“Indonesia has never excelled in the art of self-promotion. But this publication, written by those whose jobs are to conduct rigorous and timely monitoring of the state of the country’s economic health, and the country’s policy practitioners, might give a little help. It contains up-to-date analyses of the country’s important progress and diagnosis of the major challenges it faces. A must-read for those who have stakes and interests in the country.” Boediono 11th Vice President, Indonesia; former Governor, Bank Indonesia “This ambitious book captures vividly the daunting challenges facing policymakers in many commodity-exporting economies struggling to achieve sustained rapid growth without capsizing in the turbulent waters of today’s global financial markets. It is an inspiring story of the policymakers’ determination to strengthen macroeconomic resilience to external shocks while striving to unleash the economic potential of the country to meet the expectations of people for higher standards of living.” Hoe Ee Khor Chief Economist, ASEAN+3 Macroeconomic Research Office “It has been 20 years since the 1998 financial, economic, and political crisis of Indonesia—and we are still here and going strong despite dire predictions at the time. The book comes at a timely juncture and takes a “back to the future approach.” That is, there is a thorough review of the stabilization, restructuring, and reforms to get us here and, more importantly, a forward-looking view. The book does a good job of laying out the challenges Indonesia will face, as well as the potential opportunities from a young population, digital technologies, and a rising Asia. Whether or not we agree on the priorities identified if Indonesia is to move forward, the book provides an excellent platform for rich policy discourse.” Mari Pangestu Professor of International Economics, University of Indonesia ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution Realizing Indonesia’s Economic Potential EDITORS Luis E. Breuer • Jaime Guajardo • Tidiane Kinda INTERNATIONAL MONETARY FUND ©International Monetary Fund. Not for Redistribution © 2018 International Monetary Fund Cover design: IMF Creative Cataloging-in-Publication Data IMF Library Names: Breuer, Luis E., | Guajardo, Jaime. | Kinda, Tidiane. | International Monetary Fund. Title: Realizing Indonesia’s economic potential / editors: Luis E. Breuer, Jaime Guajardo, Tidiane Kinda. Description: Washington, DC : International Monetary Fund, [2018] | | Includes bibliographical references. Identifiers: ISBN 9781484337141 (paper) Subjects: LCSH: Indonesia—Economic conditions. | Economic development— Indonesia. | Finance, Public—Indonesia. | Monetary policy—Indonesia. Classification: LCC HC447.R42 2018 DISCLAIMER: The views expressed in this book are those of the authors and do not necessarily represent the views of the IMF’s Executive Directors, its management, or any of its members. The boundaries, colors, denominations, and any other information shown on the maps do not imply, on the part of the International Monetary Fund, any judgment on the legal status of any territory or any endorsement or acceptance of such boundaries. Recommended citation: Breuer, Luis E., Jaime Guajardo, and Tidiane Kinda, eds. 2018. Realizing Indonesia’s Economic Potential. Washington, DC: International Monetary Fund. ISBN: 978–1–48433–714–1 (paper) 978–1–48435–590–9 (ePub) 978–1–48435–591–6 (Mobi) 978–1–48435–595–4 (PDF) Please send orders to: International Monetary Fund, Publication Services P.O. Box 92780, Washington, D.C. 20090, U.S.A. Tel.: (202) 623–7430 Fax: (202) 623–7201 E-mail: publications@ imf .org Internet: www .elibrary .imf .org www .bookstore .imf .org ©International Monetary Fund. Not for Redistribution Contents Foreword ........................................................................................................................................v Acknowledgments ....................................................................................................................vii Contributors .................................................................................................................................ix Abbreviations .............................................................................................................................xv PART I. BUILDING UPON A STRONG FOUNDATION 1 Realizing Indonesia’s Economic Potential: An Overview ...................................3 Luis E. Breuer and Tidiane Kinda 2 Twenty Years after the Asian Financial Crisis ....................................................... 21 Muhamad Chatib Basri PART II. STRUCTURAL REFORM 3 Boosting Potential Growth ......................................................................................... 49 Jongsoon Shin 4 Developing Infrastructure ........................................................................................... 67 Teresa Curristine, Masahiro Nozaki, and Jongsoon Shin PART III. PUBLIC FINANCE 5 Supporting Inclusive Growth .................................................................................... 87 Hui Jin 6 Implementing a Medium-Term Revenue Strategy ...........................................109 Ruud de Mooij, Suahasil Nazara, and Juan Toro PART IV. CROSS-BORDER TRADE AND FINANCE 7 Spillovers from the International Economy .......................................................143 Jaime Guajardo 8 Linkages to the World Economy .............................................................................163 Mitali Das 9 Diversifying Merchandise Exports ..........................................................................187 Agnes Isnawangsih and Yinqiu Lu iii ©International Monetary Fund. Not for Redistribution iv Contents 10 Determinants of Capital Flows ................................................................................211 Yinqiu Lu PART V. MONETARY AND FINANCIAL POLICY 11 Advancing Financial Deepening and Inclusion .................................................229 Heedon Kang 12 Managing Macro-Financial Linkages .....................................................................249 Elena Loukoianova, Jorge A. Chan-Lau, Ken Miyajima, Jongsoon Shin, and Giovanni Ugazio 13 Reinforcing Financial Stability ..................................................................................271 Ulric Eriksson von Allmen and Heedon Kang Index .......................................................................................................................................... 301 ©International Monetary Fund. Not for Redistribution Foreword Indonesia has made remarkable progress over the past 20 years. This is no acci- dent. The country transformed itself by pursuing sound economic policies and by harnessing the incredible ingenuity and diversity of its people. Strong and stable economic growth sharply reduced poverty, raising living standards for millions of people and enabling the emergence of a vibrant middle class. Indonesia is one of the world’s largest emerging market economies, a founding member of the Association of Southeast Asian Nations (ASEAN), and a member of the Group of 20. Playing host to the 2018 IMF and World Bank Annual Meetings in Bali is further testament to Indonesia’s increasingly prominent role in the global policy debate. These meetings present a unique opportunity to show- case the impressive social and economic achievements of Indonesia and Asia. The world can learn much from the region, including the so-called ASEAN way of reaching across borders. This is beautifully captured in the official motto of Indonesia: “Bhinneka Tunggal Ika,” or “Unity in Diversity.” Indonesia is well positioned to pursue its further transformation toward an even more prosperous and inclusive society by taking advantage of several bene- ficial trends, including its young and expanding labor force, the rapid growth of the digital economy, and the growing role of Asia in the global economy. However, capitalizing on this favorable environment to achieve higher growth and provide quality jobs to the growing workforce will need to be supported by critical policy reforms, including mobilizing revenues to finance development spending and supporting reform of product, labor, and financial markets. This book explores the key issues policymakers will likely face in the coming years. It discusses policy priorities that can enable Indonesia to continue to pros- per, including the need to upgrade its “soft infrastructure”—that is, the institu- tions, policy frameworks, and toolkits used to manage the economy. The IMF is a committed partner in Indonesia’s transformation, sharing knowledge of interna- tional best practice through policy advice, technical assistance, and training. We are “gotong royong”—working together to achieve a common goal. Christine Lagarde Managing Director International Monetary Fund v ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution Acknowledgments This book has been a collective endeavor involving staff from many IMF depart- ments and a number of Indonesian authorities. We thank the contributing authors for their close collaboration and enthusiasm in exploring various aspects of the Indonesian economy. The book benefited greatly from the support of the staff in the IMF’s Asia and Pacific Department, particularly, Kenneth Kang, Deputy Director. We are also grateful for the valuable