We have successfully emerged from the 2008/2009 global crisis and can confirm that the Indonesian economy for 2010-2011 is in a stage of transformation from a recovery period to sustainable growth through greater stability.

As afirst line of defence, Bank Indonesia prioritises prudent and consistent monetary and banking policy. The policy response instituted by Bank Indonesia throughout 2010 aimed to maintain macro stability and the financial system. As part of the theme promoted on this occasion, greater stability is expected to buttress the post-crisis economic transformation process in Indonesia leading towards sustainable growth.

Bank Indonesia policy in 2011 will bolster the monetary and macroprudential policy mix as a continuation of that implemented during 2010. Policy will also be strengthened by considering all available instruments for optimal calibration. Such instruments include the following:

1. The policy rate (BI rate) will remain consistent and congruous to the achievement of the inflation target set, specifically 5%±1% and 4.5%±1% in 2011 and 2012 respectively, paying attention to the risk of inflationary pressures that are expected to intensify looking ahead.
2. Exchange rate policy will assist the achievement of the inflation target, consistent with the accomplishment of other macroeconomic targets, as well as provide assurance to the business community. Thepossible trinitywill consist of an optimal configuration of exchange rate stabilization, controlling capital flows and an interest rate response. In other words,considering the panoply of complexities faced, Bank Indonesia will overcome theimpossible trinityby administering amiddle ground solution, not a corner solution.
3. Monetary operations and macroprudential policy to control domestic liquidity will remain consistent and support the policy rate in order to meet the inflation target and control domestic demand.
4. Macroprudential policy regarding capital flowswill underpin exchange rate policywithout triggering any excessive impacts on domestic liquidity. Two of the policy packages issued in December 2010, namely increasing the statutory reserve requirement for foreign exchange and the reintroduction of limits on the daily position of short-term foreign bank loans, constitute macroprudential instruments used to manage capital flows. Amid a deluge of capital inflows, raising the statutory reserve requirement for foreign exchange shored up bank liquidity management. Meanwhile, limiting the daily positionof short-term foreign bank loans cemented prudential principles in the control ofsuch loans.

The formulation and implementation of this policy mixis crucial considering the interconnectedness between monetary stability and financial stability. Bank Indonesia will continue to calibrate its policy mix in order to optimise monetary stability, financial system stability and sustainable economic growth.

BANK INDONESIA POLICY DIRECTION

Economic activity intensified in 2010 on the back ofpositive banking sector performance and resilience, as reflected by well-maintained stability. The Financial Stability Indexdropped to 1.75; much lower than that reported during the 2007/2008 crisis period at 2.43. The intermediation function also improved despite pending opportunities for greater growth, credit risk remained under control (NPL below 5%), and capital was adequate (CAR reached 16%).

As reported, Bank Indonesia issued policy packages in December 2010 primarily aimed at reinforcing macroeconomic stability as well as boosting bank intermediation and resilience, namely:

1. Policy to increase bank intermediationis conducted to ensure the availability of supply through market deepening, more efficient borrowing costs, loosening the risk weighting of retail credit and working capital credit as well as efforts to reduce asymmetric informationthrough the provision of more accurate and complete credit data and information. Widespread efforts were introduced in order to increase the breadth of coverage and depth of intermediation throughfinancial inclusion programs as well as theBPD Regional ChampionProgram.
2. Policy to augment bank resilience is designed to support bank growth, competitiveness and ability to absorb risk. Accordingly, this will be achieved by refining fit and proper tests, improving the compliance function of commercial banks, risk-weighted assetsand risk management associated with Bancassurancepartnerships.
3. Policy to institutionally strengthen the competitiveness and resilience of rural banks and sharia banks aims to level the playing field with conventional banks. These efforts are supported by amending regulations pertaining to evaluating the quality of earning assets, restructuring thefinancing of banks and sharia units, limiting the financing funds of Islamic rural banks, and revising the licensing of commercial banks wishing to become sharia banks.
4. Policy to improve the efficacy of bank supervision aims to enhance the detection function of the early warning system as well assupplement the application of macroprudential supervision. This will be accomplished through the revision of regulations governing the bank supervision system based on risk, determining the status and follow-up supervisory measures of banks (exit policy) as well as evaluating bank soundness based on risk.

Future policy direction will focus on effortsto transform post-crisis economic and banking conditions towards sustainable growth through:

1. Exploiting the continuous supply of foreign exchangeto cover import requirements and financing needs, in addition to deepening the financial market as well as buoying macro stability, in particular the exchange rate.
2. Capital and institutional enhancements as well as boosting the competitiveness of national banks by expediting the consolidation process to commemorate the establishment of the ASEAN Economic Community.
3. Fostering productive growth and improving efficiency by steering the banks’ net interest marginalong a trajectory that is lower, more efficient and more conducive for the business community, including MSMEs.
4. A participative approach to broadening community access and interconnectivity in terms of financial services and banking institutions.
5. The development of a payment system that is more efficient, reliable, straightforward, and secureby emphasising infrastructural development, system development and strengthening the legal framework. Developmental efforts in the area of the payment system also relate to nurturingfinancial inclusion.
6. Implementing Indonesian Banking Architecture (IBA)by correctly positioning the various bank types in accordance with their respective roles in order to encourage synergy and consider the IBA Roadmap based on best banking practices.
7. Formulating an inclusive national financial strategy with the government taking into consideration demographics in Indonesia and relatively low public access to finance.
8. Strengthening governance to prevent excessive risk taking among executives, which could precipitate the emergence of moral hazard.