INDONESIA'S GROWTH SLOWDOWN, BALANCE OF PAYMENT PRESSURES

UNCLAS SECTION 01 OF 04 JAKARTA 000415

SENSITIVE
SIPDIS

DEPARTMENT FOR EAP/MTS, EAP/EP, EEB/IFD/OMA, E, EEB/IFD/ODF
TREASURY FOR M.NUGENT, T.RAND AND L. QUINN
COMMERCE FOR 4430 BERLINGUETTE/KELLY
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN
SINGAPORE FOR S. BAKER
TOKYO FOR R. KAPROTH

E.O. 12958: N/A
TAGS: EFIN ECON ETRD EINV EAID ID

SUBJECT: INDONESIA'S GROWTH SLOWDOWN, BALANCE OF PAYMENT PRESSURES

REFS: (A) Jakarta 91 (B) Jakarta 311

Sensitive But Unclassified. Not for Internet Distribution.


1. (SBU) Summary: Indonesia's economic growth is slowing as the
global economic downturn has become more entrenched. Market
consensus expects a growth slowdown (current IMF forecast is 3.5
percent),rather than recession, for 2009. The macroeconomic
situation remains broadly stable, though pressure on the balance of
payments (BOP),through the capital account, is viewed as the
central risk to the economy given relatively modest foreign exchange
reserves and uncertainty about the size of foreign currency debt in
the corporate sector maturing in 2009. Analysts are also concerned
about an increase in non-performing loans in Indonesian banks, given
the deteriorating economic environment. Officials described their
efforts to line up fiscal support through the contingency financing
package led by the World Bank (with contributions from the ADB,
Japan and Australia) and balance of payments support through the
Chiang Mai Initiative currency swap lines. Although most
interlocutors recognized the limits of a proposed World Bank-led
contingency financing package to help Indonesia weather a balance of
payments crisis, they stressed that the Indonesia government would
not seek assistance from the International Monetary Fund in this
election year. End summary.


2. (SBU) Treasury Director for South and Southeast Asia Malachy
Nugent, Regional Financial Attache Susan Baker and econoff met with
officials from the Indonesian Finance Ministry, Bank Indonesia (BI),
IMF, World Bank and the private sector on February 18-19 to discuss
Indonesia's current economic performance and the outlook for 2009
and to assess three areas of potential vulnerability: BOP,
financial and fiscal.

Economic Growth Down, But Better than Most, With Risks
To Balance of Payments
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3. (SBU) Effects from the continued global economic downturn are
visible in slowing domestic demand, sharply lower trade and
declining bank lending. Local IFI officials and market observers
believe Indonesia is most likely to experience a growth slowdown,
rather than a more serious economic downturn, in 2009. In the
current global environment, forecast economic growth of 3.5 percent
may be enough for Indonesia to record the third highest growth in
the G-20, following China and India, as a number of analysts are
predicting. Whether Indonesia will be able to maintain sufficient
domestic demand to support 3.5 percent growth remains uncertain.
Authorities have pursued monetary and fiscal expansion to support
domestic demand, but difficulties in implementing rapid spending and
continued currency weakness may limit the effectiveness of these
policies. Ministry officials expressed disappointment that
political opposition had prevented extension of the most effective
form of fiscal stimulus - direct cash payments to targeted poor
families - beyond February.


4. (SBU) IFI and Finance Ministry officials briefed that a lack of
confidence continues to hamper capital markets. None of the
officials or analysts consulted believed that Indonesia faces a BOP
crisis now. However, most cited pressure on the BOP, through the
capital account, as the central risk facing Indonesia. Of
particular concern are relatively large private-sector
foreign-currency loan repayments due in 2009. While the full extent
of these repayments is uncertain, Bank Indonesia officials estimated
them at USD 17.4 billion, with an estimated 30 percent involving
loans from parent or affiliated companies and another 50 percent
involving foreign borrowings by foreign companies that may have
greater access to credit lines and refinancing.


5. (SBU) The IMF res rep said he does not see risks in the current
account or the trade account, arguing that most imports are capital
goods and raw materials that respond quickly to reduced demand.
While Indonesia has lost important terms of trade gains made during
the commodities boom, contacts believed that most producers in key

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sectors such as crude palm oil and coal remain profitable. A
knowledgeable private-sector analyst expects the trade balance to be
in modest surplus (about USD one billion per month) in 2009.


6. (SBU) Nugent and Baker briefed Finance Ministry officials on
recent USG actions in response to the economic slowdown, including
the fiscal stimulus package and initiatives to improve credit market
liquidity and deal with troubled assets on bank balance sheets. GOI
officials urged the USG to provide additional information on these
initiatives at the upcoming G-20 meeting in London, particularly for
the benefit of those members outside the G-7. They expressed some
concern about the risk that emerging markets will be crowded out of
capital markets given increased U.S. and other developed country
borrowing.

Rupiah Weakness A Constraint on Further Monetary Easing;
Bilateral Currency Swaps Helpful, But Not Enough
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7. (SBU) Indonesia remains vulnerable to capital flight and changes
in sentiment by both foreign investors and, to a greater degree, by
Indonesians. Interlocutors disagreed about the extent of the risk
of further capital flight, but most agreed that reduced capital
inflows have left BI as the only major supplier of foreign currency.
Given its relatively modest foreign exchange reserves, market
participants have questioned BI's ability to support the currency,
although BI has reportedly stepped up intervention in recent weeks
to prevent the rupiah from exceeding IDR 12,000/USD. At best, BI is
likely to be able to dampen short term rupiah volatility, but not
alter the underlying trend. The IMF res rep believes BI will
continue to allow the rupiah to depreciate gradually. Several
market observers also view continued rupiah weakness as a
significant limitation on BI's ability to ease monetary policy
further. BI officials advised that they see the overnight policy
rate in the 7 to 8 percent range as inflation continues trending
down. Private-sector analysts note that the current round of
monetary easing has been relatively less effective at supporting
economic growth due to banks' current reluctance to expand credit.
Indonesian bank credit growth was one of the highest in the region
in 2008 at 30 percent. BI officials hope that banks will continue
to growth their loans in 2009, although at a more moderate rate of
15 to 18 percent expansion.


8. (SBU) BI officials briefed on plans to increase bilateral
currency swaps under the ASEAN plus 3 Chiang Mai Initiative (CMI)
and reiterated Indonesia's interest in exploring similar swap
facility arrangements with the U.S. Federal Reserve to provide a
further cushion for the BOP. Private-sector analysts noted that the
conclusion of enhanced bilateral swap arrangements through the CMI,
while helpful, provides limited additional resources, since
Indonesia can only access up to 20 percent of the swap lines without
an IMF program in place.


9. (SBU) Private-sector analysts commented that Indonesia's economic
team had adopted a sound approach in maintaining macroeconomic
stability. BI's November decision to require evidence of underlying
transactions in the purchase of foreign exchange had reduced
speculation in currency markets. The new foreign exchange rules
also appear to have kept some funds from entering Indonesia and
prompted some Indonesians to hold deposits in dollars, rather than
rupiah. These analysts also believed that efforts to require
exporters to obtain letters of credit from domestic banks (see Ref
A) would put Indonesian companies at a competitive disadvantage.
They also cited as an example of unhelpful protectionism proposed
GOI initiatives that would require oil and gas companies operating
here to make all Indonesia-related payments through banking accounts
established with Indonesian national commercial banks.

The Financial Sector: Pressures Largely Manageable, But
New Financial System Safety Net Law Needed
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10. (SBU) BI officials expect non-performing loans levels to rise
slightly (from 3.9 percent in December to 5 to 6 percent in 2009)

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and capital adequacy ratios to decline slightly (from 16 percent to
14 percent),but pressures remain manageable. BI expects loan
growth to fall from 30 percent in 2008 to 15-18 percent in 2009, and
deposit growth to reach 10-12 percent. Dollar liquidity remains
tight, while rupiah liquidity has eased, with many banks moving
extra funds into BI certificates and government bonds. World Bank
staff noted that while some banks had experienced derivative losses
related mostly to commodity positions, they do not believe the
amounts are large enough to pose a systemic risk. Private-sector
analysts agreed that banks remain well capitalized, particularly the
top 15 banks which hold more than 2/3 of all deposits. They
confirmed there has been a migration of deposits to larger banks
from smaller banks, some of which need to increase capital or merge
with other institutions. Finance Ministry officials and World Bank
officials agreed that while some companies (such as the Bakrie
Group) were overexposed after borrowing heavily (primarily from
foreign lenders in the case of Bakrie),most banks had remained
fairly conservative and were now stepping up scrutiny of new
lending.


11. (SBU) BI officials and private-sector analysts stressed the need
for swift approval of the government's new revised draft Financial
System Stability Net, following the legislature's rejection of the
initial law in December. Without it, BI and the Finance Ministry
have insufficient tools to manage a significant banking crisis.

Financing the Deficit: More Details About World Bank-led Contingent
Financing Proposal
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12. (SBU) World Bank officials told us the proposed financing
package for Indonesia (subsequently approved March 3) is unique
given its contingent nature and briefed on why they believe the
government needs this instrument under current conditions. World
Bank staff described the current macroeconomic context as sound and
not in need of fundamental adjustment. Bank staff said the USD 2
billion Public Expenditure Support Facility (PESF) Development
Policy Loan with Deferred Drawdown Option (DPL-DDO),augmented by
USD 3.5 billion in contingency financing from the Asian Development
Bank, Japan and Australia, will improve Indonesia's ability to
finance its budget and maintain macroeconomic growth. Bank staff
advise that the package is likely to be most successful if global
and domestic liquidity improves, with the DPL-DDO providing the
market with increased confidence in Indonesia's ability to meet its
financing needs, without need for any draw-down. The "insurance
value" of the package had already calmed markets to some extent, in
the view of Bank staff. Even if capital markets remain tight and
Indonesia is unable to meet its capital market financing targets and
draw from the facility, Bank officials view it as an important
resource to maintain priority spending.


13. (SBU) Finance Ministry officials confirmed their intention is to
go capital markets first, with a focus on domestic markets, to meet
their financing needs, including a fiscal stimulus equal to 1.5
percent of GDP. MOF officials said they will seek access to the
contingent financing facility only if capital markets are
essentially closed. Continued macroeconomic stability is a
prerequisite for access to the funding and the World Bank will
consult with the IMF will on this issue. The Bank, other donors,
and the GOI intend to meet quarterly to determine whether the GOI
has been able to meet its quarterly financing plan at a reasonable
cost. If there is a shortfall and conditions are met indicating
that markets were effectively closed (i.e. financing available only
at rates exceeding historical financing costs by a defined
significant margin),the World Bank and the other development
partners would cover the shortfall. MOF Debt Management officials
advised that if there is a gap under their quarterly target, they
would draw first on the ADB budget loan, to be disbursed on a
quarterly basis, and then divide any remaining gap among other
development partners. They advised the ADB Board would consider the
loan during the second week of April. They also briefed on Japan's
plans to provide a guarantee on an Indonesian yen-denominated
Samurai bond (reported Ref B).


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Domestic Bond Issuance Remains Strong, As GOI Poised to
Go to International Markets When Conditions Permit
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14. (SBU) Officials and private-sector analysts all agreed that
Indonesia continues to have good access to domestic and foreign
capital markets, and underscored Indonesia's successful tapping of
domestic capital markets in early 2009 and preparations to re-enter
global capital markets when conditions are favorable. Finance
Ministry Debt Management officials noted a series of successful
domestic auctions in January and February and the successful
issuance of its first retail sukuk (Islamic bond) in February.
Strong demand allowed the Ministry to triple its initial target and
it raised IDR 5.556 trillion (USD 464.9 million). Prior
preparations for a Global Medium-Term Notes (GMTN) issuance program
will position the GOI to take advantage of market opportunities and
issue up to USD 4 billion in 2009 and 2010. Officials also noted
that unused 2008 budget funds of IDR 51 trillion (USD 4.7 billion)
had helped keep the government's cash management position in good
shape.

The Need To Improve GOI-IMF Relations
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15. (SBU) Interlocutors across the board stressed that the
Indonesian government would not go to the International Monetary
Fund for assistance in this election year. The IMF resident
representative suggested that Indonesia might be more likely to
consider coming to the Fund if the new IMF Short-term Lending
Facility were converted into a contingent facility, rather than one
that required immediate drawing. He said the G-20 and IMF Board are
discussing this issue. Improving GOI-IMF relations is needed, as
World Bank officials and other observers acknowledge that if a
larger macroeconomic crisis develops, Indonesia would need to look
to the IMF and/or try to secure additional currency swaps.

Asking for U.S. Support in the G-20 and Elsewhere
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16. (SBU) Finance Ministry officials urged the USG to support a
capital increase for the ADB to help emerging economies manage the
fallout of the global economic crisis. They requested USG support
in the G-20, where Indonesia is co-leading Working Group IV on
reform of multilateral development banks.


17. (U) U.S. Treasury Nugent and Baker cleared cable.

HUME