has been expedited. The new land acquisition regulation allows investors to pay for land in advance and be reimbursed after. This regulation is expected to avoid delays due to unallocated budget or late budget disbursements. Using the new regulation, the land acquisition process of Palembang-Indralaya section of the Tans-Sumatera toll road project and Java North Line Double track rail project have been completed after years of delay.

Business Permit Procedures

A one-stop 3-hour licensing service has been launched for nine types of licenses. These include licenses for business startups (investment license, tax registration number, certificate of incorporation, and company registration); trade (import identification, customs registration); employment (employment plan, working permit); and land information (letter of land availability). This initiative aims to lower waiting time, particularly for the energy and mineral resources sector, which had to wait for up to 40 days to obtain each license. In 2017, 130 projects have used this service, including 40 projects in the energy and mineral resources sector.

A single submission system is being created. To expedite the issuance of business permits, the government is creating an online single submission system, where investors can obtain all required licenses at one place, including those of regional governments. The authorities are also forming task forces in ministries, agencies, and regional governments to implement the improved business licensing process and to oversee its implementation.

Construction permits are also being expedited. A direct construction permit has been adopted to attract investment in 32 industrial estates. Investors can start construction projects before obtaining construction permits, obtaining them in parallel to the construction process. Through August 2017, 91 projects had used the Direct Construction Permit.

Logistics Support

Several measures to reduce logistics costs have been adopted. These includes reducing the operational costs of transportation services; eliminating the requirement for goods transport permits; reducing the port business investment cost; standardizing documents on domestic goods flow; and developing regional distribution centers. Other measures include reducing the number of prohibited and restricted goods; strengthening the Indonesia National Single Window authority; and enhancing the role of transportation insurance.

Export and import procedures have been streamlined. Customs inspection at ports has been harmonized to curtail dwell time. Export and import permits have been simplified through single licensing at the border. Permits and documents settlement have been automated through the National Single Window in over 21 ports. Risk management at customs has been implemented, gradually moving control from border to post border. Once fully implemented, only 19 percent of products will be inspected at the border, significantly less than the current 49 percent.

A Bonded Logistics Center has been launched to improve efficiency and lower the cost of transportation. Around 30 bonded logistics centers have been introduced to support various industries, including food and beverage, textiles, automotive, oil and gas, and mining.

Indonesia: 16 Economic Policy Packages
PackageAnnouncementKey Measures
1September 9, 2015
  • Boost industrial competitiveness through deregulation

  • Curtail red tape

  • Enhance law enforcement & business certainty

2September 30, 2015
  • Interest rate tax cuts for exporters

  • Speed up investment licensing for investment in industrial estates

  • Relaxation import taxes on capital goods in industrial estates & aviation

3October 7, 2015
  • Cut energy tariffs for labor-intensive industries

4October 15, 2015
  • Fixed formula to determine increases in labor wages

  • Soft micro loans for >30 small & medium, export-oriented, labor-intensive businesses

5October 22, 2015
  • Tax incentive for asset revaluation

  • Scrap double taxation on real estate investment trusts

  • Deregulation in Islamic banking

6November 5, 2015
  • Tax incentives for investment in special economic zones

7December 4, 2015
  • Waive income tax for workers in the nation’s labor-intensive industries

  • Free leasehold certificates for street vendors operating in 34 state-owned designated areas

8December 21, 2015
  • Scrap income tax for 21 categories of airplane spare parts

  • Incentives for the development of oil refineries by the private sector

  • One-map policy to harmonize the utilization of land

9January 27, 2016
  • Single billing system for port services conducted by SOEs

  • Integrate National Single Window system with ‘inaportnet’ system

  • Mandatory use of Indonesian rupiah for payments related to transportation activities

  • Remove price difference between private commercial and state postal services

10February 11, 2016
  • Removing foreign ownership cap on 35 businesses

  • Protecting small & medium enterprises as well as cooperatives

11March 29, 2016
  • Lower tax rate on property acquired by local real estate investment trusts

  • Harmonization of customs checks at ports (to curtail dwell time)

  • Government subsidizes loans for export-oriented small & medium enterprises

  • Roadmap for the pharmaceutical industry

12April 28, 2016
  • Enhancing the ease of doing business in Indonesia by cutting procedures, permits and costs

13August 24, 2016
  • Deregulation for residential property projects for low-income families

14November 10, 2016
  • Creating a roadmap for the nation’s e-commerce industry:

    • ♦ Easing and widening access to funding

    • ♦ Offer tax incentives

    • ♦ Harmonize regulations and gradually develop a national payment gateway

    • ♦ Promote e-commerce awareness campaigns and improve e-commerce education

    • ♦ Accelerate the development of high-speed broadband network

    • ♦ Improve the e-commerce logistics system

15June 15, 2017
  • Improving Indonesia’s logistics:

    • ♦ Enhance the role of transportation insurance

    • ♦ Reduce costs for logistic service providers

    • ♦ Strengthen the Indonesia National Single Window (INSW) authority

    • ♦ Reduce the number of prohibited and restricted goods

16August 31, 2017
  • Single submission system:

    • ♦ Integrate business licensing services

    • ♦ Utilize information technology

    • ♦ Enhance cooperation/coordination among government agencies on central and local level

Source: Indonesia-investments.com.
Source: Indonesia-investments.com.
Appendix V. Impact of Fiscal and Other Structural Reforms

The IMF’s Global Integrated Monetary and Fiscal (GIMF) model is used to estimate the macroeconomic effects of fiscal reforms in Indonesia. GIMF is a multi-country general equilibrium model that includes a detailed specification of fiscal policy, including different taxes (consumption, labor, and corporate) and different expenditure items (government consumption, public investment, general and targeted transfers, and interest payments). The main properties of the GIMF model calibrated for Indonesia are as follows:

  • The multiplier on output from a 1 percent of GDP permanent increase in infrastructure investment is 1 percent in the first year, rising gradually to over 2 percent in 10 years. The rise in the multiplier in the medium term is driven by the increase in private investment, as the higher stock of public capital raises the productivity of private capital.

  • The multipliers on output from a 1 percent of GDP permanent rise in social transfers are modest in the first year, ranging between 0.15 percent for targeted transfers to the poor and 0.05 percent for untargeted general transfers. The medium-term impact is slightly negative as taxes are raised or spending is cut to keep the fiscal deficit unchanged.

  • The multipliers on output in the first year from a 1 percent of GDP permanent rise in revenue due to higher taxes are -0.2 percent for consumption taxes, -0.3 percent for labor taxes, and -0.5 percent for corporate taxes. The negative impact on output from higher consumption taxes declines over time to nearly zero after 10 years, while that from higher labor taxes rises increases to 0.5 percent in the second year, remaining at that level for the following eight years. The negative impact on output from higher corporate taxes increases gradually over time to 1.5 percent after 10 years.

As the GIMF model cannot estimate the impact of other structural reforms directly, these are estimated indirectly in the GIMF model through an estimated impact of these reforms on total factor productivity (TFP). Barnes (2014)1 finds that a benchmark reduction in the product market regulation (PMR) index could increase TFP by around 2 percent over 5 years, with larger gains for emerging market economies. For example, a 10 percent reduction in the PMR index could lead to gains in TFP of about 1.7 percent for BRICS and 1.3 percent for OECD countries. Dabla-Norris and others (2016)2 finds that trade and foreign direct investment (FDI) liberalization, as well as labor market reforms to remove excessive rigidities, can significantly boost TFP in emerging market economies. Moreover, the short-term costs of these reforms are small, while the medium-term benefits are sizable and long lasting.

The reform scenario includes higher spending in infrastructure and targeted transfers financed mainly by higher consumption taxes, reduced barriers to trade and FDI, and structural reforms to the product and labor markets. About 2 percent of GDP of the extra revenue from the MRTS would come from consumption taxes such as VAT and excises on fuel, vehicles, and plastic bags, which have low negative multipliers. The other 1 percent of GDP would come from taxes with larger negative multipliers. This extra revenue would be used to increase spending in infrastructure (1.3 percent of GDP) and targeted transfers in education, health and social programs (1.5 percent of GDP), which have larger multipliers. Other structural reforms would center on reducing restrictions to trade and FDI, and streamlining product and labor market regulations to promote entry, rationalize the role of SOEs, and foster employment.

Most of the gains in real GDP growth in the initial years would come from fiscal reforms, with gains in TFP from other structural reforms playing a role in the outer years. Real GDP growth would increase gradually to 6.5 percent by 2022, 0.9 percentage points higher than the baseline scenario. Higher infrastructure investment and FDI, which would also catalyze private investment and employment, would be the main growth drivers in the first two years, raising real GDP growth by 0.2 percent. Gains in TFP from other structural reforms would raise real GDP growth by 0.1 percent in 2020-21 and 0.2 percent in 2022. Higher public and private investment and employment growth would play an increasing role over time, raising real GDP growth by 0.5 and 0.2 percentage points relative to the baseline by 2022, respectively.

Indonesia: Growth Under Reform Scenario

(In percent)

Sources: Penn World Trade; and IMF staff estimates.

The reform scenario also assumes continued macroeconomic stability. Inflation would rise to around 4 percent (y/y) in the initial years due to the demand stimulus and higher consumption taxes, but it would moderate afterwards due to a tighter monetary stance, stronger domestic competition and expanded production capacity. The current account deficit would widen to around 2.3 percent of GDP due to higher public and private investment-related imports (or a lower saving-investment gap in the private sector), which would be partly offset by higher exports due to enhanced competitiveness.

S&P upgraded Indonesia to investment grade in May 2017, which was the last of the major rating agencies to do it.

Working age population is defined as 15–64 years old and youth as 15–24 years old. See Chapter 1 in the forthcoming selected issues.

The CA gap for 2017 (difference between the CA balance and its norm) is estimated between –1.1 percent and 0.9 percent of GDP, consistent with a REER gap between –4.5 percent and 5.5 percent.

See Chapter 2 in the forthcoming selected issues.

See Chapter 3 in the forthcoming selected issues.

See Chapter 4 in the forthcoming selected issues.

See Chapter 5 in the forthcoming selected issues.

The KUR program aims to enhance MSMEs’ access to bank loans by providing subsidized, partial credit guarantees covering 70 percent of the loss.

OJK’s relaxation on asset classification for loans up to IDR 5 billion expired in August 2017. For the past two years, banks had to fulfill only one criterion for loan restructuring—repayment capacity of borrowers. From September 2017, banks need to apply two additional criteria—financial strength and industry prospects for the borrower.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 percent and 30 percent, and “high” a probability between 30 percent and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Barnes, Sebastian, 2014, “Reforms and Growth: A Quantification Exercise,” presentation at the Nero Meeting (Paris: Organisation for Economic Co-operation and Development).

Dabla-Norris, Era, Giang Ho, and Annette Kyobe, 2016, “Structural Reforms and Productivity Growth in Emerging Market and Developing Economies,” IMF Working Paper No. 16/15 (Washington: International Monetary Fund).

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