Indonesia - iuj.ac.jpwill have to resume in 2006. GDP growth is expected to accelerate to 5.7% in...

Country Report

Indonesia

May 2005

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

Indonesia at a glance: 2005-06

OVERVIEWThe popularity of the president, Susilo Bambang Yudhoyono, is holding up,partly because of a concerted effort in the past month to tackle corruption. TheHouse of Peoples� Representatives (DPR) remains fractious, but internal faction-fighting within the opposition parties could weaken their ability to blockgovernment initiatives. Fiscal policy is expected to be more expansionary in2005, as Indonesia will benefit from debt deferral this year, but fiscal rectitudewill have to resume in 2006. GDP growth is expected to accelerate to 5.7% in2005, owing primarily to an expansion in investment, while stronger growth inprivate consumption will enable GDP growth to rise to 6% in 2006.Inflationary pressures will rise in the first half of 2005, but will ease during theremainder of the forecast period. The current-account surplus will reach 1.4% ofGDP in 2005, bolstered by a sharp jump in transfer credits, but will fall back to0.9% of GDP in 2006.

Key changes from last month

Political outlook• The government will lift the civil-emergency status in Aceh province in mid-

May, and will meet representatives of the separatist Free Aceh Movement(GAM) for the fourth time at the end of May. It now looks likely that a peaceagreement will be reached by mid-2005.

Economic policy outlook• The rupiah depreciated in April, prompting Bank Indonesia (the central

bank) to tighten monetary policy and introduce emergency measures toabsorb excess liquidity in the financial system. The Economist IntelligenceUnit�s forecast for interest rates has been left unchanged, however, as weforecast that inflation will slow and that the currency will stabilise in thesecond half of 2005.

Economic forecast• We have revised up our forecast for real GDP growth in 2005 following

strong first-quarter data. Private consumption growth proved resilient inJanuary-March despite the end-2004 tsunami disaster and the prospect offuel price and interest-rate rises.

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Indonesia 1

Country Report May 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005

Contents

Indonesia

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2005-067 Political outlook8 Economic policy outlook9 Economic forecast

13 The political scene

20 Economic policy

23 The domestic economy23 Output and demand26 Financial indicators28 Oil and gas29 Mining29 Agriculture30 Manufacturing31 Infrastructure32 Financial markets

33 Foreign trade and payments

List of tables9 International assumptions summary

10 Gross domestic product by expenditure

12 Forecast summary

21 2005 budget assumptions

24 GDP by expenditure

24 Structure of gross domestic product

25 Gross domestic product by sector

25 Consumer prices

26 One-month SBI rates and commercial bank rupiah credit rates27 Monetary aggregates

28 International reserves

32 Banking indicators, 2004

34 Merchandise trade by value

34 Main non-oil and gas export markets

35 Imports by category

2 Indonesia


36 Tourist arrivals at 13 principal gateways

36 Balance of payments

39 External debt

39 External debt servicing

List of figures

13 Gross domestic product13 Consumer price inflation26 Monetary indicators37 External balances39 External debt stock and debt-service ratio

Indonesia 3


IndonesiaMay 2005

Summary

The popularity of the president, Susilo Bambang Yudhoyono, is holding up,partly because of a concerted effort in the past month to tackle corruption. TheHouse of Peoples� Representatives (DPR) remains fractious, but internal faction-fighting within the opposition parties could weaken their ability to blockgovernment initiatives. Fiscal policy is expected to be more expansionary in2005, as Indonesia will benefit from debt deferral this year, but fiscal rectitudewill have to resume in 2006. GDP growth is expected to accelerate to 5.7% in2005, owing primarily to an expansion in investment, while stronger growth inprivate consumption will enable GDP growth to rise further, to 6%, in 2006.Inflationary pressures will increase in the first half of 2005, but will ease duringthe remainder of the forecast period. The current-account surplus will reach1.4% of GDP in 2005, bolstered by a sharp jump in transfer credits, but will fallback to 0.9% of GDP in 2006.

Mr Yudhoyono has been consolidating his hold on power with theappointment of allies to influential posts in key institutions, including thesecurity forces. Opposition parties in the DPR are in disarray, as elections fornew party leaders have been acrimonious and have revealed deep internaldivisions. Relations with Australia and East Timor are improving steadily.

A revised budget for 2005 retains a budget deficit target of 0.5% of GDP, butraises the oil price assumption to US$35/barrel, from US$24/b previously.Indonesia successfully issued US$1bn in global bonds in April. A detailed planfor the reconstruction of Aceh has been announced, and a special agency hasbeen created to oversee the operation.

The economy grew by a strong 6.4% year on year in the first quarter of 2005,partly owing to strong investment demand. Inflation spiked up to 8.8% year onyear in March 2005, following a 29% increase in fuel prices in that month. Therupiah has weakened as a result of strong corporate demand for US dollars,fears of escalating inflation and currency speculation.

Export revenue rose by 31% year on year in the first quarter of 2005, while theimport bill grew at the slightly slower rate of 28.3%. The US overtook Japan asthe single most important export market. Talks on free trade have begun withJapan, and a strategic partnership agreement has been signed with China.

Editors: Caroline Bain (editor); Gerard Walsh (consulting editor)Editorial closing date: May 16th 2005

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2005-06

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Indonesia


Political structure

Republic of Indonesia

Power has historically been concentrated in the hands of the presidency, but recentconstitutional amendments are leading to a greater role for the legislature

The presidency is the highest executive office, with direct legislative powers and authorityto appoint the cabinet

The president, Susilo Bambang Yudhoyono

The Peoples� Consultative Assembly (MPR) consists of the 550-member House of Peoples�Representatives (DPR) plus 128 regional representatives (DPD). From 2004 all politicalrepresentatives, including the president, are to be directly elected

April 2004 (DPR); the next parliamentary election is due in 2009; direct presidentialelections were held for the first time in July and September 2004; the next presidentialelection is due in 2009

In the DPR election held on April 5th 2004 Golkar emerged as the largest party, but with127 seats it does not have a majority. The Indonesian Democratic Party-Struggle (PDI-P)came a close second, and has 109 seats

There are two large nationalist secular parties, Golkar and the PDI-P, and a smaller party,the Democratic Party. The other main parties have an Islamic orientation; they are theUnited Development Party (PPP), the National Awakening Party (PKB), the NationalMandate Party (PAN) and the Prosperous Justice Party (PKS)

President Susilo Bambang YudhoyonoVice-president Jusuf Kalla

Co-ordinating minister for political, security & social affairs Widodo A SCo-ordinating minister for the economy Aburizal BakrieCo-ordinating minister for people�s welfare Alwi ShihabAgriculture Anton ApriyantonoCulture & tourism Jero WatjikDefence Juwono SudarsonoEducation Bambang SoedibyoEnergy & mineral resources Purnomo YusgiantoroFinance Yusuf AnwarFisheries & maritime affairs Freddy NumberiForeign affairs Hassan WirayudaForestry M S Ka�banHealth Fadilah SupariHome affairs & regional autonomy Mohammad Ma�arufIndustry Adung NitimiharjaLaw & human rights Hamid AwaluddinManpower & transmigration Fahmi IdrisPublic works Joko KirmantoReligious affairs M Maftuh BasyuniSocial affairs Bachtiar ChamsyahTrade Mari E PangestuTransportation Hatta Radjasa

Burhanuddin Abdullah

Official name

Form of government

The executive

Head of state

National government

Main political organisations

Key ministers

National elections

Central bank governor

National legislature

Indonesia 5


Economic structure

Annual indicators2000 a 2001 a 2002a 2003 a 2004 b

GDP at market prices (Rp bn) 1,389,770 1,684,281 1,863,275 2,045,854 2,303,031 a

GDP (US$ bn) 165.0 164.1 200.1 238.5 257.6 a

Real GDP growth (%) 5.4 b 3.8 4.4 4.9 5.1 a

Consumer price inflation (av; %) 3.7 11.5 11.9 6.8 6.1 a

Population (m) 211.6 214.4 217.2 220.6 b 223.8

Exports of goods fob (US$ m) 65,407 57,364 59,166 63,254 71,788Imports of goods fob (US$ m) 40,366 34,669 35,653 39,546 50,562Current-account balance (US$ m) 7,992 6,900 7,824 7,252 2,864

Foreign-exchange reserves excl gold (US$ m) 28,502 27,246 30,971 34,962 34,953 a

Total external debt (US$ bn) 144.4 134.0 131.8 134.4 132.3

Debt-service ratio, paid (%) 22.5 23.6 24.7 26.0 16.7Exchange rate (av) Rp:US$ 8,421.8 10,260.9 9,311.2 8,577.1 8,938.9 a

a Actual. b Economist Intelligence Unit estimates.

Origins of real gross domestic product 2004 % of total Components of gross domestic product 2004 % of totalAgriculture, forestry & fishing 16.2 Private consumption 66.5Mining & quarrying 9.0 Government consumption 8.2

Manufacturing 29.9 Gross fixed investment 21.0Construction 6.2 Change in inventories 1.8Electricity, gas & water supply 1.0 Exports of goods & services 30.9

Services 37.7 Imports of goods & services 26.9

Principal exports 2003 US$ m Principal imports 2004 US$ mCrude petroleum & products 7,175 Raw materials & intermediates 36,315Textiles & garments 7,103 Capital goods 6,093

Liquefied natural gas 6,477 Consumer goods 3,772

Main destinations of exports 2003 % of total Main origins of imports 2003 % of totalJapan 24.0 Japan 18.8US 14.9 China 14.9

Singapore 10.4 Singapore 13.8South Korea 8.4 US 8.4

6 Indonesia


Quarterly indicators2003 2004 20052 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

OutputGDP at constant 2000 prices (Rp trn) 394.24 404.71 392.64 404.94 411.52 425.35 418.77 n/aGDP at constant 2000 prices (% change,

year on year) 5.1 4.3 4.9 4.4 4.4 5.1 6.7 n/aManufacturing at constant 2000 prices (Rp trn) 108.64 113.01 112.71 113.81 116.11 118.41 120.79 n/aManufacturing at constant 2000 prices (% change,

year on year) 4.4 5.2 4.7 6.0 6.9 4.8 7.2 n/aMining at constant 2000 prices (Rp trn) 43.50 43.23 39.88 38.89 39.53 41.05 41.19 n/aMining at constant 2000 price (% change,

year on year) 4.2 -0.9 -6.1 -7.0 -9.1 -5.0 3.3 n/aPricesConsumer prices (2002=100) 106.0 106.8 108.9 110.6 112.8 114.0 115.7 119.2Consumer prices (% change, year on year) 7.3 6.4 5.7 4.8 6.4 6.7 6.3 7.8Wholesale prices (1993=100) 417 418 424 435 456 468 475 497Financial indicatorsExchange rate Rp:US$ (av) 8,479 8,441 8,482 8,470 9,001 9,156 9,128 9,274Exchange rate Rp:US$ (end-period) 8,285 8,389 8,465 8,587 9,415 9,170 9,290 9,480Deposit rate (av; %) 12.02 9.60 7.56 6.39 6.16 6.55 6.67 n/aDiscount rate (end-period; %) 9.53 8.66 8.31 7.42 7.34 7.39 7.43 n/aLending rate (av; %) 17.68 16.44 15.43 14.80 14.28 13.88 13.54 n/aMoney market rate (av; %) 8.29 5.97 5.27 6.13 4.49 5.00 6.28 n/aM1 (end-period; Rp bn) 191,797 203,825 220,552 216,317 230,934 238,377 251,243 n/aM1 (% change, year on year) 11.8 13.9 17.3 22.0 20.4 17.0 13.9 n/aM2 (end-period; Rp trn) 893.6 909.6 954.8 934.7 976.1 986.7 1,033.5 n/aM2 (% change, year on year) 6.4 5.7 8.1 6.6 9.2 8.5 8.2 n/aJSE Composite stockmarket index (end-period;

Aug 10th 1982=100) 505.5 597.7 691.9 735.7 732.4 820.1 1,000.2 1,080.2Sectoral trendsManufacturing production (1993=100)a 102.6 110.8 103.8 105.7 112.2 114.5 112.4 n/aManufacturing production (% change,

year on year)a -0.1 3.5 5.3 9.3 2.6 3.3 8.2 n/aCrude oil production (m barrels/day)b 1.01 1.00 1.00 0.98 0.96 0.96 0.97 0.95Rubber, dry production ('000 tonnes) 81.7 80.6 92.7 86.6 82.2 n/a n/a n/aNickel ore production ('000 tonnes) 1,279.2 1,227.4 978.8 1,070.4 1,034.4 932.6 n/a n/aForeign trade (US$ m)Exports fob 15,313 15,352 15,151 15,014 16,396 19,139 19,395 19,760Imports cif -7,645 -8,046 -8,485 -9,954 -10,224 -12,369 -12,843 -12,971Trade balance 7,669 7,306 6,666 5,060 6,171 6,769 6,552 6,789

Foreign payments (US$ m)Merchandise trade balance fob-fob 6,241 6,558 5,405 3,380 5,767 6,794 n/a n/aServices balance -2,706 -3,503 -2,595 -2,306 -2,520 -3,705 n/a n/aIncome balance -2,025 -1,190 -1,753 -1,819 -2,369 -1,770 n/a n/aNet transfer payments 716 393 568 309 258 319 n/a n/aCurrent-account balance 2,226 2,258 1,625 -436 1,136 1,638 n/a n/aReserves excl gold (end-period) 32,990 32,842 34,962 36,073 33,609 35,018 34,953 34,612

a Large & medium-sized companies. b Including production in Irian Jaya; excluding condensates.

Sources: International Energy Authority, Monthly Oil Market Report; IMF, International Financial Statistics; Central Bureau of Statistics (BPS); Standard & Poor�s, Emerging Stock Markets

Review.

Indonesia 7


Outlook for 2005-06

Political outlook

After a slow start, the president, Susilo Bambang Yudhoyono, appears to bemounting a concerted effort to fulfil his electoral promise to fight corruption.Apart from legislation to limit the opportunities for graft, a number of high-profile investigations have been launched, and a comprehensive campaignagainst illegal logging appears to be under way. There remain doubts about thejudiciary�s ability to follow through on these initiatives, but visible signs ofMr Yudhoyono�s commitment to reform will help to maintain his popularitywith the electorate.

Mr Yudhoyono�s support base in the House of Peoples� Representatives (DPR) isless predictable. Despite the fact that Mr Yudhoyono now has the backing ofthe secular nationalist Golkar party, the largest party in the DPR, the legislativeprocess is expected to remain unwieldy and characterised by inter-party deal-making throughout the forecast period. Mr Yudhoyono was probably hoping toincrease his following as a result of recent party leadership elections in anumber of the smaller parties. (Although these parties� representation in theDPR is relatively small, who they decide to side with will be decisive to thesmooth running of the legislative process.)

In late March, in a blow to Mr Yudhoyono�s bid to increase his support base inthe DPR, Megawati Soekarnoputri was re-elected as leader of the IndonesianDemocratic Party-Struggle (PDI-P), the second-largest party in the DPR.Ms Megawati has a deep personal antipathy to Mr Yudhoyono, and is likely toencourage her party to be obstructive in parliamentary proceedings. However,her impact may be diminished if, as the Economist Intelligence Unit expects, abreakaway reformist group from the PDI-P forms another party. The new party,if created, would have reformist credentials, and thus its members would bemore likely to side with Mr Yudhoyono�s faction in parliamentary debates.

The smaller National Awakening Party (PKB), which has 9% of DPR seats butmakes up almost one-third of the coalition in opposition to the president, isalso in disarray following a controversial party leadership election. The splithas become so bitter that the case has been referred to the Ministry of Justicefor a decision as to who is the legitimate leader of the party. This will be adifficult decision for the government, as one of the two factions bidding for theparty leadership would support Mr Yudhoyono, whereas the other would keepthe PKB in opposition. We believe it likely that the PKB will remain inopposition, but Mr Yudhoyono can take comfort from the fact that internalfaction-fighting in some of the larger opposition parties is likely to work inhis favour.

One positive outcome of the December 2004 tsunami disaster has been theresumption of talks between the Free Aceh Movement (GAM, the separatistrebel movement in Aceh province) and the government. Three rounds of talkshave been held, and GAM has dropped its insistence on outright independence;instead it is prepared to accept �self-rule�. The government is offering a special

Domestic politics

8 Indonesia


autonomy deal, involving limited self-rule, together with an amnesty for therebels. The government has accepted the rebels� request for foreign monitoring!most likely by EU countries or Association of South-East Asian Nations(ASEAN) members!but is refusing to consider allowing foreign peacekeepingforces to operate in the province. Further talks are planned from May 26th toMay 31st, and the government is hoping that a peace accord will be reached bymid-2005.

Relations with the US have improved since the more outward-looking anddiplomatic Mr Yudhoyono assumed the presidency. However, there remainstumbling blocks. The Indonesian government is keen to have full militaryrelations restored with the US, partly so as to be able to purchase US militaryequipment and parts. The US president also appears keen for relations to berestored, as Indonesia would be an important strategic ally given its location inSouth-east Asia and the fact that it is home to the largest Muslim population inthe world. In March 2005 the US reinstated a training programme forIndonesian military personnel, but the restoration of full relations remainscontroversial. In a recent visit to Indonesia the US deputy secretary of state,Robert Zoellick, repeated that the restoration of military links was dependenton the Indonesian authorities� conducting a comprehensive investigation intothe murder of two US citizens in Papua in 2002 (the Indonesian military issuspected of involvement in the murders) and on the Indonesian military�sbeing held accountable for atrocities committed during East Timor�sindependence struggle. We do not expect the Indonesian authorities to makemuch progress on either of these issues, and thus the resumption of militaryrelations is likely to necessitate a softening of the US stance.

Economic policy outlook

The government has been more proactive on policy reform in the last couple ofmonths. In late April Mr Yudhoyono announced a detailed plan to countercorruption. It involves eight specific measures and targets and, if enacted asdecreed, should improve legal procedures for corruption cases. In a popularmove, the president announced that the �cleaning-up� process was to start withthe institutions associated with the presidential palace. A detailed plan for thereconstruction of Aceh was also announced in mid-April, helping to dispelearlier criticisms that the government was failing to address the issue. Anagency has been created to oversee the reconstruction effort. The agency isdirectly accountable to the president, and three different organisations(including a private-sector accounting firm) will audit the agency�s accounts.

In its draft revision of the 2005 state budget, the government maintained thebudget deficit target at 0.8% of GDP. The deficit would have been higher were itnot for the debt moratorium, worth US$2.6bn, offered by the Paris Club ofofficial creditors. The government has raised the oil price assumption toUS$35/barrel in its draft budget revision (up from US$24/b in the originalbudget), despite the fact that international oil prices have been around US$50/bfor some time. This suggests that the government may be forced to raise fuel

Policy trends

International relations

Fiscal policy

Indonesia 9


prices again in 2005. We are forecasting a deficit of 1.1% of GDP in 2005, inview of the government�s need to continue financing the fuel price subsidy andbecause of higher state expenditure on poverty reduction programmes andinfrastructure projects. In 2006 stronger economic growth will lead to higherrevenue, but this will be offset by a return to full debt servicing, so that weforecast a rise in the deficit to 1.5% of GDP in that year.

Interest rates on the benchmark one-month Bank Indonesia Certificates (SBIs)stood at 7.87% on May 11th, up from just 7.43% on March 2nd, as Bank Indonesia(BI, the central bank) was forced to raise rates owing to concerns about risinginflation and rupiah weakness. The seven-day intervention rate (FASBI) wasalso raised by 25 basis points on April 4th to 7.25%. (The FASBI was introducedin June 2004, and had remained unchanged at 7% since its launch.) It appearsinevitable that benchmark interest rates will have to rise further. We expect SBIrates to reach around 8% in the second quarter of 2005, before starting to easeagain in the second half of the year as inflationary pressures ease and therupiah stabilises. BI appears to have taken a reactive rather than a pre-emptiveapproach in recent months: it has been reluctant to tighten monetary conditionsfor fear of depressing economic growth and raising debt-servicing costs for thegovernment. However, the prevalence of excess liquidity, as a result of loosemonetary conditions, was one of the factors leading to exchange-rate volatilityand speculation in April. Although international interest rates are expected tobe higher in 2006, Indonesia still has a relatively high differential with averagerates in the OECD, and there is scope for interest rates to move lower. Althougheconomic growth is forecast to be strong in 2006, it will not be sufficient tocreate inflationary pressures in the economy, and there will consequently be asmall fall in interest rates in that year.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2003 2004 2005 2006Real GDP growthWorld 3.9 5.1 4.2 3.9OECD 2.0 3.3 2.4 2.3EU25 1.1 2.4 1.9 2.1Exchange rates¥:US$ 115.9 108.1 102.7 93.8US$:� 1.132 1.244 1.350 1.400SDR:US$ 0.714 0.675 0.646 0.628Financial indicators� 3-month interbank rate 2.33 2.13 2.10 2.25US$ 3-month Libor 1.21 1.62 3.46 4.52

Commodity pricesOil (Brent; US$/b) 28.8 38.5 46.0 40.0Gold (US$/troy oz) 363.3 409.5 435.0 402.5Food, feedstuffs & beverages (% change in US$ terms) 6.6 9.1 -6.5 -1.4Industrial raw materials (% change in US$ terms) 13.0 21.0 3.5 -6.7

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

International assumptions

Monetary policy

10 Indonesia


We have made a significant upward adjustment to our forecast for internationaloil prices (based on dated Brent Blend), which has contributed to a slightdownward revision to our forecast for OECD growth and an upward revision toinflation expectations. We now expect oil prices to average US$46/barrel(previously US$42/b) in 2005 and US$40/b (previously US$37/b) in 2006. Oildemand, particularly from China, is expected to remain strong, and spare globalproduction capacity is likely to diminish. In view of the inflationary impact ofhigh fuel costs, international interest rates will rise steadily during 2005-06, atrend that began in mid-2004. This will have particularly negative con-sequences for the Indonesian economy when it resumes full debt-servicingin 2006.

Gross domestic product by expenditure(Rp bn at constant 2000 prices; % change year on year in brackets unless otherwise indicated)

2003a 2004 b 2005c 2006c

Private consumption 956,593 1,003,809 1,047,464 1,098,618(3.9) (4.9) (4.3) (4.9)

Public consumption 121,404 123,768 122,954 127,109(10.0) (1.9) (-0.7) (3.4)

Gross fixed investment 310,777 359,604 421,288 499,759(1.0) (15.7) (17.2) (18.6)

Final domestic demand 1,388,774 1,487,182 1,591,705 1,725,487(3.7) (7.1) (7.0) (8.4)

Stockbuilding -4,708 39,981 38,000 40,000(-1.2)d (2.8) d (-0.1)d (0.1)d

Total domestic demand 1,384,067 1,527,163 1,629,705 1,765,487(2.4) (10.3) (6.7) (8.3)

Exports of goods & services 612,559 664,463 712,164 759,065(8.2) (8.5) (7.2) (6.6)

Imports of goods & services 433,809 542,041 594,467 662,270(2.7) (24.9) (9.7) (11.4)

Foreign balance 178,750 122,423 117,698 96,794(2.3)d (-3.6) d (-0.3)d (-1.2)d

GDP 1,579,559 1,660,579 1,755,503 1,860,881(4.9) (5.1) (5.7) (6.0)

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.d Contribution to real GDP growth.

Preliminary data for GDP growth in the first quarter of 2005, at 6.4% year onyear, was surprisingly strong in view of the devastation caused by the tsunamiin late 2004 and rising expectations of interest-rate and fuel price rises. Growthin exports of goods and services was particularly robust given the generalweakening of OECD demand, and although import growth remained strong, itslowed from the 24.9% year-on-year rate recorded in the fourth quarter of 2004to 15.4% year on year in the first quarter of 2005. Although inflationarypressures, the fuel price rise and higher interest rates will slow consumerdemand growth in 2005, we expect the slack to be taken up by strongerinvestment growth. The government is prioritising infrastructure development,and there will be a boost to construction from the need to rebuild in theprovince of Aceh. Ongoing reforms in the banking sector mean that it is also ina stronger position to resume lending to the corporate sector. Real GDP growthis expected to rise to 5.7% in 2005 and again to 6% in 2006. By 2006 upward

Economic growth

Indonesia 11


pressure on inflation and interest rates will have receded, and privateconsumption will grow solidly in that year. Growth in exports of goods andservices will slow in 2005-06, owing to weaker global demand andcompetitiveness problems.

Consumer price inflation soared to a year-on-year rate of 8.8% in March 2005 (itaveraged 6.1% in 2004), owing to the 29% increase in average fuel pricesimplemented on March 1st. However, the inflation rate slipped back to 8.1% inApril, despite rupiah weakness and the filtering through the economy of higherfuel prices. We expect inflation to rise to an average of 6.9% in 2005, largelybecause of the fuel price rise, but monthly inflation rates will ease in thesecond half of the year partly thanks to a good harvest and lower food priceinflation. (Reportedly the El Niño weather phenomenon, expected to bringdrought conditions this year, has not materialised in any strength.) A morestable rupiah in the second half of 2005 will also help to contain annualinflation, and wage pressures will remain subdued owing to persistently highunemployment and underemployment. Inflation is forecast to moderate in2006, helped by lower international oil prices. Given the current low level ofcapacity utilisation (estimated at 50-60%), robust economic growth in 2006 isunlikely to generate inflationary pressures.

The rupiah weakened sharply during April and reached a three-year low ofRp9,750:US$1 on April 26th, owing to concerns about rising US interest rates, theinflationary impact of the fuel price rise and strong demand for US dollars fromlocal companies to pay their maturing debts and to finance imports. Inresponse to the slide in the currency, BI announced a raft of monetarymeasures to defend the rupiah from future volatility. These include rolling out anumber of new debt and currency-swap instruments to help absorb excessmarket funds, raising official interest rates and requiring the state oil company,Pertamina, to request US dollars directly from BI (rather than the market) tofinance its oil imports. In the second week of May BI started to offer two-daydeposits at 3.625% as an instrument for �fine-tuning� exchange-rate manage-ment. BI also announced a cut (from 30% to 20%) in the net open position ofequity capital that commercial banks are allowed to operate, and said thatit was considering raising banks� reserve requirements. The rupiah hassubsequently rallied, and stood at Rp9,430:US$1 on May 16th.

The currency is expected to strengthen in the second half of the year, supportedby inflows of foreign capital, primarily in the form of grant aid and investmentinflows. The moratorium on debt-servicing obligations in 2005 granted by theParis Club of official creditors will further support the rupiah. The rupiah islikely to weaken in early 2006 as debt servicing resumes in full, but it will besupported in the second half of the year by persistently strong economicgrowth and net positive investment flows. We expect the exchange rate toaverage Rp9,247:US$1 in 2006.

The trade surplus (on a balance-of-payments basis) is expected to fall in2005-06 to an annual average of US$20.2bn, compared with an estimatedUS$21.2bn in 2004, primarily as a result of strong growth in import demand

Inflation

Exchange rates

External sector

12 Indonesia


and prices. Import demand will be boosted not only by reconstruction work inthe wake of the tsunami but also by the government�s proposed infrastructuredevelopment plans. Import prices will be high as a result of the need to importoil at high international prices. The growth in the value of merchandise exportreceipts will slow in 2005-06 in tandem with a slowdown in OECD demand,and also because of structural weaknesses in the export sector, such as lowproductivity. Lower global oil prices in 2006 will be an additional factordepressing export revenue in that year. The deficit on the services account willrise to an annual average of US$11.7bn in 2005-06, owing to trade-relatedexpenditure associated with the rise in merchandise imports; this will morethan offset a steady rise in inflows from tourism, particularly in 2006. Theincome deficit will fall in 2005 owing to lower interest payments on externaldebt, but will rise again in 2006 as debt servicing resumes in full. In 2005 thedeficits on the services and income accounts will be offset by the arrival oftsunami-related grant aid, which will boost the transfers balance, and thecurrent-account surplus will rise to US$4bn (equivalent to 1.4% of GDP), fromUS$2.9 (1.1% of GDP) in 2004. The lower level of transfer credits in 2006 is anadditional factor leading to a forecast fall in the current-account surplus toUS$3bn (0.9% of GDP) in that year.

Forecast summary(% unless otherwise indicated)

2003a 2004 b 2005c 2006c

Real GDP growth 4.9 5.1 5.7 6.0

Industrial production growth 3.9 4.0 2.1 3.7Gross agricultural production growth 4.8 4.1 2.5 2.0

Unemployment rate (av) 9.5 9.6 9.4 9.5Consumer price inflation (av) 6.8 6.1 a 6.9 4.6Consumer price inflation (year-end) 5.2 6.4 a 5.6 5.5

Money market interest rate 7.8 5.4 a 5.7 5.3Government balance (% of GDP) -1.3b -1.5 -1.1 -1.5

Exports of goods fob (US$ bn) 63.3 71.8 78.6 86.6Imports of goods fob (US$ bn) 39.5 50.6 58.9 65.9Current-account balance (US$ bn) 7.3 2.9 4.0 3.0

Current-account balance (% of GDP) 3.0 1.1 1.4 0.9External debt (year-end; US$ bn) 134.4 132.3 133.8 135.7

Exchange rate Rp:US$ (av) 8,577 8,939 a 9,426 9,247Exchange rate Rp:¥100 (av) 7,400 8,267 a 9,182 9,864

Exchange rate Rp:� (year-end) 10,678 12,577 a 13,249 12,704Exchange rate Rp:SDR (year-end) 12,579 14,427 a 14,998 14,519

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Indonesia 13


Indonesia Asia excl Japan

Gross domestic product% change, year on year

Indonesia Asia excl Japan

Consumer price inflationav; %

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2000 01 02 03 04 05 06

0

2

4

6

8

10

12

14

2000 01 02 03 04 05 06

The political scene

During his first six months as president, Susilo Bambang Yudhoyono has begunto show aptitude for the job. He has handled domestic disasters andinternational diplomacy with aplomb, and, in cutting domestic fuel subsidies inMarch, he succeeded in easing through a crucial and long-overdue economicreform. But Mr Yudhoyono�s reputation for indecision has also been confirmedduring this formative period, as he has appeared hesitant on implementingsome of his election campaign pledges. The �shock therapy� promised againstcorruption, and swift reforms to promote and encourage investment, have notyet materialised.

Prospects for reform in the longer term look more promising, however, asMr Yudhoyono continues with efforts to strengthen his political position. Allieshave been appointed to influential posts in key institutions including themilitary and the intelligence agency, while rivals associated with the formeradministration have been quietly shifted aside. This steady consolidation hashelped to dispel the view that Mr Yudhoyono would be a weak president, heldback by a lack of support in parliament. The secular nationalist Golkar party,the largest parliamentary party, came over to Mr Yudhoyono�s side inDecember, when the vice-president, Jusuf Kalla, was elected party chairman.This breakthrough was followed by the appointment of Lieutenant-GeneralDjoko Santoso to command the army, Major-General Agustadi to lead theJakarta military command, and a retired general, Syamsir Siregar, to head (andpurge) the National Intelligence Agency (BIN).

The political parties have continued to take stock in the aftermath of the 2004elections, with many bringing in new leaderships to prepare for the cominglocal elections and the next general election in 2009. However, many partyleaders, who in many cases are also party founders, are unwilling to relinquishthe power, influence and prestige their positions bestow. This is preventinggenuine renewal within the parties concerned, and is thwarting attempts todeepen and strengthen internal governance structures.

Mr Yudhoyono�s first sixmonths yield mixed results

The president consolidates hispower

Party leaders are unwilling togo gracefully

14 Indonesia


This lack of renewal will hand the political advantage to those parties that dosucceed in adapting, most notably Golkar, which replaced its chairman inDecember and has since embarked on a programme of internal restructuring.Mr Kalla has appointed his own supporters, and figures from the New Orderperiod (during the rule of president Soeharto) who backed his leadership bid,to influential party positions. Kalla loyalists now dominate the party�s parlia-mentary faction and the influential Central Executive Board. Aburizal Bakrie, aSoeharto-era businessman and currently the co-ordinating minister for theeconomy, also wields considerable influence over the executive board, as doesGinandjar Kartasasmita, who held several ministerial portfolios in Soehartocabinets and is now the speaker of the Regional Representatives� Council(DPD). Surya Paloh, a Soeharto-era businessman with interests in media, headsthe party�s board of advisers. Given that New Order figures are back in control,policy is likely to become more explicitly based on the protection of businessinterests and the politics of gaining and maintaining power.

The Indonesian Democratic Party-Struggle (PDI-P) is at the forefront of thoseparties most unwilling to adapt, restructure and look ahead. Although the partyname suggests support for democracy, this has not yet been embraced as aprinciple of internal governance. As a result, the incumbent chairwoman,former president Megawati Soekarnoputri, stood virtually unopposed forre-election to lead the party for a third consecutive five-year term at its congressin March. Opponents were bought off, reformists were excluded from the eventand a controversial block-voting system was enforced in order to denyprovincial delegates an individual vote. Rumours of vote-buying also circulated.

Key debates at the PDI-P congress were curtailed. The debate on Ms Megawati�saccountability speech, in which she justified her record at the party�s helm(including a dreadful election performance), was concluded after only tenminutes. Parallels were drawn between the fawning, staged nature of thecongress and the charade that used to precede the re-election of Soeharto in theNew Order era. Times have changed since then, however, and the PDI-P risksfalling into irrelevance in Indonesia�s vibrant and fast-moving democracy. Theparty has thoroughly failed to modernise and to build a structure befitting amodern political entity. Instead it will continue to operate as a personality cultbuilt on the name of Soekarno, Indonesia�s founding president and the fatherof Ms Megawati. In terms of policy, the party will remain embittered and onthe margins of the political scene owing to Ms Megawati�s resentment ofMr Yudhoyono, who replaced her as president.

A reformist faction in the PDI-P, led by Roy B B Janis, a former deputy leader,and including a businessman, Arifin Panigoro, and two former governmentministers, Laksamana Sukardi and Kwik Kian Gie, will continue to campaignfor reform from inside the party. However, the tide is running strongly againstthe reformists, and disciplinary action for dissent has not been ruled out by theparty�s new secretary-general, Pramono Anung Wibowo.

The old guard of Golkar isreasserting its power

The PDI-P fails to reform

A reform faction will continueto push for change

Indonesia 15


The National Mandate Party (PAN) remains under the influence of its formerleader and founder, Amien Rais. Soetrisno Bachir, his favoured candidate, waselected as party chairman at a congress in April. Mr Bachir has no previouspolitical experience, but was one of the main financial backers of the party�s2004 election campaign. As leader he is likely to remain heavily under theinfluence of the outgoing chairman, who will stay on as head of the party�sadvisory council.

Many rank-and-file members expressed disappointment at Mr Bachir�s election,which they said had been forced through by the party elite. MuhammadiyahYouth, a division of the second-largest Muslim organisation in the country,Muhammadiyah, said that Mr Bachir�s election was evidence that authori-tarianism still endured in the party. PAN was established by Mr Rais, a formerMuhammadiyah chairman, in 1998, and has always had close links to theorganisation. The two have become less close in recent years, however.Conservative members of Muhammadiyah believe that PAN�s political agendais too secular, and have threatened to form an alternative party; Mr Bachir willhave to work hard to placate this anger.

Open rebellion has erupted in the United Development Party (PPP), which hasfaced declining popularity and internal strife in recent years. Support for theparty has fallen from a high of 28% in 1982 to 11% in 1999 and only 8.2% in2004. Reformist members blame the party leader, Hamzah Haz, for this poorperformance. At an unauthorised gathering in February senior party figures,including the state minister for co-operatives and small and medium-sizedenterprises, Suryadarma Ali, called for an immediate national congress toreview the party�s future. The next party congress is not due until 2007, whichthey argue will leave insufficient time to prepare for the 2009 election. Mr Hazresponded by sacking five party executives, including Mr Ali, who is the leader-designate of the reform faction. The reform faction now plans to hold acongress in June 2005, when they will attempt to select a new leadership forthe party. Success for Mr Ali in this coup attempt would bring the PPP moreclosely behind the administration of Mr Yudhoyono.

The rift in the National Awakening Party (PKB) is the deepest of all. At acongress held in April the former national president, Abdurrahman Wahid,retained his position as chief patron of the PKB and engineered the election ofhis favoured candidate and nephew, Muhaimin Iskandar, to the post of partychairman. This was achieved only by excluding the party�s existing chairman,Alwi Shihab, and secretary-general, Saifullah Yusuf (another nephew ofMr Wahid), from the congress. The two men were suspended by the party�scentral board, which Mr Wahid controls, after accepting ministerial posts inMr Yudhoyono�s cabinet last year (Mr Shihab as co-ordinating minister forpeople�s welfare and Mr Yusuf as state minister for the development ofdisadvantaged regions). Both men are currently pursuing legal action to havetheir suspensions reversed. Following Mr Iskandar�s election, Mr Shihabannounced that he would convene a congress aimed at reinstating him asleader. He received backing for his plan from influential clerics in the country�slargest Muslim organisation, Nahdlatul Ulama, which has close links with the

A political novice becomesPAN chairman

The PPP faces open rebellion

The PKB may split in two

16 Indonesia


PKB. Mr Shihab has also asked the Ministry of Justice and Human Rights not torecognise the new PKB leadership!government recognition is required forpolitical parties to participate in elections.

The first preoccupation of the new party leaders will be the approaching localelections, which are due to begin in June. This year polls will be held to elect 11provincial governors and 215 regents and mayors. Staggered elections will thentake place throughout the remainder of Indonesia�s 33 provinces, 354 districtsand 91 cities through to 2009. Democracy activists had argued that the lawsetting out a framework for the polls failed to guarantee a fair and impartialelectoral process, and requested a review in the Constitutional Court. The courtreturned an ambiguous verdict in March, upholding some of the initialcomplaints but maintaining a role for central government in overseeingthe polls.

The court ruled that minor political parties should be allowed to nominatecandidates for governor, regent and mayor, provided they form part of acoalition accounting for at least 15% of votes in the local legislative assembly.This ruling will allow more candidates to stand for office, so strengthening thedemocratic process. The court also annulled a ruling that would have renderedprovincial offices of the General Elections Commission (KPU) accountable tolocal legislative assemblies, compromising their independence. The provincialoffices will instead report directly to the KPU�s central headquarters. However,the court ruling also confirmed the authority of the central government in theelectoral process, by upholding a presidential instruction issued to provincialKPU offices. Non-governmental organisations including the Centre for ElectoralReform (Cetro) and the National Commission of Law Reform (KRHN) hadargued that the KPU was the sole institution with the authority to issue suchinstructions, as it is in the case of general elections. The government willnow draft a regulation in lieu of a law to accommodate the ConstitutionalCourt�s verdicts.

The military is expected to take on a greater counter-terrorist role under reformscurrently in the pipeline. A new counter-terrorism co-ordinating agency is beingplanned to escalate the campaign against Jemaah Islamiah (JI, a regionalIslamist terror organisation) and other extremist groups. The agency will bringtogether the police, the military, prosecutors and intelligence agencies, includingthe National Intelligence Agency (BIN) and the Military Intelligence Agency(BAIS). Several counter-terrorist units are also being set up within the ArmySpecial Forces (Kopassus), and will be called in when the police needassistance. This will give the military a more prominent role in domesticcounter-terrorist efforts. It may lead to a more pre-emptive approach tocombating terrorism, but the strategy also risks blurring the roles of the police,which are responsible for internal security, and the military, which isresponsible for national defence.

The new strategy may stem from frustration over the continued failure to arrestJI�s main bomb-makers, Azahari bin Husin and Noordin Mohamad Top. JI hasbeen badly weakened by the campaign waged against it since the Bali bombing

The Constitutional Court ruleson local elections

Central government maintainsa hold on the electoral process

A new counter-terroriststrategy is developed

Jemaah Islamiah continues topose a threat

Indonesia 17


in 2002, but individual cells continue to present a terrorist threat. Police believethat these cells may be changing tactics, moving away from large and imprecisecar bombs and towards smaller, better-targeted devices built into jackets andrucksacks. This switch has come in response to tightened security at high-profile targets such as embassies and hotels, and public anger at the highnumbers of Indonesian Muslims killed in recent car-bomb atrocities. In AprilSingapore�s minister of home affairs warned that JI was planning another high-profile attack and that it had recruited and trained 12 potential suicide bombers.

A third round of peace talks between the government and the Free AcehMovement (GAM) ended on April 16th with what the mediator described as a�breakthrough� that could eventually bring an end to the separatist conflict inthe province. The latest round of talks was again held near Helsinki, Finland,under the mediation of the Crisis Management Initiative, a facility establishedby a former Finnish president, Martti Ahtisaari. The two sides reportedlyreached a point of �mutual understanding� on a solution to the conflict withinthe framework of limited self-government for Aceh. One significant stepforward is that the government accepted the principle of outside monitoring!most likely by the EU (which has provided significant funding for the ongoingtalks) or by members of the Association of South-East Asian Nations, but not bythe UN. The government was adamant, though, that there would be no foreignpeacekeeping forces. The government also said that it had no objection togiving greater autonomy to the Acehnese to manage the natural resources ofthe province (primarily natural gas). However, the government refuses toconsider a ceasefire, declaring that it wants a permanent solution to the conflict.In an apparent attempt to demonstrate goodwill, the government lifted thecivil-emergency status in the province in mid-May. A fourth round of talks,scheduled for May 26th-31st, will consider more detailed aspects of thesettlement.

Both sides also agreed to restrain their forces in the field while negotiationswere ongoing, but this will prove hard in practice. Fatal clashes continuedbetween Indonesian soldiers and separatist fighters while the talks were takingplace in Finland. The limited ability of the political leadership on both sides tocontrol their armed subordinates may yet pose a serious obstacle to peace. Thisis particularly true of the Indonesian military, which lacks accountability andremains uneasy about any compromise settlement with the separatists. Militaryoperations have continued unabated since the December 26th tsunami disaster,and the army claims to have killed 260 GAM fighters during January-April.

Several military reshuffles have seen Mr Yudhoyono appoint allies to a numberof key positions. Those appointed in March include Major-General EndangSuwarya, who moves from commanding the Iskandar Muda Military Com-mand overseeing Aceh to become deputy army chief of staff. His place in Acehis taken by Major-General Syafiuddin Yusuf, who moves from the UdayanaMilitary Command overseeing Bali and West Nusa Tenggara. The president�stwo brothers-in-law were also promoted: Brigadier-General Pramono EddyWibowo was appointed deputy commander of Kopassus, and Major-GeneralErwin Sudjono was appointed to lead the Tanjung Pura Military Command

Aceh peace talks make furtherprogress

Troops and rebels continueto clash

The president promotes hismilitary allies

18 Indonesia


overseeing Kalimantan. Brigadier-General Setya Purwaka, one of the president�sclosest assistants, was promoted to deputy minister in the Co-ordinatingMinistry for Political, Legal and Security Affairs.

Human rights activists criticised the promotion of Major-General Suwarya.Imparsial, a human rights monitor, alleges that Major-General Suwarya wasguilty of numerous human rights violations during the two years that he ledoperations against GAM. Imparsial estimates that 663 innocent Acehnesecivilians died in military operations during Major-General Suwarya�s leadershipof army forces in the troubled province.

The government is proceeding with plans to take control of military-runbusinesses, as part of an effort to increase the professionalism and account-ability of the armed forces. The commander of the Indonesian military (TNI),General Endriartono Sutarto, has indicated that the TNI will relinquish itscommercial interests within two years, well in advance of the five-yeardeadline set out in Law No 32/2004 on the military. An estimated 70% of themilitary�s budget is financed by its business activities, and its legal businessassets are worth an estimated Rp10trn (US$1.1bn). The military!and thepolice!are also deeply involved in illegal business activities, including illegallogging, mining and fishing, drug-trafficking, prostitution and racketeering. Thisprivate income renders the military less than fully accountable to the civiliangovernment and the institutions of the state. Current reforms relate only to themilitary�s legal business ventures, and ignore its many illicit commercialactivities.

The government has indicated that the military�s budget allocation will beincreased to compensate for the loss of privately generated income frombusiness. In the first step towards this commitment, the government hasproposed an increase of Rp5trn (US$500m) in military spending in the revised2005 state budget submitted to the House of Peoples� Representatives (DPR) inMarch, raising total defence spending to Rp26.6trn.

Democracy campaigners have warned that this increased budgetary allocationwill be used to finance the army�s plans to expand its territorial commandstructure. They believe that the territorial structure serves as an impediment todemocracy in Indonesia and facilitates the army�s involvement in illegalbusiness activities. The expansion plans, unveiled in March, would see thearmy establish three new military commands to oversee Riau, Bangka-Belitungand Merauke in Papua; a new division of the Strategic Reserves (Kostrad), to bedeployed in Sorong, Papua; and 22 new territorial commands. Expansion of theterritorial command structure runs counter to the army�s own efforts to build amore efficient and professional force, absorbing resources into an inefficientcommand structure that shadows the civilian government down to thevillage level.

The army has also announced the raising of seven additional battalions fordeployment to restore stability in Aceh, Papua, and Poso in Central Sulawesi. Inmid-April the army chief of staff, Lieutenant-General Santoso, said that threebattalions each would be deployed in Aceh and Papua, where separatist

Reforms overlook illegalmilitary business interests

Defence spending will beincreased

More troops are readied forconflict zones

Indonesia 19


rebellions are being waged, and one would be sent to Poso, which has facedperiodic communal violence between Christians and Muslims. No schedulewas given for the raising and deployment of the extra battalions. Thedeployment appears to run counter to hopes of imminent peace in Aceh; it alsoseems questionable given recent revelations of the army�s deep involvement inillegal logging in Papua, and its generally poor record in quelling (as opposed toinflaming) unrest.

An investigation into the murder of Munir, a prominent human rights activistwho was poisoned on a Garuda flight to Amsterdam in September 2004, isleading ever closer to the BIN. Three staff members of the national carrier,Garuda, have been declared suspects in the case: Pollycarpus Budihari Priyanto,a pilot who was with Munir on the first leg of his flight to Singapore, and twoflight attendants who served the meal thought to have contained the poison.Mr Priyanto, who allegedly works for BIN, has been arrested and charged with�facilitating� the murder. Garuda�s senior management has been accused ofinvolvement in a cover-up, forging letters to justify Mr Priyanto�s presence onthe flight after the murder had taken place. The government fact-finding teamset up to assist the investigation has complained repeatedly about the failure ofBIN personnel to co-operate with the investigation, and in April called on thepresident to intervene.

Further steps were taken towards reconciliation with East Timor in March,when Mr Yudhoyono conducted an official state visit to the former Indonesianprovince. The president and East Timor�s prime minister, Mari Alkatiri, signedan agreement on the demarcation of the two countries� mutual border(agreement over small parts of the border have still to be secured).Mr Yudhoyono also laid a wreath at the Santa Cruz cemetery, the site of amassacre of unarmed East Timorese pro-independence protestors by Indo-nesian troops in 1991, when up to 250 people were killed and a further 270went missing.

Atrocities committed by Indonesian security forces and militias during EastTimor�s passage to independence in 1999 were notably absent from the agenda.Both sides wish to put the events of 1999 behind them, and in March theyestablished a �truth and friendship commission� to bring closure to this periodof their shared history. The commission has a weak mandate, and human rightsgroups warn that it will be used to absolve those guilty of orchestrating theviolence. The UN seems to share these concerns, and has appointed acommission of experts to review and explain why those responsible for theviolence have not been brought to justice. Both Indonesia and East Timoroppose UN involvement, and in April the Indonesian government warned thatit would deny entry visas to UN experts working for the enquiry.

Tensions between Indonesia and Malaysia rose in March after the latterawarded oil exploration contracts for the disputed Ambalat region of theSulawesi Sea. Ambalat lies near to the islands of Sipadan and Ligatan, whichwere ruled to be Malaysian by the International Court of Justice in 2002. Theruling still angers Indonesian nationalists, which in part explains the depth of

Intelligence agents are linkedto a murder

A state visit helpsreconciliation with East Timor

Indonesian and Malaysiannavies clash off Borneo

20 Indonesia


public feeling over the Ambalat dispute. Both countries sent warships to theregion in response to rising tensions, and two vessels suffered light damageafter colliding in mid-March. In the aftermath of the collision, steps were takento improve communications and limits were placed on the naval presence inthe disputed area. Both sides have also repeatedly emphasised their desire tosettle the dispute by negotiation, despite much public sabre-rattling.

Whereas relations with neighbouring Malaysia remain tense, relations withAustralia show signs of considerable improvement. A state visit in early Aprilled to the announcement of a �new era of relations� between the twocountries. Mr Yudhoyono and the Australian prime minister, John Howard,committed themselves to building a comprehensive partnership between thetwo countries, covering a broad range of issues including economicco-operation, education and cultural exchange, counter-terrorism and trans-national crime. Australia also confirmed its support for the territorial integrityof Indonesia, and steps were taken towards reviving co-operation in defence.The two countries subsequently held their first joint military exercises insix years.

In late April heads of state from 100 countries in Asia and Africa gathered inthe Indonesian capital, Jakarta, for a summit to mark the 50th anniversary ofthe Asia-Africa Conference, which was held in Bandung, West Java, in 1955. The1955 conference was an historic event that served to highlight the growingdiplomatic power of newly independent colonies. It also provided a basis forthe establishment later of the Non-Aligned Movement, a group of countries thatsought to remain outside the struggles of the cold war between the US and theSoviet Union. At the second Asia-Africa Conference, heads of state agreed todeepen economic and political links and to co-operate to ensure the equitablesharing of the benefits of globalisation. The summit, co-chaired byMr Yudhoyono and the South African president, Thabo Mbeki, broughttogether countries which encompass three-quarters of the world�s population.

Economic policy

The government submitted a revised 2005 state budget to the House of Peoples�Representatives (DPR) in March, featuring a weaker exchange-rate forecast, ahigher global oil price assumption, reduced fuel subsidies, and greater spendingon programmes of assistance for the poor and on reconstruction in Aceh. Theassumed exchange rate against the US dollar has been lowered to Rp8,900:US$1from US$8,600:US$1. The oil price has been raised to US$35/barrel, up fromUS$24/b, and fuel subsidies have been cut by Rp20.3trn (US$2.1bn). Spendingon programmes to ease the impact of higher fuel prices on the poor have beenraised to Rp17.8trn. The target budget deficit has been maintained at 0.8% ofGDP, thanks in part to a moratorium on debt repayments worth US$2.6bn fromthe Paris Club of creditor nations.

Relations with Australiaimprove

The Asia-Africa summit putsIndonesia on the world stage

A revised budget is submittedto parliament

Indonesia 21


2005 budget assumptionsOriginal budget Revised budget

Budget deficit (% of GDP) 0.8 0.8Real GDP growth (%) 5.4 5.5

Inflation (%) 5.5 7.0Oil price (US$/barrel) 24 35

Exchange rate (Rp:US$) 8,600 8,900Interest rate (%)a 6.5 8.0

a Annual average rate on three-month Bank Indonesia Certificates (SBIs).

Source: Ministry of Finance.

In April the president, Susilo Bambang Yudhoyono, gave his approval to a planfor the reconstruction of Aceh, which was devastated in December 2004 by anearthquake measuring 9.0 on the Richter scale and a series of giant tsunamitidal waves. The plan covers a five-year period of reconstruction, and will costalmost US$5bn to implement. It sets out development and rehabilitationprogrammes focused on the community, the economy, infrastructure andadministrative institutions. It also sets out guidelines for the rebuilding ofdamaged areas, including the need to include buffer zones between the sea andcoastal settlements. This means that many survivors will be prevented fromreturning to the site of their original homes, which were flattened by thetsunami. Government regulations to support the master plan were adopted onApril 16th. The regulations served to establish an agency to oversee thereconstruction process, and will allow the government to allocate funds to theplan during revision of the 2005 state budget.

On April 19th the Executive Agency for the Rehabilitation and Reconstructionof Aceh and Nias was inaugurated. The agency will have wide powers tomanage the reconstruction effort, including dealing directly with the privatesector and with donor countries and agencies. The governor of Aceh is to bethe vice-president of the agency, and on May 1st Mr Yudhoyono finallyannounced that a former mines and energy minister, Kuntoro Mangkusubroto,had been selected to head the agency. Mr Mangkusubroto is non-partisan andhas a reputation for integrity. The agency is directly accountable to the presidentand financially accountable to the Ministry of Finance. The Supreme AuditAgency (BPK), the State Development Comptroller and a privately ownedaccounting firm will audit the agency.

Meanwhile, the National Disaster Relief Co-ordinating Board has revised downthe official death toll from the December disaster. It now believes that 126,915people died, with a further 37,063 still listed as missing. The agency cut thenumber of missing people by 56,000 in April, with the difference beingaccounted for mostly by people found alive in emergency relief camps.

The government is currently preparing revisions to the tax system that it claimswill boost revenue and reduce the administrative burden on business.Revisions are being prepared to tax procedures, value-added tax, income tax,excise and customs, along with a controversial proposal for a tax amnesty. Coreaspects of the revisions, including the rates at which taxes are set, are still beingdebated.

A reconstruction plan for Acehis agreed

Reforms to the tax system areprepared

22 Indonesia


Under the proposed amnesty, those guilty of tax evasion would pay their backtaxes at a discounted rate with immunity from prosecution, provided that theybecame honest taxpayers thereafter. The amnesty is part of the government�splans to broaden the tax base and encourage the repatriation of billions ofUS dollars transferred overseas during the economic crisis in 1998. Theco-ordinating minister for the economy, Aburizal Bakrie, estimates that themove could raise Rp50trn in windfall revenue. The issue is politically sensitive,however, and would allow businesses to launder hidden assets. Against thismust be balanced the slim chance of tracing and prosecuting tax evadersthrough Indonesia�s corrupt tax service and court system. The amnestyproposal is strongly supported by the Indonesian Chamber of Commerce andIndustry (Kadin), of which the vice president, Jusuf Kalla, and Mr Bakrie areformer presidents.

In April the government concluded the sale of US$1bn in ten-year sovereignbonds. The sale was twice oversubscribed, with offers received from over 200investors from Asia, Europe and the US. The bonds carried a coupon rate of7.25% and a yield to maturity of 7.38%, giving them a spread of 302 basis pointsabove ten-year US Treasury bonds. The yield is slightly higher than a yield of6.85% on US-dollar bonds issued by the government in March 2004. Domesticand global bond issues form an important part of the strategy for financing thebudget deficit in 2005. In the year to end-April bonds worth Rp17trn wereissued, out of a targeted total of Rp43trn.

The drive against corruption received a lift in April when the Anti-CorruptionCourt found the governor of Aceh, Abdullah Puteh, guilty of embezzling statefunds. Mr Puteh was sentenced to ten years in prison and fined Rp500m(US$529,000), a stiff penalty that exceeded the eight-year sentence requested byprosecutors. Mr Puteh�s case was the first to be heard by the Anti-CorruptionCourt and the first high-profile graft trial to be conducted duringMr Yudhoyono�s presidency. The ruling has helped to assuage criticism of slowprogress in the government�s efforts to tackle corruption. Attempts to make anexample of Mr Puteh were undermined to some extent later in April, however,when the Jakarta High Court ruled that the defendant could remain out of jailand under city arrest in the capital pending an appeal against his conviction.

The General Elections Committee (KPU), long suspected of corruption inrelation to the 2004 elections, has been put under investigation by theCorruption Eradication Commission (KPK). The investigation began after thearrest of Mulyana Kusumah, a KPU official allegedly caught attempting to bribethe BPK in April. The bribe was part of an attempt to influence the outcome ofan audit of election funds, which the KPU management feared would exposethe misuse of funds and corruption in the procurement of election materials.The investigation will now focus on the role of the KPU chairman, NazaruddinSyamsuddin, and eight directors of the committee. The trail of corruption couldalso lead back to the minister of justice and human rights, Hamid Awaluddin,who was in charge of procuring election cards for the KPU prior to becoming a

A controversial tax amnestyproposal gains support

A US-dollar bond issuccessfully issued

The Aceh governor is foundguilty of corruption

The elections commissioncomes under investigation

Indonesia 23


minister. Mr Kalla said that Mr Awaluddin would be suspended from thecabinet if declared a suspect in the investigation.

The audit report that KPU officials had tried to influence was published in mid-May, and it seems that the KPU management had good reason to be nervous.Auditors uncovered evidence of collusion, data manipulation, documentforgery and price mark-ups associated with the procurement of materials forthe April general election and the presidential elections in July and September,resulting in losses of Rp170bn (US$19m) to the Indonesian taxpayer. The auditfocused only on the April legislative elections, and further audits of funds forthe presidential election, as well as several provincial and district KPU offices,are ongoing.

In March the Business Competition Supervisory Commission (KPPU) issued aruling on the controversial US$184m sale in 2004 of two tankers belonging tothe state oil company, Pertamina. The commission said that it had foundnumerous irregularities involving the four parties to the sale!Pertamina, a USinvestment bank, Goldman Sachs (which acted as Pertamina�s financialadviser), a Canadian-based company, Frontline (the winner of the tender) andan Indonesian shipping firm, PT Equinox (which acted as Frontline�s agent). TheKPPU ruled that the four were guilty of collusion in the sale. Pertamina�s boardof directors was ordered to explain the case to shareholders, and GoldmanSachs, Frontline and Equinox were fined Rp19.7bn, Rp25bn and Rp16.6bnrespectively. Goldman Sachs and Frontline were also ordered to pay Rp60bnand Rp120bn respectively to compensate for potential state losses arising fromthe sale. All four parties dispute the KPPU ruling and have filed objections incourt. The appeals will be heard as a single case following an April ruling onthe matter by the Supreme Court.

The domestic economy

Output and demand

Real GDP grew by a robust 6.4% year on year in the first quarter of 2005, only aslightly slower rate than the 6.7% growth recorded in October-December 2004.As expected, private consumption growth was slightly lower in January-Marchthan in the final three months of last year, as confidence weakened in the wakeof the tsunami disaster that affected Aceh in late December 2004 and theincreasing perception that interest rates and inflation were likely to movehigher in 2005. However, given these negative factors, consumption wasrelatively resilient. Government consumption was weaker in the first quarter of2005 compared with October-December 2004, but this is partly a seasonalphenomenon as consumption always weakens in the first quarter of the year.

An audit uncovers massivecorruption

Collusion is uncovered in thesale of two oil tankers

Real GDP growth exceedsexpectations

24 Indonesia


GDP by expenditure(constant 2000 prices; % change; year on year unless otherwise indicated)

2004 20051 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 1 Qtra

Household consumption 5.7 5.3 5.0 3.8 4.9 3.2 -0.1

Government consumption 10.1 4.7 -3.8 -1.3 1.9 -8.5 -23.8Gross fixed capital formation 11.5 13.1 19.7 18.3 15.7 15.0 0.2

Exports of goods & services 1.2 2.0 17.1 13.7 8.5 13.4 0.1Imports of goods & services 15.3 25.2 32.0 27.1 24.9 15.4 -0.5GDP 4.4 4.4 5.1 6.7 5.1 6.4 2.8

a Quarter on quarter.

Source: Central Bureau of Statistics.

On an encouraging note, investment continued to expand in January-March2005, suggesting that the economy is moving into a more sustainable, broad-based recovery. In particular, investment growth in the first quarter wasboosted by investment by Telkomsel, a partly state-owned mobile telecom-munications provider, to expand capacity. Anecdotal reports from the bankingsector suggest that local manufacturing companies in particular are requestingloans to expand their production facilities. The recovery in investment is alsoevident in the changing structure of GDP. Gross fixed capital formation rose toaccount for 21% of total GDP in 2004, compared with 18.9% in 2003. However,gross fixed capital formation accounted for 32% of GDP in 1997, and there is stilla long way to go before levels of investment are reached that match those seenbefore the 1997-98 Asian financial crisis. Private consumption accounted for66.5% of GDP in 2004, compared with 67.1% in 2003, and exports accounted for30.9%, virtually unchanged from 30.7% in 2003. The solid performance recordedby the export sector in the first quarter of 2005 is another factor that willencourage companies to invest in additional capacity.

Structure of gross domestic product(% of GDP; constant prices)

2003 2004Private consumption 67.1 66.5Government consumption 8.0 8.2

Gross fixed capital formation 18.9 21.0Change in stocks -1.3 1.8

Statistical discrepancies -0.3 -1.4Exports of goods & services 30.7 30.9

Imports of goods & services -23.0 -26.9GDP 100.0 100.0


Growth was shared throughout all productive sectors of the economy inquarter-on-quarter terms in January-March, with the exception of mining andquarrying, which contracted by 2.2%, and construction output, which fell by0.06%. Legal and contractual uncertainty are leading to falling output in themining sector. The highest growth was recorded in the transport and telecomssector, which expanded by 12.6% year on year, largely as a result of ongoingexpansion in the telecoms sector.

Investment shows signs ofrecovery

Economic growth isbroad-based

Indonesia 25


Gross domestic product by sector(constant 2000 prices; % change; year on year unless otherwise indicated)

2003 2004 2005Full year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 1 Qtra

Agriculture 3.1 4.9 3.8 5.3 1.9 4.1 0.5 17.9

Mining & quarrying -1.6 -7 -9.1 -5 3.3 -4.6 3.6 -2.2Manufacturing 5.0 6 6.9 4.8 7.2 6.2 7.0 0.8

Electricity, gas & water 5.9 6.1 6.8 3 7.9 5.9 8.4 1.6Construction 6.3 8.4 7.8 8.2 8.3 8.2 8.6 -0.1Trade, hotel & restaurant 6.3 2.7 4.1 6.9 9.4 5.8 10.0 1.0

Transportation & communications 11.6 12.6 13.3 13.5 11.5 12.7 12.6 0.6Financial, ownership & business 6.9 7.5 6.7 8.3 8.4 7.7 6.8 1.1

Services 4.1 4.7 5.1 4.7 5 4.9 5.1 1.6Total GDP 4.5 4.4 4.4 5.1 6.7 5.1 6.4 2.8Total GDP (non-oil & gas) 5.3 5.1 5.4 6.2 8 6.2 � �

a Quarter on quarter.


In March the consumer price index rose at its fastest rate since late 2001 as theresult of cuts to fuel subsidies introduced at the start of the month. Year-on-yearinflation rose to 8.8%, while month-on-month inflation rose to 1.91%, comparedwith a fall of 0.17% in February. The effect of the fuel price rise was mostevident in the transport index, which rose by 16.6% year on year. The year-on-year food price index also rose by a steep 8.1%, as higher transport costs hit theprice of basic foodstuffs.

Consumer prices(% change)

2004 2005Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

Month on monthFood 1.78 0.55 0.97 0.43 -2.13 -1.36 1.31 2.29 2.37 3.11 -1.46 0.12General 0.97 0.88 0.48 0.39 0.09 0.02 0.56 0.89 1.04 1.43 -0.17 1.91Year on yearFood 6.23 6.85 8.76 10.03 7.78 6.81 6.17 6.04 6.38 8.15 8.13 8.10General 5.92 6.47 6.83 7.20 6.67 6.27 6.22 6.18 6.40 7.32 7.15 8.81


Inflationary pressures look set to rise further in the months ahead, as highertransport costs filter through into prices of other goods and services. The rupiahexchange rate, which fell by over 2% against the US dollar in March, will alsopush up the price of imported goods, adding further to inflationary pressures.The revised state budget submitted to parliament in March raises the year-endinflation target to 7%, against a previous target of 5.5%, reflecting concern overrising inflationary pressures. Yet even this revised target looks optimistic. Giventhat cumulative inflation for the first quarter reached 3.2%, it must now be keptunder 4% over the remaining nine months of the year if this target is to be met.

Higher fuel prices driveinflation

A weak rupiah will add toinflationary pressures

26 Indonesia


Financial indicators

Inflationary pressures and the weaker rupiah have forced Bank Indonesia (BI,the central bank) to raise interest rates. Rates on the benchmark one-monthBank Indonesia Certificate (SBI) had been allowed to rise gradually from a lowof 7.32% in May 2004, to stand at 7.44% at end-March 2005. This stance wasinsufficient to contain the sharp rise in inflationary pressures caused by cuts tofuel subsidies, the weak rupiah and external pressure arising from an increasein the US Federal Reserve�s benchmark rate in mid-March. As a result, BI raisedthe SBI rate to 7.53% on April 6th and again to 7.7% on April 20th, signalling thestart of a more aggressive interest-rate policy to restrain inflation.

One-month SBI rates and commercial bank rupiah credit rates

SBIa Working capitalbInvestment

capital Consumption2004Jan 7.86 14.99 15.44 18.49Feb 7.48 14.79 15.29 18.47Mar 7.42 14.61 15.12 18.11Apr 7.33 14.48 14.98 17.89May 7.32 14.27 14.78 17.68Jun 7.36 14.10 14.64 17.51Jul 7.37 13.99 14.58 17.30Aug 7.34 13.84 14.45 17.08Sep 7.40 13.80 14.33 17.03Oct 7.41 13.64 14.25 16.89Nov 7.41 13.57 14.18 16.74Dec 7.43 13.41 14.05 16.572005Jan 7.42 13.40 13.98 16.32Feb 7.43 n/a n/a n/aMar 7.44 n/a n/a n/a

a Bank Indonesia Certificates; end-period. b Weighted average.

Source: Bank Indonesia.

2

4

6

8

10

12

14

16

18

2000 01 02 03 04 05 06

Money market interest rate; %

Money supply, M2; % change, year on year

Monetary indicators

Source: Economist Intelligence Unit.

Interest rates rise

Indonesia 27


In April BI entered the bond market for the first time, buying bonds worthRp4.3trn (US$46m) as part of a long-term plan to build up a stock of govern-ment bonds for monetary operations. Monetary operations have traditionallybeen focused on the sell side of the bond market, through the issue of one-month and three-month Bank Indonesia Certificates (SBIs), which are used toremove excess liquidity from the market. The effectiveness of the new policy insmoothing out market fluctuations will be limited in the short term by the longmaturities of government bonds, which run from one to twelve years. Thisshortcoming will be addressed in the future through the issue of governmentbonds with maturities of less than one year.

Monetary aggregates(Rp bn)

2004 2005Aug 31st Sep 30th Oct 31st Nov 30th Dec 31st Jan 31st Feb 28th Mar 31st

Reserve money 172,681 175,352 185,096 184,873 199,446 183,747 180,034 184,878 Currency in circulation 113,360 116,076 123,283 124,161 126,895 119,956 117,033 116,376 Bank deposits with Bank Indonesia 58,568 58,548 61,089 60,081 72,053 63,061 62,260 67,798Net domestic assets 6,436 9,720 17,759 16,065 28,600 11,270 5,531 11,596 Net claims on government 199,034 204,140 202,094 204,023 226,620 218,253 207,105 187,045 Government bonds 253,305 253,305 253,305 253,305 253,817 257,661 257,878 258,158 Bank Indonesia Support Fund 18,759 18,759 18,759 18,083 18,083 13,295 13,295 13,295 Net claims on IBRAa 14,447 14,447 14,447 13,771 13,771 9,604 9,607 9,607 Liquidity credits 12,764 12,645 12,608 12,588 12,349 12,346 12,331 12,222 Open-market operations -139,357 -139,297 -130,823 -135,834 -144,548 -153,785 -149,876 -130,783

a Indonesian Bank Restructuring Agency.


The rupiah has come under selling pressure in recent weeks, falling belowRp9,650:US$1 in late April, down from Rp9,290:US$1 at end-2004. BI intervenedto defend the rupiah in foreign-exchange markets towards the end of the April,selling US dollars to prevent any further loss in the rupiah�s value. Theweakness was attributed to concerns about rising inflation and interest rates, aswell as a high demand for US dollars as foreign (and particularly Japanese)firms repatriated profits before the end of the financial year. The weak currencywill bring further pressure to bear on the fragile fiscal position, adding to thecosts of subsidising domestic fuel, which is sold in rupiah but bought andtraded in US dollars.

BI warned in April that a shortage of foreign exchange and a severe deficit inthe oil trade account could hurt the country�s financial position in the yearahead. The central bank believes that Indonesia may experience a shortage ofUS$12bn-15bn in foreign exchange this year, owing to sluggish exports and highdomestic consumption. This imbalance is compounded by the commonpractice of holding export revenue overseas. A more severe imbalance exists inthe oil trade account, which recorded a deficit of US$2.6bn in 2004, comparedwith a surplus of US$38m in 2003. At end-March 2005 foreign-exchangereserves stood at US$36bn, down from US$36.5bn at the end of February.

A new dimension is added tomonetary policy

The rupiah weakens onconcerns over inflation

Trade imbalances may drainforeign-exchange reserves

28 Indonesia


International reserves(US$ m)

2004 2005Aug 31st Sep 30th Oct 31st Nov 30th Dec 31st Jan 31st Feb 28th Mar 31st

International reserves 34,822 34,802 35,353 35,927 36,321 36,092 36,542 36,030


The charmed existence of the Jakarta Stock Exchange (JSX) in recent months hascome to an abrupt end. By late April the JSX Composite Index was trading at1,047, down by over 10% from the record high of 1,152 recorded in February. Themarket has been unnerved by rising inflation and interest rates, high oil pricesand fears of further fuel price increases. The market has also been affected by awider flight by international investors away from riskier assets.

Oil and gas

Rising demand, waning output and falling exports mean that Indonesia couldsoon be a net oil importer. In projections for 2005 the Ministry of Energy andMineral Resources forecasts a 15% year-on-year increase in oil imports to472,000 barrels/day, a 6% decrease in exports to 411,000 b/d and a 16% fall indomestic production. The country�s growing dependence on oil imports hasraised questions over Indonesia�s continued membership of OPEC. A high-levelpanel set up to examine this question has recommended downgradingIndonesia�s membership to �observer status�!a status that does not currentlyexist within the cartel. The change has been recommended on grounds of cost,as the annual US$2m OPEC membership fee will be hard to justify for a netimporting country.

New investment is needed to stave off further decline in the oil industry, butinvestment is being deterred by contractual and legal uncertainty. The latestexample of the risks faced by investors has emerged in a contractual disputebetween the Malaysian state oil company, Petronas, a Chinese firm, PetroChina,and a district government in East Java. A joint exploration project by the twocompanies in the Bojonegoro region of the province has been shut down bythe local government, which insists that it is entitled to a 10% stake in theproject under the law on regional autonomy. This is incorrect: local authoritiesare entitled to a share of revenue from the field, which is meant to be collectedand redistributed by the Ministry of Finance once the field becomes profitable.The Oil and Gas Upstream Regulatory Body (BPMIGAS) has been asked tomediate in the dispute, and the central government has said that it willsummon the Bojonegoro regent to explain his actions.

There are renewed hopes of progress in another high-profile dispute, followingthe resumption of talks between US-based ExxonMobil, the world�s largest oilcompany, and the Indonesian state oil company, Pertamina, over the future ofthe Cepu field in Central and East Java. The government has given priority toresolving this dispute, and talks between the two parties restarted in late Aprilafter a delay of several months; the government set a deadline of May 20th foran agreement to be reached. Cepu holds Indonesia�s largest untapped reserves

The stockmarket goes into anosedive

A panel recommends lessermembership of OPEC

An East Java regent blocksexploratory drilling

Talks on the future of Cepurestart

Indonesia 29


of crude oil, estimated at 600m barrels. It is crucial to reviving oil production,and could add 170,000-200,000 b/d to the country�s flagging output.ExxonMobil�s rights to the Cepu concession run to 2010, and it has alreadyinvested around US$450m in developing the field. However, the companyargues that a longer contract is required to justify the investment of US$2bnneeded to exploit Cepu�s reserves. Pertamina�s management has opposed anextension of the contract, and has suggested that it might wait until 2010 andthen develop the field itself.

Mining

In mid-April the South Jakarta District Court began to hear a case broughtagainst the Indonesian subsidiary of a US-based mining company, Newmont,by the State Ministry of Environment. Newmont stands accused of pollutingBuyat Bay in North Sulawesi with tailings from its adjacent NewmontMinahasa Raya gold mine. The pollution is alleged to have caused skin diseasesand neurological disorders among the local population. Newmont maintainsthat waste from the mine remained within safety limits, but studies of theaffected area have returned conflicting results. The environment ministry isseeking Rp1.24trn (US$130m) in compensation from Newmont. Police are alsoconducting a separate criminal investigation into the case, and have askedprosecutors to bring criminal charges against five Newmont executives!anAmerican, an Australian and three Indonesians. Newmont has said that anycriminal charges should be directed at the company rather that individualemployees.

At the heart of the case is the controversial submarine method of disposing oftailings, which deposits large amounts of mining waste at sea. The sametechnique is used at a copper mine operated by Newmont on the island ofSumbawa in East Nusa Tenggara. The People�s Lawyers Union (SPR), a little-known non-governmental organisation (NGO), alleges that tailings from theSumbawa copper mine have polluted Senunu Bay, where the tailings aredeposited, and the coast of east Lombok, causing skin ailments among localresidents and a drop in fish catches. Newmont Nusa Tenggara has rejected theallegations. Newmont must seek to renew its licence to dump tailings at sea inMay of this year. NGOs have called on the government to ban the practice,claiming that it has not been proven to be safe.

Agriculture

Drought and harvest failures have led to widespread food shortages in easternIndonesia. In East Nusa Tenggara, 15 districts on Sumba, Timor, Flores and othersmaller islands face widespread hunger. As of mid-March the situation was saidto be critical in eight of the affected districts. Data from the East Nusa Tenggaraprovincial government show that 452,920 people in 117 districts (1,108 villages)are in need of food aid. The provincial government has been accused ofdownplaying the crisis and of being negligent in its response. At the heightof the crisis the local legislative assembly approved a budget of Rp5bn

Legal action is taken againstNewmont

Hunger grips eastern regionsof the country

30 Indonesia


(US$526,000) to renovate the governor�s official residence. Parts of Malukuprovince have also been affected, and in East Seram district at least 22 peoplehave died of hunger and related illnesses since the start of the year. Food aid isnow being supplied to all the affected areas.

In mid-March the government confirmed outbreaks of bird flu in parts of SouthSulawesi and West and Central Java. A ban has been placed on the inter-islandtrading of chickens from South Sulawesi, and 200,000 doses of vaccine havebeen distributed to contain the outbreak. A cull of birds is being planned for theprovince, and funds of Rp750m (US$79,000) have been set aside to assistaffected poultry farmers. In West Java quarantine measures and controls on thetransport of birds have been put in place.

Cocoa is expected to fare well in 2005, despite continued problems with pestinfestation. The Indonesian Cocoa Association (Askindo) forecasts output of500,000 tonnes this year, up by 25% on 2004. The improved outlook is theresult of stable global cocoa prices, the addition of new plantations and easingfears of drought in the main growing areas. Output of cocoa has fallen from apeak of 456,500 tonnes in 1998 to only 389,000 tonnes in 2003, largely as theresult of pod-borer infestation. Losses have been offset by an expansion of thearea under cultivation, which has risen from 776,900 ha in 2002 to around900,000 ha. Farmers have been drawn to cocoa owing to the fact that globalprices have been less volatile than those for coffee in recent years.

A renewed effort to control widespread illegal logging has been launched withthe strong backing of the president, Susilo Bambang Yudhoyono. In early MarchMr Yudhoyono launched a two-month �integrated operation�, code-namedHutan Lestari (�sustainable forest�), against illegal logging in Papua. Theoperation involved the dispatch of a special team of 1,500 officials from thepolice, the military, the attorney-general�s office, the Ministry of Forestry andthe immigration and customs services to carry out field operations in theprovince. Hutan Lestari has yielded some encouraging early results. As of lateMarch the team had made a total of 27 arrests and had seized nearly 65,000logs, 20,000 cu metres of processed timber, 800 pieces of heavy equipment,four ships, 34 vehicles, 11 barges and ten tugboats. Those arrested includenumerous Malaysian citizens, senior provincial and district forestry officials,and high-ranking policemen.

Manufacturing

The Association of Indonesian Electronic and Electrical Appliance Industries(Gabel) has accused the government of neglecting its industry. Electronics arethe second-largest generator of export revenue after textiles and clothing, beingworth US$7.6bn in 2004. The industry is also an important source of employ-ment, and many international brands have factories in the country. Despite this,electronics was omitted from ten priority industries identified last year under agovernment plan to revitalise the manufacturing sector. The associationbelieves that, with government support, exports could be doubled to US$15bn a

Outbreaks of bird flu areconfirmed

Cocoa output is forecast to rise

A crackdown on illegal loggingshows results

Cheap imports undermine theelectronics industry

Indonesia 31


year over the next five years. Gabel has called for assistance to preventcompanies operating factories in Indonesia from being undercut by foreignimports. Duties levied on key raw materials, such as steel, make it cheaper toimport final products than to import raw materials and manufacture electronicproducts in Indonesia.

Indonesia�s furniture industry is losing out to cheap competition and betterdesigns from rival manufacturers!particularly from those in China, which hasemerged as a major furniture exporter. The Chinese furniture industry is basedon voracious (and often illegal) timber imports, which undercut manufacturersin the countries where the timber originates, such as Indonesia. Data from theIndonesian Furniture Industry and Handicraft Association (Asmindo) showthat furniture exports declined from US$1.53bn in 2003 to US$1.35bn in 2004.Exports of wooden furniture declined by 9% year on year in 2004. The industryis facing a growing raw-material shortage as a result of illegal logging andthe smuggling of the timber thus felled to competing low-cost manufacturingcentres. The predominance of small and medium-sized enterprises in theindustry is also acting as a constraint on improving designs and marketingIndonesian products more effectively in high-value overseas markets.

The automotive industry has been angered by a recent government regulationthat cut or eliminated import tariffs on spare parts, components and buses fromChina. The regulation was introduced to assist public transport operators inlimiting price increases to less than 10% following cuts to fuel subsidies inMarch. However, the policy may inadvertently serve to undermine the localvehicle-manufacturing industry and its upstream suppliers by forcing them intohead-to-head competition with Chinese rivals.

Infrastructure

The government has approved plans to build a nuclear power plant in CentralJava, as part of its effort to boost electricity generating capacity. The project isdue to be tendered in 2008, with the plant becoming operational in 2016. Theproject was shelved in 1997 amid widespread public opposition, and its revivalhas horrified environmental campaigners. Java is the most densely populatedisland in the world, and Indonesia lies across one of the world�s most activevolcanic and tectonic zones. Large public-works projects are invariably rife withcorruption in Indonesia, with quality impaired as a result. The capacity of theIndonesian authorities to provide security and maintain such a dangerousproject has also been questioned. Critics have said that energy policy shouldinstead focus on exploiting Indonesia�s potential for hydroelectricity andgeothermal power as well as on the use of its existing reserves of coal, oil andnatural gas.

Furniture makers face a raw-material shortage

A change in policy angers localcar manufacturers

Plans for a nuclear powerplant are approved

32 Indonesia


Financial markets

Banking indicators continued to improve in 2004. Bank lending rose toRp595.1trn, up 24.7% from Rp477.2trn in 2003, while third-party liabilities rose by8.4% year on year to Rp963.1trn. The average capital-adequacy ratio in the sectorwas 19.4% as of December 2004, safely above the 18% minimum requirementimposed by BI. Further improvements in key indicators are expected in 2005,with the central bank forecasting 20-25% growth in lending and 6% growth inthird-party liabilities.

Banking indicators, 2004(Rp trn)

Jun Jul Aug Sep OctFunds 1,001.0 997.6 1,012.8 1,022.8 1,027.6 Third-party funds 9.8 9.4 10.0 10.6 10.5 In rupiah 12.7 12.7 13.0 13.1 14.8 In foreign currency 912.8 909.5 919.3 926.4 928.1 Money market borrowing 759.6 759.2 766.8 774.2 777.1 Loan obligations 153.2 150.3 152.5 152.2 151.0 Issued securities 65.6 66.0 70.6 72.7 74.2Loanable funds 823.7 818.1 843.8 809.3 863.3 Credits 110.6 103.5 110.2 63.1 100.0 In rupiah 77.1 78.6 81.1 83.6 87.6 In foreign currency 100.2 98.8 97.8 100.2 101.2 Bank Indonesia certificates 7.1 7.1 7.2 7.2 7.1 Other securities 528.7 530.2 547.5 555.1 567.3 Money market lending 397.7 401.8 414.1 425.6 437.9 Equity participation 131.0 128.4 133.4 129.5 129.3Assets 1,185.7 1,182.8 1,208.2 1,213.1 1,218.4Capital 119.8 107.1 109.2 114.0 115.1Performance Non-performing loans Value 39.9 38.9 38.2 38.2 38.2 As percentage of total credits 7.5 7.3 6.7 6.9 6.7 Profit/loss 3.6 3.4 3.1 4.3 2.4 Operational 2.1 13.4 -7.4 3.1 1.6 Non-operational 1.5 -10.0 10.6 1.3 0.9 Net interest margin 5.4 5.4 5.3 5.3 6.4


The financial sector remains fragile, however, owing to an overwhelmingreliance on banks as a source of funds. Non-bank financial institutions!pension funds, mutual funds and insurance firms!hold only 20% of the assetsof the country�s financial system, while the remaining 80% of assets are held inthe banking system. The government is preparing a regulatory framework andinstitutions to encourage development of the non-bank sector. There arealready signs of gathering growth momentum, albeit from a low base: pensionfund assets grew by 79% from 2000-03, and mutual funds have grown at anaverage of 130% annually during 2002-04. However, pension funds andinsurance firms currently hold 60% of their assets in short-term bank deposits,negating their comparative advantage in financing long-term investments. Theweakness of the non-bank sector may adversely affect the government�s

The banking sector growsstronger

Non-bank financial institutionsremain weak

Indonesia 33


plans to raise US$150bn to finance investment in infrastructure over the nextfive years.

Efforts to discourage corruption in the banking sector received a boost inMarch, when a former businessman was sentenced to life imprisonment andfined Rp1.3bn for his central role in a lending scandal at the state-owned BankNegara Indonesia (BNI), the country�s third-largest bank. Adrian HerlingWaworuntu was found guilty of violating laws on corruption and money-laundering, becoming the ninth person to be imprisoned in connection withthe case. The scandal centred around the disbursement of fake letters of creditworth Rp1.2trn through a South Jakarta branch of BNI. The letters of credit wereissued to two companies, Gramarindo and Petindo, to support fictitious exportsto several African countries. The funds were then disbursed without properchecks, with the help of corrupt bank officials.

The corruption in BNI is far from being an isolated case, and evidence of fraudand irregularities have recently come to light at the state-owned Bank Mandiri,the country�s largest commercial bank. The Supreme Audit Agency (BPK) hasuncovered irregularities in the provision of loans worth over Rp12trn to 33companies, many of which have strong political connections. Some of thecompanies did not meet the criteria required for credit to be issued, and inother cases the bank violated procedures on debt claims taken over from theIndonesian Bank Restructuring Agency (IBRA).

Several Bank Mandiri officials, including the bank�s vice-president, have beenquestioned by the attorney-general�s office over their role in the fraud.Prosecutors have said that the initial investigation will focus on loans worthRp1trn channelled to four companies: a broadcaster, Lativi Media Karya, a hotelfirm, Cipta Graha Nusantara, an oil services company, Siak Zamrud Pusaka, anda textile firm, Arutmin.

Foreign trade and payments

The value of merchandise exports (customs basis) rose to US$19.8bn in the firstquarter of 2005, up over 31% on the same period in 2004. The increase wasaided by strong growth in non-oil and gas exports, which rose by 34% toUS$15.4bn across the same point of comparison. Exports of electronics goodsand mineral fuels performed particularly strongly. Imports grew at the slightlyslower rate of 28.3%, rising to US$13.1bn in the first three months of 2005. Oiland gas imports rose by 51% year on year, while oil and gas exports rose by22.3% across the same point of comparison, reflecting Indonesia�s growingdependence on imports of fuel and related commodities. The strongerperformance of exports vis-à-vis imports boosted the trade balance for January-March to US$6.7bn.

A stiff sentence is imposed forbanking fraud

Loan fraud is uncovered inBank Mandiri

Strong exports help the tradebalance

34 Indonesia


Merchandise trade by value(US$ m)

2005 2004 2005Feb Mar % change a Jan-Mar Jan-Mar % change b

Exports fob 6,379 7,248 13.6 15,038 19,759 31.4 Oil & gas 1,338 1,766 32.0 3,540 4,329 22.3 Non-oil & gas 5,040 5,481 8.7 11,497 15,429 34.2Imports cif 3,984 4,980 25.0 10,202 13,085 28.3 Oil & gas 997 1,632 63.7 2,446 3,687 50.8 Non-oil & gas 2,987 3,349 12.1 7,756 9,398 21.2

Balance 2,395 2,268 -5.3 4,836 6,674 38.0

a Month on month. b Year on year.


The US returned to the top of the list of Indonesia�s main export markets in thefirst quarter of the year, with exports growing by nearly 50% year on yearcompared with the same period in 2004. A change in statistical reporting by theCentral Bureau of Statistics (BPS) highlights the importance of the 25-countryEU, with exports to the bloc rising by nearly 46% year on year in the firstquarter of 2005. Growth in exports to Japan, the second-largest single exportmarket, was slower, although exports were still up by 18.3% year on year. Year-on-year growth in exports to China in January-March was also relativelydisappointing, at 21%.

Main non-oil and gas export markets(US$ m)

2004 Jan-Mar 2005Jan-Mar 2004 Jan-Mar 2005 % changea % of total % of total

Japan 1,953 2,310 18.3 14.0 15.0

US 1,700 2,514 47.9 13.9 16.3Singapore 1,135 1,648 45.2 8.8 10.7

China 681 823 20.9 5.8 5.3Malaysia 591 766 29.7 4.8 5.0South Korea 430 549 27.7 3.2 3.6

Europe 1,769 2,582 45.9 � 16.7Taiwan 323 310 -4.0 2.5 2.0

Australia 233 404 73.3 1.9 2.6Total incl others 48,876 54,126 10.7 100.0 100.0

a Year on year.


Indonesia and Japan are moving closer to starting formal talks on a bilateralfree-trade agreement, building on the preparatory negotiations that resumed inJanuary. In initial talks, Japan has asked Indonesia to clarify investment rulesand eliminate tariffs on motor vehicles and car parts, while Indonesia has givenspecial emphasis to migrant labour, the removal of tariffs on forestry andfisheries products and support for small and medium-sized enterprises inIndonesia.

The US is the single mostimportant export market

Talks on free trade beginwith Japan

Indonesia 35


Late April saw the announcement of a strategic partnership between Indonesiaand China, aiming to deepen the two countries� co-operation in areas asdiverse as politics, economics, law and security. In the near term it is likely thatthe greatest impact will be felt in bilateral economic ties. Although the twocountries are in competition in the production of some manufactured goods,China is keen to tap Indonesia�s huge natural resource base as well as to usethe country to expand its exports into the Association of South-East AsianNations (ASEAN) as a whole. For its part, Indonesia is keen to take advantage ofthe potential for exports to China�s booming economy. China has also pledgedat least US$10bn in private-sector investment this year, and Indonesia hassecured agreement that investment in Indonesia will not be random but will beconfined to basic infrastructure, mining, agriculture and fisheries. The partner-ship is expected to lead to an increase in bilateral trade to US$20bn by 2008, upfrom US$14bn in 2004.

All broad classes of imports were growing strongly in the first quarter 2005.Particularly encouraging was the 39.5% year-on-year rise in imports of capitalgoods, although they still account for 13% only of total imports. The import datasupport anecdotal reports that companies are expanding capacity. Growth inthe cost of imports of intermediate goods was also strong, at 27.3% year on year,reflecting high international oil prices (and Indonesia�s need to import oil) aswell as an increase in demand for Indonesian manufactured goods in both thedomestic and international markets. (The local manufacturing sector reliesheavily on imported inputs.) There was also strong growth in the consumer-goods import bill, but this is rising from a low base, and consumer goods stillaccount for only 8.2% of the total value of imports.

Imports by category(US$ m unless otherwise stated)

Mar 2005 Jan-Mar 2004 Jan-Mar 2005 % change a % of totalConsumer goods 407 878 1,067 21.5 8.2

Intermediate goods 3,950 8,079 10,282 27.3 78.6Capital goods 623 1,245 1,736 39.5 13.3

Total 4,980 10,202.0 13,085 28.3 100.0

a January-March 2005 compared with January-March 2004.


Tourist arrivals fell by 3.3% year on year in the first two months of 2005.However, arrivals on the island of Bali, Indonesia�s main tourist destination,grew by 7.1% year on year, suggesting that the December 2004 tsunami disasterhas not deterred visitors from coming to the island. The modest growth inarrivals may have occurred because some tourists destined for the beach resortof Phuket in Thailand, which was severely damaged by the tsunami, decided toholiday in Bali instead. But higher arrivals in Bali were more than offset by asharp fall in the number of people visiting Batam (an island that attracts manyday and weekend visitors from Singapore), probably in a reflection of the factthat Batam is closer to the tsunami-affected area than Bali. Arrivals at Poloniaairport in Medan, North Sumatra, rose by nearly 50% year on year. Polonia isthe nearest international airport to Aceh, and the sharp rise in arrivals was

Imports reflect strong demandfor raw materials

Tourist arrivals fall slightly

A strategic partnership withChina is announced

36 Indonesia


owing to the large number of foreign aid workers arriving to support relief andreconstruction efforts in the province.

Tourist arrivals at 13 principal gateways2005 2004 2005

Jan Feb Jan-Feb Jan-Feb % changea

Soekarno-Hatta (Jakarta) 81,227 79,714 159,645 160,941 0.8Ngurah Rai (Bali) 107,728 105,402 198,922 213,130 7.1Batam 124,169 83,677 249,432 207,846 -16.7

Other gateways 35,522 37,460 39,577 45,656 15.4Total 348,646 309,006 679,945 657,652 -3.3

a January-February 2005 compared with January-February 2004.


The current account remained in surplus in 2004, but the surplus was markedlyreduced from 2003. The weaker position can be explained largely by thedeterioration in the trade balance, which resulted from faster growth in importsthan in exports. Exports rose by 12% year on year to US$71.8bn (on a balance-of-payments basis), while imports grew by 28% to US$50.6bn, resulting in atrade surplus of US$21.1bn, down by 14% on 2004. Net services remainedvirtually unchanged on the previous year, bringing the current-account surplusfor 2004 in at US$2.9bn.

Balance of paymentsa

(US$ m unless otherwise indicated)

2003 20041 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Exports fob 16,075 15,484 16,298 15,397 15,202 17,318 19,640 19,625Imports fob -10,571 -9,243 -9,740 -9,992 -11,626 -12,019 -13,090 -13,819Trade balance 5,504 6,241 6,558 5,404 3,576 5,299 6,550 5,806Services, incomes & net transfers -3,275 -2,359 -3,507 -2,586 -2,218 -2,396 -2,521 -4,072Current account 1,144 2,225 2,258 1,624 -284 666 2,297 196Financial account -946 -202 -629 829 1,394 -1,045 954 935Capital accountNet inward direct investment -406 257 -203 -245 449 130 -17 484Net portfolio investment liabilities -189 906 121 1,414 762 -85 971 1,146Other investment liabilitiesb -351 -1,366 -548 -339 183 -1,090 0 -695Capital & financial accounts -946 -202 -629 829 1,394 -1,045 954 935Total 198 2,022 1,629 2,452 1,110 -379 3,252 1,131Errors & omissions 740 -1,089 -1,279 -1,020 244 -1,536 -3,242 -271Balance of payments 938 934 351 1,432 1,354 -1,915 10 860Reserve assets position 32,578 34,057 34,068 36,296 37,419 34,851 34,802 36,320Debt-service ratio (%) 28.0 41.0 29.0 33.0 35.0 34.2 22.7 27.8

a Reporting of the balance of payments follows a new format effective from January 2004. b Not including IMF package.


Rising imports cut the current-account balance

Indonesia 37


0

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Current-accountTrade

External balances% of GDP


In the capital and financial account, net investment recorded an inflow ofUS$1bn, against an outflow of US$600m in 2003, providing a welcomeindication that the private sector is finally starting to invest after a long periodof stagnation. Net portfolio investment also recorded a strong surplus, rising by24% year on year to US$2.8bn, as investors were attracted to the country by thestrong performance and high returns available on the Indonesian stockmarket.Net official capital recorded an outflow of US$1.6bn, compared with anoutflow of US$2.6bn in 2003. The net result of these changes was a healthysurplus of US$2.2bn on the capital and financial account, compared with adeficit of US$900m in 2003. After accounting for errors and omissions, theoverall balance of payments came in at a surplus of US$300m, down from asurplus of US$3.7bn in 2003.

Hopes of a recovery in foreign direct investment received a further boost fromdata showing a 173% year-on-year rise in investment approvals in the firstquarter of 2005, to US$4.3bn. The figure includes 285 new projects worthUS$2.7bn, compared with 225 new projects worth US$454m in the first quarterof 2004. Domestic investment approvals have also shown signs of recovery,rising by 16% year on year to Rp9trn (US$860m) across the same period.

Investor confidence was given a lift in March with the announcement thatPhilip Morris, a giant US tobacco company, had agreed to pay US$5.2bn forSampoerna, an Indonesian clove-cigarette manufacturer. The deal is the largestforeign acquisition ever recorded in Indonesia and constitutes a strong vote ofconfidence in the Indonesian economy.

Rising investment boosts thecapital account

Investment approvals growstrongly

A huge investment deal liftsspirits

38 Indonesia


External debt(US$ m)

20042001 2002 2003 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Government 71,377 74,661 81,666 82,113 79,545 78,671 82,269Private 61,696 56,682 53,735 54,566 53,832 54,127 53,872 Financial institutions 7,713 7,642 7,537 7,991 7,515 7,762 8,184 Bank 6,649 4,870 4,316 4,502 3,773 3,736 3,876 Non-bank 1,064 2,772 3,221 3,489 3,742 4,026 4,308 Non-financial institutions 53,983 49,040 46,198 46,575 46,317 46,365 45,688Total 133,073 131,343 135,401 136,679 133,377 132,798 136,141


In mid-March the state minister of national development planning, Sri MulyaniIndrawati, indicated that the government would accept an offer of amoratorium on debt repayments worth US$2.6bn from the Paris Club ofcreditor nations. The offer has been made to help finance reconstruction inAceh following the December tsunami, which caused widespread destructionin the province. The terms of the offer would not require the government toenter into a new programme of reform under the watch of the IMF, nor toapply comparable treatment to private-sector debt, conditions that normallyapply to any Paris Club rescheduling. The postponed repayments would falldue over a period of four years beginning in 2007. The moratorium will run toDecember 31st 2005, and applies only to debt principal payments, not interestpayments. Indonesia owes the Paris Club US$48bn, roughly equivalent to 60%of the country�s December 2004 total of US$82bn of external sovereign debt.

External debt servicing(US$ m)

2002 2003 2004a

Government 7,374 6,450 8,952 Principal 5,009 4,000 6,143 Interest 2,365 2,450 2,809

Private 13,609 11,980 12,210 Principal 11,941 11,186 11,536 Interest 1,668 731 674 Financial institutions 5,808 5,437 6,719 Principal 5,323 5,306 6,580 Interest 485 131 139 Bank 4,825 4,742 6,241 Principal 4,372 4,644 6,122 Interest 453 99 119 Non-bank institutions 983 694 478 Principal 951 663 458 Interest 32 32 20 Non-financial institutions 7,801 6,543 5,491 Principal 6,617 5,880 4,956 Interest 1,183 663 535

Total external debt servicing 20,983 18,430 21,162 Principal 16,950 15,186 17,679 Interest 4,033 3,244 3,483

a Preliminary.


The Paris Club offers a debtmoratorium

Indonesia 39


105

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2000 01 02 03 04 05 0610

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Debt; US$ bn; left scale Debt-service ratio (paid); %; right scale

External debt stock and debt-service ratio


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