Statement by IMF Staff Representative February 6, 2006

Indonesia’s Fourth Post-Program Monitoring discussions highlight that short-term macroeconomic indicators and near-term prospects have deteriorated. Financial sector vulnerabilities have increased in the face of rising interest rates and a slowing economy, but the overall banking sector remains resilient to moderate credit, interest, and depreciation risks. Improved budget execution could help cushion the downturn. Reducing delays in disbursing funds to executing agencies and better project implementation would help offset the expected decline in private consumption.

Abstract

Indonesia’s Fourth Post-Program Monitoring discussions highlight that short-term macroeconomic indicators and near-term prospects have deteriorated. Financial sector vulnerabilities have increased in the face of rising interest rates and a slowing economy, but the overall banking sector remains resilient to moderate credit, interest, and depreciation risks. Improved budget execution could help cushion the downturn. Reducing delays in disbursing funds to executing agencies and better project implementation would help offset the expected decline in private consumption.

This statement provides an update of developments since the issuance of the staff report. The thrust of the staff appraisal remains unchanged. Inflation (year-on-year) was unchanged in January and the central bank is maintaining a tight bias pending clear signs that inflation is on a downward trend.

1. Recent indicators confirm that economic activity weakened further in the fourth quarter of 2005. Retail sales softened in December, though motor vehicle and motor cycle sales recovered partially from their earlier drops. Consumer confidence also recovered slightly in December, but remained well below its levels earlier in the year.

2. The latest trade figures are also consistent with a softening in domestic demand in the fourth quarter, with non-oil imports declining by about 3 percent (quarter-on-quarter). Also, following the increase in domestic fuel prices, oil imports were down by 23 percent (quarter-on-quarter). However, exports rose strongly in December, increasing by 6 percent.

3. Headline inflation remained at 17 percent in January, in part reflecting restrictions and uncertainties over rice imports. Seasonally adjusted inflation in January was close to zero. Core inflation remained unchanged in January at 9.4 percent (y/y).

4. The exchange rate is currently trading in the Rupiah 9,300-9,400 per U.S. dollar range, appreciating some 5 percent since end-December. Equity prices have remained buoyant, with the stock market up by 7 percent this year. Bond yields have remained fairly flat since the issuance of the staff report.

5. The final outcome on the budget for 2005 is not yet available as the authorities still have to reconcile monetary and fiscal data. However, preliminary information suggests that budget execution accelerated significantly in December, especially capital expenditures. In addition, all 2006 budget allocation documents have been issued which should help avoid spending delays of the kind seen last year.

6. Bank Indonesia announced some modifications in the classification rules for non-performing loans. Most notably, the requirement that if one bank downgrades the credit quality of any single debtor, all banks in the system must classify the loans accordingly, will be phased in gradually. While this represents a certain weakening of the regulations passed in July, BI is committed to fully implement this requirements once credit bureaus (that provide information on credit quality) are strengthened and become equipped to provide the requisite information.