IMF warns of threat of capital outflow

Vincent Lingga, The Jakarta Post, Jakarta Fri, 06/11/2010 9:56 AM Headlines

The International Monetary Fund (IMF) charted out Thursday a rosy outlook for Indonesia’s economy for the rest of this year with an estimated growth of 6 percent, but warned the government that a volatile global environment could heighten risk aversion and sharply reverse capital flow.

An IMF mission said at the end of its annual assessment of Indonesian’s economy that volatile capital flow complicated the country’s policy strategy, but it urged the government to maintain its policy of exchange-rate flexibility in responding to changing global conditions.

“Globally, there is a lot of liquidity, but the global environment is still volatile even though the financial situation in Europe has stabilized. If the European situation worsens, then heightened risk aversion could trigger a reversal of capital flow,” Thomas R. Rumbaugh, chief of the mission, told a news conference.

Bank Indonesia (BI)’s Senior Deputy Governor Darmin Nasution revealed last week that more than US$2 billion flew out of the country during the height of the recent Greek debt crisis.
Rumbaugh praised the country’s economic resilience in weathering the 2008-2009 global financial crisis and recent turbulence in Europe and attributed the macroeconomic stability to prudent policies the government has pursued in coping with the recent dramatic shifts in the global economy.

The IMF saw BI’s current monetary stance as appropriate but cautioned that as credit growth recovers, the central bank should act firmly to anchor inflation expectations within the target range of 4-6 percent.

Rumbaugh observed the fiscal outlook this year is also supportive of economic stability and consistent with plans to further reduce public debts relative to gross domestic product, which is currently less than 30 percent.

But he urged the government to focus its fiscal policy on structural reforms.
“The tax ratio is simply too low, the government investment spending is too low due to slow budget execution, and spending on subsidies is too much,” added Rumbaugh, division chief at the Asia and Pacific Department.

Energy subsidies alone accounted for $14.5 billion or almost 13 percent of total government spending this year, while tax revenue as a percentage of GDP is less than 13 percent, the lowest in ASEAN.

He said the IMF’s projection of a 6 percent economic growth this year was based on a strong investment recovery as private consumption growth was estimated to remain at 4 percent.
“If investments, which were rather flat last year, do not recover strongly this year, the growth could be less than 6 percent,” he said.

During its 10-day visit in light of the IMF surveillance mechanism, the mission also discussed with economy ministers about the findings of the financial sector assessment program (FSAP) on Indonesia conducted recently by the IMF and the World Bank.

“The FSAP concluded the financial system has made remarkable progress over the last decade, with most major banks reporting high capital standards, comfortable levels of liquidity and solid profitability,” said Herve Ferhani, deputy director for monetary and capital market department, which co-led the assessment.

However, he warned that the government should promulgate clear-cut, precise legal guidelines for dealing with problem banks because the legal framework currently in place was not adequate. The government is in the process of proposing to the parliament a bill on a financial system safety net.

Ferhani also stressed the need for deepening the capital market with new instruments to provide investors with a wider choice of vehicles and reducing corporate reliance on bank funding as well as strengthening the law-enforcement authority of the Capital Market Supervisory and Financial Institutions Supervisory Agency.

“A capital market with a broader variety of instruments could help stem a sudden threat of a reversal of capital flow during times of market turbulence,” he added.