Indonesia’s Economy: Strong with Room for Improvements

Prudent economic management steered Indonesia through crisis

Need to build on improved financial sector stability

Better infrastructure, targeted subsidies, social services vital for long-term growth

In their annual health check of Southeast Asia’s largest economy, IMF economists said Indonesia had emerged strongly from the global financial crisis due to robust domestic consumption and investment, and greater exports.

Last year Indonesia was the only country in the Group of 20 leading economies to lower its public debt-to-GDP ratio—a reflection of improved economic management over recent years, as well as appropriate policy responses during the crisis. But continued economic recovery has put upward pressure on prices.

The central bank needs to take a proactive approach to keeping inflation in check. Maintaining low inflation would help lower borrowing costs, supporting growth.

Inflation expectations for 2011 are currently at the top end of the 4—6 percent target range and could move higher. Since the crisis, the central bank has kept interest rates low, but in their report the IMF economists said it now needed to meet expectations that inflation would be kept within the target range.

Rapid growth attracts foreign funds

The country’s strong performance has attracted foreign investors who have been pouring into the country’s local government debt markets since mid-2009. However, Indonesia remains vulnerable to swings in investor sentiment. During the European debt crisis earlier this year, a large amount of foreign funds left Indonesia.

The authorities responded by allowing the exchange rate to adjust, while intervening to smooth sharp moves in the level of the Indonesian rupiah. They also announced regulations to reduce swift outflows in the future.

In their report, which followed a 10-day trip to the country in June, the IMF economists noted that funds had returned, but said this experience of capital flight underscored the need for preparedness. They called on the central bank to strengthen its balance sheet in coordination with the government, so that it would have more room for maneuver in the event of future volatility.

Improving the strength of the financial sector

The IMF also identified financial sector reforms to reduce future risks. This sector proved its resilience during the global downturn, and the banking system currently benefits from a large capital buffer and high profitability. However, the IMF suggested that...