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Cablegate: Financial Sector Update and Imf Briefing

VZCZCXRO0483
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0243/01 0370801
ZNR UUUUU ZZH
R 060801Z FEB 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 7910
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 1492
RUEHBJ/AMEMBASSY BEIJING 4702
RUEHBY/AMEMBASSY CANBERRA 1969
RUEHUL/AMEMBASSY SEOUL 4389
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 000243

SIPDIS

SIPDIS

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS
SINGAPORE FOR SUSAN BAKER
COMMERCE FOR 4430-BERLINGUETTE
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR FINEMAN
DEPARTMENT PASS EXIM BANK

E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: FINANCIAL SECTOR UPDATE AND IMF BRIEFING

REF: JAKARTA 208

1. (SBU) Summary. The International Monetary Fund Senior Resident
Representative in Indonesia briefed donors on the Indonesian economy
on January 29. The IMF said that GDP growth for 2008 is on target
at 6.1%, lower than the Government of Indonesia's estimate of 6.7%.
Reserves are a healthy $56 billion, covering 200% of short-term
debt. Indonesia may suffer a slowdown due to external factors, and
inflation may be higher than targeted due to global commodity prices
but the overall outlook is reasonably optimistic. One of
Indonesia's most respected economists is deeply skeptical of the
theory that Asia has "decoupled" from western economies, noting that
all emerging markets performance in 2008 will depend heavily on what
happens in the U.S. End Summary.

IMF Staff Visit - Growth 6% in 2008
-----------------------------------

2. (SBU) IMF Senior Resident Representative in Indonesia Stephen
Schwartz and his deputy, Armando Morales presented a briefing to
donors on January 29. They are reasonably optimistic about
Indonesia's economic outlook for 2008, citing stable macroeconomic
trends, robust domestic demand, and signs of higher investment
growth. Foreign exchange reserves are a healthy $56 billion,
covering 200% of short-term debt. Reserves increased by $14.3
billion last year and the Rupiah depreciated about 5%. Although
inflation accelerated in January, headline inflation remains close
to BI's stated target range of 5-7%.

3. (SBU) The IMF expects 6.1% GDP growth in 2008 due to strong
domestic demand momentum and higher investment. Their target is
below the Government of Indonesia's estimate of 6.7%, mainly due to
the IMF's expectation that net export growth will slow significantly
in 2008. The IMF does not anticipate any return to pre-financial
crisis (1997-98) growth rates unless the GOI has some "breakthrough"
on its slow investment and infrastructure. The IMF expects the
final 2007 budget deficit to be 1.2% of GDP, lower than the 1.5%
previously forecasted by the government, due in part to slow
spending rates among regional governments. The banking sector
remains strong. Non-performing loans (NPLs) have declined to 5-6% of
total loans, close to Bank Indonesia's desired maximum of 5%. Loan
growth reached a robust 21% in 2007. According to the IMF
Representative, bank loans to businesses kept pace with loans to
consumers.

4. (SBU) Schwartz noted however, that although growth in China and
India remain strong, the global outlook was "deteriorating almost by
the week," which will affect all emerging markets. Asia is less
dependent on the U.S. as a source of growth and has a diverse export
base. Asia's share of exports to the U.S. has been declining from
around 20% in the 1970s to about half that today. In 2006,
Indonesia's exports as a percentage of total value were well
diversified both in terms of export products (manufactured goods,
oil and gas, agricultural products, etc.) and destination (Japan
21%, EU 12%, U.S. 11%, China 8%, other Asia 31%), limiting the risk
that a US slowdown will significantly slow export growth. However,
as recent volatility has shown, Asian financial markets are not
"decoupled" from the U.S. Other risks to Indonesia's economy
include high international commodity prices, which have increased
uncertainty about the inflation outlook and a recent increase in
foreign currency borrowing in Indonesia, raising the risk of
currency mismatches.

Recent Sovereign Bond Issuance
------------------------------

5. (SBU) In a January 28 meeting with Fauzi Ichsan, a well-respected
economist and Vice President at Standard Chartered Bank, Ichsan
noted that provinces are sitting $10 billion in which they have not
yet spent. Why did the Government of Indonesia (GOI) rush to issue
bonds in the midst of market turmoil? (Note: On January 11, GOI
raised $2 billion from two equally valued bonds, which expire in
2018 and 2038. The 10-year bond yield is 6.95% and the 30-year
bonds offer 7.74%.) The GOI now has to spend more than 100 basis
points (bps) over last year, costing $30 million extra in interest.
Finance Minister Sri Mulyani Indrawati has received a lot of
criticism for this, Ichsan noted. The IMF disagreed noting that had
the GOI waited longer, it might have been worse. There is also the

JAKARTA 00000243 002 OF 003


belief that the first emerging market to issue bonds in the new
calendar year has an advantage with U.S investors. Ichsan said that
Indonesia will be do well by default, as U.S. interest rates drop,
the interest rate differential will make Indonesian sovereign debt
attractive.

Widening Gap Between Rich and Poor, High Food Prices
--------------------------------------------- -------

5. (SBU) Ichsan noted that the main problem in Indonesia is that the
quality of growth is not good. There is a widening gap between rich
and poor. The IMF concurred that there is only sluggish improvement
in the poverty and social indicators. The GOI is considering
another economic policy package to focus more on poverty reduction
and social programs to address this problem. Ichsan noted that
while high commodity prices are largely a global phenomenon, it will
take time for domestic farmers to increase their yields in response
to these trends due to structural inefficiencies in the sector. As
a result, in the absence of government intervention, commodity
prices in Indonesia are likely to remain high for some time,
exacerbating poverty rates. Ichsan does not anticipate much outside
investment in the agriculture in the near term with the exception of
crude palm oil.

Concern About State-Owned Enterprises
-------------------------------------

6. (SBU) The GOI has come to the IMF with concerns about state-owned
Enterprises (SOEs) and the potential liability they present. Their
financial condition is difficult to gauge given the lack of
transparency in their financial statements. The Ministry of Finance
has been making efforts at getting more reporting, but progress is
slow. State-owned Bank Nasional Indonesia (BNI), state energy
monopolies Pertamina and PLN, and Garuda Airlines are some of the
major SOEs in dubious financial shape. Many SOEs are forced to go
to the international capital markets to raise funds since there are
too few domestic investors willing to take long-term risk, raising
Indonesia's foreign currency exposure. State-owned electricity
authority PLN, for example, already has more than $2 billion in
dollar-denominated bonds outstanding and is reportedly seeking new
foreign currency loans. The GOI is seeking IMF assistance to
determine the composition of its overall foreign currency exposure,
including SOE bond and loan obligations. (Note: The Ministry of
Finance is focusing on improving its overall risk management, and
USG advisors are helping with this task. As part of this, the GOI
seeks to capture a picture of its current borrowing risk.)

Bank Indonesia Scandal
----------------------

7. (SBU) The Corruption Eradication Commission (KPK) has been
investigating BI senior officials alleged involvement in the
misappropriation of Indonesian Banking Development Foundation's
("YYPI") funds between 2003-2004. According to media reports, BI
lent Rp 100 billion from the foundation, of which Rp 31.5 billion
was disbursed to facilitate the Parliament's discussion of laws on
BI and the remaining Rp 68.5 billion was used for legal aid for the
resolution of the Bank Indonesia Liquidity Support ("BLBI") cases.
After questioning six current and former BI and YYPI officials, on
February 4 KPK named BI Governor Burhanuddin Abdullah, Oey Hoey
Tiong (BI legal affairs director) and Rusli Simanjuntak (former head
of BI communications bureau) as suspects. In 2004, the Supreme
Audit Board (BPK) audited BI's 2003 financial report and discovered
the embezzlement but did not make the case public until 2006. There
have been several front-page media reports about it in recent weeks.


8. (SBU) The IMF's Schwartz said that it is bit ironic that the
current head of the BPK, Dr. Anwar Nasution, a Harvard-trained
economist, was a Deputy Governor at BI at the time of the
misappropriation. There is no allegation of anyone taking the fund
for personal enrichment and some at BI think the investigation is
politically motivated. BI Governor Abdullah has been "trying to do
the right thing," according to the IMF. Nasution is a tough Batak
who speaks his mind, and sometime issues public statements which are
overly blunt. Nasution feels that the Ministry of Finance is
cooperative with BPK investigations, but that BI is resisting.
Schwartz was optimistic overall, however, stating that Indonesia's

JAKARTA 00000243 003 OF 003


current economic team - Coordinating Minister Boediono, Finance
Minister Mulyuni, the Director General for Taxation and other key
Directors General - is competent and reform minded.

HUME

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