© 2012 International Monetary Fund


© 2012 International Monetary Fund

Cover design: Lai Oy Louie, IMF Multimedia Services Division Typesetting: Maryland Composition, Inc.

Cataloging-in-Publication Data

Indonesia: sustaining growth during global volatility/ edited by Thomas R. Rumbaugh.

– Washington, D.C.: International Monetary Fund, 2011.

p. ; cm. –

Includes bibliographical references.

ISBN: 9781616352028

1. Indonesia – Economic conditions. 2. Economic development – Indonesia. 3. Indonesia – Economic policy. 4. Financial crises – Indonesia. 5. Inflation (Finance) – Indonesia. 6. Monetary policy – Indonesia. 7. Fiscal policy – Indonesia. 8. Debts, Public – Indonesia. 9. Foreign exchange reserves – Indonesia. 10. Corporate governance – Indonesia. 11. Corporations – Indonesia. I. Rumbaugh, Thomas. II. International Monetary Fund.

HC447.I53 2011

Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its members.

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  • Foreword

  • Preface

  • Acknowledgments

  • Abbreviations


  • 1 Explaining Higher Inflation in Indonesia: A Regional Comparison

    • Geremia Palomba

  • 2 Inflation Uncertainty and the Term Premium

    • Laura Lipscomb and Uma Ramakrishnan

  • 3 Maintaining Fiscal Sustainability Under Uncertainty

    • Nina Budina

  • 4 Volatility in External Demand: Indonesia’s Commodity Boom and Overall Competitiveness

    • Gustavo Adler

  • 5 Adequacy of Indonesia’s Foreign Exchange Reserves

    • Marta Ruiz-Arranz and Milan Zavadjil


  • 6 Corporate Governance and Leverage Trends

    • R. Armando Morales, Edo Mahendra, and Wiwit Widyastuti

  • 7 Assessing Corporate Sector Vulnerabilities

    • Marta Ruiz-Arranz

  • 8 Enhancing Financial Stability

    • Xiangming Li

  • Index


The unprecedented global financial turmoil from 2007 to 2009 was a shock to the global economy and represented the deepest deterioration since the 1930s. Amidst this turmoil, Indonesia’s economy has weathered the storm well. In 2009, Indonesia posted one of the region’s highest growth rates with substantial improvements in major indicators. The prevalent opinion points toward the improvement of macroeconomic management where Indonesia has implemented a program of wide-ranging policy reforms, particularly since the 1997–98 Asian financial crisis.

The source of Indonesia’s resilience includes a prudent monetary and fiscal policy, a sound banking system, a large stock of international reserves, and a more flexible exchange rate. These underlying strengths allowed Bank Indonesia and the government to respond with standard countercyclical monetary and fiscal policies to mitigate the adverse impact of the global financial crisis. This policy reaction contrasts sharply with past episodes such as the 1997–98 Asian crisis, when Indonesia responded procyclically by raising interest rates and tightening fiscal policies.

At this time, the immediate macroeconomic policy challenges have shifted to dealing with renewed capital inflows, booming asset prices, and an appreciating currency. Indonesia will face even larger challenges moving forward and will need to remain vigilant to the vulnerabilities arising from the global economy.

The substantial improvement in the quality of macroeconomic management and banking regulation that Indonesia has achieved in the midst of a volatile global environment are elaborated in this edited volume prepared by IMF staff, entitled Indonesia: Sustaining Growth during Global Volatility. Nevertheless, amid these achievements the book also highlights the most binding constraints that need to be addressed to sustain and increase economic growth as well as to further lower vulnerability going forward.

Overall, this book provides a deep and balanced perspective on the Indonesian economy that might help to further enrich the framework of macroeconomic management in Indonesia. We appreciate the thorough analysis of IMF staff on various issues regarding Indonesia’s economy. This in-depth and balanced analysis benefited from candid discussions between the Indonesian authorities and IMF staff during the Article IV consultations. Their analysis has provided insight to our policy discussions which should contribute to improving Indonesia’s economic performance. We sincerely hope that publication of this book will help other economies by recounting the valuable lessons learned from Indonesia’s experience.

Dr. Darmin Nasution


Bank Indonesia


Indonesia has made dramatic progress in establishing a vibrant and resilient emerging-market economy. Of all the countries affected by the 1997–98 Asian financial crisis, Indonesia arguably fared the worst. Output declined 13 percent in 1998, and the rupiah lost more than 80 percent of its value by June 1998. Unemployment, inflation, and poverty all soared. More than in any other country, this experience prompted deep-rooted institutional reforms. During the first 10 years after the crisis, conditions in Indonesia improved steadily, and included better macroeconomic performance and considerable advancements in the quality of institutions supported by a benign external environment. Rising from the ashes of the Asian financial crisis was a huge accomplishment. But how resilient would Indonesia prove to be when the global economy turned volatile?

In fact, Indonesia has continued its strong macroeconomic performance, sustained high growth, and reached the cusp of investment-grade status despite an unstable global environment. These achievements have taken place during a period of volatile global commodity prices, a global financial crisis, large changes in external demand, and high and capricious capital flows. Events of this magnitude can have substantial impacts on the banking system, corporate balance sheets, and the conduct of macroeconomic policy. Moreover, this has taken place against the backdrop of one of the most fundamental political transitions to democracy achieved by a developing emerging market.

When the 2008–09 global financial crisis erupted, spinning many advanced and emerging-market economies around the world into recession or outright financial crisis, many observers had Indonesia on their short list of vulnerable economies. And, as in other countries, the impact on Indonesia was substantial and swift. Falling commodity prices, liquidity problems in some banks, a default by a large conglomerate, and general global risk aversion led to a sharp deterioration in market conditions and to large capital outflows. Market liquidity dried up and the government was forced to suspend new debt issuance and mark-to-market valuations of banks’ government bond holdings. The currency depreciated by 40 percent and the stock market declined by a similar amount. International reserves fell by $10 billion to only $50 billion within a few weeks. Perhaps it is not surprising that some market watchers were expecting a repeat of the events of 1997.

However, although growth dropped to 4 percent in 2009, the economy sailed through this period relatively smoothly, recording the third highest growth rate in the G-20 after China and India. Real economic growth has since recovered to the 6–6.5 percent range with the Indonesian government openly discussing programs to raise growth further. Credit rating agencies have upgraded Indonesia in several steps since late 2007, with one agency having elevated Indonesia to investment grade in December 2011.

What accounts for this improved macroeconomic performance? To be sure, many obstacles still must be overcome and challenges met to sustain and increase economic growth in Indonesia. These include deficiencies in infrastructure, inefficiencies in government bureaucracy, weaknesses in governance and the rule of law, and the fragility of political stability in a large and diverse democracy. However, continued improvements in the macroeconomic framework and policies are fundamental to the optimistic outlook. The purpose of this book is to present recent IMF research that documents the improvements in macroeconomic fundamentals while also clearly laying out critical issues that need to be addressed to sustain this successful performance and achieve the economic potential of a large, diverse, and resource-rich country. Among many contributing factors, two key reasons for improved macroeconomic performance stand out:

  • An established track record. As described in recent IMF staff reports,1 Indonesia has maintained strong macroeconomic policies. The country’s prudent fiscal stance has resulted in substantial reductions in public debt ratios. The inflation-targeting framework, introduced in 2005, has helped contain inflationary pressures and kept inflation generally at single-digit rates, except when large, discrete, fuel price adjustments caused temporary spikes; but those spikes were accompanied by rising policy rates to prevent second-round effects. Financial regulation and supervision have ensured that banks maintained adequate capitalization and avoided large currency and derivative exposures. These reforms provided for strong initial conditions when the global economy veered off the tracks in 2008. Accordingly, Indonesian banks fared relatively well during this period of global financial market turmoil. Financial soundness indicators and stress tests performed in 2010 confirm that the banking system is resilient to a variety of shocks.

  • Commitment to strong policies. The authorities’ policy reaction to periods of turmoil has been an important factor in realizing positive outcomes. The authorities have consistently contained public financing needs by limiting the overall deficit to 1–1.5 percent of GDP. For example, they have taken politically difficult measures when needed to maintain a prudent fiscal stance in response to adverse shocks, as evidenced by the fuel price increases in 2005 and 2008. Monetary policy has remained flexible in the face of changing conditions and the need to strike a balance between supporting growth, lowering inflation, and maintaining confidence in the rupiah. Exchange rate policy remains committed to the floating regime while trying to moderate the impact of sharp movements in capital flows. In 2010, a comprehensive Financial Sector Assessment Program (FSAP) was completed, which confirmed the resiliency of the banking system and will provide a basis for further strengthening the financial sector.

This book is a compilation of selected papers prepared by IMF staff over the last several years as part of annual surveillance consultations with the government of Indonesia. The resulting chapters present the progress made by Indonesia in the areas of macroeconomic management and policy. Rather than just demonstrating progress in key macroeconomic indicators, the chapters delve into the ways that global volatility has affected Indonesia and how the authorities have adjusted to the policy challenges.


Indonesia has successfully reduced inflation rates to single digits in recent years. However, inflation overall remains higher and more volatile than in other countries in Asia and in other emerging markets, leading to higher nominal interest rates and higher risk premiums on government bonds. Lowering inflation further would help improve the functioning of credit markets, reduce borrowing costs, and lower overall macroeconomic vulnerabilities.

Chapter 1 looks in detail at why Indonesia has had higher and more volatile inflation than its regional peers. Using a variety of econometric techniques, the chapter finds evidence for strong inflation inertia, and also finds that periods of political instability and expansionary monetary policy are contributing causes of Indonesia’s inflation differential vis-à-vis other countries. It also finds that structural factors—commonly mentioned as a cause of Indonesia’s inflation—play no role in explaining Indonesia’s inflation differential with other countries.

The adverse impacts of higher inflation and higher inflation volatility are confirmed in Chapter 2. The high inflation volatility in Indonesia creates greater uncertainty in forecasting inflation, resulting in a relatively higher inflation risk premium. Term premium estimates quantify the compensation investors require, in addition to what they require for expected inflation, for their relative inability to predict inflation.

Chapters 1 and 2, therefore, demonstrate that lowering inflation further and keeping it low and stable will prove beneficial. Given the strong inflation persistence, this goal requires applying a consistent monetary framework and establishing credibility, because anchoring inflation expectations is critical. Bank Indonesia’s steps to establish a credible inflation-targeting regime are important measures that, if followed consistently and supported by effective communication, should lower inflation toward partner country levels. Although lowering inflation could have a short-term negative impact on growth, over a longer period, well-anchored expectations will lower the nominal cost of capital and support growth.


From a macroeconomic perspective, management of the country’s overall fiscal position and levels of public debt have been a strong point for Indonesia. The overall deficit in recent years has not exceeded 1.5 percent of GDP, and public debt has declined steadily from close to 100 percent of GDP in 2000 to about 27 percent of GDP in 2011. In fact, Indonesia’s public debt outlook going forward is stronger than that in most advanced economies and many other emerging markets. However, Indonesia, like many emerging markets, is often exposed to external shocks. How robust is the fiscal outlook to possible macroeconomic and oil price shocks?

Chapter 3 analyzes fiscal sustainability using a stochastic simulation framework. It finds that the authorities’ medium-term fiscal framework, which focuses on fuel subsidy reduction and improvements in revenue administration, is extremely robust to both macroeconomic and oil price shocks. Even large shocks do not upset the fiscal position. The main issue going forward is to make sure that plans to reform fuel subsidies and improve revenue proceed. Delaying fuel subsidy reform could increase fiscal vulnerabilities in the context of rising fuel consumption, volatile oil prices, and possible oil production shocks.


With Indonesia’s increasing integration into the global economy, the level and volatility of capital flows has been an important macroeconomic policy challenge. In general, large-scale capital inflows have been handled in a pragmatic fashion, using a combination of boosting international reserves to establish a cushion in the event of capital flow reversals, and allowing the exchange rate to adjust in line with market sentiment—for example, appreciating in the face of large-scale capital inflows.

Chapter 4 examines the value of the rupiah in the context of the country’s recent export boom and sustained capital inflows. The appreciation of the rupiah has raised questions about the effect on the manufacturing sector (Dutch disease) and that sector’s vulnerability to volatile commodity prices. The chapter finds that there is no evidence of significant Dutch disease in the manufacturing sector. Weak performance in some sectors does not seem to be linked to the recent commodity boom but instead is related to long-standing structural problems. Although Chapter 4 finds that reliance on commodity exports has increased, thus increasing export price vulnerability, the overall terms of trade have actually been stable because export and import prices tend to move together, thus mitigating potential vulnerability.

Indonesia has typically had relatively low foreign exchange reserves, at least compared with other emerging markets. However, a sharp increase in international reserves holdings has occurred recently, with holdings reaching $120 billion as of end-June 2011, a trend common to other emerging markets. How do Indonesia’s international reserves compare with various metrics of adequacy? Chapter 5 looks at this question and concludes that current reserves levels have reached the point where they are in line with (or slightly above) the level predicted by a simple model of optimal reserves, confirming yet another area in which policies have served to lower vulnerability. Therefore, the study concludes that further accumulation of reserves will do little to further lower vulnerabilities. However, in line with other empirical evidence, reserves accumulation can still have a positive impact by reducing borrowing costs for both the government and the private sector.


Corporate governance is a key issue for reducing vulnerability. Chapter 6 assesses the impact of recent improvements in corporate governance. Governance problems played a major role during the 1997–98 Asian crisis as illustrated by over-borrowing leading up to the crisis, followed by creditors’ reluctance to lend when problems materialized. Creditors’ concerns seem to have lingered until about 2005 but have since subsided. Going forward, higher levels of investment in Indonesia will be needed to accelerate growth, and this investment will be more likely to take place if the quality of investor protection is strengthened. For example, priority should be assigned to synchronizing governance regulations and practices with other emerging markets and improving protection for minority shareholders.

How has Indonesia’s corporate sector fared during the recent global volatility? Spillovers from the 2007–09 global financial crisis had substantial adverse impacts on the income and balance sheet positions of corporate entities around the world. Increases in global risk aversion and sharp drops in commodity prices combined to raise corporate sector vulnerabilities. How did the corporate sector in Indonesia withstand this global “stress test”? Chapter 7 analyzes this issue and investigates the expected losses from corporate defaults going forward and the potential spillovers to the banking system using contingent claims analysis. The results confirm the resiliency of the corporate sector and find that losses from future corporate defaults are expected to be manageable. A number of issues are identified that could reduce risks further in the future if addressed, including improvements in overall corporate governance, credit resolution practices, and the effectiveness of the judiciary.


In 2010, the IMF and World Bank conducted a comprehensive review of Indonesia under the Financial Sector Assessment Program (FSAP). This review confirmed the great strides made by Indonesia during the decade beginning in 2000 in improving macroeconomic and financial stability. Chapter 8 summarizes the main recommendations and conclusions of the FSAP review. The substantial improvements in banking regulation and supervision are reflected in much stronger financial positions for the banks. Capital adequacy ratios as well as return on assets have been high, despite the impact of the slowdown in economic activity in 2009. The authorities have introduced the main components of a comprehensive financial safety net, including a lender-of-last-resort facility and deposit insurance. Finally, extensive stress tests showed the banking system to be robust.

The FSAP exercise’s recommendations for future work emphasize three points. First, the prompt corrective action regime needs to be strengthened. Such a regime provides for mandated measures for banks having financial difficulties, which curtails supervisors’ discretion and reduces political interference. Such a system also encourages banks to maintain high capital ratios and reduce risk exposures. Bank Indonesia is already moving in this direction with new regulations issued in January 2011. Second, the work on the financial safety net needs to be completed with the passage of the Financial Safety Net law to ensure that a legal framework is in place to support crisis prevention and resolution. Third, Bank Indonesia’s financial autonomy could be strengthened by restructuring nontradable government bonds on the central bank’s balance sheet into tradable bonds at market terms. This move would increase financial independence and promote capital market deepening.

Indonesia has developed into an important part of the regional and global economy, as well as an active participant in the G-20 and other international forums. Overall, this book documents the substantial improvements in the quality of macroeconomic policy that have been achieved, while also clearly laying out the agenda of measures that need to be taken to safeguard these gains and further lower vulnerabilities going forward.


This volume is a compilation of selected papers and presentations from IMF Article IV consultations with Indonesia during 2008-10. We would like to thank Mahmood Pradhan, Senior Advisor of the Asia and Pacific Department, for constant support and encouragement for this project. Nong Jotikasthira did an outstanding job preparing the manuscript, providing administrative support, and managing the logistics of the process. Dulani Seneviratne, Agnes Isnawangsih, and Patricia Olmedo provided research assistance for several of the chapters.

Sherrie Brown edited the manuscript and Patricia Loo managed the production process with their customary efficiency.



Bank Indonesia


Bank for International Settlements


contingent claims analysis


consumer price index


Credit Suisse First Boston


Emerging Markets Bond Index


Financial Sector Assessment Program (of the IMF)


financial safety net


gross domestic product


International Country Risk Guide


Indonesia’s deposit guarantee agency


broad money


nominal effective exchange rate


newly industrialized economies


nonperforming loan


Otoritas Jasa Keuangan (Indonesia’s Financial Supervisory Authority)


prompt corrective action regime


Special Administrative Region (of China)


Bank Indonesia Certificate


Standard Industrial Trade Classification


small and medium enterprises


World Economic Outlook (of the IMF)