National economic growth has improved since the third quarter of 2020 and will increase substantially in 2021. Economic improvement is in line with the realization of the fiscal stimulus, increased mobility of people and improving global demand. The Indonesian economy in the third quarter of 2020 grew by 5.05 percent quarter to quarter (qtq) from a contraction of 4.19 percent qtq, or the contraction of growth decreased to 3.49 percent year-on-year (yoy) from 5.32 percent yoy in the previous quarter.

There was an increased realization of government stimulus, especially in the form of social assistance, spending on other goods and services as well as transfers to regions and villages.

A number of indicators show improvement, such as community mobility, non-food and online business activity and public income. Looking ahead, economic growth is predicted to pick up on the back of the improving global economy and accelerated budget realization for the central and local governments, progress on the credit restructuring program, and the continuation of Bank Indonesia (BI) monetary and macroprudential stimulus. Overall, Indonesia’s economic growth will start to be positive in the fourth quarter of 2020 and is estimated to reach 4.8 percent to 5.8 percent in 2021.

The resilience and stability of Indonesia’s external sector is well maintained. Current account transactions in the third quarter of 2020 recorded a surplus due to improvements in exports and import adjustments in line with the weak domestic demand. This is reflected in the trade balance during the third quarter of 2020, which recorded a surplus of US$9.8 billion. The current account deficit is projected to be below 1.5 percent of gross domestic product (GDP) in 2020 and around 1.0 to 2.0 percent of GDP in 2021, supporting the resilience of Indonesia’s external economic sector.

The rupiah was under pressure and reached a low of Rp 16,575 per US dollar on March 23. With the stabilization steps taken by BI and intensive communication to investors and domestic and foreign market players, the rupiah exchange rate has strengthened significantly again, reaching Rp 14,165 per dollar, representing an appreciation of 17.01 percent.

Going forward, BI sees the rupiah exchange rate remaining stable with potential to strengthen further. This is in line with its fundamentally undervalued level, supported by low and controlled inflation, a low current account deficit, high attractiveness of domestic financial assets and a declining risk premium for Indonesia.

Inflation remains low in line with weak demand and adequate supply. In October 2020, annual inflation reached a low of 1.44 percent. Low inflation was recorded in all regions and for all components of core inflation, volatile food, and administered prices. Core inflation remains low due to weak domestic demand, consistency of BI policies to anchor inflation expectations and maintained exchange rate stability.

Meanwhile, low inflation in the administered prices category was not only due to limited human mobility, but also due to lower air transportation fares. Bank Indonesia predicts that inflation at the end of 2020 will be lower than 2 percent and in 2021 will be controlled within the target range of 3.0±1 percent).

Financial system stability was maintained amid weak credit growth. The capital adequacy ratio (CAR) of banks in September was recorded at 23.41 percent, and the ratio of non-performing loans (NPL) was 3.15 percent gross and 1.07 percent net. However, the intermediation function of the financial sector is still weak due to limited credit growth in line with weak domestic demand as a result of depressed business performance and banking prudence due to the continuing COVID-19 pandemic.

Credit in October 2020 contracted by 0.47 percent yoy, meanwhile, growth in third-party funds was recorded at a higher rate of 12.12 percent yoy. Banking intermediation is predicted to improve. Growth in credit and third-party funds in 2021 is estimated to increase by 7 percent and 9 percent, respectively.

 

The prospects for Indonesia’s economic recovery in 2021 will improve in the following years and return to a trajectory toward an advanced Indonesia in the medium term. The acceleration of economic growth with a better economic structure is supported by the acceleration of economic transformation through a series of structural reform policies directed at five main strategies.

First, development of reliable human resources with mastery of technology. Second, infrastructure development that supports industrial connectivity, including MSMEs and tourism. Third, improving the investment and business climate that is better supported by the streamlining of regulations through the implementation of the Job Creation Law and the development and deepening of the financial market, which encourages the strengthening of sources of development financing.

Fourth, strengthening priority sectors that are competitive and with high added value; and fifth, optimizing the use of technology to support digital-based economic transformation. The increased economic capacity which is supported by increased economic efficiency and productivity, as a result of a series of structural reforms, promotes higher and more sustainable economic growth toward an advanced Indonesia with maintained stability.

We predict that in the medium term, Indonesia’s economic growth will continue to pick up to be in the range of 5.5 to 6.1 percent with inflation maintained at a low level of between 1.5 percent and 3.5 percent and a current account deficit in the range of 1.5  to 2.5 percent of GDP in 2025.

The improvement in the performance of the national economy is supported by synergy and close policy coordination among the government, Bank Indonesia, the Financial Services Authority (OJK), the Deposit Insurance Agency (LPS) and other relevant parties. In 2020, the government provided a relatively large fiscal stimulus with a deficit of Rp 1.03 quadrillion or 6.3 percent of GDP.

This included the budget for handling COVID-19 and the national economic recovery program of Rp 695.2 trillion for the public goods (i.e. health, social assistance and public services) amounting to Rp 397.6 trillion, as well as nonpublic goods (namely incentives to MSMEs, businesses and corporations) amounting to Rp 297.6 trillion.

Through its so-called burden-sharing mechanism with the government, Bank Indonesia provides financing and bears the burden of the entire public goods budget of Rp 397.6 trillion in the 2020 state budget through the direct purchase of government securities (SBN), and it also bears the burden of around 60 percent of the SBN interest for the nonpublic goods budget for MSMEs and corporations in the amount of Rp 117 trillion in the 2020 state budget.

Meanwhile, the OJK has provided relaxation for banks in restructuring their credit by delaying installments of principal and interest and closely coordinating with the government for national economic recovery, while maintaining macroeconomic and financial system stability. Bank Indonesia is committed to providing financing for the 2020 state budget through the purchase of SBN from the primary market or directly, so that the government can focus on accelerating budget spending.

Provision of liquidity is also continuously provided for banks to support the credit restructuring program and the business sector. The strengthening of Bank Indonesia’s policy mix covers the following aspects:

-  A decrease in the BI 7-Day Reverse Repo Rate (BI7DRR), which was cut five times in 2020 by a total of 125 basis points to 3.75 percent. This decision is in line with the need to boost economic growth amid low inflation and a relatively stable rupiah exchange rate. This BI policy rate is the lowest in history.

-  Rupiah exchange rate stabilization policy through intervention on the spot market, domestic nondeliverable forward and purchases of SBN from the secondary market, amid continued uncertainty about the global financial market.

-  Quantitative easing by injecting large amounts of liquidity into banks to support the national economic recovery. Quantitative easing is carried out by, among other measures, monetary expansion and a reduction in the reserve requirement.

-  Relaxation of macroprudential policies to boost credit and financing for the economy, such as the macroprudential intermediation ratio, loan-to-value ratio or lower down-payments for green motor vehicle loans.-       

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The writer is the governor of Bank Indonesia. This article is abridged from his monetary policy statement at Bank Indonesia’s Annual Meeting 2020 held on Dec. 3.