MONETARY POLICY STATEMENT

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2 MONETARY POLICY REVIEW 1 MONETARY POLICY STATEMENT The Bank Indonesia Board of Governors, convening on 15th January 2015, decided to hold the BI Rate at 7.75%, with the Lending Facility and Deposit Facility rates to remain at 8.00% and 5.75% respectively. An overall assessment of domestic economic performance in 2014 along with the economic outlook for 2015 and 2016 indicate that such policy is consistent with efforts to control inflation towards its target corridor of 4±1% in 2015 and 2016, as well as manage the current account deficit to a more sustainable level. Amidst a number of onerous global and domestic challenges throughout 2014, domestic economic performance in Indonesia was relatively sound with macroeconomic stability maintained and economic rebalancing ongoing in a more sustainable direction in line with solid economic fundamentals coupled with economic stabilisation polices and structural reforms implemented by Bank Indonesia and the Government. Moving forward, the Indonesian economy is expected to improve further with robust domestic economic growth and maintained macroeconomic stability, supported by global recovery momentum and ongoing structural reforms to reinforce national economic fundamentals. Bank Indonesia policy will remain directed towards achieving the inflation target, managing the current account deficit and maintaining financial system stability. To that end, Bank Indonesia will continue to strengthen its monetary and macroprudential policy mix, bolster the payment system and intensify coordination with the Government in terms of controlling inflation, reducing the current account deficit and promoting structural reforms in order to support higher economic growth. National macroeconomic stability management was required in 2014 to confront the challenge of uncertainty surrounding the normalisation of the Federal Reserve s monetary policy stance as well as a weaker-than-expected and uneven global economic recovery. On one hand, the US recovery gained momentum, while the recovery in Europe remained more moderate. On the other hand, China s economy continued to decelerate and the economy of Japan slipped back into recession. The slower global economic recovery, coinciding with a lower international oil price due to abundant supply, particularly from the US, ultimately drove down global commodity prices significantly. Growing uncertainty surrounding the normalisation policy of the Federal Reserve, especially during the second half of 2014, combined with US dollar appreciation against all global currencies, also escalated the risk of capital reversal from emerging market countries, including Indonesia. Looking ahead, economic recovery in advanced countries, specifically the US, will persist into 2015, thus bolstering growth in Indonesia through the trade channel. Nevertheless, several external risks will remain a test of national macroeconomic stability in 2015, particularly escalating volatility on global financial markets in line with possible hikes to the Fed Funds Rate and the downward trend of commodity prices. Congruent with the moderating global economy and national economic stabilisation policy, domestic economic growth slowed in The Indonesian economy achieved 5.1% growth in 2014, decelerating from 5.8% in From an external standpoint, domestic economic moderation was the result of declining exports due 1

3 to weaker demand and low international commodity prices as well as policy to restrict exports of unrefined minerals. Despite the overall decline of exports, manufacturing exports surged in line with the US recovery. On the domestic demand side, however, the slowdown was attributed to limited government consumption as budget cuts took effect. Meanwhile, investment activity also experienced limited growth. Persistently robust economic growth was maintained by solid household consumption. In 2015, stronger economic growth is forecasted, namely in the % range. In a departure from conditions in 2014, on top of strong household consumption, expanding government consumption and investment in line with greater fiscal capacity to support productive economic activities, including infrastructure development, will catalyse high economic growth. Against a backdrop of global economic dynamics, the Indonesia balance of payments improved in 2014 in line with consistent stabilisation policy. The current account deficit decreased in comparison to the previous year as manufacturing exports surged and imports declined in line with weak domestic demand, the rupiah exchange rate undulated in accord with its fundamental value and the oil price dropped. Meanwhile, the capital and financial account recorded a substantial surplus, backed by positive growth in terms of foreign direct investment and portfolio investment. Solid investment performance was bolstered by the positive perception of investors concerning the domestic economic outlook along with attractive returns. Consequently, foreign exchange reserves at the end of December 2014 swelled to US$111.9 billion, equivalent to 6.5 months of imports and servicing external debt, which is well beyond international adequacy standards of around three months. Moving ahead, the current account deficit is expected to improve. The decreasing international oil price and government subsidy reforms will improve the oil and gas account. In contrast, expanding non-oil/gas imports, as the government ramps up infrastructure projects, could potentially stifle improvements in the current account deficit. In terms of the capital and financial account, solid economic fundamentals due to ongoing structural reforms will attract capital inflows in the form of foreign direct investment and portfolio investment, which should be sufficient to offset the current account deficit. The rupiah depreciated against the US dollar in 2014 but appreciated against the currencies of other leading trading partners. Rupiah depreciation against the US dollar in the fourth quarter of 2014 was due to US dollar appreciation against nearly all global currencies after the release of improved US economic data as well as the planned hike to the Fed Fund Rate. Point to point, the rupiah depreciated 1.74% (yoy) in 2014 to a level of Rp12,385 per US dollar. Meanwhile, against other currencies, such as the yen and euro, the rupiah appreciated relatively strongly despite remaining competitive with trading partner countries. Bank Indonesia consistently maintained rupiah stability in accordance with its fundamental value, thereby supporting macroeconomic stability as well as controlled economic rebalancing in a sounder and more sustainable direction. Inflation in 2014 remained under control amidst intense pressures from administered prices and volatile foods. Inflation in 2014 was 8.36% (yoy), lower than the 8.38% posted in the previous year and in line with the inflation target set at 4±1%. Higher inflation was the result of a subsidised fuel price hike and the impact of domestic food price shocks at the end of The subsidised fuel price hike pushed up prices directly and through the second-round effect. In addition to fuel prices, administered prices were also adjusted several times in 2014, including the basic electricity rate and LPG prices. Notwithstanding, core inflation was controlled at 4.93% (yoy) in line with Bank Indonesia policy to manage domestic demand, maintain exchange rate stability and anchor inflation expectations as well as improve coordination with the government to control inflation. 2

4 Bank Indonesia is assured that inflation will remain under control within its target corridor of 4±1% in 2015, supported by stable core inflation and a declining international oil price that is projected to contribute to deflation. In order to safeguard attainment of the inflation target, Bank Indonesia will continue to bolster coordination with the central and local governments through national and regional inflation controlling teams in order to manage food inflation and administered prices. Financial system stability was maintained with the support of tenacious banking sector resilience and improving financial market performance in Banking industry resilience remained solid with credit risk, liquidity risk and market risk well mitigated and the support of a sound capital base. In November 2014, the capital adequacy ratio remained high at 19.6%, which is well above the minimum threshold of 8%, while the ratio of non-performing loans (NPL) remained low and stable at around 2.0%. Credit growth is projected at 11.9% (yoy) in November 2014, lower than the 22.2% (yoy) achieved during the same period of the preceding year. Bank Indonesia considers the credit slowdown consistent with domestic economic moderation. Meanwhile, deposit growth was 13.8% (yoy) in November 2014, unchanged from the previous year. On the other hand, bank liquidity conditions improved in line with more expansive government financial operations. In future, as the economy gains momentum, deposit and credit growth are projected to accelerate to 14-16% and 15-17% respectively. Meanwhile, the capital market also improved, as indicated by a 22.3% rally on the IDX Composite compared to the previous year. Besides, the yields of tradeable government securities (SBN) decreased. Bank Indonesia policy in 2015 will continue to focus on maintaining macroeconomic and financial system stability through efforts to strengthen the monetary, macroprudential and payment system policy mix. In the monetary sector, policy will consistently aim to control inflation towards its target corridor and reduce the current account deficit to a more sustainable level through interest rate policy and stabilising the exchange rate in line with its fundamental value. In terms of macroprudential policy, selectively looser macroprudential policy to expand funding sources for the banking sector will simultaneously support financial market deepening and catalyse credit extension to priority productive sectors. Meanwhile, payment system policy will be directed towards developing a more efficient domestic payment system industry. The panoply of aforementioned policies will be accompanied by greater coordination with the government and relevant agencies in order to maintain macroeconomic stability with an increasingly solid economic structure and to support higher economic growth. 3

5 2 THE ECONOMY AND MONETARY POLICY Global Economic Performance A slower-than-expected and uneven global economic recovery process influenced international economic performance. On one hand, the US recovery gained momentum, while the economy of Europe tended to decelerate. On the other hand, China s economic downswing persisted and the recession in Japan continued. Global economic growth in 2014 was 3.3%, lower than the 3.6% projected at the beginning of 2014 and relatively similar to that achieved in 2013 (Table 2.1). Table 2.1. World Economic Outlook IMF Consensus Forecast BI Jan Oct Jan Dec Feb Dec World Output 3,3 3,7 3,3 3,6 3,3 3,6 3,3 United States 2,2 2,8 2,2 2,8 2,3 2,8 2,3 Euro area -0,4 1 0,8 1 0,8 0,9 0,9 Japan 1,5 1,7 0,9 1,7 0,3 1,7 0,6 China 7,7 7,5 7,4 7,5 7,3 7,5 7,4 India 4,6 5,4 5,6 5,4 5,6 5,3 5,6 The US recovery became increasingly solid throughout 2014, supported by growing domestic demand due to improvements in the household sector. US economic growth began to accelerate in the second and third quarters of 2014 after inclement weather stifled growth during the first quarter. Meanwhile, the economic recovery in Europe progressed slowly, as reflected by declines in the PMI of three leading countries in Europe (Germany, France and Italy) in the fourth quarter of Such conditions were in line with lower inflation and the level of consumer confidence. In contrast, Japan s economy grew slower than previously projected as the array of government policies implemented, in the form of monetary and fiscal stimuli, were insufficient to prevent economic decline. Nevertheless, the postponed tax hike in 2015 is projected to bolster future economic growth in Japan. Economic growth slowed in developing countries. China grew slower due to weaker investment and consumption activities, as reflected by declining fixed asset investment (FAI) and retail sales. Meanwhile, India s economy rebounded as consumption increased, which was confirmed by growing consumer confidence after appointment of a new government with a comprehensive economic reform agenda. Lower international oil prices throughout 2014 favoured the India trade balance and further supported economic gains in the country. The decelerating global economic recovery, coupled with the declining international oil price, precipitated significantly lower commodity prices worldwide. The oil price dropped persistently throughout 2014 (Graph 2.1) due to an increase in supply from non-opec countries, particularly the US, against a backdrop of weaker demand due to slower economic growth in emerging market countries, including 4

6 China. Furthermore, investment diversification away from commodities to noncommodities, especially the US dollar, also occasioned the lower oil price. The decreasing oil price and global economic downturn ultimately prompted lower non-oil/gas commodity prices. Graph 2.1. Oil Price in 2014 Moving forward, the economic recovery in advanced countries, specifically the US, is projected to persist into 2015, thereby boosting the Indonesia economy through the trade channel. Due to current US economic conditions, accommodative monetary policy will be maintained in line with the IMF revising down its US growth projection. Notwithstanding, risks associated with high volatility on global financial markets in line with potential hikes in the Fed Funds Rate during the middle of 2015 demand vigilance. Economic Growth Congruous with the global economic slowdown and national economic stabilisation policy, domestic economic growth slowed in Indonesia s economy is predicted to grow by 5.1% in 2014, which is down from the 5.8% posted in From an external standpoint, declining exports were responsible for the domestic economic downswing (Table 2.2) due to weaker global demand and lower commodity prices along with restrictions on unrefined mineral exports. Despite a general decline in exports, manufacturing exports surged as the US recovery gained traction. In terms of domestic demand, the slowdown was triggered by limited government consumption in line with budget cuts. Meanwhile, investment activity also experienced limited growth. Nonetheless, persistently solid household consumption supported relatively robust economic growth. Table 2.2. Economic Growth Demand Side %Y-o-Y, 2000 Price Component I II III IV I II III 2014* Private Consumption Expenditure Government Expenditure (0.7) Gross Fixed Capital Formation Export of Goods and Services (0.4) (0.8) (0.7) (0.5) - (0.1) Import of Goods and Services (0.6) 1.2 (0.7) (5.1) (3.6) (3.2) - (2.8) GDP Source : BPS - Statistics Indonesia *Bank Indonesia's Projection 5

7 Household consumption remained solid in 2014, thereby underpinning economic growth. Household consumption growth is predicted to accelerate slightly compared to the preceding year, especially during the first semester, as spending on the general election increased. Household consumption, however, moderated as the economy slowed and the effect of the general election passed. In addition, declining consumer confidence (Graph 2.2) and weaker public purchasing power after the subsidised fuel price hike also undermined household consumption. Such conditions were evidenced by a decrease in consumer income expectations as well as weaker automotive (Graph 2.3) and retail sales, particularly of foodstuffs and household equipment (Graph 2.4). Graph 2.2. Consumer Confidence Index Graph 2.3. Motor Vehicle Sales Graph 2.4. Retail Sales Index Limited investment growth was projected. Limited investment growth, especially during the first semester of 2014, was in response to weaker exports and household consumption. Declining mining exports triggered a decrease of investments particularly in the form of heavy equipment. Meanwhile, stabilisation policy instituted by Bank Indonesia, including LTV policy in the property sector, moderated construction investment. Additionally, weaker construction investment growth was also due to capital spending cuts by the government in accord with larger budget cuts. Declining investment performance was reflected by a lower business tendency index released by BPS-Statistics Indonesia (Graph 2.5) and decreasing industrial capacity utilisation towards yearend Limited government consumption growth was projected in Government consumption growth is projected at a lower level in 2014 compared to 2013 in line with budget cuts implemented to maintain the fiscal deficit at a sustainable level. due to the large fuel subsidy burden up to the third quarter as well as potentially lower-than-targeted tax revenues. 6

8 Graph 2.5. BPS Business Tendency Index Graph 2.6. Capacity Utilization From an external perspective, export performance is expected to decline due to torpid demand and falling international commodity prices together with policy to restrict unrefined mineral exports. Deteriorating export performance was primarily linked to lower international commodity prices and sluggish demand from developing countries, as reflected by the declining world trade volume (WTV) of such countries (Graph 2.7). Furthermore, policy to restrict unrefined mineral exports, enforced since January 2014, also undermined mining export performance with exports of copper, nickel and bauxite suspended during the first semester (Graph 2.8). Mining exports gradually rebounded in the third quarter as exports recommenced at Freeport and Newmont. Notwithstanding, exports of other mining commodities, in this case coal, continued to subside as demand waned from China and prices remained low. Despite the general decline of exports, exports of several manufactured products surged, including processed foods and chemicals. Graph 2.7. WTV Import and Indonesia Export Performance Graph 2.8. Non Oil Export Real Value In response to weaker export performance and domestic demand, imports also declined in The import growth contraction primarily affected capital goods as sales of heavy equipment decreased (Graph 2.9). Moreover, imports of consumer goods dropped off significantly in line with tepid domestic demand. Declines primarily affected durable and semi-durable goods as well as imports of passenger vehicles congruent to low domestic automobile sales. Meanwhile, raw material imports also tended to decrease in response to less export activity. The majority of economic sectors, both tradable and non-tradable, moderated in In the tradable sector, declines were felt in the mining and manufacturing sectors. Weaker demand for coal exports and enforcement of the Mineral and Coal Mining (Minerba) Act undermined mining sector performance. Meanwhile, a slump in domestic demand hurt the manufacturing industry. Furthermore, weaker demand on both fronts also 7

9 adversely influenced the non-tradable sector, particularly the trade sector, transportation and communication, as well as the financial, leasing and services sector. More specifically, domestic factors linked to the general election ultimately curbed domestic demand, albeit temporarily, for the construction sector. Graph 2.9. Non Oil Import Real Value Looking ahead, the economic outlook for 2015 is better despite a number of risks that require monitoring. In 2015, stronger economic growth is projected in the % range. Departing from conditions in 2014, on top of solid household consumption, expansive government consumption and investment as fiscal capacity expands to support productive economic activities, including infrastructure development, will bolster sound economic performance in Externally, economic recoveries in advanced countries, particularly the United States, are expected to drive export growth, especially manufacturing exports. Nevertheless, a number of risks demand vigilance in relation to escalating global financial market volatility in line with the possibility of hikes to the Fed Funds Rate and tumbling commodity prices worldwide. Indonesia Balance of Payment Amidst global economic dynamics, the Indonesia balance of payments (BoP) improved during 2014 in line with consistent stabilisation policy. During the reporting year, the BoP recorded a surplus and noted significant improvements on the preceding year when a deficit was documented. The current account deficit is expected to shrink to -3.02% of GDP compared to -3.33% in the previous year, supported by a surge in manufacturing exports and a simultaneous decline in imports as domestic demand moderates, the rupiah exchange rate undulates in accordance with its fundamental value and the oil price continues to decrease. Throughout 2014, the position of Indonesia s trade balance improved due primarily to a growing non-oil/gas trade surplus. During the period from January- November 2014, the non-oil/gas trade surplus of Indonesia amounted to US$10 billion, exceeding the US$6.2 billion surplus recorded in the previous year. On the other hand, the oil and gas trade deficit totalled US$12.1 billion, surpassing the US$11.9 billion deficit registered during the same period of the preceding year. Cumulatively up to November 2014, the trade balance improved on the position in 2013 (Graphs 2.10 and 2.11). 8

10 Graph Trade Balance : Cumulative (ytd) Graph Trade Balance In 2014, imports declined as the domestic economy moderated, the rupiah exchange rate moved in line with its fundamental value and the international oil price slumped. Weak domestic demand, particularly on the consumption side, precipitated less demand for imports. On the other hand, a rupiah exchange rate moving in line with its fundamental value throughout 2014 led to more expensive import prices that stifled domestic demand pursuant to Bank Indonesia s exchange rate policy, which targets a more sustainable current account deficit. Non-oil/gas exports declined as the global economy decelerated, particularly China, and export prices of leading commodities remained low. The decreasing international oil price undermined export performance through lower commodity prices. Furthermore, less export volume of coal and rubber also indicated moderating non-oil/gas export performance. Despite the overall decline in non-oil/gas exports, manufacturing exports grew positively throughout 2014 as advanced economies continued to recover, particularly in the US, and real exchange rates depreciated. Resilient manufacturing exports affected metals, chemicals, transportation and machinery due to real exchange rate depreciation, which boosted exports of furniture and metals. The financial account improved notably on the back of a significant rise in portfolio. Non-resident funds flowed into domestic financial assets, peaking at US$15.37 billion in 2014 compared to just US$2.44 billion in 2013 (Graph 2.12). Foreign capital inflows to government bonds (SUN) and shares increased in 2014 compared to 2013 (Graph 2.13) in line with a promising economic outlook for Indonesia and persistently attractive yields. Graph Portfolio Inflows (ytd) Graph Capital Flows in Financial Markets 9

11 The position of foreign exchange reserves at the end of December 2014 was US$111.9 billion, surpassing the US$111.1 billion reported at the end of November The position of forex reserves swelled due to oil and gas export earnings, additional external debt and other government foreign exchange revenues that exceeded spending on servicing external debt and the requirement for foreign exchange to stabilise the rupiah. For 2014 in general, the position of forex reserves increased by US$12.5 billion on the total at yearend 2013 amounting to US$99.4 billion. Consequently, the position of foreign exchange reserves at the end of December 2014 was equivalent to 6.7 months of imports or 6.5 months of imports and servicing external debt, which is well above international adequacy standards of around three months. Bank Indonesia perceives the aforementioned level of forex reserves as sufficient to maintain external sector resilience and sustainable economic growth moving forward. Looking ahead, the current account deficit is projected to continue improving. The lower international oil price, coupled with government subsidy reforms, will help offset the oil and gas account deficit, although an increase in oil and gas imports due to government infrastructure projects will curb potential improvements in the current account deficit. In terms of the capital and financial account, increasingly solid economic fundamentals in line with ongoing structural reforms that maintain the influx of capital flows, in the form of FDI and domestic investment, should be sufficient to negate the current account deficit. Rupiah Exchange Rate The rupiah depreciated in 2014 against the US dollar despite appreciating against other leading trading partner currencies. Point-to-point, the rupiah depreciated 1.74% (yoy) in 2014 to a level of Rp12,385 per US dollar. On average, however, the rupiah depreciated 12% (yoy) to a Rp11,876 per US dollar from Rp10,445 in 2013 (Graph 2.14). Rupiah depreciation in 2014 is in line with the weakening of other currencies in the region but to a more limited degree. Rupiah depreciation during 2014 was better mitigated than that of the euro, yen, real and rand (Graph 2.15). In addition, rupiah volatility was less pronounced than that of the real, lira and rand (Graph 2.16). Meanwhile, against other currencies including the yen and euro, the rupiah appreciated strongly while remaining sufficiently competitive against other trading partner currencies (Graph 2.17). The rupiah depreciated against the US dollar in the fourth quarter of 2014, as the dollar appreciated against nearly all hard currencies after improved US economic data was released and the Federal Reserve acknowledged its plan to raise the Fed Funds Rate. Furthermore, pressures on the rupiah were also triggered by sentiment factors surrounding the international economic downturn, global geopolitical tensions and contagion from the crisis in Russia. Internally, however, pressures on the rupiah stemmed from the wait-andsee attitude of investors during the government interregnum process. Global economic developments will continue to influence future rupiah fluctuations. Pressures from across-the-board US dollar appreciation will amplify rupiah gyrations in line with other regional currencies as the Federal Reserve plans to normalise its monetary policy stance, which will strengthen the Dollar Index. Notwithstanding, Bank Indonesia will continue to safeguard rupiah stability in line with its fundamental value, thereby bolstering macroeconomic stability and the economic rebalancing process towards sounder and more sustainable growth. 10

12 Graph Rupiah Exchange Rate Graph Regional Exchange Rate Graph Regional Exchange Rate Volatility Graph Apr./Depr. of Rupiah to Peers Inflation Inflation was controlled in 2014 amidst intense pressures stemming from administered prices and volatile foods. Inflation was 8.36% (yoy) in 2014 compared to 8.38% (yoy) in the preceding year, which is above the inflation target set at 4.5±1%. Higher inflation was primarily a response to subsidised fuel price hikes along with the impact of domestic food price shocks at the end of Accordingly, the subsidised fuel price hike pushed up other prices directly and through the second-round effect. In addition to fuel prices, administered prices were adjusted during 2014, including basic electricity rates and LPG prices. Notwithstanding inflationary pressures, core inflation remained under control at 4.93% (yoy) (Graph 2.18). Graph Inflation 11

13 Volatile food inflation was lower in 2014 than that reported in 2013 despite intense pressures. Volatile food inflation dropped to 10.88% (yoy) in 2014 from 11.83% (yoy) in the preceding year. Volatile food inflation was managed through government efforts to stabilise prices, intensive coordination with the government during the holy fasting month of Ramadan, lower global food prices and abundant food supply. By quarter, volatile food inflationary pressures escalated relatively during the fourth quarter due primarily to limited supply, especially affecting various chillies and rice due to weather anomalies (drought from the end of September until the beginning of November and heavy rainfall from the end of November until December). Additionally, price pressures on volatile foods mounted at the end of 2014 as a result of rising distribution costs due to cost-push inflation from higher subsidised fuel prices in the middle of November as well as the suspension of the Raskin program (subsidised rice for the poor) in November and December (Graph 2.19 and Table 2.3). Table 2.3. Volatile Food Inflation/Deflation Contributor Graph Volatile Food Inflation In 2014, the subsidised fuel price hike exacerbated administered price inflation. Administered price inflation jumped from 16.55% (yoy) in 2013 to 17.57% (yoy) in the reporting year. The main source of inflationary pressures was government policy to raise subsidised fuel prices on 18 th November 2014, including its second-round effect on transportation costs. On top of higher subsidised fuel prices, inflationary pressures also originated from higher electricity rates, more expensive household fuels and higher airfreight tariffs. Meanwhile, the subsidised fuel price hike implemented in the third week of November was only partially felt that month, with the main impact occurring in December (Graph 2.20 and Table 2.4). Table 2.4. Administered Prices Inflation/Deflation Contributor Graph Administered Prices Inflation 12

14 Core inflation was controlled at 4.93% (yoy) in 2014, compared to 4.98% (yoy) in the preceding year. Core inflation was managed with the backing of limited external pressures as the impact of rupiah depreciation on core inflation was partially mitigated by lower international prices, which was evidenced by a decline in imported inflation. Meanwhile, weaker demand eased domestic pressures as economic growth slowed. In addition, mitigated cost-push inflation stemming from higher LPG prices and electricity rates helped alleviate domestic pressures. Although controlled, core inflation rose during December 2014 in comparison to the previous month, stemming from both domestic and external factors. Indications of escalating domestic inflationary pressures were reflected by higher non-traded core inflation, which affected foods and non-foods alike (Graph 2.21). The increase in nontraded core inflation was not only hastened by an increase in freight tariffs due to higher subsidised fuel prices and commercial electricity rates but also due to escalating volatile food inflation. Meanwhile, inflationary pressures on the demand side tended to ease, as evidenced by weaker retail sales and capacity utilisation as public purchasing power was eroded due to higher fuel prices. In contrast, external pressures intensified as the rupiah depreciated amidst international price corrections. Amplified external pressures in December were spurred by higher traded core inflation due predominantly to rupiah depreciation. Nevertheless, tumbling international prices (imported inflation), particularly of gold and oil, dampened external pressures (Graph 2.22). Exchange Rate (dep (+) / apr (-), %, mtm) Import Price Index (proxy Imported Inflation, % mtm) *) Core Traded Inflation (%, mtm), RHS *) Composite Index of Global Prices with weighted average (based on import ratio and CPI weighted) from food commodities (CPO, wheat, corn and soybean), world oil (WTI), gold, cotton and iron Graph Core Non-traded Inflation Graph Core Traded Inflation and External Factor In general, rising inflation expectations at the retail and consumer levels were anchored well. For retailers, higher inflation expectations for the upcoming three and six months after the 2014 fuel price hike were not as severe as that ofafter the fuel price hike in 2013 (Graph 2.23). For consumer, inflation expectations for the upcoming three and six months declined, bolstered by confidence that the impact of the fuel price hike was merely temporary (three months from November) as well as greater optimism regarding the availability of goods in the upcoming year (Graph 2.24). 13

15 Graph Retailers s Inflation Expectation Graph Consumer s Inflation Expectation By region, inflationary pressures were relatively intense and spread evenly throughout all provinces in Similar to national conditions, soaring inflation in a number of regions was attributed to higher fuel prices and city transportation tariffs coupled with higher red chilli and bird s eye chilli prices. Furthermore, higher rice prices were also a source of inflationary pressures on volatile foods. The most pronounced increases in rice prices actually affected rice production hubs on Java due to the ongoing planting season. In general for 2014, the highest inflation was found in Jakarta, Sulawesi- Maluku-Papua and Bali-Nusa Tenggara. In contrast, inflation rates on the islands of Sumatra, Java and Kalimantan were relatively low compared to the previous year (Figure 2.1). National Inflation: 8.36% Figure 2.1 Inflation by Region, December 2014 (%, yoy) Moving forward, Bank Indonesia is assured that inflation will remain under control within the target corridor of 4±1% in That prognosis is supported by controlled core inflation and a lower international oil price, which is expected to contribute to deflation. In order to safeguard the inflation target, Bank Indonesia will continue to strengthen coordination with the central as well as provincial governments through national and regional inflation controlling teams to manage inflation and administered prices. 14

16 Monetary Developments In 2014, the developments of interest rates and other monetary variables remained consistent with stabilisation policy instituted by Bank Indonesia. The interbank rate along with bank interest rates continued to rise throughout 2014 in response to a higher BI rate. Credit, on the other hand, constituting M2, grew slower in line with economic moderation. Notwithstanding, interbank money market volume remained stable and bank liquidity was sufficient. Transmitted from the higher BI rate, the overnight (O/N) interbank rate increased, accompanied by a slightly wider max-min spread. The weighted average overnight interbank rate was 5.85% in 2014, increasing from 4.81% in 2014, in line with the average BI rate, which increased to 7.52% in 2014 from 6.40% in The overnight deposit facility rate also increased to 5.75% from 4.65% in the preceding year. The maxmin spread of the overnight interbank rate widened slightly compared to that in 2013 in line with tight bank liquidity. Tight liquidity particularly affected the interbank money market in the first quarter of 2014 and gradually eased thereafter in the second semester of 2014 (Graph 2.25). Interbank money market volume was relatively stable but long-term tenors experienced a moderate decline. Interbank money market volume in 2014 was Rp11.0 trillion, which is relatively stable compared to the Rp10.7 trillion posted in 2013 (Graph 2.26). O/N tenors increased to Rp6.8 trillion (62%), while longer-term tenors decreased to Rp4.2 trillion (38%). Graph Interbank O/N Rate Graph Overnight Interbank Market Rates Bank interest rates tended to follow an upward trend. From January to November 2014, the weighted average lending rate jumped 57 bps to 12.96%, while the one-month deposit rate increased 30 bps to 8.22%. Deposit rates increased primarily during the second quarter of 2014 in line with tighter bank liquidity and a 25-bps hike in the LPS rate to 7.75%. Bank liquidity conditions improved during the third quarter of 2014, which prevented further increases in the deposit rate. Based on loan type, higher lending rates predominantly occured in working capital credit, which increased 72 bps to 12.84%. Meanwhile, investment credit and consumption credit increased respectively by 56 bps and 40 bps to 12.38% and 13.53% (Graph 2.27). Consequently, the spread between the lending rate and one-month deposit rate widened to 474 bps (Graph 2.28). 15

17 Graph Loan Rates Graph Bank Interest Rates The position of M2 in November 2014 was Rp4,076.3 trillion, growing 12.7% (yoy), which is relatively stable compared to the 12.7% (yoy) posted in December By component, stable M2 growth was credited to M1 growth (currency and rupiah checking accounts) and quasi-money (third-party deposits encompassing term deposits and savings denominated in rupiah and a foreign currency as well as foreign currency checking accounts). M1 growth achieved 9.8% (yoy), accelerating from 5.4% (yoy) in December On the other hand, quasi-money grew 13.9% (yoy), which is lower than the 14.9% (yoy) posted in December 2013 (Graph 2.29). M1 growth was driven by expanding regional government checking accounts in line with expansive central government financial operations in the form of regional transfers (Graph 2.30). Graph M2 Growth and Its Components Graph M1 Growth and Its Components Based on its determinants, stable M2 growth was attributed to an increase in net foreign assets (NFA) amidst slower growth of net domestic assets (NDA). The increase in NFA was congruous with the influx of foreign capital to domestic financial markets, while slower NDA growth was blamed on decelerating bank credit growth. Bank credit growth amounted to Rp3,626.2 trillion in November 2014, equivalent to a growth of 11.8% (yoy), which is slower than the 21.4% (yoy) achieved in December 2013 (Graph 2.31). 16

18 Graph Growth of M2 and Factors Affecting Broad Money The Banking Industry Throughout 2014, financial system stability was maintained with the support of a solid banking industry, which underpinned the economic rebalancing process. Credit risk, liquidity risk and market risk in the banking industry were relatively stable and controlled. In addition, a sound capital base buoyed the banking industry in general. Credit growth during 2014 followed a downward trend in line with moderating domestic demand. In November 2014, credit 1 grew 11.8% (yoy), which is slower than the 21.4% (yoy) achieved in December Weaker credit growth was primarily the result of slower working capital credit growth, with a share of 48% of total credit, decelerating from 20.2% (yoy) in December 2013 to 11.4% (yoy). Investment credit and consumer credit growth also slowed to 13.2% (yoy) and 11.2% (yoy) respectively from 34.4% (yoy) and 13.8% (yoy) in December 2013 (Graph 2.32). By sector, weaker credit growth affected nearly all economic sectors, including leading sectors such as the trade, hotels and restaurants sector and the manufacturing industry. In November 2014, credit growth in the trade, hotels and restaurants sector and manufacturing industry were 15.7% (yoy) and 17.2% (yoy) correspondingly, which are lower than the growth rates in December 2013 at 28.6% (yoy) and 29.3% (yoy). Credit growth in the services sector grew negatively by -13.4% (yoy), sliding from -4.2% (yoy) at the end of the preceding year. Only two sectors enjoyed stronger credit growth, namely the agricultural sector with 24.1% (yoy) and the construction sector with 23.8% (yoy), compared to 24.0% (yoy) and 21.7% (yoy) respectively in December 2013 (Graph 2.33). 1 Credit growth of 11.8% (yoy) in November 2014 was calculated using the monetary concept, namely rupiah and foreign currency loans disbursed by commercial banks and rural banks (excluding bank branches operating internationally) to residents (excluding the central government). Meanwhile, credit growth calculated using the banking concept amounted to 11.9% (yoy) in the same period. According to the banking concept, credit includes rupiah and foreign currency loans extended by commercial banks (including bank branches operating internationally) to residents (including the central government) and non-residents. 17

19 Graph Credit Growth Graph Credit by Sector Deposit growth accelerated in 2014 thanks to the contribution from term deposits. Deposits 2 achieved growth of 13.4% (yoy) in November 2014, which is slightly higher than that posted in December 2013 at 13.0% (yoy). Term deposits, with growth accelerating to 21.3% (yoy) from 13.9% (yoy) in December 2013, contributed to the increase in deposit growth. Such conditions are congruent with increasing deposit rates throughout 2014, especially during the second quarter. Conversely, growth of checking and savings accounts experienced a decline in November 2014 to 7.8% (yoy) and 7.1% (yoy) respectively from 12.2% (yoy) and 12.5% (yoy) in December 2013 (Graph 2.34). Graph Deposit Growth Against a backdrop of weaker credit growth and higher interest rates, banking sector resilience was maintained and credit risk was mitigated. In November 2014, the capital adequacy ratio (CAR) remained high at 19.6%, which is well above the minimum threshold of 8%. Additionally, the level of CAR increased slightly on the 18.4% reported in December 2013, reflecting solid bank resilience in terms of overcoming pressures and shocks, including the ongoing upward trend of bank interest rate. Meanwhile, the ratio of non-performing loans (NPL) remained low and stable at around 2.00% (Table 2.5). 2 Deposit growth of 13.4% (yoy) in November 2014 was calculated according to the monetary concept, namely third-party savings denominated in rupiah or a foreign currency held at commercial banks or rural banks (excluding bank branches operating internationally) in the form of savings accounts, demand deposits and term deposits. Pursuant to the monetary concept, third-party deposits do not include those of the central government nor non-residents. Meanwhile, deposits according to the banking concept achieved growth of 13.8% (yoy) in November True to the banking concept, deposits consist of third-party savings in rupiah or a foreign currency held at commercial banks (including bank branches operating internationally) in the form of savings accounts, demand deposits and term deposits. In accordance with the banking concept, third-party deposits also include those of the central bank and non-residents. 18

20 Table 2.5. Banking Industry Performance Indicators Indikator Utama Jan Feb Mar Apr May 2014 Jun Jul Aug Sept Oct Nov Total Aset (T Rp) 4, , , , , , , , , , ,511.1 DPK (T Rp) 3, , , , , , , , , , ,054.7 Kredit * (T Rp) 3, , , , , , , , , , ,622.8 LDR* (%) NPLs Gross* (%) CAR (%) NIM (%) ROA (%) * without channeling ** with channeling The Stock Market and Government Securities Market The domestic stock market performed positively during The IDX Composite closed at a level of 5,226.95, up by 22.3% compared to the position at the end of During 2014, the index peaked at its highest level on 8 September 2014 at 5, Investor optimism regarding the domestic economic outlook has been apparent since the release of 2013 GDP data, which was better than previously predicted. Globally, investor concerns over the Federal Reserve s tapering issue began to subside. The growing trend was maintained until the middle of the year due to bullish sentiment regarding smooth conduct of the general election and the government transition process. The policy mix response of Bank Indonesia in coordination with the Government to maintain financial market stability after the fuel price hike on 17 th November 2014 also garnered bullish market sentiment. Nevertheless, the IDX Composite dropped in line with pressures on the rupiah exchange rate in the middle of December After global investor concerns were allayed, the IDX Composite rebounded to close in the green zone. The IDX Composite performed well in comparison to regional stock exchanges (Vietnam, Thailand, Malaysia and Singapore), achieving 22.3% growth, but was outperformed by China (52.9%), India (29.9%) and the Philippines (22.8%) (Graph 2.35). Nearly all economic sectors represented on the domestic stock exchange performed positively throughout Shares in the property sector achieved highest growth of 55.8%, followed by the financial sector (35.4%) and the infrastructure sector (24.7%). Compared to 2013, only the mining sector performed negatively, contracting - 4.2%, due to a slump in mined commodity prices on the international market, which ultimately spilled over to issuers in the mining sector (Graph 2.36). World EM ASIA US (Dow Jones) Japan (Nikkei) England (FTSE) India (SENSEX) Hong Kong (Hang Seng) Shanghai (SHCOMP) Strait Times (STI) Kuala Lumpur (KLCI) Philippine Thailand (SET) Vietnam Indonesia (IHSG) 2,7% 5,7% 7,2% 5,2% 7,5% 7,1% 1,3% 6,2% 22,8% 15,3% 8,1% 22,3% 29,9% 52,9% 20% 0% 20% 40% 60% Graph JCI and Global Stock Index Graph Sectoral Index December

21 Foreign investors booked net purchases in Driven by positive global sentiment and optimism concerning the domestic economy, non-resident investors supplemented foreign holdings on the domestic stock market. In 2014, foreign investors booked net purchases totalling Rp42.6 trillion, compared to net redemptions of Rp20.65 trillion in Consequently, the position of non-resident shareholdings up to December 2014 was 34.6%, which is slightly larger than the 33.8% reported in 2013 (Graph 2.37). The tradeable government securities (SBN) market improved and the yields of all tenors decreased. Yields could be seen to decline since the beginning of the year in line with investor optimism concerning economic fundamentals in Indonesia. Fewer concerns from global investors over the normalisation policy of the Federal Reserve s monetary policy stance contributed favourably to SBN market performance. Furthermore, the smooth conduct of the general election also maintained SBN market performance. Investors responded well to a 25-bps hike in the BI rate, taken as an anticipatory measure to anchor inflation. In general, SBN yield decreased 49 bps to 7.80%. Short, medium and long-term yields dropped respectively by 21 bps, 56 bps and 72 bps to 7.41%, 7.78% and 8.36% (Graph 2.38). In comparison to neighbouring countries, the SBN market performed well, exceeding that of Malaysia and the Philippines. Graph JCI & Net Foreign Buy/Sell Graph Yield Changes Dec 2013 Dec 2014 Non-resident investors continued to supplement foreign holdings on the tradeable government securities market. In 2014, non-resident investors booked net purchases totalling Rp137.5 trillion, which is up Rp84.2 trillion on the previous year. Foreign investors purchased short, medium and long-term tenors. Compared to the position in 2013, SBN holdings of banks shrank to 29.5%, while holdings of insurance firms swelled to 12.1%, pension funds increased to 3.5% and foreign holdings increased to 37.04% from 31.54% in the preceding year (Graph 2.39). Graph Gov t Bonds Yield & Net Foreign Buy/Sell 20

22 Nonbank Financing Nonbank economic financing fell short of that noted in In 2014, total financing through initial public offerings, rights issues, corporate bonds medium-term notes (MTN), promissory notes and other financial instruments amounted to Rp97.4 trillion, which is less than the Rp112.9 trillion achieved in the previous year. Differing from conditions in 2013, corporate bond issuances dominated nonbank financing in Total financing through shares totalled Rp35.4 trillion in 2014, down 38.6% compared to the Rp57.5 trillion achieved in Financing through shares was obtained from initial public offerings totalling Rp9.07 trillion and rights issues amounting to Rp26.28 trillion. The decline is congruous with the decrease in the number of firms initiating public offerings. In 2014, the number of issuers conducting initial public offerings or rights issues totalled 24 compared to 30 in Table 2.6. Nonbank Financing Rp Trillion Dec Q1 Q2 Q3 Q4 Total Nov Dec Q1 Q2 Q3 Q4 Total Nonbank Stocks w/o Financial sector issuers Bonds w/o Financial sector issuers MTN and Promissory Notes + NCD w/o Financial sector issuers Source: OJK and BEI (processed) 21

23 3 MONETARY POLICY RESPONSE The Bank Indonesia Board of Governors, convening on 15th January 2015, decided to hold the BI Rate at 7.75%, with the Lending Facility and Deposit Facility rates to remain at 8.00% and 5.75% respectively. An overall assessment of domestic economic performance in 2014 along with the economic outlook for 2015 and 2016 indicate that such policy is consistent with efforts to control inflation towards its target corridor of 4±1% in 2015 and 2016, as well as manage the current account deficit to a more sustainable level. Amidst a number of onerous global and domestic challenges throughout 2014, domestic economic performance in Indonesia was relatively sound with macroeconomic stability maintained and economic rebalancing ongoing in a more sustainable direction in line with solid economic fundamentals coupled with economic stabilisation polices and structural reforms implemented by Bank Indonesia and the Government. Moving forward, the Indonesian economy is expected to improve further with robust domestic economic growth and maintained macroeconomic stability, supported by global recovery momentum and ongoing structural reforms to reinforce national economic fundamentals. Bank Indonesia policy will remain directed towards achieving the inflation target, managing the current account deficit and maintaining financial system stability. To that end, Bank Indonesia will continue to strengthen its monetary and macroprudential policy mix, bolster the payment system and intensify coordination with the Government in terms of controlling inflation, reducing the current account deficit and promoting structural reforms in order to support higher economic growth. 22

24 LATEST INDICATORS INDICATORS 2014 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov INTEREST RATE & STOCK Nine Months SBI Rate 1) One Month Deposit Rate 2) Three Months Deposit Rate 2) One Week JIBOR 2) JSX Indices 3) 4,419 4,620 4,768 4,840 4,894 4,879 5,089 5,137 5,138 5,090 5,150 Monetary Aggregates (billion IDR) Base Money 781, , , , , , , , , , ,029 M1(C+D) 842, , , , , , , , , , ,547 Currency (C) 380, , , , , , , , , , ,706 Demand Deposit (D) 462, , , , , , , , , , ,841 Broad Money (M2 = C+D+T+S) 3,649,270 3,639,494 3,656,440 3,732,093 3,784,518 3,861,659 3,885,137 3,885,137 4,563,795 4,568,389 4,631,113 Quasi Money (T) 2,784,379 2,783,476 2,781,019 2,824,253 2,855,355 2,899,117 2,955,221 2,976,544 3,044,547 3,066,084 3,097,888 Quasi Money (Rupiah) 2,325,640 2,332,776 2,347,505 2,387,641 2,384,784 2,432,932 2,504,468 2,522,960 2,473,236 2,498,061 2,613,964 Time Deposit 1,207,618 1,222,600 1,251,956 1,283,873 1,290,519 1,327,909 1,361,158 1,392,365 1,417,919 1,444,309 1,455,687 Saving Deposit (Total) 1,118,022 1,110,176 1,095,549 1,103,768 1,094,265 1,105,023 1,143,310 1,130,595 1,142,883 1,138,715 1,158,277 Foreign Currency Time Deposit 222, , , , , , , , , , ,034 Foreign Currency Demand Deposit 236, , , , , , , , , , ,889 Securities Other Than Shares (S) 22,223 21,492 21,928 21,220 22,417 16,758 17,684 16,873 16,136 17,719 27,837 Factors Affecting Broad Money 3,649,270 3,639,494 3,656,440 3,732,093 3,784,518 3,861,659 3,891,434 3,889,315 4,009,857 4,024,153 4,081,351 Net Foreign Assets 1,035,758 1,013, ,705 1,015,014 1,061,751 1,077,147 1,056,409 1,068,956 1,114,215 1,096,264 1,108,378 Net Domestic Assets 2,613,512 2,626,027 2,668,735 2,717,079 2,722,767 2,784,513 2,835,025 2,820,359 2,895,641 2,927,889 2,972,973 Net Claims on Central Goverment 345, , , , , , , , , , ,554 Claims on Other Sector 3,490,575 3,503,344 3,544,990 3,605,194 3,644,823 3,709,913 3,739,381 3,748,438 3,822,938 3,844,355 3,912,531 Monetary Aggregates Growth (%,YOY)) Base Money M1(C+D) Currency (C) Demand Deposit (D) Broad Money (M2 = C+D+T+S) Quasi Money (T) Securities Other Than Shares (S) Factors Affecting Broad Money Net Foreign Assets Net Domestic Assets Net Claims on Central Goverment Claims on Other Sector PRICE CPI - Monthly (%, mtm) CPI - Yearly (%, yoy) EXTERNAL SECTOR IDR/USD (end of period, mid rate) 12,210 11,609 11,360 11,562 11,675 11,855 11,578 11,698 12,185 12,085 12,204 Non Oil & Gas Export (f.o.b, million USD) 4) 11,971 11,905 12,551 11,641 12,448 12,624 11,628 11,877 12,730 12,964 11,587 Non Oil & Gas Import (c & f, million USD) 4) 11,366 10,334 10,529 12,562 11,064 12,304 9,909 11,394 11,962 11,796 10,584 QUARTERLY INDICATORS Q.I GDP Growth (%, yoy) Consumption Investment Changes in Stocks Export Import ) end of week 2) weighted average 3) end period closing 4) closed file Sources : Bank Indonesia,except CPI, export/import and GDP from BPS Q.II 2014 Q.III The Monetary Policy Review (MPR) is published monthly by Bank Indonesia after the Board of Governors Meeting each January, March, April, June, July, September, October and December. 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 adddition 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 adopteed by Bank Indonesia. For further information: Policy Regulation and Communication Division Monetary Policy Group Monetary and Economic Policy Department Telp: /6836 Fax: gkm_komunikasi@bi.go.id Website: The Board of Governors: Agus D.W. Martowardojo Governor Mirza Adityaswara Senior Deputy Governor Halim Alamsyah Deputy Governor Ronald Waas Deputy Governor Perry Warjiyo Deputy Governor Hendar Deputy Governor 23