I. MONETARY POLICY STATEMENT

The Indonesian economy has potential for sustained improvement in keeping with global economic developments. Following signs of renewed vigour in recent months, the world economy took further steps towards recovery during July 2009. Policies adopted by authorities in many nations have had a positive impact on the world economy, reflected in strengthening domestic demand in some nations, including advanced economies. This improvement is also visible in Asia with gathering momentum in the economies of China, India and Korea. Alongside this, Singapore, earlier predicted to see further economic contraction, is showing signs of turnaround. The reinvigorated domestic demand in these Asian economies has bolstered economic performance in countries across the region, including Indonesia. Despite this, the outlook for world economic recovery remains daunted by high unemployment in Europe and America.

Improving expectations for the world economy have fuelled positive developments on global financial markets. During July 2009, financial markets recorded steady improvement. Stock markets in developed economies charted index gains on the back of positive sentiment invigorated by improved results in financial statements published by some financial institutions and global corporations. Developments on world money markets were also marked by optimism. Improving risk perceptions and confidence levels in the banking community have contributed to an easing of the liquidity crunch on money markets. Conditions continue to improve in the banking sector. Banks are showing more appetite for lending, as reflected in the relaxation of loan standards. Confidence in the improvement of world economic conditions, led by Asia, has prompted renewed inflows of foreign capital into regional markets. Regional stock indices have charted gains followed by currency appreciation.

The more conducive global trends have bolstered the performance of the Indonesian economy. The latest assessments indicate potential for higher than expected domestic economic expansion during Q3/2009.Supporting this is more robust consumption and exports, surpassing earlier predictions. The upward trend in regional economies, led by China and India, have stimulated Indonesian commodity exports such as crude palm oil, coal and copper. Concerning domestic demand, consumption indicators such as sales of durables and retail goods show signs of improvement. Better than predicted private consumption spending is being fuelled not only by private savings, but also bank financing. In addition, the onset of relative improvement in incomes has helped boost private consumption. Even so, investment has seen only limited improvement. This is explained by the condition of domestic demand and the external sector, which have yet to recover to normal. In view of these developments, economic growth in 2009 is predicted at the upper limit of the 3.5%-4.0% projected range.

Concerning prices, the downward inflation trend is forecasted to last throughout 2009. In July 2009, CPI inflation came to 0.45% (mtm) or 2.71% (yoy), down from the 3.65% (yoy) recorded one month earlier. Compared to preceding months, inflation was relatively strong during this period. This is explained, among others, by seasonal factors related to the onset of the new academic year and the end of the main harvest season, which brought an end to the downward movement in rice prices over recent months. Despite this, the annual rate of inflation remains on a declining trend. Besides the  appreciation in the rupiah, weak domestic demand and improved inflation expectations in line with sustained downward inflation trend have contributed to reduced inflationary pressures.

Renewed demand in emerging markets has strengthened the performance of Indonesia’s balance of payments, which is predicted to surpass earlier projections. Key to this are improving conditions in trading partner nations that have rejuvenated demand for exports. Besides this, optimism from the renewed strengthening of international market prices since mid-July 2009 is set to bolster exports during Q3/2009. In the capital and financial account, conducive conditions on global financial markets combined with sustained positive perceptions of the domestic economy have stimulated renewed inflows of foreign portfolio capital. Foreign direct investment is also predicted to forge ahead with the easing of the global liquidity crunch and positive outlook for the domestic economy. Taken together, the balance of payments is on track to post a surplus ahead of previous forecasts. International reserves at the end of July 2009 stood at USD57.4 billion, equivalent to 5.5 months of imports and servicing of official debt.

Positive sentiment on global financial markets has led to appreciation in the rupiah. The gains in the exchange rate have been strengthened by more robust supply of foreign currency in keeping with capital inflows. Optimism for global economic recovery, accompanied by stable domestic fundamentals reflected in the current account surplus, adequate international reserves, attractive yields on rupiah-denominated instruments, improving risk perceptions and subdued socio-political conditions in the aftermath of the presidential election have stimulated interest in investing in financial market assets in emerging economies, including Indonesia. Negative sentiment flaring in the wake of the Jakarta bombings bore down on the exchange rate, but with only short-lived effect. In the outcome for July 2009, the rupiah exchange rate underwent an average 0.82% appreciation to Rp 10,098, while closing the month at Rp 9,925 or 2.85% (p-t-p) ahead of end-June 2009. In the view of Bank Indonesia, the appreciation in the rupiah remains at a level that supports Indonesia’s export competitiveness in comparison to other Asian nations.

In the financial sector, conditions on domestic financial markets are moving in a positive direction. On the stock market, share prices have been bolstered by keen interest from domestic investors. The negative impact of the terrorist bombing in Jakarta proved only temporary, giving way to renewed gains in keeping with global financial market optimism. During July 2009, the composite stock index gained 14.6%. On the bond market, improved risk perceptions concerning the domestic economy strengthened demand for government bonds. Yield on government securities eased in line with the cuts in the monetary policy rate and mounting interest among foreign investors. Despite this, yield on medium long tenors remains on the high side, due to stubbornly high perceptions of risk.

In the banking sector, overall conditions remain stable alongside improved bank interest rate response to reductions in the BI Rate. On the micro level, the national banking system remained in stable condition as indicated by the comfortable level of the capital adequacy ratio (CAR) in June 2009 at 17.0%. At the same time, the gross non performing loans (NPLs) ratio remains safely below 5% with the net ratio at less than 2%. Banking liquidity, including liquidity on the interbank money market, is steadily improving alongside growth in depositor funds. At the same time, the cumulative 250 bps cut in the BI Rate during 2009 has been followed by reductions in bank interest rates. Since the onset of monetary policy relaxation, bank interest rates (time deposits) have fallen by about 188 bps. However, the lending rate response has been considerably more limited at about 24 bps. Bank loan disbursements have begun to improve, although still at a very slow rate. As of June 2009, bank lending had widened by only 1.1% (ytd). The tight lending is explained, among others, by strong perceptions of risk in the real sector, while on the other hand, demand for credit remains weak due to flagging investment activity.

After consideration of these developments, the Bank Indonesia Board of Governors Meeting convened on 5 August 2009 decided to lower the BI Rate by 25 bps from 6.75% to 6.5%. The decision to ease the BI Rate was taken after the Bank Indonesia Board of Governors Meeting deliberated that inflation would maintain a declining trend in view of the present limited domestic demand and steady decline in inflation expectations. Bank Indonesia also believes that the reduction in the BI rate is consistent with the Bank Indonesia inflation target. Despite this, Bank Indonesia sees the likelihood of rising inflationary pressure in 2010, fuelled by escalating domestic demand and increases in international market commodity prices. Within this context, monetary policy will be directed so that this potential for stronger inflation can be better anticipated for achievement of the approximately 5% inflation target in 2010.