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2 BANK INDONESIA For further information. please contact: Short-term Outlook dan Policy Dissemination Division Monetary Policy Group Economic Research and Monetary Policy Department Telephone : Fax. : BKM_TOD@bi.go.id Website :

3 MONETARY POLICY REPORT Bank Indonesia monetary policy report QUARTER III 2012 The Monetary Policy Report is published quarterly by Bank Indonesia after the Board of Governors Meetings in December, April, July, and October. In addition to fulfilling the mandate of article 58 of Act Number 23 of 1999 concerning Bank Indonesia, amended by Act No. 3 of 2004 and Act No. 6 of 2009, the report has two main purposes: (i) to function as a tangible product of a forward-looking working framework in which formulation of monetary policy is based on economic and inflation forecasts; and (ii) as a medium for the Board of Governors of Bank Indonesia to present to the public the various policy considerations underlying its monetary policy decisions. The Board of Governors Darmin Nasution Hartadi A. Sarwono Muliaman D. Hadad Ardhayadi Mitroatmodjo Budi Mulya Halim Alamsyah Ronald Waas Governor Deputy Governor Deputy Governor Deputy Governor Deputy Governor Deputy Governor Deputy Governor i

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5 MONETARY POLICY REPORT Bank Indonesia Enhanced Monetary Policy Measures Under Inflation Targeting Framework In July 2005, Bank Indonesia implemented and enhanced monetary policy measures within the Inflation Targeting Framework (ITF) which encompasses four main areas: the use of the BI rate as an operational target, enhanced decision making process, more transparent communications strategy, and strengthened policy coordination with the Government. The measures is intended to strengthen the effectiveness and to provide good governance to its monetary policy making to achieve the price stability needed to support sustainable economic growth and attain social welfare. Underlying Principles Monetary Policy Strategy Under the ITF, the inflation target is established as the overriding objective and nominal anchor for monetary policy. In this regard, Bank Indonesia has adopted a forward looking strategy by guiding the present monetary policy response for achievement of a medium-term inflation target. The application of the ITF does not mean that monetary policy disregards economic growth. The basic monetary policy paradigm of striking the optimum balance between inflation and economic growth is retained in both setting the inflation target and in the monetary policy response by focusing on achievement of low, stable inflation in the medium to longterm. The Inflation Target Government upon coordination with Bank Indonesia has set and announce an inflation target of CPI every year. Based on PMK No.143/PMK.011/2010 the inflation targets established by the Government for are 5,0%, 5,0%, and 4,5% with ±1% deviation. Monetary Instruments and Operations The BI Rate is the published policy rate reflecting the monetary policy stance adopted by Bank Indonesia. The BI Rate is a signal for achieving the medium to long-term inflation target and is announced periodically by Bank Indonesia for a specific period. To strengthen the operational framework for monetary policy, Bank Indonesia changed from use of the 1-month SBI rate as the operational target to the overnight interbank rate with effect from 9 June In monetary operations, the BI Rate is implemented through liquidity management on the money market to achieve the monetary policy operational target, reflected in movement in the overnight interbank money market rate. To enhance the effectiveness of liquidity management on the market, a set of standing facilities in combination with an interest rate corridor is employed in day-to-day monetary operations. Policymaking Process The BI Rate is determined by the Board of Governors in the Monthly Board of Governors Meeting. In unforeseen circumstances, the monetary policy stance may be adjusted in advance of the Monthly Board of Governors Meeting in a weekly Board of Governors Meeting. Changes in the BI Rate essentially depict the Bank Indonesia monetary policy response for guiding the forecasted level of inflation within the limits of the established inflation target. Transparency Monetary policy is regularly communicated to the public through customary media for communication, such as statements to the press and market actors, website postings and publication of the Monetary Policy Report (MPR). This transparency is aimed at building improved understanding and shaping public expectations of the economic and inflation outlook and the monetary response taken by Bank Indonesia. Coordination with the Government For the purpose of coordination in inflation targeting, monitoring and control, the Government and Bank Indonesia have established a team of officials representing the various relevant agencies. The task of the Team is to deliberate and recommend the necessary policy actions for the Government and Bank Indonesia in managing inflationary pressures for achievement of the established inflation target. Steps for Reinforcing Monetary Policy with the Overriding Objective of Price Stability (Inflation Targeting Framework) In July 2005, Bank Indonesia launched a reinforced monetary policy framework consistent with the Inflation Targeting Framework (ITF), encompassing four key elements: (1) use of the BI Rate as the policy reference rate, (2) anticipatory monetary policymaking process, (3) more transparent communications strategy and (4) closer policy coordination with the Government. These measures are intended to strengthen monetary policy effectiveness and governance in order to achieve the overriding objective of price stability in support of sustainable economic growth and greater public prosperity. iii

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7 MONETARY POLICY REPORT Bank Indonesia The Governor of Bank Indonesia Foreword In Q3/2012, the Indonesian economy is forecasted to maintain a high level of growth amid the ongoing slowdown in the global economy. Driving this brisk growth are rising levels of household consumption and buoyant investment performance. Household consumption has strengthened in line with rising consumer confidence and stable levels of public purchasing power. Upbeat consumer optimism in tandem with the conducive business climate led to surging investment growth during the quarter under review. Despite this, exports are projected to taper off in Q3/2012 due to persistently weak external demand. Imports have slowed a little in line with the depreciating trend in the rupiah, despite maintaining vigorous growth in tandem with strong domestic demand. Like before, the leading sources of growth are manufacturing, the trade, hotels and restaurants sector and transportation and communications. The Q3/2012 balance of payments is predicted to show improvement, marked by a surplus. Key to the stronger balance of payments is the amelioration in the current account with a reduced deficit compared to one quarter earlier. The lower deficit follows a steeper contraction in imports compared to the decline in exports. On the other hand, an increased surplus is predicted in the capital and financial account in response to higher inflows of foreign portfolio capital. In response to these developments, international reserves at the end of September 2012 mounted to billion US dollars, equivalent to 6.1 months of imports and servicing of official external debt. Pressure continued to bear down on the rupiah during Q3/2012, but with lessening intensity. The prolonged depreciation in the rupiah has been driven by external and domestic factors. Heightened uncertainty over the handling of the debt and fiscal crisis in Europe and sustained high demand for foreign currency to finance imports has put downward pressure on the rupiah. Nevertheless, Bank Indonesia has adopted a series of policies to stabilise the exchange rate, keeping movement in line with fundamentals. CPI inflation was again subdued during the quarter under review. Core inflation was low in line with slackening demand in the wake of the Eid-ul-Fitr festivities. Volatile foods inflation eased, following significant price corrections in food items and measures to safeguard supply. In other developments, administered prices also recorded low inflation in the absence of Government policy decisions to raise prices for vital goods and services. Bank Indonesia will keep v

8 MONETARY POLICY REPORT Bank Indonesia a close watch on risks of inflationary pressure and stands ready to adjust the course of monetary policy as may be necessary to guide public expectations of inflation in line with the established inflation target. Banking system stability remained within comfortably safe limits alongside further improvement in the intermediation function to support financing of economic activity. Reflecting this are the high capital adequacy ratios and steady low level of non-performing loans gross accompanied by steady expansion in lending activity to provide necessary financing for the economy. In the Board of Governors Meeting convened on 11 October 2012, Bank Indonesia decided to hold the BI Rate at 5.75%. At this level, the rate is regarded as consistent with low, subdued inflationary pressure, in line with the 4.5% + 1% inflation target for 2012 and Like before, the policy focus is on safeguarding external equilibrium while maintaining domestic economic growth. In the opinion of the Board of Governors, various policies launched previously have succeeded in bringing down the current account deficit. Alongside this, the domestic economy has maintained brisk growth albeit not as strong as envisaged in earlier forecasts, due to continuing global economic slowdown. Looking forward, Bank Indonesia will continuously evaluate the impact of the policies implemented to date and take further policy actions as may be necessary, appropriate to the dynamics of the economy. Bank Indonesia will also forge even closer coordination with the Government in managing domestic demand and improving the balance of payments in line with the drive to safeguard macroeconomic stability and sustainability of national economic growth. This concludes the overview of the Indonesian economy during Q3/2012 and the outlook for the future. My hope is for this report to provide useful reference material for us all. The Governor of Bank Indonesia Dr. Darmin Nasution vi

9 MONETARY POLICY REPORT Bank Indonesia Contents Contents 1. Monetary Policy Response Quarter III Economic Outlook and Risks Ahead... 3 Underlying Assumptions In The Economic Forecast... 3 Economic Growth Outlook... 4 Inflation Outlook Risk Recent Macroeconomic and Monetary Developments Developments in the World Economy Economic Growth Indonesia Balance of Payments (BOP) Rupiah Exchange Rate Inflation Disagregation of Inflation Financial Market Developments Condition of the Banking System Statistics vii

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11 Monetary Policy Response Quarter III Monetary Policy Response Quarter III 2012 In the Board of Governors Meeting convened on October , Bank Indonesia decided to hold the BI rate steady at 5.75%. The current policy rate is considered consistent with inflation forecast, which is expected to remain low and contained within its target range of 4.5%±1% in 2012 and Bank Indonesia will continue to focus on policies to maintain external balance while also providing support for domestic economic growth. Board of Governors sees that some policy measures that have been taken, have encouraged lower deficit in the current account. Meanwhile, Indonesia s economic growth remains sound, albeit lower than earlier forecast, mainly reflecting a continued slowdown in the global economy. Going forward, Bank Indonesia will continue to assess the effect of some policies that has been taken and will take further policy measures if neccessary, by also considering the dynamics of the economy. Bank Indonesia will also continue to strengthen coordination with the Government in managing domestic demand and improving Balance of Payment, so that it remains in line with the effort to maintain macroeconomic stability and sustainable economic growth. Board of Governors remains vigilant on the development of the global economy, which is weaker than expected and continue to be overshadowed by uncertainty. Recovery in the US remains tepid, while the economy in the euro area remains weak as crisis continues. In addition, China s and India s economic growth are expected to slow. Global inflation is also expected to remain moderate, indicating declining global commodity prices. Under such circumstances, some countries had opted to take more accomodative policies to boost economic recovery. Those policies have triggered positive sentiment in the global financial market, including capital inflow to emerging markets. Board of Governors sees Indonesia s economy remains sound, albeit lower than earlier forecast. In the Q3-2012, Indonesia s economy is expected to chart 6.3% growth, lower than earlier forecast, mainly reflecting a slowdown in the global economy. Although growth in domestic demand-oriented consumptions and investments remain high, declining exports have adversely affected production and investment in exports-oriented sector. Going forward, growth will remain underpinned by buoyant domestic demand and the potential increase in exports, although uncertainty in the global economy still call for caution. This is also supported by robust growth in some regions, mainly in the eastern part of Indonesia (KTI) and Java. With that condition, Indonesia s economic growth in 2012 and 2013 is expected to arrive at 6.1%-6.5% and 6.3%-6.7% respectively. Balance of Payment in the Q is expected to improve and turn to surplus, supported by better current account as well as higher surplus in capital and financial account. Current account deficit in Q is expected to be lower than that in Q This was indicated by a surplus in the trade balance in August On the other hand, surplus in the capital and financial account is expected to pick up, driven by favorable portfolio inflow and Foreign Direct Investment. At the end of September 2012, 1

12 Monetary Policy Response Quarter III 2012 international reserves reached USD110.2 billion, or equivalent to 6.1 months of imports and government s external debt services. Rupiah in September 2012 moved according to market condition, with abated depreciating pressure. This is consistent with Bank Indonesia s policy to stabilize rupiah, as suggested by its fundamental. On point-to-point basis, Rupiah depreciated by 0.37% (mtm) to Rp9,570 per USD, or on average depreciated by 0.64% (mtm) to Rp9,554 per USD. Pressure on Rupiah was mainly associated with strong imports that lead to high demand for foreign currency. Pressure on Rupiah was subdued as measures to boost global economy and the prospects of the Indonesia s economy have attracted more capital inflow to Indonesia. Inflation subdued and contained at a low level. CPI inflation in September 2012 was recorded at 0.01% (mtm) or on an annual basis was recorded at 4.31% (yoy). Core inflation was at a low level (4.12%, yoy) as demand soften after Eid al- Fitr festivities and correction in the global commodity prices, as well as well-anchored inflation expectation. Volatile food inflation was lower, on the back of sharp correction in the global food prices and adequate supply, coupled with intensive measures by the government to manage food prices. Administered prices inflation was also in check as there was no change in government policy on the prices of strategic commodities. Financial system stability is well-maintained with improving intermediation function to support economic financing. Banking industry shows solid performance, as indicated by secured level of capital in which capital adequacy ratio (CAR) is well above minimum level of 8%, and gross non-performing loan (NPL) below 5%. Meanwhile, banking intermediary remains sound, reflected by credit growth in August 2012 that reached 23.6% (yoy). The credit growth is lower than that in earlier month of 25.22% (yoy), driven by lower growth in working capital credit of 23.2% (yoy), while consumption credit remain stable at 19.9% (yoy). Investment credit recorded a high growth of 29.8% (yoy), and is expected to boost Indonesia s economic capacity. Going forward, Bank Indonesia remains vigilant on the dynamics of the global economy and financial market and its impact on the Indonesia s economy. Bank Indonesia will continue to focus on policies to maintain external balance while also providing support for domestic economic growth. In addition, Bank Indonesia will continue to assess the effect of some policies that has been taken and will make an adjustment align with the dynamics of the economy. Bank Indonesia will also continue to strengthen coordination with the Government in managing domestic demand and improving Balance of Payment, so that it remains in line with the effort to maintain macroeconomic stability and sustainable economic growth. 2

13 Economic Outlook and Risk Ahead 2. Economic Outlook and Risks Ahead The continued weakening of the global economy is bearing down on the economic outlook for 2012, with growth predicted to slip behind the levels of previous years. In 2012, the Indonesian economy is forecasted to chart 6.1%-6.5% growth with domestic demand fuelled by both consumption and investment playing a predominant role. The net contribution of exports is predicted to diminish in line with downward revision in assumptions for the performance of the world economy. In 2013, Indonesia s economic growth is forecasted in the range of 6.3%-6.7%, driven by both domestic and external performance as the global economy mounts a recovery. In analysis by line of business, mainstay sectors such as manufacturing, the trade, hotels and restaurants sector and transport and communications are predicted to retain their role as engines of growth. Based on outcomes until Q3/2012, inflation in 2012 is expected to reach the targeted range 4.5% + 1% in keeping with the downward trend in global prices. On the domestic side, inflationary pressure will remain subdued with support from supplyside capability for responding to increases in demand, stable inflation expectations and minimum increases announced in administered prices. In 2013, with improvement in supply-side response and policy support, inflation is forecasted to hold within the targeting range of 4.5%±1%. The mix of monetary and macroprudential policies implemented by Bank Indonesia thus far will be adjusted to developments in the global and domestic economy and factor in an evaluation of the impact of these developments on Indonesia s future economic performance. Bank Indonesia will move forward with more intensive coordination to anticipate and minimise future inflationary pressures. UNDERLYING ASSUMPTIONS IN THE ECONOMIC FORECAST Assumptions for the International Economy Compared to earlier predictions, more modest growth is forecasted for the world economy in both 2012 and The more modest forecast for world economic growth in 2012 is explained most importantly by the continued slow growth in advanced economies and growth predictions for Asia s emerging markets. Flagging growth in advanced economies has started to bear down on the growth rates of emerging market nations through falling commodity prices and trade volume. As a result, growth for the world economy as a whole is predicted to underperform earlier forecasts. Given the persistently low level of world economic growth in the second half of 2012, the world growth forecast for 2013 has been revised downwards despite the outlook for higher economic growth compared to The world economy is predicted to chart 3.1% 3

14 Economic Outlook and Risk Ahead growth in 2012, down from the earlier 3.2% projection. In 2013, world economic growth is expected to strengthen to 3.4%, short of the previous 3.5% forecast. This projection can be achieved if downside risks can be kept to a minimum, given that such deficit reduction policies portend the fiscal cliff for the US, further weakening of growth in China and Japan and the likelihood of even longer delays in resolution of the crisis in Europe. The accommodative policy response from the ECB and Federal Reserve is expected to bolster the world economy against steeper decline amid constrained room for fiscal expansion. The general response from emerging market economies has also been accommodative. World trade volume is forecasted to chart reduced growth in 2012 and 2013, in keeping with the slowing pace of global economic activity. The IMF predicts growth in world trade volume during 2012 to reach 3.2% before strengthening in 2013 to 4.5%, a level nevertheless below the 5.8% growth recorded in With the more modest growth in volume of world trade, prices of non-oil and gas commodities are also predicted to ease. For 2012 and 2013, the IMF forecasts price corrections in non-oil and gas commodities at -9.5% and -2.9% after having charted 17.8% growth in Fiscal Policy Assumptions In the Revised 2012 State Budget, the Government has set the fiscal deficit at about -2.2% of GDP, while deficit in the Draft 2013 State Budget is projected at -1.6% of GDP. In the outcome of the Revised State Budget at end-september 2012, the fiscal deficit had reached Rp 70 trillion (-0.82% of GDP). At this level, the deficit outcome is on track for the -2.2% deficit envisaged in the Revised 2012 State Budget. The deficit envisaged in the Draft State Budget for 2013 is -1.6% of GDP, in keeping with government efforts to safeguard fiscal sustainability while promoting economic growth. Deficit reduction measures pursued by the government include a cut in energy subsidies involving a 15% hike in electricity billing rates. ECONOMIC GROWTH OUTLOOK Indonesia s economic growth forecast for Q4/2012 and 2012 overall is within the range of 6.1%-6.5%. Concerning the sources of economic growth in 2012, forecasts point to a leading contribution from domestic demand. Exports are predicted to chart reduced growth compared to previous years, in line with flagging external demand. Like before, household consumption is expected to provide the main driving force for growth on the domestic side, in keeping with sustained levels of public purchasing power also supported by subdued inflation. At the same time, investment is forecasted to play a steadily expanding role in economic growth in response to the enormous potential of the domestic market supported by Indonesia s macroeconomic stability amid the global economic slowdown, as well as the conducive investment climate. In analysis by line of business, mainstay sectors such as manufacturing, the trade, hotels and restaurants sector and transport and communications 4

15 Economic Outlook and Risk Ahead are predicted to retain their role as engines of growth. On a geographical level, the impact of the global economic slowdown is bearing down harder on economic performance at the regional level, mainly through the export channel, with the effect predicted to last for the short-term. The comparatively stable economic growth on Java and the more buoyant growth in eastern Indonesia will help the national economy achieve a growth rate of 6.1%-6.5%. In 2013, domestic economic growth is predicted to strengthen to 6.3%-6.7%, consistent with the outlook for improvement in the world economy compared to 2012 although still short of full recovery. Higher world economic growth will bolster external demand with the effect of strengthening exports. In addition, domestic demand is predicted to maintain vigorous expansion through both consumption and investment. In analysis by line of business for 2013, the mainstay sectors of manufacturing, trade, hotels and restaurants and the transport and communications sector, like before, will dominate developments in the national economy. Sectors for the most part are projected to show improved results, buoyed by the improvement in domestic and global economic condition. * Bank Indonesia s Projection C o m p o n e n t Outlook for Aggregate Demand Household consumption is forecasted to maintain vigorous growth in Q4/2012. Several indicators point to an upbeat growth trend in household consumption. The results of the BI consumer survey in September 2012 point to a more optimistic level of consumer confidence (Graph 2.1). Consumer optimism is bolstered mainly by improvement in the timeliness of durable goods purchases, the job availability index and the income index. Retail sales soared in July-August 2012 as a result of the Eid-ul-Fitr festivities. The relatively mild level of inflation in the third quarter and the downward trend in loan interest rates alongside low bank deposit rates have also helped sustain household consumption in Accordingly, household consumption in Q4/2012 is predicted to maintain growth in the 4.8%-5.2% range, with equivalent growth for the year as a whole reaching 4.7%-5.1%. In 2013, household consumption growth is projected to at a brisk 4.8%-5.2%. Key to this growth is the sustained level of purchasing power and forecasts for improvement in the global economy that in turn will generate higher incomes from exports. Despite an improving growth trend, demand-side inflationary pressure is predicted to be minimal in keeping with expanding capacity in the Table 2.1 GDP Forecasts by Expenditure I II III* IV* 2012* %Y-o-Y, 2000 Price Private Consumption Expenditures Government Expenditure Gross Fixed Capital Formation Export of Goods and Services Import of Goods and Services Gross Domestic Product * 5

16 Economic Outlook and Risk Ahead Graph 2.1 Consumer Confidence Index Graph 2.2 Investment Value Graph 2.3 Manufacturing Capacity Utilization economy. Furthermore, in 2013 the government plans to raise the annual tax-free income allowance (PTKP) to Rp 24 million, which will provide an added boost to purchasing power. During Q4/2012, growth in real government consumption is forecasted in the range of 9.1%-9.5%. The upbeat forecast for real growth in government consumption during Q4/2012 is related to the customary end-of-year absorption of government expenditures. Procurement and capital expenditures will experience a surge in Q4/2012 in keeping with historical trends. This improvement was achieved by optimising of budget absorption in actions that included accelerated processing of procurement/tendering and capital expenditures, achieved by simplifying tender procedures and fasttracking the implementation of the Land Acquisition Law. In view of this forecast, real growth in government consumption for 2012 as a whole is predicted to reach 6.5%-6.9%, ahead of the preceding year. With the government plan to bring the budget into balance in 2014, real government consumption is predicted to deliver a reduced contribution in comparison to Despite the reductions, government efforts to improve the quality of expenditures are reflected in rising levels of capital expenditures. Growth in real government consumption during 2013 is forecasted to reach 6.4%-6.7%. Investment in Q4/2012 is expected to grow in the range of 10.2%-10.6%, bringing overall investment growth for 2012 to 10.4%-10.8%. Investment is forecasted to maintain vigorous growth during Q4/2012. The forecast for more robust investment growth in 2012 compared to one year earlier is based on investment figures for Q1 and Q2/2012 placing growth at 10% and 12.3%. Furthermore, the upbeat trend in domestic household consumption and outlook for future improvement in exports also support forecasts of higher investment growth compared to the preceding year. The stable outlook in investment growth is supported by various indicators, namely brisk growth in imports of capital goods, higher government capital expenditures, the downward trend in interest rates and improvement in Indonesia s business climate, as demonstrated in improvement in the FDI confidence rating and stronger logistics performance. In 2013, investment is predicted to keep forging ahead with growth in the 11.7%-12.1% range in response to expanding domestic and external demand. Exports have potential for renewed improvement in growth during Q4/2012. During the quarter, exports of goods and services forecasted to chart 2.9%-3.3% growth. Export growth for 2012 overall is predicted below the level reached in 2011, due to the slowdown 6

17 Economic Outlook and Risk Ahead in global economic growth followed by decline in commodity prices. The more modest performance in Indonesia s exports has come about as the direct and indirect impact of the slowdown in the world economy. However, there is still potential for improvement in exports, beginning with renewed increases in commodity prices in Q3/2012 and the outlook for gains in manufacturing and household consumption in the US and Japan. Under these conditions, growth in merchandise and services exports during 2012 is forecasted to reach 3.1%-3.5%. Consistent with forecasts for higher external demand in response to more robust growth in the world economy, the potential for export growth in 2013 lies in the range of 6.7%-7.1%. In Q4/2012, growth in imports of goods and services is forecasted to reach 9.3%- 9.7%. With forecasts now pointing to renewed improvement in export growth, manufacturers will make more use of imported raw materials and capital goods for production of exported merchandise. Besides this, given the robust pace of domestic economic activity, imports are projected to grow ahead of exports. Under these conditions, import growth in 2012 is forecasted to reach 9.1%-9.5%. In 2013, in line with an expanding contribution from exports and buoyant levels of domestic consumption, import growth is projected in the range of 10.8%-11.2%. In Q4/2012, the current account deficit is predicted to ease and Indonesia s overall balance of payments will post a surplus. This is supported by forecasts of improving export performance in Q4/2012, in contrast to more modest growth in imports. The capital and financial account is also projected to chart an increased surplus from FDI, portfolio investment and drawing down of foreign borrowings to restore the overall balance of payments surplus. This forecast is consistent with the assumption of improvement in the global economy and export commodity prices towards the end of * Bank Indonesia s Projection S e c t o r s Outlook for Aggregate Supply In analysis by line of business, manufacturing, the trade, hotels and restaurants sector and transport and communications will retain their dominant position in 2012 Table 2.2 GDP Forecasts by Industry I II III* IIV* 2012* %Y-o-Y, 2000 Price Agriculture Mining and Quarrying Manufacturing Industries Electricity, Gas, and Water Supply Construction Trade, Hotel, and Restaurant Transport and Communication Financial, Ownership, and Business Services GDP * 7

18 Economic Outlook and Risk Ahead Graph 2.4 Leading Indicator of GDP Manufacturing Sector Graph 2.5 Growth of Non-Construction Investment, Exports and Manufacture Graph 2.6 Realization and Forecast of Trade, Hotels, and Restaurants Sector Activity and Recent investment and high levels of private consumption are positive factors that have sustained manufacturing performance. The continued strength of public purchasing power and the large domestic market have also spurred vibrant growth in the trade, hotels and restaurants sector. In addition, buoyant domestic activity has also engendered high levels of mobility in society and created added need for communication services. These are factors that have spurred performance in transport and communications sector. Manufacturing growth is forecasted to remain high to the end of 2012 despite slowing in comparison to The high rate of manufacturing growth is visible from manufacturing leading indicators that point to improvement in the fourth quarter, even though still in a contractionary phase (Graph 2.5). Support for improvement in the manufacturing sector comes from the sustained strength of domestic demand and predictions of improvement in exports during Q4/2012. This is predicted to boost manufacturing performance in 2012 with growth reaching 5.3%-5.7%. The most important contributions to manufacturing performance are from the food and beverages, cement industry and automotive subsectors. Indonesia s vast population and robust domestic demand are key factors driving performance in the food and beverages subsector. Alongside this, the ongoing work on infrastructure construction and property developments continue to stimulate domestic demand for cement. Regarding transportation equipment (automotive manufacturing), demand is predicted to remain strong, leading to increased orders of new vehicles. Developments in the automotive subsector are strongly supported by expansion in the middle class, which enjoys comparatively strong purchasing power. The upswing in manufacturing performance is forecasted to carry over into The sustained strength of the manufacturing sector owes much to relatively strong support from investment since early 2010, and most importantly from foreign direct investment (FDI). Indonesia s investment grade status has enhanced the nation s attractiveness as a destination for investment. With global economic conditions set to improve over 2012, exports are predicted to gain renewed momentum (Graph 2.6). This will reinforce business optimism and provide a boost to resurgent manufacturing activity. In 2013, manufacturing is forecasted to grow in the range of 5.6% The trade, hotels and restaurants sector is forecasted to maintain vigorous growth to the end of Despite the 8

19 Economic Outlook and Risk Ahead Graph 2.7 Number of Foreign Visitors Graph 2.8 Visitors Expenditure per Day Graph 2.9 Number of Flight Passengers predicted slowdown in Q3/2012, growth in the trade, hotels and restaurants sector is expected to maintain vigorous momentum during the fourth quarter with the year s growth in the sector expected to reach 8.5%-8.9%. The vibrant pace of domestic economic activity amid uncertain global conditions is a key factor in the fortunes of the trade, hotels and restaurants sector. Reflecting this are the results of the Business Activity Survey (SKDU) for trade, which point to improvement (Graph 2.7). In other developments, retail trading activity remains strong, as reflected in the booming construction of minimarkets. According to research data, 1 minimarket outlets developed under the minimarket plus restaurant approach, focused on selling fast-moving non-staple products, are on the rise. Under this concept, possibilities are being explored for Wifi facilities and collaboration with cellular operators. In the trade, hotels and restaurants sector, positive contributions are not only expected from trade, but also the hotels and restaurants subsector. Consistent with the rate of economic growth, the middle class is becoming ever larger. This is a group with a considerable need for goods and services, including recreation, needs that are also met through adequate levels of purchasing power. Not only is domestic tourism on the rise, but inbound travellers are manifesting a similar trend (Graph 2.8). These conditions will stimulate higher levels of tourism expenditures, including spending on accommodation and food and beverages (Graph 2.9). Given the outlook for improved economic conditions, the trade, hotels and restaurants sector is forecasted to chart even higher growth in Growth in this sector is expected to reach 8.7%-9.1%. Activity in the trade, hotels and restaurants sector has been steadily expanding in response to rising imports and manufacturing activity, while also supported by the continued strength of private consumption. In 2012, the transport and communications sector is predicted to maintain robust expansion. Forecasted growth in the transport and communications sector is 10.0%-10.4%. The solid outlook for the domestic economy will strengthen mobility in domestic economic activity, such as in movement of goods, travel and information flows. Movement of goods is reflected in the loading and unloading activity at ports, as well as in cargo transportation. Alongside this, mounting activity in travel is evident from the increasing numbers of passengers carried by various modes of transportation, and especially by plane. 1 Survey by AC Nielsen. 9

20 Economic Outlook and Risk Ahead Furthermore, there is a growing need for accurate and timely information to support the brisk pace of economic activity. This will drive the steady expansion in use of the internet and data communications. The vibrant activity in the transport and communications sector is predicted to continue in The government decision to develop 6 economic corridors under the Master Plan for Acceleration and Expansion of Economic Development in Indonesia (MP3EI) also requires support from a system of good connections. Therefore the government is devoting considerable effort to the development of seaports, airports and equitable broadband access through key projects implemented under MP3EI. In addition, the planned aircraft fleet expansion by several domestic airlines is expected to boost growth in the transportation sector. Under these conditions, the transport and communications sector is forecasted to maintain a high level of growth. In 2013, this sector is predicted to chart growth in the range of 10.0%-10.4%. Aside from the major sectors described above, another sector with a vital role in the economy is construction, due to the ability to create large numbers of jobs. The robust government commitment to promote the implementation of infrastructure projects, and particularly those related to the MP3EI programme, offers assurance for growth in the construction sector. The government focus on this sector relates primarily to transport infrastructure, such as toll roads, railways, airports and seaports. The push for infrastructure development projects is aimed primarily at accelerating connectivity between corridors of economic activity. Accordingly, construction sector growth in 2012 is forecasted in the range of 6.9%-7.3% and in 2013 to rise to 7.3%-7.7%. INFLATION OUTLOOK Graph 2.10 Capacity Utilization Inflation in 2012 is predicted to come within the 4.5%+1% targeting range. Price movements for goods and services remained generally subdued in figures until Q3/2012, with annual inflation recorded at 4.31% or in cumulative terms at 3.49% (year to date). The monetary and macroprudential policy mix introduced by Bank Indonesia and strengthened coordination with the Government have succeeded overall in maintaining supply-demand equilibrium. Looking forward, inflationary pressure is expected to remain mild in line with the established target at 4.5%±1% in This forecast is supported by both external and domestic conditions. On the external side, mild inflationary pressure is predicted in keeping with the downward trend in global commodity prices amid a depreciating trend in the exchange rate. At home, inflationary pressures are predicted to remain under control with support from supply-side conditions bolstered by steady investment growth that enable response to increases in demand. Besides this, the subdued level of inflation expectations and government decisions to keep hikes in administered prices to a minimum has played a role in curbing inflation in 2012 within the Bank Indonesia targeting range. 10

21 Economic Outlook and Risk Ahead Graph 2.11 Inflation Expectation (Consensus Forecast) In 2012, core inflationary pressure is forecasted to remain well within control. The multifaceted measures to manage aggregate demand, maintain a stable exchange rate and guide inflation expectations while ensuring adequate supply-side response have contributed to a low level of core inflation. Reinforcing these positive actions were domestic price corrections in the aftermath of the Eid-ul-Fitr festivities that also eased core inflation, thus offsetting inflationary pressure from gold prices and especially the steep 7% increase in gold prices over the last month. Confirmation for the forecast of mild core inflation is provided by leading inflation indicators, such as the import wholesale price index (WPI). The import wholesale price index points to an absence of significant imported inflation in the short-term, due to the falling trend in global prices, despite the concomitant depreciating trend in the exchange rate. Graph 2.12 Volatile Food Inflation The supply side is predicted to maintain adequate capacity for response to the demand side. Indications of this are evident in the relatively modest level of manufacturing capacity utilisation following the rapid growth of investment in recent years. The forecast for volatile foods inflation is quite moderate. Key to this forecast is the seasonal trend of declining food stuff production due to the onset of the dry season. To anticipate this, the Ministry of Agriculture embarked on intensive planting in September to ensure adequate supplies of rice at the end of the year. Efforts to support rice output include not only pest control, but also collaboration between the Ministry of Agriculture and the Ministry of Public Works in improvements to irrigation channels. Paddy production is expected to surpass 5 million tons in 2012, enabling the resulting surplus to be allocated to the national food reserve stocks. The predicted inflation in administered prices is minimal. Although prices mounted for such items as parking fees and fares on electric commuter trains, these are expected to have minimal impact on inflation due to their comparatively small weighting. In 2013, inflation is forecasted to hold at a subdued level on course for the inflation targeting range of 4.5%+1%. Inflationary pressures in 2013 will be fuelled by the predicted recovery in the world economy that year and the strengthening performance of Indonesia s domestic economy that is predicted will lead to higher pressures from the demand side, albeit still within moderate limits. In addition, upbeat economic performance and growth in world trade will in turn bring renewed increases in international commodity prices, which may be transmitted to domestic prices. This inflationary pressure can be minimised through adequate supply-side response to cope with the rising demand. The higher rate of inflation in administered prices is linked to the government plan to raise electricity billing rates by 15%. This increase will not 11

22 Economic Outlook and Risk Ahead only influence administered prices inflation, but will also have an indirect impact on other inflation components. Volatile foods inflation is forecasted to remain at historical average levels, assuming no disruptions in production and distribution. To secure production levels, the government has allocated an additional 2 trillion rupiahs to the Ministry of Agriculture in the Draft 2013 State Budget to be used for investment in agriculture sector infrastructure. RISKS Various external and domestic risks will determine the direction of economic forecasting in 2012 and The flagging growth in world GDP and volume of world trade may see GDP growth slip to the lower edge of the projected range. The flagging world economy will reduce demand for Indonesia s exported products, which in turn will bring about a steeper reduction in the contribution of exports to economic growth. Graph 2.13 Fan Chart Inflation Forecast Concerning inflation, a number of risk factors other than the 15% hike in electricity billing rates, which is already approved by parliament, are linked to a further 15% increase in industrial gas prices slated for April To anticipate the various risks that may stoke inflation, Bank Indonesia has embarked on more intensive coordinated actions to curb and minimise future inflationary pressures, particularly those arising from administered prices. These actions will be reinforced by various actions to maintain a low level of volatile foods inflation by promoting more expeditious supply and distribution of goods and particularly food staples through cooperation among the different regions. 12

23 Recent Macroeconomic and Monetary Developments 3. Recent Macroeconomic and Monetary Developments The uncertainty in global economic conditions is forecasted to last throughout Q3/2012. Corrections to the economic growth projections for Asian economies (China, Japan and India), uncertainty over the Eurozone debt crisis and downward revisions in the projection of world trade volume have held back the world economy from further expansion. In Asia s emerging market economies, exports from some nations are still on a downward trend due to the slowing pace of global industry that has contributed to slackening performance in Asia s locomotive economies, such as China and India. In keeping with the slowing pace of the world economy, global inflationary pressure is on a downward trend. Global financial markets have strengthened on the back of positive sentiment from the monetary stimulus launched by major world central banks (Europe, Japan, US) and the fiscal stimulus of the government of China. The policy responses of central banks in advanced nations remain largely accommodative in order to bolster economic activity. Similar policy responses have been observed in emerging markets, despite the growing constraints on room for policy actions. In Q3/2012, the Indonesian economy is predicted to maintain high growth amid the slowing condition of the global economy. Household consumption and investment are forecasted to maintain robust expansion. The ongoing weakness of external demand has resulted in a slowdown in exports. Imports have tapered off to some extent in line with the depreciating trend in the rupiah, despite continuing to chart vigorous growth in tandem with strong domestic demand. Depreciating pressure on the rupiah carried forward into Q3/2012, but with more moderate intensity and a more controlled level of volatility. The weakening in the rupiah is explained largely by the high degree of uncertainty over global economic conditions and heavy demand for foreign currencies on the domestic forex market, consistent with the high level of imports during a period of slowing exports. In regard to prices, CPI inflation remains at a subdued level. The sustained low level of CPI inflation is supported by all factors, including fundamentals and non-fundamentals. Core inflation is again low amid the downward pressure bearing on the rupiah, increases in gold prices and persistently high global food prices. Similarly, volatile foods and administered prices recorded only mild inflation following the correction in food prices after the Eid-ul-Fitr festivities 13

24 Recent Macroeconomic and Monetary Developments and in the absence of government policy decisions affecting prices of strategic goods and services. On the financial market, interbank rates edged upwards in line with the Bank Indonesia decision for a 25 bps increase in the lower interest rate corridor. Despite this, lending rates maintained a downward trend while deposit rates were largely stable. On the other hand, positive global sentiment and Indonesia s macroeconomic fundamentals helped boost domestic stock market performance during the quarter. Similarly, the market for Indonesian government bonds, while coming under mild pressure for short tenor instruments, remains positive in the medium and long tenors. DEVELOPMENTS IN THE WORLD ECONOMY The global economy remains shrouded in uncertainty and is forecasted to chart reduced growth. The lower forecast for global growth in 2012 is related to the downward revision in growth projections for Asian economies, such as Japan, China and India. Nevertheless, the stimulus policies launched by various central banks in advanced economies are expected to halt the slowdown in the global economy. Global financial markets have shown renewed positive performance with the stability achieved on financial markets in Europe, particularly following Germany s approval of the European Stability Mechanism (ESM) and the ECB decision concerning Outright Monetary Transactions (OMT). In addition, the third round of quantitative easing (QE III) by the Federal Reserve, the bond-buying programme of the Bank of Japan (BoJ) and the fiscal stimulus in China have helped to boost positive sentiment and thus bring improvement in the risk perceptions of global investors. World oil prices are on the rise, spurred by mounting geopolitical tensions in the Middle East, positive sentiment on global financial markets and increases in global demand, albeit on a limited scale. Meanwhile, global inflationary pressures are on a downward trend, despite a modest rise in keeping with price movements in international commodities, led by energy. Advanced nations and emerging markets have generally maintained an accommodative policy stance marked by reductions in the policy rates set by the central banks of Brazil, China, Colombia and Hungary in response to weakening domestic economic activity and the global outlook. In Q3/2012, the US posted fairly moderate economic growth while facing the risks associated with the fiscal cliff of deficit reduction policies. Low US growth was also reflected in the Federal Reserve s downward revision of the US economic growth projection in September 2012 from the previous 1.9%-2.4% (yoy) to a range of 1.7%-2.0% (yoy). Pressures continued to bear down on US production, as reflected in the decline in production and capacity utilisation indices during August 2012 (Graph 3.1). The gloomy condition of US manufacturing is also confirmed by the Fed Districts survey and manufacturing Purchasing Manager Index (PMI), which remained in a contractionary phase throughout June and July until August On the consumption 14