Relative to this base case scenario, the risks from COVID and monetary policy surprises in advanced economies, noticeably the USA, are thought to outweigh the possibility that the boost from commodity prices could continue longer than expected. Pockets of corporate solvency risk could develop as a result of the uneven sectoral impact of the pandemic. Nonetheless, the IMF takes comfort from the fact that Indonesia’s fundamentals are stronger than in previous episodes of global financial tightening, as is reflected in the sound fiscal framework and low public debt, a strong current account and reserves, a flexible exchange rate and well-anchored inflation expectations.
Policy Priorities
With the improved performance of the economy, the trade-off between unwinding exceptional policies and providing adequate macroeconomic support has eased. The government has made significant progress with the structural reform agenda, despite the pandemic, and the IMF has urged it to leverage the political momentum to push ahead with further reforms to promote the private sector investment that is critical to medium-term growth.
Structural Policies
The Omnibus Law is seen as a major reform to improve the ease of doing business in Indonesia, and it has the potential to help promote competitiveness and long-term growth. The authorities are currently addressing legal challenges relating to procedural flaws in its establishment, which the Constitutional Court has given the government two years to resolve. According to the IMF, it is critical that the frameworks used to implement the law follow high governance standards and that they are transparent.
Under the new law, new businesses are to be assessed based on the risk they pose to health, safety, the environment and the use of natural resources in a way that will remove the need for a separate environment licence, spatial use permit, nuisance permit and company registration certificate. In this way, the Omnibus Law seeks to reduce the regulatory burden on private sector activity, and its implementation is expected to help attract foreign capital, to reduce vulnerabilities to corruption (by decreasing the scope for discretion in licencing requirements), to reduce the cost of investment and to promote export competitiveness.
The Indonesian Investment Authority (INA) was established in 2021 and has now commenced operations. It is designed to channel investments into infrastructure with foreign, private and government participation. It plans to start with mature, relatively low-risk projects, such as toll-roads. Given the quasi-fiscal risks, the IMF notes that strong governance, and a focus on areas where other forms of financing are less competitive, will be important for its success.
Reforms contained in the new law to ease labour market restrictions (employment protection, especially high firing costs) should support growth and employment in the long-term. According to the law, the requirement that employers pay two times severance upon termination in circumstances such as company closures as a result of efficiency, is being removed. The law also introduces a cap of 25 month’s salary (19 months’ paid by the employer and 6 by a new social security programme), on termination. The IMF notes that the implementation of these reforms should take account of the pace of the economic recovery, and the establishment of unemployment insurance to help minimise short-term costs to workers.
To support the likely positive outcomes of this set of reforms, the IMF is recommending further action in the following areas:
- Education: establishing a pipeline of skilled workers; raising female labour participation
- Finance: easing constraints from shallow markets, as envisaged in the financial sector omnibus law
- Infrastructure: promoting innovation, including through digitalisation
- Government: reforms in tax administration, procurement, product market regulations, to reduce corruption risks and enhance efficiency.
The IMF has noted that progress is being made in education (teacher training, remote learning) and with the establishment of the KPK, the Corruption Eradication Commission. On the other hand, it sees a need to raise the level of government infrastructure spending from the average of 3% GDP of the past.
Climate Change Mitigation
The IMF has noted that the government is taking some steps to reduce carbon emissions, for example by considering scenarios when net zero would be reached by 2060 (or sooner), the introduction of a carbon tax on coal-fired power plants starting in April, and plans for an emissions trading system (ETS) by 2024.
However, it believes that more ambition is needed. The carbon price in the carbon tax (about $2/per ton of CO2 equivalent) is seen as being too low. The IMF suggests the ETS could be used to reduce the gap.
The IMF also notes that the ETS needs to cover sectors with the largest emissions, and that free allowances should be set at levels that have a meaningful effect. It urges the government to act to reduce energy subsidies and to reform pricing.
Fiscal Policy
The Tax Reform Bill which was passed in October 2021 is expected to raise additional revenue already in 2022. The main elements of the reform are:
- VAT: an increase in the standard rate from 10% to 12%, in two steps (April 2022 and April 2025, at the latest)
- Income Tax: a new 35% bracket for those earning over IDR5bn/year, coupled with an increase in the upper bound of the lowest bracket from ISR50mn to ISR 60mn
- Corporate Tax: cancellation of the reduction from 22% to 20%
- Tax Amnesty to encourage the declaration of unreported assets
The IMF believes these reforms could raise revenue by at least 1% GDP, but it says that revenues of about 13% GDP will still be at a level below peers and that they need to be raised further. As ways of doing this, it suggests steps to reduce the thresholds for VAT registration and personal income tax exemptions, and to improve tax compliance (eg. through imposing a minimum alternative tax on business).
Otherwise, the IMF has commended the government’s commitment to reinstating the fiscal deficit ceiling which, it says, will bolster policy credibility. According to the IMF, Indonesia’s debt-stabilising primary balance is about -1% GDP, and it expects interest payments to converge to around 2% GDP. The IMF has also noted that Indonesia’s current public debt ratios still give it some fiscal space, even after the exceptional response to the pandemic.
Looking forward, the IMF has suggested the government needs to publish an updated fiscal strategy, clarifying its objectives and priorities in terms of revenue and spending. It says that priorities should include reductions in energy subsidies and measures to raise additional revenues, to support social spending, infrastructure investment, health and education.
Financial Sector Policies
Although asset quality risks are elevated in sectors such as trade, transport and hospitality, post the pandemic, aggregate financial soundness indicators (NPLs at 3% of total loans and net provisions at below the pre-pandemic level of 3.9% of bank capital) suggest the banking system is healthy.
As expected, the IMF has recommended both that intensive supervision is required while crisis measures remain in place, and that consideration should be given to unwinding incentives as credit recovers.
Looking forward, the IMF has welcomed the moves taken by the financial services authority (OJK) to raise the minimum capital requirement for the smallest banks, which has encouraged some takeovers. However, it has suggested that consolidation will not be open to all, and that steps also need to be taken to strengthen crisis management and resolution frameworks, as outlined in its Financial Sector Action Plan.
The IMF also argues that financial deepening and greater financial inclusion should be a policy priority, with a focus on digitalisation and e-commerce.
The financial sector omnibus bill now under preparation is seen as an important step towards financial deepening, as it seeks to provide the legal foundation for the development of capital markets through fostering the development of insurance companies and pension funds.
Monetary Policy
Bank Indonesia has indicated it intends to keep monetary policy accommodative through much of 2022, based on its projections of a gradual increase in inflation.
As expected, the IMF has suggested excess liquidity should be reduced gradually as credit recovers, and that BI should be prepared to act more decisively, if broader, more sustained price pressures emerge.
The IMF has welcomed the central bank’s commitment to exit from monetary budget financing by the end of 2022. It has suggested that, if BI is faced with adverse monetary spillovers, it should allow the exchange rate to act as a shock absorber.
A summary table of the IMF’s projections for the Indonesian economy through to 2023 appears below:
For the full text of the IMF’s report, please use the following link to the IMF’s website:
https://www.imf.org/en/Publications/CR/Issues/2022/03/22/Indonesia-2022-Article-IV-Consultation-Press-Release-Staff-Report-Staff-Statement-and-515612
