Abstract
KEY ISSUES Context: Indonesia has strengthened policy and reserve buffers since mid 2013, in the face of global headwinds from the commodity down-cycle and episodes of volatility affecting emerging market economies. Policies have aimed at containing external and inflation pressures, helping to preserve macroeconomic and financial stability. With growth slowing, the new government is keen to jump start supply-side reforms aimed at raising potential growth while strengthening the external position. Upfront actions to curb fuel subsidies have opened fiscal space to support infrastructure spending. Near-term outlook: After slowing in 2014, growth is projected to tick up to 5.2 percent in 2015, factoring in an anticipated jump in public investment in infrastructure. Inflation has temporarily risen on earlier fuel price increases, but is expected to return to within the target band by year end. Notwithstanding soft commodity prices, the current account deficit is projected to narrow further in 2015. Risks to the outlook arise mainly from a deeper•than-expected slowdown in emerging market trading partners and surges in global financial market volatility, which could exacerbate strains on the domestic banking and corporate sectors. Policy mix: The current policy mix aims at improving growth potential while consolidating recent stability gains and containing vulnerabilities. Fiscal policy should be geared towards securing space for more social and capital spending, underpinned by a broad-based strategy for increasing nonoil tax revenues, while pursuing moderate deficit reduction over the medium term. Monetary policy needs to remain focused on anchoring inflation expectations and facilitating external adjustment, supported by continued exchange rate and bond yield flexibility. Bank funding pressures, while showing signs of easing, will need to be managed through stronger policy coordination and improved market functionality. Financial stability is expected to be preserved through enhanced risk assessment and effective prudential measures, anchored by a strong crisis management framework. Structural reforms should be aimed at easing supply bottlenecks and improving the investment climate in order to create new jobs, bolster medium-term growth prospects, and strengthen the external position.
The information below has become available following the issuance of the staff report. It does not alter the thrust of the staff appraisal.
1. Recent data releases are broadly consistent with staff s view on the near-term macroeconomic outlook.
The current account deficit for 2014 was in line with expectations at about US$26 billion. It remained on a downward trend, narrowing in the last quarter of 2014 to US$6.2 billion (2.9 percent of GDP), which was largely attributable to a smaller oil import bill. The overall BOP surplus was slightly larger than expected in 2014 at US$15.2 billion, with non-portfolio capital inflows the main factor. Turning to 2015, the trade surplus rose to US$0.7 billion in January from US$0.2 billion in December, with oil and gas imports further shrinking.
Headline inflation declined further to 6.3 percent (y/y) in February 2015, benefiting from lower food and transportation prices, but core inflation stayed around 5 percent. Bank Indonesia’s latest (February) consumer survey index showed price expectations continuing to fall.
2. Parliament approved a revised 2015 budget in mid February with an overall deficit target of 1.9 percent of GDP, in keeping with the government’s initial proposal. To achieve this target and boost capital spending, the budget relies on an ambitious increase in non-oil and gas revenues, which is expected to come mainly from administrative measures. The budget also provides for a recapitalization of state-owned enterprises (0.4 percent of GDP) within the financing items.
3. Bank Indonesia (BI) cut its benchmark and deposit facility rates by 25 bps to 7.5 percent and 5.5 percent, respectively, effective February 18, while leaving its lending facility rate unchanged at 8.0 percent, citing recent improvement in inflation performance and the current account. Broad money and private credit growth slowed in December 2014, as expected, to around 12 percent and 12½ percent (y/y), respectively.
4. Financial market developments have remained broadly favorable. Since Bl’s rate cut, the 10-year bond yield has declined by about 30 basis points while the rupiah has weakened slightly against the U.S. dollar. Portfolio inflows continue to be supportive.