Monetary Policy
Title Monetary Policy Report Q4 2010
Data Source

Directorate of Economic Research and Monetary Policy

Date10-12-2010 Hits1499
Contact 2310108 ext. 8163
Attachment MPR Q4 2010 (5616 Kbytes)

1. General Review
In 2010, the Indonesian economy has charted significantly accelerated growth amid the multispeed global economic recovery.  The domestic economy is forecasted to grow at 6.1% in Q4/2010, bringing overall national economic growth for 2010 to about 6%. Bank Indonesia is optimistic for even stronger recovery in 2011 and 2012, supported by rising domestic demand and further improvement in investment performance. Indonesia’s growth forecast for 2011 lies in the range of 6.0%-6.5% and for 2012 at 6.1%-6.6%.

Bank Indonesia notes the steady progress in the process of global economic recovery during 2010 despite a slowing trend that set in early in the second half of the year and varying rates of recovery in different regions of the world. The stronger recovery in emerging market economies compared to the developed world has been bolstered by solid domestic consumption and improving external performance. However, improvement in developed economies during the first half of 2010 was followed by slumping growth in the second half as the effect of the 2009 fiscal stimulus faded. Economic growth in developed nations is also daunted by the fiscal crisis in some European countries and high unemployment in the US.  This multispeed growth in economies has led to differences in monetary policy responses.  Central banks in advanced economies have leaned towards keeping accommodative policies in place, which has resulted in expansion in global liquidity. However, central banks in emerging market countries have normalised policies to curb rising inflationary pressure as economic recovery gained momentum. This has led to currency appreciation in some emerging market countries, including Indonesia, which have then responded with a combination of policy instruments. 

Global financial markets underwent a rebound after decisions by advanced nations to maintain an accommodative monetary policy stance.  Global investor risk appetite has been dampened by the fiscal crisis in the European PIIGS nations (Portugal, Ireland, Italy, Greece and Spain).  This has prompted investors to transfer assets perceived at risk, including assets in emerging market countries, thus putting pressure on global financial markets.  Despite this, pressure on financial markets began to ease and a gradual recovery followed during the second half of 2010. The monetary policy signalled by advanced economies keeping interest rates low alongside monetary stimulus packages prompted a rally on global stock markets together with emerging markets.

The dynamics in the global economy during 2010 have influenced developments in the Indonesian economy. The ongoing global economic recovery led by emerging markets and economic stability has had a positive effect in accelerating domestic growth.  The macroeconomic policies put into place have contributed to maintaining internal and external equilibrium in the Indonesian economy, now an important factor in building sustained economic growth. This year, growth in the domestic economy has been supported by greater equilibrium in sources of growth, reflected in buoyant consumption alongside high export demand and improvement in investment. The rising consumption has been driven primarily by household consumption, while government consumption remains more limited due to limited absorption of budget expenditures. Export performance has improved in 2010, with support from growing external demand in keeping with the recovery in the global economy and particularly Asia. Rising export performance has also benefited from escalating global commodity prices. Investment performance has also showed steady improvement, bolstered by strengthening market perceptions, increased financing, low prices for imported goods and launching of government policies in support of investment.

On the supply side, performance has improved in the non-tradable and tradable sectors during 2010.  Growth in tradable sectors has been driven mainly by the recovery in manufacturing, which has bounced back growth on par with levels preceding the global financial crisis at about 4%. However, the gains in manufacturing have not been matched by other tradable sectors. The agriculture sector is growing at a slower pace as a result of declining productivity and loss of land under cultivation compounded by anomalies in weather conditions. Similarly, the mining sector has also experienced disruption from adverse weather. In non-tradable sectors, the main engines of growth are the trade, hotels and restaurants sector and the transport and communications sector. However, performance in other non-tradable sectors has declined. 

In regard to prices, inflationary pressure in 2010 has been marked by an upward trend driven mainly by volatile foods. The high inflationary pressure from volatile foods is explained by anomalies in weather patterns that have disrupted crop production and distribution. Inflationary pressure also mounted in the administered prices category, albeit on a limited scale. The July hike in electricity billing rates did not produce any significant rise in commodity prices. Core inflationary pressure has climbed, although remains subdued due to the appreciating value of the rupiah. This rise in inflation has its origin in the upward trend in global market commodity prices. At the same time, inflation expectations surged in response to hikes in food prices. Taken together, CPI inflation in November 2010 reached 6.33% (yoy) or 5.98% (ytd), while core inflation came to 4.31% (yoy) or 3.89% (ytd).

The steady improvement in Indonesia's economic recovery during 2010 is also confirmed by the regional economic assessments conducted by Bank Indonesia. Across most regional economies, accelerating performance was driven by vibrant consumption, exports and investment. The Sumatra, Sulawesi, Kalimantan and Papua regions are expected to chart higher growth from improved performance in estate production as prices continue to rise. However, performance constraints on the mining operations spread across this region are expected to persist due to the anomalous weather conditions and technical problems with production.  The Jakarta, Java, Bali, Nusa Tenggara and Kalimantan regions are forecasted to maintain brisk growth on the back of performance in the manufacturing and construction sectors. The high-growth regions for construction investment were Jakarta and the Java, Bali and Nusa Tenggara region. 

In the balance of payments, vigorous export growth and heavy capital inflows for FDI and portfolio investment have contributed to an increased surplus. The ongoing global economic recovery, led by emerging market nations, has kept export growth at buoyant levels. Rising global commodity prices have also provided a boost to Indonesian exports, with resource-based commodities claiming an expanding share.  On the other hand, domestic economic expansion and exchange rate appreciation have boosted imports. Furthermore, the multispeed pace of global economic recovery has prompted a sizeable increase in foreign capital inflows.  The overall balance of payments has recorded an increased surplus in 2010 compared to past years. With these developments in the balance of payments, Indonesia's international reserves reached USD 92.759 billion at the end of November 2010, equivalent to 6.96 months of imports and servicing of official external debt.

The rupiah exchange rate has undergone significant appreciation in 2010. Rupiah gains have been bolstered by solid fundamentals, reflected in the significant surplus in the current account. Besides this, the appreciation in the rupiah rush of capital inflows are related to the abundance of global liquidity, strong expectations of continued low interest rates in developed nations and the launching of Quantitative Easing II by the Fed.  Also contributing to the surge in capital inflows are modest perceptions of risk and positive sentiment bolstered by macro and financial system stability, high economic growth and prudent fiscal sustainability. Supported by these conditions, the rupiah has appreciated in average value 3.7% (ytd) in 2010, or 4.3% (ptp) over 2009. Accompanying this appreciation is a drop in volatility to 0.4% from the previous 0.9%.

The domestic financial market has charted steady gains in 2010 in keeping with the accelerating pace of economic developments. Monetary policy transmission has also improved as reflected in the downward response in money market rates and bank interest rates as well as rising credit expansion.  On the bond market, monetary policy transmission is reflected in narrowing yield on government securities in all tenors.  Stock prices have also soared, taking the JCI to an all-time high of 3,756.9. 

Looking forward, the domestic economy is set for further improvement. Accelerated economic activity in 2011 is expected to take growth to 6.0%-6.5%. Further ahead, economic growth in 2012 is forecasted at 6.1%-6.6%. Supporting this growth will be the continued strength of household consumption, improving investment and solid export performance on the back of the sustained robust growth in trading partner nations, led by Asia. In regard to prices, Bank Indonesia predicts that inflation in 2011 can be managed in line with the inflation target, set at 5%±1% for 2011 and 4.5%±1% for 2012. However, it is also necessary to keep a watch on various risks to achievement of the inflation target and the macroeconomic outlook, such as the heightened uncertainty over global economic recovery, mounting international commodity prices and the flood of capital inflows that could trigger a currency war. At home, these risks are related party to the burgeoning excess liquidity in the financial sector and the possibility of disruption to the production and distribution of staple needs. In this regard, Bank Indonesia will emphasise the application of a mix of monetary and macroprudential policies while strengthening coordination with the government. The measures being readied by Bank Indonesia to mitigate the negative impact of capital inflows while strengthening banking system resilience are related in part to regulation of foreign currency statutory reserves and vostro accounts (rupiah demand deposit accounts held by non-residents in domestic banks).

On 3 December 2010, the Bank Indonesia Board of Governors Meeting decided to hold the BI Rate at 6.5% with an interest rate corridor at ±100 bps.  Key to this decision was the consideration that the 6.5% BI Rate level remains consistent with achievement of the medium-term inflation target and is regarded conducive to safeguarding financial stability and promoting bank intermediation. An evaluation of the overall performance and outlook for the economy points to improvement. Economic growth is forecasted to climb further in 2011 and 2012 with greater equilibrium in sources of growth.

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