REPUBLIC OF INDONESIA

Recent Economic Developments

August, 2010

Table of Contents
I. Executive Summary

II. Indonesia Story: as Acknowledged by Rating Agencies

III. Positive Macroeconomic Developments

IV. Fiscal Policy and State Budget 2010

Executive Summary
The economy grew by 6.2% in Q2-2010. The whole year it forecasted to grow within the range of 5.5%-6.0% by the end of
2010, and estimated to reach the upper limit projection, bolstered by Indonesia's external sector performance, investment, and consumer spending. The latest macro economic indicators supported us to believe that the economy, in line with the development in the global economy, is steadily moving on an upward trend accompanied by financial system stability. It bolstered Indonesia's external sector performance and investment, with domestic recovery gaining strength as the economy is no longer reliant solely on consumption. The optimism also supported by latest development in the perception indicators such as an upgrade to investment grade, yield spread, CDS, CRC-OECD, etc. An assessment of economic developments during July 2010 points to improvement in the domestic economy amid persistent risks of global uncertainties. On July 13th 2010, Japan Credit Rating Agency (JCR) upgraded Indonesia's sovereign rating to Investment Grade, from BB+ to BBB-. This upgrade was the first investment grade for Indonesia in 13 years. Currently, the Republic of Indonesias sovereig n rating BB+ /Stable from Fitch, BB+/Stable from R&I, BB/Positive from S&P, and Ba2/positive from Moodys. The latest Board Meeting convened in August 2010 resolved to hold the BI Rate at 6.5%. For the time being, the current rate considers adequate to safeguard future inflation expectations. However, BI is taking careful note of the recent onset of higher inflationary pressure and will pursue the necessary monetary and banking policy actions to ensure that future inflation remains on track with the established target at 5%+1% for 2010 and 2011. BI will soon respond with measures to tighten liquidity management without disruption to the bank intermediation function, implemented through changes in the statutory reserve requirement. Regarding prices, the Board of Governors is closely monitoring the onset of rising inflationary pressure. July 2010 recorded fairly brisk CPI inflation at 1.57% (mtm) or 6.22% (yoy). Inflationary pressure was driven mainly by higher inflation in the foodstuffs category and particularly rice, due to seasonal uncertainties. In contrast, pressure from core inflation has been kept at modest levels as a result of adequate supply-side response to increases in demand and the appreciating trend in the exchange rate.

Executive Summary
Overall, banking industry remains in a stable condition and convinced to be run prudently, which is reflected in the wellmaintained Capital Adequacy Ratio of 17.4%, and safe level of Non-Performing Loans at 3.3%, as of end of June 2010. By end of 2010, lending growth is projected to reach 22%-24%. Up to July 2010, banking industry has reached the remarkable lending growth at 19.6%. Improved market confidence also bring more optimism to further banking intermediation function. Going forward, BI will keep a close watch on bank lending growth to keep it within the range envisaged in the Bank Business Plans. Special efforts will be devoted to increase credit for productive purposes. The purpose of these measures is to ensure that demand-side increase will be adequately offset on the supply-side and thus not generate excessive inflationary pressure.

Balance of payments has posted a significant surplus over Q2-2010 at US$5.4 billion. The surplus was contributed from
both the current account and capital and financial account. The current account posted a US$1.8 billion surplus, bolstered from upbeat performance in non-oil/gas trade balance, the gas trade balance and the current transfers balance. The ongoing world economic recovery has strengthened non-oil/gas exports with growth outperforming non-oil/gas imports. The capital and financial account recorded a US$3.3 billion surplus distributed fairly among all major components. renewed growth in capital inflows in response to the upward revision of the credit rating outlook and more upbeat international perceptions.

International reserves position at 30 July 2010 reached USD78.8 billion, equivalent to 6.03 months of imports and servicing
of official external debt. This helped the rupiah to maintain stable movement throughout July 2010 with an appreciating trend. In May 2010, the parliament approved 2010 revised budget proposed by the government . The revision is perceived as a necessary measure to adjust the current economic conditions especially changes in the macroeconomic assumptions. The proposed budget adjustment would increased deficit from 1.6 to 2.1%, in order to contain increasing subsidies figures due to rising commodity prices mainly from oil.

Indonesia Story: as Acknowledged by Rating Agencies

Impressively navigates through the global crisis and as growing confidence in economic outlook, the Republic continued to receive good reviews, especially from Rating agencies Japan Credit Rating Agency, Ltd (July 13, 2010): upgraded Indonesia's sovereign rating to Investment Grade from BB+ to BBB- with stable outlook. The first upgrade to reach investment grade in the last 13 years reflects enhanced political and social stability, sustainable economic growth , alleviated public debt burden as a result of prudent fiscal management, reinforced resilience to external shocks stemming from the foreign reserves accumulation and an improved capacity for external debt management and efforts made by the current administration to outline the framework to deal with structural issues such as infrastructure development. Moodys Investors Service (June 21, 2010): revised the outlook of Indonesias foreign and local-currency Ba2 sovereign debt ratings to positive from stable. The positive outlook broadly reflects the country's capacity for sustained strong growth, the overall stability and effectiveness of its fiscal and monetary policies, and expectations of further improvements in the government's financial and debt position. OECD (April 2, 2010): upgraded Indonesias Credit Risk Classification (CRC) from category 5 to 4. This upgrade was a timely acknowledgement by the developed economies of the consistent economic improvement. This upgrade would significantly improve Indonesias credit standing in front of the creditor countries especially the credit exports creditor countries which eventually would decrease the debt burden. S & P (March 12, 2010): upgraded Indonesias long-term foreign currency rating to BB from BB- with positive outlook which indicates that Indonesia has big possibility to be upgraded within a year, even maybe faster. The main factor supporting this decision is steadily improving debt metrics and growing foreign currency reserves which reduced vulnerability to shock with continued cautious fiscal management. Fitch Ratings (January 25, 2010): upgraded the Republic of Indonesias sovereign rating to BB+ from BB with stable outlook The rating action reflects Indonesias relative resilience to the severe global financial stress test of 2008-2009 which has been underpinned by continued improvements in the countrys public finances.
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Positive Macroeconomic Developments

Real Sector: Indonesia Development Policy

Indonesia Development Policy is based on a Triple Track Strategy

1st

Pro-Growth:
Increase Growth by prioritizing export and investment

2nd

Pro-Job :
Boost up the real sector in order to create jobs

Pro-Poor:
3rd

Revitalize agriculture, forestry, maritime, and rural economy to reduce poverty

Source: Coordinating Ministry for Economic Affairs

Economic Growth Sustained

Indonesias economic growth is steadily moving on an upward trend.
Economic data up to end of Q1-2010 supported us to believe that the economy, in line with the development in the global economy, is moving toward better development than we previously expected on the beginning of this year. The optimism also supported by latest development in the perception indicators such as yield spread, sovereign rating, CDS, CRC-OECD, etc. On the backdrops, in the end of Q1-10, BI revised economic growth outlook for 2010 and 2011 to be consecutively within the range of 5.5-6.0% and 6.0-6.5%.
In the 2nd quarter of 2010, the Indonesian economy grew 6.2% (yoy), higher than forecasted at 6.0% and higher than previous quarter (5.7%). The growth driven mainly from investment and consumer spending. The economy is projected to grow within the range of 5.5-6.0 % for 2010, and is forecasted to reach the upper limit projection, bolstered by Indonesia's rising export performance, investment, and continued strength of consumption.

Sustainable Economic Growth

(*): Preliminary Source: Ministry of Finance, BPS.

Source: Bank Indonesia.

Inflation
Inflation Inflation Expectation Consensus Forecast

Stable rupiah is expected to damp pressure from higher commodity prices and pave the way for better inflation expectation. From domestic side, in addition to administered price, subtle inflationary pressure would also be the result from higher demand along with higher economic growth as production capacity remain adequate to respond to higher demand. Those conditions is projected to be reflected in inflation rate at 5+1% in 2010. BI is closely monitoring the onset of rising inflationary pressure. July 2010 recorded fairly brisk CPI inflation at 1.57% (mtm) or 6.22% (yoy). Inflationary pressure was driven mainly by higher inflation in the foodstuffs category and particularly rice, due to seasonal uncertainties. In contrast, pressure from core inflation has been kept at modest levels as a result of adequate supply-side response to increases in demand and the appreciating trend in the exchange rate. Accordingly, the most important factors in mounting inflation are seasonal, requiring action to safeguard against increased expectations of future inflation. Future inflationary pressure until end of 2010 is predicted mainly from higher electricity tariff, upcoming Ramadhan festivities and higher food prices associated with seasonal uncertainties. Going forward in 2011, inflationary pressures could be spurred by an increasingly limited supply-side response to the expected sustained growth in demand. BI will keep a close watch on the rising inflationary pressure and make the necessary adjustments to monetary policy responses to ensure that inflation remains on track with the established targeting range at 5%+1% in 2010 and 2011.
Source: Bank Indonesia

Monetary Policy Stance

Since December 2008, BI has slashed BI Rate by 300 bps. The monetary relaxation has offered ample support for the economic recovery process and bank intermediation. In the latest Board Meeting convened in August 2010, BI Rate is kept at 6.50%. For the time being, BI considers the 6.5% BI Rate adequate to safeguard future inflation expectations while closely monitoring the recent rise in inflation. However, we are taking careful note of the recent onset of higher inflationary pressure and will pursue the necessary monetary and banking policy actions to ensure that future inflation remains on track with the established target at 5%+1% for 2010 and 2011.

BI Rate

10

Source: Bank Indonesia.

Balance of Payments: Q2-2010

Indonesia's Q2-2010 balance of payments posted a significant surplus at US$5.4 billion (Q1-2010: US$6,6 billion surplus). Key to this surplus were positive contributions from the current account and the capital and financial account. The current account in Q2-2010 posted a surplus of about US$1.8 billion (Q1-2010: US$2,1 billion surplus). Bolstering this surplus was upbeat performance in the non-oil/gas trade balance, the gas trade balance and the current transfers. The capital and financial account in Q2-2010 recorded a surplus at US$3.3 billion (Q1-2010: US$4,3 billion surplus). All major components of the capital and financial account, encompassing direct investment, portfolio investment and other investment, recorded surplus. Accordingly, international reserves at end Q2-2010 mounted to US$76.3 billion, equivalent to 5.8 months of imports and servicing of official external debt.

Balance of Payments

11

Source: Bank Indonesia.

Sound Banking Sector

Protected by prudential guidelines and conservative practices, the Banking Sector has weathered the global financial turmoil and posted good performance : strong solvency, contained risk exposure and profitability
Sufficient CAR (%) Sound level of NPLs (%)

financial system stability up to July 2010 is well maintained, confirmed by Financial Stability Index (FSI) which was recorded at
1.84 (slightly lower than June 2010 at 1.87). The decrease indicates lower pressure to the financial system which mainly came from lower credit risk and lower volatility in the financial market.

Banking industry remains in a stable condition and convinced to be run prudently, which is reflected in the well-maintained Capital
Adequacy Ratio (17.4%, as of end of June 2010) and safe level of Non-Performing Loans at 3.0%, as of end of June 2010.

Intermediary function is steadily improving reflected from 19.6% (yoy) lending growth recorded in end of June 2010.
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Source: Bank Indonesia.

In 2010, the Indonesian economy is positioned to grow higher

2010 Forecast Main Factors Behind The Forecast

GDP Growth
is forecasted to be at the upper limit of 5.5%6.0% projection With more upbeat confidence to the economy, exports and investment are expected to keep climbing, providing additional boost to mounting consumption in support of higher levels of economic growth.

Export
is expected to chart higher growth

Global economic recovery will produce renewed acceleration in exports. The global economy is predicted to enter an expansionary phase in 2010. Renewed momentum is predicted in the economies of Indonesias major trading partners, such as China. This strengthened performance will position exports as one of the main engines of economic growth in 2010. Indonesian exports characteristics which is based on primary commodities has also supported export growth acceleration. Household consumption is forecasted to remain strong. The strengthening global economic outlook for 2010 will given added momentum to Indonesias exports, which in turn will produce an overall increase in private incomes. Higher investment will also contribute to rising incomes, thus paving the way for stronger public purchasing power.

Private Consumption
will remain strong

Inflation
is estimated to be on target at range of 5.0%1%

Signs of future inflationary pressures until end of 2010 are noted, which mainly predicted from administered prices and volatile food seasonal uncertainties. However, BI is positive to contain the inflation level within the target range, and will keep a close watch on the rising inflationary pressure and make the necessary adjustments to monetary policy responses to ensure that inflation remains on track with the established targeting range at 5%1% in 2010 and 2011.

13

Source: Bank Indonesia.

Main Banking Indicators

Banking system stability held firm amid the onset of renewed credit expansion (data as of May 2010)

* Preliminary figures, operational risk is calculated in June 2010 figures

14

Source: Bank Indonesia

Fiscal Policy and State Budget 2010

Overview of Fiscal Policy

Continue an effective fiscal stimulus 2009 (1.4% GDP), 2010 (1.6% GDP)
Fiscal Stimulus Policies

Reduce debt to GDP ratio: 2009 (28%), 2010 (27%). Actual fiscal deficit 1.6% of GDP, lower than 2.4% of GDP target deficit projected in 2009 Revised Budget Target fiscal deficit 1.6% of GDP in 2010 Budget (budget adjustments is in ongoing discussion with the
parliament) .

Continue tax policy and administration reform, reduce rate for companies, certainty of tax policy for oil
Tax and Administrative Reforms
companies

Implement the 1st batch of Performance Based Budget (PBB), Civil Service Reform and Remuneration
(11 ministries) and multi-years projects

Provide fiscal space for the new government to implement additional priority programs (0.4% of GDP or
equal to USD 2.5 billion)

New Feature of Fiscal Policy

Sufficient fiscal risk for oil and commodity prices, El-Nino, provide guarantee on land acquisition for
infrastructure projects, secure financing for power (PLN) and restructuring water services (PDAM), domestic oil price adjustment if necessary

Export promotion (additional capital for Indonesian Exim Bank) and incentives for real sector, climate
change projects (geothermal, bio-premium, green funds)

Maintain Social Welfare

Continue welfare programs (PNPM, BOS, Jamkesmas, Raskin) and provide budget for education
sector

16

Source: Ministry of Finance

Fiscal Policy to Promote Economic Recovery

The fiscal policy aims to promote economic recovery by providing tax incentives to various sectors and businesses which further promotes private consumption and investment spending

Reduce income tax rate for corporations from 28% to 25% Reduce income tax rate by 5% for listed companies with 40% public ownership
Incentives on General Taxation

Provide income tax facilities for businesses in specific industries or areas Free VAT for primary agriculture products Eliminate many luxury tax items Provide tax and custom Incentive for special areas in accordance with law on tax and custom Eliminate non tax revenue for export and import documentation Provide incentive for geothermal energy through income tax and VAT

Energy Incentives

Provide tax incentive on imports (both income tax and VAT on imports) for the oil and gas exploration
sector

Provide incentive for green energy through for VAT and subsidy Provide custom incentives for select industries Provide custom incentives for imported capital goods and capex

Incentives for Industry

17

Source: Ministry of Finance

Fiscal Policy to Enhance Competitiveness

The Indonesian government continues to support the development of infrastructure and enhance the social welfare through the effective fiscal policy and incentives for specific sectors
Guarantee for 10,000 MW electricity program and IPP Additional funds for land clearing for toll road building Guarantee obligation for State Water Company and subsidy on interest for clean water, and interest credit for State Water Company, business in Aceh / Nias, and KKPE Subsidy and VAT for peoples housing (low income housing) Credit for green fuel development Credit for farming and cow growers Subsidy for fertilizers, seeds and inventory Direct assistance for seeds at competitive pricing in order to revitalize plantation, cocoa and sugar industry Additional capital for LPEI (Indonesian Exim Bank) to finance export related activities, including for SMEs Provide incentives for high performance regions (e.g. performance on financial, economics and social welfare) Resolution for troubled asset at SOEs and SMEs loan

Infrastructure Development and Social Welfare

Assistance to Support Specific Sectors

18

Source: Ministry of Finance

Budget Deficit / GDP

Public Finances is a fundamental strength of the Indonesian economy; most of Indonesian ratios are strong or stronger than its peers; Fiscal Budget deficit has traditionally been limited and remained contained in 2009. Fiscal Stimulus did not impact much on fiscal deficit in 2009
Budget Deficit / GDP (%)
Revised Budget 2010

Budget Deficit / GDP 2009* vs. Emerging Markets Countries

2006 0

2007

2008 -0.1

2009

2010

-0.5

-1

-0.9

-1.5

-1.3 -1.6 -1.6

-2 -2.1 -2.5

19

Source: Ministry of Finance

State Budget 2010 and Revised Budget 2010

ITEMS A. Revenue and Grant 1. Tax 2. Non tax revenue B. Expenditure I. Central Government -Departm ental / Line Minis tries Budget 2010 949,6 742,7 205,4 1.047,7 725,2 340,1 Revised Budget 2010 992,4 743,3 247,2 1.126,1 781,5 366,2

-Non-Departm ental / non Line Minis tries -Energy Subs idies i. Fuel ii. Electricity II. Transfer to Region C. Surplus/(Deficit) Budget (A -B) % GDP D. Financing I. Dom es tic II. International (net)

385,1 106,5 68,7 37,8 322,4 -98,0 (1.6) 98,0 107,9 -9,8

415,3 143,9 88,9 55,1 344,6 -133,7 (2.1) 133,7 133,9 -0,1

M ACRO AS S UM PT IONS 2010 NO Growth Infl ati on E xc hange rates (/US D) SBI Oi l P ri c e (US D/B arrel ) Oi l Li fti ng (mi l .B arrel /Day Budget 5,5% 5% 10.000 6,50% 65 0,965 Rev ised Budget 5,8% 5,3% 9.200 6,5% 80 0,965

1 2 3 4 5 6

20

Source: Ministry of Finance

State Budget 2010 and Revised Budget 2010 - Revenue

2010 Items Budget I. Domestic Revenue 1. Tax Revenue a. Domestic Taxes i. Income Taxes 1. Oil and Gas 2. Non Oil and Gas ii. Value Added Tax iii. Land and Building Tax iv. Duties on Land and Building Transfer v. Excises vi. Other Taxes b. International Trade Taxes i. Import Duties ii. Export Duties 2. Non Tax Revenue a. Natural Resources i. Oil and Gas ii. Non Oil and Gas b. Profit Transfer from SOE's c. Other Non Tax Revenue d. BLU Income II. Grants
DEPARTEMEN KEUANGAN RI

2010 Rev. Budget 990,5 743,3 720,8 362,2 55,4 306,8 263,0 25,3 7,2 59,3 3,8 22,6 17,1 5,5 247,2 164,7 151,7 13,0 29,5 43,5 9,5 1,9 992,4
Source: Ministry of Finance

948,1 742,7 715,5 351,0 47,0 303,9 269,5 26,5 7,4 57,3 3,9 27,2 19,6 7,6 205,4 132,0 120,5 11,5 24,0 39,9 9,5 1,5 949,7

State Revenue and Grants

21

State Budget 2010 and Proposed Revised Budget 2010 - Expenditures

Items I. Central Government Expenditure - Line Ministries Expenditure - Non-Line Ministries Expenditure 1. 2. 3. 4. Personnel Expenditure Material Expenditure Capital Expenditure Interest Payments a. Domestic Interest b. External Interest Subsidies a. Energy i. Oil Subsidy ii. Electricity Subsidy b. Non Energy Grants Social Expenditure Other Expenditure Budget 725,2 340,1 385,1 160,4 107,1 82,2 115,6 77,4 38,2 157,8 106,5 68,7 37,8 51,3 7,2 64,3 30,7 322,4 306,0 81,4 203,5 21,1 16,4 9,1 7,3 1.047,7 Rev. Budget 781,5 366,2 415,3 162,0 112,1 101,9 105,7 71,9 33,8 201,3 144,0 88,9 55,1 57,3 0,2 65,5 32,9 344,6 314,4 89,6 203,6 21,1 30,2 9,1 21,2 1.126,1
Source: Ministry of Finance

5.

6. 7. 8. II.

T ransfer to Region 1. Balanced Fund a. Revenue Sharing b. General Allocation Fund c. Special Allocation Fund 2. Special A utonomy & A djustment Fund a. Special Autonomy Fund b. Adjustment Fund 3. Grants to Region

State Expenditure
22

State Budget 2010 and Revised Budget 2010 - Overall Balance

2010 Items Budget Overall Balance (A - B) % Deficit to GDP Financing I. Domestic Financing 1. Bank Investment Fund Account Government Account 2. Non Bank Privatization Assets Management Government Bonds (net) Domestic Loan Infrastructure Fund (98,0) (1,6) 98,0 107,9 7,1 5,5 1,0 100,8 1,2 104,4 1,0 (3,9) (9,9) 57,6 24,4 33,2 (8,6) (58,8) 5.981,4 5,5 5,0 6,5 10.000,0 65,0 0,965 Rev. Budget (133,7) (2,1) 133,7 133,9 45,5 5,5 39,3 88,4 1,2 1,2 107,5 1,0 (12,9) (0,2) 70,8 29,4 41,4 (16,8) (54,1) 6.253,8 5,8 5,3 6,5 9.200,0 80,0 0,965
Source: Ministry of Finance

2010

II. Foreign Financing 1. Gross Drawing a. Program Loan b. Project Loan 2. Subsidiary Loan Agreement 3. Amortizations 23

Gross Domestic Product (trillion Rp) Economic growth rate (%) Inflation rate (%) Interest rate of SBI 3 Month (%) Exchange rate (Rp/US$1) Oil price (US$/barrel) Oil production (MBCD)

Financing Trend 2005-2010

Budget Deficit Financing

24

Source: Ministry of Finance

Debt Ratio
Debt to GDP Ratio (% of GDP)
Debt Service to GDP Ratio (%)

Table of Debt to GDP Ratio

End of Year 2004 GDP Debt Outstanding (billion IDR) - Domestic Debt (Securities) - Foreign Debt (Loan+Securities) Debt to GDP Ratio - Domestic Debt to GDP Ratio - Foreign Debt to GDP Ratio 2.295.826,20 1.299.504,02 653.032,15 646.471,87 56,60% 28,44% 28,16% 2005 2.774.281,00 1.313.294,73 658.670,86 654.623,87 47,34% 23,74% 23,60% 2006 3.339.480,00 1.302.158,97 693.117,95 609.041,02 38,99% 20,76% 18,24% 2007 3.949.321,40 1.389.415,00 737.125,54 652.289,46 35,18% 18,66% 16,52% 2008* 4.954.028,90 1.636.740,72 783.855,10 852.885,62 33,04% 15,82% 17,22% 2009** 5.613.441,74 1.589.780,96 836.308,91 753.472,05 28,32% 14,90% 13,42% May 10*** 6.253.789,50 1.609.314,83 868.514,53 740.800,30 25,73% 13,89% 11,85%

Notes: * = Preliminary ** = Very Preliminary *** = Very Very Preliminary, GDP number based on Budget 2010 Assumption

25

[Outstanding as of May, 2010]

Source: Ministry of Finance