I. MONETARY POLICY STATEMENT

The Indonesian economy has been moving in tandem with developments in the global economy. The positive global financial market developments in recent months carried forward into May 2009, reflected in the improving condition of international stock markets and the steady decline in the risk perception indicator (Credit Default Swaps) in various countries. Meanwhile, stress testing of banks in the United States produced better results than many had expected, which also invigorated optimism for improvement in global economic conditions.

Expectations for improvement in the global economy have imbued market actors with positive sentiment that has also benefited the Indonesian economy. The CDS spread for Indonesia, an indicator of risk perceptions, eased from 403 bps at end-April 2009 to about 333 bps at end-May 2009. On the domestic market, capital inflows have been spurred by positive sentiment in the world economy and gradual recovery in global financial market liquidity. This in turn has led to appreciation in the rupiah, renewed growth in the composite stock index and improvement in yield on Indonesian Government Securities. Capital inflows have also bolstered Indonesia’s international reserves to 57.9 billion US dollars, sufficient for 6.0 months of imports and servicing of official external debt.

Despite signs of improvement, most developed economies are still some way from recovery and continue to show signs of slowing. Meanwhile, the global economy remains fraught with risk and uncertainty. As a result, pressure continues to bear down on the performance of the Indonesian economy. Indonesia’s exports have weakened further, despite indications of improvement in some export commodity prices. Counterbalancing this are falling imports consistent with weakening domestic demand and plunging imports of oil-based fuels as the country moves forward with kerosene energy conversion and energy diversification programmes.

Amid pressures from the global economy, the Indonesian economy has managed higher growth compared to other countries in the region. This performance is supported by still considerable levels of domestic demand, which provide the primary driving force for national economic growth. In Q1/2009, economic growth reached 4.4% (yoy). Although less vigorous than in the preceding quarter, private consumption in Indonesia charted 5.8% expansion, ahead of earlier forecasts. At this level, consumption has helped prevent further loss of economic growth. Bolstering the brisk pace of consumption are fiscal stimulus programmes such as Direct Cash Transfers, a pay rise for civil servants and increases in the Provincial Minimum Wages in some regions.  Added momentum for household consumption came from the flurry of activities surrounding the general elections, manifested on a sectoral level by spending in the subsectors of advertising, communications, food processing, hotels and restaurants and printing.

At the same time, pressure on the Indonesian economy has been evident in the falling investment growth in 2009. This decline is explained primarily by softening demand from weakening exports and domestic consumption, followed by tightening of financing sources. Non-construction investment recorded negative growth, while construction investment maintained momentum with the limited ongoing work on infrastructure construction.

Annual inflation continued on a downward trend in response to the still weakened condition of the domestic economy, low inflation in trading partner nations and improvement in supply of food stuffs. CPI inflation in May 2009 was remarkably low at 0.04% (mtm) or 6.04% (yoy). At this level, inflation was much less than the 0.48% (mtm) historical average recorded over the past five years. The low inflationary pressure is explained largely by falling pressure in non-fundamentals with low levels of volatile foods prices and administered prices. Similarly, favourable developments in fundamentals helped lower pressures in core inflation. The appreciating exchange rate, continued soft domestic demand and downward trend in inflation expectations were all factors contributing to low core inflation. In response to these developments, CPI inflation from January to May 2009 came to no more than 0.1%.

In the financial and monetary sector, indicators such as growth in cash outside banks, M1 and credit confirm the slowing economic growth trend. Cash outside banks, real M1 and banking transactions in the RTGS and clearing systems all recorded a declining trend in growth. Coupled with this was further tapering off in credit expansion. Amid brisk growth in depositor funds, the low rate of credit expansion has freed up liquidity in the bank system. Although bank lending has expanded at a very limited rate, some corporate sectors have begun seeking alternative funding sources on the stock and bond markets, an activity projected to grow in view of tax incentives and the ease of launching initial public offerings (IPOs).

The downward movement in the BI Rate since December 2008 has met with positive response in the banking system, albeit on a limited scale. Since December, bank time deposit rates have come down 136 bps in response to cuts in the BI Rate. Over the same period, rates for working capital credit eased by an aggregate 31 bps.

At the micro level, the Indonesian banking system is in comparatively stable condition. Supporting this are various indicators, including national bank capital and the capital adequacy ratio (CAR) recorded in April 2009 at a positive 17.6%. At the same time, the gross non-performing loans (NPLs) ratio has been held below 5%. Liquidity in the banking system, including the interbank money market, has progressively improved alongside growth in depositor funds. Lending began showing expansion in April 2009, although not at an optimum level.

Looking ahead, the domestic economy is predicted to slow further in Q2/2009 in line with earlier projections. Despite this, election activities are set to have a positive impact on household consumption, which is expected to maintain brisk growth during Q2/2009. Even so, the drive to sustain economic growth in subsequent quarters will require effective operation of the fiscal and monetary stimulus. If the effectiveness of economic stimuli can be improved, Bank Indonesia predicts economic growth to reach the upper limit of the 3%-4% range.

Meanwhile, the downward inflation trend is predicted to continue. Externally, this trend is supported by the prevailing low levels of inflation in trading partner nations. On the domestic front, inflationary pressure is curbed by persistent weak levels of domestic demand, low capacity utilisation and minimum pressure from administered prices. In view of these developments, the inflation forecast for Q2/2009 is 4.3%-4.6%, while inflation for 2009 will come at the lower end of the 5%-7% projection.
 After factoring in these developments, the Bank Indonesia Board of Governors Meeting decided to lower the BI Rate on 3 June 2009 by 25 bps from 7.25% to 7.00%.  This decision is expected to provide support for other measures to sustain domestic economic growth momentum while continuing to safeguard price stability and financial system stability in the medium-term.

In the months ahead, Bank Indonesia will keep a close watch on a range of domestic and global economic developments and carefully assess their impact on the overall economy. Bank Indonesia will also move forward with policies designed to support economic recovery through monetary stimulus, provided there is headroom for monetary relaxation and especially if there is further easing of inflationary pressure.