For further information : Short-term Outlook and Policy Dissemination Team Monetary Policy Bureau Economic Research and Monetary Policy Directorate

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2 For further information : Short-term Outlook and Policy Dissemination Team Monetary Policy Bureau Economic Research and Monetary Policy Directorate Phone : Fax : bkm_tod@bi.go.id Website :

3 Monetary Policy Review Januari 2011 The Monetary Policy Review (MPR) is published monthly by Bank Indonesia after the Board of Governors» Meeting each January, February, March, May, June, August, September, and November. This report is intended as a medium for the Board of Governors of Bank Indonesia to present to the public the latest evaluation of monetary conditions, assessment and forecast for the Indonesian economy, in addition to the Bank Indonesia monetary policy response published quarterly in the Monetary Policy Report in April, July, October and December. Specifically, the MPR presents an evaluation of the latest developments in inflation, the exchange rate, and monetary conditions during the reporting month and decisions concerning the monetary policy response adopted by Bank Indonesia. Board of Governor Darmin Nasution Governor Hartadi A. Sarwono Deputy Governor S. Budi Rochadi Deputy Governor Muliaman D. Hadad Deputy Governor Ardhayadi Mitroatmodjo Deputy Governor Budi Mulya Deputy Governor Halim Alamsyah Deputy Governor 1

4 Table of Content I. MONETARY POLICY STATEMENT... 3 II. THE ECONOMY AND MONETARY POLICY... 7 Developments in the World Economy... 7 Economic Growth in Indonesia Inflation Rupiah Exchange Rate Monetary Policy Interest Rates Funds, Credit and the Money Supply Stock Market Government Securities Market Mutual Funds Market Condition of the Banking System Economic Outlook for III. MONETARY POLICY RESPONSE Box: The December 2010 Policy Package

5 I. MONETARY POLICY STATEMENT As 2010 drew to a close, a range of economic indicators pointed to sustained improvement in the economy. Economic growth is expected to reach about 6% with inflation running at 6.96%. Indonesia»s balance of payments is also projected to chart a hefty surplus while the stable rupiah has maintained an appreciating trend, closing the year at Rp 9,010 to the US dollar. This buoyant growth has been bolstered by vibrant domestic demand led by consumption and investment. Also key to this performance is the global economic recovery led by emerging markets and Indonesia»s prudently managed macroeconomic stability. Indonesian economy was also influenced by developments on the external side, particularly heavy inflows of foreign capital, amid ample liquidity in the domestic economy. An added complexity is the onset of progressively mounting inflationary pressure. These conditions led to formidable challenges in the national economy during 2010 and is expected to continue. Bank Indonesia has responded to the challenges by applying an appropriate combination of available instruments, instead of focusing on a single policy instrument. The monetary and macroprudential policy mix combining a range of instruments was announced in part in the policy package of 16 June At the end of 2010, Bank Indonesia issued further monetary and banking policies with the objective of reinforcing monetary and financial system stability to support sustainable economic growth while also building resilience against possible economic shocks. These policies cover five key areas: reinforcement of monetary stability, promotion of bank intermediation, improvement in the banking system resiliency, improvement of macroprudential policies, and enhancement of banking supervision functions. On the external side, the global economic recovery regained momentum as reflected in the improvement in the latest data on the global economy, although remained overshadowed by the crisis in Ireland. Leading economic indicators, such as retail sales and manufacturing output in advanced countries, showed renewed improvement accompanied by strengthening consumer confidence. Global inflationary pressure also began to mount, particularly in emerging countries. Inflationary pressure in Japan has reached positive territory. In spite of these developments, the US still faces the looming threat of deflation as core inflation continued on a downward trend. Global economic data pointing to an ongoing recovery 3

6 have sparked positive sentiment on global financial markets. Global commodity prices also steadily went up as the global economy gathered momentum. World oil prices surged on rising demand from advanced economies to cope with extreme weather, in addition to OPEC decision to maintain existing production quotas. At the same time, the banking crisis in Ireland triggered concerns that similar crises could hit the PIIGS nations, and particularly Spain and Portugal. Policy responses by central banks in advanced countries also directed towards keeping interest rates low. In contrast, emerging market economies had started to raise their policy rates and introduced policies to manage capital inflows and stabilise exchange rate. From the domestic side, economic growth in Q4/2010 is projected to improve, compare to the preceding quarter, buoyed by vibrant household consumption and higher investment. The high rate of household consumption has been fuelled by strong purchasing power, adequate bank and non-bank financing, strong consumer confidence, and low prices of imported goods. At the same time, investment has forged ahead on the back of positive market perceptions, more financing support, low imports price due to appreciation in the rupiah, and the launching of pro-investment policies by the government. However, government consumption is estimated to have slowed in Q4/2010. This trend was also observed in export and import activity, although momentum remained strong. Taken together, the economy charted an estimated 6.1% growth in Q4/2010, bringing growth for the whole year to around 6%. CPI inflation in December 2010 was marked by strong pressure from the volatile foods category. Significant price increases for rice and chilli peppers boosted volatile foods inflation to 3.29% (mtm). Administered prices accounted for only a moderate contribution to inflation, due to the absence of government decisions to raise prices for strategic items. In addition, core inflation was subdued. The rising inflationary pressure at the end of the year was also driven by the seasonal factor of the Christmas and New Year festivities and school holidays. With these developments, CPI inflation in December 2010 reached 0.92% (mtm) or 6.96% (yoy). As a result, CPI inflation for 2010 overshot the targeted range of 5%Ø1%. This deviation is explained primarily by the non-fundamental factor of high volatile foods inflation caused by adverse weather conditions. Sharply rising volatile foods inflation has also been observed in other countries in the region. Nevertheless, pressure from fundamentals was relatively mild, 4

7 as demonstrated by contained core inflation and also moderate inflation in administered prices. Indonesia»s balance is expected to post a large surplus. Supporting this projection are high capital inflows, led by foreign direct investment (FDI) and portfolio investment. In the current account, exports remain strong although lower than previous quarter, while imports also slow, resulting in current account surplus. The current account for oil and gas came under pressure from the rising oil deficit, although this was offset by improved performance in the non-oil and gas. These developments boosted the international reserves position to 96.2 billion US dollars at end-december 2010, equivalent to 7.1 months of imports and servicing of official external debt. Against the background of Indonesia»s strong external performance, the rupiah underwent further exchange rate appreciation accompanied by low volatility. At the end of year, the rupiah gained 4.4% (point tp point) to Rp 9,010 to the USD with lower volatility. The policies taken by Bank Indonesia for managing capital inflows and exchange rate stability through forex intervention and accumulation of international reserves had helped to foster positive expectations towards the economy. The rupiah underwent relatively mild appreciation compared to other currencies in the region, enabling Indonesia to maintain a competitive position. Domestic financial market performance showed further improvement. Vibrant performance on the stock market was reflected in gains in the Jakarta Composite Index (JCI) on the back of improvement in domestic economic fundamentals and the upbeat financial outlook for listed companies. However, inflows of foreign capital on the stock and bond markets heightened the risk of capital reversal, with possible impact of price adjustment in securities prices. Improved financial market performance was also reflected in the progressively narrowing yield on Indonesian government securities, particularly for short tenors, with yield of one-year Indonesian government bonds has dropped to below the level of the BI Rate and Bank Indonesia Certificate (SBIs). Regarding monetary policy transmission, bank interest rates eased further. A fall in deposit rates was more limited compare to credit rates. In the credit channel, credit growth followed an upward trend, driven mainly by performance in working capital credit although increased contributions were also evident from consumption and investment credit. 5

8 Financial system stability remained in check, reinforced by the strength of the banking sector in coping with various risks and sound intermediation function. This was indicated by the high bank capital adequacy ratio (CAR), recorded at 16.3% in November 2010, and subdued level of nonperforming loans (NPLs) at below 5.0%. Improvement in the bank intermediation function was indicated by stronger credit expansion at 22.8% (yoy) at end-december The most important source of this growth was lending to MSMEs. So far, the Indonesian banking system has not been impacted by fallout from the debt crisis in Europe, due to the comparatively limited exposure of Indonesia»s banks to the banking system in Euro countries. In the Board of Governors» Meeting convened on 5 January 2011, Bank Indonesia decided to hold the BI Rate at 6.5%. Nevertheless, the Board is aware to an escalating trend in future inflationary pressure related to possible disruptions in supply of volatile foods and increases in administered prices. Concerning this, Bank Indonesia believes that any rise in inflation expectations can be contained with measures to improve effectiveness in production, distribution and availability of staple goods at the national and regional levels. Bank Indonesia will reinforce monetary and macroprudential policy mix introduced last year through balanced and measured optimisation of instruments. Bank Indonesia has launched a range of policies aimed at curbing liquidity and capital inflows, including an increased statutory reserve requirement (rupiah and foreign currency), the one-month holding period for Bank Indonesia Certificates (SBIs) and restrictions on short-term external borrowing by banks. 6

9 %mtm % Industrial Production Capacity Utilitization (RHS) II. THE ECONOMY AND MONETARY POLICY Developments in the World Economy until Nov Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Source: Bloomberg Graph 2.1. US Industrial Production and Capacity Utilization The recent upward trend in the global economy has boosted optimism for global economic recovery. Improvement has taken place in manufacturing sector and consumption, as reflected in rising production. More vibrant production activity was indicated by the upward movement in the Purchasing Manager Index (PMI), higher rates of capacity utilisation and stronger purchasing power as indicated by improvement in non-farm payrolls in advanced countries. However, this upbeat trend is overshadowed by high unemployment levels and the ongoing fiscal consolidation process in the Euro area. Furthermore, the recovery in advanced countries was relatively slower compare to the buoyant recovery in emerging markets. This has prompted central banks in advanced countries to maintain accommodative interest rates while launching additional monetary stimulus packages. On the other hand, inflation in emerging countries picked up, in line with escalating world commodity prices, while inflation in advanced countries was relatively benign as the economy was not fully recovered. % Thousands Monthly Change Nonfarm Payrolls (RHS) Unemployment Rate until Nov Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Source: Bloomberg Graph 2.2. US Nonfarm Payrolls and Unemployment The United States economy is forecasted to remain positive. US household consumption remains on course for recovery, bolstered by seasonal factors during the end of year holiday season. The recovering trend in consumption is reflected in retail sales indicators and households income spending and upbeat consumer confidence. In response to the surging demand from households, manufacturing has resumed expansion. Towards the end of the year, expectations of rising household consumption have prompted renewed growth in production sector with the Purchasing Manager Index (PMI) was in an expansionary phase during November The US production index recorded positive growth in November 2010 alongside a rise in capacity utilisation to 75.2% from the previous 74.9% (Graph 2.1). Despite this, recovery in the US economy remains daunted by high unemployment levels. Although the non-farm payroll indicator shows a positive trend (Graph 2.2), unemployment rate has climbed back to 9.8% in November 2010 from a level of 9.6% one month earlier. European economies are showing improvement, driven mainly by expansion in the manufacturing sector. Rising manufacturing activity in 7

10 Europe is being driven by high external demand, led by China. This upswing is also evident in the PMI, which climbed in December 2010 to 57.1 compared to 55.3 one month earlier. Despite this, Eurozone consumption remains in a vulnerable position due to stubbornly high unemployment rate at 10.1% and the fiscal tightening that put additional pressure on household consumption. China»s economy is again forging ahead on the strength of the manufacturing sector. Surging activity in the Chinese economy is reflected in the 13.3% (ytd) rise in the production index and the manufacturing PMI that climbed to 55.2 in November Improvement in the manufacturing sector is also supported by bank credit expansion forecasted to surpass the government target, despite the introduction of some tightening measures. In addition, private consumption remains solid as evident from increasing growth in M2. Oil prices climbed steadily at the end of The surge in oil prices was triggered by the OPEC decision to keep its production quotas unchanged amid expectations of soaring oil demand in response to the extreme weather conditions in Europe and some parts of the US. In addition, decisions by advanced countries to maintain low interest rates have depressed returns on US dollar investments, prompting investors to shift their investment to commodity markets. World commodity prices (reported by the IMF) also mounted in November in response to soaring oil prices. During January-November 2010, the commodity price index has climbed by 24.9% (yoy) or 3.1% (mtm). The total increase in the index was driven mainly by a 26.6% (yoy) rise in the fuel index, while the non-fuel index moved up 22.2% (yoy). The upbeat pace of economic activity has also led to rising inflationary pressure. The Consensus Forecast for December 2010 projects global inflation in 2010 at 3.25% (yoy). The rise in global inflation has been spurred mainly by inflation in emerging countries. The Consensus Forecast estimates inflation in advanced countries at 1.44% (yoy), while inflation in the emerging countries is projected at 5.54% (yoy). Higher inflationary pressure in Asia has been driven by sustained high levels of domestic demand and elevating commodity prices. The improved economic fundamentals in advanced nations (US and Europe) and escalating commodity prices have prompted a rally in global stock markets. These developments helped boost the sentiment in the 8

11 market, which had dipped significantly in the wake of the Irish crisis. In addition to tax cuts, the decision by the European Commission and the IMF to extend financial assistance to Ireland has bolstered expectations for world economic recovery. Reflecting the global stock market rally was the rising trend in the composite index for world stock market prices (MSCI world). Similar to global stock markets, Asian stock exchanges also witnessed a rally alongside an improving trend in risk indicators. The liquidity crunch in advanced countries has also eased, except in Europe. The policy course pursued by central banks in advanced countries by continuing a quantitative easing and maintaining accommodative levels of interest rates has eased the liquidity crunch on money markets. Improvement is also visible in some indicators of counterparty risk. In general, the monetary policy response in advanced countries remains accommodative. Some central banks in the advanced countries have maintained low interest rates to facilitate economic recovery amid benign inflationary pressure. In December 2010, central banks in the US (Federal Reserve), United Kingdom (BoE), Japan (BoJ), Canada (BoC), Europe (ECB) and Australia (RBA) kept their policy rates on hold. While keeping their rates at accommodative levels, the Fed alongside the ECB, BoJ, BoC, BoE and SNB (Switzerland) has extended dollar swap lines until August 1, However, the Bank of Sweden is pursing a different policy by increasing 25 bps its repo rate to 1.25% to cope with mounting inflationary pressure. Some central banks in emerging countries have reimposed monetary tightening accompanied by other policies aimed at limiting capital inflows. The central banks in emerging countries opted to raise their policy rates in December were China»s PBoC (+25 bps to 5.81%), the HNB of Hungary (+25 bps to 5.75%), Thailand»s BoT (+25 bps to 2.00%) and Chile»s CBC (+25 bps to 3.25%). Even so, some central banks have lowered rates even further to boost economic growth and simultaneously discourage capital inflows, among others the Turkish CBoRT (-0.50 bps to 6.50%) and Kazakhstan»s NBK (-50 bps to 7.00%). The monetary tightening by some emerging market central banks has also been followed by other policies to manage capital inflows. 9

12 Economic Growth in Indonesia avg. Contraction phase : 19.3 months avg. Expansion phase: 22.8 months GDP Private Consumption CLI Private Consumption (rhs) imports of consumer goods, M1 Real, CPI I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I Graph 2.3. Leading Indicators of Private Consumption %, yoy Imports of Food Consumption Imports of Non-Food Consumption Graph 2.4 Imports of Consumption Goods (%,yoy) Source : CEIC Graph 2.5. Growth of Car & Motorcycle Sales Car Sales Motorcycle Sales The Indonesian economy is expected to maintain improved growth for 2010, with exports leading the way, alongside steadily expanding private consumption and investment. Economic growth in 2010 is estimated at 6.0% (yoy), up from 4.5% (yoy) in the preceding year. The improvement in domestic and global economic conditions has spurred growth in exports and investment. At the same time, private consumption continues to forge ahead, bolstered by favorable levels of consumer purchasing power. On the supply side, various sectoral indicators also showed improvement. The performance of the manufacturing sector has been driven by increased activity in the food and beverages subsector, chemicals subsector, and transportation equipment subsector. Other sectors with a leading role in the supply side of the economy include trade, hotels and restaurants sector, as well as transport and communications sector. Those two sectors have demonstrated a steadily expanding role in the Indonesian economy. Private consumption during 2010 was marked by a more vigorous growth trend. Confirmation of this came from leading indicator of private consumption suggesting that private consumption growth remains in an expansionary phase (Graph 2.3). Key factors driving the upbeat growth in household consumption are the continued strength of public purchasing power, greater availability of financing from financial institutions, appreciation of the rupiah, and consumer optimism on the economy. The most important contribution to private consumption growth is expected to come from non-food consumption (Graph 2.4). Rising household consumption was reflected in higher sales of motor vehicles (Graph 2.5) and retail goods up to November 2010 (Graph 2.6). Investment in 2010 is expected to steadily improve. This is supported by investment leading indicator that point to an ongoing expansionary phase. Improved investment performance was also supported by higher realisation of FDI and domestic investment projects (Graph 2.8). Better investment also came from increased financing from domestic and abroad, both from financial and non-financial institutions. At the same time, investment in machinery has expanded further as suggested by the steady rise in machinery imports for telecommunications, transportation and production (Graph 2.9). Support for growing investment activity has also came from the downward trend in real interest rates for investment credit that stimulated growth in investment credit and leasing in real term as of 10

13 % yoy % yoy Food & TobaCco Clothing Household Goods TOTAL INDEX (rhs) * Source : DSM Graph 2.6. Retail Sales Index % yoy % yoy Graph 2.7. Investment Construction Cement Consumption up to Nov (rhs) Electricity Consumption for Business yoy,nom yoy,nom 70% 500% 60% 50% 400% 40% 300% 30% 20% 200% 10% 100% 0% -10% 0% -20% -30% -100% -40% -200% I II III IV I II III IV I II III IV I II III Gross Fixed Capital Formation (GFCF) Total Invesment Foreign Direct Invesment Domestic Direct Investment (rhs) Graph 2.8. Foreign & Domestic Direct Investment Realization (BKPM) I II IIIIVI II III IVI II IIIIV I II IIIIVI II IIIIV I II IIIIV I II IIIIVI II IIIIV I II IIIIV I II III IV Construction (rhs) Imports of Manuf. of glass and glass products up to Oct Imports of Manuf. of non-metallic mineral products up to Oct November 2010 (Graph 2.10). Information from the Bank Indonesia Business Survey suggests that the corporations would continue their investment plans during the second half of According to the survey, most investment was directed for new ventures as well as replacement of machinery and buildings. The Statistics Indonesia - Business Tendency Survey also indicated favorable conditions for business in Q4/2010, although slightly more pessimistic compared to the preceding quarter. Despite appreciation in the rupiah, exports growth for 2010 remains robust, although slow in the fourth quarter. Supporting this was the generally positive growth in trading partner countries and an upward trend in commodity prices. Exports figures for 2010 are expected to reveal the strongest growth during the last 10 years (except 2005), estimates at 13.4%. Exports growth in 2010 was recorded for both oil and gas commodities and non-oil and gas products. Growth in oil and gas exports was driven mainly by performance in natural gas, while non-oil and gas exports expanded mainly on the back of resource-based commodities, including coal, nickel, aluminium, tobacco and rubber. However, in Q4/ 2010, exports performance began to slow. This slowdown is explained by declining in oil production and weakening of manufacturing and agricultural products prices. Imports also climbed steeply in 2010 in response to strong domestic and external demand. The more buoyant import trend was reflected in leading import indicators suggesting that imports are also in an expansionary phase. Imports were up in both oil and gas and non-oil and gas sectors. In addition to strong domestic and external demand, another factor spurring import growth was the strength of the rupiah that has driven down prices for imported goods. However, with exports expanding less rapidly in Q4/ 2010, imports also slow in comparison to the preceding quarter. Despite improved performance in investment and quite robust domestic demand, a slowdown in exports will have an adverse effect on imports. Real import growth in early Q4/2010 reached about 21% (yoy), down from the 30% growth (yoy) of the preceding quarter. Economic performance from the production side in 2010 reveals opportunities for higher growth. Among the tradable sectors, manufacturing is expected to chart stable growth bolstered by the non-oil and gas manufacturing subsectors of food and beverages sub sector, chemicals sub sector and transportation equipment sub sector. Car and motorcycle sales, electricity used in manufaturign sector, and credit to the 11

14 manufacturing sector showed positive trends as of November Improving conditions in the domestic and global economy has been a key factor driving manufacturing sales. The mining sector also charted higher estimated growth in line with increased production of oil and natural gas up to November However, the agricultural sector underwent only modest growth due to lower productivity growth, loss of arable land, flooding and escalating pest attacks. In non-tradable sectors, trade, hotels and restaurants sector charted steadily high estimated growth bolstered by brisk domestic activity and imports. Brisk growth is also projected in the transport and communications sector as evident from a range of indicators, including more upbeat growth in number of passengers ending October 2010 and soaring growth in data services. Construction sector growth is estimated higher, with performance reflected in stable growth in cement sales. In the financial sector, the improved lending by banks and non-bank financial institutions has potential to drive stronger growth. Similarly, the electricity, gas and water utilities sector is also expected to chart higher growth along with the operation of some power plants built under the first stage 10,000 MW projects in Q4/2010 and the programme to expand the household customers on October % yoy % yoy POWER GENERATING MACH. & EQP 75 AUT.DATA PROC. - OFFICE MACH.& 74 - GENERAL INDUSTRIAL MACH.&EQP 77 - ELECTRICAL MACH., APPARATUS 72 - MACH.SPECIAL FOR PARTIC.INDS Graph 2.9. Imports of Machinery %yoy ROAD VEHICLES 73 - METALWORKING MACHINERY 76 - TELECOMMUNICATION & REP. APP 79 - OTHER TRANSPORT EQUIPMENT (rhs) 2,000 1, %yoy I n f l a t i o n Headline inflation soared at the end of 2010, exceeding the government- set targeting range. At the end of 2010, CPI inflation was recorded at 0.92% (mtm) or 6.96% (yoy). This heightened inflation was characterised by the dominance of inflationary pressure from the food stuffs category. Price surges for some food commodities caused by ongoing adverse weather conditions produced a spike in volatile foods inflation. While domestic factors have played a role, developments in international food commodity prices have also impacted commodity prices domestically, with cooking oil in particular went up during the final quarter of Nevertheless, core inflation remained in check in line with exchange rate appreciation, contained inflation expectations and adequate supply side response to rising demand. In the administered prices category, following the hike in electricity billing rates during July 2010, no further government decisions were announced concerning strategic items to the end of the year. With these developments, CPI inflation climbed above the government-set inflation target of 5Ø1% Real Credit Investment Real Interest Rate of Credit Investment (rhs) Real Leasing Graph 2.10 Real Interest Rate of Investment Credit, Real Investment Credit, and Real Leasing 0 12

15 %,yoy Graph CPI Inflation CPI Core Volatile Food Administered Prices Volatile foods inflation jumped at the end of the year. This strong inflationary pressure was fuelled by price shocks affecting shallots, red chilli peppers, rice, and cooking oil in the wake of crop losses and upward pressure from international commodity prices. Abnormal weather conditions have impacted the supply of some seasoning commodities, such as red chilli peppers and spicy chilli peppers, and inevitably resulted in soaring prices. In addition, escalation in crude palm oil (CPO) prices on world markets at the end of 2010 has prompted increases in domestic cooking oil prices and caused one of the highest contributions to inflation during the month under review. Volatile foods inflation reached 3.29% (mtm) or 17.74% (yoy) in December 2010, up from the preceding month»s levels of 1.69% (mtm) or 13.77% (yoy). %,qtq 8 7 Food Processed Food Housing Clothing Health Education Transportation Inflationary pressure from administered prices was comparatively muted, due to the minimum price adjustments announced by the government. Amid the present turbulence in food prices, the Government has decided to delay raising prices for strategic commodities such as fuel and LPG. The largest contribution to inflation came from the cigarette category. In contrast, energy related commodities under household fuels (LPG and kerosene) did not produce a significant contribution to inflation because of the absence of hindrances on the ongoing progress in the energy conversion programme. Taken together, administered prices inflation in December 2010 reached 0.18% (mtm) or 5.40% (yoy). -1 Q-I Q-III Q-I Q-III Q-I Q-III Q-I Q-III Q-I Q-III Q-I Q-III Q-I Q-III Graph Inflation by Categories (%, qtq) International Domestic (rhs) On the fundamentals side, core inflation remained contained with support from exchange rate appreciation. During the month under review, core inflation came under stronger pressure from external side due to rising international commodity prices. Nevertheless, the positive trend in core inflation was bolstered by subdued public expectations of inflation and adequate supply side response to increasing demand. Following these developments, core inflation reached 0.38% (mtm) or 4.28% (yoy) in December 2010, largely unchanged from the preceding month»s levels of 0.30% (mtm) or 4.31% (yoy) I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II I IVIII II V Graph International and Domestic Gold Price 13

16 Rupiah Exchange Rate The rupiah was largely stable during December 2010 although tend to weaken. Negative sentiment from the fiscal crisis in Ireland bore down temporarily on the rupiah, although this pressure subsequently eased. The rupiah also sustained correction from rising demand for foreign currency at the year-end. Measured as an average for December 2010, the rupiah weakened 0.9% (mtm) from the previous month to Rp 9,024 to the US dollar (Graph 2.14). At the end of the month, the rupiah closed at Rp 9,010 to the US dollar, up 0.3% (ptp) from the previous month»s level. Taken together, the average rupiah exchange rate for 2010 came to Rp 9,081 to the US dollar, representing a 3.8% appreciation from the end of During December 2010, rupiah volatility eased to 0.16% from 0.26% one month before (Graph 2.15). From the external side, mounting concern over the fiscal condition in Europe has prompted a brief downturn in capital flows to emerging markets. The fiscal crisis in Ireland at the end of 2010 has triggered a round of negative sentiment that bore down on global financial market performance from end-november to early December However, this negative sentiment has eased after the release of improved global economic data. Global stock markets resumed bullish movement and the majority of global currencies showed renewed appreciation against the US dollar at the end of In addition to the fiscal jitters in Europe, geopolitical problems on the Korean peninsular and strong signals of monetary tightening in China also acted to curb foreign capital flows into Asia»s emerging markets. On the domestic front, the robust condition of domestic economic fundamentals underpinned the stability of the rupiah. The expansion in the domestic economy and positive performance in the balance of payments have helped to provide cushion the exchange rate against external pressures. In addition, the increasing international reserves has also bolstered positive investor perceptions on Indonesia»s ability to raise external financing. Indicators of investment risk in Indonesia remained largely stable despite a brief spike from negative sentiment over fiscal conditions in Europe. The Credit Default Swap (CDS) for Indonesia fluctuated around the 132 bps mark, improved from the approximately 137 bps recorded one month before. The yield spread between Indonesian Government Bonds and US T-Notes also narrowed, in line with the movement in CDS instruments. Despite this, the swap premium, which Rp/USD Daily Exchange Rate Monthly Average Quarterly Average ,110 8,998 8,966 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Graph Rupiah Exchange Rate Graph Volatility of Rupiah EUR MYR PHP IDR THB SGD KRW JPY % IDR/USD Daily Volatility Average Volatility Daily Exchange Rate (Rp/USD)-rhs Feb Apr Jun AugOct Dec Feb Apr Jun AugOct Dec Feb Apr Jun AugOct Dec % Graph Regional Asia Exchange Rate Appreciation/Depreciation December vs November Average Point to point

17 % Risk Worsen Risk Worsen bps Yield Spread CDS Ind (RHS) EMBIG Spread (RHS) 1.0 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Source: Bloomberg Graph Indonesia Risk Perception Indicator serves as an indicator of the rupiah movement remained stable for all tenors (1, 3, 6 and 12 months). High returns on rupiah-denominated assets continue to attract foreign capital inflows. Uncovered interest parity (UIP), an indicator of interest rate differential between domestic and avroad, remained the highest in the Asia. If improvement in risk premia is taken into account, the rupiah became more attractive investment option. Reflecting this was the steadily improving trend in covered interest parity (CIP) during Heavy capital inflows and improvement in risk perceptions for Indonesia bolstered the international reserves position. At the end of December 2010, international reserves stood at 96.2 billion US dollars, equivalent to 7.1 months of imports and servicing of official external debt. % M Premium 6 M Premium 3 M Premium 12 M Premium Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Source: Reuters (processed) Graph Swap Premium Various Tenors % Malaysia Graph Uncovered Interest Parity (UIP) Indonesia Philippines Korea -3.0 Jan MayOct Feb Jun Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct

18 Monetary Policy Interest Rates Interbank rates edged downwards approaching the floor rate during December 2010, due to flush levels of short-term banking liquidity. The average overnight interbank rate in December 2010 came to 5.57%, down from the previous month»s average of 5.60%. Risk perceptions on the overnight interbank market were largely subdued, as indicated in December by the narrowing in the spread between high and low rates to 12 bps. For the year as a whole, the average spread between high and low overnight rates fell to 24 bps from the previous year»s average of 43 bps. Steady downward movement in overnight interbank rates was accompanied by falling interbank rates in longer tenors. Average rates in the above overnight tenors during 2010 were recorded in the 6.10%- 6.55% range. Concerning bank interest rates, downward movement was recorded in both deposit and lending rates. In figures for November 2010, the average 1-month deposit rate came down 3 bps from the previous month to 6.78% (Table 2.1). When compared to end-2009, deposit rates had eased 9 bps from 6.87% to 6.78%. Lending rates similarly moved lower during November Rates charged for working capital credit, investment credit and consumption that month were recorded at 12.96%, 12.35% and 14.53%. Interest rates for all three categories of credit were also down in comparison to levels at end Table 2.1 The Developments of Interest Rates Interest Rate (%) Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov BI Rate Deposit Guarantee month deposit (Weighted Average) Base Lending Rate Working Capital Credit Investment Credit Consumption Credit

19 % BI Rate 1-month Deposit Consumer Credit Investment Credit Working Capital Loans Graph Various of Interest Rates Graph Growth of Credit & Funds, and BI Rate % % Credit Funds BI Rate Graph Credit Growth by Usage Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov % yoy Working Capital Investment Consumption -10 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct In analysis by category of bank, the steepest decline in 1-month deposit rates in figures for November 2010 was recorded by private domestic banks at 19 bps. In sharp contrast, foreign and joint venture banks raised their 1-month deposit rates by 71 bps. Regarding lending rates, foreign and joint venture banks were the most aggressive in lowering their interest rates for working capital credit and consumption credit during 2010 with cuts as steep as 147 bps and 405 bps. However, the most aggressive cuts in rates for investment credit (167 bps) came from state-owned banks. Funds, Credit, and Money Supply Deposit funds have maintained steady expansion. In November 2010, growth in deposit funds reached 16.6% (yoy) (Graph 2.21). That month, deposit funds totalled Rp 2,212.2 trillion, having widened by Rp 38.3 trillion from the preceding month when funding growth was reported at 16.7% (yoy). These developments brought deposit funds growth for the calendar year ending November 2010 to Rp trillion, equal to 12.1%. In analysis by components, growth in deposit funds was explained mainly by brisk expansion in time deposits and savings deposits at 16.9% and 21.6% (yoy). These two components accounted for 76.9% of total depositor funds. Demand deposits, representing the other component of bank funding, saw more modest growth at 10.2% (yoy) despite an upward trend compared to the end of the preceding year (8.3%, yoy). Credit growth maintained an expansionary trend. In November 2010, credit growth (including channelling) increased to 21.3% (yoy) from the previous end-of-year growth recorded at 8.7% (yoy), consistent with the downward trend in loan interest rates during In response, loan disbursements expanded by Rp trillion (18.0%, ytd) during 2010 to Rp 1,736.1 trillion. Credit growth at end-2010 was estimated to reach about 23% (yoy). In analysis by purpose of use, working capital credit again provided the backbone of credit growth. In figures for November 2010, most of the added lending comprised working capital credit (Rp trillion) with growth at 24.8% (yoy), up considerably from the previous year-end growth at 2.7% (yoy). This reflected the growing contribution of working capital credit to total lending growth, to boost economic growth (Graph 2.22). On the other hand, investment credit widened by Rp 32.1 trillion with growth at 15.0% (yoy), down slightly from 16.4% (yoy) at the end of the 17

20 preceding year. Growth in consumption credit reached Rp 86.2 trillion or 22.5% (yoy), marked by a slowing trend from the beginning of the year. Analysed by sector, credit growth has again been driven by the miscellaneous sector. In November 2010, miscellaneous sector 1 expansion reached 35.5% (yoy). With a 34.1% share of total credit, this sector remains a pillar of overall credit growth despite a slowing trend associated with consumption credit. Lending to other strategic sectors, such as manufacturing, business services and social services, had further. These sectors are expected to accelerate the rate of economic growth. In analysis by currency, foreign currency lending recorded significant expansion. As of November 2010, growth in foreign currency credit reached 31.3% (yoy), well ahead of the previous year-end growth recorded at negative 17.4% (yoy). However, this acceleration in foreign currency credit had comparatively little impact on credit growth, with foreign currency lending accounting for only 15% of total credit. Rupiahdenominated credit, on the other hand, widened by 20.6% (yoy) compared to 16.5% (yoy) one year before. Growth strengthened in base money and currency outside banks. Base money growth in December 2010 reached 28.9% (yoy), having climbed significantly from 11.8% (yoy) in the preceding month (Graph 2.23). At the end of 2010, currency outside banks was similarly up by 18.3% (yoy) from 14.2% (yoy) one month earlier. The more energetic growth in base money and currency outside banks wa an indication of improvement in the economy from the private consumption side Graph Base Money and Currency % yoy M0 (RR 5%) Currency M0 Graph Growth of M1 & M2 (nominal) Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct %yoy M1 M M1 and M2 maintained stable growth. In November 2010, growth in M1 economic liquidity was relatively stable at 14.7% (yoy) compared to the previous months» growth of 14.0% (yoy). At the same time, M2 growth mounted further in November 2010 to 16.9% (yoy). This M2 growth bolstered by the additional quasi-money money differed little from the previous month»s growth recorded at 17.1% (yoy). 1 Covers home mortgages, vehicle loans and credit for household appliances. The miscellaneous sector credit expansion reflects the dominant role of consumption credit. 18

21 Stock Market The ascent in the JCI during 2010 positioned the Indonesian Stock Exchange (IDX) as the market with the steepest price gains of any country in the region. The JCI maintained a steady upward trend to the end of December 2010, closing at 3, Key developments in macroeconomic indicators and at the micro level of issuers, such as relative exchange rate stability, the outlook for economic growth, prevailing low inflation, strong earnings growth among listed companies and expectations of achieving investment grade within a shorter time frame had boosted foreign investor confidence in investing funds on the stock market. During 2010, the JCI came under repeated pressure, some related to sentiment over the Greek crisis in Q2/2010. Nevertheless, in the most recent month, the JCI sustained fairly turbulent movement, even though charting significant gains. Sparking this volatility were soaring global commodity prices amid jitters over monetary tightening in China, the crisis in Ireland and escalation of the Korean conflict. Despite considerable volatility during December 2010, the JCI still booked gains of 4.9% for the month or 46.1% (ytd). The year 2010 was also marked by achievement of an all-time high at 3,786.1 on 12 December In analysis by sector, JCI gains in 2010 were supported more by the trade and consumption goods sectors. This reflects the strengthening performance of the economy on the back of continued robust growth in the trade sector and household consumption. The brisk growth in the two sectors had displaced mining from its earlier position as the leading growth sector in % Indonesia Thailand (STI) Philippines Kuala Lumpur India England (FTSE) US (Dow Jones) EM Asia Strait Times World Hong Kong (Hang Seng) Japan (Nikkei) Vietnam Shanghai (SHCOMP) 2010 Graph JCI and Regional Index Indonesia (IHSG) India Shanghai (SHCOMP) EM Asia Strait Times Thailand (STI) Philippines 2009 Vietnam Hong Kong (Hang Seng) Kuala Lumpur World England (FTSE) Japan (Nikkei) US (Dow Jones) At the micro level, stock issuers reported improved financial outlooks in comparison to other countries in the region. Third quarter reports indicated that listed companies maintained buoyant earnings levels, fuelling positive expectations for the financial statements for In Indonesia, return on equity was superior to other countries in the region. The conducive micro condition of listed companies was also reflected in dividend payments by some issuers, signalling that these companies had maintained solvability at levels strong enough to support dividend payouts. Market actors were also optimistic of future earnings growth by listed companies in line with corporate plans calling for capital expenditures. Despite this, the surge in oil prices during December 2010 had resulted in particular susceptibility in the micro condition of stock exchange listed 19

22 companies. Rising oil prices also imply potential for increased production costs and squeezed corporate earnings. Conducive macro and micro factors and a global environment flush with excess liquidity acted to stimulate foreign capital inflows on the stock market. Foreign players booked a net selling of Rp 2.5 trillion during October and November 2010 and reentered by a similar level in December For 2010 overall, the net purchase reached Rp 19.2 trillion, representing a significant increase from only Rp 13.9 trillion one year earlier. This activity also contributed to increased liquidity on the stock market. Daily trading volume in 2010 averaged Rp 4.9 trillion, up from the previous year»s volume at only Rp 3.9 trillion per day (Graph 2.26). 4,000 3,500 3,000 2,500 2,000 1,500 1, JCI Trading Value (average)-rhs J C I (IDR, Trillion per Day) Graph Value and Volume of JCI Trading Government Securities Market Indonesia»s Government Securities outperformed other countries in the region, as reflected in the steepest decline in yield for any of the region»s economies. The drop in yield indicated that Indonesian Government Securities were keenly sought by foreign investors for their attractive yield and support from the robust condition of domestic economic fundamentals and sound fiscal conditions. In response, short, medium and long-term yield narrowed by 175 bps, 217 bps and 153 bps, producing an average 189 bps decline in yield to close at 7.39%. Supportive external factors and robust domestic economic fundamentals stimulated foreigner interest in Indonesian Government Securities. Yield on these securities was generally more attractive than for other countries in the region, such as Thailand, Malaysia and the Philippines. As a result, foreign holdings of Indonesian Government Securities expanded from the previous year. As the year progressed, indications emerged of market actors switching from long to medium tenor bonds. In December 2010, the easing of external risks and comparatively low prices for Indonesian government bonds prompted investors to seize the opportunity to resume buying, resulting in a net purchase position Yield Government Bond 10yrs BI Rate Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Graph Government Bond Yield and BI Rate % (IDR, Trillion per Day) Trading Volume (average) - RHS Yield (average) Graph Government Bond Yield and Trading Volume