(EnergyAsia, July 28 2011, Thursday) — Indonesia’s economy will continue to experience strong growth the next two years but will face rising inflationary pressures caused partly by the removal of energy subsidies, said the International Monetary Fund (IMF).

The fund gave its finding in a report submitted by its Asia Pacific division chief, Thomas Rumbaugh, who led a team to Jakarta from July 7 to 21 and met with government officials to obtain an update on the state of Indonesia’s economy as well as discuss the impact of global developments. A more detailed report will be presented to the IMF’s Executive Board in September.

In a statement, the IMF said:

“Indonesia is experiencing strong economic growth, supported by solid export income and investment. Recent falls in food prices and the postponement of a planned reduction in fuel subsidies have reduced immediate inflationary pressures. Sales and production indicators remain solid, while measures of business and consumer confidence continue to improve.

“Global market sentiment is likely to remain volatile in the period ahead. Despite this, world output growth is expected to be maintained, supported by the better performance of emerging market economies like Indonesia. In particular, the growth of Asian economies remains robust. As a result, many central banks in the region are signalling that further rate hikes may be necessary.

“A key risk to the near-term outlook would be a sharp increase in global risk aversion arising from the Euro Area. However, given strong fundamentals and relatively low dependence on external demand, the downside risks for Indonesia appear to be limited.

“Indonesian GDP growth is projected to remain robust at around 6.5% in 2011-12. Increases in both foreign and domestic investment are supporting growth, while accelerating credit growth and expected reductions in energy subsidies should push core inflation modestly higher this year and into 2012.

“Although the external current account is projected to move into deficit next year, the overall balance of payments will remain in surplus as capital inflows—which are shifting more toward foreign direct investment—continue.

“There are no signs of any misalignment in the exchange rate, and export growth is strong (including in manufacturing). In this context, continued flexibility of the exchange rate will help buffer volatile inflows.

“The government intends to increase the pace and quality of economic growth in the medium-term through a sustained increase in infrastructure investment and improvements to the business climate. Implementation of financial sector reforms and improvements to the supervisory framework would enhance financial system stability, promote capital market development, and widen the domestic investor base.

“Strengthening investor confidence will be an important factor in propelling the markets forward.

“The 2011 budget is consistent with the government’s firm commitment to fiscal sustainability and strong public finances.

However, increasing fuel subsidies are distorting the structure of the budget. Therefore, fiscal policy needs to be re-oriented away from subsidies and towards infrastructure and social spending. Continued efforts are also needed to raise the tax revenue ratio from its current low level to provide greater fiscal space through broadening tax bases and increasing tax compliance.

“Bank Indonesia (BI) has used a range of instruments to contain price pressures, including increasing its policy rate in February and raising reserve requirements. Planned reductions in energy subsidies, when they occur, will feed into core inflation, and BI will need to act decisively to contain inflationary expectations and limit the pass through of fuel prices to generalised inflation. Indonesian banks continue to be profitable and well capitalized.

“The strong GDP growth outlook suggests vulnerabilities remain low. To strengthen the framework for financial stability, the adoption of the Financial System Safety Net (FSSN) law remains a top priority.

“A lack of infrastructure remains one of the biggest constraints to boosting Indonesia’s growth potential. Significant improvements to the regulatory framework are needed to support infrastructure spending and public-private projects. Social safety nets should be increased and better targeted towards vulnerable groups, while increased and more effective education and health spending will be needed to promote improvements in human capital and generate more equitable growth.”