MONETARY POLICY REPORT Economy, Monetary, and Finance

Transcription

1 MONETARY POLICY REPORT Economy, Monetary, and Finance QUARTER II 218

2

3 Foreword Bank Indonesia has a single overarching mandate, namely to achieve and maintain rupiah stability. Nevertheless, rupiah stability encompasses two aspects, namely price stability of goods and services, as reflected in stable inflation, as well as rupiah exchange rate stability to currencies in other countries. The Government set the inflation target for 218 at 3.±1%. To that end, Bank Indonesia implements sustainable, consistent and transparent monetary policy that also pays due regard to the prevailing economic policies of the Government. In pursuance of its mandate, Bank Indonesia institutes an optimal mix of monetary, macroprudential, payment system and rupiah currency management policies. Bank Indonesia regularly publishes the Monetary Policy Report each quarter after the Board of Governors Meeting has been convened in February, May, August and November. The Report has two primary functions, namely: (i) to provide economic data, analysis and projections to help form and anchor rational expectations as part of the anticipative monetary policymaking framework; and (ii) as a medium for the Board of Governors to publicly explain and clarify the various considerations underlying monetary policy decision-making at Bank Indonesia. The Board of Governors PERRY WARJIYO Governor MIRZA ADITYASWARA Senior Deputy Governor ERWIN RIJANTO Deputy Governor SUGENG Deputy Governor ROSMAYA HADI Deputy Governor DODY BUDI WALUYO Deputy Governor Bank Indonesia Monetary Policy Report Quarter II 218 1

4 Table of contents 1. Executive Summary 3 2. Global Economic Developments Global Economy Global Financial Markets Global Policy Response Global Commodity Markets Domestic Economic and Financial Market Developments Economic Growth Prosperity Indonesia Balance of Payments Rupiah Exchange Rate Inflation Financial Markets Box: The Impact of Exchange Rate Depreciation and International Commodity Price Dynamics on Inflation Economic Outlook Global Economic Outlook Domestic Economic Outlook and Risks Box: Fan Chart: Visual Macroeconomic Projections and Risks Monetary Policy Report Quarter II 218 Bank Indonesia

5 1 Executive Summary The BI Board of Governors agreed on 14th and 1th August 218 to raise the BI 7-Day Reverse Repo Rate by 2 bps to.%, while also raising the Deposit Facility (DF) and Lending Facility (LF) rates by 2 bps to 4.7% and 6.2% respectively. The decision is consistent with ongoing efforts to maintain the attractiveness of the domestic financial markets and manage the current account deficit within an acceptable threshold. Bank Indonesia sincerely appreciates and backs the concrete measures taken by the Government to reduce the current account deficit by stimulating exports and reduce imports as well as postponing government projects with a high import content. Bank Indonesia will continue to strengthen coordination with the Government and other relevant authorities to maintain macroeconomic stability and external resilience against a backdrop of increasing global financial market uncertainty. Moving forward, Bank Indonesia will remain vigilant of global and domestic economic dynamics and monitor the economic outlook in order to strengthen the policy mix response to maintain macroeconomic and financial system stability. The policy rate is reinforced by a sound monetary operations strategy to strengthen interbank rate convergence with the BI 7-Day Reverse Repo Rate, which would enhance monetary policy transmission effectiveness. Furthermore, Bank Indonesia is also continuing measures to accelerate financial market deepening. In the money market, the successful implementation of IndONIA as the reference rate will be accompanied by development of Overnight Index Swap (OIS) and Interest Rate Swap (IRS) instruments, which will ensure a more efficient market rate structure. In the foreign exchange market, Bank Indonesia has improved the effectiveness of foreign exchange swap instruments for monetary operations or hedging through lower prices. Such policies are will provide various alternative instruments to help manage market liquidity and support rupiah exchange rate stability. Multispeed global economic growth has continued to stoke global economic uncertainty. The US economy continues to gain momentum on the back of accelerating consumption and investment. Meanwhile, the economies of Europe, Japan and China are moderating. Consequently, the Federal Reserve is expected to continue raising the Federal Funds Rate (FFR) gradually, contrasting the reluctance of the ECB and BoJ to hikes policy rates. In addition to the recent FFR hikes, widespread global uncertainty has been exacerbated by simmering trade tensions between the US and several other countries, which have triggered retaliatory actions around the world, including currency depreciation despite broad US appreciation. Global uncertainty has also been fuelled by the risk of spillovers from the economic shocks in Turkey caused by domestic economic fragilities and the adverse impact of negative sentiment surrounding the authorities policies, as well as looming tensions with the US. Bank Indonesia will remain vigilant of the external risks, including potential spillover from Turkey although sound economic fundamentals in Indonesia are indicative of solid national economic resilience, coupled with avowed policy commitment. Bank Indonesia Monetary Policy Report Quarter II 218 3

6 The national economy has accelerated significantly on strong domestic demand fuelled by private and government consumption. GDP growth was recorded at.27% (yoy) in the second quarter of 218, the fastest rate since 213. Meanwhile, household consumption stood at.14% (yoy), bolstered by rising incomes, upbeat consumers and controlled inflation. In addition, consumption associated with the local elections also posted solid growth. Meanwhile, government spending has also improved, thereby catalysing strong domestic demand. On the other hand, solid investment growth has been maintained despite fewer total work days in June 218 that restrained growth slightly. Growing domestic demand has prompted a surge of imports against comparatively subdued export performance. Regionally, the economies of Sumatra, Kalimantan and Papua have been the key drivers of growth, coupled with economic resilience in Java, Sulawesi and Maluku. Looking forward, Bank Indonesia predicts solid economic growth on sound investment and consumption performance despite limited export gains. Building and nonbuilding investment remain strong, backed by infrastructure development and investment in the manufacturing industry. Meanwhile, several upcoming events, including the general election, are expected to maintain consumption. Consequently, Bank Indonesia projects economic growth in 218 in the.-.4% (yoy) range, subsequently accelerating to.1-.% (yoy) in 219. Congruent with the uptick in terms of domestic economic activities, the current account deficit increased in the second quarter of 218. The current account deficit stood at USD8. billion (3.% of GDP) in the second quarter of 218, up significantly from USD.7 billion (2.2% of GDP) in the first quarter of 218. Nevertheless, the current account deficit has remained below the manageable threshold in the first half of the year, averaging 2.6% of GDP. The current account deficit increased on an import surge of raw materials, capital goods and consumer goods due to increasing domestic economic activity, which outpaced export growth. Meanwhile, the capital and financial account surplus increased to record a USD4. billion surplus in the second quarter of 218, up from USD2.4 billion in the previous period. Consequently, the position of reserve assets stood at USD118.3 billion at the end of July 218, equivalent to 6.9 months of imports or 6.7 months of imports and servicing government external debt, which is well above the international standard of 3 months of imports. Moving forward, Bank Indonesia perceives solid Balance of Payment (BOP) performance and the current account deficit maintained within an acceptable threshold that will reinforce external sector resilience. In addition to demandside controls, including monetary policy, the government will also reduce the current account deficit by stimulating exports and tourism, while reducing dependence on imports by postponing projects with a high import content. 4 Monetary Policy Report Quarter II 218 Bank Indonesia

7 Exchange rate volatility subsided as the rupiah defied intense depreciatory pressures. Point to point, the rupiah lost 3.94% in value during the second quarter of 218 and.62% in July 218. Rupiah depreciation was accompanied, however, by lower volatility despite broad USD appreciation. Year to date, the rupiah depreciated by 7.4%, less severe than that reported in India, Brazil, South Africa and Russia. Meanwhile, foreign capital inflows have returned to domestic financial markets, drawn to all asset types. Bank Indonesia will continue to monitor the risk of global financial market uncertainty, while stabilising the rupiah in line with the currency s fundamental value and maintaining market mechanisms, backed by financial market deepening initiatives. Such policy will be supported by dual intervention and monetary operations strategy to maintain adequate liquidity, particularly in terms of the rupiah money market and foreign exchange market. Bank Indonesia policy to improve the effective availability of cheaper foreign exchange swaps should pique investor interest at auctions of various tenors and lower the swap premium, for instance from 4.8% to 4.62% for 1-month tenors and from.18% to 4.96% for 1-year tenors. Post-Eid price corrections helped Bank Indonesia to control low and stable inflation. CPI inflation was recorded at.28% (mtm) in July 218, down from.9% (mtm) the month earlier in line with milder inflationary pressures after the Eid-ul-Fitr period. Lower headline inflation stems from deflation of administered prices. As of July 218, therefore, CPI inflation stood at 3.18% (yoy), relatively stable compared with the 3.12% (yoy) posted the month earlier. Administered prices recorded deflation after transport fares experienced corrections in the wake of the highdemand Eid-ul-Fitr period, primarily affecting airfares and intercity fares. On the other hand, inflationary pressures on volatile foods were also controlled amidst price corrections to various food commodities. Meanwhile, low core inflation was maintained despite an accumulation of inflationary pressures on services. Consequently, core inflation was recorded at.41% (mtm), up from.24% (mtm) the month earlier. The main contributors to core inflation were mobile phone tariffs and the seasonal impact of school fees. Controlled core inflation was also the result of policy consistency from Bank Indonesia in terms of anchoring rational inflation expectations, while maintaining exchange rates in line with the rupiah s fundamental value. Bank Indonesia predicts inflation within the 218 target corridor of 3.±1% (yoy). Furthermore, Bank Indonesia will strengthen policy coordination with the Government to control low and stable inflation. Bank Indonesia Monetary Policy Report Quarter II 218

8 Financial system stability was maintained in the second quarter of 218 as the bank intermediation function improved and the banking industry effectively contained credit risk. Maintained financial system stability is reflected in the high Capital Adequacy Ratio (CAR) reported by the banking industry at 22.% and the liquidity ratio of 19.4% in June 218. In addition, the banking sector maintained a low level of non performing loans (NPL) at 2.7% (gross) or 1.2% (net). Financial system stability is also contributing to improvements in the bank intermediation function. Deposit growth was reported to accelerate from 6.% (yoy) to 7.% (yoy) in June 218, while credit growth increased from 1.3% (yoy) to 1.7% (yoy). On the other hand, nonbank economic financing through the financial markets, such as initial public offerings (IPO) and rights issues, corporate bonds, medium-term notes (MTN) and Negotiable Certificates of Deposit (NCD), reached a cumulative total of Rp129.9 trillion (gross) in the first half of the year. With the recent economic gains and progress in terms of corporate and banking sector consolidation, Bank Indonesia projects credit and deposit growth in 218 at % (yoy) and 8.-1.% (yoy) respectively. Domestic economic and financial activities are improving with the backing of a secure, efficient, available and reliable payment system. The settlement of noncash transactions, including large-value and retail transactions, as well as cash transactions increased in the reporting period. The daily average value of large noncash payment transactions settled through the Bank Indonesia Real Time Gross Settlement (BI-RTGS) system jumped 13.7% (yoy) in the second quarter of 218. A similar trend was observed in terms of noncash retail transactions, with the value settled through the National Clearing System (SKNBI) rising 3.1% (yoy) and the value of retail transactions involving ATM/debit cards, credit cards and electronic money expanding 9.6% (yoy). The higher cash payment transaction is also supported by services and system availability of Bank Indonesia s secured payment system. Regarding cash payments, the position of currency in circulation increased 1.2% (yoy) in the second quarter of 218 as public demand spiked for currency in appropriate denominations and fit for circulation. 6 Monetary Policy Report Quarter II 218 Bank Indonesia

9 2 Global Economic Developments GLOBAL ECONOMY Divergent global economic growth has continued to stoke global economic uncertainty. The US economy continues to gain momentum on the back of accelerating consumption and investment. Meanwhile, the economies of Europe, Japan and China are moderating. Consequently, the Federal Reserve is expected to continue raising the Federal Funds Rate (FFR) gradually, contrasting the reluctance of the ECB and BoJ to hikes policy rates. In addition to the recent FFR hikes, widespread global uncertainty has been exacerbated by simmering trade tensions between the US and several other countries, which have triggered retaliatory actions around the world, including currency depreciation despite broad US appreciation. Global uncertainty has also been fuelled by the risk of spillovers from the economic shocks in Turkey caused by domestic economic fragilities and the adverse impact of negative sentiment surrounding the authorities policies, as well as looming tensions with the US. Bank Indonesia will remain vigilant of the external risks, including potential spillover from Turkey although sound economic fundamentals in Indonesia are indicative of solid national economic resilience coupled with avowed policy commitment. The US economy continues to gain momentum on the back of accelerating consumption and investment. The US economy posted 2.8% growth in the second quarter of 218, improving from 2.6% in the previous period (Graph 2.1). Stronger consumption data was confirmed by faster consumption growth of vehicles and services, such as recreation, accommodation and health services, backed by lower unemployment. Meanwhile, increasing residential investment % yoy Consumption Private Investment Net Export Government Expenditure GDP I II III IV I II III IV I II III IV I II Source: Bloomberg, calculated Graph 2.1 US Economic Growth Bank Indonesia Monetary Policy Report Quarter II 218 7

10 combined with solid non-residential investment continued to boost overall investment growth in the second quarter of 218, supported by corporate tax breaks that have trickled down and maintained a high level of new orders in the manufacturing industry. In addition, companies have continued to ramp up production, as indicated by a bump in the Markit Manufacturing PMI and capacity utilisation data. Congruently, the US has maintained a solid net export position based on an export growth surge of soybean coupled with subdued imports. The US labour sector has continued to improve, accompanied by higher wages and rising inflation. Such developments were confirmed by the unemployment numbers in the second quarter of 218, falling from 4.1% in the previous period to 3.9%, which is well below the Non-Accelerating Inflation Rate of Unemployment (NAIRU) at 4.7%. Less slack in the US labour sector was reflected by an increase in nonfarm payroll together with the growing number of job openings that outpaced the number of new workers joining the labour market, which raised wages and amplified inflationary pressures. Based on age bracket, young and productive workers have benefitted most from the higher wages in the reporting period PCE Projection CPI (yoy) PCE (yoy) PCE (mtm) Target 2% CPI Core (yoy) PCE Core (yoy) Source: Bloomberg, calculated Graph 2.2 US Inflation % Inflationary pressures remained in the US during the second quarter of 218, induced by rising inflation expectations and strong demand. CPI inflation and core inflation in the United States stood at 2.9% (yoy) and 2.3% (yoy) respectively in the reporting period, up from 2.4% (yoy) and 2.1% (yoy) in the previous period (Graph 2.2). In general, rising prices of clothing, energy, motor vehicles and durable goods have amplified inflationary pressures. Furthermore, inflation expectations in the near term have continued to rise and currently stand above the 2% inflation target. Data from the Consensus Forecast, April-July 218, indicates that average inflation expectations in the US 8 Monetary Policy Report Quarter II 218 Bank Indonesia

11 reached 2.% (yoy) in the second quarter of 218, up from 2.4% (yoy) in the previous period. Europe s economy moderated on the back of restrained consumption and investment growth. After achieving comparatively solid 2.% growth in the first quarter of 218, Europe s economy slumped to 2.2% (yoy) in the reporting period, below the previous projection (Graph 2.3). The economic downswing was attributed to soft consumption growth, as reflected in declining retail sales and consumer confidence in the economy. On the other hand, investment gains in the second quarter of 218 were stifled by weaker investment in machinery despite persistently solid construction investment. Europe s flagging economy was also held back by slower production activity, as confirmed by a lower Manufacturing PMI and Industrial Production index as well as capacity utilisation. The support of a net export position was also eroded by increasing imports and limited exports as a result of less demand from China. Despite persistent slack, labour market dynamics have improved in Europe. Unemployment fell to 8.3% in the second quarter of 218 but labour market slack remains, as evidenced by a significant portion of underemployed and available employees not seeking work. Such dynamics have led to moderate wage growth at 3.86% compared with the pre-crisis level of.43%. Inflation in Europe has increased significantly on the rising global oil price. CPI inflation in Europe was recorded at 2.% in the second quarter of 218, up from 1.3% in the previous period (Graph 2.4). Energy prices have risen 8% due to the higher oil price, which induced CPI inflation. On the other hand, core inflation decreased to.9% in the second quarter of 218 from 1.% in the previous period. Furthermore, the ECB has effectively anchored rational inflation expectations below the current 2% target. % yoy Consumption Investment Net Export Government Consumption GDP I II III IV I II III IV I II III IV I II-F Source: Bloomberg, calculated Graph 2.3 Economic Growth in Europe % CPI mtm CPI yoy Core yoy ECB CPI Target 2% Source: Bloomberg, calculated Graph 2.4 Inflation in Europe Bank Indonesia Monetary Policy Report Quarter II 218 9

12 Economic moderation in Japan was expected to endure throughout the second quarter of 218, with the economy impeded by slower consumption and investment growth. After moderating in the first three months of the year, Japan s economy is expected to continue declining in the second quarter of 218 (Graph 2.). Consumption has slowed in line with fading consumer confidence as well as slumping retail and motor vehicle sales. In addition, investment growth has decelerated based on less demand for machinery and a lower Manufacturing PMI. On the other hand, import and export activities have continued to accelerate, driven by exports to Europe and China as well as oil imports. Japan s labour market is improving despite persistent slack. Unemployment fell to 2.2% in the second quarter of 218 from 2.% in the previous period. Nevertheless, labour market slack persists, exacerbated by the ageing population that has undermined overall worker productivity and led to moderate wage growth. Inflation in Japan has fallen below the BOJ s target. CPI inflation stood at.7% (yoy) in the second quarter of 218, down from 1.1% (yoy) in the previous period. Durable goods, food and energy were the main drag on headline inflation in Japan. Similarly, core inflation also decreased (.8%) in the reporting period, remaining below the Bank of Japan s (BOJ) 2% target (Graph 2.6). Slower inflation growth was attributed to several factors, including a cautious corporate sector in terms of setting wages and prices, which has been compounded by tighter competition. Financial deleveraging has stifled economic growth in China. China s economy moderated slightly from 6.8% to 6.7% in the second quarter of 218 (Graph 2.7), held back by waning public and private investment (Graph 2.8). Deleveraging by local governments and state-owned enterprises has reduced public II III IV I II III IV I II III IV I II Source: Bloomberg, calculated 21 Source: Bloomberg Graph 2. Japan Economic Growth Graph 2.6 Japan Inflation Graph 2.7 China Economic Growth % yoy Consumption Investment Net Export GDP Government Consumption Tokyo CPI CPI CPI exclude fresh food CPI exclude Processed Food and Energy 216 % yoy Net Export Investment Total Consumption GDP I II III IV I II III IV I II III IV I II Source: Bloomberg, calculated % yoy Monetary Policy Report Quarter II 218 Bank Indonesia

13 investment and further exacerbated slower public investment in the infrastructure sector. Moreover, the private sector has also been less inclined to invest in line with declining real estate investment as the main driver of private investment. Similarly, consumption growth slowed in the second quarter of 218 due to financial deleveraging, which has constrained lending, including household loans. This has led to softer retail sales, particularly affecting motor vehicle sales. Nonetheless, the manufacturing industry has remained expansive despite an export slowdown triggered by the looming trade war and weaker domestic demand. On the other hand, imports also decelerated on dwindling domestic demand and deferred imports as consumers wait for lower import tariffs on consumer goods Source: Bloomberg; Notes: Data is accumulated data Graph 2.8 China Investment % ytd yoy 2 Private Investment Government Investment 2 Total Investment (FAI) 1 Food was the main drag on China s inflation, while non-food inflation remained comparatively stable. CPI inflation in China was recorded at 1.9% in the second quarter of 218, down from 2.1% in the previous period and slipping further away from the government s 3% target. Inflationary pressures on food eased as prices returned to normal after the Chinese (lunar) new year holiday. Meanwhile, milder inflationary pressures on recreation and health services helped to maintain relatively stable non-food inflation remained. Resurgent investment in India is expected to sustain solid national economic growth in the second quarter of 218. Analysts predicted solid economic growth in India during the second quarter of 218 after posting a robust 7.7% in the first quarter (Graph 2.9). A surge of investment is driving India s economy, as evidenced by a significant bump in the Manufacturing PMI during the reporting period along with a high level of industrial production growth (Graph 2.1). On the other hand, higher unemployment, a dip in the average daily wage as well as downcast automotive sales and restrained production will % yoy Consumption Investment -2 Net Export GDP Government Consumption F Source: Bloomberg Graph 2.9 India Economic Growth Bank Indonesia Monetary Policy Report Quarter II

14 impede potential consumption gains. In terms of the external sector, the large trade deficit persists as import growth rose at a faster pace than exports due to the high global oil price. Headline inflation has accelerated in India but remains within the 4.±2% target. CPI inflation was reported at 4.9% (yoy) in the second quarter of 218, up from 4.3% (yoy) in the previous period. The main contributors to inflation were core inflation, food and beverages, as well as fuel and electricity. Clothing, health as well as transportation and communication pushed core inflation (omitting food, tobacco and energy) to 6.3% (yoy) in the first quarter of 218 from.2% (yoy) in the previous period. % yoy % yoy 18 Industrial Production for Nowcast (rhs) 16 Investment Source: Bloomberg Graph 2.1 Investment and Industrial Production in India GLOBAL FINANCIAL MARKETS Risks continued to loom over the global financial markets in the second quarter of 218. The VIX index tracked an upward trend in June 218 (Graph 2.11 and Graph 2.12). Furthermore, such widespread uncertainty perpetuated broad US dollar appreciation. Global financial market uncertainty has been amplified by, amongst others, increasing economic growth divergence between the United States and other countries, expected FFR hikes and rising UST yields, a tightening of global liquidity, the higher global oil price, slower rising international commodity prices as well as an escalation of the impending trade war with retaliatory tit-for-tat measures that include exchange rate depreciation. In addition, geopolitical risks have further heightened the prevalent uncertainty due to simmering tensions around the world, including US threats against Iran, tensions on the Korean Peninsula, the tense US-China relationship, the border dispute and trade relations between the US and México, the financial crisis in Turkey as well as the domestic political issues plaguing several countries in Europe coupled with the burgeoning immigrant crisis. The build-up of Source: Bloomberg Index Indonesia CDS VIX (rhs) Index 218 Graph 2.11 Indonesia VIX and CDS Graph 2.12 DXY and ADXY Reinforcement Index Dollar Index 112 Asian Dollar Index (rhs) - Reverse Order Apr 24 Apr 18 Mei 11 Jun 29 Jun 23 Jun 14 Aug Source: Bloomberg Appreciation of US Dollar vs. Major Currency Index Appreciation of US Dollar vs. Asian Currency Monetary Policy Report Quarter II 218 Bank Indonesia

15 geopolitical risk demands increased vigilance because heightened uncertainty could thwart investment and intensify risks in the financial markets. GLOBAL POLICY RESPONSE The US Federal Reserve is continuing to normalise monetary policy through policy rate hikes and balance sheet reductions commensurate with increasing economic growth momentum. The Federal Open Market Committee (FOMC) decided in August 218 to hold the Federal Funds Rate (FFR) considering that despite stronger domestic economic growth and low unemployment, inflation remains within the 2% target range. Furthermore, the FOMC dot plot has indicated that the Fed is predicted to gradually raise the FFR four times in 218 and three times in 219. The probability of four FFR hikes in 218 currently stands at 63.3%, which is higher than the probability of three FFR hikes (Table 2.1). In addition to gradually raising the policy rate, the Federal Reserve relayed its intention to maintain balance sheet reductions by releasing US Treasury (UST) and Mortgage- Backed Securities (MBS) (Graph 2.13). In Europe, the European Central Bank (ECB) is continuing quantitative easing and has maintained its monetary policy stance apropos of forward guidance. The ECB s Monetary Policy Committee (MPC) decided on 26 th July 218 to maintain its monetary policy stance based on previous forward guidance (Diagram 2.1). The ECB is not expected to raise its policy rate until the third quarter of 219 after the net asset purchase program (APP) comes to a likely end in December 218. The decision to hold interest rates is based on the projection of low inflation in 218, below the inflation target, together with sluggish economic activity predicted this year. After the APP exit, the European Central Bank is expected to introduce QE Reinvestment to FFR 218 Increase Amount Table 2.1 Probability of Increasing FFR in 218 *Calculated based on WIRP Implied Probability Source: Bloomberg Probability* % 29 June July August Billion USD 2, UST Linear (UST) 2,48 2,46 2,44 2,42 2,4 2,38 2,36 2,34 2, Source: Bloomberg Graph 2.13 Fed ownership of UST Bank Indonesia Monetary Policy Report Quarter II

16 maintain liquidity and strengthen monetary policy. Similar to dynamics in Europe, the Bank of Japan (BOJ) is also holding its monetary policy stance. At the Monetary Policy Meeting (MPM) held on 3-31 July 218, the BOJ decided to hold its policy rate in the near and long term considering the uncertainty associated with economic activity and prices, including the impact of a hike in the consumption tax rate planned for October 219. Moreover, achieving the 2% inflation target is now expected to take longer than initially thought. In the near term, the BOJ will maintain its policy rate at -.1%. Meanwhile, seeking to hit the long-term target level, the BOJ will continue to purchase Japanese Government Bonds (JBG) until the benchmark 1-year yield hits %. In addition to buying JGB, the BOJ is also procuring Exchange Traded Funds (ETF) and Japan Real Estate Investment Trusts (J-REITs). The People s Bank of China (PBoC) has eased its monetary policy stance. The China Monetary Condition Index began to reflect policy easing in June 218 after tightening on the back of declining credit growth and rising real interest rates due to financial deleveraging that has been intensified since December 218. The PBoC is easing monetary policy through targeted reserve requirement ratios (RRRs) and by expanding the collateral for the Medium- Term Lending Facility (MLF), expanding the MLF to maintain growth stability and liquidity availability, as well as backing micro, small and medium enterprises (MSME) in accordance with the stance of the Central Government (Graph 2.14). Moving forward, the PBoC is expected to continue easing monetary policy, which will depreciate the yuan and increase volatility. To that end, the PBoC issued Statutory Reserve Requirements for forward transactions and is considering the use of countercyclical measures. Unwinding Stimulus Milestones on the ECB s Path toward monetary-policy Normalization Next change to forward guidance Net asset purchased end Deposit-rate Increase Maturing debt reinvested through Rofi-rate Increase III IV I II III IV or thereafter Source: ECB, Bloomberg survey of economic conducted July Timeline shows dates by when most economists predict a given action Diagram 2.1 Path of ECB Monetary Policy Normalization Index 12 GDP yoy China Monetary Conditions Index (rhs) Source: Bloomberg Graph 2.14 Bloomberg Monetary Condition Index weaken strengthens 14 Monetary Policy Report Quarter II 218 Bank Indonesia

17 The panoply of policy responses instituted by monetary authorities around the globe has led to increasing policy divergence between the US and the rest of the world (Graph 2.1). Such monetary policy divergence has exacerbated global financial market uncertainty and broadly influenced capital inflows to developing economies, including Indonesia (Graph 2.16). The capital reversal currently blighting developing economies has also been compounded by weaker stock market performance in China as a result of the looming trade war and the impact of deleveraging. Source: Various Source ECB Main Refinancing Rate**** Fed Funds Rate** Overnight Call Rate (Japan)*** 7-Day Repo Rate (China)*** Graph 2.1 Monetary Policy Divergence % * 219* 22* External dynamics are expected to spill over into emerging market economies, including the risk of contagion from the developments in Turkey. The current issues in Turkey were triggered by domestic economic fragilities and the adverse impact of negative sentiment surrounding the authorities policies, aggravated by festering tensions with the United States. Nonetheless, the risks are expected to prompt a negligible effect on Indonesia s economy in line with the current improvements observed in domestic economic fundamentals. Debt Flow Equity Flow Total Flow Graph 2.16 Emerging Market Capital Flows Billion USD Source: IIF Bank Indonesia Monetary Policy Report Quarter II 218 1

18 GLOBAL COMMODITY MARKETS Pervasive global economic uncertainty due to global economic growth divergence and the escalating trade war has eroded world trade and lowered commodity prices, excluding oil. Consequently, projected world trade volume (WTV) has been revised down in line with lower WTV realisation in the first quarter of 218 (Graph 2.17), as reflected by slower import and export growth in advanced economies and well as lower manufacturing PMI in advanced economies. Subdued world trade volume in the first quarter of 218 was the result of concerns stoked by protectionism stemming from the escalating trade war together with economic moderation in Europe and Japan that is expected to persist. Metal and agricultural products were the main drag on commodity prices, while coal and nickel defied further declines (Table 2.2). The latest developments revealed that crude palm oil (CPO), rubber and metal continued to track declining price trends in the second quarter of 218. CPO prices fell on dwindling demand from India and China, coupled with increasing production that led to a larger net supply. Furthermore, CPO prices have also been suppressed by lower soybean prices as a viable substitute for CPO, triggered by negative sentiment stemming from the trade war. Meanwhile, pressures on rubber prices have persisted due to abundant supply and concerns regarding the effect of the trade war on China s economy as the largest global rubber consumer. Negative sentiment surrounding the looming trade war is also responsible for pressures on copper, lead and aluminium prices. Bucking the downward trend, nickel prices continued to rise on persistently strong demand for stainless steel production in China combined with diminishing supply due to production disruptions in the major producing countries, including the Philippines, Brazil and Russia. WTV WTV Import WTV Export I II III IV I II III IV I II III IV I Source: Bloomberg Commodity Copper Coal CPO Rubber Nickel Lead Aluminum Coffee Others Indonesian Export Commodity Price Index Graph 2.17 World Trade Volume Table 2.2 Indonesian Export Commodity Prices % yoy YTD 218* Source: Bloomberg, calculated; *Data as of 1 August Monetary Policy Report Quarter II 218 Bank Indonesia

19 After experiencing pressures in the first three months of 218, the coal price has rebounded since May. The coal price hit USD9/MT after a heatwave drove up demand in China. In addition, heavy rainfall has obstructed coal exports from Indonesia, while other constraints in the coal exporting process edged up prices. Nevertheless, lower demand from India as domestic production is increased will slow the rising coal price. On the other hand, the global oil price continued to tick upwards in the second quarter of 218 due to supply disruptions (Graph 2.18). The rising oil price is primarily the result of production and export disruptions in several OPEC countries, namely Libya, Nigeria and Venezuela as well as restrained production gains in the United States stifled by limited pipe capacity in the Permian Basin (Graph 2.19). Furthermore, US sanctions against Iran have also reduced global oil supply. Despite additional OPEC production, OPEC supply has been unable to effectively offset the production disruptions. On the demand side, robust economic growth momentum in oil consuming countries, such as the US and China, has maintained strong demand for oil Source: Bloomberg Brent Price Quarterly Average Graph 2.18 Oil Price Quarterly USD per Barrel mbpd Others OPEC Iraq Nigeria Libya Canada Others Non-OPEC Source : EIA, STEO; June Graph 2.19 Production Disruption of Various Countries Bank Indonesia Monetary Policy Report Quarter II

20 3 Domestic Economic And Financial Market Developments ECONOMIC GROWTH The national economy has accelerated significantly on strong domestic demand fuelled by private and government consumption. GDP growth was recorded at.27% (yoy) in the second quarter of 218, the fastest rate since 213 (Table 3.1), evidencing the ongoing economic recovery process (Graph 3.1). Meanwhile, household consumption stood at.14% (yoy), bolstered by rising incomes, upbeat consumers and controlled inflation. In addition, consumption associated with the local elections also posted solid growth. Meanwhile, government spending has also improved, thereby catalysing strong domestic demand. On the other hand, solid investment growth has been maintained despite fewer total working days in June 218 that restrained growth slightly. Growing domestic demand has prompted a surge of imports against comparatively subdued export performance. Regionally, the economies of Sumatra, Kalimantan and Papua have been the key drivers of growth, coupled with economic resilience in Java, Sulawesi and Maluku. Looking forward, Bank Indonesia predicts solid economic growth on sound investment and consumption performance despite limited export gains. % yoy.7 GDP 6 per. Mov. Avg. (GDP) I II III IV I II III IV I II III IV I II III IV I II III IV I II Source: BPS, calculated Graph 3.1 Economic Recovery Path Table 3.1 Economic Growth by Expenditure Percent, yoy Components Household Consumption Non-Profit Institutions Serving Households Government Consumption Investment Building Investment Non-building Investment Exports Import GDP Source: BPS I II III IV I II Monetary Policy Report Quarter II 218 Bank Indonesia

21 Building and nonbuilding investment remain strong, backed by infrastructure development and investment in the manufacturing industry. Meanwhile, several upcoming events, including the general election, are expected to maintain consumption. Consequently, Bank Indonesia projects economic growth in 218 in the.-.4% (yoy) range, subsequently accelerating to.1-.% (yoy) in 219. Household consumption has accelerated, bolstered by rising incomes, upbeat consumers and controlled inflation. Household consumption hit.14% (yoy) in the second quarter of 218, up from 4.9% (yoy) in the previous period (Graph 3.2). Household income improved, particularly among low-income households, as indicated by positive growth of the farmers terms of trade and real farmworker wages (Graph 3.3). Furthermore, household income was boosted by the Government s social assistance program (bansos) as well as 13 th -month salaries and annual Eid allowances disbursed to civil servants, army and police personnel as well as pensioners. Social assistance disbursements in the second quarter of 218 exceeded those recorded in the same period one year earlier (Graph 3.4). Household consumption was in line with upbeat consumers, especially among upper-middle class consumers (Graph 3.). In addition, solid household consumption was also backed by seasonal factors during the holy fasting month of Ramadan and Eid-ul-Fitr, with the Government approving an extended public holiday period this year, which helped to stimulate broad-based improvements in the retail and automotive sales data during the second quarter of 218. Solid household consumption was also maintained by stronger public purchasing power in line with low inflation. Consumption among non-profit institutions serving households (NPISH) also recorded robust growth. After posting 8.9% (yoy) growth in the first quarter of % yoy % yoy.8.6 Private Consumption Household Consumption.4 Non-Profit Institutions Consumption (rhs) I II III IV I II III IV I II III IV I II III IV I II Source: BPS, calculated Graph 3.2 Private consumption growth I II III IV I II III IV I II Source: BPS, calculated Trillion IDR Terms of Trade Graph 3.3 Farmers Terms of Trade and Real Wages Source: Ministry of Finance Social Assistance Growth (rhs) Real Wages I II III IV I II Graph 3.4 Social Assistance Disbursements % yoy % yoy Bank Indonesia Monetary Policy Report Quarter II

22 218, NPISH consumption accelerated to 8.71% (yoy) in the second quarter of 218 (Graph 3.2). Solid NPISH consumption was attributable to local elections contested in 171 regions during the second quarter of 218. In addition to the local elections, preparations for the 219 legislative and presidential elections became more active in the second quarter of 218. Greater government spending helped to catalyse economic growth in the second quarter of 218. Government consumption grew.26% (yoy) in the third quarter of 218, reversing the previous -1.92% (yoy) contraction in the same period one year earlier as well as the 2.74% (yoy) recorded in the previous period. Higher government consumption was in line with the realisation of personnel expenditure by the central government in the form of salaries and allowances. Moreover, procurement was also noted to increase. Solid investment growth was maintained despite moderating slightly due to fewer working days in June 218 as a result of the extended public holiday. Investment grew.87% (yoy) in the second quarter of 218, down from 7.9% (yoy) in the previous period. Investment growth was buoyed by corporate expansion in anticipation of increasing demand triggered by increasing economic momentum and infrastructure development. Nevertheless, seasonal factors during Eid-ul-Fitr, namely the extended public holiday, reduced the number of working days in June 218 and, therefore, undermined production and investment activities. Slower investment growth affected building and non-building investment (Graph 3.6). Index 13 Consumer Confidence Index (CCI) Spending Rp 1-2 Million 13 Spending Rp 2- Million 12 Spending >Rp Million I II III IV I II III IV I II III IV I II III IV I II Source: Bank Indonesia Graph 3. Consumer Confidence Index Building Non-Building Investment I II III IV I II III IV I II III IV I II Source: BPS, calculated Graph 3.6 Investment Growth Contribution % Relatively solid building investment was maintained in line with the completion of several infrastructure development projects despite moderating slightly compared with the previous period. Building investment posted.2% (yoy) growth in the second quarter of 218, supported by 2 Monetary Policy Report Quarter II 218 Bank Indonesia

23 ongoing government infrastructure projects. Such developments were reflected in the import data relating to infrastructure, which increased in the second quarter of 218. Nonetheless, construction activity declined in June 218 due to the extended public holiday, thereby influencing overall building investment performance in the second quarter. This was confirmed by cement sales, which achieved positive growth in April and May 218 before subsequently fading in June 218 (Graph 3.7). Non-building investment growth moderated in the second quarter of 218. Non-building investment posted 7.41% (yoy) growth in the reporting period, decreasing significantly from 13.7% (yoy) previously. Investment in machinery and equipment remained solid, however, decelerating slightly from 23.73% (yoy) to 22.48% (yoy), in line with faster import growth of capital goods in the form of machinery and equipment. Nevertheless, non-building investment growth was restrained by slower investment in transportation equipment, which declined from 14.3% (yoy) to 8.1% (yoy) in line with fewer working days in June 218. Furthermore, sales of heavy equipment dipped in June 218 after spiking significantly in April and May 218 (Graph 3.8). Solid domestic demand triggered a growth surge of imports. In the second quarter of 218, imports grew 1.17% (yoy), accelerating from 12.66% (yoy) in the previous period. Non-oil and gas imports grew significantly, while positive growth of oil and gas imports was also observed (Graph 3.9). In terms of non-oil and gas imports, the main drivers of growth were capital goods in the form of machinery and equipment to support electricity, telecommunications and transportation infrastructure projects (Graph 3.1). Imports of consumer goods also sped up in response to increasing household consumption, including anticipation of strong seasonal demand during Ramadan and Eid- % yoy I II III IV I II III IV I II III IV I II Source: Indonesian Cement Association Forestry Construction Agriculture Mining Source: United Tractors Graph 3.7 Cement Sales Source: BPS, calculated Graph 3.8 Heavy Equipment Sales Import of Non-Oil and Gas Import of Oil and Gas Import of Services Import of Goods and Services Unit I II III IV I II III IV I II III IV I II Graph 3.9 Oil and Gas and Non-Oil and Gas Imports Contribution % Bank Indonesia Monetary Policy Report Quarter II

24 ul-fitr. Meanwhile, imports of raw materials were subdued in June 218 by high inventory levels. On the other hand, oil and gas imports achieved positive growth in the second quarter of 218, bucking the previous contraction. Oil and gas imports were driven by oil in response to higher demand in line with solid household consumption and increasing consumption of fuel during Ramadan and Eid-ul-Fitr in 218. Export growth also accelerated, albeit more sluggishly, induced by the global economic recovery and supported by mining commodity prices. Exports in the second quarter of 218 grew 7.7% (yoy), up from 6.9% (yoy) in the previous period. Stronger export performance stemmed from soaring non-oil and gas exports coupled with increasing oil and gas exports (Graph 3.11). Exports increased to fuel the global economic recovery, which stimulated world trade volume (WTV), particularly in the advanced economies. Furthermore, the global economic recovery boosted manufacturing exports, including chemicals as well as iron and steel, amongst others, primarily destined for China. Mining exports also enjoyed strong growth on persistently high prices (Graph 3.12), led by coal as well as metal and non-metal minerals. On the other hand, agricultural exports slowed, especially crude palm oil (CPO) due to slower rising prices combined with the impact of policies enacted in major export destinations, which lessened CPO demand. In terms of oil and gas, positive export growth was achieved on rising oil prices in the second quarter of 218 and increasing gas production. By sector, the primary and tertiary sectors were confirmed as the main growth drivers during the second quarter of 218 (Graph 3.13). Production activity increased in the Agricultural and Mining sectors, facilitated by weather conducive to agricultural production as well as a growth surge of mining exports. Meanwhile, seasonal Eid-ul-Fitr factors stimulated trade and leisure % yoy Import Total Consumer Goods 4 Raw material Capital goods I II III IV I II III IV I II III IV I II Source: Bank Indonesia Graph 3.1 Import of Non-Oil and Gas (Real) Export of Non-Oil and Gas Export of Oil and Gas Export of Services Export of Goods and Services I II III IV I II III IV I II III IV I II Source: BPS, calculated % 2 Graph 3.11 Oil and Gas and Non-Oil and Gas Exports Contribution % yoy Total Manufacture -1 Mining Agriculture -2-3 I II III IV I II III IV I II Source: Bank Indonesia Graph 3.12 Non-Oil and Gas Export Prices Monetary Policy Report Quarter II 218 Bank Indonesia