Budi Mulya: Indonesia - pursuing a better shape of the economy
Address by Mr Budi Mulya, Deputy Governor of Bank Indonesia, at the Deutsche Bank
Access Asia Conference, Singapore, 12 May 2010.
* * *
It is such a great pleasure to be here today, to share and exchange view with all of you. I
would like to thanks Deutsche Bank for the invitation to join at this important event where,
various investors, business leaders and senior government officers gather to have a
constructive dialogue.
It is increasingly recognized that intensive communication, such as what we have today,
becomes more important both from the authorities' perspective as well as from investors'
point of view. In particular, in the periods where despite signs of a growing global economic
recovery, some uncertainties remain. The most recent concern on global recovery is on the
sustainability path of the recovery and the further possible impact of the most recent
sovereign debt crisis that just emerged in the Euro area. As we just observed a couple of
days ago, the global financial market was again shocked by a "semi-panic" behavior brought
about by the uncertainty with regard to the rescue package on the Greece debt crises, and
sort of "safety net" provided for some peripheral countries in the Euro area.
Thus, having a more convergence view from various parties, with regards to the stage of the
particular economy and various government measures will help to avoid unnecessary
distortion into the recovery process.
With that background, I will start today with briefly describing what Indonesia has been
through during the crisis and then on how Indonesia has changed within the last decade,
before I discuss the prospect of Indonesian economy and its challenge ahead.
Indonesia during the recent global crisis
During the most recent global crisis, which we all knew as one of the worst global crises in
history, the Indonesian economy has demonstrated to be fairly resilience. Despite some
negative impacts on the economy, particularly in the domestic financial market, the
Indonesian economy was still experiencing a positive growth of 6.0% in 2008 and 4.5% in
2009. That achievement was mainly sustained by high and inclusive growth of domestic
demand, in particular consumption. Indonesia is relatively less exposed to external shocks
than other economies in the region as its trade share to GDP is relatively small at around
50 percent of GDP, with its export is still dominated by natural resource commodities.
Accordingly, the unemployment rate fell back from 9.1% in 2007 to 7.9% in 2009.
On inflation, while it has experienced an increase in 2008 of 11.68% year-on year, is now
back in a significant declining trend of 2.78% in 2009 and 3.91% in April 2010. This
development is mainly supported by rupiah exchange rate appreciation trend and adequate
supply side responses. The balance of payments is also well maintained. The current
account and capital account still record a surplus, contributed to a sizeable reserves
accumulation of around US$78 billion in April 2010, in line with the exchange rate
appreciation trend.
Meanwhile, the banking industry and the domestic financial market also showed a sound
performance despite, as I previously mentioned, some pressures during the peak of the crisis
brought about mainly by liquidity scarcity perception, and as an impact of flight to safety
phenomenon. Those pressures in the Indonesian financial market was caused by an
increasing money market interest rate spread, high exchange rate volatility, as well as the
increase of government bonds yield along the curve. All of those indicators have recently
returned to their normal pattern.
What Indonesia has achieved so far shows that various measures taken by the Indonesian
authorities can be reasonably considered effective. The fiscal and monetary stimulus
employed in measured manner has helped the economy to endure from external shock. The
various policies were mainly aimed at maintaining confidence to cope with panic and fear of
scarce liquidity, and preserving domestic purchasing power. However, we noticed that there
were some doubts, in particular from foreign investor, with regard to the strength of the
economy and the efficacy of the policy that has been taken. This clearly shows from the
significant increase of credit default swap (CDS) during the peak of the crisis. That
perception was somewhat understandable since the situation was extremely uncertain, such
that there was unclear on how the impact of the crisis would be into any particular country.
From those experiences, there are at least two important lesson learned. Firstly, it has
highlighted the more crucial role of transparency with regard to the economic fundamental
information and macroeconomic policy rationality. Secondly, it is important to preserve the
consistency of prudent macroeconomic policy. On the later, it will be very challenging
recently as the policy trade-off has significantly increased.
With regard on how Indonesia was dealing with the recent global crisis, Indonesia has
actually employed all that has been learned from a painful 1998 crisis. Ever since, the 1998
crisis has brought structural changes in Indonesian economy and financial system, and more
importantly in political structure. Indonesia was transformed into one of the largest
democratic country in the world.
Indonesia after more than a decade from 1998 crisis
As I just mentioned, Indonesia is now structurally different with what was in a decade ago.
This is as a result of more than ten years of consolidation and dynamic transition in almost all
sectors. The extensive transformation measures became a continuing agenda with full
commitment.
In the last ten years, we have embarked upon a far-reaching transformation measures,
especially in the area of improving our institutional capacity. During this process, the
Government has taken steps to improve our economic efficiency through policy reform
packages covering key areas of concern, such as taxes, customs, legal frameworks, and the
financial sector. So to speak, one of the most notable steps are the introduction of open
capital account through promulgating Law No. 24 of 1999 and increasing the investment
flexibility by stipulating Investment Law No. 25 of 2007 to encourage offshore financing for
the economy.
The Government and Bank Indonesia, as a central bank, are always committed to
consistently undertake fiscal and monetary discipline, as well as strengthening domestic
financial market resiliency. Learning from the failure of 1998 crises, our policies were focused
on enhancing policy transmission, improving financial market efficiency through prudential
practices and financial market deepening. The Government is also improving their capacity
on fiscal budgeting by adopting a better debt and cash management. Prudent fiscal policy
can partly be observed by gradually reducing the debt to GDP ratio, in particular the foreign
debt. The debt to GDP ratio has declined significantly within the last couple of years, from
77% in 2000 to around 30% recently.
From a monetary policy perspective, Bank Indonesia has consistently pursued Rupiah
stability as mandated by the new Bank Indonesia law that was first introduced in 1999. In
practice this has been manifested in an effort to focus on achieving the medium term (three
years) inflation target set by the government and avoiding excessive exchange rate volatility
consistent with the free exchange rate regime adopted since 1998. On this regard, Bank
Indonesia has increased the transparency and clarity of its monetary policy stance by
introducing "the BI Rate" as a policy rate since June 2005. Further improvement has also
been undertaken in mid of 2008 by translating the BI Rate as a short-term money market
interest rate target (known as PUAB overnight target). Thus, PUAB overnight has been used
as an operational target in executing the monetary policy decision through Bank Indonesia's
domestic market operation. The main reason behind this enhancement is based on two
reasons. First, the increasingly importance of agents' expectation in forming inflation along
with the development of domestic financial market, in particular, the government bond
market. Second, the need to increase the efficiency of domestic money market, which in turn
benefits to enhance and to further strengthen banks' liquidity management.
Steps were also taken in the area of improving the capacity of financial institution, as well as
improving financial market efficiency. Banks are encouraged to strengthen their capital and
compel to conduct best practices, especially in the area of risk management. On the other
hand, we are also bounded to increase our supervisory capacity to ensure a prudent banking
practice.
Years of strong commitment on reform has resulted in a resilient economic fundamental, at
least, in the last five years. The economic growth accelerated to a 10-year high. Fiscal
consolidation significantly reduces government debt, a proof of commitment of fiscal
discipline. Prudent macroeconomic management has also led to the declining trend of
inflation and exchange rate volatility as well. In the financial sector, the banking sector is well
capitalized and in a better balance sheet structure.
Strong macroeconomic fundamentals and resilient microeconomics structures lead to better
risk perception, or a more accurate valuation from my point of view, as reflected by the
recent rating upgrade. But to be frank, I feel that from the sovereign risk assessment,
Indonesia is still somewhat "undervalued". It is perhaps that major rating agencies tend to be
too conservative in assessing Indonesia's risk profile. This might possibly be a reflection of
the "traumatic" view relate to the 1998 crisis. However, the recent update from some rating
agencies has become a promising recognition into the fundamental transformation process in
Indonesia. Following Standard and Poor's, Fitch, and Moody's, OECD has also upgraded
Indonesia's Country Risk Classification ranks from 5 to 4 on early April 2010. Similar
progress also came from the ranking upgrade of our global competitiveness index from 72 in
2003 to 54 recently.
Prospect and challenge ahead
Global recovery coupled with favorable risk perceptions support our optimism toward the
outlook in 2010 and 2011. We are quite confident that the Indonesian economy will grow at
around 6.0% in 2010 and to 6.0-6.5% range in 2011. This is mainly supported by the upturn
on export and increasing investment. For the next periods, we expect that the economy will
keep growing in an upward trend given the proven strong commitment from the Government
to implement reform measures on infrastructure projects and investment climate. On the
later, it is important to note that the public check and balance mechanism, to ensure a more
efficient bureaucracy and to improve business climate, has been increasing significantly
compare to a decade ago. Meanwhile, the continuing prudent fiscal policy by maintaining
public debt at the manageable level will ensure fiscal sustainability, to sustain economic
growth commitment.
We expect that inflation will continue to be moderate at the lower middle of the target of
5% +/-1% in 2010, as there is still "room" from the output gap to support the increase
domestic demand. On this regard, the central bank's monetary policy will always commit to
ensure the low and stable inflation going forward. While on the external side, current account
and capital account are expected to continue reasonably strong. Overall balance of payment
is expected to strengthen, partly supported by an increasing trend of foreign direct
investment.
Stronger macroeconomic outlook and ample domestic liquidity will maintain financial stability,
especially in banking industry. Bank's loan is expected to grow at around 20% in 2010, held
by strong capital adequacy ratio of around 19%, recently. While, banks' non-performing loans
(NPL) is expected to be maintained at to below 5% level (gross).
However, we are fully aware that despite growing positive signs of the economic prospect,
yet many domestic agendas are still required to ensure their implementation. I am optimistic
on this prospect, but of course it is more in a consistent step by step progress, rather than in
an instant change.
In addition, to ensure for a sustainable and strong economic growth, Indonesia will also have
to ensure that access to financial services should be enhanced through a well-functioning
and deep financial market. The later is needed to facilitate and to promote longer term
investment, maintain markets confidence, especially on short-term investment, and thus to
prevent from the unnecessary external shocked. This can be done, partly by improving
market efficiency through enhance financial market liquidity and wider-range of financial
instruments as well as better financial market infrastructure. As part of those concerns, Bank
Indonesia will consistently improve its liquidity management strategy.
On the global economic recovery, as I previously mentioned, the risk is still quite challenging.
It will much depend on the solution prospect of Euro zone debt threat. Yet, considering the
Euro area authorities measures such as what they took during this weekend, and their
coordination with other authorities in other region, I do hope that there will be a promising
solution.
To conclude, I am very cautiously optimistic to the prospect and the direction of the
Indonesian economy ahead. I do hope that you would share the same view.
Thank you.
References
Badan Koordinasi Penamanan Modal (BKPM), Investment Policies Statement, June 2009.
Badan Pusat Statistik (BPS - Statistic Indonesia), several Press Releases and publications.
Bank Indonesia, various Monetary Policy Review, Quarterly Monetary Report and Press
Releases.
International Monetary Fund, World Economic Outlook, 2009.
Joint Asian Development Bank-World Bank Report, Improving the Investment Climate in
Indonesia, May 2005.
Moccero, Diego. Improving The Business And Investment Climate In Indonesia,
Economics Department Working Paper No. 638, OECD, September 2008.
Mulya, Budi. Delivered at JICA's
The Need To Strengthen Indonesian Financial Market,
Seminar on "The Challenge in Developing Indonesia's Financial Market", held in Nikko Hotel,
Jakarta, 11 December 2009.
Raldi Hendro Koestoer,
Promoting Regulatory Reform for Investment in Indonesia,
Office of Coordinating Ministry for Economic Affairs, Republic of Indonesia (CMEA-RI),
presented at APEC High Level Conference on Structural Reform, 8-9, September 2004,
Tokyo, Japan.
World Bank, Global Competitiveness Report, 2000 edition up to 2009-2010 editions.
World Investment Prospect 2009-2011, UNCTAD.
World Bank, Investing in Indonesia's Institutions for Inclusive and Sustainable
Development, Country Partnership Strategy For Indonesia Fiscal Year 2009-2012, 2008.