IMF hails RI economy, warns about inflation

Riyadi Suparno, The Jakarta Post, Jakarta

After more than a week of assessment, the International Monetary Fund has praised Indonesia's overall economic performance and the policy directions pursued by the government and the central bank, but has sounded warnings over a number of challenges, especially the likely increase in inflation this year.

IMF's Asia & Pacific division chief Odd Per Brekk, who led the IMF assessment team under the terms of the post program monitoring (PPM) arrangement, said on Thursday that he saw positive developments in the country, especially the return of foreign investment, which would in turn help drive economic growth.

He described the 6.35 percent year-on-year growth in gross domestic product (GDP) recorded in the first quarter of this year as "better quality growth" that was supported not only by high consumption but also by improving investment and exports.

"But you also see some signs that the work has not finished," Brekk said. "Therefore, the policy response from the government must continue to be sound."

The most obvious challenge, according to Brekk, would be inflation, which again reared its ugly head in this year's first quarter, and which as of April stood at a year-on-year rate of 8.12 percent. This was simply because of the market's anticipation of fuel price increases and the fact that these turned out to be higher than expected.

The IMF's senior resident representative to Indonesia, Stephen Schwartz, said the IMF shared most analysts projections that inflation would likely surpass the government's target of 7 percent this year. Nevertheless, it would not rise dramatically, but would rather be in the range of between 7 percent and 8 percent.

Aside from inflation, the IMF also warned about continued volatility of the rupiah in the money markets.

Brekk suspected that the rupiah's decline to its current level of around Rp 9,400 to the dollar was driven both by overseas and domestic factors. The main overseas factor was the increase in the U.S. interest rates, while many domestic factors were involved. But the most important was rising liquidity.

Therefore, Brekk said the IMF welcomed the move by Bank Indonesia to increase its benchmark one-month SBI interest rate to 7.9 percent per annum, as well as the increase in the frequency of SBI auctions from bi-weekly to weekly so as to absorb excess money.

In the long run, however, BI would have to pursue lower interest rates in a bid to drive economic growth and create employment.

He also said that the IMF supported BI's move to shift its focus on monetary policy from quantity (base-money) targeting to interest rate targeting as an intermediate step toward inflation targeting.

In the longer term, BI should set the inflation target on a par with its major trading partner, i.e., around 3 percent per annum.

In the financial sector, the IMF also noted that there was still work to be done in the area of banking supervision. The emergence of the banking scandal in Bank Mandiri should serve as a reminder that restructuring of the banking sector was not yet complete.

Schwartz, however, recognized that Bank Indonesia's banking supervision had improved a lot, but said it needed to be further strengthened to reduce risks in the banking industry.

"The next step would be for Bank Indonesia to move toward what they call risk-based supervision," Schwartz said, describing this as "a more common sense approach" in assessing risks in the banking system.