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Country Report

Indonesia

March 2005

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

Indonesia at a glance: 2005-06

OVERVIEWThe popularity of the president, Susilo Bambang Yudhoyono, is beginning towane, partly owing to his controversial decision to enact an increase in fuelprices, but also because of an apparent lack of progress in tackling corruption.Although Mr Yudhoyono now has the tacit support of Golkar, the largest partyin the House of Peoples! Representatives (DPR, the legislature), the DPR is stillhighly fragmented and the legislative process is likely to be fractious and time-consuming. Fiscal policy is expected to be more expansionary in 2005, asIndonesia will receive large amounts of grant aid and will also benefit fromdebt deferral, but these are only temporary phenomena, and fiscal rectitudewill resume in 2006. GDP growth is expected to accelerate to 5.4% in 2005,owing to reduced political uncertainty and an expansion in investment.Stronger growth in private consumption will enable GDP growth to increasefurther in 2006, to 5.7%. Inflationary pressures will rise in the first half of 2005,but will ease during the remainder of the forecast period. The current-accountsurplus will rise in 2005 because of a sharp jump in transfer credits, but willfall back to 0.5% of GDP in 2006.

Key changes from last month

Political outlook• There are now grounds for optimism that a peace accord between the

government and the armed separatist Free Aceh Movement (GAM) can bereached. In the latest talks in February GAM dropped its insistence onoutright independence and is now prepared to discuss "self-rule". Talks are toresume in April.

Economic policy outlook• Bank Indonesia (the central bank) has signalled that benchmark interest

rates will have to rise in response to rising inflationary pressures. However,the Economist Intelligence Unit expects rates to start falling again in thesecond half of 2005.

Economic forecast• Our 2005 inflation forecast has risen owing to high inflation in January and

the fuel price rise enacted on March 1st.

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Indonesia 1

Country Report March 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005

Contents

Indonesia

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2005-067 Political outlook8 Economic policy outlook9 Economic forecast

12 The political scene

18 Economic policy

22 The domestic economy22 Output and demand25 Financial indicators27 Oil and gas28 Mining29 Agriculture30 Manufacturing31 Infrastructure32 Financial and other services

33 Foreign trade and payments

List of tables9 International assumptions summary10 Gross domestic product by expenditure12 Forecast summary19 Budget assumptions, 200519 Consultative Group on Indonesia loan commitments to Indonesia22 Gross domestic product by expenditure, 2000 constant prices23 Structure of gross domestic product23 Gross domestic product by sector, 2000 constant prices24 Consumer prices25 One-month SBI rates and commercial bank rupiah credit rates26 Monetary aggregates27 International reserves29 Plantation output31 Manufacturing production indices32 Banking indicators, 2004

2 Indonesia


34 Merchandise trade by value34 Main non-oil and gas export markets35 Imports by category35 Tourist arrivals at 13 principal gateways36 Balance of payments37 External debt38 External debt servicing

List of figures12 Gross domestic product12 Consumer price inflation26 Monetary indicators33 External balances38 External debt stock and debt-service ratio

Indonesia 3


IndonesiaMarch 2005

Summary

The popularity of the president, Susilo Bambang Yudhoyono, is beginning towane, partly owing to his controversial decision to enact an increase in fuelprices, but also because of an apparent lack of progress in tackling corruption.Although Mr Yudhoyono now has the tacit support of Golkar, the largest partyin the House of Peoples! Representatives (DPR, the legislature), the DPR is stillhighly fragmented and the legislative process is likely to be fractious and time-consuming. Fiscal policy is expected to be more expansionary in 2005, asIndonesia will receive large amounts of grant aid and will also benefit fromdebt deferral, but these are only temporary phenomena, and fiscal rectitudewill resume in 2006. GDP growth is expected to accelerate to 5.4% in 2005,owing to reduced political uncertainty and an expansion in investment.Stronger growth in private consumption will enable GDP growth to increasefurther in 2006, to 5.7%. Inflationary pressures will rise in the first half of 2005,but will ease during the remainder of the forecast period. The current-accountsurplus will rise in 2005 because of a sharp jump in transfer credits, but willfall back to 0.5% of GDP in 2006.

Mr Yudhoyono!s support base in the DPR has been strengthened by theelection of his vice-president, Jusuf Kalla, to the chairmanship of Golkar. Peacenegotiations between the government and the separatist Free Aceh Movement(GAM) took place in Helsinki in January and February 2005.

On March 1st the government enacted a controversial fuel price hike in a bid tolower the cost of the fuel subsidy. The benchmark interest rates of BankIndonesia (the central bank) have been stable since mid-October 2004, but thebank has warned that rates are likely to rise.

The economy grew by an estimated 5.1% in 2004, with growth of 6.7% year onyear in the fourth quarter. The province of Aceh and part of North Sumatrawere devastated by a tsunami on December 26th 2004. Inflation spiked higherin January owing to post-tsunami demand for goods and services and highfood prices.

The trade surplus fell in 2004 owing to a surge in import demand, particularlyof capital goods, and higher global oil prices. Strong growth in tourist arrivalsboosted services revenue in 2004, and the stock of debt continued to fall.

Editors: Caroline Bain (editor); Graham Richardson (consulting editor)Editorial closing date: March 14th 2005

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2005-06

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Indonesia


Political structure

Republic of Indonesia

Power has historically been concentrated in the hands of the presidency, but recentconstitutional amendments are leading to a greater role for the legislature

The presidency is the highest executive office, with direct legislative powers and authorityto appoint the cabinet

The president, Susilo Bambang Yudhoyono. The Peoples! Consultative Assembly (MPR)consists of the 550-member House of Peoples! Representatives (DPR) plus 128 regionalrepresentatives (DPD). From 2004, all political representatives, including the president, areto be directly elected

April 2004 (DPR); the next parliamentary election is due in 2009; direct presidentialelections were held for the first time in July and September 2004; the next presidentialelection is due in 2009

In the DPR election held on April 5th 2004 Golkar emerged as the largest party, but with127 seats it does not have a majority. The Indonesian Democratic Party-Struggle (PDI-P)came a close second, and has 109 seats

There are two large nationalist-secular parties, Golkar and the PDI-P, and a smaller party,the Democratic Party, which performed strongly in the 2004 legislative election. The othermain parties are smaller and have an Islamic orientation; they are the UnitedDevelopment Party (PPP), the National Awakening Party (PKB), the National MandateParty (PAN) and the Prosperous Justice Party (PKS)

President Susilo Bambang YudhoyonoVice-president Jusuf Kalla

Co-ordinating minister for political, security & social affairs Widodo A SCo-ordinating minister for the economy Aburizal BakrieCo-ordinating minister for people's welfare Alwi ShihabAgriculture Anton ApriyantonoCulture & tourism Jero WatjikDefence Juwono SudarsonoEducation Bambang SoedibyoEnergy & mineral resources Purnomo YusgiantoroFinance Yusuf AnwarFisheries & maritime affairs Freddy NumberiForeign affairs Hassan WirayudaForestry M S Ka!banHealth Fadilah SupariHome affairs & regional autonomy Mohammad Ma!arufIndustry Adung NitimiharjaLaw & human rights Hamid AwaluddinManpower & transmigration Fahmi IdrisPublic works Joko KirmantoReligious affairs M Maftuh BasyuniSocial affairs Bachtiar ChamsyahTrade Mari E PangestuTransportation Hatta Radjasa

Burhanuddin Abdullah

Official name

Form of government

The executive

Head of state

National government

Main political organisations

Key ministers

National elections

Central bank governor

Indonesia 5


Economic structure

Annual indicators2000 a 2001 a 2002a 2003 a 2004 b

GDP at market prices (Rp bn) 1,389,770 1,684,281 1,897,800 1,786,691 2,027,405GDP (US$ bn) 165.0 164.1 203.8 208.3 226.8

Real GDP growth (%) 5.4 b 3.8 4.3 5.0 5.1Consumer price inflation (av; %) 3.7 11.5 11.9 6.8 6.1 a

Population (m) 211.6 214.4 217.2 220.6 b 223.8

Exports of goods fob (US$ m) 65,407 57,364 59,166 63,254 69,713Imports of goods fob (US$ m) 40,366 34,669 35,653 39,546 49,451

Current-account balance (US$ m) 7,992 6,900 7,824 7,252 3,845Foreign-exchange reserves excl gold (US$ m) 28,502 27,246 30,971 34,962 34,953 a

Total external debt (US$ bn) 144.4 134.0 132.2 136.5 b 135.3

Debt-service ratio, paid (%) 22.5 23.6 24.8 16.1 b 17.3Exchange rate (av) Rp:US$ 8,421.8 10,260.9 9,311.2 8,577.1 8,938.9 a

a Actual. b Economist Intelligence Unit estimates.

Origins of real gross domestic product 2003 % of total Components of gross domestic product 2003 % of totalAgriculture, forestry & fishing 16.3 Private consumption 69.3Mining & quarrying 11.3 Government consumption 9.2

Manufacturing 30.1 Gross fixed investment 19.7Construction 6.1 Change in inventories -3.8

Electricity, gas & water supply 0.7 Exports of goods & services 31.2Services 35.5 Imports of goods & services 25.7

Principal exports 2003 US$ m Principal imports 2004 US$ mTextiles & garments 7,103 Raw materials & intermediates 36,315

Crude petroleum & products 7,175 Capital goods 6,093Liquefied natural gas 6,477 Consumer goods 3,772

Main destinations of exports 2003 % of total Main origins of imports 2003 % of totalJapan 24.0 Japan 18.8

US 14.9 China 14.9Singapore 10.4 Singapore 13.8South Korea 8.4 US 8.4

6 Indonesia


Quarterly indicators2003 20041 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

OutputGDP at constant 2000 prices (Rp trn) 386.72 392.61 402.66 391.59 406.46 410.41 424.20 417.63GDP at constant 2000 prices (% change,

year on year) 5.5 4.8 3.7 4.5 5.1 4.5 5.3 6.7Manufacturing at constant 2000 prices (Rp trn) 108.99 109.58 112.46 112.82 114.88 116.22 118.52 120.91Manufacturing at constant 2000 prices (% change,

year on year) 6.2 5.3 4.6 4.8 5.4 6.1 5 7.2Mining at constant 2000 prices (Rp trn) 40.76 42.35 42.00 39.59 39.51 39.23 40.75 40.89Mining at constant 2000 price (% change,

year on year) -1.0 1.4 -3.7 -6.8 -3.0 -7.4 -3.0 3.30PricesConsumer prices (2002=100) 105.5 106 106.8 108.9 110.6 112.8 114.0 115.7Consumer prices (% change, year on year) 7.8 7.3 6.4 5.7 4.8 6.4 6.7 6.3Wholesale prices (1993=100) 430 415 420 425 433 454 472 476Financial indicatorsExchange rate Rp:US$ (av) 8,906 8,479 8,441 8,482 8,470 9,001 9,156 9,128Exchange rate Rp:US$ (end-period) 8,908 8,285 8,389 8,465 8,587 9,415 9,170 9,290Deposit rate (av; %) 13.18 12.02 9.60 7.56 6.39 6.16 6.55 6.67Discount rate (end-period; %) 11.40 9.53 8.66 8.31 7.42 7.34 7.39 7.43Lending rate (av; %) 18.20 17.68 16.44 15.43 14.80 14.28 13.88 13.54Money market rate (av; %) 11.50 8.29 5.97 5.27 6.13 4.49 5.00 6.28M1 (end-period; Rp bn) 177,322 191,797 203,825 220,552 216,317 230,934 238,377 251,243M1 (% change, year on year) 8.4 11.8 13.9 17.3 22.0 20.4 17.0 13.9M2 (end-period; Rp trn) 877.0 893.6 909.6 954.8 934.7 976.1 986.7 1,033.5M2 (% change, year on year) 5.3 6.4 5.7 8.1 6.6 9.2 8.5 8.2JSE Composite stockmarket index (end-period;

Aug 10th 1982=100) 398.0 505.5 597.7 691.9 735.7 732.4 820.1 1,000.2Sectoral trendsManufacturing production (1993=100)a 100.3 102.6 110.8 103.8 102.6 102.6 n/a n/aManufacturing production (% change,

year on year)a 7.4 -0.1 3.5 5.3 2.3 0.0 n/a n/aCrude oil production (m barrels/day)b 1.04 1.01 1.00 1.00 0.98 0.96 0.96 0.97Rubber, dry production ('000 tonnes) 82.1 81.7 80.6 92.7 86.6 82.2 n/a n/aNickel ore production ('000 tonnes) 910.0 1,279.2 1,227.4 978.8 1,070.4 1,034.4 n/a n/aForeign trade (US$ m)Exports fob 15,140 15,313 15,352 15,151 15,014 16,396 19,139 19,395Imports cif -8,375 -7,645 -8,046 -8,485 -9,954 -10,224 -12,369 -12,843Trade balance 6,765 7,669 7,306 6,666 5,060 6,171 6,769 6,552

Foreign payments (US$ m)Merchandise trade balance fob-fob 5,504 6,241 6,558 5,405 3,380 5,767 6,794 n/aServices balance -3,304 -2,706 -3,503 -2,595 -2,306 -2,520 -3,705 n/aIncome balance -1,249 -2,025 -1,190 -1,753 -1,819 -2,369 -1,770 n/aNet transfer payments 192 716 393 568 309 258 319 n/aCurrent-account balance 1,143 2,226 2,258 1,625 -436 1,136 1,638 n/aReserves excl gold (end-period) 31,559 32,990 32,842 34,962 36,073 33,609 35,018 34,953

a Large & medium-sized companies. b Including production in Irian Jaya; excluding condensates.

Sources: International Energy Authority, Monthly Oil Market Report; IMF, International Financial Statistics; Central Bureau of Statistics (BPS); Standard & Poor's, Emerging Stock Markets

Review.

Indonesia 7


Outlook for 2005-06

Political outlook

The popularity of the president, Susilo Bambang Yudhoyono, is waning, largelyas a result of his controversial decision to raise fuel prices, but also because of alack of tangible success in tackling corruption. If the Yudhoyono governmentfails to make visible progress in its anti-corruption efforts in the near future, thepublic!s disillusionment will grow. Despite the fact that Mr Yudhoyono now hasthe backing of Golkar, the largest party in the House of Peoples! Representatives(DPR, the legislature), the legislative process is still unwieldy and fractious.

The decision to raise fuel prices on March 1st was politically brave given thatprevious administrations have had to capitulate on similar plans in the face ofpublic outrage. The aftermath of the price rise will provide a clear indicator ofwhether Mr Yudhoyono will be able to legislate effectively and with credibilityduring the rest of his term in office. There have been numerous, relativelysmall-scale, public demonstrations against the increase in fuel prices, butovercoming the opposition within the DPR has become more of a challenge.

A majority (56%) of the DPR (seven factions) has supported a motion toconvene a plenary session to summon the president for a formal inquiry intofuel prices. It is unlikely that the seven factions will be able to force thepresident to revoke the price increase, as they lack strong legal grounds forcontesting the policy. However, what this incident has revealed is thepresident!s inability to cobble together a majority and his lack of a solidsupport base in the legislature. The Economist Intelligence Unit expects thepublic opposition to the fuel price rise"which has not been unduly strong"todie down; having succeeded in pushing through such a controversial policy,Mr Yudhoyono will be in a stronger position in the future.

Five of the larger parties are to hold annual congresses in March and April,where a number of party leadership posts will be contested that could alter theprofile of the DPR. The Indonesian Democratic Party-Struggle (PDI-P) is holdinga congress at end-March and is widely expected to replace MegawatiSoekarnoputri as party leader. Ms Megawati lost the presidency toMr Yudhoyono in a second-round run-off in September 2004, and the personalantipathy between the two leaders has been a major factor in the PDI-P!sopposition to the president. It is possible that a new leader will return the partyto its original reformist platform, in which case opposition to Mr Yudhoyonocould lessen. Another key party appointment that could alter the balance ofpower in the DPR is the election for a new chairman of the National AwakeningParty (PKB). The PKB has 9% of the seats in the DPR and plays a critical role as aswing voter. The party!s founder, Abdurrahman Wahid, has announced hisintention to stand for the chairmanship and is expected to win. Mr Wahid!spersonal animosity towards Mr Yudhoyono would ensure that the PKBremained firmly in opposition under his stewardship, but if Mr Wahid failed inhis bid to control the PKB the party could take a less confrontational stance.

Domestic politics

8 Indonesia


One positive outcome of the tsunami has been the resumption of talksbetween the Free Aceh Movement (GAM, the separatist rebel movement inAceh) and the government. Two rounds of talks have been held and in thesecond round, in February, GAM dropped its insistence on outrightindependence; instead it is prepared to accept "self-rule". The government isoffering a special autonomy deal, or limited self-rule, and amnesty for therebels. Further talks are planned and it looks likely that a peace accord will bereached, perhaps by mid-2005. It is difficult to be optimistic about the prospectsof long-lasting peace, given the high level of mistrust on both sides after29 years of conflict and previous failed attempts at negotiation, but there seemsto be a general appreciation that peace is needed if the reconstruction andrehabilitation of Aceh is to be successful.

Indonesia and Malaysia became involved in an ugly dispute over territorialrights in the Sulawesi Sea in early March. Diplomacy was rapidly abandoned asboth countries made military preparations"Indonesia even sent warships tothe contested area. Although a few days later the two sides started to backdown and make overtures towards a diplomatic resolution, Indonesia didappear initially to have overreacted. The Malaysian claim to the disputedterritory may have come at a particularly sensitive time, in that Indonesia wasalready feeling victimised by the Malaysian crackdown on illegal migrantworkers (the majority of whom are Indonesian and many of whom hail fromAceh"the province devastated by the December tsunami). Another explanationcould be that the Yudhoyono government hoped to divert public attentionaway from the increase in fuel prices by whipping up nationalist fervour.Whatever the justification, the government response appears foolhardy on anumber of fronts. It led to widespread street protests that could easily haveturned violent, which would only have served to tarnish Indonesia!sinternational image further. It also risked creating a long-term rift in relationsbetween two countries that should be able to benefit from each other!scomparative advantages.

Economic policy outlook

On March 1st the government enacted a controversial reduction in the fuelprice subsidy. The average price of fuel rose by 29%, but the government left theprice of kerosene, widely used as cooking fuel, unchanged. Small-scaledemonstrations, mostly by students, took place in the immediate aftermath ofthe price increase, but at the time of writing demonstrations on a larger scalewere still taking place. The fuel price rise did not come as a surprise, as thegovernment has repeatedly warned that the subsidy was unsustainable.However, given that opinion polls suggest that the government!s popularity isfalling, it was a politically brave move. The government has pledged to spendsavings from the reduction in the subsidy on health, education and povertyalleviation, but it will be some time before the public sees any tangiblebenefits. The government is now expected to focus on pursuing a high-profileanti-corruption drive in a bid to restore favour with the electorate.

Policy trends

International relations

Indonesia 9


The government has proposed revising upwards its budget deficit forecast to 1%of GDP, up from 0.8% in the original draft. It is also planning to revise theassumptions underpinning the budget in the light of persistently high global oilprices (the budget envisages an average oil price of US$24/barrel in 2005) andthe cost of reconstruction in Aceh. These two factors are expected to more thanoffset the positive impact on the budget of a debt-servicing moratorium (tobilateral creditors) and budgetary assistance from external creditors. The budgetdeficit will be largely financed domestically, but the government is to issueUS$1bn in global bonds in April, which will be used as budget financing. In2006 stronger economic growth will lead to higher revenue, but this will beoffset by a return to full debt servicing, so that we forecast a rise in the deficitto 1.4% of GDP. Capital expenditure is expected to remain at a high level overthe forecast period (at 5.8% of GDP in 2005, falling to 5.1% in 2006, comparedwith 4.1% in 2000), largely owing to the government!s commitment tospending on infrastructure.

Interest rates on the benchmark one-month Bank Indonesia Certificates (SBIs)stood at 7.43% on March 2nd, having moved in a narrow range, from 7.41% to7.43%, since mid-October 2004. There is likely to be upward pressure on interestrates in the first half of 2005 at least, owing to the inflationary impact of thefuel price rise and some supply pressures created by the effects of the tsunami.However, we do not expect a significant rise in interest rates, and we believethat rates will fall in the second half of the year. Although international interestrates are expected to be higher in 2006, Indonesia still has a relatively highdifferential with average rates in the OECD, and there is scope for interest ratesto move lower. Although economic growth is forecast to be strong in 2006, itwill not be sufficient to create inflationary pressures in the economy, and therewill consequently be a modest reduction in interest rates in that year.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2003 2004 2005 2006Real GDP growthWorld 3.9 5.0 4.2 3.9OECD 2.0 3.3 2.4 2.4EU25 1.1 2.4 2.0 2.2Exchange rates¥:US$ 115.9 108.1 97.0 93.3US$:� 1.132 1.244 1.365 1.400SDR:US$ 0.714 0.675 0.638 0.627Financial indicators� 3-month interbank rate 2.33 2.13 2.10 2.25US$ 3-month Libor 1.21 1.62 3.44 4.52Commodity pricesOil (Brent; US$/b) 28.8 38.5 37.5 33.6Gold (US$/troy oz) 363.3 410.8 433.8 396.3Food, feedstuffs & beverages (% change in US$ terms) 6.6 9.3 -5.1 -2.7Industrial raw materials (% change in US$ terms) 13.0 21.0 -1.3 -5.9

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

International assumptions

Monetary policy

Fiscal policy

10 Indonesia


World GDP growth (on a purchasing power parity"PPP"basis) is forecast toaverage 4.1% annually in 2005-06, down from 5% in 2004, largely owing to aslowdown in the US and Japanese economies. Global inflationary pressuresare expected to remain under control, but international interest rates will risesteadily during 2005-06. We now expect international oil prices to decline onlymodestly, to an annual average of US$37.5/barrel (dated Brent Blend) in 2005and US$33.6/b in 2006. Indonesia will also suffer from a decline in prices inboth years for other soft-commodity exports, such as palm oil (prices of whichare forecast to fall by 13.2% in 2005-06) and cocoa (with prices falling by 15.2%).Rubber prices, however, are expected to stabilise in 2005, after rising by 35% in2003 and 23% in 2004, before falling by 3.2% in 2006.

Gross domestic product by expenditure(Rp bn at constant 2000 prices; % change year on year in brackets unless otherwise indicated)

2003a 2004 b 2005c 2006c

Private consumption 956,590 1,003,810 1,049,355 1,108,029(3.9) (4.9) (4.5) (5.6)

Public consumption 121,400 123,770 134,746 140,458(10.0) (2.0) (8.9) (4.2)

Gross fixed investment 310,780 359,600 434,253 500,068(3.5) (15.7) (20.8) (15.2)

Final domestic demand 1,388,770 1,487,180 1,618,355 1,748,555(4.3) (7.1) (8.8) (8.0)

Stockbuilding 12,030 50,970 46,000 40,000(-1.5)d (2.5) d (-0.3)d (-0.3)d

Total domestic demand 1,400,800 1,538,150 1,664,355 1,788,555(2.6) (9.8) (8.2) (7.5)

Exports of goods & services 612,560 664,460 705,581 757,093(8.0) (8.5) (6.2) (7.3)

Imports of goods & services 433,810 542,040 623,850 694,001(2.5) (24.9) (15.1) (11.2)

Foreign balance 178,750 122,420 81,731 63,092(2.3)d (-3.6) d (-2.5)d (-1.1)d

GDP 1,579,550 1,660,570 1,750,685 1,850,247(5.0) (5.1) (5.4) (5.7)

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.d Contribution to real GDP growth.

We forecast that economic growth will accelerate to 5.4% in 2005. Althoughthere will be a negative impact on GDP from reduced productive output inAceh, we expect this to be more than offset by construction activity andstockbuilding in the province. Private consumption growth will slow slightlyfrom 2004 levels, owing to higher inflation eroding purchasing power andconcern about the likelihood of higher interest rates. Investment is expected tobe the main engine of growth in 2005, not just because of post-tsunamireconstruction, but also because the government is prioritising infrastructuredevelopment and is preparing to offer incentives to both domestic and foreigninvestors. Real GDP growth is expected to rise again in 2006, to 5.7%. By 2006upward pressure on inflation and interest rates will have receded, and privateconsumption will grow solidly in that year. Growth in exports of goods andservices is expected to slow in 2005-06, compared with its pace in 2004, owingto weaker global demand and competitiveness problems. Import growth,

Economic growth

Indonesia 11


however, will be robust, in tandem with the strong growth in investmentdemand and the need to replace capital stock.

Inflation stood at 7.15% in February, up from an average of 6.1% in 2004. Theconsumer price index is expected to rise further in the first half of 2005, owingto the increase in fuel prices, which will also affect transport costs andmanufacturer!s production costs. Supply pressures created by the relief effort inAceh will also be creating some additional inflationary pressure in theeconomy. A relatively stronger rupiah in the second half of 2005 will help tocontain annual inflation, and wage pressures will remain subdued owing topersistently high unemployment and underemployment. Monthly inflationrates are expected to start to ease in the second half of 2005 and will continueto fall, at a modest pace, in 2006. Given the current low level of capacityutilisation (estimated at about 45%), robust economic growth in 2006 is unlikelyto generate inflationary pressures.

The rupiah has weakened against the US dollar since the beginning of 2005,despite the relative weakness of the US dollar. According to Bank Indonesia (thecentral bank), the weakness has been the result of high international oil pricesand demand for US dollars by the state oil company, Pertamina, to pay forimports of oil (Indonesia imports about one-fifth of its oil needs). The currencyis expected to strength in the second half of the year, supported by inflows offoreign capital, primarily in the form of grant aid and investment inflows. Thedecision of the Paris Club of official creditors, announced in early March, toextend a temporary moratorium on debt servicing until end-2005 will furtherboost the rupiah. The moratorium will save Indonesia an estimated US$2.6bn.The rupiah is likely to weaken in early 2006 as debt servicing resumes in full,but it will be supported in the second half of the year by persistently strongeconomic growth and net positive investment flows. We expect the exchangerate to average Rp9,075:US$1 in 2005, slightly down from Rp8,939:US$1 in 2004,with a further modest depreciation in 2006 to Rp9,140:US$1.

The trade surplus is expected to fall sharply in 2005-06 to an annual average ofUS$16.7bn, compared with an estimated US$20.3bn in 2004, primarily as aresult of strong growth in import demand. Import demand will be boosted notonly by post-tsunami reconstruction work, but also by the government!sproposed infrastructure development plans. The growth in the value ofmerchandise export receipts will slow in 2005-06 in tandem with a slowdownin OECD demand, and also because of structural weaknesses in the exportsector, such as low productivity. Lower global oil prices in 2006 will be anadditional factor depressing export revenue in that year. The deficit on theservices account will fall slightly to an annual average of US$11bn in 2005-06,owing to steady inflows from tourism. (There are reports that tourist arrivalshave slowed owing to the negative publicity associated with the tsunami, butthis is expected to be a temporary phenomenon.) The income deficit will fall in2005 owing to lower interest payments on external debt, but will rise again in2006 as debt servicing resumes in full. In 2005 the deficits on the services andincome accounts will be offset by the arrival of tsunami-related grant aid,which will boost the transfers balance, and the current-account surplus will

Inflation

Exchange rates

External sector

12 Indonesia


therefore rise to US$4.2bn (equivalent to 1.7% of GDP), up from an estimatedUS$3.8bn in 2004. The lower level of transfer credits in 2006 is an additionalfactor leading to a forecast fall in the current-account surplus to US$1.3bn (0.5%of GDP) in that year.

Forecast summary(% unless otherwise indicated)

2003a 2004 b 2005c 2006c

Real GDP growth 5.0 5.1 5.4 5.7Industrial production growth 3.9 -1.7 2.1 3.7

Gross agricultural production growth 3.0 2.5 2.5 2.0Unemployment rate (av) 9.5 9.6 9.4 9.5Consumer price inflation (av) 6.8 6.1 a 7.0 5.2

Consumer price inflation (year-end) 5.2 6.4 a 6.3 5.5Money market interest rate 7.8 5.4 a 4.6 4.5

Government balance (% of GDP) -2.0b -1.5 -1.0 -1.4Exports of goods fob (US$ bn) 63.3 69.7 76.2 82.3

Imports of goods fob (US$ bn) 39.5 49.5 59.3 65.8Current-account balance (US$ bn) 7.3 3.8 4.2 1.3Current-account balance (% of GDP) 3.5 1.7 1.7 0.5

External debt (year-end; US$ bn) 136.5b 135.3 139.4 139.1Exchange rate Rp:US$ (av) 8,577 8,939 a 9,075 9,140

Exchange rate Rp:¥100 (av) 7,400 8,267 a 9,356 9,802Exchange rate Rp:� (year-end) 10,678 12,577 a 12,643 12,621Exchange rate Rp:SDR (year-end) 12,579 14,427 a 14,437 14,426

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Indonesia Asia excl Japan

Gross domestic product% change, year on year

Indonesia Asia excl Japan

Consumer price inflationav; %

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2000 01 02 03 04 05 06

0

2

4

6

8

10

12

14

2000 01 02 03 04 05 06

The political scene

On January 28th the president, Susilo Bambang Yudhoyono, completed his first100 days in office. An opinion poll conducted online by Tempo newspaper tomark the occasion found that only 20% of respondents were satisfied with hisearly performance. The attention drawn to this artificial benchmark partlystemmed from the ambitious 100-day action plan that Mr Yudhoyonopromised to implement on taking office in order to combat corruption and

The president marks 100 daysin office

Indonesia 13


restore investor confidence. Although implementation of this plan may havefallen short of the public!s high expectations, there are still good grounds foroptimism. Mr Yudhoyono has offered vision, leadership and direction, and firmsteps have been taken to court investors and discourage corruption. He alsocoped well with the aftermath of the devastating tsunami on December 26th2004, which claimed around 245,000 lives in Aceh.

The political balance swung sharply in Mr Yudhoyono!s favour during his first100 days in office, with his vice-president, Jusuf Kalla, securing the leadershipof the Golkar party. Mr Kalla defeated the incumbent chairman, AkbarTandjung, at the party!s December conference in Bali, marking the end ofMr Tandjung!s controversial political career. Golkar, the largest party in theHouse of Peoples� Representatives (DPR, the legislature), has now begun to givegreater support to Mr Yudhoyono. Mr Tandjung had steered Golkar into anopposition coalition with the Indonesian Democratic Party of Struggle (PDI-P).This "Nationhood Coalition" held a blocking majority in parliament, raisingfears that it would thwart the president!s reform efforts.

Mr Kalla!s accession to the Golkar chairmanship precipitated rumours ofgrowing rivalry between Mr Yudhoyono and his vice-president. The vice-presidency is traditionally a ceremonial post and subservient to the presidentialoffice. Mr Kalla does not fit that profile, and was influential even prior tobecoming Golkar!s new leader. Now he can draw on formidable politicalpower as well as his own private financial resources (he is a wealthybusinessman), both of which are greatly in excess of those at Mr Yudhoyono!sdisposal. Although it is possible that this imbalance may shift the centre ofpower to the vice-presidential office, Mr Yudhoyono, at least in the short term,still has the upper hand, courtesy of his solid public mandate.

With Golkar dispatching Mr Tandjung, attention now turns to the fate of theformer president and chairwoman of the PDI-P, Megawati Soekarnoputri.Ms Megawati is expected to face a leadership challenge at the PDI-P congress,which begins in late March. Her party performed dismally in the generalelection, with voters repelled by her aloof manner and weak presidency. ThePDI-P!s electoral strategy has hitherto relied heavily on her status as thedaughter of Indonesia!s founding president, Soekarno. With her aura andcredibility now irretrievably damaged, the party will be crippled for as long asshe remains leader.

The challenge will come from a group of modernisers campaigning to rescindher sole right to appoint the party!s central board. The campaign is supportedby many senior figures, including Arifin Panigoro, a wealthy businessman withinterests in the oil industry; Kwik Kian Kie, a former development planningminister; Roy B B Janis, a member of the party!s central board; LaksamanaSukardi, a former minister of state enterprises minister; and GuruhSoekarnoputra, the former president!s younger brother. Ms Megawati isexpected to resist all attempts to curtail her authority, and a leadershipchallenge appears the only option left to give the party renewed direction,assuming that Ms Megawati can be defeated.

The administration gains astronger hand in parliament

The balance of power mayshift within government

The PDI-P mulls a change ofleadership

14 Indonesia


The election and the changing political landscape have also exacted a toll onIndonesia!s mass Muslim organisations, Nahdlatul Ulama (NU) and Muham-madiyah. NU, founded in 1926 as a religious and social body, is the world!slargest Muslim organisation, with around 40m members. Muhammadiyah,founded in 1912 on similar principles, has 23m members. The two rivalorganisations adhere to different views of Islam, but share a tradition ofdisengagement from practical politics that is fomenting severe internal tensions.

Tensions within NU, which boiled over at its 31st congress in December, stemfrom its increasing politicisation since 1998. Politicisation began under itsidolised former leader, Abdurrahman Wahid, who founded the NU-affiliatedNational Awakening Party (PKB) in 1998 and used this as a vehicle to secure thepresidency in 1999. The trend has continued more overtly under Mr Wahid!scontroversial successor, Hasyim Muzadi, who stood as Ms Megawati!s vice-presidential candidate last year. Mr Muzadi!s supporters see him as a moderniserwho has strengthened NU!s financial base and organisational structure. Hiscritics believe the manner in which he aligned the organisation to Ms Megawatiturned NU into a political commodity, and they accuse him of misusing theorganisation as a base from which to strike out for high political office.

His opponents include the erratic Mr Wahid, who failed in a bid to oustMr Muzadi at the December congress. Mr Wahid threatened to call anextraordinary congress aimed at removing Mr Muzadi, and to form a rivalorganisation if that failed. However, he has now been sidelined by efforts toeffect a reconciliation between the two camps, and his defeat by Mr Muzadiseems to mark the final act of his career. However, although a split in NU maynot be on the immediate horizon, it will nevertheless prove difficult toreconcile the two camps, given their deeply divergent views.

Muhammadiyah will face similar debate and divisions at its 45th congress inJuly 2005. A former Muhammadiyah chairman, Amien Rais, founded theNational Mandate Party (PAN) in 1999 and used this to secure the speakershipof the People!s Consultative Assembly (MPR). Subsequent changes haveestranged PAN from Muhammadiyah, leaving the latter divided between thosewho favour a political future and those who seek a return to traditional socialand religious roots.

The elections in 2004 transformed national politics, and 2005 will see the start ofsimilar changes at provincial and district level. From June onwards, democraticelections will take place to elect 13 provincial governors and 225 regents andmajors. Staggered elections will take place in the rest of Indonesia!s 33 provinces,354 districts and 91 cities through to 2009. The elections will bring greateraccountability to local politics. Local democracy may also eventually help to liftsuccessful district and provincial leaders on to the national political stage. Thelocal elections follow revision of the law on regional autonomy last year(December 2004, The political scene). However a number of non-governmentalorganisations (NGOs) and provincial offices of the General ElectionsCommission (KPU) have challenged the revised law in the Constitutional Court,

Muslim organisations debatetheir future

NU faces deep internal rifts

Abdurrahman Wahid losesinfluence

Muhammadiyah faces similardivisions

The face of local politics is setto change

Indonesia 15


arguing that it fails to ensure fairness and impartiality in the electoral process.Preparations are proceeding regardless of the judicial review.

In early March a court found Abu Bakar Bashir, the alleged former spiritualleader of Jemaah Islamiah (JI), guilty of involvement in a conspiracy that ledto the 2002 bomb attacks on Bali nightclubs in which 202 people died.However, the court cleared Mr Bashir on more serious charges of planning the2003 attack on the Jakarta Marriott Hotel, and sentenced him to only30 months in prison. The ruling was condemned as too lenient by the US andby Australia, which lost 88 citizens in the Bali attacks. In return the US wascriticised by the Indonesian government for denying prosecutors direct accessto Hambali, a key witness who is being held in their custody. Prosecutors andMr Bashir have lodged appeals. Mr Bashir was tried previously on similarcharges, but was found guilty only of lesser immigration offences (September2003, The political scene).

The need to rebuild Aceh in the wake of the tsunami (see The domesticeconomy: Output and demand) has provided an unprecedented opportunity tosecure a lasting peace in the province. The Free Aceh Movement (GAM) hasbeen waging an armed campaign for independence since 1976, in a conflict thathas claimed more than 12,000 lives. The disaster has cast the violent struggle ina different light, and presented Mr Yudhoyono with a chance to show theAcehnese people that they can benefit from being part of Indonesia throughemergency relief and support for long-term reconstruction. The reverse is alsotrue. Continued military abuses, and a weak and corruption-riddenreconstruction effort from the government"which is certainly a risk"wouldserve to drive the Acehnese people further from the Indonesian fold.

Winning the hearts and minds of the Acehnese people is one part of thesolution. The other part is to secure an end to the separatist conflict andmilitary operations. The tsunami has brought opportunities on this front too,bringing the government and the exiled GAM leadership back into dialogue forthe first time since the peace process in Aceh collapsed in May 2003. Tworounds of peace talks have been in held in Helsinki, with mediation from theCrisis Management Initiative, a facility established by a former Finnishpresident, Martti Ahtisaari. At the second round of talks held in late February,GAM dropped its long-held demand for independence and indicatedwillingness to discuss a solution based on "self-government". This concept maybe reconcilable with Indonesia!s determination to find solution within theframework of "special autonomy" for Aceh.

Although it is too early to judge whether this is the first step towards apermanent solution to the conflict, it does mark a clear breakthrough. Difficultnegotiations lie ahead over the terms and conditions attached to self-government, such as demands for a withdrawal of Indonesian security forces,their replacement with Acehnese police, and wide autonomy over policy. Theseissues will be broached at a week of negotiations planned in April. The govern-ment appears cautious, but optimistic. Mr Yudhoyono welcomed the outcomeof the February talks, but warned that the road to the end of the conflict would

Reconstruction helpsreconciliation

Peace talks begin in Helsinki

A leading terrorist receives alight sentence

16 Indonesia


be long and would require patience. He will also have to pay close attention toensuring that commitments entered into in talks are respected on the ground bythe inert bureaucracy, and by hardline elements in the military.

In December, shortly before travelling to celebrate Christmas in the Christianprovince of Papua, Mr Yudhoyono signed a long-awaited presidential decree onthe Papua Peoples! Council (MRP). The decree opens the way for specialautonomy to be implemented in the province. The provincial government isnow preparing for an election to appoint the 42 members of the MRP later in2005. Membership will be equally balanced between traditional leaders,religious leaders and female representatives. The MRP will be empowered toprovide cultural representation to protect the rights of native Papuans. It willalso have a mandate to give input to byelaws drafted by the governor and theprovincial legislative assembly. These powers are much reduced from those setout in Law 21/2001 on Papuan special autonomy, which was amended by theprevious government to weaken the MRP!s authority. This erosion of powerwas further advanced by the December decree, which allows the Ministry ofHome Affairs and Regional Autonomy to veto MRP candidates. In practice thisis likely to exclude pro-independence figures from the assembly.

Proposals to partition Papua continue to sow uncertainty, with elements withinthe political and military establishment seemingly intent on dividing theterritory. In December the governor, Jaap Salossa, presented the president witha proposal to establish five provinces"West Papua, Cendrawasih Bay, NorthPapua, Central Mountainous Papua and South Papua"by 2009. Mr Salossa saidthat the planned boundaries were based on cultural and geographicconsiderations. Partition of the province is strongly opposed by local people,and it is suspected that the underlying agenda is to carve up timber and mineralresources to serve the business interests of the army and civilian politicalgroupings. The new proposal comes shortly after the Constitutional Courtannulled a plan to partition Papua into three provinces (Papua, West Irian Jayaand Central Irian Jaya). The Court nevertheless upheld the establishment ofWest Irian Jaya, despite ruling the initial proposal unconstitutional.

The Ministry of Defence is working to revise laws dating from 2002 on thenational police and defence, and a 2004 law on the Indonesian Military (TNI).The proposed revisions would place the military under the supervision of thedefence ministry and the National Police under the home affairs ministry.Both organisations currently report directly to the president. The changeswould mean that neither the military commander nor the police chief wouldbe directly involved in making decisions on government policy. Furtherplanned revisions would give the president the sole prerogative to appoint thenational police chief and the military commander, thus excluding parliamentfrom the decision.

Although it has pushed through some reforms, the government has backtrackedon a key measure already legislated for in Law No. 32/2004 on the military. Thelaw sets out provisions for the military!s private businesses to be taken understate control (December 2004, The political scene). Private business interests

Papua prepares for specialautonomy

Proposals to partition Papuaresurface

Police and military reformsare floated

The government backtracks onmilitary businesses

Indonesia 17


contribute an estimated 70% of the total military budget. Reform is vital tomake the military more accountable to the civilian government. Speakingbefore the DPR defence commission in December, the minister of defence,Juwono Sudarsono, said that the government would only take over militarybusinesses with assets above Rp5bn (US$543,000). Businesses with assetsbelow Rp5bn would be permitted to support soldiers! welfare, although nosuch clause is set out in the 2004 law. The government!s weakened stance drewa sharp reaction from parliamentarians, who argued that it would beimpossible to build a professional military for as long as military personnelremained involved in business.

New chiefs of staff have been appointed to the three arms of Indonesia!sarmed forces. In a reshuffle announced in late February, Lieutenant-GeneralDjoko Santoso was appointed to lead the army, replacing General RyamizardRyacudu. Vice-Admiral Slamet Soebijanto is to lead the navy and Rear-MarshallDjoko Soeyanto will lead the air force. The replacement for the outgoing TNIcommander, General Endriartono Sutarto, will be selected from the three newappointees and General Ryacudu. General Santoso, a moderate and an old allyof the president, is tipped to get the job ahead of the hardline and sometimesxenophobic General Ryacudu.

Several officers with poor human rights records were promoted in an earlierreshuffle in February, including the head of the Army Special Forces (Kopassus),Major-General Sriyanto Muntrasan, who was promoted to command thestrategically important Siliwangi Military Command, which oversees West Javaand Banten. General Muntrasan was brought before a human rights tribunal in2003 to face charges relating to his involvement in the 1988 Tanjung Priokmassacre of civilian protestors (December 2003, The political scene). Althoughfound not guilty by the tribunal, his appointment was criticised by humanrights groups, and reflects the tendency within the TNI to promote officersimplicated in major violations of human rights. Also strongly criticised was theappointment of Colonel Chairawan, an officer implicated in the kidnapping ofpro-democracy activists in the late 1990s, to command the Lilawangsa MilitaryResort overseeing north and east Aceh.

Human rights groups have indirectly alleged that security forces were involvedin the murder of Munir, a respected human rights activist, who was poisonedaboard a Garuda flight bound for Amsterdam in September 2004 (December2004, The political scene). Concerns are now growing about a cover-up in theinvestigation. In the aftermath of Munir!s death Mr Yudhoyono promised to setup an independent investigation team. He then prevaricated, and eventuallyagreed only to establish a weaker fact-finding team responsible for assisting thepolice investigation. Five months after Mr Munir!s death, police have yet toidentify a single suspect. Parallel investigations by the fact-finding team havehighlighted the suspicious role of an off-duty Garuda pilot, Pollycarpus, whothey believe may be linked to the National Intelligence Agency (BIN).

Despite continued concerns over the TNI!s human rights record, the USannounced in February that it would resume training Indonesian military

New chiefs of staff areappointed

Human rights are overlookedin TNI promotions

An activist's murder iscovered up

The US resumes training of theIndonesian military

18 Indonesia


officers under its International Military Education and Training Programme.Access to the programme had been suspended for Indonesian officers since1992 owing to human rights violations in East Timor, but pressure to restoremilitary-to-military links has been growing for some time as a result of areappraisal of strategic interests following the attacks on the US of September11th 2001. The US believes that the Indonesian military has a key role to play inanti-terrorism efforts in South-east Asia. In mid-March the Indonesian defenceminister, Juwono Sudarsono, flew to Washington to urge the US government torestore full military links.

The UN has announced plans to establish an inquiry into human rightsviolations that occurred during East Timor!s passage to independence fromIndonesia in 1999, in what may be the first step towards establishing aninternational tribunal. The establishment of the inquiry follows an expressionof concern issued by the UN Security Council last year over Indonesia!sfailure to punish those responsible for the violence. Calls for an internationaltribunal have grown since an Indonesian ad hoc human rights tribunalconcluded its work in unsatisfactory circumstances last year (December 2004,The political scene).

The UN investigation will be conducted despite opposition from Indonesia andEast Timor. In December the two countries agreed to establish a "truth andfriendship commission" in an attempt to put an end to the matter. The proposalappeared to be an explicit (and unsuccessful) attempt to prevent aninternationalisation of efforts to seek justice for the victims.

Economic policy

The 2004 budget deficit breached the target of 1.3% of GDP (Rp26.3trn,US$2.9bn), coming in at an estimated 1.48% of GDP (Rp29.6trn), according to theMinistry of Finance. The inflated deficit resulted from the staggering cost ofmaintaining subsidised domestic fuel prices amid record high global oil prices.Fuel subsidies soaked up Rp69trn, compared with a planned Rp14.5trn in thefirst iteration of the 2004 budget and Rp59.2trn in the final revision. By contrast,only Rp40trn was allocated for development spending (on new infrastructureand facilities) in the same year.

Fuel subsidies are both popular and politically explosive in Indonesia.Although the benefits accrue largely to the middle classes, previous attempts tocut subsidies have provoked widespread public unrest. In 1998 fuel priceincreases sparked the rioting that led to the downfall of former presidentSoeharto. In 2003 the previous government backed away from further priceincreases in the face of widespread public opposition. The 2005 budgetallocated just Rp19trn to fuel subsidies, partly because of its unrealistic oil priceassumption of US$24/barrel.

In early March the administration led by the new president, Susilo BambangYudhoyono, raised the average price of fuel by 29%. To minimise the impact onthe poor, the price of kerosene cooking fuel was left unchanged. Protests have

The UN will examine EastTimor rights abuses

The government cuts domesticfuel subsidies

High oil prices force the 2004budget off course

Indonesia 19


followed the price rises, even though the government has persistently warnedthat the fuel subsidy needed to be cut. The government has promised to spendthe saving from the fuel subsidy on poverty alleviation, health and education.It has also promised that it will not allow transport costs to rise by more than10%. Regardless of these attempts to limit the impact of the fuel price rise, it willinevitably lead to higher costs for basic goods.

In January the minister of finance, Yusuf Anwar, proposed raising the 2005budget deficit target to 1% of GDP (Rp26.2trn), from a previous target of 0.8% ofGDP (Rp17.4trn). The increased deficit, which remains manageable, is the resultof reconstruction costs in Aceh. The government has also prepared revisions tothe assumptions underlying the 2005 budget. Parliament is expected to approvethe revised budget in May.

Budget assumptions, 2005Original Revised

Budget deficit (% of GDP) 0.8 1.0Real GDP growth (%) 5.4 5.5

Inflation (%) 5.5 7.0Oil price (US$/b) 24 35

Exchange rate (Rp:US$) 8,600 8,900Interest rate (%)a 6.5 8.0

a Annual average rate on three-month Bank Indonesia certificates (SBI).

Source: Ministry of Finance.

Indonesia!s donors, meeting in the Consultative Group for Indonesia (CGI) inlate January, agreed to provide new loans worth US$2.8bn and grants worthUS$600m to finance the 2005 budget. Additional grants of US$1.2bn and softloans of US$500m were pledged to support reconstruction in Aceh. Donorsurged greater efforts to reduce poverty, fight corruption and curb illegal logging.They also urged the government to hasten the establishment of independentcommissions to oversee the police and the public prosecution service.

Consultative Group on Indonesia loan commitments to IndonesiaYear US$ bn1994/95 5.21995/96 5.4

1996/97 5.31997/98 5.3

1998/99 7.91999/2000 5.9

2000a 4.72001b 4.82002 3.1

2003 2.72004 2.8

2005 2.8

a Nine-month transitional fiscal year. b Calendar fiscal year.

Source: Bank Indonesia.

Donors commit funds to the2005 budget

The 2005 budget deficit targetis raised

20 Indonesia


On marking 100 days in office, Mr Yudhoyono was forced to respond to sharpcriticism over slow progress with the anti-corruption drive that formed thebasis of his election campaign. Mr Yudhoyono faces a daunting task in forcingIndonesia!s deeply corrupt and inefficient bureaucracy to deliver on his electionpromises, but there are indications that some progress is being made. One suchsign is a new draft regulation, in lieu of a law, that would greatly strengthen thehand of prosecutors in cases where state losses exceed Rp50bn (US$5.4m). Theregulation would shift the burden of proof to suspects to prove that personalwealth above a certain threshold had been legitimately obtained. Publicservants would have to demonstrate that payments and gifts in excess ofRp10m (US$1,000) were not the result of bribery. The regulation would alsoallow detention of suspects during investigations, and those found guiltywould be liable to forfeit personal assets up to the value of losses inflicted bytheir actions on the state.

Another positive step is the trial of the Aceh provincial governor, AbdullahPuteh, who stands accused of marking up the cost of a helicopter purchased bythe Aceh provincial administration in 2002. The Corruption EradicationCommission (KPK) alleges that his actions caused state losses of Rp10.8bn.Mr Yudhoyono suspended Mr Puteh in November to prevent him from using hisoffice to interfere with the judicial process. He is also being held in detention forthe duration of his trial. Prosecutors have demanded an eight-year sentence.

Mr Puteh!s trial is important for several reasons. It is the first case to comebefore the new Anti-Corruption Court. It is also the first high-profile corruptiontrial to take place under Mr Yudhoyono!s watch. As such it will test the newgovernment!s ability to crack down on corruption, and be seen to be doing so.The trial may also contribute substantively to a peace settlement in Aceh.Corruption and vested interests have played a major role in prolonging theconflict in the region. By moving against the provincial governor, thegovernment may also be taking a decisive step in rooting out the vestedinterests that have profited from instability in the province.

Efforts to bring further corruption cases before the Anti-Corruption Court havebeen hindered by a shortage of judges. In January the head of the SupremeCourt, Bagir Manan, said that only three posts had been filled from a total ofnine vacancies. Efforts to fill the vacant posts are continuing.

In January the government announced sweeping plans to restructure andrevitalise Indonesia!s graft-ridden and inefficient state-owned enterprises (SOEs).Indonesia has a total of 158 SOEs. Under the planned restructuring, 54 unviablecompanies would be merged into 21 larger units, 38 firms would be subsumedinto ten holding companies set up to promote better upstream and downstreamintegration in specific sectors, and 66 companies would be unaffected.

The proposed mergers would affect Indonesia!s four state-owned port operators(Pelindo I-IV), the state-owned forestry companies (Inhutani I-IV) and firmsengaged in surveying, pension management, shipyards, pharmaceuticals,publishing, fisheries, construction and pulp and paper. The changes are beingstrongly contested by departments with a vested interest in the management of

State-owned enterprises willbe restructured

The Aceh governor goes ontrial for corruption

A new anti-corruption law isbeing prepared

Indonesia 21


the affected companies, highlighting the huge conflict of interest that arisesthrough line ministries controlling large enterprises operating in their respectivesectors. Those most strongly opposed to the reforms include the Ministry ofForestry and the Ministry of Transport.

The holding companies would be established to oversee state-ownedenterprises active in the oil and gas sector, power generation, mining andplantations, among others. The state minister of state-owned enterprises,Sugiharto, said that the holding companies would serve as the investment armof the government.

Strains have been placed on the labour market by Malaysia!s decision to beginexpelling illegal Indonesian workers, who are returning to flood the domesticlabour market. Illegal migrant workers are the mainstay of Malaysia!splantations and construction industries. However in recent years they havebeen blamed for rising crime, prompting a government drive to deport them totheir countries of origin. An amnesty to allow voluntary departures expired onMarch 1st, and Malaysian security forces helped by civilian vigilantes are nowrooting out illegal workers. The workers face being caned, fined and imprisonedbefore deportation. An estimated 400,000 Indonesian workers left the countryduring the amnesty, but a further 500,000 are thought to remain.

A facility to allow expelled workers to register and return to Malaysia"whichrelies heavily on their labour"has been established in a number of cities andports in Indonesia. However, at a cost of Rp4m per worker, this facility islikely to be of little use to the majority of expelled workers, who are poor,low-wage earners.

Efforts to counter money laundering have been acknowledged by the OECD!sFinancial Action Task Force (FATF), which removed Indonesia from a blacklistof Non-Co-operative Countries and Territories (NCCTs) in February. Thedecision means that developed-country financial institutions are no longerrequired to give special scrutiny to transactions with Indonesia. Indonesianfirms should also enjoy reduced risk premiums as a result. Several countriesrelaxed their lending provision requirements for Indonesia following thedecision, according to Bank Indonesia (the central bank), including Hong Kongand the Netherlands. Removal from the NCCT blacklist follows a series ofreforms that began in 2003 with the adoption of anti-money-launderinglegislation and the establishment of a financial intelligence unit (PPATK).Although Indonesia is no longer on the blacklist, the FATF will continue itsmonitoring to ensure that the government takes investigation and prosecutionof money-laundering cases seriously. No money-laundering cases have beensuccessfully prosecuted under the 2003 law, despite the high prevalence ofcorruption and financial crime.

Indonesia is removed from amoney-laundering blacklist

Malaysia begins expellingillegal workers

22 Indonesia


The domestic economy

Output and demand

Real GDP grew by 5.1% in 2004, the highest rate of growth since 2000.Consumer spending continued to drive the economy, although there were alsosigns of a long-awaited recovery in investment. Private consumption expandedby 4.9% compared with 2003, with low consumer credit rates helping to fuel thecontinued spending spree. Government spending increased by a modest 2%year on year, and exports rose by 8.5%. Gross fixed capital formation expandedby 15.7% compared with 2003, suggesting that the economy is moving to a morebroad-based and sustainable pattern of growth. The improved rate of growthresulted in the creation of an estimated 2.5m new jobs (400,000 for everypercentage point of growth in GDP), providing a welcome and much-neededboost to employment.

Year-on-year growth for the fourth quarter rose to 6.7%, despite a quarter-on-quarter contraction in GDP of 1.6%. The Central Bureau of Statistics attributedthe poor quarter-on-quarter performance to shorter working days during theRamadan fasting month and the main holiday season.

Gross domestic product by expenditure, 2000 constant prices(% change year on year unless otherwise indicated)

2003 2004 2004Yeara 1 Qtr 2 Qtr 3 Qtra 4 Qtr 4 Qtrb Year

Household consumption 3.9 5.6 5.3 5.1 3.8 1.3 4.9Government consumption 10.0 10.4 4.6 -2.7 -1.3 17.9 2.0

Gross fixed capital formation 1.9 8.3 12.5 13.1 18.3 4.8 15.7Change in stocks (absolute level) -33.8 211.7 421.6 11.9 � � �

Exports of goods & services 6.6 1.0 4.1 19.9 13.7 -3.1 8.5Imports of goods & services 2.8 18.7 23.7 29.9 27.1 0.9 25.0GDP 4.5 5.1 4.5 5.0 6.7 -1.6 5.1

a Revised data for full-year 2003 and 3 Qtr 2004 have not yet been made public. b Quarter on quarter.

Source: Central Bureau of Statistics.

The recovery in investment is also evident in the changing structure of GDP.Gross fixed capital formation rose to account for 21% of total GDP, comparedwith 18.9% in 2003. However, gross fixed capital formation accounted for 32% ofGDP in 1997, and there is still a long way to go before pre-crisis levels ofinvestment are attained. Private consumption accounted for 66.5% of GDP in2004, compared with 67.1% in 2003, and exports accounted for 30.9%, virtuallyunchanged from 30.7% in 2003. Per-capita GDP in Indonesia now stands atRp10.6m (US$1,013), up from Rp9.6m in 2003.

Investment shows signs ofrecovery

GDP growth exceedsexpectations

Indonesia 23


Structure of gross domestic product(% of GDP at constant prices)

2003 2004Private consumption 67.1 66.5Government consumption 8.0 8.2

Gross fixed capital formation 18.9 21.0Change in stock -1.3 1.8

Statistical discrepancies -0.3 -1.4Exports of goods & services 30.7 30.9

Imports of goods & services -23.0 -26.9GDP 100.0 100.0


Growth was shared throughout all productive sectors of the economy, with theexception of mining and quarrying, which contracted by 4.6% compared with2003, as a result of continued legal and contractual uncertainty. The highestgrowth was recorded in transportation and telecommunications, whichexpanded by 12.7% year on year. Construction output grew by 8.2%, a result ofcontinued strong investment in property, particularly in the retail sector. In thefourth quarter of 2004, all sectors registered positive growth when comparedwith the year-earlier period. However, agriculture registered a 20% contractionin comparison with the third quarter of 2004, owing to drought in some areasand a natural seasonal slowdown.

Gross domestic product by sector, 2000 constant prices(% change year on year unless otherwise indicated)

2002 2003 2004 2004Year Yeara 1 Qtr 2 Qtr 3 Qtra 4 Qtr 4 Qtrb Year

Agriculture 2.8 3.1 5.7 1.7 2.4 1.9 -20.0 4.1

Mining & quarrying 0.4 -1.6 -3.0 -7.4 -6.0 3.3 0.3 -4.6Manufacturing 5.9 5.0 5.4 6.1 5.3 7.2 2.0 6.2

Electricity, gas, & water 7.5 5.9 5.0 5.5 3.4 7.9 2.5 5.9Construction 5.2 6.3 7.6 7.9 8.9 8.3 2.1 8.2

Trade, hotel, & restaurant 3.9 6.3 6.4 8.0 9.4 9.4 2.2 5.8Transportation & communication 8.4 11.6 12.9 13.8 14.2 11.5 3.5 12.7Financial, ownership & business 5.5 6.9 4.9 4.7 6.7 8.5 3.2 7.7

Services 3.2 4.1 4.6 4.9 4.5 5.0 1.3 4.9Total GDP 4.3 4.5 5.1 4.5 5.0 6.7 -1.6 5.1Total GDP (non-oil & gas) 5.0 5.3 5.7 5.4 6.0 8.0 -1.5 6.2

a Revised data for full year 2003 and 3 Qtr 2004 have not yet been made public. b Quarter on quarter.


In January consumer prices rose by 1.43% compared with December 2004, thehighest monthly increase for two years. The increase was the result of risingfood, housing and utilities prices. The food price index rose by 3.11% month onmonth, and the housing and utilities index rose by 1.48%. The unexpecteddemand for goods and services in the wake of the December 26th tsunamiaccounts for some of the upward pressure on the consumer price index inJanuary. It is also likely that some producers and retailers put up prices inanticipation of the probability that fuel price rises would increase their costs.Food prices should ease off as the main rice harvest starts to come in over the

Inflationary pressures rise inJanuary

Economic growth is broad-based

24 Indonesia


next two months, but this will be offset by the inflationary impact of the fuelprice rise.

The increase in the January index followed a period of mild inflation at the endof 2004. The consumer price index rose by 0.89% month on month in Novemberand 1.04% in December, bringing annual inflation to 6.4% at end-2004, wellbelow the 7% target set by the government. Low inflation in November camedespite the Eid al-Fitr festivities following Ramadan, a period during which highdemand commonly drives up food, clothing and transport prices.

Consumer prices(% change)

2004 2005Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

Year on yearFood -1.44 0.14 1.78 0.55 0.97 0.43 -2.13 -1.36 1.31 2.29 2.37 3.11General -0.02 0.36 0.97 0.88 0.48 0.39 0.09 0.02 0.56 0.89 1.04 1.43Month on monthFood 1.04 3.37 6.23 6.85 8.76 10.03 7.78 6.81 6.17 6.04 6.38 8.15General 4.60 5.11 5.92 6.47 6.83 7.20 6.67 6.27 6.22 6.18 6.40 7.32


On December 26th 2004 an earthquake measuring 9.0 on the Richter scaletriggered a series of tsunamis that devastated coastal areas of Aceh. Total deathsin Indonesia were in the region of 245,000 (127,414 confirmed dead and 116,368still missing as of early March), with a further 70,000 killed in ten other nationsaround the Indian Ocean, including Sri Lanka, India, Thailand and Somalia. Afurther 400,000 people were rendered homeless in Aceh; towns and cities,including the provincial capital, Banda Aceh, were flattened; the local fishingindustry was destroyed; and 36,000 ha of agricultural land were lost, withfurther vast areas caked in salty sludge left by the retreating waters.

The response of foreign governments and charities was striking. Large amountsof aid and assistance were offered as the scale of the disaster becameapparent. Difficulties in distributing aid were overcome with help from foreigntroops and military helicopters. Access to Aceh previously had been tightlyrestricted owing to anti-insurgency operations in the province, and the suddenpresence of foreign military personnel caused great unease in nationalistquarters within parliament and the military. However, the foreign interventionswere of vital importance to the aid effort, and appreciated as such by themajority of Indonesians. By mid-February the presence of foreign troops wasscaled back as the effort switched from emergency relief to reconstruction. Thegovernment estimates restructuring costs at US$4bn-5bn. Although there is asurfeit of cash for emergency relief, as a result of an outpouring of donationsfrom throughout the Western world, there is still a risk of a shortfall in fundsfor longer-term reconstruction.

Inflation in 2004 meets thetarget

Foreign governments rush toprovide aid

Giant waves devastate Aceh

Indonesia 25


Financial indicators

Interest rates on the benchmark one-month Bank Indonesia Certificates (SBIs)followed an overall downwards trend in 2004, falling from 8.31% in December2003 to finish the year at 7.43%. Commercial lending rates mirrored this trend.Rates on working capital fell from 15.07% in December 2003 to 13.57% inNovember 2004. Rates on investment capital fell from 15.68% to 14.18%, andrates on consumer loans fell from 18.69% to 16.74% over the same period. Thereis a growing likelihood that Bank Indonesia (the central bank) will liftbenchmark rates in the months ahead. On the domestic front inflationarypressure from fuel price increases may require higher interest rates; on theexternal front a narrowing differential between the US dollar and the rupiah,and expected further US interest rate increases, may compel the central bank torespond. The increasingly intense competition in the banking sector forconsumer loans might prevent loan rates from tracking the upward adjustmentto benchmark rates.

One-month SBI rates and commercial bank rupiah credit rates(%)

Working InvestmentSBIa capital b capital Consumption

2003Oct 8.48 15.77 16.27 19.00Nov 8.43 15.45 15.93 18.87Dec 8.31 15.07 15.68 18.69

2004Jan 7.86 14.99 15.44 18.49Feb 7.48 14.79 15.29 18.47Mar 7.42 14.61 15.12 18.11Apr 7.33 14.48 14.98 17.89May 7.32 14.27 14.78 17.68Jun 7.36 14.10 14.64 17.51Jul 7.37 13.99 14.58 17.30Aug 7.34 13.84 14.45 17.08Sep 7.40 13.80 14.33 17.03Oct 7.41 13.64 14.25 16.89Nov 7.41 13.57 14.18 16.74Dec 7.43 n/a n/a n/a2005Jan 7.42 n/a n/a n/a

a End-period. b Weighted average.


Key monetary indicators remained stable in 2004, despite a sharper thanexpected rise in base money growth in the last quarter of the year brought onby the Eid-al Fitr festivities and the annual holiday season. Base moneyexpanded by an estimated 14.75%-15.09% in 2004, according to the central bank.In 2005 Bank Indonesia will continue to follow "tight bias" monetary policy,aimed at restraining base money growth to an indicative projection of11.5-12.5%. The central bank intends to replace base money targets with oper-ational targets for interest rates later this year, as part of changes to meet a new

Monetary indicators remainstable

Interest rates look set to rise

26 Indonesia


government-mandated medium-term inflation target. Bank Indonesia believesthat the change will allow it to pursue a more flexible monetary policy.

0

5

10

15

20

2000 01 02 03 04 05 06

Money market interest rateMoney supply, M2

Monetary indicators% change, year on year

Source: Economist Intelligence Unit.

Monetary aggregates(Rp bn; end-period)

2004 2005Jun Jul Aug Sep Oct Nov Dec Jan

Reserve money 155,466 174,538 172,681 175,352 185,096 184,873 199,446 183,747 Currency in circulation 113,563 113,002 113,360 116,076 123,283 124,161 126,895 119,956 Bank deposits with Bank Indonesia 41,010 60,757 58,568 58,548 61,089 60,081 72,053 63,061Net domestic assets -10,408 9,113 6,436 9,720 17,759 16,065 28,600 11,270 Net claims on government 192,641 199,953 199,034 204,140 202,094 204,023 226,620 218,253 Government bonds 250,378 253,305 253,305 253,305 253,305 253,305 253,817 257,661 Bank Indonesia Support Fund 18,759 18,759 18,759 18,759 18,759 18,083 18,083 13,295 Net claims on IBRA 14,447 14,447 14,447 14,447 14,447 13,771 13,771 9,604 Liquidity credits 12,869 12,781 12,764 12,645 12,608 12,588 12,349 12,346 Open-market operations -152,801 -135,869 -139,357 -139,297 -130,823 -135,834 -144,548 -153,785


The rupiah traded at an average rate of Rp8,939:US$1 in 2004, a depreciation of3.9% on 2003. The average exchange rate masks considerable weakness towardsthe end of the year, however, at a time when other South-east Asian currenciesrose sharply against the weakening US dollar. The static performance of therupiah was attributed to high demand for US dollars to meet year-end debtrepayments, and profit-taking on the stockmarket as foreign investors convertedsizeable gains in 2004 back into hard currency. The rupiah continued toperform weakly in the early part of 2005, and at the end of February it wastrading at around Rp9,200:US$1.

The falling value of the US dollar on foreign-exchange markets in late 2004prompted Bank Indonesia to consider diversifying Indonesia!s foreign-exchangereserves into other major international currencies. Some 95% of Indonesia!sreserves is thought to be held in US dollars, leaving it exposed (along withmany other Asian countries) to a weakening US currency. Internationalreserves nevertheless rose steadily throughout the latter part of 2004, to finish

The international reserveposition strengthens

The rupiah depreciates inforeign-exchange markets

Indonesia 27


the year at US$36.3m, with revenue from the oil and gas sector and inflows offoreign loans offsetting foreign debt repayments.

International reserves(US$ m; end-period)

2004 2005Jun Jul Aug Sep Oct Nov Dec Jan

International reserve/official reserve assets 34,851 34,811 34,822 34,802 35,353 35,927 36,321 36,092


The Jakarta Stock Exchange (JSX) continued to perform strongly in 2004, withthe JSX composite index rising by 45% to finish the year above 1,000, up from692 at the end of 2003. Market capitalisation rose by 48% to Rp683trn(US$74bn). The JSX still appears undervalued compared with neighbouringmarkets, and further gains are expected in 2005. This was reflected in early-year trading. The JSX rose to new record highs throughout February, spurredon by perceptions of reduced political risk and growing optimism foreconomic prospects under the new government led by the president, SusiloBambang Yudhoyono. At the end of the month the index was trading at closeto the 1,100 mark.

Oil and gas

Production from existing oil reserves is forecast to decline by 50% over the nextten years and by 6-10% in 2005. However, exploration for new reservescontinues to be held back by legal and regulatory uncertainty, with investmentin exploration falling to a 36-year low of US$400m in 2004. Oil production fellto 1.08m barrels/day (including condensates) in 2004, down from 1.18m b/d in2003, and net exports fell to 30,000 b/d in 2004, down from 100,000 b/d in2003. Falling output was compound by a 5% rise in domestic demand resultingin part from heavily subsidised domestic fuel prices.

Falling output and exports reduced Indonesia to the status of a net oil importerfor several months in 2004, raising questions over the country!s continuedmembership of the OPEC. Indonesia joined OPEC in 1962, two years after thecartel was founded, but has for several years been unable to meet itsproduction quota of 1.4m b/d. The shift to net importing status, and the US$2mannual membership fee, make it difficult to justify continued participation.Withdrawing from the organisation could weaken cherished diplomatic links toother OPEC member states, however, and serve to unnerve investors further. Apanel has been established to review the membership question and will reportback to the minister of energy and mineral resources, Purnomo Yusgiantoro,later this year.

The government has promised action to rejuvenate the sector, but contractualproblems facing US-based ExxonMobil, the world!s largest oil company, andFrance!s Total, the world!s second-largest producer of liquefied natural gas(LNG), have overshadowed these constructive efforts. ExxonMobil is in disputewith Indonesia!s state oil company, Pertamina, over the future of the Cepu

Production and explorationfall sharply

Indonesia contemplateswithdrawing from OPEC

The stockmarket goes fromstrength to strength

Legal uncertainty discouragesinvestment

28 Indonesia


oilfield in Central and East Java (September 2004, The domestic economy: Oiland gas). The new administration has given priority to resolving the disputeand has ordered Pertamina to reopen talks with ExxonMobil, but no furtherprogress has been recorded. Total!s local subsidiary has faced a bankruptcypetition in the notorious Jakarta Commercial Court. The petition, brought bytwo former contractors over a disputed bill of Rp64bn (US$7.2m), sharedsimilarities with controversial petitions brought against the Manulife andPrudential insurance companies in 2002 and 2004, in which the localsubsidiaries of both firms were declared bankrupt. In early March the courtoverturned the petition, however, preventing another messy stand-off withforeign investors.

Negotiations over the development of the giant Tangguh gasfields in Papua areadvancing, and UK-based BP, which leads the Tangguh project consortium,must soon take a final decision on whether to press ahead with the US$5.5bnproject. Negotiations are now focusing on financial risk guarantees for theoperating consortium. BP had also been awaiting agreement to extend its rightsto the Tangguh fields in line with supply contracts signed with the US, SouthKorea and China, the longest of which runs to 2028. This agreement wassecured in early March, and construction, which has been delayed severaltimes, is now expected to start later this year. The fields are expected to beginproducing in 2008. Initial production will be in the region of 7.6m tonnes/year.The fields have total certified reserves of 14.4trn cu feet.

Mining

Legal and regulatory uncertainty also continues to blight the mining sector, asevident in the 4.6% contraction registered in the sector in the 2004 GDP data.Numerous foreign mining companies have been entangled in violent protests,legal challenges and contractual uncertainty since the advent of regionalautonomy in 2001. New investment has all but dried up as a result, withspending on exploration falling to an annual average of only US$7m in 2001-03.Falling investment and exploration mean that Indonesia has largely missed outon a global boom in minerals prices driven by China!s rapid economic growth.Lawlessness also continues to blight the sector. The Ministry of Energy andMineral Resources estimates that state losses from illegal mining run toRp20trn-30trn per year. As with illegal logging, theft of mineral resourcescommonly takes place with the backing of corrupt bureaucrats, the military andthe police.

One long-standing cause of uncertainty in the sector has been a debate overmining in protected forests. A 1999 law on forests introduced a generalprohibition on mining in protected forest areas, casting concessions that pre-dated the act into deep uncertainty. After strong and persistent lobbying fromthe mining industry, in July 2004 the House of Peoples! Representatives (DPR)endorsed a regulation allowing limited mining operations to resume inprotected forests. The regulation was subsequently subsumed into LawNo. 19/2004 on forests. Environmental groups have now launched a challenge

Mining in protected forests tobe subject to judicial review

The mining sector remainsin crisis

Negotiations continue over theTangguh gas project

Indonesia 29


in the Constitutional Court. If their complaint is upheld, mining concessions inprotected forests will be rendered null and void. The stakes are high. On theone hand is the need to uphold contractual certainty and revitalise mininginvestment, and on the other is the future of Indonesia!s rapidly vanishingforests and the critical environmental services they provide.

Agriculture

The government has extended the rice import ban to June 2005 following agood harvest in 2004. Rice production in 2004 rose to 54.34m tonnes(unhusked), equivalent to 33.37m tonnes (husked), compared with domesticdemand of 31m tonnes (husked). The import ban was first introduced for a six-month period in January 2004 to protect farmers during the main rice harvest.The latest extension comes despite warnings of a drought risk later this yearowing to the El Niño weather effect.

The Ministry of Agriculture forecasts rising production of crude palm oil (CPO),sugar and rubber in 2005. Higher CPO output will be achieved through higherproductivity, with exports expected to rise to 7.8m tonnes, up from 7m tonnesin 2004. Sugar production will be boosted by a drive to replant 50,000 ha withhigher yielding varieties under a programme to eliminate imports by 2007.Rubber production will be boosted by ongoing rehabilitation programmes.Cocoa output is expected to grow more modestly, owing to pest infestationsand a risk of drought. Output of coffee, tea and pepper will remain low in2005, largely as a result of depressed global prices. The coffee harvest in the2004/05 crop year (October#September) is expected to come in at450,000 tonnes, compared with an estimated 450,000#490,000 tonnes in theprevious crop year. The fall in output is because of erratic weather and liquidityproblems facing small farmers, which have resulted in poor maintenance ofplantations. Despite a dwindling harvest, coffee exports are expected to rise to250,000 tonnes in 2005, 11% higher than in 2004.

Plantation output(m tonnes, unless otherwise stated)

2004 2005a % change, year on yearSugar 2.0 2.2 9.0Rubber 1.9 2.0 8.0

Crude palm oil 10.3 11.8 14.5Cocoa 0.6 0.6 5.0

a Official estimate.

Source: Ministry of Agriculture.

Monsanto, a US agribusiness company, agreed in January to pay penalties ofUS$1.5m for bribing an Indonesian government official in 2001. The chargeswere brought under the US Foreign Corrupt Practices Act, which prohibits UScompanies from bribing foreign government officials. Monsanto agreed to thesettlement for paying US$50,000 to a senior official of the Ministry ofEnvironment to facilitate planting permits for genetically modified cotton inSouth Sulawesi. Monsanto admitted to spending over US$700,000 between

A US company is fined forpaying bribes

The outlook for plantationcrops is strong

The rice import ban isextended

30 Indonesia


1997 and 2002 in bribes to senior officials in the environment and agricultureministries, the development planning board, and around 140 lower officials invarious government offices. The Corruption Eradication Commission (KPK) hasnow opened an investigation into the case.-

In February a new investigative report exposed a massive trade in illegallyharvested timber from Papua to China. The investigation, conducted by theUK-based Environmental Investigation Agency (EIA) and Telapak, the agency!sIndonesian partners, highlights the deep involvement of the Indonesianmilitary and corrupt government officials in the illegal trade. The racket,valued at more than US$1bn per year, results in up to 300,000 cu metres ofMerbau logs being smuggled out of the country every month. The timber isthen re-exported as furniture and flooring to the European, Japanese and USmarkets. Indonesia and China signed an agreement to halt the trade in illegaltimber in December 2002, but the agreement has not been backed up byaction on the ground. In response to the findings, Mr Yudhoyono summonedthe ministers of forestry and home affairs, the national police chief and seniormilitary officers to an unscheduled cabinet meeting, where he ordered an"integrated operation" against illegal logging gangs and their military andpolice backers.

Manufacturing

Textile quotas came to an end on December 31st, exposing Indonesia!s ailingtextile manufacturers to savage competition from low-cost producers includingChina, Vietnam and India. Exports had been subject to a 30-year quota regimeset out in the 1974 Multifibre Agreement. The abolition of quotas was agreedten years ago, but the government has been particularly negligent in preparingthe industry for the change. An "action plan" for new investment to help thesector compete in the open market was issued only three weeks before the endof quotas. Indonesian firms will thus be hit hard, with exports predicted to fallby up to 15% this year as a result. The changes will result in further job lossesamongst Indonesia!s 3.5m textiles workers.

Motorcycle sales grew by over 38% year on year to 3.9m units in 2004,boosted by affordable prices, low interest rates and an easing of requirementsfor vehicle loans. The Indonesian Motorcycle Industry Association (AISI)expects slower growth in 2005, with sales forecast to rise by only 20%, to 4.6munits, owing to higher fuel costs. Vehicle sales rose by 36% year on year to483,295 units in 2004, up from 354,333 units in 2003. The Association ofIndonesian Automotive Industries (Gaikindo) forecasts 10% growth in 2005.Most motorcycles and cars sold in Indonesia are assembled by localmanufacturing companies.

Vehicle sales grow strongly

Textile manufacturers face cut-throat competition

Military links to illegal loggingare exposed

Indonesia 31


Manufacturing production indices(selected large and median manufacturing industries; 1993 = 100)

2002 2003 2004Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr

Textiles 87.2 79.0 77.8 78.8 74.4 77.5 83.5 70.5

Clothing 94.1 90.6 105.6 129.2 135.2 115.2 121.4 96.6Footwear 108.1 94.7 94.7 96.4 91.1 94.2 108.4 102.2

Wood 65.3 67.3 72.8 71.0 74.3 70.0 71.3 72.2Paper & paper products 135.5 129.8 127.2 126.8 131.5 128.8 141.7 139.6Industrial chemicals 104.8 105.6 139.5 138.4 140.9 131.1 135.1 134.5

Rubber & rubber products 152.6 163.5 162.9 185.5 166.3 169.6 157.2 180.0Cement 153.7 129.0 136.9 155.9 154.2 144.0 130.1 142.9

Iron & steel 128.3 109.5 104.0 92.1 73.0 94.7 107.7 91.6Electrical machines & appliances 91.7 61.4 56.6 57.0 40.5 53.9 35.0 29.1

All manufacturing industries 100.4 100.3 102.6 110.8 103.8 104.4 102.6 102.6

Source: Central Bureau of Statistics (BPS).

Infrastructure

Investment in infrastructure has been badly neglected since the 1997 economiccrisis, leading to severe bottlenecks that impair economic growth. However, thegovernment has served notice that it will place infrastructure developmentfirmly at the centre of its strategy to lift economic growth to an average of 6%annually over the next five years. At an infrastructure summit held for investorsin Jakarta in late January, ambitious plans to invest up to US$145bn ininfrastructure over the next five years were set out. The government will provideUS$25bn from the state budget, domestic financing institutions will provideUS$30bn, foreign donors will provide US$10bn and private investors US$80bn.During the summit the government gave advance notice of tenders for 91 infra-structure projects worth US$22.5bn, covering a range of sectors including tollroads, railways, water and sanitation, and power generation. A formal tenderprocess was subsequently opened on six toll road projects worth Rp3trn.

To realise these plans much work will first need to be done to convince privatecompanies that investing in infrastructure in Indonesia is a safe andworthwhile proposition. Regulatory reforms to mitigate risks, improveincentives and provide legal certainty for investors in major infrastructureprojects were announced. Many of the promised reforms have sincedisappeared into the bureaucracy and private investors are likely to wait forfirm evidence of improving legal certainty before committing funds.

Electricity market liberalisation was dealt a blow in December, when theConstitutional Court annulled Law No. 20/2002 on electricity. The lawprovided a framework for private investors to play a greater role in supplyingpower to the domestic market. The Court ruled that this violated Article 33 ofthe 1945 constitution, under which economic sectors crucial for the welfare ofthe people should be controlled by the state. Law No. 15/1985 on electricity wasre-enacted to fill the legal void left by the ruling, and a temporary supportingregulation was issued in January. The ruling means that private operators in thesector will once again be obliged to work in partnership with the state-owned

Power market liberalisation isdealt a blow

Infrastructure is central to thestrategy for economic growth

32 Indonesia


Perusahaan Listrik Negara (PLN). A revised law, which is expected to permitprivate investment in power plants, but prohibit the direct sale and distributionof electricity directly to consumers, is now in preparation.

Financial and other services

Banking indicators continued to improve throughout 2004. Bank lending rose toRp573.4trn in the year to November, up by Rp96.2trn (20.2%) from the start ofthe year; non-performing loans fell to 6.6% of the total loan portfolio as of theend of November, down from 8.2% at the end of 2003. However, although keyindicators have improved in recent years, the banking sector as a whole remainsfragile. As a result Bank Indonesia intends to step up bank supervision in 2005,and promote accelerated consolidation. To this end the central bank will offerincentives to "anchor banks" to acquire small, unhealthy banks, and encouragemergers between smaller banks to ensure a viable scale of operations.

Banking indicators, 2004(Rp trn unless otherwise indicated)

May Jun Jul Aug SepFundsThird-party funds 895.1 912.8 909.5 919.3 926.4 In rupiah 741.6 759.6 759.2 766.8 774.2 In foreign currency 153.5 153.2 150.3 152.5 152.2Money market borrowing 69.2 65.6 66.0 70.6 72.7Loan obligations 10.3 9.8 9.4 10.0 10.6Issued securities 12.3 12.7 12.7 13.0 13.1Loanable funds 806.3 823.7 818.1 843.8 809.3 Credits 513.4 528.7 530.2 547.5 555.1 In rupiah 384.5 397.7 401.8 414.1 425.6 In foreign currency 129.0 131.0 128.4 133.4 129.5 Bank Indonesia certificates 106.7 110.6 103.5 110.2 63.1 Other securities 70.5 77.1 78.6 81.1 83.6 Money market lending 108.7 100.2 98.8 97.8 100.2 Equity participation 6.9 7.1 7.1 7.2 7.2

Assets 1,179.4 1,185.7 1,182.8 1,208.2 1,213.1Capital 119.8 119.8 107.1 109.2 114.0PerformanceNon-performing loans Value 39.8 39.9 38.9 38.2 38.2 As percentage of total credits 7.8 7.5 7.3 6.7 6.9Profit/loss 3.6 3.6 3.4 3.1 4.3 Operational 2.2 2.1 13.4 -7.4 3.1 Non-operational 1.5 1.5 -10.0 10.6 1.3Net interest margin 5.3 5.4 5.4 5.3 5.3


Bank sales in 2004

The government has continued selling off its remaining minority stakes in privatebanks taken under state control during the 1997/98 financial crisis and managed bythe State Asset Management Company (PPA). In November a 16.28% stake in BankNiaga was sold to private investors for Rp585.8bn (US$53m).

Banking indicators showcontinued improvement

Indonesia 33


In the following month the government auctioned a 20% share in Bank Permata,raising Rp1.2trn (US$109m). The sale reduced the state�s holding in the bank to 26%. Aconsortium made up of the UK!s Standard Chartered and Astra, Indonesia!s largestautomotive company, purchased an 11.2% share, with the remaining 8.8% purchasedby private investors. Standard Chartered and Astra now hold a 62.2% stake in BankPermata, having purchased a 51% share in October 2004.Investment banks have now been appointed to sell the remaining minority stakes inthe six private domestic banks held by the PPA. The stakes, worth around US$800m,are in Bank Danamon (10.5%), Bank Central Asia (BCA; 5%), Bank InternasionalIndonesia (BII; 20.8%), Bank Permata (26%), Bank Niaga (2%) and Bank Lippo (2.5%).In the first of these sales, the government auctioned a 15.25% stake in BII to privateinvestors in late January, raising Rp1.35trn.Plans have also been announced to sell a 30% stake in the state-owned Bank NegaraIndonesia (BNI) in May. BNI is the country!s third-largest bank in terms of assets, andthe sale could raise up to Rp5trn. The sale was cancelled last year after thegovernment failed to secure parliamentary approval.

Foreign trade and payments

The value of merchandise exports (customs basis) rose to a record high ofUS$70bn in 2004, up by 11.5% on 2003. The increase was aided by strong salesof palm oil, electronic appliances, clothing, coal and tin, which helped to liftnon-oil and gas exports to US$54bn. The value of merchandise imports leapt by40% year on year to US$46bn. Oil and gas imports rose by 52% year on year toUS$12bn, owing to high global oil prices and rising demand, and non-oil andgas imports rose by 36% to US$35bn, driven by rising consumer andmanufacturing demand. The expansion means that imports have nowsurpassed their pre-crisis peak of US$43bn recorded in 1997. With growth inimports exceeding growth in exports, the trade surplus fell sharply toUS$23.5bn, down by 20% on 2003.

0

2

4

6

8

10

12

14

16

2000 01 02 03 04 05 06

Current-account

Trade

External balances% of GDP


The trade balance contractssharply

34 Indonesia


Merchandise trade by value(US$ m; fob-cif)

2004 2003 2004Nov Dec % change a Jan-Dec Jan-Dec % change b

Exports (fob) 5,682 6,446 13.4 62,527 69,714 11.5 Oil & gas 1,372 1,324 -3.5 13,651 15,588 14.2 Non-oil & gas 4,310 5,122 18.9 48,876 54,126 10.7Imports (cif) 3,714 4,809 29.5 33,086 46,180 39.6 Oil & gas 1,065 1,218 14.4 7,630 11,625 52.4 Non-oil & gas 2,649 3,591 35.6 25,456 34,555 35.7

Balance 1,968 1,637 -16.8 29,441 23,534 -20.1

a Month on month. b Year on year.


Japan surpassed the US as Indonesia!s main export market in 2004, accountingfor 14% of non-oil and gas exports. The US was Indonesia!s second-largestoverseas market, followed by Singapore, China and Malaysia. Exports to Chinagrew by a modest 7.5% year on year, below the rates of growth that otherSouth-east Asian economies achieved in their exports to China.

Main non-oil and gas export markets(US$ m)

2003 2004Jan-Dec 2003 Jan-Dec 2004 % changea % of total % of total

Japan 6,939 7,579 9.2 14.2 14.0US 6,986 7,518 7.6 14.3 13.9Singapore 4,664 4,772 2.3 9.5 8.8

China 2,926 3,145 7.5 6.0 5.8Malaysia 2,332 2,600 11.5 4.8 4.8

South Korea 1,793 1,740 -2.9 3.7 3.2Germany 1,412 1,428 1.1 2.9 2.6

Taiwan 1,310 1,378 5.2 2.7 2.5Australia 1,096 1,010 -7.8 2.2 1.9Total incl others 48,876 54,126 10.7 100.0 100.0

a Year on year.


Indonesia!s relationships with its major Asian markets will be deepenedthrough ongoing discussions with both Japan and China aimed at forming free-trade agreements (FTAs). In January officials from Indonesia and Japan met tobegin preparing for future formal negotiations on an FTA. Talks will be focusedinitially on import duties, labour and immigration, taxation, trade facilitationand investment. Steps are also being taken towards an FTA between China andthe Association of South-East Asian Nations (ASEAN). At an ASEAN summitheld in Laos in December, leaders from China and ASEAN agreed to proceedwith efforts to remove all tariffs by 2010. The China-ASEAN agreement willcreate the world!s largest FTA, with a market of over 2bn people. Plans are alsobeing advanced for FTAs between ASEAN and Japan and between ASEAN andSouth Korea, as well as agreements with Australia and New Zealand.

Exports to Japan grow strongly

Free-trade areas will deepeneconomic relations

Indonesia 35


Signs of recovering investment are evident in data for imports by broadeconomic classification. The cost of capital goods imports rose by 41.3% year onyear to US$6bn in 2004, suggesting that firms are spending more on newmachinery. Strong demand from the manufacturing sector for raw materialsand semi-processed goods drove a sharp increase in imports of intermediategoods, which rose by 40% year on year to US$36bn. Consumer demand alsoremained strong, with imports of consumer goods rising by 30%, from a lowbase, to US$3.8bn.

Imports by category(US$ m unless otherwise stated)

2003 2004Year % of total Year % of total % change a

Consumer goods 2,902 8.8 3,772 8.2 30.0Intermediate goods 25,871 78.2 36,315 78.6 40.4

Capital goods 4,313 13.0 6,093 13.2 41.3Total 33,086 100.0 46,180 100.0 39.6

a Year on year.


The number of tourists arriving in the country in 2004 rose to 4.5m, up by 23%on 2003. The data paint a welcome picture of recovery in tourism following thedifficult aftermath of the 2002 Bali bombing and the scare over Severe AcuteRespiratory Syndrome (SARS) in 2003. Arrivals in Bali showed particularlystrong growth, rising by over 44% to 1.5m visitors. Tourism in Bali, which isIndonesia!s main tourist destination, looks set to make further gains in 2005.The island may attract visitors who would otherwise have spent their holidaysin countries where tourism infrastructure was hit hard by the Indian Oceantsunami in December.

Tourist arrivals at 13 principal gateways2004 2003 2004

Nov Dec Jan-Dec Jan-Dec % changea

Soekarno-Hatta (Jakarta) 66,221 86,933 921,737 1,005,072 9.0Ngurah Rai (Bali) 116,901 131,511 1,054,143 1,525,994 44.8Batam 106,377 148,844 1,285,394 1,527,132 18.8

Other gateways 39,542 49,172 429,578 482,967 12.4Total 329,041 416,460 3,690,852 4,541,165 23.0

a Year on year.


Bank Indonesia (the central bank) has estimated that the balance of paymentsrecorded a deficit of US$800m in 2004, although data for the final quarter ofthe year have yet to be released. In the third quarter the balance of paymentsrecorded a small surplus of US$11m, compared with a surplus of US$351m inthe third quarter of 2003. Third-quarter merchandise exports (on a balance-of-payments basis) rose strongly to US$19.4bn, up by 19% on the third quarter of2003. However, the value of imports was also up strongly, growing by 30% yearon year. Net services fell to a deficit of US$3.7bn, with freight costs rising owing

Capital goods imports recordstrong growth

The balance-of-paymentsposition weakens

Tourist arrivals rise strongly

36 Indonesia


to increasing foreign trade volumes; overall the current account recorded asurplus of US$1.6bn in the third quarter of 2004, down by 27% year on year.

Net direct inward investment rose to US$94m in July-September 2004, a notableimprovement on the same period of 2003. Net inward investment was positivein all of the first three quarters of 2004, confirming other indications of a slowrecovery in investment. Portfolio investment also recovered strongly in the thirdquarter, with foreign investors returning to the stockmarket in the aftermath ofthe peaceful parliamentary election in April. The gains in private investmentwere partly offset by a deficit in official capital arising through the repaymentof debt, resulting in a net surplus of US$326m on the financial account,compared with a deficit of US$629 in the same quarter in 2003.

Balance of paymentsa

(US$ m)

2003 2004Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Exports (fob) 63,254 16,075 15,484 16,298 15,397 15,047 17,731 19,440Imports (fob) -39,546 -10,571 -9,243 -9,740 -9,992 -11,668 -11,964 -12,646Trade balance 23,708 5,504 6,241 6,558 5,404 3,380 5,767 6,795Services, incomes & net transfers -11,728 -3,275 -2,359 -3,507 -2,586 -2,306 -2,521 -3,705Current-account balance 7,251 1,144 2,225 2,258 1,624 -436 1,134 1,640Financial account -949 -946 -202 -629 829 1,448 -1,192 326Capital accountInward direct investment, net -597 -406 257 -203 -245 432 93 94Portfolio investment, liabilities, net 2,251 -189 906 121 1,414 782 -2 942Other investment liabilitiesb -2,604 -351 -1,366 -548 -339 233 -1,283 -710Capital & financial account balance -949 -946 -202 -629 829 1,448 -1,192 326Total 6,302 198 2,022 1,629 2,452 1,012 -58 1,966Errors and omissions -2,648 740 -1,089 -1,279 -1,020 345 -1,857 -1,955Balance of payments 3,654 938 934 351 1,432 1,357 -1,915 11Reserve assets position 36,296 32,578 34,057 34,068 36,296 37,419 34,851 34,802Debt-service ratio (%) 33.0 28.0 41.0 29.0 33.0 35.0 33.0 26.0

a Reporting of the balance of payments follows a new format effective from January 2004. b Not including IMF package.


Foreign direct investment (FDI) approvals surged by 235% year on year toUS$872m in January, up from US$260.2m in January 2004. Domesticinvestment also increased, rising to Rp1.89trn (US$172m), from Rp1.64trn inJanuary 2004. The strong January data followed a 27% year-on-year slump ininvestment approvals in 2004. In 2004 the Investment Co-ordinating Board(BKPM) approved projects worth US$10.28bn, down from US$14.05bn in 2003.Domestic investment approvals fell to Rp36.75trn in 2004, down fromRp50.75trn in 2003.

The World Bank has forecast potential investment demand growth of 11% peryear in 2005-09, given current rates of capacity utilisation and growingdemand. Reforms to improve the business climate are urgently needed toharness this potential rate of growth, and evidence suggests that these reformsare slowly getting under way. In February the government announced a reviewof 60 local byelaws that obstruct trade and investment. The byelaws are among

Investment boosts the capitalaccount

Investment approvals risestrongly in January

Disruptive local byelaws willbe annulled

Indonesia 37


hundreds of similar acts passed by district governments since the advent ofregional autonomy in 2001, which have imposed considerable cost anddisruption on business. The Indonesian Chamber of Commerce (Kadin)recently surveyed 881 byelaws issued by 225 district administrations, andconcluded that 297"one in three"were disruptive or detrimental to business.The ongoing review is expected to result in the scrapping of many nuisancebyelaws. Rules governing business permits will be harmonised across regions,and powers that allow local administrations to introduce business-retardingregulations are expected to be curbed.

A forthcoming law on investment will set out a framework for thegovernment!s plans to revitalise investment. Drafting of the law, which willreplace the 1967 Foreign Investment Law and the 1968 Domestic InvestmentLaw, is being led by the co-ordinating minister for the economy, Aburizal Bakrie.Mr Bakrie proposes to open new sectors to foreign investment, including themedia and transportation, and to smooth procedures for securing businesspermits. The bureaucracy will strongly resist the loss of discretionary powerover investors, so the final balance between regulation and deregulation willgive an indication of the new administration!s reformist mettle.

The government!s debt position continues to improve, with the debt/GDP ratiofalling to 53% in September 2004, down from 59% in 2004. The externaldebt/GDP ratio fell from 56% in 2003 to 51% in September 2004, and the ratio ofshort-term debt to international reserves, which gives an indication of liquidityrisks, fell to 38% in June 2004 (it was well above 200% in 1997).

External debt(US$ m)

2001 2002 2003 2004Dec Dec Dec Mar Jun Aug Sep Oct

Government 71,377 74,661 81,666 81,217 78,591 77,080 76,980 78,588

Private 60,058 55,212 51,942 52,836 52,080 52,382 51,783 52,438 Financial institutions 7,713 7,642 7,537 7,968 7,587 7,974 7,530 8,039 Bank 6,649 4,870 4,316 4,479 3,766 4,044 3,499 3,969 Non-bank 1,064 2,772 3,221 3,489 3,821 3,930 4,031 4,070 Non-financial institutions 52,345 47,570 44,405 44,868 44,493 44,408 44,253 44,399

Domestic securities 1,638 1,470 1,794 2,626 2,467 2,811 3,075 3,303Total 133,073 131,343 135,402 136,679 133,138 132,273 131,838 134,329


In mid-January the Paris Club of official creditors suspended Indonesia!s debt-servicing obligations for three months while an assessment was made by theWorld Bank and the IMF of whether greater debt relief was needed. On March10th the Paris Club announced that it was extending the moratorium on debtowed to Paris Club members until December 31st 2005. The idea behind themoratorium is that it will free up scarce public resources to addresshumanitarian and reconstruction needs. The debt repayments due this year areto be rescheduled over five years, with one year of grace. Indonesia was tohave paid about US$3.5bn in debt-servicing to Paris Club members over thecourse of 2005.

A new investment law is inpreparation

Indonesia's debt profile isimproving

The Paris Club extends thedebt moratorium

38 Indonesia


External debt servicing(US$ m)

2002 2003 2004a

Government 7,374 6,450 6,982 Principal 5,009 4,000 4,872 Interest 2,365 2,451 2,111Private 13,609 12,449 10,353 Principal 11,941 11,669 9,757 Interest 1,668 780 596 Financial institutions 5,808 5,656 5,676 Principal 5,323 5,521 5,563 Interest 485 136 114 Bank 4,825 5,078 5,269 Principal 4,372 4,965 5,174 Interest 453 113 94 Non-bank institutions 983 579 406 Principal 951 556 387 Interest 32 23 19 Non-financial institutions 7,801 6,793 4,676 Principal 6,617 6,148 4,195 Interest 1,183 645 481Total external debt servicing 20,983 18,900 17,334 Principal 16,950 15,669 14,627 Interest 4,033 3,231 2,707

a January-October.


105

110

115

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135

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2000 01 02 03 04 05 0610

12

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Debt; US$ bn; left scale Debt-service ratio due; %; right scale

External debt stock and debt-service ratio


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