BANK INDONESIA’S ANNUAL MEETING 2017 - bi.go.id · PDF fileLeaders of state institutions: MPR, DPR, DPD, BPK, ... Primary Industry Secondary Industry Tertiary Industry GDP Chart

STRENGTHENINGTHE MOMENTUM

GOVERNOR’S ADDRESS

BANK INDONESIA’SANNUAL MEETING

2017Jakarta, November 28th 2017

Contents

Opening Remarks ................................................................................................................... 1

Introduction ............................................................................................................................... 2

Global Economic Condition ............................................................................................... 3

Domestic Economic Condition .......................................................................................... 5

Economic Challenges ........................................................................................................... 11

Principles of Public Policy and Key Element of Economic Growth ........................ 18

Bank Indonesia’s Policy Direction ..................................................................................... 23

Policy Coordination ............................................................................................................... 32

Economic Outlook ................................................................................................................. 33

Closing Remarks ...................................................................................................................... 35

1

Strengthening the Momentum

Agus D.W. MartowardojoGovernor of Bank Indonesia

Governor’s AddressBank Indonesia Annual Meeting of 2017

Jakarta, 28th November 2017

His Excellency, ● The President of the Republic of Indonesia, Mr. Joko Widodo

Distinguished Guests,● Leaders of state institutions: MPR, DPR, DPD, BPK, Supreme Court, Constitutional Court, and Judicial Commission;● Cabinet Ministers and Leaders of Government Institutions;● Chief of the Indonesian National Police, Attorney General and Chairman of KPK;● Chairman, Deputy Chairman and Board of Commissioners of OJK;● Chairman and Board of Commissioners of LPS;● Chairman, Deputy Chairman and Members of Commission XI of DPR;● Provincial Governors from throughout Indonesia;● Former Governors of Bank Indonesia;● Members of the Board of Governors of Bank Indonesia;● Leaders of the Banking Industry and Nonbank Corporations;● Academicians, Economists, and Leaders of National Media;● Ladies and Gentlemen.

Assalamu’alaikum Warahmatullahi Wabarakatuh, Greetings to all,Om Swastiastu,Namo Buddhaya.

Praise be to Allah, God Almighty, for all blessing so that we can gather together here this evening, in good health, at the 2017 Annual Meeting of Bank Indonesia.

I extend my sincerest thanks to the President of the Republic of Indonesia, Mr. Joko Widodo, and to all guests, for coming to this event. Your presence here this evening demonstrates our keen desire to move in unity to build Indonesia into a strong, just and prosperous economy.

The current economic recovery momentum represents early stages in our transforma-tion to achieve strong, sustainable, balanced and inclusive economic growth. The complexity of the onerous challenges calls for a synergy of e�orts to maintain policy sustainability at each stage of development to achieve our noble goals.

I take this opportunity to deliver Bank Indonesia’s perspectives on the latest economic developments, the challenges faced and the outlook moving forward, as well as the policy direction, summarized in the presentation with the theme of Strengthening the Momentum, which is particularly relevant to provide guidance for Indonesia’s economy going forward.

2

STRENGTHENING THE MOMENTUMBank Indonesia Annual Meeting of 2017

Global Economic Condition

The 2017 has been the year of global economic recovery. We have witnessed the emergence of global economic reco-very momentum after its weakest point in 2016. Global economic growth has not only higher than the previous year but also become more broad-based. Furthermore, the global economic growth have been accompanied by rising international commodity prices and gradual monetary policy tightening in some advanced countries which have been well anticipated by the market, therefore reinforced global �nancial market stability this year.

We estimate the global economy will grow by 3.6% in 2017, exceeding our projection at the beginning of the year as well as last year’s growth realisation (Table 1). Furthermore, we expect to see more broad-based sources of global economic growth, with emerging countries also contributing as the engines of growth along with the advanced countries. Development in advanced countries during the �rst three quarters of 2017 con�rmed continued recovery in the US economy on the back of solid labour conditions and investment. In Euro Area

and Japan, indicators also points toward recovery in the economy.

Emerging countries have also achieved stronger economic growth in 2017. China, the world’s second largest economy and important trading partner of Indonesia, avoided the risk of slower growth through gradual economic rebalancing, which focus in domestic demand as an engine of growth. That strategy was combined with other policies to overcome �nancial sector vulnerabilities and capital out�ow pressures, amongst others, by relaxing foreign investment regulations and implementing structural policies. China’s policy mix has helped to maintain economic growth this year on par with 2016 at 6.8% (Chart 1).

The solid economic performance in China has bene�tted other developing countries. The main bene�ciaries of growth in China have been commodity-producing countries, such as those in Latin America, where growth was at -1% in 2016 to 1% in 2017. Such developments underscore the importance of China as a key source of global economic growth (Chart 2). Furthermore, the economic gains in China have maintained a solid level of world trade volume (WTV).

3

Global Economic Condition

World

Advanced Economies

Japan

United States

Euro Area

Emerging Economies

China

India

2015

Economic Growth(Percent, yoy)Region

2015 2016 2017*

3.4

1.8

(0.1)

2.4

0.9

4.6

7.3

7.3

3.4

2.1

1.2

2.6

2.0

4.3

6.9

7.9

3.2

1.7

1.0

1.5

1.8

4.3

6.7

7.1

3.6

2.1

1.4

2.2

2.2

4.6

6.8

6.9

Table 1. Global Economic Growth

Source: World Economic Outlook Database.*Bank Indonesia projection.

Primary Industry Secondary Industry Tertiary Industry GDP

Chart 1. China’s Economic Growth

Source: National Bureau of Statistics of China, calculated.

0

1

2

3

4

5

6

7

8

9

I II III IV I II III IV I II III IV I II III IV I II III

2013 2014 2015 2016 2017

Percent, yoy

Against a backdrop of economic recovery in emerging countries, India’s economy has slowed due to it’s speci�c factors relating to various domestic policies and issues.

The global economic recovery have helped pushed international commodity prices in the short run. Continuing the upward trend occurred since the middle of 2016, international commodity prices, such as coal and metals, have trended upwards this year due to higher demand from China. We predict Indonesia’s non-oil and gas export prices to tick upwards by 22% in 2017 (Chart 3). Concerning energy prices, the oil price has increased in line with OPEC and non-OPEC compliance to the oil output cut deal and higher demand for oil as global economic recovery continues.

The monetary authorities in advanced countries have responded cautiously to the stronger global economic perfor-

4


mance. The Federal Reserve is expectedto gradualy normalise US monetary policy by rising the Federal Funds Rate (FFR) three times this year, while also commencing measured balance sheet reductions in October 2017. Canada and UK have also introduced a tighter mone-tary policy stance, while the European Central Bank (ECB) has reduced its monetary stimulus. We believe that an appropriate and transparent communi-cation strategy on the implementation of monetary policy tightening has helped the markets to take anticipatory mea-sures, thereby avoiding excessive shocks on global �nancial markets.

In general, external risks have improved in 2017, thus alleviating the uncertainty in the global �nancial markets. Milder risks have stemmed from stronger global economic recovery momentum and gradual monetary policy tightening implemented in some advanced

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Asia CommodityExporter

SystemicAdvanced

Economies

EastEurope

OtherCountries

Percent

Chart 2. Impact on Exports of Shock to China’sDemand1

Source: IMF, 2016.Note: impact of 1% shock to China’s demand on export of othercountries after one year.

-20

-10

0

10

20

30

40

50

I II III IV I II III IV I II III IV I II III IV*

2014 2015 2016 2017

Indonesia Export Price Index

Average Annual Growth

Percent, yoy

Chart 3. Indonesia Export Price Index

Source: Bank Indonesia.*Projection.

1. Asia = HKG, IDN, KOR, PHL, SGP, THA. Commodity Exporters = AUS, BRA, CHL, COL, RUS, ZAF. East Europe = CZE, EST, HUN, LTU, LVA, POL, SVK, SVN, TUR. Systemic Advanced Economies = DEU, JPN, USA. Other Countries = ARG, AUT, BEL, CAN, CHE, DNK, ESP, FRA, FIN, GBR, GRC, ISR, IRL, ISL, ITA, LUX, MEX, NLD, NOR, NZL, PRT, SWE.

5

Domestic Economic Condition

countries, which was well anticipated bythe markets. The geopolitical risks have eased as elections in some advanced countries have concluded. Nevertheless, we must remain vigilant of rising political tension in the Korean Peninsula. Thus far, we view that international market players have anticipated well the global political constellation, thus avoiding any signi�-cant adverse impacts on the international �nancial market stability.


Indonesia, as an open economy, is obviously dependent on the various external developments. Our latest assessment shows that improving exter-nal conditions have been a boon to the domestic economic recovery.

Domestic economic growth momentum has strengthened in the second half of 2017 after somewhat restrained in the �rst semester. Improvement on export perfor-mance has driven investment in 2017. The Government’s strategy to accelerate spending in the second half of the year, while maintaining good governance and striking an optimal balance between

cyclical and structural polices, has provento boost higher economic growth. We predict the Indonesia’s economy to grow by 5.1% this year, exceeding that achieved in most other emerging countries (Chart 4).

Macroeconomic and �nancial system stability have been maintained in 2017. In�ation has tracked a downward trend to within the target corridor for 2017 at 4.0±1%. In addition, the current account de�cit has been managed at a healthy level. On the �nancial system side, a solid capital, coupled with low credit risk, has enabled the banking industry to maintain stability.

These condition was achieved on the back of consistent implementation of policy mix to stabilise the national economy. We still bear in our mind the economic instability we confronted in 2013, in the form of the hike of in�ation that exceeded the target and a current account de�cit that reached 4.2% of GDP in the second quarter of 2013. Addressing such challenges, we implemented stabili-ty over growth policy in order to stabilise the economy and create a solid founda-tion for sustainable economic growth. We

Chart 4. Comparison of 2017 Economic Growth in Peer Countries

0.7

1.4

6.8 6.9

5.15.4

6.6

0.7

3.7

-

1

2

3

4

5

6

7

8

Brazil Chile China* India* Indonesia* Malaysia Philippines South Africa Thailand

Percent, yoy

Average = 4.1

Source: World Economic Outlook Database, October 2017.*Bank Indonesia projection.

6


translated this strategy by strengthening the policy mix for stabilisation purposes through policy rate adjustments, strengthening monetary operations, rupiah exchange rate stabilisation in line with it’s fundamental value, and close coordination with the Government and other relevant authorities.

Close coordination with the Government, combined with policy consistency over time, has restored economic stability. In�ation has been controlled over the past three years within the target corridor. Despite in�ationary pressures from

administered prices, driven by higher electricity tari�s as part of the Govern-ment’s energy reforms, in�ation in 2017 is predicted at 3.0 – 3.5% (Chart 6). In�ation has been contained by anchored in�ation expectations, stable exchange rates, benign demand-side pressures, lower international food prices and controlled volatile food in�ation. Contained volatile food prices have led to controlable in�ation in nearly all regions in Indonesia (Chart 5). To that end, I extend my utmost appreciation to the Government for its e�orts to manage food in�ation by controlling strategic food prices, impro-

Chart 5. Regional In�ation

Inf > 5.0%

4.0% < Inf < 5.0%

3.0% < Inf < 4.0%

Inf < 3.0%

ACEH3.9

NORTHSUMATERA

3.0

RIAU4.7

JAMBI1.5

SOUTHSUMATERA

3.1

BANGKA BELITUNGISLANDS

3.8

RIAUISLANDS

4.3

WESTKALIMANTAN

4.8

CENTRALKALIMANTAN

4.0

EASTKALIMANTAN

3.5

NORTHKALIMANTAN

2.9

SOUTHKALIMANTAN

3.9

BANTEN4.1

DKIJAKARTA

3.5

WESTJAVA3.8

EASTJAVA4.0

BALI2.8

CENTRALJAVA3.5

DI YOGYAKARTA3.8

BENGKULU2.9

WESTSUMATERA

2.0

LAMPUNG3.5

Note: annual in�ation (yoy), October 2017.Source: BPS-Statistics Indonesia, calculated.

7


ving distribution and reducing logistics costs throughout Indonesia. I also thank Regional In�ation Control Team (TPID) for all their hard work to manage in�ation in their respective jurisdictions.

The ongoing improvement of current account de�cit re�ects a maintained macroeconomic stability. Controlled domestic demand, stable exchange rates and global economic recovery have contributed to current account improve-ment in 2017, which we predict to stay at below 2.0% of GDP. Surplus in the capital and �nancial account remains high,

supported by higher foreign capital in�ows in 2017, supported by solid inves-tor con�dence in Indonesia’s economy and reduced external risks (Chart 7).

Rupiah has been stable amid external pressure since September 2017, triggered by worldwide US dollar appreciation on the back of improvement in US economy. On average, rupiah untill October 2017 depreciated by merely 0.36% accompa-nied by low volatility at just 3.2% (ytd), lower than in its peers countries (Chart 8). This condition has been supported by improving risk perception amongst inves-

WEST NUSA TENGGARA

3.3

SOUTHSULAWESI

3.9

WESTSULAWESI

4.2

CENTRALSULAWESI

4.2

GORONTALO4.5

NORTHSULAWESI

3.3

NORTHMALUKU

2.3

MALUKU2.2

WESTPAPUA

2.4

PAPUA1.6

SOUTHEASTSULAWESI

2.1

EAST NUSATENGGARA

2.8

tors (Chart 9), and Bank Indonesia’s consistency in managing liquidity in the foreign exchage market while also maintaining market mechanism. This consistency has boost co�dence and therefore we saw an increase in foreign exchange supply from domestic corpora-tions.

Rupiah stability also supported by some structural improvement in domestic �nancial market. Bank Indonesia’s e�orts to create deep �nancial market has shown an encouraging result. Transaction volume in the money market and foreign

exchange market rose, followed by improved e�ciency in the transaction price (Chart 10 and 11). Improvement in the �nancial market also buoyed by issuance of regulation on Deposit Certi�cates and Commercial Paper to enhance �nancial instruments as an alternative source of �nancing.

Financial system stability has been maintained despite bank intermediation function that has not fully recovered. The banking industry has maintained solid resilience on the back of adequate capital and liquidity. Nevertheless, the bank

8


Chart 6. CPI In�ation and Target Range

Source: BPS-Statistics Indonesia and Bank Indonesia.*Bank Indonesia projection.

0

2

4

6

8

10

12

14

16

18

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

*

Target Range Actual Mid Value

Percent, yoy

Chart 7. Current Account and Capital and FinancialAccount

-40

-30

-20

-10

0

10

20

30

40

50

2010 2011 2012 2013 2014 2015 2016 2017*

Current Account Direct Investment PortfolioInvestment

Other Investment Overall Balance

Billion USD

Source: Bank Indonesia.*Preliminary �gures.

Chart 8. Rupiah Volatility

Source: Reuters, Bloomberg, calculated.

25.2

16.3

20.7

13.3

6.1 7.1 7.3 6.0

13.7

8.4

18.2 17.2

13.5

8.7

5.0 5.1 4.8 4.7 4.5 3.2

0

5

10

15

20

25

30

ZAR TRY BRL KRW INR PHP SGD THB MYR IDR

2016 ytd October 2017 Average ytd October 2017

Percent

8.5

Chart 9. CBOE Volatility Index (VIX) and IndonesiaCredit Default Swap (CDS)

Source: Bloomberg, calculated.

0

20

40

60

80

100

120

140

02468

1012141618

May Jun Jul Aug Sep Oct

VIX Index CDS (rhs)

2017

IndexIndex

9


intermediation function has not quite fully recovered as expected. Credit in 2017 are expected to grow around 8%, up from the 7.86% posted in 2016 but lower than our projection at the beginning of the year (Chart 12). Sluggish credit growth is not only attributable to weak demand stemming from the corporate sector’s current consolidation strategy, but also supply-side issue as banks remain cautious in chanelling a new credit. Congruent with limited bank intermedia-tion, credit risk in the banking industry showed an upward trend but remains well below the NPL threshold (Chart 13).

Against a backdrop of subdued credit growth, nonbank �nancing has escalated in 2017 (Chart 14). Total (gross) �nancing from the �nancial markets, namely capital market, bond market, and money market, as of October 2017 has reached Rp256 trillion, signi�cantly higher than the Rp177 trillion registered in the same period of 2016. The rapid increase of �nancing from the �nancial markets was associated to expectations on promising domestic economic outlook, coupled with the strong foreign capital in�ows that have lowered government and corporate bond yields (Chart 15). We welcome for such

Chart 10. Indonesia Forex Market Indicators

Source: Bloomberg and Bank Indonesia.

0

5

10

15

20

25

0

1

2

3

4

5

6

2013 2014 2015 2016 2017

Forex Market Average Daily Trading Volume

Bid-Ask Spread USD/IDR (rhs)

Billion USD Rp

Chart 11. Indonesia Rupiah Money Market Indicators

Source: Bank Indonesia, KSEI, and Ministry of Finance.

Rupiah Money Market Average Daily Trading Volume

Rupiah Money Market Outstanding/GDP (rhs)

0,0

0,5

1,0

1,5

2,0

2,5

3,0

0

5

10

15

20

25

30

35

2013 2014 2015 2016 2017

Trillion Rp Percent

Chart 12. Bank Loan Growth

Source: Indonesia Financial Services Authority.

-

5

10

15

20

25

30

35

40

45

1 3 5 7 9 11

2012

1 3 5 7 9 11

2013

1 3 5 7 9 11

2014

1 3 5 7 9 11

2015

1 3 5 7 9 11

2016

1 3 5 7 9

2017

Total Loan

Working Capital Loan

Investment Loan

Consumer Loan

Percent, yoy

Chart 13. Capital Adequacy Ratio and NonPerforming Loan

Source: Indonesia Financial Services Authority.

1.9

2.4

2.9

3.4

3.9

19

20

21

22

23

24

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9

2014 2015 2016 2017

Capital Adequacy Ratio (CAR) NPL (rhs)

Percent Percent

10


developments as it can provide more alternative economic �nancing, enhan-cing overall �nancial system resilience to liquidity shocks and supporting more e�cient interest rates.

As macroeconomic and �nancial system stability improved, Bank Indonesia has been able to adjust its policy mix accor-dingly. Continuing monetary policy easing undertaken since 2016, we have slashed the BI 7-Day (Reverse) Repo Rate by 50

bps this year in response to lower in�ation expectations and projections for 2017 and 2018, coupled with a healthycurrent account de�cit. This BI 7-Day (Reverse) Repo Rate cut complements monetary policy cycle to stabilise the economy that we have pursued since 2013 (Chart 16). Consistent monetary policy, prudent �scal policy and close policy coordination with the Central Government and Regional Administra-tions as well as other relevant authorities

Chart 14. Bank and Non Bank Financing (Flows)

Source: KPEI and Indonesia Financial Services Authority, calculated.Note: year to date �ows data.

Non Bank Financing Bank Loan

-200

-100

0

100

200

300

400

500

600

3 6 9 12

2009

3 6 9 12

2010

3 6 9 12

2011

3 6 9 12

2012

3 6 9 12

2013

3 6 9 12

2014

3 6 9 12

2015

3 6 9 12

2016

3 6 9

2017

Trillion Rp

Chart 15. Corporate Bond Yield

Source: KPEI and Bank Indonesia.

0

2

4

6

8

10

12

14

01/

2016

02/

2016

03/

2016

04

/20

16

05

/20

16

06

/20

16

07/

2016

08

/20

16

09

/20

16

10/2

016

11/2

016

12/2

016

01/

2017

02/

2017

03/

2017

04

/20

17

05

/20

17

06

/20

17

07/

2017

08

/20

17

09

/20

17

Loan Non Financial Corporations

10-Year Government Bonds

Percent

Chart 17. Macroeconomic Stability Indicators

6.4%

99.4

B USD

-3.2% PDB

8.4%

3.5%**

126.5 B USD*

De�cit<2% PDB**

3.2%*

In�ation

ReservedAssets

Current Account Balance

Rupiah Volatility

2013 2017

Source: BPS-Statistics Indonesia and Bank Indonesia.Note: lower scores indicate better macroeconomic stability.

*As of October 2017; **Bank Indonesia projection.

Chart 16. Monetary Policy Cycle

Source: Bank Indonesia.

2

3

4

5

6

7

8

9

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9

2013 2014 2015 2016 2017

BI Rate 12-Month MO Interest Rate

BI 7-Day (Reverse) Repo Rate 1-Week MO Interest Rate

Percent

has evidently enhanced economic stabi-lity and resilience (Chart 17). We believe that such condition represent a solid foundation to strengthen the momentum towards strong, sustainable, balanced and inclusive economic growth.

Our e�orts to maintain macroeconomic stability, supported by increasing policy credibility and a promising economic outlook, have received international recognition. Standard & Poor’s (S&P) upgraded Indonesia’s rating to invest-ment grade (BBB-) with a stable outlook in May 2017 after two other leading rating agencies a�rmed similar rating (Chart 18). This is encouraging especially when our peer countries have had their ratings downgraded this year, including Turkey, Brazil and Azerbaijan. In the real sector, progress have been made in terms of competitiveness. After three years of declining Global Competitiveness Index (GCI) rank, Indonesia climbed to 36 out of 137 countries. The gains occured in all major components, namely basic requirements, e�ciency enhancers as well as innovation and sophistication factors. Investment climate also improved as re�ected in the rating of ease of doing business from 91 to 72 for 2018 (Chart 19).

Economic Challenges

Amid ongoing economic recovery, we foresee that the domestic economy will still face both global and domestic challenges. Global challenges include monetary policy tightening in advanced countries, particularly the FFR hikes and the Fed’s plan to reduce assets on its balance sheet which has started on October 2017. Furthermore, geopolitical challenges a�ecting the Korean Peninsula are heating up. Such developments will in�uence global �nancial market dyna-mics and the direction of global liquidity. In addition, protectionism practices could hinder global economic growth and international trade.

The prospect of sustained world economic growth is also confronted by an increased accumulation of global �nancial system vulnerability. The low volatility of international �nancial markets amid abundant global liquidity prompted an improvement in investor perceptions of investment risks followed by signi�cant increase in �nancial asset prices. This is re�ected in, among others, the rise in theprice earning ratio (PER) of stocks in various countries to the PER level before

11

Economic Challenges

Chart 18. Indonesia Sovereign Rating

Source: JCRA, Fitch, Moody’s, R&I, and S&P.

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

JCRA Fitch Moody's R&I S&P

BBB-

BB+

BB

BB-

B+

Below Investment Grade

Investment Grade

Chart 19. Indonesia Ease of Doing Business Rank

Source: Doing Business, World Bank.

122 121

129 128

120114

106

91

72

2010 2011 2012 2013 2014 2015 2016 2017 2018

Rank

12


the onset of world �nancial crisis (Chart 20). In addition, the vulnerability also comes from increased leverage of non-�nancial companies, followed by an increase in the debt service ratio (Chart 21), as seen in G20 member countries (IMF, 2017). These vulnerabilities face the risk of being materialized into instability and disrupt global economic growth if

there is a change in perceptions of inves-tor risk.

In the medium-long term, the currently positive global economic performance is still unable to guarantee a sustainable improvement in global economic growth. We are of the view that the current global economic recovery momentum is still vulnerable and temporary since it was driven by monetary and �scal stimuli rather than tangible productivity gains. In this context, allow me to refer to the IMF’s 2017 study on total factor productivity (TFP) which indicates that global TFP is currently lower than that prior to the global �nancial crisis (Chart 22).

Productivity has not recovered due to persistently limited global investment. In addition to structural factors such as aging population and declining interna-tional trade, the main drag on global TFP appears to be low investment, which, in turn, impairs capital accumulation and

Chart 21. Change in Non FInancial Corporation Debt and DSR from 2006-2016

AUS

CAN

FRA

DEUITAJPN

KOR

GBR

USA

BRA

CHN

IND MEX

IDN

RUS

ZAF

TUR

-6

-4

-2

0

2

4

6

8

10

-40 -20 0 20 40 60 80 100 120

Ch

an

ge in

De

bt

Se

rvic

e R

ati

o

Change in Debt to GDP Ratio

Percentage Point

Percentage Point

Greater

Debt

Payment

Pressure

Source: IMF, 2017.Note: size of circles represent debt to GDP ratio in 2016.

Chart 20. PER in Selected Countries

Source: Bloomberg, calculated.

0

5

10

15

20

25

30

35

40

China USA BrazilArgentinaSouthAfrica

2000-2006 Average Post GFC lowest point 2017

Percent

a balanced global economic recovery and persistently high commodity prices and world trade volumes. Additionally, several aspects of the domestic economic structure need to be solidi�ed further.

First, the role of household consumption as a primary source of domestic econo-mic growth is still restricted. Despite the dominant role of household consump-tion in the domestic economy, account-ing for 54% of GDP, the contribution of household consumption to economic growth over the past two years has remained at 2.7%, down from an average of 2.9% in 2011-2014. Such sti�ed improvement in household consumption is related to the smoothing phenomenon, delayed consumption which is o�set by an increase in bank savings and other �nancial assets and a shift in consump-tion behaviour as consumers have become more rational. Therefore, we need to observe unsatisfactory house-hold micro indicators such as slow growth of real wage, declining trend of farmers’ terms of trade (ToT) surplus (Chart 24), limited absorption of formal labour force by micro and small scale businesses as well as consistently large informal sector

13

Economic Challenges

technological innovation. An OECD study (2017) showed that although the level of investment in OECD countries has begun to recover since the global �nancial crisis, it remains well below historical levels after previous crises (Chart 23). This phenome-non is mainly attributable to low expecta-tions of global economic growth combined with policy uncertainties in the medium term.

The current global structural issues may impede global economy’s ability to achieve stronger growth in the medium term. We believe that global economic recovery will continue in 2018 at a projected rate of 3.6% and shall gradually increase in the medium term. Neverthe-less, the current global structural problems may prohibit growth above 4% in the medium term.

On the domestic side, we view that the economic growth in 2017 still face several pertinent issues that demand our mutual attention. We view that the domestic economy has not adequately responded to improved global economic conditions this year. The economic growth in the �rst three quarters of 2017 were tepid despite

Chart 22. Total Factor Productivity Growth (TFP)

Source: IMF, 2017.Note: 5-year average growth rate.

-3

-2

-1

0

1

2

3Advanced Economies

1990 1995 2000 2005 2010 2015

Percent

1990 1995 2000 2005 2010 2015 1990 1995 2000 2005 2010 2015

Excluding China

Emerging Market Economies Low Income Countries

'08-'09 Global Fnancial Crisis

which primarily consist of middle and lower income groups (Chart 25). We need to discern these facts accordingly due to its potential impact on income uncertain-ty amongst middle and lower income groups which, in turn, could spur a vicious circle and undermine ongoing domestic economic recovery.

Second, the current economic growth structure is suboptimal for labour force absorption. The sectors that achieved robust growth in the third quarter of 2017 were those with limited labour absorp-

tion such as construction, transports, warehousing and communication, as well as �nancial services. In contrast, sectors that traditionally absorb more labour force, namely the manufacturing and agriculture, only showed limited growth (Chart 26). This unfavourable growth structure is one of the reasons for decreased elasticity in labour absorption elasticity in our economy. Moreover, limited labour absorption will in turn curb improvements to household consump-tion, which has always been the core of domestic economic growth.

14


Chart 23. Investment Recovery Comparison in OECD Countries

Source: OECD 2017.Note: recovery since Q1 2008, including forecast in the dotted line.

80

90

100

110

120

130

140

1 2 3 4 5 6 7 8 9 10

Current Recovery

Years After Peak

Average of 3 Previous Recoveries

Pre Recession Peak =100

Chart 25. Share of Formal and InformalEmployment

Source: BPS-Statistics Indonesia, calculated.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014 2015 2016 2017

Formal Employment Informal Employment

Percent

Chart 24. Farmers’ Terms of Trade and Real Wages

4.0

4.2

4.4

4.6

4.8

5.0

5.2

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

I II III IVI II III IV I II III Mar Apr May Jun Jul Aug Sep

2015 2016 2017 2017

Farmers’ ToT Construction Labourers' Real Wage

Farm Workers' Real Wage Household and NPISH Consumption(rhs)

Percent, yoyPercent, yoy


15

Economic Challenges

The weak economic growth structure stems from unresolved structural problems, which a�ect the supply side of the economy. Consequently, our e�orts to catalyse economic growth are often accompanied by increasing vulnerability or instability in the economy. Empirically, we have seen that periods of higheconomic growth were often character-ised by a wider current account de�cit (Table 2). Higher growth spurs imports as a result of limited economic capacity to ful�ll domestic demand, which in turn impairs further growth. Moreover, the nascent middle class, with more complex consumption habits, further drives up imports. This limited economic capacity is due to low productivity, inadequate physical infrastructure and a less condu-cive investment climate.

Our limited industrial capacity is also re�ected in the lack of broad-based export structure as we still rely on commodities. Exports from Indonesia are mainly unprocessed natural resources (raw materials), accounting to more than 50% of our exports, while exports of manufactured goods have yet to show signi�cant improvement. Such reliance on natural resources a�ects the dynamics of spatial growth throughout the archipela-go. Sumatra, an island rich in natural oil and gas, experienced pressures during the �rst half of the year due to low oil price. Conversely, the economy of Kali-mantan thrived as the prices of coal and crude palm oil (CPO) rebounded on the international market. Our reliance on commodities was also evident from the �uctuating economic growth reported in Maluku-Papua as well as Bali and Nusa Tenggara, which were linked to copper production and exports. Sulawesi is another region, whose economic perfor-mance tends to mirror nickel prices (Chart 27).

Our fragile export structure is not only re�ected in the limited types of products,

Chart 26. Economic Growth and Labour Absorption by Sector

Source: BPS-Statistics Indonesia, diolah.

35 30 25 20 15 10 5 0 0 1 2 3 4 5 6 7 8 9 10

29.7

23.3

16.9

14.1

Agriculture

Trade

Other Services

Manufacturing

Construction

Transport, Storage, and Communication

Financial Services

Mining

Electricity, Gas, and Water

6.7

4.8

3.1

1.1

0.3

2.9

5.4

4.0

4.8

7.1

8.9

6.0

1.8

4.9

Employment Distribution August 2017 (percent) Q3 2017 Economic Growth (percent, yoy)

Q3 2017 EconomicGrowth : 5.06%

Table 2. GDP and Current Account to GDPRatio

Source: BPS-Statistics Indonesia and Bank Indonesia.

Variable 1981 - 1997 1998 - 2011 2012 - 2016

Current Account / GDP

Economic Growth

-2.5 %

6.8 %

2.2 %

3.8 %

-2.5 %

5.3 %

translated this strategy by strengthening the policy mix for stabilisation purposes through policy rate adjustments, strengthening monetary operations, rupiah exchange rate stabilisation in line with it’s fundamental value, and close coordination with the Government and other relevant authorities.

Close coordination with the Government, combined with policy consistency over time, has restored economic stability. In�ation has been controlled over the past three years within the target corridor. Despite in�ationary pressures from

16


but also in less diversi�ed export destina-tions. Unlike the global trend of a more diversi�ed trade, Indonesia’s trade has become more centred on China (Chart 28). This reliance brings Indonesia to be vulnerable to China’s domestic economic shocks, especially if the expected slowdown takes hold in China.

Our limited economic capacity to meet domestic and export demand is strongly linked to the limited growth of manufac-turing industry. Since 2011, there has been declined growth of the manufacturing sector which remained consistently below the pace of economic growth (Chart 29). On the other hand, commodi-ty-based sectors have accelerated towards the growth levels achieved by the manufacturing industry. Furthermore, the share of the manufacturing sector has declined drastically since the year 2000, at a time when income per capita has remained low compared to other

countries (Chart 30). Typically, a domi-nant manufacturing industry tends to decline after a country has achieved a high level of income per capita as the services sector begins to take over.

The limited industrial capacity is charac-terised by “missing in the middle” phenomenon in our industrial distribu-tion pyramid. Our medium-scale indus-tries are outnumbered by those in peer countries (Chart 31). On the other hand, small enterprises dominate our industrial distribution. Unfortunately, due to limited capacity, these small scale businesses are unable to meet domestic demand due to limited capacity and are also unable to meet the demand for higher quality exports. There are many impediments to growth that prevent small enterprises from becoming medium and large-scale industries, including legal, licensing and tax, as well as access to �nance.

Chart 28. Indonesia’s Trade Dependence on China


2007 2016

17

Economic Challenges

end, �scal reforms to increase state revenues are necessary in order to fund development expenditure and reduce dependency on foreign debt. Currently, the ratio of tax revenue to GDP is relative-ly low and declining (Chart 35).

Another structural challenge stems from the fourth industrial revolution in the form of digital technology. This trend has not only a�ected production processes but also changed various aspect of human lives, such as decision making andinteraction, and has spurred new business models that are much more e�cient and innovative. If utilized well, the current digital revolution will provide digital dividends in the form of enhanced e�ciency and productivity in various economic sectors, while spurring new innovations and creating a more inclusive economic ecosystem, the sum of which will elevate domestic economic growth. The �ip side of this digital revolution is obsolescence of current business processes, increased automation and reduction in the role of speci�c sectors, all of which may impair labour absorption in the short term. In the �nancial sector, digital technology o�ers widened access, faster transactions and lower costs. However, business model innovation and digital technology also disrupt conventional functions, especially banking. Furthermore, �nancial sector risks are becoming increasingly complex, such as money laundering,terrorist funding, cyber threats, consumer protection risks and systemic risks which might interfere with �nancial system stability.

Limited economic capacity has not only a�ected our commodity-based sectors but also services sectors, as seen by the persistent de�cit in Services Account. The Services Account de�cit is dominated by transportation, insurance and �nancial services (Chart 32). The transportationservices de�cit is dominant at about 80%, due to export-import activities. Not only are most exports from Indonesia transported by foreign �eet, all imports are transported by foreign �eet via Singa-pore and Malaysia. Such conditions are among others due to our limited domes-tic shipping services, meaning that every increase in export-import will be accom-panied by increase in transportation costs.

In addition to the real sector, structural problems also beset the �nancial sector. Domestic sources of �nancing for medium long term projects that could enhance national production capacity and competitiveness remain limited. Such constraints have led to the dominant role of foreign �nancing in the domestic economy. It is impossible to fully avoid the use of foreign funds, although we are aware that large portion, especially short term funds, potentially expose our economy to global shocks (Chart 33). Consequently, we shall prioritise longer-term foreign �nancing, particularly if used for investments that increases exports and labour absorption.

The combination of our dependency on foreign �nancing and suboptimal export proceeds could undermine our external resilience, as evidenced by the high and rising debt to service ratio (Chart 34). Consequently, e�orts are required to o�set the burden of foreign debt repay-ments by increasing value added to exports of goods and services. Such e�orts must be accompanied by greater mobilisation of domestic funds. To that

18


while intensifying structural reforms through deregulation and debureaucrati-sation. In conjunction with the Govern-ment and other relevant �nancial authori-ties, Bank Indonesia has implemented �nancial market deepening measures to bolster �nancial system stability and promote sources of development �nan-

Principles of Public Policy and Key Element of Economic Growth

Addressing the challenges, we are aware that all authorities have already imple-mented reform measures. In the real sector, for example, the Government has accelerated the infrastructure projects,

Chart 27. Regional Economic Growth

ACEH4.78

NORTHSUMATERA

5.21

RIAU2.85

JAMBI4.76

SOUTH SUMATERA

5.56

BANGKA BELITUNGISLANDS

3.69

RIAUISLANDS

2.41WEST

KALIMANTAN5.13

CENTRALKALIMANTAN

6.13

EASTKALIMANTAN

3.54

NORTHKALIMANTAN

6.62

SOUTHKALIMANTAN

6.44

BANTEN5.62

DKIJAKARTA

6.29

WESTJAVA5.19

EASTJAVA5.16

BALI6.22

CENTRALJAVA5.13

DI YOGYAKARTA5.41

BENGKULU4.83

WESTSUMATERA

5.38

Note: Q3 2017 GDRP growth (percent, yoy).Source: BPS-Statistics Indonesia, diolah.

GDRP ≥ 7.0% 5.0% ≤ GDRP < 6.0%6.0% ≤ GDRP < 7.0%

1.37 2.01

4.92 4.44 4.67

2015 2016 I'17 II'17 III'17

Kalimantan (8%)

3.53 4.29 4.09 4.11 4.43

2015 2016 I'17 II'17 III'17

Sumatera (22%)

5.47

5.59 5.68

5.43 5.51

2015 2016 I'17 II'17 III'17

Java (58%)

LAMPUNG5.21

19


cing. Additionally, we have also taken measures with other related authorities to anticipate the rapid developments of technological innovation in the �nancial markets.

Nevertheless, the long road of structural reforms is still unwinding, and make it

work will not be a simple task. Our e�orts need to be strengthened in terms of policy implementation to ensure the recovery process. We need to strengthen this recovery momentum as successful economic recovery will serve as the foundation for creating strong, sustain-able, balanced and inclusive economic

WEST NUSATENGGARA

4.09

SOUTHSULAWESI

6.25

WESTSULAWESI

6.94

CENTRALSULAWESI

8.68

GORONTALO5.29

NORTHSULAWESI

6.49

NORTHMALUKU

7.78

MALUKU5.26

WESTPAPUA

3.48

PAPUA3.40

SOUTHEASTSULAWESI

6.54

EAST NUSATENGGARA

4.91

4,0% ≤ GDRP < 5,0% GDRP < 0%0% ≤ GDRP < 4,0%

10.45

5.89 5.24 2.47 3.24

2015 2016 I'17 II'17 III’17

Bali-NusaTenggara (3%)

NATIONAL

4.88 5.02 5.01 5.01 5.06

2015 2016 I'17 II'17 III'17

6.35 7.45

3.99 4.49 3.98

2015 2016 I'17 II'17 III'17

Maluku-Papua (3%)8.19

7.42 6.83 6.49 6.69

2015 2016 I'17 II'17 III'17

Sulawesi (6%)

20


growth. To that end, we need to imple-ment progressive economic policies that can transform Indonesia’s economy. Economic policy priority should be aimed to some weak areas, such as institution, human resources, and innovation(Figure 1).

In this context, allow me to reiterate the importance of three principles of public policy with strategy focusing on three key elements of economic growth. First, forward-looking policy is a must. We must agree on an economic end state as the basis of formulating the economic

Chart 30. Share of Manufacturing to GDP in SeveralCountries

Source: World Development Indicator, World Bank.

10

15

20

25

30

35

- 5,000 10,000 15,000 20,000 25,000 30,000

China '90

China '95

China '13

Thailand '95

Thailand '10

Thailand '15

Indonesia '90

Indonesia '00

Indonesia '15

Malaysia'90

Malaysia'00

Malaysia'15

Manufacturing Industry (% to GDP)

GDP per Capita, PPP (USD, constant 2011)

Chart 29. GDP Growth by Industrial Origin


-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2011 2012 2013 2014 2015 2016

Commodity Manufacturing Others GDP

Percent, yoy

Chart 31. Distribution of Industry in Selected Countries

MISSINGMIDDLE

PHILIPPINESVIETNAM BRAZIL

1.5%Large

13.0%Large

27.4%Medium

59.6%Small

7.4%Large

28.0%Medium

64.6%Small

16.9%Large

46.5%Medium

36.6%SMall

93.4%Small

5.1%Medium

Source: World Bank.

21


be established, thus instilling con�dence in the business community to take longer-term planning and investment.

Third, policies must be balanced. Balanced in this sense, comprises three dimensions which is relevant with current circumstances.

The �rst dimension is striking a balance between structural and cyclical policies or between long-term and short-term policies. We believe that structural policy is a must to attain sound economic growth. Nonetheless, structural reforms

policies required to transform the econo-my. The end state must be forward looking, meaning that future economic dynamics are given due consideration.

Second, policies must be sustainable and synergized. In other words, economic policies should be clearly structured and have well-de�ned stages to achieve the end state. Policy makers must avoid recurrent changes in the policy substance, for instance due to lack of coordination among sectors or political environment. By maintaining policy sustainability, long-term assurance can

Chart 32. Indonesia Services Account


-20000

-15000

-10000

-5000

0

5000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Transportation TravelCost of Using Intelectual Property Other Corporate ServicesOthers Services Account Balance

Million USD

Chart 33. Government Securities Ownership

Source: KPEI.*As of September 2017.

0

5

10

15

20

25

30

35

40

45

-

200

400

600

800

1,000

1,200

1,400

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017*

Non Resident Resident Share of Non Resident Ownership(rhs)

Trillion Rp Percent

Chart 34. Debt Service Ratio

Source: Bank Indonesia.*Annualised.

0

10

20

30

40

50

60

70

2010 2011 2012 2013 2014 2015 2016 Q2 2017*

Tier 1 Tier 2

Percent

Chart 35. Tax Revenue Comparison

Source: CEIC.

10

11

12

13

14

15

16

17

18

19

2012 2013 2014 2015 2016

IDN MYS PHL BRA IND TUR THA

Percent to GDP

often require some time before bearing result and may sacri�ce economic growth in the short run. Simultaneously, we are also facing various cyclical issues that demand immediate solution. To that end, structural policy aimed towards impro-ving fundamental of the economy should be counterbalanced by cyclical policy to overcome short-term issues.

The second dimension is seeking a balance between quality and quantity of economic growth. Higher growth should be accompanied by higher quality of growth. We are of the view that strong economic growth does not always guarantee the inclusion of participation in economic activities or in terms of enjoying bene�t from growth. Therefore, policy should be supportive to ensure that strong economic growth can also improve income inequality and participation rate in the development process. We also need to pay attention to disparities among regions as it would boost economic growth. In contrast, however, deterioration in these areas could disrupt political stability and, thus, economic stability. In this regard, we appreciate the Government's ongoing e�orts to develop infrastructure in the regions.

The third dimension relates to a balance between the conventional and modern sectors. We view that rapid development in digital technology will prompt monu-mental changes and trigger uncertainty regarding future economic models. We must anticipate the future developments come from this fundamental change. Sectors closely related to digital techno-logy must be developed to provideoptimal bene�ts. At the same time, economic sectors based on conventional technology, such as manufacturing, should also be developed. Any conven-tional sectors that remain relevant must also be strengthened utilizing new

22


opportunities come from the advance-ment of digital technology.

From the implementation side, e�orts to reinforce policy must remain focused on three key elements of economic growth. First, reinforcement in “physical capital” through acceleration of infrastructure projects. We extend our appreciation to Government's e�orts to accelerate infrastructure projects throughout Indonesia. This policy should be reinforced by some measures from �nancing aspect and private sectors participation. Second, policy to reinforce “human capital”. In this context we need to improve quality of education and labour skill, for instance through vocational school, to meet demand for skilled labour. We see a sense of urgency in reinforcing “human capital” so that we can take bene�t from prevailing demo-graphic dividend. Continued reform in the healthcare sector is also important. Third, policy focusing on improving productivity to enlarge value added on production factors. Reform in the labour market, state revenue, business regulation, corruption eradication, �nancial market deepening, and innovation, are some areas that require special attention to boost productivity in the economy so that steadily, we can be categorized as a high-income country.

Concerning the e�orts to enhance indus-trial capacity, investment in manufactu-ring sector should be based on speci�c characteristic of each region. Based on our Growth Strategy research, we have identi�ed potential and competitive regional industries based on the availa-bility of raw materials and labour, global demand, downstream and upstream linkages to other industries as well as potential labour absorption (Figure 2).

Bank Indonesia’s Policy Direction

The various risks and challenges that have arisen could disrupt the ongoing economic recovery process. Conse-quently, cooperation and coordination amongst all stakeholders when formula-ting a synergic national policy mix are critical to maintain sustainability and strengthen domestic economic recovery momentum (Figure 3).

Bank Indonesia shall continue to focus our policy mix to maintain the macroeco-nomic and �nancial system stability. We believe that maintained macroeconomic stability is a basic prerequisite to create a more sustainable economic recovery. We complement our policy orientation with other policies to enhance e�ciency and productivity, thereby ensuring that economic recovery will be promptly translated into strong, sustainable, balanced and inclusive economic growth. This policy direction is translated into Bank Indonesia’s policy mix, consisting of three pillars, namely monetary policy, macroprudential policy as well as

23


payment system policy and management of currency circulation.

In terms of monetary policy, Bank Indonesia shall consistently pursue a measured monetary policy stance that is consistent with e�orts to maintain in�ation within the target corridor and manage the current account de�cit at a healthy level. To enhance the e�ective-ness of monetary policy, Bank Indonesia will strengthen monetary operations, maintain exchange rate stability in line with its fundamental value and continue �nancial market deepening process.

Reinforcement in the monetary operation is aimed to provide �exibility in managing bank’s liquidity to help stabilize interest rate in the money market. In this regard, we will strengthen the implementation of Rupiah reserve requirement averaging. We view that the policy implementedsince July this year has had a positive impact not only on the macroeconomic perspectives but also on banks. On the macro side, the policy has helped to accelerate �nancial market deepening

Figure 1. Distance to Frontier Indicators

35%

Human Capital & Research

38%

Innovation

Frontier= Korea(Global Competitiveness Index 2017)

123

123

1. Research & development (R&D) 2. Tertiary education3. Basic education

1. Knowledge creation2. Knowledge di�usion3. Knowledge impact

72%

Quality of Overall Infrastructure

1234

1. Roads2. Railroad infrastructure3. Port infrastructure4. Air transport infrastructure

Frontier= Korea(Global Innovation Index 2017)

47%

Institutions

1. Barriers to trade and investment2. Barriers to entrepreneurship3. State control

123

Frontier= Hungary(Product Market Regulation – OECD 2013)

Frontier= USA(Global Innovation Index 2017)

Source: INSEAD, World Intellectual Property Organization, IMF, OECD, Bank Indonesia.

24


through the creation of new instruments to absorb additional liquidity during maintaining period of Rupiah reserve requirement averaging, as well as strengthen money market stability. On the micro side, the policy has helped to increase the e�ciency of daily liquidity management and optimise income, while maintaining prudential principles. Bank Indonesia will enhance the Rupiah reserve requirement averaging system so that in addition to Rupiah reserve requirement, the averaging system will also apply for foreign currency reserve requirement as well as for sharia banks. We will also make an adjustment to reserve requirement ratio as well as extending the ful�lment period. Such regulatory re�nements shall be imple-mented gradually, while paying due regard to �nancial market conditions and the preparedness of the banking industry.

Bank Indonesia shall continue measured and prudent exchange rate management to maintain exchange rate stability in line with its fundamental value, while also maintaining market mechanisms. To strengthen rupiah stability, Bank Indone-sia constantly encourages e�orts to reduce dependence on certain foreign currency. For that reason, we continuous-ly seek to strengthen bilateral coopera-tion to increase settlement of bilateral trade transactions using local currency through Local Currency Settlement (LCS). Our e�orts improve LCS scheme is facilitated by the authorities/central bank, such as Bilateral Currency Swap Arrange-ments (BCSA) LCS scheme based on Appointed Cross Currency Dealers (ACCD) that involve the authorities and private sector, which we plan to imple-ment in the early of 2018. In addition, we shall continue to develop non-USD hedging swaps at Bank Indonesia by expanding number of currencies eligible for transaction with Bank Indonesia.

Bank Indonesia shall also continue to encourage risk mitigation of nonbank corporates in managing its external debt activities. Regulations concerning the application of prudential principles to the management of nonbank corporate external debt shall constantly be strengthened, especially in terms of expanding the scope of external debt. In addition, Bank Indonesia will continue to encourage domestic banking industry to provide more e�cient hedging instru-ments, in part through structured product such as Call-Spread Options.

Bank Indonesia shall also continue to enhance �nancial market e�ciency by strengthening regulatory and institutional aspect of �nancial market. On the regula-tory side, Bank Indonesia will issue market operator regulations for money market and foreign exchange market transactions to create fair and transparent �nancial markets. From the institutional perspective, in conjunction with other relevant authorities, Bank Indonesia will institute a Central Clearing Counterparty for over-the-counter �nancial derivative transactions. In addition, we shall consistently strengthen �nancial market credibility by requiring money market and foreign exchange market players to meet mandatory treasury certi�cation policy, thereby enhancing professionalism and global competitiveness.

We shall continue to accelerate �nancial market deepening through coordination with relevant parties to create new sour-ces of economic �nancing. Under Coordi-nation Forum for Development Financing through Financial Market (FK-PPPK), Bank Indonesia will coordinate with the Ministry of Finance and Indonesia Finan-cial Services Authority (OJK) to prepare the National Strategy for Financial Market Development and Deepening (SN-PPPK). This strategy shall elaborate the work

shall implement the Macroprudential Liquidity Bu�er (MPLB) as a re�nement to the secondary statutory reserve require-ment. According to MPLB, banks are required to maintain a certain amount of liquid instruments, covering all bank securities that may be repurchased to Bank Indonesia pursuant to prevailing regulations on monetary operations. We shall determine the MPLB ratio paying due consideration to the �nancial cycle along with liquidity conditions in the �nancial system. Di�ering from the Liquidity Coverage Ratio (LCR), all banks shall be subject to the MPLB require-ments.

In terms of strengthening the quality of �nancial intermediation function, Bank Indonesia shall implement the Macropru-dential Intermediation Ratio (RIMP) to substitute and improve the loan to

25


plan based on three pillars of develop-ment covering; 1) source of economic �nancing and risk management, 2) deve-lopment of �nancial market infrastruc-ture, and 3) policy coordination, regula-tion harmonization, and education. SN-PPK will be used as joint vision and structured work program towardsstronger �nancial markets.

From macroprudential perspectives, Bank Indonesia as the authority in the macroprudential area will continue to improve macroprudential policy to enhance resiliency of the �nancial market against systemic risk amid challenges and complexity in the �nancial market.

We shall continue to emphasis macro-prudential policy towards bolstering �nancial system resilience. In terms of strengthening liquidity, Bank Indonesia

Figure 3. State of Indonesian Economy

Lower Growth

Higher Growth

2018

2017

2016

2015

2014

2013

RisingLeverage

Expansion

Decline

Recovery

Consolidation

FallingLeverage

2022

26


funding ratio (LFR). Di�ering from the LFR concept, however, RIMP will accommo-date diverse bank intermediation by including bank investments on securities,such as corporate bonds, medium-term notes (MTN) and �oating rate notes (FRN) that meet speci�c requirements, when calculating the Macroprudential Interme-diation Ratio (RIMP).

Moving forward, Bank Indonesia shall strengthen loan-to-value (LTV) policy through Targeted LTV to boost instrument e�ectiveness. Targeted LTV policy has been designed to mitigate the risk of bubble in certain sector with morespeci�c measures.

Figure 2. Selected Potential and Competitive Regional Industries

LAMPUNG3.90


SUMATERA Tourism Industry Fisheries Processing Industry Semiconductor Industry Basic Metal Industry Co�ee Processing Industry Chemical Industry

KALIMANTAN Oleochemicals Industry Biodiesel Industry Aloe Vera Processing Industry Alumina Industry

Shrimp & Prawn ProcessingIndustry

Decorative Plywood Industry Tourism Industry

JAVA Caroseries Industry Tourism Industry Traditional Medicine Industry Fisheries Processing Industry Food Industry Fiber/Yarn/Filament Industry

Primary Battery Industry Co�ee & Tea Processing Industry Boats & Ships Industry Creative Industry (Animation, Film, Application,

Games, and Fashion)

27


SULAWESI Coconut Processing Industry Cocoa Processing Industry Seaweed Processing Industry Ships Industry Boat Repair Industry Tourism Industry

MALUKU-PAPUA Fish Processing Industry Boats and Ships Industry Coconut Processing Industry Tourism Industry

BALI-NUSA TENGGARA Co�ee and Tea Processing Industry Tourism Industry Maize Processing Industry

Seaweed Processing Industry Creative Industry & Agrotourism

In pursuance of Bank Indonesia’s mandate to maintain stability, Bank Indonesia policy to develop micro, small and medium enterprises (MSME) shall bealigned with e�orts to control cost-push in�ation from the supply side. To that end, we shall strengthen MSME cluster development to control supply-side in�ation, particularly in terms of strategic

food commodities that in�uence in�ationary pressures on volatile food (VF), such as shallots, red chillies, garlic, beef and rice. We are applying avalue chain approach to development, starting by persuading members of farmer groups to produce certain commodity, then processing that commodity to realise value added and,

28


�nally, marketing the product. In addition to promoting innovation in the existing clusters, we shall also create additional new clusters and develop clusters for other food commodities in areas that cannot grow volatile food based on the results of mapping volatile food in each respective region, as contained in the TPI/TPID Blueprint.

To enhance MSMEs' capabilities, Bank Indonesia shall prepare policy and infrastructure to promote, among others, the ease of doing business, production, marketing and �nance. To that end, Bank Indonesia shall strengthen its existing entrepreneurship development program. Through this program, we hope to optimize the existence of demographic bonus by creating new, reliable and innovative entrepreneurs who can drive the growth of new economic centres and, therefore, expand the availability of new jobs. Enhancing MSMEs' capabilities, however, requires the support of increased bank intermediation with MSMEs. To that end, we extend our commitment to ensure commercial banks meet the MSME loan target ratio of 20% of total loans in 2018, without neglecting prudential principles.

Concerning the e�orts to accelerate Islamic economic development as a complement to the conventional econo-my in Indonesia, Bank Indonesia shall implement the Islamic economy and �nance blueprint that was launched earlier this year. We shall strengthen cooperation with all relevant stakehol-ders to consistently promote the three pillars of the Islamic economy and �nance development strategy.

First, Islamic �nancial market deepening, shall be achieved by promoting issuances of waqf-based Islamic �nancial instru-ments, waqf-based sukuk instruments

and Islamic Social Finance, as well as issuances of Islamic-based Bank Indone-sia liquidity instruments that I alluded to earlier.

Second, Islamic economic empower-ment, shall be implemented by expan-ding the halal supply chain by strength-ening and implementing applicable business models, supported by the establishment of Islamic economic zones, institutional strengthening and reinforcing supporting infrastructure, including the establishment of a World Islamic Invest-ment Bank and Islamic Inclusive Financial Services Board.

Third, strengthening research, assess-ments and education to develop the Islamic economy and �nance, shall be implemented by accelerating activation of the zakat and waqf information system currently under development in conjunc-tion with the Ministry of Religious A�airs, National Zakat Agency (Baznas) and Indonesian Waqf Board (BWI), while strengthening support by developing Islamic economy and �nance curricula for various educational levels.

Regarding the payment system, we shall continue to support economic e�ciency in accordance with the existing Payment System and Rupiah Currency Manage-ment Blueprint for 2017-2024. We shall ensure that all economic transactions, cash and noncash, are settled securely, e�ciently and smoothly in order to strengthen the implementation of BI task in maintaining macroeconomic and �nancial system stability, while support-ing the Government to realise its nine priority agenda items.

Bank Indonesia’s policy for the noncash payment system will focus on developing an interconnected, a�ordable, innovative and competitive noncash payment

29


Financial Inclusion (SNKI). To thatend, Bank Indonesia and the Indonesia Financial Services Authority (OJK) shall strengthen the synergy between digital �nancial services (LKD) agents and branchless banking agents (Laku Pandai).

Bank Indonesia also supports govern-ment e�orts to enhance the e�ciency and strengthen the governance of �nancial transactions at the central government and regional administrations, commencing in January 2018 as stipulated by the Minister of Home A�airs. Accord-ingly, we shall expand the electroni�ca-tion program through noncash Village Funds and School Operational Assistance disbursements, as well as the development of smart cities.

We shall promote the electroni�cation of public transport facilities and infrastruc-ture to enhance e�ciency and good governance. We shall realise e-money interoperability, as the preferred payment method in the sector, under the National Payment Gateway (NPG) policy. We shall also encourage the introduction of Electronic Fare Collection to integrate the payment systems for di�erent modes of public transport across di�erent opera-tors in preparation for integrated transportation in the Jabodetabek region, commencing in 2018. This solution presented itself, institutionally, in the Electronic Toll Collection system, striving towards contactless technology (Multi-lane Free Flow), starting in December 2018.

Third, we shall hone the regulation for Fintech players, including e-commerce, to maintain business competition, risk mitigation and consumer protection. A level playing �eld with formal �nancial institutions must be maintained. We require all Fintech players to register with Bank Indonesia, report their activities and

ecosystem that protects its users through three main strategies.

First, we shall promote the use of interconnected and interoperable instru-ments, channels and domestic retail payment infrastructure under the Nation-al Payment Gateway (NPG) policy. The respective positions and functions of Standards, Services and Switching Institu-tions, as operators of the NPG, shall be strengthened to ensure debit card and electronic money system interoperability. Furthermore, Bank Indonesia shall continue to support e�orts to create and maintain an interconnected, interopera-ble and capable noncash payment system ecosystem in terms of domestic routing. In the NPG regulations, therefore, we have formalised the standardised instruments and transactions in terms of technology, price schemes, rules of the game and national logo. Moving forward, the National Payment Gateway shall act as the backbone of national retail payment transaction processing advancements, which we shall develop gradually to accommodate various noncash transactions, such as Electronic Billing and Invoicing Presentment and Payment (EBIPP), credit cards, e-com-merce, payment hubs and other retail payment services.

Second, we shall accelerate electroni�ca-tion to support various government programs. In terms of poverty alleviation, electroni�cation synergy with govern-ment programs will be achieved by raising the target for noncash social assistance disbursements, including the Family Hope Program and the Noncash Food Aid Scheme, to 10 million bene�ciary familiesin 2018. Program realisation this year, which extended �nancial access to 24% of the lowest-income families, shall bemultiplied in accordance with the target contained in the National Strategy for

complete Regulatory Sandbox trials. We prohibit the use and processing of virtual currencies in order to prevent money laundering as well as �nancing of terror-ism and to preserve the rupiah’s status as legal tender in the territory of the Repu-blic of Indonesia. We are also actively seeking to prevent arbitrage opportuni-ties, unfair business practices and the control of businesses by parties operating beyond the legal reach of the Republic of Indonesia that could be detrimental to industry structure. We have set forth the rules of the game in Fintech regulations, while also re�ning the electronic money and Anti-Money Laundering and Terror-ism Funding Prevention (APU-PPT) regulations.

We welcome close collaboration with the Indonesia Financial Services Authority (OJK), Ministry of Trade, Ministry of Manpower and the Ministry of Communi-cation and Information. Policy synergy between the authorities through sound coordination is necessary for us to respond to the rapid development of digital technology. In addition, we also seek the commitment and compliance of all Fintech players to jointly build a healthy national �nancial industry.

We shall safeguard the aforementioned policies through the supervision function. Furthermore, we will strengthen risk-based supervision and law enforce-ment of regulatory violations and illegal business practices. We shall focus on meeting the commitments of mandatory rupiah usage, domestic processing, anti-money laundering and combatting the �nancing of terrorism, as well asconsumer protection, while overseeing the operationalisation of the National Payment Gateway (NPG) and implemen-tation of national ATM/debit card stan-dards.

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In terms of rupiah currency management, we shall ensure the adequate distribution of currency �t for circulation in the required quantity and denominations to all parts of the Indonesian archipelago through Centralised Cash Network Planning (CCNP) and protect the public from the risk of counterfeit currency through three main strategies.

First, we shall continue to synergise cash services with various parties. Through collaboration with the banking industry in the form of Cash Custodian, cash services have been extended to all disctrics and municipalities in 2017. Bank Indonesia has also extended the outreach of its cash services to sub-disctrict as well as foremost, outermost and innermost regions through BI-Jangkau and distribu-tion of rupiah bank notes to outer and remote islands. In accordance with government policy to develop borders area of the country and enforce rupiah as sovereign currency in all regions of Indonesia, Bank Indonesia together with banks and the National Agency for Border Management have provided ATM and Money Changer services at the Country Border Posts of Skouw (Papua), Entikong (West Kalimantan), Badau (West Kaliman-tan), Aruk (West Kalimantan), and Motaa-in (East Nusa Tenggara). We also prepare the same services at the Country Border Posts at Motamasin and Wini in East Nusa Tenggara. Second, we shall maintain the supply of quality rupiah currency with enhanced security features. Third, we shall constantly improve the quality of rupiah currency and protect the public from the risk of counterfeit banknotes. To that end, the mentoring of Rupiah Currency Handling Services Providers (PJPUR) shall be intensi�ed and integrated with e�orts to improve the quality of education and coordination with related apparatus and institutions,

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while integrating the BI-Counterfeit Analysis Centre with the banks and police apparatus as well as establishing labora-tories to analyse counterfeit money in West Java, Central Java and East Java.

Bank Indonesia Regional O�ces shall also be strengthened to support the transmission of the above policies in all regions and reinforce the commitment to be strategic partner of the regional governments. In this regard, we shall improve the quality of assessment and research on regional economy, control of regional in�ation, implementation of Regional Financial Surveillance to moni-tor regional �nancial stability, and super-vision of payment system. Human resources in Bank Indonesia Regional O�ces shall also be enhanced with new recruit of best talents in Indonesia that is combined with continuous and quality training to enable them to provide reliable, timely and applicable recom-mendations for the regional government.Internally, Bank Indonesia shall continue to enhance internal capacity and capabi-lities in order to optimise the central bank’s contribution to the national economy. The re�nements shall focus on three main organisational aspects, namely strengthening governance and risk management, enhancing the capacity of human capital and bolstering infrastructure.

In the context of re�ning governance and risk management at Bank Indonesia, we shall form Integrated One-Stop Licensing Services to enhance the e�ciency of licensing certain activities in the mone-tary, macroprudential and payment system/rupiah currency management sectors. In addition, Bank Indonesia shallstrengthen foreign currency asset management through derivative transac-tions to be implemented in 2018, which

aim to optimise the management of reserved assets and mitigate risks due to market �uctuations by referring to best practices in the peer group.

In terms of human capital development, Bank Indonesia is strengthening its research function and the publication of strategic research papers, to become a frontier of learning, while contributing to seek solutions to the pressing national economic issues. This is supported by having collaboration with research fellows and prominent domestic and international research institutions.

Concerning infrastructure, we have also improved the information system at Bank Indonesia by developing three Commer-cial O�-The-Shelf (COTS) strategic information systems that provide banking services to the stakeholders, foreign exchange management as well as planning, implementation, control and reporting of the �nancial business processes in order to produce better �nancial information on Bank Indonesia. Furthermore, Bank Indonesia has also initiated the Bank Indonesia – Export Proceeds Integrated Monitoring (BI-EPIM) as a prospective solution to the integrated and comprehensive manage-ment of import-export foreign exchange transactions, which had previously been managed by several institutions. Bank Indonesia has also continued to enhance its utilisation of big data in the policy formulation process. In this context, Bank Indonesia and the Government continue to develop the Information Centre for Strategic Food Price (PIHPS), which is not only available to the public seeking information on food commodities regio-nally and nationally, but also to policy-makers when formulating development policy strategy, including national food sovereignty and the development of interregional connectivity infrastructure.

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Exchange of information on the supervi-sion outcomes of the Domestic Systemi-cally Important Banks (DSIBs) has been conducted periodically as mandated by Article 17 of the Financial System Crisis Prevention and Mitigation (PPKSK) Act. Furthermore, cooperation between Bank Indonesia and the Deposit Insurance Corporation (LPS) shall be strengthened, encompassing the exchange of data and information regarding LPS government securities (SBN) holdings, following the joint agreement that allows Bank Indone-sia to purchase government securities owned by LPS.

Concerning the payment system function, coordination with all elements of the Counterfeit Money Eradication Coordi-nating Body (Botasupal) shall be strengthened, consisting of the State Intelligence Agency (BIN), the National Police, Attorney General, Ministry of Finance and Bank Indonesia to prevent, detect and prosecute illegal counterfei-ting activities. Bank Indonesia sincerely appreciates the seriousness with which the National Police is uncovering networks of counterfeiters and distribu-tors to the intellectual actors, as well as seeking the maximum legal recourse against such perpetrators.

On the international stage, we acknow-ledge the need to strengthen coordina-tion in order to anticipate the expected proliferation of international trade agree-ments and the tendency of peer countries to implement similar arrange-ments. To that end, we need to design a comprehensive strategy and workmechanisms for Indonesia to exploit the maximum bene�ts of this newfound openness. In the context of broader international cooperation, Bank Indone-sia’s involvement in the Government’s Free Trade Agreements (FTA) and

Policy Coordination

Striving to achieve our common goal of elevating public prosperity and welfare, we are starkly aware that the policies instituted by each authority must be mutually synergised. Therefore, policy at Bank Indonesia shall always be coordi-nated and aligned with other stakehol-ders, regionally and nationally.

The coordination media between Bank Indonesia and the Government is already sound, which we shall strengthen, inclu-ding in term of the Round Table Policy Dialogue (RTPD), In�ation Control Team (TPI) and Regional In�ation Control Team (TPID), Coordination Meetings between Central/Regional Governments and Bank Indonesia, the national and regional Investor Relations Units (IRU), Financial System Stability Committee, the National Islamic Finance Committee (KNKS) as well as the Indonesia Payment System Forum (FSPI).

In terms of achieving and maintaining money market stability, Bank Indonesia shall continue to coordinate with the Government to optimally manage liquidi-ty. Joint communication from the two institutions addressing the markets concerning commitment to maintain liquidity will constantly be strengthened as an anticipatory measure, especially during spikes in demand for currency due to certain events. Bank Indonesia also extends appreciation to the Government for the commitment to strengthening the liquidity management and planning system.

In relation to �nancial system stability, Bank Indonesia shall continue to strengthen coordination with the Indo-nesia Financial Services Authority (OJK) and Deposit Insurance Corporation (LPS).

Comprehensive Economic Partnership Agreements (CEPA) aims to secure policy space as well as maintain commitment consistency to liberalisation, oriented towards development of the payment system services sector and Fintech, which has fallen under the auspices of Bank Indonesia. To that end, Bank Indonesia actively supports the Government in the �nancial services sector integration process. Additionally, to strengthen the formulation process concerning Indone-sia’s position as well as to bolster national coordination, Bank Indonesia shall continue to support and facilitate dedicated team meetings with the �nancial sector to provide a means of coordination and calibration for the respective positions of the intuitions involved with FTA/CEPA.

Bank Indonesia shall consistently support the Government’s e�orts to improve Indonesia’s Sovereign Credit Rating, including creating a positive perception concerning the national economy, includ-ing ensuring investors positive perception on Indonesia’s economy. Bank Indonesia shall also re�ne the Regional Investor Relations Unit (RIRU) and Global Investor Relations Unit (GIRU) by honing the investor relations function at domestic and international representative o�ces. Strengthening the RIRU and GIRU functions is expected to help facilitate foreign capital �ows to Indonesia and, thus, support regional economic deve-lopment through linkages between the three investor relations units, namely the Investor Relations Unit at Head O�ce, RIRU at domestic representative o�cesand GIRU at international representative o�ces. We are targeting three main elements of the investor relations units, namely the institutional arrangements, investor relations strategy as well as data and information dissemination.

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Policy Coordination and Economic Outlook

Economic Outlook

The global economic dynamics, econo-mic challenges and policy direction pursued by the Government and Bank Indonesia shall determine the economic outlook moving forward. We predict global economic growth to accelerate gradually in the upcoming years. In the near term, we expect more broad-based global economic growth, originating from both advanced and developing countries. In the medium-long term, however, developing countries will play a larger role as a source of global economic expan-sion. Accordingly, developing countries are expected to accelerate, with China and India remaining the main engines of growth. Advanced countries, such as the US, Europe and Japan, are expected to slow down due to the problem of ageing populations, coupled with productivity issues.

The incremental gains in terms of global economic growth will be accompanied by a similar trend of rising commodity prices. We predict commodity prices to contract slightly next year before increasing gradu-ally in the subsequent years in line with global economic growth. In terms of the �nancial sector, we expect global interest rates to continue rising, congruent with the normalisation of US monetary policy. Furthermore, we also expect the Federal Reserve to hike its Federal Funds Rate (FFR) one more time this year and then three times next year.

Consequently, we believe economic growth in 2018 will reach 5.1-5.5%, driven primarily by domestic demand. In the near term, Government stimuli will play an important role in catalysing the national economy. Therefore, govern-ment stimuli, local elections and hosting the Asian Games in 2018 will stimulate

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economic activities. By accelerating structural reforms, economic productivity will also surely increase. Accompanied by supply-side improvements, economic growth will accelerate without disrupting stability.

We predict economic growth to accele-rate further during the period from 2019-2022, increasing to around 5.8-6.2% by 2022. A more responsive supply side to accommodate demand should help to control in�ation in the 3.0±1% range in 2022. Congruently, the current account de�cit is expected to narrow and remain healthy at below 3% of GDP. We �rmly believe that policies to build economic recovery momentum in the near term, o�set by policies to expedite economic transformation, will help us achieve strong, sustainable, balanced and inclusive economic growth.

domestic demand, particularly consump-tion. Government investment in infrastructure projects will continue to characterise future investment growth. In contrast, export growth is predicted to slow on previous years, with a concentra-tion on commodities rather than a broad-based export structure. Consistent with Bank Indonesia’s economic growth projection and commitment to steer in�ation within its target corridor, we expect in�ation within the target range for 2018 at 3.5±1%.

Based on the economic outlook, we predict bank loan and deposit growth in 2018 at 9-11% and 10-12% respectively. Meanwhile, congruous with the expected investment gains and intensi�cation of infrastructure projects, we predict the current account de�cit to widen but remain at a healthy level below 3% of GDP.

The near-term economic outlook repre-sents a solid foundation for economic growth in the medium-long run. In the medium term, we expect the global economy to gradually gain momentum, while commodity prices should begin to rise as demand increases. At home, we feel that the Government will continue to implement the structural reforms nece-ssary, based on the a�rmed commitment of the Government. Furthermore, the Government is expected to accelerate infrastructure project implementation, which will have a signi�cant impact on theeconomy, while issuing economic policy packages to create a more conducive investment climate in Indonesia. Regula-tory reforms at central and regional government ministries and institutions should restore con�dence and draw more investment. In addition, the integrated licensing system and ease of doing business should further facilitate

Closing Remarks

That is our rationale and policy direction I would like to convey at this opportunity. We know that, despite the ongoing economic recovery, many more challenges await us at home as well as in the global constellation. When confronting these challenges, we must avoid prioritising sectoral interests. We need to remain on the same page and advance through unity and synergy. When we march to the beat of the same drum, we build on the public con�dence already garnered thus far.

Before closing, I would like to express my sincere appreciation, gratitude and pride to all members of the Board of Governors and Bank Indonesia employees for their contribu-tions, dedication and diligence, thereby allowing Bank Indonesia to consistently pursue its mandate to maintain economic stability in Indonesia

Thank you.

Wassalamualaikum Warahmatullahi Wabarakatuh

Agus D.W. Martowardojo,Governor of Bank Indonesia

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Closing Remarks

Documents

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