On behalf of the Indonesian authorities, we would like to express our appreciation to the IMF mission team for the candid discussions and policy dialogue during the 2016 Article IV consultation.
The authorities are in broad agreement with the focus of this year’s consultation which is to strengthen the medium-term policy framework to support more inclusive growth, while preserving macroeconomic stability in a prolonged uncertain and volatile external environment. The authorities are encouraged by staff’s acknowledgement of Indonesia’s robust macroeconomic performance, proper policy management and ongoing structural reforms.
Nevertheless, the authorities view that the policy recommendations and risk analyses need to consistently take into account the progress made thus far by the authorities as well as Indonesia’s solid and sound macroeconomic and financial conditions. Notable examples are in staff’s assessment of the external sector development and financial and corporate sector issues. As an illustration, adding the word ‘continue’ to the last sentence of the key issues section in the staff report (“…. the policy strategy should continue to include actions to boost the economy’s resilience,…..”) would provide a more accurate picture of the Indonesian economy as well as acknowledge the efforts of the authorities.
We view that against the risks mentioned, a qualifying opinion from staff to where Indonesia currently stands and its ability to weather the risks is very important. The absence of this qualifying opinion would result in a rather pessimistic assessment and draw unnecessary attention which is inconsistent with Indonesia’s economic resilience and positive prospects. As Article IV is an important reference for the global community at large, we view it is imperative for the analysis to put more weight on coherence rather than completeness. This is important for Indonesia as well as for other emerging market economies as an overemphasis of risk aspects could affect the confidence of investors and financial market participants which is unfair to the country. In this respect, we wish to highlight the following areas.
Recent Economic Developments and Outlook
Indonesian economic policies are guided by a sound macropolicy direction which enables the economy to withstand volatile external conditions. Notwithstanding the complexity of the policy challenges emanating from the external headwinds and the on-going structural reforms in the domestic economy, the authorities have employed a so called “Bauran Kebijakan” or “the policy mix strategy”. This policy mix strategy allows the authorities to determine a harmonious combination among monetary, fiscal and structural reform policies to ensure a more sustainable and inclusive economic growth. For instance, during the episode of taper tantrum, the macroeconomic strategy placed emphasis on maintaining stability over growth, whereby monetary policy was aimed at preserving stability while fiscal policy was directed at nurturing growth. Following a clearer direction in the US monetary policy normalization, the authorities shifted the strategy by using monetary policy primarily to support growth while pursuing fiscal consolidation to retain credibility. In the current complex situation, the macroeconomic strategy places greater weight on stability, while using structural reforms to strengthen growth. Throughout these periods, the policy combination is not only accompanied by deeper and stronger structural reforms but also a more flexible exchange rate regime, ample reserve level, calibrated macro-prudential policy and better communication strategy.
The above strategies have resulted in the Indonesian economy performing well among peers (recorded the third highest growth among G20 countries). The economy grew by 5.02 percent in the third quarter of 2016, bringing the estimated economic growth to 5 percent for the whole year. Inflation, at 3.02 percent in 2016, was at the lower range of the inflation target of 4 ± 1 percent. Fiscal deficit stood at 2.46 percent of GDP, while public debt remained low and manageable at 27.7 percent of GDP at the end of 2016, with well diversified currency composition (almost 60 percent in Rupiah-denominated debt) and debt maturity (weighted average of 9 years). The balance of payments recorded a larger surplus in the third quarter of 2016, supported by a narrower current account deficit and a larger capital and financial account surplus. The 2016 current account deficit is expected to be below 2 percent of GDP. International reserves remained sufficient at USD116.4 billion as of December 2016, equivalent to 8.4 months of imports and official debt repayment.
Consistency in maintaining macroeconomic stability while optimizing economic growth has safeguarded the economy’s resilience and is recognized by international community. In December 2016, Fitch revised Indonesia’s outlook to Positive and affirmed the Investment Grade. Correspondingly, the implementation of structural reforms has contributed to the significant improvement in Indonesia’s ranking in the World Bank’s Doing Business Index.
Indonesia’s economic outlook is expected to further improve. The economy is projected to grow between 5.0–5.4 percent in 2017, supported by solid domestic demand and a recovery in exports, along with improvement in prices of Indonesia’s export commodities. The government is expected to record a prudent fiscal deficit in 2017 coupled with a more realistic tax revenue target and better subsidy scheme. The 2017 budget will be primarily allocated to productive spending to support the growth momentum and improve infrastructure and basic services, including education, health and social welfare. Meanwhile, the current account deficit is expected to remain below 3 percent of GDP. The authorities will carefully monitor the impact of the plan to lower subsidy on some tariffs, such as electricity, on inflation, and will ensure that inflation expectations are firmly anchored. In addition, financial stability and corporate sector conditions are also expected to further improve in line with a better economic outlook.
External Sector Development
The authorities are fully cognizant of the importance of the external sector and remain vigilant in maintaining and strengthening external resiliency. The authorities wish to highlight staff’s assessment that Indonesia’s external position is broadly consistent with medium-term fundamentals and desirable policy settings. Further, staff also assessed that reserves are sufficient and that in the event of severe external pressure, exchange rate flexibility would help contain risks. While staff has rightly stressed that global uncertainty can have downside risk to the economy, the authorities wonder what is staff’s final assessment of the resiliency of the Indonesian economy. Further, we would like to point out that the external risks mentioned are a global phenomenon not unique to Indonesia. Against this backdrop, the authorities would like to underline their confidence in weathering future external shocks, namely due to 3 factors: (i) sound macroeconomic discipline; (ii) intensive monitoring of debt characteristics and compositions; and (iii) sound prudential policy to mitigate risks.
On sound macroeconomic discipline, the authorities focused on three major areas, namely a sustainable current account deficit (CAD), more flexible exchange rate and sufficient level of reserves. Indonesia’s CAD has been on a declining trend and is consistent with medium-term economic fundamentals. Over the years, the CAD has declined from 3.19 percent of GDP in 2013 to 2.06 percent of GDP in 2015. By the end of 2016, the CAD is projected to be below 2 percent of GDP. The authorities are committed to further safeguard the CAD within its medium-term sustainable level and to improve competitiveness and promote exports which would in turn further improve the CAD. On the exchange rate, Indonesia has implemented a more flexible exchange rate regime in line with its fundamental value. Exchange rate flexibility has helped increase the resilience of the external sector as reflected in improvements in the CAD. Meanwhile, international reserves are sufficient at USD116.4 billion as of December 2016, equivalent to 8.4 months of imports and official debt repayment. The reserves are further supported by the availability of a second line of defense from bilateral, regional and global financial arrangements which provide further buffers against external shocks.
The authorities will continue to monitor debt characteristics and compositions. Currently, Indonesia has a healthy International Investment Position structure, where net external liabilities are mostly long-term (FDI and long term loans) that will provide positive trickle-down effects on long-term economic activities and growth. Indonesia’s long-term foreign borrowing amounts to 87.5 percent of total foreign borrowings with a balanced share between public and private debt. Short-term debt of private non-bank corporations amounts to only 5 percent of total foreign debt. Further, non-resident holders of Indonesian government bond are also dominated by long-term investors, including central banks.
In addition to implementing a strong policy framework, the authorities will continue to adopt necessary prudential regulations to maintain and strengthen external resiliency. To ensure prudent external debt management, the authorities have since end-2014 implemented prudential regulations to manage external debt of non-bank corporations, where non-bank corporations must meet minimum hedging and liquidity ratios as well as minimum credit rating requirement. This is in addition to the 3 percent fiscal deficit ceiling introduced by the State Law, a special committee to administer and approve the SOEs’ related loans, and existing banking prudential regulations on loan and foreign exchange exposures.
Financial and Corporate Sector Issues
The authorities wish to highlight that the Indonesian financial and corporate sectors remain resilient and well placed to weather the current uncertain global conditions. As noted by staff, the banking system is well capitalized and profitable, with ample liquidity. The capital adequacy ratio stood at 23 percent at end-November 2016, well above the international standard. Meanwhile, ample liquidity is reflected in the low level of volatility of interbank market rate and the ratio of liquid assets to third party fund, which stood at 20.5 percent at end-November 2016. Latest data have also signaled that NPLs’ growth is reaching its peak in addition to improved corporate performance, especially in the commodity-related sector. Taking into account the positive outlook of the Indonesian economy and the rising commodity prices, risks emanating from the banking and corporate sectors are expected to moderate in the future. In sum, the authorities would like to underline a very important conclusion of the risk assessment on the banking and corporate sectors, namely that none of the identified risks triggers systemic concerns in the financial system, despite the said “pockets of vulnerability” in those areas.
To ensure that no vulnerability in the banking and corporate sectors persist, the authorities regularly monitor and conduct stress tests in compliance with international best practices. The results again confirmed that there is no systemic risk. As an example, the result of the authorities’ stress test on liquidity shock showed that only 1 (one) small-sized banks (out of 118 banks) encountered a liquidity problem due to its reliance on short-term deposits. Nevertheless, the authorities assessed that the problem to be temporary and not a structural issue. Sufficient access to liquidity both from money market and the central bank is also available to the bank.
The same strong conclusion on the absence of systemic risk also hold true for the corporate sector. The authorities believe that corporate vulnerability will also decline in line with improvements in corporate performance as reflected in increasing profitability (data up to September 2016). This is further bolstered by improved efficiency including a tendency among corporations to reduce debts. In addition, the authorities would also like to refer to the analysis from related working paper1 draft by staff which states that risks in the Indonesian corporate sector are manageable and that the authorities have been proactive in monitoring corporate vulnerabilities. The above reference simply reinstated that there are no systemic risks stemming from the corporate sector.
In this regard, the authorities would like to convey the need to have a coherent assessment on the banking and corporate sectors to understand the depth of the problem and the ability of the authorities to handle the issues. Emphasizing the analysis on the risks would overshadow the progress made by the authorities in strengthening the resilience of the financial and corporate sectors and to address pockets of vulnerabilities.
Fiscal Policy and Reforms
On the fiscal front, the authorities appreciate staff recognition that the fiscal strategy is appropriate. The government has embarked on a gradual fiscal consolidation while protecting infrastructure priority spending. The tax amnesty program launched by the government has been successful in collecting significant tax payments and repatriated funds as well as expanding the revenue base.
Going forward, the authorities are committed to implement a growth-friendly fiscal strategy and concurred with staff’s assessment that revenue mobilization will be challenging. Nevertheless, the authorities’ commitment to achieving revenue targets remain unwavering. This effort will be supported by several factors, namely: (i) a new larger tax base as a result of information obtained through tax amnesty; (ii) potential for further revenue-raising reforms with the creation of a tax reform team in January 2017. The team will also help improve the organization and clarity of the tax reforms roadmap, which will improve credibility of the tax revenue target; (iii) plan to improve the information system to capitalize on the readily available information from tax amnesty; (iv) efforts to address complications in tax regulations as well as to implement tax policy and administration reforms by way of amendments to the VAT law and income tax law are also underway; (v) electronic invoicing. With the above progress and strategies, it is also worth noting that tax revenues will also move in line with the tax buoyancy rate. The authorities have also continued to work closely with the IMF through Technical Assistance to further improve the fiscal position.
The authorities have embarked on a series of structural reforms to improve the economy’s competitiveness and the business climate. Focus areas of the reform are on improving the ease of doing business, providing good infrastructure, diversifying sources of growth (including developing the tourism sector and more value added export products), improving purchasing power and deepening the financial market. As staff noted, there are signs of early successes, as shown in the improvement of Indonesia’s ranking in the Doing Business Index, which in 2016 moved up 15 positions to 91. The deep and intensive reforms are aimed at supporting the National Strategic Development Plan (NSDP) 2014-2019 which is led directly by the President. The NDSP comprises of three arrows, namely human development, priority sector development and equitable development.
One important landmark in improving the investment climate is the establishment of One-Stop Service (OSS) for investment under the Investment Coordinating Board Agency (BKPM), in January 2015. The objective of the OSS center is to accelerate and simplify licensing procedures for investment projects by placing the licensing processes for all businesses (except those in the banking and energy sectors) that were handled by 22 ministries and government agencies under one roof. The business climate has been further improved by the introduction of the 3-hour investment licensing service in January 2016 and the 10th Policy Package on Negative Investment List in February 2016. As many as 130 companies with investment value of IDR291 trillion have benefited from the OSS service up to October 2016. Meanwhile, up to June 2016, 527 companies have applied to invest with total planned investment of USD12.9 billion as a result of the revised Negative Investment List.
Debottlenecking effort was also done to accelerate the implementation of priority infrastructure projects. Recognizing the need to improve infrastructure, the authorities have established a body under the Economic Coordinating Minister as a Project Management Office (KPPIP) to administer 30 priority infrastructure projects, ranging from electricity, energy, seaport, airport and toll roads. One notable progress of this body is the revision of the Law on Land Acquisition for Public Interest which sets a maximum time to complete the land acquisition process, the biggest hurdle in undertaking infrastructure projects. To date, many projects, such as the Trans Sumatra Toll Road Project and Java North Line Double Track Rail Project, have benefited from the revision of this regulation.
The Indonesian economy is progressing well with well-preserved macroeconomic and financial stability. The authorities have proven their resolute commitment and are well prepared to tackle prolonged global uncertainty with appropriate policies. The authorities believe that combining policy mix with appropriate structural reforms provides optimal result for an emerging market economy such as Indonesia. To that extent, the authorities will continue its unwavering commitment to maintain macroeconomic stability and broad-based structural reforms. We believe that this commitment is a major factor in shaping the economy’s agility in weathering shifts in the external environment and has been well tested in several episodes of global financial turbulence as well as during the period of commodity down-cycle.
Chan-Lau, J. A., Miao, W., Miyajima, K., Shin, J, 2016, “Corporate Vulnerabilities in Indonesia: A Bottom-Up Default Analysis.” IMF Working Paper (draft) WP/16/XX, pp.4.