Cablegate: Indonesia - Economic and Financial Highlights June

DE RUEHJA #0053/01 2220604
R 100604Z AUG 06





E.O. 12598: N/A

1. Summary. The Central Bureau of Statistics (BPS)
announced on August 2 a slowing year-on-year (YoY) inflation
in July 2006 of 15.15 percent. Bank Indonesia (BI) lowered
interest rates on August 8 by 50 basis points (bps) to 11.75
percent. On July 26 Standard & Poor's Rating Services
raised Indonesia's long-term currency rating citing
improving fiscal performance. On July 12, the Ministry of
Finance presented the Government of Indonesia's mid-year
revision of the 2006 Budget to Parliament. The revised
budget assumes a higher oil price of USD 62 per barrel and
lower economic growth of 5.9 percent. On July 17, the
Ministry of Finance launched Indonesia's first three-year
"retail" bonds to individuals, which pay interest monthly
and offer a 12.05 percent fixed coupon rate. The Government
of Indonesia (GOI) earned USD 617 million from a monthly
bond offering on July 12. On July 25, the GOI swapped USD
265 million bonds maturing in 2007-09 as part of its bond re-
profiling program.

2. Summary - Continued: On July 5, the GOI and Bank
Indonesia (BI) launched a financial sector reform policy
package. On July 10, Finance Minister Sri Mulyani Indrawati
announced, as part of the package, a new regulation allowing
state-owned banks the same flexibility enjoyed by private
banks in addressing their non-performing loans. On July 25,
Director General for Treasury Mulia Nasution announced the
closing of 300 government accounts with individual officials
as account holders. On July 24, Bank Indonesia signed a
Memorandum of Understanding (MOU) with Malaysia's Central
Bank, on improving human resources especially in the Islamic
financial sector. Several major banks reported their
performance in the first half of 2006; loans in the "loss"
category increased. An exchange rate of 9,070 per USD is
used throughout this report. End Summary.

Inflation Slowing:
BI Cuts Interest Rate to 11.75 Percent

3. On August 2, the Central Bureau of Statistics (BPS)
announced that inflation is slowing down. July inflation
was 15.15 percent year-on-year (YoY), and 0.45 percent month-
on-month (MoM). Core inflation went up by 0.36 percent MoM,
and 9.58 percent YoY. In a widely expected move, Bank
Indonesia (BI) on August 8 cut its benchmark interest rate
by 50 bps to 11.75 percent. Coordinating Minister for
Economic Affairs Boediono reportedly stated, "I think BI has
moved in the right direction and that there is still room
for more cuts. For our part, we will follow up by
continuing to improve the investment climate, as high
interest costs are not the only factors impeding growth."
Minister for Industry Fahmi Idris reportedly stated on
August 9, "It's positive, but still far from what the
business community and the real sector have been hoping

Table 1: Inflation Components - June 2006
Component MoM YoY
Foodstuffs 0.99 15.77
Prepared food, beverages,
tobacco 0.31 11.58
Housing, water, electric, fuel 0.21 12.72
Clothing 0.36 9.56
Health 0.06 7.00
Education, recreation/sports 0.69 7.73
Transportation, communication
and financial services 0.08 30.80
Total 0.45 15.15
Source: Central Bureau of Statistics (BPS)

S&P Upgrades Indonesia's Currency Rating

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4. On July 26 Standard & Poor's Rating Services announced
that it had raised Indonesia's long-term foreign currency
rating from B+ to BB-. This is the highest rating for
Indonesia since the 1998 financial crisis and at the same
level as the Philippines, Turkey, Ukraine and Serbia. Some
analysts noted the upgrade was not expected until the fourth
quarter. The upgrade may give a stimulus to economic
growth. "While implementation remains a challenge, an
encouraging development has been the speed at which
difficult, but much-needed, reforms are happening,
especially since the new economic team was put in place in
December 2005," said S&P's credit analyst Sani Hamid. The
upgrade puts S&P's rating on a par with Fitch Ratings but
one notch above Moody's Investors Service.

5. Government debt may fall to less than 50 percent of gross
domestic product (GDP) this year from more than 100 percent
in 2000, S&P said in its statement. However, the external
debt remains high and a burden, and proved unmanageable in
the past. Lack of transparency in the finances of public
sector-related entities, and in coordinating policies
between the fiscal and monetary authorities; also remain
issues that need to be resolved. S&P estimates cleaning-up
cost associated with removing nonperforming loans from state-
owned banks to reach 3 percent of GDP. Infrastructure
shortfalls hampered competitiveness and economic growth is
below potential. Analysts, however, expects external
liquidity to strengthen through a combination of current
surplus and improved investment flows. Hamid noted, "A
faster implementation of reforms on taxes, labor,
infrastructure development, and the legal structure, coupled
with improved public sector transparency, would favorably
influence the rating outlook on Indonesia." Conversely,
Indonesia's ratings may come under pressure should
government delay reforms or reverse current fiscal policies.

GOI Submits 2006 Budget Revision to Parliament
--------------------------------------------- -

6. On July 12, the Minister of Finance (MOF) presented to
Parliament's Budget Committee, mid-year revisions to the
2006 budget. In anticipation of higher government spending
to help spur growth, the GOI increased this year's budget
deficit estimate to 1.3 percent of GDP from 0.7 percent.
The MOF also revised the oil price assumption upward to USD
62/barrel from USD 57. Observers see this as the GOI's
attempt to avoid last year's mistakes. In 2005, the GOI
stood by a low oil price assumption in a rising global fuel
price environment, leading to concerns about the swelling
fuel subsidy and fiscal sustainability. The revisions for
2006 include a stronger exchange rate of Rp 9,300/USD
instead of 9,900, and a higher benchmark interest rate of 12
percent up from 9.5 percent. Despite double digit YoY
inflation in the first half of the year, the inflation
estimate remained unchanged at 8 percent.

Table 2: Revised Macro Assumptions for 2006 Budget
--------------------------------------------- -----
Assumptions 2005 2006 2006
(Proposed Revision)
--------------------------------------------- ------

Real GDP growth (1) 6.0 6.2 5.9
CPI inflation 8.6 8.0 8.0
USD/IDR (avg) 9,800 9,900 9,300
3-month SBI rate (avg) 8.4 9.5 12.0
Budget deficit (2) 0.9 0.7 1.2
Average oil price (3) 54 57 62
Oil production (4) 1,075 1,050 1,000

(1) In percent
(2) As percentage of GDP
(3) In USD per barrel
(4) In million barrels per day

Source: Ministry of Finance

7. Bank Indonesia Governor Burhanuddin Abdullah said the

JAKARTA 00010053 003 OF 006

revised growth assumption of 5.9 percent was more realistic,
given that growth in the first half of the year would
probably be in the 4.6-to-5.1 percent range. The GOI also
anticipates higher government spending to reach Rp 689.5
trillion (USD 76 billion), or 22.1 percent of GDP, from the
previous forecast of Rp 647.7 trillion (USD 71 billion) or
21.3 percent of GDP. The budget targeted higher tax, oil
and gas revenues. The GOI expects this year's deficit to
rise to reach Rp 37.6 trillion (USD 42 billion). Most of
the spending will go to domestic sovereign debt, fuel and
electricity subsidies, education sector and social welfare.
The increased deficit will require the GOI to raise more
money from net bond sales, Rp 35.8 trillion (USD 4 billion)
compared to Rp 24.8 trillion (USD 2.7 billion) under the
original budget.

GOI Launches "Retail" Bonds

8. On July 17 the government launched Indonesia's first-ever
"retail" bond sold directly to individual customers without
an auction process. The new three-year bonds pay interest
monthly and offer a 12.05 percent fixed coupon. Individuals
can place a minimum order of Rp 5 million (USD 551) with
designated sales agents. Previous bond purchases required a
Rp 1 billion (USD 110,000) minimum, making them beyond the
reach of most individual investors. Minister of Finance Sri
Mulyani Indrawati said the new bonds will encourage the
development of an "investment society" in Indonesia, helping
finance the country's development needs by expanding capital
markets. The right to initially purchase the bonds is
limited to Indonesian citizens, although non-nationals can
buy them in the secondary market. "All the proceeds of the
bond sales will go into the state budget," Mulyani said.
She is positive about the market's appetite for the retail
bonds, pointing out the main attractions of higher yields
compared to bank deposits, and potential capital gains.
President Director of state-owned Bank Mandiri Agus
Martowardojo said that the retail bond sale was timely given
the current bullish bond market and that the coupon rate was
attractive. However, he said that the government needed to
clarify its policies on taxation and funding sources to
eliminate investor doubt. Mandiri is one of the 11
designated sales agents for the bonds. On August 7, the GOI
earned Rp 3.3 trillion (USD 364 million) from the retail-
bond sale, which will form part of the total Rp 35.8
trillion (USD 4 billion) in expected net proceeds from
government bond sales this year.

GOI Sells 7-Year Bonds;
GOI Swaps Soon Maturing Bonds

9. On July 12, the Ministry of Finance earned Rp 5.6
trillion (USD 617 million) in proceeds from bond sales. Rp
4.3 trillion (USD 474 million) of the bonds will mature in
March 2013 at a weighted average yield of 12.21 percent, and
another Rp 1.3 trillion (USD 143 million) bonds will mature
in June 2021 at a 12.41 percent yield. The Director for
Bond Management Rahmat Waluyanto said that the bullish
market gave the government the upperhand during the auction,
with only lower-yield bids being accepted. "I think these
lower yields will be positive for the future development of
our bond market," he said. Higher yields mean higher
interest costs for the government. The government is
bearing yields of nearly 13 percent for the same seven-year
and 15-year bonds it first issued in January, and for the
eight-year and 20-year bonds it sold during June's bond

10. On July 25, the MOF swapped Rp 2.4 trillion (USD 265
million) of bonds maturing in 2007-09 for bonds maturing in
2021. The old bonds had yields of 9.5 - 14 percent, while
the new bonds offer yields of 12.8 percent yield. On August
8, the MoF earned another Rp 4.4 trillion (USD 485 million)
from a similar debt exchange within the same maturity and
yield range. Those debt swaps are the latest in a series of
MOF operations designed to reduce the amount of bonds coming

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due in 2007-09.

GOI and BI Launches Financial Sector
Reform Policy Package

11. On July 5, the GOI and Bank Indonesia launched a policy
package aimed at strengthening the banking industry, non-
bank institutions and capital markets to boost the economy.
The financial sector policy package contains 13 policies, 33
programs and 59 actions plans. (Note: This is the third of
three policy packages announced by Coordinating Minister for
Economic Affairs Boediono. The first two were for
infrastructure and investment.) Minister Boediono stated,
"The government realizes that development of the Indonesian
financial sector to world class standards will be a dynamic
process requiring successive stages. Accordingly follow-up
financial sector policy packages will be developed in 2007
and beyond." Among the measures will be revisions to
existing regulations on bank debt write-offs which may allow
state banks further scope to restructure non-performing
loans (NPLs).

12. According to the timeline in the package, Bank
Indonesia will issue regulations providing incentives for
merger and acquisitions in the banking sector by October.
The GOI also plans to draw up a bill by December to
strengthen coordination between fiscal and monetary
authorities. For non-bank financial institutions, there are
steps to strengthen their capital structures, and to handle
insolvent institutions and introduce good governance
principles. A team led by Boediono and Sri Mulyani will
oversee these measures, to be completed this year and into

New Rules to Help NPL Problems

13. On July 10, the MOF announced as part of the financial
sector reform package, a revision to Government Regulation
No. 14/2005 and Finance Minister Decree No. 31/2005
regarding the procedures for non-performing loans (NPLs).
The government hopes to complete the amendments by August, a
month later than originally scheduled. The new regulations
would allow the same flexibility for state-owned banks as
for private banks in resolving NPLs. The upcoming
regulation will allow state-owned banks to apply various
debt restructuring options without having to first seek the
approval of the Finance Ministry. "Our purpose is to
provide a strong legal foundation for the handling of non-
performing loans. All NPLs should be resolved by the state
banks themselves," Mulyani said. In addition, the Ministry
of State-Owned Enterprises will require state banks to sign
a management contract to improve risk management to reduce
NPLs. The President must approve the final draft in
consultation with the Cabinet.

14. Partly due to high interest rates, the banking system's
NPL ratio rose to 9.3 percent at the end of February 2006
compared to 8.3 percent at the end of December 2005. State-
owned banks contributed the largest portion. State-owned
banks have long called on the government to revise the
regulations. They claim they have been restricted in
restructuring their NPLs, due to an inability to provide
debt reductions and other common restructuring options
available to private banks.

GOI Closes Accounts

15. On July 25, the Ministry of Finance Director General
for Treasury Mulia Nasution announced that the GOI had
closed 300 accounts held in the name of individual
government officials (current and retired). This is a
response to findings of Supreme Audit Board (BPK) revealing
that 957 government accounts with individual government
officials names as account holders, amounting to Rp 20.5
trillion (USD 2.3 billion). The BPK submitted its

JAKARTA 00010053 005 OF 006

"Performance Report of Central Government in 2004" to
Parliament on September 2005. "There might be more accounts
to close, and we are still reviewing them," Nasution said.

BI Signs MOU With Malaysia on Islamic Finance

16. On July 24, BI Governor Burhanuddin Abdullah, as the
Head of the Board of the Indonesian Banking Development
Agency (LPPI), and Malaysia's central bank governor Zeti
Akhtar Aziz, as Head of Supervisory Board for International
Center for Education in Islamic Finance (INCEIF), signed a
Memorandum of Understanding (MOU) on improving human
resources in the Islamic financial sector. Indonesia's
President Susilo Bambang Yudhoyono and Malaysia's Prime
Abdullah Ahmad Badawi witnessed the signing.

Banks Report First Half Performance

17. Several banks announced their performance for the first
half of 2006 in July. Indonesia's largest state-owned Bank
Mandiri reported on July 26 its net profit rose 32.4
percent, reaching Rp 4.9 trillion (USD 540 million), helped
by a 6.5 percent higher net interest margin (NIM) over the
previous year. Mandiri posted a net profit of Rp 815.44
billion (USD 90 million) in the January-June period compared
to Rp 616 billion (USD 68 million) in the same period last
year. With a market capitalization of USD 3.6 billion,
Mandiri's second-quarter net profit alone stood at Rp 305
billion rupiah (USD 34 million), three times the year-ago
period's figure. Mandiri, with its large volume of NPLs,
was among the hardest hit banks last year due to higher
rates and stricter central bank regulations on bad loans
classification. Its net NPL ratio fell to 24.9 percent in
the first half of 2006 compared with 26.2 percent as of June
30, 2005. Its "loss" category loans however, increased from
Rp 12 trillion (USD 1.3 billion) to Rp 19 trillion (USD 2.1
billion) in the period.

18. On July 31, the second largest state-owned Bank Negara
Indonesia (BNI) reported a 9 percent decrease in first-half
net profit, partly due to lower loan demand and higher
operating costs. BNI's net interest income rose only 1
percent year-on-year to Rp 3.7 trillion (USD 408 million),
while operating expenses increased by 24 percent to Rp 2.8
trillion (USD 309 million). BNI's President Director Sigit
Pramono commented, "With the still-high BI rate in the first
half of the year, the real sector could not borrow
significantly enough to stimulate the economy. Loan demand
declined." The bank's NPL ratio increased to 11.23 percent
from 7.82 percent previously. Loans to the corporate sector
accounted for 51 percent of the total NPLs. The bank
disclosed that the electricity sector dominated its top ten
defaulters, with loans worth of Rp 3.5 trillion (USD 386
million). BNI will offer a discount to defaulters with
debts under Rp 5 billion (USD 0.5 million) if they pay in
full within three months. The discounts would decrease with
every delay of three months.

19. Amid the high domestic interest rate, Indonesia's fifth-
largest Bank Danamon and sixth-largest Bank Internasional
Indonesia (BII), both affiliated with Singapore's Temasek
Holdings, reported a significant drop in profit for first
half of 2006. Danamon booked Rp 558 billion net profit (USD
61.5 million), a drop by 57 percent from Rp 1.3 trillion
(USD 143 million) in the same period last year. BII
recorded an 11 percent fall in net profit to Rp 352 billion
(USD 39 million). Danamon reported a 16 percent growth in
net interest margin (NIM), but had to write-off Rp 533
billion (USD 59 million) of assets while operating expenses
increased significantly. BII also reported a growing NIM,
but had to write-off Rp 196 billion (USD 22 million) of
assets. Both banks reported a significant increase in loss
category (grade 5 out of 5) and special mention loans (grade
2). Danamon's loans classified as "loss" reached Rp 733
billion (USD 81 million), doubled from Rp 331 billion (USD
36 million) from the previous year, while BII's increased to

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Rp 487 billion (USD 54 million) from Rp 322 billion (USD 36

20. Bank Niaga, the seventh largest lender, booked a net
profit of Rp 353.5 billion (USD 39 million) in the first six
months this year, up nearly 15 percent from the same period
last year. Its net interest income rose 29 percent to Rp
1.1 trillion (USD 121 million) from a year earlier on
lending growth of 19 percent to Rp 30.65 trillion (USD 3.4
billion). Niaga's net NPL ratio improved slightly to 4.11
percent from 4.44 percent last year.

Rabobank Acquires Two Domestic Banks

21. Netherlands-based Rabobank announced on July 13 it had
signed an agreement to buy two unlisted Indonesian banks,
Bank Haga and Bank Hagakita, from individual shareholders.
The two Indonesian banks, which primarily focus on small-to-
medium enterprises (SMEs) in trading, manufacturing and
business services sectors, have a combined 1,537 employees
and a network of 78 branches in Java, Bali and southern
Sumatra. The two banks have total assets of Rp 3.97
trillion (USD 438 million) as of December 2005. "Bank Haga
and Bank Hagakita have an impressive track record of
consistent growth since their founding 17 years ago. This
is an exciting platform for Rabobank to grow our business in
Indonesia," Fergus Murphy, head of Asia region for Rabobank
International said. The press release said the acquisitions
are consistent with Rabobank's strategy of being the world's
leading financier in the food and agribusiness sectors. It
did not provide the size of the acquisition or its value.
Rabobank, the world's 14th largest bank in terms of Tier I
capital, has an Indonesian subsidiary, Bank Rabobank
International Indonesia, which has been in business for 16
years and focuses primarily on corporate clients

--------------------------------------------- ------
Table 3: Selected Economic, Financial, and Trade
Statistics, April - July 2006
--------------------------------------------- ------
Apr May Jun Jul

CPI inflation (YoY) 15.4 15.60 15.53 15.15

CPI inflation (MoM) 0.05 0.37 0.45 0.45

Rp/USD Exch. rate(1) 8,775 9,220 9,300 9,070

30-day SBI rate (1) 12.75 12.50 12.50 12.25

Foreign Res. (USD bn)(1) 42.8 44.2 40.1 41.1

JSX Composite Index(1) 1,464 1,330 1,310 1,352

Exports (USD billion) 7.6 8.3 8.5

Percent change (YoY) 11.9 13.4 15.1

Imports (USD billion) 4.8 5.1 5.7

Percent change (YoY) -3.7 -2.1 1.3

Trade Balance 2.8 3.2 2.8

Source: Bank Indonesia, BPS, JSX
(1) End of period


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