00 LKM Tw II 2018 en - bi.go.id · DODY BUDI WALUYO Deputy Governor Bank Indonesia has a single...

REPORTMONETARY POLICY

QUARTER II 2018

Economy, Monetary, and Finance

Bank Indonesia Monetary Policy Report Quarter II 2018 1

The Board of GovernorsPERRY WARJIYO Governor

MIRZA ADITYASWARA Senior Deputy Governor

ERWIN RIJANTODeputy Governor

SUGENG Deputy Governor

ROSMAYA HADI Deputy Governor

DODY BUDI WALUYO Deputy Governor

Bank Indonesia has a single overarching mandate, namely to achieve and maintain rupiah stability. Nevertheless, rupiah stability encompasses two aspects, namely price stability of goods and services, as reflected in stable inflation, as well as rupiah exchange rate stability to currencies in other countries. The Government set the inflation target for 2018 at 3.5±1%. To that end, Bank Indonesia implements sustainable, consistent and transparent monetary policy that also pays due regard to the prevailing economic policies of the Government. In pursuance of its mandate, Bank Indonesia institutes an optimal mix of monetary, macroprudential, payment system and rupiah currency management policies.

Bank Indonesia regularly publishes the Monetary Policy Report each quarter after the Board of Governors Meeting has been convened in February, May, August and November. The Report has two primary functions, namely: (i) to provide economic data, analysis and projections to help form and anchor rational expectations as part of the anticipative monetary policymaking framework; and (ii) as a medium for the Board of Governors to publicly explain and clarify the various considerations underlying monetary policy decision-making at Bank Indonesia.

Foreword

Bank IndonesiaMonetary Policy Report Quarter II 20182

Table of contents

1. Executive Summary

2. Global Economic Developments

4. Economic Outlook

3. Domestic Economic and Financial Market Developments

Global Economy

Global Financial Markets

Global Policy Response

Global Commodity Markets

Global Economic Outlook

Domestic Economic Outlook and Risks

Box: Fan Chart: Visual Macroeconomic Projections and Risks

Economic Growth

Prosperity

Indonesia Balance of Payments

Rupiah Exchange Rate

Inflation

Financial Markets

Box: The Impact of Exchange Rate Depreciation and International Commodity Price Dynamics on Inflation

07

12

13

16

51

56

64

18

27

29

33

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39

47

03

07

51

18


11111111111 Executive Summary

The BI Board of Governors agreed on 14th and 15th August 2018 to raise the BI 7-Day Reverse Repo Rate by 25 bps to 5.50%, while also raising the Deposit Facility (DF) and Lending Facility (LF) rates by 25 bps to 4.75% and 6.25% respectively. The decision is consistent with ongoing efforts to maintain the attractiveness of the domestic financial markets and manage the current account deficit within an acceptable threshold. Bank Indonesia sincerely appreciates and backs the concrete measures taken by the Government to reduce the current account deficit by stimulating exports and reduce imports as well as postponing government projects with a high import content. Bank Indonesia will continue to strengthen coordination with the Government and other relevant authorities to maintain macroeconomic stability and external resilience against a backdrop of increasing global financial market uncertainty. Moving forward, Bank Indonesia will remain vigilant of global and domestic economic dynamics and monitor the economic outlook in order to strengthen the policy mix response to maintain macroeconomic and financial system stability.

The policy rate is reinforced by a sound monetary operations strategy to strengthen interbank rate convergence with the BI 7-Day Reverse Repo Rate, which would enhance monetary policy transmission effectiveness. Furthermore, Bank Indonesia is also continuing measures to accelerate financial market deepening. In the money market, the successful implementation of IndONIA as the reference rate will be accompanied by development of Overnight Index Swap (OIS) and Interest Rate Swap (IRS) instruments, which will ensure a more efficient market rate structure. In the foreign exchange market, Bank Indonesia has improved the effectiveness of foreign exchange swap instruments for monetary operations or hedging through lower prices. Such policies are will provide various alternative instruments to help manage market liquidity and support rupiah exchange rate stability.

Multispeed global economic growth has continued to stoke global economic uncertainty. The US economy continues to gain momentum on the back of accelerating consumption and investment. Meanwhile, the economies of Europe, Japan and China are moderating. Consequently, the Federal Reserve is expected to continue raising the Federal Funds Rate (FFR) gradually, contrasting the reluctance of the ECB and BoJ to hikes policy rates. In addition to the recent FFR hikes, widespread global uncertainty has been exacerbated by simmering trade tensions between the US and several other countries, which have triggered retaliatory actions around the world, including currency depreciation despite broad US appreciation. Global uncertainty has also been fuelled by the risk of spillovers from the economic shocks in Turkey caused by domestic economic fragilities and the adverse impact of negative sentiment surrounding the authorities’ policies, as well as looming tensions with the US. Bank Indonesia will remain vigilant of the external risks, including potential spillover from Turkey although sound economic fundamentals in Indonesia are indicative of solid national economic resilience, coupled with avowed policy commitment.


The national economy has accelerated significantly on strong domestic demand fuelled by private and government consumption. GDP growth was recorded at 5.27% (yoy) in the second quarter of 2018, the fastest rate since 2013. Meanwhile, household consumption stood at 5.14% (yoy), bolstered by rising incomes, upbeat consumers and controlled inflation. In addition, consumption associated with the local elections also posted solid growth. Meanwhile, government spending has also improved, thereby catalysing strong domestic demand. On the other hand, solid investment growth has been maintained despite fewer total work days in June 2018 that restrained growth slightly. Growing domestic demand has prompted a surge of imports against comparatively subdued export performance. Regionally, the economies of Sumatra, Kalimantan and Papua have been the key drivers of growth, coupled with economic resilience in Java, Sulawesi and Maluku. Looking forward, Bank Indonesia predicts solid economic growth on sound investment and consumption performance despite limited export gains. Building and nonbuilding investment remain strong, backed by infrastructure development and investment in the manufacturing industry. Meanwhile, several upcoming events, including the general election, are expected to maintain consumption. Consequently, Bank Indonesia projects economic growth in 2018 in the 5.0-5.4% (yoy) range, subsequently accelerating to 5.1-5.5% (yoy) in 2019.

Congruent with the uptick in terms of domestic economic activities, the current account deficit increased in the second quarter of 2018. The current account deficit stood at USD8.0 billion (3.0% of GDP) in the second quarter of 2018, up significantly from USD5.7 billion (2.2% of GDP) in the first quarter of 2018. Nevertheless, the current account deficit has remained below the manageable threshold in the first half of the year, averaging 2.6% of GDP. The current account deficit increased on an import surge of raw materials, capital goods and consumer goods due to increasing domestic economic activity, which outpaced export growth. Meanwhile, the capital and financial account surplus increased to record a USD4.0 billion surplus in the second quarter of 2018, up from USD2.4 billion in the previous period. Consequently, the position of reserve assets stood at USD118.3 billion at the end of July 2018, equivalent to 6.9 months of imports or 6.7 months of imports and servicing government external debt, which is well above the international standard of 3 months of imports. Moving forward, Bank Indonesia perceives solid Balance of Payment (BOP) performance and the current account deficit maintained within an acceptable threshold that will reinforce external sector resilience. In addition to demand-side controls, including monetary policy, the government will also reduce the current account deficit by stimulating exports and tourism, while reducing dependence on imports by postponing projects with a high import content.


Exchange rate volatility subsided as the rupiah defied intense depreciatory pressures. Point to point, the rupiah lost 3.94% in value during the second quarter of 2018 and 0.62% in July 2018. Rupiah depreciation was accompanied, however, by lower volatility despite broad USD appreciation. Year to date, the rupiah depreciated by 7.04%, less severe than that reported in India, Brazil, South Africa and Russia. Meanwhile, foreign capital inflows have returned to domestic financial markets, drawn to all asset types. Bank Indonesia will continue to monitor the risk of global financial market uncertainty, while stabilising the rupiah in line with the currency’s fundamental value and maintaining market mechanisms, backed by financial market deepening initiatives. Such policy will be supported by dual intervention and monetary operations strategy to maintain adequate liquidity, particularly in terms of the rupiah money market and foreign exchange market. Bank Indonesia policy to improve the effective availability of cheaper foreign exchange swaps should pique investor interest at auctions of various tenors and lower the swap premium, for instance from 4.85% to 4.62% for 1-month tenors and from 5.18% to 4.96% for 1-year tenors.

Post-Eid price corrections helped Bank Indonesia to control low and stable inflation. CPI inflation was recorded at 0.28% (mtm) in July 2018, down from 0.59% (mtm) the month earlier in line with milder inflationary pressures after the Eid-ul-Fitr period. Lower headline inflation stems from deflation of administered prices. As of July 2018, therefore, CPI inflation stood at 3.18% (yoy), relatively stable compared with the 3.12% (yoy) posted the month earlier. Administered prices recorded deflation after transport fares experienced corrections in the wake of the high-demand Eid-ul-Fitr period, primarily affecting airfares and intercity fares. On the other hand, inflationary pressures on volatile foods were also controlled amidst price corrections to various food commodities. Meanwhile, low core inflation was maintained despite an accumulation of inflationary pressures on services. Consequently, core inflation was recorded at 0.41% (mtm), up from 0.24% (mtm) the month earlier. The main contributors to core inflation were mobile phone tariffs and the seasonal impact of school fees. Controlled core inflation was also the result of policy consistency from Bank Indonesia in terms of anchoring rational inflation expectations, while maintaining exchange rates in line with the rupiah’s fundamental value. Bank Indonesia predicts inflation within the 2018 target corridor of 3.5±1% (yoy). Furthermore, Bank Indonesia will strengthen policy coordination with the Government to control low and stable inflation.


Financial system stability was maintained in the second quarter of 2018 as the bank intermediation function improved and the banking industry effectively contained credit risk. Maintained financial system stability is reflected in the high Capital Adequacy Ratio (CAR) reported by the banking industry at 22.0% and the liquidity ratio of 19.4% in June 2018. In addition, the banking sector maintained a low level of non performing loans (NPL) at 2.7% (gross) or 1.2% (net). Financial system stability is also contributing to improvements in the bank intermediation function. Deposit growth was reported to accelerate from 6.5% (yoy) to 7.0% (yoy) in June 2018, while credit growth increased from 10.3% (yoy) to 10.7% (yoy). On the other hand, nonbank economic financing through the financial markets, such as initial public offerings (IPO) and rights issues, corporate bonds, medium-term notes (MTN) and Negotiable Certificates of Deposit (NCD), reached a cumulative total of Rp129.9 trillion (gross) in the first half of the year. With the recent economic gains and progress in terms of corporate and banking sector consolidation, Bank Indonesia projects credit and deposit growth in 2018 at 10.0-12.0% (yoy) and 8.0-10.0% (yoy) respectively.

Domestic economic and financial activities are improving with the backing of a secure, efficient, available and reliable payment system. The settlement of noncash transactions, including large-value and retail transactions, as well as cash transactions increased in the reporting period. The daily average value of large noncash payment transactions settled through the Bank Indonesia Real Time Gross Settlement (BI-RTGS) system jumped 13.7% (yoy) in the second quarter of 2018. A similar trend was observed in terms of noncash retail transactions, with the value settled through the National Clearing System (SKNBI) rising 3.1% (yoy) and the value of retail transactions involving ATM/debit cards, credit cards and electronic money expanding 9.6% (yoy). The higher cash payment transaction is also supported by services and system availability of Bank Indonesia’s secured payment system. Regarding cash payments, the position of currency in circulation increased 1.2% (yoy) in the second quarter of 2018 as public demand spiked for currency in appropriate denominations and fit for circulation.


2 Global Economic Developments

GLOBAL ECONOMY

Divergent global economic growth has continued to stoke global economic uncertainty. The US economy continues to gain momentum on the back of accelerating consumption and investment. Meanwhile, the economies of Europe, Japan and China are moderating. Consequently, the Federal Reserve is expected to continue raising the Federal Funds Rate (FFR) gradually, contrasting the reluctance of the ECB and BoJ to hikes policy rates. In addition to the recent FFR hikes, widespread global uncertainty has been exacerbated by simmering trade tensions between the US and several other countries, which have triggered retaliatory actions around the world, including currency depreciation despite broad US appreciation. Global uncertainty has also been fuelled by the risk of spillovers from the economic shocks in Turkey caused by domestic economic fragilities and the adverse impact of negative sentiment surrounding the authorities’ policies, as well as looming tensions with the US. Bank Indonesia will remain vigilant of the external risks, including potential spillover from Turkey although sound economic fundamentals in Indonesia are indicative of solid national economic resilience coupled with avowed policy commitment.

The US economy continues to gain momentum on the back of accelerating consumption and investment. The US economy posted 2.8% growth in the second quarter of 2018, improving from 2.6% in the previous period (Graph 2.1). Stronger consumption data was confirmed by faster consumption growth of vehicles and services, such as recreation, accommodation and health services, backed by lower unemployment. Meanwhile, increasing residential investment

US Economic GrowthGraph 2.1

Source: Bloomberg, calculated

Government Expenditure

-2

-1

0

1

2

3

4

5

I II III IV I II III IV I II III IV I II

2015 2016 2017 2018

% yoy

Consumption Private Investment Net ExportGDP


combined with solid non-residential investment continued to boost overall investment growth in the second quarter of 2018, supported by corporate tax breaks that have trickled down and maintained a high level of new orders in the manufacturing industry. In addition, companies have continued to ramp up production, as indicated by a bump in the Markit Manufacturing PMI and capacity utilisation data. Congruently, the US has maintained a solid net export position based on an export growth surge of soybean coupled with subdued imports.

The US labour sector has continued to improve, accompanied by higher wages and rising inflation. Such developments were confirmed by the unemployment numbers in the second quarter of 2018, falling from 4.1% in the previous period to 3.9%, which is well below the Non-Accelerating Inflation Rate of Unemployment (NAIRU) at 4.7%. Less slack in the US labour sector was reflected by an increase in nonfarm payroll together with the growing number of job openings that outpaced the number of new workers joining the labour market, which raised wages and amplified inflationary pressures. Based on age bracket, young and productive workers have benefitted most from the higher wages in the reporting period.

Inflationary pressures remained in the US during the second quarter of 2018, induced by rising inflation expectations and strong demand. CPI inflation and core inflation in the United States stood at 2.9% (yoy) and 2.3% (yoy) respectively in the reporting period, up from 2.4% (yoy) and 2.1% (yoy) in the previous period (Graph 2.2). In general, rising prices of clothing, energy, motor vehicles and durable goods have amplified inflationary pressures. Furthermore, inflation expectations in the near term have continued to rise and currently stand above the 2% inflation target. Data from the Consensus Forecast, April-July 2018, indicates that average inflation expectations in the US

US In� ationGraph 2.2


3.53.02.52.01.51.00.50-0.5

4 6 8 10 1 3 5 7 9 11 1 3 5 7

2.892.40

1.7

1.8

2.12.23

1.90

0

9 11 1 3 5 7 2016

2017

2018

2015 2016 2017 2018PCE Projection CPI (yoy) PCE (yoy) PCE (mtm)Target 2% CPI Core (yoy) PCE Core (yoy)

%


reached 2.5% (yoy) in the second quarter of 2018, up from 2.4% (yoy) in the previous period.

Europe’s economy moderated on the back of restrained consumption and investment growth. After achieving comparatively solid 2.5% growth in the first quarter of 2018, Europe’s economy slumped to 2.2% (yoy) in the reporting period, below the previous projection (Graph 2.3). The economic downswing was attributed to soft consumption growth, as reflected in declining retail sales and consumer confidence in the economy. On the other hand, investment gains in the second quarter of 2018 were stifled by weaker investment in machinery despite persistently solid construction investment. Europe’s flagging economy was also held back by slower production activity, as confirmed by a lower Manufacturing PMI and Industrial Production index as well as capacity utilisation. The support of a net export position was also eroded by increasing imports and limited exports as a result of less demand from China.

Despite persistent slack, labour market dynamics have improved in Europe. Unemployment fell to 8.3% in the second quarter of 2018 but labour market slack remains, as evidenced by a significant portion of underemployed and available employees not seeking work. Such dynamics have led to moderate wage growth at 3.86% compared with the pre-crisis level of 5.43%.

Inflation in Europe has increased significantly on the rising global oil price. CPI inflation in Europe was recorded at 2.0% in the second quarter of 2018, up from 1.3% in the previous period (Graph 2.4). Energy prices have risen 8% due to the higher oil price, which induced CPI inflation. On the other hand, core inflation decreased to 0.9% in the second quarter of 2018 from 1.0% in the previous period. Furthermore, the ECB has effectively anchored rational inflation expectations below the current 2% target.

Economic Growth in EuropeGraph 2.3


Government Consumption

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-1

0

1

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I II III IV I II III IV I II III IV I II-F

2015 2016 2017 2018

% yoy

Consumption Investment Net Export

2.5 2.2

GDP

In� ation in EuropeGraph 2.4


0.1

2.0

0.9

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-1

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1

2

3

6 12 123 6 9 123 6 9 123 6 9 123 6 9 6

2013 2014 2015 2016 2017 2018

CPI mtm CPI yoy Core yoy

%

ECB CPI Target 2%


Economic moderation in Japan was expected to endure throughout the second quarter of 2018, with the economy impeded by slower consumption and investment growth. After moderating in the first three months of the year, Japan’s economy is expected to continue declining in the second quarter of 2018 (Graph 2.5). Consumption has slowed in line with fading consumer confidence as well as slumping retail and motor vehicle sales. In addition, investment growth has decelerated based on less demand for machinery and a lower Manufacturing PMI. On the other hand, import and export activities have continued to accelerate, driven by exports to Europe and China as well as oil imports.

Japan’s labour market is improving despite persistent slack. Unemployment fell to 2.2% in the second quarter of 2018 from 2.5% in the previous period. Nevertheless, labour market slack persists, exacerbated by the ageing population that has undermined overall worker productivity and led to moderate wage growth.

Inflation in Japan has fallen below the BOJ’s target. CPI inflation stood at 0.7% (yoy) in the second quarter of 2018, down from 1.1% (yoy) in the previous period. Durable goods, food and energy were the main drag on headline inflation in Japan. Similarly, core inflation also decreased (0.8%) in the reporting period, remaining below the Bank of Japan’s (BOJ) 2% target (Graph 2.6). Slower inflation growth was attributed to several factors, including a cautious corporate sector in terms of setting wages and prices, which has been compounded by tighter competition.

Financial deleveraging has stifled economic growth in China. China’s economy moderated slightly from 6.8% to 6.7% in the second quarter of 2018 (Graph 2.7), held back by waning public and private investment (Graph 2.8). Deleveraging by local governments and state-owned enterprises has reduced public

Japan Economic GrowthGraph 2.5

Japan In� ationGraph 2.6

China Economic GrowthGraph 2.7


-0.5

0

0.5

1.0

2.0

1.5

2.5

II III IV I II III IV I II III IV I II

2015 2016 2017 2018

% yoy

Government Consumption Consumption Investment Net Export GDP

Source: Bloomberg

-1

0

1

2

3

Tokyo CPICPICPI exclude fresh foodCPI exclude Processed Food and Energy

% yoy

20162015

3 51 7 9 11 3 51 7 9 11 3 51 6417 9 11

2017 2018

I II III IV I II III IV I II I IIIII IV

2015 2016 2017 2018

-2

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4

6

8% yoy

Net Export Investment Total Consumption GDP



investment and further exacerbated slower public investment in the infrastructure sector. Moreover, the private sector has also been less inclined to invest in line with declining real estate investment as the main driver of private investment. Similarly, consumption growth slowed in the second quarter of 2018 due to financial deleveraging, which has constrained lending, including household loans. This has led to softer retail sales, particularly affecting motor vehicle sales. Nonetheless, the manufacturing industry has remained expansive despite an export slowdown triggered by the looming trade war and weaker domestic demand. On the other hand, imports also decelerated on dwindling domestic demand and deferred imports as consumers wait for lower import tariffs on consumer goods.

Food was the main drag on China’s inflation, while non-food inflation remained comparatively stable. CPI inflation in China was recorded at 1.9% in the second quarter of 2018, down from 2.1% in the previous period and slipping further away from the government’s 3% target. Inflationary pressures on food eased as prices returned to normal after the Chinese (lunar) new year holiday. Meanwhile, milder inflationary pressures on recreation and health services helped to maintain relatively stable non-food inflation remained.

Resurgent investment in India is expected to sustain solid national economic growth in the second quarter of 2018. Analysts predicted solid economic growth in India during the second quarter of 2018 after posting a robust 7.7% in the first quarter (Graph 2.9). A surge of investment is driving India’s economy, as evidenced by a significant bump in the Manufacturing PMI during the reporting period along with a high level of industrial production growth (Graph 2.10). On the other hand, higher unemployment, a dip in the average daily wage as well as downcast automotive sales and restrained production will

China InvestmentGraph 2.8

Source: Bloomberg; Notes: Data is accumulated data

8.4

3.0

6.0

0

5

10

15

20

25Private Investment Government InvestmentTotal Investment (FAI)

% ytd yoy

2015

6 9 12 63 9 12 63 639 12

2016 2017 2018

India Economic GrowthGraph 2.9

Source: Bloomberg

-4

-2

0

2

4

6

8

10

12

1 2 3 4 1 2 3 4 1 2 3 4 1 2F

2015 2016 2017 2018

Consumption InvestmentGovernment ConsumptionNet Export GDP

% yoy


impede potential consumption gains. In terms of the external sector, the large trade deficit persists as import growth rose at a faster pace than exports due to the high global oil price.

Headline inflation has accelerated in India but remains within the 4.0±2% target. CPI inflation was reported at 4.9% (yoy) in the second quarter of 2018, up from 4.3% (yoy) in the previous period. The main contributors to inflation were core inflation, food and beverages, as well as fuel and electricity. Clothing, health as well as transportation and communication pushed core inflation (omitting food, tobacco and energy) to 6.3% (yoy) in the first quarter of 2018 from 5.2% (yoy) in the previous period.

GLOBAL FINANCIAL MARKETS

Risks continued to loom over the global financial markets in the second quarter of 2018. The VIX index tracked an upward trend in June 2018 (Graph 2.11 and Graph 2.12). Furthermore, such widespread uncertainty perpetuated broad US dollar appreciation. Global financial market uncertainty has been amplified by, amongst others, increasing economic growth divergence between the United States and other countries, expected FFR hikes and rising UST yields, a tightening of global liquidity, the higher global oil price, slower rising international commodity prices as well as an escalation of the impending trade war with retaliatory tit-for-tat measures that include exchange rate depreciation. In addition, geopolitical risks have further heightened the prevalent uncertainty due to simmering tensions around the world, including US threats against Iran, tensions on the Korean Peninsula, the tense US-China relationship, the border dispute and trade relations between the US and México, the financial crisis in Turkey as well as the domestic political issues plaguing several countries in Europe coupled with the burgeoning immigrant crisis. The build-up of

Indonesia VIX and CDSGraph 2.11

DXY and ADXY ReinforcementGraph 2.12

Investment and Industrial Production in IndiaGraph 2.10

Source: Bloomberg

9.1

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2015 2016 2017 2018

InvestmentIndustrial Production for Nowcast (rhs)

% yoy % yoy

Source: Bloomberg

60708090

100110120130140150160

Indonesia CDS VIX (rhs)

6 871 2 3 4 5

2018

8

13

18

23

28

33

38

43Index Index

104

105

106

107

108

109

110

111

112

113 88

89

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91

92

93

94

95

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97

Dollar IndexAsian Dollar Index (rhs) - Reverse Order

Index

Appreciation of US Dollar vs. Major Currency

Appreciation of US Dollar vs. Asian Currency

Index

Source: Bloomberg

2 Apr 24 Apr 18 Mei 11 Jun 29 Jun 23 Jun 14 Aug


geopolitical risk demands increased vigilance because heightened uncertainty could thwart investment and intensify risks in the financial markets.

GLOBAL POLICY RESPONSE

The US Federal Reserve is continuing to normalise monetary policy through policy rate hikes and balance sheet reductions commensurate with increasing economic growth momentum. The Federal Open Market Committee (FOMC) decided in August 2018 to hold the Federal Funds Rate (FFR) considering that despite stronger domestic economic growth and low unemployment, inflation remains within the 2% target range. Furthermore, the FOMC dot plot has indicated that the Fed is predicted to gradually raise the FFR four times in 2018 and three times in 2019. The probability of four FFR hikes in 2018 currently stands at 63.3%, which is higher than the probability of three FFR hikes (Table 2.1). In addition to gradually raising the policy rate, the Federal Reserve relayed its intention to maintain balance sheet reductions by releasing US Treasury (UST) and Mortgage-Backed Securities (MBS) (Graph 2.13).

In Europe, the European Central Bank (ECB) is continuing quantitative easing and has maintained its monetary policy stance apropos of forward guidance. The ECB’s Monetary Policy Committee (MPC) decided on 26th July 2018 to maintain its monetary policy stance based on previous forward guidance (Diagram 2.1). The ECB is not expected to raise its policy rate until the third quarter of 2019 after the net asset purchase program (APP) comes to a likely end in December 2018. The decision to hold interest rates is based on the projection of low inflation in 2018, below the inflation target, together with sluggish economic activity predicted this year. After the APP exit, the European Central Bank is expected to introduce QE Reinvestment to

Probability of Increasing FFR in 2018Table 2.1

Fed ownership of USTGraph 2.13

Source: Bloomberg

2,3202,3402,3602,3802,4002,4202,4402,4602,4802,500

Billion USD

UST Linear (UST)

10 11 12 1 2 3 4 5 6

2017 2018

*Calculated based on WIRP Implied ProbabilitySource: Bloomberg

29 June 2018 30 July 2018 2 August 20181234567

FFR 2018 Increase Amount

Probability* %

31.71

0 0 010.42 1.93 1.7739.36 27.0440.28 56.69 63.289.68 13.76 3.240.26 0.57 0

0 0 0


maintain liquidity and strengthen monetary policy.

Similar to dynamics in Europe, the Bank of Japan (BOJ) is also holding its monetary policy stance. At the Monetary Policy Meeting (MPM) held on 30-31 July 2018, the BOJ decided to hold its policy rate in the near and long term considering the uncertainty associated with economic activity and prices, including the impact of a hike in the consumption tax rate planned for October 2019. Moreover, achieving the 2% inflation target is now expected to take longer than initially thought. In the near term, the BOJ will maintain its policy rate at -0.1%. Meanwhile, seeking to hit the long-term target level, the BOJ will continue to purchase Japanese Government Bonds (JBG) until the benchmark 10-year yield hits 0%. In addition to buying JGB, the BOJ is also procuring Exchange Traded Funds (ETF) and Japan Real Estate Investment Trusts (J-REITs).

The People’s Bank of China (PBoC) has eased its monetary policy stance. The China Monetary Condition Index began to reflect policy easing in June 2018 after tightening on the back of declining credit growth and rising real interest rates due to financial deleveraging that has been intensified since December 2018. The PBoC is easing monetary policy through targeted reserve requirement ratios (RRRs) and by expanding the collateral for the Medium-Term Lending Facility (MLF), expanding the MLF to maintain growth stability and liquidity availability, as well as backing micro, small and medium enterprises (MSME) in accordance with the stance of the Central Government (Graph 2.14). Moving forward, the PBoC is expected to continue easing monetary policy, which will depreciate the yuan and increase volatility. To that end, the PBoC issued Statutory Reserve Requirements for forward transactions and is considering the use of countercyclical measures.

Path of ECB Monetary Policy NormalizationDiagram 2.1

III

2018

Timeline shows dates by when most economists predict a given actionSource: ECB, Bloomberg survey of economic conducted 13-18 July

2019

Deposit-rateIncrease

Ro�-rateIncrease

Maturing debtreinvested through

Next change toforward guidance

Net assetpurchased end

Unwinding StimulusMilestones on the ECB’s Path toward monetary-policy Normalization

IV III III IV 2020 or thereafter

Bloomberg Monetary Condition IndexGraph 2.14

Source: Bloomberg

13

12

11

10

9

8

7

6

GDP yoy

weakenChina Monetary Conditions Index (rhs)

2010

Index

6 12 6 12 6 12 6 12 6 12 6 12 6 12 6

2011 2012 2013 2014 2015 2016 2017 2018

120

110

100

90

80

70

60

50

40

strengthens


The panoply of policy responses instituted by monetary authorities around the globe has led to increasing policy divergence between the US and the rest of the world (Graph 2.15). Such monetary policy divergence has exacerbated global financial market uncertainty and broadly influenced capital inflows to developing economies, including Indonesia (Graph 2.16). The capital reversal currently blighting developing economies has also been compounded by weaker stock market performance in China as a result of the looming trade war and the impact of deleveraging.

External dynamics are expected to spill over into emerging market economies, including the risk of contagion from the developments in Turkey. The current issues in Turkey were triggered by domestic economic fragilities and the adverse impact of negative sentiment surrounding the authorities’ policies, aggravated by festering tensions with the United States. Nonetheless, the risks are expected to prompt a negligible effect on Indonesia’s economy in line with the current improvements observed in domestic economic fundamentals.

Monetary Policy DivergenceGraph 2.15

Emerging Market Capital FlowsGraph 2.16

Billion USD

Source: IIF

-30

-20

-10

0

10

20

30

40

50

60Debt Flow Equity Flow Total Flow

3 6 9

2012 2013 2014 2015 2016 2017 2018

12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 3 69 12 3 6 9 12

%

Source: Various Source

-0.5

0.0

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1.0

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3.5

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2017 2018* 2019* 2020*

ECB Main Re�nancing Rate****Fed Funds Rate**Overnight Call Rate (Japan)***7-Day Repo Rate (China)***


GLOBAL COMMODITY MARKETS

Pervasive global economic uncertainty due to global economic growth divergence and the escalating trade war has eroded world trade and lowered commodity prices, excluding oil. Consequently, projected world trade volume (WTV) has been revised down in line with lower WTV realisation in the first quarter of 2018 (Graph 2.17), as reflected by slower import and export growth in advanced economies and well as lower manufacturing PMI in advanced economies. Subdued world trade volume in the first quarter of 2018 was the result of concerns stoked by protectionism stemming from the escalating trade war together with economic moderation in Europe and Japan that is expected to persist.

Metal and agricultural products were the main drag on commodity prices, while coal and nickel defied further declines (Table 2.2). The latest developments revealed that crude palm oil (CPO), rubber and metal continued to track declining price trends in the second quarter of 2018. CPO prices fell on dwindling demand from India and China, coupled with increasing production that led to a larger net supply. Furthermore, CPO prices have also been suppressed by lower soybean prices as a viable substitute for CPO, triggered by negative sentiment stemming from the trade war. Meanwhile, pressures on rubber prices have persisted due to abundant supply and concerns regarding the effect of the trade war on China’s economy as the largest global rubber consumer. Negative sentiment surrounding the looming trade war is also responsible for pressures on copper, lead and aluminium prices. Bucking the downward trend, nickel prices continued to rise on persistently strong demand for stainless steel production in China combined with diminishing supply due to production disruptions in the major producing countries, including the Philippines, Brazil and Russia.

World Trade VolumeGraph 2.17

Source: Bloomberg

0

1

2

3

4

5

6

I II III IV I II III IV I III III IV

2015 2016 2017 2018

WTV WTV Import WTV Export

% yoy

Source: Bloomberg, calculated; *Data as of 10 August 2018

2016 2017 YTD 2018*

CopperCoalCPORubberNickelLeadAluminumCo�eeOthersIndonesian Export Commodity Price Index

Commodity

-10.56.8

21.3-2.2

-15.413.1-3.54.31.05.4

27.148.25.7

28.18.9

13.122.9-2.96.8

21.7

10.46.5

-14.3-14.133.03.8

10.4-12.0

2.80.5

Indonesian Export Commodity PricesTable 2.2


After experiencing pressures in the first three months of 2018, the coal price has rebounded since May. The coal price hit USD95/MT after a heatwave drove up demand in China. In addition, heavy rainfall has obstructed coal exports from Indonesia, while other constraints in the coal exporting process edged up prices. Nevertheless, lower demand from India as domestic production is increased will slow the rising coal price.

On the other hand, the global oil price continued to tick upwards in the second quarter of 2018 due to supply disruptions (Graph 2.18). The rising oil price is primarily the result of production and export disruptions in several OPEC countries, namely Libya, Nigeria and Venezuela as well as restrained production gains in the United States stifled by limited pipe capacity in the Permian Basin (Graph 2.19). Furthermore, US sanctions against Iran have also reduced global oil supply. Despite additional OPEC production, OPEC supply has been unable to effectively offset the production disruptions. On the demand side, robust economic growth momentum in oil consuming countries, such as the US and China, has maintained strong demand for oil.

Oil Price QuarterlyGraph 2.18

Production Disruption of Various CountriesGraph 2.19

20

30

40

50

60

70

80

2015 2016 2017 2018

USD per Barrel

Brent Price

Source: Bloomberg

Quarterly Average

0

1

2

3mbpd

Others OPECIraq

NigeriaLibya

CanadaOthers Non-OPEC

Source : EIA, STEO; June 2018

1 2

2017 2018

3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6


ECONOMIC GROWTH

The national economy has accelerated significantly on strong domestic demand fuelled by private and government consumption. GDP growth was recorded at 5.27% (yoy) in the second quarter of 2018, the fastest rate since 2013 (Table 3.1), evidencing the ongoing economic recovery process (Graph 3.1). Meanwhile, household consumption stood at 5.14% (yoy), bolstered by rising incomes, upbeat consumers and controlled inflation. In addition, consumption associated with the local elections also posted solid growth. Meanwhile, government spending has also improved, thereby catalysing strong domestic demand. On the other hand, solid investment growth has been maintained despite fewer total working days in June 2018 that restrained growth slightly. Growing domestic demand has prompted a surge of imports against comparatively subdued export performance. Regionally, the economies of Sumatra, Kalimantan and Papua have been the key drivers of growth, coupled with economic resilience in Java, Sulawesi and Maluku. Looking forward, Bank Indonesia predicts solid economic growth on sound investment and consumption performance despite limited export gains.

3 Domestic Economic And Financial Market Developments

Percent, yoy

Source: BPS

I IIIII III IV4.94 4.95 4.93 4.97 4.95 4.95 5.14

6.645.01

8.07 8.52 6.02 5.24 6.91 8.09 8.710.14 2.69 -1.92 3.48 3.81 2.14 2.74 5.264.47 4.77 5.34 7.08 7.27 6.15 7.95 5.875.18 5.87 6.07 6.28 6.68 6.24 6.16 5.02

2.43 1.46 3.23 9.47 9.03 5.90 13.57 8.41 1.57 8.41 2.80 17.01 8.50 9.09 6.09 7.702.45 4.81 0.20 15.46 11.81 8.06 12.66 15.175.03 5.01 5.01 5.06 5.19 5.07 5.06 5.27

20162017 2018

2017

Household ConsumptionNon-Pro�t Institutions Serving HouseholdsGovernment ConsumptionInvestment

Building InvestmentNon-building Investment

ExportsImportGDP

Components

Economic Growth by ExpenditureTable 3.1

Economic Recovery PathGraph 3.1

Source: BPS, calculated

4.74

5.06

5.27

4.50

4.70

4.90

5.10

5.30

5.50

5.70

I II III IV I II III IV I II III IV I II III IV I II III IV I II

2013 2014 2015 2016 2017 2018

GDP 6 per. Mov. Avg. (GDP)

% yoy


Building and nonbuilding investment remain strong, backed by infrastructure development and investment in the manufacturing industry. Meanwhile, several upcoming events, including the general election, are expected to maintain consumption. Consequently, Bank Indonesia projects economic growth in 2018 in the 5.0-5.4% (yoy) range, subsequently accelerating to 5.1-5.5% (yoy) in 2019.

Household consumption has accelerated, bolstered by rising incomes, upbeat consumers and controlled inflation. Household consumption hit 5.14% (yoy) in the second quarter of 2018, up from 4.95% (yoy) in the previous period (Graph 3.2). Household income improved, particularly among low-income households, as indicated by positive growth of the farmers’ terms of trade and real farmworker wages (Graph 3.3). Furthermore, household income was boosted by the Government’s social assistance program (bansos) as well as 13th-month salaries and annual Eid allowances disbursed to civil servants, army and police personnel as well as pensioners. Social assistance disbursements in the second quarter of 2018 exceeded those recorded in the same period one year earlier (Graph 3.4). Household consumption was in line with upbeat consumers, especially among upper-middle class consumers (Graph 3.5). In addition, solid household consumption was also backed by seasonal factors during the holy fasting month of Ramadan and Eid-ul-Fitr, with the Government approving an extended public holiday period this year, which helped to stimulate broad-based improvements in the retail and automotive sales data during the second quarter of 2018. Solid household consumption was also maintained by stronger public purchasing power in line with low inflation.

Consumption among non-profit institutions serving households (NPISH) also recorded robust growth. After posting 8.09% (yoy) growth in the first quarter of

Private consumption growthGraph 3.2

Farmers’ Terms of Trade and Real WagesGraph 3.3

Social Assistance DisbursementsGraph 3.4


-15-10-5051015202530

4.04.24.44.64.85.05.25.45.65.8

I II III IV I II III IV I II III IV I II III IV I II2014 2015 2016 2017 2018

Private ConsumptionHousehold ConsumptionNon-Pro�t Institutions Consumption (rhs)

% yoy % yoy


-3

-2

-1

0

1

2

3

I II III IV I II III IV I II 1 2 3 4 5 62016 2017 2018 2018

Terms of Trade Real Wages% yoy

Source: Ministry of Finance

-20

0

20

40

60

80

100

0

5

10

15

20

25

30

I II III IV I II

2017 2018

% yoyTrillion IDR

Social AssistanceGrowth (rhs)


2018, NPISH consumption accelerated to 8.71% (yoy) in the second quarter of 2018 (Graph 3.2). Solid NPISH consumption was attributable to local elections contested in 171 regions during the second quarter of 2018. In addition to the local elections, preparations for the 2019 legislative and presidential elections became more active in the second quarter of 2018.

Greater government spending helped to catalyse economic growth in the second quarter of 2018. Government consumption grew 5.26% (yoy) in the third quarter of 2018, reversing the previous -1.92% (yoy) contraction in the same period one year earlier as well as the 2.74% (yoy) recorded in the previous period. Higher government consumption was in line with the realisation of personnel expenditure by the central government in the form of salaries and allowances. Moreover, procurement was also noted to increase.

Solid investment growth was maintained despite moderating slightly due to fewer working days in June 2018 as a result of the extended public holiday. Investment grew 5.87% (yoy) in the second quarter of 2018, down from 7.95% (yoy) in the previous period. Investment growth was buoyed by corporate expansion in anticipation of increasing demand triggered by increasing economic momentum and infrastructure development. Nevertheless, seasonal factors during Eid-ul-Fitr, namely the extended public holiday, reduced the number of working days in June 2018 and, therefore, undermined production and investment activities. Slower investment growth affected building and non-building investment (Graph 3.6).

Relatively solid building investment was maintained in line with the completion of several infrastructure development projects despite moderating slightly compared with the previous period. Building investment posted 5.02% (yoy) growth in the second quarter of 2018, supported by

Consumer Con� dence IndexGraph 3.5

Investment Growth ContributionGraph 3.6

Consumer Con�dence Index (CCI)Spending Rp 1-2 MillionSpending Rp 2-5 MillionSpending >Rp5 Million

Source: Bank Indonesia

95

100

105

110

115

120

125

130

135

I II III IV I II III IV I II III IV I II III IV I II 1 2 3 4 5 6

2014 2015 2016 2017 2018 2018

Index

-10123456789


2015 2016 2017 2018

Building Non-Building Investment

%



ongoing government infrastructure projects. Such developments were reflected in the import data relating to infrastructure, which increased in the second quarter of 2018. Nonetheless, construction activity declined in June 2018 due to the extended public holiday, thereby influencing overall building investment performance in the second quarter. This was confirmed by cement sales, which achieved positive growth in April and May 2018 before subsequently fading in June 2018 (Graph 3.7).

Non-building investment growth moderated in the second quarter of 2018. Non-building investment posted 7.41% (yoy) growth in the reporting period, decreasing significantly from 13.57% (yoy) previously. Investment in machinery and equipment remained solid, however, decelerating slightly from 23.73% (yoy) to 22.48% (yoy), in line with faster import growth of capital goods in the form of machinery and equipment. Nevertheless, non-building investment growth was restrained by slower investment in transportation equipment, which declined from 14.3% (yoy) to 8.01% (yoy) in line with fewer working days in June 2018. Furthermore, sales of heavy equipment dipped in June 2018 after spiking significantly in April and May 2018 (Graph 3.8).

Solid domestic demand triggered a growth surge of imports. In the second quarter of 2018, imports grew 15.17% (yoy), accelerating from 12.66% (yoy) in the previous period. Non-oil and gas imports grew significantly, while positive growth of oil and gas imports was also observed (Graph 3.9). In terms of non-oil and gas imports, the main drivers of growth were capital goods in the form of machinery and equipment to support electricity, telecommunications and transportation infrastructure projects (Graph 3.10). Imports of consumer goods also sped up in response to increasing household consumption, including anticipation of strong seasonal demand during Ramadan and Eid-

Cement SalesGraph 3.7

Heavy Equipment SalesGraph 3.8

-15

-10

-5

0

5

10

15

20

25

I II III IV I II III IV I II III IV I II 1 2 3 4 5 62015 2016 2017 2018 2018

% yoy

Source: Indonesian Cement Association

Source: United Tractors

0

100

200

300

400

500

600

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 62015 2016 2017 2018

ForestryConstructionAgricultureMining

Unit

Oil and Gas and Non-Oil and Gas Imports ContributionGraph 3.9


-10

-5

0

5

10

15

20


2015 2016 2017 2018

Import of Non-Oil and GasImport of Oil and GasImport of ServicesImport of Goods and Services

%


ul-Fitr. Meanwhile, imports of raw materials were subdued in June 2018 by high inventory levels. On the other hand, oil and gas imports achieved positive growth in the second quarter of 2018, bucking the previous contraction. Oil and gas imports were driven by oil in response to higher demand in line with solid household consumption and increasing consumption of fuel during Ramadan and Eid-ul-Fitr in 2018.

Export growth also accelerated, albeit more sluggishly, induced by the global economic recovery and supported by mining commodity prices. Exports in the second quarter of 2018 grew 7.70% (yoy), up from 6.09% (yoy) in the previous period. Stronger export performance stemmed from soaring non-oil and gas exports coupled with increasing oil and gas exports (Graph 3.11). Exports increased to fuel the global economic recovery, which stimulated world trade volume (WTV), particularly in the advanced economies. Furthermore, the global economic recovery boosted manufacturing exports, including chemicals as well as iron and steel, amongst others, primarily destined for China. Mining exports also enjoyed strong growth on persistently high prices (Graph 3.12), led by coal as well as metal and non-metal minerals. On the other hand, agricultural exports slowed, especially crude palm oil (CPO) due to slower rising prices combined with the impact of policies enacted in major export destinations, which lessened CPO demand. In terms of oil and gas, positive export growth was achieved on rising oil prices in the second quarter of 2018 and increasing gas production.

By sector, the primary and tertiary sectors were confirmed as the main growth drivers during the second quarter of 2018 (Graph 3.13). Production activity increased in the Agricultural and Mining sectors, facilitated by weather conducive to agricultural production as well as a growth surge of mining exports. Meanwhile, seasonal Eid-ul-Fitr factors stimulated trade and leisure

Import of Non-Oil and Gas (Real)Graph 3.10

Oil and Gas and Non-Oil and Gas Exports ContributionGraph 3.11


-30

-20

-10

0

10

20

30

40

50

I II III IV I II III IV I II III IV I II2015 2016 2017 2018

Import Total Consumer GoodsRaw material Capital goods

% yoy


-10

-5

0

5

10

15

20


2015 2016 2017 2018

Export of Non-Oil and GasExport of Oil and GasExport of ServicesExport of Goods and Services

%

Non-Oil and Gas Export PricesGraph 3.12


-30

-20

-10

0

10

20

30

40

50

I II III IV I II III IV I II

2016 2017 2018

Total ManufactureMining Agriculture

% yoy


activities as well as tourism. On the other hand, increasing government spending bolstered the Government Administration and Health Services sector. Furthermore, the Utilities sector (water, gas and electricity supply) posted solid growth after several electricity infrastructure projects became operational. Nonetheless, fewer working days in June 2018 undermined performance in the Manufacturing Industry and Construction sector (Table 3.2).

In terms of the primary sector1, agricultural performance improved on conducive weather conditions, while the Mining and Quarrying sector was boosted by increasing export demand. The Agricultural sector posted 4.76% (yoy) growth in the second quarter of 2018, improving from 3.29% (yoy) in the previous period, supported by favourable weather conditions conducive to food crop, horticultural and plantation crop production despite slower export growth of agricultural commodities. Mining sector growth accelerated to 2.21% (yoy) in the reporting period, led by the metal ore mining subsector, specifically copper and gold production. The oil and natural gas subsector also contributed to stronger growth, particularly due to gains in the gas industry. The gains come amidst a significant bump in oil lifting during the second

1 The primary sector includes: (i) Agriculture, Livestock, Forestry and Fisheries; and (ii) Mining and Quarrying.

Non-Oil and Gas Export Price GrowthGraph 3.13


0

1

2

3

4

5

6

IV I II III IV I II

2016 2017 2018

Primary Secondary Tertiary Tax Subsidies Total

%

Percent, yoy

I IIIII III IV2017

20162018

2017

7.15 3.23 2.77 2.24 3.81 3.29 4.76-1.22 2.12 1.84 0.08 0.69 0.74 2.214.28 3.50 4.85 4.46 4.27 4.56 3.971.80 -2.09 4.88 2.50 1.76 3.33 7.295.96 6.94 6.98 7.23 6.79 7.35 5.734.73 3.88 5.29 4.66 4.64 5.02 5.349.39 10.05 8.85 8.64 9.22 8.55 7.175.35 5.63 5.92 4.87 5.44 4.69 4.223.69 2.56 4.04 6.84 4.34 6.00 6.815.01 5.01 5.06 5.19 5.07

3.340.954.265.265.224.198.257.124.465.03 5.06 5.27

Source: BPS

Agriculture, Livestock, Forestry and FisheriesMining and QuarryingManufacturing Industry;Utilities (Electricity, Gas and Water Supply)*ConstructionTrade, Hotel, and Restaurant**Transportation, Warehousing, Information and Communication***Financial Services, Real Estate and Corporate Services****Other Services*****GDP

Components

*)Amalgamation of two economic sectors: (i) Electricity and Gas Procurement; and (ii) Water Supply;**) Amalgamation of two economic sectors: (i) Wholesale and Retail, Car and Motorcycle Repairs; and (ii) Provision of Accommodation, Food and Beverages;***) Amalgamation of two economic sectors: (i)Transportation and Warehousing; and (ii) Information and Communication;****) Amalgamation of three economic sectors: (i) Financial Services; (ii) Real Estate; and (iii) Corporate Services;*****) Amalgamation of four economic sectors: (i) Government Administration, Defence and Compulsory Social Security; (ii) Education Services; (iii) Health Services and Other Activities; and (iv) Other Services;

Economic Growth by SectorTable 3.2


quarter of 2018 in relation to geothermal projects that began commercial operation in the period.

The contribution of the tertiary sector2 has increased, driven by the Trade, Provision of Accommodation, and Food and Beverages sector to meet stronger domestic demand. The sector posted 5.34% (yoy) growth in the second quarter of 2018, up from 5.02% (yoy) in the first quarter of 2018. Growth was primarily supported by improving performance in the wholesale and non-automotive retail sales subsector compared with dynamics in the previous period as imports increased. In addition, automobile and motorcycle sales as well as retail sales also posted gains in the reporting period. The provision of accommodation as well as the food and beverages subsectors also improved on the back of cyclical factors during Ramadan and Eid-ul-Fitr, leisure activities and tourism as well as NPISH consumption.

Services sector performance improved in the reporting period, buoyed by the Government Administration subsector, Utilities sector as well as the Transportation, Warehousing, Information and Communications sector. The Government accelerated social assistance disbursements (bansos) and government activities, which fed through to boost the Government Administration Services subsector in the second quarter of 2018. On the other hand, the Utilities (electricity, gas and water supply) sector posted gains, backed by the operationalisation of several electricity infrastructure projects. Meanwhile, the Transportation, Warehousing, Information and Communications sector maintained solid 7.17% (yoy) growth in the second quarter of 2018 despite moderating from 8.55% (yoy) in the first quarter of 2018. The slowdown was caused by the information and communications

2 The tertiary sector includes: (i) Trade, Provision of Accommodation, Food and Beverages; (ii) Transportation, Warehousing, Information and Communications; (iii) Financial Services, Real Estate and Corporate Services; (iv) Other Services; (v) Utilities; and (vi) construction.


subsector in line with policy to restrict the use of SIM cards per individual, which constrained the number of subscribers and amount of data traffic. On the other hand, the transportation and warehousing subsector achieved stable growth due to expansive warehousing activities and increasing transportation as a result of the extended Eid-ul-Fitr holiday this year, which was accompanied by a greater frequency of land, sea and air transport.

The secondary sector3, namely the manufacturing industry, has experienced slower growth due to limited CPO exports together with fewer working days in June 2018. The manufacturing industry posted 3.97% (yoy) growth in the second quarter of 2018, down from 4.56% (yoy) in the previous period. All subsectors of the manufacturing industry contributed to the decline, particularly the Food and Beverages subsector, which moderated on restrained CPO exports because of lower CPO prices and external policy factors that supressed demand. In addition, the extended public holiday during Eid-ul-Fitr this year undermined overall manufacturing production.

3 The secondary sector is the manufacturing industry.


Regionally, faster domestic economic growth was better balanced across the archipelago, driven by Sumatra, Kalimantan and Papua. In total, 23 out of 34 provinces in Indonesia recorded faster economic growth in the second quarter of 2018. The economies of Sumatra, Kalimantan and Papua accelerated, while solid growth was maintained in Java, Sulawesi and Maluku. In contrast, economic growth in Bali and Nusa Tenggara was more restrained (Figure 2.1). Balanced regional growth was also supported by the trade, hotels and restaurants (THR) sector, which stimulated trade in nearly all areas. Furthermore, government infrastructure projects also catalysed economic growth in the surrounding environs.

Aceh 5.74Sumut 5.30Riau 2.38Sumbar 5.08Lampung

Kepri 4.51Bengkulu 5.10Kep.Babel 4.51Sumsel 6.07Jambi 4.70

Source: BPS, Calculated

SUMATRA (22%)

Kalbar 5.18Kalsel 4.64Kaltim 1.84Kalteng 5.66Kaltara 4.63

KALIMANTAN (7.9%)

Gorontalo 7.45Sulut 5.83Sulteng 6.03Sulbar 6.57Sulsel 7.38Sultra 6.09

SULAWESI (6%)

Maluku 5.47North Maluku 7.31Papua 24.68West Papua 12.83

MALUKU PAPUA (MAPUA) (2.5%)Banten 5.59Jakarta 5.93West Java 5.65Central Java 5.54East Java 5.57Yogyakarta 5.90

JAVA (58.5%)

Bali 6.09NTB -0.83NTT 5.20

NATIONAL

RGDP ≥ 7.0% 5.0% ≤ RGDP < 6.0% 4.0% ≤ RGDP < 5.0% RGDP < 0%6.0% ≤ RGDP < 7.0% 0% ≤ RGDP < 4.0%

4.14 4.354.65

I'17 II'17 II'18

4.973.26 3.31

I'17 II'17 II'18

6.936.77 6.75

I'17 II'17 II'18

5.01 5.06

5.27

I'17 II'17 II'18

5.69

5.75

5.69

I'17 II'17 II'18

2.93 3.82 3.75

I'17 II'17 II'18

4.4

16.93 18.18

I'17 II'17 II'18

5.35

BALI-NUSA TENGGARA (BALINUSRA) (3.5%)

Regional Economic Growth in Quarter II 2018Figure 3.1


PROSPERITY

Poverty incidence improved in March 2018, accompanied by lower economic inequality. The poverty rate fell to a level of 9.82% in March 2018, representing the lowest level on record since the devastating 1998 economic crisis, when poverty hit 24.2% (Graph 2.14). Considering the longer-term perspective, such developments show a consistent decrease in the level of poverty, supported by rising incomes amongst low-income households together with low and controlled inflation. Less poverty has also been accompanied by lower economic inequality, as demonstrated by improvements in the Gini ratio, poverty severity and the poverty gap. The Gini ratio stood at 0.389 in March 2018, improving from 0.391 and 0.393 in September and March 2017 respectively.

The lower poverty rate has also been accompanied by a decline in the number of individuals falling below the poverty line coupled with a narrower gap between urban and rural areas. A total of 25.95 million individuals were classified as poor in March 2018, down from 26.58 million in September 2017 and from 27.77 million in March 2017, which represents the lowest level since the economic crisis in 1998. Urban and rural poverty has witnessed declines. There were 1.29 million fewer rural poor in March 2018 compared with a 534,000 decline in urban areas. Government programs disbursed through the Village Fund mechanism have helped alleviate incidences of rural poverty.

The consistent decrease in the level of poverty has been effectively supported by rising incomes amongst low-income households together with low and controlled inflation. Poverty incidence has declined as stronger economic growth stimulated higher incomes. Real farmworker wages and the farmers’ terms of trade improved in March 2018. In addition, expansive

Number of Poor Population and Poverty RateGraph 3.14

5

10

15

20

25

30

5

10

15

20

25

30

35

40

45

2005 2007 2009 Mar

2011

Mar

2012

Mar

2013

Mar

2014

Mar

2015

Mar

2016

Mar

2017

Mar

2018

Urban Rural (rhs)


Urban+Rural % Poverty level

Million People % of total population


social assistance disbursements (bansos) by the Government in the first three months of the year helped to elevate incomes amongst low-income households. On the other hand, low and controlled inflation has helped to alleviate poverty through gains in public purchasing power in line with consistently lower and stable inflation over the past several years in accordance with Bank Indonesia’s inflation target (Graph 3.15).

Regionally, most provinces effectively alleviated poverty incidence in March 2018. Broad-based poverty alleviation was demonstrated by the number of provinces that successfully lowered the poverty rate in March 2018, which exceeded the number of provinces where poverty had increased (Graph 3.16). The most significant gains in terms of poverty alleviation were reported in Central Java, Banten and Jakarta. In contrast, poverty was observed to increase in Aceh, Jambi, Lampung, Riau, North Maluku and West Sulawesi.

The lower poverty rate has also been accompanied by less economic inequality. The improvements are reflected in the indexes for poverty severity and the poverty gap. The Poverty Gap Index4 stood at 1.71 in March 2018, down significantly from 1.83 in March of the previous year and the lowest level recorded over the past five years. The index showed that the average distance of the poor to the poverty line has declined, thus bringing future poverty alleviation closer. In addition, the Poverty Severity Index5 fell from 0.48 in March 2017 to 0.44 in March 2018, the lowest level recorded since September 2016 (Table 3.3). The lower poverty severity index is indicative of less spending disparity amongst the poor.

4 The Poverty Gap Index is a measure of the intensity of poverty, namely the average poverty gap in the population as a proportion of the poverty line. A higher index indicates a higher average shortfall in income of the population from the poverty line. A lower index is desirable.

5 The Poverty Severity Index is a measure of the spending disparity of the poor. A higher index indicates a larger gap between the poor.

Mar 2011 1.52 2.63 2.08Sep 2011 1.48 2.61 2.05Mar 2012 1.40 2.36 1.88Sep 2012 1.38 2.42 1.90Mar 2013 1.26 2.23 1.74Sep 2013 1.41 2.36 1.88Mar 2014 1.25 2.26 1.75Sep 2014 1.25 2.25 1.75Mar 2015 1.40 2.55 1.97Sep 2015 1.29 2.40 1.84Mar 2016 1.19 2.74 1.94Sep 2016 1.21 2.32 1.74Mar 2017 1.24 2.49 1.83Sep 2017 1.24 2.43 1.79Mar 2018 1.17 2.37 1.71

Mar 2011 0.39 0.70 0.55Sep 2011 0.39 0.68 0.53Mar 2012 0.36 0.59 0.47Sep 2012 0.36 0.61 0.48Mar 2013 0.31 0.55 0.43Sep 2013 0.37 0.60 0.48Mar 2014 0.31 0.57 0.44Sep 2014 0.31 0.57 0.44Mar 2015 0.36 0.71 0.54Sep 2015 0.35 0.67 0.51Mar 2016 0.27 0.79 0.52Sep 2016 0.29 0.59 0.44Mar 2017 0.31 0.67 0.48Sep 2017 0.30 0.65 0.46Mar 2018 0.29 0.63 0.44

Years Urban RuralUrban

+Rural

Urban RuralUrban

+Rural

Years


Poverty Depth and Severity IndexTable 3.3

Poverty and In� ationGraph 3.15

Inter-Regional PovertyGraph 3.16

0

5

10

15

20

25

30

35

40

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

%


UrbanRuralUrban+RuralCMA In�ation (rhs)

ECONOMY CRYSIS


-20

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-5

0

5

10

15

20

0 5 10 15 20 25 30

Poverty Level (%)

Mar 2018 Mar 2017 WorseIncrease

BetterDecrease

Changes in Poverty Level (%yoy)


A decline in the Gini ratio also pointed to less economic inequality. The Gini ratio stood at 0.389 in March 2018, down from 0.391 in September 2017 and from 0.393 in March 2017. The improvements were primarily witnessed in urban areas (Graph 3.17), while rural economic inequality is yet to improve.

INDONESIA BALANCE OF PAYMENTS

The current account deficit increased in the second quarter of 2018 as domestic economic momentum continued to build. The current account deficit stood at USD8.0 billion (3.0% of GDP) in the second quarter of 2018, up from USD5.7 billion (2.2% of GDP) in the previous period (Graph 3.18). The larger current account deficit stemmed from a narrower non-oil and gas trade surplus combined with a wider oil and gas trade deficit. Cumulatively as of the first semester of 2018, therefore, the current account deficit remained within a manageable threshold at 2.6% of GDP.

The non-oil and gas trade surplus reduced in the second quarter of 2018. The non-oil and gas trade surplus narrowed from USD4.7 billion in the first quarter of 2018 to USD3.0 billion in the second quarter of 2018 as non-oil and gas imports experienced a growth surge and non-oil and gas exports moderated. Raw materials and capital goods drove imports as a result of increasing production and investment activities to fuel infrastructure development in line with the domestic economic gains. On the other hand, declining exports of several major commodities, including coal and vegetable oil (CPO), undermined non-oil and gas export performance. Coal exports decreased due to the large base effect of coal exports in the previous period. Meanwhile, vegetable oil exports faded on lower global CPO prices. The non-oil and gas trade balance recorded a deficit in July 2018 as non-oil and gas import growth outstripped that of non-oil and gas exports (Graph 3.19).

Gini RatioGraph 3.17

Current AccountGraph 3.18

0.324

0.401

0.389

0.36

0.37

0.38

0.39

0.40

0.41

0.42

0.43

0.44

0.30

0.32

0.34

0.36

0.38

0.40

0.42

0.44 Rural

Index Index

Urban Urban + Rural (rhs)

3

2011


2012 2013 2014 2015 2016 2017 2018

9 3 9 3 9 3 9 3 9 3 9 3 39

-10

-8

-6

-4

-2

0

2

4

-12-10-8-6-4-202468

I II III IV I II III IV I* II* III* IV* I* II**2015 2016 2017 2018

Services Account Trade BalancePrimary Income Account Secondary Income AccountCurrent Account Current Account De�cit to GDP (%) (rhs)

Billion USD % GDP

Source: Bank Indonesia; *Preliminary Data **Very Preliminary Data

Trade Balance (Monthly)Graph 3.19


-3

-2

-1

0

1

2

3

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2016 2017 2018

Billion USDNon-Oil and Gas Oil and Gas Total


A growing oil and gas trade deficit also contributed to the larger current account deficit in the second quarter of 2018. The oil and gas trade balance recorded a USD2.7 billion deficit in the reporting period, up from USD2.4 billion in the first quarter of 2018. The gain was attributed to an increase in oil and gas imports that outpaced the corresponding increase in oil and gas exports. Oil and gas imports soared on rising global oil prices and strong seasonal demand during Eid-ul-Fitr and the school holidays. On the other hand, oil and gas exports increased in terms of volume due to Indonesia ramping up oil lifting coupled with the higher export price, mirroring global trends. In July 2018, the oil and gas trade balance recorded a deficit after oil and gas imports continued to increase but oil and gas exports declined (Graph 3.19).

Consistent with cyclical trends, the primary income account and services trade balance recorded larger deficits in the second quarter of 2018. The primary income account deficit was exacerbated primarily by a bump in dividend payments on portfolio investment income as well as interest payments on foreign loans. Meanwhile, the larger services trade deficit was mainly caused by a narrower travel services trade surplus and growing transportation services trade deficit. The smaller travel services trade surplus reflected seasonal Eid-ul-Fitr and school holiday patterns, namely a surge of Indonesian travellers visiting abroad (outflow) together with a bump in the average spending level, contrasting the smaller inflow from international travellers visiting the Indonesian archipelago. On the other hand, the larger transportation services deficit originated from freight services in line with an import surge of goods coupled with an increase in passenger transportation services as Indonesian travellers were more inclined to visit abroad.

Capital and Financial AccountGraph 3.20


-10

-5

0

5

10

15

I II III IV I II III IV I* II* III* IV* I* II**2015 2016 2017 2018

Direct Investment Other InvestmentPortfolio Investment Capital and Financial Account

Billion USD


Reflecting foreign and domestic investor optimism in national economic performance, the capital and financial account surplus has increased. In the second quarter of 2018, the capital and financial account recorded a USD4.0 billion surplus, increasing from USD2.4 billion in the previous period (Graph 3.20). The capital and financial account surplus was buoyed by maintained FDI inflows combined with a portfolio investment surplus. In addition, the other investment surplus was also observed to increase, driven by resident withdrawals of offshore deposits to meet domestic financing needs.

Overall, Indonesia’s Balance of Payments (BOP) recorded a USD4.3 billion deficit in the second quarter of 2018 (Graph 3.21). Such dynamics were explained by a larger current account deficit than the increase in the capital and financial account surplus. Consequently, the position of reserve assets stood at USD119.8 billion at the end of the second quarter of 2018, decreasing thereafter in July 2018 to USD118.3 billion (Graph 3.22). Foreign exchange reserves were eroded by the government servicing external debt and Bank Indonesia’s intervention measures to stabilise rupiah exchange rates against a backdrop of increasing global financial market uncertainty. Therefore, the position of reserve assets at the end of July 2018 was equivalent to 6.9 months of imports or 6.7 months of imports and servicing government external debt, which is well above the international standard of three months. Bank Indonesia perceives the current position of reserve assets as adequate to maintain external sector resilience as well as macroeconomic and financial system stability.

Moving forward, Bank Indonesia expects to maintain sound BOP performance and, thus, bolster external sector resilience. For 2018, Bank Indonesia projects the current account deficit to remain within the manageable threshold of 3.0% of GDP. To that end, Bank Indonesia will continue to

Indonesia’s Balance of Payment (Quarterly)Graph 3.21


-15

-10

-5

0

5

10

15

I II III IV I II III IV I* II* III* IV* I* II**

2015 2016 2017 2018

Current AccountCapital and Financial AccountOverall Balance

Billion USD

Reserve AssetsGraph 3.22


118.3

4

5

6

7

8

9

0

30

60

90

120

150

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 72016 2017 2018

MonthBillion USD

Reserve AssetsMonth of Imports and Servicing Government External Debt (rhs)


optimise its policy mix in order to manage the current account deficit within an acceptable threshold. In terms of monetary policy, Bank Indonesia will maintain the policy rate at a level that supports internal balance. In addition, Bank Indonesia will consistently implement rupiah exchange rate stabilisation measures in line with the currency’s fundamental value. Furthermore, Bank Indonesia will also maintain adequate reserve assets to sustain external sector resilience. Concerning payment system policy, Bank Indonesia will continue to ensure the uninterrupted availability of the Bank Indonesia Payment System (SPBI) to monitor cross-border transactions and minimise unrecorded BOP transactions, while optimising foreign exchange proceeds. Bank Indonesia will constantly monitor global headwinds that could potentially influence the BOP outlook, including widespread global financial market uncertainty, the prevailing trend of inward-oriented trade policies in several jurisdictions and the rising global oil price.

In addition to demand-side controls, including through monetary policy, Bank Indonesia will also continue to coordinate with the Government to accelerate the implementation of structural reforms. To that end, the government will back efforts to reduce the current account deficit through efforts to stimulate exports and tourism, while controlling imports, including by postponing projects with a high import content and by expanding the use of biodiesel (B20). The Government is also strengthening the tourism industry, particularly in areas designated as priority tourist destinations. Bank Indonesia believes that tourism sector development will garner current account improvements.


RUPIAH EXCHANGE RATE

The rupiah continued to experience depreciatory pressures in the second quarter of 2018 triggered by broad-based USD appreciation. Point to point, the rupiah lost 3.94% (ptp) on the previous period, falling to Rp14,330/USD. Rupiah depreciation persisted in July 2018 but exchange rate volatility eased despite the USD continuing to charge higher. Point to point, the rupiah dropped another 0.62% in July 2018 to close at a level of Rp14,420/USD (Graph 3.23). Broad USD appreciation was triggered by escalating trade tensions and growing expectations of faster monetary policy normalisation in the United States. Furthermore, rupiah exchange rate depreciation was also compounded by negative sentiment surrounding economic moderation in China.

Rupiah exchange rate depreciation was less severe than that recorded in other peer countries. Point to point, rupiah depreciation in July 2018 was lower than the Turkish lira, Chinese yuan and Thai baht (Graph 3.24). On average, rupiah depreciation in July 2018 was also less acute than that posted by the Chinese yuan, South Korean won and Turkish lira. In addition, rupiah depreciation year to date of 7.04% (ytd) was lower than the Indian rupee (8.66%), Brazilian real (14.72%), South Africa rand (14.39%) and Russian rouble (15.36%).

Rupiah exchange rate depreciation was accompanied by less volatility, leading to relatively stable exchange rate movements. Rupiah volatility did increase in the second quarter of 2018 in line with intense depreciatory pressures but subsequently eased in July 2018 (Graph 3.25). Rupiah volatility in July 2018 was recorded at a level below the peer country average, including the Turkish lira, Brazilian real, South Africa rand and South Korea won (Graph 3.26).

An influx of foreign capital helped the rupiah to defy depreciatory pressures and

Rupiah Exchange Rate MovementsGraph 3.23

Regional Exchange RatesGraph 3.24

Quarterly Exchange Rate VolatilityGraph 3.25

Source: Reuters, calculated; Data as of 18 July 2018

13,200

13,400

13,600

13,800

14,000

14,200

14,400

14,600IDR/USD

IDR/USDMonthly AverageQuarterly Average

1 2 3 4 5 6 7

2018

13,378

13,603

13,760

13,809

14,043

14,058

13,576

13,952

Source: Reuters, Bloomberg, calculated; Data as of 18 July 2018

8.945.61

6.354.69

-12.29

-1.27

7.29-7.97

-12.29

- 0.30- 3.19

-3.30-5.74

-20.68- 6.92-7.15

-13.99

-20.68

-25 -20 -15 -10 -5 0 5 10 15

MYRCNYEUR

KRWTRYINRZARBRLTRY

Point-to-pointAverage

YTD 2018 vs 2017

%

Source: Reuters, Bloomberg, calculated

12.23

0

5

10

15

20

25

30

35

TRY BRL ZAR INR KRW IDR THB PHP MYR SGD

Quarter I 2018Quarter II 2018Quarter II 2018 Average

%


also eased volatility. Foreign capital inflows returned to all domestic financial market assets, primarily SBN, on rising yields. Meanwhile, for the first time in 2018, non-resident investors booked a moderate net buy in the domestic stock market in July 2018. Bank Indonesia welcomed such developments considering the outflow in the second quarter of 2018 exceeded that recorded in the first quarter of 2018 (Graph 3.27).

The foreign exchange spot market recorded a larger net demand position in the second quarter of 2018 (Graph 3.28). Increasing net demand for foreign exchange originated primarily from non-resident investors, driven by stronger dollar indexes. In July 2018, the foreign exchange spot market posted another increase in the net demand position compared with dynamics in the previous period (Graph 3.29), primarily led by companies previously recording a net supply position. Nevertheless, non-resident investors, who had booked a net demand position in the second quarter of 2018, experienced a capital reversal and posted a net supply position in July 2018. Foreign exchange supply from non-resident investors surged towards the end of the month to meet increasing demand for foreign exchange from resident investors.

In general, rupiah exchange rate depreciation was primarily due to the influence of external pressures. Moving forward, Bank Indonesia will remain vigilant of global financial market uncertainty. Bank Indonesia will continue exchange rate stabilisation measures to maintain the rupiah in line with the currency’s fundamental value. Furthermore, Bank Indonesia also maintains market mechanisms backed by financial market deepening initiatives. Policy will remain supported by dual intervention strategy and monetary operations strategy to preserve adequate liquidity, particularly in the rupiah money market and foreign exchange market. Bank Indonesia’s existing policy to improve the

Monthly Exchange Rate VolatilityGraph 3.26

Non-Resident Capital FlowsGraph 3.27

Net Supply-Demand for Foreign Exchange in the Spot Market (Quarterly)

Graph 3.28

Net Supply-Demand for Foreign Exchange in the Spot Market (Monthly)

Graph 3.29

Source: Reuters, Bloomberg, calculated

23.39 24.12 25.89

13.63

20.26

8.83 4.90

7.34 9.82 7.07

24.38

18.99

14.69

7.43 7.01

4.32 3.90 3.61 3.20 2.61

9.01

0

5

10

15

20

25

30

35

TRY BRL ZAR KRW IDR INR MYR SGD THB PHP

June 2018July 2018July 2018 Average

%

-3

-2

-1

0

1

2

3

4

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2015 2016 2017 2018

SBSN Stock SUN SBI

Billion USD

Source: Bank Indonesia; Data as of 31 July 2018


-10-8-6-4-20246810


2015 2016 2017 2018

Net S(+)/D(-) Non-residentNet S(+)/D(-) ResidentNet S(+)/D(-) Total

Billion USD

Source: Bank Indonesia; Data as of 31 July 18

12,50012,70012,90013,10013,30013,50013,70013,90014,10014,30014,500

-5-4-3-2-1012345

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2015 2016 2017 2018

Net S(+)/D(-) Non-residentNet S(+)/D(-) Resident Net S(+)/D(-) Total

IDR/USD (rhs)

Billion USD IDR/USD


effectiveness of foreign exchange swaps at a lower price has successfully drawn investor attention to auctions of various tenors and reduced the swap market premium from 4.85% to 4.62% for 1-month tenors and from 5.18% to 4.96% for 1-year tenors.

INFLATION

Consumer Price Index (CPI) inflation decreased in the second quarter of 2018. CPI inflation stood at 0.90% (qtq) in the reporting period, down from 0.99% (qtq). Lower inflation stemmed from controlled monthly inflation throughout the second quarter of 2018. Furthermore, inflationary pressures towards the end of the reporting period, relating to Ramadan and Eid-ul-Fitr, were also comparatively mild. Furthermore, rupiah depreciation during the second quarter of 2018 was not accompanied by rising inflation (refer to Box: The Impact of Exchange Rate Depreciation and International Commodity Price Dynamics on Inflation). Annually, inflation at the end of the second quarter of 2018 was recorded at 3.12% (yoy), decreasing from 3.40% (yoy) at the end of the previous period. Inflation dynamics in the second quarter of 2018 remained in line with the inflation target for 2018, namely 3.5±1% (yoy).

Lower headline inflation in the second quarter of 2018 was attributable to minimal pressures on core inflation and volatile foods, while inflationary pressures on administered prices intensified. Mild pressures on core inflation stemmed from traded core inflation as the global gold price declined. Pressures on non-traded core inflation were also minimal in line with slower inflation of services, for which communications (mobile phone tariffs) were the main drag. Inflationary pressures on volatile foods (VF) were also low because the harvesting season that began at the beginning of the second quarter of 2018 maintained food supply. Pressures on volatile


foods started to accumulate towards the end of the reporting period due to cyclical factors associated with Ramadan and Eid-ul-Fitr. Nevertheless, the increase observed in VF inflation remained below the average rise during public holidays over the past four years. On the other hand, higher intercity transport fares, airfares and train fares to meet increasing demand during Ramadan and Eid-ul-Fitr edged up administered prices (AP) in the second quarter of 2018 but the increase remained below the historical average for the past four years. A hike in excise tax, however, pushed up filtered clove cigarette prices, which also spurred inflationary pressures on administered prices along with higher prices of special fuels.

Upon entering the third quarter of 2018, CPI inflation has remained within the target corridor of 3.5±1%. CPI inflation in July was recorded at 0.28% (mtm), down from 0.59% (mtm) in June 2018. Lower monthly inflation was in line with post-Eid seasonal trends and stemmed primarily from AP deflation. Historically, headline inflation in July 2018 was consistent with the average post-Eid rate over the past four years, namely 0.27% (mtm). Cumulatively, therefore, CPI inflation as of July 2018 stood at 2.18% (ytd) or 3.18% (yoy) annually, down slightly from the 3.12% (yoy) recorded the month earlier (Graph 3.30).

Administered prices recorded deflation after transportation prices experienced post-Eid-ul-Fitr corrections. AP deflation stood at 0.68% (mtm) in July 2018, contrasting the 1.38% (mtm) inflation posted the month earlier (Graph 3.31). Post-Eid AP deflation in 2018 was deeper than the historical average from 2014-2017, namely 0.07% (mtm). Corrections to airfares and intercity fares were the main contributors to AP deflation, recorded at -12.34% (mtm) and -10.78% (mtm) respectively compared to the corresponding post-Eid historical averages of -1.84% (mtm) and -7.11% (mtm) (Table 3.5). Nonetheless, deeper AP deflation was negated by rising prices of special fuels, mirroring the upward

In� ationGraph 3.30

Administered Prices In� ationGraph 3.31


3.18

2.87

5.36

2.11-4

0

4

8

12

16

20

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2015 2016 2017 2018

% yoy

CPI Core Volatile Food Administered Prices


-10

-5

0

5

10

15

-10

-5

0

5

10

15

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2015 2016 2017 2018

Administered Prices (%, mtm) (rhs)Administered Prices (%, yoy)

% %


global oil price trend (Table 3.5). Annually, inflationary pressures on administered prices were recorded at 3.11% (yoy), decreasing from 2.88% (yoy) the month earlier and lower than the 8.70% (yoy) posted at the end of 2017.

Inflationary pressures on volatile foods were relatively stable compared with dynamics in the previous period. VF inflation in July 2018 stood at 0.90% (mtm), unchanged from actual inflation the month earlier (Graph 3.32). Stable inflation of volatile foods (VF) was supported by price corrections affecting various food commodities induced by increasing supply. Shallots and red chilli recorded deflation of -8.4% (mtm) and -4.2% (mtm) respectively (Table 3.6). Notwithstanding, the prices of several other food commodities soared in the reporting period, particularly purebred chicken eggs and meat as the price of animal feed increased. Annually, VF inflation stood at 5.36% (yoy) in July 2018, up from 4.60% (yoy) the month earlier and higher than the 0.71% (yoy) posted at the end of last year. The annual rise of VF inflation has primarily stemmed from rising meat and egg prices since the beginning of the year.

Core inflation was controlled despite escalating inflationary pressures on services. Core inflation was recorded at 0.41% (mtm) in July 2018, up from 0.24% (mtm) the month earlier (Graph 3.33). The main contributors to rising core inflation were mobile phone tariffs, school fees and house rentals. Using more granular data, both traded and non-traded core inflation contributed to rising core inflation in July 2018, predominantly driven by non-foods such as building sand, mobile phone tariffs and school fees. Annually, core inflation increased slightly from 2.72% (yoy) to 2.87% (yoy) in the reporting period. Controlled core inflation as of July 2018 was also linked to policy consistency by Bank Indonesia in terms of anchoring rational inflation expectations, including by maintaining rupiah exchange rates in line with the currency’s fundamental value. Furthermore, inflation expectations anchored

Volatile Food In� ationGraph 3.32


-2

0

2

4

6

8

10

12

-2

0

2

4

6

8

10

12

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2015 2016 2017 2018

Volatile food (mtm) (rhs) Volatile food (yoy)

% %

Contributors to Administered Price In� ation/De� ationTable 3.5

Contributors to Volatile Food In� ation/De� ationTable 3.6


Air Transport FaresInter-City Transport Fares

FuelClover Filter CigarettesCigarettesClover Cigarettes

Train Fares

0.060.020.010.01-0.15

1.830.750.750.85

-12.34-10.78-6.34

-0.08-0.01

Commodity In�ation/De�ation(% mtm)

Contribution(%)


Chicken EggChicken MeatBird’s Eye ChiliLong beansSpinachTomatoOrangeJengkolTomato Fruit KaleShallotRed ChiliBeefFly �sh

10.98 0.08

5.53 0.07

14.81 0.03

11.37 0.02

5.75 0.01

5.05 0.01

2.03 0.01

23.81 0.01

11.09 0.01

2.88 0.01

-8.4 -0.05

-4.2 -0.02

-1.5 -0.01

-6.2 -0.01

Commodity In�ation/De�ation(% mtm)

Contribution(%)


to the target corridor were also confirmed by the Consensus Forecast (CF) in July 2018, which showed a decline compared to the previous edition. Inflation expectations also remained within the target range of 3.5±1% (Graph 3.34). In addition, the Consumer Survey conducted by Bank Indonesia has also documented relatively stable 3 and 6-month inflation expectations since the beginning of the year.

Regionally, controlled inflation within the national target corridor has also been backed by controlled inflation in various regions. In general, inflation realisation in Sumatra, Java, Kalimantan, Bali and Nusa Tenggara as well as Maluku and Papua has remained within the national target. Annually, several provinces even posted comparatively low inflation, including North Kalimantan (1.9% yoy), North Sulawesi (1.9% yoy), Southeast Sulawesi (1.6% yoy) and Maluku (-2.34% yoy) (Figure 3.2). Low inflation was also realised in various parts of Java, which have larger weights in the calculation of national inflation. In contrast, realised inflation in Papua exceeded other provinces at 5.32% (yoy), edged up by airfares and fresh fish over the past year.

Consensus Forecast In� ation ExpectationsGraph 3.34

Source: Consensus Forecast

3.0

3.5

4.0

4.5

5.0

5.5

6.0

1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7

2017 2018

%yoy

2017 In�ation Expectations2018 In�ation Expectations2019 In�ation Expectations

Aceh 3.9Sumut 3.6Riau 3.1Sumbar 3.2Lampung 2.8

Kepri 4.4Bengkulu 4.3Kep.Babel 3.3Sumsel 2.9Jambi 3.2

Source: BPS, Calculated

SUMATRAKalbar 4.2Kalsel 2.2Kaltim 3.4 Kalteng 3.1Kaltara 1.9

KALIMANTAN Gorontalo 0.98Sulut 1.9Sulteng 3.8Sulbar 2.8Sulsel 3.8Sultra 1.6

SULAWESI

Maluku -2.34North Maluku 1.9Papua 5.3West Papua 4.2

MALUKU PAPUA (MAPUA)Banten 3.5Jakarta 3.2West Java 3.5Central Java 2.7East Java 2.6Yogyakarta 2.8

JAVA

Bali 3.8NTB 3.3NTT 2.9

BALI-NUSA TENGGARA (BALINUSRA)

Inf ≥ 3.0%

2.0% ≤ Inf < 3.0%

1.0% ≤ Inf < 2.0%

0% ≤ Inf < 1.0%

Inf < 0%

NATIONAL INFLATIONJULY 2018: 3.18% (yoy)

3.303.82

3.37 3.38 3.44

2017 Apr May June

3.45 2.85 2.83 2.89 3.18

2017 Apr May June July

3.94 3.12 3.76 3.54 3.04


3.78 3.42 3.19 3.04 3.11


3.20 3.15 2.90 3.25 3.52


1.53 2.33 3.13 2.541.94


Regional In� ation Map, July 2018 (%,yoy)Figure 3.2

Core Traded vs Non-Traded (mtm)Graph 3.33


0

0.2

0.4

0.6

0.8

1.0

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2015 2016 2017 2018

Core Core Traded Core Non-Traded

% mtm


FINANCIAL MARKETS

The recent BI 7-Day (Reverse) Repo Rate hikes by Bank Indonesia are effectively being transmitted through the interest rate channel to deposit rates, which the banks began to raise in the second quarter of 2018. On the other hand, the banking industry was less inclined to raise lending rates, opting instead to lower lending rates in the second quarter of 2018. Meanwhile, high seasonal demand for liquidity during Eid-ul-Fitr pushed up the overnight (O/N) interbank rate. M2 growth, as a measure of liquidity in the economy, decelerated on the back of slower Net Foreign Assets (NFA) growth in the reporting period. Furthermore, the latest developments point to less economic financing through the financial markets as a result of pervasive global uncertainty.

The O/N interbank rate ticked upwards amidst strong demand for liquidity in the second quarter of 2018. The average daily O/N interbank rate increased to 4.13% in the reporting period from 3.92% in the previous period (Graph 3.35). The O/N interbank rate was nudged upwards by high demand for liquidity in line with strong demand for Currency Outside Banks (COB) during the approach to Eid-ul-Fitr and the extended public holiday. Consequently, the spread between the O/N interbank rate and the BI 7-Day (Reverse) Repo Rate increased to 34bps in June 2018 from 23bps in March 2018. Nevertheless, the transient demand for liquidity quickly passed after Eid-ul-Fitr as currency flowed back into the banking system and the government implemented expansive financial operations in July 2018.

O/N interbank rate volatility increased in line with growing demand for liquidity and a further hike to the policy rate towards the end of the second quarter of 2018. Higher O/N interbank rate volatility was reflected in the average daily min-max

Interbank O/N Interest RateGraph 3.35


3.03.54.04.55.05.56.06.57.07.58.0

2016 2017 2018

%

BI 7DRR Rate DF RateLF Rate BI Rate

1 3 5 7 9 11 1 3 5 7 9 1 3 5 711

O/N Interbank Rate


spread of the O/N interbank rate, which nearly doubled to 39bps in the second quarter of 2018 from 21bps in the previous period. The min-max spread peaked prior to the Eid-ul-Fitr public holiday, triggered by high demand for liquidity. In addition, the broad O/N interbank rate min-max spread was also influenced by pricing adjustments caused by the policy rate hike. Nevertheless, higher O/N interbank rate volatility was effectively dampened by the large interbank money market transaction volume, with the daily average hitting Rp18.9 trillion in the second quarter of 2018, up from Rp17.1 trillion in the previous period (Graph 3.36).

Declining deposit rates began to reverse direction towards the end of the second quarter of 2018 after Bank Indonesia hiked the BI 7-Day (Reverse) Repo Rate. The banking industry lowered deposit rates in April and May 2018 before raising them again in June 2018. Consequently, deposit rates increased by an average of 2bps for all tenors to 5.86% in the second quarter of 2018 (Graph 3.37). BUKU 3 and 4 banks were most inclined to raise deposit rates, averaging 3bps and 12bps respectively.

Conversely, the higher policy rate has not effectively been transmitted to lending rates. As of June 2018, there had been no overall change in the direction of lending rates since Bank Indonesia hiked the policy rate in May 2018. In the second quarter of 2018, the weighted average lending rate stood at 11.07%, tracking a further 13bps decline on the previous period (Graph 3.38). Consumer loans led the decline, reducing by 18bps in the second quarter of 2018, followed by working capital loans and investment loans at 10bps and 3bps respectively. The downward lending rate trend coupled with rising deposit rates increased the spread between lending and deposit rates to a comparatively broad 521bps in the reporting period.

O/N Interbank VolumeGraph 3.36


30

25

20

15

10

5

03

4

5

6

7

8

9

10

11% Trillion Rp

2016 2017 20181 3 5 9 117 1 3 5 1 3 5 79 117

Vol PUAB (rhs)Vol PUAB O/N (rhs)rPUAB O/N

Spread of Banking RatesGraph 3.37

Lending RatesGraph 3.38


0

1

2

3

4

6

8

7

5

4

2

6

8

10

12

16

14

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 632015 2016 2017 2018

% %%

Credit-Depo Spread (rhs)WA Deposit RateWA Credit Rate


10

11

12

13

14

15

1 3 5 7 9 11 53 71 9 11 31 5 7 9 11 1 3 5 72015 2016 2017 2018

%

WA Credit Rate Working Capital Credit RateInvestment Credit Rate Consumption Credit Rate


Financial system stability was maintained in the second quarter of 2018, while the banking industry effectively contained credit risk. Maintained financial system stability was reflected in the high Capital Adequacy Ratio (CAR) reported by the banking industry at 22.0% and the liquidity ratio of 19.4% in June 2018 (Graph 3.39 and Graph 3.40). In addition, the banking sector maintained a low level of non-performing loans (NPL) at 2.7% (gross) or 1.2% (net).

Financial system stability effectively contributed to improvements in the bank intermediation function. The banking industry reported credit growth at 10.7% (yoy) in the second quarter of 2018, accelerating from 8.5% (yoy) in the previous period (Graph 3.41). Faster credit growth is consistent with the build-up of domestic economic activity in Indonesia, primarily driven by domestic demand. Growth of working capital loans and investment loans increased from 8.8% (yoy) and 4.9% (yoy) in the first quarter of 2018 to 11.5% (yoy) and 9.4% (yoy) respectively in the second quarter of 2018. Meanwhile, consumer loans maintained robust growth despite moderating slightly from 11.5% (yoy) to 10.7% (yoy) in the reporting period.

By sector, stronger credit growth stemmed predominantly from loans disbursed to the trade sector, which dominated total credit. Bank lending to the trade sector, accounting for 21% of total credit, accelerated from 5.6% (yoy) to 9.1% (yoy) in the second quarter of 2018 (Graph 3.42). The trade sector absorbed more loans as retail sales improved and import trade activities flourished in the reporting period. Furthermore, credit growth rose at a faster pace as the banks increased lending to the tradeable sector, including agriculture and the manufacturing industry. In the three months to June 2018, bank lending to the agricultural sector and manufacturing industry accelerated respectively from 12.2% (yoy) and 4.9% (yoy) to 12.7% (yoy) and 7.5% (yoy). In

Banking CapitalGraph 3.39


0

1

2

3

4

5

6

7

18.519.019.520.020.521.021.522.022.523.023.5

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 6

2015 2016 2017 2018

% Trillion Rp

Capital (rhs)ATMR (rhs)CAR

Liquidity RatioGraph 3.40

Credit Growth by TypeGraph 3.41


0

5

10

15

20

25

400

500

600

700

800

900

1000

1100

12001300

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 53

2015 2016 2017 2018

%Trillion Rp

LA/Third-Party Funds (rhs)LA


02468

101214161820

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 6

2015 2016 2017 2018

% yoy

Credit Total Working Capital CreditInvestment Credit Consumption Credit


addition, the banks were also more inclined to extend loans to the transportation sector and utilities sector, with credit growth increasing from 12.3% (yoy) and 11.6% (yoy) to 23.1% (yoy) and 29.6% (yoy) respectively.

The banking industry confirmed positive deposit growth in the second quarter of 2018. On a monthly basis, deposits followed an upward trend during the second quarter of 2018. Deposit growth in June 2018 stood at 7.0% (yoy), up from 6.5% (yoy) in May 2018. Nonetheless, the pace of deposit growth at the end of the second quarter of 2018 was below the position recorded at the end of the previous period, namely 7.7% (yoy) (Graph 3.43). Demand deposits and savings deposits were the main drivers of deposit growth in the second quarter of 2018, increasing from 7.7% (yoy) and 10.3% (yoy) to 10.0% (yoy) and 10.5% (yoy) respectively over the same period. On the other hand, further gains were stifled by slower growth of term deposits, decelerating from 5.9% (yoy) to 3.1% (yoy), caused by a contraction of government deposits held in the banking industry.

Credit and deposit growth are expected to improve in 2018 in line with increasing domestic economic momentum and progress in terms of banking and corporate sector consolidation. Bank Indonesia projects credit growth in the 10.0-12.0% (yoy) range and deposit growth in the slightly lower range of 8.0-10.0% (yoy). Bank Indonesia recently relaxed macroprudential policy by easing the LTV ratio and implemented the Macroprudential Intermediation Ratio (MIR), Macroprudential Liquidity Buffer (MPLB) and average reserve requirements, which are expected to stimulate the bank intermediation function.

Liquidity in the economy, or broad money (M2), posted slower growth. At the end of the second quarter of 2018, M2 growth stood at 5.9% (yoy), lower than the 7.5%

Credit Growth by SectorGraph 3.42


-20 -15 -10 -5 0 5 10 15 20 25 30 35 40% yoy

Q I 2018Q II 2018

9.1210.61

7.51

23.1218.36

12.69

8.81

13.97

29.5810.75

5.62

11.57

4.86

12.29

18.32

12.23

8.39

14.71

11.588.54

-7.29

-16.07

TradeOthers

IndustryTransportation

ConstructionAgriculture

Business ServicesSocial Services

MiningElectricity

Total

Deposit GrowthGraph 3.43


-5

0

5

10

15

20

25

30

1 3 5 7 9 11 1 3 5 7 9 11 1 3 35 7 9 11 1 6

2015 2016 2017 2018

% yoy

Total DepositDemand DepositsSaving DepositsTerm Deposits


(yoy) recorded in the previous period (Graph 3.44). Weaker growth of M1 and quasi-money were the main drag on M2 growth. M1 growth declined from 11.9% (yoy) in the first quarter of 2018 to 8.2% (yoy) in the second quarter of 2018, eroded by moderating growth of Currency Outside Banks (COB) in line with post-Eid seasonal trends. Meanwhile, quasi-money growth was recorded at 5.2% (yoy) in the second quarter of 2018, down from 6.2% (yoy) in the previous period. The downturn was precipitated by weaker deposit growth in the reporting period.

Based on the affecting factors, slower growth of Net Foreign Assets (NFA) was the main impediment to M2 growth. NFA growth was recorded at 3.4% (yoy) in the second quarter of 2018, lower than the 9.3% (yoy) posted in the previous period (Graph 3.45). Weaker growth of foreign claims undermined NFA growth, especially in terms of foreign securities, as non-resident investors released stock and SUN instruments in the second quarter of 2018. On the other hand, Net Domestic Assets (NDA) posted relatively stable growth at 6.9% (yoy) in the second quarter of 2018, backed by a faster pace of credit growth in the banking industry amidst a contraction of financial operations by the government at the end of the period.

Nonbank economic financing was recorded at Rp129.9 trillion (gross) in the period from January-June 2018. Such financing originated from the capital market, through initial public offerings (IPO) and rights issues, corporate bonds, medium-term notes (MTN) and Negotiable Certificates of Deposit (NCD). Nevertheless, nonbank economic financing has been overshadowed recently by growing global financial market uncertainty, which has forced corporations to postpone planned financing due to the rising cost of funds. In addition, corporate bond rates have begun to rise in response to the 100bps hike in the BI 7-Day (Reverse) Repo Rate during May-June 2018. As

M2 ComponentsGraph 3.44


20

15

10

5

0

%

M2 M1 Quasi

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 63

2015 2016 2017 2018

Growth of M2 and Its A� ecting FactorsGraph 3.45


-10

-5

0

5

10

15

20

25

30

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 6

2015 2016 2017 2018

% yoy

NFA NDA M2


a corollary of rising corporate bond rates and lower lending rates in the banking industry, the corporate sector has begun switching to financing through bank loans.

The domestic stock market traded down compared with conditions in the previous period. The Jakarta Composite Index (JCI) faced a 6.3% (qtq) correction in the second quarter of 2018 to close at a level of 5,799.24, down from 6,188.99 in the first quarter of 2018 (Graph 3.46). The JCI slump was triggered by widespread global economic uncertainty, primarily in line with economic gains in the United States that prompted the Federal Reserve to aggressively hike its Federal Funds Rate (FFR), coupled with the escalating trade war between the US and China. Sentiment surrounding external dynamics remained the dominant determinant of JCI trends despite solid domestic economic fundamentals, as reflected by the faster pace of economic growth in the second quarter of 2018. Non-resident investors booked another net sell in June 2018, totalling Rp9.1 trillion. Cumulatively as of June 2018, therefore, non-resident investors booked a net sell in the domestic stock market to the tune of Rp49.4 trillion. Consequently, the portion of non-resident investors trading on the domestic stock market declined in the three months to June 2018 from 46.1% to 37.8% (Graph 3.47). Notwithstanding, macroeconomic stability, improving national economic growth momentum and an appropriate policy response to maintain economic competitiveness are expected to supress capital outflows by non-resident investors, as indicated by the latest stock market numbers that pointed to a net buy booked by non-resident investors in July 2018.

Softness in the domestic stock market was consistent with global bourses, especially in emerging market economies. The JCI downturn in the second quarter of 2018 was less severe than recorded in other countries, particularly in the ASEAN region, including

JCI and Net Foreign Buy/SellGraph 3.46

Source: BEI, calculated

-25

-20

-15

-10

-5

0

5

10

15

20

4.000

4.500

5.000

5.500

6.000

6.500

7.000

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

2015 2016 2017 2018

Trillion RpIndex

Net Foreign Buy/Sell (rhs) JCI

Share of Foreign OwnershipGraph 3.47


0102030405060708090

100

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 72015 2016 2017 2018

%

Resident Non-resident


Vietnam (-18.2% qtq), Thailand (-10.2% qtq), the Philippines (-9.9% qtq) and Malaysia (-9.2% qtq) (Graph 3.48). During the same period, the stock market in China slumped 10.1% (qtq). In contrast, bourses in several advanced economies, including the United States, United Kingdom and Japan, rallied compared with conditions in the previous period.

The JCI decline was felt in most economic sectors. The most significant decrease in the second quarter of 2018 affected the agricultural sector (-15.2% qtq), property sector (-13.7% qtq) and financial sector (-11.2% qtq) (Graph 3.49). Stock performance in the agricultural sector was undermined by weaker exports of agricultural commodities, primarily CPO, due to slower rising prices and the impact of policy to restrict CPO imports in major export destination countries. Meanwhile, the stock price correction in the property sector was sparked by the wait-and-see attitude of investors in anticipation of easing macroprudential policy to stimulate growth in the property sector. Several other sectors also experienced declining performance caused by a revaluation of overvalued stock prices throughout 2017, such as in the financial sector.

In contrast, the basic industry and mining sector were the only economic sectors to achieve positive stock performance. The positive developments stemmed from a competitive valuation with the potential for improving performance. Stock prices in the basic industry and mining sector climbed 4.6% (qtq) and 3.9% (qtq) respectively in the second quarter of 2018. Share prices in basic industry rose on solid nonbuilding investment growth in the reporting period, in particular linked to the procurement of supporting machinery and equipment for industry. On the other hand, the mining sector was boosted by the metal ore subsector, including copper and gold production, together with an increase of gas lifting to fuel a geothermal project that became operational in the second quarter of 2018.

JCI and Global Stock Market Index in Quarter II 2018Graph 3.48

Sectoral Index in Quarter II 2018Graph 3.49

Source: Bloomberg, calculated; Data as of July 2018

-25 -20 -15 -10 -5 0 5 10 15% qtq

-6.30.7

8.2-10.1

-9.2-3.8

4.0- 4.6

- 18.2-10.2

7.4- 9.9

IndonesiaUSUK

ChinaMalaysia

Hong KongJapan

SingaporeVietnamThailand

IndiaPhilippines

Source: BEI; Data as of July 2018

-20 -10 0 10% qtq

- 6.3- 9.6

- 6.7-3.3

-1.93.9

-11.24.6

- 6.1-6.8

-4.2-15.2

-13.7

JCI

Main

Infrastructure

Finance

Misc. Industry

Trade

Property

LQ45

Development

Mining

Basic Industry

Consumption

Agriculture


SBN yields increased, indicating weaker market performance. The benchmark 10-year yield stood at 7.80% at the end of the second quarter of 2018, increasing 112bps on the previous period (Graph 3.50). The higher SBN yield echoed rising global yields triggered by the upward UST yield trend. Nevertheless, external pressures began to ease in July 2018, which helped to rein in the benchmark yield slightly, falling 3bps to 7.77%.

Non-resident investors booked a net sell in the SBN market at the end of the second quarter of 2018. The net sell totalled Rp3.64 trillion in June 2018. Cumulatively as of the end of the second quarter of 2018, therefore, non-resident investors booked a net sell amounting to Rp5.98 trillion. Consequently, the portion of foreign holdings in the SBN market declined from 38.6% to 37.1% at the end of the reporting period (Graph 3.51). Early indications of improvement were observed in July 2018, however, when non-resident inflows reached Rp9.1 trillion.

SBN and Net Foreign Buy/SellGraph 3.50

Net Foreign Buy/Sell (rhs) SBN Yield 10 YR


-30

-20

-10

0

10

20

30

40

50

0

2

4

6

8

10

12

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 4 6

2015 2016 2017 2018

% Trillion Rp

Changes of Foreign SBN OwnershipGraph 3.51

Source: Bloomberg, calculated; Data as of July 2018

0

5

10

15

20

25

30

35

40

45

0

500

1,000

1,500

2,000

2,500

2015 2016 2017 2018

%Trillion Rp

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

Foreign Share (rhs) Foreign Total SBN Total


The build-up of external pressures has had a limited impact on Consumer Price Index (CPI) inflation. Low and stable headline inflation has been maintained despite rupiah exchange rate depreciation and rising international commodity prices, including oil, which began in September 2017. Increasing external pressures have, however, raised inflation at the wholesale level, as indicated by imported Wholesale Price Index (WPI) inflation. Nonetheless, WPI inflation has not fed through to CPI inflation because several foods included in the basket of goods are not subject to global prices and exchange rates, combined with government policy to defer hiking subsidised fuel prices and the price setting strategy of business players in response to exchange rate depreciation. Moving forward, the external impact on inflation must be monitored.

WPI inflation increased on rising production costs triggered by exchange rate depreciation and higher international commodity prices. WPI inflation accelerated because external pressures have a direct impact on the production costs borne by producers, which is congruent with rising global commodity inflation due to higher global oil and food prices (Graph 1).

Increasing prices at the producer level (WPI) have not, however, been accompanied by an escalation of inflationary pressures at the consumer level (CPI). Consequently, the impact of accumulating external pressures on CPI inflation has been comparatively restrained. WPI inflation stood at 6.59% (yoy) in June 2018, increasing from 2.09% (yoy) in September 2017. Meanwhile, CPI inflation was recorded at 3.12% (yoy) in June 2018, decreasing from 3.72% (yoy) in September 2017. Such developments are the result of

MPR QUATERLY II 2018 BOX

The Impact of Exchange Rate Depreciation and International Commodity Price Dynamics on Inflation

Global and Domestic Food In� ationGraph 1

0

2

4

6

8

10

12

-20

-10

0

10

20

30

40

50WPIImported WPICore (rhs)Core Traded (rhs)

% yoy % yoy

2004 2006 2008 2010 2012 2014 2016 2018

Source: BPS, Bloomberg, calculated


several factors, including a more competitive market structure, government policy to refrain from hiking non-subsidised fuel prices and the price setting strategy of business players that favours smaller profit margins over raising prices.

The price dynamics of several food commodities in the domestic market do not fully reflect global price trends. This is caused by domestic conditions that are resilient to the price dynamics of several commodities, as reflected by the weak correlation of wheat and soybean products to their domestic derivatives. The low correlation is attributed to the competitive market structure for wheat and soybean derivatives despite the large portion of imports. In addition, a weak correlation is also found between the prices of red chilli in the international and domestic markets because the supply of red chilli is generally fulfilled by domestic production.

The rising global oil price has a direct impact on the business community through commercial fuel prices but is not transmitted to fuel prices at the consumer level. Global oil price developments are not always mirrored by consumer petrol prices. This is because fuel prices, such as subsidised petrol and diesel, do not fully reflect economic prices. In addition, price hikes to special fuels, including Pertamax, Pertamax Turbo, Pertalite Dex and Dexlite, remain relatively restrained. Moreover, fuel prices account for a relatively small share of the CPI basket, so rising prices do not necessarily translate into higher CPI inflation. The impact of the global oil price is more evident at the producer level, as reflected by the significant upward trend of imported WPI from September 2017 – June 2018 in line with global oil price developments and rupiah depreciation.

Business players have been willing to reduce their profit margins in order to dampen the impact of exchange rate


depreciation. Based on a real sector survey conducted by Bank Indonesia with a sample of 147 companies engaged in export-import activities and/or indebted with foreign loans, exchange rate depreciation has raised production costs but the companies are holding selling prices and, consequently, reducing margins (Graph 2). In addition, business efforts to hold selling prices despite rupiah exchange rate depreciation included reducing business margins and other cost efficiencies (Graph 3). The industry’s response to exchange rate depreciation since September 2017 in terms of profit margins has depended on the import content and export orientation of the industry (Graph 4). Industries with a high import content and sales orientated towards the domestic market (basic industry for example) would reduce profit margins in the event of exchange rate depreciation. Contrarily, industries with a low import content and sales orientated towards the export market (the mining industry for example) would enjoy larger profit margins if the rupiah depreciated. In the long term, exchange rate depreciation would be harmful to profit margins in all industries except the mining industry.

Results of Survey Related to the Response of Business Actors to the Weakening of the Value of Rupiah Currency

Graph 2

Competitiveness

Sales

Business Margin

Investment

Production Cost

Sale Price

Decrease Stable Increase

5.1%10.3% 84.6%

7.8% 70.1% 22.1%

13.0%

17.9% 1.3%80.8%

23.1% 61.5%

64.9%16.9%

15.4%

18.2%

29.9% 57.1%


Results of Survey Related to Business Actors’ Strategy to Maintain Product Selling Prices in the Middle of Weakening of Rupiah Exchange Rate

Graph 3

40%

12%

39%

41%

58%

38%

9%

14%

10%

9%

17%

14%

Other Cost E�ciency

Alternative purchase of imported

raw materials

Business Margin

Decrease Stable Increase N/A



Moving forward, external pressures are expected to intensify, which could trigger domestic inflationary pressures. The risks mainly originate from the global oil price that is predicted to keep rising. Nevertheless, global food prices are forecasted to track a downward trend. Consequently, CPI inflation could accelerate but the increase would be minimal due to the lack of price adjustments to subsidised fuel, which will not change until 2019.

Industry Response to Weakening of Exchange Rate on Pro� t MarginGraph 4

%Import Content

%Ex

port

ed P

rodu

ct

%Exported Product

%Import Content

I II

IIIIV

0

8

4

6

2

2013 2014 2015 2016 20182017

Basic Industry

0

12

6

8

10

4

2

2013 2014 2015 2016 20182017

Consumer Industry

0

15 8.58.07.57.0

6.06.5

5.5

4.54.0

5.0

6

9

12

3

2013 2014 2015 2016 20182017

Mining Industry Miscellaneous Industry (rhs)

0

35

20

25

30

15

10

5

2013 2014 2015 2016 20182017

Financial Industry Trading Industry Property Industry

Industry Quadrant E�ect of Exchange Rate onPro�t Margin

I (High Import, Low Export/Domestic Oriented)

II (High Import, High Export/Export Oriented)

III (Low Import, High Export/Export Oriented)

IV (Low Import, Low Export/Domestic Oriented)



Economic Risks And Outlook4GLOBAL ECONOMIC OUTLOOK

Solid global economic growth is projected for 2018, accompanied by broader economic growth divergence, particularly between the United States and the rest of the world (Table 4.1). The global economic outlook remains in line with the previous projection of solid growth. Nevertheless, economic growth divergence will tend to increase between the United States, where economic growth is accelerating on the back of consumption and investment, and the rest of the world. Growth in Europe and Japan is expected to moderate, prompting downgraded projections in line with restrained consumption and investment, coupled with structural labour market issues. Meanwhile, China’s economy is expected to cool off slightly but remain solid. Increasing global economic growth divergence and escalating trade tensions between the United States and several other countries could potentially undermine world trade volume in 2018. The weaker WTV outlook will also be accompanied by sliding international commodity prices, except oil. Several other risks could influence the global economic outlook, including aggressive FFR hikes and the subsequent monetary policy responses from other countries to offset the tight monetary policy stance adopted in the United States.

Global Economic OutlookTable 4.1Percent

Percent. yoy

Source: World Economic Outlook - July 2018 and Consensus Forecast - July 2018

GDP2018 20192018 20192018 20192018

April 2018 July 2018 June 2018Consensus Forecast (CF)WEO (IMF)

July 20182019

Advanced EconomiesUSEuropeJapan

ChinaIndia

Emerging Market

World 3.9 3.9 3.9 3.9 4.0 3.9 4.0 3.82.5 2.2 2.4 2.2 2.4 2 .1 2.4 2.12.9 2.7 2.9 2.7 2.9 2.6 2.9 2.62.4 2.0 2.2 1.9 2.2 1.8 2.2 1.81.2 0.9 1 0.9 1.1 1.1 1.1 1.14.9 5.1 4.9 5.1 5.4 5.3 5.4 5.36.6 6.4 6.6 6.4 6.6 6.4 6.6 6.47.4 7.8 7.3 7.5 7.4 7.6 7.4 7.5


The US economy is projected to continue accelerating, backed by strong domestic demand. Building economic momentum in the United States is supported by resilient consumption, positive labour market performance and the trickle-down effect of the recent tax package. The US is also expected to maintain solid investment performance, driven by non-residential investment. Meanwhile, the contribution of net exports will be muted by the high level of imports to meet strong domestic demand. The US economic outlook is also overshadowed by the risks associated with productivity and the participation rate, which have failed to keep pace with faster economic growth, while the budget deficit continues to increase. US economic growth in 2019 is expected to consolidate and moderate on the achievements of the previous year in line with structural labour market issues and the growing budget deficit. Consequently, the US is expected to continue normalising monetary policy through four FFR hikes anticipated in 2018 and a further three in 2019, combined with ongoing balance sheet reductions.

Economic moderation is expected in Europe, with the corresponding projection revised downwards. Gradual economic moderation is predicted in Europe in 2018 and 2019. Several institutions have projected GDP consolidation in Europe towards the long-term trend in 2018 and 2019. Such dynamics are reflected in several indicators, including consumer confidence, the Manufacturing Purchasing Managers Index (PMI) and Industrial Production (IP), which have declined in 2018. Furthermore, slower Fixed Asset Investment (FAI) in infrastructure in China is expected to undermine exports from Europe. In addition, structural issues in Europe, such as the ageing population and labour market slack, together with slower productivity growth and limited fiscal backing will also influence GDP consolidation in Europe. Besides, other risks will also continue to overshadow Europe’s


economic outlook, including the political issues in Italy after the populist government is formed as well as the drawn-out Brexit negotiations.

Japan’s economy is also predicted to moderate in 2018 and 2019 on restrained consumption and investment activities and weak exports. The latest economic indicators in Japan point to dwindling demand for machinery and equipment, less upbeat consumers as well as fading confidence in the economy and less business confidence since the beginning of 2018. Export performance and net exports are also declining in 2018 as economic moderation hits Japan’s major export destinations, including Europe, China and Asia, along with the escalating trade war. Furthermore, the economic downturn in Japan is expected to persist into 2019. The Government’s plan to raise consumption tax from 8% to 10% in October 2019 will further exacerbate economic moderation in Japan. There are also the salient labour market issues and ageing population that overshadow medium-term growth in Japan. Nevertheless, export performance is expected to improve in 2019 after the trade agreement with Europe comes into effect that eliminates 99% of tariffs.

China’s economy is also predicted to decelerate in 2018 and 2019 but solid growth should still be maintained. The projected slowdown is in line with the ongoing economic rebalancing process. In addition, investment, particularly in infrastructure, is also expected to slow, held back by deleveraging and a looser monetary policy stance. Solid consumption is supported by several government policies to reduce import tax and potentially raise wages, amongst others. Furthermore, renminbi depreciation should stimulate exports despite the escalating trade war with the United States.


India’s economy is projected to accelerate in 2018 and 2019, primarily driven by investment. Solid economic growth realised in the first quarter of 2018 strengthened projections for the year. Furthermore, robust economic growth in India is also supported by investment, with the backing of positive corporate sector performance and maintained corporate investment activity. Imports and exports are expected to keep accelerating, albeit restrained by imports outstripping exports, which will exacerbate the large trade deficit. In 2019, structural reforms will be a boon to India’s economy through GST implementation that could potentially increase productivity and catalyse economic growth beyond the achievements of 2018.

Economic moderation in Europe and Japan as well as the escalating trade war could hurt world trade volume (WTV) in 2018 and 2019 (Graph 4.1). Potentially deeper WTV declines could stem from an expansion of inward-looking trade policies in response to the escalating trade war. Similar dynamics are also expected to emerge in the trade volume of advanced economies in line with decreasing economic activity in Europe and Japan. Furthermore, weaker manufacturing PMI indicators in major global countries (Europe and Japan) also point to a continuation of such inauspicious dynamics (Graph 4.2).

Increasing global economic growth divergence and lower world trade volume are accompanied by the prospect of sliding international commodity prices, except oil. Slower growth of the Indonesia Export Price Index (IHKEI) is expected in 2018 and 2019 compared with conditions in 2017 due to softer prices of most agricultural produce and several mining commodities. CPO prices tended to decline in the first half of 2018 on net supply, which is expected to persist until the end of the year before gradually rebounding in 2019 on lower production and less supply of soybean as a viable substitute. A

Projected World Trade VolumeGraph 4.1

Manufacturing PMIGraph 4.2

0

1

2

3

4

5

6

2014 2015 2016 2017 2018f 2019f

% yoy

IMF (WEO Jul-18)WTO (Outlook Apr-18)

Source : IMF and WTO

46

48

50

52

54

56

58

60

62Index

US Japan Eurozone India

7 9 11 1 3 5 7 9 11 1 3 5 7 9 11

2018201720162015

1 3 5 7

Source : Bloomberg


low rubber price is also predicted to endure in 2018 on abundant supply before improving in 2019 as Thailand reduces supply to overcome its oversupply issues, which will lower global supply and raise prices. Meanwhile, negative sentiment surrounding the trade war at a time of net supply will supress the price outlook for metals, particularly copper, lead and aluminium.

The IHKEI declines will be offset by rising prices of coal and nickel. The price outlook for coal in 2018 has been revised upwards since the beginning of the year in line with strong demand from China, Asia and Europe to fuel air conditioning systems and combat the ongoing heatwave, coupled with supply constraints in several producing countries, including Indonesia. Notwithstanding, the coal price is expected to gradually decline in 2019 due to less demand congruent with efforts in China and India to alleviate pollution and reduce imports in order to bolster the current account. On the other hand, a strong nickel price is expected to persist on strong demand for stainless steel production and electric car sales.

The oil price is forecasted to remain high and track an upward trend in 2018 and 2019. Oil price dynamics are dictated by production and export disruptions in several countries (Venezuela, Libya and Iran) and restrained production gains in North America because of limited pipeline capacity in the Permian Basin. The oil price is predicted to gradually ease in 2019 as pipeline capacity in North America begins to pick up and the production disruptions are overcome. Increasing supply in 2019 will soften net demand, as reflected by an increase in OECD stock days of cover (Graph 4.3). OECD Oil SupplyGraph 4.3

26

28

30

32

34

36

38

400

20

40

60

80

100

120

140

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Number of days that can be ful�lledUSD/bl

Brent PriceOECD Stock - Number of days that can be ful�lled (rhs) pr

ojec

tion

Source : Bloomberg, EIA


DOMESTIC ECONOMIC OUTLOOK AND RISKS

The national economic recovery in Indonesia is predicted to persist in 2018 and 2019, primarily on stronger domestic demand. The latest developments point to an improving domestic economic outlook despite a slightly lower range, namely 5.0-5.4% in 2018 and 5.1-5.5% in 2019 (Table 4.2). A faster pace of economic growth in 2018 and 2019 will be supported by stronger private consumption and accelerating investment. Private consumption, consisting of household consumption and non-profit institutions serving households (NPISH) consumption, is expected to improve in line with stronger public purchasing power, while also supported by spending on the local elections in 2018 and the presidential and legislative elections in 2019. Investment is also expected to accelerate in 2018 and 2019 in line with the completion of infrastructure projects. Externally, a relatively restrained contribution of net exports is expected. Despite positive export growth, imports are also predicted to experience a growth surge, but efforts are being taken to control imports.

Projections of economic growth in 2018 and 2019 are fraught with uncertainty (Graph 4.4). Economic growth could slump to the lower end of the projections due to the escalating trade war. The trade war began with the US slapping import tariffs on steel and aluminium, which prompted tit-for-tat retaliatory measures in

Percent, yoy

Source: BPS; *Bank Indonesia Projection

I IIIII III IVPrivate ConsumptionGovernment ConsumptionInvestmentExportImportGDP

Components2017

2018* 2019*2018

2017

4.99 5.02 4.95 4.98 4.98 5.01 5.22 5.1 - 5.5 5.1 - 5.52.69 -1.92 3.48 3.81 2.14 2.74 5.26 2.6 - 3.0 3.4 - 3.84.77 5.34 7.08 7.27 6.15 7.95 5.87 6.7 - 7.1 6.6 - 7.08.41 2.80 17.01 8.50 9.09 6.09 7.70 6.9 - 7.3 6.8 - 7.24.81 0.20 15.46 11.81 8.06 12.66 15.17 11.1 - 11.5 8.1- 8.55.01 5 01 5.06 5.19 5.07 5.06 5.27 5.0 - 5.4 5.1 - 5.5

Projected Economic Growth by ExpenditureTable 4.2

Fan Chart of Economic Growth ProjectionGraph 4.4

%yoy

Source : Bank Indonesia

2.5

3.5

4.5

5.5

6.5

ProjectionRealization

I II III IV I II III IV I II III IV I II III IV I II III IV

2015 2016 2017 2018 2019

10% CI20% CI30% CI40% CI50% CI60% CI70% CI80% CI90% CIHistorical GDP


various trading partners. This could undermine global trade activities and ultimately affect global GDP. Such risks could potentially spillover into Indonesia’s economy through weaker exports and, therefore, affect national economic growth. The various risks could push GDP growth down to the lower end of the projection.

Private consumption is projected to increase in 2018 and 2019. Bank Indonesia predicts private consumption to grow in the 5.1-5.5% range in 2018 and 2019, backed by rising incomes coupled with low and controlled inflation. Solid investment and export performance will edge up household income, while routine government spending and social assistance disbursements (bansos) will feed through to increase income for consumption. Furthermore, consumers remain upbeat on future economic dynamics, which should elevate consumption. Various international events planned for the latter half of 2018 have also buoyed consumer optimism. In addition, private consumption is also supported by strong consumption amongst non-profit institutions serving households (NPISH) in line with the start of preparations for the legislative and presidential elections to be held in 2019.

Government Consumption is projected in the 2.6-3.0% range in 2018 and then at around 3.4-3.8% in 2019. The upgraded projection is based on growing domestic economic momentum, which will stimulate state revenues. Central Government spending on consumption in 2018 will originate from personnel expenditure, goods procurement and social assistance disbursements (bansos). The government agreed to increase the state budget allocation to social assistance programs in 2018 considering the current focus on alleviating poverty, reducing economic inequality and creating jobs. Furthermore, government spending was also induced by higher logistics costs for the local elections contested in 2018 as well as for the legislative


and presidential elections planned for 2019. The government’s propensity to spend is expected to persist into 2019.

Investment is expected to accelerate in 2018 and 2019. Gross Fixed Capital Formation (GFCF) is predicted to grow in the 6.7-7.1% range in 2018 and remain relatively stable at 6.6-7.0% in 2019. Investment growth will stem from building and non-building investment. The Government’s infrastructure development projects will boost building investment. The expansion of infrastructure in 2018 and 2019 is consistent with the scheduled completion of several strategic infrastructure projects. Infrastructure development will also influence non-building investment, primarily in machinery, equipment and supporting vehicles. In addition to infrastructure, non-building investment will also be driven by the promising economic outlook, led by the mining sector and manufacturing industry.

Exports are predicted to maintain positive growth in 2018 and 2019. Exports are projected to grow in the 6.9-7.3% range in 2018 and then by 6.8-7.2% in 2019. Global economic growth momentum could potentially stimulate international trade and, therefore, induce exports from Indonesia. The export outlook is influenced, however, by demand for manufacturing products, such as textile products and footwear, from advanced economies as well as the requirement for physical infrastructure development in China, which increases exports of iron and steel. Furthermore, government efforts to increase market and product competitiveness and diversification should also start trickling down to manufacturing exports. On the other hand, mining exports will be boosted by the prices of various base metals, including copper, nickel, lead and aluminium, as well as the upward trend of coal prices. In contrast, agricultural exports in 2018 are overshadowed by falling prices, including crude palm oil (CPO), rubber and coffee. Nevertheless, the price factor is


expected to improve gradually in 2019, with agricultural produce predicted to bounce back.

Congruent with economic gains, strong import growth is projected in 2018 and 2019, outstripping export growth. Imports are predicted to expand in the 11.1-11.5% range in 2018 before decelerating to 8.1-8.5% in 2019. High import growth in 2018 is in line with increasing domestic demand and positive export growth. Capital goods are dominating imports to support infrastructure projects and investment in the mining sector. Besides, imports of raw materials, primarily in the form of spare parts for commercial vehicles, including heavy equipment, are also increasing to meet production activities. Furthermore, imports of consumer goods are also experiencing strong growth in line with increasing household consumption. High imports despite exchange rate depreciation are evidence of resilient economic activity even against a backdrop of restrained domestic production, particularly in terms of medium-high tech goods.

By economic sector, economic growth in 2018 and 2019 is underpinned by the transportation and communication sector, construction sector as well as the trade, provision of accommodation, food and beverages sector (Table 4.3).

Percent, yoy

I IIIII III IV2017

2018^ 2019^2018

2017

7.15 3.23 2.77 2.24 3.81 3.29 4.76 3.3 - 3.7 3.4 - 3.8-1.22 2.12 1.84 0.08 0.69 0.74 2.21 1.3 - 1.7 1.1 - 1.54.28 3.50 4.85 4.46 4.27 4.56 3.97 4.3 - 4.7 4.4 - 4.81.80 -2.09 4.88 2.50 1.76 3.33 7.29 4.3 - 4.7 3.5 - 3.95.96 6.94 6.98 7.23 6.79 7.35 5.73 6.3 - 6.7 6.6 - 7.04.73 3.88 5.29 4.66 4.64 5.02 5.34 5.0 - 5.4 5.0 - 5.49.39 10.05 8.85 8.64 9.22 8.55 7.17 8.0 - 8.4 8.3 - 8.75.35 5.63 5.92 4.87 5.44 4.69 4.22 4.5 - 4.9 5.3 - 5.73.69 2.56 4.04 6.84 4.34 6.00 6.81 5.7 - 6.1 5.3 - 5.75.01 5.01 5.06 5.19 5.07 5.06 5.27 5.0 - 5.4 5.1 - 5.5

Source : BPS, ^Bank Indonesia Projections

Agriculture, Livestock, Forestry and FisheriesMining and QuarryingManufacturing Industry;Utilities (Electricity, Gas and Water Supply)*ConstructionTrade, Hotel, and Restaurant**Transportation, Warehousing, Information and Communication***Financial Services, Real Estate and Corporate Services****Other Services*****GDP

Components

*)Amalgamation of two economic sectors: (i) Electricity and Gas Procurement; and (ii) Water Supply;**) Amalgamation of two economic sectors: (i) Wholesale and Retail, Car and Motorcycle Repairs; and (ii) Provision of Accommodation, Food and Beverages;***) Amalgamation of two economic sectors: (i)Transportation and Warehousing; and (ii) Information and Communication;****) Amalgamation of three economic sectors: (i) Financial Services; (ii) Real Estate; and (iii) Corporate Services;*****) Amalgamation of four economic sectors: (i) Government Administration, Defence and Compulsory Social Security; (ii) Education Services; (iii) Health Services and Other Activities; and (iv) Other Services;

Projected Economic Growth by SectorTable 4.3


The sectoral growth outlook is influenced by domestic demand, which is expected remain strong despite uncertainty overshadowing the external factors. Regarding the primary sector, the mining sector is projected to improve in 2018 and 2019 in line with solid global economic growth and base metal prices. Agricultural prices are expected to track a downward trend in 2018, however, which will undermine performance in the agricultural sector and related industries. Meanwhile, the manufacturing industry is predicted to maintain stable growth as production strives to meet domestic and export demand. The secondary sector is expected to continue expanding, driven by the construction sector to build infrastructure and the trade, hotels and restaurants (THR) sector in line with strong domestic demand. Meanwhile, the transportation and communication sector is predicted to accelerate in line with increasing digital economy development.

The primary sector1 is projected to maintain positive performance in 2018 and 2019, backed by the mining sector. The mining sector is expected to gain momentum in 2018 and 2019 in line with potentially higher global demand and rising prices of base metals, including copper, nickel, lead and aluminium, as well as coal. Nevertheless, the mining sector is subject to commodity prices, which are expected to rise more slowly in 2019. In contrast, price corrections in 2018 have affected agricultural produce, such as crude palm oil (CPO), rubber and coffee, which could potentially undermine agricultural sector performance. Notwithstanding, agricultural commodity prices are expected to rebound in 2019, thus elevating agricultural sector performance.

The secondary sector2, namely the manufacturing industry, is expected to maintain stable growth in 2018 and 1 The primary sector includes: 1) Agriculture, Livestock, Forestry

and Fisheries; and 2) Mining and Quarrying.2 The secondary sector includes: 1) Manufacturing Industry.


2019. Manufacturing industry performance will depend on increasing domestic demand and the export outlook. Manufacturing industry gains will stem from commodity-based industries, construction as well as the transportation equipment and communication equipment industries. In general, improving external dynamics, coupled with better domestic infrastructure and greater ease of doing business, should provide adequate momentum to accelerate the manufacturing industry.

The tertiary sector3 is projected to thrive in 2018 and 2019 on the back of construction activity, THR as well as the transportation and communication sector. The expected gains in the tertiary sector will be influenced by import-export activities, the accelerating digital economy and faster investment growth. Congruent with stronger building investment in the form of infrastructure projects and property, the construction sector is expected to perform soundly in 2018 and 2019. The earlier completion of several strategic infrastructure projects in 2018 and 2019 is expected to drive up construction sector performance. Meanwhile, the THR sector is predicted to accelerate in line with strong domestic demand. Furthermore, rapid development of the digital economy will be a boon to transportation and communication sector performance in terms of communication network utilisation, especially data traffic, and logistics support (freight).

In terms of prices, Consumer Price Index (CPI) inflation in 2018 is expected to be controlled within the target corridor of 3.5±1% (yoy). Controlled inflation in 2018 will be supported by low core inflation, relatively low VF inflation and stable AP inflation. Anchored expectations will help mitigate core inflation. Relatively low AP inflation will be

3 The tertiary sector includes: 1) Electricity, Gas and Clean Water Supply; 2) Construction; 3) Trade, Provision of Accommodation, Food and Beverages; 4) Transportation, Warehousing, Information and Communications; 5) Financial Services, Real Estate and Corporate Services; and 6) Other Services.


the result of government policy to postpone adjusting subsidised fuel prices despite the upward global oil price trend in order to maintain public purchasing power. Meanwhile, maintained food supply should lead to low inflationary pressures on volatile foods (VF).

Core inflation is expected to remain low and stable. The projection is supported by rational expectations anchored to the inflation target together with the latest assessments that indicate relatively low exchange rate passthrough to core inflation due to several factors, namely rupiah depreciation which remains congruous with the current financial strategy of the corporate sector to absorb the impact of exchange rate depreciation through narrower profit margins. In addition, the knock-on effect of AP shocks to core inflation has tended to fade. Low core inflation is also the result of slower rising international commodity prices and moderating domestic demand-side pressures.

Inflationary pressures on volatile foods (VF) are expected to remain low. Maintained supply triggered a price correction for rice, which has alleviated pressures on VF inflation. Furthermore, policy coordination between the Government and Bank Indonesia to control inflation will constantly be strengthened, primarily in anticipation of escalating inflationary pressures on volatile foods.

Bank Indonesia projects CPI inflation in 2019 within the target corridor of 3.5±1%, backed by various inflation control policies and coordination with the Government. Inflationary pressures are expected to stem from increasing domestic demand in line with the ongoing economic recovery process. Anchored and rational inflation expectations will help to control core inflation. Comparatively mild inflationary pressures on volatile foods are predicted due to increasing food production and improving terms of trade (ToT). Furthermore, the Government


is not expected to hike administered prices. Moving forward, potential spillovers from the escalating trade war could amplify inflationary pressures, affecting Indonesia’s trade balance and supressing exchange rates, culminating in higher inflation. More intense inflationary pressures were corroborated by the latest fan chart, indicating an upward bias (Graph 4.5). Looking forward, policy coordination between Bank Indonesia and the Government will constantly be strengthened to control inflation, with a focus on supply availability, affordable prices, smooth distribution and effective communication (4K).

In terms of prices, near-term inflation risks demand vigilance, particularly the global oil price and exchange rate pressures. The rising global oil price could potentially trigger inflationary pressures through core inflation, volatile foods and administered prices in line with higher input costs in the manufacturing industry and for Special Fuels. Other inflation risks include exchange rate pressures against a backdrop of growing global uncertainty. The aforementioned headwinds could potentially exacerbate CPI inflationary pressures in 2018.

Fan Chart of In� ation ProjectionGraph 4.5

Source : Bank Indonesia

0

1

2

3

4

5

6

7

8%yoy

10% CI20% CI30% CI40% CI50% CI60% CI70% CI80% CI90% CIHistorical In�ation

I II III IV I II III IV I II III IV I II III IV I II III IV

2015 2016 2017 2018 2019

ProjectionRealization


MONETARY POLICY REPORT, QUARTER II 2018 BOX

Fan Chart: Visual Macroeconomic Projections and Risks

Macroeconomic projections are a critical element of central banking, especially since the adoption of Inflation Targeting Framework (ITF). Under the ITF framework, central bank policy is forward looking, with a focus on future inflation developments1. This is based on the lag between the monetary policies instituted and their impact on the real sector. The monetary policy target, therefore, is based on the (expected) inflation forecast not on actual current or past inflation. If policy formulation was based on current inflation dynamics, the central bank could potentially lose comprehensive information regarding the economic cycle and the resultant policies would tend towards procyclicality rather and stability2. Consequently, projections of inflation and other macroeconomic variables are a critical element underlying the central bank’s policymaking process.

In addition to underlying the policymaking process, inflation projections are also an important element of central bank communications. Recently, the central bank has become more open and transparent to the public. In fact, communication has become an integral component of monetary policy due to the importance of forming rational inflation expectations in order to achieve the inflation target. Central bank communication is focused on anchoring public inflation expectations to the central bank’s inflation projection. Anchored inflation expectations require central bank credibility in terms of projections and achieving the future inflation target on top of transparent and effective communication.

1 Svensson (1997), in Warjiyo and Juhro (2016). Central Bank Policy: Theory and Practices.

2 Procyclical means to coincide with the economic cycle. Procyclical policies, therefore, run concurrently with the economic cycle. In reality, monetary policies must be countercyclical in order to smooth the economic cycle and maintain stability.


Economic forecasting contains an element of uncertainty that must be accounted for. Projections that are presented as a single point are simple to understand but the projected data contains an element of risk that must be accounted for in monetary policymaking. Therefore, the forecasting process is based on certain economic assumptions, using economic models as a simplification of real sector dynamics. Naturally, the projections produced in the forecasting process contain a factor of uncertainty. Furthermore, the projections are short term (up to 2 years), medium term and long term. During the projection period, various risks and uncertainties will befall the economy, including external risks from the global economy as well as internal risks from the domestic economy that may not have been detected in the projection model. Therefore, communicating the risks is a critical element of strengthening central bank credibility.

Many central banks communicate macroeconomic risks and projections using a fan chart. Such communication does not merely rely on single-point projections but is backed by illustrations of uncertainty and risk as a fan chart, providing a comprehensive narrative of the economic outlook. The Bank of England introduced the concept of fan charts in 1996 though publication of the Inflation Report, as the flagship monetary policy communication. Since introduction by the Bank of England, fan charts have become popular amongst central banks, particularly those applying the Inflation Targeting Framework (ITF). A number of central banks use fan charts for their GDP and inflation projections, including Armenia, Brazil, Czech Republic, Hungary, México, Norway, Peru, Poland, South Africa, South Korea, Sweden, Thailand and UK, while several other central banks apply fan charts to just their inflation projections.


A fan chart is a simple graphical representation that combines the previous and current projections of a macroeconomic variable. The macroeconomic projection is accompanied by a range of possibilities that reflect the risks. A macroeconomic projection, therefore, becomes less certain as the horizon is extended, which can be seen in the broader fan shape of the graphic, hence the name ‘fan chart’. In addition to presenting a probability distribution of macroeconomic variables for the projection period, the fan chart is complemented with features that illustrate the risks associated with the projections, namely with an upward or downward bias.

A fan chart displays the projections after the uncertainty and risks have been considered. This is achieved through a number of stages. First, calculate the most likely projected value of a macroeconomic variable as the central bank’s forecast using macroeconomic models that produce a baseline projection. Second, calculate the forecast error based on actual and projected data in several previous periods. This will provide the magnitude of error, or uncertainty, in the projection. Fundamentally, the forecast error is the deviation between the projections and the actual data, typically measured using the Root Mean Square Error (RMSE). The RMSE is calculated for each projection horizon, namely from 1-8 quarters ahead. Third, perform simulations using the macroeconomic models to investigate the risk impact on the domestic economy in terms of economic growth and inflation. The simulations produce a number of risk scenarios. The differences between the risk scenarios and the baseline, normalised using RSME, determine the skewness of the fan chart.

Fan Chart IllustrationFigure 1

% yoy6.50

Uncertainty

CentralProjection

Balanceof Risks

6.25

6.00

5.75

5.50

5.25

5.00

4.75Q1F Q2F Q3F Q4F Q5F Q6F Q7F Q8F



Fan charts are expected to increase our understanding of economic projections and risks. As illustrated in Figure 1, the value of the central projection is the most probable outcome. In addition to the most likely central projection, a range of possible outcomes is also presented and shaded in different colours over several layers. The dark blue area shows a range of possibilities with a lower confidence interval, in this case 15%. Thereafter, the shades become lighter as the confidence interval increases to 30%, 60% and 90%. A confidence interval of 30% implies that the probability of the actual value of the variable projected under the shaded area is 30%. The fan chart is not symmetrical. At various points, Q4F for example, the fan chart skews downwards, indicating the presence of risks that could adversely impact the economy during the period.

The central bank uses fan charts to emphasise the uncertainty contained within the macroeconomic projections. Based on the fan chart, the central bank can also explain to the public the various risks faced by the domestic economy as well as their impact on economic growth and inflation. This is explicitly displayed by the fan chart in the form of skewness, thus confirming that the projections have accommodated the risks.

For further information:Monetary Policy Coordination and Communication Division Monetary Policy Group Economic and Monetary Policy Department

Telp : +62 21 2981 6836/5919Fax : +62 21 345 2489Email : [email protected] Website : http://www.bi.go.id

00 LKM Tw II 2018 en - bi.go.id · DODY BUDI WALUYO Deputy Governor Bank Indonesia has a single...

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