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EXECUTIVE SUMMARY

The economy of Indonesia indicated clear signs of maintained macroeconomic and financial system stability during the third quarter of 2014, coupled with the ongoing economic rebalancing process. Such conditions were reflected by a declining current account deficit along with managed domestic demand in line with economic stabilisation policy that consistently maintains macroeconomic and financial system stability. Throughout 2014, Bank Indonesia has held its BI rate at a level of 7.50%, with the Lending Facility (LF) and Deposit Facility (DF) rates remaining at 7.50% and 5.75% respectively. Such policy is consistent with efforts to control inflation towards its target corridor of 4.5±1% in 2014 and 4.0±1% in 2015, while simultaneously reducing the current account deficit to a more sustainable level. The current policy of Bank Indonesia is further bolstered by close coordination with the Government to control inflation and reduce the current account deficit in order to strengthen economic fundamentals in the medium-long term.

From a global perspective, the global economic recovery persisted albeit at an uneven pace. The global economic recovery was underpinned by gains in the US economy in the form of stronger production indicators and a lower unemployment rate. The situation in the United States underscored the prognosis of normalisation policy to be instituted by the Federal Reserve in the middle of 2015. In contrast, the economies of Europe and Japan experienced a downswing. At the same time, China’s economy also tended to decelerate. Consequently, international commodity prices continued to slump, including the global oil price, as supply surged amidst weaker demand.

In line with moderating global demand, domestic economic growth also slowed. Domestic growth was 5.01% (yoy) in the third quarter of 2014, lower than the 5.12% (yoy) posted in the previous quarter. Consumption increased due to resilient private consumption and greater government procurement expenditure. Meanwhile, investment activity, specifically non-construction investment activity, remained weak. Concerning the external sector, exports continued to experience a contraction, primarily stemming from weaker exports of primary goods, while manufacturing exports consistently improved. Such conditions are illustrated by regional economic growth figures, where sources of decline originated in Sumatera as a primary commodity exporting region. Meanwhile, economic growth in Eastern Indonesia accelerated as mineral exports recommenced, and economic growth of Java remained relatively high as manufacturing exports continued to expand.

The position of the Indonesia balance of payments (BOP) strengthened in the third quarter of 2014, buoyed primarily by a declining current account deficit. The current account deficit amounted to US$6.836 billion in the reporting quarter (3.07% of GDP), down from US$8.689 billion in the second quarter (4.07% of GDP) as well as from US$ 8.635 billion in the third quarter of 2013 (3.89% of GDP). Improvements in the current account were primarily supported by a significant surplus in non-oil/gas trade balance, in line with the adoption of economic stabilisation policy amidst the increased deficit in the oil and gas balance. The improvements were further nurtured by positive manufacturing export performance stemming from the US recovery after licenses were granted to recommence unrefined mineral exports. Meanwhile, the capital and financial account recorded a significant surplus as the inflow of foreign direct investment escalated in line

MONETARY POLICY REPORT Quarter III 2014

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with the positive perception of foreign investors concerning the domestic economic outlook. Foreign capital inflows were maintained in October 2014. Consequently, the position of foreign exchange reserves in Indonesia increased to US$112.0 billion in the reporting period, equivalent to 6.6 months of imports or 6.4 months of imports and servicing the government’s external debt, which is well in excess of international adequacy standards amounting to approximately three months of imports.

The rupiah depreciated slightly due to global sentiment. During the third quarter of 2014, the rupiah depreciated by an average of 1.2% (qtq) to a level of Rp11,770 per US dollar. Pressures on the rupiah were influenced by external factors, namely concerns over normalization of the Federal Reserve’s monetary policy, global geopolitical dynamics and the global economic downturn. Internally, however, rupiah depreciation was triggered by the wait-and-see attitude of investors towards the formation of the new government cabinet and work programs. Pressures on the rupiah persisted into October. Accordingly, the rupiah depreciated by an average of 2.01% (mtm) to a level of Rp12.142 per US dollar.

Inflation was controlled and continued to follow a downward trend, thereby bolstering the prospect of achieving the 2014 inflation target of 4.5±1%. Inflation dropped to 4.53% (yoy) in the third quarter of 2014 from 6.70% (yoy) in the previous period. Controlled inflation was bolstered by managed core inflation and lower inflation of volatile foods. Controlled core inflation was a result of decreasing international commodity prices, moderating demand and anchored inflation expectations. Meanwhile, inflation of volatile foods was relatively low in line with abundant food supply. In contrast, inflation of administered prices increased as residential electricity rates and prices of 12 kg canisters of LPG were raised. Controlled inflation endured into October 2014 despite increasing to 4.83% (yoy).

Financial system stability remains solid, underpinned by banking resilience and relatively sound financial market performance. The banking industry has remained resilient, with credit risk, liquidity risk as well as market risk well mitigated and supported by a strong capital base. At the end of the third quarter of 2014, the Capital Adequacy Ratio (CAR) remained high at 19.40%, well above the minimum threshold of 8%, while the ratio of non-performing loans (NPL) remained low and stable at around 2.0%. In terms of the intermediation function, credit growth continued to decelerate to 13.16% (yoy) from 17.2% (yoy) at the end of the second quarter in accord with the economic rebalancing process. Despite decelerating in comparison to the preceding quarter, deposit growth in September 2014 accelerated compared to the previous month, recorded at 13.32% (yoy), as the Government adopted expansive financial operations. Consequently, bank liquidity was relatively well maintained in the reporting quarter. Meanwhile, capital market performance continued to improve as indicated by the upward IDX Composite trend.

Looking ahead, Bank Indonesia predicts the economic rebalancing process to persist with a more favourable economic outlook as well as maintained macroeconomic stability. Economic growth in 2014 is projected at the lower end of the 5.1-5.5% range, accelerating to 5.4-5.8% in 2015. Lower growth is expected in 2014 compared to 2013 due to the declining contribution of exports and investment in line with sluggish mineral exports, limited international demand, negative commodity price growth as well as the wait-and-see attitude of investors. Nonetheless, economic growth is projected to accelerate in 2015 in line with predicted improvements in global economic conditions. As economic growth moderates in 2014, inflation is forecasted at a lower level than that recorded in 2013, namely within the target corridor of 4.5±1%. In 2015, however, measured monetary policy in conjunction with policy coordination with the

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Government will control inflation down to 4.0±1%. In terms of external imbalances, the current account deficit is estimated to continue declining as manufacturing and mineral exports rebound and oil and gas imports are managed.

Bank Indonesia will continue to monitor external and domestic economic risks, including higher inflation expectations in line with the government’s plan to raise subsidised fuel prices. Globally, risks stem from the normalisation policy of the Federal Reserve, which could undermine foreign direct investment. Another international risk is linked to economic downturns in leading global players. From a domestic standpoint, Bank Indonesia will remain vigilant of various inflation risks, such as the planned adjustment to subsidised fuel prices that has manifested in the form of higher inflation expectations. Confronting these issues, Bank Indonesia will institute policy to ensure the impact of fuel price hikes on inflation is minimal and temporary through stronger inflation control coordination with central and local governments.

Considering the latest economic conditions, outlook and risks faced, the Bank Indonesia Board of Governors, convening on 13th November 2014, decided to hold the BI rate at 7.50%, with the Lending Facility and Deposit Facility rates to remain at 7.50% and 5.75% respectively. Such policy is consistent with efforts to guide inflation towards its target corridor of 4.5±1% in 2014 and 4.0±1% in 2015, as well as to reduce the current account deficit to a more sustainable level. To that end, Bank Indonesia will continuously strengthen its monetary and macroprudential policy mix to safeguard macroeconomic and financial system stability as well as strengthen the domestic economic structure. Furthermore, Bank Indonesia will tighten policy coordination with the Government to control inflation and reduce the current account deficit in order to ensure smooth economic rebalancing towards more sustainable economic growth.

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THE ECONOMY AND MONETARY POLICY

The economy of Indonesia in the third quarter and October 2014 showed macroeconomic stability and maintained financial system to support the economic adjustment process towards more balanced condition. Such conditions were reflected by a shrinking current account deficit and managed domestic demand despite a persistent decline in domestic economic growth in the period. The current account performed better during the third quarter as a result of a significant increase in the non-oil/gas trade balance. Additionally, financial system stability remained solid in the third quarter of 2014, supported by banking system resilience and relatively well maintained financial market performance.

Prevailing economic conditions are inextricably linked to the panoply of stabilisation policies implemented by Bank Indonesia and the Government since the middle of 2013. From the first until the third quarter of 2014, and in October 2014, Bank Indonesia held its BI rate at 7.50%, with the Lending Facility (LF) and Deposit Facility (DF) rates remaining at 7.50% and 5.75% respectively. Such policy is consistent with efforts to control inflation within the specified target corridor of 4.5±1% in 2014 and 4.0±1% in 2015, as well as reduce the current account deficit to a more sustainable level. Current policy is further strengthened through intense coordination between Bank Indonesia and the Government to control inflation and the current account deficit in order to ensure smooth economic rebalancing towards more sustainable economic growth.

The Global Economy

The global economic recovery persisted, albeit at an uneven pace. The global economic recovery was underpinned by gains in the US economy in the form of stronger production indicators and a lower level of unemployment. The situation in the United States underscored the prognosis of normalisation policy to be instituted by the Federal Reserve in the middle of 2015. In contrast, the economies of Europe and Japan experienced a downswing. Simultaneously, China’s economy also tended to decelerate. Consequently, international commodity prices continued to slump, including the global oil price, as supply surged amidst weaker demand. In terms of the trade channel, such development in the international economy will affect export performance in Indonesia, with manufacturing exports continuing to improve amidst weak exports of primary goods. Concerning the financial channel, however, the flow of foreign capital to Indonesia is predicted to endure but with greater volatility particularly due to the normalisation of the Federal Reserve policy. Bank Indonesia will remain vigilant of various external risks in the interest of preserving the stability of the national economy.

The US economy continues to improve. On the production side, the Purchasing Managers’ Index (PMI) increased to 59.0 on 14th October 2014 on the back of new domestic orders and a peak in production output since May 2004 (Graph 1.1). The unemployment rate dropped from 5.9% to 5.8% in line with new job openings. However, US economic growth figures for the third quarter of 2014 was recorded at 2.3% (yoy), down slightly on the 2.6% (yoy) posted in the preceding quarter. Such situation was

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attributed to a decline in personal income, thereby limiting household purchasing power and leading to lower retail sales.

Graph 1.1. US Manufacturing PMI Graph 1.2. US Unemployment Rate andJob Openings

Economies in Europe tended to decelerate as external and production pressures persisted along with potential deflation. External pressures were evident from the decline in export growth as the economy of China slowed (Graph 1.3). In addition, deflationary pressures and ongoing geopolitical tensions in Russia also stifled production, which is illustrated by the downward PMI trend (Graph 1.4).

Graph 1.3. European Trade Graph 1.4. European PMI

Japan’s economy also experienced a slowdown precipitated by sluggish production and indicated by contracting production indices as well as a lower PMI at the end of the third quarter compared to the previous period (Graph 1.5). Yen depreciation undermined output due to soaring import prices amidst limited export growth. Negative growth in terms of department store sales further indicates that demand has not recovered(Graph 1.6). Meanwhile, based on the Reuters Tankan survey, business sentiments of large companies worsened for both manufacturing and non-manufacturing firms. Bearish sentiment stemmed from a bump in the sales tax, rising input prices due to exchange rate depreciation as well as the general weakness in the global economy, predominantly in China and Europe.

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Graph 1.5. Japan Manufacturing PMI Graph 1.6. Japan Retail Sales China’s economy continued to show signs of decline. From the demand side, the downturn stemmed from slower consumption and investment growth (Graph 1.7). From the production side, weaker growth emanated from the real estate sector (a tertiary industry) (Graph 1.8). Responding to the situation, the People’s Bank of China (PBoC) decided to relax the regulations concerning housing loans by lowering downpayments on a second home from 60% to 30% of the value of the property, effective from the beginning of October 2014.

Graph 1.7. China Economic Growth Graph 1.8. China Industrial Development

India’s economy expanded beyond previous projections as a result of escalating production activity. This is reflected by manufacturing PMI in India that continues to increase while production indices remain stable. Additionally, the infrastructure index also continues to enjoy an upward trend. From a domestic perspective, national automotive sales and stronger import growth are indicative of economic gains. Sound economic performance in India is congruous with bullish sentiment after the recent government election that prompted structural reforms in key areas such as energy, infrastructure development and direct investment.

With the international economy overshadowed by a slump in leading global economies, world trade activity also tended to decelerate. Such inauspicious conditions were confirmed by world trade volume, which was lower than previous projections, and the ongoing downward trend of international commodity prices. The decline in world trade volume was attributable to geopolitical issues and the impact of extreme cold weather in United States during the first quarter of 2014 that lingered into the third quarter (Graph 1.9). Furthermore, international commodity prices continued to decrease. Abundant supply and weak demand, primarily for China, undermined the coal price. In addition, sluggish economic performance in China also influenced the prices of nickel, tin, aluminium and rubber. The oil price continued to decline as supply increased but

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global demand waned. The drop in the price of oil was credited to several factors, including fundamental factors, competition amongst oil producers, as well as geopolitical factors. Competition amongst oil producers stemmed from Saudi Arabia that decided not to reduce their supply despite weaker demand in order to maintain market share. Geopolitical factors included easing tensions in the Middle East and North Africa, thereby facilitating the recommencement of oil production in Iraq and Libya.

Corrections on the global financial markets are intensifying as the Federal Reserve seems set to normalise its monetary policy stance in the middle of 2015. Pressures on financial markets also stemmed from an IMF release that contained a revised down global growth forecast and sparked negative sentiment. Meanwhile, the majority of global currencies tended to depreciate against the US dollar, especially the currencies of emerging market countries in Asia, including Indonesia, as investor concerns arose over global geopolitical shocks. However, stock exchanges in Asia rallied, despite persistent decline in non-resident inflow to bourses in Asia (Graph 1.10).

Graph 1.9. World Trade Volume Graph 1.10. Global Stock Markets

Economic Growth

Domestic economic growth moderated in line with consistently weak international demand. The domestic economy achieved growth of 5.01% (yoy) in the third quarter of 2014, which is lower than the 5.12% (yoy) posted in the preceding quarter (Table 1.1). Consumption surged in line with resilient private consumption and increased government procurement expenditure. Conversely, investment activities, specifically non-construction investment, remained weak. In terms of the external sector, exports continued to contract, particularly exports of primary goods, while manufacturing exports consistently improved. In general for 2014, economic growth is expected at the lower end of the 5.1-5.5% range and then at around 5.4-5.8% in 2015.

%Y-o-Y, 2000 Price

I II III IV I II IIIPrivate Consumption Expenditure 5.2 5.1 5.5 5.3 5.3 5.6 5.6 5.4Governmetn Expenditure 0.4 2.2 8.9 6.4 4.9 3.6 (0.7) 4.4Gross Fixed Capital Formation 5.5 4.5 4.5 4.4 4.7 6.0 5.2 4.0Export of Godds and Services 3.6 4.8 5.2 7.4 5.3 (0.4) (0.8) (0.7)Import of Godds and Services 0.0 0.7 5.1 (0.6) 1.2 (0.7) (5.1) (3.6)GDP 6.0 5.8 5.6 5.7 5.8 5.2 5.1 5.0Source : BPS - Statistics Indonesia

Table 1.1Economic Growth - Demand Side

Component2013

20132014

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Despite tenacious growth, household consumption decelerated in the third quarter of 2014 after the recent general election. Household consumption achieved growth of 5.44% (yoy) in the reporting quarter, lower than that posted in the preceding quarter at 5.59% (yoy). The slowdown was ascribed to the conclusion of activities associated with the legislative and presidential elections held recently, which has helped bolster consumption growth in the previous quarter. Less public optimism also contributed to the deceleration in household consumption growth, as reflected in the Consumer Confidence Index (CCI) released by BPS-Statistics Indonesia, which began to slide in the third quarter (Graph 1.11). Weaker automobile and motorcycle sales data in the third quarter (Graph 1.12) further confirmed the slowdown in household consumption. Additionally, imports of consumer goods grew at a slower pace during the reporting quarter.

Graph 1.11. Consumer Confidence Index Graph 1.12. Motor Vehicle Sales

Government consumption grew strongly in line with increased public sector expenditure. Government consumption increased significantly from -0.71% (yoy) in the second quarter of 2014 to 4.37% (yoy) in the subsequent quarter congruent with annual trends. By component, an acceleration of procurement spending contributed to the growth in government consumption.

Investment performance tailed off slightly during the third quarter of 2014, primarily triggered by weaker non-construction investment. In general, investment growth slowed from 5.21% (yoy) in the second quarter to 4.02% (yoy) in the third. The slowdown predominantly affected non-construction investment in line with a deeper contraction in imports of capital goods during the reporting period. Such conditions were further verified by sales of domestic heavy equipment, which remained in negative territory due to a sluggish mining sector. Another indicator of inauspicious investment conditions was a decline in production capacity utilisation in the manufacturing sector, which illustrated the lack of incentives for business players to invest (Graph 1.13). In line with the downturn in non-construction investment activity, construction investment also tended to grow more slowly. In accordance with established seasonal trends, weak investment activity was blamed on the wait-and-see attitude of investors after the recent legislative and presidential elections. Weaker sales data for cement and imports of construction materials in the third quarter further confirmed the slowdown in construction investment activity (Graph 1.14).

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Graph 1.13. Utilization Capacity Graph 1.14. Building Investment Indicators

On the external side, exports continued to contract. Exports contracted in the third quarter by -0.70% (yoy), which is slightly better than the -0.76% (yoy) contraction recorded in the previous quarter. The contraction in exports, particularly affecting primary export commodities, was credited to persistently weak international demand (Graph 1.15). Despite the contraction, export growth did improve on the back of positive manufacturing export performance and the recommencement of exports of natural resources (mining), specifically mineral concentrates.

Graph 1.15. World Trade Volume (Impor) Graph 1.16. Non-Oil Export (Real Value)

Responding to limited export and non-construction investment performance, imports also contracted during the third quarter of 2014. Import growth contracted again in the third quarter, by -3.63% (yoy), which is not as deep as the -5.05% (yoy) contraction reported in the preceding quarter. By commodity group, the contraction mainly affected imports of capital goods as non-construction investment activity slowed (Graph 1.17). Meanwhile, imports of consumer goods also contracted due to less imports of passenger vehicles, durable goods, and non-durable goods. In contrast, material imports grew positively, amongst others in the form of commercial foodstuffs (raw and processed), raw materials for industry as well as fuel for industrial machinery.

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Graph 1.17. Non-Oil Import (Real Value) By sector, slower economic growth in the third quarter of 2014 stemmed from weaker growth in the manufacturing industry and non-tradeables sector (Table 1.2). Slower manufacturing sector growth was reported as domestic demand moderated and export performance was limited. The slowdown principally affected the food, beverages and tobacco subsector, the chemicals subsector and the cement subsector. The construction sector also contracted due to the wait-and-see attitude of the business community in terms of post-election investment. The trade, hotels and restaurants (THR) sector decelerated due to weak international trade activity as well as less impact from the general election-related activitiesthan in the previous quarter. Despite persistently robust growth, the transportation and communications sector grew more slowly than in the preceding quarter due to the conclusion of election campaigns. Meanwhile, the slowdown in the financial, leasing and corporate services sector was attributed to weaker credit growth. On the other hand, the agricultural and mining sectors expanded on the previous quarter. Growth in the agricultural sector stemmed from the food crop subsector, primarily corn and soybean. The mining sector, which contracted during the first two quarters of 2014 due to restrictions on mineral exports, rebounded to enjoy positive growth after enforcement of the Mineral and Coal Mining (Minerba) Act.

By region, an economic downswing on the island of Sumatra contributed to the national economic slowdown. In addition to Sumatra, slower economic growth in the Special Capital Region of Jakarta and a contraction in West Nusa Tenggara also contributed to the national economic downturn. Weaker growth in Jakarta was blamed on the

%Y-o-Y, 2000 Price

I II III IV I II IIIAgriculture 3.7 3.3 3.3 3.8 3.5 3.2 3.4 3.7Mining and Quarrying 0.1 (0.6) 2.0 3.9 1.3 (0.4) (0.3) 0.3Manufacturing Industries 6.0 6.0 5.0 5.3 5.6 5.1 5.0 4.6Electricity, Gas and Water Supply 7.9 4.0 3.8 6.6 5.6 4.8 8.1 6.2Construction 6.8 6.6 6.2 6.7 6.6 6.7 6.4 6.3Trade, Hotel & Restaurant 6.5 6.4 6.1 4.8 5.9 4.8 4.5 4.2Transport and Communication 9.6 10.9 9.9 10.3 10.2 10.2 9.8 9.0Financial, Ownership and Business 8.2 7.7 7.6 6.8 7.6 6.1 6.2 6.0Services 6.5 4.5 5.6 5.3 5.5 5.7 5.7 6.5Gross Domestic Product 6.0 5.8 5.6 5.7 5.8 5.2 5.1 5.0Source : BPS-Statistics Indonesia

Table 1.2Economic Growth - Supply Side

20132014

Sector2013

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construction sector. Meanwhile, West Nusa Tenggara suffered a relatively deep contraction due to sluggish performance in the mining sector. Conversely, economic growth in Eastern Indonesia rebounded thanks to the recommencement of mineral exports. Meanwhile, the economy of Java (excluding Jakarta) benefitted from robust and stable growth as manufacturing exports continued to improve in line with the US recovery (Figure 1.1).

Figure 1.1. Economic Growth by Region – Quarter III 2014

In line with the sluggish domestic economy, the unemployment rate climbed in August 2014 to 5.94% from 5.70% in February 2014. The higher unemployment rate stemmed from a decline in labour absorption in line with slower growth in the manufacturing industry, the transportation and communications sector, the financial and services sector as well as other sectors. Meanwhile, labour absorption in the agricultural sector remained stable but actually increased in the construction and trade sectors.

Indonesia Balance of Payments

The Indonesia balance of payments (BoP) continued to improvein line with the economic rebalancing process currently underway towards more balanced and sustainable growth. In general, the BoP surplus swelled in the third quarter of 2014 to US$6.5 billion from US$4.3 billion in the preceding quarter (Graph 1.18). The growing BoP surplus was the result of a shrinking current account deficit, which ultimately augmented foreign exchange reserves from US$107.7 billion at the end of the second quarter to US$111.2 billion at the end of the third quarter. The current position of foreign exchange reserves in Indonesia is equivalent to 6.3 months of imports and servicing public external debt, which is well in excess of international adequacy standards. In October 2014, the position of foreign exchange reserves increased again to US$112.0 billion (Graph 1.19).

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Graph 1.18. Indonesia’s Balance of Payment

Graph 1.19. Indonesia’s International Reserves

Stabilisation policy instituted by Bank Indonesia in conjunction with the Government helped to reduce the current account deficit. The current account deficit totalled US$6.8 billion (3.07% of GDP) in the third quarter of 2014, compared to US$8.7 billion (4.06% of GDP) in the previous quarter and US$8.6 billion (3.89% of GDP) in the same period of the preceding year (Graph 1.20). Current account performance thrived on a commodity trade balance that rebounded to a surplus in line with the non-oil/gas trade surplus, amidst a persistently large oil and gas trade deficit (Graph 1.21). The growing non-oil/gas trade surplus, in comparison to the previous quarter, was attributed to a decline in non-oil/gas imports, especially of raw materials, in line with moderating domestic demand. Annually, non-oil/gas imports contracted 2.7% in the third quarter of 2014. On the other hand, exports of primary products surged as licenses to recommence mineral exports were granted, which contributed to the non-oil/gas surplus despite non-oil/gas exports in general noting a deceleration. Despite a quarterly decrease, annual growth of non-oil/gas exports rebounded to 3.1% in the third quarter after two years of decline. Non-oil/gas export growth was the result of higher export prices and greater demand, primarily affecting vegetable oil and manufactured products. Furthermore, as the US recovery endured, a number of manufacturing export products enjoyed an upsurge, including textiles and textile products, metal products, processed foods as well as automobiles and their component parts. In terms of the oil and gas account, a large oil and gas trade deficit in the reporting quarter originated from persistently high oil and gas imports against a backdrop of declining oil exports due to tumbling international prices. In addition, pressures on the current account deficit were alleviated by seasonal trends in terms of smaller deficits in the services account and the primary income account.

Graph 1.20. Current Account Graph 1.21. Trade Balance

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Investor confidence in the economic outlook of Indonesia remained positive, which maintained the influx of foreign capital flows. In the third quarter of 2014, the capital and financial account surplus swelled to US$13.7 billion as the deluge of foreign capital in the form of direct investment and the withdrawal of corporate external loans was maintained (Graph 1.22). On the other hand, inflows of portfolio investment ebbed in comparison to the previous quarter as a result of external and domestic sentiment factors. Furthermore, domestic deposits placed internationally also increased. In general, the capital and financial account surplus remained large in the third quarter of 2014 and could fully offset the current account deficit despite being not as large as the US$14.3 billion surplus reported in the second quarter.

Graph 1.22. Capital and Financial Account

Rupiah Exchange Rate

The rupiah depreciated as a result of global sentiment. In the third quarter of 2014, the rupiah depreciated by an average of 1.2% (qtq) to a level of Rp11,770 per US dollar. Point-to-point, however, the rupiah depreciated by 2.71% to a level of Rp12,185 per US dollar (Graph 1.23). Depreciatory pressures on the rupiah stemmed from external as well as internal factors. Concerns over the Federal Reserve’s plan to normalise monetary policy, global geopolitical dynamics and the global economic downturn triggered external pressures that were felt by currencies in the region, including Indonesia (Graph 1.24). Internally, however, the wait-and-see attitude of investors concerning the formation of a new government cabinet and future government work programs sparked internal pressures. Depreciatory pressures on the rupiah in the third quarter of 2014 were confirmed by a number of external indicators, such as the VIX Index and CDS, which increased (Graph 1.25). Nonetheless, rupiah exchange rate volatility was well mitigated and lower than that recorded on the Turkish lira, Brazilian real and South African rand (Graph 1.26).

Depreciatory pressures on the rupiah persisted into October 2014. On average, the rupiah depreciated 2.01% (mtm) to a level of Rp12,142 per US dollar. Point-to-point, however, the rupiah appreciated 0.83% and closed at a level of Rp12,085 per US dollar. Ongoing depreciation was a result of growing concerns regarding the global economic downturn. Moving forward, Bank Indonesia will continue to maintain exchange rate stability in line with its fundamental value.

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Graph 1.23. Exchange Rate

Graph 1.24. Apr./Depr. Regional Currencies

Graph 1.25. VIX and CDS

Graph 1.26. Exchange Rate Volatility (Peer Group)

Inflation

Inflation was controlled and maintained a downward trend, thereby supporting the prospect of achieving the inflation target in 2014 at 4.5±1%. Inflation was 4.53% (yoy) in the third quarter of 2014, which is lower than the 6.70% (yoy) posted in the preceding quarter. Lower inflation was attributable to controlled core inflation and inflation of volatile foods. Core inflation was controlled due to declining international commodity prices, moderating demand and anchored inflation expectations. Meanwhile, inflation of volatile foods remained relatively low in line with abundant supply. In contrast, inflation of administered prices escalated as a result of higher electricity rates and more expensive 12 kg LPG canisters. Controlled inflation endured into October 2014, despite climbing to 4.83% (yoy).

The easing trend of inflationary pressures during the third quarter of 2014 was bolstered by relatively low inflation of volatile foods at a level of 4.21% (yoy) in the quarter, compared to 6.74% (yoy) in the previous period (Graph 1.27). The drop in volatile food inflation was due to plentiful supply of foodstuffs and relatively uninterrupted distribution. The corrected prices of various Alliums (onions, garlic and shallots) helped ease inflationary pressures in line with abundant supply as the main harvest season persisted at many production centres. Meanwhile, a relatively low price of rice was maintained due to copious supply at the end of the second (gadu) rice harvest. Furthermore, the delayed El Nino weather phenomenon until the fourth quarter also helped mitigate inflation of volatile foods during the reporting quarter.

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Inflation of volatile foods increased to 0.24% (mtm) in October 2014 (Graph 1.28). Higher inflation was the result of rising chilli prices due to drought at various production hubs (West Java, East Java and the Special Region of Yogyakarta). Additionally, spiralling rice prices due to drought at several production centres (including East Java and the Special Region of Yogyakarta) and increasing demand from outside of Java also contributed to volatile food inflation. Looking forward, the government will begin to gradually import more rice up to the end of the year in anticipation of higher prices. On the other hand, further increases in volatile food inflation will be offset by price corrections affecting chicken meat and eggs as supply surges and demand subsides. Furthermore, the price of cooking oil was also corrected in light of lower international CPO prices.

Graph 1.27. Diaggregation of Inflation

Graph 1.28. Volatile FoodInflation/Deflation

Declining inflation during the third quarter of 2014 was supported by controlled core inflation as domestic and external pressures eased. Core inflation was recorded at 4.04% (yoy) in the third quarter, which is down on the 4.81% (yoy) posted in the previous quarter. Lower international commodity prices alleviated core inflationary pressures amidst rupiah depreciation at the end of the quarter. Domestically, despite increasing due to seasonal factor of Eid-ul-Fitr and the new academic year, fundamentally demand pressures eased in line with declining economic activity. In addition, inflation expectations were also well anchored during the third quarter.

Controlled core inflation persisted into October 2014 in line with moderating domestic economic growth amidst escalating external inflationary pressures. Moderating domestic demand was reflected by a decline in actual non-traded core inflation of foodstuffs and non-foods as inflation of education services eased due to the conclusion of the academic year. Non-traded core inflation of foodstuffs decreased as demand returned to normal after Eid al-Adha. Meanwhile, the decline in non-traded core inflation of non-foods was precipitated by less intense inflationary pressures on education services as the academic year came to an end (Graph 1.29). Conversely, external inflationary pressures mounted as the rupiah continued to depreciate and international commodity prices increased slightly. As a monthly average, the rupiah depreciated 2.05% (mtm) from Rp11,897 (September) to Rp12,141 (October). On the other hand, international commodity prices experienced a moderate rebound, evidenced by a slight rally of 0.05% (mtm) on the Imported Inflation Price Index (IIPI), as food prices increased (sugar, maize and wheat) due to delayed harvests in the United States. In contrast, price corrections also affected non-foods, such as gold. The gold price correction was transmitted to domestic gold jewellery prices. When gold is omitted, however, traded core inflation remained sufficiently low at just 0.29% (mtm), which is up slightly on the 0.22% (mtm) recorded in the preceding month (Graph 1.30).

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Graph 1.29. Educational Cost Inflation Graph 1.30. Core Traded Inflation and External Factor

Indications surfaced of higher inflation expectations stemming from planned fuel price hikes. Accordingly, the inflation expectations of retailers increased up to yearend 2014 in line with growing concerns over planned fuel prices hikes (Graph 1.31). In addition, higher inflation expectations were also prevalent in the financial sector (Graph 1.32).

Graph 1.31. Retailer’s Inflation Expectation

Graph 1.32. Financial Sector’s Inflation Expectation

Meanwhile, inflationary pressures from administered prices escalated in line with higher electricity rates and more expensive 12 kg LPG canisters. The Phase I (1st July 2014) and Phase II (1st September 2014) increase of residential electricity rates (R-1 and R-2), together with the adjusted tariff for R-3 properties (>6,600 VA), exacerbated the contribution of electricity rates to inflation amounting to 0.25% (Graph 1.33). Furthermore, a spike in seasonal demand in the run up to Eid-ul-Fitr prompted higher transportation fares, such as intercity transport and airfares. Pressures from administered prices persisted into October 2014, increasing from 6.53% (yoy) in the previous month to 7.57% (yoy). The increase primarily stemmed from Phase II electricity rate hikes and the knock-on effect of more expensive 12 kg LPG canisters, which led to a scarcity of 12 kg canisters and higher prices of 3 kg canisters as demand outstripped supply. In addition, higher airfares were also a source of pressure on administered prices during the reporting period (Table 1.3).

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Table 1.3. Administered Prices Inflation Contributor

Graph 1.33. Increase and Contribution of Residential Electricity Rates 2014

Geographically, inflationary pressures in various regions were relatively well controlled during the third quarter of 2014 in line with low volatile food inflation due to abundant food supply amidst stronger demand in the approach to religious festivities. Nevertheless, several regions, such as West Sumatra, Bengkulu, Bangka Belitung, Banten and West Kalimantan, reported high inflation in excess of 6% (yoy) as an impact of higher electricity rates and more expensive 12 kg LPG canisters. Annual inflation (yoy) in various regions tended to increase during October 2014 as a knock-on effect of higher electricity rates and 12 kg LPG canisters. In addition, volatile food inflation was also a source of inflationary pressures as the planting season commenced against a backdrop of drought stemming from prolonged dry spells. A number of regions, such as West Sumatra, Banten, Central Sulawesi and North Sulawesi, reported inflation above the national average (4.83%) in the range of 6-7%. In contrast, several other regions, such as West Java, South Sulawesi, Southeast Sulawesi and East Java experienced inflation below the national average in the 3.3-4.6% range (Figure 1.2).

Figure 1.2. Map of Inflation by Region (%, yoy)

Moving ahead, an increase in the provincial minimum wage is expected to have a relatively limited impact on inflation. Up to the first week of November 2014, the increase in the provincial minimum wage in 11 provinces totalled a weighted average of 10.94%, which is lower than the nearly 15% noted in the previous year. In 2014, as many as 16 provinces set their minimum wage at a level exceeding the basic living wage, while a number of other provinces maintained a minimum wage below the basic living wage, with a ratio of 84%. A greater increase in the basic living wage compared to the increase in CPI

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inflation was due to the large portion food accounts for in the living wage (Graph 1.34). Nonetheless, the impact on inflation of higher provincial minimum wages is predicted to be relatively limited as the increase is not fully transmitted to the manufacturing industry because the level of nominal wages in the sector already exceeds the minimum requirements (Graph 1.35). Furthermore, the impact of higher minimum wages on pay in the informal and household sectors is also limited.

Graph 1.34. Basic Living Wage and Inflation

Graph 1.35. Wages in Manufacturing Sector and Provincial Minimum Wages

Monetary Development

Interest rates and money supply remained consistent with the monetary policy stance adopted by Bank Indonesia. During the third quarter of 2014, the interbank rate was relatively stable, while bank interest rates continued to climb. Higher bank rates, against the backdrop of an economic downswing in the reporting quarter, further influenced the dynamics in economic liquidity. For instance, liquidity on the interbank money market remained relatively stable, whereas bank liquidity tended to increase.

The interbank money market was characterised in the third quarter of 2014 by a relatively stable overnight interbank rate, while average transaction volume declined. Such conditions denote comparatively stable overnight interbank liquidity conditions. The weighted average overnight interbank rate was relatively stable compared to the preceding quarter at 5.86%. A stable interbank rate led to a steady 11 bps spread between the overnight interbank rate and the overnight deposit facility rate. Meanwhile, the spread between the overnight interbank rate and the BI rate was also stable at 164 bps, indicating adequate liquidity on the interbank money market. Average interbank transaction volume declined from Rp12.1 trillion to Rp11.8 trillion, while average overnight deposit facility transaction volume increased to Rp129.4 trillion from Rp88.5 trillion (Graph 1.36). Overnight tenors, with a declining frequency from Rp4.4 trillion to Rp3.9 trillion, contributed to the decrease in interbank transaction volume. Notwithstanding, the weighted average of interbank rates for a variety of tenors was reasonably stable with a tendency to decline in the longer term (Graph 1.37).

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Graph 1.36. Overnight Interbank Market Rates

Graph 1.37. Weighted Average of Overnight Interbank Rates Per Tenor

Bank interest rates continued an upward trend during the third quarter of 2014. One-month term deposits increased 18 bps to a level of 8.48% from 8.30%, while the weighted average lending rate jumped 11 bps to 12.87% from 12.76% (Graph 1.38). The increase in the weighted average lending rate was primarily contributed by working capital credit, which increased 15 bps to 12.78%. Meanwhile, investment credit increased 10 bps to 12.34% and consumer loans 8 bps to 13.38% (Graph 1.39). Higher interest rates are the result of monetary policy transmission that persisted during the third quarter of 2014. Consequently, the spread between the lending rate and deposit rate narrowed in the third quarter to 439 bps from 446 bps as the increase in the deposit rate surpassed that of the lending rate.

Graph 1.38. Bank Interset Rates Graph 1.39. Loan Rates Higher bank interest rates in the third quarter of 2014 influenced the dynamics of M2 and M1 growth. M2 growth slowed in the reporting quarter to 11.9% (yoy) from 13.3% (yoy). By component, a decline in quasi-money growth from 14.1% (yoy) in the second quarter to 12.8% particularly contributed to the deceleration in M2. Furthermore, the slowdown in M1 also influenced slower M2 growth. M1 growth slowed to 9.4% (yoy) from 10.2% (yoy) in the preceding quarter as rupiah demand deposits declined from 10.3% (yoy) to 9.1% (yoy), while growth of currency outside banks (COB) decelerated moderately from 9.9% (yoy) to 9.8% (yoy) (Graphs 1.40 and 1.41).

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M o n e t a r y P o l i c y R e p o r t | 21

Graph 1.40. Growth of M2 and Its Components

Graph 1.41. Growth of M1 and Its Components

Based on its determinants, the decline in Net Foreign Assets (NFA) was the primary cause of the decrease in M2 amidst an upward trend in terms of Net Domestic Assets (NDA). NFA growth slowed dramatically to 14.6% (yoy) from 29.2% (yoy), while NDA actually increased from 8.1% (yoy) to 10.5% (yoy). A lower position of foreign exchange reserves held at the central bank along with increasing commercial bank net liabilities to non-residents prompted the drop in NFA, while the increase in NDA stemmed from a surge in the central government’s payables (Graph 1.42).

Graph 1.42. Growth of M2 and

Its Contributing Factors The Banking Industry

Robust banking industry resilience and maintained financial market performance contributed to solid financial system stability. Banking industry resilience remained resolute, with credit risk, liquidity risk and market risk well mitigated and supported by a sound capital base. A thriving capital market during the third quarter of 2014 has bolstered financial market performance despite higher yields of tradeable government securities (SBN) across all tenors (qtq).

Credit growth eased particularly due to slow growth in working capital credit. As of the third quarter of 2014, credit growth had slowed to 13.2% (yoy) from 17.2% (yoy); equivalent to 8.2% (ytd). Working capital credit, with a market share of 48.0%, continued to contribute chiefly to the deceleration in credit growth. Growth of working capital credit and investment credit decelerated correspondingly to 13.3% (yoy) and 16.4% (yoy) from 17.3% (yoy) and 22.5% (yoy) in the second quarter. Furthermore, growth of consumer loans also slowed, from 12.7% (yoy) to 10.1% (yoy) (Graph 1.43). By sector, the trade sector continued to dominate total credit with a share accounting for 22%, followed by the

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manufacturing sector with 18%. Consequently, slower bank credit growth originated principally from the manufacturing industry and trade sector. Credit growth in the manufacturing sector slowed from 24.9% (yoy) to 16.1% (yoy), while credit growth in the trade sector declined from 18.3% (yoy) to 13.9% (yoy) (Graph 1.44).

Graph 1.43. Credit Growth Graph 1.44. Credit Growth by Economic Sector

Deposit growth decelerated moderately as a result of a decline in the Current Account Savings Account (CASA), comprising of demand deposits and savings accounts. During the third quarter of 2014, growth of demand deposits and savings accounts decreased to 7.0% (yoy) and 7.1% (yoy) respectively from 10.2% (yoy) and 9.5% (yoy). Meanwhile, time deposit growth accelerated from 18.5% (yoy) to 21.4% (yoy). Subsequently, slower deposit growth was attributed to a decline in the share of demand deposits and savings accounts (CASA) from 54.2% in the preceding quarter to 53.1% (Graph 1.45). Despite slowing in comparison to the second quarter, deposit growth rebounded in September 2014 to 13.32% (yoy) as the government adopted expansive financial operations. Accordingly, bank liquidity was maintained during the third quarter of 2014.

Graph 1.45. Deposit Growth

Banking conditions were adequately maintained against a backdrop of sluggish economic and credit growth, as evidenced by various banking indicators. Banks capital resilience in the third quarter of 2014 was adequate with a Capital Adequacy Ratio (CAR) of 19.44%. In terms of profitability, bank ROA remained sound at 2.81% despite a moderate decline on the previous quarter (Table 1.4).

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Table 1.4 Banking Indicators

The Stock Market and Government Securities Market

The domestic stock market performed positively during the third quarter of 2014 in line with improvements in domestic economic data. The IDX Composite reached a level of 5,137.58 on 30th September 2014, which is up 5.3% (yoy) on the 4,878.58 achieved in the second quarter. The rally was sparked by euphoria after the election results came out in line with market expectations. The rally was also supported by improved domestic economic data and commitment from the new government to reform subsidised energy policy. From a global perspective, the gains were prompted by an increase in monetary stimuli implemented by China’s government as well as the Federal Reserve’s decision at the FOMC meeting to maintain the policy of low interest rate. The IDX composite performed better than bourses in Malaysia, Singapore and Vietnam but was outperformed by stock exchanges in the Philippines and Thailand (Graph 1.46).

Latest developments indicate slightly weaker stock exchange performance in October 2014. The IDX reached a level of 5,089.55 on 31st October 2014, which is down 1.3% (yoy) on the 5,137.58 achieved in September 2014. Market concerns over political dynamics in parliament, higher inflation expectations due to planned fuel price hikes and rupiah depreciation led to the decline. Global sentiment factors were also blamed, including the political situation in Hong Kong, expectations of a higher Federal Funds Rate and heightened tensions in Ukraine (Graph 1.47).

Graph 1.46. JCI and Global Stock Index Quarter III-2014

Graph 1.47. JCI and Global Stock Index October 2014

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Foreign investor behaviour also precipitated favourable stock market performance. Foreign investors booked net purchases throughout the third quarter of 2014, at a time when positive global economic conditions and investor optimism concerning the domestic economic outlook encouraged foreign investors to expand their shareholdings on the stock market. Consequently, foreign investors booked net purchases totalling Rp4.35 trillion, which is lower than the Rp19.50 trillion booked in the previous quarter. The position of non-resident shareholdings accounted for 65% of the total in the third quarter, with local investors accounting for 35% (Graph 1.48). On October 2014, foreign investors booked net redemptions totalling Rp3.20 trillion in the reporting month compared to Rp7.40 trillion in September as a result of uncertainty surrounding global conditions as well as the wait-and-see attitude of investors concerning the domestic political sphere (Graph 1.49).

Graph 1.48. Foreign Shareholdings in Stock Market

Graph 1.49. JCI and Net Foreign Buy/Sell

On the tradeable government securities (SBN) market, yields increased across all tenors. The increase in yield was triggered by rupiah depreciation as investors waited for the formation of a new government cabinet and its new program, as well as bearish sentiment globally stemming from political unrest in Hong Kong. Overall, yield increased 31 bps in the third quarter of 2014 to 8.37% from 8.06% in the second quarter. Short, medium and long-term yields increased respectively by 36 bps, 34 bps and 19 bps to 7.76%, 8.42% and 9.06%.

Recent developments on the SBN market in October 2014 indicate lower SBN yields for all tenors as a result of bullish sentiment over new leadership in the government. Meanwhile, external positive sentiment factors include additional stimuli instituted by the European Central Bank (ECB) as well as the PMI release in China that exceed expectations. In general for October 2014, yield declined 30.78 bps to 7.95% compared to 8.37% in September. Short, medium and long-term yields decreased respectively by 30.78 bps, 43.83 bps and 51.47 bps to 7.45%, 7.99% and 8.55% (Graph 1.50).

Non-resident investors exploited weaker SBN pricesto augment their holdings on the SBN market. Accordingly, foreign investors booked net purchases totalling Rp43.79 trillion in the third quarter of 2014, exceeding the Rp42.68 trillion booked in the second quarter. During the same period, the SBN holdings of banks, non-residents, insurers and pension funds increased, while the proportion of SBN holdings of Bank Indonesia decreased. Foreign investors purchased tradeable government securities of all tenors, with the share of non-resident SBN holdings increasing from 34.51% in the preceding quarter to 36.17% in the third quarter. In October 2014, foreign investors continued to book net purchases totalling Rp12.49 trillion compared to Rp13.17 trillion in September 2014. The SBN holdings of non-residents, Bank Indonesia and pension funds increased in October,

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while those of banks and insurers decreased. Foreign investors favoured medium and long-tenor SBN, thus non-resident SBN holdings swelled to 36.74% in October 2014 from 36.17% in September (Graph 1.51).

Graph 1.50. Monthly Changes of Governtment Bonds Yield

Graph 1.51. Government Bonds Yieldand Net Foreign Buy/Sell

Non-Bank Financing

Non-bank economic financing was maintained albeit at a lower level than that achieved in the same period of the previous year. Total financing in the third quarter of 2014 through initial public offerings (IPO), rights issues, corporate bonds, medium-term notes, promissory notes and other financial instruments amounted to Rp9.0 trillion, which is well above the Rp3.6 trillion achieved in the same quarter of the preceding year. Notwithstanding, financing up to the third quarter of 2014 totalled Rp73.2 trillion, which is less than the total in the third quarter of 2013 at Rp78.2 trillion.

Developments in October 2014 indicate that total financing through initial public offerings (IPO), rights issues, corporate bonds, medium-term notes, promissory notes and other financial instruments amounted to Rp9.6 trillion, which surpasses the Rp9.0 trillion achieved in October 2013. By component, bonds continued to dominate non-bank financing in October 2014, amounting to Rp4.0 trillion (Table 1.5).

Table 1.5. Non-Bank Financing

Rp Trillion

Okt Q1 Q2 Q3 Q4 Total Okt Q1 Q2 Q3 Total

Nonbank 9.0 16.3 58.3 3.6 34.7 112.9 9.6 23.2 41.1 9.0 82.8

Stocks 6.6 2.8 29.3 2.8 22.7 57.5 2.5 8.8 21.3 0.9 33.4

w/o Financial sector issuers 3.5 0.3 6.0 1.2 9.1 16.6 0.0 3.1 4.3 0.1 7.6

Bonds 2.1 12.7 27.7 0.3 9.9 50.5 4.0 12.8 16.0 6.7 39.4

w/o Financial sector issuers 2.1 9.9 13.5 0.0 7.5 30.8 4.0 6.4 8.2 2.3 20.9

MTN and Promissory Notes 0.3 0.8 1.3 0.6 2.2 4.9 3.1 1.6 3.8 1.4 10.0

w/o Financial sector issuers 0.3 0.7 1.3 0.1 1.1 3.2 1.3 1.2 3.2 1.2 7.0

20142013

M o n e t a r y P o l i c y R e p o r t | 26

The Payment System

In general, the cash payment system performed in line with the development in the domestic economy, particularly household consumption. Average daily currency in circulation during the third quarter was Rp491.3 trillion, equivalent to growth of 12.6% (yoy), lower than that posted in the preceding quarter at 13.9% (yoy) and yet stronger than the 11.1% (yoy) achieved in the same quarter of 2013. The performance of currency in circulation remained in accordance with slower household consumption and GDP growth during the reporting period (Graph 1.52).

Graph 1.52 Currency in Circulation (yoy)

Amidst a slowing growth of currency in circulation, Bank Indonesia continuously strived to improve currency fit for circulation. During the third quarter of 2014, 1.3 billion banknotes and coins unfit for circulation with a value of Rp29.7 trillion were destroyed and replaced with currency fit for circulation. The amount of currency unfit for circulation destroyed in the reporting quarter exceeded the total in the second quarter at 1.1 billion banknotes/coins to the tune of Rp22.6 trillion. The increase stems from an escalation in currency unfit for circulation deposited at Bank Indonesia by the banking industry.

Payment system transactions were securely settled and uninterrupted during the third quarter of 2014. Non-cash payment system transactions increased in terms of both value and volume during the reporting quarter. The increase in transaction value amounted to Rp8,742.8 trillion (26.97%, qtq) and in volume to 36.12 million transactions (3.16%, qtq) on the preceding period (Tables 1.6 and 1.7). During the reporting quarter, the increase in transaction value affected all types of transaction group, particularly monetary transactions. On the other hand, the bump in transaction volume stemmed primarily from public transactions through non-cash instruments in the run up to religious festivities and the 2014 presidential election.

Table 1.6. Value of Non-Cash Payment System

Q I Q II Q III Q IV Q I Q II Q III

BI‐RTGS 18,778.31      21,410.40      26,369.50     24,403.80     23,817.80     24,150.40   29,866.56        

BI‐SSSS 4,939.05        5,299.70        8,259.90       8,233.40       7,173.60       6,396.90      9,366.77          

Clearing 547.87            605.70            680.80           708.00           667.80           710.70         716.36              

Card Payment 917.78            989.60            1,039.40       1,073.90       1,082.20       1,158.52      1,208.91          

Credit Card 51.44              55.20              57.10             59.60             59.78             63.65            64.41                

Debit and ATM/Debit Card 866.34            934.40            982.40           1,014.30       1,022.42       1,094.87      1,144.50          

Electronic Money 0.59                 0.70                 0.90               0.70               0.73               0.83              0.86                  

Total 25,183.59      28,306.10      36,350.50     34,419.80     33,860.26     32,417.39   41,159.47        

Non Cash Payment System 

Transaction

2013 2014

Value (Rp Trillion)

M o n e t a r y P o l i c y R e p o r t | 27

Consistent with the increase in non-cash payment system transaction volume and value during the third quarter of 2014, payments settled through the Bank Indonesia – Real Time Gross Settlement (BI-RTGS) system also increased in terms of both transaction volume and value. The availability of the Bank Indonesia – Real Time Gross Settlement (BI-RTGS) system as a means to settle funds, BI-SSSS to settle government and Bank Indonesia securities as well as the National Clearing System achieved 100% during the third quarter of 2014. Payment transaction value settled through the BI-RTGS system increased Rp5,716.17 trillion (23.67%, qtq) from Rp24,150.39 trillion in the previous quarter to Rp29,866.56 trillion in the reporting period. Similarly, payment transaction volume settled through the BI-RTGS System also increased, by 48.60 thousand transactions (1.09%, qtq) from 4.47 million in the second quarter to 4.52 million in the third.

Tabel 1.7 Volume of Non-Cash Payment System

Q I Q II Q III Q IV Q I Q II Q III

BI‐RTGS 4,250.03        4,499.00        4,263.50            4,621.00               45,226.01          4,471.34            4,519.95           

BI‐SSSS 34.16              34.20              28.50                  35.13                     32.92                  38.69                  35.57                 

Clearing 24,341.27      25,946.40      26,270.70          27,751.07             25,179.21          26,786.05          27,102.83         

Card Payment 849,409.97    917,524.30    945,361.60        987,952.48          992,728.89        1,068,963.66    1,099,594.29   

Credit Card 56,667.47      59,557.70      61,329.40          61,543.89             61,867.08          64,241.35          63,045.29         

Debit and ATM/Debit Card 792,742.50    857,966.60    884,032.20        926,408.60          930,861.82        1,004,722.31    1,036,549.00   

Electronic Money 30,728.04      34,259.60      35,850.10          37,063.07             36,827.86          44,245.79          49,374.56         

Total 908,763.47    982,263.40    1,011,774.40    1,057,422.79       1,059,294.88    1,144,505.53    1,180,627.20   

Non Cash Payment System 

Transaction

2013 2014

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M o n e t a r y P o l i c y R e p o r t | 28

ECONOMIC OUTLOOK

Bank Indonesia predicts the economic rebalancing process to continue, bolstered by maintained macroeconomic stability. Economic growth in 2014 is projected at the lower end of the 5.1-5.5% range as a result of weaker-than-expected global GDP growth along with domestic budget cuts. The weaker prognosis for global growth in 2014 undermined export performance to a level below previous projections, while budget cuts eroded government consumption. Economic growth is expected to rebound in 2015 to a projected range of 5.4-5.8% as global conditions continue to improve on the preceding year. Accordingly, the contribution of exports to growth is also forecasted to increase.

Congruous with moderating economic growth, lower inflation is projected than that achieved in 2013, in line with the 2014 inflation target of 4.5±1%. Inflation is expected to increase in the fourth quarter of 2014, assuming continued rupiah depreciation and taking into consideration the high level of actual inflation in October 2014 and recent airfare hikes. Consequently, inflation in 2014 is forecasted to remain on target with the previous projection of 4.5±1% with a bias towards the upper end of the range. Inflation in 2015, however, is predicted to escalate further as a result of adjustments to a number of administered prices, such as the upper limit on airfares and the price of LPG (March and August 2015), as well as intense pressures on volatile foods and an increasingly depreciating rupiah. Nevertheless, inflation in 2015 is projected to remain within the target corridor of 4.0±1%.

Bank Indonesia will continue to monitor the array of risks that overshadow the domestic economic rebalancing process moving forward. From a global perspective, the risks are linked to the planned normalisation policy of the Federal Reserve, economic vulnerabilities in emerging market countries and economic downturns facing a number of countries. Domestically, the risks that demand vigilance include potential inflationary pressures emanating from administered prices, such as subsidised fuel prices and electricity rates. In addition to inflation, domestic risks could also emerge from a potential capital reversal spurred by the Federal Reserve’s normalisation policy and spiralling external debt.

Global Economic Outlook

The global economy is projected to continue improving, albeit at a more moderate pace than previously thought. Global economic growth in 2014 and 2015 is forecasted at 3.3% (yoy) and 3.6% (yoy) respectively, which is revised down slightly from the 3.4%

2

2014 2015

World GDP 3.3 3.3 3.6

Advanced Countries 1.4 1.8 2.3

United States 2.2 2.2 3.0

Euro Zone -0.4 0.8 1.3

Japan 1.5 0.9 0.8

Emerging and Developing Economies 4.7 4.4 4.6

China 7.7 7.4 7.1

India 4.6 5.6 6.4

Other Emerging Market Countries 3.1 2.7 3.0

Table 2.1 World GDP Projection(%, yoy)

Projection2013

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(yoy) and 3.8% (yoy) projected previously. Global growth is buoyed by optimism concerning the US economy, which rebounded in the second and third quarters of 2014 after decelerating in the first quarter due to extreme cold weather. Nonetheless, economic growth projections for Japan and Europe were revised down in line with worsening development indicators. Meanwhile, economic growth projections for developing countries were also revised down but remain robust. World trade volume (WTV) is projected to grow slower in 2014 than previously assumed due to lower actual data in the first semester due to geopolitical issues and extreme inclement weather in the United States.

The global economic recovery is projected to persist on the back of economic momentum in advanced countries. US growth in 2014 and 2015 is predicted at 2.2% (yoy) and 3.0% (yoy) respectively in line with ongoing improvements in terms of production indicators as well as indications of a rebound. The unemployment rate has continued to fall to a level of 5.8% in line with the creation of job openings. Meanwhile, the economic recovery in Europe remains stifled by external and production pressures. Export growth decelerated as demand for exports moderated, especially in China. Furthermore, potential deflation and geopolitical issues in Russia will also persist. The European economy is projected to grow at 0.8% (yoy) in 2014, increasing to 1.3% (yoy) in 2015.

Japan’s economy is projected to remain sluggish due to production weaknesses in line with limited capital growth. Accordingly, the economy of Japan is forecasted to grow at 0.9% (yoy) in 2014 and 0.8% (yoy) in 2015 (Table 2.1).

Departing from the improving economic outlook for advanced countries, limited growth is expected in developing countries. China’s economy continues to follow a downward trend, with growth predicted at 7.4% (yoy) and 7.1% (yoy) in 2014 and 2015 respectively. On the demand side, the slowdown in China is primarily attributed to weaker consumption and investment growth. On the production side, however, slower growth stems from the real estate sector (tertiary industry). Meanwhile, growth in India is forecasted to accelerate beyond previous assumptions. Positive sentiment emerged after the appointmentof a new government cabinet with a promising economic reform agenda. In addition, PMI in India is currently experiencing an expansionary phase accompanied by a stable production index.

World trade volume (WTV) growth is projected at a lower level than previously assumed. Sluggish WTV growth is ascribed to weaker actual data in the first semester due to geopolitical tensions and extreme cold weather in United States. The latest data (August 2014) reveals WTV growth at 2.63% (yoy), which is lower than the 2.72% (yoy) reported in the preceding month. Based on IMF WEO data for October 2014, world trade volume is projected to grow at 3.8% (yoy) in 2014 and 5.0% (yoy) in 2015.

Non-oil/gas commodity prices (IHEX) are expected to grow in line with previous assumptions in 2014, while a contraction is predicted in 2015 that surpasses the previous assumption. The IHEX decline in 2015 is congruent with the projections of the World Bank and IMF, which also predict a decline in non-oil/gas prices. IHEX in 2015 is projected to grow negatively at -0.16% in line with tumbling coal prices in response to abundant supply. Demand for coal is also moderating, particularly from China as the largest coal consumer where an economic downswing is ongoing.

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Domestic Economic Outlook

GDP is predicted to grow more slowly in the fourth quarter of 2014. Slower GDP growth will stem from weaker government consumption as a result of budget cuts. Limited export growth will persist in line with sluggish world trade volume and a weak rebound in terms of international commodity prices. Additionally, household consumption is expected to grow slowly in line with consumer income expectations that have not increased as well as limited sales data. In response to the export outlook and post-election business activity, investment is predicted to increase. Meanwhile, imports are expected to mirror export performance, namely to experience negative growth in the fourth quarter. Consequently, economic growth in 2014 is projected in the range of 5.1-5.5%, which is lower than that achieved in 2013.

The pace of growth during 2015 is predicted to hasten in the range of 5.4-5.8%. In comparison to the preceding year, domestic economic performance is forecasted to improve in line with global economic momentum and a growing contribution from exports. On top of external factors, internal factors such as higher incomes and lower inflation will stimulate domestic demand.

Slower household consumption is projected in the fourth quarter of 2014 in line with consumer income expectations that have not increased as well as weak sales indicators. Several measures of consumer income indicate a deceleration in terms of consumption. The average nominal increase in the provincial minimum wage in 2015 (preliminary data from 19 provinces) is just 13.73%, which is lower than that recorded in 2014 at 16.17%. The salary increase of civil servants has been set at 6% in 2015, the same as the previous year. Furthermore, slow growth in terms of consumer purchasing power among non-formal workers is predicted. Farmers’ terms of trade will also grow slowly and likewise the real wages of farmers. Additionally, uncertainty surrounding future economic conditions, including fuel price hikes, will influence consumer confidence. The performance of several retail sales indicators corroborated weaker household consumption. Automobile sales also declined in October, continuing the trend of the preceding month. National motorcycle sales also decreased in October with weak sales expected to endure until yearend. In general, household consumption indicators are in line with steady figure in composite leading indicators (CLI).

Government consumption is projected to contract in line with budget cuts. According to seasonal trends, government consumption will pick up in the fourth quarter. Notwithstanding, budget realisation up to the third quarter of 2014 remains low due to

%Y-o-Y, Tahun Dasar 2000

I II III IV I II IIIPrivate Consumption Expenditure 5.2 5.1 5.5 5.3 5.3 5.6 5.6 5.4 5.2 - 5.6 5.0 - 5.4Government Expenditure 0.4 2.2 8.9 6.4 4.9 3.6 (0.7) 4.4 0.8 - 1.2 4.9 - 5.3Gross Fixed Capital Formation 5.5 4.5 4.5 4.4 4.7 6.0 5.2 4.0 4.9 - 5.3 6.3 - 6.7Export of Godds and Services 3.6 4.8 5.2 7.4 5.3 (0.4) (0.8) (0.7) (0.5) - (0.1) 4.2 - 4.6Import of Godds and Services 0.0 0.7 5.1 (0.6) 1.2 (0.7) (5.1) (3.6) (3.2) - (2.8) 3.5 - 3.9GDP 6.0 5.8 5.6 5.7 5.8 5.2 5.1 5.0 5.1 - 5.5 5.4 - 5.8Source : BPS - Statistics Indonesia*Bank Indonesia's Projection

Economic Growth - Demand SideTable 2.2

Component2013

2014* 2015*20132014

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ongoing budget cuts. Nominally, government consumption is projected to grow by just 2.9% (yoy) in the fourth quarter in line with less government procurement spending.

Limited investment growth is predicted in the fourth quarter of 2014 in accord with the inauspicious export outlook and sluggish household consumption growth. Investment is expected to grow moderately at 4.39% (yoy) during the fourth quarter in line with a decline in the business tendency index published by BPS-Statistics Indonesia. In general for 2014, the Indonesia Investment Coordinating Board (BKPM) targets investment amounting to Rp450 trillion, representing growth of 15%, which is lower than the 25% achieved in 2013. Meanwhile, investment funding support is declining, reflected by moderating real growth of investment credit allocation by the banking industry in October 2014. Support in the form of government capital spending is also limited as a result of budget cuts. Up to September 2014, the realisation of new capital spending totalled Rp59.8 trillion (37.2% of the target), which is lower than that in the preceding year at Rp72.3 trillion (37.5% of the target). In line with budget absorption trends over the past few years, government capital spending will peak in the fourth quarter of 2014.

Export growth will be stifled in the fourth quarter of 2014 by weak trade volume growth both in emerging market and advanced countries. Trade volume in emerging market countries followed a downward trend during the third quarter of 2014 (up to August), which is expected to persist in line with low GDP growth in emerging market countries. Less trade is expected to undermine gains in terms of manufacturing exports. Furthermore, the absorption of imports from advanced countries will also decline, as indicated by the import trade volume of advanced economies that decreased in August. The ongoing trend of lower non-oil/gas prices will continue to place pressure on general export performance in Indonesia.

In line with export performance, negative import growth is expected in the fourth quarter of 2014. A contraction in imports of capital goods will precipitate limited imports in the fourth quarter, as indicated by persistently declining capital goods imports up to September. This prognosis is based on weak non-construction investment activity, which undermines the incentive to import capital goods. Notwithstanding, a potential rebound in imports could occur, particularly imports of raw materials. In September 2014, raw material imports had begun to rebound, achieving 8.3% (yoy) growth, in the form of commercial foodstuffs (raw and processed), raw materials for industry and raw materials for industrial machinery.

Household consumption is projected to grow in the range of 5.0-5.4% in 2015, which is lower than that posted in the preceding year in line with economic moderation and the base effect of the general election held at the beginning of 2014. Additionally, weaker household consumption in 2015 is also linked to higher inflation as a result of further hikes to the LPG price and electricity rates. Nevertheless, household consumption growth in 2015 will remain robust in excess of 5% due to the demographic advantage of a large working-age population. Indonesian consumers are also increasingly optimistic, as evidenced by the Global Consumer Confidence Nielson survey conducted in the third quarter of 2014, which placed Indonesian consumers second highest in the world.

Investment in 2015 is projected to accelerate on the preceding year to around 6.3-6.7%, primarily contributed by construction investment in line with the large demand for infrastructure to support economic development. After successfully traversing the political year of 2014, investment growth is expected to surge in 2015 in line with greater economic

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and political assurance. In addition, the favourable perception investors have concerning the business climate in Indonesia will also bolster investment activity. The results of the latest Ease of Doing Business survey conducted by the World Bank revealed greater competitiveness in Indonesia across a number of areas. The results of an Economic Intelligent Unit (EIU) survey showed that excluding BRICS countries, Indonesia is the most promising country in terms of potential economic growth.

In general, export growth is expected to pick up in 2015 as the global economic recovery persists and mineral exports rebound further. Indonesian exports to advanced countries, such as US and Germany, should offset limited exports to countries experiencing economic moderation, including China and Japan. Export performance is supported by measures to boost competitiveness, for instance more competitive exchange rates, controlled inflation as well as market and product diversification.

Import growth in 2015 is projected to accelerate as domestic demand increases and export activity intensifies. In line with stronger investment growth, imports of capital goods in the form of machinery and equipment will also increase. Production activity to meet the domestic and export demand will also stimulate demand for imported raw materials. Meanwhile, imports of consumer goods are projected to maintain pace with robust household consumption growth.

The agricultural sector is projected to decelerate in the fourth quarter of 2014, stemming from declining rice production in accordance with BPS forecasts and less palm oil production. Palm oil production at PT Astra Agro Lestari (AALI) declined in the third quarter of 2014. Nevertheless, there are a number of positive factors including increased food crop production. Such increase was particularly observed in maize and soybean due to a prolonged dry season, which encouraged farmers to diversify land use from rice to maize. The fisheries subsector is also predicted to perform better, as evidenced by increased export growth in the third quarter of 2014.

Mining sector performance is projected to continue improving as mineral exports recommence and oil lifting expands. At the end of September 2014, Newmont was permitted to recommence exports of mineral concentrates to a number of countries, including Germany, South Korea, India, Bulgaria and Sweden, totalling 50 thousand tons per month. Production at Freemont also accelerated dramatically, with gold production growing 43% (yoy) in the third quarter of 2014. Against a backdrop of sliding coal prices, production at PT Adaro still achieved 2.2% (yoy) growth in the third quarter through operational efficiency and a declining stripping ratio.

%Y-o-Y, 2000 Price

I II III IV I II IIIAgriculture 3.7 3.3 3.3 3.8 3.5 3.2 3.4 3.7 3.3 - 3.7 3.1 - 3.5Mining and Quarrying 0.1 (0.6) 2.0 3.9 1.3 (0.4) (0.3) 0.3 0.0 - 0.4 2.3 - 2.7Manufacturing Industries 6.0 6.0 5.0 5.3 5.6 5.1 5.0 4.6 4.6 - 5.0 4.7 - 5.1Electricity, Gas and Water Supply 7.9 4.0 3.8 6.6 5.6 4.8 8.1 6.2 6.1 - 6.5 5.9 - 6.3Construction 6.8 6.6 6.2 6.7 6.6 6.7 6.4 6.3 6.4 - 6.8 6.4 - 6.8Trade, Hotel & Restaurant 6.5 6.4 6.1 4.8 5.9 4.8 4.5 4.2 4.3 - 4.7 5.1 - 5.5Transport and Communication 9.6 10.9 9.9 10.3 10.2 10.2 9.8 9.0 9.3 - 9.7 9.7 - 10.1Financial, Ownership and Business 8.2 7.7 7.6 6.8 7.6 6.1 6.2 6.0 6.0 - 6.4 6.0 - 6.4Services 6.5 4.5 5.6 5.3 5.5 5.7 5.7 6.5 5.6 - 6.0 4.7 - 5.1Gross Domestic Product 6.0 5.8 5.6 5.7 5.8 5.2 5.1 5.0 5.1 - 5.5 5.4 - 5.8Source : BPS-Statistics Indonesia* Proyeksi Bank Indonesia

Table 2.3Economic Growth - Supply Side

20132014* 2015*2013

2014Sector

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Slower growth is projected for the manufacturing sector in the fourth quarter of 2014 based on several indicators such as automobile and motorcycle sales that continued to contract in October 2014. Meanwhile, the Industry Production Index published by BPS-Statistics Indonesia was lower in the third quarter of 2014 than the previous two quarters. The Purchasing Managers’ Index (PMI) released by HSBC further confirmed weaker manufacturing sector performance up to October 2014. In addition, declining CPO production in the third quarter of 2014 is also evidence of weaker manufacturing sector performance.

Growth in the utilities sector (electricity, gas and sanitary water) is also forecasted to decelerate in the fourth quarter of 2014. The predicted slump in manufacturing production will precipitate less electricity consumption. Furthermore, incrementally higher residential and commercial electricity rates will also influence electricity subsector performance. The city gas subsector is also projected to decelerate, as reflected by distribution growth at PT PGN.

The construction sector is projected to improve in the fourth quarter of 2014 in line with post-election historical trends. Based on information from property consultant Jonas Lang Lasalle, investors are adopting a wait-and-see attitude towards the results of the recent presidential election in order to avoid risk. Such circumstances are further substantiated by the stagnant sovereign rating affirmed by S&P, held at BB+ due to a low score in terms of government effectiveness.

The trade, hotels and restaurants (THR) sector is forecasted to improve in the fourth quarter of 2014 as export trade begins to rebound. The up-trending Retail Sales Index in October 2014 illustrates the projected improvements in the trade, hotels and restaurants (THR) sector. Meanwhile, hotel subsector indicators also improved up to September 2014.

Persistently robust growth is predicted for the transportation and communications sector in the fourth quarter of 2014 as air and rail transportation continues to expand. Stronger growth in the air transportation subsector is evidenced by an increase in the number of passengers and new routes available on a number of airlines. Transportation subsector performance is further buoyed by solid growth in the rail subsector after the operation of the Jakarta-Surabaya double track. On the other hand, moderating growth will stem from the communications subsector, which is projected to slow down after completion of the election campaigns. Road transportation also contributed to moderating growth as infrastructure remains unconducive to logistics.

In the fourth quarter of 2014, the financial, leasing and services sector will achieve limited growth. Bank credit and non-bank financing growth data up to September 2014 indicates a slowdown. On the other hand, the real estate subsector is projected to improve in line with the post-election historical trend of construction sector growth.

In 2015, the manufacturing industry is projected to grow in the 4.7-5.1% range. A sluggish global economy, coupled with sliding international commodity prices, will undermine external demand for industrial goods. Notwithstanding, growth will be maintained in this sector due to support from (secondary) manufacturing sector realisation as the primary destination for foreign investment from 2010 until the second quarter of 2014. Amidst such optimism, the manufacturing sector will confront the challenge of incrementally higher commercial electricity rates throughout 2015.

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The trade, hotels and restaurants (THR) sector is predicted to grow relatively stably in the range of 5.1-5.5%. THR sector growth is driven by tenacious public purchasing power in line with anchored inflation expectations. Retail, as a supporting industry, is projected to expand rapidly, including those outside of Java. A growing tourism industry in line with government efforts to raise the number of international and domestic tourist visitors through the marketing and promotion of 18 tourist destinations should bolster sector expansion. Such optimism will, in turn, benefit supporting industries, such as hotels, restaurants, transportation and retail. The THR sector, however, also faces a number of salient challenges, for example higher leasing costs, workers’ wages and licensing costs.

The transportation and communications sector is expected to continue following the positive growth trend achieved over the past few years, namely in the 9.7-10.1% range. Escalating trade and import/export activity will drive transportation subsector performance. In terms of land transport, smelter construction projects are predicted to buoy logistics businesses in line with the potential requirement to convey mined materials from the mine to the smelter. Pursuant to the national strategy to strengthen connectivity, the Government is also building transportation facilities, including 75 buses and 48 diesel-powered trains. In terms of maritime transportation, the Government is continuously striving to strengthen the maritime-based logistics network and connectivity. To that end, Kuala Tanjung and Bitung were designated as international ports. Meanwhile, in line with technological development and a thriving middleclass, the requirement for communication networks will continue to expand. Latest developments indicate that download speeds, as a proxy of demand for broadband and mobile networks, are continuing to increase. Notwithstanding, Indonesia is being left behind other countries in this regard. Consequently, there remains a large potential to expand data communication capacity.

The financial, real estate and corporate services sector is projected to grow moderately in the 6.0-6.4% range. The prospects of the banking industry are expected to begin improving, signalled by stronger credit growth after a year of deceleration as a consequence of the economic stabilisation process. Stronger credit growth will ultimately boost the net interest margin (NIM).

The mining sector is projected to rebound, achieving growth in the 2.3-2.7% range. From a domestic standpoint, the promising outlook is congruent with the plan to commence operations at 15 smelters in 2015, which will bolster mining sector performance to meet additional demand for raw materials. Externally, however, prolonged negative growth in terms of international commodity prices could stifle mining sector performance. Meanwhile, oil and gas subsector performance is projected to improve as oil production is ramped up at the Cepu Block, which has the potential to lift 165 thousand barrels per day. Furthermore, a number of upstream projects, which are dominated by the gas sector, will also foster stronger sector performance.

The utilities sector (electricity, gas and sanitary water) is projected to expand in the range of 5.9-6.3%. The electricity subsector contributes favourably to growth in line with the 7,761 MW of additional electrical capacity planned for 2015, sourced from the planned operation of a gas power plant in Bali and a thermal power plant in Karimunjawa. In the gas subsector, the Government is striving to expand the allocation of natural gas, primarily to meet the commercial requirement along with that for electricity and fertiliser. More than 59% of gas production will be utilised to meet the domestic requirement.

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The construction sector will experience stable growth in 2015 at around 6.4-6.8%. Sector development is supported by government efforts to improve the capacity and quality of the infrastructure network. The government’s work plan in 2015 in relation to infrastructure development involves the construction of 143.1 km of new roads, 264.7 km of new railways, 50 ferry ports, 21 dams and 15 new airports. In addition to infrastructure projects, construction sector performance will be bolstered by the large housing backlog. In 2015, the Government aims to reduce the housing backlog to 11.5 million homes from 15 million in 2014. Such circumstances will provide an opportunity to construct more housing. Meanwhile, the favourable construction sector outlook is also supported by the manufacturing sector through the planned construction of 13 industrial zones outside of Java and 2 industrial zones on the island of Java as well as the construction of smelters.

The agricultural, livestock, forestry and fisheries sector is projected to grow in the 3.1-3.5% range. Pursuant to the government’s strategy to ensure food security, the agricultural sector is predicted to continue growing, amongst others, through efforts to meet the rice production target of 73.4 million tons and maize target of 20 million tons. Nevertheless, international non-oil/gas prices, which are assumed to maintain negative growth, could potentially undermine gains in the sector. Meanwhile, forecasts of a weak-moderate El Nino global weather phenomenon at the beginning of 2015 will reduce the amount of land allocated to various leading crops. The forestry sector is expected to maintain positive growth in line with mandatory conversion to biodiesel, which will prop up CPO production.

Inflation Outlook

The inflation outlook for 2014 and 2015 is projected in the ranges of 4.5±1% and 4.0±1% respectively. Easing inflationary pressures are a result of consistent macroeconomic stabilisation policy, involving tight coordination with the government. Furthermore, moderating domestic demand and sliding international commodity prices will also contribute to the inflation drop.

Despite increasing during the fourth quarter of 2014, inflation for the year overall is predicted within the target corridor. Higher inflation in the fourth quarter will stem from more rupiah depreciation, high actual inflation in October and an increase in the upper limit of airfares. On the other hand, prices on international markets will remain low due to an abundance of stock from bumper harvests. Future downward price trends will affect gold, wheat, oil and soybean. Consequently, inflation for 2014 will generally tend towards the upper limit of the previous projection.

Inflation in 2015 is projected at a lower rate than in the preceding year, approaching the upper limit of the 4.0±1% inflation target. Inflation expectations will remain anchored through policy support and coordination between Bank Indonesia and the Government. Intense external inflationary pressures are not expected due to relatively limited international commodity price gains coupled with a global economy that continues to recover gradually.

Moderate core inflationary pressures are projected in 2015. Core inflation is estimated within its average historical range. External pressures on core inflation will be relatively well mitigated in line with limited increases in terms of international commodity prices. Meanwhile, exchange rate pressures on inflation, which are less intense than in the previous year, will limit further depreciation in 2015. Inflationary pressures on the demand

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side are also expected to be comparatively minimal. The projected increase in domestic demand will be met through national production capacity utilisation, which is currently low and reflected by below-potential GDP growth. In addition, inflation expectations appear to be well maintained in line with the policy mix instituted by Bank Indonesia in conjunction with the Government.

Inflation of volatile foods is forecasted to escalate moderately in 2015 in line with a potential change in the climate and more rupiah depreciation. The Indonesian Meteorology, Climatology and Geophysics Agency (BMKG) forecasts the wet season in 2014 to commence in December, which is one month later than the initial forecast. The dry season, however, is forecasted to return in April 2015, therefore, the window of water availability for irrigation will be shorter than in previous years. An increase in production is required, accompanied by sound stock management and a more favourable trade system, in order to alleviate inflationary pressures on volatile foods. At the technical level, a solution is required in the form of boosting capacity and enhancing irrigation channels as well as constructing dams in water catchment areas.

Inflation of administered prices will be lower in 2015 than in 2014 but slightly above the historical average. In 2015, price adjustments on a number of strategic goods and services are expected, such as residential electricity rates (6,600 VA) and LPG gas canisters of 12 kg and 3 kg. Furthermore, given the large government subsidies on energy, the distinct possibility remains for further adjustment to administered prices.

Risk Factors

Moving forward, Bank Indonesia will continue to monitor a number of external and domestic economic risk factors. The increasingly integrated global economy has led to greater connectedness between countries. Consequently, an external economic shock could subsequently spread through contagion to the national economy through the trade and financial channels. Meanwhile, the dynamics of the domestic economy also contain risks, including potential inflationary pressures and a plausible capital reversal.

From a global standpoint, the risks faced are still linked to uncertainty surrounding the normalisation policy of the Federal Reserve. At the October 2014 FOMC meeting, the Federal Reserve maintained its accommodative monetary policy stance and explicitly stated that improvements in the labour sector and in terms of inflation had exceeded previous projections. Such conditions indicate the possibility of the Fed raising its policy rate (the federal funds rate) earlier than previously expected. A Bloomberg survey published on 16th October 2014 revealed that the majority of market players are expecting the hike in the FFR to come in the middle of 2015. In other words, respondents who projected a hike in the FFR during the first quarter of 2015 decreased from 8% to 6%, while those who predicted an increase in the FFR in the fourth quarter of 2015 swelled from 11% to 15%.

Global risks will also emerge from economic vulnerabilities in emerging markets as well as sluggish economies in a number of countries. The risk in Indonesia of vulnerabilities from emerging market countries is actually less intense than in other peer countries. Notwithstanding, Indonesia’s position dropped slightly due to the lower realisation of GDP, depreciatory pressures on the rupiah and gains in other countries. Meanwhile, global risks linked to weaker leading economies will stem primarily from China, where growth of 7.5% (yoy) in 2014 and 7.1% (yoy) in 2015 is projected. The economic

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recovery in Europe is also expected to slump in comparison to previous projections. In Japan, production is constrained in line with bearish sentiment due to the recent sales tax hike and exchange rate depreciation as well as weak capital stock, labour market and total factor productivity (TFP).

From a domestic perspective, there are several risks that could endanger economic performance. Inflation risks emerged from the planned hike to subsidised fuel prices and the ongoing scarcity of 3 kg LPG canisters that has spread to outlying areas. Furthermore, adjustments to commercial and residential electricity rates could also exacerbate inflationary pressures. On the other hand, moderate inflation of food prices is projected. In addition to inflation,domestic risks also stem from a potential capital reversal in line with the Federal Reserve’s normalisation policy. Potential outflow is predicted primarily from non-resident investors in government bonds (SUN). Another domestic risk that demands vigilance is increasing vulnerability in terms of the debt-to-GDP ratio and debt-to-export ratio. Notwithstanding,the debt service ratio (DSR) dropped in the reporting quarter to 42.9% from 48.5% in the preceding period.  

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MONETARY POLICY RESPONSE

The Bank Indonesia Board of Governors, convening on 13th November 2014, decided to hold the BI rate at 7.50%, with the Lending Facility and Deposit Facility rates to remain at 7.50% and 5.75% respectively. Such policy is consistent with efforts to guide inflation towards its target corridor of 4.5±1% in 2014 and 4.0±1% in 2015, as well as to reduce the current account deficit to a more sustainable level.

Bank Indonesia considers that the consistent economic stabilisation policy implemented can maintain macroeconomic and financial system stability as well as bolster the economic rebalancing process. Such conditions are reflected by reductions in the current account deficit and managed domestic demand.

Moving forward, Bank Indonesia will remain vigilant of higher inflation expectations in relation to the government’s planned energy policy. To that end, Bank Indonesia will reinforce its monetary and macroprudential policy mix in order to maintain macroeconomic and financial system stability as well as strengthen the structure of the domestic economy. Furthermore, policy coordination between Bank Indonesia and the Government will be intensified in terms of inflation control and reducing the current account deficit in order to ensure measured economic rebalancing and nurture sustainable economic growth.

3

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Box: Notable Cooling of Rising Property Prices

Rising property prices are decelerating due to enforcement of LTV policy and sluggish economic growth. Such conditions alleviated the breakneck pace of rising residential property prices, especially during the past year. Accordingly, indications of a property price bubble also evaporated, as noted in the declining price-to-rent ratio. Meanwhile, rising prices of commercial property have also slowed over the past two years as the domestic economy moderated. Furthermore, less intense market activity is also credited with slowing the pace of rising prices, evidenced by a steep decline in supply-demand, primarily affecting office space, retail and industrial zones.

I. Residential Properties

The rapidity of rising residential property prices has tended to decline since the middle of 2013. The deceleration in prices affected small, medium and large houses alike (Graph 1). Accordingly, growth of mortgage loans has also slowed during the past year (Graph 2). Furthermore, the slowdown in residential property prices has affected all regions of Indonesia almost universally despite double-digit growth maintained in Makassar, Manado and Surabaya due to tenacious demand (Table 1). In general, the notable deceleration in property prices has also precipitated a decline in the price-to-rent ratio, which is indicative of a shrinking property price bubble.

Graph 1. Residential Property Prices –Primary Market

Graph 2. Property Credit Growth

Table 1. Heatmap Inflation of Residential Property

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II. Commercial Properties

Commercial properties, such as offices, apartments, industrial buildings and retail space, have also noted a slowdown in terms of rising prices in line with a slump in economic activity (Graph 3). Demand for office space has waned over the past two years, thereby lowering selling prices and leasing rates. Looking ahead to the next few years, supply is predicted to increase, occasioning a potential decline in occupancy rates and alleviating price pressures (Graph 4).

Graph 3. Commercial Property Price Graph 4. Office Supply-DemandProjection

Activity in the retail subsector has declined during 2014 in comparison to previous years. Furthermore, demand for retail space has also diminished, which offset rising prices when supply was limited (Graph 5). Sales have also declined in terms of industrial space due to limited additional supply in light of inadequate supporting infrastructure (Graph 6). Amidst limited supply, sales figures over the past three years have also evidenced waning demand.

Graph 5. Supply-Demand of Retail Space in Jakarta

Graph 6. Supply-Demand of Industrial Land

Furthermore, the supply-demand condition of (strata title) apartments eased, which slowed the pace of rising selling prices. Nonetheless, demand for leased apartments continued to grow, which raised leasing rates (Graph 7). Consequently, rental rates rebounded after falling for the past three consecutive quarters (Graph 8).

M o n e t a r y P o l i c y R e p o r t | 41

Graph 7. Apartment Sell and Rental Rate (IDR/m2)

Graph 8. Apartment Rental Rate(Annually)

M o n e t a r y P o l i c y R e p o r t | 42

The Monetary Policy Report is published quarterly by Bank Indonesia after the Board of Governors’

Meetings in February, May, August, and November. In addition to fulfilling the mandate of article 58 of Act Number 23 of 1999 concerning Bank Indonesia, amended by Act No. 3 of 2004 and Act. No. 6 of 2009, the report has two main purposes: (i) to function as a tangible product of a forward-looking working framework in which formulation of monetary policy is based on economic and inflation forecasts; and (ii) as a medium for the Board of Governors of Bank Indonesia to present to the public the various policy considerations underlying its monetary policy decisions.

For further information: Policy Regulation and Communication Division Monetary Policy Group Monetary and Economic Policy Department Telp: +62 21 2981 4402/6836 Fax: +62 21 2311219 Email: gkm_komunikasi@bi.go.id Website: http://www.bi.go.id

Board of Governors Agus D.W. Martowardojo – Governor Mirza Adityaswara – Deputy Governor Senior Halim Alamsyah – Deputy Governor Ronald Waas – Deputy Governor Perry Warjiyo – Deputy Governor Hendar – Deputy Governor