1. Half-yearly Indonesia Economic Update and Outlook William E. Wallace Lead Economist, World Bank Indonesia 10 December 2008

2. Overview  The Indonesian economy coming in strong… -Growth at post-crisis highs -Strong fiscal position -Inflation waning -Banking sector ratios are healthy  Turmoil in global finance has affected Indonesia’s markets  Global developments cloud Indonesia’s economic outlook -Drop in commodity prices hitting export values, incomes and investment -Slower global growth dragging down manufactured exports -Tighter domestic credit pressures domestic demand

3. Overview Commodity prices boom …and bust Int’l financial market turmoil Global economic downturn Impacts domestic economy IDN financial markets 2007 Q32008 Q12008 Q32008 Q4 2009 H1 → Stage 1 ↔Stage 2↔Stage 3

4. Approaching the crisis: Economy coming in strong Volatile & weaker Indo. financial mkts Commodity prices boom International financial market turmoil Global economic downturn Impacts domestic real economy 2007 Q3 2008 Q1 2008 Q32008 Q4 2009 H1  Commodity prices burst Higher export prices, stronger terms of trade Higher inflation Lower poverty Share market  Supports currency Real wages  Invest’t  Employ’t  Incomes  Higher poverty Slower decline in poverty Export prices , terms of trade weaken

5. Approaching the crisis: The commodity boom supported growth Sources: BPS and World Bank  Exports have grown very strongly… (year-on-year percentage change)  As Indonesia’s export prices rose with global commodity prices… (Index, Jan 2005 = 100) 0 5 10 15 20 25 30 20042005200620072008* Manufactured Products Mining & Mineral Agriculture & Forestry Oil and Gas %

6. Approaching the crisis: Growth coming in strong…  Strongest GDP growth post-crisis in 2007 and 2008, bringing average per capita incomes to 20 percent above pre-crisis levels  Only major economy in the region not to slow significantly in 2008 to date Sources: BPS and World Bank

7. Approaching the crisis: …and has been broadly based  Investment growth has been strong  Net exports made a positive contribution, despite the slow- down in global growth  There has been a rising contribution from government spending Sources: BPS and World Bank (Year-on-year growth and contributions)

8. Approaching the crisis: Healthy public finances  Government deficits remains small (percent of GDP)  And the debt ratio continues to fall dramatically (percent of GDP) Sources: Ministry of Finance, IMF, BPS and World Bank

9. Approaching the crisis: The rise in commodity prices fed inflation Volatile & weaker Indo. financial mkts Commodity prices boom International financial market turmoil Global economic downturn Impacts domestic real economy 2007 Q3 2008 Q1 2008 Q32008 Q4 2009 H1  Commodity prices burst Higher export prices, stronger terms of trade Higher inflation Lower poverty Share market  Supports currency Real wages  Invest’t  Employ’t  Incomes  Higher poverty Slower decline in poverty Export prices , terms of trade weaken

10. Approaching the crisis: Inflation, a concern early this year, is waning  However, BI responded aggressively  But concern has shifted to the real economy, motivating December’s rate cut (year-on-year)  With higher food prices, poor households’ cost of living increased faster than the average inflation (year-on-year) Sources: BPS and World Bank

11. Approaching the crisis: Inflation, a concern early this year, is waning  Upstream prices have now begun to fall (year-on-year)  Feeding into lower inflation expectations (year-on-year) Sources: BPS, BI and World Bank

12. Approaching the crisis: With a strong economy, poverty has fallen Volatile & weaker Indo. financial mkts Commodity prices boom International financial market turmoil Global economic downturn Impacts domestic real economy 2007 Q3 2008 Q1 2008 Q32008 Q4 2009 H1  Commodity prices burst Higher export prices, stronger terms of trade Higher inflation Lower poverty Share market  Supports currency Real wages  Invest’t  Employ’t  Incomes  Higher poverty Slower decline in poverty Export prices , terms of trade weaken

13. Approaching the crisis: With a strong economy, poverty has fallen  In rural areas, wages have grown more… (year-on-year growth) Sources: BPS and World Bank  …and poverty rates fallen faster than in urban areas

14. The global financial market turmoil Impacting Indonesian financial markets… Commodity prices boom International financial market turmoil Global economic downturn 2007 Q3 2008 Q1 2008 Q32008 Q4 2009 H1  Commodity prices burst Higher export prices, stronger terms of trade Higher inflation Export prices , terms of trade weaken Lower poverty Supports Indonesia’s real economy IDR weaker Stocks fall Slower fall in poverty Invest’t  Income  Employ- ment  Credit tighter Higher inflation Yields on gov’t debt ↑ Supports Indon. financial markets

15. The global financial market turmoil Impacting Indonesian financial markets…  Sharp IDR depreciation and greater volatility after an extended period of stability  Stock market fallen, along with world markets (USD Index, 1 Jan-08 = 100) Sources: CEIC and World Bank

16. The global financial market turmoil …especially government debt market  Government bond yields and spreads sharply higher, and rose more than elsewhere in the region Sources: IDX, CEIC, JP Morgan, World Bank (Indonesian gov’t USD bonds)(Indonesian gov’t IDR bonds)

17. The global economic downturn Slower global growth will impact Indonesia Higher inflation Commodity prices boom International financial market turmoil Global economic downturn 2007 Q3 2008 Q1 2008 Q32008 Q4 2009 H1  Commodity prices burst Higher export prices, stronger terms of trade Higher inflation Lower poverty Supports Indon. financial markets Supports Indonesia’s real economy Slower fall in poverty Income  Employ- ment  IDR weaker Stocks fall Invest’t  Higher inflation Weaker export demand, especially manufactures

18. The global economic downturn Sharply lower global GDP growth Sources: BPS and World Bank  Global growth prospects have been revised sharply lower  Q4 slowdown looks sharper than expected  Will impact manufacturing most  Lower profits, employment, investment and FDI  Some offset from the lower IDR (yearly ave. percentage change)

19. Impact of the global downturn Sharply lower global commodity prices will lower Indonesia’s terms of trade Sources: World Bank and BPS  Export prices will fall with global commodity prices…  Int’l price forecasts suggest Indonesia’s export prices fall ~15% (Index, Jan 2005 = 100)  …reversing recent improvements in Indonesia’s terms of trade  Some offset from weaker IDR (Index, Jan 2005 = 100)

20. Impact of the downturn Slower growth in Indonesia…  Growth slowing in 2009 before recovering in 2010  Significant downside risks: Commodity prices falling faster and further, and Q3 & Q4 2008 growth and indicators in most economies much weaker than expected Sources: BPS and World Bank

21. Impact of the downturn …especially in externally-oriented industries Sources: BPS and World Bank Sectoral output (year average growth)  Manufactures, and cash crops important recent drivers of growth, will be hit by lower external demand and prices  Conventional agriculture and services expected to do better (and the rainy season has started well)

22. Impact of the downturn But inflation should continue slowing Sources: BPS and World Bank  One positive from the downturn : lower inflation  Lower commodity prices more than offset the IDR’s depreciation  Food & basic goods prices should fall most, benefiting poorer households Inflation for the average and for the poor consumer (year-on-year)

23. Impact of the downturn Slower poverty reduction in 2009  More people remain poor: 1.6 million more in 2009 2.8 million more in 2010 Sources: BPS and World Bank

24. Indonesia’s pro-active policy response Addressing the immediate crisis  Supporting the financial sector:  Injecting liquidity into inter-bank market, cutting interest rates  Increased flexibility on deposit insurance, including raising limit to IDR 2 billion  Regulation to allow intervention in troubled financial institutions  Using public finances to support financial markets & economic activity:  Target deficit of 1.0% GDP in 2009, reducing financing needs  Cut in tax rates for corporations and individuals coming in 2009  Sustaining social and infrastructure spending  Lower fuel prices with a linkage of diesel and gasoline prices to market prices proposed

25. Indonesia’s policy response Positioning for a strong, sustainable recovery  Enhance the financial system’s robustness  Improve banking and capital market supervision  Social policy  Put monitoring program in place -- Given the degree of uncertainty and understanding improved monitoring will be needed. A monitoring system could build on the experience from the crisis updated for new institutions and technologies  Developed response mechanisms that build on existing programs to provide targeted income and job support in rural and urban areas (building on PNPM, BLT, PKH, etc.)  Invest in infrastructure  Increase Indonesia’s competitiveness (transportation and energy)  Stimulate economic activity and employment

26. Half-yearly Indonesia Economic Update and Outlook William E. Wallace Lead Economist, World Bank Indonesia 10 December 2008

27. The global financial & economic turmoil Impacting Indonesian financial markets… Commodity prices boom International financial market turmoil Global economic downturn 2007 Q3 2008 Q1 2008 Q32008 Q4 2009 H1  Commodity prices burst Higher export prices, stronger terms of trade Higher inflation Export prices , terms of trade weaken Lower poverty Supports Indonesia’s real economy IDR weaker Stocks fall Slower fall in poverty Invest’t  Income  Employ- ment  Credit tighter Higher inflation Yields on gov’t debt ↑ Supports Indon. financial markets

28. Overview Volatile & weaker Indo. financial mkts Commodity prices boom International financial market turmoil Global economic downturn Impacts domestic real economy 2007 Q3 2008 Q1 2008 Q32008 Q4 2009 H1  Commodity prices burst Higher export prices, stronger terms of trade Higher inflation Slower decline in poverty Export prices , terms of trade weaken Lower poverty Supports Indon. financial markets Supports Indonesia’s real economy