Table of Contents I. Macroeconomic Condition II. Rupiah Exchange Rate III. Inflation IV. Monetary Policy V. Balance of Payment VI. Public Finance VII. Banking Sector VIII. Economic Outlook 2006 1
I. Macroeconomic Condition The Indonesian economy in 2005 grew 5.6% and was supported mainly by the growth of domestic demand, which was relatively high during the first half of 2005. Although the growth was slightly above that of the previous year of 5,1%, it came below initial prediction and tend to slow down. After reaching 6,1% in Q1-2005, the economic growth keep on declining and reach 5,1% at the end of the year. The economic slowdown resulted mainly from more sluggish expansion in consumption and investment. Key to weakening consumption was the weakened of public purchasing power and weakened of public expectation to economic condition. These were related to the increase of oil price in March and October 2005 and volatility of Rupiah exchange rate in Q3-2005, due to the increase of external pressure. Meanwhile, there was a strong expansion in government consumption in 2005 compared to that of 2004, particularly in the second half of 2005. Table 1.1 SECTOR GDP Growth by Expenditure 2004** 2005** I II III IV Total I II III IV Total 1. Consumption 6.36 5.45 4.32 3.42 4.86 2.03 2.63 5.52 7.33 4.41 Household 5.67 5.29 5.11 3.86 4.97 3.42 3.78 4.42 4.18 3.95 Government 12.48 6.82-1.81 0.39 3.99-9.60-6.67 14.69 29.98 8.06 2. Investment 11.43 28.83 11.02 27.89 19.00 25.86 21.12 14.28-9.44 13.20 Gross Domestic Capital Formation 10.46 14.12 17.36 16.08 14.58 14.11 15.58 9.37 1.78 9.93 3. Export of goods and services 4.97 5.17 21.96 22.18 13.50 11.80 11.19 4.76 7.41 8.60 4. Import of goods and services 16.72 26.68 33.46 31.16 27.07 18.84 17.86 10.56 3.74 12.35 5. Gross Domestic Product 4.10 4.36 4.63 7.13 5.05 6.25 5.63 5.63 4.90 5.60 Source: Central Bureau of Statistics (BPS) The investment growths for overall 2005 tend to slow down and it was caused by several factors. Escalating costs for inputs brought on by mounting inflation eroded corporate margins. The absence of structural change in the investment climate and continued difficulties with legal certainty also hindered efforts to build investment performance. The slow growth of investment also influenced by the low realization of government consumption for investment due to late issuance of budget allocation approvals (DIPA). The growth of export was relatively high although tend to weaken in Q3-2005. This was driven more by non-oil and gas exports. Oil exports are sluggish due to Indonesia s falling oil production while the performance of non oil and gas export only improves mildly against the slow down in world demand and weak competitiveness of Indonesia s export products. Import growth that was relatively high in the first half of 2005, weakened in the following semester. This is due to less vigorous expansion in domestic demand and slow growth of export in which the import contents is quite high. 2
From the supply side, positive growth was recorded in all sectors although some important sector experienced slow growth. Rising input costs and falling purchasing power after the increase in fuel prices were the main factors responsible for declining growth. SECTOR y-o-y Table 1.2 GDP Growth by Expenditure 2004 2005 Q.1 Q.2 Q.3 Q.4 Total Q.1 Q.2 Q.3 Q.4 Total 1. Agriculture 5.32 3.39 2.84 1.27 3.26 1.10 0.92 2.95 5.46 2.49 2. Mining & Quarrying (9.65) (8.63) (5.67) 6.93 (4.48) 4.06 (0.53) 1.01 1.92 1.59 3. Manufacturing & Processing 5.93 7.19 4.99 7.43 6.38 6.31 4.94 4.46 2.91 4.63 4. Electricity, Gas & Water Utility 4.78 6.17 3.20 6.81 5.22 6.36 6.86 6.60 6.13 6.49 5. Construction 7.75 7.16 7.46 7.59 7.49 7.42 8.23 6.91 6.86 7.34 6. Commerce, Hotel & Restaurang 2.80 4.02 6.61 9.23 5.69 9.88 10.01 8.65 6.01 8.59 7. Transport & Communication 13.37 13.82 14.06 12.37 13.38 14.27 14.10 12.99 10.78 12.97 8. Finance, Leasing & Services 6.70 5.85 8.43 9.77 7.70 6.66 8.86 7.86 5.21 7.12 9. Other Services 4.93 5.05 4.43 4.98 4.85 4.64 4.43 5.58 5.97 5.16 Gross Domestic Product 4.10 4.36 4.63 7.13 5.05 6.25 5.63 5.63 4.90 5.60 - Non Oil and Gas 4.88 5.14 5.62 8.33 5.99 7.18 6.58 6.48 5.70 6.48 - Oil and Gas (2.95) (2.88) (4.56) (3.66) (3.52) (2.70) (3.93) (3.15) (3.27) (3.26) Source : Central Bureau of Statistics The brisk growth was recorded in the electricity, mining, trade, transportation and services sector. Meanwhile, growth was down in the manufacturing, agriculture and construction sector. The slow growth in the agriculture sector stemmed from several natural disasters like floods and increasing production cost as domestic oil prices increased significantly. Declining growth in construction sector mainly influenced by the delay of some infrastructure project by the Government II. Rupiah Exchange Rate In general, Rupiah exchange rate in 2005 experienced a depreciating trend. The average exchange rate during 2005 reached Rp 9713/ US$, depreciated 8,6% from average exchange rate during 2004. This condition is related to the weak performance of balance of payment that caused by unfavorable external and internal sector, which therefore gave fundamental pressure to the exchange rate. On the external side, world oil price hike and continuing tight monetary policy in US contributed to depreciating pressure on Rupiah. On the internal side, the increase of foreign currency demand to fulfill import needs and foreign debt repayment was the main factor behind the strong pressure on Rupiah. 3
Rp/USD 10500 10000 9500 9000 8500 8000 Source : Bank Indonesia Graph 2.1 Average Rupiah Exchange Rate After being under depreciating pressure especially in Q3 2005, Rupiah strengthens and stabilizes in Q4/2005 in step with improved market confidence on the fiscal soundness and management as well as on the commitment of monetary policy to safeguard the price stability. At the end of 2005, rupiah is traded around Rp9,800 per US dollar. III. Inflation The strong external pressure that was above the previous forecast due to the hike of world oil price and continuing monetary tightening cycle in the global economy had influenced inflation development in Indonesia. The policy response to increase domestic fuel price in order to maintain fiscal sustainability in line with the hike in world oil price, had given strong pressure on inflation in 2005. Alongside this, difficulties in supply and distribution after the occurrence of natural disasters in various areas in Indonesia, the increase of inflation expectation and Rupiah depreciation had also increase the pressure to inflation. After period of stability, CPI inflation climbed sharply in Q4 2005 and reached 17.11 % on yearly basis at the end of 2005, far above the targeted inflation of 6% ± 1% or 2004 CPI inflation of 6.4%. The hike in CPI inflation is mostly attributable to a steep increase in administered prices and transportation costs following higher domestic fuel price in early October 2005. Core inflation also rises to 9.4% on yearly basis, above its earlier prediction of 6.8%, as consequence of weaker Rupiah and mounting public expectation of inflation emanating from the steep increase in fuel prices. 4
Table 3.1 CPI Inflation Year Month Monthly (%) Annually (%) (m-t-m) (y-o-y) 2004 Jan 0.57 4.82 Feb -0.02 4.60 Mar 0.36 5.11 Apr 0.97 5.92 May 0.88 6.47 Jun 0.48 6.83 Jul 0.39 7.2 Aug 0.09 6.7 Sep 0.02 6.7 Okt 0.56 6.22 Nov 0.89 6.18 Dec 1.04 6.4 2005 Jan 1.49 7.32 Feb -0.17 7.15 Mar 1.91 8.81 Apr 0.34 8.12 May 0.21 7.4 Jun 0.5 7.42 Jul 0.78 7.84 Aug 0.55 8.33 Sep 0.69 9.06 Okt 8.7 17.89 Nov 1.31 18.36 Dec 0.04 17.11 Source : Central Bureau of Statistics (BPS) Volatile food inflation reached 15.51% on yearly basis, far above the same period in 2004, which was 5.95% (yoy). This was mainly caused by an increase in food prices particularly rice and seasonings due to distribution and supply problems. Administered prices inflation reached 41,7% on yearly basis, far above initial forecast. This was mainly driven by an increase in fuel price and transportation fares IV. Monetary Policy The effort to maintain monetary stability in 2005 faced enormous challenges. The strong influence from external side namely world oil price hike and continuing world global tight monetary cycle, had given pressure on domestic macroeconomic stability, which was reflected by sharp depreciation of Rupiah exchange rate and high CPI inflation. The challenge to maintain monetary stability become heavier amid domestic banking conditions that experiencing excess liquidity. In such situation, Bank Indonesia took a consistent step to control inflation and maintain exchange rate stability through tight biased monetary policy. This is reflected in the multiple increases in the BI rate from 8.50% at the launching of Inflation Targeting Framework (ITF) in early July 2005, to 12.75% in December 6 th, 2005. This measure is taken to curb inflationary pressure generated by rising expectation of inflation and deterioration in the exchange rate. By doing so, BI aims at consistently guiding expectations of inflation towards achievement of the medium-term inflation target. The interest rate measure is accompanied by measures that include higher statutory reserves to reduce the excess liquidity in the banking sector and a simpler mix of monetary instruments to reinforce the monetary direction (signal). In addition to the monetary policy actions described above, the continued sterilization of foreign currencies and a better management of foreign currency demand from state owned companies (SOEs) also play a significant role in halting the slide in rupiah. It is however understood that a more structural nature of policy 5
actions is needed to maintain the stability and prevent further decline in rupiah. This supply is expected to come from more foreign direct investment (FDI) and stronger export performance. For greater effectiveness in management of liquidity, Bank Indonesia has taken the measures such as: a. Introducing higher Rupiah statutory reserve requirement (effective as of Sep 8, 2005) based on deposit and achievement of loan to deposit ratio (LDR). In a similar measure designed to boost the incentive for banks to carry out their intermediary function, on December 1, 2005, Bank Indonesia will raise the deposit interest paid on bank demand deposit funds held at Bank Indonesia in excess of the statutory reserve requirement to 6.5%. b. Restricting foreign exchange transactions not accompanied by underlying transactions. c. Reducing bank foreign currency exposure through:? Net Open Positions (NOP) (on and overall balance sheet max. 20%).? Reduction of Banks NOP to 20% if they take into account market risk.? Requiring banks to maintain the Net Open Positions (NOP) at all times throughout the day.? Applying penalty and administration sanctions to those who break the NOP regulation. d. Activating the O/N FTC (Fine Tune Contractions) instrument. e. Launching currency swap interventions as an OMO instrument with 1-7 day tenor. f. Extending the windows for the O/N FASBI at a rate set at 500 bps below the BI Rate g. Launching of swap hedging facility for investor with 3-6 months tenor, effective from October 3, 2005. h. Banning on Rupiah margin trading against all foreign currencies, effective from September 15, 2005. To further strengthen international reserves and support balance of payments as well as a safety net measure, Indonesia has entered into a swap agreement with ASEAN countries as well as bilateral swap arrangements (BSA s) with other countries. Bank Indonesia on behalf of the government has signed BSAs with Japan, China and South Korea. The total amount available under Bilateral Swap Arrangements is US$ 9 billion. V. Balance of Payment 6
Indonesia s balance of payments (BOP) in 2005 recorded a deficit of US$0.4 billion, compared to a surplus of US$0.3 billion in 2004. This was attributable in part to rising oil prices and increasing U.S federal funds rate. The current account recorded a surplus of US$3.0 billion, nearly at the same level achieved in 2004. The surplus in the balance of goods, both for non oil & gas and oil & gas, increased by 5.7% from the previous year. Exports recorded double-digit growth of 20.1% (yoy) due to the increased demand for a wide range of export items such as textile, copper, coffee, and also the increased market price. Imports also registered a double-digitgrowth of 26.2% (yoy) due to the higher market price. Indonesian imported goods dominated by raw materials to support the exportoriented industry. The y.o.y increase in the surplus of the balance of goods began to shrink in the second half of the year. This was explained by a slowdown in exports while import growth surpassed the export growth. The capital account recorded a net inflow of US$6.3 billion, increased sharply from a net inflow of US$2.6 billion in 2004. This high growth was contributed both by public and private sector of US$1.2 billion and US$5.1 billion respectively. The surplus in the public sector was due to increasing loan disbursements from program aid; the proceeds from the issuance of US$2.5 billion of government bonds; and debt moratorium received from Paris Club member countries following the Tsunami disaster in the amount of US$2.7 billion. The surplus in the private sector was mostly due to a sharp increase in FDI surplus from US$1.0 billion in 2004 to US$2.3 billion in 2005. This surplus mostly due to the Philip Morris transaction with the PT. HM Sampoerna in the first and third quarter of 2005. Inward investments in bonds and notes also showed a significant net inflow. This is attributed to the fact that foreign investors purchased a large amount of Indonesia s Government Bonds (SUN) and Bank Indonesia Certificate (SBI). At the end of 2005, the official reserves decreased by 4.4% from US$36.3 billion in 2004 to US$34.7 billion. This amount is sufficient to cover 4.4 months of imports and official debt repayments. 7
VI. Public Finance In the midst of various external and internal pressures in 2005, the government consistently continues its fiscal consolidation process therefore the government could achieve fiscal sustainability. Such consolidations among others were fuel subsidy reduction policy and moratorium of government debt. At the same time, in the transition period of new budget system, the realization of government expenditure was not effective. Consolidation process and lower realization of government expenditure had caused the decline in state budget deficit ratio to GDP. From financing side, fiscal consolidation policy had also taken by reducing government debt stock to GDP. In general, fiscal policy in 2005 only provided small contribution to economic growth. The deficit of State Budget 2005 was 0.5% of GDP and was significantly below the level prescribed in the second revised budget at Rp. 29.94 trillion or 0.9 or GDP. The 2005 State Budget came under heavy pressure from external and internal factors. External pressure had been fueled by record high oil prices and the depreciation of the Rupiah against the US dollar. Added to this were internal pressures from budget spending in the wake of tsunami in Aceh and Nias and expanded budget allocations related to the new Law on Regional Governments (No. 32/2004). For these reasons, the 2005 State Budget had undergone two revisions. In most fiscal years, the budget is revised only once. While the first revision in July concentrated on few items such as rehabilitation and reconstruction in Aceh and Nias (funding and debt moratorium), regional elections, fuel subsidy and compensation program, the second revision took into account the change in macroeconomic condition of particular concern, which is revision of oil price assumptions to better reflect market price. 8
Item (in IDR billion) Realization State Budget 2005 ( In Rp. billion) Budget 2 nd revision % to GDP 2005 Realisation up to Dec 30, 2005 % to GDP % to budget 2nd revision A. Total Revenue and Grants 540,126.1 20.4 495,444.4 18.2 91.7% I. Domestic Revenue 532,671.0 20.1 494,148.3 18.2 92.8% 1. Tax Revenue 351,973.6 13.3 346,833.8 12.7 98.5% 2. Non Tax Revenue 180,697.4 6.8 147,314.5 6.4 81.5% II. Grants 7,455.1 0.3 1,296.1 0.0 17.4% B. Expenditures 565,069.8 21.3 509,418.9 18.7 90.2% I. Central Government Expenditures 411,667.6 15.5 358,902.5 13.2 87.2% 1. Personnel expenditure 61,167.2 2.3 55,589.2 2.0 90.9% 2. Material expenditure 42,311.8 1.6 33,059.6 1.2 78.1% 3. Capital expenses 54,746.6 2.1 36,853.6 1.4 67.3% 4. Interest payments 60,982.2 2.3 57,650.8 2.1 94.5% 5. Subsidies 119,089.5 4.5 120,707.8 4.4 101.4% 6. Grants - - - - - 7. Social assistance 29,996.5 1.1 24,247.3 0.9 80.8% 8. Other 43,373.7 1.6 30,794.2 1.1 71.0% II. Regional Transfer 153,402.2 5.8 150,516.4 5.5 98.1% 1. Balanced funds 146,159.7 5.5 143,301.2 5.3 98.0% 2. Special autonomy & adjusment fund 7,242.5 0.3 7,215.2 0.3 99.6% C. Primary Balance 36,038.5 1.4 43,676.3 1.6 121.2% D. Overall Balance (24,943.7) 0.9 (13,974.5) (0.5) 56.0% E. Financing 24,943.7 0.9 18,988.9 0.7 76.1% I. Domestic financing 29,785.9 1.1 30,265.6 1.1 101.6% 1. Domestic bank financing 4,270.6 0.2 6,776.2 0.2 158.7% 2. Domestic non bank financing 25,515.4 1.0 23,489.4 0.9 92.1% II. Foreign financing (4,842.2) (0.2) (11,276.6) (0.4) 232.9% 1. Gross drawing 35,540.7 1.3 25,817.1 0.9 72.6% 2. Amortizations (40,382.9) (1.5) (37,093.7) (1.4) 91.9% Surplus (Deficit) Financing 5,014.5 - - Source : Ministry of Finance Table 4.1 VII. Banking Sector Despite some challenges in 2005, The Indonesia s Banking Industry continued to perform reasonably well. The resilience of the banking industry in absorbing the risk of instability has been improved adequately. Efforts to improve bank s capital, implementation of risk management and be consistent in the application of the prudential banking principles which have long been the focus in strengthening the industry were apparently effective in preventing the industry from a more drastic weakening. In fact, several indicators showed that the growth of the banking sector was adequately satisfactory. All Indonesian banks remain adequately capitalized with average CAR of 19.5 % as of December 2005 The intermediary function of the banking industry throughout 2005 went smoothly as planned although a little bit slower than that of previous year. Total loans grew by 22.7% and deposits increased by 17.1%. Realization of credit line to Micro, Small and Medium Enterprises was rising higher than the targeted amount. However, with mounting credit risk associated with higher interest rates and increased risk in the real sector, the NPLs ratio crept upwards to 8.3% as of December 2005. Table 6.1. 9
Main Banking Indicators Indicators 2004 2005 (+/-) (%) Dec Mar Jun Sep Dec Dec 04-Dec 05 Total Assets (Rp. Tr) 1273.3 1344.6 1344.6 1418.6 1469.83 197.5 15.5 Deposit Funds (Rp. Tr) 963.1 1011.6 1011 1077.5 1127.94 164.8 17.1 Credit *) (Rp. Tr) 595.1 664.3 664.3 715.3 730.2 135.1 22.7 LDR (%) 50 53.1 53.1 54.2 53.2 NPLs Gross (%) 5.8 7.9 7.9 8.8 8.3 NPLs Net (%) 1.7 3.7 3.7 5 4.8 CAR (%) 19.4 19.5 19.5 19.4 19.5 NIM (NII/AP) (%) 0.6 0.5 0.5 0.5 0.5 * Include channeling Source : Bank Indonesia VIII. Economic Outlook Opportunities remain for the Indonesian economy to achieve higher growth in 2006 despite the heavy challenges face. Up to first half of 2006, impact of the increase domestic fuel price will still hamper the economic growth. Nonetheless pressure on economic growth should lift early in the second half of 2006 with more stable price movements, improving public expectations and results from the series of real sector policies now being formulated by the Government. In this regard, Bank Indonesia has resolved to maintain the tight bias monetary policy considering the relatively high pressure of inflation in the future. In this policy stance, Bank Indonesia is consistently working to guide public expectation of inflation toward achievement of the medium term inflation target. The adjustment of monetary policy will be taken if comprehensive analysis indicates the inflation pressure has decreased in line with the medium term inflation target. With the investment climate starting to improve in the second half of the year there is a room for BI to adjust its monetary policy to a more neutral stance from tight biased stance now. 10