monetary policy report quarter ii 2014 - bank indonesia · monetary policy report| 3 19.1% (yoy) in...

M o n e t a r y P o l i c y R e p o r t | 1

EXECUTIVE SUMMARY

During the second quarter of 2014, the Indonesian economy indicated the ongoing economic structural rebalancing process, underpinned by maintained macroeconomic stability. Economic performance has been inextricably linked to policy consistency instituted by Bank Indonesia in conjunction with the Government since the middle of 2013 to reinforce economic stability and manage economic growth in a more balanced and sustainable manner. During the first two quarters and in July of 2014, Bank Indonesia held its benchmark BI rate at 7.50%, while the lending facility rate and deposit facility rate were maintained at 7.50% and 5.75% respectively. Current policy remains consistent with ongoing efforts to steer inflation towards its corresponding target corridor of 4.5±1% in 2014 and 4.0±1% in 2015, while concomitantly reducing the current account deficit to a more sustainable level. Such policy is strengthened through coordination with the Government in the context of cyclical policy to manage domestic demand as well as to implement structural and medium-term policy measures.

The global economic recovery persisted. It was supported by economic momentum in advanced countries as accommodative monetary policy endured and fiscal pressures eased. Revised up GDP figures in the first quarter along with sound actual GDP in the second quarter, evidenced stronger US economic recovery momentum as investment, consumption and the external sector expand. Meanwhile, economic growth in developing countries is expected to remain relatively limited, thereby exacerbated the ongoing downward trend in international commodity prices. China’s economy improved during the second quarter of 2014 as a result of the stimuli introduced.

Domestically, the Indonesian economy cooled off during the second quarter of 2014 due to a contraction in exports, particularly natural resource based commodities. Economic growth reached 5.12% (yoy) in the reporting quarter, decelerating from 5.22% (yoy) in the preceding quarter. Weak export performance of natural resources, for instance coal, crude palm oil (CPO) and minerals, was responsible for the economic downswing and indicated by sluggish regional economic performance on the islands of Sumatra and Kalimantan, where mining and plantation production is based. Concerning domestic demand, the economic downturn was precipitated by a contraction in government spending due to the suspension of social assistance disbursements and a slump in non-construction investment. Notwithstanding, tenacious household consumption, linked to activities associated with the recent presidential election as well as maintained public purchasing power as inflation decreased, bolstered economic growth in the second quarter of 2014.

The Indonesia balance of payments (BoP) improved during the second quarter of 2014 despite a growing current account deficit. Sound financial and capital account performance helped sustain the BoP surplus. Nonetheless, the current account deficit reached US$9.1 billion (4.27% of GDP) in the second quarter of 2014, which lower than the deficit reported in the same period of the previous year at USD10.1 billion (4.47% of GDP). This figure is in accordance with the stabilisation policy instituted by Bank Indonesia together with the Government, despite expanding from US$4.2 billion (2.05% of GDP) in the previous quarter due to seasonal trends. A growing non-oil and gas trade surplus was

MONETARY POLICY REPORT Quarter II 2014


insufficient to offset the expanding oil and gas trade deficit. Export commodities such as coal, CPO and minerals declined in line with moderating emerging market economies, coupled with enforcement of the Mineral and Coal Mining (Minerba) Act. Conversely, manufacturing exports, such as automotive, textiles and clothing continued to expand in line with economic recoveries in advanced countries. Imports, especially of consumer goods and oil, were relatively high during the second quarter of 2014 in accordance with seasonal factors during the holy fasting month and Eid-ul-Fitr celebrations. Meanwhile, servicing external debt and repatriating dividends/coupons, which intensified due to seasonal trends during the reporting quarter, compounded pressures on the current account deficit. In the capital and financial account, a larger surplus than that registered in the preceding quarter was reported due to a surge in portfolio investment inflows and FDI in line with the favourable perception of investors regarding the domestic economic outlook. Consequently, foreign exchange reserves in Indonesia increased to US$110.5 billion, equivalent to 6.4 months of imports or 6.2 months plus servicing external debt, which is well above minimum international adequacy standards of around three months. Looking forward, the current account deficit is expected to recover in upcoming quarters as manufacturing exports rebound and exports of minerals recommence, accompanied by a deceleration of non-oil and gas imports.

The rupiah experienced depreciatory pressures but volatility was mitigated. Point to point, in the second quarter of 2014 the rupiah slumped 4.18% (mtm) to a level of Rp11,855 per US dollar, while on average the rupiah appreciated during the reporting period by 1.76% to Rp11,629 per US dollar. Strong corporate demand in line with seasonal trends that favour servicing external debt and repatriating dividends/coupons placed additional pressures on the rupiah. Additionally, the wait-and-see attitude of investors concerning the results of the presidential election, coupled with external conditions such as geopolitical tensions in Ukraine and the ongoing conflict in Iraq, also affected rupiah performance. In July 2014, the rupiah appreciated on the back of a peaceful and orderly presidential election. On average, the rupiah strengthened 1.8% (mtm) to a level of Rp11,682 per US dollar, compared to 2.4% point-to-point, and closed at a level of Rp11,578 per US dollar. Looking ahead, Bank Indonesia will consistently maintain rupiah exchange rates in accordance with its fundamental value.

Inflation was controlled and continued to follow a downward trend, thereby supporting achievement of the inflation target in 2014, namely 4.5±1%. Headline inflation in the second quarter of 2014 was 6.70% (yoy), down from 7.32% (yoy) posted in the previous quarter. Controlled inflation endured into July 2014, at a rate of 0.93% (mtm) or 4.53% (yoy), which is relatively low compared to the seasonal average during Ramadan over the past three years. Lower inflation is credited to less intense inflationary pressures on volatile foods along with controlled core inflation. Inflation of volatile foods eased as supply increased upon the arrival of the harvest season at a number of production centres. Meanwhile, moderating domestic demand, minimal international price pressures and well-anchored inflation expectations helped control core inflation.

Solid financial system stability was supported by banking system resilience and relatively well-maintained financial market performance. Banking industry resilience was resolute, with credit risk, liquidity risk and market risk all well mitigated and supported by a sound capital base. At the end of the second quarter of 2014, the Capital Adequacy Ratio (CAR) of the banking industry was high at around 19.40%, which is well in excess of the minimum 8% threshold. In addition, non-performing loans (NPL) were low and stable at around 2.00%. Credit growth to the private sector decelerated to 16.6% (yoy) from


19.1% (yoy) in the previous quarter in line with the ongoing economic rebalancing process. Sound liquidity conditions in the economy and banking industry were maintained during the reporting period, as reflected by growth of M2 and deposits that expanded 13.1% (yoy) and 13.6% (yoy) respectively, accompanied by relatively stable interest rates on the money market. Tight liquidity was experienced at several banks, especially those pursuing aggressive expansion strategies and due to internal conditions, which helped drive healthy competition for funds and raised bank interest rates. Meanwhile, the capital market performed well during the second quarter and July of 2014, substantiated by gains in the IDX Composite.

Looking ahead, Bank Indonesia predicts economic rebalancing to continue, supported by maintained macroeconomic stability. Economic growth in 2014 is projected in the range of 5.1-5.5%, unchanged from the preceding BI projection, with a bias towards the lower end of the range as a result of weaker-than-expected global GDP along with curtailed government spending in the 2014 budget. Revised down global economic growth projections prompted weaker export performance, while reduced government spending undermined government consumption. In 2015, the domestic economy is projected to expand in the range of 5.4-5.8%, again unchanged from the previous estimate. The projected economic upswing in 2015 is based on a global economy more conducive to growth than during the previous year. Accordingly, the contribution of exports to growth is also expected to increase. In line with a moderating economy in 2014, inflation is projected at a lower rate than in 2013, falling within the target corridor of 4.5±1%. Furthermore, in 2015, measured monetary policy, reinforced by policy coordination with the government, is expected to further lower inflation to a rate of 4.0±1%.

Bank Indonesia will tirelessly monitor potential risks that could intensify pressures on macroeconomic stability, undermine the achievement of the inflation target and hamper efforts to reduce the current account deficit. Globally, imminent risks are linked to uncertainty surrounding the normalization policy of the Federal Reserve, which could weaken foreign capital investment. Another global risk is potential spillover and spillback from the downturn in emerging market countries. Domestically, the risks stem from corrections to administered prices, such as electricity rates, and soaring food prices.

Considering the latest economic conditions, outlook and risks moving ahead, it was decided at the Board of Governors’ Meeting, convened on 14th August 2014, to hold the BI rate at a level of 7.50%, with the lending facility and deposit facility rates maintained at 7.50% and 5.75% respectively. Such policy is consistent with efforts to guide inflation towards the target corridor of 4.5±1% in 2014 and 4.0±1% in 2015 as well as reduce the current account deficit to a more sustainable level. To that end, Bank Indonesia will continue to strengthen its monetary and macroprudential policy mix as well as implement policies to bolster the structure of the domestic economy and manage external debt, especially corporate external debt. In addition, Bank Indonesia will also tighten policy coordination with the Government to control inflation and reduce the current account deficit in order to ensure a smooth economic rebalancing process towards more sustainable economic growth.


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THE ECONOMY AND MONETARY POLICY

Indonesia’s economy during the second quarter and in July of 2014 evidenced ongoing economic structural rebalancing, underpinned by preserved macroeconomic stability. This is reflected by controlled domestic demand and declining inflation despite a growing current account deficit attributable to prevailing seasonal trends. Although the current account deficit swelled significantly compared to the previous quarter, the current account actually performed better than during the same period of the previous year, supported by a growing non-oil and gas trade surplus as imports declined in the face of moderating domestic demand.

Recent economic performance was linked to stabilisation policy introduced by Bank Indonesia and the Government in the middle of 2013 and bolstered by the global economic recovery. During the first two quarters and in July of 2014, Bank Indonesia held the BI rate at 7.50%, with the lending facility rate and deposit facility rate maintained at 7.50% and 5.75% respectively. The policy direction is consistent with efforts to guide inflation towards the target corridor of 4.5±1% in 2014 and 4.0±1% in 2015, while simultaneously reducing the current account deficit to a more sustainable level. In addition, BI policy is further strengthened through coordination with the government in the context of cyclical policy to manage domestic demand as well as structural and medium-term policies.

The Global Economy

The global economic recovery persisted. This followed a strong support from advanced countries, such as the United States and countries in Europe, in line with accommodative monetary policy and easing fiscal pressures. Consequently, economic momentum spurred an increase in world trade volume. Nevertheless, economic growth in emerging market countries was expected to remain relatively limited, which extended the downward trend in international commodity prices, particularly CPO due to a combination of weak demand and increased supply.

Revised up GDP figures in the first quarter of 2014 and higher actual GDP in the second quarter provided strong evidence of an increasingly robust US recovery. US GDP data for the first quarter of 2014, which was previously projected at 1.5% (yoy), was revised up to 1.9% (yoy) as a result of higher consumer spending and investment compared to the previous estimate. During the second quarter of 2014, actual US GDP was 12.4% (yoy), driven by a surge in investment, restocking inventory and a rebound in import/export activity. Improvements were noted in nearly all leading US performance indicators. For example, gains in the Purchasing Managers’ Index (PMI) indicated improvements in the US manufacturing sector (Graph 1.1). In terms of consumption, US retail sales soared in the wake of the Big Freeze at the beginning of the year. Meanwhile, a downward unemployment rate helped buoy the labour market (Graph 1.2).

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Graph 1.1US PMI

Graph 1.2 US Unemployment Rate

The economies of Europe also fared better during the reporting period supported by European Central Bank (ECB) policy package to stimulate credit and investment. The policies include a negative deposit rate (standing facility) as well as targeted long-term refinancing operations, which will increase the disbursement of credit and enhance the investment climate, thereby catalyzing economic growth in Europe. Key indicators in Europe continue to perform respectably, with PMI data up to June 2014 continuing to expand, albeit slower than during the past two months (Graph 1.3). In terms of consumption, retail sales data for June 2014 was solid, although weaker than in the preceding month (Graph 1.4). Meanwhile, unemployment rate in Europe continued its downward trend (Graph 1.4).

Graph 1.3European PMI

Graph 1.4 European Retail Sales and

Unemployment Rate

The economy of Japan performed favourably during the reporting period. After the government policy to hike sales tax, the manufacturing sector expanded (Graph 1.5), which spurred improvements in working conditions in line with higher basic salaries, bonus and overtime payments as well as additional full-time employment. Improvements on the labour market had succesfuly transmitted into greater public consumption and boost business sentiment looking forward (Graph 1.6). Consequently, the policy of Abenomics is subsequently expected to bolster sustainable growth in the country, aiming to achieve potential 2% growth on the back of enhanced productivity amidst the demographic challenge of a shrinking working-age population.


Graph 1.5. Japan Manufacturing PMI Graph 1.6. Japan Retail Sales and Economic Sentiment

Growth in developing countries, however, was expected to remain relatively limited despite the economic upturn experienced in China during the second quarter of 2014 resulting from the stimuli introduced. Economic growth in China accelerated to 7.5% (yoy) in the second quarter from 7.4% (yoy) in the previous period as public consumption picked up along with investment activity. A demand revival since May has sparked stronger retail sales, which evidenced the increase in public consumption (Graph 1.7). Meanwhile, expansive manufacturing sector performance helped stimulate investment (Graph 1.8). Investment in fixed assets escalated in June 2014 as a result of the mini-stimulus implemented by the Government of China, which targeted under-capacity sectors, such as the infrastructure sector in rural areas, housing for first-time homebuyers, irrigation projects as well as MSME credit. Despite the latest developments indicating gains, the economic rebalancing process persists in China. Additionally, the Indian economy continued to improve in line with previous projections, as reflected by an increase in PMI from 51.5 to 53.0 in July.

Graph 1.7. Retail Sales and Investment in China

Graph 1.8. China’s Manufacturing PMI

In line with increased global economic momentum, international trade activity also increased despite the ongoing downward trend in commodity prices. Improving economic conditions in the United States and other advanced countries helped catalyse international trade. Consequently, world trade volume is projected to increase but the impact of the global recovery on prices remains weak. Up to the second quarter of 2014, international commodity prices remained in negative territory, primarily attributable to the price of palm oil (CPO) as supply increased and the prices of alternatives were low, for instance soybean, in line with abundant supply from the United States. Moving forward, the international oil price will continue to fall as a result of additional supply in OPEC and non-OPEC countries alike.


Global financial markets were conducive to growth despite experiencing pressures stemming from a revision to the global economic outlook by the International Monetary Fund (IMF). The IMF revised down its growth projection from 3.6% to 3.4% at the end of July 2014 due to sluggish economic performance in China and the United States, coupled with more intense military conflicts that pushed up the international oil price. Notwithstanding, favourable financial market conditions returned upon the release of stronger economic data from China and the US, which bolstered bullish sentiment on the majority of stock exchanges globally (Graph 1.9). Furthermore, the release of robust income data from issuers also strengthened stock exchange performance. Congruent with favourable performance on global stock exchanges, the majority of global currencies also appreciated against the US dollar, especially the currencies of emerging market countries in Asia.

Graph 1.9

Global Stock Markets Economic Growth Economic growth decelerated in Indonesia during the second quarter of 2014 as a result of a contraction in exports, particularly those based on natural resources. The domestic economy achieved 5.12% (yoy) growth in the reporting quarter compared to 5.22% (yoy) in the preceding period, which is slightly below the previous BI projection (Table 1.1). The economic downswing was precipitated by weak export performance of commodities such as coal, CPO and unrefined minerals. In terms of domestic demand, the economic slump primarily emanated from a contraction in government spending due to the postponement of social assistance disbursements and weaker non-construction investment. Nonetheless, tenacious household consumption and construction investment propped up the economy during the second quarter of 2014. Meanwhile, imports tailed off as domestic demand moderated, which helped alleviate external pressures stemming from the decline in exports.


Moderating demand from developing countries along with enforcement of the Mineral and Coal Mining (Minerba) Act triggered a contraction in exports during the second quarter of 2014. Exports contracted more deeply during the reporting period, slipping from -0.44% (yoy) to -1.04% (yoy). A number of mining exports were suspended due to restrictions on exports of unrefined minerals, while exports of coal and CPO faced weak demand. As of June 2014, no exports of copper, bauxite or nickel were realised. Furthermore, export performance was also constrained by weak global demand for CPO and coal. CPO exports waned as demand from China moderated. Sluggish demand from China and India also suppressed coal exports during the reporting period. Nevertheless, real manufacturing exports, such as textiles, footwear and electrical equipment expanded in June 2014 as economic recoveries gained traction in advanced countries (Graph 1.10). Other manufacturing exports, for instance base metals such as copper and nickel, also increased. In addition, leading export commodities, specifically fish and spices, boosted agricultural exports.

Graph 1.10 Non Oil Export – Real Value

Domestically, a contraction is government consumption during the second quarter of 2014 prompted an economic slowdown. Growth in government consumption totalled -0.71% (yoy) during the reporting period, down from 3.58% (yoy) in the preceding quarter and lower than the previous BI projection. By component, the contraction in government consumption was the result of postponing social assistance disbursements, which reduced consumer spending in terms of GDP.

In addition to government consumption, another slump in investment activity, particularly non-construction investment, triggered a domestic economic downswing. In general, investment growth decelerated from 5.14% (yoy) in the first

%Y-o-Y, 2000 Price

I II III IV I IIPrivate Consumption Expenditures 5.24 5.15 5.48 5.25 5.28 5.61 5.59

Government Expenditure 0.44 2.17 8.91 6.45 4.87 3.58 (0.71)

Gross Fixed Capital Formation 5.54 4.47 4.54 4.37 4.71 5.14 4.53

Export of Goods and Services 3.58 4.82 5.25 7.40 5.30 (0.44) (1.04)

Import of Goods and Services (0.03) 0.69 5.09 (0.60) 1.21 (0.73) (5.02)

Gross Domestic Product 6.03 5.76 5.63 5.72 5.78 5.22 5.12

Source : BPS-Statistics Indonesia

20132013 2014

Table 1.1Economic Growth - Demand Side

Component


quarter to 4.53% (yoy) in the second quareter due to negative growth in non-construction investment, specifically investment in foreign transportation equipment in line with weak mining export performance. Such conditions were evidenced by a slump in import data for capital goods in the form of passenger vehicles and equipment. Domestic sales of heavy equipment waned as a result of the ongoing contraction in the mining sector (Graph 1.11). In contrast to the slowdown in non-construction investment, construction investment growth during the reporting period surpassed that posted in the preceding quarter, as indicated by figures for cement sales and imports of construction materials (Graph 1.12). Such conditions were buoyed by greater optimism on construction sector performance compared to conditions at the beginning of the year.

Graph 1.11Non-building Investment Indicators

Graph 1.12 Building Investment Indicators

Resolute household consumption bolstered economic growth in the second quarter of 2014. The performance of household consumption still strong despite its slightly moderating growth to 5.59% (yoy) in the reporting period from 5.61% (yoy) in the previous quarter. Spending associated with the presidential election helped underpin household consumption, indicated by improved performance in the food and beverage industry as well as the paper industry. A number of surveys also revealed greater public optimism in line with growing consumer confidence in the second quarter of 2014 (Graph 1.13). In addition, consumer purchasing power was maintained as inflation declined, which favoured stable household consumption. Strong motorcycle sales in the run up to Eid-ul-Fitr further substantiated the strength of household consumption (Graph 1.14).

Graph 1.13Consumer Confidence Index

Graph 1.14 Motorcycle Sales

Amidst the contraction in exports, a larger decline in imports due to moderating domestic demand eased external pressures on economic growth. Imports experienced a larger contraction in the second quarter of 2014, from -0.73% (yoy) to -5.02% (yoy), in line with the slowdown in exports and non-construction investment


activity. By component, the deeper contraction was credited to imports of raw materials and consumer goods (Graph 1.15). Meanwhile, the contraction in imports of capital goods, albeit less pronounced, continued due to a decline of transportation equipment imports.

Graph 1.15 Non-Oil and Gas Import-Real Value

By economic sector, growth in the tradables sector was relatively stable during the second quarter of 2014 compared to the preceding period (Table 1.2). The mining sector continued to contract due to the suspension of mineral exports and moderating demand for coal exports. The manufacturing sector achieved stable growth through solid performance in the food and beverage industry as well as the paper industry in response to an increase in election activity. Meanwhile, the agricultural sector continued to expand in line with previous projections due to sound performance in the plantation and animal husbandry subsectors. Concerning the non-tradables sector, the trade, hotels and restaurants (THR) sector, the transportation and communications sector as well as the utilities sector all experienced slower growth. The downturn in the THR sector primarily affected the trade subsector as import/export performance slumped. Moderation in the transportation sector stemmed from weaker performance in terms of shipping due to inadequate infrastructure. Conversely, other subsectors of the non-tradables sector, such as the construction sector, the financial, leasing and corporate services sector as well as the services sector achieved more robust growth during the reporting period.

I II III IV I IIAgriculture 3.70 3.30 3.30 3.80 3.54 3.22 3.39

Mining and Quarrying 0.10 (0.60) 2.00 3.90 1.34 (0.26) (0.15)

Manufacturing Industries 6.00 6.00 5.00 5.30 5.56 5.13 5.04

Electricity, Gas and Water Supply 7.90 4.00 3.80 6.60 5.58 6.31 5.77

Construction 6.80 6.60 6.20 6.70 6.57 6.54 6.59

Trade, Hotel & Restaurant 6.50 6.40 6.10 4.80 5.93 4.79 4.53

Transport and Communication 9.60 10.90 9.90 10.30 10.19 10.21 9.53

Financial, Ownership and Business 8.20 7.70 7.60 6.80 7.56 6.16 6.18

Services 6.50 4.48 5.60 5.30 5.46 5.71 5.68

Gross Domestic Product 6.00 5.83 5.62 5.70 5.78 5.22 5.12


20132013

2014

Table 1.2

Economic Growth - Supply Side

S e c t o r


Regionally, the domestic economic decline during the second quarter of 2014 originated from a slowdown on the island of Java, as well as at a number of mining and plantation production bases on the islands of Sumatra and Kalimantan. The economies of Java and Sumatra slowed as a result of weaker agricultural sector performance. In contrast, the manufacturing sector expanded in line with improved manufacturing export performance and gains accomplished in the trade, hotels and restaurants (THR) sector, which offset a deeper contraction on Java and Sumatra. Meanwhile, economic growth in Eastern Indonesia accelerated thanks to the manufacturing sector in Sulawesi, Maluku and Papua (Sulampua). Notwithstanding, weak mining sector performance persisted as a result of moderating demand for coal. A number of mining production regions, such as the provinces of East Kalimantan, West Nusa Tenggara, Riau and Central Sulawesi achieved slower growth that that posted in other areas (Figure 1.1).

Figure 1.1 Economic Growth by Region - Quarter II 2014 Indonesia Balance of Payments

The Indonesia balance of payments (BoP) improved during the second quarter of 2014 amidst a growing current account deficit. The BoP surplus swelled from US$2.1 billion in the preceding quarter to US$4.3 billion in the reporting period (Graph 1.16). A significantly expanding capital and financial account surplus, in comparison to the previous quarter, boosted the balance of payments and fully offset the growing current account deficit in line with seasonal trends. The increasing BoP surplus in the reporting quarter ultimately swelled the position of foreign exchange reserves from US$102.6 billion at the end of the first quarter to US$107.7 billion at the end of the second quarter of 2014. The current position of forex reserves in Indonesia is equivalent to 6.1 months of imports and servicing external debt, which is well in excess of international adequacy standards amounting to around three months. In July 2014, the position of foreign exchange reserves expanded further to US$110.5 billion (Graph 1.17).


Graph 1.16Indonesia Balance of Payment

Graph 1.17 Indonesia’s International Reserves

Despite a larger deficit than in the preceding quarter, the current account performed more favourably compared to the same period of the previous year. The current account deficit totalled US$9.1 billion (4.27% of GDP) in the second quarter of 2014, compared to US$10.1 billion (4.47% of GDP) in the same period of 2013 (Graph 1.18), in line with the economic stabilization policy instituted by Bank Indonesia in conjunction with the Government. Improvements in the current account stemmed predominantly from a growing non-oil and gas trade surplus as imports tailed off in line with moderating domestic demand. Nonetheless, the non-oil and gas surplus was insufficient to counteract the expanding oil and gas trade deficit. In accordance with seasonal trends, the current account deficit in the second quarter exceeded that recorded in the preceding quarter at US$4.2 billion (2.05% of GDP).

Regarding non-oil and gas, the trade surplus narrowed while non-oil and gas imports surged 12.4% (qtq) as demand spiked in the approach to the holy fasting month and Eid-ul-Fitr celebrations, amongst others. On the other hand, non-oil and gas exports grew just 1.0% (qtq) as demand for exports of natural resources waned, such as coal and vegetable oil, in line with slower growth in emerging market countries, coupled with the impact of policy to restrict exports of unrefined minerals. Meanwhile, manufacturing exports, such as automotive, textiles and clothing, continued to accelerate in line with ongoing recoveries in advanced countries. The oil and gas trade deficit widened as imports increased, particularly in terms of crude oil volume, while oil and gas exports slowed, primarily due to declining LNG exports. In addition, a wider deficit in the services account and primary income account intensified pressures on the current account deficit. In the second quarter of 2014 and congruent with established seasonal trends, the services account deficit increased due to higher service payments for transportation goods as imports accelerated and increasing numbers of Indonesians vacationed abroad during the national school holidays. During the same period, the primary income account deficit also swelled as a result of dividend payments and servicing external debt to foreign investors.


Graph 1.18Current Account

Graph 1.19 Trade Balance

Pertinacious foreign investor confidence concerning the domestic economic outlook precipitated an increase in the financial and capital account surplus. The surplus in the second quarter of 2014 topped to US$14.5 billion compared to just US$7.6 billion in the preceding period (Graph 1.20), bolstered by a deluge of foreign portfolio investment and FDI. In addition, other investment transactions, which also rebounded to record a surplus after a period of deficit, buoyed the financial and capital account surplus. Such transactions primarily stemmed from deposit withdrawals by domestic banks operating internationally to meet customer demand and to exploit deposit facilities in the form of foreign currency term deposits provided by Bank Indonesia. Furthermore, foreign capital inflows endured into July 2014.

Graph 1.20 Capital and Financial Account

Rupiah Exchange Rate

The rupiah experienced depreciatory pressures with volatility well managed. Point-to-point, the rupiah slipped 4.18% (qtq) to a level of Rp 11,855 per US dollar during the reporting quarter, while on average the rupiah appreciated 1.76% (qtq) to a value of Rp11,629 per US dollar (Graph 1.21 and 1.22). Growing corporate demand congruent with seasonal trends that favour servicing external debt and repatriating dividends/coupons influenced pressures on the rupiah. Furthermore, sentiment associated with the wait-and-see attitude of investors concerning the results of the presidential election as well as external conditions, such as the geopolitical crisis in Ukraine and the conflict in Iraq, also affected the value of the rupiah (Graph 1.23). External indicators in the second quarter of 2014 also evidenced pressures on the rupiah. For example, bond yield, DCS, the VIX Index and the positive spread of the NDF-onshore spot rate increased as exchange rate pressures


intensified. Amidst the various pressures experienced, however, rupiah exchange rate volatility was well mitigated and eased in comparison to the previous quarter (Graph 1.24).

In July 2014, the rupiah appreciated on the back of a secure and orderly presidential election. On average, the rupiah strengthened 1.8% (mtm) to a level of Rp11,682 per US dollar. Moving forward, Bank Indonesia will consistently maintain rupiah exchange rate stability in accordance with its fundamental value.

Graph 1.21 Rupiah Exhange Rate

Graph 1.22

Appreciation/Deppreciation Regional Currencies

Graph 1.23 VIX & CDS

Graph 1.24

Rupiah Volatility - Quarterly

Inflation

Inflation was maintained and continued to follow a downward trend that supported the achievement of the inflation target in 2014, namely 4.5±1%. Inflation was 6.70% (yoy) in the second quarter, down from 7.32% (yoy) previously (Graph 1.25). Controlled inflation persisted into July 2014 at just 0.93% (mtm) or 4.53% (yoy), which is sufficiently low compared to the seasonal trend around Eid-ul-Fitr during the past three years. Lower inflation was attributable to less-intense inflationary pressures on volatile foods as well as well-controlled core inflation. Inflation of volatile foods eased as supply rebounded in line with the onset of the harvest season. Meanwhile, core inflation was controlled due to moderating domestic demand, minimal pressures on international prices as well as anchored inflation expectations.

Less pressure on volatile foods, amongst others, maintained the easing trend of inflationary pressures during the second quarter of 2014. Volatile food deflation in the reporting quarter helped lower annual inflation of volatile foods to 6.74% (yoy), compared to 7.25% (yoy) in the preceding quarter (Graph 1.25). Abundant supply upon


arrival on the harvest season for several commodities, such as rice and chilli, led to deflation. Price hikes affecting other commodities, such as chicken meat and eggs, prevented further deflation of volatile foods.

Inflation of volatile foods was adequately controlled in July 2014 despite exceeding the rate reported for the previous month (Graph 1.26) as a result of a surge in demand during the run up to Eid-ul-Fitr and reflected in higher prices of several foodstuffs. The largest contributors to inflation were spices, beef, vegetables, rice and fresh fish. The impact of growing seasonal demand was observable in the price of shallots despite adequate supply on the market due to the ongoing harvest in various production hubs. Meanwhile, the price of rice soared on the island of Java and elsewhere as supply dwindled in line with the advent of the planting season. On the other hand, unfavourable weather conditions and less fishing activity in the approach to Eid-ul-Fitr undermined fresh fish production and triggered inflation. Despite increasing, inflation of volatile foods during this year’s Eid-ul-Fitr celebrations was relatively well controlled due to adequate supply on the market.

Graph 1.25 Disaggregation of Inflation

Graph 1.26 Volatile Food Inflation/Deflation

Controlled core inflation also supported lower headline inflation during the reporting quarter, recording a rate of 4.81% (yoy), which was relatively stable compared to the 4.61% (yoy) noted in the previous period. Stable core inflation was credited to moderating domestic demand, minimal international price pressures and anchored inflation expectations. Core inflation remained under control into July 2014, amounting to 0.52% (mtm), which is slightly lower than the previous BI projection of 0.55% (mtm). Excluding seasonal demand during the holy fasting month and the new academic year, fundamental inflationary pressures, domestically and globally, were relatively minimal.

Domestically, despite a spike in seasonal demand, pressure on core inflation, in general, moderated during July 2014, which was confirmed by an increase in actual non-traded core inflation from 0.18% (mtm) to 0.54% (mtm) (Graph 1.27). The surge in demand was reflected in processed foods (predominantly non-traded) as well as non-traded clothing. Meanwhile, the increase in the cost of education upon entering a new academic year was relatively low.


Graph 1.27Core Nontraded Inflation

Graph 1.28 Core Traded Inflation

External inflationary pressures were also relatively moderate as international prices slumped (excluding gold) accompanied by rupiah appreciation. When excluding gold, the Imported Inflation Price Index (IIPI) declined by -0.95% (mtm) in July 2014, compared to an increase of 1.1% (mtm) with the inclusion of gold1. Minimal external pressures emanated from traded core inflation amidst growing seasonal demand (Eid-ul-Fitr and the new academic year). Traded core inflation was controlled well, increasing just 0.49% (mtm) on the previous month (0.34%, mtm) (Graph 1.28). With the exclusion of gold, the increase in traded core inflation was less pronounced, from just 0.33% (mtm) in the previous month to 0.45% (mtm) in line with seasonal trends. In terms of the monthly average exchange rate, the rupiah appreciated significantly by 1.8% (mtm) from Rp11,892 (June) to Rp11,682 (July).

On top of moderating domestic demand and minimal external price pressures, improvements in inflation expectations also bolstered the performance of core inflation. Inflation expectations followed a downward trend as demand returned to normal in the wake of Eid-ul-Fitr. On the commodities market, the inflation expectations of consumers eased for both the upcoming three and six months (Graph 1.29). A deep correction in consumer inflation expectations for the upcoming three months brought expectations to their lowest level over the past four years. Meanwhile, retail traders also lowered their inflation expectations for the upcoming three months (Graph 1.30) despite expectations in the upcoming six months increasing due to the regular spike in demand experienced during the Christmas and New Year holiday season. The Consensus Forecast further corroborated the well-anchored nature of inflation expectations, indicating a stable level at around 6.20% (average yoy) (Graph 1.31). Additionally, according to the Consensus Forecast, inflation at yearend 2014 will drop to around 5.60% (yoy). Inflation expectations on the financial markets also tended to subside, approaching levels enjoyed prior to the unpopular fuel price hikes, as actual inflation continues to follow a downward trend.

1 The global price composite index with a weighted average (based on the percentage of imports and weight of headline inflation) of food commodities (CPO, wheat, sugar, corn and soybean), WTI oil, gold, cotton and iron.


Graph 1.29Consumer’s Inflation Expectation

Graph 1.30 Retailer’s Inflation Expectation

Graph 1.31

Inflation Expectation - Consensus Forecast

Inflation of administered prices declined during the second quarter of 2014, due to the base effect of fuel price hikes in June 2013, from 17.47% (yoy) in the previous quarter to 13.47% (yoy). Notwithstanding, escalating seasonal demand and higher residential electricity tariffs drove up inflation of administered prices in July 2014, reaching 1.32% (mtm) compared to 0.45% (mtm) in the preceding month. The spike in seasonal demand during the approach to Eid-ul-Fitr occasioned an increase in transportation fares, such as intercity transport, airfares and train fares, contributing as much as 0.13% to inflation (Table 1.3). Concerning economy class fares, operators raised tariffs to the maximum level permitted by the government. On the other hand, higher electricity rates for R-2 and R-1 category residential properties, enforced on 1st July 2014, along with a correction to the electricity tariff for R-3 properties (>6,600 VA) raised the contribution of electricity rates to inflation, amounting to 0.06%2.

2 Government policy agreed by the House of Representatives in the 2014 Budget includes an incremental increase in electricity rates for six categories commencing on 1st July 2014, including residential properties as follows: (i) R-2 properties (with a capacity of 3,500 – 5,500 VA) will incur an average bimonthly increase of 5.70%; (ii) R-1 properties (capacity of 2,200 VA) will incur an average bimonthly increase of 10.43%; (iii) R-1 properties (capacity of 1,300 VA) will incur an average bimonthly increase of 11.36% as well as non-listed commercial properties (I-3). For pre-paid electricity customers, the hike has already been included in the calculation of inflation in July 2014.


Table 1.3 Penyumbang Inflasi Administered Prices

The Eid-ul-Fitr effect triggered higher inflation in all regions, however, inflation in the majority of regions on Java and in Eastern Indonesia was adequately controlled. In addition to the surge in seasonal demand, the onset of the planting season also exacerbated inflation in a number of areas. Demand pressures in the run up to Eid-ul-Fitr triggered inflation in Jakarta and other areas of Java (Figure 1.2). Nevertheless, inflation on the island of Java remained at a relatively low level as food security was maintained. The rate of increase in food inflation on Java was offset slightly by the arrival of the peak harvesting season for shallots and red chillies in the provinces of East and Central Java. Meanwhile, inflationary pressures in Eastern Indonesia stemmed from rising strategic food prices (fresh fish and spices); however downward food price corrections occurred in a number of areas, for instance chicken meat (in Kalimantan, with the exception of East Kalimantan), rice (in Central Kalimantan), bird’s eye chillies and shallots (Bali) and fresh fish (Maluku). Inflationary pressures, particularly in Kalimantan and Bali-Nustra, were less intense during this year’s period of Ramadan than the historical average.

Figure 1.2. Map of Inflation by Region (%,mtm)

No. Administered Prices %,mtmContribution

(%,mtm)

1 Air Travel Fee 7.74 0.06

2 Electricity Fare 2.13 0.06

3 Rate of Inter‐City Transportation 9.39 0.06

4 Filter Cigarette 1.04 0.02

5 Fuel 0.45 0.02

6 Railway Tariff 9.21 0.01

Inflation


Monetary Performance

Interest rates and money supply remained consistent with the monetary policy adopted by Bank Indonesia. The interbank rate was stable during the second quarter of 2014, while bank interest rates tended to climb, which, amidst moderating economic growth, influenced the liquidity dynamics of the economy.

The interbank money market was characterised by increasing volume and a relatively stable overnight (O/N) rate. The weighted average O/N interbank rate remained steady at around 5.86% during the reporting quarter, compared to 5.88% previously, in line with Bank Indonesia holding its benchmark policy rate. Consequently, the spread between the O/N interbank rate and the O/N deposit facility (DF) was relatively stable at 11 bps compared to 13 bps in the preceding quarter. Meanwhile, average interbank money market volume increased to Rp12.1 trillion from Rp10.2 trillion in the previous quarter. Latest indicators in July 2014 show that the weighted average O/N interbank rate increased slightly to Rp13.0 trillion in June 2014 as the banks’ requirement for liquidity grew during the approach to Eid-ul-Fitr (Graph 1.33). Nonetheless, the decrease in the spread of the interbank money market to O/N tenors and the max-min spread compared to conditions in the previous month indicated that the issue of tight liquidity eased.

Graph 1.32Overnight Interbank Market Rates

Graph 1.33 Overnight Interbank Rates and Volumes

Bank interest rates continued an upward trend. On one hand, the 1-month term deposit rate increased 31 bps to 8.30% from the 7.99% posted at the end of the first quarter. The largest increase affected 3-month rupiah term deposits, more specifically climbing 82 bps from 8.28% at the end of the first quarter of 2014 to 9.10%. A number of banks experienced tight liquidity, particularly those pursuing aggressive expansion strategies, driving competition for funds and raising bank lending rates. On the other hand, the weighted average bank lending rate jumped 20 bps to 12.76% from 12.56% (Graph 1.34). By loan type, the most pronounced increase affected the interest rate of working capital credit, climbing 26 bps to 12.63%, while the interest rate of investment credit and consumer loans increased respectively by 24 bps and 9 bps to 12.24% and 13.30%. Accordingly, the spread between the lending rate and deposit rate narrowed to 446 bps from 457 bps as the increase in the 1-month term deposit rate exceeded that of the corresponding lending rate (Graph 1.35).


Graph 1.34Loan Rates

Graph 1.35 Bank Interest Rates

Higher bank interest rates subsequently influenced liquidity dynamics in the broader sense of M2. During the second quarter of 2014, M2 growth increased to 13.1% (yoy) from 10.0% (yoy) in the previous quarter. By component, M2 growth emanated from quasi-money, which expanded as bank deposit rates increased, and M1, to which rupiah demand deposits contributed (Graphs 1.36 and 1.37).

Graph 1.36

Growth of M2 and Its Components Graph 1.37

Growth of M1 and Its Components

Based on its determinants, the acceleration in M2 was the result of Net Foreign Assets as foreign exchange reserves held at Bank Indonesia swelled. The position of forex reserves at the end of the second quarter of 2014 totalled US$107.7 billion, up from US$102.6 billion in the previous quarter. Conversely, Net Domestic Assets decelerated due to weaker credit growth as the economy cooled (Graph 1.38). Credit growth3 was 16.65% (yoy) in the reporting quarter, down from 19.06% (yoy) in the first quarter.

3 Credit growth of 16.65% (yoy) in the second quarter of 2014 was calculated using the monetary concept, namely rupiah and foreign currency loans disbursed by commercial banks and rural banks (excluding bank branches operating internationally) to residents (excluding the central government). Nonetheless, credit growth calculated using the banking concept amounted to 17.2% in the same quarter. Credit according to the banking concept includes rupiah and foreign currency loans disbursed by commercial banks (including bank branches operating internationally) to residents (including the central government) and non-residents.


Graph 1.38

Growth of M2 (Contributing Factors) The Banking Industry

Robust banking industry resilience contributed to solid financial system stability, which supported the economic moderation process. Banking industry resilience was resolute, with credit risk, liquidity risk and market risk all well mitigated and supported by a sound capital base..

Credit growth continued to decelerate as domestic demand moderated. As mentioned previously, at the end of the second quarter credit grew 16.65% (yoy), down on the 19.06% (yoy) posted in the preceding quarter (Graph 1.39). The slowdown in credit growth affected investment credit and consumer loans, decelerating to 21.71% (yoy) and 12.3% (yoy) respectively from 33.56% (yoy) and 13.02% (yoy) at the end of the preceding quarter. In contrast, working capital credit growth accelerated slightly from 16.34% (yoy) in the previous quarter to 16.82% (yoy). By sector, credit growth slowed in nearly all economic sectors, including key sectors such as trade and the manufacturing industry. Credit growth in the two aforementioned sectors eased from 23.5% (yoy) and 25.5% (yoy) in the preceding quarter to 17.9% (yoy) and 24.6% (yoy) respectively (Graph 1.40).

Graph 1.39 Credit Growth Graph 1.40 Credit Growth by Sector


Deposit growth picked up during the reporting quarter as deposit rates climbed. Deposits4 achieved growth of 13.67% (yoy) at the end of the second quarter of 2014, surpassing that posted in the previous quarter at 10.26% (yoy). Deposit growth was attributed specifically to demand deposits and term deposits, which grew respectively at 11.91% (yoy) and 17.77% (yoy) compared to growth in March 2014 at 6.23% (yoy) and 12.29% (yoy). Meanwhile, growth of savings accounts slowed to 9.45% (yoy) from 10.23% (yoy) in March 2014 (Graph 1.41).

Graph 1.41 Depositor Fund’s Growth

Amidst moderating domestic demand, a sound capital base reinforced banking sector resilience accompanied by mitigated credit risk. In June 2014, the Capital Adequacy Ratio (CAR) of the banking industry remained high at 19.40%, which is well above the statutory minimum of 8%. Such auspicious conditions reflect solid banking industry resilience in the face of pressures and shocks, including the ongoing rising interest rate trend. In addition, non-performing loans (NPL) remained low and stable at around 2.00% (Table 1.4).

Table 1.4 Banking Indicators

4 Deposit growth of 13.67% (yoy) in the second quarter of 2014 was calculated using the monetary concept, namely third-party savings in rupiah or a foreign currency held at commercial banks and rural banks (excluding bank branches operating internationally) in the form of savings accounts, demand deposits and term deposits. According to the monetary concept, deposits exclude savings owned by the Central Government and non-residents. In keeping with the banking concept, however, deposit growth achieved 12.6% (yoy) in the second quarter of 2014. Congruent with the banking concept, deposits include third-party savings in rupiah or a foreign currency held at commercial banks (including bank branches operating internationally) in the form of savings accounts, demand deposits and term deposits. True to the banking concept, deposits encompass savings owned by the Central Government and those of non-residents.

Jun Jul Aug Sept Oct Nov Dec Jan Feb Mar Apr May JunTotal Asset (T Rp) 4,461.8 4,510.3 4,581.1 4,737.3 4,717.0 4,817.8 4,954.5 4,880.5 4,888.8 4,933.0 5,008.1 5,097.5 5,198.0Third Party Fund (T Rp) 3,374.4 3,392.9 3,440.2 3,526.2 3,520.9 3,563.4 3,664.0 3,594.7 3,603.6 3,618.1 3,694.8 3,763.5 3,834.5Credit * (T Rp) 2,959.1 3,021.1 3,067.4 3,147.2 3,159.5 3,214.4 3,292.9 3,258.4 3,267.8 3,306.9 3,361.3 3,403.1 3,468.2LDR* (%) 87.7 89.0 89.2 89.3 89.7 90.2 89.7 90.6 90.7 91.4 91.0 90.4 90.5 NPLs Gross* (%) 1.9 1.9 2.0 1.9 1.9 1.9 1.8 1.9 2.0 2.0 2.1 2.2 2.2 CAR (%) 18.0 18.0 17.9 18.0 18.4 18.6 18.4 19.6 19.8 19.8 19.4 19.5 19.4 NIM (%) 5.4 5.5 5.5 5.5 5.5 5.5 4.9 4.1 4.1 4.3 4.3 4.2 4.2 ROA (%) 3.0 3.0 3.0 3.0 3.0 3.0 3.1 2.8 2.7 2.9 2.9 2.9 3.0 * without channeling

Primary Indicators2013 2014


The Stock Market and Government Securities Market

The domestic stock market performed promisingly during the second quarter of 2014 in line with bullish sentiment globally and improving domestic economic data. The IDX Composite index reached a level of 4,878.58 on 30th June 2014, up 2.3% (yoy) compared to the position on 28th March 2014 at 4,768.28. Controlled inflation and optimism surrounding corporate earnings triggered the rally on the IDX Composite. Meanwhile, external positive sentiment manifested in the form of speculation over Chinese Government policy to stimulate the stock market as well as the release of trade balance data from China, which evidenced a surplus that exceeded previous expectations. IDX Composite performance surpassed that of Bursa Malaysia and the Singapore Exchange but fell short of the Stock Exchange of Thailand and the Philippine Stock Exchange (Graph 1.42).

The latest developments in July 2014 indicated that the IDX Composite gains would continue. In July, the IDX Composite rallied 4.3% (yoy) to 5,088.80 compared to a level of 4,878.58 in June. A secure and orderly presidential election along with global bullish sentiment stemming from allayed concerns over policy rate hikes in the United States, improved performance at international issuers and stronger economic data from China prompted the IDX Composite rally, which outperformed other regional stock exchanges in Southeast Asia (Graph 1.43).

Graph 1.42. JCI and Global Stock Index Quarter II 2014

Graph 1.43. JCI and Global Stock Index July 2014

Sound stock market performance was also inextricably associated with the behaviour of foreign investors, who booked net purchases during the reporting quarter but to a lesser extent than in the preceding period. Accordingly, foreign investors booked net purchases totalling Rp19.50 trillion in the second quarter of 2014 compared to Rp24.62 trillion in the first quarter. Additionally, the position of non-resident shareholdings accounted for 64%, with the remaining 36% held by local investors. Latest developments indicate that during July 2014, foreign investors continued the positive trend of previous months, with net purchases amounting to Rp13.07 trillion, up from Rp2.74 trillion in June (Graph 1.44).


Graph 1.44. JCI and Net Foreign Buy/Sell

A different trend was observable on the tradable government securities (SBN) market, with SBN yield increasing during the reporting quarter as investors adopted a wait-and-see attitude until the results of the presidential election were announced. In the second quarter of 2014, the yield of tradable government securities increased 16.83 bps to 8.05% compared to 7.89% in the preceding quarter. The yields of short, medium and long-term tenors increased respectively by 2.05 bps, 11.52 bps and 18.27 bps to 7.38%, 7.97% and 8.87% (Graph 1.45).

Latest developments on the tradable government securities market in July 2014 show a decline in yield after a secure and orderly presidential election. In general, yield slumped 10.16 bps in July 2014 to 7.95% compared to 8.05% in June. The yields of short, medium and long-term tenors decreased respectively by 2.05 bps, 11.52 bps and 18.27 bps to 7.38%, 7.97% and 8.68% (Graph 1.45).

Non-residents exploited lower SBN prices during the reporting quarter in order to bolster their holdings on the SBN market. Foreign investors booked net purchases amounting to Rp42.68 trillion in the second quarter of 2014 compared to Rp37.08 trillion in the previous quarter. During the same period, SBN holdings of foreign investors, Bank Indonesia and the insurance industry expanded, while those of the banking sector and pension funds decreased. Foreign investors favoured short and long-term tenors. Consequently, the portion of foreign SBN holdings swelled to 34.51% compared to 32.56% at the end of the first quarter of 2014. The purchasing trend of foreign investors persisted into July 2014, booking net purchases totaling Rp14.67 trillion, up from Rp6.44 trillion in the preceding month (Graph 1.46). During the same period, SBN holdings of foreign investors, the insurance industry, pension funds and Bank Indonesia expanded, while those of the banking sector declined. Therefore, foreign investor holdings of tradable government securities amounted to 35.17% in July 2014 compared to 34.51% in June.

Graph 1.45 Monthly Changes of

Government Bonds Yield Graph 1.46. Government Bonds Yield

and Net Foreign Buy/Sell


Non-Bank Financing Sluggish nonbank economic financing continued as the domestic economy moderated. Total financing amounted to Rp20.3 trillion in the second quarter of 2014, contracting 0.65% (yoy) compared to positive growth of 0.12% (yoy) in the preceding quarter (Table 1.5). By component, bonds continued to dominate nonbank financing in the second quarter, totaling Rp15.5 trillion, while shares amounted to Rp1.0 trillion with 12 companies conducting initial public offerings (IPO) up to June 2014 out of the 30 planned for this year.

Developments in July 2014 indicated that total financing through initial public offerings, rights issues, corporate bonds, medium-term notes, promissory notes and other financial instruments added up to Rp5.1 trillion, up 2.33% (yoy) compared to a -0.67% (yoy) contraction in the previous month. Based on its components, nonbank financing was still dominated by bonds in July 2014, amounting to Rp4.0 trillion.

Table 1.5. Non-Bank Financing

Source: OJK, BEI, proceed

The Payment System

The average amount of currency in circulation increased as public demand for money surged. During the second quarter of 2014, average daily total currency in circulation was Rp452.1 trillion, equivalent to growth of 13.9% (yoy) compared to growth of 13.2% (yoy) in the previous quarter. Currency in circulation was increased to meet public demand for money in the approach to national school holidays, a new financial year and preparations for the holy fasting month of Ramadan (Graph 1.47).

Graph 1.47 Currency in Circulation (yoy)

Rp Trillion

Jun Q1 Q2 Q3 Q4 Total Jan Feb Mar Apr May Jun Jul Q1 Q2 Total

Nonbank 25.7 16.3 58.3 3.6 34.7 112.9 3.4 4.9 10.2 2.8 9.0 8.4 5.1 18.4 20.3 38.7

Stocks 10.2 2.8 29.3 2.8 22.7 57.5 2.7 0.0 5.5 0.4 0.5 0.2 0.9 8.2 1.0 9.2

o/w Financial sector issuers 3.8 0.3 6.0 1.2 9.1 16.6 0.4 0.0 0.0 0.0 0.0 0.0 0.1 0.4 0.0 0.4

Bonds 15.4 12.7 27.7 0.3 9.9 50.5 0.0 4.8 3.7 1.9 6.6 7.0 4.0 8.5 15.5 24.0


MTN and Promissory Notes 0.0 0.8 1.3 0.6 2.2 4.9 0.6 0.1 0.9 0.5 2.0 1.3 0.2 1.6 3.8 5.4


20142013


Amidst the growing trend of currency in circulation, Bank Indonesia tireless worked to ensure currency fit for circulation. To this end, as many as 1.1 billion banknotes and coins were removed from circulation and destroyed in the second quarter of 2014 with a value of Rp22.6 trillion, replaced with currency fit for circulation. In comparison, the amount of currency unfit for circulation in the first quarter of 2014 totalled 1.3 billion banknotes and coins with a value of Rp28.6 trillion. The decline in currency unfit for circulation was credited to banking sector deposits at Bank Indonesia, which generally remained fit for recirculation.

Noncash payment system transactions tended to tail off in line with the moderating domestic economy. During the second quarter of 2014, transaction volume of the noncash payment system totalled Rp1,144 million, growing 16.52% (yoy) compared to 17.24% (yoy) in the previous quarter (Table 1.6). In terms of value, growth in noncash payment system transactions also tended to decelerate, from 29.99% (yoy) in the previous quarter to 14.52% (yoy) (Table 1.7). The decline in transaction value primarily affected the Bank Indonesia – Real Time Gross Settlement (BI-RTGS) system and the Bank Indonesia – Scripless Securities Settlement System (BI-SSSS).

Table 1.6. Volume of Non Cash Payment System

Despite the decline in transaction volume, the noncash payment system operated smoothly and supported economic activity. The availability of the Bank Indonesia Real Time Gross Settlement System (BI-RTGS) as a means to settle funds, BI-SSSS to settle government and Bank Indonesia securities, as well as the National Clearing System achieved 100% during the second quarter of 2014. Secure and uninterrupted transactions were also noted for card-based payment instruments such as ATM cards, ATM/debit cards, credit cards and electronic money. Such instruments experienced no significant disruptions during the reporting quarter.

Table 1.7 Value of Non Cash Payment System

2012 2014 2014

Q IV Q I Q II Q III Q IV Q I Q II

BI‐RTGS 4,719.10 4,250.03 4,499.00 4,263.50 4,621.00 4,171.30 4,471.30

BI‐SSSS 39.14 34.16 34.20 28.50 35.10 36.20 38.70

Clearing 28,193.28 24,341.27 25,946.40 26,270.70 27,751.10 25,179.20 26,786.10

Debit 10,585.89 10,615.23 10,902.10 10,596.90 10,504.30 10,012.10 10,544.30

Credit 17,607.39 13,726.04 15,044.20 15,673.80 17,246.70 15,167.10 16,241.80

Card Payment 816,490.61 849,409.97 917,524.30 945,361.60 1,037,011.30 998,153.60 1,068,963.70

Credit Card 56,786.93 56,667.47 59,557.70 61,329.40 61,543.90 59,160.30 64,241.30

Debit and ATM/Debit Card 759,703.68 792,742.50 857,966.60 884,032.20 975,467.40 938,993.30 1,004,722.30

Electronic Money 30,875.31 30,728.04 34,259.60 35,850.10 37,063.10 37,924.30 44,245.80

Total 880,317.45 908,763.47 982,263.40 1,011,774.40 1,106,481.60 1,065,464.60 1,144,505.60

Non Cash Payment System

Transaction

2013

Volume (Thousand)

2012

Q IV Q I Q II Q III Q IV Q I Q II

BI‐RTGS 19,972.81 18,778.31 21,410.40 26,369.50 24,403.80 23,817.80 24,150.40

BI‐SSSS 5,456.24 4,939.05 5,299.70 8,259.90 8,233.40 7,173.60 6,396.90

Clearing 573.89 547.87 605.70 680.80 708.00 667.80 710.70

Debit 397.99 394.76 414.80 421.20 425.60 399.10 417.90

Credit 175.90 153.11 190.80 259.60 282.40 268.70 292.80

Card Payment 871.72 917.78 989.60 1,039.40 1,073.90 1,077.30 1,158.50

Credit Card 52.47 51.44 55.20 57.10 59.60 56.90 63.60

Debit and ATM/Debit Card 819.24 866.34 934.40 982.40 1,014.30 1,020.50 1,904.90

Electronic Money 0.65 0.59 0.70 0.90 0.70 0.70 0.80

Total 26,875.31 25,183.59 28,306.10 36,350.50 34,419.80 32,737.20 32,417.30

Value (Rp Trillion)

Non Cash Payment System

Transaction

2013 2014


ECONOMIC OUTLOOK

Bank Indonesia expects the domestic economic rebalancing process to persist, supported by maintained macroeconomic stability. Economic growth for 2014 is forecasted in the range of 5.1-5.5% (yoy), unchanged from the previous projection but with a bias towards the lower limit of the range as a result of global GDP growth that is weaker than expected, coupled with budgetary savings. Projections of sluggish global GDP growth undermine export performance, while budget cuts slow government consumption. In 2015, however, growth is predicted to rebound in the range of 5.4-5.8% (yoy), also unchanged from the previous projection consistent with the ongoing global economic recovery. Consequently, the contribution of exports to growth is also expected to increase.

In line with a moderating domestic economy in 2014, lower inflation is projected than that recorded in 2013 and is on track to achieve the inflation target of 4.5±1% in 2014. In 2015, measured monetary policy supported by policy coordination with the government is expected to push inflation down further in the range of 4.0±1%.

Economic rebalancing is expected to steer the current account deficit and credit growth in a more sustainable direction. In line with a moderating economy, credit growth is projected in the range of 15-17% in 2014, which is consistent with efforts to guide the economy in a more balanced and sounder direction. Meanwhile, the current account deficit is expected to decrease to around 3.0% of GDP. The increase in the current account deficit during the second quarter of 2014 was the result of a surge in imports as the holy fasting month approached along with repatriation of dividends/coupons. Moving forward, the current account deficit is expected to decline over upcoming quarters as manufacturing exports increase and mineral exports recommence, bolstered by a downward trend in non-oil and gas imports.

Bank Indonesia will continue to monitor several risks that overshadow the economic rebalancing process looking ahead. Globally, the risks include the economic downswing in China, the normalisation policy of the Federal Reserve as well as the risk of spillover and spillback from slowdowns in emerging market countries. Domestically, the risks include potential pressures on administered prices, such as electricity rates, and rising food prices.

Global Economic Outlook

Going forward, the global economy is expected to continue improving, albeit at a more moderate pace than previous projections. Global economic growth for 2014 and 2015 is forecasted at 3.4% and 3.8% respectively, down from the previous projections of 3.6% and 3.9%. Stronger economies in advanced countries as monetary stimuli endure and fiscal pressures ease will underpin global economic momentum. Nevertheless, the global economic recovery is progressing at different speeds. For instance, economic growth in emerging market countries is expected to be relatively limited as a result of economic rebalancing in China and the ongoing downward trend of international commodity prices, amongst others. Although uneven, the global economic outlook will boost world trade volume in 2014 and 2015 to the tune of 3.4% and 5% respectively.

2


The global economic recovery will continue, bolstered by gains in advanced countries. Despite accelerating, economic growth in advanced countries will be lower than previously thought in line with weaker-than-expected US growth figures. The US economy is predicted to achieve growth of 2.0% in 2014, increasing to 3% in the following year as a result of solid consumption and a buoyant housing market. Meanwhile, economies in Europe will expand at a slightly faster pace than previously forecasted, namely 1.1% in 2014 and 1.5% in 2015, in line with ECB policy relating to long-term refinancing operations that are expected to boost credit and investment. Furthermore, a stronger economy in Japan, based on Abenomics, will also support the global recovery (Table 2.1).

Departing from the promising outlook of advanced countries, economic growth in developing countries will remain relatively limited. The economy of China is forecasted to expand by 7.4% and 7.1% in 2014 and 2015 respectively, with the slowdown attributable to ongoing economic rebalancing policy. Meanwhile, a similar prognosis to that projected previously is expected for India. A downswing in other emerging markets as a result of vulnerability to external conditions, rebalancing in China and the protracted slump of international commodity prices will spur slower growth in emerging market countries generally.

Non-oil and gas commodity prices are expected to remain sluggish in 2014 as supply improves, especially palm oil, in line with favourable weather conditions. In addition to moderating demand from India, lower prices of alternatives, such as soybean oil, will further undermine demand for palm oil. Moving forward, an abundant supply of soybean will persist as weather conditions in the United States remain conducive to production of the legume, leading to excess supply with the potential to undermine the price of palm oil. Nonetheless, the downward international commodity price trend will be offset by the rising price of rubber in line with strong demand from China. Non-oil and gas export commodity prices will improve as the global recovery persists but the prices of coal and palm oil will be supressed by abundant supply.

Domestic Economic Outlook

Congruent with global economic performance and relatively stable domestic conditions, Bank Indonesia maintains its projections for economic growth in 2014 and 2015. The domestic economy is projected to expand in the range of 5.1-5.5% in 2014 with a bias towards the lower end of the projection following weaker-than-expected growth in the first two quarters. In 2015, however, growth is forecasted to rebound in the range of 5.4-5.8% (Table 2.2).

2014 2015World GDP 3.1 3.4 3.8Advanced Countries 1.4 2.0 2.4 United States 2.2 2.1 3.0 Euro Zone -0.4 1.1 1.5 Japan 1.5 1.6 1.1Emerging and Developing Economies 4.7 4.6 5.0 China 7.7 7.4 7.1 India 4.6 5.4 6.4 Other Emerging Market Countries 3.1 3.1 3.6

Table 2.1

2013Projection

World GDP Projection (%, yoy)


Despite the unchanged projection, economic growth in 2014 will tend towards the lower end of the range as a result of weak export growth in line with limited economic growth in emerging market countries. In addition, government consumption will ease as budget cuts take effect in 2014. Notwithstanding, strong consumer confidence and maintained purchasing power will reinforce the tenacity of household consumption.

Robust household consumption growth is projected in the range of 5.1-5.5%, unchanged from the previous forecast, despite slowing in line with the limited impact of the presidential election. A sound Consumer Confidence Index (CCI) moving into the third quarter, in terms of both current and future economic conditions, confirms persistent household consumption. Additionally, solid public income, coupled with maintained purchasing power as inflation continues to fall, supports a favourable consumption outlook, reflected by growth in real wages for non-formal labour as well as more favourable terms of trade for farmers. Disposable income from real interest rates of term deposits is also set to increase as interest rates climb amidst lower inflation. Furthermore, an increase in the income of entrepreneurs, indicated by wider profit margins, will also catalyse consumption. Notwithstanding, the pace of consumption growth will tail off until the end of the year as the effect of the presidential election fades, to which the income expectations of consumers, as revealed in the Consumer Survey conducted by Bank Indonesia, attest.

Limited government consumption is predicted in the range of 3.2-3.6%, compared to the 6.2-6.6% previously projected as government spending is reduced in the 2014 budget. Meanwhile, the postponement of social assistance disbursements contributed to the contraction in government consumption in the second quarter of 2014.

Investment is forecasted to grow in the range of 4.9-5.3%, surpassing the previous projection of 4.8-5.2% due to solid construction investment congruent with historical trends in the wake of a presidential election. A number of recent surveys, for instance the Business Survey conducted by Bank Indonesia, reveal that actual investment is increasing moderately, verifying historical trends. Similarly, the BPS Business Tendency Index, which rallied in the second quarter of 2014 and will continue into the third quarter, confirms flourishing optimism in the business community. Solid construction investment growth is expected in accord with greater optimism in the construction sector compared to the beginning of the year, which is substantiated by sales of cement and imports of construction materials that surged in the second quarter. However, limited export growth will supress the outlook for non-construction investment. Meanwhile, support from government capital spending up to June 2014 was less than that enjoyed in the previous year. Capital spending is expected to peak in the fourth quarter in step with the historical trend of budget absorption at yearend.

%Y-o-Y, 2000 Price

I II III IV I IIPrivate Consumption Expenditures 5.24 5.15 5.48 5.25 5.28 5.61 5.59 5.1 - 5.5 5.2 - 5.6

Government Expenditure 0.44 2.17 8.91 6.45 4.87 3.58 (0.71) 3.2 - 3.6 3.0 - 3.4

Gross Fixed Capital Formation 5.54 4.47 4.54 4.37 4.71 5.14 4.53 4.9 - 5.3 5.7 - 6.1

Export of Goods and Services 3.58 4.82 5.25 7.40 5.30 (0.44) (1.04) (0.3) - 0.1 4.6 - 5.0

Import of Goods and Services (0.03) 0.69 5.09 (0.60) 1.21 (0.73) (5.02) (2.2) - (1.8) 3.5 - 3.9

Gross Domestic Product 6.03 5.76 5.63 5.72 5.78 5.22 5.12 5.1 - 5.5 5.4 - 5.8


* Bank Indonesia's Projection

2014* 2015*20132013 2014

Component

Table 2.2Economic Growth Forecasts - Demand Side


Export performance is predicted to slow in the range of -0.3-0.1%, compared to the previous forecast of 1.5-1.9%, in line with a lower-than-expected realisation of exports. Limited export growth is attributable to a decline in exports of natural resources, such as CPO, coal and minerals pursuant to enforcement of the Mineral and Coal Mining (Minerba) Act as well as moderating emerging market economies. The decline will, however, be counteracted by robust manufacturing export growth as the economies of advanced countries continue to recover. Furthermore, non-oil and gas exports have the potential to expand as the first exports of copper concentrates from Freeport commence after restrictions were imposed at the beginning of the year. Consequently, PT. Freeport is permitted to export a quota of 756 thousand tons of copper concentrate up to yearend 2014.

Import performance for 2014 is forecasted to drop within a range of -2.2% to -1.8%, below the previous prediction of 0.5-0.9% in line with the significantly low realisation of capital goods imports during the second quarter. Actual imports of heavy equipment subsided, mirroring mining sector performance. Furthermore, the decline in import performance also reflects slower export and non-construction activity.

In 2015, in tune with stronger domestic demand and global economic conditions, domestic economic growth is projected to accelerate in the range of 5.4-5.8%. A stronger global economic recovery than in the previous year will prop up domestic economic performance. Accordingly, the contribution of exports to growth will expand. Furthermore, higher incomes and lower inflation will help drive domestic demand.

In general, dogged household consumption is projected in the range of 5.2-5.6%, slightly below the previous forecast of 5.3-5.7%. A thriving working-age population will reinforce solid household consumption through a swollen labour force (Graph 2.1), thereby lowering the poverty rate and expanding the fledgling middle class, leading to more household consumption. The contribution of exports in 2015 will extend beyond that achieved in 2014, hence increasing public purchasing power and, therefore, household consumption. Inflation will hit its national target corridor of 4±1%, thus maintaining public purchasing power.

Table 2.3 IMD Scoreboard 2014

Graph 2.1Dependency Ratio of Indonesia vs Other

Countries

Investment growth in 2015 is expected to outpace that posted in the previous year at around 5.7-6.1%, exceeding the past projection of 5.3-5.7%, stemming primarily from non-construction investment as a consequence of the large investment requirement to enable economic growth. After the political year of 2014, investment growth will rebound in 2015 thanks to strong domestic demand and a surge in external demand for


products exported from Indonesia. Additionally, the favourable perception of investors concerning the economic outlook of Indonesia will also garner investment growth. The 2014 World Competitiveness Scoreboard published by International Management Development (IMD), places Indonesia 37th in 2014 compared to 39th in the previous year. Indonesia posted strong gains in nearly all categories (government efficiency, business efficiency and infrastructure), while the constraints include lower economic growth in 2014 (Table 2.3).

Export growth in 2015 will increase to around 4.6-5.0%, below the previous prediction of 5.1-5.5%, due to weaker-than-projected global economic growth. In comparison to 2014, however, more robust export growth is forecasted in line with stronger export and global economic growth. Indonesian exports to advanced countries, such as the United States and nations in Europe, will increase and help offset limited export growth to emerging market countries. Nascent mineral exports will also boost export performance in 2015. Through measures to foster competitiveness, including a more competitive exchange rate, low and stable inflation as well as product and market diversification, export growth in 2015 should surpass that achieved in 2014.

Import growth is forecasted in the range of 3.5-3.9%, which is lower than the past projection of 4.9-5.3% in line with expected export growth and domestic demand, especially weaker household consumption. In comparison to 2014, however, imports will accelerate with domestic demand, specifically investment growth that will stimulate imports of capital goods in the form of machinery and equipment. Solid production activity will drive demand for imports of raw materials. Meanwhile, imports of consumer goods will continue to grow in line with unwavering household consumption.

By sector, the manufacturing sector in 2014 will grow at a pace slower than previously thought. Meanwhile, a more promising mining sector outlook is expected as mineral exports recommence and the Cepu Block begins production activity. In the services sector, growth projections for the trade, hotels and restaurants (THR) sector were revised down as a result of sluggish international trade activity. In addition, projections for the transportation and communications sector were also revised down due to a moderating transport subsector in the second quarter. In contrast, the construction sector is expected to perform better based on greater realisation during the second quarter and growing optimism in the sector. The financial, leasing and corporate services sector will also improve in line with greater realisation in the second quarter of 2014 and the business outlook in the aftermath of the presidential election (Table 2.4).

%Y-o-Y, 2000 Price

I II III IV I IIAgriculture 3.70 3.30 3.30 3.80 3.54 3.22 3.39 2.8 - 3.2 2.8 - 3.2

Mining and Quarrying 0.10 (0.60) 2.00 3.90 1.34 (0.26) (0.15) 0.6 - 1.0 2.6 - 3.0

Manufacturing Industries 6.00 6.00 5.00 5.30 5.56 5.13 5.04 4.6 - 5.0 5.0 - 5.4

Electricity, Gas and Water Supply 7.90 4.00 3.80 6.60 5.58 6.31 5.77 5.6 - 6.0 5.7 - 6.1

Construction 6.80 6.60 6.20 6.70 6.57 6.54 6.59 6.4 - 6.8 6.4 - 6.8

Trade, Hotel & Restaurant 6.50 6.40 6.10 4.80 5.93 4.79 4.53 4.4 - 4.8 5.1 - 5.5

Transport and Communication 9.60 10.90 9.90 10.30 10.19 10.21 9.53 9.5 - 9.9 10.2 - 10.6

Financial, Ownership and Business 8.20 7.70 7.60 6.80 7.56 6.16 6.18 6.0 - 6.4 6.1 - 6.5

Services 6.50 4.48 5.60 5.30 5.46 5.71 5.68 5.5 - 5.9 5.3 - 5.7

Gross Domestic Product 6.00 5.83 5.62 5.70 5.78 5.22 5.12 5.1 - 5.5 5.4 - 5.8


* Bank Indonesia's Projection

2014* 2015*2013

2013

Table 2.4

Economic Growth Forecasts - Supply Side

2014S e c t o r


Agricultural sector growth is forecasted in the range of 2.8-3.2%, unchanged from the past projection, supported by slight gains in the fisheries subsector as exports increased, primarily of fish products. In addition, the impact of a dry spell, triggered by an El Nino event, has had little effect on agricultural performance. According to the Indonesian Agency for Meteorology, Climatology and Geophysics as well as climatological institutions from the United States, Japan and Australia, weather conditions up to August 2014 remain normal, with the potential for drought, or a weak El Nino episode, at the end of the year.

The mining sector is projected to grow by around 0.6-1.0% in 2014, up from 0.3-0.7% previously, supported by the start of production at the Cepu Block and the recommencement of mineral exports pursuant to a Memorandum of Understanding (MoU) signed between PT. Freeport and the government. During the first week of August 2014, PT. Freeport began exporting copper concentrate to China with a quota amounting to 756 thousand tons until the end of the year. Conversely, Newmont has not been granted an export license because the government refuses to negotiate until the current arbitrage lawsuit filed by Newmont is withdrawn. Oil lifting was extended during the second quarter of 2014, which is predicted to continue as the Cepu Block commences production.

The manufacturing sector is expected to grow in the range of 4.6-5.0% in 2014, compared to the previous projection of 4.9-5.3%. The slowdown is attributable to weak export demand, demonstrable by a decline in CPO production and manufacturing exports, especially those based on natural resources, in line with less trade volume in emerging market countries as the primary market for such commodities. A deceleration in the Industrial Production Index published by BPS-Statistics Indonesia further corroborates such conditions.

The utilities sector (electricity, gas and sanitary water) is projected to grow in the range of 5.6-6.0% in 2014, down from 6.4-6.8% predicted previously as a result of sluggish manufacturing production that consequently requires less electricity. In addition, incremental hikes in electricity rates for both residential and commercial properties also influenced utilities sector performance. Meanwhile, the city gas subsector shows signs of growth with PT. PGN expanding distribution in a number of regions, targeting two million households as well as commercial and industrial properties in 2104 under the auspices of the Ministry of Energy and Mineral Resources as well as PT. PGN.

The construction sector is forecasted to expand in the range of 6.4-6.4% in 2014, exceeding the previous estimation of 6.2-6.6%, bolstered by greater realisation in the second quarter and positive sentiment in the wake of the presidential election. Strong sales of cement and imports of construction materials also evidence gains in the sector. On the other hand, the growth rate of the construction sector will pick up at the end of the year in line with historical trends after a presidential election.

The trade, hotels and restaurants (THR) sector is projected to grow in the range of 4.4-4.8% in 2014, falling short of the 4.8-5.2% predicted previously, due to less trade volume through imports and exports. Furthermore, gains in the Retail Sales Index in June and projected retail sales for July 2014 also slowed.

Strong growth in the transportation and communications sector is expected in the range of 9.5-9.9% in 2014, lower than the previous projection of 10.1-10.5%. Despite slowing, growth in the sector will remain robust due to improvements in the railway subsector as the number of railway passengers increased up to June 2014. However, the communications subsector will tail off in the second semester of 2014 as


election campaigns end that increased the data, voice and SMS traffic of telecommunications providers.

The financial, real estate and corporate services sector is projected to slow down in 2014 in the range of 6.0-6.4%, surpassing the 5.8-6.2% predicted previously. The sector will accelerate in line with greater realisation in the second quarter as well as the promising post-election business outlook.

In 2015, economic growth is projected to achieve 5.4-5.8% on the back of solid performance in the manufacturing, THR as well as transportation and communication sectors. Resilient purchasing power as the middle class flourishes, coupled with low inflation, will ameliorate the economic outlook of the aforementioned sectors.

Growth of the agricultural sector is estimated in the range of 2.83.2% in 2015, down from the 2.9-3.3% projected previously. Planted area of several leading food crops will expand, thereby boosting production. Meanwhile, indications of global weather disruptions due to a weak-moderate El Nino episode are expected to persist into 2015. Nevertheless, the sector is expected to rebound, predominantly in the plantation subsector such as rubber. In addition, the plantation subsector (CPO) is predicted to record positive growth in line with policy to promote biodiesel use, which will drive production in response to demand.

The mining sector is projected to expand in the range of 2.6-3.0%, exceeding the previous forecast of 1.4-1.8%. Domestically, the prospects are in line with the planned construction and operation of 15 smelters in 2015. Externally, international non-oil and gas commodity prices should rebound into positive territory, transcending performance in the preceding year, which will provide a boost to the mining sector. Furthermore, the oil and gas subsector is also poised to improve, supported by ramped up oil production at Cepu Block to a potential 165 thousand barrels daily. Meanwhile, a number of upstream projects in the gas sector will also augment performance. In terms of coal, the prospects can be considered moderate as abundant supply on the market drives down prices, further exacerbated by possible restrictions on low-grade coal imports to China, including those from Indonesia, which will affect actual coal exports from Indonesia.

The manufacturing sector is projected to grow in the range of 5.0-5.4% in 2015, which is unchanged from the previous forecast, indicating relatively strong growth of the manufacturing industry as the global economy recovers in line with increased world trade volume. Furthermore, several smelters will come online. Manufacturing sector realisation (secondary), as the main destination of foreign investment from 2010 until the second quarter of 2014, will also reinforce robust growth in the sector (Graph 2.2). Going forward, the positive trend is expected to persist. Additionally, confronting the imminent establishment of the ASEAN Economic Community in 2015, the government implemented a number of preparatory measures by increasing competitiveness through industrial structural reforms and an enabling industrial climate. The structure of the manufacturing industry will be strengthened by expediting the development of downstream industries, such as agribusiness, oil and gas, and mined minerals as well as exploiting the domestic market and ASEAN as the base-load. In terms of a supportive industrial climate, the government strives to reduce the cost of capital, energy and logistics, while simultaneously enhancing the competence of human capital as well as research and development in the manufacturing sector. Nevertheless, optimism of stronger growth in the sector is marred slightly by the challenges facing labour-intensive industries, such as the textile industry, as


well as upstream industries, such as cement and steel, for instance the planned incremental hikes in electricity rates.

Source: BKPM, processed

Source: BPS, BMI

Graph 2.2Investment by Sector 2010-2014

Graph 2.3 Number of Foreign Tourists

The utilities sector (electricity, gas and sanitary water) is projected to expand in the range of 5.7-6.1% in 2015, falling short of the 6.5-6.9% predicted previously. Despite the downward revision, the electricity subsector contributes most to the sector with an additional capacity of 4,250 MW planned in 2015, stemming from a new gas power station in Bali and a thermal power station in Karimunjawa. Concerning the gas subsector, the government plans to expand the allocation of natural gas to meet the requirement from industry, electrical power and fertilizer production. Of total gas allocation, more than 59% will be allotted to satisfy domestic demand.

The construction sector is expected to achieve moderate growth in 2015 in the range of 6.4-6.8%, unchanged from the previous forecast, supported by government efforts to expand the capacity and quality of infrastructure. In addition to infrastructure, the favourable outlook is based on a backlog of housing amounting to 7.6 million houses5. Such conditions should prompt additional housing development. Meanwhile, the construction of smelters in response to enforcement of the Mineral and Coal Mining (Minerba) Act will also drive growth in the sector.

The trade, hotels and restaurants (THR) sector is projected to strengthen in the range of 5.1-5.5% in 2015, down on the previous estimate of 5.4-5.8%. Despite the downward revision, THR sector growth remains robust, which is credited to solid public purchasing power as the fledgling middle class continues to thrive. Retail, as the cornerstone of the sector, will grow rapidly, including areas outside of Java. Additionally, tourism is forecasted to expand, evidenced by the growing number of domestic and international tourists (Graph 2.3). Such optimism will ultimately spillover to supporting industries, such as hotels, restaurants, transportation and retail. Notwithstanding, the challenges confronting the sector include leasing costs, rising wages and higher licensing fees, amongst others.

The transportation and communications sector will continue the upward trend of the past few years, with growth projected in the range of 10.2-10.6% in 2015, up on the previous forecast of 10.1-10.5%. Increasingly intense trade activity along with a surge in imports and exports will support transport subsector performance. Concerning land transport, smelter projects will drive logistics businesses to meet the requirement to

5 The Ministry of Public Housing, April 2014. Draft Housing and Settlement Development Program for 2015-2019. Public Housing Coordination Meeting, 2014.


freight mining commodities from the mine to the smelter. With respect to shipping, through the Master Plan for the Acceleration and Expansion of Indonesia's Economic Development (MP3EI) the government will continue to expand connectivity and the maritime-based logistics network. One such effort includes the designation of Kuala Tanjung and Bitung as international shipping ports, long considered a critical factor in boosting the competitiveness of logistics in Indonesia (Graph 2.4). Both ports will soon be operational to maintain national economic competitiveness during the open market era of AEC in 2015.

Source: KP3EI

Graph 2.4Strengthening Plan for Connectivity and

Logistics Network Based Maritime

Graph 2.5 Download Speed Level in Indonesia

In accord with technological advances and the flourishing middle class, demand for communication data and traffic will continue to expand. Download speeds, which represent the network requirement, continue to increase in terms of both broadband and mobile (Graph 2.5). Nevertheless, the level of internet penetration currently stands at just 15%, which is relatively low compared to advanced countries, where penetration exceeds 80%. In addition, broadband speeds in Indonesia are considerably slower than in other countries, placing Indonesia 148th out of 174 countries. Such conditions indicate the vast potential to expand communication data capacity in the future.

The financial, real estate and corporate services sector is projected to grow in the range of 6.1-6.5%, surpassing the previous estimate of 5.9-6.3%. The outlook for the banking industry is promising, marked by solid credit growth that will increase net interest margin (NIM). Meanwhile, the housing subsector (real estate) will accelerate as the thriving middle class continues to prosper and as a relatively stable alternative investment instrument.

Inflation Outlook

The inflation outlook for 2014 and 2015 remains in line with the target corridor of 4.5±1% and 4.0±1% respectively, supported by ongoing macroeconomic stabilisation policy that includes tight policy coordination with the government. Furthermore, moderating domestic demand and sliding commodity prices will help control inflation.

Inflationary pressures in 2014 will be controlled as international commodity prices remain weak, domestic demand continues to moderate and expectations are anchored well. The imported inflation price index indicates that international commodity


prices will continue to slide, while the futures price of four different commodities that have a strong contribution to inflation, namely oil, wheat, palm oil and soybean, experienced a downward correction compared to previous observations. Consequently, international commodity prices, as a composite, also experienced a downward correction. Furthermore, a number of indicators such as the Consumer Confidence Index (CCI), retail sales, capacity utilisation, estimated output gap and inflation expectations reveal moderate demand. Nonetheless, inflationary pressures will emanate from subsidised fuel policy commencing in August 2014. Furthermore, inflation in 2014 faces the risk of potential corrections to administered prices, such as electricity tariffs, as well as rising food prices.

Inflation in 2015 will continue to decline compared to the preceding year. Domestically, the impact of stabilisation policy, implemented since the middle of 2013, has sparked relatively moderate inflationary pressures on the demand side as economic growth remains below its potential and capacity utilisation is low, amidst growing household consumption. Inflation expectations will remain anchored with support from policy coordination between Bank Indonesia and the Government. External inflationary pressures will be weak as a result of limited increases in international commodity prices consistent with the gradual global economic recovery.

Core inflationary pressures will be moderate in 2015, with external pressures stemming from rising international commodity prices mitigated. Meanwhile, limited rupiah depreciation in 2015 will alleviate inflationary pressures from the exchange rate. Domestically, a surge in domestic demand should be met by the supply side, thus inflationary pressures from the demand side will also be minimal. In addition, inflation expectations will be anchored thanks to the coordinated policy mix instituted by Bank Indonesia in conjunction with the Government.

Inflation of volatile foods will ease in 2015 compared to the previous year, assuming no price intervention policy on strategic goods in the upcoming year, coupled with expanding food production and uninterrupted distribution as well as a more favourable trade system.

Inflationary pressures on administered prices will ease in 2015 back towards historical norms. Considering the large burden fuel subsidies places on the government budget, however, further price corrections are possible for goods and services administered by the government.

Risk Factors

Moving forward, Bank Indonesia will remain vigilant of several domestic and global risks that could potentially disrupt the economic rebalancing process. The increasingly integrated global economy is rapidly intensifying the connectedness or contagion from one country to another. Contagion could affect the domestic economy through the trade and financial channels. Meanwhile, there are a number of domestic risks to inflation that must be anticipated.

Globally, the risks faced are linked primarily to uncertainty surrounding the normalisation policy of the Federal Reserve, namely policy instituted by the Fed to normalise its monetary policy stance in line with indications of growing US economic momentum. The Federal Open Market Committee will discontinue the policy of Quantitative Easing III in October 2014, with expectations of a rising federal funds rate in the second and third quarters of 2015 as the US recovery persists. In addition, a median


survey of FOMC members indicated an increase from 1% (FOMC March 2014) to 1.00-1.25% (FOMC June 2014), bolstered by the ‘slightly hawkish’ tone of the Fed at the FOMC on 30-31 July 2014.

On top of the Federal Reserve’s normalisation policy, the economy also faces risks associated with the vulnerability of emerging market countries, an economic downswing in China as well as global spillover and spillback. Risk in Indonesia related to the vulnerability of emerging market countries is moderate compared to other peer countries as a consequence of easing inflationary pressures, swollen foreign exchange reserves and a relatively strong exchange rate. Allayed concerns over the banking crisis in Portugal helped alleviate vulnerability risk from emerging market countries. Meanwhile, the impact of default in Argentina had a limited impact on the economy there as an interruption of debt service transfers rather than a scarcity of funds. On the other hand, risks linked to economic rebalancing in China demand attention due to China’s status as a leading trade partner of Indonesia. One risk associated with the economic downturn in China stems from the property sector in the form of investment and shadow banking. Meanwhile, the risk of global growth spillover and spillback between advanced and emerging market countries could manifest through four channels, namely trade, commodity prices, the global financial system and the neighbourhood effect.

Domestically, a number of risks threaten inflation, including the planned government policy for strategic prices as well as potential price pressures triggered by EL Nino. The planned hike in the upper limit of airfares as the operating costs of airlines soar could prompt inflationary pressures and potentially be exacerbated further by government efforts to manage the enormous burden of energy subsidies. The intensity of the forecasted El Nino event will also influence inflation. Empirical experience has shown that an El Nino episode can destroy land (drought) and reduce rice production. In 2003, a moderate El Nino decimated 550 thousand tons of rice production, which disrupted supply and occasioned higher food prices.


MONETARY POLICY RESPONSE

At the Board of Governors’ Meeting convened on 14th August 2014, it was decided to hold the Bank Indonesia policy rate at 7.50%, with the lending facility rate and deposit facility rate maintained at 7.50% and 5.75% respectively. Such policy is consistent with efforts to steer inflation towards its target corridor of 4.5±1% in 2014 and 4.0±1% in 2015 as well as reduce the current account deficit to a more sustainable level.

Bank Indonesia envisions structural economic rebalancing to continue, supported by concrete macroeconomic stability and reflected by controlled domestic demand as well as lower inflation despite a growing current account deficit during the second quarter in line with seasonal trends.

Going forward, there remain several external and domestic risks that demand vigilance, which could undermine achievement of the inflation target and improvements in the current account. To that end, Bank Indonesia will tirelessly reinforce its monetary and macroprudential policy mix in order to strengthen the structure of the domestic economy and manage external debt, particularly corporate external debt. Bank Indonesia will also bolster policy coordination with the Government to control inflation and reduce the current account deficit, thereby maintaining the economic rebalancing process and sustainable growth looking ahead.

3


Boks: CPO Export Outlook

CPO exports in 2014 will confront moderating demand, while the slump in exports during April 2014 was in line with seasonal factors, namely the month’s distinction as the lowest season. The aforementioned decline was also due to export constraints in the form of higher export duties on CPO. Considering ongoing trends as well as seasonal factors and demand, CPO exports will rebound after April 2014 despite relatively stagnant growth annually at just 1%. Information gleaned from liaisons with export-oriented CPO producers confirmed the sluggish export trend. In the long term, the CPO export outlook is promising. Increased demand for biofuel through the drive towards greener energy will bolster international demand. Indonesia, supported by underexploited land and productivity gains, will continue to dominate the export market in future.

CPO exports to all destinations tailed off dramatically in April 2014 (Graph 1). According to historical seasonal factors, CPO exports are always lowest in the month of April. Nevertheless, a deeper contraction this year is blamed on export constraints. Greater seasonal deviation in April (the lowest season) compounded export growth volatility. Sluggish CPO exports were not linked to production, evidenced by the lowest season of production occurring in December but the lowest season of exports not occurring until February. The CPO export slump, therefore, related more to logistics issues, primarily an increase in export duties from 10.5% to 13.5% on 1st April 2014.

Graph 1. CPO Export: Destination Countries

Graph 2. Seasonal Pattern of CPO Export

CPO production is predominantly export oriented, with an increasingly diversified market (Graph 3). CPO production since 2011 has grown on average by 12.1% per annum. Export growth, however, has not kept pace due to increasing domestic utilisation. Meanwhile, the CPO export market is now more diverse, dominated by China and India but with a growing share to Africa and Asia (Graph 4).


Graph 3. CPO Production, Consumption, and Export

Graph 4. Composition of CPO Export Destination

Graph 5. Global CPO Production and Consumption

Indonesia is the largest CPO producer in the world followed by Malaysia

(Graph 5). Production growth in Indonesia is robust and also more stable than other leading producers. The expanding planting area and a growing gap between planted area and harvested area indicates the large potential for greater production (Graph 6). The primary production locations are found on Sumatra and Kalimantan. Indonesia, followed by Malaysia, is the largest CPO exporter.

Moving forward, Indonesia will continue to dominate global CPO exports, with India, China, EU and Indonesia as the main consumers (Graph 7). The three main consumers of Indonesia’s CPO are also the three main importers globally.

Graph 6. Indonesia CPO Area


Graph 7. Global CPO Exporter and Importer

The requirement for biofuel will drive future CPO demand (Graph 8). Growing demand for biofuel as a result of the green energy program is reflected by the expanding share of CPO use for biodiesel in various countries. The propensity for biodiesel is also evident in Indonesia with up to 25% of fuel earmarked for conversion to biodiesel by 2025 (Graph 9). Furthermore, developing countries will continue to dominate demand.

Graph 8. Share of CPO Used fir Biodiesel

Graph 9. Estimation for Global CPO Demand

Graph10. Estimation Level for CPO Export


Table 1. Timetable of Biodiesel Used in Indonesia

The US Department of Agriculture (USDA) projects stable CPO growth in Indonesia at around 8% (yoy) in 2014. Considering the forecasted El Nino, however, CPO growth was revised down to 5.6% (yoy). The latest release from the Australian Bureau of Meteorology predicts the chance of El Nino at around 70%, or Alert status. Meanwhile, the Indonesia Palm Oil Association (GAPKI) projects stagnant CPO export volume in 2014 due to weak demand and policy factors in importing countries, coupled with mandatory biofuel use domestically.

Considering seasonal trends and future demand, CPO exports will rebound after April 2014 but growth will stagnate relatively, achieving just 1%. Information obtained through liaisons with CPO exporters substantiated the sluggish export market.

Sector Sep‐13 Jan‐14 Jan‐15 Jan‐16 Jan‐20 Jan‐25

Subsidized transportation 10% 10% 10% 20% 20% 25%

Non‐subsidized transportation 3% 10% 10% 20% 20% 25%

Industry 5% 10% 10% 20% 20% 25%

Power plant 7,5% 20% 25% 30% 30% 30%

Source: Ministry of Energy and Mineral Resources Decree No.25, August 29, 2013


The Monetary Policy Report is published quarterly by Bank Indonesia after the Board of Governors’

Meetings in February, May, August, and November. In addition to fulfilling the mandate of article 58 of Act Number 23 of 1999 concerning Bank Indonesia, amended by Act No. 3 of 2004 and Act. No. 6 of 2009, the report has two main purposes: (i) to function as a tangible product of a forward-looking working framework in which formulation of monetary policy is based on economic and inflation forecasts; and (ii) as a medium for the Board of Governors of Bank Indonesia to present to the public the various policy considerations underlying its monetary policy decisions.

For further information: Policy Regulation and Communication Division Monetary Policy Group Monetary and Economic Policy Department Telp: +62 21 2981 8509/5726 Fax: +62 21 2311219 Email: [email protected] Website: http://www.bi.go.id

Board of Governors Agus D.W. Martowardojo – Governor Mirza Adityaswara – Deputy Governor Senior Halim Alamsyah – Deputy Governor Ronald Waas – Deputy Governor Perry Warjiyo – Deputy Governor Hendar – Deputy Governor

monetary policy report quarter ii 2014 - bank indonesia · monetary policy report| 3 19.1% (yoy) in...

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