Move on with Grace in Steadiness

Transcription

1 Move on with Grace in Steadiness Tradition brings innovation that perfects through generations to keep the balance of the ark. Thus, although the storm hits the sea, the steadiness still preserved. And keep the ark moves on in grace, sails through the ocean. i

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3 CHAPTER I THE INDONESIAN ECONOMY IN 2009

4 The Indonesian Economy in 2009 The global economy that was still under pressure from the crisis posed major challenges for the Indonesian economy during These challenges emerged mainly at the beginning of the year due to the lingering impact of the global economic crisis that reached its peak in the fourth quarter of The uncertainties correspond to the depth of the global contraction and the speed of the global economic recovery, not only heightened risks in the financial sector, but also adversely impacted economic activity in the domestic real sector. These unfavourable circumstances bore down heavily on monetary and financial system stability in the first quarter of 2009, while economic growth posed downward trend contributed from steep contraction in exports of goods and services. These adverse developments in turn undermined the confidence of economic agents both in the financial sector and real sector and potentially reduce positive achievements in the previous years. Bank Indonesia and the Government took a series of policies during 2009 to address these challenges. These policies were essentially a continuation of the measures adopted by Bank Indonesia and the Government in the fourth quarter of Amid considerable uncertainties in the financial sector and real sector, the policies were aimed to safeguard macroeconomic and financial system stability as well as to strengthen domestic economic resilience. In monetary policy, Bank Indonesia adopted an easy monetary policy stance in combination with 2

5 various other policies, including measure to curb excess volatility in the foreign exchange market. Bank Indonesia policies for the banking system were focused on improving banking industry resilience through further actions to strengthen the banking intermediation function. In fiscal policy, the Government with approval of the Indonesian Parliament implemented a substantial fiscal stimulus, involving tax relief and measures to safeguard public purchasing power. Furthermore, the Government in the beginning of the year has lowered prices for subsidised premium gasoline and automotive diesel. In addition the government has implemented sectoral policies to bolster the resilience of the domestic economy. These policies persued succeeded not only in safeguarding macroeconomic and financial system stability, but also in strengthening domestic economic resilience, with the economy showing initial improvement in the second quarter of Financial system and macroeconomic stability also maintained steady improvement for the rest of 2009, reflecting in various improvement financial sector indicators such as CDS, the Jakarta Composite Index, yield on government securities and the exchange rate. The improvement in financial system stability subsequently paved the way for strengtened confidence among economic agents in the real sector and subsequently invigorated economic activity, which passed its lowest growth in the third quarter of Overall, the Indonesian economy emerged from the challenging year in a good shape. Despite lower than 2008, economic grew 4.5% in 2009, the third highest growth in the world after China and India. Further slowdown in economic growth was avoided due to the domestic demand-driven structure of the economy. Inflation also came to a modest 2.78%, the lowest level in the past decade. The financial system stability was maintained with the onset of recovery in the bank intermediation function mainly during the second half of Further downward pressure on the domestic financial system was contained to some extent by regulations prohibiting domestic banks from engaging in speculative activities, most importantly that related to structured products. These regulations comprise the series of policies for strengthening and consolidating the banking system in the wake of the 1997/1998 crisis. This chapter elaborates further on the dynamics of the domestic economy. The analysis is divided into three parts. The first part explains the global economy as a factor exerting considerable influence over the Indonesian economy in The second part presents the various policies pursued by Bank Indonesia and the Government in response to the global economic downturn. The third part discusses domestic economic performance during the period of the global economic downturn. The third part begins with analysis of the balance of payments, followed by the financial market, banking industry, The Indonesian Economy in 2009 CHAPTER I 3

6 economic growth, inflation and lastly unemployment and poverty. The analysis of economic growth and inflation will also be presented from a regionallybased economic perspective. 4 CHAPTER I The Indonesian Economy in 2009

7 The Global Economy 1.1 The global economic crisis that reached its peak in the last quarter of 2008 still continued until early of Global financial markets remained fraught with instability due to strong negative sentiment of the outlook for global economic recovery as well as deteriorating the performance of leading US financial institutions such as Citigroup, AIG and BoA. This unfavourable environment lead the investors to scaled back their portfolios in credit markets and capital markets, both in advanced and emerging markets. The declining fund placements on emerging markets was also driven by heightened risk perceptions on emerging markets as described, among others, in the CDS levels for some Asian emerging markets which remained high, averaging 450 bps at end-march 2009 compared to the normal level of about 100 bps recorded in the first half of 2008 (Chart 1.1). Under these uncertainties, global investors shifted their portfolios to risk-free assets such as US Treasury Bonds. On money markets, the continuing liquidity crunch was reflected in the widening USD LIBOR-Overnight Index Swap (OIS) spread (Chart 1.2). At the end of March 2009, the spread in advanced economies such as the US, UK and the European Union was still around 150 bps, well above the normal level of about 70 bps such as recorded in the first half of On stock markets, an ongoing exodus of investor funds continued to bear down on global stock indices (Chart 1.3). The development in the global financial sector impacted global economic growth. The consolidation process and uncertainties in the financial sector impoded flows of liquidity to the real sector and contributed to further The Indonesian Economy in 2009 CHAPTER I 5

8 bps bps I II III IV I II III IV I II III IV I II III IV Thailand Malaysia Indonesia Vietnam Korea US Euro UK AUS Source: Bloomberg Source: Bloomberg Chart 1.1 CDS of the Emerging Countries Chart 1.2 LIBOR and 3 Months OIS Spread contraction in the global economic growth. Following the uncertainties in the financial sector, global economic growth projections were steadily revised downwards. International financial institutions such as the IMF made several revisions to world economic growth projections during In April 2009, the IMF forecasted that the world economy would pose 1.3% contraction, down considerably from November 2008 when growth was still projected at a positive 2.2% (Table 1.1). The global economic contraction was driven to a large extent by contraction in advanced economies, while growth in developing economies remained in positive territory, driven by the performance of China, India and Indonesia. In line with the declining of world economic growth, contraction also took place in world trade volume (Table 1.1). In April 2009, world trade volume in 2009 was estimated to record a negative growth around 11.0%, down considerably from the positive 3.0% in This contraction represents the steepest decline since the first publication of world trade volume statistics in 1970 (Chart 1.4). In this respect, some Asian economies heavily reliant on trade recorded a significant contraction due to declining exports, triggered by plunging commodity prices and falling demand in developed economies. Table 1.1 World Economic Growth percent Periods of Projection Countries Nov-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 World Advanced Economies USA European Union Japan Emerging Markets Commonwealth Countries in Eastern Europe Asian China India ASEAN Middle East Western Hemisphere World Trade Volume (goods and services) Source: World Economic Outlook (WEO), IMF 6 CHAPTER I The Indonesian Economy in 2009

9 index 110 index 110 percent 15, Euro US Japan Thailand Singapore Indonesia Hong Kong Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov ,0 5,0 0,0-5,0-10,0-15, Rebased 1/1/2008 = 100 Source: Bloomberg Source: IMF Chart 1.3 Stock Indices of Developed and Emerging Countries Chart 1.4 World Trade Volume Growth The downturn in global economic growth in turn contributed to low levels of global commodity prices and weak global inflationary pressures. Decreasing demand for global commodities pushed downward pressure on prices for energy and non-energy commodities (Chart 1.5). Despite a modest upturn after the end of March 2009, world oil prices in first quarter of 2009 stayed at around 48 US dollars per barrel (Chart 1.6). Low commodity prices and the slowdown in global demand eased inflationary pressures, both in the advanced economies and the developing economies (Chart 1.7). The uncertainties and pressures in the global economy triggered by the ongoing global liquidity crunch, had led many countries to implement intensive policy responses, both for conventional and un-conventional policy. Central banks pursued conventional policies by cutting policy rates to near-zero levels in some developed economies. The conventional policy was reinforced by un-conventional policies in some advanced economies, such as expanding the basis of collateral used in central bank monetary operations, extending the tenor of liquidity support and buying securities including mortgage-backed. Other policy actions included blanket guarantees on bank deposits, recapitalisation of financial institutions and measures to limit portfolio losses in the banking sector. Financial institutions in some advanced countries, including the United States and Europe, were bailed out by central banks in order to preserve financial system stability and to prevent further negative impact on the economy. The force of the pressure bearing down on financial markets also prompted the Federal Reserve, Bank of England, European Central Bank, Bank of Japan and the Swiss National Bank to set up currency swap agreements to ease the US dollar liquidity crunch in some regions. On the fiscal side, governments in developed and developing countries implemented substantial fiscal index (2005=100) USD/barrel USD/barrel Rincian (Indeks 2005=100) 2009 Total Commodity Indices -30,9 Non-Energy Index -18,3 - Food and Baverages -13,1 - Agriculture Raw Materials -16,8 - Metal -27,5 Energy Index -36,9 - Crude Oil Price Index -36, AVERAGE* WTI Minas Source: IMF I II III IV I II III IV I II III IV Total Non-Energy Energy Chart 1.5 Commodity Price Index Source: Bloomberg Minas WTI (rhs) Chart 1.6 International Oil Price 20 The Indonesian Economy in 2009 CHAPTER I 7

10 percent,yoy percent,yoy millions of USD 16 Advanced Country Developing Country (right side) Europe Japan US UK I II III IV I II III IV I II III IV Indonesia China Philippines India I II III IV I II III IV I II III IV Source: Bloomberg Source: Bloomberg A week moving average 4 week moving averages Chart 1.7 Inflation of Advanced and Developing Countries Chart 1.8 Capital Flow to Asia Stock Market stimulus to push demand and to mitigate rising unemployment. Governments took these policies after considering that the room for further interest rate cuts became more limited. The fiscal stimulus in the US soared to 787 billion US dollars (5.5% of GDP) comprising 287 billion US dollars in tax relief, which 500 billion US dollars allocated for infrastructure projects and other social programmes. In Europe, fiscal stimulus packages in the four major economies (Germany, UK, France and Italy) amounted to 1% of GDP, while three stimulus packages launched by the government of Japan totalled 12 trillion yen representing an equivalent 122 billion US dollars. In China, the government released 4 trillion yuan into the economy, an amount equivalent to 586 billion US dollars or 13.3% of GDP, allocated primarily for infrastructure development. The various policy measures launched in many countries succeeded in reducing systemic risk on financial markets and restoring market participants confidence since second quarter of The liquidity injections by central banks eased credit market tightness as well as lowering the LIBOR-OIS spread down to levels before the Lehman Brothers bankruptcy in September At the same time, intervention by central banks in developed countries through expanded scope and intensity of monetary operations, as well as measures to consistently safeguard the financial system have diminished the systemic risk on financial markets. On one hand, the response from some major central banks to buy higher-risk securities had increased markets activities that were previously weaken due to the reluctance of market participants to engage in transactions. On the other hand, the purchase of securities was also aimed at reducing short-term financing costs for the private sector. In subsequent developments, the decline in financial market risk were also described in the narrowing of the CDS and 3-month LIBOR-OIS spread in some countries since the second quarter of 2009 (Charts 1.1 and 1.2). In line with this environment, the risk perceptions in stock market also improved, generating incrising global financial markets, including stock markets in Asia (Chart 1.3). The rising stock market performance in Asia were partly contributed by low interest rates and slower economic recovery in developed countries, that subsequently encouraged higher capital flows into Asian stock markets (Chart 1.8). With recovery under way in the financial sector, the improvement was also observed in world economic growth. The significant fiscal stimulus had a beneficial effect on household consumption, which resumed an upward trend. The positive indicator in consumption was followed by improvement in manufacturing sector starting in third quarter of Even the US housing sector, the original trigger of the crisis, was believed to have passed its lowest point since the third quarter of Aggressive interest rate cuts accompanied by purchasing policies of mortgage-based debt securities had also reduced the cost of home financing in the US. Responding to low interest rates on home mortgages, home purchases by the households had resumed, resulting in a gradual rise in housing prices. The role of developing Asian countries to global economic recovery were quite substantial. In this regards, 8 CHAPTER I The Indonesian Economy in 2009

11 higher economic growth in Asia s emerging markets had compensated the sluggish recovery in advanced economies (Chart 1.9). In China, the fiscal stimulus had boosted growth in government-sponsored infrastructure projects, minimizing the impact of slow recovery in exports. In India, the vibrant manufacturing sector had helped sustain positive growth in the economy. Rising demand from China and India had benefited exports from other Asian economies. The improvement in exports along with fiscal stimulus and accommodative monetary policy had contributed to Asian economies to reach a more rapid recovery compared to other regions. Along with this improving trend, the world economy had undergone a faster than expected recovery and estimated to record 0.8% contraction, a more favourable figure when compared to earlier forecasts (Table 1.1). 1 The faster than predicted recovery in the global economy and accommodative global policies had boosted the prices of the world energy and non-energy commodities. While demand in advanced countries remained weak, demand in emerging markets, led by China, had spurred increases in commodity prices. Robust demand in Asian emerging markets for biofuels as an alternative energy, had boosted the prices for primary commodities such as soy beans and CPO. The rising prices for mining commodities such as coal and metal ores were also consistent with the increasing trend of manufacturing sector in developing countries. Oil prices at end-december 2009 reached 79.4 US dollars per barrel, up from of 33.9 US dollars recorded in the second week of February The escalation in global commodity prices and strengthening world demand subsequently contributed to rising global inflationary pressure at the end of 2009 (Chart 1.7). percent, qtq, annualized Source: IMF I II III IV I II III IV I II III IV I II III IV World Advanced Country Developing Country Chart 1.9 World Economic Growth During the period of global economic recovery, many countries have taken policies to safeguard financial system stability and promote economic recovery. Albeit pursued less intensively compared to the first quarter of 2009, monetary policy remains in easing stance,. Approaching year end, some central banks started to raise their policy rates to respond to future inflationary pressure. In addition to monetary relaxation, central banks in developed countries, such as the Federal Reserve, Bank of England, European Central Bank, Bank of Japan and the Swiss National Bank extended their currency swap agreements to ease pressure on US dollar liquidity in some regions until October The Federal Reserve also expanded the guarantee for securities accepted within the framework of the Term Asset-Backed Securities Loan Facility (TALF) and eased the term of collateralised securities. 1 For the latest estimation of world economic growth in 2009, see the WEO Update January 2010 The Indonesian Economy in 2009 CHAPTER I 9

12 Policy Responses 1.2 To mitigate the impact of the global economic crisis on the Indonesian economy, Bank Indonesia and the Government took a series of policies to reinforce earlier measures. Some policies were aimed at restoring confidence among economic agents both in the financial and non-financial sectors, overcoming the liquidity tightness in the banking system and strengthening economic growth momentum. Other policies were also implemented to mantain financial system resilience and monetary stability, in order to support sustainable economic growth. The various policies undertaken in 2009 were a continuation of the series of policies implemented by Bank Indonesia and the Government in the fourth quarter of In response to instability in the financial market, the Government issued three new Government Regulations in Lieu of Low (PERPPU), namely PERPPU No. 1 of 2008 concerning Amendment to the BI Law, permitting credit rated with current collectibility to be used as collateral for the Short-Term Funding Facility (FPJP), PERPPU No. 3 of 2008 concerning Amendment to the Indonesian Deposit Insurance Corporation (LPS) Law, setting forth the basis for increasing the LPS customer deposit guarantee ceiling from Rp 100 million to Rp 2 billion, and PERPPU NO. 4 of 2008 concerning the Indonesian Financial Safety Net (IFSN), used among others to provide settlement guarantee if a bank or non-bank financial institution (NBFI) experiences liquidity difficulties 2 A full description of the policies adopted by Bank Indonesia and the Government in Q4/2008 is presented in Indonesian Economic Report CHAPTER I The Indonesian Economy in 2009

13 or is declared a systemically important failed bank or NBFI. PERPPU No. 4 of 2008 also stipulates the establishment of the Financial System Stability Committee (FSC) comprising the Minister of Finance, Governor of Bank Indonesia and the FSC secretary. Besides these policies, Bank Indonesia announced some improvements to existing regulations in the fourth quarter of 2009, including updating regulation concerning Short-Term Funding Facility (FPJP) which subsequently revised as the Emergency Liquidity Assistance (ELA), extending the FX swap tenor, issuing regulation limiting currency speculation against the rupiah and a prohibiting transaction on structured product derivatives linked to foreign exchange transactions. g Monetary Policy Response Bank Indonesia maintained easing monetary policy stance during With minimum inflationary pressure, Bank Indonesia saw the necessity to boost the domestic economy while ensuring financial system stability. The inclusion of financial system stability in these monetary policy formulation has a strategic importance, because Bank Indonesia observed for continuation instability in the financial system may trigger further pressure on macroeconomic stability and potentially disrupt the economy. This policy direction and strategy is consistent with the implementation of the ITF in striking the optimal balance between achievement of the inflation target and economic growth over the last 5 years. With this monetary policy direction, Bank Indonesia lowered the BI Rate in 2009 in different magnitudes, divided into three phases, based on a comprehensive assessment on the current state and the outlook of the economy. During the first phase in January-March 2009, the BI Rate was cut by 50 bps each month to 7.75% (Chart 1.10). The bold response in the BI Rate cuts was taken by considering the remain considerable pressure still linger the financial system and the continuing slowdown in economic growth. Against this, future inflationary pressures were estimated to be benign. In the second phase of April-August 2009, BI Rate cuts were done in lower magnitude of 25 bps per month, bringing the rate to 6.50% in August This policy course was taken after considering waning pressures on the financial system and contained inflationary pressure, while economic growth was quite mild. In the third phase from September to December 2009, the BI Rate was held steady at 6.50%. With financial system stability firmly in hand, the 6.50% level of the BI Rate was adequately consistent with the inflation target for , while allowing room for measures to boost economic growth. During 2009, the BI Rate was slashed 275 bps from the December 2008 level of 9.25%. Bank Indonesia also implemented some operational policies on the foreign exchange and rupiah money markets to strengthen monetary policy effectiveness. The objective of these polices is to provide assurance for short-term liquidity in money market while simultaneously optimising bank liquidity management. On the foreign exchange market, Bank Indonesia pursued an exchange rate stabilisation policy to mitigate the impact of the global liquidity crisis on domestic foreign exchange liquidity. This policy was undertaken in a measured action, while maintaining an adequate foreign exchange reserves (Chart 1.10). The policy was adopted amid continued heavy pressure on the rupiah, particularly during the first quarter of 2009, due to the mounting capital outflows from the financial market. Bank Indonesia also adopted another policy on 30 January 2009 to ensure adequate liquidity on the forex market by launching foreign currency repurchase agreements (repo) using the Government Global Bonds as its underlying instruments in these transactions. 3 This policy enables domestic banks to repo their Global Bonds to Bank Indonesia in order to obtain foreign currency liquidity. To provide greater asuransse of adequate foreign exchange liquidity, Bank Indonesia also strengthened bilateral and multilateral cooperation with regional central in the form of currency swap agreements. In March 2009, 3 Bank Indonesia Regulation No. 11/4/2009 concerning Bank USD Repurchase Agreements with Bank Indonesia dated 30 January billions of USD I II III IV I II III IV I II III IV I II III IV International Reserves BI Rate (rhs) Chart 1.10 BI Rate and International Reserves percent The Indonesian Economy in 2009 CHAPTER I 11

14 Bank Indonesia and the People s Bank of China concluded a Bilateral Currency Swap Arrangement (BSCA). This arrangement provides for a rupiah/renmimbi swap line valued at Rp 175 trillion/rm 100 billion and get to be effective for 3 years. This arrangement can be extended by mutual agreement. 4 This agreement is not only expected to ensure short-term liquidity, but also support trade and investment between the two countries. Bilateral agreement was also established between Bank Indonesia and Bank of Japan, acting on behalf of the Minister of Finance, by the signing of amendment to increase the value of the BSA concluded under the Chiang Mai Initiative as part of the financial cooperation among ASEAN+3 member countries in April The amendment permits 4 This cooperation exists outside the Bilateral Swap Arrangements under the Chiang Mai Initiative framework. Indonesia to swap rupiah against USD to a maximum of 12 billion US dollars, higher than the previously agreed 6 billion US dollars. In a further cooperation under a multilateral arrangement, Indonesia also signed the CMIM agreement with other ASEAN+3 members in December Under the CMIM cooperation framework, Indonesia has a borrowing quota of billion US dollars. On the rupiah money market, Bank Indonesia also implemented various measures to safeguard money market stability. Within this context, Bank Indonesia opened repo windows for 1 and 3 month tenors to provide a guarantee and temporary cushion for banking liquidity, from mid-april 2009 to September This strategy complements existing measures such as standing facilities, comprising standing deposit facilities and standing lending facilities. In addition to these policies, Bank Indonesia Table 1.2 Additional of Fiscal Stimulus Stimulus Allocation (trillion rupiah) I. Increasing Purchasing Power A. Tax 2.50 B. Subsidy on Expenditure Tax Subsidy (DTP) Non Tax Subsidy 0.35 II. Improving Business and Exports Competitiveness and Resiliancy A. Tax B. Subsidy on Expenditure Tax Subsidy (DTP) Non Tax Subsidy 4.17 C. Financing 0.50 III.Improving Labor Intensive Infrastructure A. Institutional Expenditure Public work Transportation Energy Public housing Market Farming Training for Labor Special Housing Health 0.15 B. Non Institutional Expenditure 0.72 Total Stimulus 73.3 Source : Ministry of Finance 12 CHAPTER I The Indonesian Economy in 2009

15 was maintaining economic liquidity while simultaneously reinforcing the banking liquidity structure of the banking system with a 2.5% additional secondary statutory reserve requirement effective from October g Fiscal Policy Response Fiscal policy in 2009 focused on delivering a stimulus to the economy during the period of the global economic downturn, while simultaneously maintaining the fiscal sustainability. The fiscal stimulus package approved by the Indonesian Parliament was launched with three key objectives: (i) maintain and/or boost public purchasing power, (ii) bolster corporate/business sector resilience in coping with the global crisis and (iii) create jobs and mitigate the impact of worker lay-offs through labourintensive infrastructure development policies. This additional stimulus totalled Rp 73.3 trillion was packaged into tax savings and tax subsidies for business and the infrastructure package (Table 1.2). This stimulus raised the deficit in the Revised 2009 Budget to 2.4% of GDP from the originally targeted 2009 Budget deficit at 1% of GDP (Table 1.3). The additional fiscal stimulus in the Revised 2009 Budget increased the previously planned stimulus. In the 2009 Budget, the scope of stimulus actions also extended to personnel expenditures and subsidies. Related to personnel expenditures, basic salaries were raised by an average of 15% and a 13th month salary was paid for civil servants and members of the armed forces and police. Subsidies were also allocated for fuel, electricity, fertilisers and foodstuffs. Under the food subsidy policy, the Government provided subsidised rice for the poor, covering 18.5 million target households. Each target household received an average of 15 kg rice each month sold at Rp 1,600/kg for 12 months. The realization of the 2009 budget (APBN-P2009) turned to be lower than the target deficit. The 2009 Budget deficit came to Rp 87.2 trillion or 1.6% of GDP, below the earlier target set at 2.4% (Table 1.3). Even so, the adjusted budget adequately supported the original programmes and objectives. This was possible because the lower deficit was resulted from differences in the assumptions used. For example, savings were achieved on the fuel subsidy, which came 14% below target due to the lower than predicted of Mid Oil Platts Singapore (MOPS) price. Added to this was 14.4% saving on debt interest payments as a result of appreciation in the rupiah beyond the assumed percent Source: Ministry of Finance Foreign Debt Government Security Total Chart 1.11 Public Debt to GDP Ratio level and draw down on foreign borrowings below the budgeted target. 47 The financing strategy for the 2009 budget deficit also sought to avoid pressure on the fiscal sustainability. This financing strategy involved the prioritising of domestic market issuances of government securities, implementation of a front loading strategy, utilizing foreign currency government securities as a supplementary instrument and activating of the buyback and debt switching. Under the buyback strategy, the Government bought government securities twice for total Rp 8.52 trillion. Debt switching was carried out by holding six debt switching auction of government securities accounted Rp 2.93 trillion. The debt switching strategy was implemented to extend debt maturity and reduce refinancing risk. This strategy has kept the official debt burden in comparison to the capacity of the economy on a downward trend, reflected in the decrease the official debt to GDP ratio from 33% in 2008 to 29% at the end of 2009 (Chart 1.11). The financing strategy was also supported by the approximately Rp 38.1 trillion financing surplus in the 2009 budget outcome, which can be used as source of future financing (Table 1.3). In addition to the expansionary fiscal policy implemented in the stimulus, the Government also lowered prices for subsidised gasoline and automotive diesel fuels on 15 January Premium gasoline was reduced 18.2% from Rp 5,500/litre in December 2008 to Rp 4,500/litre and automotive diesel by 6.25% from Rp 4,800/litre in December 2008 to Rp 4,500. The decision to reduce prices for subsidised fuels was done after earlier price cuts announced in December 2008 in response to the The Indonesian Economy in 2009 CHAPTER I 13

16 Table 1.3 State Budget trillions rupiah Items 2008* Budget (Law No.41/2008) Revised Budget Realization % Budget-r A. Government Revenues and Grants I. Tax Revenues Domestic Taxes International Trade Taxes II. Non-Tax Revenues National Resources Revenues Profit Transfer from SOEs Bank Indonesia Surplus Other Non-Tax Revenues III. Grants B. Government Expenditures I. Central Government Expenditures II. Regional Expenditures C. Primary Balance Budget Surplus/Deficit Surplus/Deficit (percent of GDP) Financing I. Domestic Financing Banks Non-Banks II. Foreign Financing (nett) Surplus/Deficit of Financing * Based on Central Government Financial Report Source : Ministry of Finance downward trend in world oil prices that commenced during the second half of g Banking Policy Response Bank Indonesia policy for the banking system focused on building the resilience of the banking industry through further actions to strengthen the banking intermediation function. In early 2009, a policy framework to resolve the liquidity crunch in the banking system was established under the second amendment to Act No. 23 of 1999 concerning Bank Indonesia in Act No. 6 of This law sets forth the legal basis for Bank Indonesia to extend credit or financing to banks with short-term funding difficulties and to extend the emergency liquidity assistance (ELA) to systemically effected banks. To promote banking intermediation, Bank Indonesia also lowered the risk weighted assets for credit to micro, small and medium enterprises (MSMEs). Other policies also pursued by Bank Indonesia to bolster resilience in the banking system include implementation of risk management and prudential principles in activities related to structured products. In regard to risk management, Bank Indonesia introduced a policy to include of operational risk as one factor in the capital adequacy calculation. 5 Another regulation on bank risk management, was also issued, especially the one that prioritising customer protection through product and banking activities information transparency. 6 To 5 Circular Letter No. 11/3/DPNP dated 27 January 2009 concerning Calculation of Risk-Weighted Assets for Operational Risk, using the Basic Indicator Approach 6 Bank Indonesia Regulation No. 11/25/PBI/2009 concerning 14 CHAPTER I The Indonesian Economy in 2009

17 compliment regulations related to bank risk management, updated rules have also been introduced for banks conducting mutual fund-related activities. 7 Alongside the issuance of the Bank Indonesia Regulation concerning implementation of risk management, prudential regulations have also been launched for banks conducting business in structured products. 8 A key provision in the Bank Indonesia Regulation pertaining to structured products is the requirement for banks to obtain approval principle from Bank Indonesia before launching a structured product activity. In addition, banks must also implement internal policies and procedures to support the prudential principles when launching these structured products. Besides these two major policies, changes were also made to the institutional regulation of the banking system in response to the rapid pace of change and growing integration of the banking industry. 9 Banking policies were also supported by policy actions in the payment system aimed at strengthening the reliability of the payment system infrastructure. Among these was the continuation of development of the BI-RTGS system and Bank Indonesia Scriptless Securities Settlement System (BI-SSSS) commenced in The more reliable, secure and efficient infrastructure and increased capacity is expected to mitigate risks in the BI-RTGS system and support financial system resilience. Implementation of Risk Management for Commercial Banks 7 Circular Letter No. 11/36/DPNP dated 31 December 2009 concerning Implementation of Risk Management at Banks Conducting Mutual Fund-Related Activities. 8 Bank Indonesia Regulation No. 11/26/PBI/2009 concerning Prudential Principles for Structured Products Activities Conducted by Commercial Banks 9 Bank Indonesia Regulation No. 11/1/PBI/2009 concerning Commercial Banks g Sectoral Policy Response The Government also introduced a range of sectoral policies to strengthen the resilience of the real sector in the economy. In the mining sector, the Government announced major changes to the regulation on mining production and licensing with greater consideration to geographical conditions, the carrying capacity of the environment and regional autonomy. 10 In agriculture, the Government issued regulations to assure availability of arable land for food crops and optimum use of fisheries resource potential. 11 To provide more adequate infrastructure, the Government has opened the door for private sector in providing power supply and assigned an expanded role to regional governments in supplying of electrification. 12 In regard to infrastructure financing, the Government set up a state owned company in 2009 specifically to assist the funding of infrastructure projects. Other sectoral policies were also targeted at mitigating impact from the global financial crisis. To protect domestic manufacturing from illegal imports, the Government took action in January 2009 to tighten controls on imported goods. These measures included restrictions on certain imports such as food and beverages, footwear, garments, toys and electronics. Accompanying these policy actions were regulations for improving management of other general imports. The Government also took action to accommodate direct imports of used capital goods by industry actors. 10 Act No. 4 of 2009 concerning Mining of Minerals and Coal 11 Act No. 41 of 2009 concerning Sustainable Protection of Land for Food Crop Cultivation 12 Act No. 30 of 2009 concerning Electricity The Indonesian Economy in 2009 CHAPTER I 15

18 Performance of the Domestic Economy 1.3 Pressures on the global economy had inevitably impacted Indonesia s economic performance in 2009 especially during Q1/2009. As an open economy, Indonesia felt the blow of the global economic downturn through a twofold transmission, the financial channel and trade channel. Through the financial channel, the lingering global financial market turbulence had kept risks in the domestic financial market and investment in Indonesia to remain high in Q1/2009. Heightened risk perceptions were evident from various financial market risk indicators for Indonesia such as CDS, the EMBIG spread and the yield spread for Indonesia Global Bond over US T-Notes. In Q1/2009, the CDS spread reached a high level of 713, well above the normal level of about 200. Similarly, the yield spread for Indonesia Global Bond over US T-Notes remained wide reaching 8.9% compared to the 3% precrisis average (Chart 1.12). The heightened perceptions of risk in turn prolonged the wave of short-term capital outflows with pressure bearing down on domestic financial system stability during Q1/2009. Impact from the trade channel was evident in the sizeable contraction in exports of goods and services, which slowed the overall growth of the economy. The various policy responses launched by Bank Indonesia and the Government, including the policies of Q4/2008, contributed positively to the restoration of financial system stability from Q2/2009 and paved the way for renewed impetus in economic activity. Contributing to the ongoing financial system stability were the diminishing uncertainties in the global economy. Both factors had a role in lowering risk in the financial sector, as reflected 16 CHAPTER I The Indonesian Economy in 2009

19 percent Higher Risk bps global financial market turmoil was similarly constrained. Another factor bolstering the resilience of the banking system was the positive effect of the many actions for reinforcement and consolidation of the banking system in the aftermath of the crisis g Balance of Payments Source: Bloomberg Yield Spread Global Bond RI vs US T-Note CDS of Indonesia (rhs) EMBIG Spread Chart 1.12 Risk Perception Indicators in the sharp drop in CDS to 160 and the narrowing of the yield spread for Indonesia Global Bonds over US T-Notes to the 1.7% level (Chart 1.12). In response, positive capital inflows resumed into the domestic financial market and the financial system began regaining ground. The improvement in financial system stability then set the stage for renewed confidence among economic actors in the real sector and provided a fresh boost to economic growth. The slide in financial sector performance and economic growth amid the turmoil in the global economy was also mitigated through the positive contribution of a number of domestic 13 factors that operated as an effective buffer absorbing the impact of the global economic downturn. The first domestic factor was related to the sizeable role of household consumption, which kept the Indonesian economy from becoming overly susceptible to global economic contraction. Healthy corporate balance sheets reflected in low levels of leverage and relatively strong cash flow also provided the economy with an extra measure of resilience to financial market shocks, such as exchange rate volatility. The second domestic factor was related to the characteristics of Indonesian banks and financial institutions, which still leaned towards a conventional stance of minimum exposure to problematic foreign securities. As a result, the direct impact of the 13 The effect of domestic factors in restraining the global economic turmoil was in line with the argument from Berkmen et. al (2009). By using cross-country data, the study of Berkmen et. al (2009) showed that domestic factors affected the differences in economic growth across countries during the period of global economy turmoil. Complete analysis of this matter can be seen in Berkmen P., Gelos, Rennhack, and Walsh (2009), The global Financial Crisis: Explaining Cross-Country Differences in the Output Impact, IMF Working Paper 280, December The strong impact of the global economic turmoil on the domestic economy was initially reflected in the current account and the capital and financial account. In 2009, the current account recorded a 10.6 billion US dollar surplus, up considerably from 126 million US dollars in 2008 (Table 1.4). The increased current account surplus resulted from strong exports, which despite contraction from reduced global growth did not diminish to the same extent as imports. A key factor in the export performance was demand for resource-based and particularly mining products, which maintained positive growth during the period of global economic contraction. Exports were also bolstered by demand for manufactured goods near the end of 2009 in response to the mounting pace of economic recovery in advanced economies led by the US and Japan. During this time, imports slowed significantly in response primarily to falling domestic demand as the impact of flagging domestic economic growth took hold. Imports also contracted from reduced demand for raw materials for export-oriented manufactured goods, which normally have high imported content. For the year as a whole, the capital and financial account posted a 3.7 billion US dollar surplus despite coming under considerable pressure from heavy private capital outflows during Q1/2009 (Table 1.4). The positive outcome in the capital and financial account was partly explained by Bank Indonesia and Government policies in restoring the market confidence that subsequently encouraged renewed inflows of short-term capital beginning in Q2/2009. Merchandise exports plunged in 2009 in line with the powerful effects of global economic contraction. In 2009, these exports totalled billion US dollar, or a negative growth of 14.4% compared to Growth turned negative for both oil and natural gas exports and non-oil and gas exports. Oil and natural gas exports underwent a 35.5% contraction from the 2008 levels to 20.5 billion US dollars. The dominant factor driving down oil and natural gas exports was falling world oil prices. Calculated by the index for Indonesia s oil exports, oil was down by 34%. Meanwhile, total non-oil and gas exports in 2009 slipped to 99.1 billion US dollars, The Indonesian Economy in 2009 CHAPTER I 17

20 Table 1.4 Balance of Payment millions USD 2009* ITEMS 2008 Q I Q II Q III Q IV TOTAL I. CURRENT ACCOUNT 126 2,509 2,481 2,150 3,442 10,582 A. Trade balance 22,916 6,886 8,367 8,491 11,454 35,197 - Export, fob. 139,606 24,179 28,130 31,273 35, ,513 - Import fob. -116,690-17,293-19,763-22,781-24,478-84, Non Oil and Gas, nett 15,130 5,335 6,436 6,647 8,442 26, Export, fob. 107,885 20,530 23,751 25,603 29,178 99, Import, fob. -92,755-15,196-17,315-18,956-20,736-72, Oil, nett -8, , Export, fob. 15,387 1,781 2,366 2,922 3,556 10, Import, fob. -23,749-1,974-2,338-3,741-3,635-11, Gas, nett 16,147 1,744 1,903 2,663 3,091 9, Export, fob. 16,333 1,867 2,013 2,748 3,198 9, Import, fob B. Services, nett -12,998-2,743-3,310-3,517-4,585-14,155 C. Income, nett -15,155-2,742-3,776-4,072-4,742-15,331 D. Current Transfer, nett 5,364 1,109 1,200 1,247 1,315 4,871 II. CAPITAL and FINANCIAL TRANSACTION -1,876 1,502-1,757 2,523 1,405 3,673 A. CAPITAL TRANSACTION B. FINANCIAL TRANSACTION -2,170 1,483-1,785 2,489 1,390 3, Direct Investment 3, , Portfolio Investment 1,721 1,859 1,959 2,988 3,298 10, Other Investment -7, , ,896-8,838 III. TOTAL (I+II) -1,750 4, ,673 4,847 14,255 IV. ERRORS and OMISSIONS , ,749 V. OVERALL BALANCE (III+IV) -1,945 3,955 1,052 3,546 3,954 12,506 VI. International Reserves and Other Related Item (A+B+C) 1,945-3,955-1,052-3,546-3,954-12,506 Notes: * Provisional Figures International Reserves Position 51,639 54,840 57,576 62,287 66,105 66,105 (Equivalent to Imports and Servicing of Official External Debt) Current Account/GDP (%) CHAPTER I The Indonesian Economy in 2009

21 index (2006=100) I II III IV I II III IV I II III IV Non-Oil Oil & Gas Total IHKEI Growth (yoy) Non-Oil & Gas Agriculture Mining Manufacturing Oil & Gas Total Chart 1.13 Indonesian Exports Price Index representing a negative 8.2% growth compared to The downturn in non-oil and gas exports resulted not only from the contraction in global economic activity, but also falling prices for Indonesia s non-oil and gas export commodities. The developments of 2009 point to downward price movement for a wide range of Indonesian non-oil exports, with the steepest drop recorded for agricultural commodities at 24% (Chart 1.13). Falling prices for agricultural commodities in turn caused export revenues in the agriculture sector to contract by 6.6%. The contraction in exports was offset somewhat by the still robust demand for resource-based exports. During 2009, the mining sector charted positive 45.0% growth, partly on the back of coal exports that mounted by 33.6% (Table 1.5). Based on the quarterly movement, the steepest decline in Indonesian exports took place in Q1 and Q2/2009. Oil and natural gas exports in the two periods came to only 3.6 billion US dollars and 4.4 billion US dollars, respectively, with an average growth of negative 54% (yoy) (Table 1.4). The dramatic contraction in oil and natural gas exports during these periods was explained by world oil prices that plunged to a low of 39.0 US dollars per barrel. Alongside this, non-oil and gas exports also contracted by 22.2% in Q1/2009 due to the global economic slowdown and low commodity prices. Exports began regaining momentum in Q2/2009 in response to improving conditions in the global economy although annual growth remained negative. Driving this improvement was the onset of significantly rising global demand led by China and non-japan Asia, in addition to the continued downward trend in the US dollar. In addition, price gains for some of Indonesia s primary commodities, beginning in Q2/2009, provided significant lift that brought improvement in export performance until the end of 2009 (Chart 1.13). Strengthening world demand enabled Indonesia s non-oil and gas exports to resume positive growth in Q4/2009 at 17.6% (yoy). However, imports contracted sharply due to tumbling domestic demand. In 2009, merchandise imports reached 84.3 billion US dollars with a negative growth of 27.7%, a markedly steeper drop compared to the 14.4% contraction in merchandise exports. Imports contracted in both the oil and natural gas sector and the non-oil and gas products. Oil and gas imports reached 12.1 billion US dollars, tumbling 49.4% from levels reached in 2008 (Table 1.4). The drop in oil and gas imports resulted not only from falling world oil prices and flagging domestic demand, but also the positive impact of the government-sponsored kerosene to gas conversion programme. Similarly, non-oil and gas imports (f.o.b.) reached 72.2 billion US dollars, down 22.2% from 2008 (Table 1.4). The sharp drop in non-oil and gas imports during 2009 produced a widening in the growth differential between non-oil and gas exports and non-oil and gas imports to pre-2008 levels (Chart 1.14). The correction in merchandise import growth to pre-2008 levels was strongly influenced by the steep drop in imports of consumer goods and raw materials. In 2009, consumer goods and raw material imports contracted 32.0% and 27.4%, respectively, while the value of imported capital goods (c&f) eased only 1% from 2008 to 20.6 billion US dollars (Table 1.6). Table 1.5 Value of Non Oil and Gas Export by Sector FoB, millions USD Items * Provisional Figures Value Share (%) * Growth % (yoy) Value Share (%) Total Export 107, , I. Agriculture 4, , II. Mining 13, , Growth % (yoy) III. Manufacturing 89, , The Indonesian Economy in 2009 CHAPTER I 19