The Indonesian authorities would like to express their appreciation to the IMF mission team for the constructive discussions and policy dialogue during the 2017 Article IV consultation. They are encouraged by staff’s acknowledgement of Indonesia’s solid performance and resilience. Indonesian economy has continued to perform well with a well-maintained macroeconomic and financial stability. The authorities have also proceeded to implement a series of structural reform with positive results, and will continue to strengthen structural reform efforts in order to increase Indonesia’s potential output. To that end, the authorities will maintain their unwavering commitment towards macroeconomic and financial stability as well as broad based structural reform. The authorities broadly concur with the gist of the Indonesia 2017 Article IV and would like to raise several points for emphasis.
Recent Economic Development and Outlook
Indonesian economy continues to perform well, supported by prudent macroeconomic policies and a concerted strategy of structural reforms. Economic growth has exhibited an upward trend since the last three years, on the back of exports and investment recovery. Overall, the economy is expected to grow at 5.1% in 2017, higher than last year’s growth. Macroeconomic stability has been maintained as indicated by benign inflation, sound current account deficit, and stable exchange rates. Going forward, economic growth is expected to improve further. Growth in 2018 is projected at 5.1-5.5% (yoy). The continuing growth momentum will likely be driven primarily by domestic demand, particularly investment growth. In addition, recovery of export growth is also expected to continue.
Fiscal and Structural Reform
Fiscal realization continued to improve in 2017, with higher revenue collection and better quality of expenditure. Budget deficit realization was maintained below statutory ceiling at around 2.6 percent of GDP, while government debt ratio remained at low level of 28.6 percent of GDP. Revenue collection increased by 6.4 percent, with the strong growth in VAT and non-oil and gas income tax. The quality of spending has also been improving as indicated by continuous increase in the share of capital expenditures to total expenditure (18.7 percent) to support infrastructure development. Looking ahead, fiscal policy in 2018 remains directed to support growth, while at the same time to maintain the fiscal sustainability. The budget deficit in 2018 is targeted to 2.2 percent of GDP. The fiscal strategy focuses on optimizing revenue, improving the quality of public spending, and ensuring sustainable budget financing. To optimize tax revenue, comprehensive tax reform will focus on expanding taxpayer database, improving human resources and business processes, and strengthening IT support system. On the expenditure side, efforts to enhance the quality of public spending will include improving the quality of capital expenditure, ensuring efficient non-priority spending, refocusing priority spending (infrastructure, education, and health), synergizing social protection programs, and improving quality of fiscal decentralization.
The Indonesian authorities have implemented a concerted strategy of structural reforms with positive results. The authorities have embarked on a series of structural reforms to improve the economy’s competitiveness and the business climate. These efforts in combination with the authorities’ consistency in preserving macroeconomic stability have been recognized by credit rating agencies and international organizations. Standard & Poor’s (S&P) rating upgraded Indonesia to investment grade (BBB-) with a stable outlook in May 2017, confirming the upgrade to investment grade by rival agencies (Fitch and Moody’s) in 2011 and 2012. More recently (December 2017), Fitch Ratings (Fitch) upgraded Indonesia’s sovereign credit rating by a notch from BBB- to BBB with stable outlook. Additionally, Indonesia’s rank in the World Bank’s Doing Business also improved from 91 to 72 in 2018.
The authorities welcome IMF’s focus on structural reforms in this Article IV and the results of the IMF’s policy scenario noting that Indonesia’s potential growth can reach 6.5% in the medium term with a combination of fiscal and structural reforms. The authorities would also like to emphasize the importance of a sequential phase to implement structural reform efforts, especially in light of the long-term nature of these reforms. They would also like to stress the significance of choosing appropriate reforms that would benefit the country most. Thus, the authorities encourage the IMF to advice the authorities on the optimal sequence of the reforms which is currently missing in the report.
The authorities would like to emphasize that reform progress is not necessarily reflected in the form of market access and/or market price. Indonesia currently continues to implement a wide range of structural reform efforts to ensure economic competitiveness, diversify the source of growth, and improve the social welfare. The implementation of the said reforms would require strategy and finesse including ways to phase out the process whilst taking into account the impact to low-income society. The authorities would like to highlight that the effort to move from product subsidy towards a more targeted subsidy in the energy sector has been progressing very well in an integrated approach. In particular, for fuel subsidy, they have combined the pace of the shift towards pure market-based fuel price with quantitative measures1 by limiting the volume and availability of gas stations providing subsidized fuel (RON 88), as well as limiting the types of vehicles allowed to consume the subsidized fuel. These efforts have increased the usage of market-based fuel type (i.e. RON 90 and RON 92). Additionally, since the abolishment of fuel subsidy policy, the authorities no longer allocate fuel subsidy fund in the fiscal budget. Thus, the authorities’ effort to ensure smoothness of reform implementation should not be seen as a delay, rather it should be seen as progress in the right direction.
The authorities continue to press ahead with major infrastructure projects. In this context, various reforms have been made, including by the establishment of Committee for Acceleration of Priority Infrastructure Delivery (KPPIP) to carry out feasibility study, monitoring, and debottlenecking strategies of priority projects, and the establishment of Indonesia Asset Management Agency (LMAN) to expedite land acquisition procedures. The significant progress has been made in expediting infrastructure projects after SOEs played key role in the projects that had been stalled for years under the privates. While the SOEs’ financial performance involved in infrastructure projects are sound, indicated by strong profits and low leverage, the authorities continue to closely monitor the implication on fiscal risks and prudently keep the pace of infrastructure development in line with the financial availability.
Monetary policy is always geared to maintain macroeconomic and financial stability, so as to allow policy room to support recovery momentum of domestic economy. The authorities view current monetary policy stance as neutral and will continue to ensure macroeconomic and financial stability. The strategy has allowed the monetary policy to support a more sustainable and inclusive economic growth. They will continue to employ “the policy mix”, namely monetary policy, exchange rate policy, macro-prudential policy, payment system policy, and strong coordination with the government. Looking ahead, the authorities will remain vigilant of global and domestic risk development and will formulate monetary policy accordingly in line with the above-mentioned developments. Thus, the authorities caution IMF in using a directive forward guidance especially in emerging market countries as it can possibly trigger unintended consequences. Further, they believe building authorities’ credibility in managing macroeconomic and financial condition is of far more importance compared to establishing such forward guidance.
The authorities continue to be committed to maintain exchange rate flexibility. Exchange rate flexibility is always at the core of Indonesia’s exchange rate policy. To that end, as a lesson learned from the taper-tantrum episode, Indonesia has also strengthened the exchange rate policy by ensuring the rupiah to be in line with its fundamental value. Nevertheless, in the event of excessive volatility or fundamental exchange rate misalignment, the authorities will not shy away from conducting FX intervention to prevent disorderly market condition as well as to mitigate risk to the achievement of the inflation target.
The Indonesian authorities largely concur with staff assessment on Indonesia’s external position. The external position is seen as broadly consistent with fundamental and desirable policies while external debt remains sustainable. The authorities are pleased with the progress Indonesia has achieved thus far, namely on directing the current account deficit (CAD) from a peak of 3.2 percent of GDP in 2013 towards a more sustainable CAD (forecasted at 1.7 percent of GDP for 2017). They are cognizant of the importance of external sector sustainability and value the importance of a reliable reference on it. This includes Current Account norm (CA norm) result from the IMF EBA methodology. Therefore, they have voiced concern regarding the level of CA norm for Indonesia. This is especially pertaining to consistency between the CA norm and the overall macroeconomic scenario. The authorities view that the estimated CA norm (-1.3 percent of GDP) does not adequately reflect Indonesia’s need of higher CA deficit to finance investment on infrastructure and other structural reforms. Noting that the EBA model is based on a multilaterally consistent approach with a limited set of explanatory variables, the authorities encouraged the IMF to always consider additional country specific factors in its external assessment.
On the issue of external debt, the authorities concur with staff assessment that Indonesia’s external debt remains sustainable. Currently, external debt remained moderate at 34.4 percent of GDP (September 2017). They believe that this condition is the result of measures implemented by the authorities to moderate risks from external debt. One such measures is the corporate external debt regulation2 (KPPK) which requires hedging (at least 25 percent) of net FX liability of corporate with external debt maturing within six months.3 he authorities view that this prudential regulation has helped curb the rise of corporate external debt and moderate the risks of overall external debt. In the end, the measure has helped improve Indonesia’s resilience toward the external shocks. This corporate external debt regulation was never intended to limit capital flows and is aimed to ensure macro financial stability through the adoption of prudential principle of corporate borrowing, thus it should be categorized as ‘other policies’ and not as a CFM or CFM/MPM. That said, the authorities remain open to conduct a cost-benefit analysis to extend the coverage of the regulation.
The authorities welcome staff’s assessment on financial sector reform and concurred that the Indonesian banking system has remained sound, liquid, and profitable. The financial soundness indicators point to high capital adequacy, strong profitability, improved banking efficiency, relatively stable NPL, and sufficient liquidity. High capital buffers and strong profitability has also helped to absorb most of credit losses, under the most severe FSAP’s stress tests. The authorities have also continued to strengthen financial oversight and crisis management in line with FSAP recommendation. However, regarding staff’s suggestion in paragraph 534 to “extend emergency lending to banks that are assessed by OJK as viable even if its capital is temporary below minimum requirements”, they would like to convey that Indonesia has deliberately chosen to limit the eligibility of ELA for solvent banks. In this case, the parliament, in line with global standard recommendation, has strongly disapproved the use of public funding to extend ELA for insolvent banks. To that end, the authorities encourage the IMF to honor the authorities’ decision on this issue.
Indonesia has embarked in an integrated policy reform efforts to improve resilience and boost potential growth so as to achieve strong, sustainable, balanced and inclusive growth. Indonesia is ready to be part of the major players in the global economy. To that end, the authorities will maintain their unwavering commitment towards macroeconomic and financial stability as well as broad-based structural reforms.
On a special note, the authorities would like to appreciate the excellent collaboration between the Fund and the authorities in preparing the 2018 IMF-WB Annual Meetings. They would also request IMF member’s support to ensure the success of the event. Soon, they will be arriving at another important milestone for Voyage to Indonesia (VTI), which is the High Level Conference on “New Growth Model in a Changing Global Landscape” in February. This conference will be held in Jakarta, Indonesia and in this occasion, the authorities would like to invite all IMF members to attend.
Except for a very small fixed subsidy on diesel and kerosene, which is mostly consumed by low-income society.
Sometimes also referred as “corporate prudential FX regulation”.
Corporate external debt maturing up to 3 month and maturing between 3 to 6 months.
“Consideration should be given to 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 collateral, to request an indemnity from the government subject to appropriate safeguards.”