“This is the time for Indonesia to move forward, and we will”
Bp. Perry Warjiyo, Ph.D., Deputy Governor, Bank Indonesia believes that in 2016, the economic prospects for Indonesia will be better, with higher economic growth and macroeconomic and financial stability. It will be even more promising in 2017 and beyond. Following the success of strong macroeconomic policy adjustments since the Federal Reserve’s “Tapper Tantrum” in May 2013, the Indonesian economy has shown signs of turning around since the second half of 2015.There has been macroeconomic and financial stability in Indonesia, despite the continued turbulence in the global and financial environment.
Excerpts from Perry Warjiyo’s speech at the BNP Paribas Economic Outlook 2016 event held on March 23, 2016 in Jakarta…
Global outlook and risks
We put particular emphasis on three aspects of the global economic and financial outlook and risk: global economic growth, commodity prices, and divergence of monetary policies. In addition, we also monitor closely the developments in China because of its important role in the global and regional economy.
On commodity prices: Last year, we saw a decline in our export commodity price index. This year, it will decline further before rebounding in 2017. This means that commodity prices will touch the bottom this year, and will start rising next year. Although volatile in the short-term, oil prices are likely to be around $35 per barrel, much lower than the $50 per barrel assumed in the budget. That means our inflation will be lower, even though it puts pressure on budget revenues. All in all, it is imperative for Indonesia to move from being a commodity exporter to an exporter of manufactured products.
On the divergence of monetary policy: After the first Federal Funds Rate (FFR) increase of 25 bps at the end of last year, most markets predicted further 50 bps increases this year, once probably in June and another at the end of year. We already included this scenario in our policy making. Although it is still challenging, I think the uncertainty and volatility will be lower this year compared to 2015. We closely monitor the negative policy rates of Euro and Japan. Frankly, I doubt that these will be effective in addressing their deflation problems; quantitative easing may work better. All in all, the FFR outlook and negative rates in Europe and Japan will be the “push factors”, with the positive outlook in our part as the “pull factor”, and will have a positive effect on foreign direct investment (FDI) and portfolio inflows into Indonesia and the rupiah exchange rate.
On China: There are three factors related to China that we need to take into account: trade, renminbi depreciation, and investment. On the trade front, the slowdown in China and decline in commodity prices continue to put pressure on our exports. Our simulation shows that every 1per cent decrease in the growth rate in China corresponds to a 0.3 per cent slowdown in Indonesian economic growth. I do not believe there will be a big devaluation in the renminbi that we saw last year. I think the People’s Bank of China (PBoC) will continueto interveneand reckon that renminbi depreciation will be gradual this year. The challenge in China is, of course, the policy adjustments that are being implementedright now, i.e., further capital account liberalisation, financial market development, and greater exchange rate flexibility. This leads to the third China factor that we must not forget. China is aggressively pursuing its outward investment to support economic growth, manifested in its ambitious silk road strategy. So we have to prepare and open our arms for greater investments from China, as we have done in the case of Japan and South Korea.
These are what we see from the global economic and financial condition. Last year, the period until September was the most difficult time, but after December, we see some improvements. The uncertainty is still there, but overall, we are more confident now. We have incorporated these uncertainties in our policy making. Indonesia has shown its resilience in the past, and it is poised to progress well now and in the future.
Indonesia economic outlook and risks
With stimulus on the fiscal and monetary fronts, as well as accelerated structural reforms in many key areas, we will be seeing significant improvements in the Indonesian economy this year and beyond. The fiscal stimulus started to kick in around the third and fourth quarter of last year, and budget absorption has been accelerated since early of this year, notably in capital expenditures. The continuous series of deregulation packages from the government will provide a better investment climate, improve competitiveness, and boost economic activity. We are seeing the accelerated completion of key infrastructure projects: toll roads, airports, energy, irrigation, and more. Our macro prudential relaxation and monetary easing will also provide support for higher economic growth.
On economic growth: Last year, we recorded an economic growth of 4.79 per cent with the fiscal stimulus. Economic growth touched a low of 4.66 per cent in the second quarter of last year and picked up to 5.04 per cent in the last quarter. Investment in construction related to government projects together with private and government consumptions supported the recovery. This year will be much better. Compared to early last year, where the government had to deal with administrative issues, this year the fiscal stimulus through the acceleration of government projects has already started to kick-in in the first quarter. With that, our economic growth forecast for this year will be around 5.2-5.6 per cent. It will be supported by fiscal stimulus as well as monetary policy easing to accelerate economic growth. Private consumption will still be robust. Government related expenditures, especially investment in infrastructures, will boost the economy, as we have seen since the third quarter of 2015. That is why the sectors that start rebounding will be construction, transportation, communication, and electricity, which are the sectors that have benefited the most from the government’s fiscal stimulus package. I am sure that the trade and manufacturing sectors will follow as economic growth starts to gain momentum. This is the dynamics of the stimulus to economic growth that we will be seeing to the future.
On inflation: We managed to lower inflation from 8.3 per cent in 2014 to only 3.3 per cent in 2015. I think a part of our success was due to the credibility that our monetary policy gained since 2013. This year and next year, we forecast inflation within the range of 4±1 per cent. In the past, the challenge of price stability mainly came from administered prices, namely the subsidy onfuel and electricity. But the government has succeeded in introducing subsidy reforms. This helps the central bank to be more certain in forecasting and controlling inflation. Unlike in the past, both the consumer price index (CPI) and core inflation will be convergent and under control. Exchange rate pass-through has been benign, because of weak domestic demand, a decline in commodity prices, and well anchored inflation expectations.
On current account deficit: Our macroeconomic adjustments in the past have succeeded in lowering the current account deficit (CAD) from apeak of 4.4 per cent of GDP in the second quarter of 2013 to about 2 per cent for the year 2015. For Indonesia, a CAD of 2.5-3 per cent is still sustainable, because we still need to grow and for that, we need sustainable financing from FDI and other long-term financing. That is why, with a 2 per cent CAD in 2015, we have room for monetary easing without worrying about external sector stability. This year, as economic recovery gains momentum, CAD will be expected to widen, but still, within our long term sustainable CAD norm of 2.5-3 per cent of GDP. We expect more than enough external financing for these deficits, with FDI constitutingmost of the capital inflows and, to a lesser extent, long-term private external borrowing and portfolio investments.
On financial system stability: Overall, the banking industry is sound, with a relatively high capital adequacy ratio (CAR) of about 21 per cent. Growth in lending is slowing;it was only about 10 per cent in January 2016. But with both fiscal and monetary stimulus, as well as liquidity injection resulting from the 1 per cent reduction in the reserve requirements that Bank Indonesia decided upon recently, we expect lending growth to increase to about 12-14 per cent this year. Overall, non-performing loans (NPL) is low at 2.7 per cent (gross) or 1.4 per cent (net), although the percentage of non-performing loans has been increasing a bit for some banks, especially on loans to the mining sector. We have analysed corporate risks as well as household risks. Last year, we recorded declining corporate earnings as the economy was slowing down. But overall, corporates are adjusting quite well, as they have been making efforts to improve efficiency and repay their debts, both local and external, early. With the economy rebounding, overall corporate performances will also improvethis year.
Bank Indonesia policy mix
Bank Indonesia’s mandate is to achieve price stability (inflation) and maintain exchange rate stability to support economic growth. We also support financial system stability. For policy making, we analyse and forecast macroeconomic condition two years ahead – inflation, economic growth, exchange rate, current account balance, and bank lending – taking into account the latest assessment offiscal and financial conditions as well as global economic growth, interest rates, and commodity prices. We do not rely only on one instrument, i.e. interest rate, but employ a policy mix of monetary, macro prudential, capital flow management and payment systems. As such, in every monthly board meeting, we formulate interest rate, exchange rate, monetary operation, capital flows management, and macro prudential measures based on the latest assessment and forecast of overall macroeconomic and financial conditions.
Early last year, we noted the need for balancing macroeconomic stability and supporting economic growth. We forecast at the time that inflation would be within the targeted level, the current deficit would narrow, while economic growth would slow down because of both external and domestic factors. That was the theme of policy co-ordination between Bank Indonesia and the government. We agreed to increase the fiscal stimulus to support economic growth, benefiting from the savings following subsidy reforms in 2014. At Bank Indonesia, we also rebalance our policy mix. While an interest rate cut was not possible at that time because of the possibility of FFR increases, we have started to relax our macro prudential policy. We relaxed loan-to-value (LTV) ratios by an average 10 per cent in June 2015 and lowered reserve requirements in June and December 2015. Following the first FFR increase in December 2015 and less uncertainty about possible FFR increases, we started to cut our policy rates this year. Thus, both our monetary and macro prudential policies have now been eased. Together with the fiscal stimulus and structural reforms by the government, the national policy mix, i.e. fiscal, monetary and structural reforms, are likely to accelerate economic growth while maintaining macroeconomic and financial stability.
Let me brief you on the latest board decision on Bank Indonesia’s policy mix.
On the monetary policy: Since inflation will remain low and within target for this year and the next, and the current account deficit will be under control and within the sustainable range, there has been room for monetary easing. We started to cut our BI policy rate by 25 bps in January 2016.
We cut again the BI rate in February and March by 25 bps each to 6.75 per cent. More than that, we cut again our reserve requirement by 1 per cent to 6.50 per cent in February 2016, which we expect will add liquidity in the banking system by about IDR 34 trillion (about $2.6 billion) and, with a money multiplier of about 4.8, add liquidity in the economy of about IDR 163 trillion ($12.5 billion). Our signal is clear: macroeconomic stability provided us room for monetary easing to support economic growth through interest rate cuts and injecting liquidity in the banking system. Even though there is still room for further easing, we will be cautious in considering further monetary easing. We will assess overall economic and financial developments, both domestic and global, thoroughly when we formulate monetary policy in our board meetings. In the meantime, we will focus on strengthening our monetary operations to reinforce the monetary policy transmission mechanisms.
On the exchange rate policy: We will allow for greater exchange rate flexibility. We will let the market mechanism determine the exchange rate according to evolving supply and demand. And we are proud that with continuous financial market deepening, the foreign exchange market has become more developed now, allowing greater dependence on market forces to determine exchange rates. That is why, in most cases, the exchange rate reflects the market mechanism. But we do not shy away from intervening in the market if the exchange rate becomes volatile and leads to jitters in the market, especially in the case of large foreign capital reversals. If necessary, we intervene by both supplying the foreign exchange and buying government bonds from the secondary market. That is why you do not see excessive volatility either in the exchange rate or in the government bond yield. Last year was a bit difficult because there were equity capital outflows due to turbulence in the global market. But it has been reversed this year, with accumulated inflows from both fixed income and equity. Our exchange rate appreciated by 5.5 per cent year-to-date by mid-March. Going forward, with the economy rebounding, I do believe that both domestic and global factors will provide a favourable environment for our exchange rate and financial market.
On the macro-prudential policy: We started with relaxing our loan to value ratio, on average about 10 per cent in June last year. We also eased liquidity in the banking system, both through our monetary operations as well as a reduction in the reserve requirement. Overall lending growth is still low at about 10 per cent now as demand is just rebounding and is not strong as yet. However, a close look at different sectors shows that construction loans increased by 20 per cent and real estate loans by 23 per cent, showing a significant rise in demand for bank lending from fiscal stimulus-related activities. We havenot seen the impact on mortgage loans yet; it grew by about 10 per cent last month, as demand for housing has not shown signs of recovery yet. In the second half of last year, with the fiscal stimulus and monetary easing, domestic demand kept pace and so did demand for bank lending. We are seeing now increasing demand for loans for government project related activities, but we will be seeing increasing demand for bank loans to other economic sectors as domestic economic growth becomes more broad-based.
Final remarks
Economic growth will be higher, withmacroeconomic and financial stability. There are some risks, of course, that we need to closely monitor and address, e.g. FFR increases, developments in China, commodity price declines, and fiscal revenues. This is the time for Indonesia to move forward, and we will. The three aspects of the policy mix at the national level, i.e. fiscal stimulus, monetary easing, and accelerated structural reforms, will reinforce higher economic growth. We know it, and investors see it. That is why investors have already singled out Indonesia as one of the promising economies.
