FINANCIAL SECTOR UPDATE AND IMF BRIEFING

UNCLAS SECTION 01 OF 03 JAKARTA 000243 SIPDIS SIPDIS DEPT FOR EAP/MTS AND EB/IFD/OMA TREASURY FOR IA-SETH SEARLS SINGAPORE FOR SUSAN BAKER COMMERCE FOR 4430-BERLINGUETTE DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR FINEMAN DEPARTMENT PASS EXIM BANK E.O. 12598: N/A TAGS: EFIN EINV ECON PGOV ID SUBJECT: FINANCIAL SECTOR UPDATE AND IMF BRIEFING REF: JAKARTA 208 ¶1. (SBU) Summary. The International Monetary Fund Senior Resident Representative in Indonesia briefed donors on the Indonesian economy on January 29. The IMF said that GDP growth for 2008 is on target at 6.1%, lower than the Government of Indonesia's estimate of 6.7%. Reserves are a healthy $56 billion, covering 200% of short-term debt. Indonesia may suffer a slowdown due to external factors, and inflation may be higher than targeted due to global commodity prices but the overall outlook is reasonably optimistic. One of Indonesia's most respected economists is deeply skeptical of the theory that Asia has "decoupled" from western economies, noting that all emerging markets performance in 2008 will depend heavily on what happens in the U.S. End Summary. IMF Staff Visit - Growth 6% in 2008 -------------- ¶2. (SBU) IMF Senior Resident Representative in Indonesia Stephen Schwartz and his deputy, Armando Morales presented a briefing to donors on January 29. They are reasonably optimistic about Indonesia's economic outlook for 2008, citing stable macroeconomic trends, robust domestic demand, and signs of higher investment growth. Foreign exchange reserves are a healthy $56 billion, covering 200% of short-term debt. Reserves increased by $14.3 billion last year and the Rupiah depreciated about 5%. Although inflation accelerated in January, headline inflation remains close to BI's stated target range of 5-7%. ¶3. (SBU) The IMF expects 6.1% GDP growth in 2008 due to strong domestic demand momentum and higher investment. Their target is below the Government of Indonesia's estimate of 6.7%, mainly due to the IMF's expectation that net export growth will slow significantly in 2008. The IMF does not anticipate any return to pre-financial crisis (1997-98) growth rates unless the GOI has some "breakthrough" on its slow investment and infrastructure. The IMF expects the final 2007 budget deficit to be 1.2% of GDP, lower than the 1.5% previously forecasted by the government, due in part to slow spending rates among regional governments. The banking sector remains strong. Non-performing loans (NPLs) have declined to 5-6% of total loans, close to Bank Indonesia's desired maximum of 5%. Loan growth reached a robust 21% in 2007. According to the IMF Representative, bank loans to businesses kept pace with loans to consumers. ¶4. (SBU) Schwartz noted however, that although growth in China and India remain strong, the global outlook was "deteriorating almost by the week," which will affect all emerging markets. Asia is less dependent on the U.S. as a source of growth and has a diverse export base. Asia's share of exports to the U.S. has been declining from around 20% in the 1970s to about half that today. In 2006, Indonesia's exports as a percentage of total value were well diversified both in terms of export products (manufactured goods, oil and gas, agricultural products, etc.) and destination (Japan 21%, EU 12%, U.S. 11%, China 8%, other Asia 31%),limiting the risk that a US slowdown will significantly slow export growth. However, as recent volatility has shown, Asian financial markets are not "decoupled" from the U.S. Other risks to Indonesia's economy include high international commodity prices, which have increased uncertainty about the inflation outlook and a recent increase in foreign currency borrowing in Indonesia, raising the risk of currency mismatches. Recent Sovereign Bond Issuance -------------- ¶5. (SBU) In a January 28 meeting with Fauzi Ichsan, a well-respected economist and Vice President at Standard Chartered Bank, Ichsan noted that provinces are sitting $10 billion in which they have not yet spent. Why did the Government of Indonesia (GOI) rush to issue bonds in the midst of market turmoil? (Note: On January 11, GOI raised $2 billion from two equally valued bonds, which expire in 2018 and 2038. The 10-year bond yield is 6.95% and the 30-year bonds offer 7.74%.) The GOI now has to spend more than 100 basis points (bps) over last year, costing $30 million extra in interest. Finance Minister Sri Mulyani Indrawati has received a lot of criticism for this, Ichsan noted. The IMF disagreed noting that had the GOI waited longer, it might have been worse. There is also the JAKARTA 00000243 002 OF 003 belief that the first emerging market to issue bonds in the new calendar year has an advantage with U.S investors. Ichsan said that Indonesia will be do well by default, as U.S. interest rates drop, the interest rate differential will make Indonesian sovereign debt attractive. Widening Gap Between Rich and Poor, High Food Prices -------------- -------------- ¶5. (SBU) Ichsan noted that the main problem in Indonesia is that the quality of growth is not good. There is a widening gap between rich and poor. The IMF concurred that there is only sluggish improvement in the poverty and social indicators. The GOI is considering another economic policy package to focus more on poverty reduction and social programs to address this problem. Ichsan noted that while high commodity prices are largely a global phenomenon, it will take time for domestic farmers to increase their yields in response to these trends due to structural inefficiencies in the sector. As a result, in the absence of government intervention, commodity prices in Indonesia are likely to remain high for some time, exacerbating poverty rates. Ichsan does not anticipate much outside investment in the agriculture in the near term with the exception of crude palm oil. Concern About State-Owned Enterprises -------------- ¶6. (SBU) The GOI has come to the IMF with concerns about state-owned Enterprises (SOEs) and the potential liability they present. Their financial condition is difficult to gauge given the lack of transparency in their financial statements. The Ministry of Finance has been making efforts at getting more reporting, but progress is slow. State-owned Bank Nasional Indonesia (BNI),state energy monopolies Pertamina and PLN, and Garuda Airlines are some of the major SOEs in dubious financial shape. Many SOEs are forced to go to the international capital markets to raise funds since there are too few domestic investors willing to take long-term risk, raising Indonesia's foreign currency exposure. State-owned electricity authority PLN, for example, already has more than $2 billion in dollar-denominated bonds outstanding and is reportedly seeking new foreign currency loans. The GOI is seeking IMF assistance to determine the composition of its overall foreign currency exposure, including SOE bond and loan obligations. (Note: The Ministry of Finance is focusing on improving its overall risk management, and USG advisors are helping with this task. As part of this, the GOI seeks to capture a picture of its current borrowing risk.) Bank Indonesia Scandal -------------- ¶7. (SBU) The Corruption Eradication Commission (KPK) has been investigating BI senior officials alleged involvement in the misappropriation of Indonesian Banking Development Foundation's ("YYPI") funds between 2003-2004. According to media reports, BI lent Rp 100 billion from the foundation, of which Rp 31.5 billion was disbursed to facilitate the Parliament's discussion of laws on BI and the remaining Rp 68.5 billion was used for legal aid for the resolution of the Bank Indonesia Liquidity Support ("BLBI") cases. After questioning six current and former BI and YYPI officials, on February 4 KPK named BI Governor Burhanuddin Abdullah, Oey Hoey Tiong (BI legal affairs director) and Rusli Simanjuntak (former head of BI communications bureau) as suspects. In 2004, the Supreme Audit Board (BPK) audited BI's 2003 financial report and discovered the embezzlement but did not make the case public until 2006. There have been several front-page media reports about it in recent weeks. ¶8. (SBU) The IMF's Schwartz said that it is bit ironic that the current head of the BPK, Dr. Anwar Nasution, a Harvard-trained economist, was a Deputy Governor at BI at the time of the misappropriation. There is no allegation of anyone taking the fund for personal enrichment and some at BI think the investigation is politically motivated. BI Governor Abdullah has been "trying to do the right thing," according to the IMF. Nasution is a tough Batak who speaks his mind, and sometime issues public statements which are overly blunt. Nasution feels that the Ministry of Finance is cooperative with BPK investigations, but that BI is resisting. Schwartz was optimistic overall, however, stating that Indonesia's JAKARTA 00000243 003 OF 003 current economic team - Coordinating Minister Boediono, Finance Minister Mulyuni, the Director General for Taxation and other key Directors General - is competent and reform minded. HUME