Monetary Policy Report Quarter III-2008 - Bank Sentral Republik Indonesia
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October 22, 2020

General Review

Inflationary pressure in Indonesia remained strong during Q3/2008. Driving this were high public expectations of inflation, buoyant domestic demand and the impact of imported inflation related to the potential for rupiah depreciation brought about by the US financial crisis. In their policy response to these developments, the Bank Indonesia Board of Governors sees the need for curbing of inflationary pressure to achieve the medium-term inflationary target and safeguard the stability of the economy as a whole.

Q3/2008 was dominated by global financial markets woes and the fallout of these problems on the Indonesian economy. The world economic slowdown has now taken hold in several industrialised nations and begun spreading to emerging markets, including Indonesia. The turmoil on global markets has spread inexorably further, with the Indonesian economy also affected. Despite Indonesia's robust economic fundamentals, the negative sentiment engendered by the crisis prompted a new wave of capital outflows. This has put pressure on both the stock market and the rupiah exchange rate. The stock index plunged dramatically alongside depreciation in the exchange rate. Both developments augur for a pessimistic outlook for the domestic economy. In response, Bank Indonesia and the Government have maintained close policy coordination and continue to monitor developments in the economy on a regular basis.

With conditions still shrouded in these problems, inflation and economic stability remain the primary focus of Bank Indonesia. Efforts to strike an overall balance between inflation control and the risk of instability on the money market are ongoing. To curb inflation, Bank Indonesia has pursued a tight bias monetary stance by raising the BI Rate 75 bps during Q3/2008 and optimising the use of all monetary policy instruments at its disposal. The upward movement in the BI Rate was followed by higher rates for bank time deposit and lending rates. As of August 2008, time deposit rates had climbed faster than the BI Rate, with rates for working capital credit and investment credit following suit. Rates for consumption credit, however,were relatively stable.

Bank Indonesia has kept a close watch on money market liquidity, with several banks caught in a liquidity squeeze. This tightening was triggered by disparities in liquidity held by banks, given that liquidity in the banking system was still adequate overall. Added to this, high-paced bank credit expansion not balanced by sufficient growth in depositor funds led to a liquidity crunch at some banks. The cautious stance taken by banks to anticipate the surge in demand in advance of the religious festivities and low rate of expansion in the government account put added pressure on liquidity in the banking system. Nevertheless, this tightening of liquidity is predicted to be temporary. The liquidity squeeze is forecasted to ease after the end of the Eid-ul-Fitr period, when cash begins returning to the banking system. Added Monetary Policy Report - Quarter III-2008 to this will be the expansionary trend in government accounts during Q4/2008. To resolve the problem of tight liquidity, Bank Indonesia has pursued a series of measures through improvements in monetary operations.

Amid the global financial turmoil of Q3/2008 and slowing world economic growth, the Indonesia economy still managed to chart healthy growth. In preliminary figures, the GDP grew by 6.3% (yoy) in Q3/2008, following 6.4% growth (yoy) in Q2/2008. Household consumption was again indicated as the main driving force for this growth. Vigorous growth in consumption was bolstered by continued strength of purchasing power and increased availability of consumer finance. Investment, another component of domestic demand, also recorded high growth, particularly for non-construction activities. Nevertheless, the slowdown in the world economy has also taken the edge off Indonesia's export growth, although growth remains strong. Alongside this, imports are forecasted to expand rapidly as suggested by the strength of domestic demand and export production needs.

Global economic developments subsequently put pressure on Indonesia's balance of payments in Q3/2008. Export growth is lagging behind that of imports. Imports maintained a rapid pace of expansion, driven by heavy domestic demand and also price increases. The combination of the economic slowdown in the developed world and falling world commodity prices is set to bear down on Indonesia's export performance. However, this decline is not expected to be excessive, given that Indonesia's exports are natural resource-based and therefore less sensitive to an economic slowdown in the developed world. In addition, international trade in the Asia-Pacific region, led by rapid expansion in China and India in recent years, is adequate to keep exports from steeper decline.

Analysis of the composition of imports reveals that import growth has taken place mainly in raw materials and capital goods. This in turn will spur growth in domestic production and production capacity, which will benefit the economy in the medium to long-term. Leading importers were the industry sector (specifically the chemical industry subsector, the base metals, iron and steel subsector and the transportation equipment, machinery and tools subsector) and the transport and communications sector, both of which have substantial backward and forward linkages.

In the capital and portfolio account, negative sentiment spurred by the turbulence on global financial markets prompted a wave of capital outflows. In portfolio investments, foreign capital recorded net outflows. To cover the costs of rising imports, domestic economic actors have drawn on assets placed overseas and some have availed foreign financing, as indicated by the other investment component that recorded net inflows. In the upshot of these developments, international reserves reached USD57.1 billion, equivalent to 4.2 months of imports and servicing of official debt.

The outflows of foreign capital put downward pressure on the rupiah during Q3/2008. Nevertheless, Bank Indonesia kept a close watch on movement in the exchange rate under the forex market stabilisation policy aimed at mitigating pressures and easing rupiah volatility. As a result, the average value of the rupiah in Q3/2008 appreciated further over the earlier period. Measured as a quarterly average, the rupiah gained 0.47% from Rp 9,259 to the USD to Rp 9,216 to the USD. Downward pressure began to set in near the end of Q3/2008 as foreign investor behaviour came under the influence of global economic developments. Risk aversion among investors led to pressure on the rupiah. Downward pressure was also sustained by regional currencies that weakened from the spillover effects of external turbulence. On the other hand, the rupiah still offered attractive investment yields, reflected in the broad interest rate differential. This in turn eased pressures and helped stem further capital outflows from rupiah instruments.

In related developments, the Indonesian Composite Index (IDX) closed at 1,832 at the end of the period under review (September 2008), a drop of 21.9% compared to end Q2/2008. The disappointing Q3/2008 performance of the IDX Index is explained more by the influence of deteriorating global financial markets as more and more international financial institutions faced bankruptcy.

Looking forward, economic growth is predicted to remain at a healthy 6.2%-6.4% amid the turmoil besetting the world economy in 2008 before tapering off slightly in 2009. The continued strength of economic growth is driven primarily by domestic demand. In turn, domestic demand is not only supported by availability of financing, but also the continued strength of public purchasing power. Household consumption is forecasted to maintain momentum. At the same time, investment growth is being fuelled mainly by non-construction investment. Externally, the fast-rising imports of capital goods and raw materials are expected to boost the future capacity of the Indonesian economy. Underlying this optimism are the substantial multiplier effects on the economy in the industry sectors importing these capital goods and raw materials. On the other hand, growth in exports of goods and services is forecasted to decline in keeping with the slowdown in the world economy and falling international commodity prices. Inflationary pressure is also predicted to remain high during the coming months. CPI inflation in 2008 is forecasted in the range of 11.5%-12.5% (yoy). In 2009, inflationary pressure is expected to ease midway through the year in response to the current monetary policy stance and falling imported inflation as international commodity prices maintain a downward trend. Accordingly, inflation in 2009 is forecasted in the range of 6.5%-7.5% (yoy).

Looking forward, the Indonesian economy is also confronted by various risks. These risks are explained largely by developments in the world economy, and most importantly the outworking of the global financial crisis. Economic growth may take a downward bias due to the crisis, which is also likely to affect balance of payments performance given the potential for falling international commodity prices. Within the future policy framework, Bank Indonesia will focus on efforts to curb the risk of inflation while avoiding excessive disruption to the upward trend in economic growth. To this end, Bank Indonesia will continue to implement a prudent,measured monetary policy stance while sustaining the momentum for economic growth. The decision of the BI Board of Governors to raise the BI Rate a further 25 bps to 9.5% in October 2008 was based primarily on this reasoning. In regard to financial stability, the Bank Indonesia policy is also expected to safeguard the stability of the domestic financial system. The policy will also be reinforced by more optimum use of other monetary instruments, such as forex market interventions to minimise volatility in the rupiah exchange rate and maintain adequate liquidity on the money market. Bank Indonesia will maintain a close watch and monitor global economic developments and make immediate policy adjustments if necessary to safeguard macroeconomic stability and achievement of the medium to long-term inflation target.

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