0,4 THE ECONOMY AND MONETARY POLICY

Monetary Policy Review - September 2010 9 Economic Growth in Indonesia Following a period of brisk growth in Q22010, a period of stable growth Following a period of brisk growth in Q22010, a period of stable growth Following a period of brisk growth in Q22010, a period of stable growth Following a period of brisk growth in Q22010, a period of stable growth Following a period of brisk growth in Q22010, a period of stable growth is predicted for the Indonesian economy in Q32010 is predicted for the Indonesian economy in Q32010 is predicted for the Indonesian economy in Q32010 is predicted for the Indonesian economy in Q32010 is predicted for the Indonesian economy in Q32010. On the demand side, the forecast is that strengthening domestic demand coupled with sustained high external demand will keep driving the growth of the economy. Household consumption is predicted to expand even faster in response to strong public purchasing power, support from consumer credit and relatively low prices of imported goods due to the appreciation of the rupiah. Accelerated investment growth is estimated to have carried over into Q32010 in keeping with the improvement in the global economy, a conducive investment climate and progress on government infrastructure projects. Increased investment has also been supported by availability of financing from domestic sources and foreign companies. While a modest slowdown is predicted for the external side, exports and imports are forecasted to maintain high growth. On the supply side, recent developments in various indicators point to potential for higher growth in tradable sectors. In Q32010, household consumption is forecasted to maintain a brisk pace In Q32010, household consumption is forecasted to maintain a brisk pace In Q32010, household consumption is forecasted to maintain a brisk pace In Q32010, household consumption is forecasted to maintain a brisk pace In Q32010, household consumption is forecasted to maintain a brisk pace of growth of growth of growth of growth of growth. The latest developments in leading indicators for household consumption suggest that growth in household consumption is still on the expansionary phase. During the month under review, growth in household consumption was supported by consumption of both food and non-food items. This is consistent with movement in leading consumption indicators, such as the brisk pace of motor vehicle sales in July and the upward trend in sales of electronic goods Graphs 2.3 and 2.4. At the same time, other consumption indicators such as the retail sales index are generally stable Graph 2.5. Despite pressure from mounting prices, food consumption is predicted to mount as the preparations for the Eid-ul-Fitr festivities move forward. On the financing side, the potential for increased household consumption growth is also reflected in the rapid expansion of consumption credit extended by banks alongside surging growth in consumer financing from multifinance companies. In early Q32010, consumer confidence was dented slightly in response to upward pressure on prices. The electricity billing rates announced on 1 July 2010, mounting consumer spending for education new academic year and higher prices for staple commodities throughout July 2010 are thought to have produced a downturn in the consumer confidence index during August 2010 Graph 2.6. A similar trend was also visible in the Consumer Graph 2.3. Sales of Motor Vehicle PY_Car ,yoy PY_Motorcycle Source : CEIC -50 -30 -10 10 30 50 70 90 110 2008 2009 2010 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 Graph 2.4. Sales of Electronic Product yoy Source : EMC -40 -20 20 40 60 80 2008 2009 2010 Television Refigerator Washing Machine Air Conditioner 1 2 3 4 5 6 7 8 9 1011 12 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 Monetary Policy Review - September 2010 10 Graph 2.5 Retail Sales Index Tendency Survey fielded by the Central Statistics Agency BPS, in which consumer confidence for Q32010 is down slightly at 104.34 compared to 105.32 for the preceding quarter. Nevertheless, expectations of rising consumer incomes during Q32010 have bolstered consumer confidence against further decline. Investment is predicted to mount further in Q32010 Investment is predicted to mount further in Q32010 Investment is predicted to mount further in Q32010 Investment is predicted to mount further in Q32010 Investment is predicted to mount further in Q32010. More vigorous investment is expected in response to high growth in household consumption, persistently strong external demand and statements by various international institutions affirming the improvement in investment conditions in Indonesia. In addition, more upbeat business tendencies during the second half of 2010 will also boost investment performance. Recent developments in various leading indicators also confirm predictions for sustained investment growth during Q32010, particularly for machinery investment Graph 2.7 and construction Graph 2.8. Positive indications of rising construction investment are high levels of cement and power consumption. At the same time, the machinery and tools production index, electricity consumption in the business sector, imports of machinery and imports of machine parts have steadily climbed since Q4 2009 in line with rising investment in machinery. Imports have mounted for machinery used in telecommunications, transport and production. This trend is estimated to have carried over into Q32010. Accompanying this has been a steady rise in realisation of new investments and investment in previously licensed companies FDI and domestic investment projects Graph 2.9. The increased investment has also been supported by greater availability of financing from both domestic and foreign sources Graph 2.10. Estimates for exports in early Q32010 point to more moderate albeit still Estimates for exports in early Q32010 point to more moderate albeit still Estimates for exports in early Q32010 point to more moderate albeit still Estimates for exports in early Q32010 point to more moderate albeit still Estimates for exports in early Q32010 point to more moderate albeit still high growth high growth high growth high growth high growth. Exports have slowed primarily for non-oil and gas commodities, due to flagging economic growth in some of Indonesia»s key export destinations such as Japan and China. This has produced a slowdown in non-oil and gas export performance, while exports of oil and natural gas show potential for growth. On one hand, indications of slowing non-oil and gas performance are found mainly in falling non- resource-based exports and slowing exports of resource based products. In July 2010, resource-based exports slowed in response to smaller volume of mining exports, led by coal and copper, a development matched by reduced volume of agricultural exports such as timber and shrimp. At the same time, non-resource-based exports have declined. In the particular Graph 2.6. Consumer Confidence Index √ BI Consumer Survey 30 20 10 10 20 30 40 50 2008 2009 2010 Food Tobacco Cloth and Equipment Stationery TOTAL INDEX rhs yoy yoy Source : DSM 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 -60 -40 -20 20 40 60 80 100 120 140 Index Source : DSM 60.0 70.0 80.0 90.0 100.0 110.0 120.0 130.0 140.0 2008 2009 2010 1 2 3 4 5 6 7 8 9 1011121 2 3 4 5 6 7 8 9 1011121 2 3 4 5 6 7 Optimist Pesimist Economic Conditions Today Index Consumer Expectation Index Consumer Confidence Index 8 Graph 2.7. Machinery Investment -10 -5 5 10 15 20 25 30 -100.00 -50.00 0.00 50.00 100.00 150.00 yoy Machine IPI Machinery and Equipments M Spare Part Capital Goods Equipment M Capital Goods except transport Equipment Industrial Electricity Consumer up to May rhs yoy yoy 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II Monetary Policy Review - September 2010 11 case of exported cement, chemical products and paper, exports have been impacted by falling production in these sectors. On the other hand, indications of higher oil and natural gas exports in Q32010 are supported by steadily rising gas exports since the beginning of the year, as well as higher oil exports. In keeping with strong domestic and external demand, imports are In keeping with strong domestic and external demand, imports are In keeping with strong domestic and external demand, imports are In keeping with strong domestic and external demand, imports are In keeping with strong domestic and external demand, imports are forecasted to maintain brisk growth during Q32010 forecasted to maintain brisk growth during Q32010 forecasted to maintain brisk growth during Q32010 forecasted to maintain brisk growth during Q32010 forecasted to maintain brisk growth during Q32010. Movement in leading indicators for imports also show that import growth remains in an expansionary phase. In real data for the first half of 2010 average until June 2010, import growth reached 31.3 yoy, contrasting with the steep drop during the same period last year at -28.5 yoy. The brisk growth in imports in early Q32010 is thought to be driven more by steady improvement in consumption and investment, in addition to the appreciating trend in the exchange rate compared to 2009. In disaggregation by use, import growth is fuelled primarily by raw materials, followed by capital goods and consumer goods. In analysis by sector, recent developments in various indicators point to In analysis by sector, recent developments in various indicators point to In analysis by sector, recent developments in various indicators point to In analysis by sector, recent developments in various indicators point to In analysis by sector, recent developments in various indicators point to potential for high growth in tradable sectors during Q32010 potential for high growth in tradable sectors during Q32010 potential for high growth in tradable sectors during Q32010 potential for high growth in tradable sectors during Q32010 potential for high growth in tradable sectors during Q32010. Several leading indicators for manufacturing, such as automotive sales, production indices, imports of raw materials and industrial machinery and power consumption, reflected positive developments as of July 2010. The mining sector is predicted to maintain stable growth, as indicated by the stable trend in crude oil lifting and renewed improvement in exports of some mining commodities. However, reduced growth is predicted for the agriculture sector, mainly as a result of falling growth in the food crops subsector following the end of the harvest season, as well as weather conditions. However, performance in the estates and forestry subsectors still points to positive developments, which may help to prevent further slowdown. Developments in indicators in non-tradable sectors also point in an improving direction. Improvement is visible in leading indicators for the trade, hotels and restaurants sector, such as VAT on imports, hotel occupancy and foreign tourist arrivals. Besides this, the impact of the Eid- ul-Fitr festive season is also expected to boost performance in this sector for Q32010. The transport and communications sector is also predicted to chart improved growth indicated by gains in some leading indicators, such as total passengers and freight carried, imports of transportation equipment Graph 2.8. Investment √ Construction and Non Construction Graph 2.9. Realisation of Foreign Investment and Domestic Investment √ BKPM Graph 2.10. Investment Credit and Leasing -5 5 10 15 20 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 PMTB rhs Transportation Machinery Construction rhs I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II -40.00 -20.00 0.00 20.00 40.00 60.00 80.00 100.00 yoy yoy 40 30 20 10 10 20 30 40 50 60 200.0 0.0 100.0 200.0 300.0 400.0 500.0 yoy,nom 100.0 yoy,nom 2007 2008 2009 2010 I II III IV I II III IV I II III IV I II GFCF Foreign Investment Total Foreign Domestic Investment Domestic Investment rhs yoy Source : DPNP, DSM -20 -10 10 20 30 40 2008 2009 2010 Riil Investment Credit Riil Leasing 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 Monetary Policy Review - September 2010 12 and the rapid advancement in the telecommunications subsector. The Eid- ul-Fitr holiday season also has potential for increased passenger and cargo movement as well as cellular telephone traffic including speech, sms and data. In the financial sector, increased lending by banks and non-bank financial institutions has potential to fuel brisk growth in this sector. Similarly, the construction sector is also expected to show increased growth, reflected in higher levels of cement sales, imports of building materials and property credit. A further positive factor in construction sector performance is the higher level of realised government spending during Q32010. Despite this, growth in the electricity, gas and water utilities sector may stagnate, given present indications of slowing growth in electricity consumption. In addition, the hike in electricity billing rates and limited construction of urban gas networks is predicted to have adverse impact on performance in this sector. Monetary Policy Review - September 2010 13 Inflation CPI inflation in August 2010 was marked by rising pressure from CPI inflation in August 2010 was marked by rising pressure from CPI inflation in August 2010 was marked by rising pressure from CPI inflation in August 2010 was marked by rising pressure from CPI inflation in August 2010 was marked by rising pressure from fundamentals, while pressure eased from non-fundamentals and fundamentals, while pressure eased from non-fundamentals and fundamentals, while pressure eased from non-fundamentals and fundamentals, while pressure eased from non-fundamentals and fundamentals, while pressure eased from non-fundamentals and particularly volatile foods particularly volatile foods particularly volatile foods particularly volatile foods particularly volatile foods. Pressure in core inflation during August 2010 came mainly from a surge in educational expenses in the seasonal trend marking the beginning of the new academic year, as well as increases in air fares. Increases in the processed foods category triggered by volatile foods inflation and the seasonal rise in demand in advance of religious festivities added to the pressure in the core inflation category. On the external side, the impact of imported inflation caused by increases in global commodity prices and inflation in trading partners has not generated significant upward pressure on core inflation, due to the appreciating trend in the rupiah. Regarding non-fundamentals, inflationary pressure during August was fuelled by the direct impact of increased electricity billing rates for household consumers. In contrast, volatile foods inflation eased in line with the harvest of some seasonings and vegetable commodities. Amid these developments, CPI inflation was recorded at 0.76 mtm for the month under review, down from the preceding period. In annual figures, however, inflationary pressure is up, having mounted from 6.22 yoy in July 2010 to 6.44 yoy Graphs 2.11 and 2.12. Inflation in administered prices mounted higher in August 2010 due to the Inflation in administered prices mounted higher in August 2010 due to the Inflation in administered prices mounted higher in August 2010 due to the Inflation in administered prices mounted higher in August 2010 due to the Inflation in administered prices mounted higher in August 2010 due to the direct impact of higher electricity billing rates on August 2010 inflation direct impact of higher electricity billing rates on August 2010 inflation direct impact of higher electricity billing rates on August 2010 inflation direct impact of higher electricity billing rates on August 2010 inflation direct impact of higher electricity billing rates on August 2010 inflation. The new base electricity tariffs announced on 1 July 2010 were reflected in household billing during August. Other commodities in the administered prices category with inflationary impact include cigarettes. However, movement in energy prices has been largely subdued as a result of smooth implementation of the conversion programme. Taken together, the administered prices category recorded monthly inflation at 1.09 mtm, producing a fairly steep rise in the annual inflation figure to 4.67 compared to the previous month»s level of 3.74 yoy. Although domestic demand soared during the fasting month, volatile Although domestic demand soared during the fasting month, volatile Although domestic demand soared during the fasting month, volatile Although domestic demand soared during the fasting month, volatile Although domestic demand soared during the fasting month, volatile foods inflation generated minimal pressure foods inflation generated minimal pressure foods inflation generated minimal pressure foods inflation generated minimal pressure foods inflation generated minimal pressure. During August 2010, inflation was up mainly in the miscellaneous meats and rice categories, while pressure from seasonings eased. The rise in demand throughout the Ramadan fasting month has sent meat prices soaring. Similarly, escalating demand for rice during the fasting month has driven up prices in spite of adequate supply conditions, intensive open market operations and faster, more widespread distribution of subsidised rice for impoverished citizens. Graph 2.11. Inflation Graph 2.12. Inflation by Category Goods and Services , yoy 2007 2008 2009 2010 24 18 12 6 -1 -7 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 CPI Core Volatile Food Administered Prices 8

4.67 4.53

6.44 15.09

Transportation, Communication, and Finance Service Education, Recreation, and Sport Healthy Clothing Housing, Electricity, Water, Gas, and Fuel Food, Beverages, Cigarettes, and Tobacco Foodstuff Share mtm Inflation mtm 0.0 0.5 1.0 1.5 2.0 0.06 0.09 0.11 0.67 0.39 1.59 0.01 0.27 1.27 0.09 0.36 0.01 0.06 0.47 Monetary Policy Review - September 2010 14 In response to these developments, volatile foods inflation in reached 0.45 mtm or 15.09 yoy, down from the previous 5.46 mtm or 16.18 yoy. Pressure began to mount in core inflation during August 2010 due to Pressure began to mount in core inflation during August 2010 due to Pressure began to mount in core inflation during August 2010 due to Pressure began to mount in core inflation during August 2010 due to Pressure began to mount in core inflation during August 2010 due to seasonal trends seasonal trends seasonal trends seasonal trends seasonal trends. The rise in core inflation during August came mainly from a surge in educational expenses consistent with the seasonal trend at the start of the new academic year, as well as increases in air fares. Furthermore, the price escalation for seasonings in recent months has boosted inflation in the processed foods category, which represents part of core inflation. Soaring demand during the fasting month and exploitation by traders of the opportunity for higher profit margins has driven up prices for some food commodities. Taken together, inflation in the core category mounted from 0.49 mtm or 4.15 yoy in the preceding month to 0.80 mtm or 4.53 yoy. On the external side, the impact of imported inflation from increases in global commodity prices and inflation in trading partners has not generated significant upward pressure on core inflation, due to the appreciating trend in the rupiah. External influence on core inflation came more from gold prices, in keeping with higher prices commanded by gold on the international market Graph 2.13. Graph 2.13. International Domestic Gold Prices International Gold Price Domestic Gold Price right 1800 1600 1400 1200 1000 800 600 500000 450000 400000 350000 300000 250000 200000 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 2008 2009 2010 Monetary Policy Review - September 2010 15 Rupiah Exchange Rate The solid fundamentals of the economy and sustained high yields The solid fundamentals of the economy and sustained high yields The solid fundamentals of the economy and sustained high yields The solid fundamentals of the economy and sustained high yields The solid fundamentals of the economy and sustained high yields underpinned the attractiveness of investment in domestic instruments, underpinned the attractiveness of investment in domestic instruments, underpinned the attractiveness of investment in domestic instruments, underpinned the attractiveness of investment in domestic instruments, underpinned the attractiveness of investment in domestic instruments, which bolstered exchange rate during August 2010 which bolstered exchange rate during August 2010 which bolstered exchange rate during August 2010 which bolstered exchange rate during August 2010 which bolstered exchange rate during August 2010. During the month, the exchange rate averaged Rp 8,972 to the US dollar, representing an appreciation of 0.78 over July 2010. At end-August 2010, the rupiah closed at Rp 9,035 to the US dollar, having weakened 0.95 point to point from July 2010 Graph 2.14. Accordingly, the average value of the rupiah has advanced 13.4 to Rp 9,137 to the US dollar in 2010 from Rp 10,361 in 2009. The rupiah appreciation during August was accompanied by slightly increased volatility. The level of volatility in movement in the rupiah reached 0.28 in August 2010, up from 0.19 one month earlier Graph 2.15. The heightened volatility in the rupiah is explained in part by a renewed surge in capital inflows. Externally, the risk of slowdown in the global economic recovery has Externally, the risk of slowdown in the global economic recovery has Externally, the risk of slowdown in the global economic recovery has Externally, the risk of slowdown in the global economic recovery has Externally, the risk of slowdown in the global economic recovery has become a factor bringing capital inflows into the region become a factor bringing capital inflows into the region become a factor bringing capital inflows into the region become a factor bringing capital inflows into the region become a factor bringing capital inflows into the region. The weakening in various US economic indicators and high levels of unemployment have reinforced perceptions of road blocks to recovery in the US economy. In Europe, concerns escalated in the wake of the downgrading of Ireland»s credit rating, which then widened yield spreads for the PIIGS nations over German bonds. This is feared will create added difficulties for the PIIGS countries in bringing down their fiscal deficits. By contrast, Asian nations have taken the lead in economic improvement. This has also heightened the threat of inflation in the region, compelling some central banks in Asia to raise their policy rates. This has become a key factor attracting investors to place their funds in emerging market financial instruments. During August 2010, the majority of Asian currencies moved upward in relation to the US Dollar Graph 2.16. Domestically, the solid fundamentals of the domestic economy have led to Domestically, the solid fundamentals of the domestic economy have led to Domestically, the solid fundamentals of the domestic economy have led to Domestically, the solid fundamentals of the domestic economy have led to Domestically, the solid fundamentals of the domestic economy have led to improvement in investment risk indicators for Indonesia improvement in investment risk indicators for Indonesia improvement in investment risk indicators for Indonesia improvement in investment risk indicators for Indonesia improvement in investment risk indicators for Indonesia. By the end of August 2010, the EMBIG spread eased to the 307 bps range while yield spread on Indonesia Global Bonds over US T-Notes narrowed to 160 bps Graph 2.17. This reflects investor confidence in Indonesian debt instruments. The safeguarding of domestic risk perceptions has raised covered interest parity CIP, the interest rate spread after factoring in risk, to 4.6 August 2010 from 4.1 July 2010. At this level, the CIP is wider than for many other countries in Asia Graph 2.18. Graph 2.14. Average Rupiah Exchange Rate RpUSD 8500 9000 9500 10000 10500 11000 11500 12000 12500 Feb Apr Jun Okt Des Aug 2008 2009 2010 Daily Exchange Rate Monthly Average Quarterly Average Feb Apr Jun Okt Des Aug Feb Apr Jun Aug 9,110 9,007 9256 9224 10937 11317 10527 9973 9459 9254 Graph 2.15. Rupiah Exchange Rate Volatility 8900 9400 9900 10400 10900 11400 11900 12400 2 4 6 8 10 12 Daily Volatility Volatility Average Daily Exchange Rate RpUSD - rhs IDRUSD Feb Apr Jun Ags Oct Des Feb Apr Jun Ags Oct Des Feb Apr Jun Ags Graph 2.16. Asian Currencies Appreciation Depreciation, Average August 2010 compare to July 2010 2.31 -0.93 0.49 3.16 -0.95 0.53 1.32 -2.49 2.62 1.99 1.58 1.81 0.78 2.45 1.64 1.02 -3.00 -2.00 -1.00 0.00 1.00 2.00 3.00 4.00 JPY KRW SGD THB IDR PHP MYR EUR Average Point-to-point