Indonesia: Selected Issues

June2023 INDONESIA SELECTEDISSUES IMFCountryReportNo.23/222 ThispaperonIndonesiawaspreparedbyastaffteamoftheInternationalMonetaryFundasbackgrounddocumentationfortheperiodicconsultationwiththemembercountry.ItisbasedontheinformationavailableatthetimeitwascompletedonMay5,2023. Copiesofthisreportareavailabletothepublicfrom InternationalMonetaryFundPublicationServicesPOBox92780Washington,D.C.20090Telephone:(202)623-7430Fax:(202)623-7201 E-mail:publications@imf.orgWeb:http://www.imf.orgPrice:$18.00perprintedcopy InternationalMonetaryFundWashington,D.C. ©2023InternationalMonetaryFund May5,2023 INDONESIA SELECTEDISSUES PreparedByMinsukKim(APD),AmrHosny(FAD)andBrunoAlbuquerque(SPR). ApprovedBy AsiaandPacificDepartment CONTENTS NOTALLINVESTORSARETHESAME:LESSONSFORACHANGINGINVESTORBASEININDONESIA3 A.Introduction3 B.DoDifferentInvestorsRespondDifferentlytoGlobalandDomesticFactorsinIndonesia?6 C.MacroeconomicandFinancialImplicationsoftheChangeintheInvestorBase9 D.LessonsfromEpisodesofRapidandLargeDeclinesintheNRShareof LCDebtinEMs10 E.WhoistheMarginalInvestorofLCSovereignDebt?12 F.ConcludingRemarks14References15 FIGURES 1.CumulativeResponsestoaOne-StandardDeviationIncreaseintheNRShare10 2.CumulativeResponsestoNRShocksOutsideofFinancialStress11 3.CumulativeResponsestoNRShocksDuringFinancialStress12 TABLE 1.ADRLLong-RunModelforIndonesia,2002M12–2022M128 ESTIMATINGTHENEUTRALREALINTERESTRATEFORINDONESIA17 A.Introduction17 B.EmpiricalMethods18 C.MainFindings24 INDONESIA References26 TABLES 1.NRIRBasedonHPFilter19 2.EstimationResultsfromHolston,Laubach,andWilliams(2020)21 3.NRIRfromConsumptionModel24 4.SummaryofNRIREstimates24 2INTERNATIONALMONETARYFUND NOTALLINVESTORSARETHESAME:LESSONSFORACHANGINGINVESTORBASEININDONESIA1 Againstthebackdropofasignificantshiftintheinvestorbaseoflocalcurrency(LC)sovereigndebtinIndonesia,thispaperfindsthat:(i)NRholdingsofLCdebtinIndonesiaaremostlydrivenbyglobalfactors,whileBankofIndonesia(BI)actsasaresidualfinancier;(ii)higherNRholdingssupportthebondmarketanddomesticcredit,butincreaseexchangeratevolatility;andepisodesofrapidandlargedeclinesintheNRshareofLCdebtinEMsareassociatedwithhigherfuturemarketvolatilityandlowercredittotheprivatesector;and(iii)domesticnonbanksplayakeyroleinabsorbingnewLCdebt,especiallyduringepisodesoflargeandrapidnonresidentoutflows.Theseresultscallforafurtherdeepeningoftheinvestorbase,especiallydomesticnonbanks,tosupportmarketdepthandreducevolatility. A.Introduction 1.Indonesiahasexperiencedasignificantdeclineinthenonresident(NR)shareof local-currency(LC)debtcoincidingwiththepandemic.Publicdebtisestimatedtohavereached 40.1percentofGDPin2022from30.6percentin2019,mostlydrivenbyhigherLCdebtissuances,owingtotheexceptionalfiscalmeasuresdeployedin2020-22tofighttheCOVID-19pandemic,duringwhichthefiscalrulewastemporarilysuspendedandtheBI-MoFintroducedaburden-sharingfinancingagreement.Atthesame,time,theNRshareofLCdebtdeclinedfrom39percentin2019Q4(oneofthehighestratiosacrossalargesampleof EMsfromArslanalpandTsuda2014)toabout14percentatend-2022.Whiletheinstitutionalinvestors’(mutualfunds,insurancecompanies, andpensionfunds)shareofLCdebtholdingshaveremainedbroadlystable,thesharesofBankofIndonesia(BI)anddomesticbankshaveincreasedduringCOVIDyears,inlinewithBI’sprimarymarketpurchasesundertheBI-MoF burden-sharingfinancingagreement.NRholdingshaveshownsomesignsofrecoveryinrecentmonthsandremainmostlyconcentratedin long-datedsecurities. 1PreparedbyBrunoAlbuquerque(SPR)andAmrHosny(FAD).AgnesIsnawangsihprovidedexcellentresearchassistance.TheauthorsbenefittedfromusefulinputsduringthemissionfromparticipantsataseminarattheMinistryofFinanceofIndonesia. INTERNATIONALMONETARYFUND3 2.TherecentfallintheNRShareofLCdebtisunprecedentedhistorically,andrelativetootherEMs.SinceCOVID-19,IndonesiahasrecordedthelargestdeclineintheNRshareofLCdebt,ofroughly25percentagepointsuntil2022Q4,comparedtootherperiodsoffinancialstress(leftpaneloffigure).ThedeclineinNRholdingsofLCdebthasbeeneconomicallyimportant:almost3percentofGDP.ThedeclineintheNRshareofLCdebtsincetheCOVIDshockcanbebrokendownintotwoperiods.Inthefirstperiod,covering2020and2021,largeNRoutflowsmainlyreflectedtheCOVIDshock,andBIstartedprimarymarketpurchasesundertheBI-MoFagreementamidrisingfiscaldeficits.ThedeclineinNRholdingscontinuedin2022,amidthetighteninginglobalfinancialconditionsdrivenbytheFedtightening.Inturn,theshareofNRsinforeign-denominateddebthasfallenbysignificantlylessduring2020-22,likelyduetolimitedexchangerateriskinthissegment,althoughithasdeclinedbymoresincetheFedtightening.Bycontrast,theaverageEMcountrydidnotexperiencesuchasignificantfallinLCdebtsince2020(rightpaneloffigure).2 2WefindasimilarpatternforASEANcountries. 3.ThedeclineintheNRsharemayreflectacombinationofdifferentfactors,includingalargerdeclineintheyielddifferentialrelativetoUSbondyields.First,thedeclineinreturnssincetheCOVID-19pandemic–asmeasuredbythe differencebetweentheyieldonLCdebtandtheequivalentUSbondyield–hasbeenlargerforIndonesiarelativetootherEMs,drivenfullybyhigh