Global economic developments continue to influence the dynamics of the domestic economy. Risks on emerging markets improved in response to recent positive developments on global financial markets, with similar improvement also taking place in Indonesia. Key to this is the ongoing stabilisation in the US banking sector and the commitments of the G-20 nations, who are cooperating in serious actions to resolve the current crisis. At the outbreak of the global crisis, the CDS spread, a key indicator of risk perceptions concerning Indonesia, surged to 985 bps. Since then, however, this spread has narrowed to about 403 bps.

At home, the secure atmosphere of the national legislative elections and easing of investor concerns over the widening private sector external financing gap helped boost positive sentiment for the Indonesian economy and strengthen capital inflows. This in turn led to appreciation in the rupiah, renewed growth in the composite stock index and improvement in Government Securities yield. Capital inflows also bolstered Indonesia’s international reserves to 56.6 billion US dollars, sufficient for 6.2 months of imports and servicing of official external debt.

Away from Indonesia, improvement in global financial indicators buoyed more by sentiment has not been reflected in global economic recovery. Global economic indicators continued to deteriorate with slumping performance in developed economies accompanied by uncertainty over recovery from the credit crunch. Given these conditions, pressure is expected to keep bearing down on Indonesia’s exports, despite indications of improvement in some export commodity prices. Imports also weakened in response to softening domestic demand. The steep drop in imports of raw materials and capital goods since Q1/2009 is feared to put further downward pressure on domestic investment in Q2/2009. Within this context, the planned implementation of the fiscal stimulus through infrastructure construction in Q2/2009 is expected to slow the rate of investment decline. In the household consumption sector, while some indicators point to slowing growth, the downward trend in April 2009 was halted to some extent by a surge in spending related to the legislative elections and a civil servant pay rise. Various surveys conducted by Bank Indonesia also indicate improvement in the consumer confidence index.

Annual inflation came down further in response to the continued weakening in the economy, the deflationary trend in trading partner nations and improvement in supply of food stuffs. Monthly CPI figures for April produced 0.31% deflation (mtm) with annual inflation at 7.31% (yoy), considerably below the 7.92% level of the preceding month. This softening of inflationary pressure resulted largely from deflation in volatile foods in the customary seasonal trend. Plentiful supply on the domestic market - mainly from the onset of the harvest season – pushed volatile foods inflation well below the level reported in the preceding month. Pressure from administered prices, another non-fundamental, similarly eased. At the same time, core inflation, a more stable reflection of fundamentals, recorded an unusual -0.06% deflation (mtm) during April.

In the financial and monetary sector, indicators such as growth in the money supply and credit expansion offered confirmation of slowing economic growth. In April 2009, M0 growth remained negative, confirming this stagnating trend. Bank credit expansion reached 24.3% (yoy) in March 2009, down from 27.6% (yoy) in February primarily due to weakening credit demand in the corporate sector. Contrasting this was more vigorous credit growth for micro, small and medium enterprises (MSMEs), reflecting the relative resilience of this business category. On the supply side, the reduced credit expansion is explained by bank caution in lending, due to heightened credit risk. The tightened availability of credit financing has prompted the corporate sector to seek alternative funding from stocks and bonds, a trend that is predicted to continue.

Response to the BI Rate has begun to take hold in the banking system. The cumulative 200 bps cut in the BI Rate since December 2008 has met with 126 bps reduction in time deposit rates. Over the same period, working capital lending rates eased by an aggregate 16 bps. The lag in bank lending rate response is explained by the still high level of time deposit rates and the sizable risk premium assessed by banks in their loan interest rates.

Stress tests conducted by Bank Indonesia indicate generally stable conditions in the national banking system. The various indicators of this include upward trends in bank capital measured for all banks nationwide and in the capital adequacy ratio. The capital adequacy ratio remained strong at 17.4 % with non-performing loans (NPLs) under relative control (NPLs Gross at 4.5%, NPLs Net at 1.9%). Banking liquidity, including liquidity flows on the interbank market, has steadily improved with reduced market segmentation and growth in depositor funds.

Looking ahead, the domestic economy is predicted to slow further in Q2/2009 in line with earlier projections. This is also consistent with the forecast for further contraction in the global economy. In addition, caution is warranted with regard to recent upswings in the global financial market. These gains may not last long given that estimated losses booked by global financial institutions are predicted to swell to 4 trillion US dollars, far greater than originally suspected. As a result, the ongoing deleveraging process could take longer than expected. With these developments in the global economy, the Q2/2009 performance of the Indonesian economy will depend to a great extent on domestic demand, led by consumption and investment. The effectiveness of the banking system in responding to the monetary stimulus and fiscal stimulus in the infrastructure sector, expected to begin flowing in Q2/2009, will therefore be crucial. After factoring in these developments, Bank Indonesia forecasts that the Indonesian economy will stay on track with the originally projected growth range of 3%-4%.

Current developments in external and domestic factors augur for a future downward trend in inflation. In externals, the deflationary trend in trading partner nations and presently low international commodity prices support predictions of further decline in future inflationary pressure in Indonesia. On the domestic front, inflationary pressure will be curbed by low levels of capacity utilisation, adequate supplies of staple goods and minimum pressure from administered prices. In view of these developments, the inflation forecast for Q2/2009 is 4.3%-4.6%, while for 2009, inflation is expected to reach the lower end of the 5%-7% projected range.

On 5 May 2009, after careful consideration of persistent inflationary pressure and the still flagging pace of the domestic economy, the Bank Indonesia Board of Governors’ Meeting decided to lower the BI Rate 25 bps from 7.50% to 7.25%. This decision is expected to shore up other measures to sustain the momentum of domestic economic growth while continuing to safeguard price stability and financial system stability in the medium-term.

In the months ahead, the downward trend in inflation and slowing economic activity will afford Bank Indonesia added room for relaxation of monetary policy. However, this monetary relaxation cannot produce results on its own, and instead will need to be supported by banking sector responses and synergy with the Government fiscal stimulus. To this end, Bank Indonesia and the Government will maintain close coordination to ensure the effective operation of the various stimulus measures for the domestic economy.