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Jakarta Post

Indonesia: Resilient growth to continue

Asia, with solid economic growth of 8

Anoop Singh (The Jakarta Post)
Jakarta
Mon, May 2, 2011

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Indonesia: Resilient growth to continue

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sia, with solid economic growth of 8.3 percent in 2010, continues to drive the global recovery. In the IMF’s latest Asia and Pacific Economic Outlook, Asia is projected to grow by about 7 percent in both 2011 and 2012 fueled by robust domestic demand and rising exports.

Risks to the growth outlook have become more balanced now than last October, thanks to the strengthened prospects for sustained growth and reduced uncertainties of private domestic demand in advanced economies.

Meanwhile, new downside risks have arisen such as the turmoil in the Middle East and North Africa region and the related risk of further spikes in oil prices, greater than expected spillovers from the earthquake-related tragedy in Japan, as well as the underlying fiscal and financial vulnerabilities in several advanced economies.

However, potential overheating pressures, in particular, a rise of inflation pressures are posing more domestic risks to the outlook in emerging Asia. Upward pressure on prices is expected to persist in 2011, before decelerating modestly in 2012 as global commodity prices stabilize and projected further efforts to tighten monetary policy in the region become effective.

Strong economic growth and overheating concerns imply that the need to tighten macroeconomic policy stances in Asia has become more pressing than it was six month ago. Chapter 2 of our Economic Outlook suggests that an effective tightening of the monetary policy stance in Asia will require higher short term interest rates. Exchange rate appreciation should also be a key line of defense to avoid overheating. In economies that still face large capital inflows, macro prudential measures can usefully complement monetary policy in addressing specific risks to financial stability.

Over the medium term, to sustain robust growth, Asia needs to continue efforts to rebalance growth toward private domestic demand. The Economic Outlook shows that intra-regional exports are a growing source of demand for many Asian economies. However, Asia still relies heavily on demand from the rest of world and has made only limited progress toward reducing external imbalances after the global financial crisis. Without further measures to strengthen domestic demand, the region’s external imbalance would reemerge as the global economy recovers and demand from advanced economies picks up.

Indonesia has been one of the world’s best performers during the global financial crisis. The economy continues to show resilience, expanding at a better than expected growth of 6.1 percent in 2010 driven by strong domestic demand and exports. Growth is projected to remain strong at 6.2−6.5 percent, mainly driven by buoyant domestic demand, especially a projected increase in investment.

However, inflation has picked up since late 2010 and is expected to be above the top of BI’s target range of 5 percent +/−1 percent in 2011. Rising domestic food prices have been the main driver of inflation, but there is increasing evidence of spillover to core inflation. Bank Indonesia’s recent decision to raise policy rate by 25 bps is a step in the right direction. Further monetary tightening will likely be necessary to contain rising inflation expectations and emerging general price pressures.

As in many other countries in emerging Asia, capital is expected to continue flowing into Indonesia in 2011 and 2012, attracted by its strong growth prospects and fueled by abundant global liquidity and risk appetite, but at a more moderate pace. Bank Indonesia (BI) has managed capital flow volatility relatively well using a combination of currency appreciation and reserve accumulation. Going forward, exchange rate flexibility will continue to serve as an important tool for managing the risks associated with volatile capital flows, as well as containing inflation.

The government has targeted GDP growth of around 7−8 percent after 2013, which would make Indonesia one of the world’s ten largest economies by 2025. For Indonesia to achieve this goal it will need greater efforts to address long-standing constraints to growth. Supportive policies for infrastructure development, such as a more effective fiscal policy through improved budget execution would be crucial to this effort.

The IMF remains closely engaged with Indonesia. In January, IMF Managing Director Dominique Strauss-Kahn visited Indonesia. Following his meeting with President Susilo Bambang Yodhoyono he said it was “the foundation of rebuilding the new kind of relationship between the IMF and Asia in general, and Indonesia in particular.”

In March, the IMF and the Indonesian government jointly held a conference in Bali entitled “Coping with Asia’s Large Capital Inflows in a Multi-Speed Global Economy” to exchange views on the benefits of capital flows and how best to manage them. The one-day conference is part of the strengthened ongoing engagement between the IMF and Asian policymakers following the major IMF-sponsored conference in Daejeon, Korea, in July 2010, at which the Fund committed to cementing a new and mutually beneficial relationship with Asia. Indonesia will play an international role in this partnership.

The writer is Director, Asia and Pacific Department International Monetary Fund.

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