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Speech by Mr Hendar, Deputy Governor of Bank Indonesia, at the Signing of Work Guidelines between Bank Indonesia and the State Police of the Republic of Indonesia concerning Procedures for Implementation of Securing Bank Indonesia and Escorting State-owned Valuables, Jakarta, 23 February 2015.
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Hendar: Increasing cooperation between Indonesia’s central bank and state police Speech by Mr Hendar, Deputy Governor of Bank Indonesia, at the Signing of Work Guidelines between Bank Indonesia and the State Police of the Republic of Indonesia concerning Procedures for Implementation of Securing Bank Indonesia and Escorting State-owned Valuables, Jakarta, 23 February 2015. * * * The Honorable, • Head of Baharkam Polri, Komjen Pol Drs. Putut Eko Bayuseno, SH • Head of Korps Brimob Polri, Irjen Pol Drs. Robby Kaligis • Kadivkum Polri, Irjen Pol Drs. Moechgiyarto, SH, Mhum • Departments’ Heads of Bank Indonesia, attendees and guests Assalamualaikum warahmatullahi wabarakatuh, Good day and Greetings to us all, 1. First of all, I would like to ask us all to praise our gratitudes to Allah SWT, God the Almighty, for His grace we could attend this ceremony of the Signing of Work Guidelines between Bank Indonesia and the State Police of the Republic of Indonesia (POLRI), in this case the Brimob (Mobile Brigade) Corps, concerning “Procedures for Implementation of Securing Bank Indonesia and Escorting Stateowned Valuables”. 2. The signing of this Work Guidelines is a follow-up of the Memorandum of Understanding signed between the Head of the State Police of the Republic of Indonesia and the Governor of Bank Indonesia on “Cooperation in Order to Support the Duty Implementation and Authority of Bank Indonesia and the State Police of the Republic of Indonesia” on 1 September 2014, particularly which governs “cooperation in the field of securing Bank Indonesia and escorting state-owned valuables”. 3. The signing of this Cooperation Agreement constitutes part of a series of intensive discussions processes at technical level which took place earlier. Hence, on behalf of the Board of Governors, we would like to express our thanks for the support of Polri, so that the signing of this Work Guidelines can be realized. This cannot be separated from the high commitment and support of Polri for the implementation of duty and function of Bank Indonesia. The importance of Security Aspect for BII Attendees, Ladies and Gentlemen, 4. As we all know, as a strategic state institution, Bank Indonesia has an important function in the national economy. To run its function, Bank Indonesia owns a variety of important assets both in the form of hardwares and softwares which securities have to be assured. 5. In implementing the function of cash payment system, Bank Indonesia has money storage treasury that highly needed for ensuring the availability of cash in sufficient nominal amounts as well as fractions to meet the public needs. This treasury is also BIS central bankers’ speeches highly required for storage of the State foreign exchange reserves in the form of gold. 6. Meanwhile, to support non-cash payment system, Bank Indonesia also has various vital payment system instruments such as Real Times Gross Settlement (RTGS) system, Sistem Kliring Nasional-SKN (National Clearing System) and data centre which must function safely, smoothly and efficiently. 7. How important the roles of the various assets or system can be seen, among others, from the value of the transaction or money deposited. The RTGS system currently serves transaction settlements with an average value of Rp 469 trillion per day and SKNBI serves banking clearing transactions with an average value of Rp 11 trillion per day. Meanwhile, the amount of cash money ready for circulation both in the treasuries of Bank Indonesia’s head office and representative offices in the regions in the month of January has reached approximately 222 trillion. 8. Another important activity of money circulation that requires escorting is the distribution of money. This activity includes among others the delivery of money fit for circulation from Peruri to Bank Indonesia’s Head Office and delivery of money from Bank Indonesia to the centres of public economic activities such as clean money policy program or money distribution in order to maintain the availability of cash money in remote areas. 9. Disruption and threats against various assets, system and smooth distribution of money, which naturally can harm the economy in the Republic of Indonesia. 10. Therefore, Bank Indonesia requires personnel support from the State Police of the Republic of Indonesia that capable to implement the duties of securing and escorting with qualification and competency in confronting disturbances and threats of security with high intensity, which in this case owned by the Brimob (Mobile Brigade) Corps of Polri. 11. This good cooperation and coordination needs to be poured into a clear and transparent mechanism, in accordance with the duty and authority of BI and Polri, and shall refer to the applicable laws and regulations by considering the principles of justice, benefit and legal certainty. 12. We welcome the signing of the Work Guidelines concerning the “Procedures for Implementation of Securing Bank Indonesia and Escorting State-owned Valuables”. This work guidelines implementation will also be follow-up through cooperation between Bank Indonesia Representative Offices with the local Regional Police. BI Efforts in the Strengthening of Security System Ladies and Gentlemen, 13. We are aware that as a strategic institution, we must have a security system that can integrate and utilize both internal and external resources to ensure the smooth implementation of Bank Indonesia duties. At this time we continue to strengthen the security system of Bank Indonesia, commonly called Sispambi. 14. Several security efforts referred to, among others are in the form of the division of security area classification, i.e.: limited, very limited, prohibited and closed areas. We restrict access to those areas both by access rights and escort officers. Gradually, we have modernized security system devices integrated with the building security. 15. Related to HR, we also continue to improve their quality and skills through various training such as Reskrim/Intelkam (Detectives & Criminal / Intelligence & Security), BIS central bankers’ speeches SAR, Fire Fighters, Security for VIP, and other various training which frequently conducted in cooperation with Polri. Expectation with the Signing of the Work Guidelines Attendees,Ladies and Gentlemen 16. The signing of the Work Guidelines today should be able to become a good communication adhesive, an intensive coordination, and also a synergic collaboration between Bank Indonesia and POLRI, specifically Korbrimob, both at central level and regional levels. We also are convinced that securing Bank Indonesia and escorting state-owned valuables can be run more smoothly and effectively. 17. Thus this speech, may Allat SWT be with us always, to bless and ease our step in the future. Wassalamualaikum Wr. Wb. BIS central bankers’ speeches
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Speech by Dr Halim Alamsyah, Deputy Governor of Bank Indonesia, in the Signing of Cooperation Agreement between Bank Indonesia and the Ministry of Home Affairs of the Republic of Indonesia, Jakarta, 23 February 2015.
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Halim Alamsyah: Bank Indonesia – improved efficiency through data collection Speech by Dr Halim Alamsyah, Deputy Governor of Bank Indonesia, in the Signing of Cooperation Agreement between Bank Indonesia and the Ministry of Home Affairs of the Republic of Indonesia, Jakarta, 23 February 2015. * * * The honorable, • Directorate General of Population Affairs and Civil Registration Services of the Ministry of Home Affairs, Mr. H. Irman, • Heads/Officials in the Ministry of Home Affairs, • Heads/Officials in the state ministries and institutions, • Heads of Working Units in Bank Indonesia and Financial Services Authority (OJK), • Heads of financial institutions, association of financial institutions, and Indonesia Consumers Organization (YLKI), • Distinguished guests, Assalamu’alaikum Wr. Wb, Good morning and may God bless us all, 1. On this great occasion, let us praise God the Almighty for the blessings bestowed upon us so that we can attend the “Signing of Cooperation Agreement on Utilization of National Identity Numbers, Population Data, and Electronic Resident’s Identity Cards within the Scope of Duties of Bank Indonesia”. 2. This cooperation agreement signing is the follow-up to the Memorandum of Understanding on Utilization of National Identity Numbers, Population Data, and Electronic Resident’s Identity Cards within the Scope of Duties of Bank Indonesia signed by the Governor of Bank Indonesia and Minister of Home Affairs on 6 May 2013. This follow-up takes a relatively long time because in-depth reviews of many aspects are necessary, including infrastructure preparation and primarily the impacts of such utilization policy on Bank Indonesia and the financial industry broadly. 3. The duties of Bank Indonesia in the fields of monetary, macroprudential, and payment system require data and information as important elements in formulating appropriate policies and decisions to maintain financial system stability and ensure a reliable and smooth payment system. Such data and information are gathered by Bank Indonesia from various sources through reports and/or surveys of, among others, bank and non-bank financial institutions, government institutions, the capital market, exporters, companies with external debt exposure, and even households. 4. In relation thereto, Bank Indonesia strongly supports the application of National Identity Numbers and electronic Resident’s Identity Cards by the Ministry of Home Affairs because the fundamental issue of population registration in Indonesia is data singularity. The program conducted by the Ministry of Home Affairs to digitize population data by biometric verification technology in the BIS central bankers’ speeches forms of fingerprint recording and retina scanning to ensure one’s singularity is a very progressive step to address the issue. 5. In its development, the population data gathered and managed by the Ministry of Home Affairs may have wider benefits, including the implementation of duties of Bank Indonesia and even other relevant institutions. Some examples of the population data benefits in the implementation of duties of BI and financial institutions, particularly banks, are as follows: a. First, to increase efficiency and effectiveness of services provided to customers and the community in credit extension. As we all know, Bank Indonesia is currently managing Debtor Information System (DIS) which has gathered around 82 million debtors’ data from bank and nonbank financial institutions with more than 180 million credit facilities. The DIS data is utilized by bank and non-bank financial institutions as one of the main considerations in credit extension process to verify debtors’ identities, credit facilities extended by other financial institutions, payment history, collateral, etc. Therefore, accuracy and singularity of debtors’ data are very important factors. b. Second, to increase effectiveness of Bank Indonesia in conducting assessments and designing more efficacious credit policies. c. Third, to support banks to better understand and recognize customer candidates as well as financial behavior in a more prompt and accurate manner. Accordingly, banks are also expected to design cheap credit extension patterns without any collateral for individuals or households with sound financial behavior. We often call this financial inclusion program. Ladies and gentlemen, 6. In many occasions, I often say that the Global Financial Inclusion Index data in 2011 recorded only around 20%1 of adult population in Indonesia who have accounts with formal financial institutions; in other words, there are more than 135 million people with limited or no access to formal financial institutions (commonly called unbanked people). Poor access by the community to formal financial institutions becomes a national strategic issue considering the strong correlation between expanded financial access and economic growth. Therefore, financial inclusion has become the government’s priority agenda as specified in the National Financial Inclusion Strategy. 7. One of the causes of poor access of unbanked people to formal financial institutions is asymmetric information. Generally, data of unbanked people is difficult to obtain as preliminary data for customer potential analysis. For that reason, information provision facilities are necessary, which allow adequate mapping of unbanked people potential, so that formal financial institutions may provide the required financial products and services. Starting from this identified information requirement, one of the financial inclusion programs promoted by Bank Indonesia is the Financial Identity Number (FIN). 8. FIN is a unique, inherent, lifetime, simple, transparent, and interoperable number provided to the community, including unbanked people. The aim is to reduce asymmetric information & risk premium, facilitate and increase financial access of the community, and facilitate financial institutions to obtain World Bank report “Global Financial Inclusion Index“. BIS central bankers’ speeches information on customer candidates/customers. For Bank Indonesia, FIN is very useful to produce more structured database and information on people receiving services from formal financial institutions. However, more importantly, FIN will become one of the main data sources to make profiles (rating) of accurate individual or household finance to facilitate banks in extending cheap but quality credit package without any collateral. 9. BI has been developing FIN since 2012 by collecting information through a baseline survey using secondary data and comprehensive survey by direct interviews with respondents. BI is consistently improving FIN business model, among others through information system development and database expansion by formulating digital questionnaire concept, which, at the initial phase, will be tried through Digital Financial Services agents. In this relation, the NIN (e-Resident’s Identity Card) database will be used to establish FIN data to allow acceleration of data capturing process and avoid FIN data duplication, thereby ensuring FIN data singularity of each person. Ladies and gentlemen, 10. We are pleased that Bank Indonesia’s policies and work programs to increase public welfare, among others through electronification and financial inclusion, may synergize with the Program for Population Data, National Identity Numbers, and Electronic Resident’s Identity Cards by the Ministry of Home Affairs, to give greater benefits for the financial system in particular and Indonesian people in general. 11. We believe this Cooperation Agreement signing is the first step for both institutions, and further technical steps are definitely necessary to realize the expected benefits. 12. To conclude, we would like to extend our highest appreciation and gratitude to the Ministry of Home Affairs and all parties supporting the realization of this Cooperation Agreement. May God the Almighty bless our sincere intention and steps and bestow us with smooth implementation thereof. Thank you. Wassalamualaikum wr. wb. BIS central bankers’ speeches
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Keynote address by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the IFSB International Seminar "Enhancing Financial Inclusion through Islamic Finance", Jakarta, 31 March 2015.
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Agus D W Martowardojo: Enhancing financial inclusion through Islamic finance Keynote address by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the IFSB International Seminar “Enhancing Financial Inclusion through Islamic Finance”, Jakarta, 31 March 2015. * * * Bismillahirrahmanirrahiim, • His Excellency: Mr Jaseem Ahmed, Secretary General – Islamic Financial Services Board; • His Excellency: Dr. Muliaman D Hadad, Chairman of OJK, Board of Commissioners; • Prominent speakers, • Distinguished Delegates and all participants, Assalamualaikum Warahmatullah Wabarakatuh, A very good morning to all of you. Greeting 1. It is a great honor for me to deliver a keynote address in this IFSB international seminar that is emphasizing on the need to enhance financial inclusion through Islamic finance. Having observed that providing greater financial access is very crucial in delivering equitable opportunities to all segments in the society and preserving more sustained economic development, I am pleased to observe that Islamic finance has a great concern over having a better outreach in delivering financial services. The international seminar that we have today may serve as one of the efforts to deliberate ideas on how Islamic finance could formulate its roles through better financial products and regulations. Recent development of Islamic financial industry Distinguished Guests, Ladies and Gentlemen, 2. We have already witnessed that Islamic financial industry has been rapidly developing in terms of economic sectors, asset size, physical outreach, and financial products offered. Islamic financial products have been used in commercial retail products, corporates, and government. The products of Islamic banks, takaful, and capital market have been widely used in various economic sectors including agriculture, manufacturing, trade finance, transportation, infrastructure development, and others. Branches of Islamic financial institutions have also been established to reinforce physical presence in the market; besides technological advancement that allows the customers to enjoy sophisticated Islamic financial products such as mobile banking and e-finance. The global Islamic financial industry is expected to reach the total assets of USD 2 Trillion this year. The industry is growing at about 17.3 percent compounded average growth rate. It is almost twice as much as the conventional industry has achieved. 3. The development of Islamic financial services industry is still dominated by the 2 major industries, namely the Islamic banking sector and Islamic capital market with the share of 80 percent and 15 percent respectively. The interest of non-Muslim populated countries like the United Kingdom, South Africa and Luxembourg to issue BIS central bankers’ speeches global Sukuk has been monumental. The total of Sukuk issuance in 2014 has reached the amount of USD 114.7 Billion. At the regulatory and infrastructure side, we could also see some significant progress taking place. The Islamic Financial Services Board has consistently produced regulatory references that are beneficial to enhance governance of the industry. Those cover prudential measures for Islamic banking, takaful (or Islamic insurance), and Islamic capital market. 4. The latest efforts coming into plates are the Guidance Note on Liquidity Risk Management and the core principles of Islamic banking supervision. Those regulatory references are expected to further streamline Islamic finance operations globally and serve as a basis for assessing the strength and effectiveness of regulation and supervision. The International Islamic Liquidity Management Corporation has also shown its presence by increasing its sukuk issuance that can be used for liquidity management of the internationally operating Islamic banks more efficiently. Despite some exogenous disturbing factors like geopolitical crises and shocks to oil prices, we could expect that the industry could sustain its development until it reaches its significant role as one of key drivers of the global economic development. 5. Cross sector activities between Islamic banking and capital market in terms of Basel III compliant sukuk, “green” sukuk issuance, and social based sukuk have also indicated progressive innovation in the industry. The central banks have also equipped themselves with some innovation allowing them to perform monetary operations using sharia compliance financial instruments and enriching the industry with more compatible products such as sharia compliance repurchase agreement (repo). At the industry level, we could also see the involvement of Islamic Development Bank as one of the Multilateral Development Banks deserves appreciation. It was through its initiatives that the establishment of supporting institutions like the Islamic Financial Services Board (IFSB), International Islamic Financial Market (IIFM), the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), and the International Islamic Liquidity Management (IILM) was successfully arranged. The latest Ten-Year Framework and Strategies tries to consolidate all the efforts into a well-developed program. Current global Islamic financial industry development Distinguished Guests, Ladies and Gentlemen, 6. The global economy is still trying to regain its momentum for the economic development in the last 5 years. The economic recovery is surrounded by uncertainty which could easily affected by economic policies of advanced economies and other disturbances. The tapering of the US quantitative easing and the shock of international oil price caused a destabilizing force to the emerging economies that are fundamentally sustained by domestic demands well-formulated monetary policy. The growth in the capital market has also been challenged by the oil price decline and low interest policy in the advanced market. 7. Despite the uncertainty faced by the industry, I am confident that the Islamic financial industry could maintain its pace of growth in years to come. There are at least five driving forces to sustain the industrial development including the growth of emerging economies, cross-border financial transactions, innovative Islamic financial products, regulatory advancement driven by more advanced and comprehensive regulatory standards, and continuous growth of Muslim population. BIS central bankers’ speeches Achieving greater sustainability in the economic development and financial outreach Distinguished Guests, Ladies and Gentlemen, 8. The development of Islamic finance is expected to provide benefits to wide range of customers. Those include the low income society that currently does not have access to the financial system to make their life better. According to some studies, it is found that there are quite many people in OIC member countries that still live under poverty line. Most of them is unable to upgrade their quality of life and turn themselves into productive society due to the lack of assets in hand and the absence of financial products and services with low cost of funds. 9. Moreover, due to lacks of other resources, they are also remote from supportive education program and health facilities that are potential to strengthen the basic necessities to gain quality in human capital. Without properly designed poverty alleviation program that particular group of people may be trapped in the poverty for ages. In some occasion, low income society has been perceived as involving high risk and too expensive to manage since it requires an extensive effort to manage highly dispersed customers. As a matter of fact, if proper mechanism and procedures supported by well-developed regulation, microfinance industry can also be highly lucrative. 10. Islamic finance with a wider application of equity-based financing and micro-finance products can facilitate greater outreach to medium, small and micro enterprises to promote entrepreneurship and value-creating activities. Conceptually, greater access to financial services can be provided by commercial based Islamic financial institutions such as Islamic banks providing microfinance products or micro takaful provided by takaful institutions. Other steps can be formulated such as integrating commercial sector with Islamic social sector to come up with financial services that are reachable by the micro entrepreneurs and low income society in general. The program is aimed at improving social welfare arrangement through variety of vehicles such as optimization of awqaf funds, innovative zakat disbursement program that is contributive to the job creation initiatives and poverty alleviation program. 11. Conceptually, the practice of Islamic finance signifies its favor to financial stability and quality economic development which is characterized by the use of risk-sharing concept, discouragement to excessive debt, the emphasis on ethical investment activities, and other sharia specific preferences. The emphasis on equity based investment underlines the importance of reinforcing the basic relationship between financial sector and real economy. 12. The development of Islamic financial sector could reduce over-reliance to the debt funding and excessive speculation. Having observed from the past economic crises, it has been evidence that excessive debt funding and speculation significantly contributed to the financial system fragility. In relation to the formulation of public preference, the principle to the prohibition of excessive debt taking could serve as a medium of public education that could create positive effect on the moderation of the aggregate demand; and thus more stable macroeconomic condition. 13. The application of risk-sharing principle could give more gravity to partnership in the society rather than creating lender-debtor relationship. Despite the requirement to have a favorable environment that promotes more symmetric market, the application of sharing concept could offer the potential to reinforce the link between financial sector and the real economy which base the financial contracts on value creation and viability of the enterprises. Once the transparency and governance are in place to allow better partnership, over-creation of financial engineering can be minimized since the financial activities will be focused on the intrinsic value added offered in the financial contracts. BIS central bankers’ speeches 14. From the governance perspective, the risk sharing concept strengthens the incentive to the financial institutions to exercise appropriate due diligence to the financial transactions assuring that the expected profits commensurate their risk taking. Supported by sound information and reporting system, the risk-sharing contract opens up opportunities for the entrepreneur and the financier to monitor and calculate the intrinsic values of the financial transaction that is reflected by its expected profit, cash-flow, risks involved and other influencing factors to the projects. This concept promotes greater discipline and responsibility to all contracting parties to assure its success. The combination of good governance, greater transparency and well-designed risk management would shape trust-based relationship that is essential to make the intermediation process efficient. 15. The attention of the IFSB towards enhancing the role of microfinance in the Islamic finance industry deserves appreciation. The Islamic financial institutions should be able to play significant roles in the economic development covering all segments in the society. The availability of standards on the microfinance activities is important to ensure operational prudence practiced by the Islamic financial institutions when extending their facilities to the low income society. Some regulatory incentive needs to be created in terms of relatively lower risk weighted asset to provide lower cost of capital when entertaining the micro-entrepreneurs. Although, further research need to take place to find the optimal number and prerequisites when applying the incentives. Closing 16. Finally, please allow me to wish you all a productive discussion and deliberation in this important seminar. I am confident that supported by internationally reputable academics and players, we can achieve significant outcomes that are beneficial to promote development in the area of microfinance for Islamic finance. I wish this program a great success. Thank you very much. Wassalamu’alaykum warahmatullah wabarakatuh. BIS central bankers’ speeches
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Keynote speech by Mr Ronald Waas, Deputy Governor of Bank Indonesia, at the Visa Card Managers Annual Meeting, Bali, 27 February 2015.
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Ronald Waas: Digitization in a growing economy Keynote speech by Mr Ronald Waas, Deputy Governor of Bank Indonesia, at the Visa Card Managers Annual Meeting, Bali, 27 February 2015. * * * Distinguished, • President Director of Visa and his team for organizing this event, • People of Payment System Industry, • Ladies and Gentlemen, Good Morning and May God Bless Us All, Om Swastiastu, 1. To begin this speech, please allow me to invite all of us to praise God the Almighty for his blessings so that we meet in a healthy and favorable condition in Sofitel Hotel, Nusa Dua – Bali, in the Visa Card Managers Annual Meeting. 2. I welcome the theme “Digitization in a Growing Economy”, particularly because digital technology has been a consistently increasing part of our daily lives at the local, Asian, and international levels. 3. On this great occasion, I would also like to extend my appreciation to Visa and all System Payment people who are present here and constantly show their commitment to promote a better Payment System in Indonesia in the future. Ladies and Gentlemen, distinguished guests, Regulatory function 4. On several occasions of interacting with industries and the wider community, I always quote a famous American writer in the beginning of the 19th century, James F. Cooper: “the very existence of government at all, infers inequality”. The most fundamental essence of the existence of authorities is to guarantee that any unbalanced social and economic establishments in the community may be managed for the welfare of the wider community. 5. This adagio is important, primarily related to the massive potentials of Indonesian domestic market with a consistently increasing economic capacity. Without acceptable management, our nation will never be “the host” in its own country. 6. Therefore, in line with the complex social plurality and highly dynamic digital technology development, the authority’s function as a control tool to organize people’s life to become more strategic, especially to achieve a completely safe, smooth, and efficient payment system. Ladies and Gentlemen, distinguished guests, Indonesia’s economic development 7. Millennium 21 is a new horizon which opens many opportunities for Indonesia to become a country providing better welfare. With such determination, Bank Indonesia will keep strengthening its contribution to the national economy. 8. In the last few years, the magnitude of global environmental change keeps happening to the domestic economy. Amidst such unfriendly strategic environment, our economic foundation needs improvement and strengthening in some parts. 9. History shows that although Indonesia’s economy keeps experiencing turbulence, it always manages to survive by creating stabilization and even to rise by recording high growth. The year 2011 marks the end of Indonesia’s recovery transition period BIS central bankers’ speeches by successfully entering into the category of middle income country with per capita income of over USD 3,000. The World Bank has ranked Indonesia’s economy 10th in the world through Purchasing Power Parity (PPP). 10. It is certainly the pride of Indonesia as a big nation. However, it also leaves a challenge and work for all of us to allow the wider community to enjoy the benefits of the nation’s huge economic capacity. Ladies and Gentlemen, distinguished guests, Domestic market potential 11. We realize that the huge potential of Indonesia’s market has not been optimally explored. In spite of the increasing use of payment system, a survey by McKinsey & Company (2013) shows that the volume of use of cash for retail transactions is still dominant, i.e. 99.4%, which is one of the highest compared to ASEAN peer countries. 12. In such condition and in line with the digitization trend development of Indonesian people and the international world, we are confident that the future potentials of electronification increase will become higher. Some factors may boost such payment system potentials. 13. First, payment system development in Indonesia keeps increasing. Statistics show that non-cash transactions grow by 22% in average annually (in terms of volume) and 21% (in terms of transaction value). Out of all non-cash instruments, the most rapid development is shown by electronic money by around 30% in 2014. 14. Second, digitization trend through the use of telecommunication device by the community, including in remote areas, consistently indicates an increase, which now has reached 270 million 1 users. Penetration of internet users in Indonesia is also very high, reaching 74.6 million in 2014 2. 15. Third, Indonesia has very high population of around 250 million people or half of the total population of ASEAN countries. With the increasing number of middle class growth reaching 150 million people in 2014, more than 50% of Indonesian people may potentially become payment system users. 16. Fourth, we record that payment infrastructure development also shows significant growth every year, such as ATM, EDC, and use of electronic channels, e.g. mobile banking, internet banking, and phone banking. Payment infrastructure growth of ATM and EDC in the last two years reaches 14% and 50% respectively. 17. Fifth, Non-Cash National Movement (GNNT) launched in 14 August 2014 gains strong supports from various Government institutions. Bank Indonesia consistently makes extensification and intensification programs for effective GNNT program. Ladies and Gentlemen, distinguished guests, Mandates of Bank Indonesia 18. As a payment system authority, the mission of Bank Indonesia is to manage and maintain safe, efficient, and smooth Payment System and Money Management through access expansion and by considering the national interest. The mission will be achieved through two important aspects: first, Payment System strengthening and second, proactive in initiating cooperation and collaboration. Data of MOCIT, 2014. Mark Plus Insight Netizen Survey, 2014. BIS central bankers’ speeches 19. Payment system strengthening is specified in four pillars: first, effective and efficient money management system; second, payment electronification expansion; third, reliable and safe Payment Infrastructure; fourth, strong and rigorous supervision and oversight. On this occasion, we will focus more on exploration of the second pillar, i.e. Payment Electronification Expansion. 20. In relation to the Payment Electronification Expansion, one of the visions of Bank Indonesia in non-cash sector is to realize a society with strong preference to using non-cash payment instruments and facilities in making financial transactions, also known as Less Cash Society. 21. The realization of Less Cash Society is important to boost more efficient economy, in addition to promoting better governance in financial management by the community, businesses, and government institutions. Ladies and Gentlemen, distinguished guests, Electronification 22. In the beginning, we frequently use the term Digital Payment Services; however, in line with the focus and efforts to achieve the mission in non-cash sector, we consider Electronification as a more appropriate term. 23. Electronification is an incorporated and integrated effort to change cash payment into non-cash payment. Expanded use of electronification is defined as an effort to change most payment mechanism from physical into digital or from manual into electronic and to increase limited financial access to wider (inclusive) financial access. 24. Expanded payment electronification strategy is made through an integrated campaign effort involving all stakeholders. We will seek facilitation with the Government and the relevant institutions which may potentially serve as the catalyst of use of payment system electronification. 25. Expanded payment electronification is also an integral part of financial inclusion policy to increase the access of unbanked people to financial institutions. Through the use of information technology, we expect that the launched electronification program may serve as a drive to answer this challenge by providing services to such people in a safe and efficient manner. Ladies and Gentlemen, distinguished guests, Bank Indonesia’ policy to promote less cash society 26. Bank Indonesia’s authority in payment system is embodied in the following 4 roles: (1) establishment of policy, (2) authority in the entry and exit policy of payment system industry, (3) payment system operators, and (4) oversight. Through such 4 roles, we may determine the future direction of payment system development. 27. The established policy is directed to achieve targets of non-cash transactions of up to 2.4 times of GDP by 2015 and 3 times of GDP by 2016. The entry and exit policy aims to make the payment system industry healthier and ready to compete with the global industry. As an operator, Bank Indonesia consistently builds a safe and reliable payment system following the requirements of the community and payment industry. Lastly, Bank Indonesia continuously strengthens payment system oversight to ensure any payment system development innovation is followed by good risk mitigation aspect which in turn will increase public trust in non-cash payment system. 28. To boost non-cash expansion, Bank Indonesia has launched less cash society achievement strategy in 4 focus activities, namely (1) change of public culture BIS central bankers’ speeches towards non-cash transactions, (2) expanded services of non-cash payment, (3) development of supporting infrastructure, and (4) alignment of regulations. 29. First, culture change strategy will be realized through an integrated campaign involving all stakeholders. We will seek facilitation with the Government and the relevant institutions which may potentially serve as the catalyst of use of payment system electronification. The efforts made jointly by Bank Indonesia and the industry among others are e-ticketing cooperation in public transportation sector and development of Government’s assistance distribution (government to people). 30. On the other hand, we are also seeking to increase public awareness on non-cash transactions through a sustainable education program, like integration of non-cash study into the education curriculum. 31. Second, expanded payment electronification is also an integral part of financial inclusion policy to increase the access of unbanked people to financial institutions. Through the use of information technology, we expect that the launched electronification program may serve as a drive to answer this challenge by providing services to such people in a safe and efficient manner. 32. Bank Indonesia has presently expanded payment electronification through development of Electronic Bill Presentment and Payment to integrate bill payment. 33. Third, to realize reliable, efficient, and safe payment infrastructure through National Payment Gateway (NPG) and National Scheme. NPG infrastructure development eventually aims to increase PS service efficiency, including in terms of cost, to add PS service coverage through interconnection and interoperability among operators, and to build independency of national retailers PS by domestic processing. 34. PS independency closely relates to the national standard implementation. Bank Indonesia will ensure that the set standard is in line with the national interest and implemented according to the determined time target. We all have started it and it is our obligation to complete it. I am aware that something we originally start may have downsides, but it is our task to cover those downsides. 35. Fourth, strong and transparent regulations and oversight must be applied to all payment system operators. In the aspect of oversight of payment system instruments, BI will surely strengthen the capability of payment system oversight. 36. In addition, we will strengthen coordination and consolidation between policy authorities and payment system businesses. The step is realized through a plan to establish a high level coordination medium consisting of payment system authority and businesses. Intensive coordination and consolidation is expected to synergize various interests and direct industries for their efficient movements, to promote favorable climate, and to strengthen customer protection by upholding the national interest. Ladies and gentlemen, Closing 37. To conclude my speech this morning, I wish to remind us all that payment system development must be built under the principle of a sound competition to minimize any negative impacts potentially resulting in public confusion, to open access reachable by domestic actors and the wide community, and to eliminate economic rent. 38. Particularly in connection with Expanded Electronification, I also wish to reemphasize that the realization of the expected less cash society basically aims to a cultural/behavioral change instead of system change. Therefore, improvement of BIS central bankers’ speeches education quality for the public is the most strategic phase. The reason is only through improvement of education quality we can open comparative excellence window and build the foundation to reach excellent and prosperous Indonesian society. 39. In this regard, Bank Indonesia as the Payment System Authority will seek to direct the industry for their efficient movements, promote favorable climate for payment system and settlement of financial transactions, and strengthen customer protection by upholding the national interest. 40. I conclude this speech with the confidence that God will always be with us to support and smooth our moves towards a better future. Thank you. BIS central bankers’ speeches
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Keynote address by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the discussion and launching of the 2014 Indonesia Economic Report (LPI), Jakarta, 29 April 2015.
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Agus D W Martowardojo: Strengthening stability, accelerating structural reform to reinforce economic fundamentals Keynote address by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the discussion and launching of the 2014 Indonesia Economic Report (LPI), Jakarta, 29 April 2015. * * * The honorable former Governors of Bank Indonesia, Members of the House of Representatives and Audit Board of RI, Members of BSBI, Members of the Board of Governors of Bank Indonesia, Speakers, Responders, and Moderators, Dear Invitees and Ladies and Gentlemen, Assalamu’alaikum warahmatullahi wabarakatuh, Good morning and may God bless us all, 1. First of all, allow us to ask you to thank God the Almighty for his blessings that we are given the opportunity to attend this event. Insya Allah, we will soon witness the launching of 2014 Indonesia Economic Report (LPI) Book, which will continue to a discussion themed “Strengthening Stability, Accelerating Structural Reform to Reinforce Economic Fundamentals”. 2. LPI Book is an annual publication of Bank Indonesia, which comprehensively contains national economic dynamics in 2014. In addition to documenting the journey of Indonesia’s economy, LPI also seeks to present the lessons learned during such period. The efforts to learn such lessons are very important as a foundation for strengthening and improvement of policies in the future. Ladies and Gentlemen, 3. Slide 2: 2014 turns out to be full of challenges for Indonesia’s economy. Global economic condition is not as bright as initially predicted. Recovery is still taking place in various major economies in the world, but at an unexpected and unequal speed. The world’s commodity prices continuously decrease due to weakening demands, particularly from China. 4. Slide 3: As a country with open economic and financial system, Indonesia will closely relate to the global economic constellation. Furthermore, amidst the world’s divergent monetary policies and changing perception of external risks resulting in the increasingly stronger US dollar on a global scale. 5. Slide 4: Throughout 2014, Indonesia must face different financial market turbulence. Occurrences throughout 2014, such the default of Argentine, stronger expectation for interest rate increase in US, decrease in euro exchange rate as the impact of loosening monetary policies by ECB, and sharp fall in Russian ruble at the end of 2014, contribute to the Indonesia’s economic dynamics. 6. Such different external pressures have in turn resulted in domestic economy instability, one of which is the outgoing foreign capital flows from Indonesia. Such instability also serves to reflect different structural issues in the real sector. The structural issues are not new since they have been subsisting within the last several years. 7. Slide 5: We observe that our high dependency on exports of low value- added natural resources has resulted in vulnerable economic growth against price fluctuation. Our BIS central bankers’ speeches exports sharply fall due to weakening demands from major trade partner countries and declining prices of natural resources based export commodities. Consequently, the economic growth in most provinces whose economy is based on exports of extractive products, primarily Sumatera and Kalimantan, also drastically decreases. 8. Slide 6: Moreover, weak energy resilience makes energy requirements fail to be fulfilled by ourselves, thereby we keep importing. Such weak energy resilience has also caused the Government to adjust fuel price in June 2013 and November 2014 to maintain fiscal sustainability. It then triggers inflation, which pressure we still experience until the end of 2014. 9. Slide 7: Our fragile production structure amidst external pressure has made the national economic growth rate hindered by deficit in the current transaction balance, which has been taking place until now. As a result, exchange rate depreciation becomes inevitable and even necessary to ensure such deficit will not increase and economic slowdown will be controlled. 10. Slide 8: In addition, we still also see the emerging additional vulnerabilities at a micro level. The first is the increasingly higher corporate external debts, but most are unprotected from fluctuating exchange rate risks. Slide 9: The second is a huge accumulated portfolio capital by foreign investors on government bonds, which may easily flow out of the country and trigger exchange rate fluctuation. In addition, our shallow financial market may intensify such turbulence if spillover effects occur. Ladies and Gentlemen, 11. The Government and Bank Indonesia adopt various policies to maintain macro stability in order to control economic growth slowdown in the short run. Policies are directed to ensure inflation is controlled, stability of rupiah exchange rate is maintained on its fundamental condition, and deficit in the current transaction balance may be reduced towards a healthier level. 12. Slide 10: In such policy direction, Bank Indonesia has strengthened its policy mix, namely (i) continue the “tight bias” policy by increasing BI Rate by 25 bps to 7.75% in November 2014, (ii) strengthen monetary operations, (iii) stabilize rupiah exchange rate, and (iv) strengthen macro- prudential policy. 13. Slide 11: Bank Indonesia’s policy to increase BI Rate in November 2014 is an “ahead to curve” step to mitigate expected inflation increase risks and ensure inflation pressure post-increase in subsidized fuel price will be controlled and temporary and may immediately return to the targeted track. 14. We believe that with inflation and its expectation anchored to low rate, people’s real savings and purchase power will not be eroded; therefore, it becomes the foundation for stronger economic growth and poverty alleviation in the future. 15. The monetary policies we have adopted are accompanied by the strengthening of inflation control coordination through the Inflation Control Team (TPI) and Regional Inflation Control Team (TPID). 16. The tight bias policy we have adopted also aims to ensure that the deficit in the current transaction balance, which has been taking place for three years, will remain controlled at 2.5–3 percent of GDP and will not increase. Controlled deficit in the current transaction balance is very vital to ensure the national economy will grow strong and balanced and job creation will continue. BIS central bankers’ speeches Ladies and Gentlemen, 17. We also see that efforts to maintain macroeconomic stability must also be supported by the principle of prudence in the business world. We observe that such prudence is primarily required for businesses obtaining foreign loans. 18. Slide 12: In this relation, Bank Indonesia has obliged corporations to do hedging by applying the following rules: (i) minimum hedging ratio, (ii) maintenance of forex liquidity adequacy, and (iii) minimum credit rating. We will consistently monitor the private foreign loans and take advanced steps if necessary. 19. Slide 13: In the financial sector, we also see that structural challenges must also be tackled to deepen financial market. Alternative financing sources in our economy still focuses on the banking sector and remains undiversified, while the roles of bond market have been insignificant. 20. Slide 14: Efforts to deepen financial market by developing “hedging” market have become very urgent as well because we will face increasingly complex global challenges. Therefore, Bank Indonesia in cooperation with the Financial Services Authority (OJK) has established a foreign exchange market committee, issued market conduct, simplified and deregulated some provisions to facilitate hedging transactions on the forex market, encouraged interbank repurchase activities, and improved provisions for JIBOR (Jakarta Interbank Offer Rate). Distinguished Ladies and Gentlemen, 21. We are pleased and record that strategic and tactical steps have been initiated by the Government on urgent structural reform nodes in order to build a stronger supporting environment for investment. Such nodes, primarily strengthening of physical connectivity focusing on maritime and its integration to land connectivity, we believe will significantly decrease logistics cost, making businesses more competitive in the global market and eventually achieving equal cost efficiency throughout the country. 22. Slide 15: Another important thing is the Government’s efforts to reform fuel subsidy, which is very vital to be shifted to strengthen development’s basic capital. Development of HR quality, infrastructures, and innovative and institutional capacity, which are the basic capital for the national economy to grow stronger and more sustainable, has been hostage to improperly targeted subsidy. Therefore, Bank Indonesia fully supports the “firm step”, the benefits of which will be experienced in the coming years. Distinguished Ladies and Gentlemen, 23. Slide 16: At the end of 2014, some initial indications of economic recovery have been observable. Stability oriented policies have prevented the national economy from increasingly stronger pressures. The deficit in the current transaction balance in 2014 has been lower to reach –2.87% of GDP, compared to –3.18% in 2013. 24. Slide 17: Stability oriented policy has also put more confidence of investors in the quality of Indonesia’s macroeconomic policies. It is depicted by the large incoming flows of portfolio investment, which reaches Rp 181.5 Trillion in 2014. The flows maintain investment enthusiasm in the market price and government securities (SBN). 25. Slide 18: Along with direct investment, such portfolio investment flows have supported the surplus in Indonesia’s Balance of Payment, making the foreign exchange reserves at the end of 2014 reach USD 111.9 billion (equal to 6.5 months of requirements for imports and payment of the Government’s external debts), compared to USD 99.40 billion at the end of 2013. BIS central bankers’ speeches 26. Therefore, it will not be exaggerating to say that policy measures taken by the Government and Bank Indonesia have been proven successful at recovering the macroeconomic condition in 2014 to the “path of stability”. Ladies and Gentlemen, 27. Overall, Indonesia’s economic dynamics in 2014 bring some valuable lessons to support sustainable economic growth. 28. First, it is important to maintain consistent macroeconomic policies, both fiscal and monetary policies. Such maintained consistency will grow trust in and credibility for the policies. Second, amidst diverse and increasingly complex economic challenges as well as various vulnerabilities, including high current transaction deficit and inflation, a synergy of monetary and fiscal policies and structural reform are required to allow higher economic growth with maintained macro stability. Third, timeliness is important in adopting policies. Bank Indonesia considers that policy mix should be implemented in a timely and measurable manner. Ladies and Gentlemen, 29. Although external and internal challenges for the national economy ahead will become increasingly serious, it does not necessarily mean that the enthusiasm of our present economic achievement prospect will go dim. We think optimism over our economy ahead will remain high. 30. Slide 19: With such optimism, we estimate that Indonesia’s economy will grow by 5.4%–5.8% in 2015 and 5.6%–6.0% in 2016, in a reduced deficit in the current transaction balance. With such prognosis, it is estimated that real exchange rate will relatively stable. To ensure that different structural reform programs supporting economic growth will be implemented, we are consistent in seeking to anchor inflation rate and its expectation on the medium term target at 4±1%. 31. However, various positive prospects are not easily realized because there are some risks and challenges ahead. Global economic condition ahead will remain full of uncertainty. Divergent global monetary policies will make the world’s financial market vulnerable to shifting perception. Global turbulence risks may spillover quickly to our economy through the financial market and trade. 32. Meanwhile, we are still struggling with diverse structural rigidity and inefficiency, thereby making the supply side of our economy unresponsive. 33. Considering the global and domestic economic constellations require consistent stability-oriented monetary policies and “firm” structural reform policies to increase the capacity and competitiveness on the supply side; therefore, we expect our economy ahead will sustainably grow high from “non-artificial” forces. Ladies and Gentlemen, 34. I conclude my brief introduction. Further description of the journey of Indonesia’s economy in 2014 has been prepared in a 2014 Indonesia Economy Report book (LPI), which you all will receive at the end of this event. 35. We invite all of you to thoroughly observe the contents of the book, which is the eminent regular publication of Bank Indonesia. As an illustration of the book cover, we have selected a figure of the “Gradon Boat” traditional sport, representing our fighting spirit in work. In addition to power and speed, a dragon boat also requires coordination and teamwork to be able to come out as a winner. BIS central bankers’ speeches 36. I also wish to extend my appreciation to the resource persons, responders, and moderator who accept our invitation to this morning’s discussion. We expect the discussion will make our determination stronger to reinforce economic fundamentals. 37. To conclude, on behalf of the Board of Governors of Bank Indonesia, I present 2014 LPI and expect this book will give broad knowledge to the readers. This is book is expected to be able to continue LPI’s reputation as a quality and reliable reference for the journey of Indonesia’s economy in wading through the sea of challenges towards the port of welfare and prosperity. 38. May God bless our steps and always give the guidance, direction, and blessings to Indonesia to remain productive. Thank you. Wassalamu ‘alaikum warahmatullahi wabarakatuh. BIS central bankers’ speeches
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Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the discussion and launching of the Financial Stability Study book, Jakarta, 8 May 2015.
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Agus D W Martowardojo: Strengthening financial system stability amidst global and domestic challenges Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the discussion and launching of the Financial Stability Study book, Jakarta, 8 May 2015. * * * The honorable: Former Governors of Bank Indonesia, Members of the Board of Governors of Bank Indonesia, Heads of State Ministries and Institutions, Members of Bank Indonesia Supervisory Board, Representatives associations, Representatives of research institutes, observers, and academicians, Heads of national banks, Speakers and moderators, Distinguished invitees and ladies and gentlemen, of businesses, industrial associations, and banking Assalamu’alaikum warahmatullahi wabarakatuh, Good morning and may God bless us all, 1. First of all, let us praise God the Almighty for all blessings so that we are given the opportunity and good health to attend this event. Insya Allah, we will follow a discussion themed “Strengthening Financial System Stability amidst Global and Domestic Challenges” and launching of Financial Stability Study Book No. 24, March 2015. 2. This FSS book reflects the dynamics in the second semester of 2014 and is a part of Bank Indonesia’s routine publications to meet transparency and accountability of implementation of Bank Indonesia’s duties in macroprudential field. 3. In general, the book’s contents are the results of Bank Indonesia’s monitoring and analysis of the development and dynamics covering our financial system. This includes description of assessment of potential risks and financial imbalance in financial institutions, financial markets, financial infrastructures, and corporations as well as households. 4. We expect such monitoring and analysis results may help the community and other stakeholders understand macroprudential policies adopted by Bank Indonesia to maintain and sustain financial system stability. Distinguished Ladies and Gentlemen, 5. We just left 2014, a year full of challenges for Indonesia’s economy. Many events to tell on how Indonesia’s economy must face unfavorable global economic dynamics and domestic situations. BIS central bankers’ speeches 6. On the global level, we witness that global economic recovery is ongoing, but at an unexpected and unequal speed. Such dynamics transforming into global pressure become more apparent when world’s commodity prices keep decreasing due to weak global demand, primarily from China. The emerging markets are then influenced and may potentially suffer from rapid capital reversal, including Indonesia. 7. Within the country, we also observe equally enormous pressures against the economy. Domestic economic growth slowdown is more intensified by vulnerabilities in the financial sector, such as increasing credit risks and rising private external debts exposed to exchange rate risks. 8. In addition, many issues must be immediately resolved since they affect financial system stability. Such issues among others are (i) frail domestic financial market, (ii) segmented Interbank Money Market, (iii) increase in short term high-cost fund in the bank’s third party fund, and (iv) continued increase in property prices. Distinguished Ladies and Gentlemen, 9. Alhamdulillah, amidst global and domestic challenge dynamics, Indonesia’s financial system stability in the second semester of 2014 could be maintained in general as supported by better financial market performance. It is in line with the increasing global financial performance and high foreign capital inflow to Indonesia in 2014 reaching Rp181.5 trillion. 10. In addition, well maintained financial system condition is also supported by strong banking condition. It is among others reflected from bank’s capital adequacy ratio (CAR) much higher than the minimum requirements, relatively high industrial liquidity, and relatively low ratio of non-performing loans. Moreover, more efficient, secure, and smooth payment system condition also contributes to the maintained financial system condition. 11. However, we must keep cautious of and observing different risks potentially arising against the financial system. We certainly do not wish to become indifferent to various achievements supporting financial resilience in 2014. 12. With the current economic and financial system characteristics of Indonesia, we note sources of financial vulnerability and imbalance may result in systemic risks. Such sources are apparent in at least 5 (five) areas. 13. First, banking procyclicality behavior following financial cycle and increase in short term high-cost fund in the bank’s third party fund. Second, private external debt growth partially unprotected by hedging. Third, continuous decrease in the world’s commodity prices affecting Indonesia’s exports, which still rely on natural resources commodities. 14. Fourth, continuous uncertain normalization of the Fed’s monetary policies and better US economy resulting in stronger US dollar. Fifth, continuous excessive increase in property prices resulting in intensifying credit risks and affecting inflation control efforts. Distinguished Ladies and Gentlemen, 15. Imbalance sources and their potentials to become systemic risks must be carefully anticipated and responded in an effective and synergic manner. In this case, coordination and collaboration of policies between authority and institutions under the Financial System Stability Coordination Forum, namely Ministry of Finance, Bank Indonesia, OJK, and LPS, become an inevitable necessity. 16. As a macroprudential authority, in maintaining and sustaining financial system stability, Bank Indonesia contributes by continuing various macroprudential policies adopted since the middle of 2013. BIS central bankers’ speeches 17. Such macroprudential policies among others include application of Secondary Reserve Requirement (RR), RR connected with the Loan to Deposit Ratio (LDR), Loan to Value (LTV) policy, and financial market deepening as well as financial inclusion increase. In addition, Bank Indonesia has also issued policies which may be used as prudential guidelines in External Debt management by non-bank corporations. 18. We need to inform you that such macroprudential policies are basically temporary and not cross-sectoral. The policies may be at any time reviewed, fine-tuned, and refined to maintain financial system balance and stability as the objective of macroprudential policies. Ladies and Gentlemen, 19. Observing the financial system condition and pressures as well as challenges of the national economy, Bank Indonesia’s macroprudential policy direction in 2015 will focus on efforts to: (i) mitigate financial imbalance risks, (ii) maintain liquidity adequacy and deepen financial market, and (iii) boost quality credit growth in productive economy sectors to support economic capacity increase. 20. Such macroprudential policy direction is implemented among others through preparation of national and regional financial balance sheet, application of bank capital components in the form of Countercyclical Capital Buffer (CCB), and improvement of RR-LDR provisions. 21. Furthermore, macroprudential policy direction is implemented through the adoption of incentive/disincentive mechanism to boost quality MSME credit extension and strengthen the legal basis for Financial System Security Net (JPSK). 22. One thing we need to emphasize is efforts to maintain and sustain financial system stability and resilience relate not only to conventional financial system. Bank Indonesia, OJK, and the Government must also seek to increase stability and resilience in sharia finance. It is conducted among others through development of sharia finance instruments, Sukuk market deepening, and enabling regulation formulation. 23. We must also be alert to the constellation of global monetary policies, where divergence occurs in monetary policies of the Fed and other developed countries, which results in stronger US dollar. It will bring different challenges for us because Indonesia is at the same time facing current transaction balance deficit that still needs to be controlled. If improperly anticipated and responded, this condition will affect exchange rate stability, which will in turn influence financial system stability. Distinguished Ladies and Gentlemen, 24. Above is my introduction to the discussion and launching of Financial Stability Study No. 24, March 2015. We expect the discussion will open wider horizons of Indonesia’s financial system and result in constructive and strategic thoughts to maintain financial system stability. 25. To conclude, may God bless and guide our steps. Thank you. Wassalamu ‘alaikum warahmatullahi wabarakatuh. BIS central bankers’ speeches
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Speech by Mr Ronald Waas, Deputy Governor of Bank Indonesia, at an event entitled "Dissemination of Mandatory Use of Rupiah within the Republic of Indonesia", Bank Indonesia, Jakarta, 15 June 2015.
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Ronald Waas: “Implementation of Use of BI-RTGS System in Money Settlements for Transactions in the Capital Market” Speech by Mr Ronald Waas, Deputy Governor of Bank Indonesia, at an event entitled “Dissemination of Mandatory Use of Rupiah within the Republic of Indonesia”, Bank Indonesia, Jakarta, 15 June 2015. * * * Distinguished: • Heads of banks in Indonesia; • Chairs or representatives of banking associations or organizations in Indonesia; • Heads of Departments of Bank Indonesia; • Ladies and gentlemen. Good Morning and May God Bless Us All 1. To begin our event this morning, I would like to invite all of us to praise God the Almighty for giving us the opportunity to meet in this favorable occasion titled “Dissemination of Mandatory Use of Rupiah within the Republic of Indonesia”. 2. Today, we invite you to have a discussion to establish the same perception and improve our understanding on banking, as well as disseminate and educate on the implementation of mandatory use of Rupiah within the Republic of Indonesia. We are aware that the enforcement of the regulation on Mandatory Use of Rupiah within the Republic of Indonesia (BI Regulation No. 17/3/PBI/2015 dated 31 March 2015 and BI Circular No. 17/11/DKSP/2015 dated 1 June 2015) is of significant importance for today’s attendees and the community. The reason is the use of Rupiah closely relates to economic activities in general, primarily payment transactions in Indonesia. Ladies and gentlemen, 3. I consider the awareness of mandatory use of Rupiah within the Republic of Indonesia is based on three significant main dimensions and determines our identity as a nation. 4. First, legal dimension. This is not a new regulation enforced by Bank Indonesia. Since 2011, we already have a Currency Law, regulating Rupiah as one of the symbols of state sovereignty which must be respected and honored by all Indonesian people. The establishment of Bank Indonesia regulation related thereon is expected to promote strengthening and purifying payment transactions within the Republic of Indonesia by the use of Rupiah. 5. Various other regulations have been established, such as Law on the Flow of Foreign Exchange, Law on Special Economic Zones, Presidential Regulation on the Blueprint of National Logistics System Development, Regulation of Minister of Trade on Inclusion of Prices and Tariffs of Goods and Services, and many other relevant regulations on rupiah, all of which provide a very strong foundation for the use of Rupiah in the country. 6. Such regulations, directly or indirectly, confirm the mandatory use of Rupiah in any payment transactions conducted within the Republic of Indonesia, either in cash or non-cash. 7. Second, nationhood dimension. Many parties see and believe that the main purpose for Bank Indonesia to implement mandatory use of Rupiah is solely to BIS central bankers’ speeches support the stability of Rupiah exchange rate. It is not wrong, but other than economic aspect, one more basic and fundamental reason is to uphold the sovereignty of the Republic of Indonesia. 8. I would like to use an analogy to explain the nationhood dimension delivered by President Jokowi in his inauguration speech as the President of the Republic of Indonesia. He said “we have been ignoring the sea.” Indonesia must honor its own civilization, by returning to the position of Indonesia as a maritime country. 9. In relation to enforcing Rupiah, I would not wish that within the next 5 or 10 years or even longer, our president will say “we have been ignoring Rupiah.” 10. It seems an irony because honestly, it is apparent that the tendency to use dollar has become increasingly dominant and a daily practice in certain economic activities. 11. We easily find that dollar is frequently used, starting from quotations, individual (customer) payment transactions, such as purchases of electronic devices and apartments, until non-cash payment transactions in a large amount. 12. One of the noteworthy historical records serving as a lesson for us is the release of Sipadan and Ligitan Islands from the Republic of Indonesia. One of the global considerations in releasing Sipadan Island is lack of economic transactions and activities using Rupiah therein. 13. Third, economic/business aspect. Foreign currency transactions within the country become one of the factors resulting in increasing foreign currency demand. Such high foreign currency demand in economic transactions will make our economy vulnerable to economic fluctuations. The trust of Indonesian people and the international world in Rupiah will strengthen national economic resilience in general, thereby resulting in the rising dignity of Rupiah, both within and outside the country. 14. In the excessive net demand for foreign currency within the country, such use of foreign currency will increase the pressure against Rupiah exchange rate depreciation. It will potentially disrupt Rupiah stability and add to the complexity of monetary and exchange rate policies. 15. Bank Indonesia as the central bank realizes that the use of Rupiah as a lawful means of payment in any payment transactions is a very fundamental element and serves as a pillar of successful and robust national economy. In the long run, the mandatory use of Rupiah may also prevent the increasingly spreading dollarization in our economy, which in turn will support a more sound economic structure. Ladies and gentlemen, 16. Bank Indonesia realizes that enforcement of mandatory use of Rupiah will not be easy. Therefore, Bank Indonesia and the government will cooperate with the law enforcement and state institutions and also collaborate with the private sector. 17. In this regard, we have also cooperated and agreed with the Indonesian Airline Ticketing Association (ASTINDO) and the Indonesian Hotel and Restaurant Association (PHRI) to uphold the mandatory use of Rupiah within the Republic of Indonesia in any transactions related to the business fields of the two associations. 18. We also consider that law enforcement efforts must be balanced with an intense dissemination and education to the community. Such community awareness is the first line of defence we must consistently embed to the whole community. Only in that way will Rupiah become ”host” in its own country. BIS central bankers’ speeches Ladies and gentlemen, 19. We expect that the series of dissemination on mandatory use of Rupiah will strengthen our commitment to realize the sovereignty of Rupiah within the Republic of Indonesia and support to achieve stability of Rupiah exchange rate. 20. To conclude, may God will always accompany, guide, and facilitate our steps towards a better future. Thank you. BIS central bankers’ speeches
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Speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the inauguration of Indonesia Payment System Forum (FSPI), Jakarta, 27 August 2015.
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Agus D W Martowardojo: Inauguration of Indonesia Payment System Forum Speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the inauguration of Indonesia Payment System Forum (FSPI), Jakarta, 27 August 2015. * * * Distinguished, • Minister of Finance of RI, Bambang Brodjonegoro • Minister of Trade of RI, Thomas Lembong • Member of Board of Commissioners of Financial Services Authority, Firdaus Djaelani • Deputy Commissioner for Bank Supervision Financial Services Authority, Mulya E. Siregar • Deputy Governor of Bank Indonesia, Ronald Waas • Director General for Treasury of Ministry of Finance, Marwanto Harjowiryono • Director General for Domestic Trade of Ministry of Trade, Srie Agustina • Director General for Application and Information of Ministry of Communication and Information, Bambang Heru Tjahjono • Chair of Indonesia Payment System Association, Darmadi Sutanto • Officials of Ministry of Finance, Ministry of Trade, Ministry of Communication and Information, and Financial Services Authority • Heads of Working Units in Bank Indonesia • Distinguished ladies and gentlemen, Assalammualaikum Wr Wb, Good afternoon and may God bless us all, “Salam” 1. To begin our meeting this afternoon, I would like to invite all of you to praise God the Almighty. Because of God’s blessings, we have the opportunity to gather to witness the inauguration of Indonesia Payment System Forum or FSPI. Please also allow me to extend my gratitude and appreciation to all parties supporting the process of FSPI establishment. 2. As a cross-institutional forum, FSPI is expected to become a forum of effective coordination, communication, and harmony between Bank Indonesia, Financial Services Authority, Ministry of Finance, Ministry of Trade, and Ministry of Communication and Information in supporting the implementation and development of Payment System in Indonesia. 3. With a close synergy through FSPI, it is expected that a smooth, safe, efficient, and reliable national Payment System for all Indonesian people may be realized. Furthermore, all stakeholders will also benefit from the planned collaboration. BIS central bankers’ speeches Distinguished ladies and gentlemen, “Background of FSPI Establishment” 4. Following the current development of Indonesia’s economy, we observe at least 3 (three) issues of Indonesia’s economic management under the international spotlight. First, the ability in execution and implementation of policies. Second, transparency in policy making with sufficient public consultation. Third, how coordination is built between the Central Government, Regional Governments, and relevant authorities, thereby avoiding overlapping policy making. 5. Today, we gather to inaugurate FSPI and address the concern for coordination issues between authorities in Indonesia. In FSPI, we will consistently cooperate, build coordination, and immediately catch up Indonesia’s lagging development in acceptable Payment System. 6. We certainly expect the support and commitment of some of you as the heads of the relevant ministries and authorities to realize it. In addition, we believe that on the technical level, all technical teams need the commitment and direction of their respective leaders to allow effective role playing. Distinguished ladies and gentlemen, “BI’s Duties and Authorities in PS” 7. Every Ministry and Authority present today has their own regulations. In its capacity as a Central Bank, BI’s mandates specified in the law include not only ensuring effective monetary policies, but also maintaining financial system stability and implementing smooth, safe, efficient, and reliable payment system. Furthermore, the law also mandates Bank Indonesia to grant permits for Payment System implementation. 8. Implementation of such mandates correlates and supports one another in order to achieve the objectives of Bank Indonesia. The reason is the roles of monetary policies in affecting real sector will be transmitted through financial and payment systems. 9. Availability of adequate instruments and infrastructures of payment system, which can support financial system activities, will serve as a highly significant factor to facilitate public payment transactions. Without such supports, monetary policies will not be transmitted effectively. Distinguished ladies and gentlemen, “Development of PS in Indonesia” 10. In line with national economic growth, Indonesian people make more payment transactions every year. Various non-cash payment instruments have started to become an inseparable part of our daily lives. 11. The use of instruments, such as debit cards, credit cards, and electronic money, keeps developing, as followed by growing new payment channels. Through the internet, mobile banking and internet banking facilitate transactions made by the people. The strong penetration of internet also offers a new online shopping medium for the people, which is also known as e-commerce. 12. If we follow the recent growth of e-commerce, it is unbelievable. We see that the rapid growth of e-commerce matches the penetration of cellular phones. Facing such development, we as the regulator may not delay in our response. We should have been able to make an architecture, making all industries develop in a consistent manner. Consistent means constantly following international best practices and accommodating the needs of Indonesian people. BIS central bankers’ speeches Distinguished ladies and gentlemen, “Challenges of Domestic PS” 13. We warmly welcome such positive achievements. However, we observe there are at least 3 (three) domestic challenges ahead. First, compared to countries in ASEAN, electronic payment transactions in Indonesia are relatively low. With the high number of population in Indonesia, there is a huge potential to expand payment system service access in Indonesia. 14. Therefore, in 2014, Bank Indonesia has launched Non-Cash National Movement in order to encourage the expansion of electronification. The National Movement has a mission to establish a less cash society (LCS). 15. In its implementation, Bank Indonesia involves the Central Government, which is represented by different Ministries, and Regional Governments to encourage the use of non-cash transactions in the Governance and daily transactions by the community. 16. Second, with the vast archipelago of Indonesia, we observe unequal Payment System services. People in remote areas may not experience the benefits of familiar services in big cities. 17. The challenging supporting infrastructure availability, like quality telecommunication network, is key to help service expansion. Moreover, we all experience the benefits of quick and easy transactions provided by the latest Payment System services. 18. Third, we observe that the rapid development of information, communication and technology has security risks. Crimes or fraud in online transactions will eventually pose legal and reputation risks to Payment System service providers. 19. Therefore, we consider that consumer protection aspect must also become our priority. We must seek to do the following, including to increase the system security; expand consumer care channels to allow quick and easy access ; increase consumer awareness on safe transactions ; and increase supervision of Payment System implementation. Distinguished ladies and gentlemen, “Global & Regional PS Challenges” 20. In addition to the three challenges, we also face global and regional development requiring close anticipation. As a country with an open economy system, Indonesia needs to consistently increase compliance with the international standard in Payment System. 21. Fulfillment of the international standard, one of which is specified in the Principle of Market Infrastructure (PFMI), will help us ensure Payment System infrastructure supporting global financial market to have better resilience. Then, safety, reliability, and efficiency need continuous attention for improvement. 22. Development of international standards is followed with the developing cooperation initiatives between countries to develop a cross border Payment System infrastructure. Amidst the increasing interdependence of economy between nations, various efforts have been made to allow development of more efficient cross-country clearing and settlement mechanism. 23. As we all know, the economic integration trend of ASEAN Economic Community will affect the dynamic national Payment System industry. In order to reduce economic constraints between countries, Payment System industry will receive challenges from the regional industries. We need to act on it by increasing competitiveness and BIS central bankers’ speeches service quality in order to create fair competitiveness climate by prioritizing national interests. Distinguished ladies and gentlemen, “Objectives of FSPI Establishment” 24. The different challenges I mention above require our preparedness. However, we realize that to respond to such challenges, a strong collaboration is needed. 25. The relevant Ministries and Authorities will play a very important role to establish a better Payment System in Indonesia. Different initiatives by the Government may serve as an effective drive, such as by facilitating social support distribution, services related to tax and non-tax state revenue, and efforts to drive transactions through e-commerce. 26. Last but not least, the roles of industries to provide infrastructures and services and consumers as the users will definitely serve as a very constructive part for the future development of national Payment System, primarily in identifying needs and evaluating development plan feasibility. 27. Therefore, we consider it necessary for us to communicate, coordinate, and collaborate in Indonesia Payment System Forum. We consider that Ministries, Authorities, and Institutions you lead play vital and strategic roles to harmonize various regulations, implement joint programs, and formulate the future direction of Payment System policies. In addition, with the collaboration, different innovations in Payment System are also expected to be made. Distinguished ladies and gentlemen, “Closing” 28. To conclude, I believe that FSPI will be able to produce feedbacks, ideas, breakthroughs, and anticipatory ideas in the episode of Indonesia’s Payment System journey in the future. 29. The inauguration and signing of FSPI charter today are expected to serve as a symbol of our commitment, where the Steering Committee and Technical Committee of FSPI are prepared to play their roles optimally. 30. I would like to congratulate the Steering Committee and Technical Committee of FSPI, and please allow me to hereby inaugurate the establishment of Indonesia Payment System Forum. Thank you. Wassalamu’alaikum Wr. Wb. 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Welcoming remarks by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Joint IMF-Bank Indonesia Conference "The Future of Asia s Finance: Financing for Development", Jakarta, 2 September 2015.
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Agus D W Martowardojo: The future of Asia’s finance – financing for development Welcoming remarks by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Joint IMF-Bank Indonesia Conference “The Future of Asia’s Finance: Financing for Development”, Jakarta, 2 September 2015. * * * • Honorable Managing Director Christine Lagarde, the co-host of this Conference; • Honorable Minister Bambang Brodjonegoro, • Honorable Governors, Deputy Governors, Ambassadors, Representatives from regional and multilateral institutions, business community, our colleagues from academics, distinguished panelists, • Ladies and Gentlemen, Good morning and warm welcome to all of you. 1. It offers me great pleasures to welcome you to this Conference jointly co-hosted by Bank Indonesia and the IMF with the topic of “The Future of Asia’s Finance: Financing for Development.” The topic is indeed crucial considering wide financial gaps still exist in the region. In this regard, searching for an optimum financing would be challenging in the midst of current circumstances. 2. Before I share my views on financing issues, allow me to discuss the global economic development. Asia’s finance is now facing great challenges. In the near term, we may still confront an episode of heightened capital flows volatilities as consequences of unfavorable global economic condition. Sluggish global economic growth continues to depress production and outlook. Strong U.S. dollar following partial U.S. recovery and easing in Europe and Japan have tested some of Asia’s economic buffers. Weak commodity price has significantly hurt exports of some key regional economies. And more recently, China’s decision to rejuvenate its moderating growth through exchange rate policy has made the risk of external funding intensified. In fact, the increasing, yet again, global financial volatility, in a tune of 2013 global tantrum, is happening as we are sitting here, and it has led to a pull-back in capital flows from some emerging markets, including in Asia. 3. While Asia has remained broadly resilient to the risks, and it has led global growth for the past thirty years, its role to support global economic recovery seems to be weakening a little bit. A number of emerging market economies in the region are experiencing a declined economic growth and facing increased financial vulnerability, mostly related to capital reversal. 4. Asia definitely needs the right policy mix to secure growth and contain risks. Past experience taught us the importance of authorities to take decisive and credible policy actions to safeguard macroeconomic and financial stability. “Stability over growth” policy direction following May 2013 the Federal Reserve’s move is an interesting example. Indeed, the subsequent moderated growth is considered very crucial for the economy to progress further, not only in the near term but also for a longer horizon. 5. In Indonesia’s case, in response to current situation, Bank Indonesia has consistently implemented tight bias monetary policy since mid-2013. Some positive results have emerged. Although Indonesia’s economic growth is slowing following the global economy slowdown, the growth was still recorded at a relatively high rate of 4.67% in the second quarter of 2015. The fundamental economy of Indonesia BIS central bankers’ speeches remains sound and shows some improvements as indicated by improvement of current account deficits, trade balance surplus in the last two quarters of 2015, and a managable inflation rate which is expected to fall within Bank Indonesia’s target of 4±1% in 2015. 6. Furthermore, financial system stability remained solid, underpinned by a resilient banking system and relatively stable financial markets. To further support the macroeconomic stability, Bank Indonesia introduced prudential measure for business sectors which have access to foreign debt to conduct hedging by applying hedging ratio rules and preserve adequate foreign exchange liquidity by implementing liquidity ratio rules. In addition, to accelerate the deepening of financial markets, Bank Indonesia has revised some measures relating to foreign exchange transactions against the rupiah and net foreign exchange position of commercial banks. 7. Those positive achievements gained recognition from international institution, among others Standard and Poor’s (S & P) that has revised Indonesia’s rating outlook from Stable to Positive. Distinguished guest, ladies and gentlemen, 8. Given the unfavorable global economic development, it is important for emerging market economies to improve domestic demand in order to sustain and bolster economic growth. In that respect, infrastructure investment will help to unlock potential growth and preserve sustainable growth in the medium term. However, this effort should be accompanied by structural reforms to improve business climate and to strengthen institutional capacity. Thus, to set infrastructure investment priorities by taking into account country specificities and lesson learned from successful countries would be of important in doing the infrastructure investment. 9. Infrastructure investment definitely requires long-term financing. The challenge has been how to provide sustainable financing in the midst of heightened financial regulation, weak corporate sector spending, limited government resources, and lingering global uncertainty. We note that there are regional and global arrangements initiated to deal with infrastructure financing, to name a few: the Asian Bond Markets Initiative (ABMI) under ASEAN+3 cooperation, the ASEAN Infrastructure Fund (AIF) under ASEAN cooperation together with ADB, Global Infrastructure Fund (GIF) under the G20 cooperation. Further in national level, government has also set aside the funding for infrastructure development. Would all initiatives be sufficient? 10. Let us look into this question. How much does Asia need to finance its economy? ADB estimates that over USD1 trillion must be spent on infrastructure to maintain ASEAN’s current economic growth trajectory in a ten-year period. Furthermore, it is also estimated that during the same period, Asia will need to invest approximately USD8 trillion in overall national infrastructures for energy, transport, telecommunications, water, and sanitation. In addition, the region will need to spend approximately USD300 billion on regional pipeline infrastructure projects, involving physical construction works and coordinated policies spanning two or more Asian countries as well as having a significant cross-border positive impact. 11. Financially, the demand for cross-border and regional infrastructure funding often competes with funding for improved national infrastructure. The tremendous need on building infrastructure projects has resulted a large financing gap, or the difference between total financial requirements and the likely available financing through direct public resources. BIS central bankers’ speeches 12. On that note, it is inevitably we need to redouble the effort of financing for development. Allow me to name a few options. Private-Public Partnership (PPP) is an alternative solution to accelerate infrastructure development. While it potentially advances infrastructure investment, we should be mindful of its risk to fiscal position as PPP typically creates contingent for future liabilities. Good projects have to be selected carefully. Good governance and strong regulation enforcement are necessary. 13. Furthermore, financial sector should definitely play an active role in financing for development. Strengthening prudential and safeguarding measures should also complement this role. With its sound macroeconomic policies, rising middle-income, high saving, abundant labor resources, higher education level, and rapid technological adoption, Asia has the right components for sustaining growth and attracting investment. 14. I am also of the view that promoting capital market development and reducing heavy reliance of bank-based financial intermediation are both urgent and essential. Asia has embarked into this area by furthering its integration in financial sector. When ASEAN Economic Community is finally established at the end of this year, we should start thinking beyond 2015, and among ultimate objectives of post-2015 ASEAN financial integration in my opinion should be the creation of the best ecosystem of financing for development in the region. 15. That said, central banks in Asia have challenging tasks, i.e., to balance the need to deepen the financial market and to ensure the financial stability. Deepening capital markets and fostering financial inclusion would expand investor base and providing alternative financing. Financial inclusion should change the face of finance to become more people-centered, supporting investors with more outlets, small and medium enterprises with more funds to tap, and consumers with mortgages and other credits to smooth consumption. However, we should remain cautious as more dynamic capital market may also invite risks related to commitment and composition of capital flows. Distinguished guest, ladies and gentlemen, 16. Now allow me to provide you with a glimpse on Indonesia. The current administration has put great attention on boosting infrastructure investment to facilitate stronger and sustainable growth. The government in particular places priority on strengthening of physical connectivity, primarily in marine connectivity as well as integration between marine and land connectivity such as railway and digital connectivity. Improvement in these nodes will profoundly lower the logistical cost, increasing competitiveness, and lead to cost efficiency across the nation. In the next five years, the government aims to build 5,000 km of railways, 2,600 km of roads, 49 dams, 24 seaports and power plants with a capacity of 35,000 megawatts. 17. On the financing side, the government has committed to conduct fuel subsidy reform. The government’s decision to reduce fuel subsidy in 2014 created a fiscal space of approximately US$19 billion for infrastructure investment. Furthermore, various measures have been undertaken such as providing fiscal incentives for investment with a better-targeted system, providing social safety net for the poor, continuing the financial deepening program to mobilize domestic savings for private and public investment financing, and increasing private sector involvement through enhancing PPP framework and establishing PPP Center. Yet, with the immense magnitude of financing needed, more initiative is needed to materialize our plan comprehensively. Distinguished guest, ladies and gentlemen, 18. As a final note, I would emphasize that today’s Conference is very important as it will discuss the key opportunities for Asia’s development financing now and in the future. It is also a good avenue for authorities and private sector to share their BIS central bankers’ speeches experience and exchange their views for breakthrough in creating sustainable financing for development. Asia is now facing great challenges and we must work together to choose the right path. I have no doubt that this Conference will contribute useful understanding and policy advice on this very crucial subject. 19. Lastly, allow me to thanks the distinguished panelists and guests for coming to Jakarta and the organizing committee for arranging this conference. Thank you and I hope you will have a fruitful discussion. BIS central bankers’ speeches
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Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Discussion and Launching of the Financial Stability Review Book, Jakarta, 10 December 2015.
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Agus D W Martowardojo: Maintaining financial stability amid continued economic growth deceleration Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Discussion and Launching of the Financial Stability Review Book, Jakarta, 10 December 2015. * * * Honorable, Our Predecessors Governors of Bank Indonesia, Members of the Board of Governors of Bank Indonesia, Officials in the Ministries and State Agencies, Banking Leaders Representatives of Industry Associations Academicians and Economic Observers Attendees and Invitees, Assalamu’alaikum warahmatullahi wabarakatuh, Good afternoon and best wishes to us all, First of all, let us pray our praise and gratitude to Allah SWT, the God Almighty for only upon His grace and blessing, we can all gather here in good health to participate in the discussion and launching of the Book on Financial Stability Review (Kajian Stabilitas Keuangan-KSK) No. 25, September Edition Year 2015. The development of this KSK constitutes a part of the transparency and accountability of Bank Indonesia’s duty implementation in the field of macro- prudential. As one of the routine semester publications, KSK contains the results of assessment and review of Bank Indonesia toward the condition of the national financial system. Such assessment also covers our monitoring to the sources of vulnerability and imbalance of the financial system that can be found in the financial markets; financial agencies/institutions, namely households and corporates; banking; and Non-Bank Financial Institutions (Institusi Keuangan Non-Bank-IKNB); and also financial infrastructures. Due to the deceleration of economic growth experienced by Indonesia, it is critical for Bank Indonesia as the authority in the field of macro-prudential to continue maintaining the stability of financial system. Especially, as the dynamics of the global financial system continue to remain under uncertainties. Therefore, the edition of KSK this time takes up the theme of “Maintaining Financial Stability amid Continued Economic Growth Deceleration” We are convinced that our duty in maintaining the stability of economy will be more challenging. Hence, we expect that depth assessment and review on the condition of national financial system will be a valuable reference for us in taking measures in the future. Ladies and Gentlemen, The condition of Indonesia’s financial system in 2015 in general is still overwhelmed by various challenges and fluctuations, both sourced from global and domestic. The still weak global economic recovery, the continued declining price of commodities and the decreasing capital inflows to developing countries have become the pressure trigger to the developing countries’ economics including Indonesia. BIS central bankers’ speeches Those conditions are also hardened by the uncertainty and magnitude of the Fed interest rate normalization as well as the measures of monetary easing by European countries, Japan, and China in the efforts to recover their economic growth. One of the China’s efforts, i.e. by unexpectedly devaluating Yuan currency, has also triggered fluctuations in the global financial market and given additional pressure to the developing countries. From the domestic side, the development of financial system in Indonesia also encountered several challenges. Amidst the slowdown of economic growth, pro-cyclical banking reflected in the slowdown of credit growth needs to be looked more closely. Besides, the high pressure against Rupiah exchange rate as well as the non-optimal absorption of fiscal budget also colors the dynamics of Indonesia’s financial system. Attendees, Ladies and Gentlemen, In response to the increasing pressure against the economic stability derived from global and domestic, Bank Indonesia as the macro-prudential authority has pursued the policy which focused to encourage the realization of macro- economic stability while maintaining the momentum of growth. Efforts carried out by Bank Indonesia has been taken through loosening measurable macroprudential policies in order to give space for recovery, for the economic sectors with relatively controlled risk. The easing macro-prudential policies taken, i.e.: • Loan to Value Ratio (LTV) magnitude adjustment for property loan, and a decrease in advance for motor vehicle loan in order to provide stimulus from the demand side. • Improvement of regulation of statutory reserves (Giro Wajib Minimum-GWM) of Loan to Funding Ratio (GWM-LFR) to expand space for banking in channeling loans, including MSME’s credit, by taking into account commercial papers (securities) issued by banks as third party fund components. In addition to that, Bank Indonesia also performed macro-prudential supervision, among others was realized by implementing surveillance and joint audit with OJK toward banks that have highest foreign exchange risk exposure, in order to mitigate the emergence of systemic risk in banking in the midst of weakening pressure of Rupiah exchange rate. To strengthen that, Bank Indonesia also continues conducting assessments to the overall national financial system. Furthermore, the maintained financial stability system has also been the result of Bank Indonesia policy-mix synergy, namely, by exercising monetary policy carefully and consistently, as well as solid coordination with the Government and relevant authorities, both in the form of bilateral coordination and within the framework of Financial System Stability Coordination Forum (Forum Koordinasi Stabilitas Sistem Keuangan-FKSSK). Attendees, Ladies and Gentlemen, The Banking industry as the main part of the national financial system, currently is in a maintained state. The banking capital is maintained at high level, far above the minimum requirement. Whereas, the ratio of non- performing loan also remains relatively low. Therefore, the banking industry resilience represented the largest asset share in the domestic financial system is still quite strong to absorb arising risk potential, especially credit risk, market risk and liquidity risk. Moreover, non-bank financial industry is also still capable to stay at a safe level, although with a risk that tends to increase, following the still weak global economic recovery, the deceleration of domestic economy, and the continued declining commodity prices. BIS central bankers’ speeches In the household sector, credit risk is still relatively maintained although we need to remain cautious as there is increasing Debt Service Ratio (DSR). The increase of DSR reflects the decrease in the ability of the household sector in paying their debts in line with the slowdown of domestic economy. On the side of financial system infrastructure, we are grateful that implementation of payment system has been able to run safely, efficiently and reliably so that it become one of the main supporting factors of the maintained financial system stability. In the effort to continue strengthening the national financial infrastructure, consecutively in June and November 2015, Bank Indonesia has implemented National Clearing System of Bank Indonesia (Sistem Kliring Nasional Bank Indonesia-SKNBI) and Real Time Gross Settlement (RTGS) as well as Scriptless Securities Settlement System (SSSS) of Generation II. The overall effort of strengthening, both in the context of retail payment activities and high value, is intended to enhance the efficiency of the national payment system and to increase the protection and speed of service for customers. With the availability of increasing quality of the payment system service, the supports to the activities in the financial system, which in turn contributed in maintaining the financial system stability, are also expected to continue improving. Nevertheless, the stability of the financial system is still not immune from the risk potentials, whether liquidity risk, credit risk or market risk. Therefore, Bank Indonesia will constantly take macro-prudential policy directed at efforts to control key risks that could potentially pose a systemic risk and maintain the balance of the financial system. Attendees, Ladies and Gentlemen, In the future, the global economy will still be faced with the tough challenges, especially if the deceleration of China’s economic structural still continues, commodity prices still experience pressures, and the plan of The Fed monetary policy normalization continues to create fluctuation in the global financial market. Those three factors will impact significantly to the Indonesia’s economy and the condition of the financial system. In the midst of those challenges, the policy of financial system stability needs to continue to be strengthened in order to enhance financial system resilience against various risk potentials, and all at once to motivate the function of banking intermediation to be more efficient and equitable to support the financing of the economy. In the effort to maintain the stability of the national financial system, which is our joint responsibility, Bank Indonesia will always promote coordination and intensive communication with the Government and relevant Authorities in responding to the existing challenges. We believe that the key to overcome various challenges in the future is to establish a close synergy among all stakeholders in Indonesia. Ladies and Gentlemen, Attendees, Thereby, what we can convey as an introduction. We, naturally, hope that the book on Financial Stability Review – Bank Indonesia could become an increasingly quality reference in the future, and so that this discussion forum also contributes in expanding the insight, in building the understanding, and in encouraging constructive measures in the effort to create the stability of financial system in Indonesia. In closing, may Allah the God Almighty always bless us and lighten our steps. Thank you, Wassalamu’alaikum warahmatullahi wabarakatuh. BIS central bankers’ speeches
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Remarks by Mr Hendar, Deputy Governor of Bank Indonesia, at the Graduation of the STIE Indonesia Banking School Year 2015, Jakarta, 14 November 2015.
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Hendar: Indonesia’s recent economic and financial sector challenges Remarks by Mr Hendar, Deputy Governor of Bank Indonesia, at the Graduation of the STIE Indonesia Banking School Year 2015, Jakarta, 14 November 2015. * * * Honorable, • Chairman of Commissioners of Financial Services Authority, Dr. Muliaman D, Hadad; • Head of STIE Indonesia Banking School (IBS), Dr. Subarjo Joyosumarto; • Coordinator of Kopertis Wilayah III, Dr. Ir. Illah Sailah; • Honorable faculty of STIE IBS: o o o o o o Drs. Rachmat Saleh Prof. Adrianus Mooy Dr. Darmin Nasution Dr. KH. (HC) Ma’ruf Amin Drs. Binhadi Prof. Dr. H. Djokosantoso Moeljono; • Members of Academic Senate of STIE IBS; • Founders of STIE IBS: • Managing Director of LPPI, Dr. Hartadi A. Sarwono and the Board of Directors of LPPI; • Chairman of YPPI – Mr. Abdul Aziz; • The Academic Community of STIE IBS, Lecturers, and Students; • Attendees and Invitees, Assalamualaikum Wr. Wb. 1. To start the remarks, please allow me to ask you all to praise and thank God the Almighty, as only for His blessing we are able to gather here in the good atmosphere, attending and witnessing the Graduation of STIE Indonesia Banking School (IBS) Year 2015. On behalf of the Board of Governor of Bank Indonesia and I personally, we would like to congratulate the graduates of STIE IBS and the parents attending today’s graduation ceremony. 2. Before I read the remarks of the Governor of Bank Indonesia as the Chairman of the Board of Curators, allow me to convey the Governor of Bank Indonesia, Bapak Agus Martowardojo’s apology for not being able to attend today’s graduation of STIE IBS. Since last Thursday up to Sunday, tomorrow, all Members of the Board of Governors of Bank Indonesia have been and are in Yogyakarta in a series of activities of the Board Seminar on Regional Financial and Economic Study and coordination between Bank Indonesia-Central Government-Regional Government in Yogyakarta. Such activities are a routine agenda since the beginning of 2015 as a part of Bank Indonesia efforts to promote structural reformation both at the central level and regional level. BIS central bankers’ speeches Ladies and Gentlemen, and attendees, Latest economic challenges 3. Imperceptibly soon, we will leave year 2015 behind, a year that was full of challenges for Indonesian economy. I noted there were at least 4 challenges faced by Indonesian economy in this year 2015. First, it was the uncertainties of the global economy. The global economic conditions this year, in reality was not as bright as originally forecasted. Recovery of the global economy indeed continued in the various major economics of the world, although not in the speed according to our expectation and also uneven. This was indicated by several downward revisions of the world economic growth projections by various international institutions. The world commodity prices also continued to decline due to the weak demand, especially from China. As a country with open financial system and economy, Indonesia could not be separated from the global economic constellation. Moreover in the midst of divergence of the world monetary policy and the change of external risk perception causing the US Dollar on the global scale continued to strengthen. Such various external pressures, in turn caused instability on the domestic economy, among others the weakening of Rupiah, the outflows of capital both in the capital market and stock market, as well as the increase of returns or yield of SBN (Government securities). 4. Second, the slowdown of economic growth. As we all know, up to the end of Quarter III-2015, Indonesia economy grew below 5%. In Quarter I it grew 4.71%, in Quarter II grew 4.67%, while in Quarter III, that has just been announced last week, it slightly increased to 4.73%. This deceleration was due to the decline of export performance resulted from the continuing decline in prices of some major primary commodities such as CPO, rubber, coal and petroleum. The decrease in prices caused the economic growth in most provinces, which economy based on natural resources, especially in Sumatra and Kalimantan, dropped drastically. And even some provinces experienced negative growth such as in the Provinces of KaltimKaltara, Riau, and Aceh. This economic slowdown started to have an impact on the increase of unemployment rate. The rate of Open Unemployment of August 2015 released on 5 November 2015 indicated an increase from 5.9% to 6.2% due to the decrease in the number of labors in the sector of agriculture, industry, and services. Even, this increase of open unemployment rate in Riau and Kaltim-Kaltara rose above 7%. 5. The third challenge is the implementation of ASEAN Economic Community (Masyarakat Ekonomi ASEAN-MEA) that should be started by end of December 2015. On one hand the MEA commitment will open market opportunities with freer flows of goods, services, investments, workforce and capital. But on the other hand, this will provide consequences of higher competition in the domestic market of the respective country. With the massive market potentials, I see the most fundamental tough challenge of the MEA commitment is our ability to create competitiveness that is competitive. Can we utilize MEA as an opportunity to act as the major actor of the global production chain, or will we only be the target market and spectator? In my opinion, at this point our capability to read and anticipate the economic movement ahead is getting tested. 6. The fourth challenge was the normalization of the Fed interest rate. This issue dominated the dynamics of the financial markets, both in the advanced economy and emerging markets since May 2013. This normalization of interest rate caused uncertainties that often changed the behavior of risk on-risk off rapidly from the investors. Post data release of the US labor which was improving in the month of October 2015, the Bloomberg survey indicated market expectation to the increase of BIS central bankers’ speeches the Fed interest rate, Fed Fund Rate, in December 2015 increasing from 56% to 68%. Ladies and Gentlemen, and attendees, Latest policy of Bank Indonesia 7. To face the quite tough challenge in economy, various policies have been carried out. In the field of monetary, BI remains maintaining a tight bias monetary policy in order to maintain market confidence and suppress the current account deficit. Although the pressure toward macro stability started to decline, so that there is a space for easing the monetary policy, we still need to observe the high risk of global uncertainties, in particular due to the plan of Fed Fund Rate increase in December and the preparedness in mitigating its risk. 8. In line with the said matter, the focus of BI policy in the short run remains directed to the measures of stabilization of the exchange rate, strengthening rupiah liquidity management, and also strengthening foreign exchange supply-demand management. Bank Indonesia also welcome and appreciate the series of the Government and OJK policy packages in supporting economic growth and structural reformation needed to strengthen the foundation of Indonesia economy. The various measures of policies are expected to create investment climate that increasingly conducive, which in turn can improve the outlook of the Indonesia economy. 9. These several measures of policies have provided positive impacts, although not yet fully up to the expectation. The good news issued just last week, stating that Fitch Rating has given affirmation for Indonesia sovereign rating with a stable outlook (BBB-). We should be grateful for that, it in the midst of global volatility that increases again. Nevertheless, the pressure against rupiah is still not abating, although Bank Indonesia has done quite a lot in stabilizing the foreign exchange market. Aware of the complexity of the challenge faced, we will continue what we are doing and strengthen policy coordination between institutions. Confidence and positive perception 10. We are aware that it is not easy for us to go through the variety of challenges faced by the economy. However, we must remain optimistic, as history proves that we had good experiences in running the economic reformation. First, at the era pre the old order, Indonesia has ever been recorded in the book of Economics Development written by Benjamin Higgins in 1963 as “the chronic drop out” and declared as the example of failure in managing economy. However, within 30 years, IMF and the World Bank declared that Indonesia was one of the “Asian Miracle”, with a high and stable economic growth, a successful structural transformation, and a controlled inflation. 11. Second, at the time of Asia financial crisis in 1997, Indonesia along with Thailand and Korea became the countries experiencing the worst impacts, so that it ended in political crisis and change of power. Nonetheless, with the various reformation we conducted, in 2008 global financial crisis, Indonesia together with China and India became the few countries surviving the vortex of the largest world economic crisis after the 1930 economic crisis, with economic growth above 4%. 12. Such experiences conveyed a message to us all that we can get through any tough challenge provided that we remain maintaining confidence and deliver positive perception that we have, are, and will conduct structural reformation. This requires synergy of Indonesia Incorporated, whether the government, central bank, OJK and the business world including the banking and financial sector. BIS central bankers’ speeches Ladies and Gentlemen, invitees and attendees, 13. In facing this challenge, in particular to face MEA 2015, actors in the financial sector must prepare themselves well so as to have competitiveness and high professionalism in order to be first class bankers. We must be able to show that the banking people and professionals of Indonesia’s financial sector are the best in ASEAN. 14. The following matters need to be prepared to enhance the competitiveness of professionals in the financial sector. First, standardization of HR quality which is link and match with the market need. Academic education is required to have a curriculum and teaching method that can generate ready-to-use graduates. Therefore, the academic world needs to continue updating itself with the current development in the financial world that continues to develop. A special time requires to be provided to the students to have discussions with the professionals and policy makers in the financial field. 15. Second, the existence of competency certification in the financial sector is inevitability. In order to compete with the skilled workforce from other ASEAN countries, college degree solely is not enough. Nowadays, there are many new professions that have not been touched and require certifications, both globally and nationally. Degrees in accounting and management may become financial, management, and operational auditors, but they might not be able to audit information system, software, and application system. Whereas in the next 5 years, we must compete with HR from members of MEA countries. 16. Third, the importance of sharpening the competitiveness of HR in sharia financial and banking. Post issuance of Law No. 21 year 2008 concerning Sharia Banking and the proliferation of sharia financial instruments such as sukuk and sharia capital market has triggered the need of a large workforce. Apart from having skills in the field of finance, sharia financial HR is required to have an understanding in sharia principles. Although the ratio of sharia banking asset to banking asset currently is still below 5%, the supply of HR in the field of sharia financial and banking is still quite limited. To face MEA 2015, moreover with the superiority of the neighboring countries in sharia financial and banking, it feels that we need to sit together to overcome this issue. 17. Last but not least, as the foundation of the abovementioned three things, I would like to underline the importance of education to integrity. I believe that education and skills realized by mastering the standard of competency and professional expertise will not have any meaning without good integrity, as the business in the financial sector is a business of trust. Ladies and Gentlemen, invitees and attendees, 18. Finally, we congratulate the STIE IBS that has successfully graduated around 120 alumni in this 2015 graduation. Hopefully this will be a better motivation to give birth to other better STIE IBS graduates in the coming year. I also would like to congratulate the STIE IBS graduates. The bachelor and master degrees that you have earned today are the equipment of you all to enter the new world. After being equipped with knowledge in banking and finance in this STIE IBS campus, now it is the time of you to create value. I always remember Einstein’s words, “Try not to become a man of success, but rather try to become a man of value.” 19. Hopefully, our good intention to build a nation and state through the development of banking human resources and financial sector that has quality and integrity always be blessed by Allah SWT, the God Almighty. Thank you. Wassalamualaikum Wr. Wb. BIS central bankers’ speeches
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Keynote address by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Euromoney Indonesia Investment Forum, Jakarta, 22 March 2016.
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Agus D W Martowardojo: Building resilience, diversifying growth Keynote address by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Euromoney Indonesia Investment Forum, Jakarta, 22 March 2016. * * * Honorable speakers, Distinguished guests; Ladies and Gentlemen,….Good Morning. 1. It has always been a great pleasure to be part of the Euromoney Indonesia Investment Forum. Let me first thank the organizers for inviting me to this prestigious event. 2. This morning, I would like to share my views, on how we should build resilience and diversify growth engines, and how Bank Indonesia’s role in supporting the Indonesian economy as we venture ahead in the volatile world. Ladies and Gentlemen 3. The past few years have brought us many economic surprises and challenges. Even today the global economy is still surrounded by substantial risks and uncertainties. 4. Concerns and uncertainty about the global outlook have weighed heavily on world financial markets. Last year, Emerging Market have been particularly hard hit and their currencies have weakened and sovereign credit spreads have continued to widen. 5. Entering 2016 market developments have taken a further turn for the worse. Concerns about growth and financial stability in China came back to the fore in early January 2016 that struck global investor risk appetite. 6. Coupled with worries about the broader Emerging Market economic outlook and ample supplies, these concerns affected heavily on commodity prices, with oil and metal prices falling to their lowest level in years. 7. Indeed, growth in Emerging Markets – while still accounting for over 70 percent of global growth – declined for the fifth consecutive year. 8. What may be most disconcerting is that the rise in global risk aversion is leading to a sharp retrenchment in global capital and trade flows. Last year, for example, Emerging Markets saw about – $735 billion in net capital outflows, compared with – $111 billion in net capital outflows in 2014. 9. Heavy capital outflows from emerging markets have fed into falling official reserves, as some EM central banks have consistently intervened to support their currencies. 10. Global trade flows, meanwhile are being pulled down by weak export and import growth in large Emerging Markets such as China, Russia, and Brazil, which have been under considerable pressure. 11. Everywhere, inflation has fallen to historical lows. At the recent G20 meetings in China there was broad recognition of the risk of a prolonged low global demand, and adverse feedback loops between the real economy and financial markets may engender the global economy fall into deflation. 12. The global risks of deflation are clearly much more pronounced than before, whose vicious and self-reinforcing dynamics―in the form of higher real interest rates, falling nominal GDP, and rising unemployment―are notoriously difficult to combat once they become deeprooted. Ladies and Gentlemen 13. Notwithstanding headwinds from (i) the taper tantrum episode in 2013, (ii) the economic slowdown in China, (iii) the continued fall in commodity prices, (iv) the normalization of US interest rate policy, and (v) the increased volatility in global financial BIS central bankers’ speeches markets, the Indonesian economy has thus far held up well, emerge with its economic standing intact, standing out among the fastest growing and stable emerging economies. 14. Certainly, this has been made possible owing to mix of prudent and consistence monetary and fiscal policies, exchange rate flexibility – while managing to enact a comprehensive set of bold reforms, which mutually reinforce each other to bring in macroeconomic stability while nurturing stronger growth. 15. Growth has continued at a solid pace and remains among the highest in Emerging Market. Private consumption remains solid with domestic demand compensating for the slowdown in the external sector. 16. Inflation is well contained at 3.35 percent (yoy), which is within the target of 4±1 percent for the year. Well-managed inflation expectations, lower exchange rate passthrough, and a small negative output gap, have all contributed to lowering core inflation. 17. Indonesia is convincingly in an era of structurally lower inflation, in my view. This was evidently reflected from the trajectory of Consumer Price Inflation (CPI) which have been converging towards Core Inflation. 18. The stability over growth strategy demonstrated in monetary policy tightening since mid-2013, fuel subsidy reform, and greater exchange rate flexibility, have helped improve the external position. In 2015, the current account deficit falling to a healthy level at 2.06 percent of GDP, from – 3.00 percent of GDP in 2014. 19. Furthermore, international reserves continued to be sufficient at US$105.9 billion as of end-2015, which is equivalent to 7.45 months of imports and official debt repayments. Ladies and Gentlemen 20. Going forward, Indonesia’s economic outlook remains solid. We are confident that growth will pick up to the 5.2–5.6 percent range in 2016. Domestic demand would be the main driver of growth, while exports are expected to remain weak reflecting low commodity prices. 21. Growth will be led by capital spending of the government in the first half of the year, and by private investment later in the year conditioned on positive reform momentum. Private investment is fairly pro-cyclical and should therefore improve as public sector infrastructure spending accelerates and the overall growth outlook improves, in my view. 22. The current account deficit (CAD) is projected to increase to around –2,5 percent of GDP in 2016, on the back of a pickup in fixed investment and a further deterioration in commodity export prices, while the balance of payments (BOP) is projected to return to a surplus. 23. Inflation in 2016 is expected to stay within the 4±1 percent target, backed by well managed domestic capacity utilization, anchored inflation expectations, and declining commodity prices. Ladies and Gentlemen 24. Indonesia, being a small open economy, cannot escape from greater volatility in the global economy and financial markets. Therefore, positive outlooks, such as the one I just described, may change quickly as subject to critical risks tilted to the downside. 25. While global financial markets in recent weeks appear to be coping better, risks and vulnerabilities could elevate at some time in the future. Monetary policy developments in advanced economies will continue to shape EM capital flows in important ways, particularly volatile portfolio flows. 26. The fact that the long-awaited beginning of the Fed’s interest rate hiking cycle did not spark excessive market volatility was encouraging, given the long road of policy normalization that lies ahead for the Fed. Nonetheless, we have to be mindful with the BIS central bankers’ speeches unpredicted shifts in investor expectations of Fed tightening speed which again would likely to spark periods of volatility in coming quarters. 27. Hence, in an unforgiving global environment we need to make ourselves as resilient as possible to ride the waves, being prepared and well equipped with buffers and policies to cope with adverse shocks, and require a high degree of vigilance and ingenuity. 28. On domestic front, we should also acknowledges that there remain key challenges, including (i) low productivity in the agriculture sector, (ii) land acquisition problems for infrastructure projects, and (iii) bottlenecks at the local government level. 29. The headwinds blowing from abroad and challenges at home calls for a broadbased policy mix focused on the need to manage short-term vulnerabilities and to boost potential growth as well as diversify growth engine in the medium-term. 30. In the short term, we face the inescapable task to reduce some vulnerabilities to put Indonesian economy on a strong footing to deal with some turbulence on the external front ahead. Countries with large current account and fiscal deficits, high levels of FX corporate indebtedness, and questionable macro policy frameworks typically come under particular pressure in the event of global market risk-off. 31. Over the medium term, we need a mix of mutually-reinforcing demand and supply policies, which both supports growth in the short term and essentially lifts “potential growth” over the longer term. 32. At the current juncture, both fiscal and monetary policies are sharing burden to lift aggregate demand. Nonetheless, in tandem with demand-side policies, we need to boost supply side in order to unlock the long-run potential growth through structural reforms. Without structural reform long run growth prospects will be inadequate. 33. In this context, a wide ranging reform initiatives taken to address long-standing infrastructural bottlenecks and improve the business climate are currently seem gaining traction, with the government continuing to emphasis on a more consistent basis the need to improve implementation. 34. Structural reforms to close the infrastructure gap, streamline business regulation, improve the trade and investment regime, enhance the functioning of the labor market, and foster human resource development, remain critical to strengthen the export base connected to global values chains, create jobs, and raise growth potential. 35. And, this can benefit greatly from the favorable demographics, abundant natural resources, and large domestic market. Hereafter, provided that we could unwaveringly sustain the reforms’ momentum, I am convinced that GDP growth will turn up above 6,0 percent in the medium term. Ladies and Gentlemen 36. I hope we are now in the same page about the need of Indonesia to move forward with structural reform. This brings me to the final part of my address about Bank Indonesia commitment to safeguard economic resiliency and sustainable growth path. 37. We believe the relatively tight monetary stance of 2015, which reflected the our emphasis on stability, allowing exchange rates flexibility, together with modest use of international reserves to ensure orderly market conditions, has enabled the economy to weather external turbulence, bring inflation back to within the target, without putting much risk on growth. 38. Against the background of much lower inflation and a small negative output gap, the Board Meeting carefully adjusted the degree of policy stance to ensure sufficient support to domestic demand since December 2015. Indeed, with a more volatile and uncertain external environment, calibrating monetary policies towards supporting growth have become a delicate task. BIS central bankers’ speeches 39. Moving forward, priority would continue to be placed on stability, although with policy calibrated carefully and gradually to support economic growth. 40. We will remain vigilant and stress the importance of monitoring risks to price stability closely, while stand ready to respond if external pressures resume or inflationary pressures reemerge. This holds particularly true given the high volatility of food prices as well as potential pressure on the financial account in an uncertain external environment. 41. To help manage external financial volatility, we will further progress on financial market deepening as a continued priority, allowing exchange rate volatility as automatic stabilizer while its extreme movements will be carefully managed through judicious foreign currency interventions, and preserving the relatively comfortable international reserves as the first line of defenses. Ladies and gentlemen, 42. To end my address, allow me to conclude that with a strong buffer, Indonesia has fared well from external headwinds. However, this does not mean we can be complacent. 43. As the world economy is in transition to a new steady state, we are still facing greater volatility ahead. Hence, we have to continuously build a robust macroeconomic policy management -primarily well-tailored, consistence, and prudent monetary and fiscal policy mix-, which should be underpinned by a well implemented structural reforms. 44. We are convinced that with maintaining reform momentum would shore up public confidence and create investment-friendly environment. Apart from that, it would allow the country to diversify economic growth away from its reliance on natural resources, in a better position to withstand against global shock, and ultimately to sustain its economic growth in the longer term. 45. We applaud the government bold steps and moving rapidly in implementation of many of the reforms initiatives. At the same spirit, Bank Indonesia will continue to strengthen coordination with government to ensure that monetary policy, fiscal policy, and structural reform mutually support each other, to preserve macroeconomic stability and achieve a strong and sustainable growth. 46. I hope that this investment forum will also provide us with a clearer understanding and pave way for effective preparation to meet future challenges as well as to smooth our journey towards the sustainable growth. Thank you very much. BIS central bankers’ speeches
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Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Bank Indonesia-Asian Development Bank International Seminar "Structural Reform in Emerging Asia", Jakarta, 23 March 2016.
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Agus D W Martowardojo: Growth diagnostic for Indonesia – focusing on human capital and infrastructure Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Bank Indonesia-Asian Development Bank International Seminar “Structural Reform in Emerging Asia”, Jakarta, 23 March 2016. * * * Distinguished speakers, seminar participants, ladies and gentlemen, Good Morning. 1. It is such a pleasure for Bank Indonesia to host this international seminar jointly organized with Asian Development Bank, and I am very delighted to welcome you all to this event. 2. I find the theme of this seminar “Structural Reform in Emerging Asia” both relevant and important for all of us today, with the global economy still in a state of growth deficit, and the future path seems to look bleak if not uncertain. 3. I believe that the seminar will provide a great opportunity to discuss how structural reform can provide a breakthrough which accelerates growth, and make it more sustainable and inclusive. The discussion will also be a good platform for sharing of experiences on the implementation of structural reforms in various countries, and from that we can draw valuable lessons. 4. I am also excited to know that the seminar has been preceded by a technical workshop on issues surrounding the similar topic, particularly the use of Growth Diagnostic method and relevant economic models to identify the growth most binding constraints and the needed policy reforms. Ladies and gentlemen, Global and Indonesia’s recent economic development and challenges 5. Entering 2016, the global economy continues its period of uncertainty that has lingered since the global financial crises in 2008. With global growth declining and inflation remaining low, another sign of ambiguity in the global economy emerged, which is divergence of economy and monetary policies among major economies. 6. Pressures in the financial market in the beginning of 2016, in the middle of uncertain bottoming-up of oil prices, have added to concerns about global growth. Conversely, the deteriorating macroeconomic outlook and worries about medium-term vulnerabilities in the global economy have unsettled financial markets. With financial institutions under renewed pressure, adverse feedback effects between finance and the real economy could become significant. 7. The emerging economies have once withstood the recent global economic turmoil by taking advantage of credit-fuelled growth as a spillover effect from large accommodative monetary policy in advanced economy. What may happen next after the recent normalization of US monetary policy and China’s current economic rebalancing process could be a heightened pressure in emerging economies’ growth and financial market. We may simply face a period of emerging market-originating spillbacks, from the previous emerging marketreceiving spillovers. 8. Despite tangible results from efforts to increase resilience to external shocks, the vulnerability of emerging economies remain, due to their rather weak economic structure. BIS central bankers’ speeches Indonesia’s economy in particular, has managed to pick up its growth in 2015 with the help of increased government consumption on goods and investment in infrastructure projects. 9. In the meantime, dissipating global economic uncertainty and improved confidence on Indonesia’s economy have led to a surplus in capital and financial account during the last quarter of 2015, bolstered by increase in foreign capital inflows, mainly to government securities. 10. The confidence on Indonesia’s economy also contributed to a more stable Rupiah with an upward trend and less volatility, while foreign exchange reserves still hover well above the international standards. Moreover, the low global prices amid weakened domestic demand also brought domestic CPI inflation to slow down. Outlook, risks and policies 11. Against the background of maintained stability with carefully monitored vulnerabilities, we are still optimistic that domestic economic growth is going to be slightly higher in 2016, supported by the acceleration of infrastructure projects on the fiscal side, and increased private investment as a result of government policy packages and measurable monetary easing while maintaining macroeconomic stability. 12. Inflation is expected to be at around of the 4±1% inflation target, with the current account deficit projected to be below 3% of GDP. 13. However, this outlook is presented with some overshadowing risks in the horizon, both external and domestic, including another FFR increase expected in the second half of 2016, the slowdown in the Chinese economy, the continuing decline in commodity prices, and domestically, rising volatile food inflation. Distinguished guests, ladies and gentlemen, 14. The recent economic dynamics show us the significance impact of external economic conditions on Indonesia’s economy, and emerging economies in general. While Indonesia is still optimistic toward rising growth, risks are weighing down, especially those from the external sector, normally uncontrollable to a small open economy or emerging markets in general. 15. In this juncture, we are arriving at the point why domestic economic strength needs to be increased, and the effective way to do it is by rising its own growth potential. Monetary and fiscal policies are mainly aimed at supporting demand, but demand cannot be optimized if structural problems are not addressed well. Therefore, I believe it is timely for policymakers in emerging economies, Indonesia included, to focus on structural reform to boost economic growth in a sustainable manner. Growth dynamic analysis 16. On that note, it is important to point out that reform needs will differ from one country to another. History reveals that reform packages commonly prescribed only provide small benefits for countries that tried to adopt it. On the other hand, countries that implemented well-focused reforms in key areas have accelerated their growth. Having that said, we certainly need growth strategy that cater to domestic opportunities and constraints. 17. Economists have concluded that growth accelerations materialize when binding constraints on growth are removed. Many countries including Indonesia, have keen interest in a growth diagnostic approach, which aims at identifying the most binding constraints on economic activity, and the respective set of policies that should be prioritized and implemented to allow for accelerated and sustainable growth. 18. Growth diagnostic method has been profound and used by a number of countries as well as international organizations such as the IMF, the World Bank and the ADB itself for BIS central bankers’ speeches their country analysis. A number of donor agencies has also used this approach as part of their toolkit when formulating their operational strategies in developing countries. Growth diagnostic analysis for Indonesia 19. Bank Indonesia has also conducted research using growth diagnostic analysis, which takes into account the view that development priorities should not only put emphasis on factor-driven aspects, but also efficiency-driven and innovation-driven areas, all combined to avoid middle-income trap. 20. BI’s growth diagnostic research is unique since it takes into account different characteristics of Indonesia’s regional economies and brings up quantified analysis for policy response. The result reveals that the low level of return from economic activities is the main factor that hinders Indonesia’s economic growth. 21. Further analysis shows that the root of the problem, which is the most binding constraints hindering the country’s economic growth, are in the area of human capital enhancement and infrastructure development, particularly in relation to connectivity and logistics. 22. Human capital issues is indeed a classical problem for middle income countries. Human development is certainly important for inclusive growth. Currently, Indonesia is in the period of demographic bonus for up to 30 years ahead, where the period of 2015–2045 will be marked by 70% working class out of the total population. 23. However, having large population without appropriately large proportion of highly skilled and educated people would make it difficult to exit the middle income trap. Labor force with high education is crucial to shift the existing majority of labor-intensive/low-technology and resource-based industry up to the middle or high technology industry. 24. The development of human capital would lift up the productivity level of the labor force, which would in turn enhance Indonesia’s competitive advantage, which is an important prerequisite to excel within the current ASEAN Economic Community Era. 25. Infrastructure problem also poses as Indonesia’s major constraint for accelerated growth. Connectivity issues among regions, including the need for high quality and high capacity harbors, airports, roads and railways in Indonesia have spurred logistical costs. Manufacturing activities related to exports and imports are especially in need of appropriate harbors, even for Java region which contribute the largest part to the national economy. 26. In addition, energy particularly electricity, also becomes a crucial issue and serves as important prerequisite for domestic industry’s development. A reliable and adequate supply of electricity would attract investors’ interest to build manufacturing facilities in Indonesia. The increased foreign direct investment will enhance Indonesia’s role within the global value chain. 27. Policy simulation in our growth diagnostic research indicates the importance of resolving these human capital and infrastructure issues for growth acceleration process. Bank Indonesia found that modest increase in electricity capacity and human development will each enhance growth of around 0.25% per year, while enhancement in the quality human capital will contribute to an increase in employment of around 0.50%. Ladies and gentlemen, Policy priorities 28. To address the existing challenges, I believe we have come to a common understanding that reforms to improve the economic structure should be underlined and properly implemented. Cyclical policies from monetary and fiscal domains remain indispensable indeed, but not sufficient as it only responds to short term recurrent symptoms. BIS central bankers’ speeches 29. Thus far, Bank Indonesia’s monetary and macroprudential policies have been among the key factors in safeguarding macroeconomic stability, which support the structural reforms pursued by both central and regional government. 30. Bank Indonesia has lowered BI Rate and Primary Reserve Requirement as available room to ease monetary policy became apparent on the back of solid macroeconomic stability, including lower inflationary pressures going forward. However, stability remains the priority. 31. In this regards, Bank Indonesia will also continue to strengthen coordination with the Government. In addition, by cooperating in harmony with other authorities such as Indonesia Financial Service Authority (OJK), Bank Indonesia also strives to maintain financial stability, which together with macroeconomic stability, will provide strong ground for the country’s accelerated and sustainable growth. 32. The needed structural reforms itself should be targeted to address the most binding constraints. For Indonesia in particular, it may include building more education facilities, providing highly competent teaching resources, as well as increasing funds for education both from government and private sector. 33. To address infrastructure problem, providing sufficient land for power plants, improving business climate for investment in infrastructure, and enhancing regional tax collection, as well as public private partnership to raise funds for infrastructure projects can become priority policies to implement. Ladies and gentlemen, Going forward 34. Let me reiterate that a good balance of monetary policy, fiscal policy and structural reform will altogether bring out a policy mix that will take the country many steps forward toward faster and more sustainable growth. Lessons from countries that are successful in implementing structural reforms to boost their economic growth such as China and India, will be especially valuable. 35. Let me also express my special appreciation for the successful collaboration between ADB and BI in producing a joint book entitled “Growth Diagnostic of Indonesia.” I am looking forward to the launching of the book, which I am certain will provide valuable insight to all of us. 36. As a final note, I would like to wish you a pleasant and fruitful experience during this one day seminar. I believe that ideas, insights, and experiences shared among international and domestic experts as well as the audiences during the sessions will contribute to better understanding on the important topic of Growth Diagnostic, and bring refreshed ideas for policy formulation and priorities. Thank you. BIS central bankers’ speeches
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Keynote speech by Mr Perry Warjiyo, Deputy Governor of Bank Indonesia, at BNP Paribas Economic Outlook 2016, Jakarta, 23 March 2016
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Perry Warjiyo: Indonesian economic outlook this year and the years ahead Keynote speech by Mr Perry Warjiyo, Deputy Governor of Bank Indonesia, at BNP Paribas Economic Outlook 2016, Jakarta, 23 March 2016. * * * Introduction Following the success of strong macroeconomic policy adjustments since the Fed tapper tantrum Mei 2013, Indonesia economy is already surpassing its turning point since second half of 2015. Macroeconomic and financial stability have been intact at the back of continued turbulences in the global economic and financial environments. There was an unintended consequence of the policy adjustments, though, that the domestic economic growth has been slowing, albeit still at relatively comfortable level compared to other emerging countries. I do believe Indonesia economy will be better this year. And even it will accelerate further next year and years to come. Let me persuade you on this. • First, we will continue to stress the importance of macroeconomic and financial stability as a prerequisite for sustainable growth. We already show our commitment and long-standing track record on this, and we will continue to do so. The recent global economic and financial condition is still challenging and uncertain. But compared to last year, which was I reckon the challenging year, there are some elements of certainty that will make 2016 better than 2015, including the likelihood of FFR increases. • Second, this is the time where all the three policy mix of Indonesia economic developments, i.e. fiscal, monetary, and structural reforms, are working together and reinforcing each other. This is where actually Indonesia differs with other countries. Following the brave removals of subsidies, fiscal stimulus has been in effect and accelerated for higher economic growth. Structural reforms have been speed up too. The government has done remarkably well in accelerating reforms in many key areas: better investment climate, infrastructure developments, manufacturing and industry, agriculture, maritime, and tourism. • Third, central bank policies have been reinforcing the fiscal stimulus and structural reforms by the government. Last year, at the backdrop of uncertainty surrounding FFR increases, we started to relax our macroprudential policy of LTV ratio and reserve requirements to support bank lending for economic growth. This year we already cut our BI policy rates three times in January, February, and March a total of 75 bps to 6.75%. We believe that monetary and macroprudential easing are consistent with our forecast of stable macroeconomic condition and higher economic growth. These three reasons why I am very confident that in 2016 Indonesian economic prospect will be better, with higher economic growth and sound macroeconomic and financial stability. And I believe it will be even more promising in 2017 and beyond. Now let me talk on these three following aspects: first, our assesment on the global economic and financial outlook, and the challenges that we saw; second, Indonesian economic outlook, how we try to stimulate our economic growth and maintain the stability; and third, how BI policy mix plays a key role in this road to Indonesia promising outlook to the future. BIS central bankers’ speeches Global Outlook and Risks We particularly put emphasize on these three aspects of global economic and financial outlook and risk: global economic growth, commodity prices, and divergence of monetary policies. In addition, we also monitor closely the development in China, as its important role in the global and regional economy. On the global economic growth. It is still a challenging year. IMF just released in January the world economic outlook for this year and next year of 3.4% and 3.6%, respectively, a 0.2% lower than earlier forecasts. The US is still the main engine of the global economic growth, at 2.6% for both 2016 and 2017. We see slower recovery in Europe at 1.7% for both years, slightly higher than 1.5% in 2015. So I think that parts of developed economies have started their economic recovery albeit at slow pace. The challenge is, of course, on China, which is forecasted to grow around 6.3% this year and 6.0% next year. These are the main challenges from the global economic growth, which force us to rely more on domestic demand to support our growth. On the commodity prices. Last year, we saw a decline on our export commodity price index. This year it still declines before rebound in 2017 with slightly positive increase. This means that the commodity prices will reach at the bottom this year, and will start rising next year. In fact, palm oil price already stated to rebound, forecasted to increase this year. Though volatile in the short-term, oil prices will likely be around $35 per barrel, much lower than $50 per barrel assumed in the budget. That means our inflation will be lower, even though it puts pressures on budget revenues. All in all, it is imperative for Indonesia to ladder up from commodity export base to manufacturing. On the divergence of monetary policy. After the first FFR increase of 25bps at the end of last year, most of the markets predicted another 50bps increases this year, once probably in June and another at the end of year. We already included this scenario in our policy making. Although it is still challenging, but compared to 2015 I think the uncertainty and volatility will be lower this year. We closely monitor the negative policy rates of Euro and Japan. Frankly, I am in doubt that these will be effective to address their deflation problems compared to their quantitative easing. All in all, these FFR outlook and negative rates in Europe and Japan as the ‘push factors’, with the positive outlook in our part as the ‘pull factor’, will be positive for FDI and portfolio inflows to Indonesia and rupiah exchange rate. On China. There are three channels that we need to anticipate from China factors: trade, renmimbi depreciation, and investment. On trade, China slowdown and commodity price declines continue to put pressures on our export. Our simulation shows that every 1% of economic slowdown in China corresponds to 0.3% slowdown in Indonesian economic growth. On renmimbi, I do not believe there will be big devaluation as we saw last year. I think PBoC will continue to intervene and reckon that renminbi depreciation will be gradual this year. The challenge in China is of course the policy adjustments that being implemented right now, i.e.: further capital account liberalization, financial market development, as well as greater exchange rate flexibility. This leads to the third China factor that we must not forget. China is aggressively pursuing its outward investment to support economic growth, embedded into its ambitious silk road strategy. So we have to prepare and open our arms for greater investments from China, as we have done to Japan and South Korea. These are what we see from the global economic and financial condition. Last year up until September was the most difficult time, but after December we see some improvements. The uncertainty is still there, but overall we are more confident now. We have incorporated these uncertainties in our policy making. Indonesia has shown its resilience in the past, and it poises to progress well now and to the future. BIS central bankers’ speeches Indonesia Economic Outlook and Risks With stimulus from both fiscal and monetary fronts, as well as accelerated structural reforms in many key areas, we will be seeing significant improvements on Indonesia economy this year and beyond. The fiscal stimulus started to kick in in the third and fourth quarter last year, and budget absorption has been accelerated since early of this year, notably in capital expenditures. The continuous series of deregulation packages from the government will provide greater impetus for better investment climate, competitiveness, and buoyant economic activities. We are seeing accelerated completions of key infrastructure projects: toll road, airports, energy, irrigation, and more. Our macroprudential relaxation and monetary easing will also provide supports for higher economic growth. Let me provide our latest economic outlook for this year and next year. On economic growth. Last year, we recorded an economic growth of 4.79%. With the fiscal stimulus, the economic growth reached the bottom of 4.66% in the second quarter of last year and picked up to 5.04% in the last quarter. Investment in construction related to government projects together with private and government consumptions support the recovery. This year will be much better. Compared to early of last year, where the government must deal with the administrative procedures, this year fiscal stimulus through the acceleration of government projects already started to kick-in in the first quarter. With that, our economic growth forecast for this year will be around 5.2–5.6%. It will be supported by fiscal stimulus as well as the monetary policy easing to accelerate economic growth. Private consumption will still be robust. Government related expenditures, especially investment in infrastructures, will boost the economy, as we saw since Q3-2015. That is why the sectors that start rebounding will be construction, transportation, communication, and electricity, which are most of the government related fiscal stimulus sectors. I am sure that trade and manufacturing sectors will follow as the economic growth starts to gain broad momentum. This is the dynamic of the stimulus to economic growth that we will be seeing to the future. On inflation. We managed to lower inflation from 8.3% in 2014 to only 3.3% in 2015, which I think a part of its success owes to our monetary policy credibility that we gain since 2013. This year and next year we forecast inflation within our range of 4±1%. In the past, the challenge of price stability mainly came from administered prices, namely the subsidy of fuel and electricity. But the government has succeded in reforming these subsidies. This helps the central bank to be more certain in forecasting and controlling inflation. Unlike in the past, both CPI and core inflations will be convergent and under controlled. Exchange rate passthrough has been benign, because of the weak domestic demand, commodity price declines, and very well anchored inflation expectation. On current account deficit. Our macroeconomic adjustments in the past have succeded in lowering the CAD from the peak 4.4% of GDP in Q2-2013 to about 2% for the whole year 2015. For Indonesia, a CAD of 2.5–3% is still sustainable, because we still need to grow and for that we need sustainable financing from FDI and other long-term financing. That is why, with 2% CAD in 2015, we have room for monetary easing without worrying to external sector stability. This year, with the economic recovery gains momentum, CAD will be expected to widened but still within our long term sustainable CAD norm of 2.5–3% of GDP. We expect more than enough external financing for these deficits, with FDI constitutes the majority of the capital inflows and to a lesser extent long-term private external borrowing and portfolio investments. On financial system stability. Overall banking industry is sound, with CAR relatively high at about 21%. Lending growth is slowing, only about 10% in January 2016. But with economic stimulus from both fiscal and monetary, as well as liquidity injection with 1% reduction of reserve requirement that Bank Indonesia decided recently, we expect lending growth to increase to about 12–14 % this year. Overall NPL is low at 2.7% (gross) or 1.4% (net), although a bit increasing for some banks especially for the mining sectors. We have done BIS central bankers’ speeches analysis on the corporate risks as well as household risk. Last year we record corporate earnings were declining as economy was slowing down. But overall corporates are adjusting quite well, as they are doing a lot of efficiency and early repayments of their debts, both local and external debts. With economy is rebounding, overall corporate performances will also improving this year. Bank Indonesia Policy Mix Bank Indonesia mandate is to achieve price stability (inflation) and maintain exchange rate stability to support economic growth. We also support financial system stability. For our policy making, we analyze and forecast macroeconomic condition two years ahead: inflation, economic growth, exchange rate, current account balance, and bank lending, taking into account the latest assessment on fiscal and financial system conditions as well as on global economic growth, interest rates, and commodity prices. We do not rely only one instrument, i.e. interest rate, but employ a policy mix of monetary, macroprudential, capital flow management and payment systems. As such, in every monthly board meeting we formulate interest rate, exchange rate policy, monetary operation, capital flows management, and macroprudential measures based on the latest assessment and forecast on overall macroeconomic and financial system. Early last year, we noted the need for balancing of macroeconomic stability and supporting economic growth. We forecasted at the time that inflation would be under controlled within target, current deficit narrowed, while economic growth slowed because of both external and domestic factors. That was the theme of policy coordination between Bank Indonesia and the government. We agree to accelerate fiscal stimulus for supporting economic growth, benefiting the savings from subsidy reforms in 2014. At Bank Indonesia, we also rebalance our policy mix. While interest rate cut was not possible at that time because of possibility of FFR increases, we have started to relax our macroprudential policy. We relaxed LTV ratios by an average 10% in June 2015 and lower reserve requirements in June and December 2015. Following the first FFR increase in December 2015 and less uncertainty about the future courses of possible FFR increases, we started to cuts our policy rates this year. Thus, both of our monetary and macroprudential policies are now on easing modes. Together with fiscal stimulus and structural reforms by the government, all of the national policy mix, i.e. fiscal, monetary and structural reforms, are reinforcing for accelerating economic growth while maintaining macroeconomic and financial stability. Let me brief on the latest board decision of Bank Indonesia policy mix. On the monetary policy. With inflation will remain low and within target for this year and next year, and current account deficit under controlled witin sustainable range, there has been room for monetary easing. We have communicate since October last year, and started to cut our BI policy rate by 25bps in January 2016. We cut again the BI Rate in February and March by 25bps each to 6.75%. More than that, we cut again our reserve requirement by 1% to 6.50% in February 2016, which we count would add liquidity in the banking system by about IDR 34 trillion (about USD 2.6 billion) and with money multiplier of about 4.8 times add liquidity in the economy of about IDR163 trilliun (USD12.5 billion). Our signal is clear, that macroeconomic stability provided us rooms for monetary easing for supporting economic growth through interest rate cuts and ample liquidity in the banking system. Eventhough there is still room, we will be cautious in deliberating our further monetary easing. We will assess throughly overall economic and financial developments, both domestic and global, when we formulate monetary policy in every monthly board meeting. In the meantime, we will focus on strengthening our monetary operations to reinforce the monetary policy transmission mechanisms. On the exchange rate policy. We adopt greater exchange rate flexibility. We will let the market mechanism to determine the exchange rate according to evolving supply and demand. And we are proud that with continuous financial market deepening the size and BIS central bankers’ speeches price mechanisms in the foreign exchange market has been much developed now. That is why in most cases the exchange rate reflect the market mechanism. But we do not shy away to intervene in the market if exchange rate moves excessively and there is jittery in the market, especially in cases of large foreign capital reversals. If necessary, we intervene by both supplying the foreign exchange and buying government bonds from the secondary market. That is why you do not see excessive volatility both in the exchange rate as well as in the government bond yield. Last year was a bit difficult because there was capital outflows from the equity due to turbulences in the global market. But it has been reversed this year, with accumulated inflows from both fixed income and equity. Our exchange rate appreciated by 5.5% year-to-date to mid March. Going forward, with the economy rebounding, I do believe that both domestic and global factors will provide favorable environment for our exchange rate and financial market. On the macroprudential policy. We started with relaxing our loan to value ratio, on average about 10% in June last year. We also ease liquidity in the banking system, both through our monetary operation as well as reductions in the reserve requirement. Overall lending growth is still low at about 10% now as demand is just rebounding and not as strong as yet. However, looking closer to each sectors, the construction loan increased by 20% and real estate loan increased by 23%, showing that significant demand for bank lending from the fiscal stimulus related activities. We haven’t seen the impact on mortgage loan yet, it grew by about 10% last month, as demand for housing is not recovering yet. On the second half of last year, with the fiscal stimulus and monetary easing, the domestic demand will keep a pace and it will be so for demand for bank lending. We are seeing now increasing demand for lendings to government project related activities, but we will be seeing increasing demand for bank loans to other economic sectors as domestic economic growth becomes more broad based. Final Remarks I have shared my optimisms about positive Indonesian economic outlook this year and the years ahead. Economic growth will be higher, and macroeconomic and financial stability will be sound. There are some risks, of course, that we need to closely monitor and address, e.g. FFR increases, China factors, commodity price declines, and fiscal revenues. This is the time for Indonesia to move forward, and we will. All the three policy mix at the national level, i.e. fiscal stimulus, monetary easing, and accelerated structural reforms, are reinforcing to support higher economic growth. We know it, and investors see it. That is why investors already make differentiation of their views and valuations among emerging countries, where Indonesia as one of the promising economies. That will support for the better Indonesia to the future. Hope I bring more optimisms to you. I thank you. BIS central bankers’ speeches
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Keynote Speech by Mr Hendar, Deputy Governor of Bank Indonesia, at the Islamic Development Bank (IDB) Seminar "Producing Competitive Human Capital for Economic Empowerment", Jakarta, 13 May 2016.
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Hendar: Producing competitive human capital for economic empowerment Keynote Speech by Mr Hendar, Deputy Governor of Bank Indonesia, at the Islamic Development Bank (IDB) Seminar “Producing Competitive Human Capital for Economic Empowerment”, Jakarta, 13 May 2016. * * * Bismillahi rahmani rahiim, • Distinguished: Director General of Resources for Science, Technology and Higher Education , Prof. Ali Gufron Mukti; • Distinguished: Director General of Islamic Research and Training Institute-Islamic Development Bank, Prof Azmi Omar; • Distinguished panelist, ladies and gentlemen Assalamu’alaikum Warrahmatullah Wabarakatuh, A very good morning to all of you. 1. Praise to Allah the Almighty, the Most Gracious and the Most Merciful, for His Blessing so that we are able to take part on this meeting in good health and high spirits. Prayers and peace be upon the Last Prophet of Allah, the prophet Muhammad, his family, his companions and followers. 2. First of all, allow me to warmly welcome all of you in this seminar on Human Capital Development in Jakarta, and welcome to Bank Indonesia. It is an honor for Indonesia to be the host of the 41st Islamic Development Bank Group Annual Meeting, which formally will be held in the next few days. In conjunction with the IDB Group Annual Meeting, there are series of side events organized by the IDB Group in collaboration with various institutions in Indonesia. Our seminar today is the first program among those events. This seminar is organized by Bank Indonesia in collaboration with the Islamic Research and Training Institute (IRTI), a member of the IDB Group which takes the theme: “Producing Competitive Human Capital for Economic Empowerment”. 3. Muslim population has a huge potential to develop Islamic economic and finance globally. In the last two decades, we have seen so much development which takes shapes in terms of outreach, financial products, business volume, and financial subsectors. However, if we want to see the Islamic economic and finance stand equally with its conventional counterpart and serve as the other formidable economic pillar to sustain the national economic development, more progressive actions needs to take place. This forum demonstrates our commitment towards better quality of Islamic human capital. Therefore, the theme of “Producing Competitive Human Capital for Economic Empowerment” is very relevant for us to think through the future directions of the human capital development. Distinguished Guests, Ladies and Gentlemen, 4. We have witnessed significant global growth in Islamic Economics and Finance. Since the global financial crisis, the islamic finance institution has grown at double digit rates, outpacing growth of the conventional sector. Based on Islamic Financial Services Industry Stability Report 2016, the global Islamic financial services industry has reached an overall total value of USD1.88 trillion in 2015. 5. Despites those achievements, the industry still suffers from certain technical flaws namely relatively low operational efficiency, availability of full range of financial products to entertain the customers, and appropriately designed regulatory BIS central bankers’ speeches framework. In most instances, these lacks are associated with the low quality of human capital involved in the development of Islamic finance industry. Poor promotion strategy that leads to misperception in understanding Islamic economic and finance results in unnecessary burden to the industrial development program. I am of a view that we should pay more attention on improving low quality of human resource. 6. This unfortunate phenomenon has been a common fact in many countries including Indonesia. The lacks of adequate number of universities, available high quality reading material, and dedicatedly designed curriculum have prevented the industry from achieving progressive developments. We realise that the quality of human resources cannot be developed over night. This requires very deep and comprehensive analysis and implementation program. In order to maximise its benefits, the human capital development program should be able to cover all segments in the society besides the level of education. The organization of this seminar that is aimed at exchanging information is very important and timely. 7. Allow me to offer three basic ingredients that can be adopted when developing human capital in Islamic economic and finance. First is ‘link and match’. The universities that offer Islamic economic program should be able to provide teaching materials that has relevance to the current challenges. The graduates produced by the educational institutions, formal as well as vocationals, should be ready for fierce competition and understand all the requirements demanded by the market. The combination between Islamic economic specific and fluency in general knowledge is very important. Second, technology based development program. Now is era of digital technology. There so many development and invention by young entrepreneurs using information technology. In area of financial technology (fintech), many startups provide financial services with lower cost and easier requirements. Some startups also begin using Islamic finance as their business model. In my views, the graduates of should acquire certain level of knowledge in the area of technology considering that the financial industry has become technologically intensive. Failure in acquiring certain level of technology would fail the economic agents in winning the competition. Third, establishing solid platform for cooperation among the educational institutions globally as well as domestically. With the technology in hand, the cooperation between different parties may be conducted more easily. 5. Islamic Development Bank has involved in many education development project conducted in any countries. IDB intervention in Indonesia has been conducted in terms of the physical development of university building. I hope that further intervention may also cover the development of curriculum so that the universities offering Islamic economics and finance may equip young generation with the knowledge and skills which relevant to the market requirement. Distinguished Guests, Ladies and Gentlemen, 6. In this occasion, allow me to share Bank Indonesia initiatives in the area of Islamic economics and financial development, especially in the human capital development. In my opinion, when driving Islamic economics and finance as an inclusive system in the national economy, human capital serves as the main pillar. Therefore, we support the development in three components of human capital in the market that consist of academics, practitioner and society. 7. First, at academic side, Bank Indonesia has enhanced the collaboration and cooperation with universities, particularly in the area of research, public lecture, scholarships and research grant. In addition, Bank Indonesia has published a number of books on Islamic Economics and Finance serving as academic references to the academics. The most recent book launched by Bank Indonesia entitled “The journey of Islamic Banking in Indonesia: Institution, policy and challenges”. Beside universities, Bank Indonesia also allocated its resources to human capital development on earlier education including Islamic Boarding Schools or “Pesantren”. Currently, Bank Indonesia is preparing a set of lecture BIS central bankers’ speeches modules which cover the area of: i) Islamic social finance, including zakat and waqf; ii) Empowerment of Micro and Small Enterprise; and iii) Entrepreneurship development. Expectedly, these materials are ready to launch by next July and adopted by 5 universities. Moreover, in order to encourage and foster research activities in the area of Islamic Economics, Monetary and Finance, Bank Indonesia has launched Journal of Islamic Monetary Economics and Finance. The latest volume has just been issued in February 2016. We hope that this journal will be a bridge between theory and practice in the area Islamic Economics, Monetary and Finance. 8. Second, at practitioners’ side, Bank Indonesia also continuously conducts capacity building programs to enhance the competence of human resource in Islamic Finance industry. We maintain good cooperation with local and international institutions, for facilitating expert visit to Indonesia, conducting seminars, workshop and facilitating joint research activities on Islamic Economics and Finance. Next week, we will organize Sukuk Master Class Workshop to develop the competence of practitioner of Islamic banking and finance community, particularly in sukuk issuance. In our views, corporate sukuk should be encouraged along with the development of sovereign sukuk. 9. Third, at society’s side, in order to enhance awareness and commitment of stakeholders in supporting Islamic economic acceleration, Bank Indonesia organize Indonesia Sharia Economic Festival since 2014. This event provides intellectual discussions and business avenues among industry practitioners, business leaders, regulators and Shariah scholars to spur the future growth of Islamic finance. 10. In terms of organization, after sharia banking department moved to OJK, Bank Indonesia has established new department on Shariah Economics and Finance. It is our commitment to strengthen some initiatives to achieve Indonesia as regional center of Islamic Economic and Finance. Distinguished Guests, Ladies and Gentlemen, 10. Please allow me to end my speech by expressing appreciation and sincere gratitude to all speakers and participants, particularly the willingness to attend this special event. I also would like to wish you all a productive discussion and deliberation in this important event. I am confident that supported by all participants in this room, we can achieve significant outcomes that are beneficial to promote human capital development in the area of Islamic economy and finance. 11. Finally, allow me to thank all the hard-working and dedicated staff, both from Bank Indonesia and IRTI-IDB, for making this seminar possible. However, we fully understand that the seminar one way or another is still far from perfect. In this respect, therefore, we would like to seek forgiveness for any inconveniences occur in this seminar. I once again welcome you to this seminar and wish you every success in your deliberations. Thank you very much. Wa billahi tawfiq wal hidayah. Wassalamu’alaikum warahmatullahi wabarakatuh BIS central bankers’ speeches
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Welcoming remarks by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Bank Indonesia-Federal Reserve Bank of New York Joint International Seminar "Managing Stability and Growth under Economic and Monetary Divergence", Bali, 1 August 2016.
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Agus D W Martowardojo: Managing stability and growth under economic and monetary divergence Welcoming remarks by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the Bank Indonesia-Federal Reserve Bank of New York Joint International Seminar “Managing Stability and Growth under Economic and Monetary Divergence”, Bali, 1 August 2016. * * * Your Excellencies: Central Bank Governors and Heads of Financial Services Authorities of the EMEAP Jurisdiction, Mr. Boediono, Former Vice President of the Republic of Indonesia and also Former Governor of Bank Indonesia Mr. Mitsuhiro Furusawa, Deputy Managing Director, IMF Mr. William C. Dudley, President of Federal Reserve Bank of New York Mr. Raghuram Rajan, Governor, Reserve Bank of India Mr. Thomas Jordan, Chairman of the Swiss National Bank Mrs. Zeti Akhtar Aziz, Former Governor of Bank Negara Malaysia Distinguished Guests, Ladies and Gentlemen, Good morning and warm welcome to all of you. It is such a privilege for Bank Indonesia and Federal Reserve Bank of New York to welcome you all in this international seminar. Together with President William C. Dudley of Federal Reserve Bank of New York, I am very grateful to host this event here in Bali, Indonesia, where we can mix some meaningful discussions with the beauty of nature and culture of this island of Gods. Today we have an excellent line of speakers, who will be deliberating a current and important issue in the global economy: an increasingly divergent global recovery paths in growth and policies, particularly from central bank perspectives. In particular, I would like to welcome Mr. Boediono, a former Vice President of the Republic of Indonesia who is also a former Governor of Bank Indonesia, for taking time to join us in this seminar. Later we will have an honor to learn from his vast experience and wisdom by listening to his luncheon speech. Distinguished Guests, Ladies and Gentlemen, This is a timely seminar given that we all acknowledge that the global economy is still in high uncertainty which influences its growth prospect. The divergence in economic recovery and monetary policy among major economies are still the focus of global issues. Normalization in US monetary policy has been underway, while the Euro area and Japan have been proceeding with monetary easing. At the same time, the development in China has seen gradual slowdown as a consequence of its economic rebalancing. Some countries have adopted negative interest rate policies, with some jurisdictions going even more negative. The most recent UK’s decision to leave the European Union adds another complication to the already bleak global economic outlook. Moreover, Brexit, which some said has produced a seismic political shock, has shifted the nature of global concerns from heightened vulnerabilities towards a new era of political uncertainty. The previous episode of heightened vulnerabilities were characterized by rising risk of weakening growth, unresolved legacy issues in banks from Advanced Economies, leveraged and increasingly fragile corporates from Emerging Markets, and the existence of systemic liquidity. All of these urgently require more balanced and potent policy mix. BIS central bankers’ speeches Now, in the new era of political uncertainty, there seems to a strong link between political uncertainty and market confidence. A political shock results in economic and financial fallout, and has tremendous financial stability implication. Therefore, in this new episode, apart from addressing vulnerability, we need also to strengthen the foundations of global financial system. Otherwise, there is a likelihood that we will be trapped in a vicious circle, in a way that the policy uncertainty undermining confidence will instill slower and stagnant growth, which will erode political cohesion, making the crisis legacy challenges harder to resolve, which will later induce further increase in policy uncertainty. Such new dynamics and concerns have given rise to a new set of policy challenges, not only on how to simultaneously maintain stability and revive growth, but also on how to strengthen the foundations of global financial system. Against this backdrop, Bank Indonesia and the Federal Reserve Bank of New York have decided to co-host a seminar that will look deeper and expand the boundaries of thinking, nurturing, and offering new insights pertaining to these challenges, with the spirit of putting both East and West perspectives on the table. In our opinion, the boundaries would encapsulate three areas. First, pursuing growth objectives after the crisis, where factors impeding the global economy will be discussed, and initiatives to balance structural reform and support for growth will be deliberated. Topics surrounding challenges that are unique to small open economies, along with strategies to achieve sustained economic growth, hopefully will make this seminar very relevant and interesting. Second, monetary policy tradeoffs in the open economy, where challenges stemming from divergent monetary policies, linkages between economic and financial cycles, dealing with capital flow reversal risks, and new roles of exchange rate in external adjustment, will be discussed. Third, achieving financial stability in periods of monetary policy divergence, in which important issues such as policy responses to promote financial stability, tradeoffs between financial sector reform and growth, and country experiences with macroprudential tools, will be deliberated. Distinguished Guests, Ladies and Gentlemen, Recent global development has tested the creativity and innovation of central banks to the limit. A number of unconventional monetary policies were put forward. Acting boldly in the midst of a massive crisis, central banks have moved forward to prevent the world from a depression that would have far outreaching negative effect. It turns out that such creativity and innovation did not stop with the success of central banks in calming a financial crisis that had brought the global economy to a virtual standstill. Subsequently, central banks have assumed the tasks to continue with the next stage of recovering the economy and maintaining its stability. However, the challenges for central banks remain. The concern should not be about an upcoming inflation fueled by the expansion of central bank balance sheets and enormous liquidity injections. Instead, the real concern should be about stimulating economic momentum, unemployment and capacity, along with excessive financial risk taking, resource misallocations, and threats to the stability of markets. Moreover, in a new normal world today, central banks have not been able to completely resort to reliable insights and information from historical precedents, analytical models, or past policy experiences. Courageously but prudently, central banks took the helmets on unprecedentedly large responsibilities for the economy as a whole. Central banks felt a moral and ethical obligation to expand their policy toolkits in responding to such challenges. In my opinion, there has come a time for central banks to move forward, by taking the role of institutional leadership, on top of the policy excellence they have always delivered. BIS central bankers’ speeches Distinguished Guests, Ladies and Gentlemen, Looking from a central banker perspective, to stay relevant, resilient, and agile, I agree that policy makers should be more inventive in tackling global challenges. The prime challenge has been how to nurture the sustainability of growth while keeping monetary and financial stability in check, including mitigating the risk of capital reversals. Naturally, stability should serve as the basic foundation for growth to flourish. Having said that, focusing too much on stability could trade off the economic expansion, which in turn could risk a negative spillback through financial channel and hence the stability itself. In other words, we need to balance the long term objective of strong, sustainable and inclusive economic growth with the short term concerns of stability, in its many facets. The situation truly explains many countries’ challenges including Indonesia. In this regard, Bank Indonesia cannot solely rely on the policy rate as a single monetary policy instrument. In fact, we employ a variety of policy instruments which we call “the policy mix.” The “policy mix” consists of (a) policy rate to anchor inflation expectation complemented by (b) exchange rate flexibility to lessen pressure on external sector, (c) capital flows management to mitigate short-term excessive volatility, (d) macroprudential measures to manage procyclicality, and (e) we also continue to strengthen policy coordination with the Government and ensure good communication to the public. This year the policy mix focuses on maintaining macroeconomic and financial system stability, while stimulating economic momentum. In the monetary sector, gradual monetary easing remains consistent with efforts to maintain macroeconomic and financial system stability. Such policy is supported by measures to maintain exchange rates in line with economic fundamental, strengthen the position of reserve assets and manage flows of foreign capital. Bank Indonesia also maintains accommodative macroprudential policy, while continuing the effort of financial market deepening. In terms of macroprudential policy, Bank Indonesia has been implementing a number of regulations, namely, the loan to deposits ratio (LDR) linked to the reserves requirement (RR) and loan-to-value (LTV) ratio on property loans and automotive loans. We adjust the rate according to the need of real sector. Distinguished Guests, Ladies and Gentlemen, In the midst of continuing global challenges, Bank Indonesia always strives to advance its central banking practices, particularly its policy frameworks. In order to improve the effectiveness of monetary policy transmission, Bank Indonesia has reformulated the policy rate from the BI Rate into the 7-day (Reverse) Repo Rate, which will become effective on August 19, 2016. Such enhancement does not imply a change in the prevailing monetary policy stance. During the transition period prior to August 19, 2016, the BI Rate remains as Bank Indonesia’s policy rate. Within that timeframe, BI has started to announce BI 7-day Repo Rate as part of the term structure. The enhancement of monetary operation framework has three objectives. First, to improve the policy signaling of policy rate as primary reference for interest rates in the financial market. Second, to strengthen the effectiveness of monetary policy transmission through its stronger impact on short term money market rates and bank rates. Third, to support financial market deepening, especially in encouraging transactions and developing interbank rate structure for 3 month to 12 month terms. In line with the enhancement, Bank Indonesia also accelerates the implementation of financial market deepening program by pursuing the following steps: (i) strengthening the role of Jakarta Interbank Offered Rate (JIBOR) in shaping the interest rate structure of the money market across tenors from overnight to 12 months; (ii) accelerating the Repo transactions in the money market by promoting banks participation in General Master Repo Agreement (GMRA); and (iii) BIS central bankers’ speeches alleviating market segmentation and boosting the market’s transaction capacity by encouraging banks to open more access to counterparty. Distinguished Guests, Ladies and Gentlemen, It seems that under the current global dynamics, the only certainty is the uncertainty itself. And therefore the focus of central banks should be on nurturing the economic growth, while maintaining stability. Across the globe, central banks are pressured to continuously pull a rabbit from a hat, offering a formula to tackle the important issues of economic slowdown. Nonetheless, we should be mindful that in an era of new normal with political uncertainty, all of us should relentlessly and collectively strengthen the foundations of global financial system. In this spirit, we are bringing all the relevant stakeholders to the table to continue the policy dialogue. Hence, I am pleased to have the presence of the participants from east and west: central bankers, financial regulators, global policy makers, and market players. I sincerely believe that sharing perspectives and experiences among stakeholders will equip us with additional significant insights to enhance mutual understanding between authorities and industries towards sound policy responses and implementations. Moreover, the presence of all distinguished participants would strengthen communication and collective action commitments in facing the challenges of economic and monetary divergence. Finally, once again I would like to express my appreciation to Honorable Governors, Heads of Financial Supervision Authorities, distinguished speakers and all guests for your participation in the seminar, and wish you an enjoyable and fruitful deliberation. I also hope that in the middle of the seminar’s tight schedule, some of you are able to enjoy Bali and experience its picturesque view and unique cultural identity. After all, this is the place where the movie “Eat, Pray and Love” was taken. So please make your time. Thank you. BIS central bankers’ speeches
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Speech by Mr Erwin Riyanto, Deputy Governor of Bank Indonesia, at the 10th International Conference on Bulletin of Monetary Economics and Banking and book launch, Jakarta, 8 August 2016.
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Erwin Riyanto: Unveiling macroprudential policy Speech by Mr Erwin Riyanto, Deputy Governor of Bank Indonesia, at the 10th International Conference on Bulletin of Monetary Economics and Banking and book launch, Jakarta, 8 August 2016. * * * Honorable, Governor of Bank Indonesia Bapak Agus Martowardojo Former Governors of Bank Indonesia Bapak Rachmat Saleh Bapak Arifin M Siregar Bapak Adrianus Mooy Bapak Syahril Sabirin Bapak Burhanuddin Abdullah Chairman of Indonesia Deposit Insurance Corporation Bapak Halim Alamsyah Directorate General of Culture Ministry of Education and Culture Bapak Hilmar Farid Head of Fiscal Policy Agency, Ministry of Finance of the Republic of Indonesia Bapak Suahasil Nazara Head of National Library of the Republic of Indonesia Bapak Muhammad Syarif Bando Head of National Archives of the Republic of Indonesia Mustari Irawan Former Bank Indonesia Board Members Distinguished Guests, Ladies and Gentlemen Assalamu’alaikum Wr. Wb, Introduction – greeting & objectives 1. It is a great honor for me to be here in this 10th International Conference and Book Launch event. Please allow me to divert your attention to review the next book entitled “mengupas kebijakan makroprudensial” or “unveiling macroprudential policy”. This book I believe is not just any other book. It is the first book ever published about macroprudential policy in Indonesia. It is one that is meant to educate the public with a better understanding of what is macroprudential policy, why is it important, what are the policy instruments, how it interacts with other policies and who should better have the mandate. 2. Since work in the macroprudential field has only gained momentum globally following the 2008 crisis, much of the concepts are still evolving. In this book, we will come across many new financial terminologies that in principle have already been around for some time but have not yet explored. To name a few of the new terminologies are systemic risk, contagion, interconnectedness, shocks, vulnerabilities, idiosyncratic vs cross-sectional risk dimensions and macroprudential. While macroprudential policy and the aforementioned terminologies are more understood by those directly involved in the field, there is a growing need to familiarize the notion to the public-at-large. BIS central bankers’ speeches 3. Why? because evidently, implementation of macroprudential policy directly touches upon financial agents and more than often requires inter-agency support for its effectiveness. With proper knowledge and understanding of the macroprudential framework including the transmission of systemic risk, the public can gauge their contribution to preserve financial stability. In this case, limiting the tendency for risk exuberance behavior. Furthermore, the recent enactment of the Law on Financial System Crisis Prevention and Resolution not only compels the public to be equipped with a stronger understanding of systemic risk but also with regards to the importance of institutional arrangement and crisis management protocol. 4. The Law on Financial System Crisis Prevention and Resolution provides a legal standing for the institutional arrangements between BI, OJK, Ministry of Finance and the Deposit Insurance as part of The Financial System Stability Committee. The Act stipulates the roles of each institution in deliberating coordination to safeguard financial system stability, mitigate financial system crisis and handling of systemic bank problems; during normal and financial system crisis conditions. The Act was constructed on the basic principle of alienating the use of tax-payers money. This is achieved with reference to Basel III principles that focus heavily on mitigating systemic risk and strengthening banks’ resilience, particularly the ability of systemic banks to bail itself. The basic concept of macroprudential policy and systemic risk 5. The next question is then what is systemic risk? What is macroprudential policy? Macroprudential policy has been well defined in the IMF, BIS and FSB’s documents, as well as published papers. There are at least 3 (three) key elements to describe macroprudential policy. First, it aims to safeguard financial system stability. Second, the focus is on systemwide perspectives instead of individual financial institution’s safety and soundness level. Third and most central element is that it aims to limit the build-up of systemic risk. 6. Systemic risk itself is known as the risk of widespread disruption to the provision of financial services, which can cause serious negative consequences for the real economy. Systemic risk can be recognized through vulnerabilities related to the build-up of risks over time or from interconnectedness and the distribution of risks within a financial system at any given point in time. By mitigating systemic risk, macroprudential measures ultimately aim to reduce the frequency and severity of financial crises. 7. How can this be achieved? Lessons from the 2008 crisis taught us that microprudential policy alone tends to overlook the build-up of risk taking behavior of financial institutions. Furthermore, long periods of low interest rates and a single monetary objective geared towards low inflation may also give rise to the build-up of systemic risk when uncoupled with sufficient prudential measures. Therefore, macroprudential policy aims to maintain a balance between macroeconomic and microeconomic objectives through implementation of prudential principles in the financial system. The notion is to limit risk-taking behavior of financial agents. The history of macroprudential policy in Indonesia 8. While much attention and work on addressing systemic risk through macroprudential policies became viral after the financial global crisis, a number of countries in the emerging market have used macroprudential tools well before. Bank Indonesia has implicitly paid due consideration and acknowledgement to the importance of macroprudential aspects in terms of maintaining financial system stability since early 2000. Such acknowledgment gave rise to the establishment of the Financial System Stability Bureau in 2003. 9. The assessment on financial system stability has also been deliberated through the publication of the Financial Stability Review every semester since 2003. Inevitably, our early experience in managing financial stability following the Asian financial crisis in 1999 managed to salvage the Indonesian economy from adverse impact of the 2008 turmoil. BIS central bankers’ speeches Why the central bank has an important role in macroprudential policy? 10. Now, one might question, who should be most suited to receive the mandate for macroprudential policy? Observably, there are considerable differences in the institutional arrangements across countries as there is no “one size fits all”. However, in most jurisdictions, regardless of the type of institutional setup, the central bank is given an important role, including veto powers in a committee setup. 11. The pivotal role of the central bank is mainly supported by the uniqueness of the central banks function as lender of last resort and as an independent authority. The ability of the central bank to create liquidity in the banking system is a unique advantage in preserving financial stability. The central bank as monetary authority also has considerable information advantage concerning the complex interactions of the financial intermediary system and the operation of the real economy. Such advantage would allow the central bank to gauge potential systemic risk, for example through calibrating the impact of macro-stress scenarios to the resilience of financial intermediaries. Furthermore, the primary objective of the central bank to achieve price stability, also goes hand in hand with financial stability; that is, they mutually reinforce each other in most cases. Another unique function of the central bank is in the payment systems. The central bank has the information and expertise to identify potential risks and deadlocks in the payment system, which may cause serious disruptions to the financial system. Macroprudential policy mandate & the MP framework in Bank Indonesia 12. Based on a joint progress report of the FSB, IMF and BIS to the G20, effectiveness of macroprudential policy is served by providing the relevant authority with a clear mandate. In this case, Bank Indonesia has the mandate to perform the role of a systemic regulator and to exercise macroprudential supervision as stipulated in the Act No.21 of 2011 concerning the Financial Services Authority. Given the role of Bank Indonesia as the systemic regulator, we continue to strengthen our expertise in monitoring systemic risk through developments in our macroprudential policy framework. The framework must provide clear, transparent and accountable objectives with a focus on maintaining financial system stability. 13. The macroprudential policy framework maintains financial system stability through four objectives that are: (i) early identification and mitigation of systemic risk, (ii) minimization of financial imbalances to improve the quality and soundness of intermediary functions, (iii) efficient financial systems and (iv) improving access to finance by expanding SMEs access and financial inclusion. In an emerging economy, improving access to finance is a continuous effort integral to financial market development; either through financial broadening or financial deepening. It also aids in mitigating systemic risk that may arise from a financial system that is still concentrated in a particular corporate sector and certain segments of society. 14. In order to operationalize these macroprudential objectives, there are 4 main elements to focus on that are: (i) identification of the sources of systemic risk; (ii) macroprudential surveillance through monitoring and analyzing identified risks; (iii) formulation of policy responses through implementation of macroprudential tools; and (iv) crisis management protocol. Sources of systemic risk: shocks and vulnerabilities 15. The process of identifying sources of systemic risk involves identifying shocks and vulnerabilities. Materialization of systemic risk is triggered by an interaction between shocks and vulnerabilities. In this case, a shock may come through changes in macro-economic conditions. Meanwhile, vulnerabilities are associated with pre-existing fragilities of the financial system which will amplify and propagate the initial shocks to the financial system. Examples of vulnerabilities include high levels of leverage, maturity transformation, interconnectedness, and complexity. Bank Indonesia is currently developing the Balanced Approach Method to BIS central bankers’ speeches identify the key source of potential systemic risks that will be considered as top priority to monitor and address. 16. It is important to highlight that while shocks are inevitable, identifying and addressing vulnerabilities becomes the key to ensuring robustness of the financial system. In addition, a number of early warning indicators and methodologies can be useful to assess vulnerabilities well before the emergence of stress. In this case, Bank Indonesia has employed many indicators and developed several models to detect the vulnerabilities in the financial system as well as the build-up of systemic risk. We have also developed models to assess the systemic impact and the resilience of the financial system to systemic risk, such as the Indonesian Financial Cycle as imbalances indicator, Financial System Stability Index as stress indicators, macro stress test and also top-down bank stress test models. 17. Given that vulnerabilities and systemic risks may arise from different sectors as well as changes in market behavior and in macro-economic conditions, Bank Indonesia must have access to a wide-range of information sources. This includes the authority to conduct off-site and on-site examination if needed. It is worth highlighting that there is a considerable difference in the main objective of Bank Indonesia’s examination to the OJK. That is to identify the potential systemic risk as an impact of macroeconomic condition to the bank’s resiliency, and its potential contagion impact to the industry. Furthermore, on-site examination will have an objective to ensure compliance of Bank Indonesia regulation covering monetary, payment system and macroprudential. Macroprudential policy instruments 18. Furthermore, following the identification of possible systemic risks, macroprudential policy instruments are tailored to address such risks in both time and cross section dimensions. Macroprudential instruments in the time dimension, aim at increasing resilience to shocks and contain pro-cyclical build-up of systemic risk. The instruments often used include (i) capital based tools (ii) asset side tools or loan restrictions and (iii) liquidity related tools. In a cross section dimension, macroprudential tools aim to reduce contagion risks by improving resilience of systemic institutions for example, via additional capital surcharge and loss absorbency requirements. Other prudential tools in the cross section dimension include increasing risk weights and large exposure limits. 19. Overtime, Bank Indonesia has implemented a broad range of macroprudential instruments including capital-related tools as required by Basel III such as Counter Cyclical Capital Buffer as well as asset-side tools and liquidity-related tools. Asset-side tools include certain loan restrictions, such as LTV caps and to boost credit have put in place incentives and disincentives in the form of reserve requirements linked to loan to funding ratios. To strengthen corporates resilience to exchange rate shocks, Bank Indonesia also introduced requirements for hedging ratio and forex liquidity ratio. Macroprudential policy interaction with others policies 20. In the areas where macroprudential policy interacts with microprudential policy, Bank Indonesia and OJK work hand in hand in formulating the optimum policies. For instance, Bank Indonesia has contributed work and research to the formulation of LCR requirements with OJK and in the identification of systemically important bank as mandated by the Law on Financial System Crisis Prevention and Resolution. Bank Indonesia and OJK have also established a bilateral coordination framework to facilitate and to optimize cooperation and coordination in carrying out the function, duties, and authorities of Bank Indonesia and OJK. 21. Recognising the potential interaction of macroprudential policy with other policies that also have a bearing on systemic risk, requires strengthening of inter-agency coordination. Such interaction between macroprudential policy not only applies with microprudential policy but also with monetary and fiscal policies. As mentioned by the IMF in their recent stock taking paper, BIS central bankers’ speeches boundaries and interactions between policies are complex and can give raise to both complementarities and tensions that may need to be resolved. For example, via suitable institutional arrangements which we effectively already have in place. Closing remarks 22. To conclude, it is my greatest hope that this book can serve as a gateway for the public to better understand macroprudential terms and concepts as well as its main objective in mitigating systemic risk. With better understanding of the systemic risk transmission, we as individuals can help contribute in preserving financial system stability by limiting exuberance risk taking behaviour. Hopefully, despite our inability to read the crystal ball of the next crisis, we would presumably have better ammunition to deal with the headwinds and financial turbulences that are yet to come. Thank you. BIS central bankers’ speeches
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Keynote speech by Mr Erwin Riyanto, Deputy Governor of Bank Indonesia, at the International Workshop on Credit Reporting System "Strengthening CRS in Indonesia: Role, Challenge, & Future Development", Jakarta, 22 September 2016.
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Keynote Speech International Workshop on Credit Reporting System “Strengthening CRS in Indonesia: Role, Challenge, & Future Development” Bismillahirrahmanirrahim, Distinguished Speakers, a) Mr. Yudi Permana, Head of Licensing and Banking Information Department, Otoritas Jasa Keuangan; b) Ms. Fredesvinda Fatima Montes, Senior Financial Specialist; World Bank Group; c) Mr. Humberto Panuco Laguette, Senior Economist in Directorate of Financial System Analysis, Banco de Mexico; d) Ms. Megan Cox, Bureau of Consumer Protection, Federal Trade Commission, USA; e) Ms. Teh Sew Mei, Deputy Registrar in Registrar Office of Credit Reporting Agencies, Ministry of Finance, Malaysia. Distinguished Ladies and Gentlemen, Assalamualaikum warahmatullahi wabarakatuh, Very good morning to all of you, 1. Allow me to begin by thanking Allah SWT who has blessed us with the opportunity to rare but beneficial event. I would like to express my sincere gratitude towards our distinguished speakers who have travelled a long way to be with us today. On behalf of Bank Indonesia, I would like also to take this opportunity to express my appreciation to World Bank for arranging the speakers to join this event. Ladies and gentlemen, < Overview of Credit Reporting System > 2. We have witnessed the transformation of credit reporting system in Indonesia. Since 1969, Bank Indonesia has been collecting information from regulated entities and managing the credit reporting system. In June 2006, Bank Indonesia has launched Debtor Information System (SID) that gather positive and negative information on both individual and business, provided by banks and other creditors. With the establishment of the SID, the growth of Non-Performing Loan (NPL) can be prevented and financial system stability can be maintained. 3. Between 2010-2016, Indonesia has made structural reform including simplified rules and regulations to support Ease of Doing Business. In 2010, BI has developed basic report which contains historical credit information for the last 24 (twenty four) months, called Historical Information Individual Debtor (Informasi Debitur Individual Historis/IDIH). 4. In 2013, Bank Indonesia enacted BI Regulation concerning Credit Bureau (LPIP) that covers certain aspects of credit bureau operations, especially on the LPIP licensing and the transfer of SID data to licensed credit bureaus (LPIPs). With this regulation, Indonesian management of credit reporting system is transforming, from single credit reporting to dual credit reporting, that synergize Public Credit Registry operated by BI, with Private Credit Bureaus. 5. Indonesia EoDB’s indicator of improvement reflected by rating upgrades, which is in 2011 Indonesia rating was 126 then in 2016 upgrade to 109. The rating upgrades supported by Getting Credit aspect – Depth of Information Index rating which is in 2011 Indonesia rating was 116 and in 2016 upgrades to 70. 6. Based on OJK Law, since December 2013, the authority of Credit Reporting System has been transferred from Bank Indonesia to Otoritas Jasa Keuangan. Both Bank Indonesia and Otoritas Jasa Keuangan realized that the transfer process wouldn’t be easy and need preparations. Bank Indonesia and Otoritas Jasa Keuangan were agreed to collaborate and to share the responsibilities during certain time of transition period. Ladies and gentlemen, <The Background of the Workshop> 7. The Workshop on Credit Reporting System (CRS) is held in cooperation between Bank Indonesia, the Indonesia Financial Services Authority (OJK), and the World Bank under the framework of the Financial Inclusion Support Framework Program (FISF); a multiyear program to support Indonesia in enhancing financial inclusion, start from 2015. 8. In this opportunity, please allow me to reveals the conditions we face today as the basis and background of why we need to support FISF program. 9. Based on Doing Business survey in 2015, World Bank, with assumption that data in credit registry reflects number of adult that have access to finance, then number of adult in Indonesia that have access to finance only 68% from total adult population or 82,2 billion from 120,8 billion people. A similar situation faced by the SME sector which is based on data from the Ministry of Cooperatives and SMEs in 2013 amounted to more than 57.8 million units. From that number, only 10 million units or around 17% of them are able to access to finance. 10. In general, financial institutions in Indonesia had asymmetric information and had struggled to identify potential credit risk and creditworthiness for both the individual and the MSME sector. As the result, the credit interest rate charged to them tends to be high because of the high risk premium. 11. One component of the FISF program is Credit Reporting System (CRS). With the CRS, it is expected that the classic problem of asymmetric information that has become the critical issue in the provision of funds, can be solved. With the CRS, the financial institutions are able to know and analyze the profile of prospective debtors, can assess possible risks, can streamline the cost, can lower NPL and create sound credit culture. In the end, it will support the financial inclusion, and support the ultimate goal of macro economy, namely financial sector stability and economic growth. Ladies and gentlemen < The Purpose of the Workshop > 12. In September 2013, World Bank issued The General Principles of Credit Reporting (GPCR). The GPCR intends to provide an international agreed framework in the form of international standards for credit reporting systems’ policy and oversight. These Principles suggest the key characteristics that should be satisfied in order to ensure that credit reporting systems are safe, efficient and reliable. 13. As part of FISF Indonesia program, an assessment against the implementation of General Principles of Credit Reporting (GPCR) in Indonesia was conducted in 2015, involving associations, financial institutions, public utilities institutions, and the relevant authorities. The assessment found that there are some critical issues that need to be addressed by Indonesian authorities, which includes legal gaps, oversight function and consumer protection aspects. 14. This workshop is expected to provide knowledge about the current condition, the development, and challenges of the implementation of CRS in Indonesia while learning from the experience of other relevant countries. Such knowledge will provide input to the authorities in defining implementable actions on the management of CRS in line with the GPCR. Ladies and gentlemen, 15. Before closing my speech, I would like to give thanks to the committee which have thoroughly initiated and prepared such a great event. I would also like to thank all the speakers and partcipants for the willingness and enthusiasm to participate in this event. 16. With that final note, I hope this event provides us with an understanding of the role and contribution that we can give in order to implement the GPCR, particularly with regards to the Indonesian context. I strongly believe it will be beneficial for the industry and related authorities. Henceforth, I would like to invite all of us here to share thoughts in what I hope would be a spirited discussions filled with fruitful conclusions. May Allah bless and lighten our steps forward. Thank you. Erwin Rijanto Deputy Governor
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Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the International Seminar and the 2nd JIMF Call for Papers, Surabaya, 27 October 2016.
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Keynote Speech “Integrating Islamic Commercial and Social Finance to Strengthen Financial System Stability” Agus D.W. Martowardojo Governor of Bank Indonesia at International Seminar and the 2nd JIMF Call for Papers Surabaya – Indonesia, 27-28 October 2016 Distinguished Speakers, Seminar Participants, Ladies and Gentlemen, Assalamualaikum Warahmatullahi Wabarakatuh, And very good morning to all of you. [Introduction] 1. It is a great honour for me to be here today and to have this opportunity to welcome you in this International Seminar on Islamic and Finance, which also facilitate the 2nd Call for Paper Conference for the Journal of Islamic Monetary Economics and Finance in 2016. 2. As we have already seen across the globe, many people are in a search for a comprehensive formulation of Islamic economics and finance which can be developed not only conceptually, but also implementable to support the economic development in complement to the existing one. 3. The financial turbulence that has deeply impacted to the global economy is still waiting for a momentum to regain its strength and stability. The economic challenges that we are facing today has proven that even for the long standing conventional economics, new approaches and formulations are required to address and to overcome the challenges, such as sustainability of the economic growth and inclusive economic development. 4. The new approach in economic development concept, including the development of Islamic economic concept, should be able to address current issues and to provide credible solutions to the government. This conference serves as one of effective vehicles to facilitate exchange of thoughts and to formulate possible new approach that are worth-considering to complement the existing economic policy to come up with greater inclusiveness and sustainability. Distinguished ladies and gentlemen, 5. The development of Islamic economic and finance has been promising. The three sectors covering Islamic banking, Islamic capital market and also takaful could serve as additional pillars to foster the Islamic economic development. Those three elements have shown tremendous progress in terms of business volume, financial products and also the wider networks to entertain the customers. 6. The Global Islamic commercial finance still dominated by Islamic banking sector, which is accounted for 80% of the whole system. While Islamic banking sector has demonstrated its resilience aftermath the global financial crises by delivering a strong average growth of 17.1% in 2008 to 2011, the latest development showed a moderation pace of growth with an average of 13.8% during 2011 to 2014, or in particular 10% for 2013 and 2014. Nevertheless, the first half of 2015 has posted a non-annualized upswing growth of 7.96% and therefore, global Islamic banking assets growth in 2015 is expected to once again sustain its double-digit rate. 7. However, subdue global macroeconomic outlook poses considerable risks to global banking sector performance in general. Similar with the performance of Islamic banking sector, the global Sukuk market also experience a slowdown after reached record years for global Sukuk issuances in 2012 and 2013. In 2014 the Sukuk market slowed down to just over USD100 billion issuances, and the downward trend continue to 2015 where the issuance slides 43% to just around USD60 billion. 8. The development of Islamic commercial finance in Indonesia has similar down trend as the development of global Islamic commercial, especially in 2012-2015, where the growth of Islamic banking reached its lowest of 8.8% annually in 2015, compare to 9.2% annually of its conventional counterpart. However, by July 2016, the growth of Islamic banking has rebounded to reach 12.0% y.o.y, while its conventional counterpart still showed down trend to reach 7.2% y.o.y. Meanwhile, the share of Islamic banking has been stagnant at 4.8%. 9. Nevertheless, Islamic banking in Indonesia is claimed to be the biggest retail Islamic banking in the world with more than 18 million customers and more than 4.500 branches in 2015. 10. The development of Sukuk in Indonesia showed a slight down trend for corporate sukuk in 2009-2014 and for government sukuk in 20112014. However, the growth of sukuk has rebounded to 39.4% in 2015 and 29.8% by July 2016 for corporate sukuk, as well as 39.7% in 2015 and 36.28% by July 2016 for government sukuk. The share of sukuk by July 2016 has reached 3.8% for corporate sukuk and 15.6% for government sukuk. 11. The Islamic social finance sector comprises zakat, awqaf and nonprofit microfinance institutions. Although development around Islamic social finance sector is not globally well documented, countries data indicates promising potential. Research by the Islamic Research and Training Institute of IDB (IRTI-IDB) shed some light for the development of global Islamic social finance. 12. It is estimated that the potential zakat collection in South Asian and South East Asian countries is around USD30 billion in 2011, while in Sub-Saharan Africa countries it could reach around USD24 billion in 2013. On the other hand, the process of estimation of potential resources from awqaf is more challenging due to gross absence of data in most countries. 13. The Islamic social finance allows the government to reach wider segment to entertain, particularly the low income society that have been neglected due to inability to provide low cost funds. Henceforth, it becomes our real challenge to better formulate and define the concept of Islamic economics to reach compatibility in both concept and implementation, so that it can be integrated in to the mainstream economic policy. In this international seminar, the Islamic social sector becomes the center point of discussion after considering its potential to further equip the government in delivering prosperity to the society. Distinguished guests, ladies and gentlemen, 14. Zakat enables those who are considered poor and extremely poor to fulfill their basic needs. Zakat can also be a mean of empowering the poor capable of doing work for producing goods and/or services, but have no or little access to the formal financing. so that the selfemployed poor will be empowered to take care for himself and his family. Hence, poverty could be alleviated. 15. Similar to zakat, the management of awqaf also contributes to socioeconomic wellbeing. Traditionally, the charitable purpose of awqaf includes educational institutions, orphanages, roads, graveyards, and religious establishment such as mosques. However, in the modern days, the institution of awqaf is encouraged to make awqaf either cash or estates more productive. 16. Through awqaf, charitable clinics, medical centers, shopping complex and commercial centers can be established. This large socialcommercial projects finance by the raising awqaf in a planned manner are considered as an important instruments to improve socioeconomic wellbeing in a sustainable way. 17. Unlike the other commercial sources of funds, the zakat funds would never cause unnecessary burden to the economy since the type of the funds is not commercially claimable, and hence, no excessive social costs will occur. The same also goes to the awqaf sector, where, as a matter of fact, more people are endowed with low cost assets. With this huge potential of zakat and awqaf land, we can expect Islamic social finance a significant drive to economic development. 18. Both zakat and awqaf as Islamic social finance can become a buffer as well as an economic stabilizer. Zakat funds provide a transfer payment to the hardest hit poor and needy people caused by recession. Since zakat is a levy on both income and wealth, the redistribution of wealth will always be functional and operative in an Islamic economy due to wealth zakat irrespective of the phase of business cycle. 19. Transfer payments to needy people will continue when the economy faces further recession. Due to its simple and certain collection and also religious obligations than just an involuntary tool of fetching wealth, zakat is always available in good time (peak) and bad time (recession). 20. On the macroeconomic level, proportional zakat linked with income acts as an automatic stabilizer. When personal disposable income decreases due to recession, obligatory zakat also decreases. They do not have to pay the same proportional amount as before, thereby providing an automatic relief for income earners. 21. On the contrary, when aggregate personal disposable income increases (boom period), more zakat is collected and more amount remains at the disposal of government to allocate as transfer payments. Thus zakat enables the distributive allocation works independently and help stabilize the extreme business cycles. As for awqaf, since the principal of awqaf will always increase from time to time, due to return of productive activities and new awqaf collection, awqaf could act as shock absorber of economic shocks. Distinguished guests, ladies and gentlemen, 22. Despite the potential, we also realize that in order to manage zakat and awqaf efficiently and prudently so that poverty alleviation and socio-economic wellbeing can be materialized, the regulatory framework of this sector has to be improved. To this end, Bank Indonesia jointly together with Islamic Research and Training InstituteIslamic Development Bank (IRTI-IDB) and Baznas has established International Working Group on Zakat Core Principles in 2014. 23. Alhamdulillah, the Core Principles initiative has been finalized and launched in the World Humanitarian Summit of United Nations in Istanbul on May 23rd, 2016. The Core Principles serve as the main reference to further elaboration of Zakat regulations. Meanwhile, the development of Awqaf Core Principles has also been underway, following the success of Zakat Core Principles. 24. Realizing the potential of this Islamic social sector, Bank Indonesia puts greater attention to enhance zakat and awqaf system nationally and internationally. The Islamic economic and finance development program has put as one of the strategic objectives of Bank Indonesia Strategic Function 2024 and enhance inter-institutions cooperation and coordination programs including the development of inclusive finance and MSME, as well as Islamic economics and finance. Bank Indonesia has set a vision of Indonesia to become a center of Islamic Finance Center in the region. Distinguished Guests, Ladies and Gentlemen, [Closing] 25. Relating to the Journal that we are trying to develop, this conference serves as the platform to communicate and to elaborate the topics compiled in the Journal. We wish the journal can play a role as one of main compiler of repository knowledge in the area of Islamic economics and finance. 26. Up to this point, Alhamdulillah, we have an honor to facilitate important discussion attended by prominent scholars, representatives of several embassies, colleagues from governmental insitutions, researchers, and academicians on integrating Islamic commercial and social finance to strengthen financial system stability, which is a timely topic nowadays. 27. In this special moment, I am pleased to inform you that this Conference is conducted concurrently with “Indonesia Sharia Economic Festival (ISEF) 2016” which choose “Leading Roles in the Development of Islamic Economic and Finance to Achieve the Prosperity of the Nations” as the theme of the conference. This Festival will be held here in Surabaya, 25-30 October, 2016. 28. Allow me to conclude my speech by expressing my appreciation and sincere gratitude to all speakers and participants for the willingness to join this special event. I also would like to wish you all a productive discussion and deliberation in this important event. I am confident that supported by all participants in this room, we can achieve significant outcomes that are beneficial to promote development in the area of Islamic commercial and social finance. 29. Finally, I am delighted to officially open “International Seminar and the 2nd Journal of Islamic Monetary Economics and Finance Call for Papers”, please enjoy the discussion and the rest of the session at this second biggest Metropolitan city in Indonesia and also known as “City of Heroes”, due to the importance of the Battle of Surabaya in galvanizing Indonesian and international support for Indonesian independence during the Indonesian national revolution. Thank you very much. Wassalamu’alaikum warahmatullahi wabarakatuh. Surabaya, 27 October 2016 Agus D.W. Martowardojo Governor of Bank Indonesia
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Talking points by Mr Erwin Riyanto, Deputy Governor of Bank Indonesia, at the Regional Forum on "Emerging opportunities and challenges of financial inclusion", Kathmandu, 9 November 2016.
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REGIONAL FORUM ON “EMERGING OPPORTUNITIES AND CHALLENGES OF FINANCIAL INCLUSION” TALKING POINTS Mr. Erwin Rijanto, Deputy Governor of Bank Indonesia “FINANCIAL INCLUSION FOR SME IN INDONESIA” Kathmandu, 9 November 2016 I. INTRODUCTION 1. A very good afternoon and warm greetings to: a. Mr. Shitangshu Kumar Sur Chowdhury, Chairman of APRACA; b. Mr. Shiba Raj Shrestha, Vice Chairman of APRACA; c. The member of APRACA; d. Ladies and gentlemen. Distinguished guests, 2. We are all aware that financial inclusion has become a priority in the world, but it has now also been considered as national agenda for Indonesia. 3. In this honorable meeting, I would like to share Indonesian’s experience regarding the financial inclusion in Indonesia, and its relation to SME. Ladies and gentlemen, II. CURRENT CONDITION IN INDONESIA 4. Considering the current condition, Indonesia with its population of almost 250 million people which 28 million people living in poverty line remains to be unbanked. Taking a closer look these large portion of the unbanked clustered around poverty line remains vulnerable. Geographic condition adds the challenge in providing access to this target group as Indonesia consist of almost 17.000 island and most of poor people live in a very remote area with different culture. On the supply side, there are several factors inhibiting services to the community such as limited communication network and electricity infrastructure. 5. Based on our survey, banked people reached 39% in 2015. It is still in a long journey to reach the target of 75% banked people at the end of 2019. The percentage of 39% in our survey means they have a savings or credit account, insurance or formal means of low-cost payments. Outside of 39% still use financial services but rely on the age-old informal mechanisms: family and friends, the rotating savings club, the moneylender, the pawnbroker, cash under the mattress and long-term savings in the form of livestock. These mechanisms are incomplete, and can be very unreliable, risky and expensive. 6. Interestingly, Indonesia is one of the fastest-growing user smartphone in the world: Nearly 60 million of the country's citizens will have smartphones in 2016. Continuously, Indonesia’s smartphone users are expected to grow at a compound annual growth rate (CAGR) of 11.2% between 2016 and 2020, to reach more than 100 million and become the fourth-largest global market. 7. On the other hand, Indonesia faces some challenges regarding the implementation of digital financial inclusion such as cash based mindset, lack of information of non-cash instrument, limited interconnection, coordination amongst stakeholders, and lack of infrastructure. 8. Regarding the challenges as mentioned, Indonesia has high concern to increase financial access, especially for unbanked and underbanked, through the financial inclusion policy. Financial inclusion policy will eliminate the barriers for people to reach financial access. Ladies and gentlemen, III. PRESIDENTIAL DECREE NO. 82 YEAR 2016 REGARDING NATIONAL STRATEGY OF FINANCIAL INCLUSION ON SEPTEMBER 1ST 2016 9. Financial Inclusion has been considered as national priority for Indonesia; therefore in 2012, Indonesia launched its National strategy for Financial Inclusion (NSFI)1. With the vision to improve the coordination between ministries, Bank Indonesia, related institutions and bodies in implementing this strategy, NSFI has been amended and formulated as legal entities in Presidential Decree No. 82 Years 2016 regarding National Strategy for Financial Inclusion. 10. NSFI has 5 Pillars and 3 enablers as follow : a. Pillar 1: Financial Education, aims to improve public knowledge and awareness about the formal financial institutions, financial products and services, as well as to improve public’s skills in financial planning and management. b. Pillar 2: Public Property Rights, aims to expand the guarantee thus people could access credit from formal financial services. c. Pillar 3: Financial Intermediation Facility and Distribution Channels aims to expand the range of financial services to meet the needs of the different groups of people. d. Pillar 4: Financial Service in Government Sector, aims to improve the governance and transparency of public services in 1 In NSFI, Financial Inclusion is defined as: a condition when every individual has access to a wide range of quality formal financial services in a timely, clear, and secure with affordable price according to the needs and capabilities in order to improve their welfare the distribution of government funds. This can be achieved by distribution of aid through non cash which is expected to increase targeting accuracy, quantity, price, time, quality, and administrative. e. Pillar 5: Consumer Protection, aims to provide a sense of security to the community to interact with financial institutions, and take advantage of the products as well as financial services and payment systems offered. Principle of consumer protection are transparency, equal treatment, reliability, confidentiality and security of data / consumer information, and complaint handling, as well as consumer dispute resolution in a simple, fast, and affordable cost. 11. The five pillars of National Strategy of Financial Inclusion must be supported by three enablers as follows: a. Conducive Policies and Regulations: The implementation of inclusive financial programs needs policies and regulations of the government and authorities/regulators. b. Supportive Infrastructure and Information Technology: It is necessary to minimize information asymmetry that is obstacles or bottlenecks in accessing financial services. c. Effective Organization and Implementation Mechanism: The diversity of financial inclusion actors and organizations leads to a need of mechanism to encourage the implementation of various activities together and integrated. Distinguished guests, IV. ROBUST, SOUND, EFFICIENT AND SECURE PAYMENT SYSTEM TO SUPPORT FINANCIAL INCLUSION INITIATIVES 12. Bank Indonesia as the payment system regulator also put high concern in financial inclusion. By bringing people to financial system, we believe it will support financial stability. First, it will increase the resilience of financial system through the increase of financial buffer from the retail deposits. Second, with expanding financial access to retail sector, for both saving and borrowing side, it will diversify liquidity and credit risk. Meanwhile, financial inclusion combined with electronification2 will increase the efficiency of financial transaction. For the benefit of the economy, financial inclusion will bring positive impact in minimizing the gap, reducing the poverty level, and increasing asset accumulation of people. 13. To support access to finance, Bank Indonesia implements a dual policy approach, which include financial inclusion and electronification. Currently, 64% of the unbanked people in Indonesia are subject to financial inclusion through electronification via e-money and Digital Financial Services agents. Once these unbanked people are accustomed to perform cashless transactions and able to maintain the amount in their electronic money (registered with maximum amount Rp 5 million), they will be asked to open a savings account at a bank through the Laku Pandai program. Thus, overtime, these unbanked people will become bankable and are subsequently expected to utilize other financial service products through Banks and Insurance. 14. In the mean time, the 36% banked people are also encouraged to utilize electronic payments. This is carried out through the National Non Cash Movement initiative that is supported by G to P (Government to Person), P to G (Person to Government), and P to P (Person to Person) programs. 15. Payment technology in terms of financial inclusion implementation is perceived as enabler because it creates more efficient usage of 2 Electronification is a change mechanism from cash to non-cash and from manual to electronic. financial services and plays an important role to enhance financial access for the society. To increase the effectiveness and efficiency of transaction, Indonesia supports the interoperability and interconnectivity among payment infrastructure. 16. In order to increase financial access, Bank Indonesia implement financial inclusion program. Most of our financial inclusion programs are developed based on digital technology. As a main access is Digital Financial Services (DFS) and develop ecosystem through electronification. Both programs are implemented through sectoral approach, such as electronic Government to People (G2P) assistance, People to Government payment, especially public services, electronification for migrant worker and fisher community, and electronic payment in smart city. 17. Implementing the financial inclusion strategy will promote the financial access of SME as well because it is fundamental for enabling SME, as the engine of economic growth and employment, to expand their business. Distinguished guests, V. SME FINANCING 18. Indonesian SME dominates the number of business units with the percentage of 99%. They also create employment opportunity for 97% of the total workforce and contribute to 60% of Indonesia’s GDP. In contrast with the number and contribution of SME, their financing is still relatively low. The SME loans share on August 2016 is 19.7%. Most of them are disbursed to trade sector for about 53%. Some issues trigger the low percentage of SME financing are a. Banks encountered difficulties in assessing the financial viability of SMEs. b. There is asymmetric information where Banks require the information on the potential SMEs and the eligibility of SMEs. c. Banks looked at SMEs as high risk business. d. The limited public access to finances, especially in remote areas. Ladies and gentlemen, VI. CONCLUSION 19. Despite the limitation in telecommunications network in Indonesia and lack of socialization and assistance for end user, Bank Indonesia continuously perform our best efforts to improve SME access to finance through the means of information technology (IT) since IT will broaden the range of SME access to finance facilities/infrastructure in an easier, cheaper, and reach out to broader and remote region. Then, it could also facilitate change of SME behavior in recording and conducting financial transactions of its business. Finally, information technology is also expected to encourage SME to utilize the development/innovation of technology in conducting its business Distinguished guest, ladies and gentlemen, I would like to conclude my presentation by quoting the statement from Christine Lagarde, Managing Director of the IMF: “Greater financial inclusion has tangible economic benefits, such as higher GDP growth and lower income inequality. By providing access to accounts, credit, infrastructure, women and low income users, financial inclusion helps make growth more inclusive”. Thank you. Kathmandu, 9 November 2016 Mr. Erwin Rijanto Deputy Governor of Bank Indonesia
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Address by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at Bank of Indonesia's Annual Meeting of 2016, Jakarta, 22 November 2016.
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GOVERNOR’S ADDRESS OPTIMIZING POTENTIAL, STRENGTHENING RESILIENCE BANK INDONESIA’S ANNUAL MEETING JAKARTA, NOVEMBER 22nd 2016 Table of Contents Greetings............................................................................................................................................. Preface................................................................................................................................................. Developments in Global Economies......................................................................................... Developments in Domestic Economy....................................................................................... Economic Policy Challenges and Direction............................................................................ Economic Potential......................................................................................................................... Basic Function and Principle of Policy..................................................................................... Bank Indonesia’s Policy Direction............................................................................................... Policy Coordination......................................................................................................................... Bank Indonesia’s Internal Strengthening................................................................................ Economic Prospects........................................................................................................................ Conclusion......................................................................................................................................... Optimizing Potential, Strengthening Resilience Agus D.W. Martowardojo Governor of Bank Indonesia Governor’s Address Bank Indonesia Annual Meeting of 2016 Jakarta, 22nd November 2016 His Excellency, • The President of the Republic of Indonesia, Head of State: Mr. Joko Widodo Distinguished Guests, • Leaders of State Institutions: MPR, DPR, DPD, BPK, the Supreme Court, Constitutional Court, and Judicial Commission • Cabinet Ministers and Head of Government Agencies • Commissioner of the National Police, Attorney General, and Chairman of KPK • Chairman, Deputy Chairman and Board of Commissioners of OJK • Chairman and Board of Commissioners of LPS • Chairman, Deputy Chairman and Members of Commission XI of DPR • Provincial Governors from throughout Indonesia • Former Governors of Bank Indonesia • Members of the Board of Governors of Bank Indonesia • Leaders of the Banking Industry and Non-Bank Corporations • Academicians, Economists, and Leaders of National Media • Ladies and Gentlemen Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Assalamualaikum Wr. Wb., Greetings to all, Om Swastiastu, Namo Buddhaya, Praise be to Allah SWT, God the Almighty, as it is upon His blessings that we may all gather here today, in a good health, at the “2016 Annual Meeting of Bank Indonesia”. I am grateful and deeply honoured by the presence of His Excellency the President, and all other distinguished guests, here at the the “2016 Annual Meeting of Bank Indonesia”. The presence of His Excellency the President and of distinguished guests testify to our commitment to create synergy, to develop the national economy, and to strive towards equitable welfare for for the nation. This commitment will hopefully encourage the optimization of the potentials and the resilience of our economy, and to further promote a more efficient, productive and competitive national economy. This evening, allow me to present the Bank Indonesia’s perspectives on the latest economic condition and the prospects, under the theme “Optimizing Potential, Strengthening Resilience”. In our view, the theme is relevant as response to the unfavourable global economic development, and the positive achievements of the domestic economy. Developments in Global Economies Developments in Global Economies Our latest assessment concludes that the the global economy continues to weaken, which is followed by the continuation of the low commodity prices, and the declining of capital flows to emerging countries. The momentum for global economic recovery that we initially anticipated would begin this year has yet to materialize and is visibly weakening in a number of areas. We estimate global economic growth in 2016 to be at around 3.0%, which is lower than in 2015 of 3.2% (Figure 1). In the developed countries, the United States (US), which was previously expected to be the engine of global economic growth, has yet to be solid in its development up to the First Half of 2016. Recovery in Europe and Japan has also yet to strengthen. The Brexit Referendum that led the UK out of the Figure 1. World GDP and Global Commodity Prices European economic zone even has the potential to reduce Europe’s economic prospects in the medium term. Developing countries also need to continue to be monitored. China, as one of Indonesia’s export destinations, continues to consolidate and rebalance its economy. We estimate that China’s economic growth in 2016 will likely continue to be restrained despite improvements and a 6.6% growth, but this achievement is lower compared to growth achieved in previous years of above 7% (Figure 2). Likewise for India’s economic growth, which in previous periods was fairly impressive, seemed to lose its momentum in the recent periods. Meanwhile, Brazil and Russia’s performance also needs to continue to be monitored despite the fact that the pressure of a decline has begun to recede. Figure 2. China’s Economic Growth % yoy % yoy -10 -20 % Contribution 8.1 2016p I 6.7 6.7 6.7 IV I 7.7 7.4 7.5 7.1 7.2 7.0 7.0 6.9 6.8 -40 7.9 -30 7.6 -1 Oil & Gas and Non-Oil & Gas Commodity Prices (Right Scale) p) Bank Indonesia Projection Source: World Economic Outlook Database 8.1 7.9 World GDP 7.6 7.5 II III IV I Primary Industry II III I II III Secondary Industry IV I II III IV Tertiary Industry II III GDP yoy Source: National Bureau of Statistics of China Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Figure 3. Capital Flow To Emerging Markets USD Billion Global financial crisis in 2008 Figure 4. Emerging Market Potential Output % Large Scale Capital outflow since 2015 -200 -400 Total Factor Productivity (TFP) -600 -800 2016p Labor Capital Output 2006-07 2008-10 2011-12 2013-14 p) IIF Projection April 2016 Source: Institute of International Finance (IIF) Source: World Economic Outlook Database As in previous years, the global economy, which has yet to strengthen, had an impact on the continuation of low global commodity prices. We estimate Indonesia’s non-oil & gas export commodity prices in 2016 will slighty be higher the 2015 levels. Meanwhile, world oil prices continue to follow a declining trend brought about by the increasing oil supply from OPEC and the US. led to lingering high uncertainty in the global financial markets. Market players continue to focus on the uncertainty of the anticipated Fed Fund Rate’s hike, which up to November 2016 continues to be maintained at a level of 0.250.50%. This is in addition to the impact brought about by geopolitical uncertainties that includes the US presidential elections. These various uncertainties subsequently led to the decline in capital flow to the emerging markets and followed by global fund outflow volatility. (Figure 3). Positive expectations has begun to be seen in coal and palm oil (CPO), which in recent months has begun to increase. However, this price increase was largely driven by reduced production as opposed to increased demand. The global economy, which has not strengthened, and the anticipation of the Fed Fund Rate’s hike once again In our view, these various global economic changes in 2016 reinforce indications of structural problems in the global economy. Problems that in our view contributed to decline in economic productivity in numerous countries and subsequently reduced the global economy’s potential output, Developments in Global Economies Figure 5. GDP vs World Trade Volume Figure 6. Projected World GDP % yoy % yoy 5.5 5.0 4.5 4.0 -5 -10 3.5 -15 -20 3.0 World GDP 2016* World Trade Volume *) up to August 2016 Source: Bloomberg, CPB, processed data Developments in Global Economies including those of the emerging markets (Figure 4). One structural problem of the global economy that we need to highlight and affects emerging markets such as Indonesia, is the diminishing impacts of the global economic growth on the world trade. Data shows that the relationship between world GDP with the volume of world trade is not as strong as it was in previous years (Figure 5). World economic growth elasticity towards world trade that since early 2000 was within the range of around 1.3 has weakened and in the last five years elasticity that occured was only around 0.9. Various studies have argued that there are a number of factors that led to this condition. One of these states Actual WEO April 2015 WEO April 2016 WEO October 2016 WEO October 2015 Source: World Economic Outlook Database that this phenomenon was caused by the decline in global investment and increased global trade protectionist issues. Moreover, declining Global Value Chain (GVC), which among others was brought on by a maturing process, mastering technology and reshoring process, also further receded the relationship between the both elements. Structural global issues subsequently needs to be further monitored due to its implication on the completion process, which certainly cannot be carried out within the short-term. In other words, we will continue to face global economic downturn within a longer timeframe, which may risk spreading to the emerging markets, including Asia. The global economic recovery up to 2020 is expected to continue to remain below 4% (Figure 6). . The production maturing process in a number of major countries, such as China and the US, is a result of technological mastery that allows for foreign input goods substitution by domestic input. Meanwhile, the reshoring process mainly occuring in the US is driven by the impact of increased manufacturing sector labor costs outside of the US and declining energy costs within the US. Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Figure 7. Economic Growth Contribution Figure 8. Economic Growth of Peer Countries % yoy % yoy -2 -2 -4 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 Domestic Demand (Excludes Inventory) Net Exports Source: BPS-Statistics Indonesia Developments in Domestic Economy As an open economy, Indonesia’s economy is not immune from the unfavorable global condition. However, our national economy has the flexibility to adjust and respond to the global economic risks. Indonesia’s economy continues to grow 5.02% (yoy) up to the Q3 2016, which represents an increase compared to that achieved in 2015 (Figure 7). Bank Indonesia estimates Indonesia’s economic growth in 2016 to be at around 5%. This amount is much lower than our initial estimates submitted at the end of 2015 of around 5.2%-5.6% brought about by the the global economy’s impact that was actually much lower than initially projected. However, this amount is still considered to be impressive in comparison with the other countries that continued to struggle to boost its economic growth (Figure 8). -4 Brazil India South Africa Q2 2016 Indonesia* Malaysia* Russia Thailand Turkey Vietnam* *) Q3 2016 Data Source: CEIC, processed data Data shows that the flexibility of Indonesia’s economy is mainly driven by domestic demand. Domestic demand as of Q3 2016 continues to follow an upward trend thereby minimizing the impact of a decline in the external sector’s performance. Moreover, non-food household consumption has already registered an upward trend since 2011. In line with this, the role of Rupiah lending as a source of domestic financing is also in an upward trend. In regional terms, a number of provinces have registered growth of above 6%, such as the regions of Sulawesi, Bali, and Nusa Tenggara (Figure 11). This condition is driven by the positive impact of the economic transition taking hold in these regions, from a previous dependence on raw commodities to value-added commodities through the construction of smelters and industrialization of the agricultural sector. Despite this, a number of provinces Sumatra, Developments in Domestic Economy Kalimantan and Papua continues to grow below 4% thereby requiring continued attention. in inflation that continues to be low and stable (Figure 11), the Rupiah’s exchange rate that continues to be under control, the current account deficit (Figure 10) and 2016 budget deficit that remains to be within a healthy level, as well as the banking sector’s resilience and a strong financial system. Apart from these consistency factors, economic stability also attributed to a stable political situation and conducive domestic environment supported by the parliaments and national security institutions. Inflation also continues to be maintained within a low and stable level. We project inflation for 2016 will be in the target range of 3.0-3.2%, which is lower than that achieved in 2015 of 3.4% (Figure 9). This low inflation is also attributed to the consistency of monetary policy and coordination with the Government to control prices of volatile foods and strategic commodities. In spatial terms, inflation is also low with Java, a number of areas in Eastern Indonesia and Lampung registering inflation of below 3% (Figure 12). Meanwhile, high inflationary pressure mainly occured in North Sumatra and West Sumatra that registered rates of above 5%. The preserved economic stability and the controlled economic risks subsequently provided the basis for the businesses to move freely to respond the existing conditions. Two aspects at the very least drove the national economy’s flexibility in response to the global economic downturn. The first factor deals with consistency in maintaining economic stability. The outcome of this consistency is reflected The second factor deals with the impact of the Government and Bank Indonesia’s countercyclical policies. The sizeable fiscal stimulus, including infrastructure spending, supported sectors that are directly related to the government, such as construction Figure 9. Inflation and Its Components Figure 10. Current Account Balance % yoy % yoy % PDB -1 -2 CPI Inflation (Right Scale) Core Government Administered Prices 2016* -10 -3 -4 2016* *) up to Q3 2016 Source: Bank Indonesia Volatile Food *) up to October 2016 Source: BPS-Statistics Indonesia, processed data Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Figure 11. 2016 Regional Economic Growth (Cumulative up to Q3 2016) Aceh 2.9 North Kalimantan 2.5 North Sumatera 5.1 Riau 2.0 West Sumatera 5.4 Riau Islands 4.9 Jambi 3.7 Bengkulu 5.2 South Sumatera 4.2 East Kalimantan -0.8 Bangka Belitung Islands 3.6 West Kalimantan 5.4 Central Kalimantan 5.6 South Kalimantan 3.8 Jakarta 5.7 gPDRB ≤ 0,0% 0,0% < gPDRB ≤ 4,0% Lampung 5.2 Banten 5.2 West Java 5.6 4,0% < gPDRB ≤ 6,0% Central Java 5.2 DI. Yogyakarta 5.0 6,0% < gPDRB ≤ 8,0% gPDRB > 8,0% East Java 5.6 Bali 6.3 West Nusa Tenggara 7.5 Source: BPS-Statistics Indonesia, processed data investment. Government’s deregulation and debureaucratization through a number of policy packages as part of the structural reform efforts, also positively contributed to enhance business confidence in Indonesia. The relaxation of Bank Indonesia’s monetary policy has improved the domestic demand. In the last year, Bank Indonesia has reduced its benchmark rate by up to 150 bps and Minimum Reserve Requirement (GWM) of up to 150 bps. The monetary policy’s relaxation is also applied in Developments in Domestic Economy North Sulawesi 6.0 Gorontalo 6.4 North Maluku 5.5 West Papua 4.3 Central Sulawesi 12.0 West Sulawesi 5.7 Maluku 5.9 Papua 4.9 Southeast Sulawesi 6.1 South Sulawesi 7.4 East Nusa Tenggara 5.2 synergy with macro-prudential policy through relaxation of Loan To Value (LTV) for property loan and Financing To Value (FTV) for property financing, as well as increasing the GWM-Loan To Funding Ratio (LFR) limit from a previous of 78% to 80%. As a note, we have reformulated the monetary policy’s operational framework by replacing interest rate policy from the BI Rate to the BI 7-day Reverse Repo Rate on 19 August 2016. This is carried out to strengthen monetary policy transmission effectiveness and promote deepening Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Figure 12. 2016 Regional Inflation (up to October 2016) Aceh 3.7 North Kalimantan 4.5 North Sumatra 7.4 West Sumatra 6.1 Riau 3.9 Riau Islands 3.9 Jambi Bengkulu 5.7 South Sumatra 4.2 3.0% ≤ Inf < 4.0% Inf < 3.0% Bangka Belitung Islands West Kalimantan 3.6 South Kalimantan 4.2 Lampung 2.9 Banten 3.1 West Java 2.8 Central Java 2.8 DI. Yogyakarta 2.7 Source: BPS-Statistics Indonesia, processed data of the financial markets. We are grateful that through the support, coordination, and trust of various parties this policy can be effectively implemented. BI 7-day Reverse Repo Rate currently is within the 4.75% level, which in our view is consistent with the Central Kalimantan 2.2 Jakarta 2.7 Inf ≥ 5.0% 4.0% ≤ Inf < 5.0% East Kalimantan 3.1 East Java 2.8 Bali 3.6 West Nusa Tenggara 2.9 achivement of the inflation target and macroeconomic stability. Amidst the global economic situation that has yet to strengthen, the domestic economy’s flexibility has been duly recognized by a number Developments in Domestic Economy North Sulawesi 0.78 Gorontalo 2.3 North Maluku 2.9 West Papua 3.2 Central Sulawesi 2.3 West Sulawesi 3.1 Maluku 2.6 Papua 4.4 Southeast Sulawesi South Sulawesi 3.2 East Nusa Tenggara 2.9 of global ratings agencies. Fitch Ratings, Moody’s Investors Service, Japan Credit Agency, and Rating and Investment Information Inc. maintained the Indonesia’s Investment Grade Rating in 2016 due to its ability to grow solidly, backed by the robust domestic demand. In terms of investment climate, we appreciate the government’s efforts in promoting the Indonesia’s Ease of Doing Business ranking from 106 to 91. Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Economic Policy Challenges and Direction The prospects for the global economy’s conditions that have yet to recover and some risks in the commodity and the financial markets, will continue to pose a challenge to our economy going forward. Challenges that we must continue to strive to find comprehensive solutions to mitigate the impact of global economic conditions on the domestic economy. We view global challenges as one that increasingly needs to be closely monitored so as to ascertain its impact on the national economy as we continue to face various short-term and domestic structural challenges that have yet to be resolved and may potentially slow the economic recovery process. Short-term challenges derive from the effects of the fiscal stimulus that has yet to attract private investment, particularly Figure 13. Time Deposit and Lending Rates for non-construction investments. Nonconstruction investment growth up to Q3 2016 remains low. Our assessment indicates that this condition is related with business consolidation at the private sector by enhancing efficiency, both in production activities as well as in managing loans. The monetary policy easing’s effects on the banking sector has not been fairly transmitted. The effects of the decline in policy rates on lending rates was registered to be smaller than the decline in deposit rates. The decline in lending rates from the beginning of the year up to September 2016 has only reached 60 bps, which is lower than the decline in deposit rates that has already reached 108 bps (Figure 13). The ongoing consolidation by the private sector and limited decline in the lending rate subsequently affected loan growth performance that was not as strong as expected before. The Figure 14. Credit Growth and NPL % % yoy % 4.0 3.5 3.0 2.5 2.0 Deposit Credit *) up to September 2016 Source: Bank Indonesia 2016* Credit Growth 1.5 *) up to September 2016 Source: Bank Indonesia NPL (Right Scale) 2016* Economic Policy Challenges and Direction banking sector’s loan growth up to Q3 2016 only arrived at 6.5% (yoy), which is substantially lower than that achieved in 2015 of 10% (yoy). Low credit growth was also influenced by bank’s tighter credit policy in response to increasing NonPerforming Loan (NPL) (Figure 14). In regional terms, the Kalimantan region registered the lowest loan growth compared to other regions and was followed by the highest NPL (Figure 15). This was caused by the performance of the mining and manufacturing sector within this region that has yet to recover. Slow loan growth in other regions were caused by, among others, loan to the trading sector. Meanwhile, domestic structural challenges were closely linked to a number of aspects in the real sector, particularly in terms of supply, and in the financial sector. In terms of the real sector, we registered challenges linked with export product composition that are largely dependent on natural resource products, market structure and trade system that requires to be more efficient, and the role of the manufacturing industry that continues to decline. In terms of the financial sector, the challenges continues to come from unvaried domestic financing structure, unbalanced bank’s funding structure, as well as shallow financial market. Amidst looming uncertainty that affects global conditions, the presence of these cyclical and structural challenges requires us to constantly strive to seek strategies that simultaneously can optimize existing domestic potential while reducing various challenges that continues to surface. In this regard, therefore it becomes relevant that going forward our policy will be aimed at optimizing various domestic potential to reinforce the national economy’s resilience. Figure 15. Regional Credit Growth and NPL Credit Growth (% yoy) NPL (%) I II III Sumatra IV I II III Java IV I II III I II III IV Kalimantan I II III IV I Sulampua II III Balinusra Source: Bank Indonesia Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 The strengthening and optimalization of the domestic potential does not mean that we retreat from the global constellation. This means that we need to improve and prepare ourselves by utilizing the existing domestic potential, thereby serving as a firm basis to leverage the domestic economy once the global economy recovers. external sector’s resilience in the form of declining dependence on foreign debt. We believe the economy’s resilience will be strengthened with effective implementation of deregulation policies that can resolve many structural issues. In terms of the domestic sector, we need to continue to build a strong national industry so that once the global economy recovers we will get the benefit for our economy. In terms of the external sector, we need to prepare some leading sectors that are competitive in the global market. Competitiveness that is backed by productivity and not merely in terms of nominal factors such as the exchange rate. We registered that there are at least 3 (three) economic potential that needs to be optimized to support Indonesia’s economic resilience. The first potential is the high level of trust and strong confidence of the economic agents to the government and policy makers. We believe that the results of the Tax Amnesty program is unlikely to be accomplished without the high level of trust on the government’s policy direction and Indonesia’s economic prospects. Strengthening and optimizing this domestic potential is subsequently directed towards reinforcing the national economy’s resilience. This potential includes the huge potential sources of domestic financing, as reflected in the results of the Tax Amnesty program. Optimizing financing sources can strengthen the economy’s resilience from the aspect of fiscal sustainability, corporate sector’s resilience, and Economic Potential Macroeconomic policy management discipline, including fiscal policy management with a realistic target and medium to long-term vision, as well as monetary policy that is committed to maintain macroeconomic stability in our view serves as one of the main elements for trust and confidence of these economic agents. In addition, the confidence of the economic agents is also driven by the implementation of the government’s structural reform policies. Economic Potential The second potential that has surfaced and deserves special note in 2016 is the emergence of ample sources of economic financing. We extend our appreciation to the Government for its success to unravel this potential through the Tax Amnesty program. Up to 14 November 2016, this program has successfully collected tax payments amounting to Rp94.8 trillion, with repatriated funds amounting to Rp142.7 trillion and declared funds of Rp3,773.2 trillion. The accomplishment deserves to be appreciated since the Tax Amnesty program is the most succesfull program in the world. confident that the tax intensification through the benefit of a wider tax basis, will serve as a solid ground for the efforts to widen fiscal space to support economic growth, without jeopardizing the sustainability of its prospects. The third potential is digital technology that has rapidly developed. In 2016, we witnessed that the sharing economy and digital economy has sharply increased as reflected in Fintech and e-commerce activities. This positive development will, if it is used properly, enhance efficiency and support domestic economic activities. We view that this potential can serve as the solid momentum for the Government to accelerate tax reforms in Indonesia. The broadened tax base is expected to be followed by tax intensification in order to boost the role of tax as the source of development financing. These three potentials that emerge in 2016 will, if it is effectively and optimally empowered, strengthen and boost the benefits from the existing domestic resource potential, specifically human and natural resources. In Indonesia, the role of tax in the development financing only reached 11% of GDP in 2015, which is lower compared to that achieved by a number of countries in the region such as Singapore and Malaysia that achieved around 14% of GDP. We are The sizeable population represents a huge market potential to support domestic demand through household consumption. Moreover, this huge market potential will readily serve to be the driver for more sizeable added value if it is subsequently followed by an increase in domestic production activities. Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 In this context, the demographic bonus that is represented by a larger number of productive-aged population compared to senior citizens and children will serve as potential from the labor perspective and a large consumer base in line with the growth of the middle class in Indonesia. This demographic bonus will, if adequately managed, provide opportunities for Indonesia to become more prosperous. We also specifically noted the importance of women’s participation in economic development. The population of women in the world today comprise of more than a half of the world’s population, but their contribution to the economy is still far below their potential. Many studies have shown that the performance of the economy will increase when women’s potential in the labor market is properly utilized. However, it should be noted that the demographic bonus which will reach its peak in the next fifteen years will lose its momentum after those period, which is in line with the increasing dependency level of the population (Figure 16). As a consequence, we are raving against the time in utilizing each aspect of the potential. Efforts to increase women’s participation in the economy also serves as a challenge for Indonesia. Data show that female labor participation compared to male labor in 2016 declined and was lower than in neighboring countries (Chart 17). This is a challenging figure since the potential of Indonesian women to contributing in the economy is quite substantial, especially in reviving the real sector. Figure 16. Dependency Ratio Figure 17. Ratio of Female to Male Labor Force % Ratio to Male 1.00 0.90 0.80 0.70 Old-Age Child 0.60 Total Source: Hayes, Adrian and Diahhadi Setyonaluri. 2015. “Taking Advantage of The Demographic Dividend in Indonesia: A Brief Introduction to Theory and Practice”. Jakarta. Policy Memo UNFPA Indonesia. Page 4 0.50 Indonesia Thailand Malaysia Source: WEF - Global Competitiveness Report Phillipines Vietnam Basic Function and Principle of Policy Diagram 1. Vicious Circle Increased Risk Weakened GDP Growth Decline in Credit Growth Rupiah’s Depreciation Increased NPL The World Bank’s Survey (2016) reveals that the ratio of female business ownership in Indonesia is higher compared to the same ratio at a global level, particularly for micro and small businesses. The survey also found that most of the bank and non-bank financial institutions perceives female owned businesses as profitable (Graph Figure 18. Perception of Female Clients in Indonesia Depositors % Bank Profitable Source: World Bank Non-Bank Neutral Capital Outflow Declining Corporate Performance 18). However, financing for micro and small businesses operated by women is still limited. Basic Function and Principle of Policy Going forward, we need to continue to promote economic growth so as to avoid the emergence of vicious circle risk. The economic downturn poses a risk that may affect corporate and financial sector performance, thereby requiring efforts to strengthen the economic resilience (Diagram 1). Optimization of various domestic potential to promote economic resilience should refer to to the three basic function of public policy, namely (I) stabilization function, (II) allocation function, (III) distribution function. These three functions needs to be supported by policy makers through strengthening the regulations. Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Within this context, various policies that are aimed at resource allocation can be utilized as instrument of economic stabilization through countercyclical policies and also as a tool to promote equitable distribution of economic development outcomes. We support the government’s efforts to maintain a balance between strengthening the role of government spending as a countercyclical policy instrument with efforts to maintain fiscal sustainability. In this context, we view that efforts to increase the composition of capital expenditure, particularly infrastructure projects, should be maintained. This step is needed to preserve economic stability, while simultaneously ensuring the resource allocation efficiency. In the short term, infrastructure projects will boost the purchasing power of the society, including the bottom layer group, as the projects can absorb sizeable amounts of labor. In line with this, vocational education to address labor demands for infrastructure projects as well as industry, also needs to be reinforced. In the medium to long term, we believe that the emphasis on infrastructure spending will positively improve the economy’s efficiency and productivity. In line with the spirit to maintain stability and promote efficient resource allocation, the spending aiming to strengthen the social safety net policy through the fulfillment of basic needs in health and education also needs to continue. This policy will sustain the purchasing power of middle and lower layers of society. In line with this, we believe that strengthening the institutions that are responsible for the implementation of the social safety net program will support government efforts to provide social protection. The various steps mentioned above will lead to improvements if it is also coupled with the policy aiming to promote distribution to reduce income gap and expand labor absorption. Recently, the Gini Ratio disparity indicator has already shown a sloping trend in recent years thereby posing a challenge for us to reduce it to a lower level (Figure 19). Basic Function and Principle of Policy In addition to the high level of disparity, the absorption of economic growth on the work force is still low. Data shows that the absorption of the economy on the work force is declining (Figure 18). In this regard, structural reforms, particularly to address economic productivity, has become vital to elevate the economy to a higher level which in turn will absorb more work force. In line with efforts to promote equitable distribution of economic development outcomes, Bank Indonesia has welcomed the Government’s initiative to explore the eminent sectors. The diversification of source of economic growth, both in sectoral as well as spatial terms, will create a buffer for the economy. On spatial terms, regional development needs to be harmonized with the characteristic of each region considering that the region may have diverse potential (Diagram 2). Figure 19. Gini Ratio On a sectoral basis, the promoted leading sector is the maritime considering the fact that Indonesia is the largest archipelago country in the world. Policy direction in this sector indeed represents a challenge since the contribution of the non oil & gas maritime subsector’s remains insignificant compared to other island nations (Figure 21). Current account, which in recent years registered a deficit, was also contributed by services account deficit, particularly derived from maritime transportation services (Figure 22). Once drawn further, various factors that led to this deficit can be to two sizeable parts, namely port infrastructure support and ship industry development that has yet to strengthen. Figure 20. Labor Force Participation Rasio Thousands of Laborers (Labor Force Participation per 1% GDP) 0.45 0.43 0.41 2010-2012 average 0.39 0.37 0.35 0.33 0.31 2013-2016 average 0.29 0.27 -100 0.25 Q1 Source: BPS-Statistics Indonesia Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Source: BPS-Statistics Indonesia, processed data Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Diagram 2. Regional Potential SUMATRA • Development of maritime and shipping industry • Optimize capability and plantation industry processing (palm oil, rubber, coffee) • Strengthening tin, coal, and petroleum industries • Develop potential for the biomass industry JAVA • Enhance competitiveness of the manufacturing industry (automotive, textile, and textile product, socks, food-beverage, chemical, agroindustry, paper) • Development of the creative and handicrafts industry, as well as enhance MSME competitiveness • Development of big cities towards smart city Notes: KALIMANTAN • Development of the petrochemical industry (petroleum) • Development of the coal industry and gasification • Enhance added value for minerals and forestry products • Enhance competitiveness for the palm oil industry BALINUSRA • Development of the fisheries and poultry industry • Strengthening tourism infrastructure • Development of the creative industry (including handicrafts) • Downstreaming of minerals (copper, gold, manganese) Coffee or Cocoa Plantation Petroleum or Natural Gas Maritime and Shipping Creative Industry Palm OIl Natural and Processed Rubber Mining Textile Industry and its Products Basic Function and Principle of Policy SULAMPUA • Development of the fisheries industry • Development of the tourism industry • Optimize the plantation industry (coconut, palm oil, cocoa, coffee) • Downstreaming of minerals (copper, nickel, gold) • Enhance competitiveness of the natural gas industry Source: Bank Indonesia abstracted from Regional Financial & Regional Research (KEKR) of all Provincial Level Domestic Representative Offices Automotive Industry Coal Mining Fisheries and Marine Products Food and Beverage Industry Food Crops Coconut Plantation This regional potential map just takes one example of regional potential that can be developed or enhanced within the context of promoting economic growth. Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Considering the potential of maritime sector, Bank Indonesia supports the Government’s efforts to strengthen the ship industry on an integrative basis together with the development of ports. The successful development of the ship industry will have an immense impact that is mutually beneficial, beginning with the steel industry, as the raw material suppliers of ship machinery and equipment, and up to support for the fisheries sector, tourism, as well as the maritime fishing, cruise, and other maritime transport industries. decades. This growth is reflected in the number of internet users, which continues to increase, and the relatively high investment value placed on the telecommunications field, particularly in Asia (Figure 23 and Figure 24). Aside from promoting economic efficiency, the rapid growth in the use of digital technology can also replace the conventional methods of doing business. An example of this is perhaps the current application of digital technology and robotics in the advanced economies, which has led to the decline of cheap labor’s competitive advantage in the developing countries. The strengthening of the maritime sector becomes increasingly meaningful if the ship industry and port infrastructure as the enabler can be incorporated with an interconnected of the economic zone ecosystem. This condition in turn has led to the export-led manufacturing growth model in the developing nations to become increasingly irrelevant. Phenomenon such as this needs to be constantly monitored to ensure that we can maximize the benefits while simultaneously minimize the negative excesses through effective policies. Other sectors that also require attention as it promotes the acceleration of structural reforms involve the application of digital economy. The digital eeconomy has grown tremendously over the last two Figure 21. Maritime Sector’s Share of GDP Figure 22. Balance of Trade in Services % of GDP USD Billion 2016* -2 -4 -5 -8.3 -10 -9.8 -9.8 -12 Indonesia Source: CEIC, processed data Phillipines Japan -10.0 -10.6 -12.1 -14 -4.8 -8 *) up to Q3 2016 Source: Bank Indonesia Basic Function and Principle of Policy Meanwhile, in line with the reinforcement of the regulatory function, allow us to convey our appreciation to the Government that has optimized the regulatory function through the issuance of 14 deregulation and debureaucratization policy packages. We believe that these policies will reinforce steps to accelerate structural reforms, particularly in terms of micro regulatory aspects, such as regulations on a technical level, which can be harmonized and synergized. and sustainably. In the second principle, a policy needs to be in line with the philosophical foundation that serves as a basis so that this policy is consistent across time, across sectors, consistent across central-regional policies, as well as across regional policies. On the third principle, synergy between policy makers both in the central as well as regional needs to be carried out so as to ensure mutually beneficial impact on the policy that is implemented. To operate the three basic public policy functions mentioned above and reinforce the regulatory function, we need to uphold the three policy management principles, namely the sustainability principle, consistency principle, and synergy principle. We believe that the synergy and coordination between the policy makers will minimize the disruption of the policy implementation, as well as enhance efficiency and effectiveness of economic activities. In this regard, allow us to reiterate that the various economic policy that is carried out needs to be consistent with and supported by the Regional Government. Within the context of the first principal, a policy must be directed towards a longer time horizon that allows the economy to be able to grow equitably Figure 24. Investment in Telecoms Figure 23. Number of Internet Users Millions of Users USD Million 3,000 4,000 3,500 2,500 3,000 2,000 2,500 1,500 2,000 1,000 1,500 1,000 Asia-Pacific Latin America Europe North America Middle East and Africa Indonesia Phillipines Malaysia Thailand Source: World Development Indicators Source: eMarketer Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Improvement of the economy will be achieved if the Regional Government can also effectively and efficiently enhance the use of regional transfer fund. The utilization of Regional Government funds can fill the gap that has yet to be utilized by the Central Government. Synergy aspects is also related with the need to harmonize policy between authorities in formulating interest rates, such as monetary policy rates, deposit rates, and government bond yields. The formulation of the last two rates must correspond with monetary policy rates that is aimed at maintaining conducive macroeconomic conditions, thereby minimizing risks of market uncertainty that can potentially lead to distortion once the liquidity adjustment process takes place in the economy. In this regard, Bank Indonesia will consistently direct the policy mix to maintain macroeconomic stability. We perceive economic stability will play an important role in supporting consumer purchasing power and efficient allocation of resources. We wil also continue to promote financial market and payment system efficiencies so as to provide the solid foundation to boost economic efficiencies and competitiveness. This policy direction will be carried out by optimizing Bank Indonesia’s three main policy pillars, namely monetary, macroprudential, as well as payment systems and Rupiah cash management. Monetary policies continues to be focused on efforts towards maintaining macroeconomic stability. We will synergize monetary policy with macro prudential policy to maintain financial system stability. Bank Indonesia’s Policy Direction In the spirit of building synergies, we at Bank Indonesia will also optimize the policy mix to strengthen economic stability, which subsequently support the allocation and distribution functions. Meanwhile, payment system and Rupiah cash management policy is aimed to enhance efficiency in the national economy and provide support for the transmission of monetary and macro prudential policy. We will certainly strengthen these various policies by closely coordinating with the Central and Regional Governments as well as other related authorities in order to effective national economic policy. Bank Indonesia’s Policy Direction From monetary policy, Bank Indonesia consistently will implement policies to maintain inflation within its target and keep the current account deficit at a safe level. To enhance the effectiveness of the policies, monetary policy is supported by strengthening the monetary operations strategy and exchange rate policy, as well as financial market deepening. In regards to monetary operations strategy, we view that the flexibility in the liquidity management for banks will enhance the bank’s ability to absorb temporary liquidity shock thereby avoiding excess interest rate fluctuations. For that purpose, Bank Indonesia will begin to introduce the Reserve Requirement (GWM) Averaging system in 2017. With reserves averaging, banks are required to maintain an average of GWM within maintenance period. Through this relaxation, we expect inter bank transactions will become increasingly active, interest rate fluctuation will become manageable, and monetary policy transmission will be strengthened. The strengthening of the monetary operations framework will also be carried out by optimizing the use of Government Securities or SBN as a monetary instrument. In line with that mandated by the Bank Indonesia Law and State Treasury Law, as well as efforts to enhance the bank’s participation in the financial market, Bank Indonesia would gradually replace the Bank Indonesia Certificate (SBI) with the SBN as the monetary instrument. Foreign exchange management policy will continue to pruduently implemented so as to maintain the stability of Rupiah’s currency value with the value of its fundamental. To support foreign exchange policy and the development of the domestic foreign currency market, Bank Indonesia initiated a hedging transaction to Bank Indonesia that covers foreign exchange transactions denominated in USD and non-USD. Other efforts that will be pursued to reduce the dependence on the US dollar involve bilateral cooperation, particularly with countries within the region. This bilateral cooperation seeks to promote transaction settlements in the domestic financial market by using local currency in international trade and investment transactions. Bank Indonesia will also embark on a number of priority initiatives to accelerate the deepening of the financial markets. First is through Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 the development of money market instruments, foreign exchange markets, and strengthening coordination with relevant authorities in order to develop capital market instruments, such as infrastructure bonds. Second is by inreasing financial market participants, particularly through increased use of repo transactions by financial institutions, banks and non-banks. Third is through the development of infrastructure in order to reduce segmentation and strengthen risk mitigation in financial transactions. To support these priority initiatives, Bank Indonesia will accelerate the follow up of two strategic financial market deepening issues that require support from the related authorities. The first is to align tax regulations governing financial market instruments to support the development of the financial market. Secondly, seek to align financial market development initiatives by implementing prudent financial institution practices. Bank Indonesia views these two issues as strategic as it is not enough for financial institutions to be merely safe and sound, but they must also fairly developed through growing activities in the financial markets. Therefore, we hope that the commitment between the Ministry of Finance and the Financial Services Authority (OJK) to share a common vision to develop the financial market under Development Financing Coordination through the Financial Markets Forum (FK-PPK). Macro prudential policy in 2017 will constantly be directed towards maintaining the financial system’s resilience. Apart from macro prudential regulations on banking industry, Bank Indonesia will strengthen assessment and surveillance of financial system participants, not only financial services institutions but also the users of financial services such as corporations. In this regard, Bank Indonesia will strengthen and expand its macro prudential surveillance coverage towards households, corporations and non-financial corporate groups. The results of our assessment shows that non-financial corporate’s weak performance can result in potential risks to the financial system, particularly banking. For that purpose, macro prudential surveillance needs to be strengthened in order to be able to identify at an early stage the source of the risk and the relationship of nonfinancial corporate risk with other participants in the financial system, particularly banking. Risk monitoring outside the banking sector has also become increasingly vital in line with the development of financial technology (fintech). In this regard, Bank Indonesia will scrutinize the risk potential and risk mitigation Bank Indonesia’s Policy Direction from fintech as macro prudential assessment to anticipate the sources of new risks from fintech activities. Therefore, risks occured from fintech activities, as an alternative financing for the public, will remain contain. Moreover, Bank Indonesia will continue to reinforce macro prudential assessment by using the National and Regional Balance Sheet approach to strengthen systemic risk assessment and identify financial system imbalances, as an input to formulate policy options. This approach is expected to reinforce risk measurement in every element and interconnected risk between the financial system elements as well as strengthen vulnerability mapping and sources of regional financial system disruptions. the region, Bank Indonesia views a sense of urgency to promote banking corporate actions to obtain optimal benefit from an integrated financial system. We believe that this corporate action will enhance the economies of scale and efficiency of Indonesia’s banks, thereby the banking sector’s intermediary role is expected to become increasingly optimized and boost the national banking industry’s competitiveness. Eventually, through the presence of strategic steps that includes banks corporate actions, Bank Indonesia will restructure the operational relationship of banks with Bank Indonesia, such as in the context of licensing in the area of Monetary, Payment Systems and Rupiah Currency Management, as well as Macroprudential. The issuance of UU PPKSK serves as the momentum to enhance the capacity to prevent and handle a financial system crisis. In this regard, Bank Indonesia will strengthen sensitivity and calibrate early warning indicators and policy options under Bank Indonesia’s Crisis Management Protocol in the area of monetary and foreign exchange, payment system, and macroprudential. As part of efforts to accelerate economic development and shariah financing in Indonesia, to complement the conventional economy, Bank Indonesia will launch the sharia economic development and financing blueprint at the end of December 2016. The program is focused on strengthening the Islamic social finance sector as well as promotion of the shariah financial markets. Subsequently, through the enhanced integration of Indonesia’s financial system and to reduce level playing field disparity with other countries in In terms of strengthening the Islamic social financial sector, which is expected to strengthen the social safety net as well as to tap funds Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 for infrastructure financing, Bank Indonesia will focus on improving the role of Islamic Social Finance such as through zakat and wakaf and pursuing initiatives to establish an Islamic Inclusive Financial Services Board (IIFSB) as part of efforts to make Indonesia as a “centre of excellence” for sharia global financial sector. Meanwhile, in the area of shariah financial market deepening, Bank Indonesia will promote the implementation of the Sukuk Linked Wakaf. For that purpose, Bank Indonesia will work together with the Ministry of Finance, Ministry of State Owned Enterprises, Badan Wakaf Indonesia, and Agrarian Ministry/ National Land Agency to ensure the certification status of existing wakaf lands, thereby optimizing its use. Moreover, Bank Indonesia will also conduct further studies on to the issuance of sharia-based government securites, enhance transaction mechanisms, as well as complement other shariah financial market infrastructure. Bank Indonesia will also strengthen its strategic alliance with ministries and authorities related to the development of the economy and shariah finance under National Shariah Finance Committee. In line with the Government’s commitment to improve the quality of growth through increasing level of economic participation, Bank Indonesia also placed special emphasis on the development of Micro, Small and Medium-Scale Enterprises (MSME). The vital and relevant meaning of increasing economic participation, is to provide the opportunity as well as embrace a wider segment of the community, which includes MSME’s, to play a more active role in stimulating economic activity, toghether with the Government. As we all know, MSME’s play a vital role in Indonesia’s economic structure, whereby approximately 99.9% of business units in Indonesia are MSME’s and absorb nearly 97% of Indonesia’s labor (Figure 25). However, financial support that is channeled to MSME’s in Indonesia is only amounted to 7.2% of GDP, which is the lowest, compared to other ASEAN countries such as Malaysia, Thailand, Korea, and Cambodia (Figure 26). In this regard, Bank Indonesia implemented the MSME development policy through two main approaches, namely encouraging the banking intermediation role for MSME’s and increases MSME’s economic capacity. Bank Indonesia’s Policy Direction Figure 25. Share of Total Employment by Enterprise Size Category Figure 26. SME Financing % 4,0 % 5,7 % 3,3 % 87,0 % Korea Cambodia Indonesia Malaysia Thailand SME Loan to GDP SME Loan to Total Loan Micro Enterprises Medium Enterprises Small Enterprises Large Enterprises Account Ownership Source: ADB, WB Global Index Source: Ministry of Cooperatives and SMEs One of Bank Indonesia’s efforts to enhance banking intermediation to MSME is by requiring Commercial Banks to gradually fulfill its target of MSME loan proportion relative to total loan. This target is 10% in 2016, 15% in 2017, and 20% in 2018, by constantly taking into consideration prudent principles. In addition to this, Bank Indonesia intends to pursue its expansion and deepening of the MSME infrastructure loan program so as to reduce asymmetric information obstacles brought about by disparities between MSME capacity and the banking sector’s financing capacity. This is carried out by, among others, developing a financing scheme for the unbanked people by using the value chain financing (VCF) concept approach, as well as promoting the digitalization of financial services that facilitates MSME participants to carry out non-cash transactions specifically for strategic commodities. Meanwhile, to enhance MSME economic capacity, Bank Indonesia will strengthen the implementation of the program to create new economy activities in the region and rural area through the development of leading MSME through the local economy/ Local Economic Development (LED) approach. In regards to efforts to control prices, particularly volatile food, Bank Indonesia will promote to expand and develop MSME-based inflation control clusters through the downstream approach. This inflation control cluster also serves as one of the instruments of the Regional Inflation Control Team (TPID). In addition to this, Bank Indonesia also facilitates means to record MSME financial transaction so as to enhance MSME management capacity. To intensify its support towards MSME development, Bank Indonesia is currently preparing an MSME development blueprint and roadmap Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 that will serve as a guide for Bank Indonesia in its MSME development program and MSME financial access in future. One of the efforts to promote role of micro and small businesses in the economy, including the disbursement of micro credit (KUR). Bank Indonesia supports the channeling of the new KUR scheme that is operated by the Government since August 2015. Nevertheless, we see that there is considerable room for improvement to appropriately and accurately make KUR more well-targeted. Among the few things that require attention is the tendency of shifting small business borrowers of commercial banks, rural banks, cooperatives, and other non banking financial institutions to the KUR program. This shifting may result in the KUR goal to provide eased access to micro finance that have not yet gained the opportunity of financing from banks to be not fully realized. In addition to this, we also noted the need to pursue a more equitable KUR distribution so as not to concentrate only within a number of banks, certain regions and sectors. In this regard, one also needs to consider refocusing KUR such as on startups and the creative industry sectors, as well as Supermicro KUR scheme that is targeted to female beneficiaries by using the team approach. Other policies required includes a policy that minimizes KUR to borrowers that have already received loans from commercial banks. Utilizing the Credit Program Information Systems (SIKP) also need to be optimized so as to minimize redundancy in terms of the disbursement of the Government’s lending program. Furthermore, to optimize the distribution of the new KUR scheme and remain in line with efforts to maintain the stability of the financial system, Bank Indonesia views that the planned reduction in the KUR’s effective interest rate by the Government should be gradual. This is needed to minimize the impact on small non-KUR distribution banks. Meanwhile, to maintain KUR’s sustainability as well as its quality in the long term, a scheme need to be formulated that allows for KUR interest rates to be kept low, without the need to continuously extend interest subsidies. Bank Indonesia’s Policy Direction In the area of payment system, Bank Indonesia’s policy direction will be realized in steps aimed at strengthening the institutional and infrastructure elements of the domestic payment system as well as promote financial inclusion. Implementation of this policy direction will be grounded in the mission to create a Payment System that is safe, efficient, smooth and reliable, by taking into consideration efforts to expand access and consumer protection, in order to support the stability of the monetary and financial system. In regards to strengthening the institution and infrastructure, we will embark on a number of initiatives. First is to implement rules relating to Payment Transaction Processing (PTP) that applies to all payment services providers (PJSP), including Fintech the participant. Second, to promote the development of a healthy Fintech, we will ensure that the FinTech Office and regulatory sandbox function that was established on 14 November 2016 works effectively and productively. Third, we will also accelerate the establishment of institutions that will operate the management functions of the National Standard of Indonesian Chip Card Specification (NSICCS) that we are targeting to be established no later than June 30, 2017. Fourth, we will accelerate the National Payment Gateway (NPG), which at this point of time has gone through the concept testing and is in the engagement process with the main participants in the industry. Fifth, require the providers of the payment system service to process financial transactions locally, place data locally, and store funds in local banks, using the central bank money, and comply with requirement to use the Rupiah currency within the territory of Republic of Indonesia. Meanwhile, in regards to efforts to promote financial inclusion, we will continue to expand financial access and enhance efficiency by integrating the non-cash electronic ecosystem within the Government’s program and services. We will direct the policy’s strategy by expanding the Government to People scheme, namely non-cash social assistance that is channeled through a system of Digital Financial Services agents, and development of People to Government, namely the smart city program that, among others, covers retribution and public services payments to the public. In regards to Rupiah cash management (PUR), we will promote for a clean money policy to distant and furthest areas through the Centralized Cash Network Plan (CCNP) masterplan. In the near term, we will initiate with the printing of a new series of Rupiah currency for all denominations outright. Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 The various policies that we described above will be supported by strengthening the role of Bank Indonesia as a strategic partner of the local government. In this context, Bank Indonesia will improve network quality and capabilities of the Bank Indonesia Representative Office at the provincial as well as municipal level, in order to improve the value proposition that it has, particularly in performing their tasks in the field of monetary, macroprudential, as well as payment systems and Rupiah currency management. To support the role as a strategic partner of Regional Government, we will constantly strive to improve the quality of research so as to produce the formulation of policy recommendations that is more precise and relevant to the area. In regards to the macroprudential field, we will drive for KPwDN to more actively continue to strengthen the Regional Financial Surveillance (RFS) function in order to understand the regional economy’s strength and vulnerabilities, strengthen the identification and assessment process towards financial imbalances and systemic risk in the region. In the area of payment systems, Bank Indonesia will strengthen Rupiah Currency Payment and Management System (SPPUR) sector’s onsite and off-site supervision in a comprehensive, directed, and efficient manner. Furthermore, in the field of Rupiah cash management, Bank Indonesia will strengthen infrastructure and expand distribution network coverage of money in order to provide the Currency Fit For Circulation (ULE) evenly and access remote areas in the entire territory of the Republic of Indonesia. Policy Coordination We are fully aware that sharing a common view and harmonious steps is needed to achieve our common aspirations. In line with this, the various policies that Bank Indonesia intends to carry out will likely be synergized and coordinated with the various policy makers, both in the central as well as in the regional levels, so as to ensure its effective implementation. We intend to intensify coordination that we have effectively implemented to date through various forms of coordination such as the Round Table Policy Dialogue (RTPD), BI–Central/ Regional Government Coordination Meeting, Inflation Control Team (TPI), Regional Inflation Control Team (TPID), Financial System Stability Committee (KSSK) and Indonesia Payment System Forum (FSPI). In the area of financial system stability, within the context of the PPKSK Law, coordination with the Financial Policy Coordination Services Authority is focused on applying Systemically Important Bank (SIB) and short-term liquidity loan coordination mechanism. Meanwhile, coordination with the Indonesia Deposit Insurance Corporation (LPS) is focused on the handling of bank solvency issues relating to the sale of Government Securities (SBN) owned by the LPS to Bank Indonesia. Within the context of international assessment, Bank Indonesia coordinates closely with the related authorities in implementing the Financial Sector Assessment Program (FSAP) that comprehensively evaluates financial sector stability and changes in Indonesia. Internationally, Bank Indonesia will also strengthen coordination with the Government to secure national interests and enhance Indonesia’s role in the international arena. Moreover, Bank Indonesia will constantly support the Government in its efforts to promote improvement of Indonesia’s Sovereign Credit Rating (SCR), including ensuring the creation of a positive image of Indonesia’s economy. In this regard, Bank Indonesia is fully committed to constantly strengthen the role of the Investor Relation Unit (IRU) and will continue to enhance coordination with the central and Policy Coordination regional governments as well as with government representatives overseas to ensure the effectiveness of these activities. In regards to improving Indonesia’s role internationally, Bank Indonesia is fully committed to support the holding of the IMF-World Bank Annual Meeting in Bali in 2018 with the tag line that was mutually agreed upon with the government, namely “Voyage to Indonesia”. In this regard, Bank Indonesia has prepared a structured and comprehensive program to support the IMF-World Bank 2018 Annual Meeting. Bank Indonesia is also constantly actively involved and support the government to promote cooperation in the area of development financing, including those regarded as international cooperation. The form of this international cooperation is among others, through the formation of the Islamic Investment Infrastructure Bank or World Islamic Investment Bank (WIIB) that can be used to support infrastructure project financing in Indonesia. Subsequently, support for the government was also extended within the context of an investment and infrastructure agenda initiative Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 within the cooperative forum of the G-20 Global Infrastructure Connectivity Alliance, which is aimed at facilitating cross-border infrastructure development connectivity through the involvement of non-G20 member states. Bank Indonesia’s Internal Strengthening From an internal perspective, in response to various changes taking place and to provide optimum support towards Bank Indonesia’s contribution, Bank Indonesia has carried out various efforts to improve internal capacity and capability that is focused on reinforcing the four aspects. First, improving the organization and human resources by, among others, forming two new departments, namely the Shariah Economics and Finance Department, and the Financial Market Development Department. Moreover, the Treasury and Loan Operations Department have been formed that represent as a merger of a number of functions already in existence in Bank Indonesia. Second, strengthening research and statistics functions as well as strengthening the Bank Indonesia Representative Office locally by, among others, implementing big data technology to support the decision making process, and updating the regional office handbook to support the role of the Bank Indonesia Representative Office as a strategic partner of the Regional Government. Third, is by strengthening information system by applying Information System – Enterprise Architecture (ISEA) and improving system governance. Fourth, strengthening governance and risk management. In 2017, internal strengthening will be aimed at supporting the implementation of policy mix and accelerating transformation within Bank Indonesia. Various strategic program has been planned, which includes strengthening the implementation of human resources management system, enhance human resources competency in the head office and representative offices, develop special initiatives to anticipate cyber attacks, and begin to implement the IS-EA road map. Economic Prospects Economic challenges, domestic potential, as well policy synergies that will be implemented by the Bank Indonesia’s Internal Strengthening Economic Prospects Government and Bank Indonesia will likely characterize our economy’s prospects. The global economy that has yet to strengthen as well as our efforts to build the domestic economy’s foundation so as to become resilient and sustainable, will likely affect economic growth achievements in the short-term. However, in the mediumterm, we believe our economy will grow faster as it is supported by a stronger and better economic structure. In 2017, we estimate economic growth to reach 5.0-5.4%, supported mainly by domestic demand. The benefits of various potential that we had previously revealed will affect private sector business confidence and appetite. Private sector confidence to revive activities amidst the looming weak global economy will be the determinant for an accelerated economic growth. Meanwhile, inflation will remain within the target range of 4.0±1% in 2017, which is in line with Bank Indonesia’s commitment to drive inflation within its target range. With these economic prospects, we estimate that bank credit and deposits growth in 2017 will arrive at 9-11% and 10-12% respectively. Meanwhile, the current account deficit is expected to increase slightly in line with the intensification of infrastructure projects, but will remain within a healthy level of below 3%. Through stronger resilience, the economy in 2017 will become the turning point for a more solid economic growth. The implementation of structural reforms will serve as the basis for more solid economic growth in the medium term. Structural reforms that were implemented will enhance productivity thereby allowing the economy to grow to a higher level. This higher growth and improved structure in turn will enhance employment and prevent the economy from the middleincome trap. On this basis, we project economic growth within the 2018-2021 period will be on an upward trend and arrive at 5.9-6.3% in 2021 through the support of low and controlled inflation. Meanwhile, the current account deficit is expected to be trend down and remain within a healthy level of below 3%. We are confident that the policy synergy to accelerate economic transformation can bring the economy to grow healthier, inclusive, as well as sustainable. Optimizing Potential, Strengthening Resilience Bank Indonesia’s Annual Meeting 2016 Conclusion These are Bank Indonesia’s 2017 policy ideas and direction that we can convey in this opportunity. We would like to extend our appreciation and gratitude to all Members of Bank Indonesia’s Board of Governors and Employees for their utmost contribution, dedication, and hard work thereby allowing Bank Indonesia the opportunity to consistently execute its mandate of maintaining Indonesia’s economic stability. Thank you Wassalamualaikum Wr. Wb. Agus D.W. Martowardojo Governor of Bank Indonesia
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Opening remarks by Mr Erwin Riyanto, Deputy Governor of Bank Indonesia, at Bank Indonesia's Pre Annual Investment Forum 2017, Surabaya, 24-25 November 2016.
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Pre Annual Investment 2017 pemerintah daerah Opening Remarks “Global Economic and Market Outlook 2017” (as prepared for Pre Annual Investment Forum 2017) 24-25 November 2016, Surabaya, Indonesia Honorable, Our esteemed guest speakers, o Mr. Richard Kellly from TD Securities o Mr. Bilal Hafeez and Euben Paracuelles from Nomura o Mr. Jahangir Aziz from JP Morgan o Mr. Andre De Silva from HSBC o Mr. Gundy Cahyadi from DBS My fellow colleagues from Bank Indonesia, Distinguished Guests, Ladies and Gentlemen, Good morning, 1. I would like to begin by thanking God the Almighty, Allah SWT who has blessed us with the opportunity to meet here in the occasion of Bank Indonesia Pre Annual Investment Forum 2017. I would like to express my sincere appreciation towards our international guest speakers who have travelled a long way to attend this event. I also hope that you can take time to explore the beauty of East Java as part of the magnificent Indonesia. 2. The main agenda of this forum is to discuss about the “Global Economic and Market Outlook 2017”. I believe now is a perfect time for such discussions to take place, in the face of heightened global uncertainty. On this note, I encourage all of us here today to actively Page 1 of 5 Pre Annual Investment 2017 participate in exchanging views and ideas so that we can have a spirited discussion filled with fruitful conclusions. Distinguished Guests, Ladies and Gentlemen, 3. As we all may know, the financial market in 2016, has been moderately challenging compared to 2015 and shall face more headwinds ahead. To this date, the global market has been filled with surprising “tail risk” events and outcomes. The two main unpredictable events that we can easily recall are Brexit in last June and the elected US President, Mr. Donald Trump in last November 8th. 4. Aside from “tail-risk” events, the main challenge we face ahead is growth. The global economic outlook projection by IMF has shown that global economic recovery remains sluggish as reflected by a more subdued outlook for advanced economies. This becomes more evident following the Brexit and weaker-than-expected growth in the United States. 5. In October, IMF downgraded the outlook for growth in advanced economies, down by 0.2 percentage points in 2016 and unchanged in 2017. On the other hand, the outlook for emerging markets was raised by 0.1 percentage points in 2016 and unchanged in 2017. 6. Under this backdrop of sluggish growth, most central banks in advanced economies have set an accommodative monetary policy and even negative policy rates in order to boost the economy and escape the deflation trap. While there has been a downward pressure on global interest rates due to slow growth, heightened uncertainty following the “trump fever” have led to further volatility that is caused by movements in the global capital flow. 7. Global investors are speculating against Trump’s expansionary fiscal policy that is expected to drive higher economic growth and inflation, Page 2 of 5 Pre Annual Investment 2017 beyond the current Fed inflation target. Meanwhile, US Treasuries 10 year yield has strengthen to its highest level in a week of about 11%. Movements in global capital flow which has a significant impact to exchange rate and global financial market volatility will greatly affect the way Central Banks manage their reserves. Distinguished Guests, Ladies and Gentlemen, Now, allow me to talk about the developments in our domestic market. 8. I will start by highlighting the uniqueness of Indonesia given the Indonesia’s national motto, Unity in Diversity. Indonesia is the largest economy in South East Asia. The world’s fourth most populous country which approximately 64% of the population are in productive age, growing middle class income, and entering a period of political consolidation in an open and free democracy. All of which has gone hand in hand with positive economic performance. 9. We believe the impact of Brexit and the new President of United States to the Indonesian economy are relatively limited as the economy remains on strong grip. Indonesia’s economy performs relatively well in 2016. In the 2nd quarter of 2016, economic growth picked up to 5.18%, higher than it was in the 1st quarter of 2016 at 4.91%. The economic growth of 2016 is expected to be in the range of 4.9 to 5.3%. This is supported by fiscal stimulus to accelerate infrastructure project developments. Private investment is expected to rise as well as a result of government policy packages and measurable monetary easing. We expect inflation to be within the targeted range of 4 ± 1% as well as the current account deficit maintained below 3% of GDP. Credit growth is expected in the range of 7-9% supported by monetary easing, macroprudential loosening and acceleration of fiscal stimulus. Page 3 of 5 Pre Annual Investment 2017 10. Indonesia’s tax amnesty program is turning out to be one of the world’s most successful repatriation program. A total of nearly 90,000 people have participated in the program. The declared assets have reached 1,030 trillion rupiahs with 69% from domestic assets, 25% from foreign assets not repatriated, and 5% from foreign assets that is repatriated. This have well succeeded earlier market expectation of 30 to 50 billion USD or equivalent to 390 to 650 trillion rupiahs (if using exchange rates of 13,000 rupiahs per USD) in declared assets. Most economist expect the amounts to be doubled by next March to about 2,000 trillion rupiahs and create fiscal income ranging around 0.3 to 0.5% of total GDP. 11. I am also delighted to share that based on The Economist, Asia Business Outlook Survey 2016, Indonesia is among the top three most attractive destination to invest in Asia after India and China. Also, according to Japan Bank for International Corporation (JBIC) Survey, amongst the ASEAN Countries, Indonesia is the most preferred place for business investment. This is in line with the World Bank’s Ease of Doing Business (EODB) 2016 survey, whereby Indonesia is ranked at number 109, up by 11, for ease of doing business out of 189 surveyed countries. Distinguished Guests, Ladies and Gentlemen, 12. This Pre Annual Investment Forum is expected to provide our Reserve Management Department with valuable insights on the global economic and market outlook of 2017. We hope this forum will provide us with a more comprehensive overview on the current and future investment challenges to better manage our reserves in future. 13. Therefore, I have high expectations that this forum will bring-in new insights on how as an investor we can seize the opportunity for better Page 4 of 5 Pre Annual Investment 2017 returns amidst higher volatility, whilst maintaining the common Central Banks principles of safety, liquidity, and profitability. 14. Before we start the discussion, please allow me to thank the committee for their hard work in preparing this event. Also, I would like to thank all the speakers, respectable asset managers and my colleagues from Bank Indonesia for the willingness and enthusiasm to participate in this event. 15. With that final note, I hope this forum can continue to have a positive impact on our reserve management strategy, specifically in seizing a workable strategy that optimizes our investment goals, while minimizing our risk. May The Almighty bless us and lighten our steps forward. Thank you. Deputy Governor Bank Indonesia Erwin Rijanto Page 5 of 5
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Welcome address by Mr Erwin Rijanto, Deputy Governor of Bank Indonesia, at the Twelfth Asia-Pacific High Level Meeting on Banking Supervision, jointly organised by the Basel Committee on Banking Supervision (BCBS), the Financial Stability Institute (FSI), and the Executives' Meeting of East Asia-Pacific Central Banks Working Group on Banking Supervision (EMEAP WGBS), hosted by Bank Indonesia, Bali, 22-23 March 2017.
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WELCOME ADDRESS Twelfth Asia-Pacific High Level Meeting on Banking Supervision Jointly organised by the Basel Committee on Banking Supervision (BCBS), the Financial Stability Institute (FSI), and the Executives’ Meeting of East AsiaPacific Central Banks Working Group on Banking Supervision (EMEAP WGBS), hosted by Bank Indonesia “Taking stock of post-crisis regulatory reforms in Indonesia – progress made and challenges ahead” Bali, Indonesia, 22-23 March 2017 Remarks by Mr. Erwin Rijanto, Deputy Governor of Bank Indonesia Honorable Mr. Fernando Restoy, Chairman FSI, BIS Mr. Nestor A. Espenilla, Chairman EMEAP WGBS and Deputy Governor Bank of Sentral Ng Pilipinas, Mr William Coen, Secretary General BCBS, BIS and fellow delegates from financial stability authorities and representatives of the financial industry Good morning to all of you, 1. It is my pleasure to welcome you to the 12th Asia-Pacific High Level Meeting on Banking Supervision. Together with the Bank for International Settlement and EMEAP, Bank Indonesia is honoured to host this event in the beautiful island of Gods. 2. In my welcome address today, I will slightly touch upon the global financial sector reform initiatives to give a flavour of the speech and emphasize more on the progress and challenges in Indonesia. I would like to highlight that the progress so far is due to the joint efforts of relevant authorities and the support from the industry. 1 of 6 Ladies and Gentlemen, 3. The costs of the financial crisis are significant. According to the Financial Stability Board (FSB), the cumulative loss of output since the crisis, compared to its pre-crisis trend, is estimated around 25% of one year’s world GDP. 4. To address the fault lines that caused the financial crisis, the G20 Leaders in 2008 agreed to initiate a comprehensive programme of regulatory reforms which covers 4 (four) core elements: 1.) Building resilient financial institutions; 2.) Ending too-big-to-fail; 3.) Making derivatives markets safer; and 4.) Transforming shadow banking into resilient market-based finance. 5. As a member of the FSB and the Basel Committee on Banking Supervision (BCBS), Indonesia endevours to implement the reforms in a full, timely and consistent manner albeit challenges due to differences in the characteristic of our financial market with that of advance economies, in which the regulation is build upon. Ladies and Gentlemen, 6. Building resilient financial institutions. The first element of reforms centered on the Basel III package. The quality and level of capital has been increased and new standards for liquidity has been introduced. In addition, leverage has been constrained and explicit macroprudential dimension has been introduced. 7. Although we started a year late, Basel III implementation in Indonesia has been in accordance with BCBS phase-in arrangements since 2014. I am pleased to inform you that Indonesian banks are not facing significant challenges, especially with regards to the capital reform, due to the high levels of capital ratio dominated by Common Equity Tier 1. Indonesia has also 2 of 6 implemented the countercyclical capital buffer and capital conservation buffer in addition to the minimum capital requirement. 8. In terms of Liquidity Coverage Ratio, banks that are required to adopt the standard have no major difficulties complying. Nonetheless, we continued to monitor the long run impact of the requirement. 9. Ending too-big-to-fail. The next core element is ending too-bigto-fail. A set of measures, known as the Systemically Important Financial Institutions (SIFI) Framework, has been introduced. 10. Although Indonesia is not home jurisdiction of the Global Systemically Important Banks, a number of domestic banks are required to meet capital surcharge that varies between 1% to 2.5% to reflect their systemic importance in the domestic financial system. 11. Indonesia has also passed the Law on Prevention and Resolution of Financial System Crisis in April 2016. The law enables related financial stability authorities to implement a more rigorous banking regulation and supervision, particulary for Domestic Systemically Important Banks, including the provision of recovery plans. It also provides legal foundation of bail-in mechanism. Ladies and Gentlemen, 12. Making derivatives markets safer. The third fundamental area of reform is in the OTC derivatives market. The crisis highlighted how the opaque inter-connections across financial institutions engaged in trading complex derivative contracts over-the-counter and poor risk management led to rapid contagion and systemic crisis. 3 of 6 13. The reform has focused on 5 (five) areas: standardization of derivative contracts; platform trading; central clearing; higher margin and capital requirements for non-centrally cleared trades; and mandatory reporting of all trades. Indonesia has implemented reporting requirement for banks engaging in OTC derivatives transactions. In addition, platform trading are required for both equities and commodities derivatives. National authorities are also in the proceses of establishing a CCP for OTC derivatives. This step would complement the higher capital requirement for Non-Centrally Cleared OTC derivatives regulation issued in September 2016. 14. Transforming shadow banking into resilient market-based finance. Compared to other elements of the reform, internationally-wide implementation of the agreed reforms related to shadow banking remains at relative early stage. The FSB and jurisdictions are planning to conduct more work to assess and respond to potential financial stability risk in this area. 15. With regards to monitoring and regulation of non-bank financial entities (NBFEs), the Indonesian FSA is responsible to supervise these institutions. It also has the authority to pass regulations on new and existing NBFEs activities. Bank Indonesia also performs periodic assessments of emerging non-bank financial intermediary activities from a macroprudential perspective. Efforts to reduce gaps between the risk assessment framework for NBFEs and the banking system are on-going. Ladies and Gentlemen, 16. Implementation of the reforms is challenging. Of importance, is ensuring that the implementation of the regulatory reforms does not impair the ongoing economic recovery process and that resilience of the banking system is preserved. 4 of 6 17. We noted several challenges need to be address. First, with regards to BCBS review of the regulatory treatment of sovereign risk. We underline the need to undertake due consideration on the important role of sovereign debt in monetary operation, the financial market and economic development financing, especially in emerging economies. A one-size-fits-all approach may not be suitable due to different sovereign instrument and financial market characteristics among regions. 18. Second, revision on the standardized approach for credit risk and market risk. BCBS is working on revising the standardized approaches for credit risk and has revised the framework for market risk to enhance robustness and risk sensitivity of both framework. Consequently, the standardized approach will be more granular and complex. On the other hand, Indonesian banks mostly engage in traditional banking activities. Hence, regulators and the industry will need to adjust their skills and information system accordingly. 19. Last but not least, as a number of regulatory reforms are finalized, member jurisdictions including Indonesia are expected to implement these reforms expeditiously according to the commited time line. Given limited resources, authorities will need to strengthen coordination to ensure full and timely implementation. Ladies and Gentlemen, 20. I have no doubt the 12th Asia-Pacific High Level Meeting on Banking Supervision will be fruitful as we have an excellent line of speakers, who will be deliberating current and critical issues in Supervision and Banking in this post crisis era. 21. I believe there is no right or wrong when discussing frameworks for effective supervision and banking regulation. The effectiveness of the agreed standards depends on many aspects and that there is no 5 of 6 one-size-fits-all approach. As many have said: “Economics is the only field in which two people can get a Nobel Prize for saying the opposite thing” is true. 22. Before I close my welcome address, allow me to offer my warmest welcome to you all and express my deepest gratitude to your visit. I hope you will make the most of your stay in Bali and take home with you warm memories of your visit. 23. I would also like to remind you that Indonesia will be hosting IMF – World Bank Annual Meeting on October 2018 in this beautiful island of Bali. I would like to invite you to visit Bali, not only to attend the workshops, but also to participate in a series of activities in connection to the Annual meeting. Please save the date, and mark your agenda. Thank You. 6 of 6
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Keynote speech by Mr Agus D W Martowardojo, Governor of Bank Indonesia, at the High-Level International Seminar "Global Economic Outlook in ASEAN Perspective", Jakarta, 28 April 2017.
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Governor Agus D.W. Martowardojo At the High-Level International Seminar “Global Economic Outlook in ASEAN Perspective” Bank Indonesia April 28, 2017 Learn from the Past, Seize Opportunities, and Enhance Synergy Keynote Speech Distinguished Speakers, Mr. Maurice Obstfeld, Economic Counsellor and the Director of Research of the International Monetary Fund; Deputy Governor Diwa Guinigundo from Bangko Sentral ng Pilipinas, Deputy Managing Director Ong Chong Tee from Monetary Authority of Singapore, Deputy Governor Sukhdave Singh from Bank Negara Malaysia, Deputy Governor Mathee Supapongse from Bank of Thailand, Deputy Governor Perry Warjiyo from Bank Indonesia; Other Members of Board of Governors of Bank Indonesia; Mr. Chatib Basri, former Finance Minister of the Republic of Indonesia, who will be chairing the seminar; Department Heads and Senior Officials from Bank Indonesia; Colleagues from Ministries, Government Institutions, Embassies, International Organizations, Financial Institutions, and Academia; Participants of Bank Indonesia International Workshop on Policy Mix; Ladies and Gentlemen; 1. First, allow me to welcome you to Bank Indonesia and to the High Level International Seminar on “Global Economic Outlook in ASEAN Perspective.” We are very privileged with the presence of Mr. Maurice Obstfeld to share his opinion and thought on the development and prospect of the global economy, especially concerning ASEAN region, and its challenging path ahead. We are also delighted to have speakers from ASEAN central banks who will share their views on a number of key issues surrounding the economic development in ASEAN. 2. The half-day seminar we are having today serves as the regional kick-start event for a series of seminars and other activities under the Voyage to Indonesia theme designed to lead up to the 2018 IMF-World Bank Annual Meetings in Nusa Dua, Bali, Indonesia. 3. This particular seminar is aimed to showcase ASEAN as a reformed, resilent and progressive region to the world. Therefore, the discussion will touch upon how ASEAN countries have progressed in various areas especially in central banking policy making, and in furthering the ASEAN economic integration process to form what we call the ASEAN Economic Community. [Global economy and challenges ahead] Distinguished Guests, Ladies and Gentlemen, 4. The global economy has entered the interesting yet still challenging stage. Among the key takeways from the recently concluded IMF-World Bank Spring Meeting is that, in the near term, the global economic recovery is better than expected for the first time after some years of downward revision, with the resurgence of commodity prices, and less pressure on deflationary trend. The IMF has revised its assessment in April pointing to the 2017 growth of 3.5% vis-a-vis 3.4% in the previous projection, and by 3.6% in 2018. The economic recovery is happening both in Advanced Economies and Emerging Market Economies, including ASEAN region. Emerging Market Economies have remained the source of engine of growth. 5. However, the positive outlook is still facing huge challenges stemming from uncertainty in the political and economic policies, such as general election in major European economies, as well as in the policy fronts, including trends towards trade protectionism by some Advanced Economies. The downside risks would produce some degree of financial tightening, causing more volatility of capital flows while generating negative spillovers, especially to Emerging Markets Economies. In the longer term, global economy is also facing persistently low productivity in both Advanced Economies and Emerging Market Economies. 6. Clearly, we should remain vigilant on the global economy, especially its fundamental issues such as how to improve productivity and deal with aging population. Given the complex nature of the current global economic environment, it is important for policy makers to use all policy levers to ensure that growth benefits each and every layer of society. 7. In fact, the issue of inequality has been occupying the attention of policy makers, while some have been challenging the concept of multilateralism that we all have known. Debates on the inward-looking policy have come forward. The situation has definitely caused uneasiness to Emerging Market Economies who have adopted the the open economy concept, and have contributed to the improved global growth. The question is that, in the current global setting, how ASEAN would cope with such challenges. [ASEAN during the crisis] 8. Two decades ago, Asia experienced a heavy financial crisis. A very deep economic contraction was shared by every country in the region, with Indonesia, Thailand and Korea bearing the greatest brunt. Currency depreciation, growth slump and shooting inflation were widespread. 9. The crisis also destabilized financial sector, leading to a mounting government debt from blanket guarantee and bank restructuring. It even set in motion social and political unrest as public confidence diminished. The full blow of the crisis also brought Indonesia and Thailand to enter into IMF programs. 10. With the crisis, ASEAN as a region suffered heavy losses not only in economic performance, but also in global perception. The spillover effects in the crisis was paramount and had played a massive role. Therefore at that time, ASEAN was seen as a fragile group of economies. [ASEAN recent developments] Distinguished Guests, Ladies, and Gentlemen, 11. In the aftermath of the crisis, ASEAN countries conducted vast restructuring towards recovery. ASEAN economy rebounded with improved economic structure. The region quickly learned from the unfortunate experience. ASEAN strived to regain domestic and international confidence. And now, the region has revived with healthy growth and stable financial sector. 12. On average, ASEAN grew at 5.5% per annum in the last 15 years, higher than the growth of the global economy of 3.9%. This higher growth rate led to ASEAN’s rising share of world GDP. In 2016, the share of ASEAN GDP is 6.1% relative to that of the global economy. 13. The ASEAN share of world trade also increased significantly. ASEAN trade value as a share of the world trade value rose to 6.9% in 2015. The growing trade value indicates an evolving structural change within the region where the economy is becoming more open. The similar improvement also happens in foreign direct investment. 14. On average, foreign direct investment in ASEAN amounted to USD121.9 billion annually within the period of 2011–2015, increased significantly from around USD 29.8 billion per annum in 2001–2005. Good economic performance with relatively high GDP growth has been a pull factor for FDI in this region. ASEAN has become once again an attractive investment destination. The confidence to the region is back. [ASEAN integration] Distinguished Guests, Ladies, and Gentlemen, 15. The ASEAN rapid and successful recovery is only the first main achievement of the region. With economic stability firmly gained, countries in the region have further progressed the regional economic integration to be able to play bigger roles in the future global economy, which is the second main achievement. After 20 years since the Asian financial crisis, we now proudly see ASEAN as a region of promising world power with a strong cohesion and togetherness, owing to the ASEAN economic integration agenda. The regional integration project acknowledges and takes care of different levels of preparedness by ASEAN member states. It also upholds harmony and synergy by employing ASEAN own values. 16. The initiative of ASEAN economic integration has reached an important milestone in 2015 with the establishment of ASEAN Economic Community 2015. After the 2015 graduate, the economic integration agenda in financial sector is now being pushed to be more balanced and inclusive. Indeed, ASEAN financial integration does not treat integration as a matter of liberalisation, but provides focus on stability and inclusion as its equally important pillars. The three pillars of financial integration, financial inclusion and financial stability ensure that the strength, resilience and inclusiveness of the benefits of regional integration in the financial sector are pursued and subsequently achieved. 17. A number of financial integration initiatives in the form of endorsed strategic action plans are put forward. These include the ASEAN Banking Integration Framework, the safeguard measures of capital flows, and the build-up of financial inclusion infrastructure. A more recent initiative on Local Currency Settlement is another clear contribution from central banks to advance inter-ASEAN trade and investment. 18. Under the ASEAN+3 financial cooperation, ASEAN has reached significant progress in strengthening the regional self-help mechanism, especially compared to the time of Asian financial crisis. The continuously improved Chiang Mai Initiative Multilateralisation as a reginal financial safety net arrangement with the support of AMRO has made the region more ready to any risks, vulnerabilities and spillovers from the external sector. 19. Moving forward, ASEAN will consistently maintain and improve its framework as a unique economy group with strong visions. ASEAN is ready to move to the next level, that is to become a highly integrated and cohesive economy; a competitive, innovative and dynamic region; with enhanced connectivity and sectoral cooperation; as well as a resilient, inclusive, people-oriented and people-centered orientation; and at the same time being truly a global player. [Key takeaways] Distinguished Guests, Ladies, and Gentlemen, 20. Global economy has been far more integrated than 20 years ago, and yet the challenges are also increasingly multifaceted. Although in the near term the outlook is promising, some downside risks remain, requiring us to live with prudence. Protectionism and anti-multilateralism are taking shape, but I believe that ASEAN have enough experiences since the 199798 crisis to stay strong and vigilant. 21. First, ASEAN is an agile and adaptive region and it has entered once again into a group of emerging market economies with strong macroeconomic performance, good policy formulation as well as high external confidence. In this regard, central banks are playing a crucial role in managing the stability of the economy by facilitating the recovery from the crisis, ensuring price and financial stability along the way, and preparing for the rainy days with multiple layers of defence and solid track-record of policy making. 22. Second, with ASEAN Economic Community 2025 agenda underway, the region will be increasingly integrated, stable and inclusive. Our regional integration is well-organized, and this will bring ASEAN to play greater roles in the global economy. ASEAN financial integration is now fully equipped with visions, action plans, and performance indicators, ready to be a region with responsibility and become a winning global player. ASEAN is a region that always learns from the past, seizes opportunities ahead, and enhances synergy towards shared visions. 23. Indonesia would certainly play a part in this process, with the consistent adoption of the three-pronge approach combining monetary policy, fiscal policy and structural reform with the right mix. Despite the global economic slowdown, Indonesia’s economy is able to advance by 5.02% yoy in 2016 supported by strong domestic consumption, reviving export and investment. Although this is still below our historical growth rate of 5.8% during 2005-2015, this rate of growth is still favorable compared to peer countries. Our robust economic growth is also supported by stable macroeconomic environment. In 2016, inflation was registered at 3.02%, a continued record of contained inflation period after charted an inflation hike in 2013 of 8.4% yoy and 2014 of 8.4% yoy. Our latest figure of inflation for March 2017 is 3.61% yoy, which is still within our target range of 4±1%. 24. On the external front, we consistently recorded smaller current account deficit over the years, moving from minus 3.19% in 2013 to minus 1.8% in 2016. We also retain an adequate level of reserve position whereby at end-March 2017 reached USD121.8 billion which can adequately cover 8.6 months of imports and servicing of government external debt repayments. Meanwhile financial system stability was maintained along with banking system resilience. In January 2017, the Capital Adequacy Ratio (CAR) was recorded at 23.0% and non-performing loans (NPL) stood at 3.1% (gross) or 1.4% (net). Moreover, our banking system is among the most capitalized and profitable in EMs, which provides strong buffers to support financial stability. Distinguished Guests, Ladies, and gentlemen 25. To conclude, as I have mentioned in the beginning, this seminar is part of a series of activities organized as the groundwork for the IMF-World Bank Annual Meetings 2018 in Bali. These activities are interwoven under the theme “Voyage to Indonesia”, a journey that will bring the world to the renewed Indonesia and ASEAN region. It is my hope that all of us will continue to be engaged in various programs of the “Voyage to Indonesia.” We also hope that you will attend and experience the IMF–World Bank Annual Meetings in Bali along with its enriching back-to-back programs in October 2018. Finally, I wish you all a pleasant and fruitful seminar and let me stop here. Thank you.
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Speech by Mr Perry Warjiyo, Governor of Bank Indonesia, at Bank Indonesia's Annual Meeting 2018, Jakarta, 27 November 2018.
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Speech by Mr Perry Warjiyo, Governor of Bank Indonesia, at Bank Indonesia's Annual Meeting 2020, Jakarta, 3 December 2020.
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BANK INDONESIA’S ANNUAL MEETING 2020 BANK INDONESIA’S ANNUAL MEETING 2020 BANK INDONESIA’S ANNUAL MEETING 2020 BANK INDONESIA’S ANNUAL MEETING 2020 TABLE OF CONTENT Global Economic Performance and Prospects: Recovery Underway, Financial Market Uncertainty Eases National Economic Performance and Prospects: Recovery Process Underway, Stability Maintained Bank Indonesia Policy Mix 2020: Strengthening Stability, Supporting National Economic Recovery • Rupiah Exchange Rate Stabilization Policy • Monetary Policy Stimulus • Monetary Policy Mix and Macroprudential Policy • Implementation of Law No. 2 of 2020: Supporting State Finances and Financial System Stability • Digitalization of Payment Systems: Accelerating National Digital Economic and Financial Integration • Money Market Deepening: Effectiveness of Policy Transmission and Financing • Empowerment of Sharia Economy and Finance, and MSMEs • Strengthening International Policy • Transformation of Bank Indonesia Synergize to Build Optimism for Economic Recovery: One Prerequisite, Five Principal Strategies Bank Indonesia Policy Mix for 2021: Supporting Optimism for National Economic Recovery • Monetary Policy Direction • Macroprudential Policy Direction • Payment System Policy Direction • Acceleration of Money Market Deepening • MSMEs Policy and Sharia Economy and Finance • International Policy Moving Forward with Optimism BANK INDONESIA’S ANNUAL MEETING 2020 SYNERGIZE TO BUILD OPTIMISM FOR ECONOMIC RECOVERY Speech of the Governor of Bank Indonesia BANK INDONESIA’S ANNUAL MEETING Jakarta, 3 December 2020 His Excellency, • The President of the Republic of Indonesia, Joko Widodo. Honourable Guests, • Leaders and Members of the House of Representatives and House of Regional Representatives of the Republic of Indonesia; • Leaders of State Institutions; • Ministers of Indonesia Onward Cabinet (Kabinet Indonesia Maju), • Chairman and Members of the Board of the Financial Services Authority (OJK) and Deposit Insurance Corporations (LPS) • Former Governors and Board members of Bank Indonesia; • Provincial Governors from all across Indonesia; • Leaders of the Banking Industry, Corporate Sector and National Media; • Awardees of 2020 Bank Indonesia Award; • Distinguished Ladies and Gentlemen, BANK INDONESIA’S ANNUAL MEETING 2020 Assalamualaikum Warahmatullahi Wabarakatuh, Greetings to everyone, Shalom, Om Swastyastu, Namo Buddhaya, Salam Kebajikan. First of all, let us express our gratitude to the Almighty God, because only with His grace and blessings today we could gather at this Bank Indonesia Annual Meeting of 2020. With all humility, we would like to extend our gratitude Mr. President who has been pleased to attend this convocation along with all the invited guests. We congratulate the banks, corporations, and individuals who received the Bank Indonesia Awards 2020. A total of 41 awards in 4 areas and 13 categories in the fields of monetary stability and financial system management, payment systems and Rupiah money management, MSMEs development and sharia economy and finance, as well as Bank Indonesia policies’ supports. This award is held annually, together with the Annual Meeting of Bank Indonesia, as an appreciation and recognition to partners who have supported the implementation of Bank Indonesia’s tasks. On this auspicious occasion, allow us to present an evaluation of economic performance in 2020 as well as the economic prospects and the policy direction of Bank Indonesia for 2021, which we summarize under the theme “Synergize to Build Optimism for Economic Recovery”. In our opinion, this theme is appropriate to strengthen the momentum for the national economic recovery process. After struggling to cope with the impact of the COVID-19 pandemic, thanks be to God the Indonesian economy has shown strong resilience. The worst is over. Stability has been maintained and the process of economic recovery is ongoing. The synergy of national economic policies is very close, and it is this synergy that we need to continue to strengthen in the future to build optimism for the national economic recovery. Bank Indonesia has, and will always, synergize with the Central and Regional Government, the Financial System Stability Committee (Komite Stabilitas Sistem Keuangan - KSSK), the House of Representatives (Dewan Perwakilan Rakyat - DPR), the banking sector, the bussinesses, and all parties to jointly build this optimism. God willing, the national economy will get better and continue to improve towards an Advanced Indonesia in 2045. We present the presentation in 5 (five) sections, namely: (i) Global economic performance and prospects that indicate recovery, financial market uncertainty has eased; (ii) National economic performance and prospects that demonstrate resilience in the recovery process; (iii) Bank Indonesia policy mix for 2020; (iv) Synergy of national economic policies to build optimism for future economic recovery; and (v) The direction of the Bank Indonesia policy mix for 2021. Our presentation is at the same time a manifestation of Bank Indonesia’s accountability and transparency as mandated in the Bank Indonesia Act. BANK INDONESIA’S ANNUAL MEETING 2020 Global Economic Performance and Prospects: Recovery Underway, Financial Market Uncertainty Eases The COVID-19 pandemic had an extraordinary impact on humanity, economy and finance worldwide. The scale and speed of the spread of the pandemic around the world to 138 countries has far exceeded previous pandemics (SARS and MERS). This has had an unprecedented impact on health and humanity with more than 60 million people testing positive and 1.4 million died from COVID-19. The impact on human mobility and world economic and financial activities has been unparalleled. The COVID-19 pandemic has caused a worldwide economic recession and in many countries, financial market panic and uncertainty, as well as many people falling into poverty. Because of the complexity of the problems, it requires an extraordinary policy response in terms of health, fiscal stimulus, monetary stimulus, and also in the financial sector. The crisis conditions we face from the COVID-19 pandemic are very different from previous crises, whether the depression in the 1930s, the debt crisis in Latin America in the 1980s, the Asian crisis in 1997/98, or the global financial crisis in 2008/2009. The epicenter of the crisis this time is the COVID-19 pandemic, attacking human mobility, and therefore economic mobility, resulting in an economic recession affecting the monetary and financial sectors. Graph 1. Additional Global COVID-19 Cases (%) Africa 8,220 Asia 62,898 600,000 MENA 35,196 America 235,279 500,000 Europe 279,151 Global 620,744 Thousand 1,600 1,400 8.00 1,200 6.00 400,000 1,000 4.00 300,000 2.00 200,000 100,000 The speed and progress in handling the COVID-19 pandemic determines the process of economic recovery. To mitigate the health impact of the COVID-19 pandemic, governments in many countries have implemented the 3 Ts, namely: Trace, Testing and Treatment; while the community carries out the 3 Ms: Memakai Masker (Wearing a Mask), Menjaga Jarak (Keeping a Distance), and Mencuci Tangan (Hand Washing). Application varies from country to country, for example, there are very stringent restrictions 10.00 Additional Cases as of Nov 22nd 700,000 be carried out more widely in 2021, including in Indonesia. Graph 2. Global COVID-19 Fatality Rate Person 800,000 The COVID-19 pandemic has an impact on health and humanitarian problems around the world. COVID-19, which first appeared in Wuhan, China, has spread rapidly throughout the world (Graph 1). Until now, more than 60 million people have tested positive for COVID-19, mostly in the United States (US), India, Brazil, and Russia. COVID-19 has also claimed more than 1.4 million lives (Graph 2). After reaching its peak in the second quarter of 2020, additional cases and mortality rates began to slightly subside. However, the risk of a COVID-19 second or even third wave pandemic is the focus of attention in various countries. Meanwhile, vaccine development is continuing with a number of successful trials and ready to be administered in stages estarting in December 2020. It is likely that vaccinations can 0.00 Africa Asia Europe Global Data as of 20 November 2020 Source: WHO, compiled MENA -2.00 America Global America Europe The Number of Global Death Asia Data as of 20 November 2020 Source: WHO, compiled BANK INDONESIA’S ANNUAL MEETING 2020 Graph 3a. Limited Mobility of Developed Countries Graph 4a. Retail Sales AE Index Index Index 100 = Q4 2019 7 Days Moving Average -20 US Germany UK Spain France US Germany France Italy Italy UK Australia Canada Japan Singapore New Zealand Average AE Japan Data as of 20 November 2020 Source: Goldman Sachs Research, GS Effective Lockdown Index, compiled Source: CEIC, compiled on mobility (lockdown) in China, strict in Europe and relatively more relaxed in the US (Graphs 3a and 3b). These policies have limited economic activity, particularly in the second quarter of 2020. Retail sales have decreased, impacting declining consumption, production and investment (Graph 4a and 4b). The volume of international trade has also decreased due to the disruption of global supply chains that have been dominated by China. Economic activity has gradually improved from the third quarter of 2020, along with the increase in human mobility, although it still needs time to recover to the conditions before COVID-19. Global economic performance has begun to show improvement, and will increase even further in 2021. After the contraction in the second quarter of 2020, world economic activity began to increase, although it is still overshadowed by the risk of a COVID-19 second wave. Economic improvements differ from country to country, depending on the size of fiscal and monetary stimuli, as well as the successful handling of COVID-19 and increased human mobility. The Chinese economy began to record positive growth in the third quarter of 2020 and is estimated to be the first country to begin to recover in the fourth Graph 3b. Mobility Restrictions on EMEs Graph 4b. Retail Sales EMEs Index Index Q4 2019 7 Days Moving Average 88.32 -20 Index 100 = Hongkong China Brazil Russia India Data as of 20 November 2020 Source: Goldman Sachs Research, GS Effective Lockdown Index, compiled 86.96 Indonesia China Indonesia Russia Turkey Source: CEIC, compiled Philippines Brazil Thailand Mexico Malaysia Average EM BANK INDONESIA’S ANNUAL MEETING 2020 Table 1: Global Economy: Growth, Trade Volume, Commodity Prices (%, yoy) 2020* 2021* Global Economic Growth 3.6 2.8 -3.8 5.0 Advanced Economies 2.2 1.6 -4.9 4.0 US 2.9 2.2 -3.8 4.3 Euro Area 1.9 1.3 -7.2 5.0 Japan 0.3 0.7 -5.7 2.5 4.5 3.7 -2.9 5.6 China 6.7 6.1 2.1 7.8 India 6.1 4.2 -8.8 8.2 South America 1.1 0.0 -7.5 3.1 World Trade Volume 3.8 -0.4 -6.3 4.4 Indonesian Export Commodity Price Index -2.8 -3.0 -5.8 4.0 Emerging Economies Source: World Economic Outlook Database October 2020, Bank Indonesia Projection Description: * projection quarter of 2020 (Table 1). Economic improvements were also recorded in the United States (US), although accompanied by the highest cases of COVID-19. Meanwhile, economic recovery was more limited in Europe, India and Latin America. The global economic recovery could be seen in the improvement of several early indicators in October 2020, such as global community mobility, the Manufacturing and Services Purchasing Managers’ Index (PMI) in several countries, and consumer confidence in the US and Europe. World trade volume and commodity prices have also increased. Going forward, the global economic recovery is predicted to continue with a growth of 5.0% in 2021, after contracting by 3.8% in 2020. occurred in large numbers and within a very short time period, resulting in the scarcity of the US dollar that put major depreciation pressures on the EME’s currency exchange rate (Graph 6). With the handling of COVID-19 and the response with fiscal and monetary stimulus policies in many countries, global financial market uncertainty has begun to subside and the flow of portfolio investment has begun to return to EMEs. Since early November 2020, global uncertainty has been decreasing after the results of the US Presidential election, although volatility On global financial markets, uncertainty has eased, although caution is warranted. The rapid spread of the COVID-19 pandemic around the world caused a global financial market panic in March 2020, resulting in the Volatility Index (VIX) and Credit Default Swap (CDS) risk indexes for Indonesia soaring to 83 and 272 from previously 19 and 66 respectively (Graph 5). The wave of portfolio investment withdrawals from developing countries (Emerging Market Economies - EMEs) Graph 5.Risk Indicators for Global and Indonesian Financial Markets pts Index 83 272 78 30 24 20 CDS Indonesia VIX Index (rhs) Data as of 20 November 2020 Source: Bloomberg, compiled BANK INDONESIA’S ANNUAL MEETING 2020 Graph 6. USD vs World Exchange Rates Graph 7. Increase in Fiscal Deficit in the World Index Index Dollar appreciation vs Asia Currencies Dollar appreciation vs Major Currencies % of GDP -4 -4.2-3.4 -1.9 -3.1 -1.6 -4.2 -5.2 -6 -8 -8.4 -9.8 -8.7 -9.8 -8.4 -10.1 -11.7 -12 -13.3 -12.8 90 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 109 Dollar Index -16 IND MEX MAS PHP THA RUS IDN HK TWN VIET CHN KOR SIN GER JPN US SPA UK FRA ITA Emerging Market Asia Dollar index (rhs) - Reverse Order Advanced Economies Data as of 20 November 2020 Source: Bloomberg, compiled Data as of 20 November 2020 Source: OECD, MoF, Bloomberg needs to be watched out for amid concerns over a second wave of the COVID-19 pandemic. The VIX indicator decreased to 24 while the CDS also fell to 78 which then encouraged the strengthening of many Asian currencies against the US dollar. The reduction in global uncertainty is expected to stimulate foreign capital inflows and further appreciation of the exchange rates in developing countries, including Indonesia. 2021 period is expected to narrow in 2022-2023 as economies in many countries recover (Graph 8). A large fiscal stimulus was provided by many countries for economic recovery from the impact of the COVID-19 pandemic. Fiscal stimulus were generally allocated for health budgets, social assistance programs for the community, incentives for the business world, especially for Micro, Small and Medium Enterprises (MSMEs), and tax relief for corporations. Meanwhile, tax revenues dropped dramatically due to the economic recession. The sheer amount of additional spending amid falling tax revenues has led to a widening of the fiscal deficit in many countries, with a large increase in deficit exceeding 8% of GDP in developed countries compared to deficits in EMEs, which are generally lower due to the limited financing required (Graph 7). The size of the fiscal stimulus has had a positive impact on encouraging economic recovery since the third quarter of 2020 and is expected to accelerate future economic recovery from the COVID-19 pandemic. The widening output gap in the 2020- The process of economic recovery from the COVID-19 pandemic was also supported by monetary stimulus from central banks in many countries. In developed countries, with monetary policy interest rates approaching zero percent, central banks have taken monetary stimulus by injecting liquidity (Quantitative Easing - QE) into the financial sector, particularly banking. This has been done by, among others, through an asset purchase program from the market, including government bonds, private bonds, and credit securities. As a percentage of GDP, the largest amount of QE was carried out by the European Central Bank (ECB) then by the Bank of Japan (BoJ), Graph 8. Forecast for Output Gap, 2020-2023 (%) -1 -2 -3 -4 -5 -6 -7 -8 -9 ESP ITA FRA GBR AUS DEU JPN CAN USA Ave, 2020-2021 Source: IMF WEO October 2020 -2.4 -2.3 -3.2 IND ZAF MEX BRA IDN TUR CHN POL POL Ave, 2022-2023 BANK INDONESIA’S ANNUAL MEETING 2020 Bank of England (BoE) and The US Federal Reserve (Graph 9). In EMEs, monetary stimulus is implemented through a combination of lowering policy interest rates and injecting liquidity into banking and financial markets. The magnitude of the reduction in interest rates is in line with lower inflation and the need to maintain exchange rate stability. Meanwhile, liquidity injection (QE) is generally carried out through monetary operations, given the limited financial assets on the secondary market. In percentage of GDP, the largest amount of QE was carried out by Bank Indonesia followed by Mexico, Chile, and the Philippines (Graph 10). A number of international policy coordination steps were taken to support the global economic recovery. A number of important agendas surfaced in the G20, IMF, FSB and BIS forums. One of them was the need to continue fiscal and monetary stimulus in accordance with economic conditions and the handling of the COVID-19 pandemic in each country. This is because the COVID-19 pandemic will continue in 2021, even though vaccinations have been carried out. Other agendas relate to anticipatory measures for the impact of the decline in economic activity on corporate conditions, including credit and business restructuring programs, fiscal incentives, and the possibility of bankruptcy. Discussion of policies included efforts to maintain financial system stability Graph 9. Quantitative Easing of Developed Countries % of GDP Fed ECB BoJ Usage BoE RBNZ Riksbank Max Size Note: Including APP (include loan purchases) andschemes; term funding schemes; Note: including loan purchases & term funing excluding short-term liquidityfacilities facilities not included short-term liquidity Source: Central Bank, RBA, compiled RBA Graph 10. Quantitative Easing of EMEs % of GDP 4.5 4.4 4.0 3.3 3.5 2.8 3.0 2.5 2.0 1.6 1.5 1.0 0.6 0.5 0.0 0.2 Indonesia Mexico Chile Philippines Thailand India Source: Haver, Central Bank, Tellimer Research, Bank Indonesia from the impact of declining corporate performance, including how to overcome very low credit growth (credit crunch), the risk of increasing non-performing loans (loan at risk), a large excess of liquidity in financial markets (liquidity trap), and to anticipate the risk of excessive price bubbles for financial assets. Meanwhile, for developing countries, the main issues discussed were the impact of the COVID-19 pandemic on increasing poverty and unemployment, declining ability to pay and the need for restructuring of foreign debt as well as mobilization of social assistance from donor countries. The COVID-19 pandemic has also exposed a number of weaknesses in the world’s trade, monetary and financial system arrangement. In the field of international trade, in the short term the COVID-19 pandemic encouraged countries to prioritize domestic interests (inward looking policy), both by increasing domestic sources of growth and limiting trade relations with other countries. The weakness of the international trade system, which has so far relied on China in the global supply chains, creates vulnerabilities (Scheme 1). This needs to be addressed by building domestic supply chains and establishing trade relations bilaterally and with a number of regions (bilateral and regional free-trade agreements) so as to form multiple links in world trade (multi-polar supply chains). In the monetary sector, the dependence of world financial markets on the domination of the US dollar went close to BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 1. The Role of China in the Global Supply Chain $1.03 T $1.55 T $2.07 T Share of total global trade: USA 15.8% Germany 8% Japan 6.8% France 4.8% UK 4.8% China 4.8% Canada 4.1% Italy 3.5% Netherlands 3.3% (10) Mexico 2.7% ................. (28) Indonesia 0.8% $2.32 T Net Imports Net Eksports $3.47 T $4.63 T Share of total global trade: China 15.6% US 13.8% Germany 9.1% Japan 4.9% France 4.2% Netherlands 4.2% UK 3.8% South Korea3.7% Italy 3.4% (10) Mexico.3% ................. (28) Indonesia 1.27% Net Imports Net Eksports Source: Bloomberg, compiled re-creating the global financial crisis at the end of March 2020. A systemic risk arises when all global investors simultaneously withdraw, in large numbers, their portfolio investment assets and exchange them for US dollars as a safe heaven currency. To overcome this, it is increasingly important to encourage bilateral and regional cooperation to use more local currencies in the settlement of trade and investment transactions (local currency settlement), as are steps to internationalize the Chinese Renminbi currency. In the financial sector, the growing number of hedge funds using algorithmic trading (AI machine trading) proves the vulnerability of the global financial system to pressure conditions such as at the peak of the COVID-19 pandemic at the end of March 2020. A number of initiatives were undertaken to regulate and supervise Non-Bank Financial Institutions (NBFIs), including these hedge funds in strengthening the resilience of the global financial system. National Economic Performance and Prospects: Recovery Process Underway, Stability Maintained The COVID-19 pandemic also had a tremendous impact on Indonesia’s health, economy and finances, especially in the second quarter of 2020. As of 25 November, there were more than 500,000 positive COVID-19 cases in Indonesia, with around 425,000 recovered patients and 16,100 deaths (Graph 11). The social restriction policies that need to be taken to prevent the spread of COVID-19 have had an impact on decreasing human mobility in almost all major cities in the period from April to June, and also have an impact on decreasing economic activity in the second quarter of 2020 (Graph 12). Human mobility has gradually improved since July 2020, in line with the easing of social restrictions in various regions, which has also stimulated improvement in BANK INDONESIA’S ANNUAL MEETING 2020 Graph 11. COVID-19 cases in Indonesia Graph 12. Human Mobility in Large Cities Person (%) 500,000 502,110 400,000 84.12 Index 5.00 0.00 -5.00 300,000 200,000 100,000 3.19 4,442 Confirmed Cases New Confirmed Cases Fatality Rate (rhs) Recovery Rate (rhs) -10.00 -15.00 -20.00 -25.00 -30.00 -35.00 -40.00 -45.00 Jakarta Bali W. Java N. Sumatra E. Java C. Java S. Sumatra E. Kalimantan Data as of 23 November 2020 Source: Task Force for the Acceleration of Handling COVID-19, compiled Source: Google Mobility Report economic activity since the third quarter of 2020. In the monetary sector, the global financial market panic at the end of March and April 2020 resulted in a large outflow of foreign portfolio investment with a very high depreciation pressure on the Rupiah. With a strong commitment to stability policies from Bank Indonesia, the Rupiah exchange rate has strengthened significantly since the end of March 2020, thus supporting the national economic recovery. Thanks be to God, the hardest times have passed. Stability is maintained and the process of economic recovery is ongoing. National economic growth has improved since the third quarter of 2020 and will increase substantially in 2021. Economic improvement is in line with the realization of the fiscal stimulus, increased mobility of people and improving global demand. The Indonesian economy in the third quarter of 2020 grew by 5.05% (qtq) from a contraction of 4.19% (qtq), or the contraction of growth decreased to 3.49% (yoy) from 5.32% (yoy) in the previous quarter (Table 2). There was an increased realization of Government stimulus, especially in the form of social assistance, spending on other goods and services, as Table 2. GDP by Expenditure (%, yoy) Component 2018* 2019** I II III IV 5.17 5.07 5.05 5.02 4.97 Private Consumption 5.05 5.02 5.18 5.01 Government Consumption 4.80 5.22 8.23 Investment 6.64 5.03 Non building Investment 10.31 Building Investment 2019** 2020*** I II III 5.02 2.97 -5.32 -3.49 4.97 5.04 2.83 -5.52 -4.04 0.98 0.48 3.25 3.75 -6.90 9.76 4.55 4.21 4.06 4.45 1.70 -8.61 -6.48 3.69 1.96 1.95 -0.13 1.80 -1.46 -18.62 -8.99 5.41 5.48 5.46 5.03 5.53 5.37 2.76 -5.26 -5.60 Exports 6.55 -1.58 -1.73 0.10 -0.39 -0.87 0.23 -11.68 -10.82 Imports 11.88 -7.47 -6.84 -8.30 -8.05 -7.69 -2.18 -16.98 -21.86 GDP Source : BPS Note: * Preliminary figures; ** Figures are very provisional; *** Figures are very, very provisional BANK INDONESIA’S ANNUAL MEETING 2020 Graph 13. Regional Economic Growth in Quarter III-2020 (%, yoy) Kalimantan Sumatra 4.50 4.61 5.67 3.23 ACEH (0.11) 3.73 2.31 (3.10) (2.22) III IV I II N. SUMATRA (2.60) (4.34) (4.23) III III IV I II III N. KALIMANTAN (1.46) RIAU (1.67) KEP. RIAU (5.81) W. SUMATRA (2.87) JAMBI (0.79) BENGKULU (0.09) 3.42 S. KALIMANTAN 3.72 BANTEN (5.77) (6.69) III IV I II C. KALIMANTAN (3.12) S. SUMATRA (1.40) Java 5.34 W. KALIMANTAN (4.46) KEP. BABEL (4.38) LAMPUNG (2.41) 5.51 E. KALIMANTAN (4.61) DKI (3.82) W. JAVA (4.08) C. JAVA (3.93) DIY (2.84) (4.00) E. JAVA (3.75) BALI (12.28) NTB (1.11) III Q III ≥ Q II Q III < Q II Source: BPS, compiled well as transfers to regions and village funds (transfer kedaerah dan dana desa - TKDD). Export performance has also improved, driven by global demand, especially from the US and China, that is recorded in a number of commodities such as iron and steel, pulp and waste paper, as well as textiles and textile products (tekstil dan produk tekstil - TPT). A number of indicators show improvement, such as community mobility, non-food and online retail sales, PMI Manufacturing, and public income. Looking ahead, economic growth is predicted to pick up on the back of the improving global economy and accelerated budget realization for the Central and Local Governments, progress on the credit restructuring program, and the continuation of Bank Indonesia monetary and macroprudential stimulus. Overall, Indonesia’s economic growth will start to be positive in the fourth quarter of 2020 and is estimated to reach 4.8% -5.8% in 2021. Spatially, economic recovery is faster in a number of areas outside Java. Economic improvement in the third quarter of 2020 was recorded in almost all regions in Indonesia, although 7 (seven) provinces, including Bali, are still under pressure (Graph 13). In fact, 2 (two) provinces had positive growth which were Central Sulawesi with 2.82% (yoy) growth and North Maluku which grew at a high rate of 6.66%, supported by the positive performance of export-oriented industries. The easing of social activities by more than 31 Regional Governments (4 Provinces and 27 Regencies/Cities) encouraged economic improvement in the third quarter of 2020. In addition, the Government’s policy of accelerating BANK INDONESIA’S ANNUAL MEETING 2020 Sulampua 5.21 2.32 3.55 NATIONAL 5.02 (1.48) (1.10) III IV I II 4.97 (5.32) III GORONTALO (0.07) W. SULAWESI (5.26) 2.97 III N. SULAWESI (1.83) IV I II (3.49) III NORTH MALUKU 6.66 WEST PAPUA (3.35) C. SULAWESI 2.82 SE. SULAWESI (1.82) S. SULAWESI (1.08) PAPUA (2.61) MALUKU (2.38) Balinusra 5.34 5.52 0.92 NTT (1.68) (6.32) (6.80) III IV Transfers to Regions and Village Funds (Transfer ke Daerah dan Dana Desa - TKDD) by easing transfer requirements supported the realization of regional expenditures so as to increase regional economic improvement, especially in Java. From the external side, the recovery of the Chinese and US economies has been the driving force for improvements in the export performances of a number of industrial products in Java, Sulawesi-Maluku-Papua (Sulampua) and Sumatra. In terms of business sector, economic recovery in the Sulampua region has been driven by continued investment and increasing demand in the steel and mining industries from abroad. In Java, the economic recovery was mainly supported by improved consumption due to accelerated budget realization and increased mobility, thus supporting improvements in the industry business I II III sector. Meanwhile, the trade sector has improved in all regions in line with improving consumption and export-import activities. The improvement in regional economic growth is expected to continue in 2021, in which the regions of Java, Sumatra, Kalimantan, Bali and Nusa Tenggara (Balinusra), and Sulampua will grow respectively by 5.2%-5.6%; 4.0%-4.4%; 2.4%-2.8%; 5.2%-5.6%; and 7.8%-8.2%. The resilience and stability of Indonesia’s external sector is well maintained. Current account transactions in the third quarter of 2020 recorded a surplus due to improvements in exports and import adjustments in line with the weak domestic demand. This is reflected in the trade balance during the third quarter of 2020 which recorded a surplus of US $ 9.8 billion, much higher than the BANK INDONESIA’S ANNUAL MEETING 2020 Table 3. Indonesia’s Balance of Payments Component (USD billion) 2019* I II III* IV* 2019* 2020** I* II* III** Current Account -30.6 -6.6 -8.2 -7.5 -8.1 -30.4 -3.7 -2.9 1.0 A. Goods -0.2 1.3 0.6 1.4 0.3 3.5 4.4 4.0 9.8 - Export, fob 180.7 41.2 40.2 43.7 43.4 168.5 41.7 34.6 40.8 - Import, fob -181.0 -39.9 -39.6 -42.3 -43.1 -164.9 -37.3 -30.7 -31.0 a. Non Oil & Gas (Net) 11.2 2.9 3.1 2.7 3.2 12.0 5.8 3.3 9.4 b. Oil & Gas (Net) -11.4 -2.1 -2.9 -2.1 -3.2 -10.3 -2.7 -0.8 -0.7 B. Services, primary Income & Secondary Income -30.4 -7.8 -8.8 -8.9 -8.4 -33.9 -8.1 -6.9 -8.8 Capital and Financial Account 25.1 9.9 6.8 7.4 12.5 36.6 -3.1 10.6 1.0 1. Direct Investment 12.5 5.9 5.8 5.2 3.1 20.1 4.0 3.9 1.1 2. Portfolio Investment 9.3 5.5 4.6 4.6 7.3 22.0 -6.1 9.8 -1.9 3. Other Investment+ 3.3 -1.6 -3.6 -2.4 2.1 -5.4 -1.0 -3.0 1.8 -7.1 2.4 -2.0 0.0 4.3 4.7 -8.5 9.2 2.1 - Reserve Assets Positions 120.7 124.5 123.8 124.3 129.2 129.2 121.0 131.7 135.2 In Month of Import and Official Debt Repayment 6.4 6.7 6.8 6.9 7.3 7.3 7.0 8.1 9.1 - Current Account (% GDP) -2.94 -2.45 -2.95 -2.61 -2.83 -2.71 -1.34 -1.20 0.36 Overall Balance Memorandum: + includes financial derivatives Source: Bank Indonesia previous quarter’s trade balance surplus of US $ 4.0 billion (Table 3). The capital and financial account balance also remains strong, mainly supported by inflows of foreign portfolio capital in line with large global liquidity, the attractiveness of domestic financial assets, and continued investor confidence in the prospect for the domestic economy. Foreign exchange reserves in October 2020 were recorded at 133.7 billion US dollars, far above the international adequacy standard. Going forward, it is estimated that Indonesia’s external stability will be maintained. The balance of payments is expected to experience Note: * Preliminary figures; ** Figures are very provisional a surplus with a lower current account deficit and a larger capital account surplus. The current account deficit is projected to be below 1.5% of GDP in 2020 and around 1.0%-2.0% of GDP in 2021, supporting the resilience of Indonesia’s external economic sector. With the stabilization policy of Bank Indonesia, the Rupiah exchange rate is stable and has the potential to strengthen. As stated above, the COVID-19 pandemic caused panic among investors and global market players, especially at the end of March and BANK INDONESIA’S ANNUAL MEETING 2020 April 2020 which prompted large capital flight flows and weakened exchange rates for various world currencies, including Indonesia. The Rupiah was under pressure and it reached Rp. 16,575 per US dollar on 23 March 2020 (Graph 14). With the stabilization steps taken by Bank Indonesia and intensive communication to investors and domestic and foreign market players, the Rupiah exchange rate has strengthened significantly again, reaching Rp. 14,165 per US dollar; or it appreciated 17.01% from 23 March 2020 to 20 November 2020 (Graph 15). Going forward, Bank Indonesia views the Rupiah exchange rate will remain stable and still has the potential to strengthen. This is in line with its fundamentally undervalued level, supported by low and controlled inflation, low current account deficit, high attractiveness of domestic financial assets and a declining risk premium for Indonesia. Bank Indonesia continues to strengthen its Rupiah exchange rate stabilization policy in accordance with its fundamentals and market mechanisms. Inflation remains low in line with weak demand and adequate supply. In October 2020, the Consumer Price Index (CPI) inflation was recorded at a low of 1.44% (yoy) (Graph 16). Low inflation was recorded in all regions of the Republic of Indonesia and for all components of core inflation, volatile food (VF), and Graph 14. Rupiah Exchange Rate Againts US Dollar vs Several Countries: 31 Dec 2019 - 23 March 2020 BRL -21.68 ZAR -21.51 IDR THB TRY KRW MYR SGD INR EUR JPY CNY PHP -25.0 Graph 15. Rupiah Exchange Rate Againts US Dollar vs Several Countries: 23 March - 20 November, 2020 TRY EUR BRL INR CNY PHP JPY MYR SGD THB KRW ZAR IDR -14.09 -9.54 -4.05 2.87 4.39 6.41 7.10 8.66 8.75 8.80 13.70 15.84 17.01 -20.00 -15.00 -10.00 -5.00 0.00 5.00 -20.0 -15.0 point-to-point -10.0 -5.0 (%) 20.00 Source: Reuters and Bloomberg, compiled administered prices (AP). Core inflation remains low due to weak domestic demand, consistency of Bank Indonesia policies to anchor inflation expectations, and maintained exchange rate stability. Volatile food inflation remains low in line with weak domestic demand, adequate supply, managed distribution, and a more effective coordination between National Inflation Task Force (TPI) and Regional Inflation Task Force (TPID). Meanwhile, low inflation in the administered prices category was not only due to limited human mobility, but also due to lower air transport fares. Bank Indonesia predicts that inflation Graph 16. Inflation: Core, Volatile Food, and Administered Prices (%,yoy) October - 2020: CPI = 1.44 Core =1.74 VF = 1.32 AP = 0.46 -9.69 -9.31 -8.72 -8.01 -7.88 -6.42 -4.54 -2.36 -1.77 -1.30 15.00 point-to-point -16.24 10.00 -2 (%) 0.0 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 CPI Core Volatile Food Administered Price Target Range Source: Reuters and Bloomberg, compiled Source: BPS, compiled BANK INDONESIA’S ANNUAL MEETING 2020 Graph 17. Realization and National Inflation Targets (%, yoy) (%) 12.12 3.61 3.35 3.13 3.02 2.72 -2 Range Inflation Target -0.47 2020* Inflation Realization Credit 12 4 Deposits Source: BPS and Bank Indonesia projections Source: Bank Indonesia at the end of 2020 will be lower than 2% and in 2021 will be controlled within the target of 3.0±1% (Graph 17). Bank Indonesia consistently maintains price stability and strengthens policy coordination with the Government, both at the central and regional levels through the Inflation Task Force (TPI and TPID), in order to keep inflation within its target range. (NPL) was recorded at 3.15% (gross) and 1.07% (net), respectively. (Graph 18). However, the intermediation function of the financial sector is still weak due to limited credit growth in line with weak domestic demand as a result of depressed business performance and banking prudence due to the continuing COVID-19 pandemic. Credit in October 2020 contracted by -0.47% (yoy), meanwhile, growth in Third Party Funds (TPF) was recorded at a higher rate of 12.12% (yoy) (Graph 19). The weak credit growth in October 2020 occurred in almost all regions of Indonesia, except in West Nusa Tenggara and Papua. Going forward, banking intermediation is predicted to improve. Growth in credit and Third Party Fundsin 2021 is estimated to increase each by 7.0% -9.0% respectively. This prediction is consistent with the prospect of economic recovery as well as continued fiscal and monetary as well as macroprudential policy stimulus. Corporate performance has also gradually improved and reflected in increased sales, ability to pay, and tax revenues, particularly in the Industry and Trade sectors. Financial system stability was maintained amidst weak credit growth. The capital adequacy ratio (CAR) of banks in September 2020 was recorded at 23.41%, and the ratio of non-performing loans Graph 18. Bank Capital and Non Performing Loans (%) (%) 5.0 4.5 23.41 24 4.0 3.5 3.0 3.15 2.5 2.0 NPL (Gross) Source: Bank Indonesia, OJK, compiled Graph 19. Growth in Banking Credit and Deposits CAR (rhs) Payment System Transactions increased in line with economic improvements, accompanied by accelerated economic and financial digitalization. The growth of currency in circulation (Uang Kartal Yang Diedarkan - UYD) in October 2020 was BANK INDONESIA’S ANNUAL MEETING 2020 recorded at 14.61% (yoy) amounting to Rp. 806.8 trillion. Payment transactions using ATMs, Debit Cards, and Credit Cards showed a lower growth contraction to 3.97% (yoy) in October 2020 (Graph 20). On the other hand, digital economic and financial transactions continue to grow positively in line with the use of digital platforms and instruments during the pandemic, as well as the strong public preferences and acceptance of digital transactions. The value of EU transactions in October 2020 continued to grow positively by 14.80% (yoy). The value of digital banking transactions recorded a positive growth of 10.50% (yoy) in September 2020. (Graph 21). Likewise, e-commerce transactions and the use of the Indonesian Standard Quick Response Code (QRIS) in various transactions have increased rapidly. Going forward, Bank Indonesia believes that the development of the digital financial economy in Indonesia will be more rapid, especially e-commerce transactions, electronic money, and digital banking, thus supporting the national economic recovery from the retail and MSME sectors. Bank Indonesia continues to accelerate the digitalization of payments through the implementation of the 2025 Indonesian Payment System Blueprint (Blueprint Sistem Pembayaran Indonesia - BSPI), in collaboration with the Government, banking, fintech, and e-commerce. In addition, the rapid growth of the digital financial economy is also in line with Graph 20. Growth in use of ATM Cards, Credit Cards, and Electronic Money (%,yoy) (%,yoy) -2.2 -10 -3.5 200 -20 -41.3 150 -30 -40 -50 -60 14.8 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 ATM-Debit Card Credit Card Total -50 Electronic Money (rhs) Graph 21. Growth in Digital Banking (%,yoy) IDR Million 10.50 - 6 7 8 SMS/Mobile Banking 9 10 11 12 1 Internet Banking 5 6 Growth (rhs) Source: Bank Indonesia the improving national economic conditions and increasing public preference and acceptance of digital transactions. The prospects for Indonesia’s economic recovery in 2021 will improve in the following years and return to a trajectory towards an advanced Indonesia in the medium term. The acceleration of economic growth with a better economic structure is supported by the acceleration of economic transformation through a series of structural reform policies directed at 5 (five) main strategies. First, development of reliable human resources with mastery of technology. Second, infrastructure development that supports industrial connectivity, including MSMEs and tourism. Third, improving the investment and business climate that is better supported by the streamlining of regulations through the implementation of the Job Creation Law and the development and deepening of the financial market which encourages the strengthening of sources of development financing. Fourth, strengthening priority sectors that are competitive and with high added value; and fifth, optimizing the use of technology to support digital-based economic transformation. The increased economic capacity which is supported by increased economic efficiency and productivity, as a result of a series of structural reforms, promotes higher and more sustainable economic growth towards an advanced Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Indonesia with maintained stability. We predict that in the medium term, Indonesia’s economic growth will continue to pick up to be in the range of 5.5% - 6.1% with inflation maintained at a low level of 1.5% - 3.5% and a current account deficit in the range of 1.5% - 2.5% of GDP in 2025. Overall, with this projected trajectory, Indonesia is predicted to become a high-income developed country by 2045. Bank Indonesia Policy Mix 2020: Strengthening Stability, Supporting National Economic Recovery The improvement in the performance of the national economy is supported by synergy and close policy coordination among Government, Bank Indonesia, Financial Services Authority(Otoritas Jasa Keuangan - OJK), the Deposit Insurance Agency (Lembaga Penjamin Simpanan - LPS) and other related parties. In 2020, the government provided a relatively large fiscal stimulus with a deficit of Rp. 1,039.2 trillion or 6.3% of GDP. This included the budget for handling COVID-19 and the national economic recovery program of Rp. 695.2 trillion for the public goods (i.e. health, social assistance, and public services) amounting to Rp. 397.6 trillion, as well as non-public goods (namely incentives to MSMEs, business, and corporations) amounting to Rp. 297.6 trillion. Bank Indonesia, in addition to stabilizing the Rupiah exchange rate, also provided a large monetary stimulus in the form of lowering interest rates and quantitive easing, as well as easing macroprudential policies and digitalizing the payment system. Through the “burden sharing” mechanism with the Government, Bank Indonesia provides financing and and bears the burden of the entire public goods budget of Rp. 397.6 trillion in the 2020 State Budget through direct purchase of Government Securities (Surat Berhaga Negara - SBN), and also bears the burden of around 60% of the SBN interest for the non-public goods budget for MSMEs and corporations in the amount of Rp. 117.0 trillion in the 2020 State Budget. Meanwhile, OJK provides relaxation for banks in restructuring their credit by delaying installments of principal and interest of credit toavoid increasing non-performing loans and worsening capital. Likewise, the theLPS also ensures that public savings in the banking sector are guaranteed to support the stability of the financial system. Bank Indonesia is fully committed to directing all policy instruments for the national economic recovery. Since the outbreak of of COVID-19, Bank Indonesia’s policy mix has been strengthened and closely coordinated with the Government and the KSSK for national economic recovery, while maintaining macroeconomic and financial system stability. Bank Indonesia is committed to provide financing to the 2020 State Budget through the purchase of Government Securities (SBN) from the primary market or directly, so that the Government can focus on accelerating budget realization. Provision of liquidity is also continuously provided for banks to support the credit restructuring program and the business sector. The strengthening of the Bank Indonesia policy mix covers the following 6 (six) aspects: i. A decrease in the BI 7-Day Reverse Repo Rate (BI7DRR) which was cut 5 (five) times in 2020 by 125 bps to 3.75%. This decision is in line with the need to boost economic growth, amidst low inflation and relatively stable Rupiah exchange rate. This Bank Indonesia policy interest rate is the lowest level in history. ii. Rupiah exchange rate stabilization policy through intervention on the spot market, Domestic NonDeliverable Forward (DNDF), and purchases of SBN from the secondary market, amid continuing uncertainty global financial market. iii. Quantitative Easing by injecting large amounts of liquidity into banks to support the national economic recovery program. Quantitative easing is carried out by, among others, monetary expansion and a reduction in the reserve requirement (Giro Wajib Minimum - GWM). iv. Relaxation of macroprudential policies to boost credit and financing for the economy, such as the Macroprudential Intermediation Ratio (MIR), Loan to Value (LTV) ratio, or lending downpayment for green motor vehicle loans. BANK INDONESIA’S ANNUAL MEETING 2020 v. Provision of funding and burden sharing for the 2020 State Budget to support the national economic recovery program through the purchase of SBN from the primary market (based on the Joint Decree by the Minister of Finance and Governor of Bank Indonesia dated 16 April 2020) and direct purchase (based on the Joint Decree by the Minister of Finance and Governor of Bank Indonesia 7 July 2020). Also, providing funding for LPS to anticipate and handle problem banks through the repo mechanism and / or purchase of SBN (PP No. 33 of 2020). vi. Accelerate digitalization of payment systems based on the Payment System Blueprint (BSPI) 2025 to expand the digital economy and finance as part of economic recovery efforts, through electronification of the distribution of Government social assistance, expansion of QRIS, and collaboration between banks and fintech for easy access for MSMEs and the public to financial services. Rupiah Exchange Rate Stabilization Policy With the stabilization policy adopted by Bank Indonesia, the Rupiah exchange rate strengthened significantly, which was conducive to the national economic recovery. Bank Indonesia’s stabilization Graph 22. Foreign Investment Flows to SBN IDR Trillion -10 -20 -30 -40 Graph 23. Yield Spread on Government Bond against UST bps 1,500 1,200 1.204 541 540 516 TR ZA BR ID MX RU IND CN SK 53 56 PL TH Source: Bloomberg, compiled policy was supported by intensive communication with investors as well as domestic and foreign market players. As we have previously stated, the Rupiah, which touched Rp. 16,575per US dollars on 23 March 2020, then strengthened to Rp. 14,165 per US dollar on 20 November 2020. Investor’s confidence have improved as can be seen in renewed foreign portfolio flows into Indonesia. From 14 April to 20 November 2020, foreign portfolio inflows to the SBN market were recorded at Rp. 48.6 trillion (Graph 22). Foreign reserves pick up and reach 133.7 billion US dollars at the end of October 2020, higher than the level before COVID-19. We are of the view that the current Rupiah exchange rate is still fundamentally undervalued, and, God willing, the Rupiah still has the potential to strengthen. The stability and strengthening of the Rupiah exchange rate is supported by a number of factors, namely: (a) low and controlled inflation, (b) low current account deficit, which is below 1.5% of GDP for the whole of 2020, (c) high interest rate differential between domestic interest and overseas market (Graph 23), (d) increased foreign exchange reserves, and (e) reduced risk premiums in line with less uncertainty on global and domestic financial markets. -50 Jan Jan Jan Feb Feb Mar Mar Apr Apr May May Jun Jun Jul Jul Jul Aug Aug Sep Sep Sep Oct Oct Nov I III V II IV 0-<5 Years II IV II IV I III I III 5-<10 Years I III V I III I III V II IV II >10 Years Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Monetary Policy Stimulus Graph 25. Banking Interest Rates Lower interest rates and relaxation of Bank Indonesia’s monetary policy has led to lower bank interest rates and financial market stability, although the decline in lending rates is still modest. As we noted above, during 2020 Bank Indonesia lowered the monetary policy rate by 125 bps, bringing the BI7DRR interest rate to 3.75%. This Bank Indonesia policy interest rate is a record-low in the history of Indonesian economy. The decline in the BI7DRR interest rate and the easing of liquidity pursued by Bank Indonesia was accompanied by a 154 bps cut in the Interbank Money Market (Pasar Uang Antar Bank - PUAB) interest rate, resulting in a very low overnight PUAB interest rate of around 3.27% in November 2020 (Graph 24). Likewise, the yield on 10-year SBNs also fell by 75 bps from a high of 8.31% at the end of March 2020 to 6.13% on 18 November 2020. Banking interest rates also went down, particularly deposit rates by 138 bps to 4.93%, despite the 70 bps drop in lending rates to 9.84% at the end of October 2020 (Graph 25). With the large decline in policy interest rates and the easing of Bank Indonesia’s monetary policy, the slow decline in bank credit interest rates is due to increased credit risk that requires banks to increase their reserves. We hope that banks will be able to accelerate the reduction in loan interest rates, (%) Graph 24. JIBOR Interest Rate (O/N, 1 month, 12 months) (%) 10.00 9.00 8.00 7.00 6.00 5.00 4.51 4.00 3.83 3.00 3.04 5 9 5 9 JIBOR O/N (IndONIA) Data as of 20 November 2020 Source: Bank Indonesia 5 9 5 9 JIBOR 1 month JIBOR 12 months 11.05 9.84 9.38 9.01 4.93 4 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 Lending Rate Consumption Lending Rate Deposit Rate Investment Lending Rate Working Capital Lending Rate Source: Bank Indonesia, compiled thereby supporting credit growth and financing for the national economic recovery. To encourage financing for business and the national economic recovery, Bank Indonesia also extended the monetary stimulus in the form of a quantitative easing (QE) policy to a large number of banks. As of 20 November 2020, Bank Indonesia has injected Rupiah liquidity of around Rp. 682.0 trillion or nearly 4% of GDP, mainly from a reduction in the statutory reserve requirement (Giro Wajib Minimum - GWM) of around Rp. 155 trillion and a monetary expansion of around Rp. 511.2 trillion. As shown in Graph 10, the amount of QE by Bank Indonesia is the largest among EMEs countries. In more detail, the expansion of monetary operations was carried out through provision of term-repos to banks with underlying SBN and FX swaps totaling Rp. 345.0 trillion. Monetary expansion was also carried out through the purchase of SBN from the secondary market amounting to Rp. 166.2 trillion, as part of the Rupiah exchange rate stabilization policy pursued by Bank Indonesia. This was conducted, particularly in the period of March and April 2020 when there was a withdrawal of foreign portfolio investment, particularly from Government SBNs, that put pressure on the Rupiah. In addition, Bank Indonesia cut the Rupiah reserve requirement 3 (three) times by 300 bps, thereby increasing liquidity to around Rp. 155 trillion during 2020. Bank Indonesia also did not BANK INDONESIA’S ANNUAL MEETING 2020 impose additional demand deposits penalty if banks do not comply with Macroprudential Intermediation Ratio, thereby increasing liquidity by around 15.8 trillion. 0.2 0.2 0.1 NPL/NPF (Bruto) <5% & NPL/NPF (Bruto) <5% & CAR CAR>19% 0.0 CAR ≥ CAR Incentive 0.0 CAR < CAR Incentive Incentive<CAR<19% Lower Disincentive Parameters Before Source: Bank Indonesia 13.3 11.7 7.5 Graph 26. RIM’s Disincentive Parameters 0.0 13.3 Bank Indonesia has relaxed its macroprudential policy to encourage bank lending and financing . During 2020, Bank Indonesia relaxed the regulation on Macroprudential Intermediation Ratio (RIM / RIM Sharia), which is the ratio between financing and bank funding, without imposing penalties on banks that have RIM or RIM Sharia outside the target range, that has been set at 84% - 94%, for the next year starting from 1 May 2020 (Graph 26). The provisions for the Loan to Value (LTV) ratio, namely the down payment policy in bank credit distribution, for environmentally sound motor vehicle loans were also relaxed to 0% (Graph 27). In addition, regulation on Macroprudential Liquidity Support (Penyangga Likuiditas Makroprudensial - PLM / PLM Sharia), namely the ratio of liquid assets in the form of ownership of SBN and SBI as liquidity buffer, was strengthened from 4% to 6% Deposits for conventional banks and to 4.5% against Rupiah Deposits for Islamic banks. All securities used for 0.0 (%) Monetary Policy Mix and Macroprudential Policy 0.0 Graph 27. Average LTV/FTV Down Payment for Property and Environmentally Friendly Motor Vehicles Upper Disincentive Parameters After Properties Motor Vehicles Before After Source: Bank Indonesia compliance of or RIM sharia can be repoed to Bank Indonesia to meet liquidity needs. We view that the easing of the macroprudential policy can provide flexibility for banks in channeling credit to promote national economic recovery while maintaining priority on sustaining financial system stability. The reduction in interest rates and relaxation of monetary and macroprudential policies by Bank Indonesia have provided support maintain financial system stability. Ample liquidity conditions in the banking sector were reflected in the high ratio of Liquid Assets to Third Party Funds (LA / TPF), namely 30.65% in October 2020. Per the BUKU (Bank Umum Kegiatan Usaha / Commercial Bank Business Activities) bank group, LA / TPF ratio reached around 28.91% to 34.19% for BUKU bank 2 to BUKU bank 4, while the LA / TPF ratio for BUKU bank 1 was also relatively high, namely at 17.83% (Graph 28). Deposit growth in the banking sector was also high, namely 12.12% (yoy) in October 2020, while credit growth contracted 0.47% (yoy). Related to monetary aggregates, growth in the M1 and M2 in October 2020 remained high, at 18.5% (yoy) and 12.5% (yoy). The extraordinary liquidity easing by Bank Indonesia in remains circulated in the banking and money market, and is not yet channeled to the real sector in the form of credit. However, on the other hand, lowering interest rates and loosening liquidity played an important role in maintaining financial BANK INDONESIA’S ANNUAL MEETING 2020 Graph 28. LA / TPF Ratio per BUKU Bank Graph 30. Estimates of Credit Demand and Supply (%) (Log) 34.19 30.97 28.91 0.1 8.8 0.05 8.6 8.4 17.83 8.0 7.8 7.6 1 2 3 4 5 6 7 8 91011 121 2 3 4 5 6 7 8 91011 12 1 2 3 4 5 6 7 8 91011 121 2 3 4 5 6 7 8 910 Group of Business Activities 1 Group of Business Activities 2 Group of Business Activities 3 Group of Business Activities 4 8.2 -0.05 -0.1 7.4 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 9 -0.15 Demand Excess Supply (+)/Demand (-) (rhs) Supply Source: Bank Indonesia Source: Bank Indonesia, staff calculations system stability. This was primarily due to maintained risk in interest rate and liquidity aspect. Moreover, the liquidity loosening has also played a favourable role in bank profitability by improving revenue from investing its liquidity in SPN and SBN instruments, in addition to interbank lending (Pinjaman Antar Bank - PUAB). Overall, ownership of securities in banks reached Rp. 1,443 trillion at the end of October 2020, most of which were owned by BUKU bank 3 and 4 (Graph 29). Weak demand is the dominant factor in explaining a contraction of credit (Graph 30). Credit in October 2020 contracted by 0.47% (yoy) despite high growth in banks deposits of 12.12% (yoy). On the supply side, banking capacity to provide lending was more than adequate in line with the easing of Bank Indonesia’s monetary policy in the form of lowering interest rates and large liquidity injections, as well as a relaxation of macroprudential policies. The banking survey by Bank Indonesia in the third quarter of 2020 also showed that the standard of lending was improving (Graph 31). Therefore, we view that this low credit growth condition is caused mainly by weak demand. This is closely related to weak domestic demand and unfavorable Graph 29. SBN Ownership per BUKU Bank Graph 31. Standard Lending Index IDR Trillion (Index) 1,600 1,400 1,200 Tighter 1,000 12.4 11.0 12.0 8.1 1 2 3 4 5 6 7 8 9 10 1112 1 2 3 4 5 6 7 8 9 10 1112 1 2 3 4 5 6 7 8 910 Group of Business Activities 1 Group of Business Activities 3 Source: Bank Indonesia Looser (Log) 9.0 -10 I II III IV I II III IV I II III IV I II III IV* *) Estimation Group of Business Activities 2 Group of Business Activities 4 Source: Bank Indonesia Banking Survey Q3 2020 Description: * projection BANK INDONESIA’S ANNUAL MEETING 2020 conditions in the business sector due to economic slowdown caused by COVID-19 pandemic as described above. As domestic economy recovers in the aftermath of COVID-19 pandemic, the gradual easing of restrictions on human mobility, acceleration of the realization of the APBN and APBD by the Government, a loose mix of monetary and macroprudential policies including more than adequate banking liquidity by Bank Indonesia, as well as progress on credit restructuring by banks, we estimate that bank lending and financing from the capital market will gradually pick up going forward. Implementation of Law No. 2 of 2020: Supporting State Finances and Financial System Stability Bank Indonesia has followed up through all the authorities given by Law Number 2 of 2020 as part of the national policy response to a situation of extreme urgency due to the COVID-19 pandemic. As it is known, the national policy response in Law no. 2 of 2020 includes state budget policies and financial system stability policies. In this regard, the authority of Bank Indonesia related to state budget policies in Law no. 2/2020 includes the purchase of SBN in the primary market from the Government, while related to financial system stability policies include improvements to the ShortTerm Liquidity Loan / Sharia Short-Term Liquidity Financing (Pinjaman Likuiditas Jangka Pendek/ Pembiayaan Likuditas Jangka Pendek Syariah - PLJP / PLJPS), purchase / repo of SBN with LPS, foreign exchange activities regulation, and access funding to corporations/private sector by means of repo of Government Securities/State Sharia Securities (Surat Utang Negara/Surat Berharga Syariah Negara - SUN / SBSN) through banks. Bank Indonesia’s follow-up on the authority of Law no. 2 of 2020 is as follows: i. Long-term SUN / SBSN purchases on the primary market for APBN state budget financing in the context of the COVID-19 pandemic and national economic recovery (Article 16 (1) (c) & 19) have been implemented based on 2 (two) agreements between the Ministry of Finance and Bank Indonesia. First, the purchase of SUN / SBSN from the primary market by Bank Indonesia through a market mechanism to provide financing for 2020 State Budget in accordance with the Joint Decree by the Minister of Finance and the Governor of Bank Indonesia dated 16 April 2020. Second, direct purchase of SUN / SBSN by Bank Indonesia for financing as well as burden sharing of the 2020 State Budget in a Joint Decree by the Minister of Finance and the Governor of Bank Indonesia dated 7 July 2020. ii. The provision of PLJP / PLJPS to solvent and healthy banks (Article 16 (1) (a) and 17) has been followed up with changes to the two Bank Indonesia Regulations (PBI) No.22 / 5 / PBI / 2020 and PBI No.22 / 6 / PBI / 2020 dated 30 April 2020 which was later revised with the third amendment in PBI No.22 / 15/2020 and PBI No.22 / 16/2020 dated 29 September 2020. iii. Provision of Special Liquidity Loans (Pinjaman Likuiditas Khusus - PLK) to Systemic Banks experiencing liquidity difficulties that do not meet the requirements of PLJP / PLJPS guaranteed by the Government based on the KSSK Decree (Article 16 (1) (b) & 18). We discussed this at the Board of Governors Meeting on 27 May 2020 and currently it is still in discussion at KSSK. iv. Purchases and / or repurchase agreement (repo) transactions of SBN with the Deposit Insurance Corporation to recover the cost incurred for handling solvency problems of Systemic Banks and Banks Other Than Systemic Banks (Article 16 (1) (d) & 20). The mechanism has been followed up as set forth in the amendment to the Memorandum of Understanding between Bank Indonesia and IDIC dated 23 July 2020. v. Regulations on the obligation to receive and use foreign exchange for residents, including provisions regarding the transfer, repatriation and conversion of foreign exchange to maintain macroeconomic and financial system stability (Article 16 (1) (e)), have been followed up with a plan to issue a Bank Indonesia Regulation (PBI) concerning the obligation to repatriate BANK INDONESIA’S ANNUAL MEETING 2020 foreign exchange proceeds from the export of natural resources. Consultation on the PBI implementation plan for the banking and the business community has been carried out. However, until now we have no plans to enforce it. vi. Funding to corporations / private companies by means of repo SUN / SBSN owned by corporations / private through banking (Article 16 (1) (f)) can be implemented with existing regulation(PBI and PDG of Monetary Operations. Bank Indonesia is fully committed to realizing the purchase of SBN from the primary market for funding and burden sharing for the 2020 State Budget to support national economic recovery in accordance with Law no. 2 of 2020. As stated above, the purchase of SUN / SBSN on the primary market by Bank Indonesia for financing the 2020 State Budget is carried out through 2 (two) “Burden Sharing” mechanisms. First, the Joint Agreement by the Minister of Finance and the Governor of Bank Indonesia dated 16 April 2020 regarding the Purchase of SUN / SBSN from the primary market by Bank Indonesia through a market mechanism. In this case, the purchase of SUN / SBSN can be made through a non-competitive bidder in the main auction, a green shoe option in an additional auction, or a private placement. Second, the Joint Agreement by the Minister of Finance and the Governor of Bank Indonesia dated 7 July 2020 regarding the purchase of SUN / SBSN directly for the financing of the 2020 State Budget, as a follow-up to the decision by Commission XI-DPR RI at the Working Meeting on 6 July 2020. Direct purchase of SUN / SBSN for public goods financing in the 2020 State Budget is Rp. 397.56 trillion, namely for health, social assistance, and public services, all of which are borne by Bank Indonesia. In addition, Bank Indonesia also bears the burden of financing non-public goods in the 2020 State Budget related to MSME and corporate incentives totaling Rp. 177.03 trillion. The large amount of funding and burden sharing by Bank Indonesia for the 2020 State Budget allows the Government to focus on accelerating budget realization for national economic recovery. Since the signing of the Joint Agreement between the Minister of Finance and the Governor of Bank Indonesia regarding the “Burden Sharing” scheme I, up until 20 November 2020 Bank Indonesia has purchased SBN from the primary market amounting to Rp. 72.5 trillion in 31 (thirty one) auctions conducted by the Government during 2020. Meanwhile, the realization of funding and burden sharing for public goods funding in the 2020 State Budget by Bank Indonesia through the direct purchase of SBN is in accordance with the Joint Decree by the Minister of Finance and the Governor of Bank Indonesia dated 7 July 2020 (“Burden Sharing” II Scheme) to 20 November 2020, amounted to Rp. 297.03 trillion. Thus, the overall purchase of SBN by Bank Indonesia along with the distribution of the burden for funding the 2020 State Budget has reached Rp. 369.52 trillion. In addition, Bank Indonesia will also realize the burden sharing with the Government for funding the 2020 State Budget for Non Public Goods-MSMEs amounting to Rp. 114.81 trillion in accordance with the Joint Decree by the Minister of Finance and the Governor of Bank Indonesia dated 7 July 2020 (“Burden Sharing” Scheme II). With the commitment of Bank Indonesia in purchasing SBN from the primary market, the Government can focus on efforts to accelerate the realization of the State Budget to encourage national economic recovery. Bank Indonesia refined the PLJP / PLJPS provisions to provide liquidity for solvent and healthy banks to strengthen financial system stability. As stated, two improvements were made so that the PLJP / PLPS provision could be implemented and that it conformed to international standards in supporting financial system stability. The third improvement has been published in PBI No. 22/15/2020 and PBI No. 22/16/2020 on 29 September 2020 regarding the third change of PLJP to conventional banks and PLJPS to Islamic banks respectively. Improvements in particular related to interest rate settings, simplification BANK INDONESIA’S ANNUAL MEETING 2020 of credit collateral requirements, as well as the verification and valuation process for credit collateral by KAP / KJPP in the banking application process for PLJP / PLJPS. We have also established the Macroprudential-Microprudential Supervision Coordination Forum (Forum Koordinasi Pengawasan Makroprudensial-Mikroprudensial - FKMM) between Bank Indonesia and OJK for this purpose, according to the Joint Agreement between the Governor of Bank Indonesia and the Chairman of the OJK Board of Commissioners, dated 19 October 2020. In this case, the granting of PLJP / PLJPS was agreed to be part of the supervisory action by OJK so that banks that need and fulfill the requirements of PLJP / PLJPS are required to prepare verification and valuation of credit collateral by KAP / KJPP so that Bank Indonesia will be able to accelerate the provision of PLJP / PLJPS in the event that it is needed. Digitalization of Payment Systems: Accelerating National Digital Economic and Financial Integration To encourage the digital economy and finance as sources of economic growth, Bank Indonesia is accelerating the digitalization of the payment system with the implementation of the 2025 Indonesian Payment System Blueprint (Blueprint Sistem Pembayaran Indonesia - BSPI). This is in line with the 5 (five) directives of the President on 3 August 2020 to accelerate digital transformation towards an advanced Indonesia. The acceleration of digitalization of the payment system is an implementation of the 5 (five) visions in BSPI 2025 which we launched in May 2019, that are directed at encouraging: (i) integration of the national digital financial economy, particularly the retail and MSME sectors, (ii) banking digitization (open banking) ), (iii) digital banking interlink with fintech, (iv) start-up innovation while still considering the principle of prudence, and (v) basing national interests in payment system cooperation between countries. BSPI 2025 is implemented through 5 (five) main initiatives, namely: (i) digitalization of banking through open banking and interlinking with fintech through Application Programming Interface (API), (ii) digitizing retail payment systems through expanding QRIS and developing BI-FAST Payment, (iii) development of large value payment system infrastructure and modern and international standard financial markets, (iv) development of public infrastructure for data through Data Hub and Payment ID, and (v) progressive regulatory reform and development friendly industry. A number of rapid advances have been made in the implementation of the 2025 BSPI, in close synergy with banks and the Indonesian Payment System Association (Asosiasi Sistem Pembayaran Indonesia - ASPI), OJK, and the Government (Central and Regional). Digitalization of the payment system has driven digital economy transactions through e-commerce amid the COVID-19 pandemic. While economic transactions and physical payments have decreased, in 2020 the nominal value of e-commerce transactions is estimated to reach Rp. 253 trillion, up 23% from 2019, and expected to again increase by 33.2% to Rp. 337 trillion in 2021 (Graph 32). In addition to increasing public preferences amidst limited mobility due to the COVID-19 pandemic, the rapid increase in e-commerce transactions is also driven by a number of marketplace strategies, such as promotional events with free shipping and cashback, safe shopping on official e-commerce platforms, convenience for consumers to choose goods through Graph 32. Nominal of E-Commerce Transactions IDR Trillion 205.5 105.6 42.2 2020* 2021* Source: Bank Indonesia Description: * Proyeksi Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Graph 33. E-Commerce Payment Methods % 0.11 0.25 0.72 1.25 12.18 80 11.18 70 7.48 17.32 18.54 12.46 Million 1.77 2.04 1.96 100 0.25 0.18 0.15 0.10 1.65 0.08 0.16 0.25 0.74 2.00 21.81 22.41 22.57 19.92 20.75 7.72 2.63 19.73 18.87 16.19 7.43 7.53 12.47 13.39 14.22 14.61 13.57 7.41 6.31 5.90 5.68 5.47 9.51 10.90 3.63 16.49 5.22 22.02 26.31 4.31 II III IV I II III 9.38 9.68 4.21 9.71 14.69 5.69 9.05 7.78 IV 33.93 3.49 44.37 I Bank Transfer Credit Card / Online Debit Kiosk / Minimarket Credit Without Card II 37.37 45.79 42.81 4.05 40.02 I 5.55 14.53 10.14 18.10 68.73 62.19 57.47 56.77 56.55 56.04 55.29 57.50 52.28 Graph 34. Development of QRIS III 31.55 IV 3.34 3.26 III 27.56 27.25 24.83 II Electronic Money CoD / Cash 2.69 I IDR Billion Numbers of Merchant Transactions Volume Transactions Amount (rhs) Other Source: Bank Indonesia Source: Bank Indonesia interactive communication, and the use of big data and algorithms that enable a personal shopping experience. In line with the fast pace of e-commerce transactions, digital payment transactions also increased rapidly, as reflected in the use of Electronic Money (EU) which reached 42.8% in e-commerce transactions in the third quarter of 2020,increased by 225.3% (yoy) from 2019 (Graph 33). Meanwhile, payment methods via bank transfer and cash accounted for 24.8% and 14.7% of e-commerce transactions, respectively. widespread and popular throughout Indonesia. This can be seen from the rapidly increasing development of QRIS, both in terms of volume and the nominal value of transactions as well as the number of merchants (Graph 34). Currently, the use of QRIS has connected approximately 5.3 million retail merchants nationally (Table 4). Most of these merchants are MSMEs, with more than 3.4 million Micro Business (Usaha Mikro - UMI) merchants and around 1 million Small Business (Usaha Kecil - UKE) merchants. Through QRIS, the digitalization of MSMEs can be The national and regional QRIS expansion campaign is able to accelerate the digital financial economy, particularly MSMEs and retail trade. Since its launch in August 2019, Bank Indonesia has carried out a massive campaign using QRIS as the only standard used in Indonesia, both nationally and in various regions, especially for MSMEs, traditional markets, and the academic world. The campaign was carried out through all 46 (forty six) Bank Indonesia offices in synergy with banks, payment system associations, institutional ministries, local governments, and strategic partners. QRIS provides various advantages, namely it is fast with recorded transactions, efficient and free of charge, “cool” and up-to-date because it is supervised by Bank Indonesia, and more hygienic because there is no physical contact. The use of QRIS in payment transactions is increasingly Table 4. QRIS Registered Merchants Merchants’ Criteria March November Growth (%) Large Enterprises 129,834 284,309 119% Medium Enterprises 265,077 489,770 85% Small Enterprises 304,420 1,069,490 251% Micro Enterprises 2,378,026 3,426,123 44% Donation/ Social 3,996 12,763 219% 3,081,353 5,282,455 71% TOTAL Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 accelerated so that it supports national economic and financial inclusion, including the availability of MSME data, which has been one of the obstacles in its development. Moreover, the expansion of the use of QRIS nationally and in the regions has overcome many of the previous problems associated with using QR from other countries in Indonesia. Electronification payments for distribution of social assistance programs, modes of transportation, as well as electronification of local government finances also accelerates the digital economy and finance. Payment electronification supports the distribution of Government social assistance in a more targeted, correct amount, on time, and with better governance. Until September 2020, Rp. 29.1 trillion in non-cash social assistance has been distributed to the Family Hope Program (Program Keluarga Harapan - PKH) and Rp. 30.0 trillion for the Basic Food Program (Scheme 2). Likewise, the electronification of various modes of transportation continues to be expanded, both for air, land and sea transportation. Moreover, the electronification of regional government financial transactions has progressed rapidly. To date, 542 Regional Governments have electronified their financial transactions, namely 34 provinces, 93 cities and 415 districts. The level of payment electronification varies from Cash Management System (CMS), online SP2D, to the use of QRIS, Electronic Money, and online banking. The electronification of local government financial transactions is not only for collecting taxes and levies, but also for spending and expenses. Payment electronification has been proven to increase tax revenue, expenditure efficiency and optimization, and strengthen local government financial governance. Digitization of the payment system has also accelerated the development of fintech and digitalized banking. Payment transactions using Electronic Money in 2020 are estimated to have increased from 2019 by 38.4% to Rp. 201 trillion, and Scheme 2. Electronification of Government Social Assistance Payments Nominal: Rp37.4 T PKH Frequency of distribution: monthly Staple Food Target 2020 After Covid-19 Recipient: 10 million KPM Nominal: Rp43.6 T Frequency of distribution: monthly Target 2020 After Covid-19 Recipient: 20 million KPM REALIZATION OF NON-CASH SOCIAL ASSISTANCE (PKH AND STAPLE FOOD PROGRAM) until July 2020 until August 2020 until September 2020 PKH 24.1 T 64.38% 26.6 T 71.09% 29.1 T 77.90% of target of target of target STAPLE FOOD PROGRAM 22.4 T 51.31% 26.2 T 60.14% 30.0 T 60.85% of target of target of target Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Graph 35. Development of Electronic Money Graph 36. Development of Digital Banking IDR Trillion IDR Trillion 20,000 15,000 2020* 2021* 21,860 16,998 2020* 2021* Source: Bank Indonesia Description: * Bank Indonesia projections Source: Bank Indonesia Description: * Bank Indonesia projections are expected to increase by 32.3% to Rp. 266 trillion in 2021 (Graph 35). Meanwhile, digital banking payment transactions via SMS / mobile banking and online banking in 2020 are estimated to reach Rp. 27,036 trillion, slightly higher than in 2019, and are expected to increase significantly by 19.1% to Rp. 32,206 trillion in 2021 (Graph 36). About 15 banks have carried out a digital transformation so as to improve digital financial services, such as opening savings accounts, transfers and payments online, to live-chat services with customers. This development shows that digital banking in Indonesia has developed rapidly, and is able to catch up and even compete with payment transactions through fintech. Bank Indonesia continues to accelerate digital payment transactions through digital banking and fintech as well as interlinking both through Open API (Application Programming Interface) standards so that the public and the business world can choose which one is the cheapest, fastest, and safest. interests. The transformation is carried out through three pillars. The first pillar, Availability of Quality and Reliable Rupiah Currency, is through strengthening planning for meeting the needs of the Rupiah currency; strengthening of materials, safety elements and designs of Rupiah currency; preparing the implementation of redenomination, as well as strengthening integrity and a culture program to care for the Rupiah. The second pillar, Efficient Money Distribution System and Prime Cash Services is through efficient money distribution networks, strengthening cash services, and strengthening institutional architecture. The third pillar, Development of Adequate and TechnologyBased Rupiah Currency Management Infrastructure, is through digitizing processing of the Rupiah currency, infrastructure optimization, as well as integrated and compatible cash equipment. The transformation of Rupiah currency management through these three pillars is a manifestation of Bank Indonesia’s strong commitment to maintaining the integrity and credibility of the Rupiah as legal tender, as well as a unifier and pride for the Republic of Indonesia and the Indonesian nation. In Rupiah currency management, Bank Indonesia has also carried out a transformation in the printing and circulation of money through centralization, automation and efficiency, throughout the Republic of Indonesia. This transformation is directed at providing currency fit for circulation, appropriate denomination, “just in time”, is “central bank driven”, aligning the direction of non-cash policies and taking into account efficiency and national 27,036 5,000 12.4 26,639 10,000 47.2 32,206 30,000 25,000 145.2 35,000 Money Market Deepening: Effectiveness of Policy Transmission and Financing Bank Indonesia has accelerated money market reforms to strengthen monetary policy transmission BANK INDONESIA’S ANNUAL MEETING 2020 and to support financing for the economy. To that end, Bank Indonesia has formulated the Money Market Deepening Blueprint (Blueprint Pendalaman Pasar Uang - BPPU) 2025. The goal is to create fluid and efficient financial market conditions to support monetary stability, financial system stability and to create a conducive climate for financing national development (Scheme 3). The focus is on developing a market ecosystem that is modern with international end-to-end standards covering the 3Ps + I aspects, namely Products (instruments), Providers (and users of funds, intermediaries), and Pricing (benchmark rates and standardization), with Infrastructure (market infrastructure, regulatory framework, as well as coordination and education). This target is achieved through 3 (three) main strategies, namely: (i) Encouraging Digitalization and Strengthening of the Financial Market Infrastructure (FMI), (ii) Strengthening the Effectiveness of Monetary Policy Transmission, and (iii) Developing Sources of Economic Financing and Risk Management. Bank Indonesia focuses on the development of the money market, foreign exchange market and Islamic money market, in close coordination with the OJK that focuses on the stock market, bond market and structured product markets. BPPU 2025 is implemented through 3 (three) main initiatives to develop a modern and international standard money market. The Strategic Business Plan (SBP) for the three main initiatives will be implemented from 2020 to 2025 (Scheme 4). The first initiative is to encourage digitization and strengthening of money market infrastructure including trading venues such as the electronic trading platform (ETP), central counter party (CCP), BI-SSS, BI-RTGS, and trade repositories (TR). The second initiative is to increase the effectiveness of monetary policy transmission through the expansion of the instruments of the Repurchase Agreement (Repo), IndONIA and JIBOR, Overnight Index Swap (OIS), DNDF, and Local Currency Settlement (LCS) with a number of countries. Meanwhile, the third initiative is to develop sources of economic financing and risk management, such as long-term hedging instruments, asset securitization, Scheme 3. Money Market Deepening Blueprint (Blueprint Pendalaman Pasar Uang - BPPU) 2025 VISION Creating a liquid and efficient financial market condition to support monetary stability, the stability of financial system, and a conducive climate for financing national development MISION Implementing the development of the Money Market and Forex Market and Other Financial Markets through Strengthening the Elements of the Financial Market Ecosystem to increase Market Credibility The creation of a deep, liquid, efficient, inclusive and safe financial market Money Market Forex Market Encouraging Digitalization & Strengthening the Financial Market Infrastructure (FMI) The availability of sources to finance the national economy 6 MARKET Bond Market Strengthening the Effectiveness of Monetary Policy Transmission Developing Sources of Economic Financing & Risk Management Stock Market Financial Market Ecosystem Instruments Providers and Users of Funds Intermediaries Benchmark Rate & Standardization Market Infrastructure Regulatory Framework Coordination & Education Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 4. The Three Main Initiatives of Money Market Deepening Blueprint 2025 Initiative of Money Market Deepening Blueprint Encouraging Digitization and Strengthening of The Financial Market Infrastructure Increasing The Effectiveness of Monetary Policy Transmission Developing Sources of Economic Financing and Managing Risk Trading Venue/BI-ETP Repo Central Counterparty IndONIA dan JIBOR Long Term Hedging Instrument BI-SSSS Overnight Index Swap Sustainability and Green Financing BI-RTGS DNDF Retail Investor Trade Repository LCS Asset Securitization Source: Bank Indonesia sustainable and green finance, and expansion of the retail investor base. For the successful implementation of BPPU 2025, especially with the third initiative, Bank Indonesia is coordinating closely with the Government and OJK in the Financial Market Deepening Coordination Forum (Forum Koordinasi Pendalaman Pasar Keuangan -FK-PPK) as well as with the financial industry and with strategic partners. Empowerment of Sharia Economy and Finance, and MSMEs communities, to large scale at the industrial level. This is applied in the leading sectors of agriculture, fashion, Muslim friendly tourism, and renewable energy. The second pillar, Islamic finance, expands financial products and access both commercial - namely banking, financial markets and other financial institutions; and social finance - namely zakat, infaq / shodaqoh, and waqf. The third pillar, education and outreach, is implemented through the development of a curriculum for Islamic economy and finance, entrepreneurship, as well as the establishment of three Sharia Financial Economics Festivals (Fesyar) at the regional level, and ISEF at the national and international. Bank Indonesia continues to accelerate the development of Islamic economy and finance as a new source of growth for the Indonesian economy. The goal is to build a halal value chain ecosystem through three main pillars. The first pillar, the sharia economic empowerment, is directed at building halal supply chains, from small and medium scale in Islamic boarding schools (pesantren) and Muslim Sharia financing for economic recovery has also been strengthened through improved liquidity management of sharia banks. In 2020, Bank Indonesia issued provisions for a new Sharia Interbank Money Market (Pasar Uang Antar bank Syariah - PUAS) in the form of an Interbank Sharia Fund Management Certificate (Sertifikat Pengelolaan Dana Berdasarkan Prinsip Syariah Antar bank - SiPA), with a wakalah bi al-istitsmar BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 5a. PaSBI Mechanism TRANSACTION MECHANISM “PaSBI” 3. Delivery of Funds (without ujrah) *) 1. Statement letter and sales power agreement 2. Wakalah bi al-istitsmar contract, among others: a. Transaction Value b. Period of Time c. The expected rate return of the OMS d. Nominal value and type of SBS collateral (SBSN/SukBI/SBIS) 3. SBS collateral pledge 4. Fund management that produces a minimum return equals to the expected return rate of OMS SHORT (BUS/UUS) 5. Returns of funds and investment returns**) *) 1st leg Value = SBS nominal pledged x (SBS Price – haircut) Overall sharia banks /sharia business units BI-SSSS 5. Released pledge of SBS collateral **) 2nd leg Value = 1st leg Value + management result (istitsmar) 6. Execution of SBS collateral Source: Bank Indonesia Scheme 5b. FLiSBI Mechanism TRANSACTION MECHANISM “FLiSBI” 3. SBS collateral pledge 3. Delivery of funds*) 1. Power of sale agreement letter (once at the beginning) 2. Qardh and rahn contracts, among others: a. Transaction Value b. Period of Time c. FF Rate, or the level of cost of storage and maintenance of collateral (mu’nah) d. Nominal value and type of SBS collateral (SBSN/SukBI/SBIS) 4. Refunds and cost of storage and maintenance collateral (mu'nah) **) BI-SSSS SHORT (BUS/UUS) 4. Released pledge agunan SBS 5. Execution of SBS collateral *) Value at disbursement(1st leg) = SBS nominal pledged x (SBS Price – haircut) **) Value at due time (2nd leg) = Value at disbursement (1st leg) + collateral storage and maintenance costs (mu’nah) Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 contract. SiPA can be traded at PUAS in three types, namely with the project being financed of securities as the underlying, or securities, or a combination of both. In addition to multiplying PUAS instruments as liquidity management for sharia banking, SiPA is also in line with Bank Indonesia Sukuk (Sukuk Bank Indonesia - SukBI) which has been issued as a monetary operation instrument with SBSN as the underlying transaction. In addition, Bank Indonesia also strengthened the sharia monetary operations by issuing new liquidity injection instruments in the form of Bank Indonesia Sharia Principles Liquidity Management (Pengelolaan Likuiditas Berdasarkan Prinsip Syariah Bank Indonesia - PaSBI) with a wakalah bi al-istitsmar contract and Bank Indonesia Sharia Based Liquidity Facility (Fasilitas Likuiditas Berdasarkan Prinsip Syariah Bank Indonesia - FLiSBI) with a qard contract and rahn (Schemes 5a and 5b). All of these are expected to further enhance the role of Islamic banking in financing the economy. The series of Fesyar and ISEF events in 2020 will further strengthen the synergy and the progress achieved in the development of Sharia economy and finance in Indonesia. The series of Fesyar and ISEF activities include national and international webinars, business coaching and matching, workshops, international showcases, with more than 700 exhibition participants (Scheme 6). Most of the activities were aimed at accelerating sharia economy, including through the development of Islamic boarding school businesses, halal economic associations and industries, halal certification, international tourism forums, and digitalization and economic inclusion conferences. In the field of Islamic finance, activities include Islamic financial investment forums, waqf development, and a number of international conferences. These include the organization of “Financial Intermediary Day Business Deals (Banks, Fintech, and Businesses)”, as well as “Indonesia Modest Fashion Show” by Scheme 6. 2020 Fesyar and ISEF: Indonesia, the Center of the World Sharia Economy and Finance SYNERGY OF ECONOMIC DEVELOPMENT AND SHARIA FINANCE AS A SOURCE OF INDONESIA'S NEW ECONOMY ISEF FESYAR PARTICIPANTS 7 August - 31 October 2020 EAST REGION SUMATRA REGION JAVA REGION EVENTS SHARIA FORUM SMES EXHIBITION COMPETETION BUSINESS COACHING BUSINESS MATCHING ACTIVITIES 431,685 EXHIBITOR INTERNATIONAL WEBINAR INTERNATIONAL SHOWCASE WITH 100 CONTRIBUTORS COUNTRIES 166,4K DESAINER SUSTAINABLE FASHION TOTAL TRANSACTIONS BUSINESS COACHING-MATCHING COMPETITIONS Rp VIRTUAL VISITOR WAQAF COMMITMENT POTENTIAL BUYER Rp Source: Bank Indonesia Trillion 30.3 billion BANK INDONESIA’S ANNUAL MEETING 2020 185 designers from all over Indonesia. The ISEF series was attended by more than 430 thousand participants and resulted in a total transaction of around Rp. 5 trillion and Rp. 30.3 billion in waqf commitments. It is a great pride that an increasing number of institutions, associations, and various parties, national and international, has joined and congregated in ISEF for the acceleration of the economy and Islamic finance. We continue to enhanceour MSMEs development program through 3 (three) policy pillars, namely Corporatization, Capacity, and Financing (Scheme 7a). The MSMEs institutional aspects continue to be strengthened through corporatization, supported by strong social capital. Groups are built on the basis of mutually beneficial cooperation, directed at increasingly formal and modern institutional forms, including cooperatives, limited liability companies, and other institutional forms. MSMEs engaged in export potential businesses are supported, such as handicrafts, fabrics and fashion, food and beverages, including coffee, as well as agriculture and other local potential sectors. Integration of digital economy and finance is accelerated through a payment system infrastructure that is fast, easy, cheap, safe and reliable through MSMEs onboarding program. In addition, business cooperation between MSMEs and between MSMEs and large businesses and financial institutions are also initiated. Bank Indonesia also builds synergies with ministries, institutions, associations and communities to encourage MSMEs to graduate (Scheme 7b). This synergy is in the form of capacity building, MSME onboarding, talk shows, business matching, business coaching, and joint expos in the regions and abroad. Likewise, synergy is also build to support the National “Proudly Made in Indonesia Movement” (Gerakan Nasional Bangga Buatan Indonesia -Gernas BBI). The above synergy for the development of MSMEs is the spirit of the series of Indonesia Creative Work (Karya Kreatif Indonesia - KKI) events held by Bank Indonesia in 2020. The three 2020 KKI Scheme 7a. Indonesian MSME Development Framework Encouraging Competitive MSME's for Accelerated Inclusive Economic Growth Subsistence Group Micro Group Corporatization 1. Synergy Between Central And Regional National Policies End to End Technical Assitant Marketing Access Ease of Business Facilities / Infrastructure Access to Finance Ministries / Agencies / Legislative / Regional Governments Financial Services Industry / Investor / Philanthropy Small Group Capacity Medium Group Financing 2. Priority Sectors Agriculture Fisheries Manufacturing Tourism University Company (Supply Chain) 3. Integrated Business Model Cluster Formation, Halal Value Chain Ecosystem Capacity Building and Financing, Replication Association / Community / Islamic Boarding Chool Business Community Digital Platform Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 7b. MSMEs as the New Sources of Economic Growth Economic and Financial Inclusion as New Sources of Economic Growth SUBSISTENCE SMALL AND MEDIUM MICRO POLICY SYNERGY CREDIT/COMMERCIAL FINANCING Fintech Direct Credit, Linkage Credit, Special/Sectoral Credit, P2P Lending, Crowd Funding Factory, Venture Capital, ISWAF Special Financial Institutions (LPEI) Revolving Fund, KUR, Kreasi UlaMM, Umi, PMD (daya), Mekaar,PKBL BLU (LPDB, PIP) State-owned enterprises /Corporation SOCIAL FUNDING/ ZISWAF PRIORITIZATION BUDGET STATE PRIVATE INSTITUTION DONORS / FOUNDATIONS / INTERNATIONAL / MULTILATERAL ORGANIZATIONS SOCIETY PAYMENT SAVING CREDIT INVESTMENT Policy Synergy Mekaar, Filantropi (BMGF, Dompet Dhuafa), BWM, CSR, PSBI Village Goverment Donor state-owned enterprises/ corporation profit state budget/ regional budget/ revolving budget INSURANCE Channels of Delivery i.e NGO, Fintech, Social Institution (LAZ) SOURCES OF FINANCING EDUCATION AND LITERACY Bank & Non-bank financial institutions Special Financial Institutions (Pegadaian, PNM) CREDIT/SUBSIDIZED FINANCING INTEGRATION OF DIGITAL ECONOMY AND FINANCE MANAGEMENT AGENCY Commercial Productive Financing Financial Activities Financial Activity Small is Beautiful Source: Bank Indonesia series have the theme “Encouraging MSMEs as New Strengths of the National Economy in the Digital Age”. The 2020 KKI series 1 on 28-30 August was as a synergy between Bank Indonesia, the Ministry of Foreign Affairs, the Ministry of Cooperatives and MSMEs, the Ministry of Industry, and the Ministry of Trade to focus on encouraging exports by MSMEs. The 2020 KKI Series 2 dated 7-9 October 2020 promoted a synergy between Bank Indonesia, the Ministry of Manpower, the National Craft Council (Dewan Kerajinan Nasional - Dekranas), the Ministry of Tourism and Creative Industries, the Ministry of Communication and Information to focus on encouraging Digital MSMEs. Lastly, the 2020 KKI 2020 on 20-22 November, that was opened by the First Lady, was focused on encouraging synergy for MSMEs as Friends of Millennials. The three 2020 KKI series events featured superior products of MSMEs that are under the guidance program of by Bank Indonesia which were displayed with leading Indonesian designers. Likewise, virtual showcase on the KKI platform nationally, as well as, physically showcases with COVID-19 protocols, at various Bank Indonesia Representative Offices were held. Workshop activities, business matching and coaching, and international showcases were also held to strengthen the existence of MSMEs as a new force for the national economy (Scheme 8). Strengthening International Policy Bank Indonesia continues to strengthen international cooperation in coordination with the Government to support economic recovery and maintain macroeconomic and financial system stability, both globally and domestically. International policy diplomacy strategies are continuously being developed, both in terms of stance as well as diplomacy strategies, enhancing cooperation, managing partner countries’ perceptions, and strengthening global surveillance, BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 8. 2020 KKI in Figures: MSMEs the Strength of Indonesia’s Economy Synergy Encourages MSMEs as a New Economic Force for the Economy in the Digital Era JOINT EVENT ONBOARDING EDUCATION DEKRANAS/DEKRANASDA (NK) MINISTRIES/ INSTITUTION KEMENKO MARVES (HIS) KEMENKOP DAN UKM (HIS) KEMENLU (WEBINAR BERSAMA) KEMENKEU (BC) KEMENPAREKRAF (HIS) KEMENDAG (HIS, EDUKASI ONBOARDING, BC) KEMNAKER (MT, JOINT EVENT) KEMENDIKBUD (MT) KEMENDES PDTT (MT) KEMENKOMINFO (HIS) OJK (HIS, JOINT EVENT) KADIN (WEBINAR BERSAMA) IDEA-ASOSIASI E-COMMERCE INDONESIA (EDUKASI ONBOARDING) SCAI-SPECIALITY COFFEE ASSOCIATION OF INDONESIA (DIALOG KOPI) AFPI - ASOSIASI FINTECH PENDANAAN BERSAMA INDONESIA (BM) DIGITAL PLATFORM ALIBABA.COM BLIBLI.COM FINANCIAL INSTITUTION BUSINESSES YUSHOGI MEDIA GROUP JUARA SNACK AFBI-19 EATLAH BANDROS BUJUK RAYU BUMI KARDUS BRI BANK MANDIRI BNI PNM COMMUNITIES TANGAN DIATAS COMMUNITY DESIGNER COMMUNITY NUMBER OF VISITORS 64,763 60,000 40,000 20,000 ACTIVITIES CREATIVE WORK PERFORMANCES TALKSHOW WORKSHOP BUSINESS COACHING BUSINESS MATCHING MINISTRY TALKS EDUKASI ONBOARDING JOINT EVENT DENGAN K/L: WEBINAR DAN HIGH IMPACT SEMINAR 18,911 4,465 7,592 10,901 TOTAL TURNOVER 16.51 12.39 2.68 4.5 7.01 BUSINESS MATCHING SME’s PARTICIPANTS JAVA BALI NUSA TENGGARA SUMATRA SULAWESI 113.2 73.4 Source: Bank Indonesia to support the interests of Bank Indonesia and / or the Indonesian economy at the international level, including cooperation in managing the economic impact of the COVID-19 pandemic. International and Asia regional cooperation is increasingly expanded, including in the form of International Financial Safety Net (Jaring Pengaman Keuangan Internasional -JPKI) and Local Currency Settlement (LCS). Currently, Bank Indonesia has collaborated in the Bilateral Currency Swap Arrangement (BCSA) with China, Japan, South Korea, Australia and Singapore, as well as a Repo Agreement with the New York Fed and the BIS. Meanwhile, LCS cooperation has been established with Japan, China, Malaysia and Thailand. Institutional cooperation has also been expanded under the framework of Structured Bilateral Cooperation (SBC) with a number of central banks such as the New York fed, Japan and Central Bank of The Republic of Turkey, as well as with international institutions such as the BIS. Bank Indonesia has also played an active role in bolstering positive international perceptions, particularly rating agencies and foreign investors, on the Indonesian economy. This is done through intensive communication and engagement with rating agencies and foreign investors on a regular basis, especially the Investor Conference Call (ICC) a each monthly Board of Governors Meeting and any strategic policies that need to be communicated. Investment and trade promotions are also carried out through the Investor Relations Unit (IRU) both nationally, regionally and globally, through Bank Indonesia representative offices in various regions, in collaboration with the Government (Central and Regional), as well as Indonesian Embassies abroad. For example, during 2020 Bank Indonesia cooperated and actively participated in the Indonesia Investment Forum (IIF) in Singapore, the Central Java Investment Business Forum (CIJBF), and the West Java Investment Summit (WJIS), all of which were held virtually. BANK INDONESIA’S ANNUAL MEETING 2020 Bank Indonesia also continues to gain international recognition as the best central bank among emerging market countries. This is supported by increased representation of Bank Indonesia in international cooperation fora, both through membership and chairmanship, in international cooperation forums. The reputation of Bank Indonesia is also enhanced by gaining international awards from reputable international institutions, application of a number of international standards, publishing internationally acclaimed research publications and journals, as well as being reference and resource persons in various strategic international events. In 2020, Bank Indonesia was awarded as The Best Macroeconomic Regulator in the Asia Pacific Region 2020 from the Asian Banker; QRIS-the Best Payments Innovation Award from Central Banking Publication; and Asia Pacific Stevie Awards - Award for Innovation in Technology Management, Planning, and Implementation 2020 from The Stevie Awards. This international recognition was received after in 2019, Bank Indonesia was also awarded the Central Bank Governor of the Year, Asia Pacific 2019, from Global Capital and the 2019 Contact Center Award from Contact Center World. Transformation of Bank Indonesia Internally, we continue to improve through the transformation of policies, organization and work processes, human resources (HR) and work culture, as well as digitization. This institutional transformation of Bank Indonesia was realized by strengthening the Vision, Mission, and the formulation of the 2020-2025 Strategic Business Plan (SBP), namely to realize “Bank Indonesia as the leading digital central bank in contributing significantly to the national economy and the best among Emerging Markets for Advanced Indonesia.” We will not only strengthen the response to the Bank Indonesia policy mix for economic recovery as described above, but also to support economic transformation towards an advanced Indonesia. The transformation of Bank Indonesia since May 2018 Scheme 9. Organizational Transformation Building Superior Performance ORGANIZATIONAL TRANSFORMATION Implementing an Excellent Performance Organizational Framework and ensuring a more effective and efficient work process Digitization of policy and institutional business processes to support BI digital Ensuring the availability of resources (HR, assets and IT) to support policy transformation and institutional management Prepare the organization, business processes, and infrastructure in the context of moving to a new IKN Source: Bank Indonesia Creating an Excellent Performance and Digital-Based Organization Creating a Prime and Credible Governance Optimizing the integrated role of the 4 governance functions in overseeing the formulation and implementation of policies and institutions Ensuring BI's medium-term financial sustainability and credibility through WTP audit opinion Maintain the legal mandate of BI in various laws and regulations. Strengthening stakeholder engagement through synergy and communication BANK INDONESIA’S ANNUAL MEETING 2020 has been strengthened and expanded into 4 (four) main agendas, namely: (i) policy transformation, (ii) organizational transformation, (iii) human resources transformation, and (iv) digital transformation. The entire SBP 2020-2025 has been translated into 12 Strategic Programs, with targets to be achieved and main strategies to be implemented in the next 5 years. More than that, the 2020-2025 SBP has also been equipped with resource planning, including financial planning, human resources, information systems, as well as logistic assets and work facilities. We are strengthening our organizational transformation to create a digital-based superior performance organization and create prime and credible governance that is in line with the strategic direction of Bank Indonesia. The refinement of the new Bank Indonesia organization was supported by the digitization of business processes to support various business procedures, from policy formulation to institutional management (Scheme 9). Organizations with prime and credible governance are strengthened by the integration of 4 (four) governance functions (strategic management, strategic finance, strategic risk management, and strategic risk based internal audit) in overseeing the formulation and implementation of policies in core and institutional management areas. To support the policy and institutional transformation, the availability of resources (human resources, assets and information technology) has also been formulated, including more optimal logistics management and preparation for the organization, business processes and infrastructure. Organizational strengthening in the area of institutional governance is also pursued through more accountable financial management to ensure the medium-term financial sustainability of Bank Indonesia and the achievement of an audit opinion (Wajar Tanpa Pengecualian - WTP). We continue to improve HR transformation to strengthen competent, professional, and principled leadership and employees of Bank Indonesia. Since May 2018, HR policies have been implemented in a programmed, scheduled, and transparent manner covering 4 areas, namely Planning, Fulfillment, Scheme 10. Transformation of Professional, Competent, and Principled Human Resources TRANSFORMATION OF HUMAN RESOURCES PLANNING 1. Strengthening and perfecting manpower planning that is in line with the needs of the digital era and in the context of moving to a new IKN; 2. Mapping of new capabilities & suitability of human resources to carry out policy and institutional work processes in the digital era. COMPLIANCE 1. Improvement of compliance strategies in terms of quality & quantity that support digitalization; 2. Optimization of HR analytics for employee fulfillment. 4P 1. Strengthening the mindset and behavior of human resources that support the digital era 4.0 through work culture programs; 2. Change program platform integration with other HR management; 3 Strengthening the Employee Value Proposition (EVP) PRESERVATION 1. Strengthening strategy & development of competencies regarding central bank in the digital era 2. Embody BI as a leading think tank in economic policy analysis 3. Optimization of technology based learning, supporting the implementation of the Kampus Merdeka 4.0 & the initiation of central banking 5.0 DEVELOPMENT Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Development and Maintenance of HR (Scheme 10). Human resource transformation is emphasized on quality over the quantity. HR planning has been prepared for the next 5 (five) years as the basis for HR development, both per work unit, level of position, task group (job family), and competence. Fulfillment strategies in terms of quality and quantity that support digitalization are enhanced, including specific human resources competency such as data scientists, data engineers, cyber security specialists, and project management. In the area of human resource development, the transformation is carried out by intensively strengthening central banking competencies in the digital era through the BI Institute, and in efforts to make Bank Indonesia a leading think tank in economic policy analysis, and optimization of technology based learning. The leadership regeneration program has been organized and programmed through a strict selection of Potential Employee Groups (Kelompok Pegawai Potensial - KPP) and 4 (four) levels of Leadership Schools and will continue to be implemented consistently. The work culture program that is packaged into BI-Prestasi, BI-Inovasi, BI-Religion, and BI-Digital is implemented in an integrated manner into business processes so that it truly integrates with the implementation of Bank Indonesia’s duties. Digital transformation at Bank Indonesia is thoroughly implemented in both policy and institutional areas so as to become the leading digital central bank. The digital transformation aims to turn Bank Indonesia into a data driven institution with high analytics capability, digitalization of business processes, international standard information system service quality, as well as high data and digital literacy (Scheme 11). In order to maintain good governance, all of these digital transformations are included in the 2025 Bank Indonesia Information System Master Plan (Rencana Induk Sistem Informasi Bank Indonesia - RISIBI). Digital transformation is focused on (i) building an omni experience technology platform and technology support including cyber security and Scheme 11. Digital Transformation: Towards the Leading Digital Central Bank DIGITAL TRANSFORMATION Digital Transformation is implemented through the IS Transformation Architecture which includes; 1 Information Architecture DEVELOPMENT IN INFORMATION SYSTEM IMPLEMENTATION FRAMEWORK POLICIES AND INSTITUTIONS OMNI EXPERIENCE PLATFORM 3 Technology and Security Architecture 1. Development of payment system business platforms and financial market infrastructure 2. Development of a business platform to support the digitization of policy and institutional business processes 1. Building a data center and policy information service (INDRA) and institutional (INTUERI) 2. Building data analysis tools and digital citizens (such as monthly RDG usecase, integration of 4 functions, etc.) 3. Leveraging data analytics to support key policy business processes DEVELOPING INFORMATION SYSTEM (IS) INFRASTRUCTURE 1. Revitalizing DC-1 and builing DC-2 2. Adopting cloud technology 3. Developing data and identity-based information system security 4. Modernization of End User Devices A ROBUST INFORMATION SYSTEM (IS) OPERATIONAL MANAGEMENT 1. Maintain service quality according to international standards and best practices 2. Continuously increase the capacity of the information system 3. Strenghten cyber resilience Source: Bank Indonesia 2 Application Architecture BANK INDONESIA’S ANNUAL MEETING 2020 networks, (ii) building an omni channel repository (data center) that includes metadata preparation and data capturing mechanisms, and (iii) encouraging policy and institutional digitization initiatives. Digitalization is done top-down, maximizing the existing information and reporting system platform, compiling massive metadata as needed, and changing the mindset to improve experience. Digital transformation is expected to provide an omni experience that further strengthens engagement internally between Bank Indonesia leaders and employees, as well as externally with partners in a seamless, fast and interactive manner. Synergize to Build Optimism for Economic Recovery: One Prerequisite, Five Principal Strategies National economic recovery is underway and will continue to increase in 2021 as well asin the medium term. As stated above, Bank Indonesia estimates that Indonesia’s economic growth in 2021 will reach 4.8-5.8%, supported by an increase in export performance, private and government consumption, as well as investment from both Government capital expenditures and foreign capital inflows as a positive response of the implementation of the Job Creation Act. Spatially, growth will increase in all regions, especially Java and the Sulawesi-Maluku-Papua region. Macroeconomic and financial system stability will be maintained. Inflation will be controlled within the target of 3±1% in 2021, while the Rupiah exchange rate will be stable and still have the potential to strengthen. External stability will be maintained, with a balance of payments surplus supported by a low current account deficit of around 1.0-2.0% of GDP and foreign capital inflows, both FDI and portfolio investment. Financial system stability is also getting better, with a high capital adequacy ratio, low non performing loan, and growth in deposits and credit that will increase to around 7.0-9.0% in 2021. In the medium term, we predict that Indonesia’s economic growth will continue to increase in the range of 5.56.1% with low inflation in the range of 1.5-3.5% and a current account deficit in the range of 1.5-2.5% of GDP in 2025. Overall, with this projected trajectory, Indonesia is predicted to become a high-income country by 2045. We need to encourage the momentum for national economic recovery by strengthening the synergy to build optimism. Synergy by all parties: The Government (Central and Regional), Bank Indonesia, Financial Services Authority (Otoritas Jasa Keuangan - OJK), Deposit Insurance Corporation (Lembaga Penjamin Simpanan - LPS), the banking and financial sector, business, academia, media, and the society. United, synergized, and working together to build optimism for economic recovery. In this regard, we are of the view that there is theneed for vaccination and discipline in applying the COVID-19 protocols as a necessary condition, as well as 5 (five) policies as sufficient conditions, namely: (i) opening of the productive and safe from COVID-19 sectors, (ii) acceleration of fiscal stimulus, (iii) boosting credit both from demand and supply sides, (iv) continuing monetary and macroprudential stimuli, and (vi) economic and financial digitization, particularly MSMEs (Scheme 12). In the synergy to build optimism for national economic recovery, Bank Indonesia is committed to strengthening the fourth policy, namely continuing monetary and macroprudential stimulus, as well as the fifth policy, namely accelerating the implementation of BSPI 2025 to encourage economic and financial digitization, especially MSMEs. God willing, we are optimistic that with the synergy of these policy steps, we can realize national economic recovery in 2021. Vaccination and the discipline of COVID-19 protocols are prerequisite conditions for national economic recovery. It needs to be emphasized again that the epicenter of the problems we are facing is the COVID-19 pandemic. Therefore, speed and success in dealing with the COVID-19 pandemic is a prerequisite so that the impact on health can be minimized, human mobility can gradually return to normal, economic activity and business conditions improve, while the impact of the spread to the BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 12. Building Optimism: One Prerequisite, Five Strategies Synergizing to Build Optimism for Economic Recovery PREREQUISITE CONDITIONS MAINTAINED STABILITY Vaccinations and Covid-19 Protocol Discipline IMPROVING GROWTH 7.07 2.98 9.99 9.84 8.14 INFLATION EC GR ON O 10.36 NFC EXTERNAL DEBT CONSTANT 1.44 2.19 9.24 RY ETA TY ON BILI M TA S C MI O TH W CREDIT INTEREST RATE 14.885 GOLD INFLATION 30.98 14.113 15.95 33.71 4.599 13.767 6.61 6.76 5.072 5.855 JCI 7.75 5 POLICY RESPONSE 1. Opening of Productive and Safe Sectors EXCHANGE RATE SY F I N ST A N CIA L Y E M S BILIT TA YIELD SBN10 Pre-COVID (Feb’20) Peak COVID (May’20) 2. Acceleration of Fiscal Stimulus (budget realization) 3. Credit Increment from Supply and Demand Side 4. Monetary Stimulus and Macroprudential Policy 5. Economic and Financial Digitalization, especially MSME October 2020 Source: Bank Indonesia financial and monetary sectors can be overcome. This optimism for economic recovery is what we need to create. In this regard, we fully support the Government’s efforts to order vaccines from a number of countries, including Sinovac from China, AstraZeneca from the UK, and possibly from other sources. Bank Indonesia has also committed to finance part of the cost of ordering the vaccine by purchasing and bearing the entire burden of Indonesia Government Bond (SBN) as part of the Joint Decree between the Minister of Finance and Bank Indonesia on “Burden Sharing” for Public Goods dated 7 July 2020. In this regard, it is important to remember that the vaccination process for most of the population will need time and, unlike any previous virus pandemic, strengthening antibodies to COVID-19 requires two vaccinations within a period of 6 (six) months. This means that even if vaccinations are carried out, the implementation of the COVID-19 protocols must still be carried out to prevent the second and even third waves of the COVID-19 pandemic. This is to ensure that economic recovery will continue through vaccinations and COVID-19 precautions. Opening economic sectors gradually that give large added value to growth and are relatively safe from the COVID-19 pandemic. Prioritization can start with a risk map for COVID-19 transmission in 52 (fifty-two) economic sectors compiled by the National Disaster Management Agency (Badan Nasional Penanggulangan Bencana - BNPB), with the highest priority given to sectors with the lowest risk of transmission, followed by sectors with medium or high risk where it will be necessary to implement COVID-19 protocols according to the risk level (Scheme 13). Meanwhile, prioritization based on economic impact can be prioritized on sectors that have the highest contribution to GDP and/or exports. Scheme 13 shows the results of mapping 52 (fifty-two) sectors according to their productivity and level of safety. The first priority, namely 6 (six) BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 13. Mapping of Priority Sectors: Productive and Safe LOW RISK – MEDIUM IMPACT 20.35% RISK OF TRANSMISSION (BNPB) • Other Financial Services • Financial Intermediary Services • Forestry and Logging • Fishery • Livestock • Coal and Lignite Mining • Ore Mining • Holticulture Plants • Plantation Corps • Government Administration, Defense, and Mandatory Social Security MEDIUM RISK – MEDIUM IMPACT 41.75% • Land Transportation • Sea Transportation • Rail Transportation • Transportation Equipment Industry • Metal Goods Industry • Non-Metal Mineral Industry • Furniture Industry • Rubber Industry • Wood Industry • Other Manufacture Industry • Food and Beverages • Machinery Industry • Textile and Apparel Industry • Company Services • Electricity • Construction • Wholesale and Retail Trade • Gas Supply and Ice Production • Real Estate • Tobacco Processing LOW RISK – HIGH IMPACT 12.15% 1ST PRIORITY • Crops • Agricultural and Hunting Services • Insurance and Pension Funds • Financial Support Services 2nd PRIORITY MEDIUM RISK – HIGH IMPACT 3.99% • Chemicals, Physics, and Traditional Medicine Manufacture • Base Metal Industry • Water Supply, Waste Management, Waste and Recycling • Leather Industry • Paper Industry 16.8% • Food and Beverages Industry • Chemicals, Physics, and Traditional Medicine Manufacture • Forestry and Logging • Holticulture Plants • Plantation Corps • Ore Mining • Information and Communication 21.6% • Wood Industry • Furniture Industry • Livestock • Base Metal Industry • Crops • Agricultural and Hunting Services • Water Supply • Tobacco Processing • TPT Industry • Information and Communication • Real Estate • Metal Goods Industry • Non-Metal Mineral Industry • Leather Industry • Machinery Industry ECONOMIC IMPACT (Deviation, Growth, Multiplier Output, Labor, And Value-Added) Source: Bank Indonesia sectors that are safe and provide a large contribution to both GDP and exports include the manufacture of food products and beverage industry; manufacture of chemical, pharmaceuticals, and botanical products; forestry and logging; horticultural crops; plantation; and iron ore mining. The second priority, namely 15 (fifteen) economic sectors that are safe and make a large contribution to GDP or exports, as shown in Scheme 13. Overall these two priorities contribute around 38% of national GDP. Thus, the opening of productive and safe sectors can be focused on companies that are included in these two priorities, both to ensure the COVID-19 protocols and with a number of incentive policies from related ministries and fiscal incentives for business. A relatively large amount of fiscal stimulus is still needed to support the national economic recovery. In the 2021 State Budget, the Government has budgeted for a fiscal deficit of IDR1,006.4 trillion (5.7% of GDP) after a deficit of IDR1,039.2 trillion (6.3% of GDP) in 2020. With a total state expenditure of IDR2.750.0 trillion, Central Government expenditure is allocated at IDR1,954.5 trillion. Of this amount a large portion, amounting to IDR1,686.2 trillion (86.3%), is allocated for strategic policies in the 2021 State Budget to support the acceleration of economic recovery and economic transformation towards an Advanced Indonesia (Scheme 14). We believe that the relatively large fiscal stimulus in the 2021 APBN will be able to encourage national economic recovery, both in terms of consumption and investment. The budget allocation for continued social protection of IDR408.7 trillion will be able to support consumption growth in GDP, as in 2020, through various programs including PKH, Cash Transfer, Basic Food Cards (Kartu Sembako), and Health Insurance Contribution Beneficiaries (Penerima Bantuan Iuran Jaminan Kesehatan - PBI-JKN). On the investment side, a large increase in the allocation of capital expenditures for infrastructure development to IDR417.8 trillion, after BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 14. Strategic Policies in the 2021 State Budget EDUCATION (Rp 550.0 T) 2021 STATEBUDGET STRATEGIC POLICIES Supporting economic recovery acceleration and transformation towards Advanced Indonesia INFRASTRUCTURE (Rp 417.8 T) Provision of basic services (flat, dam, access to sanitation, irrigation network) Improved connectivity (roads, bridges, airports, railroads) Support for economic recovery and continue delayed priority programs PISA score improvement Strengthening Early Childhood Education and Development (ECED) Improving of Teacher’s Competencies Through central government spending & Transfers to Village & Village Funds; School Operational Assistance Fund Program, Village Funds for ECED, Smart Indonesia Card (SIC), Teacher Allowances, Bidik Misi / SIC-College, Indonesia Endowment Fund for Education FOOD SECURITY (Rp 99.0 T) Increasing food production (rice, corn, soybeans, meat, etc.) Revitalizing the national food system Food estate development (Central Kalimantan, South Sumatra,Papua) HEALTH (Rp 169.7 T) Accelerating health recovery due to Covid-19 National health insurance reform Health Security Preparedness Priority for 2021: anticipating the procurement of vaccines & vaccinations, fulfillment of infrastructure/ lab/ R&D/ PCR, contribution assistance for participants who receive national health insurance contributions, construction / rehabilitation of health centers & hospitals, health operational assistance TOURISM (Rp 15.0 T) Encouraging the recovery of the tourism sector with a focus on 5 super priority areas (Lake Toba, Borobudur, Mandalika, Labuan Bajo, Likupang) PPP scheme development SOCIAL SECURITY (Rp 408.7 T) Continuing social protection Gradual reform: comprehensive social protection based on life cycle and anticipation of aging population Improvement of integrated social welfare data Priority for 2021: Family Hope Program (10 million beneficiary families), Cash Social Assistance (9 million beneficiary families), Basic Food Cards (20 million beneficiary families), National Health Insurance Contribution Beneficiaries (96.8 million people) ICT (Rp 26.0 T) Optimization of utilizing ICT to support and improve the quality of public services (efficiency, convenience and acceleration) Priority: Provision of BTS 5.053 in village locations, providing internet access in 12,377 public service locations, national data centers, etc. Source: Ministry of Finance being lowered to IDR281.1 trillion in 2020will raise investment growth in GDP in 2021. In addition, the increase in investment in 2021 is also supported by the continuation of a number of National Strategic Projects (Proyek Strategis Nasional - PSN) and the realization of foreign investment in utilizing various facilities and incentives in the Job Creation Law. Synergy in boosting bank credit from the demand and supply side is necessary, particularly in productive and safe sectors. As stated above, the growth of bank credit in this year is estimated to reach the range of 7% - 9%. Demand for credit will increase in line with improving corporate conditions, particularly large ones, with increased sales, the ability to pay (interest coverage ratio, ICR), as well as surveys showing increased financing needs and plans for credit applications, issuance of bonds and stocks, as well as for domestic debt in the next 3 to 6 months. Credit supply will also remain conducive supported by low interest rates, abundant liquidity, improved credit requirements (lending standards), and the extension of the credit restructuring program by OJK. The problem, however, is that there is still high risk perception from the banking side and from the corporate side to start expanding, due to the high level of uncertainty due both to the COVID-19 pandemic and the process of economic recovery. Synergy in overcoming the asymmetric information in the credit crunch needs to be done by bringing together corporations, particularly in sectors that contribute to high growth and exports, with the readiness of banks to extend credit. The fourth quadrant (colored green) in Scheme 15 shows the industries that need to be continuously encouraged for growth and exports because of the highest banking readiness with increasing credit growth and large remaining credit limit (undisbursed loan). Meanwhile, the first quadrant (colored red) requires credit guarantees and interest subsidies from the Government to overcome the perception of high credit risk in banks. This kind of synergy will be even stronger when combined with vaccinations and BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 15. Boosting Credit: Demand-Supply Matching CREDIT GROWTH MAPPING (%YTD) AND UNDISBURSED LOAN (%YTD) BY SUBSECTOR (PER AUGUST 2020) 3rd Quadrant: Credit (-) and UL (+): Lagging Credit Growth Area 4th Quadrant: Credit (+) and UL (+): Sustainable Credit Growth Area Decrease in corporate credit along with increase in undisbursed loan Leverage Low -80 Non-Metallic Mineral Industry Medium Risk of Transmission Low Risk of Transmission 1st priority subsector Basic Metals Industry -40 -20 Livestock -40 2 priority subsector Credit Growth (Ytd %) Crops Forestry Industry -20 Clean Water Provision Agriculutral Services st nd Food and Beverage Industry Chemical Industry -60 Leverage Profitabilitas Overall High High Higher Quality 1 1 priority subsector 3 2 priority subsector Leather, Leather Products, and Footwear st -100 Likuiditas Low Post and Telecommunications Wood Industry Tobacco Industry Undisbursed Loan (Ytd %) Repayment High Metal Products Industry 2 1 priority subsector 4 2 priority subsector Sales High Horticultural Agriculture nd Non financing support Increase in corporate credit and undisbursed loan Profitabilitas Overall High Higher Quality Growth Sustainability Likuiditas High Furniture Industry Machinery and Equipment Industry Real Estate Metal Ore Mining nd -60 0 1 priority subsector 3 2 priority subsector Plantation Crops 3 1 priority subsector 5 2 priority subsector st st nd Sales Low Repayment Low Likuiditas High Leverage High -80 Profitabilitas Overall Low Lower Quality nd Textile Industry Sales Low -100 Repayment Low Likuiditas Low Leverage Profitabilitas Overall High Low Lower Quality Guarantee + Interest Subsidy Repayment High Non financing support Sales High 1st Quadrant: Credit (+) and UL (-): Limited Credit Growth Area 2nd Quadrant: Credit (-) and UL (-): Avoided Credit Growth Area Increase in corporate credit along with decrease in undisbursed loan Decrease in corporate and undisbursed loan Note: There are two additional industrial subsectors, namely motor vehicles and pulp in the 4th quadrant, calculated using HS8 data. Source: Bank Indonesia provision of fiscal simulus such as tax incentives and ease of doing business from the Government. Bank Indonesia is committed to continuing to work together to build optimism for national economic recovery through the fourth policy, namely monetary and macroprudential stimulus, and the fifth policy, namely economic and financial digitization. Bank Indonesia will continue to direct all policy instruments to support the national economic recovery, while keeping inflation under control, maintaining stability of the Rupiah exchange rate, and supporting financial system stability. We will also continue to coordinate closely with the Government and the Financial System Stability Committee (KSSK) to strengthen the national economic recovery, while maintaining macroeconomic and financial system stability. The monetary stimulus and accommodative macroprudential policies will be continued and closely coordinated with the Government’s fiscal stimulus and OJK’s policies to support credit/financing, thereby further stimulating economic demand and growth. Payment system digitalization and money market deepening efforts will be accelerated to further encourage the digital economy and finance, including MSMEs and the Islamic finance economy, in a close synergy with the Government, KSSK, banking, fintech, the business world and the wider community. We believe that the digital economy and finance will increasingly play an important role in the recovery of the national economy. The following section describes in detail the Bank Indonesia policy mix for 2021. Bank Indonesia Policy Mix for 2021: Supporting Optimism for National Economic Recovery The policy mix of Bank Indonesia for 2021 is directed towards strengthening optimism for the national economic recovery while maintaining macroeconomic and financial system stability. The policy mix will be implemented through both BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 16. Bank Indonesia Policy Mix for 2021 BANK INDONESIA 2021 POLICY MIX: REINFORCING ECONOMIC RECOVERY OPTIMISM Exchange Rate Stability Monetery Foreign Policy Payment System Digitalisation Easing Liquidity Payment System Accommodative Macroprudential Macroprudential Policy Financial Market Deepening Digitalisation of Cash Distribution Sharia economics and finance Low Interest Rate Digital MSMEs & Exports Supporting Policies Source: Bank Indonesia monetary, macroprudential, and payment system policies as well as supporting policies in MSMEs, shariaeconomy and finance, international area (Scheme 16). Monetary policy stimulus will continue up until there are signs of increasing inflationary pressure, while stability of the Rupiah exchange rate remains our priorities. The accommodative macroprudential policies will be continued to boost credit and financing for national economic recovery, while maintaining financial system stability. The digitalization of the payment system according to BSPI 2025 and the management of Rupiah currency according to BPUR 2025 continues to be accelerated to support the digital financial economy as a source of economic recovery, especially MSMEs and the retail sector. Bank Indonesia will continue to strengthen synergies with the Government, the KSSK, banks and the business world to strengthen optimism for national economic recovery. Monetary Policy Direction Monetary policy stimulus will continue in 2021. The stability of the Rupiah exchange rate in accordance with the fundamentals and market mechanisms continues to be a major concern to ensure that it remains conducive to national economic recovery. Low interest rates and loose liquidity will be maintained until there are signs of increasing inflationary pressure. As noted, the current Bank Indonesia policy rate of 3.75% is the lowest in history. Liquidity will also remain loose to support bank lending and financial system stability. As previously stated, Bank Indonesia has implemented Quantative Easing of IDR682.0 trillion, or around 4.4% of GDP, the largest monetary stimulus among EMEs central banks. The monetary operation strategy will be pursued to support this monetary policy stance. With Bank Indonesia’s low policy BANK INDONESIA’S ANNUAL MEETING 2020 interest rates and large liquidity easing, it is time for banks to immediately lower interest rates and increase credit for the business world. This step is a joint commitment to strengthen optimism for national economic recovery. Indonesia’s large balance deficit starting in 2021 and the following years. The close coordination between the Bank Indonesia monetary stimulus and the Government’s fiscal stimulus continues to strengthen the national economic recovery. In this regard, Bank Indonesia will continue to purchase SBN from the primary market to finance the 2021 State Budget through regular auction as a non-competitive bidder, greenshoe option, or private placement in accordance with the Joint Decree between the Minister of Finance and the Governor of Bank Indonesia on 16 April 2020. The amount will be determined based on prudent fiscal and monetary policies, among others by prioritizing the Government’s plan to fulfill the 2021 State Budget financing from its own funds, foreign debt, issuance of global and domestic bonds; market capacity to absorb primary market SBN auctions; and the impact of monetary expansion from the purchase of SBN by Bank Indonesia on inflation. Meanwhile, the direct purchase of SBN by Bank Indonesia in accordance with the Joint Decree on 7 July 2020 only applies to the 2020 State Budget and will not be continued for the 2021 State Budget. The purchase of SBN by Bank Indonesia through the primary market mechanism allows the Government to focus on accelerating the realization of the APBN 2021 to accelerate national economic recovery. The impact of monetary expansion from the purchase of SBN on the primary market in 2020 and 2021 on inflation will still be considered. With the improving global financial market conditions and the high attractiveness of investment in Indonesia, it is expected that most of the issuance of SBN for financing the 2021 State Budget will be absorbed by the market and therefore will reduce the size of the purchase of SBN from the primary market by Bank Indonesia. The close synergy between fiscal stimulus and monetary stimulus is a manifestation of Bank Indonesia’s strong commitment to work with the Government to strengthen the national economic recovery, even though it has an impact on Bank Bank Indonesia continues to strengthen synergy with the KSSK to bring together banks and business to encourage credit and financing for the national economic recovery. As stated above, the problem of low credit growth needs to be addressed jointly by the Government, Bank Indonesia, KSSK, banks and business. Initial priorities need to focus on priority sectors that are capable of providing a boost to high growth and exports, as mentioned in the first and third policies in the above national policy synergy. For these priority sectors, the Government can provide fiscal incentives as well as ease in overcoming problems in the business world such as electricity, logistics, and licensing. OJK can give its own consideration to banks that extend credit to priority sectors, either through microprudential policies or from the supervisory side. Bank Indonesia has taken and will pursue options for easing macroprudential policies that can further boost credit and financing for business. Macroprudential Policy Direction Macroprudential policy will remain accommodative to continue to encourage credit expansion and financing for the national economic recovery. As stated above, Bank Indonesia maintains a Countercyclical Buffer (CCB) ratio of 0%, a Macroprudential Intermediation Ratio (Rasio Intermediasi Makroprudensial - RIM) in the range of 84-94% with a disincentive parameter of 0%, and a Macroprudential Liquidity Buffer (Penyangga Likuiditas Makroprudensial - PLM) ratio of 6% - which can be used as collateral for repo transaction with Bank Indonesia in the event that the bank requires additional liquidity. Bank Indonesia will continue to assess the possibility of further easing a number of existing and new macroprudential policy instruments to boost credit and financing for the business sector. The transparency policy on bank interest rates will be strengthened to encourage a faster reduction BANK INDONESIA’S ANNUAL MEETING 2020 in loan interest rates. To encourage MSMEs-based growth, Bank Indonesia will issue a Macroprudential Inclusive Financing Ratio (Rasio Pembiayaan Inklusif Makroprudensial - RPIM) policy by expanding the target and coverage of inclusive financing, incentives for banks that encourage the corporatization of MSMEs and priority sectors, as well as encouraging the securitization of MSMEs loans. Bank Indonesia macroprudential supervision and coordination with microprudential supervision by the OJK will be strengthened to ensure financial system stability is maintained. The integrated banking supervision forum between Bank Indonesia and OJK has been running well, and has even been expanded with the LPS. Regular meetings at the Deputy level are held once a month, and at the Head of Department level every two weeks. The forum discusses the latest individual banking conditions, assessment of liquidity conditions, credit quality, capital and other aspects, including its resilience from developments in financial market, monetary sector, corporation and macroeconomy. Thus, the forum can take the necessary steps according to the authority of each institution to jointly maintain financial system stability. This includes an assessment of the possibility of a solvent bank requiring PLJP / PLJPS from Bank Indonesia as well as bank restructuring efforts that OJK needs to take in coordination with the LPS. be expanded with Customer Presented Mode (CPM) so that it will further expand digital payment transactions according to consumer’s preferences with low costs, fast, and safe. Digital banking continues to be encouraged to expand and simplify retail financial services, both stand-alone and in collaboration with FinTechs. Innovation in digital payment transactions continues to be encouraged through Sandbox 2.0., so that it is expected to spur more start-ups, especially for the retail and MSME sectors. The electronification of social assistance, transportation sector, local governments, and municipalities financial transactions continues to be improved. The digitalization, centralized distribution, and efficiency of the management of Rupiah currency throughout the Republic of Indonesia jurisdiction continues to be accelerated, including in the frontier, outer, and most remote (terdepan, terluar, dan terpencil - 3T) areas. Payment system regulatory reform is underway to further encourage industrial development, spur innovation, and integrate the ecosystem of digital economy and finance nationally. Regulatory reform in accordance with BSPI 2025 is directed at the establishment of an end-to-end digital economy and finance ecosystem between digital banking, Scheme 17. Digital Ecosystem: Open Banking, FinTech, E-Commerce, Merchants, and Consumers Payment System Policy Direction Bank Indonesia continues to accelerate the digitalization of payment systems as part of the implementation of the 2025 BSPI in enhancing the role of the digital economy and finance as a source of economic recovery. As stated, since launched in May 2019, various implementation programs of BSPI 2025 have recorded rapid progress and will be improved in 2021 and in the coming years. National and regional QRIS campaigns continue to be intensified to reach 12 (twelve) million MSME merchants digitally registered nationally. The current QRIS with Merchant Presented Mode (MPM) will FUND FUND DATA CONSUMER DATA MERCHANT E-COMMERCE FUND DATA BANK FUND THE ROLE OF BANK INDONESIA Source: Bank Indonesia FINTECH FUND OPEN API IMPLEMENTATION CHEAPER PRICING SYSTEM THROUGH BI-FAST EXPANDING THE USE OF QRIS BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 18. Standard Open API: Interlink between Open Banking and FinTech MARCH 30th, 2020 OPEN API STANDARD AND INTERLINK BETWEEN BANK AND FINTECH CONSULTATIVE PAPER FOR PAYMENT SYSTEM SERVICES Source: Bank Indonesia FinTech, e-commerce, merchants, and consumers. Through the restructuring of the payment system service industry within the integrated ecosystem of national digital economy and finance, the regulatory reform will also provide a clear direction and be more industry-friendly and flexible, inline with the rapid development of technological cycle (Scheme 17). As part of the formation of the above ecosystem, in addition to expanding the use of QRIS starting in 2021, important initiatives that will also be implemented are the Open API and the development of the retail payment system infrastructures. The implementation of the Open API is aimed at strengthening the interlink between open banking and FinTech so as to prevent shadow banking. Bank Indonesia published a consultative paper on the Open API in March 2020 of which is currently being developed together with the Indonesian Payment System Association (Asosiasi Sistem Pembayaran Indonesia - ASPI) representing from both banking and FinTech (Scheme 18). Through the Open API standardization, various payment transaction services can be provided by digital banking and FinTech by means of interlink and interconnection so that they can further expand and increase the volume and value of transactions as well as services to consumers more broadly, quickly, safely, and at a low cost. The development of retail and large value payment system infrastructures plays an important role in accelerating the digitalization of the national economy and finance. To reform the retail payment system infrastructures, Bank Indonesia is building BI-FAST to replace the Bank Indonesia National Clearing System (Sistem Kliring Nasional Bank Indonesia - SKNBI). BI-FAST will become a payment system infrastructure that can facilitate retail payment transactions using a variety of instruments and channels in real time and 24/7 operation, strengthened by robust security features and the use of digital identities (Scheme 19). Thus, every retail transaction can be digitally and immediately settled end-to-end, starting from QRIS at the merchant level, continue to FinTech and/or digital banking, and then promptly cleared and settled through BI-FAST system quickly, easily, cheaply, and safe. BI-FAST will begin to be implemented in 2021 for credit transfer transactions, and will then be followed by debit transfers and other transactions. Bank Indonesia is also planning to upgrade the infrastructure ofa large value payment system, Real Time Gross Settlement (RTGS), with a newer generation equipped with settlement features for multi-currency transactions and enhanced security including to counter cyber attacks. In addition, Bank Indonesia will also build a Payment Data Hub, which is a public payment portal/data hub that integrates the acquisition of granular data as public goods. The availability of granular data for public payment systems can be processed and analyzed, including with AI and machine learning, for policy formulation and new products and business innovations to further accelerate the digital financial economy. Acceleration of Money Market Deepening Bank Indonesia is accelerating money market deepening in accordance with the 2025 Money Market Deepening Blueprint (Blueprint Pendalaman Pasar Uang - BPPU) to strengthen the effectiveness of monetary policy transmission and support the financing of the national economy. Therefore, the development of an efficient, safe, reliable, and BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 19. BI-FAST: Real Rime and 24/7 Retail Payment Infrastructure I m p l e m e n t a ti o n Payment System Infrastructures that facilitate retail payment using various real time and 24/7 instruments and canals Operational Hours Banks and Customers Credit transfer Implementation Various Payment Instrument Bulk, debit transfer Implementation Fraud detection, AML/CFT Digital ID usage Conceptual design Development Phase 2 Development Source: Bank Indonesia international standard money market infrastructure is the focus of Bank Indonesia’s reform policy in 2021. The development of money markets is carried out end-to-end, from trading platforms, clearing and settlement, to the trade repository (Scheme 20a). For the trading venue, Bank Indonesia will follow up on the PBI Market Operator that was enacted in 2019 with the development of an electronic trading platform (ETP) both in the market, with the availability of a multimatching trading system on the money market in 2021, and modernization of BI-ETP for monetary operations in 2022. Likewise, following up on the PBI that we have enacted, the Central Counterparty (CCP) infrastructure development is targeted to be operational starting in 2021 (Scheme 20b). We believe that the development of ETP and CCP will increase interest rate derivative transactions, particularly interest rate swaps (IRS) and SBN repos, as well as exchange rate derivatives, particularly DNDF and foreign currency swaps. The money market infrastructure development is also integrated and interconnected with the payment system infrastructures, both BI-RTGS and BI-FAST, as well as the BI-SSSS infrastructure which will also be modernized and complied with international standards. We believe that such financial market infrastructure (FMI) will increase the transaction volume, lower interest rates, and lower transaction costs so that it is more liquid, efficient, developed, and supporting the effectiveness of monetary policy transmission and the provision of financing to the economy. The development of money market instruments will be further expanded to increase the volume, liquidity, and efficiency of transactions, including instruments for hedging. In the money market, instrument development is focused on the repurchase agreement (repo) transaction instruments, interest rate derivatives such as Overnight Index Swaps (OIS) and Interest Rate Swaps (IRS), as well as financing instruments such as BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 20a. The Development of Financial Market Infrastructure Ecosystem Supporting the National Economy towards Indonesia as an Advanced Country in 2045 Real Sector Financial Sector Financial Market Development that Supports Monetary Policy Transmission The Development of Economic Financing Resources Instruments MONEY MARKET TRADING VENUE FOREX MARKET FMI environment that is safe, efficient, reliable and suitable to international standards TRADE REPOSITORY CSD/SSS SHARIA FINANCIAL MARKET STRUCTURED PRODUCT MARKET CENTRAL COUNTERPARTY BOND MARKET PAYMENT SYSTEM STOCK MARKET Financial Market Infrastructure Source: Bank Indonesia Scheme 20b. Roadmap for Money Market Infrastructure Development CURRENT STATE MARKET OPERATOR 1. PBI & PADG MO has been published 2. Multiple MO Permit Processing BI-ETP 1. Implementation of BI-ETP alternate system 2. Conceptual Design BI-ETP CCP 1. PBI & PADG CCP has been published 2. There are several candidates of CCP SBNT ETP & IS Provider Application Processing The availability of Multimatching System Conceptual Design BI-ETP Publication of PADG CCP TR 1. TR study for the direction of TR development in Indonesia BI-RTGS Gen III Conceptual Design TR Study Documents BI-ETP Business Requirement Design BI-ETP System Construction BI-ETP Functional and Design Specification System Testing BI-ETP Live 2022 BI-ETP Live CCP Mandatory Clearing Main Points “Development is carried out based on PFMI, best practices, and domestic market conditions” SBNT CCP was established BI-RTGS Business Requirement Design BI-RTGS Vendor Procurement Developing and Regulating TR Recommendations END STATE Market Operator (Multimatching) Live 2021 BI-SSSS Interconnection 1. SBN clearing agreement between BI-SSSS BI-SSSS Business Requirement Design with PT KPEI and KPEI 2. System interconnection BI-SSSS vendor between KPEI and BI-SSSS Conceptual Design procurement BI-SSSS BI-RTGS 1. Full implementation of CeBM 2. BI-RTGS Conceptual Design BI-SSSS Functional and Design Specification BI-SSSS testing is completed BI-SSSS construction is completed BI-SSSS Gen III Live BI-RTGS Functional and Design Specification Konstruksi BI-RTGS BI-RTGS Gen III Live TR Academic Manuscripts & Regulations Establishment of TR institution CCP Live 2021 BI-SSSS Live 2024 BI-RTGS Live 2024 Trade Repository Live 2023 Source: Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 Scheme 21. Synergy in the Development of Economic Financing Instruments ECONOMIC GROWTH THE FINANCING OF INFRASTRUCTURE Supporting the National Economy towards Indonesia as an Advanced Country in 2045 FINANCIAL SYSTEM STABILITY CONVENTIONAL & SHARIA FINANCING INSTRUMENTS RETAIL & INSTITUTIONAL INVESTORS FINANCE SOURCES SECURITIZATION GREEN & SUSTAINABLE FINANCING INTEREST RATE HEDGING EXCHANGE RATE HEDGING Source: Bank Indonesia Negotiable Certificate Deposits (NCD), Commercial Securities (Surat Berharga Komersial - SBK), Asset Backed Securities (ABS), and retail money market instruments. In the FXmarket, instrument development is focused on exchange rate derivative instruments such as Domestic Non-Deliverable Forward (DNDF), Cross Currency Swap (CCS), and Local Currency Settlement (LCS). The development of the LCS is integrated with cooperation agreements with a number of countries, including China, Japan, Malaysia and Thailand, so that it will not only deepen the domestic money market but also increase the use of local currencies for trade and investment among countries in Asia. This step is also a joint effort in the Asian region to reduce dependence on the US dollar currency and support the stability of the Rupiah exchange rate. The development of money market instruments and infrastructure is also directed at supporting financing for the economy. In this regard, policies are directed at 4 (four) main areas (Scheme 21). First, encouraging the development of alternative sources of financing through innovative instruments such as asset securitization, ABS, green and sustainable financing, and hedging instruments for risk mitigation. Second, encouraging the use of digital technology in developing financing through digital platforms in issuance, offerings to investors, and capacity building for both wholesale instruments, such as DINFRA and DIRE, as well as for retail investors. Third, supporting financial literacy education and development of the investor base through the development, socialization and education of retail financial instruments in collaboration with the financial industry (FinTech, digital banking, and other digital platforms) as well as with educational institutions, financial market associations, and digital media. Fourth, strengthen the coordination of financial market development between Bank Indonesia, OJK, and the Ministry of Finance through synergy and coordination in the Forum on Development Financing by means of Financial Market (Forum Koordinasi BANK INDONESIA’S ANNUAL MEETING 2020 Pembiayaan Pembangunan melalui Pasar Keuangan - FK-PPPK), including harmonizing regulations on macroprudential, microprudential and taxation policies. MSMEs Policy and Sharia Economy and Finance Bank Indonesia continues to expand its MSME development program, both under its own guidance and in collaboration with the Government and other partners at central and regional levels. The development of MSMEs is carried out through corporatization, capacity building, and financing to increase the economic scale of MSMEs, especially in priority sectors so that they can increase the contribution of MSMEs to GDP and encourage MSMEs to “Go Export” and “Go Digital”. The corporatization program is aimed at encouraging MSMEs to enter the digital ecosystem by facilitating easy licensing, forming productive clusters, and digital infrastructure for MSMEs. The capacity building program is aimed at improving the capacity of MSMEs end to end; starting from product development, management and financial training programs, to preparing market access, through the UMKM on Boarding Program (e-payment, e-commerce, and e-financing). Meanwhile, the financing program was pursued through the implementation of provisions regarding the achievement of MSME credit fulfillment for banks and non-banks, as well as expanding MSME access in empowering subsidized credit / KUR to accelerate the integration of economic inclusion and digital finance nationally. The implementation of Indonesian Creative Works (Karya Kreatif Indonesia - KKI) which is increasingly successful in elevating UMKM “Go Export” and “Go Digital” will be further enhanced in 2021, as well as strengthening synergies with the Government in the success of the Proudly of Indonesian Product National Movement (Gerakan Nasional Bangga Buatan Indonesia - GerNas BBI). The important role of Bank Indonesia in the development of the sharia economy and finance will continue to be enhanced as a new source of growth for the Indonesian economy as well as to become a reliable global player. To that end, Bank Indonesia continues to strengthen synergies with relevant parties, both within the Sharia Financial Economy National Committee (Komite Nasional Ekonomi Keuangan Syariah - KNEKS) as well as Islamic boarding schools, business associations, banks, as well as sharia scholars, academics and the wider community. The acceleration of the implementation of the halal value chain ecosystem (local and global halal value chain) continues to be improved, including with the aspects of actors and economic sectors, institutions, and supporting infrastructure. Sharia economic empowerment is focused on priority sectors, namely agriculture for halal food, fashion, Muslim friendly tourism, and renewable energy. Islamic finance is expanded both in the financial sector and the mobilization of productive ZISWAF. This includes the development of Islamic financial instruments, such as foreign exchange instruments and long-term financing instruments, as well as the development of Islamic social finance and its integration with commercial finance as an alternative to financing. The campaign for Islamic economic and financial literacy continues to be expanded through the holding of three Sharia Financial Economic Festivals (Festival Ekonomi Keuangan Syariah - Fesyar) at the regional level, and the ISEF on a national and international scale. International Policy On international policy, we will continue to be active in various international forums to further increase investment and trade in support of the national economic recovery. In synergy with the Government and various parties, Bank Indonesia continues to increase positive perceptions of investors and rating agencies through more proactive BANK INDONESIA’S ANNUAL MEETING 2020 engagement activities. We also continue to play an important role in facilitating trade and investment promotion in priority sectors through the support of the Investor Relations Unit (IRU) at the regional, national, and international levels. In this regard, a number of policies were strengthened, including mapping project availability according to investor preferences and organizing joint promotional activities both abroad and domestically for products / projects in priority sectors. In particular, we need to strengthen collaborated actions in the use of the FTA / CEPA and Local Currency Settlement (LCS) agreements to optimize the foreign trade and investment. Foreign cooperation is also continuously strengthened with a number of central banks and international institutions. Moving Forward with Optimism Indonesia’s economic prospects in 2021 will improve, and Bank Indonesia will continue to strengthen synergies to build optimism for economic recovery. Growth is projected to be higher and macroeconomic and financial system stability to be maintained. Mobility and economic activities are expected to increase with vaccination and discipline in implementing COVID-19 protocols. Bank Indonesia will strengthen synergies with the Government (Central and Regional), KSSK, banks, and the business sector in building optimism for the national economic recovery. Policy synergies are also relentlessly build to support the opening of productive and safe sectors, relatively large fiscal stimulus, increased credit and financing, continued monetary and macro prudential stimuli, and rapidly developing digital economy and finance. We will also continue to work together with the DPR, especially Commission XI, the banking and financial sectors, the businesses sector, scholars, the media, and relevant parties. With this synergy, Indonesia has shown demonstrated and momentum for economic recovery from the COVID-19 pandemic. Also with synergy, Indonesia’s economic prospects will be better in the future, supported by a national economic policy mix that is closely coordinated, with economic transformation and the development of digital economy and finance innovation. This is toward an increasingly prosperous Advanced Indonesia. That is all, and thank you Wassalamualaikum Warahmatullahi Wabarakatuh, Jakarta, 3 December 2020 Perry Warjiyo Governor of Bank Indonesia BANK INDONESIA’S ANNUAL MEETING 2020 BANK INDONESIA’S ANNUAL MEETING 2020
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Speech by Mr Perry Warjiyo, Governor of Bank Indonesia, at Bank Indonesia's Annual Meeting 2021, Jakarta, 24 November 2021.
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TABLE OF CONTENT Global Economic Performance and Outlook: Divergent Recovery, Persistent Financial Market Uncertainty National Economic Performance and Outlook: The Recovery Process Continues, Stability is Maintained Bank Indonesia Policy Mix 2021: Encouraging National Economic Recovery, Maintaining Stability • Rupiah Exchange Rate Stabilization Policy • Monetary Policy Stimuli • Macroprudential Policy Easing • Acceleration of Payment System Digitalization • Accelerating Money Market Deepening • Empowerment of Sharia Economy and Finance and MSMEs • Strengthening International Policy • Bank Indonesia Transformation Rise and be Optimistic: Synergy and Innovation for Economic Recovery Bank Indonesia Policy Mix Direction for 2022: Encouraging Acceleration of Economic Recovery, Maintaining Stability • Monetary Policy Direction • Macroprudential Policy Direction • Payment System Policy Direction • Accelerating Money Market Deepening • Inclusive and Green Economic-Financial Policy • International Policy Rise and be Optimistic for an Advanced Indonesia Speech of the Governor of Bank Indonesia BANK INDONESIA’S ANNUAL MEETING Jakarta, 24th November 2021 We are honored to welcome, The President of the Republic of Indonesia, Joko Widodo, Distinguished guests, • Leaders and Members of DPR and DPD RI, • Leaders of State Institutions, • Ministers of the Advanced Indonesia Cabinet, • Chairman and Members of the OJK and LPS Board of Commissioners, • Former Governors and fellow Members of the Board of Governors of Bank Indonesia, • Governors, Mayors and Regents from all over Indonesia, • National Banking, Corporate and Media Leaders, • Recipients of the 2021 Bank Indonesia Awards, • Invitees. Assalamu’alaikum Warahmatullahi Wabarakaatuh, Greetings to everyone, Shalom, Om Swastyastu, Namo Buddhaya, Greetings of Virtue. First, let us express our gratitude to the presence of Allah subhanahu wa ta’ala,one Almighty God, because only with His grace and blessing can we gather today at the 2021 Bank Indonesia Annual Meeting. With all humility, we would like to express our gratitude to the President who was willing to attend along with all invitees. We congratulate the banks, corporations, and individuals who have received the Bank Indonesia Awards 2021 a number of 57 awards in 4 areas and 17 categories in the fields of managing monetary stability and financial systems, payment systems, MSME development and Islamic finance and economy, as well as supporting Bank Indonesia policies. The awards are presented annually, in conjunction with the Bank Indonesia Annual Meeting, as a form of appreciation and, at the same time, national recognition of business partners who have supported task implementation at Bank Indonesia. At this auspicious opportunity, allow us to present an evaluation of economic performance in 2021 as well as the economic outlook and direction of Bank Indonesia’s policy in 2022, which we summarize under the theme “Rise and be Optimistic: Synergy and Innovation for Economic Recovery”. A theme we think is appropriate to show our shared enthusiasm to rise from the impact of the Covid-19 pandemic, with the national economy continuing to improve in 2021. Optimistically, the national economy, God willing, will be even stronger in 2022. Synergy, through strong policy coordination between the Government (Central and Regional), Bank Indonesia, and the Financial System Stability Committee (KSSK - Komite Stabilitas Sistem Keuangan), the banking industry and payment system, the business community, and all parties to continue accelerating the national economic recovery, while maintaining macroeconomic and financial system stability. Innovation, both in the coordination of national economic policies that includes fiscal-monetary coordination for financing the State Budget during the pandemic, as well as in expediting digitalization and national economic-financial inclusion by digitizing the payment system, the National Movement (Gernas - Gerakan Nasional) in Proudly Made in Indonesia (BBI - Bangga Buatan Indonesia) and Proud to Travel in Indonesia (BWI - Bangga Berwisata di Indonesia). It is this national economic policy synergy and innovation that we need to continue to strengthen going forward in order for us to remain optimistic about the national economic recovery in 2022 and subsequent years, towards an advanced Indonesia. Our presentation consists of 5 (five) parts, namely: (i) Global economic performance and outlook, which shows a divergent and asynchronous recovery, with persistently elevated global financial market uncertainty; (ii) National economic performance and outlook that continues to improve towards recovery with maintained macroeconomic and financial system stability; (iii) Bank Indonesia’s pro-growth 2021 policy mix while maintaining monetary and financial system stability; (iv) Increasing national economic policy synergy and innovation and optimism about future economic recovery; and (v) The direction of Bank Indonesia’s policy mix in 2022 to encourage acceleration and foster innovation of the national economic recovery, while maintaining monetary stability from the impact of global policy normalization. This explanation also serves as the fulfillment of Bank Indonesia’s accountability and transparency responsibilities as mandated in the Bank Indonesia Act. Global Economic Performance and Outlook: Divergent Recovery, Persistent Financial Market Uncertainty The global economy continues to recover from the deleterious effects of the Covid-19 pandemic. The world has been living with Covid-19 for twenty one months. From living in fear and panic, then surviving, until now - rising and optimistic for a better life, with new habits, cultures, and civilizations. Likewise, economic developments, after surviving last year’s recession, are now steadily improving and heading towards recovery. Macroeconomic stability and the financial system, which were threatened by the crisis at the beginning of the pandemic, have since improved and been maintained. However, we cannot be careless. The pandemic has not ended, and may become endemic with the emergence of several new Covid-19 variants. Vaccine distribution and ability to achieve herd immunity remain asynchronous throughout the world; with fast roll outs in advanced economies (AEs) but more sluggish progress in many emerging markets and developing economies (EMDEs). Uncertainty continues, with many unknown unknowns. We must remain vigilant, therefore, to better anticipate the risks that may arise and take appropriate containment measures by approaching and praying to God Almighty. The pandemic raises several issues and challenges that demand vigilance and must be anticipated properly, now and moving forward. There are at least seven important aspects we need to pay attention to. First, vaccinations are still not evenly distributed to achieve herd immunity, thus increasing the risk of Covid-19 becoming endemic. Second, the imbalances in the global economic recovery process, which is progressing more quickly in AEs yet slowly in EMDEs. Third, the occurrence of disruptions in the global supply chain and the emerging threat posed by energy scarcity. Fourth, the asynchronous plan for monetary and fiscal policy to return to a new normal (exit policy) between AEs and EMDEs, as well as the ensuing impact of global financial market uncertainty. Fifth, the scarring effect impact of the pandemic on corporate conditions and the risks that may occur to economic recovery sustainability and maintaining financial system stability. Sixth, the fast-paced digitalization of the financial economy with the dominance of several global big technology (BigTech) players and the expansion of cross-border payment systems. Seventh, growing demand for the green economy and sustainable finance in AEs must be well prepared concerning the transition by EMDEs. The following is an explanation of the seven challenges and anticipatory policy measures in Indonesia. The Covid-19 pandemic, which subsided at the end of 2020, re-emerged with the Delta variant in India in February 2021 and quickly spread to Asia and various other parts of the world, threatening health and humanity. The Delta variant is highly contagious and has a more virulent impact on human health and mortality than the Alpha and other variants. In 2021 more than 95% of Covid-19 transmission cases in various countries, including Indonesia, were due to the Delta variant with a viral load 1,260 times higher than the original variant. Furthermore, the incubation period for Delta is also shorter, at about 4 days after exposure, compared to an average of 6-14 days in the original variant. It is this combination of a high viral load and short incubation period that has resulted in very fast transmission rates and a higher mortality rate. Transmission in Asia peaked in early May, before decreasing slightly in June but re-emerging in August 2021 (Graph 1). In the Americas and Europe, the spread of Delta peaked in August 2021 yet, until now,remains high. The impact on health has also been more severe, leading to a rapid rise in fatalities in Asia 1.54 % in late August and more steeply thereafter, Graphic 1.Global Daily New Covid-19Cases Cases Graph 1. Additional Global Covid-19 Thousands (7d MA) Graph 3. Global Vaccination and(Fully Hospitalization Graphic 3. Vaccination Progress Vaccinated) Rate & Hospitalization Daily New Cases (Thousand) as of 12 Nov Africa Region Asia Middle East and North Africa US Euro Area Global 140 88 Africa Region Middle East and North Africa Euro Area Asia % total Population per million 76 76 75 69 67 67 fully vaccinated 62 59 58 58 UEA ESP DNK IRL CAN ITA FRA GBR DEU ISR BRA TUR USA POL MEX RUS IDN IND AE (rhs) others EM (rhs) Data as of 12 November 2021 As of 8 Nov'21 Source: WHO, calculated Data as of 12 November 2021 Source: WHO, calculated Source: Our8World In Data, calculated Data as of November Source: Our World in Data, calculated having hit a low in early May 2021 (Graph 2). The impact on mortality rates in the United States and Europe is not significant, however, partly because of relatively high vaccination rates and herd immunity in both parts of the world. namely the inequality of vaccination rates between AEs and EMDEs. In developed countries, given the availability of vaccine supplies and the large fiscal capacity of the government, vaccination rates have reached an average of 66% of total population, leading to lower rates of Delta variant transmission and mobility restrictions (Graph 3). Overall, herd immunity has begun to form in the community against Covid-19, with vaccination rates above 61% of the population, with the highest rates recorded in the United Arab Emirates (UAE) at 88% to the US at 58%. Meanwhile in EMDEs, with limited vaccine The vaccination rate and restrictions on community mobility determine transmission of the Covid-19 Delta variant, as well as its impact on health and humanitarian problems, including economic activity. Here in lies one of the fundamental problems of the Covid-19 impact in different parts of the world, Graph 2.2.Global Fatality Rates Grafik GlobalCovid-19 Fatality Rate 3.5 Graph 4. Mobility Restrictions EMDEs Grafik 4. Tingkat Pembatasan Mobilitas Emerging Market % Index, 100 = most stringent 3,0 2.5 2.0 1.5 1.0 Global US Euro Area Asia Data as of 12 November 2021 Source: WHO, calculated Data as of 12 November 2021 Source: WHO, calculated WRL AE EM % current target, assumed by the end of 2021 Herd Immunity (Full Dose) reached Hopitalization per million 1 2 9 10 11 12 1 As of: 15 Nov 2021 Brazil China India Russia Indonesia Malaysia Source: Research 2021 Data asGoldman of 15 Sachs November Goldman Sachs ELI: Oxford Stringency Index + Google Mobility Report Source: Goldman Sachs Research Goldman Sachs ELI : Oxford Stringency Index + Google Mobility Report 9 10 11 supply and fiscal capacity, the vaccination rate has only reached an average of 34% and, therefore, the spread of the Delta variant is more extensive. Moreover, the level of mobility restrictions that must be enforced to prevent Covid-19 transmission is higher in EMDEs, though differing in terms of time and duration (Graph 4). Disparity between vaccination rates in AEs and EMDEs also explains the different negative effects of the Delta variant on the pace of economic recovery. Several indicators point to a relatively rapid increase in economic activity in early 2021 before decelerating with the spread of the Delta variant. The level of restrictions on public mobility due to the second wave of the Delta variant and concerns about a possible third wave have affected the Consumer Confidence Index and retail sales in various countries. Again, the effects differ from country to country, depending on vaccination rates as well as consumer perception and fears of a third wave of infections. In advanced economies, for example, the Retail Sales Index, which had been increasing rapidly since the end of 2020, has declined since March 2021 in the US and July 2021 in Europe (Graph 5a). In fact, the Consumer Confidence Index declined more sharply in the US than in Europe. In China, the Retail Sales Index and consumer confidence have Graph 5a. Retail Sales AE Grafik 5a. Penjualan Ritel Negara Maju Index, 100 = Q IV 2019 12 1 9 10 11 12 US Euro Area Japan 9 10 Graph 5b. SalesSales EMDEs Grafik 5b.Retail EM Retail Index, 100 = Q IV 2019 1 2 3 4 5 6 7 9 10 11 12 1 2 3 4 5 6 7 9 10 China Indonesia Mexico Turkey Russia Brazil Thailand Sumber: CEIC, diolah Source: CEIC, calculated been retreating since June 2021 (Graph 5b), while the Consumer Confidence Index in India, which had been decreasing since the emergence of the Delta variant in February, has rebounded since July 2021. This pattern of increasing retail sales will also have an impact on the downward trend in the rate of increasing consumption. Delta variant transmission and mobility restrictions have also affected the Business Confidence Index and Purchasing Managers’ Index (PMI), which in turn affects the level of production and investment. Economic activity has gradually improved since the third quarter of 2021 in line with the decline in Delta variant cases and greater public mobility. Nevertheless, the possible emergence of new Covid-19 variants and the risk that the pandemic will last for a long time, potentially becoming endemic,with the inherent impact on the world economic recovery, must be considered. Global economic improvements will continue throughout 2021, though uneven, with recovery expected in 2022.The speed of a country’s economic improvement is strongly influenced by the vaccination rate to achieve herd immunity, the magnitude of fiscal and monetary policy stimuli, as well as resilience in the face of Delta variant transmission. In advanced economies, particularly Source: CEIC, calculated Source: CEIC, calculated the US, economic recovery is progressing more rapidly, supported by unprecedented fiscal and monetary stimuli. The stimulus package from the government and central bank is funneled into vaccination programs, social and business assistance, as well as the injection of massive liquidity (quantitative easing) to the financial system. On the other hand, most EMDEs, except China, are still struggling to improve their domestic economic conditions towards economic recovery. In addition to limited vaccine supply, finite fiscal and monetary stimulus capacity has also undermined the economic recovery process. Most EMDEs have restrained ability to raise larger budgets, primarily as a corollary of lower tax revenues reduced by declining business activity, as well as limited debt capacity to finance larger fiscal deficits. Meanwhile, monetary policy effectiveness to boost the economy has been hampered by the suboptimal condition of the banking and financial sectors, which have also been affected by the pandemic. Overall, after experiencing a 3.1% contraction in 2020, the world economy is expected to grow by around 5.7% in 2021 and 4.4% in 2022 (Table 1). Economic recovery has occurred in the two largest global economies, namely China with 8.0% and 5.4% growth in 2021 and 2022 after growing 2.3% in 2020, and the US with 5.9% and 3.9% growth in 2021 and 2022 after a 3.4% contraction in 2020. Meanwhile, economic recovery in other countries is expected to occur in 2022 with continued economic improvements in 2021. Among the advanced economies, Europe is expected to grow 4.8% and 4.4% in 2021 and 2022 after a 6.3% contraction in 2020, similarly Japan will grow 2.4% and 2.5% in 2021 and 2022 after a 4.6% contraction in 2020. Among Asian countries, India is estimated to grow at around 8.8% and 8.1% in 2021 and 2022 after a 7.1% contraction in 2020. Likewise, ASEAN-5 will grow 3.9% and 5.4% in 2021 and 2022 after a 3.4% contraction in 2020. The increase in world trade volume and international commodity prices will continue, thus underpinning the outlook for exports and economic Table 1. Global Economy: Growth, Trade Volume, Commodity Prices (%) 2021* 2022* Global Economic Growth 2.8 -3.1 5.7 4.4 Advanced Economies 1.6 -4.5 5.1 3.9 US 2.2 -3.4 5.9 3.9 Euro Area 1.3 -6.3 4.8 4.4 Japan 0.0 -4.6 2.4 2.5 3.7 -2.1 6.1 4.9 China 6.0 2.3 8.0 5.4 India 4.8 -7.1 8.8 8.1 ASEAN 5 4.9 -3.4 3.9 5.4 Latin America 0.1 -7.0 5.1 2.8 Emerging Europe 2.5 -2.0 4.7 3.7 Middle East dan Asia 1.4 -2.8 3.9 3.8 World Trade Volume -0.4 -5.3 8.3 3.8 Indonesia Export Commodity Price Index -3.0 -0.8 60.3 2.5 Emerging Economies Source: IMF WEO Database October 2021, Bank Indonesia’s Projection Description: * projection recovery in various EMDEs. The world economic recovery is expected to gain momentum in the second half of 2022 and 2023 and beyond. 5-year average despite indications of an increase in exploration and production (Graph 7). Increasing demand fueled by the economic recovery that has exceeded supply capacity owing to limited mobility caused by the Covid-19 pandemic has disrupted global supply chains and created energy scarcity. Delta variant transmission has caused numerous problems in the distribution and supply of energy and production globally, as reflected in the scarcity of containers, backlogs at many ports, longer delivery times, and rising shipping costs between countries, especially since April 2021 (Graph 6). In the US, gaps are also appearing in the labor market, as seen in the voluntary unemployment rate that is still increasing, and also in increasing wages in the hospitality and restaurant service sectors, education and health, retail sales, manufacturing, as well as trade. Meanwhile, in producing countries, particularly China and other Asian countries, the enforcement of mobility restrictions to break the domestic chain of Delta variant transmission has resulted in production and inventory declines, as well as the ability to ship, both for production and energy inputs such as oil, coal, and others. Concerning oil, inventories in the US have fallen below the Disturbances in the distribution and supply of goods, exacerbated by energy scarcity, have impact ed inflation globally. In addition to the divergent economic recovery and mobility restrictions due to Covid-19, the problem is also driven by policy factors, namely stronger demand for a green economy in Europe and the US amid production restrictions in China and a number of other producing countries that require a transition period towards more environmentally friendly production (Scheme 1). At the same time, demand for energy is increasing in advanced economies in anticipation of supplies for winter. These factors have resulted in a productiondemand gap and higher international commodity prices, such as oil, coal, and food prices (Graph 8). Next is the impact on increasing actual inflation as well as forecasts of future inflationary pressures in AEs, particularly the US, Europe, UK, Canada, and Japan (Graph 9). The pertinent question, therefore,is whether such inflationary pressures are temporary or permanent? Graph 9 shows that the inflation forecast in several developed countries, as a whole, will be transient in nature, i.e., it will rise for the remainder of 2021 until at least mid-2022, and then move downwards. Consequently, we need to be aware of Graph 6. Shipping Rate Index: World and China Graphic 6. Freight Rate Index Graph 7. Oil Inventories in the US and World OilGrafik Prices7. Inventory, Rig Count, and WTI Prices USD/40ft Index 3,500 3,000 2,500 2,000 1,500 1,000 WCI - Drewry (rhs) *Data as of 11 November 2021 Source: *Data asBloomberg of 11 November 2021 Source: Bloomberg 11,000 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 China Containerized Freight Index counts, bbl million USD/bbl -100 1 3 4 6 7 8 10 11 1 3 4 6 7 8 10 11 1 3 4 6 7 8 10 11 1 3 4 6 7 8 1011 1 3 4 6 7 8 10 US Inventory 5 year average of US Inventory Rig Count WTI (rhs) Data as of 12 November 2021 Data as of 12 November Source: Bloomberg, calculated 2021 Source: Bloomberg, calculated Scheme 1. Energy Crisis and Inflation Pressure - Power rationing in China - Green economy in Emerging Asia and the US - The green economy policy transition encourages high polluted energy sources production restrictions thus increasing the green energy demand POLICY DESIGN Hurricane Ida & Nicholas in the US, interconnector fire in the UK and France (Promote Green Economy) WEATHER, NATURAL DISASTER & FIRES ENERGY CRUNCH Extreme weather : longer winter LOW INVENTORY Coal and oil inventories are at a low level compared to the long-term average WINTER DEMAND 1. Decreasing Production 2. Rising Inflation Source: Bank Indonesia these developments over time to anticipate the positive and negative impacts on the Indonesian economy. The asynchronous global economic recovery, coupled with supply disruptions and energy scarcity, have led to a misalignment of fiscal and monetary exit policy plans between AEs and EMDEs. In general, all countries will normalize fiscal policy, with deficits starting to reduce from 2021, although the pace is much faster in AEs to around 3.6% in 2023, while in EMDEs it will be more gradual to around 4.8% in 2024 (Graph 10). Likewise for monetary policy, it is likely that normalization will be quicker in AEs and slower in EMDEs, reflecting the pattern of economic growth and the intensity of inflationary pressures in each country. This can be seen from market expectations concerning policy Graph 8. World Commodity Prices: Oil, Coal, Grafik 8. Harga Komoditas Dunia: Minyak, Batu Bara, Pangan and Metal Composite Graph 9. Actual and Forecasted Inflation: US, GrafikJapan, 9. Inflation Europe, UK,(Realisation and Canada& Projection) Index, 100 = January 2020 Index, 100 = January 2020 -1 Inflasi refer to the CPI, except US (PCE) Realisation until Oct 2021, except AS and Jp Survey Bloomberg as of Nov 2021 Oil (Brent) Food Imported Inflafion Price Index Data as of 12 November 2021 Sumber: Bloomberg, calculated Data as of 12 November 2021 Source: Bloomberg, calculated % 8 11 Metal Composite Indonesia Coal (rhs) -3 9 11 1 9 11 1 US Canada UK Japan Source: Bloomberg Survey, BI Estimation, calculated 9 11 1 Euro Area Source: Survey Bloomberg, Bank Indonesia’s Projection, calculated 9 11 Graph 10. Fiscal Policy Normalization Plan: AEs and Grafik 10. Rencana Normalisasi Kebijakan Fiskal: EMDEs AEs dan EMDEs % of GDP Projection 0.0 -2.0 -4.8 -6.0 -3.6 -2.4 -2.5 -2.7 -4.0 -3.0 -3.0 -3.5 -4.1 -5.2 -3.0 -3.7 -7.9 -4.8 -10.2 -4.7 -6.6 -8.0 -5.8 -3.6 -5.2 -3.5 -3.6 -3.8 -4.2 -3.1 -3.0 -3.2 -4.8 -4.1 -4.4 -8.8 -9.6 -10.0 -10.8 -12.0 2016 2017 World Graph Treasury Yields Imbal by Tenor Grafik12. 12.US Perkiraan Kenaikan Hasil US Treasury per Tenor Jangka Waktu Yield (%) 2.5 2.0 1.5 0.5 -0.5 1M Emerging Market Advanced Economy Change of yield (bps) 2M 3M 6M 1Y 2Y 3Y 5Y 7Y Δ Oct-21 vs Sep-21 (rhs) Oct-21 Jun-21 Mar-21 10Y 20Y 30Y -10 Sep-21 Source: Bloomberg Source: IMF Fiscal Monitoring October 2021 Source: IMF Fiscal Monitoring October 2021 Source: Bloomberg, calculated interest rates, which are generally higher than the current situation (Graph 11). Even in the US, with the economic recovery running faster, as evidenced by rising inflation and declining unemployment, the Fed has regularly conveyed plans to start reducing monetary liquidity (tapering) in early 2022 and this will likely be followed by a Fed Funds Rate (FFR) hike in the third quarter of 2022. This plan to normalize monetary policy by the Fed has pushed up US Treasury yields (Graph 12), although the effect was lower in September 2021 compared with March 2021 in response to unambiguous communication by The Fed. Nevertheless, uncertainty in global financial markets persists and has increased, influenced by the spread of the Delta variant as well as the impact of global supply chain disruptions and energy scarcity on rising inflation in the US and several other advanced economies. As a result, the relatively high inflow of portfolio investment into EMDEs in early 2021 has decreased rapidly, especially since March2021 (Graph 13) and the impact on currency pressure and exchange rate volatility in EMs has Graph 11. Monetary Policy Normalization Plan: Grafik Rencana Normalisasi Kebijakan Moneter: AEs and 11. EMDEs AEs dan EMDEs Graph 13. Portfolio Investment Flows to Emerging Grafik 13. Aliran Investasi Portoflio ke Emerging Markets (EMs) Economies (EMs) USD Billion % -30 -80 -130 BCB Banxico RBI BNM EM LATAM Current BOK BOT EM Asia Market Expectation Source: Bloomberg, data as of 16 November 2021 Data as of 16 November 2021 Source: Bloomberg RBNZ FED BOE RBA ECB Advanced Economies Market Expectation Africa & Middle East Latin America Emerging Europe Emerging Asia Source: IIF Source: IIF Graph 14. Leverage of Non-Financial Grafik 14. Leverage Korporasi Non-Finansial: Corporations: Global, AEs and EMs Global, AEs dan EMs Graph 16. BigTech Active Users Grafik 16. Pengguna Aktif BigTech USD Billion % (Debt ratio to GDP) USD Billion 2.4 0.06 1.6 0.04 0.8 0.02 Global Advanced Economies (lhs) Emerging Markets Alibaba Tencent Facebook Google (rhs) Kakao Groupon Sumber: BIS Source: GFSR, April 2021 Source: IMF GFSR April 2021 Source: BIS also increased. This asynchronous normalization of fiscal and monetary policies as well as increasing uncertainty in global financial markets have further complicated efforts to improve economic recovery in EMDEs, including Indonesia. capital. The level of debt (leverage) has increased since the Covid-19 pandemic, both in AEs and EMDEs (Graph 14). In fact, the number of corporate defaults has soared to almost global financial crisis levels, dominated by the US, then Europe and EMs (Graph 15). Cases of corporate default that have occurred in both the US and China are clear examples. Not all companies have been affected similarly, however, depending on the impact mobility restrictions have had on their respective economic sectors. Notwithstanding, corporate damage demands continuous monitoring for risks that could spread and have an adverse impact on individual banking conditions and the stability of the financial system as a whole. That is why the normalization of regulations concerning the relaxation of credit restructuring provisions in many countries is meticulously carried out. In fact, financial sector supervisory authorities in many countries have extended the regulatory relaxation period for delays in principal and interest installment payments, thereby providing concessions for the recognition of non-performing loans (NPLs) in the banking industry. The problem of corporate damage and its impact on financial institutions and financial system stability still needs to be observed during the ongoing Covid-19 pandemic. In fact, even though the overall economy has recovered, corporate damage from the Covid-19 pandemic requires more time to heal. The prolonged Covid-19 pandemic has had a scarring effect on corporate conditions and poses risks to financial system resilience. Restrictions on public mobility as part of Covid-19 pandemic handling have squeezed business activity, resulting in declining sales, liquidity, profitability, and corporate Graph 15. Total Corporate Defaults: GrafikUS, 15. Jumlah Korporasi: Global, Europe,Kegagalan EMs Global, AS, Eropa, EMs Corporate Global Speculative-Grade Corporate Defaults 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 US Emerging markets Sumber: IMF AprilApril 2021 2021 Source: IMFGFSR GFSR 0.00 0.0 Euro Others EM Graph 17. of E-Commerce E-Commerce Grafik 17.Share Pangsa % of total retail sales China Japan US UK Germany Data s.d. Nov 2020 (AS), Okt 2020 (Tiongkok), Sep 2020 (Jerman, Jepang dan Inggris) Sumber: BIS Data as of Nov 2020 (US), Oct 2020 (China), Sep 2020 (Germany, Japan and UK) Source: BIS On the other hand, payment system digitalization and the financial economy are expanding with rapidity, increasingly dominated by BigTech and e-commerce. Digitalization occurred before Covid-19, driven by advances in digital technology, including artificial intelligence,as well as BigTech that was able to provide personal and economicfinancial services through mobile phones and other devices, anytime and anywhere (Graph 16). Artificial intelligence technology that can process personal behavioral data is becoming increasingly sophisticated, offering consumer experiences to meet various needs for faster and more frequent economic-financial transactions through e-commerce platforms at massive volumes and frequencies despite low value per transaction (retail) (Graph 17). Since the onset of the Covid-19 pandemic, however, with restrictions on public mobility and activity, digitalization of the financial economy and payment system has accelerated quickly. Digital economyfinancial transactions, previously dominated by young people and millennials, have now spread to various levels of society, becoming ubiquitous and the new norm because of the convenience, speed, as well as low prices and transaction fees afforded. This is not restricted to urban areas, yet extends to smaller regions and across national boundaries. The digital financial economy represents a new source of economic growth and is accelerating economic and financial inclusion. On the other hand, however, a number of new problems are emerging, including personal data ownership, digital economic-financial transaction taxes, financial services by non-financial entities (shadow banking), the spread of privately created currencies (crypto currencies), and regular cyberattacks. In response to the various opportunities and challenges posed by expansion of the digital financial economy, appropriate policy measures are required to re-position the role of the state, including the finance ministry, central bank, supervisory bodies for financial institutions, technology and information, as well as security and defense, in a new - digital - civilization. In addition to the rapid pace of digitalization, the Covid-19 pandemic has also increased demands for the need to accelerate the green economy and finance. In fact, country commitments to the problem of climate change and the need to immediately adopt a green economy-finance model existed before the Covid-19 pandemic, as stipulated in the 2015 Paris Climate Agreement. Various negotiations and agreements for trade and investment cooperation, both between countries and regions, have also included the need for adoption of the green economy-finance. Even in financial investor relations, including portfolio investment, the preferences and demands of fund owners (large and small) color the formation of investment portfolios by global investment managers, including choices that tend to favor EMs that are more pro-economy and green finance. Since the Covid-19 pandemic, demands for a green economy-finance have been getting stronger from advanced economies, with, among others, efforts to reduce carbon emissions that are much larger, namely 8-9%,than around 2-3% during the 2007/2009 global financial crisis (Graph 18). Various countries, therefore, especially EMDEs including Indonesia, must seriously develop carbon emission reduction programs in order to fulfill the Paris commitments above Graph 18. Carbon Emissions and Reduction Targets: Grafik 18. Emisi Karbon dan Target Penurunan: Towards Zero Emissions Menuju Zero Emission CO2 Emission reduction carbon during pandemi Emission reduction carbon during GFC parties Path to 2OC Target Intermediate goal for 2OC Path to 1,5OC Target Intermediate goal for 1,5OC CO2 CH4, N2O and F-gases Source: UNCTAD (April 2020) Source: UNCTAD (April 2020) (Graph 19). This includes incentives provided by the Government and central bank for projects and financial products that are environmentally friendly, both through tax incentives and carbon taxes as well as macroprudential policies that provide incentives for green financing. Investment managers and financial institutions worldwide are also increasingly able to offer investment product options in EMs that are environmentally friendly, based on a country’s commitment to reducing carbon emissions and also financial investment projects, called Sustainable Finance. In fact, trading with carbon emission reduction programs has started and is known as Carbon Trading. A number of international policy coordination steps have been taken to strengthen the global economic recovery and address emerging problems. Several important agendas have surfaced in the G20, IMF, FSB, BIS, and other forums. First, the need to further expand the supply and distribution of vaccines from AEs to EMDEs, including the provision of soft loans and debt relief for Less Developed Countries (LDCs) as well as additional Special Drawing Rights (SDR) allocations with a request that AEs and EMs participate in assisting LDCs. Second, the need for clarity of communication and phasing in the normalization of fiscal and monetary policy (exit Graph 19. Paris Climate Agreement: Grafik 19. Paris Climate Agreement: Emission Reduction Targets by Country Target Penurunan Emisi per Negara Tonga St Kitts & Nevis Timor Leste Nepal Korea Utara Brunei Uzbekistan Venezuela Angola Nigeria Tuvalu Palau Jamaica Malaysia Niue Kuwait Bahrain Micronesia Cuba Yemen South Sudan Guyana Iran - Country Emissions Pledges 52,4 billion tonnes of emissions* 100% RU 30% EU 40% CA 30% KR 37% US 28% JP 26% CN 65% IN 35% MX 40% PH 70% BR 43% 99,0% of territorial emissions covered under current pledges Has submitted climate pledge MY 45% ID 41% AU 28% 2030: 41% Carbon Emission Reduction 2060: Carbon Neutral Yet to submit pledge Submitted but exiting the deal Source: UNCTAD (April 2020) *of greenhouse gases in 2012 excluding international aviation and shipping *of greenhouse gases in 2012 excluding international aviation and shipping Source: UNCTAD (April 2020) policy) to address the global economic recovery imbalances and the impact on global financial market stability. Third, the need for joint measures to overcome global supply chain disruptions and energy scarcity in order to support economic recovery and overcome the global inflation spike. Fourth, the need for fiscal, monetary, macroprudential, and real sector policies (such as structural and labor reforms) as well as financial institution regulation to overcome the scarring effect of the pandemic on corporate conditions so as not to disrupt the sustainability of economic recovery and prevent spillover risks to financial system stability. Fifth, the need to expand international cooperation in terms of increasing economic-financial digitalization, including crossborder payment system cooperation, development of Central Bank Digital Currency (CBDC), regulation and supervision of BigTech, data, cyber-attacks, and accelerating digitalization towards economicfinancial inclusion, such as remittances, retail trade, and MSMEs. Sixth, the need for a transition period towards a green finance-economy, including the fulfillment and transparency of carbon emission data, preparation of a carbon emission transition program, and carbon taxes, to the development of green financial products (sustainable finance). Seventh, the need to observe and anticipate the formulation of necessary policy measures in Indonesia towards various international agendas that dominate discussions in international cooperation forums, including the G20, IMF, FSB, and BIS. This is more pertinent than ever with Indonesia’s G20 Chairmanship in 2022. Graph 21. National Bed Occupancy Rate (BOR) Graphic 21. Bed Occupancy Rate (BOR) Nasional %, Bed Occupancy Rate Number of Bed (thousand) 74% 63% National Economic Performance and Outlook: The Recovery Process Continues, Stability is Maintained Graph 20. Covid-19 Cases in Indonesia Grafik 20. Covid-19 Cases in Indonesia (MA7) Thousand people 9 10 11 12 1 New Confirmed Cases Data s.d. 16 November 2021 Sumber: Gugus Tugas Percepatan Penanganan Covid-19 diolah 9 10 11 A ctive Cases (rhs) Data as of 16 November 2021 Source: Gugus Tugas Percepatan Penanganan Covid-19 calculated 7% 4% 3% 20 24% Transmission of the highly contagious Delta variant of Covid-19, which peaked in July 2021, has decreased in response to rapid Government action and community support. The Delta variant reached its peak around July-August 2021 and we are grateful that Indonesia has again survived through the quick handling and prevention measures taken by the Government, including the imposition of strict Community Activity Restrictions (PPKM Pemberlakukan Pembatasan Kegiatan Masyarakat) in Java-Bali, acceleration of the vaccination program, as well as the preparation of more treatment facilities with hospitals and other infrastructure. Thanks be to God, positive Covid-19 cases have quickly declined to an average of below 500 per day, compared with an average of 50,000 cases per day in the third week of July 2021 (Graph 20). The use of treatment Thousand people 40 34% 3 4 5 6 7 8 9 10 11 1 2 3 4 5 6 7 8 Vacant (rhs) 9 10 11 Occupied (rhs) BOR Data as of 16 November 2021 Source: Ministry of Health Data as of 16 November 2021 Source: Ministry of Health rooms in hospitals and other healthcare facilities (bed occupancy rate) has also decreased dramatically from around 74% in June 2021 to only 5% today (Graph 21). The vaccination program is also accelerating,with approximately 38% of the Java-Bali population vaccinated and 22% in other areas, thus averaging 31% of the Indonesian population. Therefore, the Government plans to gradually start reopening sectors and/or areas where there area low number of severe cases, low hospital utilization rates, and low mortality rates. Several indicators show that national economy improvement shave resumed after experiencing a slowdown caused by Delta variant transmission in July and August 2021.This is reflected by increasing indicators until early November 2021, such as community mobility, retail sales, consumer expectations, Manufacturing PMI, and the realization of exports and imports. Rising demand and high commodity prices prompted a rapid export (Graph 22) recovery, not only limited to natural resource commodities but also downstream products that the Government continues to push. Accelerating domestic demand was also supported by household consumption, especially food (Graph 23), in line with the relaxing of PPKM restrictions and export performance, especially in Eastern Indonesia Graph 22. Value Grafik 22.Indonesia’s Nilai EksporExport Indonesia Graph 23. 23. Value of Household Consumption Graphic Household Consumption IDR Trillion IDR Trillion 1,550 1,500 1,450 1,400 1,350 I II III IV I II III IV I II III IV I II III IV I II III IV* I II Source: BPS, *Proyeksi Bank Indonesia III IV I II III IV I II III IV I II III IV I II III IV* Source: BPS, *Proyeksi Indonesia Projection Source: BPS, *BankBank Indonesia’s Source: BPS, *Bank Indonesia’s Projection and Sumatra, although the increase in private consumption was subdued, especially in Java and Bali due to the impact of PPKM as a countermeasure to break Delta variant transmission. Likewise, the increase in investment, especially non-construction, was consistent with improvements in exports and ease of foreign investment in accordance with the Job Creation Act (Graph 24). Overall, after a delay during July-August 2021, the Indonesian economy has gradually returned to pre-pandemic levels (Graph 25). National economic growth has continued to improve since the second quarter of 2021 and will increase significantly in 2022. In the third quarter of 2021, economic performance continued to grow positively at 3.51% compared with a 3.49% contraction in the same period last year (Table 2). This growth is below, however, the 7.07% recorded in the second quarter of 2021. Transmission of the Delta variant and tighter measures, especially in the Java and Bali regions, which the Government Graph 24. Investment Grafik 24.Indonesia’s Nilai Investasi Indonesia Value Graph 25. GDP Value Grafik 25.Indonesia’s Nilai PDB Indonesia IDR Trillion IDR Trillion 1,000 2,900 2,800 2,700 2,600 2,500 2,400 I II III IV I II III IV Source: BPS, *Proyeksi Bank Indonesia Source: BPS, *Bank Indonesia’s Projection 1,300 I II III IV I II III IV I II III IV* 2,300 I II III IV I II III IV Source: BPS, *Proyeksi Bank Indonesia Source: BPS, *Bank Indonesia’s Projection I II III IV I II III IV I II III IV* Table 2. GDP by Expenditure Component 2019* 2020** I II III IV 2021*** I II III GDP 5.02 2.97 -5.32 -3.49 -2.19 -2.07 -0.71 7.07 3.51 Private Consumption 5.04 2.83 -5.52 -4.05 -3.61 -2.63 -2.21 5.96 1.03 Government Consumption 3.26 3.77 -6.90 9.76 1.76 1.94 2.58 8.03 0.66 Investment 4.45 1.70 -8.61 -6.48 -6.15 -4.95 -0.23 7.54 3.74 Building Investment 5.37 2.76 -5.26 -5.60 -6.63 -3.78 -0.74 4.36 3.36 Non Building Investment 1.83 -1.46 -18.62 -8.99 -4.71 -8.38 1.39 18.58 4.89 Exports -0.86 0.36 -12.02 -11.66 -7.21 -7.70 7.09 31.98 29.16 Imports -7.39 -3.62 -18.29 -23.00 -13.52 -14.71 5.38 31.72 30.11 Source : BPS Description: *Preliminary figures; ** Figures are very provisional; *** Figures are very, very provisional had to take, undoubtedly had an impact on the economy, especially private consumption that grew by just1.03% in the third quarter of 2021. Similarly, restrictions on mobility resulted in a lower-thanexpected increase in investment at 3.74% in the third quarter of 2021. Growth support from export performance remained high, namely 29.16% in the third quarter of 2021, in line with persistently solid demand from major trading partners, yet has been unable to compensate the decline in private consumption and investment growth. In terms of major economic sectors (LU - Lapangan Usaha), the performance of Manufacturing, Trade and Mining grew positively. National economic growth in Indonesia is predicted to improve again in the fourth quarter of 2021 and beyond, propelled by increasing mobility together with a faster vaccination rollout, strong export performance, the broader reopening of priority sectors, as well as maintained policy stimuli. Overall, in 2021 economic growth will remain within the range of Bank Indonesia’s 3.2%-4.0%projection, before accelerating in 2022 to 4.7%-5.5%. Spatially, national economic growth is supported by almost all regions. The economy in nearly all regions continued to expand in the third quarter of 2021, with the highest growth recorded in the Sulawesi-Maluku-Papua (Sulampua) region, followed by Kalimantan and Sumatra. Several regions, namely Aceh, Jambi and South Kalimantan, grew higher than the previous quarter, primarily supported by export performance in line with Mining sector improvements, particularly coal (Graph 26). Economic growth in Papua also increased on the back of continued investment activity for underground mining and final construction of the PON XX (National Sports Week) venues. Externally, improving global demand and rising prices of key Graph 26. Regional Economic Growth in Q3/2021 (%, yoy) Grafik 26. Pertumbuhan Ekonomi Regi KALIMANTAN SUMATERA 5.28 6.29 3.78 4.52 ACEH 2.8 -0.86 -2.26 NORTH SUMATRA 2.6 III -2.21 IV -4.21 I II -2.81 III III -2.24 IV I II III KALTARA 5.2 RIAU 4.1 WEST SUMATRA 3.3 RIAU ISLANDS 3.0 JAMBI 5.9 BABEL ISLAND 6.1 JAVA 7.92 3.03 BANTEN 4.6 -0.92 I II SOUTH SULAWESI 3.2 DKI 2.4 WEST JAVA 3.4 CENTRAL JAVA 2.6 DIY 2.3 -2.60 IV WEST SULAWESI 2.5 KALTENG 3.6 KALSEL 4.8 LAMPUNG 3.0 III KALBAR 4.6 SUMSEL 3.9 BENGKULU 2.5 -3.91 KALTIM 4.5 EAST JAVA 3.2 BALI -2.9 WEST NUSA TENGGARA 2.4 III Positive, Q III’21 > Q II’21 Contraction, Q III’21 > Q II’21 Positive, Q III’21< Q II’21 Source: BPS, calculated Source: BPS, calculated export commodities have supported regional economic performance, particularly in Sumatra and Kalimantan. From a foreign sector perspective, external demand has boosted performance of the main export-oriented regional foreign countries. In line with export performance and rising commodity prices, Mining sector performance improved and supported the production-based regional economy. Coal mining performance in Sumatra and Kalimantan remains solid, driven by strong Chinese demand. In contrast, the performance of domestically-oriented Manufacturing Industry subsectors has moderated, particularly in Java, in line with restrictions on production activities in essential sectors. However, external demand is still strong enough to support the Processing Industry, particularly the CPO (crude palm oil)industry in Sumatra and the base metal industry in Sulampua. Restrictions on community mobility have also hindered Trade sector performance, especially in Java and the Balinusra region. Improvements in regional economic growth are expected to continue in 2021, with the regions of Java, Sumatra, Kalimantan, Balinusra, and Sulampua growing3.1-3.9%; 2.7-3.5%; 2.8-3.6%; 0.2-1.0%, and 5.8-6.6%. C Q an Ekonomi Regional Triwulan III 2021 (%, yoy) NATIONAL 7.07 3.51 A NUSA GARA I’21 GORONTALO 3.0 CENTRAL SULAWESI 10.2 WEST SULAWESI 2.5 -0.71 -2.19 -3.49 NORTH SULAWESI 3.2 III SOUTH-EAST SULAWESI 4.0 IV I II NORTH MALUKU 11.4 III WEST PAPUA -1.8 PAPUA 14.5 MALUKU 4.2 SOUTH SULAWESI 3.2 EAST NUSA TENGGARA 2.4 BALINUSRA SULAMPUA 8.62 3.77 5.79 3.29 -0.09 0.36 Contraction, Q III’21 < Q II’21 -5.12 -6.81 III -7.43 IV I II III Indonesia has maintained external sector resilience, supported by a solid and improving Balance of Payments (BOP). A positive current account was recorded in the third quarter of 2021, bolstered by strong export performance in line with growing global demand and higher international commodity prices (Table 3). A capital and financial account surplus was maintained by foreign capital in flows in the form of direct investment and portfolio investment. In the fourth quarter, the trade balance recorded a USD5.7 billion surplus in October 2021, the highest in recorded history, underpinned by -1.05 III IV I II III the export performance of key commodities, such as coal, CPO, as well as iron and steel. Meanwhile, portfolio investment in the fourth quarter of 2021 (as of 16th November 2021) recorded a net inflow of USD0.14 billion. The position of Indonesia’s foreign exchange reserve assets at the end of October 2021 stood atUSD145.5 billion, equivalent to 8.5 months of imports or 8.3 months of imports and servicing government foreign debt, which is well above the 3-month international adequacy standard. Looking ahead, the current account is fore casted in a range Table 3. Indonesia’s Balance of Payments Component (USD billion) 2020* I II III* IV* 2021** I* II* III** Current Account -30.3 -3.5 -2.9 1.0 0.8 -4.5 -1.1 -2.0 4.5 A. Goods 3.5 4.5 4.0 9.8 10.0 28.2 7.6 8.3 15.0 - Export, fob 168.5 41.7 34.6 40.8 46.2 163.4 49.4 54.3 61.7 - Import, fob -164.9 -37.2 -30.7 -31.0 -36.2 -135.1 -41.7 -46.0 -46.7 a. Non Oil & Gas (Net) 12.0 5.8 3.3 9.4 11.3 29.9 10.0 11.6 18.1 b. Oil & Gas (Net) -10.3 -2.6 -0.8 -0.7 -1.2 -5.4 -2.3 -3.1 -2.9 B. Services -7.6 -1.7 -2.1 -2.8 -3.1 -9.7 -3.4 -3.7 -3.6 C. Primary Income -33.8 -7.9 -6.2 -7.4 -7.4 -28.9 -6.7 -8.1 -8.3 D. Secondary Income 7.6 1.7 1.4 1.4 1.4 5.9 1.4 1.5 1.4 Capital and Financial Account 36.6 -3.0 11.0 0.9 1.0 7.9 5.7 1.6 6.1 1. Direct Investment 20.5 4.3 4.5 1.0 4.3 14.1 4.4 5.3 3.3 2. Portfolio Investment 22.0 -6.3 9.7 -2.0 2.0 3.4 4.9 4.0 1.1 3. Other Investment+ -6.1 -0.6 -3.4 1.9 -7.4 -9.6 -3.7 -7.7 1.5 4.7 -8.5 9.2 2.1 -0.2 2.6 4.1 -0.4 10.7 - Reserve Assets Positions 129.2 121.0 131.7 135.2 135.9 135.9 137.1 137.1 146.9 In Month of Import and Official Debt Repayment 7.3 7.0 8.1 9.1 9.8 9.8 9.7 8.8 8.6 - Current Account (% GDP) -2.7 -1.3 -1.2 0.4 0.3 -0.4 -0.4 -0.7 1.5 Overall Balance Memorandum: Description:* Preliminary figures; ** Figures are very provisional Source: Bank Indonesia of 0.3% of GDP surplus to 0.5% of GDP deficit in 2021, and will remain low within a manageable deficit of 1.1% to 1.9% of GDP in 2022, thus supporting external sector resilience in Indonesia. The rupiah is stable with potential to appreciate, supported by domestic economic fundamentals, particularly export and external performance, foreign capital inflows, and the exchange rate stabilization policy measures taken by Bank Indonesia. As of 17th November 2021, the rupiah depreciated 0.53% point- to-point and 0.56% on average compared to October 2021 levels. The weaker rupiah was attributable to restrained foreign capital inflows despite positive perception concerning the domestic economic outlook and maintained domestic foreign exchange supply. As of 17th November 2021, therefore, the rupiah has depreciated 1.35% (ytd) compared with the level recorded at end of 2020, lower than the currency depreciation experienced in other developing economies, such as India, Malaysia,Philippines and Thailand (Graph 27a). Rupiah stability is also supported Graph 27a. Rupiah Exchange Rate vs Multiple Grafik 27a. Nilai Tukar Rupiah vs Beberapa Negara Currencies TRY JPY EUR THB KRW ZAR BRL PHP MYR SGD INR IDR CNY % (yoy) -29.88 -15.92 -10.10 -8.68 -2.25 4.08 -8.50 12.11 -5.56 -4.35 -4.70 0.39 -1.35 1.61 2.23 0.0 point-to-point 2.82 -1.40 -10.0 1.55 -2.58 -20.0 0.98 -3.43 -30.0 3.58 -6.06 October-21: CPI = 1,66 Core = 1,33 VF = 3,16 AP = 1,47 -1.67 -8.13 -40.0 Graph 28. Inflation: Core, Volatile Food Grafik 28. Inflasi: Inti, Volatile Food, dan Administered Prices and Administered Prices 6.80 % 10.0 20.0 -2 7 10 1 7 10 1 7 10 1 CPI average 7 10 1 Core 7 10 1 7 10 Volatile Food Administered Prices Data as of 17 November 2021 Source: Reuters and Bloomberg Data as of 17 November 2021 Source: Reuters dan Bloomberg Source:: BPS Source: BPS by the low risk perception of global investors regarding portfolio investment in Indonesia, as reflected in relatively stable Credit Default Swap (CDS) performance (Graph 27b). Bank Indonesia continues to strengthen rupiah exchange rate stabilization policy in accordance with the currency’s fundamental value and market mechanisms through effective monetary operations and loose market liquidity. headline inflation for the calendar year to0.93% (ytd). Annually, CPI inflation stood at 1.66% (yoy), up marginally from 1.60% (yoy) in September 2021 (Graph 28). Core inflation remains low despite growing domestic demand, supported by maintained supply, a stable exchange rate, and anchored inflation expectations. Volatile food (VF) inflation slowed due to adequate goods supply. Inflationary pressures on administered prices (AP) intensified marginally in line with the continuing knock-on effect of higher tobacco excise duty. Consequently, inflation is predicted below the lower point of the 3.0±1% target corridor in 2021 Inflation remains low, thus supporting economic stability. The Consumer Price Index (CPI) in October 2021 recorded inflation of 0.12% (mtm), bringing Graph 27b. EMs and Indonesian CDS Risk Grafik 27b. Persepsi Resiko EMs dan CDS Indonesia Perception bps Grafik 29.National Realisasi Inflation dan Sasaran Inflasi Nasional Graph 29. Realization and Targets bps % (yoy) 0 1 2 3 4 5 6 7 8 9 10 11 121 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 0 EMBI Data s.d. 16 November 2021 Data as of 16 November 2021 Sumber: Bloomberg Source: Bloomberg CDS (rhs) 3,4 3,6 3,0 Range Inflation Target 3,1 2,7 2021* Inflation Realization *Data as of 5 November 2021 Data as of October 2021 Source: BPS Source: BPS and within the target range in 2022 (Graph 29). Bank Indonesia is committed to maintaining price stability and strengthening policy coordination with the Central and Regional Governments through the Inflation Control Teams (TPIP and TPID - Tim Pengendalian Inflasi Pusat dan Daerah) to maintain CPI inflation within the target range. by fiscal expansion and growth of outstanding loans disbursed by the banking industry. Liquidity conditions remain very loose in line with Bank Indonesia’s accommodative monetary policy stance and the impact of synergy between Bank Indonesia and the Government to support the national economic recovery. Bank Indonesia has again injected liquidity through quantitative easing into the banking industry totalingRp137.24 trillion as of 16th November 2021. Since 2020, therefore, quantitative easing policy has reached Rp863.8 trillion or around 5.3% of GDP, one of the largest liquidity injections amongst developing economies. The expansive monetary policy stance supported very loose liquidity conditions in October 2021, as reflected by the high ratio of liquid assets to deposits(AL/DPK - Alat Likuid terhadap Dana Pihak Ketiga) at 34.05%, with deposit growth recorded at 9.44% (yoy). Liquidity in the economy has also increased, as indicated by narrow (M1) and broad (M2) money supply aggregates, which grew 14.6% (yoy) and 10.4% (yoy), primarily driven Bank Indonesia’s decision to maintain a low policy rate, coupled with very loose liquidity conditions in the banking industry, have prompted lower lending rates. In the markets, the overnight interbank rate and 1-month deposit rate have fallen 52bps and 151bps respectively since October 2020 to 2.80% and 3.17% in October 2021. In the credit market, the banking industry continues to lower prime lending rates (PLR), accompanied by low interest rates on new loans. Increasing economic activity and public mobility have improved risk perception in the banking industry, prompting lower interest rates on new loans. Bank Indonesia expects the banking industry to continue lowering lending rates as part of the joint efforts to revive lending to the corporate sector. Financial system resilience is solid, accompanied by a gradual revival of the banking intermediation function. The Capital Adequacy Ratio (CAR) in the banking industry remained high September 2021 at 25.18%, with persistently low NPL ratios of 3.22% (gross) and 1.04% (nett) (Graph 30). Boosted by growing supply and demand, the bank intermediation function expanded 3.24% (yoy) in October 2021 (Graph 31). Demand for Graph 30. Bank Capital and Non-Performing Loans Grafik 30. Permodalan dan Non Performing Loan Perbankan Graph 31. Credit Growth and Bank Deposits Grafik 31. Pertumbuhan Kredit dan DPK Perbankan % % % 4.0 3.5 5.0 25.18 4.5 3.0 3.22 2.5 2.0 NPL (Gross) 12 4 8 9.44 3.24 -5 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 9 12 3 6 10 CAR (rhs) Credit Source: Bank Indonesia Source: OJK Source: Bank Indonesia Source: Bank Indonesia Deposit loans is increasing in line with business activity and consumption as restrictions on public activity are relaxed. On the supply side, the banking industry loosened lending standards in line with lower risk perception. All loan types recorded positive growth, led by consumer loans and working capital loans, while housing loans (KPR - Kredit Pemilikan Rumah) posted higher growth at 8.87% (yoy). Meanwhile, growth of MSME loans accelerated to 3.04% (yoy) in the reporting period. Such developments demonstrate ongoing gains in the real and corporate sectors, micro, small and medium enterprises (MSMEs) in particular. Bank Indonesia will maintain an accommodative macro prudential policy stance as well as policy synergy with the Government and other financial sector authorities to revive bank lending. Therefore, credit and deposit growth in 2021 is predicted to be in the range of 4.0-6.0% and 8.0-10.0%, respectively, and increases to be in the range of 6.0-8.0% and 7.0- 9.0% by 2022. Bank Indonesia continues to accelerate payment system digitalization and expedite the national digital economy and finance. Various payment system digitalization programs, such as expansion of QRIS (Quick Response Code Indonesian Standard), the National Open API Payment Standard (SNAP - Standar Nasional Open API Pembayaran) and regulatory reforms, as well as the BI-FAST implementation plan, remain an ongoing priority. Digital economic and financial transactions continue to proliferate given greater public acceptance and growing public preference towards online retail as well as the expansion of digital payments and digital banking. The value of e-money transactions increased 55.54% (yoy) to Rp29.23 trillion in October 2021. Similarly, the value of digital banking transactions increased 63.31% (yoy) to Rp3,910.25 trillion in the same period and the value of payment transactions using ATM cards, debit cards and credit cards grew 6.37% (yoy) to Rp664.26 trillion(Graphs 32 and 33). Such achievements were reinforced by expansion of the QRIS ecosystem, with QRIS now accepted by over 12 million merchants, thus exceeding the target for 2021. This achievement Graph 32. Growth of ATM, Credit Cards Grafik 32. Pertumbuhan and Electronic Money ATM, KK, dan UE % (yoy) -10 -20 -30 -40 -50 -60 % (yoy) 6.37 55.54 0 -50 24.50 2 4 6 81012 2 4 6 81012 2 4 6 81012 2 4 6 81012 2 4 6 81012 2 4 6 8 10 ATM-Debit Card Credit Card Total Electronic Money (rhs) Source: Bank Indonesia Source: Bank Indonesia is the result of collaboration and synergy between the central and regional governments, government ministries and agencies, associations/organizations and the industry as well as all elements of the public. On the cash side, currency in circulation in October 2021 grew 5.9% (yoy) to reach Rp854.3 trillion. Bank Indonesia continues to ensure cash availability in all regions of Indonesia, while digitalizing rupiah currency management and providing educational activities concerning love, pride and understanding the rupiah (Cinta Bangga Paham (CBP) Rupiah). Graph 33. Banking Growth Grafik 33.Digital Pertumbuhan Digital Banking Billion transactions % (yoy) -20 -40 -60 - SMS/Mobile Banking 9 10 -80 Internet Banking Growth (rhs) Source: Bank Indonesia Source: Bank Indonesia The national economic outlook is expected to improve further in 2022 with stability maintained. As stated, national economic growth in 2022 is projected to reach around 4.7%-5.5%, beyond projected growth of approximately 3.2%-4.0% in 2021. Assuming no third wave of Covid-19, the achievement of herd immunity, and the gradual recovery of community mobility, private consumption is expected to recover and grow by around 5% in the second half of 2022. Exports shall remain a source of economic growth on the back of high demand and rising international commodity prices, although with a lower growth rate than in 2021 due to the base effect. Growing domestic demand, solid export performance, higher foreign investment due to implementation of the Job Creation Act, as well as restarting postponed national strategic infrastructure projects will encourage high investment growth. By sector, the economy will be supported by several growth drivers, such as Mining, Manufacturing, Trade and Agriculture. Meanwhile, inflation is expected to remain under control and within the target corridor of 3%±1%, with sufficient national production capacity to meet the increase in aggregate demand until the end of 2022, although the impact of rising global energy prices demands vigilance. External stability is also expected to be maintained with a manageable current account deficit at around 1.1%-1.9% of GDP, as well as a wider capital and financial account surplus, boosted by foreign capital inflows, especially in the form of foreign investment with implementation of the Copyright Law. Solid economic fundamentals in Indonesia will support rupiah stability despite potentially higher global financial market uncertainty stemming from tapering policy by the Fed and in several other advanced economies. Bank Indonesia will continue to take the policy measures necessary to achieve the inflation target and rupiah stability, while continuing to support joint efforts to accelerate the national economic recovery. Financial system stability will be maintained with stronger growth of outstanding loans disbursed by the banking industry in 2022.The Capital Adequacy Ratio (CAR) remains high and the ratio of NPL low, including the credit restructuring arrangements of the Financial Services Authority (OJK - Otoritas Jasa Keuangan). Bank intermediation will continue to improve, with credit and deposit growth expected to reach 6%-8% and 7%-9% compared with4%-6% and 8%-10% in 2021,as discussed previously. Demand for loans is expected to continue improving given increased growth of consumption, investment, and exports in line with the incremental recovery of economic activity from the Covid-19 pandemic. On the supply side, credit growth is supported by very loose liquidity conditions and lower risk perception in the banking industry, in addition to the current accommodative macroprudential policies. The very high ratio of liquid assets to deposits (LA/DPK - alat likuiditas/dana pihak ketiga)will not affect the banks’ ability to disburse loans or purchase Government Securities (SBN - Surat Berharga Negara), although Bank Indonesia will likely taper liquidity as part of monetary policy normalization. The national digital economy and finance will continue to grow rapidly in 2022, supported by faster payment system digitalization implemented by Bank Indonesia. E-commerce transactions in 2022 are projected to increase, supported by expansion of the e-commerce ecosystem, an ongoing shift in consumer preferences for online retail, as well as various innovations and promotions by the private sector, as well as Government and Bank Indonesia programs. The rapid increase of electronic money (e-money) transactions is also expected to continue, driven by greater e-money use in e-commerce and various other online platforms. Growth is slowing, however, in line with the convenience and efficiency of other digital payment methods, as well as limited promotions for consumers. Likewise, digital banking transactions in 2022 are projected to continue growing, supported by greater convenience and digital innovations by the banking industry. Various Bank Indonesia initiatives to digitize the payment system will be accelerated to create fast, convenient, affordable, secure and reliable payment system transactions, thus improving the national digital economy and finance. Based on experience from 2021, several factors demand attention to nurture Indonesia’s economic recovery. First, synergy needs to be strengthened to accelerate the vaccination roll out and Covid-19 containment with the reopening of priority sectors and further bolster the national economic recovery. Synergy must be directed towards growth drivers with a multiplier effect to economic growth, particularly the export sector and to meet rising domestic demand, including MSMEs. Synergy must also be extended to sectors reeling from the scarring effect of Covid-19 and that pose a relatively high risk to financial system stability, tourism in particular. Second, amid global financial market uncertainty along with plans to normalize monetary policy by the Fed and several other central banks, synergy to strengthen the national economic policy mix must be strengthened to maintain stability and accelerate the national economic recovery. Policy synergy is required to accelerate structural reforms in the real sector, particularly the continuation of infrastructure projects and the implementation of the Job Creation Act, fiscal sustainability and State Budget (APBN Anggaran Pendapatan dan Belanja Negara) funding from Bank Indonesia for the national economic recovery, and Financial System Stability Committee (KSSK - Komite Stabilitas Sistem Keuangan) synergy to encourage financing for the corporate sector. Third, innovation must be strengthened, in terms of synergy regarding the intended national economic policies, as well as to expedite national economic and financial digitalization and inclusion through payment system digitalization as well as MSME development programs and the local economy. Moreover, policy and program innovation are also required in development of the green economy and finance for sustainable national economic development and in response to increasing demands from developed countries. Bank Indonesia Policy Mix 2021: Encouraging National Economic Recovery, Maintaining Stability Close national policy synergy to overcome the Covid-19 pandemic since 2020 has been strengthened in 2021 to maintain stability and foster further improvements. In this regard and as conveyed at the Bank Indonesia Annual Meeting last year, there is one prerequisite, namely a fast and comprehensive vaccination program roll out, coupled with disciplined application of the Covid-19 protocols, as well as 5 (five) policies as necessary preconditions, namely: (i) reopening productive and safe sectors, (ii) accelerating fiscal stimulus realization, (iii) boosting credit growth on the supply and demand sides, (iv) sustaining monetary and macro prudential stimuli, and (v) digitizing the economy and finance, particularly MSMEs. The vaccination roll out, as a prerequisite, accelerated in 2021 given greater supply and orderly distribution of global vaccines, especially since the outbreak of the Delta variant. Productive and safe sectors continued to reopen amid relentless efforts to overcome the pandemic, specifically the property and automotive sectors, accompanied by close coordination with the Financial System Stability Committee to revive lending to the corporate sector. Meanwhile, synergic payment system digitalization with Gernas BBI and BWI between Bank Indonesia, the Government, banking industry, payment service providers, FinTech, and e-commerce accelerated the national digital economy and finance to support inclusive economic growth. Strong national economic policy synergy between the Government, Financial System Stability Committee, and Bank Indonesia turned the national economy around, while maintaining macroeconomic and financial system stability. In 2021, the Government maintained an extraordinary fiscal stimulus to mitigate the health and economic impacts of Covid-19. The fiscal deficit in 2021 is estimated to have reached Rp961.49 trillion or 5.82% of GDP, comprising the Covid-19 containment budget and the national economic recovery program totalingRp744.77 trillion, including a health budget of Rp214.96 trillion and social protection budget of Rp186.64 trillion. Close coordination with the Financial System Stability Committee was pursued to improve the property and automotive sectors through fiscal incentives by the Government and the relaxation of macroprudential policies by Bank Indonesia to maintain financial system stability and revive financing to the corporate sector. Meanwhile, the Financial Services Authority continued to relax credit restructuring requirements in the banking industry by delaying principal and interest installments to avoid increasing non-performing loans and eroding capital by extending Consumer Protection in the Financial Services Sector (POJK - Perlindungan Konsumen Sektor Jasa Keuangan) through OJK Regulation (POJK) No. 48 of 2021, valid until March 2023. Likewise, the Indonesia Deposit Insurance Corporation (LPS-Lembaga Penjamin Simpanan) guaranteed private deposits in the banking system, thus helping to maintain financial system stability, and lowered the guaranteed interest rate to support the national economic recovery. Fiscal and monetary policy coordination have been strengthened, not only to maintain macroeconomic stability and reinforce the national economic recovery, but also through Bank Indonesia’s participation in State Budget funding through purchases of Government Securities in the primary market in accordance with Act No. 2 of 2020.In 2020, Bank Indonesia supported State Budget financing to the tune of Rp473.2 trillion by purchasing Government Securities through primary auction (Joint Decree - KB I) totalingRp75.86 trillion and direct purchases of Government Securities as part of a burden sharing mechanism in the State Budget (Joint Decree - KB II) totalingRp397.56 trillion. In 2021, Bank Indonesia is again supporting State Budget funding through the purchase of Government Securities in the primary market in accordance with KB I amounting to Rp143.32 trillion as of 31stOctober 2021, consisting of Rp67.87 trillion through primary auction and Rp75.46 trillion through Greenshoe Options (GSO). Furthermore, addressing the growing need for a state budget focusing of health and humanitarian financing due to the rapid spread of the Delta variant, Bank Indonesia also committed to purchasing Government Securities directly from the Government in accordance with Joint Decree III (KB III), totaling Rp215 trillion in the 2021 State Budget and Rp224 trillion in2022, with a low interest rate commensurate with the 3-month BI 7-Day Reverse Repo Rate (BI7DRR). In addition to low interest rates, Bank Indonesia also returned some of the coupon payments received from the purchase of Government Securities worth Rp58 trillion for the 2021 State Budget and Rp40 trillion for the 2022 State Budget, thus avoiding an interest expense in the State Budget for the Government. This demonstrates the strong commitment of Bank Indonesia to support state budget funding in terms of health and humanitarian financing and accelerating the national economic recovery with implementation carried out in accordance with applicable regulations. Bank Indonesia has maintained a pro-growth policy stance, directing the full panoply of monetary, macroprudential and payment system policy mix instruments towards supporting the national economic recovery in close coordination with the Government. The salient points of the policy mix implemented by Bank Indonesia include: i. In the monetary sector, an historically low policy rate has been maintained along with rupiah exchange rate stability and liquidity injections through quantitative easing. The low policy rate will be maintained until there are indications of rising inflation. Since 2020, Bank Indonesia has lowered the BI7DRR policy rate 6 (six) times to 3.50%, the lowest in history. The rupiah exchange rate stabilization policy was implemented using triple intervention in the spot market, DNDF (Domestic Non-Deliverable Forwards), and the purchase of Government Securities in the secondary market, amid persistent global financial market uncertainty. Likewise, Bank Indonesia continued to inject liquidity via quantitative easing to strengthen the banks’ ability to extend credit/financing to the corporate sector. From 2020 to 16thNovember 2021, the quantitative easing policy reached Rp863.8 trillion, or 5.3% of GDP, through liquidity injections into the banking industry to support the national economic recovery program, which we will explain in more detail later. ii. Accommodative macroprudential policies continue to revive bank financing disbursed to the corporate sector in synergy with Financial System Stability Committee policy. This includes loosening the down payment requirements on automotive loans,Loan/Financing-to-Value (LTV/FTV) Ratio on Property Loans and(sharia) Macroprudential Intermediation Ratio (MIR), encouraging the banks to lower Prime Lending Rates, as well as other accommodative macroprudential policies. Bank Indonesia has also refined and modernized the MSME Credit Ratio policy into the Macroprudential Inclusive Financing Ratio (RPIM - Rasio Pembiayaan Inklusif Makroprudensial). iii. Bank Indonesia continues to accelerate payment system digitalization for integration of the national digital economy and finance, including expansion of QRIS (Quick Response Code Indonesian Standard) acceptance to 12 million merchants by the end of 2021, including cross-border QRIS, implementation of the National Open API Payment Standard (SNAP), as well as electronification of social aid program (bansos) disbursements, transportation modes, and government financial operations. Various agendas in the Indonesia Payment System Blueprint (BSPI - Blueprint Sistem Pembayaran Indonesia) 2025 have also been accelerated, including development of BI-FAST as a real-time retail payment system available 24/7, along with interlinkages between digital banking and FinTech, as well as payment system regulatory reform. iv. In addition to the three main policy initiatives above, Bank Indonesia also oriented all four supporting policies towards the national economic recovery. Close synergy with the Government, banks, and other institutions has been enhanced to develop MSMEs as well as the Islamic Economy and Finance as a new source of national economic growth in Indonesia. Financial market deepening has also accelerated, particularly the rupiah and foreign exchange money markets, to strengthen monetary policy transmission, support financial system stability, and finance development, including infrastructure. International policy has been directed towards not only strengthening Bank Indonesia’s policy diplomacy, but also to support the Government in facilitating and promoting trade and investment in various countries. v. Besides, Bank Indonesia also adjusted its operational activities and public services to support Government restrictions on public mobility during the Covid-19 pandemic, including cash services, payment systems, monetary operations, and central banking services to the Government. In addition, Bank Indonesia also temporarily increased the maximum limit on cash withdrawals through ATM machines using chip technology until 30th September 2021. Rupiah Exchange Rate Stabilization Policy The rupiah has appreciated significantly thanks to the stabilization policy adopted by Bank Indonesia, which was conducive to the national economic recovery. Triple intervention exchange rate stabilization policy,targeting the spot market, Domestic NonDeliverable Forwards (DNDF), and purchases of Government Securities in the secondary market, was reinforced via intensive communication with investors Graph 34. Foreign Investment Flows to Grafik 34. Aliran Investasi Asing ke SBN Government Securities Graph 35. Government Securities Yield Spread Grafik 35. Yield Spread SBN dengan UST with UST IDR Trillion bps -5 -10 -15 -20 473 453 -25 Jan Jan Feb Feb Mar Mar Mar Apr Apr Mei Mei Jun Jun Jul I III I III I III V II IV II IV II IV I 5-<10 Years >10 Years 131 128 69 31 Jul Aug Aug Sep Sep Oct Oct III I IV II IV I IV TR 0-<5 Years Source: Bank Indonesia BR ZA RU MX IND ID PH MA PL CN SK TH Source: Bloomberg, calculated Source: Bloomberg, calculated Sumber: Bank Indonesia as well as domestic and overseas market players. As mentioned, the rupiah has regained lost value, hitting Rp14,610 per US dollar on 15thApril 2021 before strengthening to Rp14,243 on 17thOctober 2021. Investor confidence has drawn foreign portfolio in flows into Indonesia. From April 2021 to October 2021, foreign capital inflows to the government securities market stood at Rp6.7 trillion (Graph 34), while the position of reserve assets increased to USD145.5 billion at the end of October 2021, surpassing the USD135.9 billion position recorded at the end of 2020. Looking ahead, the rupiah is expected to remain relatively stable, supported by controlled inflation within the target corridor, a manage able current account deficit, attractive returns on domestic financial assets for investment and a stable risk premium (Graph 35). Graph 36. RatePUAB on Interbank Money Market Grafik 36.Interest Suku Bunga O/N Graph 37. Prime Lending Rate (SBDK- Suku Bunga Dasar Kredit) Transmission % Monetary Policy Stimuli A historically low policy rate and loosening of Bank Indonesia’s monetary policy stance have prompted further declines in bank lending rates, while maintaining financial market stability. As stated, since 2020 Bank Indonesia has lowered the BI7DRR policy rate 6 (six) times to 3.50%. The low % 4,25 3,50 2,80 2,75 1 2 3 5 6 7 9 1011 1 2 3 5 7 8 9 1112 1 3 4 5 7 8 101112 2 3 5 6 7 9 1011 1 2 3 5 6 8 9 1012 1 3 4 6 7 8 1011 8.75 9.06 5.47 5.25 3.50 3.17 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 8 9 10 DF rate LF rate BI7DRR PUAB O/N Spread (PLR - 1 Month TD) PLR 1 Month TD BI7DRR Interest Rates on New Loans Source: Bank Indonesia Source: Bank Indonesia Spread (SBDK - BI7DRR) Source: OJK, Bank Indonesia, calculatedcalculated Source: OJK, Bank Indonesia, BI7DRR and loose liquidity were accompanied by lower market rates. In the markets, as mentioned earlier, the overnight interbank rate and banking 1-month deposit rate have decreased 52bps and 151bps respectively since October 2020 to 2.80% and 3.17% in October 2021 (Graph 36). Likewise, the benchmark yield on 10-year government securities also fell 228bps from a high of 8.31% at the end of March 2020 to 6.02% on 18th November 2021. In the credit market, the decline in bank prime lending rates continued, followed by a decline in interest rates on new loans (Graph 37). Bank Indonesia also continued the monetary stimulus in the banking industry in the form of massive quantitative easing (QE) to revive financing to the corporate sector and support the national economic recovery. As of 16th November 2021, Bank Indonesia has injected liquidity via quantitative easing to the banking industry totaling Rp137.2 trillion. Since 2020, therefore, quantitative easing policy has reached Rp863.8 trillion or around 5.3% of GDP, one of the largest liquidity injections in developing economies. Though massive liquidity injections to the banking industry have thus far failed to fully revive bank lending due to softness on the demand side from the corporate sector, very loose liquidity conditions play an important role in maintaining overall financial system stability. In addition to injecting liquidity to the banking industry, Bank Indonesia also continued to purchase government securities in the primary market to fund the 2021 State Budget to the tune of Rp143.32 trillion, consisting of Rp67.87 trillion through primary auction and Rp75.46 trillion through Green Shoe Options (GSO). The purchase of government securities to fund the State Budget also increased liquidity in the economy in line with government spending realization. Macroprudential Policy Easing The macroprudential policy stance remains accommodative and synergized with Financial System Stability Committee policy to revive financing to the corporate sector and accelerate the national economic recovery. Bank Indonesia has loosened several macroprudential policies. First, relaxing the loan-to-value (LTV) ratio on property loans and down payment requirements on automotive loans to 0%, effective from 1st March 2021. Bank Indonesia initiated the policy in synergy with the Government and Financial Services Authority (OJK), which issued a separate policy package to stimulate the property and automotive sectors – as sectors with strong (backward and forward) linkages to other economic sectors. Second, conducting and publishing in-depth assessments of Prime Lending Rate (PLR) transparency in the banking industry since February 2021 to strengthen the transmission of accommodative monetary and macroprudential policies. Third, the gradual reactivation of the Macroprudential Intermediation Ratio (RIM - Rasio Intermediasi Makroprudensial) by raising the lower limit to 75% in May 2021, 80% in September 2021, and 84% in January 2022. Strengthening efforts were also achieved by including letters of credit (L/C) heldby banks into MIRcalculations. Bank Indonesia has synergized these policy measures with efforts to maintain adequate banking liquidity through a Countercyclical Buffer (CCyB) held at 0% and a Macroprudential Liquidity Buffer (MPLB) (Penyangga Likuiditas Makroprudensial) of 6% - which are eligible for repurchase with Bank Indonesia. Bank Indonesia has also refined and modernized the MSME Credit Ratio into the Macroprudential Inclusive Financing Ratio (RPIM). To promote inclusiveness, Bank Indonesia has improved policy by expanding the financing target beyond MSMEs to include low-income individuals (PBR - Perorangan Berpenghasilan Rendah). In addition, Bank Indonesia provides flexibility to allow banks to participate in financing MSMEs and low-income individuals based on their expertise and business model by expanding the financing options for MSMEs and low-income individuals. In this case, banks can contribute to inclusive financing through 3 (three) modality schemes, namely: (1) direct supply chain inclusive financing, (2) financing through financial institutions and service agencies, including (sharia) rural banks, FinTech, Permodalan Nasional Madani (PNM), and Sarana Multi Finance (SMF), and financing through the purchase of inclusive financing securities, such as Inclusive Government Securities, Inclusive Medium-Term Notes (MTN), and Inclusive Asset-Backed Securities (EBA - Efek Beragun Aset). Moving forward, expansion of the inclusive financing scheme is expected to indirectly foster banking innovation and financial market deepening. RPIM implementation will be incremental to achieve a target portion of MSMEs and other inclusions in bank loans of at least 30% (thirty percent) by the end of June 2024. positive territory in October 2021 at 3.24% (yoy), supported by growing demand for loans, especially in the corporate and consumption sectors in response to increasing public activity and the looser bank credit supply in accordance with lower lending standards,lower risk perception, loose liquidity conditions as well as lower interest rates on new loans. Liquidity in the economy has increased, as reflected in the narrow (M1) and broad (M2) money supply aggregates, which expanded by 14.6% (yoy) and 10.4% (yoy) respectively (Graph 38). Bank lending was the main driver of money supply growth, indicating increasing financing for the national economic recovery. Bank Indonesia has held a low policy rate as well as an accommodative monetary and macroprudential stance to also support financial system stability. Bank liquidity conditions in October 2021 were very loose, as reflected by a high ratio of liquid assets to deposits(AL/DPK - Alat Likuid/Dana Pihak Ketiga) at 34.05%, with deposit growth recorded at 9.44% (yoy), moderating on the previous period in line with the recovery of business activity and private consumption. Bank intermediation charged into Demand and supply-side improvements are reviving the bank intermediation function. Demand for loans has improved, particularly from the business and consumption sectors, in response to increasing public activity. On the supply side, the banking industry has eased lending standards in line with lower risk perception, in addition to very loose liquidity conditions and lower interest rates on new loans (Graph 39). All loan types recorded positive growth, led by consumer loans and working capital loans, while housing loans (KPR - Kredit Pemilikan Rumah) posted higher growth at 8.87% (yoy) in Graph 38. Money Supply Grafik 38. Uang Beredar Graph 39. Standards Index Grafik 39.Lending Indeks Lending Standard % (yoy) Index % (yoy) 10.4 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 910 M1 Source: Bank Indonesia Source: Bank Indonesia 10.9 Looser 14.6 Tighter 34.4 4.0 1.2 2.0 -0.4 -10 I II III IV I II III IV I II III IV I II III IV* *) Estimation M2 Source: Survey Perbankan Bank Indonesia Tw III 2021 Source: Bank Indonesia’s Bangking Survey Q3 2021 Graph 40. Segment Grafik 40.Loans Kreditby per Segmen improvements in bank lending and financing from the capital market in line with national economic recovery momentum after the Covid-19 pandemic, increased public mobility and economic activity, faster State and Regional Budget realization, an accommodative monetary and macroprudential policy mix, including very loose liquidity in the banking industry, and progress in terms of credit restructuring by banks. (%, yoy) -5 -10 Acceleration of Payment System Digitalization 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 10 Consumption Credit Commercial Credit MSME Total Credit Corporation Bank Indonesia continues to accelerate payment system digitalization and integrate the national digital economy and finance. Concerning implementation of the Indonesian Payment System Blueprint (BSPI - Blueprint Sistem Pembayaran Indonesia) 2025, Bank Indonesia in 2021 focused payment system digitalization based on 3 (three) priorities and important achievements, namely regulatory reform, retail payment system infrastructure, and payment system standardization Sumber: Bank Indonesia Source: Bank Indonesia October 2021 in line with KSSK policy to stimulate the property sector. Meanwhile, growth of MSME loans accelerated to 3.04% (yoy) in the reporting period. Such developments demonstrate ongoing gains in the real and corporate sectors, micro, small and medium enterprises (MSMEs) in particular (Graph 40). Moving forward, Bank Indonesia predicts gradual Figure 1. Development of BSPI 2025 INDONESIA PAYMENT SYSTEMS BLUEPRINT (BSPI) 2025: QUICK WINS 2021 IN 2021, THERE ARE AT LEAST 3 (THREE) IMPORTANT MILESTONES FOR BSPI 2025, NAMELY REGULATORY REFORM, RETAIL PAYMENT INFRASTRUCTURE, AND PAYMENT SYSTEM STANDARDIZATION (SNAP AND QRIS)… 1. REGULATORY REFORM BSPI 2025:WORKING GROUP 5 INITIATIVES 2. RETAIL PAYMENT INFRASTRUCTURE 3. PAYMENT SYSTEM STANDARDIZATION REGULATORY REFORM BI-FAST Integrated Regulatory, Licensing, Supervisory, and Reporting The Efforts to Find a Balanced Point between Optimizing Onnovation and Maintaining Stability and National Interest Regulatory Framework Restructurization Payment Systems Regulatory Reform through Restructuring Regulatory Framework and Drafting Bank Indonesia Regulation (PBI) concerning the Payment System Regulatory Drafting/ Adjustment End to End Risk-based Principle-based REGULATORY PRINCIPLES Structured Agile & Forward Looking Proportional 3 STAGES FOSTERS INTERCONNECTION, INTEROPERABILITY, AND COMPATIBILITY ASSURES INTERLINK BETWEEN FINTECH AND BANKS MAINTAIN THE LEVEL PLAYING FIELD TO MITIGATE SHADOW-BANKING PRACTICES Credit Transfer (Phase 1, Stage 1) Issued Bank Indonesia Regulations (PBI): PBI No. 22/23/PBI/2020 concerning the Payment System, December 20, 2020 PBI No. 23/6/PBI/2021 concerning Payment System Provider and PBI No. 23/7/PBI/2021 concerning Payment System Infrastructure Providers, July 1, 2021 PBI No. 23/11/PBI/2021 concerning Payment System National Standard, August 12, 2021 QR Code Indonesian Standard ISSUED PADG NO. 23/15/PADG/2021 CONCERNING NATIONAL STANDARD OF PAYMENT OPEN API, AUGUST 20, 2021 Integrated Function Strengthening PBI concerning the payment system Activity-based Standardized, Integrated Payment system infrastructure which facilitates retail payment from multiple instruments and operates 24/7 Debit, Bulk, RFP (Phase 1, Stage 2) >2023 QRIS FEATURES: MPM, CPM, TTM, TTS, CROSSBORDER Expansion (Phase 2) *Request for payment Source: Bank Indonesia (Figure 1). In terms of regulatory reform, policy transformation is key to consolidate the national payment system industry, while streamlining licensing procedures. To that end, Bank Indonesia is strengthening the Bank Indonesia Payment System Regulation issued at the end of 2020, with promulgation of the Payment Service Provider PBI (PJP) and the Payment Infrastructure Provider PBI (PIP) on 1st July 2021. The two BI regulations intend to strengthen the Indonesian payments ecosystem end-to-end and encourage healthy business practices through industry collaboration to accelerate an inclusive digital economy and finance. Licensing has been simplified by applying principle-based rules and granting permits to groups of payment service types rather than the previous arrangement with rigid (rules-based) requirements for each service type. This has been applied to processing licenses for payment service providers (PSP),designating payment system infrastructure operators (PIP)as well as processing the development of risk-based activities, products, and/or cooperation. Bank Indonesia also continues to develop integrated, interoperable, and interconnected payment system infrastructure to support the national digital economic and financial ecosystem. In this case, Bank Indonesia has modernized retail payment infrastructure to operate in real-time (as it happens) non-stop (24/7) by launching BI-FAST in December 2021. BI-FAST was built to support the industry by integrating and consolidating the digital economy and finance (EKD -Ekonomi dan Keuangan Digital) nationally end-to-end, with implementation of BSPI 2025, and supporting a fast, affordable, convenient, secure and reliable payment system (CEMUMUAH). At the initial stage, BI-FAST services are focused on individual credit transfer services. There are various implementation policies to prepare for the BI-FAST roll out, such as open participation, the option of providing infrastructure independently or jointly/sharing, setting a maximum limit of Rp250 million and a BI-FAST price scheme limit of Rp2,500 to bank customers with a Bank Indonesia fee to participants of just Rp19 per transaction. The first batch of 22 BI-FAST participants is set for December 2021 and a second batch of 22 participants in January 2022. BI-FAST implementation is also consistent with Bank Indonesia’s monetary, macroprudential and payment system policy direction moving forward, while modernizing national payment infrastructure according to international standards and in accordance with the principles issed by the Committee on Payments and Market Infrastructures (CPMI), and simultaneously supporting the creation of an integrated, interoperable, and interconnected digital ecosystem (3 “i”). In addition to BI-FAST, Bank Indonesia has also launched the National Open API Payment Standard (SNAP)to standardize the EKD ecosystem. SNAP is a national standard for protocols and instructions that facilitate open interconnection between applications in processing payment transactions, prepared by Bank Indonesia in collaboration with the Indonesia Payment System Association (ASPI - Asosiasi Sistem Pembayaran Indonesia). SNAP intends to create a healthy, competitive, and innovative payment system industry that can provide efficient, secure and reliable payment system services to the public. SNAP was launched on 17th August 2021 and will be adopted gradually, commencing in June 2022 for first mover payment service providers and in December 2022 for other PJPs. Bank Indonesia is confident that SNAP implementation will facilitate interconnection, interoperability, and compatibility between Open API payment providers, thereby strengthening the links between PJP banks and non banks. In addition, SNAP also establishes a level playing field between payment industry players, thus minimizing fragmentation and accelerating the digital economy and finance in Indonesia. Payment system digitalization is also supported by QRIS extensification as the national standard for QR Payments in various digital economic and financial transactions. QRIS expansion has been realized through a massive national campaign to onboard 12 million connected merchants using QRIS in the national ecosystem by the end of 2021. Bank Indonesia used several incentives, such as extending the 0% merchant discount rate (MDR) for micro businesses until 31stDecember 2021, as well as increasing the QRIS transaction limit from Rp2 million per transaction to Rp5 million per transaction to increase QRIS transactions in the middle segment, since 1stMay 2021. Synergy and coordination with the Government continues to be strengthened through QRIS use in the BBI and BWI. QRIS expansion in the local government environment was also expanded as part of the Regional Digitalization Expansion and Acceleration Team (TP2DD). Thanks be to God, the various policies and close coordination have produced positive results. The target of 12 million merchants (Table 41) connected to QRIS was achieved on 1st November 2021. Furthermore, QRIS, which operates in 34 provinces and 480 regencies/cities, is used by 88% of micro and small businesses, and is operated by 68 payment service providers, both banks and nonbank institutions. Moreover, the use of QRIS is also increasing both in terms of volume and value, which demonstrates burgeoning public acceptance of QRIS (Graph 41). Bank Indonesia continues to expand the payment electronification program for social aid program (bansos) disbursements, transportation modes, and regional government financial transactions to support acceleration of the digital economy and finance. Bank Indonesia fully backs government efforts to disburse social assistance more quickly, on target, and with good governance through the social assistance electronification program. To that end, Bank Indonesia continues to encourage the digitalization of social assistance 4.0 by strengthening business models, regulations and payment methods that are in line with prevailing needs, including improving data quality. Meanwhile, in terms of transportation electronification, Bank Indonesia encourages the integration of payment systems and data in the transportation sector. Bank Indonesia provides support for the preparation of a payment aspect business model for integrated transportation modes as well as multi-lane, free-flow toll roads that will gradually begin operating in 2022. Furthermore, to strengthen the electronification of regional government transactions, Bank Indonesia in 2021 strengthened synergy with the Acceleration and Expansion Regional Digitalization Task Force. As of 14th October 2021, a total of 482 TP2DD have been established, accounting for 88% of local Table 4. QRIS Registered Merchants Grafik 41. Perkembangan QRIS Graph QRIS Grafik41. 42.Development PerkembanganofQRIS Million transactions IDR billion Merchant 22/03/2020 05/11/2021 Growth (%) Big Enterprise 129,834 449,311 246% Usaha Mikro Social/Donation TOTAL 3.000 2.500 Medium Enterprise 265,077 Small Enterprise 3.500 304,420 928,005 250% 3,203,652 952% 2.000 1.500 1.000 2,378,026 7,532,134 217% 3,996 124,484 3015% 3,081,353 12,237,586 - 297% Nominal Source: Bank Indonesia Source: Bank Indonesia 9 10 11 12 1 9 10 Volume (rhs) Sumber: Bank Indonesia Source: Bank Indonesia governments in Indonesia, comprised of 33 provincial governments, 360 districts and 89 cities. Synergy between the relevant authorities and stakeholders is continuously built through, among others, the successful Indonesia Digital Economy and Finance Festival in 2021 (FEKDI - Festival Ekonomi Keuangan Digital Indonesia), as a forum for policy synergy and the basis for implementing various development and expansion initiatives for the digital economy and finance in order to accelerate digital transformation and accelerate national economic recovery. Graph 43. Development of Digital Bangking Grafik 45. Perkembangan Digital Banking IDR Thousand Trillion 48.6 40.0 27.3 27.4 21.9 17.1 The various payment system digitalization programs (above) are accelerating and integrating the national digital economy and finance today and moving forward. E-commerce transactions, which are estimated to have grown 51.6% in 2021, will continue to increase in 2022 to reach Rp530 trillion, or grow 31.4% (Graph 42). In line with these developments, digital banking payment transactions in 2021 are projected to increase by 46.1% (yoy) and increase again by 21.8% to reach Rp48.6 quadrillion in 2022 (Graph 43). Meanwhile, the use of Electronic Money in 2021 is also estimated to increase by 41.2% (yoy) and will again grow at a high level of 16.3% (yoy) to reach Rp337 trillion in 2022 (Graph 44). Increasingly rapid development of digital economic and financial transactions is in line with growing public acceptance Graph 42. Development of E-Commerce Grafik 43. Perkembangan E-Commerce 2021* 2022* Sumber: Bank Indonesia; *Proyeksi Bank Indonesia Source: Bank Indonesia; *Bank Indonesia’s Projection and preference for online shopping, expansion of the e-commerce ecosystem, development of digital payment services, improving domestic economic conditions, and the acceleration of various payment system digitalization programs in accordance with BSPI 2025. Concerning rupiah currency management, Bank Indonesia continues transformation efforts through centralization, automation, and efficiency in the printing and circulation of money throughout the territory of the Republic of Indonesia. Transformation is oriented - Sumber: Bank *Proyeksi Bank Indonesia’s Indonesia Source: BankIndonesia; Indonesia; *Bank Projection IDR Trillion Graph 44. Development of E-Money Grafik 44. Perkembangan Uang Elektronik IDR Trillion 2021* 2022* Sumber: Bank Indonesia; *Proyeksi Bank Indonesia Source: Bank Indonesia; *Bank Indonesia’s Projection 2021* 2022* towards providing money fit for circulation in appropriate denominations, just in time through the central bank, aligning the direction of non-cash policies, and paying attention to efficiency and the national interest based on the 2025 Rupiah Currency Management Blueprint (BPPUR - Blueprint Pengelolaan Uang Rupiah). Transformation is based on 3 (three) keys milestones, namely distribution centralization, digitalization, and efficiency supported by strengthening information systems, regulations, organization, and human resources. Distribution centralization is achieved by aligning distribution lines and layers, strengthening command centers, centralizing cash inventory management, and optimizing the use of infrastructure and transportation modes based on 4.0. Meanwhile, endto-end digitalization of rupiah currency management begins with planning and printing, to issuing, circulating, removing and destroying rupiah currency. In the context of efforts to increase efficiency, Bank Indonesia continues to make various improvements in rupiah currency management, including the efficient management of currency supply, distribution and cash services, meeting spatial-based cash needs, as well as strengthening the quality of currency materials and security features. The transformation of rupiah currency management based on the three key milestones represents a manifestation of Bank Indonesia’s firm commitment to maintaining the rupiah integrity and credibility as legal tender, as well as a unifying and instilling a sense of pride for the Republic of Indonesia and the Indonesian nation. Accelerating Money Market Deepening Bank Indonesia is accelerating money market deepening to strengthen monetary policy effectiveness and support economic recovery. Various programs were carried out as part of the Blueprint for Money Market Development (BPPU) 2025 based on three main initiatives, namely: (i) encouraging digitalization and strengthening financial market infrastructure, (ii) strengthening the effectiveness of monetary policy transmission, and (iii) developing financial instruments as a source of economic financing and strengthening risk management (Scheme 2). In an effort to strengthen the monetary policy transmission effectiveness, Bank Indonesia focused on accelerating the development of repo and DNDF transactions between market participants in 2021. To that end, Bank Indonesia strengthened the Jakarta Interbank Spot Dollar Rate (JISDOR) as a reference rate for the rupiah against the US dollar. Strengthening efforts carried out both during the transaction monitoring period and at the time of Scheme 2. Linkages Between BPPU Initiatives 2025 INITIATIVE 2 INITIATIVE 1 Financial Market Infrastructure* Hard Structure Soft Structure Effectiveness of Monetary Policy Transmission Efficient pricing Varied and liquid products Broader participants (include MCoC) INITIATIVE 3 Liquid and Efficient Financial Market Price Stability: Inflation Financial System Stability Economic Growth *) Money market, Forex Market & Sharia Market Support National Economy toward a Developed Indonesia Inclusivity of Roles of MSME Economic Financing Sources Asset Securitization Varied and liquid hedging Retail Based Participants JISDOR issuance intend to increase forex market credibility and reinforce exchange rate stability. The development of DNDF instruments continued through efforts to increase supply in the market and balance the supply and demand sides, including by allowing DNDF participants to rollover maturing DNDF. In addition, the Local Currency Settlement (LCS) scheme has been strengthened continuously and expanded to alleviate dependence on specific currencies. The LCS framework has been strengthened between Indonesia-Malaysia and Indonesia-Japan, while expansion of LCS partner countries was followed by the implementation of the Indonesia-China LCS in September 2021. The development of JISDOR, DNDF, and LCS also forms part of Bank Indonesia’s efforts to enrich financial instruments as a source of economic financing and strengthen risk management. In addition, Bank Indonesia in synergy with the Ministry of Finance and OJK,through the Financial Market Deepening Development Forum (FP-PPK), continue to develop financial instruments for economic financing, including Commercial Securities (SBK - Surat Berharga Komersial) and expanding interbank repo transactions with SBN as the underlying transaction, while campaigning to mobilize SBN retail investors. Bank Indonesia has created a regulatory framework through promulgation of money market regulations (PBI) with the industry to hasten digitalization and strengthen money market infrastructure. This includes development of a Multimatching Electronic Trading Platform (ETP) with money market and forex market transactions executed jointly by standardizing instruments and determining prices more transparently among market participants, shifting from bilateral OTC transactions. Implementation of ETP Multimatching will encourage efficient and transparent pricing and better risk management. In the early stages, ETP Multimatching will be implemented for foreign exchange transactions, especially spot transactions, before being extended to cover other types, including repo, swap, and DNDF transactions. In addition, Bank Indonesia is coordinating with the relevant authorities and industry to accelerate the establishment of a central counter party (CCP) to improve transaction Scheme 3. Development of Indonesian CCP SBNT VISION CCP Interest Rates and Exchange Rates in accordance with international standards and best practices MISSION Support the streamline transmission of monetary policy, contribute to maintaining financial system stability, encourage financial market development, and support the domestic economy Indonesian Legal Entity Supported by Strong Capital Based on Risk Management and Governance Interconnection and Interoperability with Other Systems INFORMATION SYSTEMS AND HUMAN RESOURCES Source: Bank Indonesia efficiency, strengthen transparency, and reduce the risks associated with repo transactions using SBN as underlying transactions (Scheme 3). In contrast to bilateral OTCSBN repo transactions, repo transactions through CCP are performed jointly through ETP Multimatching with product standardization, transaction contracts, price transactions, as well as a closed-out netting mechanism on the basis of SBN submitted as the underlying transaction from market participants to the CCP agency. Therefore, CCP-SBN NT will increase the volume and liquidity of interbank SBN repo transactions, strengthen transparency in the formation of marketrates, and eliminate counterparty risk arising in bilateral OTCrepo transactions. The CCP-SBN NT will reduce the large disparity between SBN yields (approximately 5.2% ona 5-year tenor) and money market interest rates (approximately 3.7% ona 12-month tenor) and, therefore,support government efforts to reduce the interest burden on government debt. Efforts to strengthen market infrastructure will not only deepen the Indonesian money market yet are also consistent with the G20 OTC Derivative Market Reform agenda. To that end, the modernization of Indonesia’s money market infrastructure requires the support of all Bank Indonesia stakeholders, including market players, the Government, OJK, and the DPR-RI. Empowerment of Sharia Economy and Finance and MSMEs Bank Indonesia continues to accelerate development of the national sharia economy and finance as a new source of inclusive and sustainable economic growth, and part of the structural reforms towards an Advanced Indonesia (Onward Indonesia). Bank Indonesia continues to strengthen and expand the halal value chain ecosystem through three development pillars, namely institutional strengthening, expanding implementation, and strengthening the supporting infrastructure, including digitalization. In the first pillar of sharia economic empowerment, the institutional arrangements of the halal value chain ecosystem are being strengthened by accelerating the corporatization of pesantren (Islamic boarding school) holding business units. This is achieved through the establishment of the Pesantren Economy and Business Association (HEBITREN - Himpunan Ekonomi dan Bisnis Pesantren) in various provinces. Meanwhile, sectoral strengthening is carried out by accelerating the Halal Assurance System for the halal food sector with the Halal Certification Agency (BPJPH) as well as government ministries and agencies as well as other stakeholders, while supporting the implementation of Halal Industrial Estates (KIH - Kawasan Industri Halal). The sectoral performance of the sharia economy is also supported by strengthening the halal value supply chain in the agricultural sector, as well as implementing business matching, business intermediaries, and on boarding domestic and global e-commerce. Likewise, the modest fashion sector is being strengthened in terms of the capacity of sharia business players who are ready to export and unlock market access. The second pillar of Islamic finance entails strengthening monetary operations and Islamic money market deepening to support financing. This is achieved, among others, by expanding BI Sukuk (SukBI). In addition, preparations for RPIM implementation in the sharia banking industry are carried out in coordination with the Ministry of Finance for the underlying project of Inclusive SukBI in order to encourage sharia financing for MSMEs as part of the efforts to recover the national economy. Furthermore, measures to optimize Islamic social finance as an alternative financing source are also continuously encouraged by strengthening productive waqf with relevant government ministries/agencies. As mandated by Act No. 2 of 2020, improvements were made to the provisions of sharia-compliant short-term liquidity assistance in order to maintain financial system stability during economic recovery. The third pillar is education and socialization, with the national contribution of the Sharia Economic Festivals (FESyar) in 2021 and Indonesia Shari’a Economic Festival (ISEF) to the sharia economy and finance increasingly evident. A series of Road to ISEF activities, including three FESyar events in Java, Sumatra, and Eastern Indonesia, covering various activities, from webinars to business matching and business deals, were again held in 2021. Market expansion, domestically and to unlock global markets, includes on boarding to global e-commerce platforms. From sharia finance, the collaborative “Sharia Financing Month” was organized with OJK and various other relevant stakeholders, including productive waqf. The series of hybrid virtual FESyar activities with ISEF attracted more than 290 thousand participants and 970 exhibitors (Scheme 4). At the 8thISEF, activities to accelerate the sharia economy focused on the halal food and modest fashion sectors,including “Global Halal Dialogue”, as well as the “Indonesia Sustainable Modest Fashion Show” by 420 designers throughout Indonesia. The series of FESyar and ISEF activities generated transactions totaling Rp25.8 trillion and collected Rp669 billion worth of zakat, infaq, sadaqah and waqf (ZISWAF) funds. Overall, this achievement is much improved on previous years. What is even more encouraging is the increasing number of institutions, associations, and various parties, national and international, that have joined ISEF to accelerate the sharia economy and finance in support of the national economic recovery. Bank Indonesia continues to strengthen its MSME development program to promote digital and exporting MSMEs. Bank Indonesia consistently implements MSME development programs through 3 (three) policy pillars, namely corporatization, capacity building, and financing in order to create productive, innovative, and adaptive MSMEs (Scheme 5). The strengthening of corporatization is carried out through the formation of groups based on strong social capital and the strengthening of formal and modern institutions. MSMEs are encouraged to collaborate with other MSMEs,large businesses and financial institutions to increase economies of scale. Capacity building is focused on increasing productivity through innovation and digitalization of business processes to improve MSME competitiveness. The MSME digitalization program aims to increase productivity and efficiency, expand MSME marketing access both nationally and globally, facilitate MSME access to finance, and facilitate MSME transactions as entry points into the digital economic and financial ecosystem through greater QRIS adoption. In terms of financing, Scheme 4. Fesyar and ISEF 2021: Indonesia is the Center of the World Islamic Financial Economy FESYAR dan ISEF 2021: Indonesia Center for the World Islamic Finance Economy AGENDA ACTIVITY WEBINAR (NATIONAL & INTERNATIONAL)/ WORKSHOP/TALKSHOW/BUSINESS COACHING/BUSINESS MEETING/ MATCHING/FGD/TABLIG AKBAR/ FASHION SHOW OUTCOME 1. Declaration of October as the Syaria Economic Month 2. Halal Certification Acceleration, reaching to 1 Million halal certification for the SME PARTICIPANT MODEST FASHION SHOW 293,401 BUSINESS TRANSACTION 25,8 T FESYAR - ISEF ZOOM - YOUTUBE - INSTAGRAM SUSTAINABLE FASHIONSUSTAINABLE LIFESTYLE FESYAR- ISEF PARTICIPANT DESIGNER VIRTUAL I INTERNATIONAL BRANDING I 39 K THE 8TH INDONESIA SHARIA ECONOMIC FESTIVAL “MAGNIFYING HALAL INDUSTRIES THROUGH FOOD AND FASHION MARKETS FOR ECONOMIC RECOVERY” 3. Mosque economic revival through the youngster FESYAR - ISEF VIRTUAL BOOTH AMOUNT ISEF- FESYAR WILL BE HELD UNTIL DECEMBER 2021 COMPETENCY 4,452 PARTICIPANT 8 TYPES OF COMPETITION ISYEFPRENEUR. HIJRAHPRENEUR 2.0, NATIONAL SHARIA ECONOMIC COMPETITION, FASHION COMPETITION, SHARIA ECONOMIC AND FINANCE BRAND VIDEO COMPETITION 82,7 K PARTICIPANT 5. Acceleration of the Wakaf & Zakat collection 7. Competency strengthening in the fashion sector and halal companion BUSINESS OWNERS ISEF PARTICIPANT 4. Sharia Commercial Financing acceleration 6. Research and Education Ecosystem Strenghtening, through the center of excellence, National Research Framework, and networking strengthening SHARIA FINANCIAL INSTITUTION FINANCING, BTOB TRANSACTION, BTOC TRANSACTION & EXHIBITION EXHIBITOR PERIOD: 5 SEPT- 29 OCTOBER ACCESSED BY VISITORS FROM 119 COUNTRIES & 5 CONTINENTS ZIZWAF COLLECTION Billion Zizwaf AMOUNT OF ZIZWAF COLLECTED DURING THE FESYAR & ISEF 2021 CERTIFICATION CERTIFICATES THROUGH THE PPH EDUCATION CERTIFICATION, HALAL SELF DECLARE CERTIFICATION AND FASHION DESIGNER CERTIFICATION Scheme 5. Export MSME Development Strategy PULL STRATEGY PUSH STRATEGY Identification of export destination Identification of standardization and certification gaps Identification of export destination country certification standards and requirements Facilitating capacity building and assistance to fulfill certification Synergy with relevant stakeholders to identify standards and requirements for certification of export destination countries MARKET DRIVEN Synergy with related Ministries/Agencies for the implementation of training and assistance, as wellas product testing Bringing MSMEs together with potential buyers broader access will facilitate business expansion with healthier MSME financing. Bank Indonesia also continues to promote MSME exports through 2 (two) strategies, namely a pull strategy (market driven) to identify standards and requirements according to export destination countries and a push strategy by facilitating the fulfillment of certification required by MSMEs. MSME PILOT PROJECT 6 COFFEE MSMES 7 Fabric/ Craft MSMEs 2 Processed F&B MSMEs CERTIFICATION FACILITATION business matching, facilitating access to finance, exhibitions, and promoting international trade. Bank Indonesia has also consistently supported the Gernas BBI and BWI by involving all Bank Indonesia representative offices in an effort to boost economic recovery, including through a retail program for MSME products, expanding the use of MSME QRIS and organizing various strategic Bank Indonesia events (Figure 2). In line with Bank Indonesia’s strategic role in the Gernas BBI Team, Bank Indonesia will continue to strengthen its active role in supporting the success of Gernas BBI and BWI. Bank Indonesia strengthens synergy with ministries, institutions, associations, and communities to increase MSME competitiveness. Synergy intends to increase MSME capacity, MSME onboarding, Figure 2. Distribution of Gernas BBI BBI in 12 Travel Destination Regions Aceh September #RAGAMACEH East Kalimantan October North Sulawesi (Likupang) JJuly - August #PELANGISULAWESI North Sumatra (Toba) February #BELIKREATIFTOBA Jakarta December #DISKONESIA West Java April #UKMJABARPATEN JOGLOSEMAR May #FESTIVALJOGLOSEMAR East Java August #LOKALKERENJATIM Maluku November #AROMAMALUKU NTB March #EKSOTISMELOMBOK Bali January #ARTBALI NTT June #KILAUDIGITALPERMATAFLOBAMORA Source: Bank Indonesia, The Coordinating Ministry of Maritime and Investment Affairs (Kemenkomarves), The Ministry of Tourism and Creative Economy (Kemenparekraf) Through close synergy, a series of activities for the Indonesian Creative Works exhibition (KKI Karya Kreatif Indonesia) in 2021, organized by Bank Indonesia, represented a moment or turning point for the rise of MSMEs in the Covid-19 era. KKI 2021 had the theme “Synergy, Globalization, and Digitalization of MSMEs and the Tourism Sector”. Series 1 of KKI in March 2021 was aligned with Bank Indonesia’s role as movement manager for Gernas BBI 2021 with the hashtag #EksotismeLombok, synergizing with relevant government ministries/ agencies and the West Nusa Tenggara Regional Government. The 2021 KKI peaked on 23rd– 26th September with the hashtag #RagamAceh, which was opened by the First Lady, successfully becoming a moment in the revival of MSMEs during the pandemic to encourage digital MSMEs and export MSMEs. The scale of KKI 2021 increased significantly on the previous year, both in terms of turnover (94%), number of visitors (130%), as well as commitments created from export business matching (17%) and financing (548%), reflecting the improving performance of MSMEs and optimism to rebound after riding the pandemic storm (Figure 3). Closer and more intensive coordination with government ministries/agencies provided value added in capacity building, marketing access, and access to MSME financing, while increasing public awareness and garnering public interest in MSME products. Strengthening International Policy Bank Indonesia’s international policies are implemented in close coordination with the Government, aimed at supporting the main policies of Bank Indonesia to achieve macroeconomic and financial system stability, while campaigning for the interests of Bank Indonesia and the Indonesian economy. International and regional cooperation in Asia continues to strengthen to increase economic resilience and support growth. Bank Indonesia also strengthens international cooperation, including in the framework of the International Financial Safety Net (JPKI - Jaring Pengaman Keuangan Internasional). Currently, Bank Indonesia has a Bilateral Currency Swap Arrangement (BCSA) with China, Japan, South Korea, Australia, and Singapore, as well as repo agreements with Figure 3. Achievements of KKI 2021 KKI 2021 ACHIEVEMENT Total : IDR32.03 Billion 94% (YoY) EVENT The closing of Karya Kreatif Indonesia #RagamAceh Synergy, Globalization and Digitalization of MSME and Tourism Sectors The closing of KKI 2021 Perry Warjiyo Governor of Bank Indonesia KKI MARCH 2021 #EksotismeLombok The Closing of KKI 2021 #RagamAceh Total : IDR21.5 Billion 5 KPw BI with Biggest Revenue Total : IDR10.53 Billion* 5 KPw BI with Biggest Revenue Celebration of the realization of the BM on Financing and Export Riau Islands Bali West Java Jambi South Sulawesi IDR 3.8 Billion IDR 2.4 Billion IDR 2.3 Billion IDR 1.5 Billion IDR 1.3 Billion D.I Yogyakarta South Sulawesi DKI Jakarta Bali Banten IDR132.8 Billion Total IDR11.4 Billion *Until 26 September 2021 BUSINESS MATCHING (BM) IDR825.5 Million IDR786.21 Million IDR735.81 Million IDR700.06 Million IDR669.29 Million 17% (YoY) One on One Meeting Financing One on One Meeting Commitment IDR74.4 Billion 548% (YoY) 1. One stop virtual event that is quality, structured, and integrated. 2. Presenting quality MSME products that can be accessed from anywhere, anytime, through the Karya Kreatif Indonesia (KKI) website, supported by a fast, easy, affordable, safe, and reliable payment system. 3. Prioritizing synergy and collaboration with government ministries/agencies and regional governments Sales per Product Type Cloth/Fashion Craft Processed Food and Beverages Sales per Product Type 158 Cloth/Fashion 119 Craft 165 Processed Food and Beverages 51 Coffee Country Indonesia 97.63% Age Jakarta 31.74% 18-24 20.80% Gender 65+ 5.71% 55-64 12.17% Others 42.83% ACTIVITY 82 Event 130% (YoY) City Achievement of Road to KKI and Closing of KKI 2021 Opening Ceremony | Virtual MSME Product Exhibition Policy Dialogue | Talk Show | Business Coaching Webinar | Karya Kreatif Show | Business Matching Podcast | MSME Onboarding Graduation Podcast Competition | Featured MSME Award Closing Ceremony | Art & Culture Performance IDR4.47 Billion IDR2.7 Billion IDR3.3 Billion VISITORS 148.716 (Participants / Viewers) VIRTUAL EXHIBITION PARTICIPANT 2021: 525 UMKM Cloth/Fashion Craft Processed Food and Beverages IDR11.3 Billion IDR3.7 Billion IDR6.5 Billion Singapore 0.44% US 0.41% 25-34 22.78% Others 1.14% United Kingdom 0.13% Malaysia 0.25% Surabaya 9.35% 45-54 19.10% Medan 4.74% Depok 6.38% Bandung 4.97% Male 50.30% Female 49.70% 35-44 19.44% Support the “Proud of Made in Indonesian Product” and “Proud to Go Travelling to Indonesia” National Movement #DiIndonesiaAja the New York Fed and BIS. Efforts to increase the positive perception of global investors and rating agencies on the Indonesian economy will continue. Bank Indonesia also encourages faster implementation of Local Currency Settlement (LCS) to facilitate trade and investment with partner countries by strengthening synergy with the Government, Financial System Stability Committee, banking industry, and business community. In addition, the SCS framework has been strengthened between Indonesia-Malaysia as well as the LCS scheme between Indonesia-Japan, while expanding SCS partner countries through implementation of the Indonesia-China LCS in September 2021. Bank Indonesia is also increasing cooperation in the development of the financial system and/or financial system payments to support efficient and secure transactions as well as digital financial innovation. In addition, Bank Indonesia has strengthened the Anti-Money Laundering and Prevention of Terrorism Financing (APU PPT) framework through agreements with the central banks of Thailand, Malaysia, the Philippines, and Brunei Darussalam. Bank Indonesia plays an active role in strengthening positive international perception of the Indonesian economy, particularly rating agencies and foreign investors,. This is done through intensive communication and engagement with rating agencies and foreign investors on a regular basis, especially the Investor Conference Call at the monthly Board of Governors Meeting (RDG - Rapat Dewan Gubernur), and when there is a strategic policy that needs to be communicated. Investment and trade are promoted by the Investor Relations Unit (IRU) nationally, regionally, and globally, through Bank Indonesia representative offices at home and abroad in collaboration with the (Central and Regional) Government as well as Indonesian embassies abroad. During 2021, for example, Bank Indonesia cooperated and actively participated in investment promotional activities at the Indonesia Business and Investment Forum in Shanghai, the Indonesia Investment Forum in London, New York Now and the London Coffee Festival. Bank Indonesia also continues to enhance international recognition as the best central bank among emerging market countries. This is achieved by increasing Bank Indonesia representation, either through membership or chairmanship, in various international cooperation forums. In addition, Bank Indonesia’s reputation has been improved by receiving international awards from prominent and reputable international institutions, implementing a number of international standards, publishing research and international journals, as well as serving as a reference and resource at various strategic international events. In 2021, Bank Indonesia won an international award as Reserve Manager of the Year from the Central Banking Awards, a gold medal at the 15th Annual Next Generation Contact Center & Customer Engagement Conference, and Best Systemic and Prudential Regulator in Asia Pacific from The Asian Banker Regulation and Supervision Awards 2021, and a gold medal in the Annual Report Competition, and a gold medal at the International Business Awards (IBA) Stevie Winner. Policy synergy still faces tough challenges in handling Covid-19 amid the outbreak of new variants, thus impacting domestic demand that has not fully recovered. Several factors have become challenges to accelerating domestic demand and the economic recovery. First, the relatively limited global supply and distribution of vaccines has hampered efforts to accelerate the vaccination roll out as a prerequisite for economic recovery. Second, the subsequent waves of Covid-19, especially the emergence of new variants, including the faster and more virulent Delta variant, entail the reintroduction of mobility restrictions accompanied by muted economic activity. Third, discipline in implementing Covid-19 protocols needs to be continuously improved as part of the efforts to mitigate the risk of further Covid-19 transmission. The spread of Delta amid ongoing efforts to strengthen the vaccination and containment of Covid-19 has had an impact on economic actors, namely households, corporations, and banks, forcing extreme caution and delaying economic decisions in terms of consumption, production, and investment. This compressed domestic demand and, in turn, resulted in a limited increase in bank lending despite ample banking capacity to disburse loans in line with looser monetary policy in the form of lower interest rates and large liquidity injections, as well as accommodative macroprudential policy. Further measures to accelerate vaccinations and mitigateCovid-19,accompanied by the reopening of priority sectors, are expected to have a net positive impact on controlling the spread of Covid-19, thus allowing for the broader reopening of priority sectors to further revive economic activity. Bank Indonesia Transformation The overall transformation that has been undertaken by Bank Indonesia since 2018 has continued to expand and strengthen, both in terms of policy transformation and institutional transformation, including in response to rapid digitalization. To that end, Bank Indonesia has prepared a strategic business plan (SBP) through to 2025, for Bank Indonesia as a whole and for each of the 12 strategic programs. Bank Indonesia’s policy transformation is achieved by strengthening the policy mix to discharge the mandate of maintaining the rupiah stability (inflation and exchange rates), preserving financial system stability, and promoting sustainable economic growth. Bank Indonesia’s independence is a central part of the synergy and coordination to strengthen national economic policy. In its application, Bank Indonesia has pioneered the implementation of a central bank policy mix of monetary and macroprudential policy to more optimally achieve monetary, financial system and macroeconomic stability as well as support sustainable economic growth. In the payment system, policy transformation entails BSPI 2025 implementation to accelerate and integrate the digital economy and finance as a source of national economic growth. Money market deepening has been expedited in accordance with BPPU 2025 through the development of money market instruments and financial market infrastructure to create a modern and advanced money market. Synergy and policy coordination with the Government continue to be strengthened, both between monetary and fiscal policies and accelerating real sector reform. In addition, the synergy and coordination under the auspices of the Financial System Stability Committee focuses on maintaining financial system stability and reviving financing to the corporate sector. Synergy and coordination with the Government, Financial System Stability Committee, the banking industry and payment systems are constantly enhanced to deepen the financial markets and hasten the integration of the digital economy and finance nationally. Bank Indonesia continues to strengthen institutional transformation as a concrete step to develop Bank Indonesia as a leading central bank. This ensures the implementation of Bank Indonesia’s mandate in a credible manner. Institutional transformation through an institutional policy mix aims to enhance performance based on effectiveness, efficiency, and governance (2EG) (Scheme6.). This is necessary as a step in creating a balance between ensuring the achievement of Bank Indonesia’s mandate through effective performance with efforts to promote efficient resource productivity, coupled with legal compliance and accountability through good governance. Institutional transformation encompasses the work areas and processes, human resources and work culture, as well as digital transformation. Organizational transformation entails: (i) formulation of an institutional policy mix based on effective, efficient, and governance principles, (ii) integration of strategic institutional functions, namely Strategic Management, Strategic Finance, Strategic Risk Management and Strategic Risk-Based Internal Audit, as well as the function of managing non-financial resources, (iii) improvement of the audit framework for internal control, (iv) strengthening risk management, and (v) strengthening the functions of procurement and asset management. Bank Indonesia continues the transformation of human resources to achieve excellent performance in the digital era, accompanied by digital transformation Scheme 6. Institutional Transformation Effective performance to ensure BI's mandate is achieved Efficient performance to drive resource productivity Streamlining business processes to improve Effective Performance efficiency in policy formulation and decision making. Strengthening BI financial management framework. resources, risks, and audits. & sustainability. Ensuring high work productivity supported by sufficient number of human resources, competent, engaged, and of noble character. Good governance performance to ensure legal compliance and accountability Efficient Performance Strengthen the integration of strategic management, financial management, risk management and auditing in planning and controlling work programs, in order to maintain financial accountability Building a 2EG-based Institutional Policy Mix Accelerate the alignment of risk management and risk-based internal audit. Strengthening the alignment of compliance & legal risk functions. Strengthen the strategic audit framework to ensure the effectiveness of 2EG performance controls. Assessment of governance performance in terms of risk management, audit, legal, and communication. of both the policy and institutional arrangements. HR transformation focuses on four aspects, namely HR Planning, Fulfillment, Development, and Maintenance. Transformation in the planning space means HR planning no longer only focuses on quantity but also on quality. In terms of fulfillment, transformation implies compliance with organizational needs in a Transparent, Programmed and Scheduled manner. In the development area, transformation applies the concept of a new Learning Task Program (PTB - Program Tugas Belajar) with institutionally driven principles, managed endto-end in line with employee career management. Regarding maintenance, transformation aims to maintain motivation and engagement. Meanwhile, digital transformation is implemented comprehensively in both the institutional and policy areas through system development (toolset), human resource development (mindset and skillset) and maintaining the quality and reliability of information system (IS) services. In general, the transformation intends to fulfill Bank Indonesia’s vision of becoming a leading digital central bank and creating a tangible contribution to the national economy as the best emerging market central bank towards an Advanced Indonesia. Strengthening the Major Project management framework Effective performance assessment based on 2EG performance. Governance Performance Rise and be Optimistic: Synergy and Innovation for Economic Recovery Close policy synergy and economic performance in 2021 form the basis for a further revival and stronger optimism for a better national economic recovery in 2022. Therefore, the domestic economic recovery must constantly be accelerated by strengthening synergy and innovation based on a strong spirit to rise, coupled with upbeat optimism. Synergy and innovation are focused on achieving herd immunity from Covid-19 and reopening priority sectors, promoting economic recovery in the near term through demand-boosting policies, and strengthening higher growth in the medium term through structural reforms (Figure 4). In this regard, we consider the framework presented at the annual meeting in 2020 still relevant, namely the need to strengthen 1 (one) prerequisite and accelerate implementation of 5 (five) policy responses necessary for the national economy to return to a normal long-term trajectory. In this case, policy synergy is required to accelerate the vaccination rollout and Covid-19 response by reopening priority economic sectors as a prerequisite to maintain national economic recovery momentum. Figure 4. Synergy of National Policy PRECONDITION (NECESSARY) OMIC ON EC GROWT 2 FISCAL AND MONETARY STIMULI SYNERGY 4 DIGITALIZATION OF THE ECONOMIC AND FINANCE NE M O A BI ST 3 FINANCIAL SECTOR TRANSFORMATION ACCELERATION T LI A R TY Y N C 1 REAL SECTOR TRANSFORMATION ACCELERATION SYNERGY FOR VACCINE ACCELERATION AND OPENING OF ECONOMIC PRIORITY SECTORS ST IA L A B S YS T E M ILI T Y 5 POLICY RESPONSES (SUFFICIENT) A FIN ECONOMIC OBJECTIVES MASS IMUNITY AND THE ECONOMIC REOPENING SHORT TERM ECONOMIC RECOVERY THROUGH THE STIMULI MID AND LONG TERM SUSTAINABLE GROWTH 5 GREEN ECONOMIC AND FINANCE Source: Bank Indonesia Furthermore, 5 (five) policy measures are needed to accelerate the national economic recovery, namely: (i) faster real sector transformation and reform, (ii) synergy between monetary stimuli, macroprudential policy and fiscal policy, (iii) faster financial sector transformation, (iv) economic and financial digitalization, and (v) green economy and finance. Stronger synergy and innovation will build optimism in accelerating the national economic recovery moving forward, while elevating the growth rate in the medium-long term towards an Advanced Indonesia in 2045 (Onward Indonesia). Synergy in terms of a faster vaccination roll out and reopening priority sectors is a prerequisite for a sustainable national economic recovery process. A valuable lesson gleaned from experience in 2021 is that a rapid and measurable policy response through synergy to accelerate the vaccination program and Covid-19 response with the reopening of priority sectors is decisive for economic recovery. Lest we forget, the current epicenter of economic woe is the Covid-19 pandemic and ensuing restrictions on mobility and community activities. By accelerating the vaccination roll out, Indonesia will again survive the latest Covid-19 attack, this time the Delta variant. After witnessing a significant spike in JuneJuly 2021, daily new cases of Covid-19 have tracked a downward trend since August 2021. Therefore, the Government plans to gradually start reopening sectors and/or regions with low numbers of severe cases, where hospital utilization rates are low, and mortality rates are low. Economic sectors will be reopened in stages, including preparations for the first and second transitions of living with Covid-19, taking into account also the strategy to fulfill the pandemic response, namely by accelerating the vaccination program, increasing 3Ts (testing, tracing, treatment), and implementing strict health protocols and concern for the environment (Figure 5). Irrespectively, the vaccination program must be accelerated to achieve herd immunity, thus boosting resilience against the possible spread of new Covid-19 variants and to ensure the sustainability of further national economic gains. This reaffirms the importance of synergy when accelerating the vaccination program and reopening priority sectors as prerequisites of economic recovery as well as the Figure 5. Preparation Plan for the New Normal, Living with the Endemic Relaxation is carried out after vaccination reaches 70% (dose 2) Economic relaxation and social activities are carried out more widely when vaccination reaches 805 (dose 2) and if conditions are controlled and health capacity does not exceed the limit PREPARATION TRANSITION I TRANSITION II Low hospitalization rates Low death rate LIVING WITH COVID-19 FULFILLMENT STRATEGY 3 REFERENCE INDICATORS Low number of severe cases Covid-19 is treated the same as any other infectious disease High vaccination coverage at least 70% dose 2, with high risk priority (elderly) 3T Enhancement (Testing, Tracing, Treatment) Health protocol: 3M + Isoter and CareProtect Sumber : Kemenkomarves Source : Kemenko Marves impact on the financial and monetary sectors. Bank Indonesia is confident that the fulfillment of these prerequisites will continue to propagate enthusiasm and optimism towards the economic recovery. Bank Indonesia fully supports Government efforts and actively funds the State Budget to accelerate the vaccination roll out as well as the health and humanitarian response to Covid-19. As stated, the vaccination program and Covid-19 response are prerequisites for economic recovery and, therefore, must be synergized with the reopening of priority sectors. Rapid transmission of the Delta variant in June-August 2021 triggered a spike in positive cases and the mortality rate. At the same time, the supply, capacity, and distribution of vaccines as well as the ability of hospitals, medical personnel, and treatment needs were very limited and incurred massive costs. Consequently, Bank Indonesia was called upon to participate in joint measures to provide healthcare and save lives from the Delta variant as a state duty for humanity, health, and public security. This call prompted Bank Indonesia to take the extraordinary initiative of funding the 2021 and 2022 State Budget through the purchase of SBN in the primary market via private placement in accordance with the Joint Decree issued by the Minister of Finance and Governor of Bank Indonesia on 23rd August 2021. The SBN purchased directly by Bank Indonesia to cover health costs in the State Budget amounted to Rp215 trillion in 2021 and Rp224 trillion for 2022, and applied a very low interest rate 3-month BI 7-Day Reverse Repo Rate. Bank Indonesia’s participation also contributes to the interest costs incurred for financing the vaccination program and healthcare, capped at Rp58 trillion (in 2021) and Rp40 trillion (in 2022) based on the financial capacity of Bank Indonesia. With full funding from Bank Indonesia for all health costs in the 2021 and 2022 State Budgets, the Government responded to the Delta variant with rapidity and is accelerating the vaccination roll out to achieve herd immunity towards greater resilience against the spread of potential new viruses and strains. This is critical to ensure that economic sectors and activities can restart with adequate risk mitigation concerning the Covid-19 pandemic. By accelerating the vaccination program to achieve herd immunity, the national economic policy response must focus on the immediate recovery of priority sectors capable of driving growth and creating jobs. Synergy and policy innovation are essential to overcome the emergent issues, such as debottlenecking the real sector as well as providing fiscal policy incentives and macroprudential policy support in the financial sector. This approach has been initiated through KSSK policy synergy targeting the property and automotive sectors prior to Delta variant outbreak, encompassing three stages. First, map priority sectors as resilient, growth drivers or slow starters to support the economic recovery. In this regard, eight priority sub-sectors have been identified that can support economic growth and exports, namely: (1) Food and Beverages, (2) Leather, Leather Goods and Footwear, (3) Textiles and Apparel; (4) Chemicals, Pharmaceuticals, and Traditional Medicaments; (5) Paper and Paper Products; (6) Basic Metals; (7) Transportation Equipment; and (8) Rubber, Rubber Products and Plastics (Figure 6). In addition to the industrial sector, MSME development remains a priority agenda because of the significant contribution to economic growth and job creation, not to mention economic and financial inclusion. The reopening of these priority recovery sectors needs to be synergized with integrated measures to accelerate vaccination and strengthen the Covid-19 response. Second, identify the obstacles faced in the recovery of priority sectors, both in the real sector and in terms of financing. For this reason, it is necessary to conduct joint discussions through coordination forums with the Central Government (relevant ministries and agencies), the Financial System Stability Committee, industry players, the banking industry, and regional governments. Various real sector issues relate to improving the factors of production, such as raw materials, energy and labor, regulatory and institutional arrangements, especially policy clarity and licensing, as well as promotional aspects and market access at home and abroad. In terms of finance, problems can arise on the demand and supply sides. Several sectors, Figure 6. Synergy of National Economic Policies to Accelerate Recovery of Priority Sectors 8 SUBSECTOR PRIORITY TO RECOVER VACCINATION & INDUSTRY OPENING SYNERGY RECOMMENDATION TO SYNERGIZE FOR VACCINATION AND OPENING PRIORITY INDUSTRY Kementerian Perindustrian REPUBLIK INDONESIA MANUFACTURE HIGH LEVEL MEETING (HLM) IDENTIFYING & DEBOTTLENECKING HIGH LOW Food and Beverage Industry Chemical Industry Automotive and Other Transport Equipment Industry READY I IV NOT READY Base Metal Industry Footwear Industry Rubber Industry Paper Industry PRODUCTION FACTORS POLICY: RAW MATERIALS, ENERGY,INFRASTRUCTURE, LABOR EASE OF REGULATIONS AND LICENSES: IMPLEMENTATION OF COPYRIGHT LAW EXPANSION OF MARKET ACCESS: PROMOTION, INTERNATIONAL COOPERATION, ANTI-DUMPING II III Textile and TextileProducts Industry FISCAL POLICY F&B CHEMICAL AUTOMOTIVE P1: Increase in the price of imported raw materials, lower palm productivity P1: The road infrastructure for the Petrochemical industrial center is not sufficient P1: Exports for Patimban are still limited due to road constraints and the depth of the port P2: The implementation of PP 74/2021 has not been followed by the issuance of technical rules P2: Regulatory certainty after the moratorium ends P3: Container constraints, esp. related to MSMEs RUBBER P1: The absorption of natural rubber in domestic, including industry, is still constrained due to the law quality BASE METAL P1: The new smelter power supply problem in North Halmahera P2: waste management environmental permit P2: The implementation of industrial gas prices is not optimal THE MAIN CHALLENGES OF PRIORITY INDUSTRIES INCENTIVES OF IMPORT DUTIES TAX, CORPORATE TAXES, ETC. TO SUPPORT PRIORITY SECTORS PAPER P2: Excluded from the recipient of industrial gas prices FINANCING POLICY P3: Container cost related to non-FOB mechanisms MACROPRUDENTIAL POLICY TO SUPPORT PRIORITY SECTORS AND MSME TEXTILEGARMENT P2: Domestic garments are flooded with imported products and container constraints, especially related to MSMEs BUDGET FOR INFRASTRUCTURE, FOOD SECURITY, TOURISM, ICT P1: Increase in the cost of imported raw materials FOOTWEAR EXTENSION OF CREDIT RESTRUCTURING P2: Container constraints, especially related to MSMEs CREDIT EASING, SECURITIZATION, AND OTHER FINANCING ALTERNATIVES P3: Barriers to steel antidumping tariffs MSME DEVELOPMENT Source: Bank Indonesia POLICY SYNERGY FOR NATIONAL ECONOMIC RECOVERY REAL SECTOR POLICY SUPPLY FOR CREDIT DEMAND FOR CREDIT 24 SUBSECTOR PRIORITY TO RECOVER FINANCING MAPPING THE PRIORITY SECTOR TO RECOVER REAL SECTOR CHALLENGES GERNAS BBI, BWI, DIGITALIZATION particularly export-oriented sectors, have expanded and, therefore, lending has increased, while other sectors still require an appropriate policy response to increase demand for loans in the real sector and to address the perception of credit risk in the banking industry. Third, national economic policy synergy and coordination must be planned and implemented according to the conditions prevalent in each productive sector. Overall, the required policies relate to the real sector, fiscal policy, and financing policy. In terms of the real sector, policies relate to the production factors, such as raw materials, energy, infrastructure, and labor; policies to facilitate regulations and licensing, including implementation of the Job Creation Act; and policies to expand market access, such as promotional activities and international cooperation. In the fiscal sector, policies involve budget allocations for infrastructure, food security, tourism, ICT, as well as import duty incentives, corporate taxes, and others for priority sectors. On the financing side, this includes macroprudential policies targetting priority sectors and MSMEs by Bank Indonesia, extending credit restructuring by OJK, as well as facilitating bank credit, securitization, and other financing alternatives. The second policy response for the national economic recovery relates to synergy between the Government’s fiscal policy and the monetary and macroprudential stimuli from Bank Indonesia to boost demand, particularly in the near term. A relatively large fiscal stimulus will support the national economic recovery process. To revive the economy and hit development targets, the 2022 State Budget includes planned state revenues of Rp1,846.1 trillion and state expenditures of Rp2,714.2 trillion, resulting in a deficit of Rp868 trillion or 4.85% of GDP. Most of the budget, amounting to Rp1,711,5 trillion (63%) was allocated to strategic programs in the 2021 State Budget to support a faster recovery and economic transformation towards Advanced Indonesia (Figure 7). Meanwhile, Bank Indonesia is strengthening its funding role in the 2021 and 2022 State Budgets through contributions to the cost of financing the vaccination drive and healthcare, capped according to Bank Indonesia’s financial capacity. Through such synergy, the Government can focus more on efforts to accelerate the 2021 and 2022 State Budget and build national economic recovery momentum. Accommodative macroprudential policies have continued to revive the intermediation function through CCyB, RIM, LTV/downpayment ratios Figure 7. Fiscal Stimulus HEALTH SOCIAL PROTECTION Continued handling of Covid-19 Continuing to improve DTKS and synergize (a.l. Government vaccination, patient care) with various related data Increasing the effectiveness of Childbirth Support gradual reform Assurance (Jampersal) and its integration Support the Job Loss Guarantee Program into the JKN program Development of adaptive social protection Strengthening national health system reform schemes 2022: IDR256,0 T 2022: IDR429,9 T Rp Continued acceleration of stunting reduction EDUCATION INFRASTRUCTURE Improving the competence and professionalism of teachers Acceleration of rehabilitation of facilities and infrastructure Strengthening vocational education a.l. through quality standardization and research and innovation development Increased synergy between the Central Government, Regional Governments, and between K/L Support basic service infrastructure 2022: IDR542,8 T 2022: IDR367,8 T Drive productivity (connectivity and mobility) Providing energy and food infrastructure Equitable infrastructure and access to ICT INFORMATION AND COMMUNICATION TECHNOLOGY (ICT) FOOD SECURITY/FOOD ESTATE TOURISM Build and develop ICT infrastructure for equitable access Increased affordability and food sufficiency Acceleration of development of five Super Priority Tourism and connectivity Increased productivity and income of farmers Destinations namely Lake Toba, Borobudur, Mandalika, Drive digital transformation and prepare digital ecosystem and fishermen Labuan Bajo, and Likupang National Data Center Development and SPBNE Strengthening sustainable food systems Tourism and creative economy development implementation Development of Food Production Center Areas Tourism market recovery and rebranding ICT HR Development (Food Estate) 2022: IDR 27,1 T 2022: IDR 78,7 T 2022: IDR 9,2 T Source: Ministry of Finance and other policy tools conducive to stimulating intermediation, including priority sectors, exports as well as financial and economic inclusion. The third policy response towards acceleration involves improving the ease of financing from the financial sector to the corporate sector. In the near term, policies to revive bank lending are needed by addressing supply and demand-side issues. Mapping the priority sectors is crucial to understand which factors are more dominant and, thus, the appropriate policy response. As stated, problems have arisen in terms of demand for corporate loans and supply or bank loans. For Food and Beverages, Chemicals, Automotive and Transportation, loans disbursed by the banking industry have increased in line with corporate demand and the banks’ willingness to lend. For other sectors, however, incentives are needed to revive credit, including incentives in the real sector for better business prospects, and incentives for banks in the form of credit guarantees and interest rate subsidies. In addition to bank credit, more financing from the capital market is also needed through issuances of shares or corporate bonds. Asset-backed and earning-backed securities need to be developed further. In this regard, the role of the Indonesia Investment Authority (INA) is indispensable as a pioneer in the securitization of assets and revenues from infrastructure projects that have been performing well with promising corporate financial conditions. In addition, money market and foreign exchange market development by Bank Indonesia in accordance with BPPU 2025 also plays an important role in the issuance of short-term securities, such as Commercial Papers (SBK), expansion of repo transactions, as well as the provision of hedging instruments for rupiah exchange rates, such as DNDF, and hedging interest rates, such as Interest Rate Swaps (IRS). Financial market transformation is urgently required to further expand financing alternatives to the corporate sector and reinforce the national economic recovery. The fourth policy response is to accelerate digitalization, accompanied by national economic and financial inclusion. Successful policy synergy in 2020 and 2021 must be improved and expanded continuously. Gernas BBI and BWI have proven to expand the economic role of MSMEs, including the MSME retail program, while expanding the use of MSME QRIS to encourage national economic and financial inclusion. Bank Indonesia has consistently supported the Gernas BBI and BWI movements in close synergy with the (central and regional) Government as well as with the business community, holding various monthly joint activities in diverse regions and strategic events initiated by Bank Indonesia, such as the annual Indonesian Creative Works exhibition (KKI - Karya Kreatif Indonesia). Bank Indonesia’s strategic role in supporting Gernas BBI and BWI implementation was confirmed by promulgation of Presidential Decree No. 15 of 2021 concerning the Proudly Made in Indonesia National Movement Team. The decree appoints the Governor of Bank Indonesia as Deputy Chair in conjunction with the Coordinating Minister for Economic Affairs and Chairman of the OJK Board of Commissioners. This clearly demonstrates government appreciation for Bank Indonesia’s active role in supporting Gernas BBI and BWI. Bank Indonesia’s firm commitment to economic and financial inclusion is also apparent by accelerating payment system digitalization in accordance with BPSI 2025 towards the efficient and inclusive integration and strengthening of the national digital economy and finance. In addition, payment system digitalization is oriented towards supporting Government programs through the electronification of social aid program (bansos) disbursements, various transportation modes and regional government finances. The fifth policy response relates to the green economy and finance in the pursuit of sustainable economic growth. Environmental degradation and climate change pose physical risks and transition risks with implications on monetary stability and financial system stability. The transition to a green economy, namely a low-carbon economy, needs to be gradual and moderate to optimize the policy response to climate change. In this regard, Bank Indonesia will continue to strengthen green finance policies and encourage the creation of a sustainable financial system through close coordination with the relevant authorities and active involvement in various international forums focusing on green finance. Bank Indonesia has taken several initiatives in the form of policies and the application of sustainable investment principles in the allocation of the foreign exchange reserve portfolio in line with the strengthening of global financial policies that lead to sustainability. In addition, Bank Indonesia supports transformation towards a green financial system to increase the domestic financial sector’s contribution to reducing carbon emissions. The initiative was implemented to support Indonesia’s carbon emission reduction target in the spirit of the Paris Agreement, ratified by various governments to limit the rise in mean global temperature. The five policy responses for economic recovery are consistent with Indonesia’s G20 Presidency in 2022, themed “Recover Together, Recover Stronger”. Indonesia’s G20 Presidency will focus on boosting productivity, increasing economic resilience and stability, and ensuring sustainable and inclusive growth. To that end, the G20 Presidency of Indonesia has 6 (six) priority agendas in the financial track. First, the formulation of policy normalization (exit strategy), especially in the US and several other AEs, thereby remaining conducive to a shared and less divergent global economic recovery (“recover together”) and to mitigate the risk of potential global financial market uncertainty: well calibrated, well planned and well communicated. Second, the formulation of a structural reform policy response in the real sector to overcome the scarring effect of the Covid-19 pandemic by increasing productivity and overcoming problems in employment, households, corporations and the financial sector, thus restoring the long-term economic growth trajectory. Third, to encourage cooperation between countries in digital payment systems through implementation of the entire G20 Roadmap for Enhancing CrossBorder Payments (CBP) and development of the General Principles for Developing CBDC. Fourth, the formulation of steps towards a green economy and sustainable finance by addressing the risks associated with climate change and the transition towards a low-carbon economy, especially from a macroeconomic and financial stability perspective. Fifth, to enhance productivity, economic expansion and financial inclusion by increasing entrepreneurial capacity and utilizing open banking, particularly for MSMEs, women, and the youth, including crossborder aspects. Sixth, international coordination in the tax agenda to achieve a fair, sustainable and modern international taxation system, including implementation of the global agreement on digital taxation and carbon tax that was achieved in 2021. Bank Indonesia Policy Mix Direction for 2022: Accelerating Economic Recovery, Maintaining Stability Bank Indonesia’s policy mix for 2022 will continue to be synergized as part of the national economic policy mix to accelerate economic recovery, while maintaining stability. The direction of Bank Indonesia’s policy mix will continue to observe the global economic outlook, along with the six issues on the international policy coordination agenda, with Indonesia as Chair of the G20 in 2022. Bank Indonesia will perform meticulous calculations, careful planning, and clear communication regarding the mix of 5 (five) key policy instruments, namely: monetary policy, macroprudential policy, payment system digitalization, money market deepening, as well as inclusive and green finance and the economy (Figure 8). Given the risk of increasing global financial market instability pressures stemming from monetary policy normalization by the Fed and Figure 8. The Policy Mix of Bank Indonesia in 2022 Exchange Rate Interest rate International Policy MONETARY Liquidity OMIC ON EC PAYMENT SYSTEM MACROPRUDENTIAL M O NE Digitization of Money Circulation GROW TH RY TA ST AB Digital and Export MSME ILIT Y INCLUSIVE AND GREEN FINANCIAL ECONOMY FI N ST C IA A B L SY IL I S T E M TY Payment System Digitization AN MONEY MARKET DEVELOPMENT Intermediation and resilience Integration of Monetary policy, Monetary Operation and Money Market Sharia Economics-Finance Sustainable Financing Source: Bank Indonesia in several AEs, Bank Indonesia’s monetary policy in 2022 will be oriented towards maintaining inflation and rupiah stability, as well as macroeconomic and financial system stability. Monetary policy tapering will be prudent and measured to avoid disrupting the national economic recovery. Meanwhile, 4 (four) Bank Indonesia policies in 2022 will be directed at joint efforts to accelerate national economic recovery momentum (pro-growth). Bank Indonesia will maintain an accommodative macroprudential policy stance to revive bank lending to priority sectors and MSMEs and accelerate the national economic recovery, while maintaining financial system stability and developing the green economy and finance. Payment system digitalization based on BSPI 2025 will continue to accelerate end-to-end integration of the digital economy and finance as a new source of economic growth. Money market and foreign exchange market deepening in accordance with BPPU 2025 will strengthen policy transmission effectiveness, money market infrastructure modernization in accordance with international standards, and the development of instruments of sustainable finance. Inclusive economic and financial development programs for MSMEs and sharia-compliant finance will be expanded, including digitalization and unlocking domestic and export market access. Synergy and close coordination between the Bank Indonesia policy mix and the policies of the Government and Financial System Stability Committee, with the financial industry, corporate sector, and relevant associations will be strengthened to ensure the national economy rises quickly and recovers fully from the impact of Covid-19, thereby returning to the mediumlong-term growth trajectory towards an Advanced Indonesia. Monetary Policy Direction Bank Indonesia’s monetary policy in 2022 will be more focused on maintaining stability, while still supporting the national economic recovery. The direction and phasing of monetary policy will be pre-emptive, ahead of the curve and front-loading to maintain stability in anticipation of tapering policy, global fiscal policy consolidation and Fed Funds Rate (FFR) hikes, while still supporting the national economic recovery (Figure 9). The low policy rate will be maintained until there are early signals of rising inflation. As stated, Bank Indonesia’s current policy rate is the lowest in history at 3.50%. The focus of interest rate policy is oriented towards strengthening monetary policy transmission effectiveness to lower bank lending rates through a policy of interest rate transparency and money market deepening to reduce the high disparity between medium-long-term SBN yields and interbank rates. The normalization of Bank Indonesia’s monetary policy will be gradual by absorbing the huge excess liquidity in the banking system. The liquidity adjustment will be carried out in a measurable and very prudent manner so as not to interfere with the banks’ ability to channel credit and purchase SBN, while continuing to maintain monetary and financial system stability as well as the ongoing national economic recovery process. Meanwhile, the policy response to the impact of monetary policy normalization by the Fed and several other AEs focuses on exchange rate policy to maintain external stability and avoid disrupting monetary and financial system stability and the national economic recovery process. In this regard, room for adjustments in rupiah exchange rates and SBN yields in line with movements in global exchange rates and US Treasury yields will remain possible in a measured manner and within normal limits to maintain attractive SBN yields and a competitive interest rate differential. Bank Indonesia will continue to monitor and maintain market Figure 9. Monetary Policy Direction in 2022 NORMALIZATION OF GLOBAL LIQUIDITY POLICY GLOBAL FISCAL CONSOLIDATION FFR HIKE IN 2023 AND 2024 SUPPORT DOMESTIC ECONOMIC RECOVERY POLICY MIX BASED MONETARY POLICY: PREEMPTIVE, AHEAD THE CURVE, FRONT LOADING EXTERNAL RESILIENCE THROUGH YIELD FLEXIBILITY & EXCHANGE RATE STABILIZATION IN SYNERGY WITH MINISTRY OF FINANCE Rp Yield STRENGTHENING INTEGRATED MONETARY MANAGEMENT STRATEGIES 3 COORDINATION WITH GOVERNMENT SEQUENCING POLICY FOR THE STABILIZATION OF EXCHANGE RATE, LIQUIDITY, AND INTEREST RATE IN 2022 Stabilization Of Exchange Rate Exchange rate stabilization through triple intervention in anticipation of the normalization of global monetary policy Liquidy Gradual absorption of liquidity through contraction of Monetary Operations and an increase in the Statutory Reserves (GWM) taking into account bank credit and Government SBN issuance Interest Rate Low interest rates until there are signs of rising inflation taking into account economic growth OPTIMIZATION OF FOREIGN EXCHANGE RESERVE MANAGEMENT RUPIAH AND FOREX MARKET DEEPENING 1. INFLATION CONTROL 2. FISCAL FINANCING 3. PRIORITY SECTORS (MANUFACTURING AND TOURISM) SYNERGY AND COORDINATION Source: Bank Indonesia presence, while poised to take the rupiah exchange rate stabilization policy measures necessary, through triple intervention in the spot market, DNDF market, and the purchase of SBN in the secondary market, to maintain exchange rate stability in line with the currency’s fundamental value and market mechanisms. Close coordination with the Ministry of Finance will be strengthened further to maintain rupiah and SBN market stability as well as manage adjustments according to prevailing global developments. The monetary operations strategy will also be strengthened to support monetary policy effectiveness. Bank Indonesia will continue to strengthen coordination between monetary policy and fiscal policy to recover the national economy and maintain macroeconomic stability. In this case, coordination is carried out at several levels. First, monetary and fiscal policy coordination to stimulate economic growth on the aggregate demand side in the discussion concerning macroeconomic assumptions in the State Budget and in the meeting between the Ministry of Finance and Bank Indonesia to assess the latest economic developments, taking into account the realization of State Budget expenditures and monetary management. Quarterly discussions on macroeconomic, monetary and financial system stability are also facilitated through the Financial System Stability Committee. Second, monetary and fiscal policy coordination to issue SBN, domestically and globally, in terms of meeting State Budget financing based on global financial market developments and the impact on monetary stability and domestic financial markets. Third, coordination in the purchase of SBN in the primary market by Bank Indonesia to fulfill State Budget funding in accordance with Act No. 2 of 2020 until the end of 2022. Bank Indonesia will continue to purchase SBN through primary auction in 2022 for State Budget financing as a standby buyer in pursuance of the Joint Decree issued by the Minister of Finance and Governor of Bank Indonesia on 16th April 2020. In addition, Bank Indonesia will continue to purchase government securities directly, amounting to Rp224 trillion in 2022, to finance the health and humanitarian budgets in the 2022 State Budget due to Covid-19, as stipulated in the Joint Decree issued by the Minister of Finance and Governor of Bank Indonesia on 23rd August 2021. Close fiscal and monetary policy coordination will become increasingly important in 2022 as a joint step in managing the national economy amid the tangible possibility of elevated global uncertainty due to the normalization of monetary and fiscal policies in the US and several other AEs. Coordination between BI policy and Government policy will be strengthened to control inflation and revive priority sectors towards national economic recovery. Overall inflation in 2022 is expected to remain under control and within the 3%±1% target corridor with adequate aggregate supply to meet increasing aggregate demand, anchor inflation expectations and stabilize the rupiah, including the policy response taken by Bank Indonesia and the Government. Inflation control will still be coordinated through the (central and regional) inflation control teams, particularly the possible increase in global energy commodity prices as well as price pressures on basic necessities. Meanwhile, coordination to stimulate priority sectors is strengthened with support from Bank Indonesia to assess developments and identify issues occurring at both the central and regional levels, as well as to provide national economic policy recommendations, including results of the Regional Financial-Economic Study (KEKDA - Kajian Ekonomi Keuangan Daerah) conducted by Bank Indonesia offices in various regions. Full coordination and support from Bank Indonesia will be strengthened in the development and improvement of MSMEs and Islamic finance, both nationally and in various regions. Macroprudential Policy Direction supervision of banks. Moreover, loose macroprudential policy will be expanded to revive sectoral credit/financing as part of KSSK policy coordination for the national economic recovery. The formulation and implementation of macroprudential policy will be adjusted to the conditions of priority sectors and the disbursement constraints faced by banks, including incentives/disincentives for Statutory Reserves and others. Meanwhile, to support an inclusive economy and finance, especially MSMEs, the Macroprudential Inclusive Financing Ratio Policy (RPIM) will continue to improve in terms of implementation effectiveness through MSME clustering and corporatization in synergy with the Government, while encouraging bank collaboration with MSME partner institutions to channel funds, and developing securities appropriate for MSME financing. Bank Indonesia also cooperates in synergy with the Government to unlock access to finance Bank Indonesia will maintain loose macroprudential policy in 2022 to revive bank loans/financing and support the national economic recovery, while maintaining financial system stability. Macroprudential policy has been relaxed by holding the 0% CCyB, providing flexibility in fulfilling the PLM ratio of 6% with SBN that can be repurchased with Bank Indonesia, as well as the 100% FLTV/ LTV ratio on housing loans and 0% downpayment requirements on automotive loans for banks that meet the NPL/NPF criteria, which will remain effective until the end of December 2022 (Figure 10). Macroprudential policies to increase bank financing, such as the Macroprudential Intermediation Ratio (MIR) and prime lending rate transparency, will be continued and their effectiveness strengthened by the macroprudential Figure 10. Macroprudential Policy Direction in 2022 ACCOMODATIVE MACROPRUDENTIAL POLICY TO SUPPORT INTERMEDIATION PRIORITY SECTOR AND EXPORT ORIENTED KSSK SECTORS INCLUSIVE SME 38 KSSK Sectors RESILIENCE GROWTH DRIVER SLOW STARTER SUSTAINABLE FINANCE Sustainable Economy with Stable, Growing, Inclusive and Green Financial System LOW INCOME INDIVIDUAL 24 SUB SECTOR (P1 - P2 - P3) OPENING 8 Export Sectors Main Commodity (Bank Indonesia) Food and Beverages Paper Basic Metal Automotive Textile and Textile product Rubber Chemical Footwear SUBSISTENCE Carbon Emission Green Finance Green Inclusive Finance Pillar 1 Pillar 2 Pillar 3 Pillar 4 Transformation Policy Macroprudential Green Depth Money market Green Development Finance Green Inclusive Transformation Institutional Bank Indonesia Green National Green Finance Coordination RIM LTV and DP RPIM Incentive RR for the priority sectors, export and inclusive Green Research Carbon Emission Measurement Strengthening the effectiveness of the transmission of policy rates to loan rates PRIORITY SECTOR AND EXPORT ORIENTED MACROPRUDENTIAL POLICY MIX TO MAINTAIN RESILIENCE MACROPRUDENTIAL POLICY TO IMPROVE FINANCIAL INCLUSION PLM Flexibility CCB RPIM min 20% DSRS Strenghtening Suptech Development Mapping of MSME financing through multiple e-commerce channels and partnerships National Policy Mix Synergy Preparation of the digital financial services education module Green SME study and pilot project Strengthening financial management capacity for MSMEs Goverment Source: Bank Indonesia and develop MSMEs, including low-income and subsistence groups. Furthermore, Bank Indonesia is also synergizing with the Financial System Stability Committee and related government ministries/ institutions to development of sustainable finance and support transformation of the green financial system, including macroprudential policies that support green finance. Bank Indonesia continues to strengthen policy synergy with the Financial System Stability Committee to revive lending from banks and other financial institutions to the corporate sector to support the national economic recovery. As mentioned, the national economic recovery process is highly dependent on the availability of corporate financing. Moreover, bank financing is necessary to overcome the scarring effect of the Covid-19 pandemic, which will also influence the sustainability of short-term and medium-long-term economic growth. Therefore, synergy and policy coordination are required to mitigate various real sector issues, focusing on priority growth drivers. Synergy and policy coordination are also need under the auspices of the Financial System Stability Committee to overcome lending issues on the supply and demand sides. The effectiveness of loose macroprudential policy is strongly influenced by the synergy and coordination of these policies. From a government perspective, policy support includes utilizing state budget instruments to overcoming the pandemic, providing social protections and fiscal incentives, as well as various other business facilities. OJK uses various microprudential instruments, such as stimulus policies for financial institutions and adjustments to Risk-Weighted Assets and Advances for Financing Companies, while LPS is pursuing a policy of strengthening the deposit guarantee program in the form of a low guaranteed interest rate and incentives to relax late fees for guaranteeing premiums. In addition to focusing on the economic recovery, Bank Indonesia and the Financial System Stability Committee will strengthen coordination to anticipate the potential risk of a spike in cases of new Covid-19 variants. Coordination between macroprudential supervision by Bank Indonesia, microprudential supervision by OJK and deposit insurance by LPS will be strengthened to maintain financial system stability. Within the framework of the Integrated Banking Supervision Forum between Bank Indonesia, OJK and LPS, regular coordination is implemented at both the Deputy and Head of Department levels. Some of the salient discussions in the forum include the latest individual banking conditions, the assessments of liquidity conditions, credit quality, capital and other aspects, such as developments in monetary conditions, financial markets, corporations and the macroeconomy. In addition to macroprudentialmicroprudential policy synergy, Bank Indonesia and OJK continue to strengthen the basis for cooperation in the disbursement of (sharia-compliant) short-term liquidity assistance. In addition, Bank Indonesia and LPS intensively and continuously coordinate to strengthen the resolution of troubled banks as necessary. Payment System Policy Direction Bank Indonesia will continue to expand payment system digitalization in 2022 to accelerate integration of the digital economic and financial ecosystem, including financial and economic inclusion. Various programs announced in BSPI 2025 will be implemented, in addition to payment system digitalization programs according to the stipulated schedule and targets. Payment system policy in 2022 will remain focused on five main strategic areas (Figure 11). First, accelerating healthy, competitive, and innovative payment system industry consolidation through regulatory reform in accordance with industry-friendly policies and regulations in the Payment System Bank Indonesia Regulation (PBI), along with ease of licensing and approval with service level agreements (SLA) between Bank Indonesia and the payment system industry, as well as strengthening payment system supervision, particularly in terms of capital compliance, risk management, and cyber security. Figure 11. Payment System Policy Direction in 2022 2021 & 2022 : RECOVERY AND REFORM DIGITALIZATION TREND FASTER DIGITAL BANKING TRANSFORMATION GREATER COMPETITION AND COLLABORATION (BANK-FINTECH) RAPID E-COMMERCE INNOVATION SPPUR POLICY DIRECTIONS FOR 2022 PAYMENT SYSTEM AND RUPIAH CURRENCY MANAGEMENT (SPPUR) POLICY IN 2021 SUPPORTING NATIONAL ECONOMIC RECOVERY THROUGH A NON-CASH PAYMENT SYSTEM POLICY PAYMENT SYSTEM POLICY FOR A HEALTHY, COMPETITIVE AND INNOVATIVE PAYMENT SYSTEM INDUSTRY ELECTRONFICATION: TP2DD REGULATORY REFORM G2P 4.0 LICENSING AND APPROVAL SLA MLFF PAYMENT SYSTEM SURVEILLANCE ELECTRONIFICATION SOCIAL ASSISTANCE (BANSOS) ELECTRONIFICATION IMPROVEMENT WITH G2P 4.0 STRENGTHENING ETP WITH TP2DD EXPANDING ELECTRONIFICATION IN THE TRANSPORTATION SECTOR ENCOURAGING THE INCLUSIVE AND EFFICIENT DIGITAL ECONOMY AND FINANCE ENSURING THE AVAILIBILTY OF CASH-IN-CIRCULATION FOR ECONOMIC REACTIVATION PUR RUPIAH CURRENCY MANAGEMENT DIGITALIZATION IN BANKING INDUSTRY RUPIAH DIGITAL DEVELOPMENT MULTIMODE INTEGRATION SAFE, EFFICIENT AND REASONABLE MARKET PRACTICES IN PAYMENT SYSTEM IMPLEMENTATION RUPIAH CURRENCY AVAILIBILITY THE 3I (INTEGRATED, INTERCONNECTED, INTEROPERABLE), SAFE, AND RELIABLE INFRASTRUCTURE THROUGH: PAYMENT SYSTEM PRICE SCHEME POLYCY QRIS CYBER SECURITY AND RESILIENCE BI-FAST AML CTF COMPLIANCE SNAP DATA OPTIMIZATION THE AVAILIBILITY & RELIABILITY OF BANK INDONESIA PAYMENT SYSTEM COORDINATION AND SYNERGY Source: Bank Indonesia This strategy is oriented towards establishing an end-to-end ecosystem from digital banking, FinTech, and e-commerce through business cooperation, ownership, or other forms. Second, the development of 3I (interoperable, interconnected, and integrated) payment system infrastructure that is secure and reliable will continue, thus increasing economic and financial inclusion, including MSMEs and retail transactions. The expansion of QRIS uptake continues as a contactless payment tool that complies with health protocols through the QRIS READY program at markets/shopping centers, including the service features for greater convenience in the community. The expansion of the use of QRIS is carried out to increase the number of transactions so that MSME merchant credit profiles can be compiled to support increasing banking credit to MSMEs, reducing the space for illegal online lending activities, and to achieve the target of 15 million QRIS users by 2022. SNAP implementation to connect payment transaction services between banks and FinTech will be accelerated to expand integration of the national digital economic and financial ecosystem. Likewise, the operationalization of BI-FAST and expansion of participants will continue, with the goal of connecting all banks as participants to provide retail payment services in real time available continuously (24/7). Connected banks can take full advantage of BI-FAST to provide the best retail payment services to the public. In addition to the three flagship programs, namely QRIS, SNAP and BI-FAST, Bank Indonesia will also strengthen digital payment system reforms with development programs to optimize data and maintain the availability and reliability of the Bank Indonesia Payment System. Third, development of safe, efficient and fair market conduct to further realize a fast, convenient, affordable, secure and reliable payment system. To that end, a pricing policy will be adopted to simplify, harmonize, and simultaneously reduce transaction costs in the digital payment system. The current payment system service price scheme contains too much variation in the types of service from one payment service company to another as well as the speed at which merchant sellers receive payments from buyers. Of course, the price scheme must continue to incentivize the industry to invest and innovate without burdening the consumer. Strengthening risk management and monitoring payment systems will also continue, particularly in the implementation of cyber security and resilience as well as strengthening compliance with the antimoney laundering/combating the financing of terrorism (AML/CFT) principles. Bank Indonesia will also accelerate preparations to issue digital rupiah and rupiah currency management digitalization. Bank Indonesia continues to develop digital rupiah as a legal payment instrument and supports the mandate and task implementation of central banks in the digital era, while accelerating and integrating the national digital economic and financial ecosystem. Plans to issue digital rupiah are based on at least three main considerations, namely: (i) Digital rupiah as legal tender in the Republic of Indonesia issued and circulated by Bank Indonesia as the central bank institution mandated in the Constitution and Law, (ii) Readiness of payment system infrastructure and financial markets that are integrated, interconnected, and interoperable, which in time will become wholesalers of digital rupiah, and (iii) Choice of technology platforms that support the issuance and circulation of digital rupiah, such as Distributed Ledger Technology (DLT) or Centralized Ledger. In 2022, Bank Indonesia will issue a conceptual design for digital rupiah. In terms of the cash payment system, the policy direction will focus on providing quality rupiah currency and maintaining adequate cash throughout the territory of the Republic of Indonesia in accordance with BPUR 2025. This policy direction is pursued to achieve 3 (three) key milestones at once, namely (i) efficiency in the printing and circulation of banknotes and coins, (ii) centralizing currency distribution and circulation from central to remote areas, including 3T territories (Terdepan, Terluar dan Terpencil - Frontier, Outermost, and Isolated), and (iii) digitalization based on harmony with the ongoing economic and financial digitalization. Bank Indonesia will continue to strengthen synergy and coordination with the (central and regional) Government, banks, and associations in the payment system, FinTech and e-commerce. Coordination with the Government will primarily focus on expanding the electronification of regional government financial transactions by strengthening TP2DD, encouraging the distribution of Government to Private (G2P) 4.0 social assistance, expanding electronification and integration between transportation modes and implementing Multi-Lane Free-Flow (MLFF), while expanding MSME and tourism digitalization through Gernas BBI and BWI in various regions and in the main tourism destinations that have been determined. Synergy and coordination between payment system digitalization policies from Bank Indonesia and financial institution digitalization from OJK specifically relates to FinTech development through sandboxes and digital banks. Synergy with banks, payment system associations, FinTech associations and other associations will be strengthened by expanding the various payment system digitalization programs that are already running, such as QRIS, SNAP and BI-FAST, as well as expanding services to the wider community. Accelerating Money Market Deepening Accelerating financial market deepening to strengthen the monetary policy transmission effectiveness as well as infrastructure and business financing to support the national economic recovery. Money market deepening in 2022 will still be directed towards building a modern money market in accordance with international standards, as well as supporting the transformation of monetary management that is more supportive of market development in terms of the instruments (products), participants as well as pricing mechanisms, with integrated, interconnected and interoperable infrastructure between money markets and payment systems. Development of the main BPPU 2021 initiatives will continue based on three policy pillars (Figure 12). In the first pillar, money market infrastructure development will focus on implementation of the central counterparty (CCP), which is expected to start operating in 2022, in addition to expanding money market transactions through ETP multi-matching for the rupiah and foreign exchange money markets. In addition, Bank Indonesia will also finalize the Conceptual Design (CD) for the development of money market infrastructure as well as integrated, interconnected, Figure 12. Acceleration of Money Market Deepening in 2022 ETP Matching Implementation of ETP Matching for Spot Market Instrument expansions: Repo and DNDF Key Initiatives Blueprint for Money Market Development Improving the Effectiveness of Monetary Policy Transmission Develop Economic Financing Sources and Risk Management Trading Venue/BI-ETP Repo Central Counterparty IndONIA and JIBOR Long-Term Hedging Instrument BI-SSSS Overnight Index Swap Sustainability dan Green Financing BI-RTGS DNDF Retail Investor Trade Repository LCS Asset Securitization Promote FMI Digialization & Strengthening FMI Focus 2021-2022 Repo Expansion of Repo transaction participant Expansion of underlying Repo Development of efficient pricing Repo rate Strengthening treasury certification and market conduct Utilization of Mini GMRA Syariah Development of Securities Lending and Borrowing (SLB) DNDF Expansion of DNDF transaction participant Efforts to balance supply-demand Development of currency and DNDF tenors variations Strengthening JISDOR as a credible DNDF fixing rate Other Instrument Overnight Index Swap and IRS Long Term Hedging Instrument Local Currency Settlement Source: Bank Indonesia and interoperable payment systems, including BI-APS, BI-SSSS, BI-RTGS Gen 3, and the Trade Repository. Based on the second pillar, strengthening monetary policy transmission effectiveness will focus on the implementation of money market instruments using the ETP multi-matching system, as well as development of Repo, DNDF, and LCS transactions. In this regard, various programs continue to be improved to accelerate the increased use of the Local Currency Settlement (LCS) framework to facilitate trade and investment with partner countries by strengthening synergy and coordination with other relevant authorities. The LCS campaign continues to broadly extend the use of Appointed Cross Currency Dealers (ACCD) to banks, corporations, and other potential users in collaboration with relevant domestic agencies and in partner countries. The program includes implementation of the non-USD/IDR reference rate for the development of derivative instruments within the LCS framework. In addition, Bank Indonesia will also strengthen transaction regulations in the foreign exchange market by simplifying and integrating regulations to foster market deepening and support financial system stability. This money market regulatory reform will simplify provisions through a principles-based approach to increase implementation flexibility and effectiveness for market participants. Under the third pillar, economic financing will continue to be strengthened through 3 (three) policy strategies, namely (i) encouraging the development of asset securitization through the KIK-EBA and EBA-SP programs, (ii) encouraging the development of retail investors and financial literacy on a regular basis, and (iii) strengthening coordination and communication related to the Sustainable Green Finance (SGF) program. The financial market deepening policies will be supported by close synergy between Bank Indonesia, the Ministry of Finance, OJK and LPS within the Coordination Forum for Financial Market Development Financing (FK-PPPK). Various derivative products in the money and foreign exchange markets will be developed by Bank Indonesia, particularly relating to exchange rate hedging instruments (such as DNDF), interest rate swaps, repo and LCS, which will also catalyze medium- to long-term financing. Inclusive and Green Economic-Financial Policy Bank Indonesia will continue to expand and strengthen MSME development programs through corporatization, capacity building, and access to finance, while improving MSME competitiveness. Corporatization involves institutional strengthening, expanding partnerships, and developing business models for nascent subsistence groups to create new entrepreneurs. End-to-end MSME capacity building will focus on digitalization to increase production, enhance financial management, and expand market access. Market access will be unlocked by facilitating product certification and curation, promoting of international trade, and encouraging interlinkages with local value chains (LVC) and global value chains (GVC). Bank Indonesia will also support the Green MSME movement, beginning with studies and pilot projects to hone current practices. Access to MSME financing will be facilitated to fulfil inclusive financing regulations, among others by mapping patterns of MSME financing through multiple e-commerce channels and partnerships, as well as facilitating business meetings (business matching). The Indonesian Creative Works (KKI) exhibition to encourage Go Export and Go Digital MSMEs will be improved in 2022, while strengthening synergy with the Government towards the success of the GerNas BBI and BWI with the involvement of all Bank Indonesia offices (Figure 13). Bank Indonesia will continue to develop the Islamic economy and finance as a new source of economic growth. The halal value chain ecosystem will be expanded locally and globally in terms of the actors, institutions, and supporting infrastructure. Developing the halal value chain ecosystem will continue to prioritize the leading sectors of halal food and Muslim fashion (modest fashion). In terms of sharia finance, sharia money market deepening to support sharia financing will be pursued through, among others, development of foreign exchange transaction instruments and inclusive BI Sukuk. Optimizing Islamic social finance as an alternative source of financing for the leading sharia economic sectors will continue, especially through productive waqf. In addition, Bank Indonesia will continue to increase business linkages through a series of national Fesyar activities in three regions (Java, Sumatra, Eastern Indonesia) and thhe international ISEF event. Bank Indonesia will strengthen the Center for Excellence in Islamic Economics and Finance through higher education as an integral part of implementing strategies to raise public literacy. To that end, Bank Indonesia will continue to strengthen synergy with various parties, including the National Islamic Economy and Finance Committee (KNEKS), Islamic boarding schools (pesantren), the Islamic Economic Community (MES), business associations, banks, as well as scholars, academics, and the wider community. Figure 13. Strengthening the MSME Development Program Supporting Major Policy of Bank Indonesia Final Target Intermediate Target Policy Pillar MACROECONOMIC AND MONETARY STABILITY FINANCIAL SYSTEM STABILITY PAYMENT SYSTEM STABILITY Encouraging Competitive MSMEs to Accelerate Inclusive Economic Growth CORPORATE CAPACITY FINANCING Bank Indonesia continues to strengthen green finance policies towards realizing a sustainable economy with a stable, inclusive and green financial system. In response to the challenges of future climate change that could threaten economic stability, and as part of Bank Indonesia’s active contribution to achieving a Indonesia’s low carbon target, Bank Indonesia will undertake a comprehensive transformation by strengthening green finance policies. Studies on green macroprudential policies to support sustainable finance continue to be performed. Bank Indonesia also continues to encourage financial market deepening through the development of green money market instruments. The development of a green inclusive economy and finance continues through, among others, the development of a circular economy business model, green farming, and green financial reports for MSMEs and sharia economic players. In addition, Bank Indonesia will continue institutional transformation, encompassing governance, risk management, strategies, and green performance indicators. In its development and implementation, Bank Indonesia will continue to synergize and coordinate closely with the Financial System Stability Committee, government ministries/ agencies and relevant stakeholders. International Policy On the international policy side, Bank Indonesia will remain active in various international cooperation forums to support the national economic recovery. Indonesia’s G20 Presidency in 2022 will be optimized to support the interests of Indonesia and the global economy through substance formulation and the best possible implementation. Beyond the G20 Presidency, substance formulation that support the interests of Indonesia and the region will be the focus of Indonesia’s ASEAN Chairmanship in 2023. Strengthening international cooperation will also continue at the multilateral, regional and bilateral levels relating to the International Financial Safety Net, SCS, Payment Systems and Digital Financial Innovation, anti-money laundering/combating the financing of terrorism (AML/CFT), as well as Structured Bilateral Cooperation with central banks and other international institutions. Bank Indonesia continues to improve the positive perception of investors and rating agencies through proactive engagement activities. Bank Indonesia will also play an important role in promoting trade and investment in priority sectors through the support of the Investor Relations Unit (IRU) at the regional, national and international levels. Bank Indonesia will conduct a massive campaign to encourage and expand the use of LCS, including outreach activities to potential business actors in collaboration with Foreign and Domestic Representative Offices and other strategic partners of Bank Indonesia. Bank Indonesia’s policy response in synergy with the national economic policy mix will accelerate economic growth in 2022 and moving forward towards the medium-term trajectory in pursuit of an Advanced Indonesia. As stated, Bank Indonesia predicts national economic growth in 2022 to reach 4.7-5.5%, driven by the ongoing global economic recovery, which will impact strong export performance, as well as increasing domestic demand from higher consumption and investment. Economic recovery will take place, supported by increased mobility after controlling the spread of Covid-19 and accelerating the vaccination roll out, broader reopening of priority sectors accompanied by optimizing the KSSK Integrated Policy Package, as well as the fiscal policy stimuli and Bank Indonesia policy mix. In the medium to long term, the economic outlook will improve on track to an advanced Indonesia, driven by the promising global economic outlook as well as increases in investment and productivity through structural reform policies in the real sector and accelerating the national digital economy and finance. Increasing economic competitiveness as well as industrial capacity and capability will support solid and resilient economic growth with a stronger economic structure. In addition, a conducive business and investment climate, including the Job Creation Act, will strengthen sources of higher economic growth. Bank Indonesia predicts that, in the medium term, national economic growth will continue to accelerate to 4.95.7% in 2026. Inflation is predicted to remain low and under control at 1.5-3.5%, supported by higher national production capacity through efficiency and productivity gains to meet rising aggregate demand. The current account deficit will remain manageable at 1.5-2.3% of GDP, thereby underpinning external sector resilience in Indonesia. Based on the current outlook, Indonesia is set to become a high-income developed economy by 2045. Rise and be Optimistic for an Advanced Indonesia The national economic outlook in 2022 will improve, and Bank Indonesia will continue to maintain revival momentum and build optimism surrounding the national economic recovery. Economic stability will be maintained amid the ongoing economic recovery process. Mobility and economic activity will continue to improve in line with the Covid-19 response and accelerated vaccination roll out. Synergy between Bank Indonesia the (central and regional) Government, Financial System Stability Committee, banking industry, and business community will continue to be strengthened to improve sustainable national economic performance. Bank Indonesia will also continue to maintain good synergy with the People’s Representative Council (DPR), especially Commission XI, the banking and financial industries, academia, media, and various other parties. Policy mix innovations that include monetary, macroprudential and payment systems will be aligned with global and domestic developments as well as fiscal conditions to support ongoing structural reforms in the national economy. In closing, through synergy and innovation, Indonesia has been able to survive the deleterious impact of the Covid-19 pandemic and is now rising again with optimism that the economic recovery will gain momentum in 2022 and moving forward. Through synergy and innovation, Indonesia’s economic outlook is improving, supported by national economic policy mix synergy, accelerated transformation in the real and financial sectors, as well as innovation and acceleration of the digital economy and finance. Towards that end, let us continue to strengthen synergy and innovation for national advancement. Let us continue to work and create together, to build and spread hope, confidence, and optimism for the national economic recovery towards an Advanced Indonesia. May Allah SWT, God Almighty, always provide guidance, convenience, perfection, and blessings to the Indonesian nation and to us all. That is all, and thank you Wassalamualaikum warahmatullahi wabarakatuh, Jakarta, 24 November 2021 Perry Warjiyo Governor of Bank Indonesia
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Speech by Mr Perry Warjiyo, Governor of Bank Indonesia, at Bank Indonesia's Annual Meeting 2022, Jakarta, 30 November 2022.
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TABLE OF CONTENT Synergy and Policy Innovation: Key to Resilience and Saving the Economy from Crisis Risk Global Economic Performance and Prospects: Deteriorating with High Risk of Recession, High Inflation, and High Uncertainty National Economic Performance and Prospects: Optimistic and Vigilance Bank Indonesia Policy Mix in 2022: Maintaining Stability and Momentum for National Economic Recovery • Rupiah Exchange Rate Stabilization Policy • Liquidity Normalization Policy • Interest Rate Policy • Accommodative Macroprudential Policy • Acceleration of Payment System Digitalization • Money Market Deepening • Development of Sharia Economic and Finance, and MSMEs • International Policy • Bank Indonesia Transformation National Economic Policy Mix Synergy and Innovation Moving Forward: Strengthening Resilience, Fostering National Economic Revival Bank Indonesia Policy Mix Direction in 2023: Maintaining Stability, Accelerating Economic Recovery • Monetary Policy Direction • Macroprudential Policy Direction • Payment System Policy Direction • Money Market Deepening Policy • Inclusive and Green Economic-Financial Policy • International Policy • Institutional Reform Policy Moving Forward with Optimism and Vigilance: Strong, Recover, and Revival Towards Advanced Indonesia SYNERGY AND INNOVATION STRENGTHENING RESILIENCE AND REVIVAL TOWARDS ADVANCED INDONESIA Speech of the Governor of Bank Indonesia BANK INDONESIA ANNUAL MEETING Jakarta, 30 November 2022 We are honored to welcome, The President of the Republic of Indonesia, Joko Widodo, With respect to, Leaders and Members of DPR and DPD RI, Leaders of State Institutions, Ministers of the Advanced Indonesia Cabinet, Chairman and Members of the OJK and LPS Board of Commissioners, Our predecessors of Governors and fellow Members of the Board of Governors of Bank Indonesia, Governors, Mayors and Regents of Regional Heads from all over Indonesia, National Banking, Corporate and Media Leaders, The recipients of the 2022 Bank Indonesia Awards, Invitees. Assalamu’alaikum Warahmatullahi Wabarakaatuh, Greetings to everyone, Shalom, Om Swastyastu, Namo Buddhaya, Greetings of Virtue. First of all, let us express our gratitude to the presence of Allah subhanahu wa ta’ala, God Almighty, for His mercy and blessing we were able to gather at the 2022 Bank Indonesia Annual Meeting today. With all humility, we would like to express our gratitude to His Excellency, the President of the Republic of Indonesia, who is willing to attend along with all the invitees. We congratulate banks, corporations, and individuals who received the 2022 Bank Indonesia Awards totaling 58 (fifty eight) awards in 4 (four) areas and 18 (eighteen) categories in the field of managing monetary and financial system stability, payment systems and the management of Rupiah, the development of MSMEs and the Sharia financial economy, as well as supporting Bank Indonesia policies. This award is held annually, in conjunction with the Bank Indonesia Annual Meeting, as an appreciation and at the same time national recognition to partners who have supported the implementation of Bank Indonesia’s tasks. At this auspicious opportunity, allow us to present an evaluation of economic performance in 2022 as well as economic prospects and the direction of Bank Indonesia’s policies in 2023 which we summarize under the theme “Synergy and Innovation Strengthening Resilience and Economic Revival Towards Advanced Indonesia”. Our presentation is presented in six parts, namely: (i) The importance of synergy and innovation as the key to resilience and saving the economy from crisis risk; (ii) The performance and prospects of the global economy that is full of risks and uncertainties; (iii) Performance and prospects of the national economy showing resilience and recovery; (iv) Bank Indonesia’s 2022 policy mix to maintain stability and promote economic growth; (v) Synergy and innovation in the national economic policy mix to strengthen resilience and resurgence; and (vi) The direction of Bank Indonesia’s policy mix in 2023. This explanation also serves as the fulfillment of Bank Indonesia’s accountability and transparency as mandated in the Bank Indonesia Law. Synergy and Policy Innovation: Key to Resilience and Saving the Economy from Crisis Risk As a small country in an open economic system, Indonesia is not immuned from the impact of global turmoil which often leads to higher risk of economic crisis. What happened in the last 5 (five) years serves as a concrete example. In 2017 and 2018, there was a trade war between the United States (US) and China which caused global financial market turmoil and decreased the volume of world trade. At the same time, to reduce inflation to the 2% target, the US central bank, The Fed, raised its monetary policy interest rate 4 (four) times during 2018 or 9 (nine) times since the normalization of monetary policy began in December 2015, to 2.25%-2.50%, an interest rate hike that President Donald Trump opposed. The impact of the US-China trade war and US monetary policy tightening through trade channel led to the global economic slowdown. The slowdown was felt not only in these two largest economies in the world, but also in other countries due to China’s central position in the global supply chain. Even larger and immediate impact occured in financial channel. The US-China trade war caused global financial market panic, foreign capital flight and pressure on exchange rate depreciation in developing countries, including Indonesia. The Rupiah exchange rate depreciated to Rp15,000 per US dollar in mid2018 before stabilizing at around Rp13,500 per US dollar at the end of 2018 after a large intervention by Bank Indonesia. At the IMF and World Bank Annual Meeting in Bali in October 2018, President Joko Widodo voiced out loud “The Winter is Coming”, referring to the famous television drama series “Game of Thrones”, to stop the trade war between the two economic giants and seek solutions to save the world economy. Indonesia was also affected by the extraordinary impact of the Covid-19 pandemic that hit the world since February 2020, almost causing a multidimensional crisis. There are at least 4 (four) crisis threats from Covid-19, namely monetary, social, economic, and humanitarian. The threat of a monetary crisis occurred at the beginning of the Covid-19 pandemic which spread rapidly throughout the world and caused fear and panic with the threat of death and worsening economic conditions. Global financial market panic occured in early April 2020, prompting investors to withdraw their portfolio investments and convert them to more liquid assets denominated in US dollars, known as “cash is the king” phenomenon. This mass global phenomenon led to the large amounts of foreign capital flight in short periods of time from developing countries. Indonesia was no exception and experienced a capital flight of around USD11 billion in just two weeks and caused the Rupiah to weaken to Rp16,575 per US dollar in March 2020, before moving to appreaciate and stabilize at around Rp14,000 per US dollar in December 2020. There was a real threat of a monetary crisis if Bank Indonesia did not persistently intervene in the foreign exchange market and the government bond (SBN) market in a large amount to stabilize the Rupiah exchange rate and save the Indonesian economy. The threat of a social crisis from the Covid-19 pandemic occured due to the restrictions on mobility, raising unemployment and reducing people’s income, especially the lower income class. The policy to restrict mobility must be taken to prevent more deaths due to the rapid spread of the Covid-19 pandemic, while waiting for vaccines to achieve herd immunity. As a result, while people with fixed incomes and the upper middle income class were still able to use their savings to make a living, people on lower income class with non fix income were at risk of starvation as they could not work and had no savings. The ability of the APBN to provide social assistance was crucial to avoiding a social crises. We are grateful that while many countries facing limited fiscal space, the Government of Indonesia was able to increase the budget for social assistance program with direct cash assistance (BLT), health assistance, and funds for preemployment cards. The threat of an economic crisis almost occured because the Covid-19 pandemic lasted for a very long time, even its effects are still being felt today. Restrictions on mobility which must be carried out as part of the handling of the Covid-19 pandemic, have also caused the halt of various economic and financial activities. Income declined had led to significant reduction in the demand for goods and services. Likewise, business activities were limited or even stopped, resulting in a decline in sales, liquidity, profitability, and corporate capital. Debt-equity leverage ratio has increased since the Covid-19 pandemic, both in Advanced Economies (AEs) and in the Emerging Market and Developing Economies (EMDEs). In fact, the number of corporate failures soared to almost the same rate of the global financial crisis, with the largest in the US, then Europe, and EMDEs. The prolonged Covid-19 pandemic also had a scarring effect on corporate conditions and increased risks to financial system resilience and stability. The scarring effect on corporations has a negative impact on the high risk of credit default, large losses, decreased capital, and the risk of failure in individual banks and financial system stability. Consequently, the relaxation on credit restructuring provisions has been implemented in many countries, including Indonesia, to postpone principal and installment payments, thereby providing concessions for the recognition of Non Performing Loan (NPL) in banks. The Covid-19 pandemic which subsided at the end of 2020, spread again with the delta variant that quickly reached Indonesia in May-August 2021, threatening a health and humanitarian crisis. The delta variant is highly contagious and more virulent in its impact on human health and mortality. The days of May to August 2021 were full of heartbreaking events with hundred of thousands of deaths, hospitals and cemeteries were full, unavailability of medicines and limited medical equipment. Even vaccines were still very limited in number and the Government had to pay a premium to order them. The level of vaccination and the strictness of restrictions on mobility determined the level of spread of the Covid-19 delta variant, as well as its impact on the risks to health, humanity, and economic. However, there was a large disparity in the ability to vaccinate between AEs and EMDEs. In developed countries, the availability of vaccine supplies and large government fiscal spending allowed a faster vaccination rates and therefore a faster economic recovery. Meanwhile in EMDEs, as limited vaccine supply and fiscal spending capacity, the vaccination rate was slower and so was the opening up of mobility and economic activity. As a result, there has been an imbalance in the global economic recovery from the impact of the Covid-19 pandemic, which is faster in AEs and slower in EMDEs. We should be grateful that in the midst of the global pressures, national economy shows strong resilience and even with a commendable performance. Over the last 5 (five) years, Indonesia’s economic performance has been among the best in the world (Table 1). National economic growth reached more than 5.0% before the Covid-19 pandemic and recorded an average of 3.38% in the 2017 - 2021 period. Even the economic contraction during the Covid-19 pandemic stood at 2.07%, among the smallest in the world. Macroeconomic stability has also been maintained. The average inflation rate was relatively low at 2.60% and never exceeded its target, thus supporting high economic growth. Moreover, the average depreciation of the Rupiah exchange rate was recorded as low as 1.18% with the highest depreciation of 5.97% in 2018 before an appreciation of 3.44% in 2019, thereby volatility was also low. The current account deficit was maintained below 3% of GDP and even very low during the Covid-19 pandemic period and recorded a surplus of USD3.46 billion in 2021. Meanwhile, foreign exchange reserves was high, reached USD144.9 billion at the end of 2021, more than sufficient to pay for imports, government debt, and to support the stabilization of the Rupiah exchange rate. On the other side, the fiscal deficit was maintained below 3% of GDP, and even during the 2020 - 2022 Covid-19 pandemic period the fiscal deficit was among the lowest in the world. Likewise, financial system stability was maintained as indicated by among others a high capital adequacy ratio (CAR), a low NPL ratio, and increasing credit growth in line with the recovery in economic activity and business Table 1. Indonesia’s Selected Economic Indicators (2017-2021) Economic Growth (%) 5.07 5.17 5.02 -2.07 3.69 Headline Inflation (%) 3.61 3.13 2.72 1.68 1.87 Current Account (USD billion) -16.20 -30.63 -30.28 -4.43 3.46 Foreign Exchange Reserves (USD billion) 130.20 120.65 129.18 135.90 144.91 Rupiah Exchange Rate (IDR/USD) 13,565 14,375 13,880 14,040 14,250 Monetary Policy Rate (%) 4.25 6.00 5.00 3.75 3.50 Source: BPS, Bank Indonesia sectors. Indonesia also continues to record progress in various economic reforms through infrastructure development, downstreaming of natural resources, and digitalization of economic-financial during the Covid-19 pandemic. Synergy and innovation are the two keywords of Indonesia’s economic resilience in the face of global turmoil and for economic revival towards Advanced Indonesia. Synergy is the collaboration of two or more public policy authorities to optimize their policy instruments for achieving common goals for the national economy, while respecting and upholding each other’s independence. Synergy comes from the understanding by each authority on the need to achieve a common goal for the national economy, namely the balance between stability and growth. From the understanding of the intended targets, optimality of the policy mix according to each authority can be formulated, both in terms of the complementarity of policy instruments and the effectiveness of their transmission in achieving the targets. Thus, inter-authority policy synergy fulfills 3 (three) conditions of the “Pareto optimum”, namely optimization of target, policy instruments, and effectiveness of transmission. Indeed, the threat of an economic crisis, such as when facing global turmoil and the Covid-19 pandemic, makes it easier to achieve optimal policy synergy between authorities. In addition, the professionalism of authority leaders and institutional arrangements can strengthen the realization of the policy synergy, in the spirit of interdependence and simultaneity of policies in the framework of recognition and appreciation for the independence of their respective authorities. The close synergy between the Government’s fiscal policy and Bank Indonesia’s monetary policy serves as a strong pillar of resilience and revival of the national economy from the impacts of global turmoil. In the May-August 2018 period, when Bank Indonesia had to save Indonesia from the threat of an exchange rate crisis through a large-scale intervention in the foreign exchange market and an increase in interest rates, fiscal policy was also directed at controlling domestic demand by reducing the fiscal deficit to strengthen macroeconomic stability while continuing to increase the allocation of the capital expenditure budget for infrastructure development to support economic growth. In fact, the Government continued to issue global bonds to prevent a drastic decline in foreign exchange reserves in order to support exchange rate stabilization by Bank Indonesia. On the other hand, at the beginning of the Covid-19 pandemic, around April-June 2020 when there was an outflow of foreign investors from holding large amounts of goverment securities (SBN) which caused high yields increases and pressure to weaken the Rupiah exchange rate, Bank Indonesia strengthened its intervention by selling foreign exchange reserves in spot, on a forward basis (Domestic Non-Deliverable Forward, DNDF), and simultaneously buying SBN sold by foreign investors from the secondary market. The foreign exchange market operation, called triple intervention (spot, DNDF, and buy SBN from the secondary market), was able to stabilize the Rupiah exchange rate and increase SBN yields. At the same time, the liquidity contraction resulting from the sale of foreign exchange was neutralized by expanding liquidity from the purchase of SBN on the secondary market, thereby avoiding tight liquidity in the money market and banking sector. As result, not only was a monetary crisis prevented, but it also avoided an increase in fiscal burden due to the rise in SBN yields, as well as risks of banking failure and financial system stability. The fiscal-monetary policy synergy was strengthened during the Covid-19 pandemic to save Indonesia from the risk of a multidimensional crisis. Based on the Enactment of Government Regulation in Lieu of Law (Perppu) No. 1 2020 which was later ratified into Law No. 2 2020, the fiscal deficit is allowed to exceed 3% of GDP and Bank Indonesia is also allowed to purchase SBN directly from the primary market for fiscal financing (Figure 1). The close coordination of fiscal-monetary policy during the Covid-19 pandemic emergency situation was carried out through 3 (three) types of Joint Agreement mechanisms between the Finance Minister and the Governor of Bank Indonesia. First, the purchase of SBN by Bank Indonesia from the primary market as a stand-by buyer with a yield rate according to the market mechanism, when not all of the SBN auction targets for Government fiscal funding can be absorbed by the market. This mechanism is valid for a period of 3 (three) years 2020, 2021, and 2022. In this regards, as of 15 November 2022, Bank Indonesia has purchased SBN amounted of Rp266.11 trillion. Second, the purchase of SBN by Bank Indonesia in the primary market directly with a burden sharing mechanism to meet the increasing needs of the APBN for social protection programs (Rp397.6 trillion with a net burden of 0% for the Government) and national economic recovery (Rp117 trillion) with a net charge of 1% below the Bank Indonesia Reverse Repo interest rate for 3 (three) months for the Government, due to the worsening of the Covid-19 pandemic. This burden-sharing mechanism only applied to the 2020 APBN financing. Third, the purchase of SBN by Bank Indonesia in the primary Figure 1. Coordination of Fiscal Policy and Monetary Policy during the Covid-19 Pandemic LAW NO. 2 of 2022 - Fiscal Deficit of more than 3% of GDP until 2022 (Article 2) - APBN financing by Bank Indonesia through the purchase of Goverment Bonds (SBN) in the primary market (Article 16) JOINT DECREE BETWEEN THE MINISTER OF FINANCE AND THE GOVERNOR OF BANK INDONESIA - MECHANISM FOR SBN PURCHASES IN THE PRIMARY MARKET FOR APBN FINANCING 1. JOINT DECREE I (KB I) – APRIL 16, 2020 • Bank Indonesia participates in the SBN auction in the primary market according to market interest rates, as a noncompetitive bidder (stage I of the auction), greenshoe option (stage II of the auction), or private placement (stage III of the auction). • For general purpose spending in APBN. Valid for three years according to Law No. 2 of 2020. • Total purchases of SBN by Bank Indonesia amounted to Rp75.9 trillion for the 2020 APBN, Rp143.3 trillion for the 2021 APBN, and Rp46.9 trillion (as of 15 November 2022) for the 2022 APBN. 2. JOINT DECREE II (KB II) – JULY 7, 2020 • For social protection budget allocation and the national economic recovery program from the impact of the Covid-19 pandemic. Only applies to the 2020 APBN. • SBN purchases by Bank Indonesia in the primary market through private placement mechanism with a burden sharing mechanism. • A total of Rp397.6 trillion for the public goods budget (social protection) with SBN coupons equal to Bank Indonesia's three-month tenor reverse repo interest rate. All coupons are returned by Bank Indonesia to the Government so that the burden on the Government is 0%. • A total of Rp117 trillion for the nonpublic goods budget (subsidies for MSMEs and corporations) with SBN coupons equal to Bank Indonesia's three-month tenor reverse repo interest rate. Part of the coupons were returned by Bank Indonesia to the Government so that the burden was very low. 3. JOINT DECREE III (KB III) – AUGUST 23, 2021 • For the health and humanitarian budget allocation to overcome the impact of the Covid-19 pandemic. • SBN purchases by Bank Indonesia of SBN by Bank Indonesia in the primary market through private placement mechanism amounted Rp215 trillion for the 2021 APBN and Rp224 trillion for the 2022 APBN. • Bank Indonesia three-month tenor reverse repo interest rate for the SBN coupon, much lower than market interest. Coupons for SBN of Rp58 trillion in 2021 and Rp40 trillion in 2022 are returned by Bank Indonesia to the Government so that the burden on the Government is 0%. Source: Bank Indonesia market directly with a coupon at the Reverse Repo Bank Indonesia interest rate for 3 (three) months to finance the enormous health and humanitarian funding needs in the 2021 APBN (Rp215 trillion) and the 2022 APBN (Rp224 trillion) due to the outbreak of the Covid-19 delta variant. These health and humanitarian budget allocation needs include vaccination programs, hospital fees, medicines, medical devices and medical personnel. Once again, the close synergy between fiscal policy and monetary policy has saved Indonesia from a multidimensional crisis, namely the health crisis, social crisis, exchange rate and monetary crisis, fiscal crisis, financial system crisis, and economic crisis. The resilience of the Indonesian economy is also the result of policy innovations taken by the Government and Bank Indonesia. The challenges we face, both because of the Covid-19 pandemic and the impact of global spillover, are complex and multidimensional. Conceptual understanding of theory and practice in dealing with crises is clearly needed. However, the global turmoil that continues to hit our economy also requires creativity, innovation, speed, and courage in the formulation and decision-making of policy mix responses from each institution as well as policy synergies with other institutions. That is our spirit and commitment at Bank Indonesia to continue to innovate with a policy mix in maintaining monetary stability to support the national economic recovery from the Covid-19 pandemic and the impact of global spillover. i. First, we eased all instruments in the Bank Indonesia policy mix in 2020 and 2021 to support economic growth after the impact of the Covid-19 pandemic and avoid tight liquidity that could lead to a domestic monetary and financial system crisis. As the economy begins to recover in 2022 and to protect the domestic economy from global ramifications, we changed the monetary policy direction to maintain stability, while macroprudential policies, payment systems, financial market deepening, and economic inclusion continue to focus on economic growth. ii. Second, monetary policy continue to rely on the main policy instrument of the BI7DRR interest rate. In this regard, we lowered the BI7DRR interest rate to the lowest level of 3.50% in line with low inflation and the need to encourage economic growth after the impact of the Covid-19 pandemic. However, we have strengthened our policy of intervention in the foreign exchange market in spot, DNDF, and through buying/selling of SBN from the secondary market, or what we called triple intervention, to maintain the stability of the Rupiah exchange rate from the impact of the global financial market turmoil. Moreover, we also adopted a quantitative easing (QE) policy through a large amount of liquidity injection to ensure the banking system is protected from a financial system crisis and to contribute to the national economic recovery. iii. Third, we eased our macroprudential policy with a number of instruments, such as lowering the down payment policy to 0%, or increasing the loan-to-value ratio (LTV) to 100% for property and automotive loans, reducing the obligation for Macroprudential Liquidity Buffers (MPLB), Macroprudential Intermediation Ratio (MIR), providing incentives to banks for lending to 38 priority sectors, including MSMEs, to spur national economic recovery. iv. Fourth, accelerating the digitalization of the payment system to strengthen the integration of the national economic-financial digital ecosystem through the use of QRIS (Quick Responses Code Indonesian Standard, the only QR standard for payments), the implementation of BI-FAST (a cheap, 24/7 real-time, retail payment infrastructure), and one language in payment services of the National Standard Open API Payments (SNAP). Regulatory reform of the national payment industry (bank and nonbank) is pursued through facilitating licensing according to its classification (systemic, critical, and general) as well as accelerating the integration, interconnection, and interoperability of payment infrastructure and money markets. Bank Indonesia in collaboration with the national payment industry have also accelerated the electronification of the distribution of Government social assistance programs, various modes of transportation, as well as regional government financial transactions. v. Fifth, we continue to encourage economicfinancial inclusion, both through the MSME development program, as well as the sharia economic and finance. The MSME development program is pursued through 3 (three) pillars, namely corporatization (including institutional strengthening and partner expansion), endto-end capacity building (including through strengthening entrepreneurship and market expansion), and financing for expansion of financial access (including digitalization of payments). The MSME development program is focused on food clusters, especially to support controlling inflation, as well as handicraft clusters for export promotion according to the beauty and diversity of Indonesian culture. The sharia economic chain ecosystem development program is focused on halal food, modest fashion, and Muslim-friendly tourism. Digitalization of payments with QRIS and BIFAST as well as financial literacy and consumer protection programs are encouraged to expand access for MSME financing and the sharia economic and finance. The MSME promotion program is carried out through a national event called the “Karya Kreatif Indonesia (KKI)” which held once a year, while for the sharia economic and finance is carried out through the Sharia Economic-Financial Festival (FESyar) event which held in three regions (Sumatra, Java, and Eastern Indonesia) and the Indonesia Sharia Economic Festival (ISEF) which is an international event. We also pursue synergy and policy innovation in maintaining financial system stability in close coordination with the Financial System Stability Committee (KSSK). The Covid-19 pandemic has caused a scarring effect to the business sectors in the form of declining business conditions, balance sheets, and increasing debts that will take a long time to heal. If not addressed timely and properly, the deteriorating condition of corporations could en masse spread to the banking system with large amount of credit defaults that could undermine financial system stability. Coordinated policy responses from KSSK members are needed to address them from both demand and supply side. In this regard, Bank Indonesia’s policy instruments are directed at reducing BI7DRR to the lowest level, injecting large amounts of liquidity (QE), stabilizing the exchange rate, as well as providing incentives for banks to channel into priority sectors for national economic recovery. The government provides fiscal incentives in the form of interest rate subsidies to MSMEs, corporate tax reductions, to the placement of funds in a number of banks to channel credit to priority sectors, especially MSMEs. The Financial Services Authority (OJK) provides relaxation of provisions in credit classification in the banking credit restructuring program to the business sectors so that there is no mass credit default. The Deposit Insurance Agency (LPS) ensures that public deposits are guaranteed in banks, thus supporting the financial system stability, as well as as lowering the guaranteed interest rate to support national economic recovery. Global Economic Performance and Prospects: Deteriorating with High Risk of Recession, High Inflation, and High Uncertainty Synergy and innovation in the policy mix need to be continuously improved to strengthen the resilience of the national economy from the impact of increasingly volatile global economic spillover in future. Geopolitical tensions are further exacerbating the fragmentation of global economy prospects. The continuation of the Russia-Ukraine war and the imposition of sanctions on Russia have resulted in limited supplies of energy and food prices which in turn led to a very significant increase in prices. Meanwhile, the continuing trade war between the impact on global economic and financial spillover, both from trade and financial channels, on EME countries including Indonesia. US and China and the restrictions on mobility due to Covid-19 in China have further exacerbated disruptions to global supply chains and Chinese tourist travel to various countries. The high level of political and economic fragmentation as well as worsening disruptions in global supply chains have caused and will further weaken global economic growth from the supply side. At the same time, very high energy and food prices have caused global inflation to soar and prompted central banks in developed countries, especially the Fed and the European Central Bank (ECB) as well as a number of Emerging Market Economy (EME) countries such as Brazil, Chile, and Mexico to aggressively increase policy rates. As a result, world economic growth has slowed and is at risk of recession in line with Continuing political and economic fragmentation as well as aggressive monetary policy tightening in developed countries have led to a slowdown in the world economy, accompanied by the increasing risk of recession. Global economic growth was revised down to 3.0% in 2022 and further slower to 2.6% in 2023 with a downward risk trend, before improving to 2.8% in 2024 (Table 2). All countries have experienced a slowdown in growth, though to varying degrees. The sharp downward correction mainly occurred in the US, Euro Area, and Latin America in 2023 which was accompanied by the increasing risk of recession. This is because in the three regions the contraction in growth occurred simultaneously, both from the supply side due to limited energy supply caused by the geopolitical tensions, and from the demand side due to aggressive monetary tightening and declining purchasing power of consumption due to high inflation. Meanwhile, growth correction was relatively smaller in countries where monetary policy tightening was relatively non-aggressive and/or had better domestic energy and food supplies. Japan and India, which in 2022 grew by 1.7% and 6.6%, will the decline in aggregate demand due to monetary tightening and the weakening purchasing power of public consumption due to high inflation. Meanwhile on global financial markets, the very aggressive increase in policy rates by the Fed has driven the US dollar exchange rate to be extremely strong and put downward pressure on various world currencies, including the Rupiah. The negative risk perception in global financial markets has worsened, prompting global portfolio investors to withdraw and convert their funds to liquid instruments (the “cash is the king” phenomenon), and further exacerbate the Table 2. Global Economic Performance and Prospects (%) 2022* 2023* 2024* World -3.0 6.0 3.0 2.6 2.8 Advanced Economies -4.4 5.2 2.4 1.1 1.5 US -3.4 5.7 1.9 1.0 1.1 Euro Area -6.1 5.2 3.1 0.7 1.5 Japan -4.6 1.7 1.7 1.5 1.2 -1.9 6.6 3.5 3.6 3.8 China 2.2 8.1 3.2 4.5 4.6 India -6.6 8.3 6.6 6.0 6.2 ASEAN-5 -3.4 3.4 5.0 5.0 5.6 Latin America -7.0 6.9 3.0 1.3 1.3 Emerging Economies Source: WEO-IMF, Bank Indonesia Note: *Bank Indonesia’s projection decline to 1.5% and 6.0% in 2023, which are then projected to grow by 1.2% and 6.2% respectively in 2024. China’s growth is expected to improve from 3.2% in 2022 to 4.5% and 4.6% in 2023 and 2024 in line with the gradual easing on mobility restriction. The ASEAN-5 region is considered the most resilient from the impact of global spillover with a projected stable growth of 5.0% in 2022 and 2023 and then improving to 5.6% in 2024. Risk of slower than expected in the global growth and various countries could realized if the high level of political and economic fragmentation continues, and monetary policy tightening takes longer to reduce inflation in each country. Therefore, the risk of economic slowdown and high inflation (stagflation), and even recession and high inflation needs to be watched in the future, to strengthen the synergy and innovation of national economic policies in maintaining the resilience of the Indonesian economy that has been achieved so far. Inflationary pressures will remain high going forward due to continued fragmentation of the world’s politics and economy, although it will gradually ease as a result of the monetary policy tightening by the central bank. Global inflation is expected to rise from 6.4% in 2021 to 9.2% in 2022, and then begin to decline to 5.2% in 2023 and 3.8% in 2024. On a quarterly basis, global inflation is forecasted to Graph 1.a. Prospects of Inflation in Developed Countries peak at 10,0% in the third quarter of 2022 before declining to 5.2% in the fourth quarter of 2023. The highest increase in inflation is in developed countries, from 5.2% in 2021 to 7.2% in 2022 before declining to 3.2% in 2023 with a more aggressive response to monetary tightening and forecasts for a decline in energy and food prices (Graph 1.a). Inflation in the US and the Euro Area is expected to rise to the highest of 7.0% and 8.8% in 2022. For Emerging Market and Developing Economies (EMDEs), inflation is expected to rise from 7.3% in 2021 to 10.6% in 2022, before falling to 6.5 % in 2023 (Graph 1.b). The rise in inflation in 2022 differs from country to country, with lower increases in Asia than in Latin America. After that, starting in mid-2023, inflation will decrease in China, India, the ASEAN-5 region, and Latin America. Overall, the impact of political-economic fragmentation on inflation in EMDEs was not as high as in AEs, except in Latin America. The inflation forecast is based on the assumption that the Russia-Ukraine political tensions and the US-China trade war will not be prolonged, so that inflationary pressures from high world energy and food prices will ease at the end of 2023 before returning to a low and stable level in 2024 as predicted above. The high interest rate policy is predicted to be maintained for a longer period (“higher for longer”) Graph 1.b. Prospects of Inflation in EME Countries %, yoy %, yoy I II III US Euro Area Source: Consensus Economics IV I II III Japan England IV I II Australia Canada I II III IV I II III China India Thailand Philippines Malaysia Vietnam Source: Consensus Economics IV Graph 2.a. Fed Funds Rate (FFR) Forecast % 5.25 % The Fed: Implied Rate (Fed Funds Future) ECB: Implied Rate (Overnight Index Swaps) 3.25 Current implied rate: 3.86 Current implied rate : 1.4 3.00 5.00 4.71 4.75 4.50 Graph 2.b. ECB and BoE Interest Rate Forecast 4.86 4.91 4.91 4.84 2.43 2.50 4.75 2.25 4.60 1.50 3.76 3.75 5.00 4.75 4.50 4.25 4.00 3.75 3.50 3.25 3.00 3.54 3.50 3.25 2.92 2.89 4.00 2.94 1.75 4.32 4.25 3.00 2.91 2.03 2.00 4.46 4.36 2.87 2.72 2.75 2024 2025 % BoE: Implied Rate (Overnight Index Swaps) 4.77 Current implied rate : 2.9 4.54 4.39 4.64 4.61 4.02 3.57 Data as of 15 November 2022 Source: Bloomberg Data as of 14 November 2022 (ECB); 7 November 2022 (BoE) Source: Bloomberg to lower high inflation back to its long-term level. In the US, the Fed Funds Rate (FFR) which is currently at 3.75%-4.00% is predicted to rise to around 4.75%-5.00% in the first quarter of 2023 and will be maintained at this level throughout 2023 and slightly down to around 4.25%-4.50% in 2024 (Graph 2.a). The same trend also applies to the policy rates of the European Central Bank (ECB) and Bank of England (BoE), which are currently at 2.5% and 3.75% respectively, and are predicted to increase to 3.0% and 4.25% respectively, and maintained in 2023 and 2024 (Graph 2.b). The higher policy rate Table 3. Forecast of Monetary Policy Interest Rates in Various Countries (%) Group EM Europe EM Latin America Central Bank I II III IV* I* II* III* IV* I* II* III* IV* CBRT 17.00 14.00 14.00 14.00 12.00 9.00 9.00 11.50 16.13 17.25 17.25 17.25 17.25 19.00 Russian Fed 4.25 8.50 20.00 9.50 7.50 7.50 7.28 7.00 7.00 7.00 6.00 5.75 5.75 5.75 BCB 2.00 9.25 11.75 13.25 13.75 13.75 13.75 13.25 12.25 11.00 10.50 9.50 8.50 8.00 Banxico 4.40 5.43 6.51 7.75 9.25 10.50 10.75 10.75 10.75 10.13 9.00 8.13 7.75 7.50 BCCH (Chile) 0.50 4.00 7.00 9.00 10.75 11.25 11.25 10.75 9.50 6.75 5.50 5.00 5.00 5.00 RBI 4.00 4.00 4.00 4.90 5.90 6.25 6.40 6.40 6.40 6.25 6.25 6.25 6.25 6.25 BSP 2.00 2.00 2.00 2.50 4.25 4.00 4.50 4.50 4.50 4.50 4.50 4.50 4.38 4.25 BNM 1.75 1.75 1.75 2.25 2.50 2.75 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 BOK 0.50 1.00 1.25 1.75 2.50 3.25 3.50 3.50 3.50 3.50 3.25 3.00 2.88 2.50 BOT 0.50 0.50 0.50 0.50 1.00 1.25 1.50 1.75 1.75 1.75 1.75 1.75 1.63 1.38 PBOC 2.95 2.95 2.37 2.00 1.67 2.35 2.30 2.28 2.28 2.28 2.20 2.20 2.20 2.20 RBNZ 0.25 0.75 1.00 2.00 3.00 4.25 4.63 4.63 4.63 4.63 4.50 4.25 4.00 3.75 FED 0.25 0.25 0.50 1.75 3.25 4.50 5.00 5.00 5.00 5.00 5.00 5.00 4.75 4.50 BOE 0.10 0.25 0.75 1.25 2.25 3.75 4.25 4.25 4.25 4.25 4.00 3.88 3.75 3.50 RBA 0.10 0.10 0.10 0.85 2.35 3.10 3.35 3.35 3.35 3.35 3.35 3.10 2.73 2.48 BOJ ECB 1.25 2.50 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 EM Asia Advanced Economies Source: Bloomberg Note: *Projection has caused not only economic fragmentation (growth and inflation) but also global monetary fragmentation. requires central banks, especially in Asian EMEs to intervene the foreign exchange market to stabilize exchange rates. Looking ahead, the US dollar is predicted to continue to strengthen in line with the hike in the FFR, and therefore it is necessary to continue to be vigilant and strengthen the policy response to mitigate the spillover impact on stability and to the domestic economy. Vigilance also needs to be increased over the increase in UST yields which are predicted to reach around 4.25% in the first quarter of 2023 for a 10-year tenor. The increase in UST yields is even higher for short-term tenor, which is around 4.6% after almost reaching 7% in August 2022 (Graph 3.b). The phenomenon of inverted UST yields reflects investors’ perceptions on global financial markets and influences the pattern of portfolio capital flows, especially in bonds, exchange rate movements, and the increasingly expensive financing of fiscal deficits in various countries. The aggressiveness of the increase in the FFR interest rate led to a very strong US dollar against various world currencies and an increase in high US Treasury (UST) yields. The US dollar index against world currencies (DXY) reached 114.1 on 27 September 2022, or strengthened around 19.3% (ytd) from the end of 2021 and 22.2% on year-on-year basis (Graph 3.a). This phenomenon of the very strong US dollar has put pressures on the depreciation of currencies in various countries, and The high perception of risk in global financial markets encourages investors to withdraw their portfolio investments from EMEs and accumulate them in liquid assets (the “cash is the king” phenomenon). Financial risk in the US, Europe, and China is on the rise in term of interest rates, exchange rates, financial asset valuations, and credit spreads. The rise is due to continuing global geopolitical tensions, increasing risk of economic recession, high inflation, aggressive interest rate Graph 3.a. Strong US Dollar Phenomenon Graph 3.b. US Treasury Yield Development is also predicted to continue in Latin America, such as in Brazil which will be remain high at 13.75% until the first quarter of 2023, and Mexico which is currently at 9.25% will become at 10.75% in the first quarter 2023. Policy rate at both central banks will remain high throughout 2023, before declining to 8.00% and 7.50% respectively at the end of 2024 (Table 3). Meanwhile, the increase in monetary policy rates in the EMs Asia Region was relatively lower. Monetary policy rates in India and South Korea, for example, will increase to 6.40% and 3.50% respectively in the first quarter of 2023 and be maintained throughout 2023. The phenomenon of higher and longer monetary policy rates in developed countries compared to EME countries shows that fragmentation due to geopolitical tensions Index Index USD appreciation against Major Currencies EMBI Spread Data as of 14 November 2022 Source: Bloomberg Dollar Index (rhs) 8 11 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 bps % 1M 2M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y Increase in yield (rhs) Yield as of 15 Nov-2022 Source: Bloomberg Yield as of 31 Des-2021 hikes, and the strong US dollar (Graph 4.a). In such conditions, the risk premium is more decisive in portfolio investment decisions than the difference in interest rates between countries. Moreover, the lack of clarity over the solution to global geopolitical tensions has further encouraged global investors to be extra risk averse in holding securities and shifting them to liquid assets. This has resulted in continued capital outflows of bond investment portfolios from EMEs since early 2022 as global geopolitical tensions intensify (Graph 4.b). This development has put further pressure on the exchange rates and the ability to issue bonds to finance fiscal deficits in various EME countries. The amount of capital outflow will of course differ from one country to another, depending on the condition of the domestic economy and the credibility of the policy response adopted. Indonesia expresses and mobilizes the need to strengthen international coordination and cooperation to overcome various problems and prevent the deterioration of the global economy, especially through the Indonesia’s Presidency of the G20 2022 on the finance track according to the theme “Recover Together, Recover Stronger”. As is known, there are 6 priority agenda of finance track for the Indonesia’s Presidency of the G20 2022, namely: (i) coordination in the normalization of global macroeconomic policies; (ii) coordination in the regulation and supervision of the financial system to overcome the Covid-19 pandemic’s scarring effect; (iii) strengthening cooperation in payment systems between countries and developing Central Bank Digital Currency (CBDC); (iv) policy development in the transition to green and sustainable finance; (v) expanding the development of economic and financial inclusion, in particular to MSMEs, women, and youth; and (vi) advanced policies in international taxation. After extra hard diplomatic efforts, both formally and through holding side events to promote economic progress and cultural diversity in Indonesia, at the fourth meeting of the Finance Minister and Central Bank Governors Meeting (FMCGM) in Washington, DC, USA on 12 to 13 October 2022, an agreement was reached on the various priority agendas of the financial channel. A total of 13 (thirteen) out of 15 (fifteen) paragraphs in the fourth Chair Summary of the FMCGM have been agreed. Meanwhile, the 2 (two) paragraphs regarding the deteriorating condition of the global economy as well as global health and food issues, the disagreement is mainly due to the underlying factors related to political tensions in relation to the war in Ukraine. A total of 11 (eleven) G20 countries, especially the G7 countries, alleged that this was caused by the Russian invasion of Ukraine, on the other hand Russia said it was the imposition of sanctions, while 3 (three) countries stated that it was because of the invasion and the imposition of sanctions. Graph 4.a. Global Financial Condition Index Graph 4.b. Bond Portfolio Flows to EMEs Index Index Tight 101.5 101.0 100.5 100.0 Loose 1 2 3 4 6 7 8 9 10 11 12 1 2 3 4 GS Financial Condition - US Data as of 14 November 2022 Source: Bloomberg 6 7 8 9 10 11 USD billion 102.0 -20 -40 99.5 -60 99.0 -80 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 GS Financial Condition - Euro Area (rhs) China India Indonesia Thailand Malaysia South Korea Source: IIF (calculated) As a shared ambition to “Recover Together, Recover Stronger”, the G20 countries reaffirmed their commitment to take “well-calibrated, wellplanned, and well-communicated” policies to support sustainable economic recovery. To that end, various steps have been taken to strengthen macroeconomic policy coordination and maintain financial system stability and long-term fiscal sustainability. Responsive and flexible fiscal policies continue to be pursued, including the provision of targeted budgets to help maintaining the purchasing power of the most vulnerable groups of people and to mitigate the impact of rising commodity prices, including energy and food prices, on inflationary pressures. The G20 central banks are strongly committed to achieving price stability, by tightening monetary policy in accordance with data developments and communicating clearly to ensure inflation expectations remain anchored, as well as considering the process of economic recovery and the impact of spillover between countries. Exchange rate stability needs to be maintained according to market mechanisms as part of controlling inflation. The independence of the central bank is very important and decisive to achieve these goals and strengthen the credibility of monetary policy. Macroprudential policy continues to be directed at monitoring and mitigating systemic risks in the financial system from current economic dynamics. To strengthen these macroeconomic (fiscal and monetary) policies, the G20 asked the IMF to continue to refine and strengthen the implementation of the Integrated Policy Framework (IPF) in surveillance and policy recommendations that need to be taken by each country and multilaterally. Coordination of macroeconomic and macroprudential policies also needs to be strengthened through the integration of the IPF by the IMF with the Macro-Financial Stability Policy Framework (MFSF) developed by BIS. It should be noted that Indonesia’s experience of very close coordination between the Government’s fiscal policy and Bank Indonesia’s monetary policy, as well as policy coordination in preventing and handling crises through the KSSK, is widely praised as an important pillar in maintaining Indonesia’s economic resilience and recovery from the effects of global economic and financial turmoil. In the field of financial sector reform, the G20 countries are committed to continue maintaining the stability of the global financial system, including by coordinating policy measures and implementing international standards. To that end, the G20 asked the Financial Stability Board (FSB) and the IMF to continue to monitor the condition of the global financial sector and recommend policy responses that need to be taken. The final report from the FSB on the exit strategy in dealing with the scarring effects of the Covid-19 pandemic and policy recommendations for financial system stability will be finalized before the G20 Leaders’ Summit in Bali, November 2022. In particular, G20 countries support joint global action coordinated by the FSB to strengthen the resilience of the financial system from cross-border spillovers, including by addressing the structural vulnerabilities of nonbank financial intermediation from a systemic risk perspective. The FSB will soon complete a follow-up report and recommendations for strengthening the regulation and supervision of nonbank financial institutions, including in the activities of open-ended funds and the regulation of margining practices. The G20 countries also support the FSB’s proposal to strengthen the regulatory framework and supervision of a comprehensive and international standard for cryptoasset activities by applying the principle of “same activity, same risk, same regulation”. This is because cryptoasset activities and ecosystems have developed rapidly and pose systemic risks to international and global financial systems. In addition, the G20 countries also support the FSB consultative report on recommendations for regulation and supervision of the “global stablecoin” mechanism by encouraging consistent implementation and public awareness of the risks it poses, while continuing to foster digital innovation. Very encouraging progress in Indonesia’s G20 Presidency in 2022 was achieved in accelerating cross-border payment system cooperation and CBDC development. In this regard, the G20 Roadmap for Enhancing Cross-Border Payments initiated by Saudi Arabia in 2020 has began to be implemented with 18 (eighteen) blocks of clear programs, their prioritization, and concrete achievement indicator targets, as stated in the 2022 Progress Report. The goal is to reduce the cost of transfers and remittances between countries to be as low as possible, including through digitalization, infrastructure development, and expansion of cross-border payment system coordination. Reports on progress in payment system interoperability, including through the use of Application Programming Interfaces (APIs), were submitted by the BIS Committee on Payments Systems and Market Infrastructures (CPMI) in collaboration with the BIS Innovation Hub (BISIH) in side events of the G20 Indonesia Digital Economy and Finance Festival (FEKDI) in Bali, July 2022. Indonesia leads the ASEAN-5 (Indonesia, Thailand, Malaysia, Singapore, and the Philippines) in payment system cooperation for the use of Quick Response (QRIS in Indonesia) and retail fast payments (BIFAST in Indonesia) with using Local Currency Transactions. Meanwhile, important progress in Indonesia’s Presidency of the G20 was achieved in the development of CBDCs with a focus on 3 (three) important aspects, namely: CBDC design (wholesale and/or retail CBDC), the use of CBDCs in financial inclusion (directly or through digitalization of payments system), and CBDC cooperation between countries (regional Asia and multilateral through the BIS and also the IMF). To realize these three focuses, Indonesia in collaboration with BISIH successfully held the G20 TechSprint 2022 as an annual competition for practical and feasible solutions for CBDC development on three issues, namely: (i) robust and effective publishing, distribution, and transmission; (ii) capacity for financial inclusion; and (iii) connectivity and interoperability. Competition enthusiasm was very high with almost 100 (one hundred) participants from all over the world where the jury selected 21 (twenty one) participants as finalists and then determined 3 (three) winners for each of the aspects of the above CBDC development. Moreover, Indonesia’s Presidency of the 2022 G20 strengthens coordination of BIS CPMI, BISIH, IMF, and the World Bank in the preparation of integrated assessment reports and recommendations for options in CBDC access and interoperability for cross-border payment systems, while maintaining the stability and integrity of the international monetary and financial system. In addition, the FSB has also issued a consultative report to achieve greater convergence in reporting and handling cyber incidents. Indonesia’s Presidency in the G20 2022 has also succeeded in encouraging the economic and financial inclusion development program by displaying the progress of Indonesia’s MSMEs development. The Covid-19 pandemic has had an impact on increasing inequality among the poorest and most vulnerable groups of society, especially for MSMEs, women and youth. To that end, the G20 agreed on the “G20 Financial Inclusion Framework in Harnessing Digitalization to Increase Productivity, Sustainable, and Inclusive Economy of Women, Youth, MSMEs” which aims to increase productivity and develop an inclusive and sustainable economy, based on the G20 2020 Financial Inclusion Action Plan. The framework is built on policy practices, regulations, and development programs in a number of EME countries in accordance with the Implementation Guide for the G20 High-Level Principles for Digital Financial Inclusion, as a reference in the use of financial products and services and digital payments in expanding access to MSME finance in addition to bank credit/financing. To strengthen the development of digital and sustainable finance, as well as to support financial inclusion and the welfare of small communities, the G20 agreed to update the G20/OECD High-Level Principles on Financial Consumer Protection and on MSME Financing. In this regard, the progress of policy practice, regulation, and development of MSME in Indonesia is included as a reference in the preparation of the framework, in addition to a number of countries such as India and Mexico. Likewise, various side events and exhibitions of Indonesian MSME products at every G20 FMCBG meeting were visited and praised by delegates from G20 countries. Indonesia’s Presidency of the G20 2022 also reached an agreement on international tax cooperation, infrastructure development, assistance to poor countries, as well as promoting further steps in a green and sustainable economic transition. In the field of international tax cooperation, the G20 agreed on the rapid implementation of the two pillars of the OECD/G20 international taxation package, with the finalization of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) in the first pillar and progress in Global Anti-Base Erosion (GloBE) Model Rules in the second pillar. In addition, the G20 is also committed to continue strengthening the implementation of tax transparency globally and regionally in Asia in accordance with the Asia Initiative Bali Declaration agreement in July 2022, as well as the reporting framework for the application of taxation on cryptoasset. In the field of infrastructure development, the G20 focuses on efforts to expand private participation, capacity building, and financing cooperation among the Multilateral Development Banks (World Bank, ADB, IsDB, AIB, and others), as well as the development of InfraTracker 2.0 that allows the public and private sectors to play a role in the post-Covid-19 transformation on infrastructure investment. To help low and middle-income countries recover from the impact of the Covid-19 pandemic and global turmoil, the G20 agreed to establish a Pandemic Prevention, Preparedness, and Response Financial Intermediary Fund (PPR FIF) facility with funding commitments from donors of more than USD1.4 billion, a restructuring program external debt of debtor countries in Africa through the Common Framework (CF), as well as commitments from IMF member countries to channel part of the Special Drawing Rights (SDRs) allocation of USD81.6 billion (from the target of USD100 billion) into the fund. Resilience and Sustainability Trust (RST) fund to assist the eligible low and middle-income countries in addressing structural problems that exacerbate macroeconomic risks from pandemics and climate change. In the transition to a green economy and sustainable finance, the G20 agreed on global efforts to achieve the goals of the United Nations Framework Convention on Climate Change (UNFCCC) and the Paris Agreement, including the implementation of the COP26 commitment, through a policy mix towards carbon neutrality and net zero carbon which includes fiscal policies, market mechanisms, and the necessary arrangements. In accordance with the conditions of each country, a number of these steps include the use of carbon pricing, carbon non-pricing mechanisms and incentives, and gradually reducing inefficient energy subsidies in the medium term that have an impact on excessive consumption, while continuing to provide assistance to the poor and vulnerable. National Economic Performance and Prospects: Optimistic and Vigilance Synergy and innovation in the macroeconomicfinancial system stability policy mix are needed to enhance further to strengthen resilience and national economic recovery from the impacts of the global turmoil. Close coordination between the Government’s fiscal policy and Bank Indonesia’s policies are increasingly needed to ensure that the inflation can return to the target expeditiously, the Rupiah exchange rate is stable, the fiscal deficit is manageable, and monetary stability is maintained. Fiscal policy must continue to be directed as a shock absorber against the impact of soaring global energy and food prices on domestic inflation by providing subsidies and social assistance programs, while simultaneously lowering the deficit to below 3% of GDP, as stipulated in the 2023 State Budget (APBN). Monetary policy still needs to be directed towards stability (pro-stability) with a measurable increase in interest rates to control core inflation and inflation expectations, as well as foreign exchange intervention to maintain Rupiah exchange rate stability, and to ensure adequate banking and economic liquidity. Meanwhile, macroprudential policy, payment system policy, financial market deepening, as well as economic and financial inclusion are directed towards promoting national economic recovery (pro-growth). Microprudential regulation and supervision by OJK needs to be directed at continuing the credit restructuring program and strengthening the supervision of the financial sector (banks, nonbank financial institutions, and capital markets) to resolve the impact of the Covid-19 pandemic on the corporate and banking sector, in particular the possibility of increasing Loan at Risk (LaR) and Non Performing Loan (NPL). In the midst of the global economic slowdown, Indonesia’s economic recovery remains intact, with an expected of slight moderation in 2023. The national economy is predicted to continue improving, supported by increasing private consumption and investment, strong exports, and maintained households purchasing power notwithstanding the rising inflation. Several indicators and results from the latest surveys conducted by Bank Indonesia, such as consumer confidence, retail sales, and the Manufacturing Purchasing Managers’ Index (PMI) point to an ongoing domestic economic recovery. Externally, export performance is predicted to remain strong, particularly for coal, CPO, as well as iron and steel, in line with strong demand from several major trading partners and the Government policy to stimulate exports of CPO and its derivatives. Spatially, positive export performance was supported by all regions, especially Kalimantan and Sumatra, which continued to score a high growth. Improvements in the national economy are also reflected in the performance of the main economic sectors, such as trade, mining, and agriculture. As a result, economic growth in 2022 is predicted have an upward bias towards the upper bound of Bank Indonesia’s 4.5-5.3% projection. Economic growth in 2023 is predicted to remain strong, though growth will decelerate slightly to the midpoint of the 4.5-5.3% range before increasing to 4.7-5.5% in 2024 (Table 4). Indonesia’s ongoing economic recovery is driven by solid domestic demand, both private consumption and investment, in line with the continued increase in mobility and economic-financial activity, positive export performance supported by higher value added from downstream natural resource-based industries, as well as the ongoing completion of the National Strategic Projects (PSN). Spatially, ongoing economic recovery in 2022 is supported by increased growth in all regions of Indonesia. The economy in all regions of Indonesia in the third quarter of 2022 continued to score strong growth, confirming the continued national economic recovery. This positive development was supported by improving domestic demand in line with greater mobility in all regions and various large-scale events, including activities related to the Indonesia’s Presidency of the G20 2022, as well as exports performance. Growth in the regions of Bali-Nusa Tenggara (Balinusra), Java, and Kalimantan accelerated in the third quarter of 2022 to 6.69% (yoy), 5.76% (yoy) and 5.67% (yoy) respectively. Economic gains in those three regions were mainly supported by domestic demand in line Table 4. Indonesia’s Economic Growth: 2022-2024 (%,yoy) 2021** 2022*** 5.72 4.5-5.3 4.5-5.3 4.7-5.5 5.49 5.41 4.4-5.2 4.6-5.4 4.7-5.5 -6.94 -4.86 -2.88 -5.1- -4.3 3.2-4.0 3.0-3.8 3.80 4.09 3.07 4.96 3.8-4.6 6.8-7.6 6.9-7.7 - Exports 24.04 16.70 20.02 21.64 14.9-15.7 6.0-6.8 6.0-6.8 - Imports 23.31 15.88 12.37 22.98 12.3-13.1 6.6-7.4 6.5-7.3 I II III 3.69 5.02 5.45 - Private Consumption 2.01 4.37 - Goverment Consumption 4.17 - Investment Economic Growth Source: BPS, Bank Indonesia Note: ** very temporary figure; *** very very temporary figure; Bank Indonesia’s projection Indonesia’s Balance of Payments (BOP) performance remains solid in line with strong export performance, thereby supporting external resilience. The current account is forecasted to maintain a surplus, potentially reaching 0.4-1.2% of GDP in 2022, supported by strong export performance in line with high commodity prices and persistent demand for Indonesian commodities (Table 5). Export performance in 2023 is expected to be moderated, in line with the global economic slowdown, while imports will increase with improvement in domestic demand. Accordingly, the current account surplus will decrease to within the range of 0.4 - -0.4% of GDP. Against the backdrop of intense pressures from foreign portfolio investment outflows in line with with increased mobility, including tourism-related activities. In addition, economic growth in Balinusra was also supported by copper exports from West Nusa Tenggara. Likewise, export performance in Kalimantan remains strong, especially CPO and coal. Meanwhile, the Sulawesi-Maluku-Papua (Sulampua) and Sumatra regions posted strong growth of 8.04% (yoy) and 4.71% (yoy) respectively, despite slightly moderating from the previous quarter, supported by solid domestic demand and natural resource-based exports. For 2022 overall, therefore, the regional economies of Sumatra, Java, Kalimantan, Balinusra and Sulampua are predicted to grow in the range of 4.2 - 5.0%, 5.0 -5.8%, 3.8 - 4.6%, 4.5 - 5.3%, and 6.9 - 7.7% respectively. Table 5. Indonesia’s Balance of Payments (USD Billion) Component I II III IV TOTAL I* II** III** Current Account -4.43 -1.09 -1.93 4.95 1.52 3.46 0.57 4.02 4.38 A. Goods 28.30 7.63 8.34 15.41 12.43 43.81 11.30 16.80 17.51 - Exports, fob 163.40 49.38 54.32 61.65 67.49 232.84 66.77 75.17 77.84 - Imports, fob -135.10 -41.75 -45.98 -46.24 -55.05 -189.03 -55.47 -58.38 -60.32 a. NonOil & Gas 29.95 9.98 11.58 18.12 18.13 57.80 17.21 24.44 25.16 b. Oil & Gas -5.39 -2.27 -3.14 -2.51 -5.04 -12.97 -5.69 -7.19 -6.59 B. Services -9.76 -3.39 -3.71 -3.60 -3.96 -14.64 -4.38 -4.94 -5.27 C. Primary Income -28.91 -6.75 -8.02 -8.27 -8.91 -31.96 -7.85 -9.35 -9.27 D. Secondary Income 5.93 1.43 1.46 1.42 1.95 6.26 1.49 1.52 1.41 Capital and Financial Account 7.92 5.77 1.66 6.90 -2.10 12.42 -1.99 -1.16 -6.07 1. Direct Investment 14.14 4.49 5.40 3.38 3.84 17.42 4.19 3.40 2.78 2. Portfolio Investment 3.37 4.90 3.99 1.20 -5.02 5.07 -3.19 -0.35 -3.11 3. Other Investment -9.64 -3.73 -7.76 2.14 -1.01 -10.41 -3.13 -4.13 -5.75 Overall Balance 2.60 4.06 -0.45 10.69 -0.84 13.46 -1.82 2.39 -1.30 Memorandum: - Reserve Assets Position 135.90 137.10 137.09 146.87 144.91 144.91 139.13 136.38 130.78 In Months of Imports & Official Debt Repayment 9.76 9.66 8.77 8.64 7.76 7.76 6.97 6.41 5.72 - Current Account (% GDP) -0.42 -0.39 -0.66 1.65 0.48 0.29 0.18 1.19 1.28 Source: Bank Indonesia Note: * temporary figure, ** very temporary figure high global financial market uncertainty, the capital and financial account balances will be supported by investment in the form of Foreign Direct Investment (FDI), leading to a relatively narrow BOP deficit in 2022. Looking forward, the 2023 BOP is predicted to remain sound, supported by a capital and financial account surplus stemming from higher FDI and returned portfolio investment inflows, amidst the well-maintained current account. Meanwhile, the position of foreign exchange reserves, which at the end of October 2022 stood at USD130.2 billion, will increase and be more than sufficient to support Indonesia’s external resilience. The Rupiah stability has been maintained amidst the strong US dollar and elevated global financial market uncertainty. As noted above, the aggressive pace of FFR hikes, the strong US dollar, and the perceived of high risk by global investors (“cash is the king”) have led to portfolio investment outflows and depreciatory pressures on exchange rates in EMEs, including Indonesia. To mitigate the impact of this global turmoil, Bank Indonesia strengthened Rupiah stabilization policy through large foreign exchange market intervention, both on spot and Domestic Non-Deliverable Forward (DNDF) transactions, in addition to buying/selling SBN in the secondary market to maintain the SBN yields attractiveness to foreign portfolio investors. Rupiah stabilization measures are critical to prevent a crisis in Indonesia from the impact of global turmoil, particularly on increasing import prices (imported inflation) thereby supporting inflation control efforts, as well as to maintain monetary-financial system stability and macroeconomic stability. The US dollar exchange rate index against major currencies (DXY) reached a high of 114.11 on 27 September 2022 and was recorded at 106.40 on 15 November 2022 or increased by 11.22% (ytd) during 2022. As of 15 November 2022, Rupiah exchange rate depreciated 8.27% (ytd) compared to the level at the end of 2021, which is comparatively lower than the currency depreciation experienced in other developing countries, such as India 8.38% and the Philippines 10.90% (Graph 5.a). Moving forward, Bank Indonesia will continue to strengthen the Rupiah exchange rate stabilization policy in accordance with market mechanisms and the fundamental value. With forecasted global financial market uncertainty easing, at least after the period of peak FFR hikes in the first quarter of 2023, the Rupiah exchange rate is predicted to stabilize and appreciate in line with its fundamental value. This is consistent with forecasts of a surplus of BOP performance, controlled inflation returning to the 3±1% target, well-maintained fiscal deficit below 3% of GDP, and continued economic recovery, in addition to yields on Indonesian government securities remain attractive compared to other EMEs (Graphic 5.b). Graph 5.a. Currency Movement Against USD Graph 5.b. Risk Adjusted Return (RAR) % %, ytd TRY JPY PHP KRW CNY EUR INR MYR IDR ZAR THB SGD BRL -28.50 15 13.3 -17.51 -10.90 -9.77 -9.64 12.0 10.7 7.0 -9.28 9.7 6.9 5.7 4.7 3.2 -8.38 -8.33 -5 -8.27 -7.48 -10 -6.06 -1.32 -12.8 -15 4.71 BRL MXN IDR PHP ZAR KRW MYR INR THB TRY -35 -30 -25 -20 -15 -10 -5 point-to-point Data as of 15 November 2022 Source: Reuters, Bloomberg Source: Bloomberg (calculated) Inflation is lower than the initial projection and is expected to return to the target in 2023. Consumer Price Index (CPI) inflation in October 2022 was recorded at 5.71% (yoy), down from 5.95% (yoy) in the previous month, driven by a lower than expected second-round effect of fuel price adjustments to volatile food (VF) inflation and administered prices (AP). Volatile food inflation was controlled as a result of synergy and close policy coordination through the Central and Regional Inflation Control Teams (TPIP-TPID) and the National Movement for Food Inflation Control (GNPIP) to support supply availability, smooth distribution, price stability, and effective communication. The build-up of inflationary pressures on administered prices was also not as high as expected, in line with lower adjustment in fuel prices and transportation fares. Meanwhile, core inflation was maintained at a low level in line with lower than expected second-round effect of fuel price adjustments and a lack of strong inflationary pressures from the demand side. Consequently, Bank Indonesia expects lower inflation in 2022 than the initial forecast, though still above the 3.0±1% target. Inflation in 2023 is predicted to decline and return to the aforementioned target corridor in 2023. Core inflation is predicted to return to target more quickly as imported inflation remains under control in line with the stable Rupiah exchange rate, as well as a front loaded, pre-emptive, and forward looking monetary policy response to control inflation expectations and core inflation going forward (Graph 6.a). The increase in volatile food inflation will also be negated by declining global commodity prices, more conducive weather in 2023, and close coordination to stabilize food prices between the Central/Regional Government and Bank Indonesia through TPIP-TPID and GNPIP (Graph 6.b). Likewise, administered prices inflation will also be low with minimal potential adjustments to energy prices due to the decline in the price of fuel. Policy synergy between the Central and Regional Governments and Bank Indonesia will continue to be strengthened to ensure that inflation returns to the target soon. Graph 6.a. Core Inflation and Inflation Expectation Graph 6.b. Global Commodity Prices Forecast %, yoy %, yoy 5.9 3.2 3.3 9 10 11 12 Inflation Expectation (CF November 2022) Source: BPS, Consensus Economics Liquidity conditions in the banking sector and the economy remain loose, thereby supporting intermediation and the APBN financing. As part of the policy response for economic recovery from the Covid-19 pandemic, Bank Indonesia in 2020 and 2021 injected large amounts of quantitative easing to the banking industry to maintain financial system stability and simultaneously to revive bank lending/financing to the business sectors. By the end of 2021, the quantitative easing policy reached Rp874.4 trillion or around 5.2% of GDP, one of the largest liquidity injections among developing countries. With the economy starting to recover, Bank Indonesia in 2022 is normalizing monetary 9 10 11 12 Core Inflation -20 -40 -60 -80 6 8 12 2 6 8 12 2 4 Import Price Index - Food Soy Source: Bloomberg, Bank Indonesia 6 8 12 2 4 Wheat 8 12 2 4 Sugar CPO Corn 8 12 Graph 7.a. Ratio of Liquid Assets to Deposits Graph 7.b. M1 & M2: Growth and Components %, yoy % 35.1 29.5 20.7 11 1 9 11 1 11 1 Ratio of Liquid Assets to Deposits 8 10 12 8 10 12 M1 8 10 12 Currency Outside Bank (COB) Ratio of Liquid Assets to Deposits - Risk Appetite Demand Deposits M2 Quasi Money Savings Deposits Source: Bank Indonesia Source: Bank Indonesia policy by gradually absorbing excess liquidity through higher Rupiah Reserve Requirements (RR) ratio, among others, while still supporting the ability of the banking industry to disburse loans and purchase SBN in the primary market to finance the APBN. In October 2022, the ratio of liquid assets to deposits remained high at 29.46%, though down from the 35.12% position recorded at the end of 2021, as shown in Graph 7.a. Moving forward, Bank Indonesia will continue to ensure that liquidity conditions in the banking sector remain loose, thereby supporting the ability of banks to disburse loans and purchase SBN in the primary market for the APBN financing. Economic liquidity also remains ample, as reflected in the narrow money (M1) and broad money (M2) aggregates, which grew 13.5% (yoy) and 9.1% (yoy) respectively, as shown in Graph 7.b. Money supply growth stems from an increase in savings and quasi-money in line with income from high private consumption. In terms of use, the growth in money supply was dominated by bank credit, thus indicating more financing available for the national economic recovery. pre-emptive and forward looking measure to anchor overshooting inflation expectations and ensure that core inflation returns to the 3.0±1% target earlier in the first half of 2023, while strengthening Rupiah stabilization policy in line with its fundamental value as a corollary of the strong US dollar and elevated uncertainty in global financial markets, amidst increasing demand in the domestic economy. In the money markets, the IndONIA rate on 15 November 2022 rose 149bps compared with rate at the end of July 2022 to 4.29%, in line with the BI7DRR increase and Bank Indonesia’s monetary operations strategy. Yields on short-term SBN rose 289bps, while yields on long-term SBN were relatively subdued. Meanwhile, the increase in bank interest rates, both funding costs and lending rate, only rose to 3.40% and 9.09% respectively at the end of October 2022 (Graph 8.a). This rigidity was in line with ample liquidity, which is prolonging the lag effect of policy rate transmission on funding and lending rates. Meanwhile, the yield on 2-year SBN rose to 6.66% and the benchmark 10-year SBN rose to 7.05% in line with market mechanisms and rising US Treasury yields (Graph 8.b). Bank Indonesia sold short-term SBN and purchased long-term SBN in the secondary market (twist operation) as part of the Rupiah stabilization strategy, while simultaneously dampening the impact of rising US Treasury yields. Ample liquidity has supported relatively limited increased in bank lending rates amid rising money market rates in line with the increase of the policy rates. In August-November 2022, Bank Indonesia raised BI7DRR by 175bps to 5.25% as a front loaded, Graph 8.a. Banking Interest Rates Graph 8.b. SBN Yield Structure per Tenor % % - bps 8.0 8 10 12 8 10 12 8 10 12 8 10 7.5 7.0 6.5 6.0 5.5 5.0 4.5 -20 4.0 1m 2m 1b 3b 6b 9b 12b 2t 3t 4t 5t 6t 7t 8t 9t 10t 15t 20t 30t Yield SBN 10Y BI7DRR Weighted Average Lending Rate DF rate LPS rate Weighted Average Deposit Rate Weighted Average OMO Contraction -40 SUN(FR) 30 Sep-2022 15 Nov-2022 Spread (rhs) Source: Bank Indonesia, OJK, Bloomberg Source: Bank Indonesia, OJK, Bloomberg The bank intermediation function continues to improve and support the economic recovery. Credit growth in October 2022 stood at 11.95% (yoy), boosted by broad-based increases across all loan types and all economic sectors (Graph 9.a). Working capital loans grew by 11.90%, while investment loans and consumption loans grew by 15.47% and 8.79% respectively. Intermediation in the sharia banking industry also continues to recover, with financing growth of 18.4% (yoy) in October 2022. On the supply side, a stronger intermediation function was supported by lending standards that remain loose in the banking industry given the improving appetite to disburse loans, primarily to the manufacturing industry, construction, trade, and agriculture sector (Graph 9.b). On the demand side, an ongoing corporate and household sector recovery is driving intermediation. Corporate sector performance is reflected by improving repayment capacity, sales, and capital expenditures (Capex), particularly in the trade and mining sectors. Similarly, household performance is improving as indicated by improving consumption and investment in line with consumer optimism. In terms of MSME, loan growth Graph 9.a. Credit Growth Graph 9.b. Lending Standard Index %, yoy Index Stringent Investment Working Capital Source: Bank Indonesia, OJK Loose -5 -10 -10 -1.9 I II III IV I II III IV I II III IV I II III IV* Consumption Total Source: Bank Indonesia Note: * Projection was recorded at 17.50% (yoy) in October 2022, primarily underpinned by the micro segment. Bank Indonesia appreciates the banks’ contribution to accelerate national economic recovery by increasing lending and financing to the business sectors, while maintaining accommodative lending rates. Considering such developments and the synergic efforts made by the authorities, financial sector and corporate sector, Bank Indonesia projects credit growth in 2022 in the 9-11% range and will continue to increase to 10-12% in 2023. The resilience of the financial system, particularly the banking industry, has been maintained, in terms of capital, credit risk, and liquidity. The Capital Adequacy Ratio (CAR) in the banking industry was still high in September 2022 at 25.09% in line with rising capital components of accumulated profit and risk-weighted assets (RWA) with mitigated credit risk as reflected by low NPL ratios in September 2022 of 2.78% (gross) and 0.77% (net) - (Graph 10.a). This confirms that the provisions for impairment losses prepared by the banking industry are sufficient to mitigate credit risk. Liquidity risk in the banking industry is also low with ample liquidity, as indicated by the ratio of liquid assets to deposits as described above. However, the potential impact of a number of risk factors, both in terms of domestic Graph 10.a. Banking Capital and Credit Risk % % Index 3.4 3.2 2.8 2.6 2.4 2.2 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 NPL (gross) Source: Bank Indonesia, OJK 2021 2022 CAR (rhs) Digital economy and finance transactions are growing rapidly in line with Bank Indonesia’s policy to accelerate payment system digitalization in order to support national economic recovery. Digital economic and financial transactions continue to increase with rapidity in line with greater public acceptance and growing public preference towards online retail as well as the Graph 10.b. Perceptions of Financial System Stability 3.6 macroeconomic conditions and external shocks, still demands vigilance in order to maintain the resilience of the banking system. These risks include credit risk with continued Loan at Risk (LaR) in several economic sectors, such as construction and accommodation, due to the scarring effect of the Covid-19 pandemic, liquidity risk due to faster credit growth than deposits, as well as market risk due to the Rupiah depreciation and rising SBN yields. Meanwhile, Bank Indonesia’s simulations confirmed that bank resilience has been maintained. This is also in line with the results of the Systemic Risk Survey conducted by Bank Indonesia based on a sample of 120 respondents from financial institutions, corporations, economist, and academics in October 2022, showing that most respondents confident and strongly confident that financial system stability would be maintained up to or beyond the next 6 (six) months (Graph 10.b). 66.9 68.0 Up until 6 months ahead 29.8 27.2 22.5 3.3 Strongly Confident Confident Index 73.3 76.0 4.8 2.5 Unsure 0.0 0.0 1.7 Very Unsure 72.0 71.7 Over the next 6 months 21.5 22.4 25.8 2.5 Strongly Confident Semester II 2021 Confident 5.6 1.7 Unsure Semester I 2022 0.0 0.0 0.8 Very Unsure Semester II 2022 Source: Bank Indonesia expansion and convenience of the digital payment system and accelerating digital banking. The value of electronic money transactions is projected to increase by 32.2% (yoy) in 2022 to reach Rp404 trillion before increasing another 25.7% to a value of Rp508 trillion in 2023 (Table 6). In addition, the value of digital banking transactions is projected to increase by 30.2% (yoy) in 2022 to reach Rp53,144 trillion, before gaining another 27.2% in 2023 to reach Rp67,600 trillion. The acceleration of payment system digitalization also prompted strong e-commerce transactions growth, which are estimated to increase by 21.9% to reach Rp489 trillion in 2022 and then increase by 17.0% to Rp572 trillion in 2023. To support payment system acceleration and innovation, Bank Indonesia cooperation in terms of cross-border payment systems in ASEAN and other countries. In terms of cash, currency in circulation is predicted to increase 7.6% (yoy) in 2022 to Rp1,033 trillion and then by 7.5% in 2023 to reach Rp1,111 trillion. Furthermore, Bank Indonesia continues to ensure the availability of quality Rupiah currency fit for circulation throughout the territory of the Republic of Indonesia, including the new 2022 issuance of Rupiah banknotes. continues to implement the Indonesia Payment System Blueprint (BSPI) 2025, both the expansion of acceptance and payment service features of QRIS and BI-FAST, as well as the application of SNAP and the consolidation of the Indonesian payment system industry to form strong and competitive unicorns from Indonesia. Bank Indonesia is also expanding in the following years. In the medium-long term, the economic outlook will improve on a trajectory to achieve Advanced Indonesia, driven by the improving global economic outlook as well as increasing investment and productivity from the implementation of structural reform policies in the real sector and the acceleration of the national National economic resilience and recovery from the projected impact of global turmoil in 2023 will bring the prospect of a medium-term economic revival in pursuit of Advanced Indonesia. Bank Indonesia’s policy response in synergy with the national policy mix will accelerate growth and economic revival Table 6. Indonesia’s Payment System Forecast: 2022 - 2024 Transaction Growth (%) 2022* 2023* Value (IDR trillion) 2024* 2022* 2023* 2024* Digital Economy and Finance E-Commerce 21.9 17.0 20.4 Digital Banking 30.2 27.2 29.0 53,144 67,600 87,233 Electronic Money 32.2 25.7 26.1 Card-Based Payment ATM-Debit Cards 21.4 2.3 3.9 7,959 8,140 8,457 Credit Cards 31.4 13.4 13.8 Bank Indonesia Payment System SKNBI 3.1 BI-FAST BI-RTGS 15.1 2.2 3.1 5,054 5,166 5,324 2.0 0.7 1,986 5,919 9,884 12.8 13.6 98,141 110,979 126,037 1,111 1,197 Rupiah Currency Distribution Currency in Circulation (UYD) Source: Bank Indonesia 7.6 7.5 7.8 1,033 Note: * Bank Indonesia’s Projection digital economy and finance. Increasing economic competitiveness as well as industrial capacity and capability support higher and more resilient economic growth with a better economic structure. The success of downstreaming policy will increase not only the value added of exports, but also boost investment and productivity. In addition, a more conducive business and investment climate, including through the implementation of the Job Creation Law, will strengthen sources of higher economic growth. We predict that in the medium term, Indonesia’s economic growth will continue to increase in the range of 4.8-5.6% in 2025, 4.9-5.7% in 2026, and 5.0-5.8% in 2027. Inflation is predicted to remain low in the range of 1.5-3.5%, supported by increases in national production capacity through higher efficiency and productivity to meet rising aggregate demand in the economy. The current account deficit is also predicted to remain manageable at a low level, thereby underpinning the resilience of Indonesia’s external sector. Overall, with this trajectory of projected outlook, Indonesia is expected to become a high-income developed economy by 2047. We need to remain vigilance of several risks going forward to bolster economic resilience in Indonesia in the face of world economic turmoil. As explained above, the global economic turmoil is expected to continue in 2023 as reflected by an economic slowdown and potential risk of economic recession in several countries, persistently high inflation due to energy and food prices, high monetary policy interest rates and US Treasury yields, strong US dollar, and uncertainty in global financial markets. The impact through trade channels poses the risk of declining export performance in supporting economic growth as well as persistently strong domestic inflationary pressures due to high global energy and food prices. A larger and immediate impact will be felt in the financial channel. The strong US dollar, high monetary policy interest rates, as well as the risk premium and uncertainty in global financial markets portend the risk of foreign portfolio outflows (capital outflows), rising SBN yields, and depreciatory pressures on the Rupiah. Furthermore, the risk of financial system instability may also increase, both from market risk due to the weakening of the exchange rate and rising SBN yields, as well as credit risk due to declining domestic economic activity. In addition to the risks in the near term, several medium-term risks demand vigilance in terms of strengthening Indonesia’s economic revival towards Advanced Indonesia. From a global perspective, as explained above, political and economic fragmentation will lead to multipolar world trade. The dominance of the US and Europe in the global economy will decrease, while the role of Asia will continue to expand. In addition to China, which will play an increasingly important role, India’s role in the global trade and economic arena will also increase. A number of countries in Africa will also grow and become a global trade destination. The occurrence of the multipolar trend at the center of world economic growth and trade requires a change in our strategy and approach in establishing international trade and investment relations, namely from multilateralism to a regional and even bilateral approach to each strategic country. What is more important is the ability to position and increase the competitiveness of the Indonesian economy in the global economy. This is the importance of structural reforms and the development of connectivity infrastructure (physical and digital), which have developed rapidly under the leadership of President Joko Widodo. Therefore, infrastructure development (physical and digital) needs to be continued by focusing on support to increase competitiveness and integration with economic connectivity in Indonesia, as well as establishing linkages for trade and investment with strategic partner countries and regions. The existing downstreaming policy for natural resources needs to be improved moving forward, not only to increase value added in our growth sources and economic structure, but also as a policy to further strengthen trade relations and to attract foreign investment. Improvements in the investment and business climate must remain continuous, both through bureaucratic reform and by increasing the capability of human resources. Economic digitalization is increasingly important, as well as the transition to a green and sustainable economy and finance. Bank Indonesia Policy Mix in 2022: Maintaining Stability and Momentum for National Economic Recovery The acceleration of vaccination and the opening of priority economic sectors, which are the prerequisites for the continuation of national economic recovery, as we stated at the 2021 Bank Indonesia Annual Meeting on 24 November 2021, can be carried out well in 2022. Close policy synergy between the Government, Bank Indonesia, and Financial System Stability Committee (KSSK), was able to support the acceleration of vaccination in 2022, thereby enabling the easing of restrictions on mobility to support economic growth in 2022. With the acceleration of vaccination by the Government, which is also supported by financing from Bank Indonesia, Indonesia was able to achieve herd immunity in the second quarter of 2022. In fact, the Government also able to carry out booster vaccinations which had reached 40% of the target in October 2022. The very positive development of vaccination and the increasingly controlled spread of Covid-19 have become a strong basis for the Government to continue easing the mobility restrictions and opening up priority sectors of the economy thereby stimulating economic activity, as well as improvement in the expectation of Indonesia’s economic prospects. In line with these policies, the coordination and synergy of KSSK policies in providing fiscal, monetary, macroprudential, and microprudential incentives to these priority sectors also continues to be strengthened. In addition, the scope of priority sectors which received policy incentives was also expanded from 38 priority sectors to 46 priority sectors to further accelerate the recovery of the national economy. These various policy coordination and synergies were able to support Indonesia’s continued economic growth to reach 5.72% (yoy) in the third quarter of 2022. Fiscal and monetary coordination continues to be strengthened in promoting national economic recovery and maintaining stability, including Bank Indonesia’s participation in the state budget (APBN) funding through the purchase of SBN in the primary market in accordance with Law No. 2 of 2020. In terms of price stability, the Government increased the allocation of subsidies and energy compensation funds from Rp152.5 trillion to Rp502.4 trillion in 2022 to mitigate the impact of rising global oil prices on inflation and public purchasing power. This role of fiscal policy as a shock absorber, has effectively dampened higher inflation in Indonesia in 2022, with smaller increments than recorded in various other countries. Consequently, the policy response to increase the BI7DRR benchmark rate was also lower than in other countries, both in advanced economies, such as the US, Europe, and the UK, as well as developing economies, including Brazil, India and the Philippines. In addition, as we have explained above, Bank Indonesia in 2022 also supported APBN financing of Rp142.35 trillion, consisting of the purchase of SBN from the primary market based on the joint decree I (KB-I) mechanism of Rp46.93 trillion and joint decree III (KB-III) of Rp95.42 trillion, until 15 November 2022. The continued purchase of SBN from the primary market in 2022 demonstrates Bank Indonesia’s strong commitment in supporting APBN funding, both in terms of health and humanitarian financing due to the impact of the Covid-19 pandemic, and accelerating national economic recovery. Coordination of inflation control between Bank Indonesia and the Central and Regional Governments was strengthened to control the spillover impact of fuel price adjustments. Geopolitical tensions and rampant food and energy protectionism policies have pushed up global food and energy prices, which in turn led to increased domestic inflationary pressures. The world oil price soared to USD112 per barrel causing the Government to adjust the price of subsidized fuel in September 2022 to maintain fiscal sustainability and reallocate subsidies to be more well-targeted. In this context, Bank Indonesia strengthened coordination and synergy with the Central and Regional Governments through the Central and Regional Inflation Control Teams (TPIPTPID) to manage the second round impact of fuel price adjustment and the increase in global food prices through various measures (Figure 2). This includes the coordination of inflation control from the demand and supply sides, among others through the National Movement for Food Inflation Control (GNPIP), additional fiscal budget support to lower regional inflation through the Regional Incentive Fund (DID) and the use of Unexpected Expenditures component (BTT), transportation subsidies using the General Transfer Fund (DTU), as well as other stabilization policies that were able to reduce inflationary pressures. This can be seen from inflation in October 2022 which was recorded at 5.71%, lower than the initial estimate. at maintaining stability (pro-stability), while the other four instruments, namely macroprudential policies, digitalization of the payment system, deepening of the money market, as well as inclusive and green economy-finance are aimed to accelerate national economic recovery (pro-growth). The salient points of Bank Indonesia’s policy mix implemented in 2022 are as follows: i. The direction of the Bank Indonesia policy mix in 2022 continues to be synergized as part of the national policy direction to accelerate economic recovery while maintaining stability. In this regard, in line with the risk of increasing uncertainty in the global financial markets due to tightening monetary policy in advanced economies, especially the US, amid the early stages of economic recovery in the Indonesian economy, Bank Indonesia adopted a policy mix consisting of “one policy to maintain stability and four policies to support economic growth” as we have alluded to before. Monetary policy is directed In regard to monetary policy, liquidity, exchange rate and interest rate policies are aimed at ensuring macroeconomic stability. Thus, the monetary policy stance is not only measured through changes in interest rate policy, but also liquidity policy, as supported by exit policy implementation around the world. Practices in various countries show that there is no uniformity of priorities for monetary policy strategies. Some countries, especially those with large excess liquidity, prioritized normalization of liquidity over interest rate hikes, while countries with high inflationary pressures tended to prioritize increasing interest rates. This emphasize the need to consider both liquidity and interest policy in measuring central bank monetary policy stance. Figure 2. Policy Coordination for 2022 Inflation Control ADDITIONAL BUDGET SUPPORT FOR INFLATION CONTROL INFLATION CONTROL POLICY COORDINATION 4K K1: Affordability of Prices K3: Smooth Distribution K2: Supply Availability K4: Effective Communication DEMAND SIDE POLICY AND EXPECTATION MANAGEMENT - BANK INDONESIA DID TPID Award 2021 Rp100.4 billion 1. Expanding and optimizing the National Movement for Food Inflation Control/GNPIP (K1-K4). 2. Incentive Fund for the TPID Award (K1-K4). + DID for Current Year (Controlling Regional Inflation 2022) Rp402.0 billion = Total DID for controlling inflation Rp520.4 billion DID is used to support the acceleration of regional economic recovery, e.g. through efforts to reduce the inflation rate. 1. Front loaded, pre-emptive, and forward looking monetary policy tightening (K1): 2. Stabilization of the rupiah exchange rate (K1). 3. Strengthening the policy communication strategy (K4). SUPPLY SIDE POLICY – BANK INDONESIA COORDINATION WITH CENTRAL & REGIONAL GOVERNMENTS INCREASED REGIONAL INCENTIVE FUND (DID) BUDGET FOR INFLATION CONTROL UNEXPECTED EXPENDITURES (BTT) FOR INFLATION CONTROL Optimizing the utilization of the BTT budget for inflation control, among others, through: i. maintaining the affordability of prices and public purchasing power (social assistance for vulnerable people affected by 3. Optimizing Unexpected Expenditures (BTT) to control inflation (K1-K4). 5. Establishment of post-harvest storage facilities in production center by National Food Agency (Bapanas) (K2). ii. encouraging smooth distribution and transportation 6. Strengthening government rice reserves (CBP) and Supply Availability and Price Stabilization (KPSH) for rice by Circular Letter of the Ministry of Home Affairs No.500/4825/SJ dated 19 August 2022 the Bureau of Logistics (BULOG) (K2). 7. Expedite the implementation of meat imports (K2). 8. Increasing in cooking oil supply and distribution: MGCR, Minyakita, and DMO-DPO CPO (K2, K3). 9. Facilitating food distribution by Bapanas (K3). SUBSIDIES FOR TRANSPORTATION SECTOR 10. Transportation subsidies (K3). Headline inflation in October 2022 recorded a deflation of -0.11% (mtm) or 5.71% (yoy) √ The impact of the increase in fuel prices was lower than expected TRANSPORTATION SUBSIDY FROM THE GENERAL TRANSFER FUND (DTU) TO REDUCE THE SECOND ROUND IMPACTS OF INCREASING FUEL PRICE Regulation of Minister of Finance No.134/PMK.07/2022 concerning mandatory expenditures in order to reduce the impact √ Inflation expectations decline of inflation fiscal year 2022: 2% of the General Transfer Fund Decreasing VF Inflation 7.19% VARIOUS CHILI Monitoring and facilitation of production, harvest distribution. Expanding of market operations to maintain stock availability. Facilitating distribution from surplus to deficit regions. Urban farming campaign. Application of post-harvest technology with controlled atmosphere storage (CAS). Cooperation in the provision of land for chili planting in Jabodetabek. Campaigning to switch consumption to processed chilies ONION Monitoring of production. Facilitation of distribution from production centers to deficit regions. Utilizing warehouse receipts with CAS. RICE Increased productivity (use of superior seeds) and expansion of the planting area. Revocation of grain and rice price flexibility. Assignment to BULOG to increase absorption of rice production to reach CBP of 1.2 million tons by the end of the year. inflation) 4. Optimizing Specific Allocation Fund (DAK) for Food Security (K1-K4). Controlled Core Inflation 3.31% OTHER PRICE STABILIZATION MEASURES Decreasing VF Inflation 13.28% (DTU), among others, to subsidize the public transportation sector in the regions. CHICKEN MEAT AND EGGS Importation of animal feed grain. Supporting the distribution of eggs from surplus to deficit areas. Conducting highest retail prices (HET) evaluation of purebred chicken meat and eggs. Government feed corn reserves. Livebird absorption by state-owned enterprises (BUMN) and the private sector. SOYA BEAN Expedite the import realization. Extension of the subsidy for the difference in the price of soybean raw materials of Rp1,000/kg for tofu and tempeh producers until the end of the year. The target for distribution by BULOG is max. 200 thousand tons/month. COOKING OIL DMO and DPO policies. Bulk Cooking Oil (MGCR) according to HET, Minyakita. Involve BULOG and ID Food in distribution. Red cooking oil industry initiation. Source: Bank Indonesia In this context, in line with the low core inflation pressures, especially in the first semester of 2022, the monetary policy response was taken by normalizing liquidity in a well-calibrated, wellplanned, and well-communicated manner through a gradual increase in the reserves requirement (RR) ratio to 9% for conventional commercial banks and 7.5% for sharia commercial banks and sharia business units. This policy was adopted so that Bank Indonesia would not fall behind the curve in responding to the impact of global financial market uncertainty on macroeconomic stability. Exchange rate stabilization was also strengthened by conducting triple intervention policy in the spot market, DNDF, and buying/ selling SBN in the secondary market. Meanwhile, the BI7DRR rate has been raised by 175bps since August 2022 to 5.25% in response to a potential build-up of core inflationary pressures and overshooting inflation expectations moving forward. ii. Macroprudential policies have been relaxed in synergy with the integrated policy package of the Financial System Stability Committee to support the national economic recovery. Bank Indonesia has increased incentives for banks that disburse loans to priority sectors and MSME and/ or meet the Macroprudential Inclusive Financing Ratio (RPIM) target in the form of easing Rupiah reserve requirements and expanding the coverage of priority sectors. The relaxation of macroprudential policies further strengthened other accommodative macroprudential instruments, including the Countercyclical Capital Buffer (CCyB), Macroprudential Intermediation Ratio (MIR), conventional and sharia Macroprudential Liquidity Buffer (MPLB), and Loan to Value/Financing to Value (LTV/FTV) ratio for property loans/financing. iii. We continue to strengthen payment system policies to support economic recovery and accelerate inclusive digitalization. This includes: (i) expanding the use of QRIS; (ii) intensification of electronification on Government transactions through the digitalization of government social assistance (bansos) programs, electronification of local government services, particularly through the Acceleration and Expansion of Local Digitalization (P2DD) initiative, as well as integration of transportation modes; (iii) strengthening the implementation of the National Open API Payment Standard (SNAP) by accelerating SNAP adoption for banks and nonbank institutions, as well as providing alternative infrastructure options in accordance with the capacity of participants; (iv) accelerating BI-FAST implementation through increased participation, service expansion, and acceptance of BI-FAST; and (v) payment system pricing policies to support national economic recovery. iv. The three main policies above are also supported by close synergy between Bank Indonesia and the Government, banks, and other institutions to continue support for MSMEs as well as the sharia economy and finance as new sources of economic growth in Indonesia. Foreign exchange market deepening was pursued to support Rupiah stability and to expand hedging instruments. Promotion of trade and investment between countries, including through the expansion of Local Currency Transactions, also continues to be accelerated. International policy continues to be strengthened by expanding international cooperation with other central banks and monetary authorities, promoting trade and investment in priority sectors in synergy with other relevant institutions as well as ensuring the success of the six priority agendas in the Finance Track of Indonesia’s G20 Presidency in 2022. Rupiah Exchange Rate Stabilization Policy Bank Indonesia continues to strengthen Rupiah exchange rate stabilization measures to maintain the currency in line with its fundamental value against the backdrop of increasing external pressure. Rupiah exchange rate stabilization measures were carried out as part of the efforts to control Liquidity Normalization Policy inflation, especially imported inflation, through intervention in the foreign exchange market, via spot transactions, DNDF, as well as buying/ selling SBN in the secondary market by increasing SBN yields to attract foreign portfolio investors. Innovation in the Rupiah stabilization policy was also implemented in the form of “twist operation” by buying/selling SBN in the secondary market to increase the attractiveness of returns on shortterm SBN portfolio investments and to encourage a flatter long-term SBN yield structure - which we will explain further in the next chapter. This takes into account the transient nature of inflationary pressures, which will decline back to the target in the medium-long term. As we have said before, amid intense external pressures, Rupiah depreciation in 2022 is still lower than in several other emerging economies. This is inseparable from Bank Indonesia’s consistency in monitoring and intervening in the market to maintain Rupiah stability in line with the fundamental value and market mechanisms, as well as the positive perception of foreign investors concerning the promising outlook for the Indonesian economy. Foreign portfolio inflows have returned to the stock market, while capital outflows from the SBN market have subsided, especially since October 2022 (Graph 11). Bank Indonesia monetary policy normalization policy were conducted by gradually reducing the excess liquidity in the banking system. Liquidity policy normalization is administered by raising Rupiah reserve requirements in a well-calibrated, well-planned, and well-communicated manner. With this strategy, the increase in the Rupiah reserve requirements will not adversely affect the ability of banks to disburse loans and participate in purchasing SBN to finance state budget (APBN), thereby preserving monetary and financial system stability as well as the ongoing national economic recovery process. Liquidity policy normalization will also support the effectiveness of the BI7DRR policy rate transmission in longer-term tenors. Raising Rupiah reserve requirements has effectively absorbed excess liquidity without adversely impacting liquidity conditions in the banking industry. Bank Indonesia has raised Rupiah reserve requirements gradually for conventional commercial banks from 3.5% to 9% in September 2022, and for sharia banks and sharia business units from 3.0% to 7.5% in September 2022. Banks that meet these requirements will receive remuneration of 1.5% after considering the incentives for banks disbursing Graph 11. Bond and Stock Market Portfolio Capital Flows 2022 IDR billion -10 -20 -30 I Jan III I Feb III I Mar III V Apr May II IV III I Jun III V Jul II IV Aug Sep II IV I III I Oct III Nov I II Source: Bank Indonesia SBN Stock loans/financing to priority sectors and MSMEs and/ or achieving the RPIM target. The impact of the increase in the Rupiah reserve requirements on banking liquidity conditions was as expected. At the end of September 2022, this policy has absorbed liquidity to the tune of approximately Rp269.3 trillion. Accordingly, the ratio of liquid assets to deposits decreased from 35.12% in December 2021 to 29.46% in October 2022, which is still nevertheless higher than the average ratio prior to the Covid-19 pandemic, at around 21%. Therefore, bank’s support to finance the APBN and to the business sectors was maintained. BI7DRR policy rate, which was kept low until July 2022, was raised in August 2022 as a front loaded, pre-emptive, and forward looking measure to ensure inflation stability is maintained going forward. Until mid-2022, core inflation was maintained at a low level below 3% (yoy), in line with the limited impact of demand-side inflation, well-anchored inflation expectations, maintained exchange rate stability, and fiscal policy support in maintaining subsidized fuel prices. Given low core inflationary pressures and an improvement in the national economy, which is still in the early stages of national economic recovery, Bank Indonesia continues to maintain a low BI7DRR policy rate of 3.50%. However, in line with the increasing intensity of global uncertainty, and higher global energy and food prices, the core inflation and inflation expectations were showing signs of rising. Responding to rising core inflation and inflation expectations as a second round impact of rising volatile food inflation and fuel price adjustments, Bank Indonesia began to increase BI7DRR by 25bps in August 2022. This policy was strengthened by additional BI7DRR hike in September 2022, October 2022, and November 2022, each by 50bps to 5.25%, to reduce inflation expectations that are still too high (overshooting) and ensure that future core inflation can quickly return to the 3±1% target in the first half of 2023. The BI7DRR hikes also take into account the need to strengthen the exchange rate stabilization policy, to keep Rupiah in line with its fundamental value, due to the strengthening of the US dollar and high uncertainty in global financial markets, amidst increasing demand in the domestic economy. In addition, the monetary operations were also strengthened by increasing the interest rate structure on the money market in line with the BI7DRR rate hike to lower inflation expectations and ensure that core inflation returns to its target range earlier (Graph 12). With a consistent implementation of monetary policy tightening along with policy coordination with the Central and Graph 12. BI7DRR and Interbank Money Market Graph 13. Inflation Expectations Interest Rate Policy % %, yoy 7.5 6.5 6.00 5.25 5.5 5.9 4.5 4.50 3.5 2.5 1 3 5 7 11 1 3 5 7 11 1 3 5 7 11 1 3 5 7 11 1 3 5 7 11 1 3 5 7 11 LF Rate Source: Bank Indonesia BI7DRR IndONIA DF Rate 1.5 3.2 9 10 11 12 1 Sep-2022 Source: Consensus Economics 9 10 11 12 1 Oct-2022 Nov-2022 Regional Governments (TPIP and TPID) and National Movement for Food Inflation Control (GNPIP) as we explained above, inflation is lower than the initial estimate. Inflation expectations also began to decline from 6.7% in October 2022 to 5.9% in November 2022, thus will support accelerated decline in core inflation in 2023 (Graph 13). Accommodative Macroprudential Policy Bank Indonesia continues to strengthen the accommodative macroprudential policy stance in synergy with the Financial System Stability Committee (KSSK) policies to revive lending/ financing to the business sector and to support the national economic recovery. First, we have made improvements to Macroprudential Inclusive Financing Ratio (RPIM) policy, specifically in terms of fulfilling the banks’ commitment to the RPIM target set based on the expertise and business model of each bank. With this improvement, bank financing to MSMEs and low-income earners is expected to increase. Second, providing incentives for banks disbursing lending/financing to priority sectors and MSMEs and/or banks achieving the RPIM target, effective 1 September 2022 in the form of increasing the incentives up to a maximum of 1.5% from 0.5% previously, with the incentives for achieving RPIM Graph 14. Credit Growth in Priority and Non-Priority Sectors remain at a maximum of 0.5%. Meanwhile, the scope of priority subsectors has expanded from 38 to 46 priority subsectors. Third, we have maintained the accommodative macroprudential policies instituted previously, by holding the Countercyclical Capital Buffer (CCyB) ratio at 0%, the Macroprudential Intermediation Ratio (MIR) at the range of 84-94%, and the Macroprudential Liquidity Buffer (MPLB) ratio at 6% with repo flexibility of 6%, and the sharia MPLB ratio at 4.5% with repo flexibility of 4.5%. Bank Indonesia has also continued to relax the Loan to Value/Financing to Value (LTV/FTV) ratio for property loans/financing to a maximum of 100% and relaxed the down payment requirements for automotive loans to 0% for all types of new vehicles. Prime lending rate (SBDK) transparency policy is also continuously strengthened to support the effectiveness of the transmission of the policy rate and macroprudential policy. Accommodative macroprudential policy in synergy with KSSK, limited transmission of policy rate hike to banking interest rate, and ample liquidity are able to sustain the improvement of banking intermediation. As explained above, credit growth accelerated to reach 11.95% in October 2022, supported by improvements on both the demand and supply sides. On the supply side, credit growth was also supported by the policy of providing reserves requirement Graph 15. Automotive Loan Growth %, yoy %, yoy -2 -4 -6 11.2 11.0 10.91 17.8 12.8 3.5 -10 -20 12% -30 81% -40 Priority sector Source: Bank Indonesia, OJK Non-priority sector Total -50 Passenger car Motorcycle 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 Loans of Motor Vehicles - Total Loans of Motor Vehicles - Passenger car Loans of Motor Vehicles - Motorcycle Source: Bank Indonesia, OJK Graph 16. Lending Requirements Index Graph 17. Banking Prime Lending Rate Component TIGHTENING Index % % 1.0 0.5 - -0.5 2.65 -1.0 2.60 -1.5 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 8.62 11 1 11 1 11 1 Profit Margin incentives to banks that disbursing financing to priority sectors, which triggered higher credit growth in priority sectors (Graph 14). The improvement in credit growth was also supported by property and automotive loans, which continued to improve in line with maintained accommodative LTV ratios for property sector and down payments requirements for automotive loans (Graph 15). In addition, the improvement of credit growth in 2022 was also supported by a looser Lending Requirements Index (LRI) in line with lower prime lending rates and lending rates supported by Prime Lending Rate (SBDK) transparency policy (Graph 16 and Graph 17). Acceleration of Payment System Digitalization BSPI 2025 INTERLINK BETWEEN FINTECH AND BANKS BALANCE BETWEEN INNOVATION AND STABILITY SNAP OPEN API LICENSING SANDBOX 2.0 DATA POLICY REGULATORY REFORM WG 1 UMBRELLA REGULATOR WG 5 WG 4 DATA DIGITAL ID PAYMENT ID REGULATORY SANDBOX IPT RETAIL PAYMENT INFRASTRUCTURE BI-RTGS WHOLESALE PAYMENT & FMI BI-APS TR CCP Phase 1 Stage 1 Credit Transfer > Phase 1 Stage 2 Debit, Bulk, RFP Phase 2 Expansion 3 Stages WG 3 DATA HUB Source: Bank Indonesia INDUSTRIAL SANDBOX Bank Indonesia Regulation (PBI) concerning Payment System Infrastructure Providers BSPI 2025 SEC INNOVATION LAB Bank Indonesia Regulation (PBI) concerning National Standard on Payment System WG 2 RETAIL PAYMENT CYBER Integrated function strengthening Bank Indonesia Regulation (PBI) concerning Payment Payment Service Providers Providers SUPER- FRAMEWORK Setting/ Adjusting regulations NATIONAL INTEREST AND CROSS-BORDER Sandbox 2.0 Efforts to find a balance point between innovation, maintaining stability, and national interest Restructuring regulatory framework Bank Indonesia Regulation (PBI) concerning Payment System QRIS REGULATORY REFORM VISORY REGULATORY REFORM BI-FAST BI-SSSS Bank Indonesia in 2022 continues to accelerate and expand the digitalization of payment systems in order to expedite the integration of the economicfinancial digital ecosystem while promoting economic recovery. Referring to the Indonesia Payment System Blueprint (BSPI) 2025, the focus of the payment system policy in 2022 is on 3 (three) main priorities, namely regulatory reform, retail payment system infrastructure development, and payment system standardization (Figure 3). Regulatory reform Figure 3. Development of BSPI 2025 DIGITAL BANKING TRANSFORMATION Prime Lending Rate (rhs) Source: Bank Indonesia, OJK Source: Bank Indonesia INTEGRATION OF NATIONAL DIGITAL ECONOMY AND FINANCE Overhead Cost Cost of Funds for Credit 3.37 -1.46 -2.0 Regulation of Member of Board Governers (PADG) concerning Open API Payment National Standard NATIONAL STANDARD ON PAYMENT SYSTEM 1. Encouraging interconnection, interoperability, and compatibility 2. Encouraging interlinks between banks and fintech 3. Encouraging level of playing field, including preventing shadow banking National Standard on QR Code Payment Features : MPM, CPM, TTM, TTS, Cross-border continues as a manifestation of our commitment to simplify licensing procedures supported by strengthening regulations and supervision to encourage innovation while managing risks in the payment system industry. We simplified licensing with a risk-based and activity-based approach, as well as the fulfillment of service standards for efficiency and prudence. The simplification of licensing procedures has shown positive results post-regulatory reform, in which Bank Indonesia has issued almost fivefold the number of principal licenses for organizers compared to the previous period, and nearly twofold approvals for product development and cooperation during July 2021-October 2022. To support the licensing simplification, the supervisory function as part of the payment system regulatory reform in Indonesia is also continued to be strengthened. providing independent or sharing infrastructure, the setting of a maximum transaction limit of Rp250 million per transaction, and the pricing scheme of a maximum of Rp2,500 per transaction for customers with Bank Indonesia fee of Rp19 per transaction for participants, BI-FAST is increasingly in demand by the public. It is reflected by the rapid growth of transactions using BI-FAST in terms of volume and nominal value (Graph 18). In addition, the number of transfer transactions on the digital banking channels has increased by threefold as a result of BI-FAST (Graph 19). The positive performance of BI-FAST shows that BSPI 2025 is able to support industry consolidation and end-to-end integration of the national digital economy and finance, as well as the achievement of a fast, affordable, easy, safe, and reliable payment system (CEMUMUAH). The development of an interconnected, interoperable, and integrated payment system infrastructure is carried on to support the national economic-financial digital ecosystem. Bank Indonesia continues to modernize the retail payment infrastructure that is national-driven, real-time settlement, and operates 24/7 through BI-FAST to meet the rapidly growing needs of retail transactions. In the initial stage, BI-FAST services are focused on individual credit transfers before gradually extending to other service channels. With the support of various facilities such as open membership, the option of Bank Indonesia continues to expand the usage of QRIS as a national QR standard to accelerate payment system digitalization. The expansion of QRIS adoption continues, both in terms of the number of merchants and users. This year, Bank Indonesia is targeting 15 million new QRIS users across Indonesia. For this reason, a number of initiatives and incentives have been taken, including the extension of the 0% QRIS merchant discount rate (MDR) for micro businesses until 31 December 2022 and an increase in the QRIS transaction limit from Rp5 million to Rp10 million per transaction since 1 March 2022. Graph 18. BI-FAST Transactions Graph 19. Digital Banking Transactions IDR trillion million transac�on - Nominal Volume (rhs) % of total off-us transfer transaction via digital banking million transaction 0 -1 10 1 10 1 10 1 Transfer off-us Digital Banking 10 1 % Transfer SKNBI (rhs) % Transfer BI-FAST (rhs) Source: Bank Indonesia Source: Bank Indonesia Figure 4. Distribution of QRIS Users in Indonesia Kalimantan 1,170,341 users Sumatra 4,447,615 Sulawesi-Maluku-Papua 1,105,675 users users Java 18,947,255 Bali-Nusa Tenggara 935,044 users users Data as of October 2022 Source: Bank Indonesia In addition, the development of QRIS features also continues, including preparation for the implementation of the QRIS Transfer Withdrawal Deposit (TTS) feature, in collaboration with Indonesia Payment System Association (ASPI) and the industry. Alhamdulillah, thanks to the hard work and synergy of various parties, the target of 15 million new QRIS users has been achieved in October 2022. Today, QRIS, which has covered 22.5 million merchants and more than 26.6 million users, has become an entry point into the digital ecosystem for MSME to support economic and financial inclusion (Figure 4). The development of QRIS is also aimed to support cross-border payments in order to increase the efficiency of transaction costs between countries. In this context, Bank Indonesia and the Bank of Thailand (BOT) have been implementing crossborder QR code-based payment linkage since the end of August 2022. The transaction settlement mechanism uses the Local Currency Transactions (LCT) method through the Appointed Cross Currency Dealer (ACCD) banks. Cooperation in the use of cross-border QR code is also being expanded, including piloting with Bank Negara Malaysia (BNM) Figure 5. Cross-Border QRIS Transaction Scheme Merchant Acquirer Issuer Switching Acquirer Merchant Switching Issuer API Settlement Bank Issuer (Account Issuance Services) : The party administering the source of funds Acquirer (payment initiation/acquirer services): The party forwarding the payment transaction Switching (PIP): The party who conducting clearing and settlement of the payment transactions Bank Settlement: Bank appointed by the authority to facilitate the implementation of LCT through the opening of accounts in the partner country's currency in their respective countries Source: Bank Indonesia Settlement Bank since the end of January 2022 and preparation for implementation with the Monetary Authority of Singapore (MAS) which is planned to start in the fourth quarter of 2023 (Figure 5). These various cooperation initiatives are believed to be able to promote the digitalization of payments and crossborder payments, as planned in BSPI 2025, and are in line with one of the priority agendas of Indonesia’s G20 Presidency in 2022 as well as the ASEAN Central Bank Governors’ Meeting in April 2022. The implementation of the Open API Payment National Standard (SNAP) is strengthened by involving the role of market leaders to accelerate the development of the economic-financial digital ecosystem. SNAP, a result of cooperation between Bank Indonesia and the ASPI, was launched on 17 August 2021, and since then, its adoption as a national standard for protocols and instructions that facilitate an open interconnection between applications within payment transaction processing, has been accelerated. The acceleration strategy is implemented by appointing several market leaders as the first movers who are expected to expand the adoption of SNAP. The operationalization of the SNAP in these first movers has represented more than 50 percent of the market share for each segment of the digital economy and finance, such as e-commerce, electronic money, and digital banking. In this context, since June 2022 SNAP has included 15 operators (comprising of 5 bank Payment Service Providers (PJPs), 4 electronic money PJPs, 3 payment gateway PJPs, and 3 e-commerce providers) as the first movers who are market leaders (Figure 6). In the next phase, 86 additional PJPs have been targeted to become the second movers and to start operating in early 2023. The expansion of SNAP implementation is expected to strengthen the interlink between the bank and nonbank PJPs and maintain a level playing field between players, thereby reducing fragmentation and supporting the acceleration of the digital economy and finance in Indonesia. Payment system policy support for economic recovery through pricing policies continues. First, Bank Indonesia has extended the validity period of the minimum payment limit and the value of late payment penalties policy for credit cards from 30 June 2022 to 31 December 2022. The extension of this policy is aimed at supporting the economic recovery by providing relief to credit card holders in paying bills, maintaining a portfolio of credit card Non-Performing Loan ratios, and reducing the moral hazard risk of credit card holders so that they continue Figure 6. SNAP First Mover Participants as Market Leader “MARKET LEADER” STRATEGY FOR SNAP FIRST MOVERS Before X-Service User After A-Service Provider X-Service User SNAP First Movers participants have obtained on-target approval by June 30, 2022 A-Service Provider 5 BANKS 4 ELECTRONIC MONEY (EM) OPERATORS 3 PAYMENT GATEWAY 3 E-COMMERCE PROVIDERS Y-Service User B-Service Provider Y-Service User B-Service Provider Z-Service User C-Service Provider Z-Service User C-Service Provider SUB API SERVICES MARKET SHARE SNAP FIRST MOVERS API digital banking API server based EM API online commerce 86% 54% 80% of total volume of digital banking transactions of total volume of server based EM transactions of total value of e-commerce transactions Source: Bank Indonesia to fulfil their obligations. Second, Bank Indonesia has also extended the validity period of Bank Indonesia National Clearing System (SKNBI) tariff policy of Rp1 from Bank Indonesia to banks and a maximum charge of Rp2,900 from banks to customers from 30 June 2022 to 31 December 2022. The extension of the policy is intended to increase cost efficiency and economic activity for the public, as well as facilitating financial transactions to support economic recovery. The policy synergy between the central and regional governments, banking, and payment industry associations is also continued to be strengthened to encourage innovation and integration of the digital economy and finance. Under the implementation stages of BSPI 2025, Bank Indonesia in synergy with the Government and State-Owned Banks have issued the Government Domestic Credit Card (KKP) that utilizes the QRIS mechanism on the basis of credit as its source of fund so that all transactions are processed domestically. By using the Domestic KKP, which was launched by the President of the Republic of Indonesia on 29 August 2022, the Central and Regional Governments can perform transactions at more than 22 million QRIS merchants in Indonesia to support short-term economic recovery, increase financial inclusion, including MSMEs, support fiscal health, and encourage economic efficiency. This is also a form of affirmation of the Proud of Indonesian Product National Movement (Gernas BBI). The synergy of national digital payments acceleration is also pursued to increase the acceptance of digital payments through healthy, innovative, and safe to use QRIS (S.I.A.P QRIS) program in various traditional markets and shopping centers in Indonesia. The synergy of payment system electronification acceleration is also pursued by continuing to encourage system integration and intermodal payments, including supporting the preparations for implementing contactless technology on toll roads, which will begin operating gradually by the end of 2022. Furthermore, Bank Indonesia continues to strengthen the electronification of regional government transactions through the synergy of the strategic program of the Task Force for the Acceleration and Expansion of Regional Digitalization (TP2DD), including preparing the flagship championship program for TP2DD. The synergy between ministries/institutions and authorities is carried on by organizing the Indonesia Digital Economy and Finance Festival (FEKDI) as a forum for policy synergy and various programs to accelerate the digital financial economy and national economic recovery. FEKDI activities in 2022 also became a side event in the G20 Finance Track series: Finance and Central Bank Deputies (FCBD) and the 3rd Finance Ministers and Central Bank Governors Meeting (FMCBG) in Nusa Dua, Bali. Figure 7. Digitalization of Rupiah Currency Management PLANNING DIGITALIZATION OF RUPIAH CURRENCY MANAGEMENT POLICY ISSUING Digital Inventory 1. ERP 2. Host to Host with ERP Peruri 3. Warehouse Management System (WMS) 4. Barcode scanning DISTRIBUTION Digitalization of Cash Services 1. CBS 2. BI-SILK 3. BI-CAC 4. Queue system 5. E- Banking Digitalization of Cash Distribution 1. Digital Tracking 2. Digital Logistic 3. ERP Digital Warehousing 1. Warehouse Management System (WMS) 2. Paletizer and Conveyor 3. Materials Handling Equipment: Automated Storage Retrieval System (ASRS) dan Automated Guided Vehicle (AGV) Digitalization of Currency Production 1. Serial Bank Note Reader 2. Digital Coin Exchange 3. Cash Equipment information system Source: Bank Indonesia DESTRUCTION Digital Shredding 1. MSUK-R 2. Optical banknote inspection system 3. Core Banking System (CBS) In the field of Rupiah money management, Bank Indonesia continues the transformation of Rupiah money management in accordance with the implementation stages of the 2025 Rupiah Money Management Blueprint (BPPUR). The transformation is directed at providing currency fit for circulation with appropriate denominations, just-in-time money management driven by the central bank, in line with the direction of less-cash policies, whilst paying attention to efficiency and the national interest. The implementation of the transformation is conducted by promoting digitalization at all stages of Rupiah money management from planning, storage and processing to distribution (Figure 7). In the planning stage, Bank Indonesia implements digitalization in preparing the money demand projection using the Rupiah Money Demand Application and Integrated Analytics (AKURAT) platform to improve the efficiency of the money planning business process. In the storage and processing stage, digitalization is implemented through the principle of less human intervention with the use of robotic machinery and equipment, as well as the implementation of a warehouse management system using a racking system to support the digitalization of money storage. In the distribution stage, Bank Indonesia digitalizes cash services to the public through the provision of the Rupiah Money Order and Withdrawal Application (PINTAR) so that public can order Bank Indonesia cash services online, easier, safer, and more convenient. Policy synergy is also pursued by Bank Indonesia together with the Indonesian Navy by continuing the 2022 Sovereign Rupiah Expedition activities to support the circulation of money to reach the Frontmost, the Outermost, and the Remote areas (3T). Bank Indonesia has issued new, innovative banknotes in 2022 to improve the quality of Rupiah money. Coinciding with the celebration of the Republic of Indonesia’s 77th Independence Day, Bank Indonesia issued new banknotes that embody the spirit of nationhood, nationalism, and sovereignty to foster optimism for national economic recovery. The 2022 issuance of banknotes consists of Rp100,000, Rp50,000, Rp20,000, Rp10,000, Rp5,000, Rp2,000, and Rp1,000 banknotes (Figure 8). The design of the 2022 banknotes retains the main image of national heroes on the front, as well as the theme of Indonesian culture on the back, as with the 2016 banknotes. Moreover, Bank Indonesia has made 3 (three) innovations to strengthen the 2022 Reverse Main Image Size Dominant Color Betawi Mask Dance, Raja Ampat, and Orchid Flowers 151 mm x 65 mm Red Rp50,000 Ir. H. Djuanda Kartawidjaja Legong Dance, Komodo National Park, and Balinese Japanese Flowers 146 mm x 65 mm Blue Rp20,000 Dr. G.S.S.J. Ratulangi Gong Dance, Derawan Island, and Black Orchid Flowers 141 mm x 65 mm Green Rp10,000 Frans Kaisiepo Pakarena Dance, Wakatobi National Park, and Rough Forest Cempaka Flowers 136 mm x 65 mm Purple Rp5,000 Dr. K.H. Idham Chalid Gambyong Dance, Bromo Montain, and Tuberose Flowers 131 mm x 65 mm Brown Rp2,000 Figure 8. Speciment of Rupiah Banknotes for 2022 Emission Mohammad Hoesni Thamrin Minangkabau Plate Dance, Sianok Canyon Natural Scenery, and Jeumpa Flowers 126 mm x 65 mm Grey Tjut Meutia Tifa Dance, Banda Neira, and Larat Orchid Flower 121 mm x 65 mm Green Rp1,000 Rp100,000 Design Of Rupiah Banknotes for 2022 Emission Observe Main Image Dr.(H.C.) Ir. Soekarno and Dr. (H.C.) Drs. Muhammad Hatta Source: Bank Indonesia banknotes, namely a sharper colour design, more reliable security elements, and better durability of money materials. With these innovations, it becomes easier to recognize the authenticity of Rupiah, as well as making Rupiah more comfortable and safe to use, and more difficult to be counterfeited. Therefore the Rupiah becomes trusted, more qualified, and a source of pride as a symbol of sovereignty of the Republic of Indonesia. Graph 20. Transactions through BI-ETP USD million 126.5 37.9 Money Market Deepening 10 11 12 Digitalization and strengthening of financial market infrastructure are continued by strengthening Central Counterparty (CCP) Wholesale Payment System Digital Rupiah Back End Retail Payment System Cross-border Financial Market Infrastructure Conventional Asset Transactions Data *for CCP Source: Bank Indonesia Trade Repository* Average Daily Volume 2021 Front-middle end Clearing Recording the money market infrastructure which are interconnected, integrated, interoperable, secure and reliable. To promote a more efficient and transparent pricing structure, the development of financial market infrastructure in 2022 is focused on developing the Electronic Trading Platform (ETP) and Central Counterparty (CCP), including granting licenses to existing ETP providers in the money and foreign exchange markets and those with domestic institutions. With the official operation of bilateral and multilateral ETP providers in the money market and foreign exchange market, the participation of market participants to conduct transactions through ETP has Trading Platform CSD/SSS Source: Bank Indonesia Pre-Trade &Trade Central Securities Depository Securities Settlement System Average Daily Volume 2022 (up to Oct-2022) Scheme 1. Financial Market Infrastructure Linkage Settlement Average Daily Volume Financial market deepening is accelerated to strengthen the effectiveness of monetary policy transmission as well as financing for infrastructure and business sectors to support the national economic recovery. Various financial market deepening and development programs are carried out as part of the Money Market Development Blueprint (BPPU) 2025 based on three main pillars: (i) digitalization and strengthening of financial market infrastructure; (ii) strengthening effectiveness of monetary policy transmission; and (iii) developing financial instruments as a source of economic financing and strengthening risk management. Data Centre Digital Asset Transactions Data/Information Transfer increased almost twofold, from 21 banks in June 2021 to 41 banks in October 2022, accompanied by an increase in the daily average volume of USD/ IDR spot transactions through ETP from USD37.9 million in 2021 to USD126.5 million in 2022 (Graph 20). Coordination with relevant authorities and industry associations is also carried on to accelerate the establishment of CCP institutions in the money market and foreign exchange market that are integrated, interoperable, interconnected (3I), both in terms of technical and nontechnical readiness, as a systemically important financial market infrastructure. This development is also supported by the criteria for CCP members, which are in line with the roadmap for participation in payment system infrastructure and Bank Indonesia’s financial market infrastructure. In addition, Bank Indonesia is also continuing to develop the BI-Auction Platform System (BI-APS), BI-Scripless Securities Settlement System (BI-SSSS) and BI-Real Time Gross Settlement (BI-RTGS) to align with BSPI 2025 and the future development of digital technology (Scheme 1). To strengthen the effectiveness of monetary policy transmission, in 2022 Bank Indonesia focus on the repo transaction development program and strengthening the Rupiah reference rate. Repurchase agreement (repo) transactions have been developed in close coordination with the relevant authorities and industry association in the context of standardizing repo transactions between market participants and repo transactions in Bank Indonesia Open Market Operations (OMO), providing liquid and transparent information on repo prices between participants, and expanding the base of nonbank players. With such synergy, the daily average volume of repo transactions increased from Rp4.4 trillion in 2021 to Rp7.2 trillion in 2022 (as of November 2022) - (Graph 21). During the same period, the average repo transaction ratio to total money market transactions also rose from 39% to 45%. Meanwhile, the domestic benchmark reform to strengthen the Rupiah reference rate was conducted by establishing the Indonesia Overnight Index Average (IndONIA) as the Rupiah reference rate for the overnight tenor on 31 March 2022. Synergy with the National Working Group on Benchmark Reform (NWGBR) was also pursued to accelerate the transition of the domestic benchmark reform to IndONIA. This is expected to improve IndONIA-based financial market products and strengthen the integrity of the Rupiah benchmark rate to support financial market deepening, effective monetary policy transmission and financial system stability. In line with this, average daily transactions of overnight index swap (OIS) derivatives using the IndONIA rate increased from Rp20.4 billion in 2021 to Rp56.3 billion in 2022 (as of November 2022) - (Graph 22). Graph 21. Daily Average Repo Volume Graph 22. Daily Average OIS Volume USD million USD trillion 7.2 4.4 56.3 1 2 3 4 5 6 7 9 10 11 12 1 2 Daily Average Volume 3 4 5 6 7 9 10 11 -0 20.4 1 2 3 4 5 Daily Average Volume 2021 9 10 11 12 1 2 3 4 5 6 7 9 10 11 Daily Average Volume OIS Daily Average Volume 2021 Daily Average Volume 2022 (up to 15 Nov 2022) Daily Average Volume 2022 (up to 15 Nov 2022) Source: Bank Indonesia 6 7 Source: Bank Indonesia Bank Indonesia also continues to develop the foreign exchange market with a focus on developing Domestic Non-Deliverable Forward (DNDF) transactions as well as expanding and strengthening the Local Currency Settlement (LCS) framework. The initiative to develop DNDF transactions is carried out by increasing transaction flexibility to stimulate supply–demand and foster efficient price formation through implementation of non-USD/IDR reference rates. The DNDF development initiative aims to improve the terms of transactions in the foreign exchange market, including integration and simplification of provisions; arrangements with a principle-based approach to increase flexibility and effectiveness of implementation; and support for optimal supply and demand of foreign exchange. In line with these initiatives, as well as the continued national economic recovery and the increasing need for hedging on securities holdings, average daily DNDF transaction volume increased from USD99.1 million in 2021 to USD112.7 million in 2022 (as of November 11, 2022) - (Graph 23). Meanwhile, Bank Indonesia continues to expand the use of the LCS, including through the establishment of the National LCS Task Force in May 2022, as a form of synergy and national commitment to accelerate the use of the LCS. Furthermore, we also expanded the scope of LCS cooperation with Thailand by including DNDF in the cooperation. The LCS framework was also strengthened and developed into Local Currency Transactions (LCT), which include not only current account transactions but also capital and financial account transactions, including as a transaction settlement mechanism in the context of implementing cross-border QR Code cooperation (QRIS Cross-border) with Thailand and piloting with Malaysia. These various measures supported an increase in LCS transaction volume from an average monthly amount of USD211.2 million in 2021 to USD354.0 million in 2022 (as of October 2022) – (Graph 24). Graph 23. Daily Average DNDF Transactions Graph 24. LCS Monthly Volume USD million USD million 112.7 99.1 211.2 1 2 3 4 5 6 7 9 10 11 12 1 2 3 4 5 6 7 9 10 11 Daily Average Volume Daily Average Volume 2021 Daily Average Volume 2022 (up to 15 Nov 2022) Source: Bank Indonesia 354.0 Bank Indonesia continues to develop financial instruments as a source of economic financing and to strengthen risk management in synergy with the financial sector authorities and market players. Synergy in the Coordination Forum for Financing Development through Financial Markets (FK-PPPK) was strengthened, among others, through the development of asset securitization with underlying lending/financing for MSMEs, the development and piloting instruments of sustainable financing and derivative transactions (environmental, social and governance/ESG). The synergy was also strengthened by developing programs to expand retail investors through the financial literacy education program (LIKE IT), which this year focused 1 2 5 6 7 8 9 10 11 12 1 2 Malaysia Thailand Monthly Average Total Volume 2021 Source: Bank Indonesia 5 6 7 8 9 10 Japan Tiongkok Monthly Average Total Volume 2022 (up to Oct 2022) on literacy for green finance and sharia finance instruments. Synergy for the development of the money market and foreign exchange market was also carried out by harmonizing money market taxation arrangements to support the development of money market instruments as a source of financing for national economic development. Development of Sharia Economy and Finance, and MSMEs Bank Indonesia continues to accelerate the national sharia economy and finance as a new source of inclusive economic growth, in synergy with the Government and other stakeholders. Strengthening and expansion of the sharia economy and finance ecosystem continues through three strategic pillars, namely development of the halal value chain, sharia finance, as well as education and socialization. In the first pillar, the halal value chain is developed by strengthening the capacity of sharia businesses and business models, institutional arrangements, as well as supporting infrastructure, which includes accelerating the halal certification process. In 2022, the policy focused primarily on the major sectors of the sharia economy, in particular halal food and modest fashion. In the halal food sector, strengthening is pursued through the development of a community-based food commodity business model to increase production, particularly for commodities that contribute to inflation as well as substitutes for imported raw materials. Technical assistance support to accelerate the halal product certification process remains ongoing. In the modest fashion sector, development efforts continue to be made, among othe by holding the Indonesia International Modest Fashion Festival (In2MotionFest) at the 9th Indonesia Sharia Economic Festival (ISEF) in 2022 in collaboration with the Ministry of Cooperatives and SMEs. This international event represents the manifestation of end-to-end efforts to develop the Indonesian modest fashion sector, from increasing the capacity of business actors and improving product quality to expanding market access. In the sharia finance pillar, the development of sharia money market instruments, strengthening regulations, and expanding transactions were continued to increase sharia financing. Instrument development was pursued by, among others, issuing the Inclusive BI Sukuk (SukBI) to support the development of sharia monetary and money market instruments. This Inclusive SukBI is a BI Sukuk issued by Bank Indonesia using SBSN inclusive as the underlying, namely SBSN issued by the Government to finance certain inclusive activities, such as empowerment of MSMEs and low-income earners as well as green economy. The Inclusive SukBI is also expected to be utilized by sharia banking to meet macroprudential policy provisions, including the Inclusive Macroprudential Financing Ratio (RPIM) and Macroprudential Liquidity Buffer (MPLB). Bank Indonesia has also developed a swap instrument for hedging by sharia banks to Bank Indonesia to strengthen the exchange rate management of sharia banking and to support monetary management that is integrated with money market development. This hedging swap instrument is carried out with a complex hedging transaction scheme (akad al-tahawwuth al-murakkab) in accordance with the fatwa of the National Sharia Council No. 96/DSN-MUI/IV/2015. The availability of hedging swaps is expected to strengthen risk management for sharia banks and bolster confidence to conduct foreign exchange transactions to support economic financing. Standardization of cooperation agreements for Interbank Sharia Principles-Based Fund Management Certificate (SiPA) transactions, as well as support to increase outright transactions of sharia securities in the secondary markets and underlying for SiPA and sharia repo transactions have also been implemented to support the expansion of sharia financing transactions. Sharia finance infrastructure and regulations continue to be strengthened through the promulgation of regulations in the foreign exchange market based on sharia principles. In addition, strengthening the social finance sector continues, including the development of an integrated model of commercial and social finance in the form of a productive waqf model – in collaboration with the Awqaf Properties Investment Fund – Islamic Development Bank (APIF-IsDB) – and non-cash ZIS distribution. Alhamdulillah, with close synergy between Bank Indonesia and the National Sharia Economy and Finance Committee (KNEKS), relevant ministries/ institutions and other strategic partners, including international organizations, such as IsDB, UNDP, IILM, IFSB and the World Zakat Waqf Forum, the 9th ISEF series of activities in 2022 produced very encouraging results. This year’s series of FESyar and ISEF activities were attended by more than 560 thousand visitors and 950 participants, many more than the previous year (Figure 9). Total transaction value during FESyar and ISEF also increased to Rp27.6 trillion, including financing disbursed by sharia financial institutions, business-to-business transactions, business-to-customer transactions, as well as zakat, infaq, sadaqah and waqf (ZISWAF). In the education and socialization pillars, synergy to organize the series of FESyar and ISEF activities in 2022 was strengthened to provide a significant contribution to advance the sharia economy and finance in Indonesia. In 2022, Sharia Economic Festivals (FESyar) were held in three regions as the Road to ISEF, namely in Makassar for Eastern Indonesia, Aceh for the Sumatra region, and Surabaya for the Java region. The 9th ISEF in 2022 was also strengthened by the announcement of three activities to advance the national sharia economy moving forward. First, declaration of the Global Halal Hub (GHH) as an integrated ecosystem to accelerate the development of flagship local Bank Indonesia sincerely appreciates all parties that halal products with a global orientation to support supported the successful implementation of FESyar efforts to establish Indonesia as the largest halal and ISEF in 2022 for the advancement of the sharia product producer globally. Second, launching of economy and finance in Indonesia. the Halal Certification Acceleration Movement through close synergy among policymakers. Third, Bank Indonesia continues to work in synergy to the In2MotionFest as the world pre-eminent modest promote an inclusive and green economy and Gambar 3. Outcome Penyelenggaraan Rangkaian Kegiatan ISEF ke-9 Tahun 2022 fashion show. finance that supports economic recovery by Figure 9. Outcome of the 9th ISEF and FESyar 2022 Agendas AGENDAS Webinar (National & International) • Workshop • Talkshow • Business Coaching • Business Matching • FGD • Tablig Akbar • Fashion Show Participants FESyar - ISEF 566.181 PARTICIPANTS • FESyar (513,181) • ISEF offline (19,096) • Online (34,326) IN2MOTION FEST Business Transactions Exhibitors Competitions 27,6T FESyar - ISEF EXHIBITORS 4.553 Participants Sharia Financing, B to B, B to C, Exhibition 283 Competition exhibitors and 667 Virtual exhibitors 4 Competitions Hijrahpreneur 3.0 • National Sharia Economy Competition (KESN) • Youth Sharia Sociopreneur Competetition (YSSC) • Modest Young Designer Competition (MYDC) DESIGNERS Modest Fashion, domestic and international • 1200 looks in 17 parades • 29 Associations • 14 Wastra Nusantara (Indonesian Traditional Fabrics) Certifications 106.355 Halal Companion PPH (1690), Halal Certification Self-Declare Per 1 Sept – 9 Oct visitors from 92 countries CERTIFICATES Main Outcomes of 9th ISEF 1. The Launch of the Indonesia International Modest Fashion Festival (IN2MOTION FEST) as global reference for modest fashion 2. Strengthening Global Halal Hub Ecosystem 3. Halal Certification Acceleration Domestic Forum Outcomes 1. Council of Experts Annual Meeting (Ijtima’) and SILAKNAS MES: Recommendations for reviewing the Indonesian Sharia Economy and Finance Masterplan (MEKSI) to adapt to the latest developments 2. Islamic Boarding School Business Economic Association (Hebitren): 1) Outline of Program Direction as a reference for the Hebitren 2023 business development program implementation accelerating the development of Hebitren businesses and expanding cooperation with strategic partners and cooperation between regional Hebitren Source: Bank Indonesia International Forum Outcomes 1. 4th International Halal Dialogue: Exploration of cooperation between halal certification authorities from several countries (China, South Korea, Malaysia, the United States, and Saudi Arabia) 2. International Moslem Friendly Tourism Conference: “Resolution for Indonesian Muslim Friendly Tourism Development” 3. International Conference on Zakat and Waqf: Launch of the Technical Note on Zakat Core Principles, Technical Note on Waqf Core Principles and Good Nazir governance, and the Social Impact Sukuk Waqf product 4. 8th International Islamic Monetary Economic and Finance Conference: 200 papers from 21 countries and 48 selected scientific papers presented during the conference 5. 4th INHALIFE Conference: There are 42 MSMEs that have the opportunity and are in the process of entering into modern retail outlets 6. High Level Discussion Islamic Financial Services Board (IFSB) – Islamic Development Banks (IsDB). In general, it emphasizes the importance of moral values according to maqasid sharia or value-based intermediation, which also emphasizes sustainability and green finance Certifications 1.898 VISITORS FESyar Outcomes 1. FESyar KTI (Eastern Region of Indonesia), implemented digitalization programs in 106 Islamic boarding schools and encouraged the use of QRIS in 5,000 mosques in Eastern Indonesia 2. FESyar Sumatra, carried out the launching of the digital platform Aceh Sharia Funding Aggregator (ASIFA) as an initiative of the digital platform for sharia social finance to bridge fund owners who wish to distribute ISWAF or other productive investments 3. The declaration of the MSME export expansion program through "Indonesia Spice Up the World" through the implementation of programs that encourage MSMEs to enter the world halal product market; Sharia Bank financing for Islamic Boarding Schools and Cooperation in the Marketing of Halal Products get on board with e-commerce using QRIS and BI-FAST strengthening MSME competitiveness as a new source of national economic growth. MSMEs are levelling up to “go export and go digital”, which Bank Indonesia strengthened through three main strategies, namely corporatization, capacity building and financing. The corporatization of MSME aims to increase economies of scale through the formation of groups supported by strong social capital as well as formal and modern institutions that support improvements in efficiency, market access, as well as MSME access to finance. This is achieved by, among others, nurturing: i) collaboration between MSMEs, collaboration with large enterprises and collaboration with financial institutions; ii) corporatization of subsistence groups vulnerable to negative economic shocks and with limited access to formal financial services and economic opportunities; and iii) corporatization of underserved and unbanked conventional and sharia MSMEs, including ultramicro entrepreneurs, beneficiaries of philanthropic funds, and recipients or family members of social assistance programs, such as the Family Hope Program (PKH). Capacity building focuses on increasing productivity by expanding market access as well as fostering innovation and digitalization of the business processes to improve MSME competitiveness. In an effort to develop “go export MSMEs” Bank Indonesia implemented two major strategies, namely the pull strategy (market driven) and the push strategy (Figure 10). The pull strategy utilizes market intelligence to identify market potential and standardization, trade facilitation, and synergy with relevant stakeholders. Through the push strategy, certification is facilitated along with product curation to ensure high quality standards as well as interconnectedness with global supply chains (Figure 10). Meanwhile, the development of “go digital MSMEs” continues through adoption of digital technologies to increase productivity and efficiency, unlock market access nationally and globally online and offline, expand MSME access to finance, and facilitate transactions as the entry point to the economic-financial digital ecosystem through, among others, greater QRIS adoption. In addition, Bank Indonesia also continues to encourage the development of green MSME. This includes the development of green MSME business models and the adoption of environmentally friendly MSME business practices, from the use of raw materials and the application of a circular economy to the efficient use of energy. Expanding access of MSME financing is continuously encouraged to support business expansion. In line with government policy to increase MSME loans, which is targeted to reach 30% by 2024, Bank Indonesia has also strengthened RPIM policy implementation, as described above, and has also implemented various other strengthening measures. These include the development of a multiple channel financing business model, financing business matching, the Financial Information Figure 10. Export-Oriented MSME Development Strategy Pull Strategy Facilitate trade promotions Identification of market trend gaps, standardization, and certification Identification of standards and requirements of export destination countries Market Driven Utilizing market intelligence information to identify potential export commodities and trends in destination countries Synergy with stakeholders to fulfill the quantity and quality of products according to standards Business matching with potential buyer Push Strategy Facilitation of capacity building programs and assistance to fulfill quantity, quality and continuity Synergy with the government for the implementation of training and mentoring programs, as well as product testing MSMEs Pilot Project 6 MSMEs Coffee 7 MSMEs Fabrics / Crafts 2 MSMEs F&B Certification Facilitation Source: Bank Indonesia Recording Application (SIAPIK), Potential Funded MSME Database (BISAID), and expansion of QRIS uptake. With such strengthening measures, MSMEs will become more bankable, thus facilitating access to formal financing from financial institutions. Synergy with ministries/institutions, associations, and communities is continuously strengthened to increase the competitiveness of MSMEs. The development of subsistence groups to increase financial inclusion is carried out in synergy with academics, non-governmental organizations (NGOs), regional government, financial institutions, and industry. Synergy to improve MSME competitiveness is undertaken by strengthening the capacity of MSMEs to “go export and go digital,” increase access to finance, and increase access to marketing through various national exhibitions, while promoting international trade. To accelerate the national economic recovery, Bank Indonesia has consistently supported the Proud of Indonesian Product National Movement (Gernas BBI) and Proud Traveling #DiIndonesiaAja (BWI) movement through Gambar x. Gerakan GBBI dan BWI Nasional active contributions from all of Bank Indonesia representative offices, including hybrid retail program for MSME products and expanding the use of MSME QRIS at various strategic Bank Indonesia events (Figure 11). Close synergy with ministries/institutions, associations and communities also succeeded in organizing the Karya Kreatif Indonesia (KKI) 2022 event as a momentum for the post-pandemic revival of MSMEs. The KKI in 2022, which was held in a hybrid format after the two previous years of virtual events, took the theme “Indonesian MSME Revival through Digitalization and Globalization Towards Sustainable Economic Growth”. This theme contains three keywords, namely synergy, digitalization, and globalization, as represented by the hashtags #BersamaUMKMbangkit and #UMKMgodigital_goglobal. At this KKI, Bank Indonesia together with 13 ministries/institutions, 5 associations, 26 industry players, the banking industry, payment system players, marketplaces, export aggregators and designers collaborated in synergy to revive Indonesian MSMEs and support the domestic economic recovery. The digitalization of MSMEs was also encouraged through the use of QRIS, thus enabling Indonesian MSMEs to not only become reliable players at the national level but also internationally. Through close cooperation to realize the shared commitment to encourage Indonesian MSMEs to level up, KKI in 2022 recorded very encouraging performance. Turnover increases by 42%, number of visitors increases by 541%, financing grows by 2,924%, and commitments from business Figure 11. GBBI and National BWI Movement #DiIndonesiaAja BBI in 12 Tourist Destination Areas Sumbar (April 2022) “UMKM Bangkit, Ekonomi Tumbuh” Sumsel (November 2022) “Beli Kreatif Sumsel” Source: Bank Indonesia, Kemenkomarves, Kemenparekraf Lampung (June 2022) “Lagawifest” 10 Sulbar (October 2022) Babel (May 2022) “Laskar UMKM Kepulauan Bangka Belitung Mendunia” Jambi (January 2022) “Eksotisme Jambi dari lokal menuju global” Kepri (March 2022) “Expanding to the new market” “Sandeq Semangat Sulbar” Malut (September 2022) “Gelora Malut” Kalbar (November 2022) “Bangun UMKM Kalbar Go Global” Kalsel (July 2022) “Jelajahi Warna Warni Kalsel” Sulsel (February 2022) “Semangat PINISI” Papua (August 2022) “Binar Digital Papua” Figure 12. Outcome of Gernas BBI (Bank Indonesia as Movement Manager), including the KKI 2022 SEMANGAT PINISI Business Matching (Export) Strengthen real initiatives through innovation and synergy for economic recovery “Recover Together, Recover Stronger” Rp198.1 billion Top 3 : COMMODITIES COUNTRIES OF DESTINATION Jember (Co Host) : 171 B Babel (GBBI) : 8.40 B Sulsel (GBBI) : 4.6 B Jember : USA Babel : Singapore & Malaysia Sulsel : China & Hong Kong Jember : Coffee Babel : Fabrics, Crafts, Processed F & B Sulsel : Nutmeg, Pepper, Pecan, Cinnamon TOTAL MSMEs Jember : 1 Babel : 5 Sulsel : 2 #BBIBWISulsel2022 Business Matching (Financing) OUTCOME Rp3.0 trillion Business Matching (Domestic Sales) Rp93.2 billion Transactions (Overseas Sales) Rp119.6 billion Exhibition Transactions Rp34.6 billion E-commerce Transactions OUTPUT Rp30.1 billion MSMEs participation 70,352 MSMEs in 46 Bank Indonesia Representative Offices BANKS: Top 3 : Top 3 : Kepri : Singapore, China, Japan, Netherlands Sumut : Asia, Europe, USA (9 countries) Jabar : Asia, Europe, USA (11 countries) in 46 Bank Indonesia Representative Offices COMMODITIES MEDIA : Jateng : Marketplace (Blibli.com) Kepri : Marketplace Lampung : Marketplace Top 3: Top 3: TOTAL MSMEs Jambi: Coffee, Fabrics, Crafts, Processed F & B Sumut : Coffee Kepri : 6 Sumut : 1 Jabar : 6 TOTAL MSMEs DKI Jakarta : Coffee, Fabrics, Crafts, F & B Sumut : Coffee, Fabrics, Crafts, F & B, Herbal Banten: Coffee, Fabrics, Crafts, F & B Sulsel (GBBI) : 55,928 MSMEs Jambi (GBBI) : 1,253 MSMEs Jateng (Co Host Sulsel) : 1,173 MSMEs MSMEs Onboarding 4,079 MSMEs Pematangsiantar : 1 Jabar : 32 Jambi : 101 COMMODITIES : Top 3 : DKI (Jakreatifest) : 3.85 B Sumut (KKSU) : 3.60 B Banten (KKB) : 3.54 B Top 3 : TOTAL MSMEs Pematangsiantar : Coffee Jabar : Coffee Jambi : Coffee, Horticulture COUNTRIES OF DESTINATION Jateng (Gayeng) : 7.90 B Kepri (GBBI) : 7.41 B Lampung (GBBI) : 3.46 B Sulsel : 51.130 Maluku : 17.873 Papua: 60 COMMODITIES : Top 3 : P. Siantar (SSCF): Rp48.69 B Jabar (CoE): Rp29.74 B Jambi (GBBI): Rp5.80 B Kepri (GBBI) : 93.77 B Sumut (KKSU) : 10.13 B Jabar (CoE) : 5.72 B TOTAL MSMEs Sulsel : 4 banks (Mandiri, BTN, BNI, BRI) Maluku : 4 banks (BRI, Mandiri, BNI, BSI) Papua : 3 banks (Mandiri, BRI, BNI) Sulsel (GBBI) : 2.16 T Maluku (Manggurebe): 678.6 B Papua (GBBI) : 60.8 B Jambi (GBBI) : 1.044 MSMEs Babel (GBBI) : 400 MSMEs Sulsel (GBBI) : 324 MSMEs DKI Jakarta : 39 Banten : 230 Banten : 108 COMMODITIES : Jateng : Coffee, Fabrics, Crafts, F & B Kepri : Coffee, Fabrics, Crafts, F & B Lampung : Coffee, Fabrics, Crafts, F & B MSMEs as New QRIS Users 5,602 in 46 Bank Indonesia Representative Offices Number of visitors 1,032,835 in 46 Bank Indonesia Representative Offices TOTAL MSMEs Jateng : 152 Kepri : 250 Lampung : 60 3 Terbesar : Sumut (KKSU): 1,487 UMKM Jambi (GBBI): 1,000 UMKM Aceh (KKA): 400 UMKM Top 3: Sulsel (GBBI): 433.237 participants Malang (Techibition) : 101.222 participants Solo (Kenduren) : 63.875 participants Source: Bank Indonesia matching domestic sales and export transactions increases by 36% from the previous year (Figure 12). Policy synergy is also pursued to encourage the role of MSMEs in efforts to control food inflation through the National Movement for Food Inflation Control (GNPIP). The national movement to control food inflation is implemented in an integrated, end-to-end, and innovative way by prioritizing the 4K approach, namely price affordability, supply availability, smooth distribution, and effective communication. The GNPIP program has been initiated in various regions by 43 Bank Indonesia representative offices and regional Governments, as well as other strategic partners in Regional Inflation Control Teams (TPID). GNPIP is implemented through market operations, urban farming and digital farming, utilization of agricultural tools and machinery and agricultural production facilities, transportation subsidies, and strengthening interregional cooperation. Alhamdulillah, with the support of all parties, the national movement has been able to support controlling volatile food inflation, which in July reached 11.47% before subsiding to 7.19% in October 2022, as explained earlier. International Policy Bank Indonesia’s international policies continue to be carried out in synergy with the Government to achieve macroeconomic and financial system stability, support economic recovery, and strengthen diplomacy efforts for the interests of Bank Indonesia and the Indonesian economy. Despite elevated global economic uncertainty, which has impacted the external sector, international and regional cooperation in Asia continues to be strengthened to support external resilience and bolster economic recovery. In this context, Bank Indonesia maintains international cooperation under the framework of the International Financial Safety Net, including through Bilateral Currency Swap Arrangements (BCSA), Local Currency Bilateral Swap Arrangements (LCBSA) and the Bilateral Swap Arrangements with South Korea and Malaysia. Bank Indonesia has also extended the arrangements with China, Australia, Singapore, Malaysia and Japan this year, in addition to a repo agreement with the New York Federal Reserve. Moreover, in June 2022, Bank Indonesia, the Bank for International Settlements (BIS), and several central banks in the Asia-Pacific region signed the Renminbi Liquidity Arrangement (RMBLA) that provides liquidity through a reserve pool scheme, as a liquidity support that can be utilized for financial market stabilization as required. Bank Indonesia is also expanding and strengthening the implementation of Local Currency Settlement (LCS) cooperation. Indonesia’s LCS partners, which are currently Malaysia, Thailand, Japan, and China has been expanded in 2022 with the signing of a memorandum of understanding on Local Currency Transaction (LCT) cooperation between Bank Indonesia and the Monetary Authority of Singapore (MAS). The LCT scheme is an innovation on LCS by expanding the scope of cooperation to accommodate cross-border payment system transactions as an anticipatory measure to the growing digitalization of payment systems. LCT development also intends to strengthen Regional Payment Connectivity initiative through the ease of transaction settlement between ASEAN-5 countries in local currencies to support cross-border trade and investment in the region. Synergy between LCT and RPC is also in line with G20 and regional efforts to diversify currencies, overcome potential obstacles in crossborder payment activities, strengthen economic recovery after the Covid-19 pandemic, and support the ASEAN 2023 priority agenda under the Chairmanship of Indonesia. Bank Indonesia continues to play an active role in strengthening positive international perception to the Indonesian economy, particularly among rating agencies and foreign investors. This is achieved through regular communication and engagement with rating agencies and foreign investors, including through scheduled investor conference calls to communicate the results of the monthly Board of Governors Meeting (RDG). Investment and trade are also promoted continuously through the Investor Relations Unit (IRU) regionally, nationally, and globally, of Bank Indonesia representative offices at home and abroad, in collaboration with the Central and Regional Governments, as well as representatives of the Government of the Republic of Indonesia abroad. In 2022, for example, Bank Indonesia actively participated in investment and trade promotion activities at the US-Indonesia Investment Forum in New York, the Indonesia Investment Forum in London, and the Singapore International Jewelry Expo in Singapore. Alhamdulillah, with the hard work and close synergy of all policymakers, Indonesia in 2022 managed to maintain its rating issued by three major global rating agencies at the investment grade level, even upgrading the outlook to stable. Bank Indonesia also continues to strengthen international recognition as the best central bank among emerging market countries. This is achieved by increasing Bank Indonesia representation through membership or chairmanship of various international cooperation forums. The increase of Bank Indonesia’s reputation is also reflected in the various awards received from highly reputable international institutions, the application of international standards, publication of research and international journals, as well as serving as a reference and resource at various strategic international events. In 2022, Bank Indonesia received international awards as Best Central Bank of the Year from the Global Islamic Finance Awards (GIFA), Contact Center World 2021 Global Top-Ranking Performers at the 15th Annual Next Generation Contact Center and Customer Engagement Conference, Cyber Resilience Initiative Award from Central Banking Publications, Gold Winner 2022 for the International Business Awards (IBA) Stevie Winner and ARC Awards. Bank Indonesia and the Ministry of Finance during Indonesia’s G20 Presidency have discussed six priority agendas in the Finance Track and reaffirmed commitment to confront emerging challenges of the global economy. Indonesia’s G20 Presidency has successfully held four Finance Ministers and Central Bank Governors (FMCBG) meetings along with various side events, including high-level seminars, while delivering concrete results on G20 actions in the Finance Track, which are reflected in the various priority agendas of the Finance Track that have been agreed, as described in detail above. One of the important achievements of Indonesia’s G20 Presidency was the signing of a memorandum of understanding on Regional Payment Connectivity between the five ASEAN central banks, namely Bank Indonesia, Bank Negara Malaysia, the Monetary Authority of Singapore, Bank of Thailand, and Banko Sentral ng Pilipinas. This collaboration is based on the need to implement an integrated cross-border payment system between countries in ASEAN-5 to foster more inclusive and sustainable regional economic growth by taking advantage of the rapid digitalization in the economy. These diverse achievements not only reflect global recognition regarding the success of Indonesia’s leadership on the international stage but are also concrete actions to support the domestic economic recovery, including the revival of the tourism sector and the promotion of Indonesia’s flagship products, which are increasingly going global. Bank Indonesia Transformation Comprehensive transformation of Bank Indonesia that has been undertaken since 2018 continues to be expanded, strengthened, and accelerated, both policy transformation and institutional transformation. This transformation is directed to realize Bank Indonesia’s 2025 vision to become the foremost digital central bank that creates a tangible contribution to the national economy and the best amongst emerging market countries towards Advanced Indonesia. In line with the rapidly changing strategic environment, Bank Indonesia continues to adapt the policy and institutional transformation as outlined in the Strategic Business Plan 2025, which includes responding to rapid digitalization and the impact of climate change on the implementation of public duties by Bank Indonesia. Policy transformation in 2022 includes strengthening the Main Policy Mix Framework that integrates three key policies, namely monetary, macroprudential and payment system policies, with supporting policies including regional economic policy, international policy, central banking service, data and information systems, and organizational and governance. The Main Policy Mix Framework is oriented towards achieving Rupiah stability, maintaining payment system stability, and contributing to financial system stability, in order to support sustainable economic growth. The Main Policy Mix Framework is also synergized with national policies, namely: (i) accelerating real sector and financial sector transformation; (ii) synergy between monetary, fiscal, macroprudential and microprudential stimuli; (iii) economic and financial digitalization; and (iv) green economy and finance development. In addition, we have accelerated payment system transformation through Indonesia Payment System Blueprint (BSPI) 2025 implementation, including initiatives to develop the Digital Rupiah as Central Bank Digital Currency (CBDC) in Indonesia moving forward. In this regard, Bank Indonesia initiated the “Garuda Project” which explores the Digital Rupiah design through the preparation of a White Paper. We will provide further explanation regarding the Digital Rupiah in the chapter on the direction of the Bank Indonesia policy mix in 2023. In addition, the money market deepening transformation will also continue through implementation of the Money Market Deepening Blueprint (BPPU) 2025 in order to create a modern and advanced money market. Synergy and coordination with the Government continues to be strengthened, both through fiscal and monetary policy synergy to manage the economy in the near term, while accelerating structural reforms to strengthen the structure of the Indonesian economy. Synergy between Bank Indonesia and other policymakers in the Financial System Stability Committee (KSSK) is constantly strengthened to maintain the stability of the financial system and foster business financing to support the national economic recovery after the Covid-19 pandemic. In addition, synergy and coordination with the Government, the KSSK as well as the banking sector and payment system industry will be expanded to accelerate financial market deepening and national integration of the digital economy and finance. Institutional transformation continues to be strengthened to support the implementation of key policies and to realize the Bank Indonesia’s 2025 vision. Institutional transformation is focused on three strategic areas (Figure 13). First, strengthening the Institutional Policy Mix Framework (BKK) based on effective, efficient and managed (2EG) performance, which began in 2021 to support the achievement and credible implementation of Bank Indonesia’s mandate. The BKK framework is also strengthened by Bank Indonesia’s Green Institutional Framework, which is the tangible manifestation of Bank Indonesia’s role in implementing environmentally friendly policies in the execution of Bank Indonesia’s public duties and functions (lead by example). The development of a Green Institutional Framework focuses on four areas, namely: (i) strategic management and governance to ensure the implementation of green initiatives that are more comprehensive and integrated with the overall strategy and governance in various areas and functions of Bank Indonesia; (ii) internal finance, which includes Bank Indonesia internal financial management in line with green finance principles; (iii) facilities and infrastructure to ensure the gradual transition of physical assets and information system assets, including the procurement process, to be more in line with green principles; and (iv) human resources, with the main target of instilling a green mindset in competent and capable human resources at Bank Indonesia. Second, digital-based business process reengineering (BPR) in order to create an organization with simpler, concise and standardized business processes and work processes, supported by digital technology, while still meeting governance aspects. BPR is carried out through the alignment of actors, processes, and technology to support the implementation of a more efficient Bank Indonesia business process with the “One Input, One Process, Multi Purposes” approach. Strengthening is carried out based on five main principles, namely: (i) process simplification; (ii) maintaining good governance; (iii) document standardization; (iv) digitalization; and (v) phased implementation. In the initial stage, Bank Indonesia implemented BPR for the policy formulation and decision-making processes. The decision-making process was simplified while maintaining the effectiveness and quality of the results. Governance is maintained through clarity of decision-making responsibilities and jurisdiction, as well as ensuring clear checks and balances in the decision-making process. The standardization of documents is carried out by taking into account the need for governance of decision-making and Figure 13. Bank Indonesia Institutional Transformation Bank Indonesia 2025 Vision “To become the foremost digital central bank that creates a tangible contribution to the national economy and the best amongst emerging market countries towards Advanced Indonesia” Future Challenges Bigger unknown: Post-pandemic exit policy strategy Bank Indonesia’s core policy DIGITAL MEGATREND (CBDC, cross-border payment, de-Fi, crypto assets, metaverse) Financial system disruption, cyber attack, data protection Institutional Transformation Institutional Policy Mix Effective Sustainability issues: Climate change Economic/financial inclusion Efficient Business Process Re-engineering Digitalization Source: Bank Indonesia Digitalization Document standardization Bank Indonesia’s Green Institutional Framework Demands for strengthening central bank’s performance Bank Indonesia Digital Innovation Master Plan Process simplification Good governance Governed Performance Advancing Digital Transformation Gradual implementation End-to-end data management Modern and user-centric technology Main strategy Digital business platform Omni-data intelligent People and Culture Focus on mindset, capacity, and capability: digital & green Resilient digital infrastructure communication processes in policy formulation. The decision-making process is also supported by the Digital Workplace Platform (DWP), which was developed as an end-to-end super app, enabling work collaboration on a seamlessly integrated platform. Digital-based BPR is implemented in stages and will continue to be expanded to create an organization with streamlined business processes and agile work processes and in line with the needs of the digital era. Third, strengthening digital innovation through the implementation of the Bank Indonesia Digital Innovation Master Plan (RIVIBI) 2025. In this context, Bank Indonesia is pursuing a strategy that focuses on developing data centers and BPRbased digitalization to support recent policies. Strengthening is also carried out in the areas of technology and security with three strategic areas, namely digitalization, end-to-end data management, as well as modern and user-centric technology. This is achieved through three main strategies, including (i) digital business platform that supports policies and institutions, (ii) omni-data intelligence, and (iii) resilient digital infrastructure. The development of various strategic areas to transform the institution is also supported by strengthening the transformation of human resources to create high-performing human resources with a digital mindset, capacity, and capabilities. National Economic Policy Mix Synergy and Innovation Moving Forward: Strengthening Resilience, Fostering National Economic Revival National economic policy mix synergy and innovation must be enhanced further to strengthen resilience, recovery momentum and the national economic revival. The national economic policy mix covers five salient aspects, namely: (i) fiscal and monetary coordination; (ii) acceleration of the financial sector transformation; (iii) acceleration of the real sector transformation; (iv) digitalization of the economy and finance; and (v) green economy and finance (Figure 14). To strengthen resilience against the impact of global turmoil, close coordination between fiscal policy and monetary policy must be enhanced further as a shock absorber to maintain macroeconomic stability, both internally (inflation returns to the 3±1% target, fiscal deficit returns to below 3% of GDP) and externally (stable Rupiah exchange rate, Figure 14. National Economic Policy Mix Synergy and Innovation NATIONAL ECONOMIC POLICY MIX: SYNERGY TO STRENGTHEN ECONOMIC RESILIENCE AND REVIVAL FIVE RESPONSES OF THE NATIONAL ECONOMIC POLICY MIX: ECONOMIC GOALS: 1 FISCAL AND MONETARY COORDINATION 2 ACCELERATING FINANCIAL SECTOR TRANSFORMATION 4 DIGITALIZATION OF THE ECONOMY AND FINANCE NE M O A BI ST 3 ACCELERATING REAL SECTOR TRANSFORMATION T LI A R TY Y I TE N A M N CIAL S TA BILIT Y MIC ONO EC ROWTH G F SY S RESILIENCE: MAINTAINING STABILITY FROM THE IMPACT OF GLOBAL TURMOIL RECOVER: GROWTH MOMENTUM FROM DOMESTIC DEMAND REVIVAL: MEDIUM-TERM SUSTAINABLE HIGH ECONOMIC GROWTH 5 GREEN ECONOMY AND FINANCE Source: Bank Indonesia attractive SBN yields, and BOP balance or surplus). Strengthening policy coordination between the Ministry of Finance, Bank Indonesia, OJK and LPS within the Financial System Stability Committee (KSSK) framework is also increasingly required to ensure the resilience of financial institutions, both individually and system-wide, in the face of arising global and domestic economic shocks. The coordination between fiscal policy, through the allocation of State Budget expenditures to nurture consumption and investment, and monetary policy, through macroprudential easing, digitalization of payment system, money market deepening, as well as financial-economic inclusion, must be enhanced further to continuously promote the momentum of national economic recovery. to prevent macroeconomic instability or disruption to the ongoing national economic recovery process. This is achieved through budget allocations aimed at: (i) managing inflation and maintaining people’s purchasing power; (ii) maintaining recovery momentum (reducing unemployment and alleviating poverty); and (iii) maintaining priority spending (strengthening productivity and the foundations of the national economy). At the same time, consolidation and fiscal reform will be strengthened to maintain the soundness of the medium-long term of the APBN by: (i) setting up buffers to anticipate uncertainty; and (ii) strengthening the foundations for medium-term fiscal consolidation and sustainability. Moving forward, fiscal policy aims to strengthen resilience and national economic recovery momentum, while consistently pursuing the outlined consolidation and reforms. Amid soaring commodity prices and the risk of escalating global uncertainty, fiscal policy in 2023 must be vigilant, anticipatory, and responsive (Scheme 2). For this reason, the 2023 state budget (APBN) was formulated as a shock absorber to dampen the impact of global turmoil and Based on the direction of fiscal policy, the APBN architecture in 2023 has been formulated to strengthen resilience and to generate national economic recovery optimism, while remaining vigilant to the impact of global turmoil. The APBN 2023 was prepared based on several macroeconomic assumptions, namely economic growth of 5.3%, inflation of 3.6%, average 10year SBN yield of 7.9%, average exchange rate of Rp14,800 per US dollar, and oil price of USD90 per Scheme 2. Fiscal Policy Direction in 2023: Shock Absorber and Consolidation AMID THE RISK OF ESCALATING GLOBAL UNCERTAINTY, THE STATE BUDGET (APBN) IS OPTIMIZED AS A SHOCK ABSORBER The APBN as Shock Absorber Controlling inflation and maintaining public purchasing power Amid soaring commodity prices and escalating risk of global uncertainty "The APBN must be Vigilant, Anticipatory and Responsive" Maintaining recovery momentum (reducing unemployment and alleviating poverty) Maintaining priority spending (strengthening productivity and the national economic foundation) Optimizing Expenditure: Compensation, Social Protection, and Priority Spending (infrastructure, health, education, and support for structural reforms) Maintaining a Healthy Medium-Long Term APBN FISCAL CONSOLIDATION AND REFORM Momentum for Strengthening Fiscal Resilience Preparing buffers to anticipate uncertainties Strengthening the foundations for medium-term fiscal consolidation and sustainability Source: Minister of Finance, Keynote Address, National Seminar and Conference on the Acceleration of Economic Recovery and Strengthening Sustainable Development”, Jakarta, 19 October 2022 Figure 15. The 2023 State Budget: Optimistic and Vigilant POSTURE OF THE 2023 APBN: “RAISING OPTIMISM BUT REMAINING VIGILANT” The APBN deficit is back to below 3% of GDP and for the first time the tax target is above Rp2,000 trillion and state expenditure is above Rp3,000 trillion Development Goals and Indicators Basic Assumptions of Macroeconomics Unemployment rate (%) 5.3 - 6.0 Economic Growth (%) Poverty (%) 7.5 - 8.5 Inflation (%) Gini Ratio (index) 0.375 - 0.378 Human Development Index (index) 73.31 - 73.49 5.3 3.6 14,800 Exchange Rate (IDR/USD) 7.9 10-year SBN Yield (%) Oil Price (USD/barrel) Farmers' Terms of Trade (index) 105 - 107 Oil Lifting (thousand barrel/day) Fishermen's exchange rate (index) 107 - 108 Gas Lifting (thousand of barrel of oil equivalent/day) 1,100 State Revenue Optimizing State Revenue by taking into account the risk of moderating commodity prices State Expenditure POSTURE OF APBN Supports increased productivity and acts as a shock absorber in facing uncertainty Rp2,463.0 Trillion Tax Revenue Rp3,061.2Trillion Rp2,021.2 Trillion Non-Tax Revenue Rp441.4 Trillion Central Government Expenditure Rp2.246,5 Trillion FINANCING DEFICIT Transfer to Region Rp598.2Trillion 2.84% GDP Rp814,7 Trillion “More efficient debt financing in line with reduced deficits and utilization of Remaining Budget (SAL)” Source: Minister of Finance, Keynote Address, National Seminar and Conference on the Acceleration of Economic Recovery and Strengthening Sustainable Development”, Jakarta, 19 October 2022 barrel (Figure 15). Fiscal consolidation is carried out with the APBN deficit of 2.84% of GDP as a form of commitment to normalizing policies after three years of the Covid-19 pandemic, during which time the deficit was allowed to be above 3% of GDP. The need for debt financing also decreased to Rp696.3 trillion in line with the reduction in the fiscal deficit and utilization of the Remaining Budget (SAL) from 2022, which partly stems from the purchase of SBN in the primary market by Bank Indonesia in accordance with the third Joint Decree between the Finance Minister and the Governor of Bank Indonesia in pursuant to Law No. 2 of 2020. As a shock absorber against the soaring world energy and food prices, energy subsidies and compensation in the 2023 APBN are allocated to the amount of Rp339.6 trillion, thus the Government is expected no longer needs to adjust the domestic energy prices, which helps to control inflation and to maintain people’s purchasing power. The energy subsidy is also part of the social protection budget allocation of Rp479.1 trillion. To manage inflation, especially from food prices, the Government has allocated a budget for food security in the 2023 APBN of Rp95.0 trillion to ensure and increase food availability, access, and quality. In addition, the Government has also allocated a budget to support the economic transformation of education (Rp612.2 trillion), infrastructure (Rp392.0 trillion), and health (Rp169.1 trillion). With the continuation of fiscal subsidies in the 2023 APBN to absorb high global energy and food prices, inflation will be more controlled, therefore the normalization of Bank Indonesia’s monetary policy does not have to be too tight. Bank Indonesia policy mix in 2023 will be oriented towards maintaining stability and accelerating the national economic recovery. The focus of monetary policy normalization is to reduce inflation from the impact of fuel price adjustments in 2022 and to stabilize the rupiah from the impact of the strong US dollar due to rising global interest rates. To that end, Bank Indonesia will measurably continue its front loaded, pre-emptive, and forward looking interest rate policy to lower inflation expectations and to ensure that core inflation returns to the 3±1% target corridor earlier in the first half of 2023. Given that the inflation is under control, people’s purchasing power can be maintained to boost consumption and Scheme 3. Economic Capacity Building Policy: Endogenous Growth Model Industry and Export Downstreaming Policy USD million Scenario of the Impact of Downstreaming Policy on Trade Balance Structural Reform Infrastructure Development % Total Factor Productivity TFP (yoy) 2,00 2.0 1.60% 1,50 1.5 1.13% 1.23% 1,00 1.0 1.13% 1.17% 1.34% 1.22% Baseline 1.49% 1.33% Optimistic %, yoy Pessimistic Investment 9.0 1.59% 8.0 7.95 7.0 1.39% 7.09 7.09 6.0 7.31 5.0 0,50 0.5 4.0 3.0 0,00 0.0 3.80 7.00 7.13 5.76 5.99 7.52 6.14 4.43 2.0 -0,50 -0.5 -0.42% 1.0 - -1,00 -1.0 Baseline Optimistic Optimis Baseline Optimistic Human Capital Development Economic Digitalization Estimate of the Impact of Digitalization on Productivity Growth Δln At = γ0 + γ1 Δ ln Xdt-1 + γ2 [EKD] + γ3 Δ ln Xft + γ4 ln (X/Q)dt + γ5 ln (X/Q)ft + γ6 ln (AJPN/AIDN)t-1 + γ7 FLt+ γ8 DUMt + et X = Research and development input P = Sharia Financing Q = Variety of Product EKD = Proxy Variable for Digital Economic Finance 9.5 9.4 9.3 9.2 9.1 9.0 8.9 8.8 8.7 8.6 8.5 year Years of Schooling 9.36 9.27 9.18 9.09 9.00 8.91 8.82 Baseline = Optimistic Source: Bank Indonesia thus stimulate economic growth. Bank Indonesia will continue to pursue Rupiah stabilization policy as an integral part of controlling inflation and supporting macroeconomic and financial system stability as prerequisites for national economic recovery. Meanwhile, Bank Indonesia policy mix instruments, namely macroprudential policy, payment system digitalization, money market deepening, as well as economic and financial inclusion are still aimed at supporting economic growth. The direction of the Bank Indonesia policy mix in 2023 will be explained in a more detail in the next section. While fiscal policy and monetary policy are focused on strengthening resilience and economic recovery momentum against the backdrop of global turmoil, real sector transformation policies need to be improved to further encourage the revival of the national economy towards Advanced Indonesia. According to the endogenous growth model, transformation policy to increase economic capacity encompasses five mutually supporting aspects that need to be integrated, namely: infrastructure development, downstreaming policies, structural reform, economic digitalization, and human resources development (Scheme 3). The development of physical and digital connectivity infrastructure will increase economic capacity and growth, both in terms of increasing capital (investment growth) and productivity (efficiency and competitiveness). Downstream processing of natural resources to various derivative industries increases economic supply capacity (aggregate supply) by increasing capital and nurturing growth on the demand side (aggregate demand) along with increasing value added in exports. Human resources development must be continued, not only through formal education but also vocational training as well as research and technology development that increases the number of workers and the quality of their productivity. Meanwhile, structural reforms to facilitate investment and business, such as implementation of the Job Creation Law, will boost economic capacity through greater efficiency and productivity. Likewise, digitalization of the economy and finance will increase the efficiency and competitiveness of the national economy, particularly the retail transaction segment as well as MSMEs and local economies. The success of the real sector transformation policy is largely determined by the ability to integrate these five important aspects to mutually strengthen the sources of capacity building for the national economy. Downstreaming policy, infrastructure development, human resources development and digitalization supported by structural reforms to increase economic capacity will underpin stability and achieve high growth in the medium term. As explained above, aggregate supply will increase so that potential output capacity will be greater in line with the increase in the amount and productivity of capital and labor due to the real sector transformation policy (Scheme 4). On the demand side, the downstreaming policies will encourage a greater increase in exports with value added generated, in addition to an increase in foreign direct investment (FDI) as well as investment for infrastructure development. Overall, the increase in potential output capacity will be greater in the medium term, thus prompting higher growth accompanied by maintained stability. External resilience will be stronger with an increase in exports that reinforce the current account surplus and an increase in FDI, which supports the capital and financial account surplus. Balance of Payment performance will be stronger and, therefore, have positive implications to Rupiah stability. At the same time, an increase in potential output capacity will improve the output gap to meet rising demand, thereby supporting price stability, and controlling inflation at a declining and low rate. The prospect of Indonesian economy with high economic growth and maintained macroeconomic stability as described in the previous section, illustrates the positive results of the economic transformation policy. Infrastructure development will increase economic capacity and growth in terms of higher capital and productivity. Therefore, infrastructure development Scheme 4. Capacity Building and Medium-Term Economic Revival: High Growth, Maintained Stability Downstreaming Policy • A more positive trade balance of metal industry mainly supported by nickel downstreaming policy • Strengthen export structure towards higher value-added Infrastructure • The completion of National Strategic Project (PSN) through 2027 promotes higher investment Net Export Current Account Exchange Rate Consumption post-Covid-19 Government (fiscal) Demand Investment (I/Y; ICOR) Output gap Inflation Digitalization • Promote higher efficiency and productivity as well as economic inclusion • Efficiency in process and production cost lower inflation Structural Reform • Structural reform (the Law on Harmonization of Tax Regulations, the Job Creation Law, etc.) promotes higher productivity (TFP) Productivity Supply Green Economy* * Require high transition cost however delayed green transition process may reduce export product's competitiveness Source: Bank Indonesia Figure 16. National Strategic Projects (PSN) and Investment Growth Projection of PSN Infrastructure Completion Investment IDR trillion Period Projection September 2022 468.46 713.40 823.60 557.81 381.37 162.86 49.78 14.32 Projection January 2022 458.13 717.28 884.34 554.60 311.88 132.75 49.78 14.32 Projection December 2021 472.63 717.20 863.97 529.48 303.06 132.96 50.03 13.60 %, yoy Investment Growth 7.95 7.31 7.09 7.09 3 3.80 7.00 7.13 5.76 5.99 7.52 6.14 4.43 - Baseline Optimis Source: KPPIP, Bank Indonesia (calculated) is oriented towards strengthening national supply chains and integration with multipolar global supply chains in accordance with Indonesia’s strategic trade and investment partners. Moreover, the development of infrastructure connectivity also needs to support the downstreaming policies of industry and exports of natural resources, dominated by the mining industry in Eastern Indonesia as well as the manufacturing industry and its various subsectors in the Java region, thereby further strengthening national supply chains. Likewise, the development of infrastructure connectivity to support an integrated tourism development in 10 priority tourism destinations needs to be continued. The above strategic direction of infrastructure connectivity development policies serves as a key consideration in the implementation of National Strategic Projects (PSN) moving forward, as well as the basis for foreign trade and investment policies with strategic partner countries, both in supporting the development of natural resources downstreaming and tourism. PSN projections based on data as of September 2022 indicate that the realization of infrastructure investment in 2022 is lower than was planned in 2021, but will increase in 2023-2024 before retreating in 2025. Based on PSN projections, investment growth (increase in capital investment) in supporting economic growth is projected to increase to almost 8% by 2024, compared to around 7.3% without infrastructure development (Figure 16). The positive impact of infrastructure investment on higher economic productivity remains increasing although the PSN investment value returns to normal. The investment growth will potentially reach 7.5% by 2027 compared to 6.1% without infrastructure investment. This projection shows the importance of developing connectivity infrastructure to achieve high economic growth through increased capital and productivity according to the Endogenous Growth model as described above. Downstreaming policies for industrial development and manufacturing exports based on natural resources must be expanded and improved to support high economic growth. The accomplishment Scheme 5. Natural Resources Downstreaming Policy STRATEGY FOR STRENGTHENING THE MANUFACTURING INDUSTRIES NEED DOWNSTREAMING ACCELERATION Nickel Adequacy of reserves New technological developments SUBSTANCE OF POLICY COORDINATION • Impact of external policies, such as the Inflation Reduction Act in the US • EXPANSION OF DOWNSTREAMING INTO NON-METALLIC MINERALS Determining medium-long term priority industries aligned with National Industry Development Master Plan (RIPIN) and critical minerals Encouraging financing to support resources downstreaming COORDINATION FORUM REPRIORITIZING INDUSTRIAL DEVELOPMENT IN THE MEDIUM-LONG TERM KEMENTERIAN KOORDINATOR BIDANG KEMARITIMAN DAN INVESTASI Alignment with National Industry Development Master Plan (RIPIN) 2015-2035 by considering critical minerals Source: Bank Indonesia of nickel downstreaming into lithium batteries and the electric automotive industry, as well as its various derivative products has been proven to be able to promote higher economic growth and to strengthen external resilience, as described above by the Endogenous Growth Model approach. The higher export value added from nickel processing has stimulated growth from aggregate demand side and bolstered a healthier current account. Furthermore, the increased capital in the mining and industrial sectors generated by nickel downstreaming has expanded the potential output capacity from the aggregate supply side and supported sustainable growth. Therefore, the downstreaming of natural resources and their derivative industries should be accelerated to further increase the potential output capacity and economic growth, while taking into account the resilience of natural resources reserves, the development of new technologies, as well as the transition to green economy and sustainable finance. Accordingly, concrete measures need to be implemented further to expand the downstreaming policies to other mineral commodities, metals and nonmetals, including a reprioritization of industrial development based on the downstreaming of these natural resources in the medium-long term (Scheme 5). The strategy and downstreaming policy of natural resource-based industries moving forward requires adjustments to the 2015-2035 National Industrial Development Master Plan (RIPIN). In its implementation, coordination between the Coordinating Ministry for Maritime and Investment Affairs, the Ministry of Industry, the Ministry of Finance and Bank Indonesia needs to be strengthened moving forward. The goal of inter-ministerial/institutional policy coordination is to strengthen joint measures, among others, on determining the alignment of the medium-long-term priority industries with the revised RIPIN, promoting financing to support downstreaming, as well as formulating and implementing the transition to green economy and sustainable finance. The tourism sector, which was severely impacted by the Covid-19 pandemic, must be developed moving forward to support the recovery and revival of the national economy. The relevant policies need to remain focused on the further development of 10 priority tourism destinations, particularly the 5 super priority tourism destinations (DPSP), while not ruling out the possibility of developing other destinations. In line with increasing public mobility after the Covid-19 pandemic, the Government is targeting 1.4 billion trips by domestic travelers in 2023 (Scheme 6). For this reason, the strategy of accelerating recovery and strengthening tourism can be continued and strengthened through the 3A (Attractions, Access, Amenities) and 2P (Player, Promotion) approaches. Coordination under the auspices of the Joint Secretariat for the Acceleration of Tourism Development (Sekber Pariwisata) between the Coordinating Ministry for Maritime and Investment Affairs, the Ministry of Tourism and Creative Economy, Bank Indonesia, as well as relevant ministries/institutions and strategic partners has produced agreement on joint priority measures that include: relaxation of tourist visas/entry requirements, increasing the carrying capacity of air transport, accelerating the development of five DPSPs, securing major national and international events, implementing MICE activities (meetings, incentives, conventions, and exhibitions), financing support for tourism and creative economy players, developing MSMEs for tourism and tourism villages, expanding Indonesian tourism promotions, accompanied by an accelerated vaccination program and expansion of the application of CHSE (cleanliness, health, safety, and environmental sustainability) at all destinations. Promotional programs, both domestically through the Proud Travelling #DiIndonesiaAja (BWI) movement and other programs, as well as targeted international promotions, need to be improved further. Bank Indonesia will continue to support the success of various targeted tourism development programs abroad. Overall, along with national economic policy mix synergy and innovation, the outlook of the Indonesian economy will exhibit resiliency, recovery and revival. Facing the global turmoil, fiscal-monetary close coordination supported by financial system stability policies, will be further strengthened to support Scheme 6. Tourism Development Policy ACCELERATION IN RECOVERY AND STRENGTHENING OF TOURISM INDUSTRY CHALLENGES RISK OF STAGFLATION AND GLOBAL UNCERTAINTY OPPORTUNITIES BUSINESS OPERATIONS AND AIR TRANSPORT SUPPORT HAVE NOT BEEN FULLY RECOVERED THE DEMAND OF TOURISTS REMAINS STRONG DESTINATION DEVELOPMENT CONTINUES NEW TREND OF TOURISM OPTIMIZING DOMESTIC TOURISTS AND THE OPENING OF FOREIGN TOURISTS' ACCESS AGREEMENT ON HIGH LEVEL COORDINATION MEETINGS IN THE JOINT SECRETARIAT OF TOURISM DEVELOPMENT 2022 1. Continuing and optimizing 6. Increasing support for tourist relaxation implementation of MICE 2. Increasing the carrying 7. Continuing financial support for capacity of air transport tourism and creative economic 3. Accelerating the development agents of five Super Priority Tourism 8. Development of MSMEs in tourism Destinations (DPSP) and creative economic agents and 4. Continuing the development of tourist villages Priority Tourism Destinations 9. Expanding national tourism (DPP) and other destinations promotion 5. Ensuring the implementation 10. Accelerating vaccination and of scheduled main events expanding implementation of CHSE DOMESTIC TOURISTS MOVEMENT TARGETS FOREIGN TOURIST VISITS 1.4 (in billion) (in million) 16.16 0.7 0.5 0.6 0.7 2022 Forecast 5.7 4.06 1.56 2022* 2023* COORDINATION THROUGH THE JOINT SECRETARIAT OF TOURISM DEVELOPMENT Source: Bank Indonesia 2022* * Bank Indonesia Projection Note: Including MPD and non-MPD resilience and economic recovery in 2023-2024. Indonesia’s economic outlook is promising with high and sustainable growth in the medium term through economic transformation policies, including infrastructure development, downstreaming policies, structural reform, digitalization and human resources development. Growth will continue to accelerate, with macroeconomic and financial system stability maintained. Bank Indonesia Policy Mix Direction in 2023: Maintaining Stability, Accelerating Economic Recovery Bank Indonesia policy mix in 2023 will still be directed towards strengthening economic resilience, recovery and revival in close synergy with national economic policy. The direction of the policy mix is intended to simultaneously counteract the effects of global turmoil, both the risk of economic recession and high inflation, policy rate hikes by the Fed and other central banks, depreciatory pressures on the exchange rate due to a very strong US dollar, as well as persistently high global financial market uncertainty. To that end, Bank Indonesia monetary policy in 2023 will still be focused on maintaining stability (“pro-stability”), particularly the achievement of the inflation target and Rupiah stability, as well as supporting macroeconomic and financial system stability (Figure 17). Meanwhile, the four other key of Bank Indonesia policies will continue to be directed and as part of a joint effort to accelerate the national economic recovery (“pro-growth”). Accommodative macroprudential policy will continue to encourage bank credit and financing to priority sectors and MSMEs, in order to accelerate national economic recovery, while maintaining financial system stability and developing a green and inclusive economic and finance. Payment system digitalization based on the Indonesia Payment System Blueprint (BSPI) 2025 will accelerate national integration of the digital economy and finance, cross-border payment system cooperation, and development of the Digital Rupiah. Money market and foreign exchange market deepening will be accelerated in accordance with the Money Market Development Blueprint (BPPU) 2025 to strengthen policy transmission effectiveness, develop modern and world-class money market infrastructure as well as financial instruments, including sustainable finance. Financial and economic inclusion programs targeting MSMEs will be expanded along with sharia finance, including through digitalization, and unlocking domestic and Figure 17. Bank Indonesia Policy Mix Direction 2023 PRO-GROWTH PRO-STABILITY & GREEN STABILITY MACROPRUDENTIAL PAYMENT SYSTEM MONEY MARKET DEVELOPMENT INCLUSIVE & GREEN FINANCIAL ECONOMY GRO W T H IVE US CL MONETARY IN Source: Bank Indonesia export markets. Bank Indonesia will also continue to strengthen policy synergy and coordination with the Government and the Financial System Stability Committee (KSSK), as well as collaborate with the financial industry, corporate sector, and industry to strengthen national economic resilience, recovery, and revival in the medium-long term towards Advanced Indonesia. Rupiah. Pressures on exchange rates as well as monetary, fiscal, and financial system stability have intensified with portfolio investment outflows, particularly from government securities (SBN), due to the high perceived risk and “cash is king” attitude of global investors. To mitigate the monetary policy trilemma against the impact of global turmoil, Bank Indonesia will continue to optimize three monetary policy instruments, namely interest rate policy, Rupiah stabilization and strengthening foreign exchange reserves (Scheme 7). Interest rate policy is directed towards lowering core inflation back to target earlier in close synergy with the Government to control inflationary pressures on administered prices and volatile food. Rupiah stabilization policy is critical to control the impact of high global energy and food prices on domestic inflation (imported inflation), as well as to support maintaining macroeconomic and financial system stability for the national economic recovery. Simultaneously, Bank Indonesia will continue to buy/sell SBN in the secondary market to maintain yields attractiveness (twist operation), thus increasing foreign portfolio investment inflows, which will stabilize the Rupiah and ensure adequate foreign exchange reserves. Monetary Policy Direction Bank Indonesia monetary policy in 2023 will focus on stabilizing the Rupiah and managing inflation towards the target corridor, as part of the mitigation measures against the impact of global spillovers. Global turmoil has, and will continue to have, an impact on national economic performance, including inflation, exchange rates, and foreign capital flows. Soaring global energy and food prices intensify inflation pressures and undermine the ability to stimulate domestic economic growth in various countries. At the same time, the Fed’s policy rate hikes and the strong US dollar exert depreciatory pressures on various currencies, including the Scheme 7. Bank Indonesia Monetary Policy Direction in 2023 MITIGATING THE IMPACT OF GLOBAL SHOCK SPILLOVER STAGNATION - RECESSION HIGH INFLATION GLOBAL POLICY RATE "HIGHER FOR LONGER" STRONG US DOLLAR AND WEAKENING CURRENCY ACROSS THE WORLD HIGH RISK PERCEPTION AND "CASH IS THE KING" Monetary Policy "Pro Stability" : Front Loaded, Pre-emptive, Forward Looking MONETARY POLICY TRILEMMA POLICY RATE FOR INFLATION RUPIAH STABILIZATION FOREIGN EXCHANGE RESERVE ADEQUACY STRENGTHEN THE STRATEGY OF INTEGRATED MONETARY POLICY MANAGEMENT Source: Bank Indonesia TARGET CORE INFLATION WITHIN TARGET 3±1% ON THE FIRST HALF OF 2023 AND RUPIAH EXCHANGE RATE STABILIZATION POLICY COORDINATION WITH GOVERNMENT Policy Rate BI7DRR On a front loaded, pre-emptive and forward looking basis to lower inflation expectation and core inflation ealier, in the first half of 2023 1. Inflation control with TPIP/TPID Exchange Rate Stabilization Stabilization of Rupiah exchange rate to control inflation, particularly imported inflation, through spot intervention, DNDF, and SBN transaction in secondary market Twist Operation SBN sale/purchase in secondary market to maintain the attractiveness of SBN yield to draw foreign portfolio investment in order to strengthen the stabilization of Rupiah exchange rate OPTIMIZATION OF FOREIGN EXCHANGE RESERVE MANAGEMENT RUPIAH AND FOREIGN CURRENCY MONEY MARKET DEEPENING and GNPIP 2. Fiscal-Monetary coordination 3. Development of priority sector SYNERGY AND COORDINATION Bank Indonesia will continue to implement the BI7DRR interest rate policy on a front loaded, pre-emptive and forward looking basis to rein in overshooting inflation expectations and further reduce core inflation to the 3±1% target range earlier in the first semester of 2023. We are grateful for close fiscal-monetary policy coordination to mitigate the impact of high global energy and food prices on inflation in the country. In 2023, the Government will continue to provide energy subsidies and social assistance program (bansos) to low-income earners, thus ensuring milder CPI inflationary pressures from administered prices. Close coordination between the Government (central and regional) and Bank Indonesia to control volatile food inflation through the Central and Regional Inflation Control Teams (TPIP-TPID), as well as the National Movement for Controlling Food Inflation (GNPIP) will also be enhanced further. Simultaneously, Bank Indonesia will continue to take interest rate policy and Rupiah stabilization measures to reduce core inflation, which increased recently due to the second-round effect of fuel price adjustments in September 2022. Consistent with the direction of monetary policy, Bank Indonesia has raised the BI7DRR rate by 175bps from August-November 2022 to 5.25% as a front loaded, pre-emptive and forward looking measure to rein in overshooting inflation expectations and to ensure core inflation returns to the 3±1% target earlier in the first semester of 2023. Going forward, Bank Indonesia will consistently institute a wellcalibrated, well-planned, and well-communicated policy response to ensure the core inflation target is achieved earlier in the first semester of 2023. The magnitude and timing of the policy rate response will be based on the latest developments, particularly in terms of inflation expectations and core inflation against the initial forecast and targets that need to be achieved (data dependent). Further developments in the global economy, particularly the impact on Rupiah stability and the attractiveness of SBN yields, as well as the domestic economy, specifically economic growth and bank lending, will also be considered. In this regard, Bank Indonesia believes that the impact of the BI7DRR rate hike on bank lending rates and medium-long-term SBN yields will not be too large, although interbank and deposit rates and short-term SBN yields will adjust. This considering that the current loose liquidity conditions in the banking industry and the economy will be maintained by Bank Indonesia. Thus, the hikes in the policy rate to control inflation and maintain Rupiah stability will not hampering the ability of banks to channel credit to the business sectors nor their ability to purchase SBN for fiscal financing, while continuing to support monetary and financial system stability and national economic growth. Bank Indonesia will continue to pursue Rupiah stabilization to mitigate the impact of global spillover on inflation and maintaining macroeconomic and financial system stability to support the national economic recovery. As stated earlier, the Fed’s aggressive pace of rate hikes and the strong US dollar has exerted intense pressures on various global currencies, including the Rupiah. Rupiah stability is critical to control the impact of imported inflation from high global energy and food prices on domestic inflation. Rupiah stability is also important to support fiscal performance, especially in terms of maintaining SBN yields attractiveness for state budget (APBN) financing needs. In addition, Rupiah stability is also critical for financial system stability so that the currency risks on banking and corporate balance sheets are mitigated, while maintaining consumer and business confidence. Bank Indonesia expects currency pressures to ease before and after the FFR hikes peak in the first quarter of 2023. Subsequently, the Rupiah will appreciate and stabilize in line with Indonesia’s solid economic fundamentals, particularly with inflation forecasted to decline towards the target, positive current account, attractiveness of SBN yields, as well as promising national economic prospect. To that end, Bank Indonesia will continue to monitor and intervene in the market, while taking necessary Rupiah stabilization measures, through triple intervention in the spot market, DNDF, and through the buy/sell of SBN in the secondary market, to maintain Rupiah stability in line with its fundamentals and market mechanisms. The monetary operations strategy will also be strengthened to support the effectiveness of transmission mechanism of BI7DRR hike and Rupiah stabilization measures. Adequacy of the foreign exchange reserves, which stood at USD130.2 billion, will be maintained and bolstered by optimizing foreign exchange management and increasing the supply of foreign exchange in the market from the repatriation of foreign exchange proceeds from exports (DHE) of natural resources. Close coordination between Bank Indonesia and the Ministry of Finance will be strengthened to maintain Rupiah stability and SBN market stability in terms of managing the adjustments to global developments. Bank Indonesia will continue to optimize the buy/ sell of SBN in the secondary market to maintain the attractiveness of SBN yields for foreign portfolio investors, thus strengthening Rupiah stability. As noted, aggressive FFR increase to address soaring inflation in the US have edged up US Treasury yields and created a very strong US dollar. Coupled with perceived high risk and the “cash is the king” attitude of global investors, have triggered global financial turmoil and thus put depreciatory pressures on currencies, including the Rupiah, along with large outflows of portfolio investment from EMEs, including Indonesia, especially from SBN. To that end, Bank Indonesia is closely working with the Ministry of Finance to take joint measures to maintain the attractiveness of SBN yields and stabilize the Rupiah. This prompted Bank Indonesia to initiate “twist operation” by utilizing SBN holdings totaling approximately Rp1,300 trillion, by buying/selling SBN in the secondary market to maintain the attractiveness of SBN yields for inflows of foreign portfolio investment (Scheme 8). Through twist operation, SBN yields rose in line with the BI7DRR rate and boosted portfolio investment inflows, thereby supporting Rupiah stabilization without compromising the Government’s ability to issue longer-term SBN for fiscal financing. Meanwhile, the purchase of long-term SBN will spur a bump in SBN yields, which will remain attractive but not excessive, thereby attracting portfolio investment inflows, stabilizing the Rupiah, and allowing the issuance of long-term SBN for fiscal financing in 2023. Meanwhile, the Ministry of Finance continues to issue SBN regularly in the primary market for the APBN financing according to market mechanisms. The APBN financing is also carried out through the issuance of global bonds and withdrawal of program loans from multilateral and regional institutions, with both strengthening foreign exchange reserves and the ability of Bank Indonesia to stabilize the Rupiah. Policy coordination between Bank Indonesia and the Government is also continuously strengthened Scheme 8. Monetary Policy Direction of Twist Operation in 2023 Rt = Rt* + E ( St ) + ρt BANK INDONESIA’S TWIST OPERATION • INCREASE IN SBN YIELD Rt = SBN Yield tenor t IN LINE WITH BI7DRR, Rt* = US Treasury Yield tenor t E ( St ) = Rupiah depreciation expectations SHORT TERM SBN SALES ρt = Indonesian risk premium % 8.0 SBN Yield Structure per Tenor 6.0 5.5 5.0 4.5 -20 1m 2m 1b 3b 6b 9b 12b 2t 3t 4t 5t 6t 7t 8t 9t 10t 15t 20t 30t SUN(FR) 15 Nov-2022 Source: Bank Indonesia, OJK, Bloomberg 6.5 30 Sep-2022 Source: Bank Indonesia FINANCING bps 7.0 Weighted Average OMO Contraction Spread (rhs) INFLOWS, • RUPIAH STABILIZATION • NO IMPACT ON FISCAL 7.5 4.0 • PORTFOLIO INVESTMENT -40 • MILD INCREASE IN SBN YIELD LONG TERM SBN BUY • PORTFOLIO INVESTMENT INFLOWS, • RUPIAH STABILIZATION • MAINTAINED FISCAL FINANCING to control inflation and revive priority sectors for national economic recovery. As stated, Bank Indonesia will continue to direct the policy rate towards reducing core inflation back to the 3±1% target earlier in the first semester of 2023, while Rupiah exchange rate stabilization policy to control imported inflation. Meanwhile, the Government has allocated budget for energy subsidies and social assistance program so as inflationary pressures on administered prices remain manageable. To control volatile food inflation, Bank Indonesia will continue to work closely with the Government through TPIP-TPID and GNPIP in various regions. Such synergy and coordination include food market operations, inter-regional cooperation, and urban farming movement. The Ministry of Finance even provides fiscal incentives for regional governments that are successful in controlling food inflation. With close synergy and coordination, Bank Indonesia believes that core inflation will return to the target of 3±1% earlier in the first semester of 2023, with CPI inflation following suit at the beginning of the second semester of 2023 after the base effect of fuel price adjustments in September 2022 fades. Meanwhile, coordination to bolster priority sectors is strengthened with the support of Bank Indonesia, both in assessing the latest developments and issues that occur at the central and regional levels, as well as providing policy recommendations, including the view from regional area through the Regional Economic and Financial Assessment (KEKDA) conducted by Bank Indonesia representative offices in various regions. Bank Indonesia will also strengthen coordination and support in the development and improvement of MSME, and the sharia economy and finance, both nationally and in various regions. Macroprudential Policy Direction Bank Indonesia will hold its accommodative macroprudential policy stance in 2023 to increase bank lending to support the national economic recovery, while maintaining financial system stability. The direction of macroprudential policy remains based on the optimality of three targets, namely balanced intermediation, maintained financial system stability, and economic and financial inclusion (Scheme 9). In this case, Indonesia’s financial cycle has just begun in its upward phase following Scheme 9. Macroprudential Policy Direction in 2023 MACRO-FINANCIAL LINKAGES: OPPORTUNITIES AND CHALLENGES ECONOMIC GROWTH AND INFLATIONPERFORMANCE OF CORPORATE AND HOUSEHOLD NORMALIZATION OF FISCAL AND MONETARY POLICY EXCHANGE RATE VOLATILITY AND FOREIGN DEBT INCREASE OF SBN YIELD AND MARKED TO MARKET BALANCE SHEET MACROPRUDENTIAL POLICY "Pro Growth" Balanced Intermediation, Sound and Resilience Financial System, Economic-Financial Inclusion MACROPRUDENTIAL POLICY TRILEMMA BALANCED INTERMEDIATION MAINTAINED FINANCIAL STABILITY ECONOMIC AND FINANCIAL INCLUSION CREDIT SUPPLY TARGET CREDIT GROWTH AT 10-12%, MAINTAINED FINANCIAL SYSTEM STABILITY'S RESILIENCE AGAINST RISKS, AND GROWING MSMEs FINANCIAL SYSTEM STABILITY COMMITTEE (KSSK) Accomodative Macroprudential Policy Loosening all instrument of macroprudential policy and providing incentive on credit/financing provision to banks 1. Strengthening resilience and financial system stability risk's prevention Macro systemic surveillance on financial system stability Strengthening systemic surveillance on banks' resilience against liquidity risks, market risks (exchange rate and SBN yield), and credit risks Economic and Financial Inclusion Policy Expanding MSMEs Go Export and Go Digital program, as well as strengthening financial literacy and consumer protection on products under Bank Indonesia's licensing MIR RR Incentive MPLB LTV & DP CCyB RPIM 2. Increasing credit/financing to real sector 3. Financial sector reform Transparency of SBDK BANK BANK CREDIT DEMAND Policy Synergy CORPORATE MSMEs FINANCING Source: Bank Indonesia The relaxation of all macroprudential policy instruments and the provision of incentives for banks is pursued with the target of lending/ financing to grow by around 10-12% in 2023 to support further economic recovery, as well as to promote sustainable economic and financial inclusion. In this case, Bank Indonesia will continue with accommodative macroprudential policy stance by maintaining the CCyB Ratio at 0%, flexibility in fulfilling the MPLB ratio of 6%, where all SBN owned could be repurchased to Bank Indonesia, and the LTV/FTV ratio of 100% for property loans and down payment requirements of 0% for automotive loans for banks that meet the low NPL/NPF criteria, which will remain in effect until the end of December 2023. Macroprudential policies to revive bank financing, such as the Macroprudential Intermediation Ratio (MIR) and interest rate transparency will also be continued and their effectiveness will even be strengthened with the macroprudential supervision of banks. Moreover, accommodative macroprudential policy in the form of reserves requirement (RR) incentives will also be expanded to stimulate intermediation to economic sectors as part of Financial System Stability Committee (KSSK) policy coordination in national economic recovery. The formulation and implementation of this macroprudential policy will be adjusted to the the economic cycle that began to recover in the second quarter of 2022. Based on the historical trends of both cycles, Bank Indonesia predicts that the economic and financial cycles will continue to increase until reaching “boom” period in 20242025 for the economic cycle and in 2025-2026 for the financial cycle. Therefore, accommodative macroprudential policy stance will be maintained in 2023 and until mid-2024 as a countercyclical instrument to increase financing when the financial cycle is picking up, and then tightened when the financial cycle is nearing its peak to avoid potential risk to financial system stability. The push to increase bank lending though macroprudential policies will also be directed to the MSME and the green economy, thus supporting the expansion of economic inclusion and sustainable finance. Nevertheless, a number of short-term risks from macro-financial linkages demand vigilance and, therefore, systemic surveillance must be strengthened to avoid creating vulnerabilities in the financial system. The strengthening of systemic surveillance should be carried out by stress-testing the financial sector individually and as the system against liquidity risk from normalizing fiscal and monetary policy, market risk from Rupiah volatility, increases in monetary policy rates and SBN yields, as well as credit risk due to the possibility of an economic slowdown before restructuring has ended. 25. Indonesia's Financial Cycle and Macroprudential Intermediation Ratio Graph 25. Indonesia’sGraph Financial Cycle and Macroprudential Intermediation Ratio % -2 -4 -6 -8 -10 Indonesia's Financial Cycle 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 %, yoy -2 -4 -6 I II III IV I II III Third Party Funds Source: Bank Indonesia, OJK % Outlook of Third-Party Funds, Loans, and Macroprudential Intermediation Ratio (MIR) IV I II III Loan IV I II III IV MIR (rhs) I II III IV conditions of the priority sectors and the constraints faced by the bank in extending credit to these priority sectors. With the easing of macroprudential policy, Bank Indonesia is confident that Indonesia’s financial cycle will continue to increase, and credit needs for optimal economic growth will be met, with MIR even predicted to reach 84% in 2024 (Graph 25). Meanwhile, to support financial and economic inclusion, especially MSMEs, the Macroprudential Inclusive Financing Ratio (RPIM) policy will continue to improve in terms of implementation effectiveness, in the form of MSME clustering and corporatization in synergy with the Government, while fostering bank cooperation with MSME channeling partner institutions, as well as by developing MSME financing securities that can meet the requirements. Bank Indonesia also synergizes with the government to expand access to financing and develop MSMEs, including low-income and subsistence groups. Furthermore, Bank Indonesia is also synergizing with KSSK and related government ministries/institutions to continue in developing sustainable finance to support the transformation of the green financial system, including macroprudential policies that support green finance. The increase in lending/financing going forward is supported by both adequate supply capacity of banks and increasing corporate demand in line with the national economic recovery. As described above, the supply capacity of banks in terms of lending/ financing is supported by loose liquidity conditions, attractive lending rates, strong capital, improving lending requirements, favorable economic prospects, and accommodative macroprudential policy from Bank Indonesia. On the demand side, the increase in intermediation is supported by a continued recovery in corporate and household performance. Corporate performance is reflected by improvements in repayment capacity, sales, and capital expenditures, particularly in the trade and mining sectors. The improvement in corporate performance implies that the scarring effect of the Covid-19 pandemic is fading in line with the increases in mobility and economic growth. Furthermore, positive interaction between bank supply and corporate demand is evident from the growing number of economic subsectors in the positive credit growth and loose lending requirements quadrant (Quadrant I) in September 2022, namely 19 subsectors, compared to September 2021 with 16 subsectors. (Figure 18). The subsectors experiencing Figure 18. Improved Credit Growth and Lending Requirements CREDIT GROWTH & LENDING REQUIREMENT (LR) BY ECONOMIC SUBSECTOR SEPTEMBER 2021 ii Positive loan growth Accomodative LR Negative loan growth Accomodative LR Insurance and Pension Funds CREDIT GROWTH & LENDING REQUIREMENT (LR) BY ECONOMIC SUBSECTOR SEPTEMBER 2022 i ii Negative loan growth Accomodative LR Other Services Food Crops Fishing Mining of Coal and Lignite Manufacture of Metal and Electronic Product Plantations Manufacture of Leather & Footwear Products Other Services Information and Telecommunications Horticulture Public Administration Manufacture of Machinery and Equipment Financial Support Services Warehousing & Postal & Courier Transportation Support Services Construction Other Manufacturing Company Services Sea and Coastal Water Transport Manufacture of Furniture Car, Motorcycle Trade and Its Reparation Real Estate Mining of Metal Ores Land Transportation Wholesale and Retail Trade Manufacture of Wood Manufacture of Paper & Paper Products, Printing & Reproduction of Recorded Media Manufacture of Basic Metals Agricultural & Hunting Services Other Manufacturing Manufacture of Rubber & Plas�cs Products Inland Water Transport Accommoda�on and Food Service Ac�vi�es Manufacture of Transportation Equipment Water Supply Wholesale and Retail Trade Manufacture of Tex�les and Wearing Appareli Other Financial Services Agricultural & Hunting Services Warehousing & Postal & Manufacture of Machinery and Equipment Courier Transportation Air Transportation Support Services Insurance and Pension Funds Manufacture of Paper & Paper Products, Printing & Reproduction of Recorded Media Mining of Coal and Lignite Animal Husbandry Food Crops Financial Support Services Manufacture of Furniture Manufacture of Food Product & Beverages Horticulture Car, Motorcycle Trade and Its Reparation Manufacture of Chemicals and Pharmaceuticals Plantations Accommoda�on and Food Service Ac�vi�es Tobacco Processing Manufacture of Rubber & Plas�cs Products Fishing Manufacture of Tex�les and Wearing Apparel Forestry and Logging Company Services Financial Intermediary Services Real Estate Manufacture of Metal and Electronic Product Education Services Manufacture of Transportation Equipment Manufacture of Non-Metallic Mineral Products Mining of Metal Ores Forestry and Logging Manufacture of Basic Metals Land Transportation Manufacture of Leather & Footwear Products Inland Water Transport Sea and Coastal Water Transport Education Services LR Score LR Score Financial Intermediary Services Tobacco Processing Health Services i Public Administration Manufacture of Wood Manufacture of Food Product & Beverages Manufacture of Chemicals and Pharmaceuticals Animal Husbandry Other Financial Services Positive loan growth Accomodative LR Health Services Construction Information and Telecommunications Transport via Railway Air Transportation Water Supply Transport via Railway Manufacture of Non-Metallic Mineral Products iii Positive loan growth Tight LR Negative loan growth Tight LR Loan Growth iv iii Positive loan growth Tight LR Negative loan growth Tight LR iv Loan Growth Source: Bank Indonesia improvement included the nonmetallic minerals industry and the transportation equipment industry. On the other hand, the number of economic subsectors with negative credit growth and tight lending requirements (Quadrant III) decreased from 12 to 5 subsectors, including the transportation subsector (rail, sea, rivers, and lakes), water supply, as well as the rubber and plastic industry. Bank Indonesia views that banks can further relax lending requirements in subsectors with mitigated credit risk in line with improving corporate performance and future economic growth. Considering such developments and the synergic efforts that are continuously being carried out by the authorities, financial sector and corporate sector, Bank Indonesia projects credit growth in the range of 10-12% (yoy) function will continue to improve in line with the national economic recovery. This is evident from the Financial System Stability Index (FSSI) and the Financial System Vulnerability Index compiled by Bank Indonesia (Graph 26). Nevertheless, several short-term risks from macro-financial linkages need to be monitored so as not to create vulnerabilities in the financial system. The normalization of fiscal and monetary policies will reduce liquidity, although Bank Indonesia will ensure sufficient availability for banks to channel credit/financing to businesses and purchase of SBN from the primary market for the APBN financing. Rupiah volatility, coupled with increases in monetary policy rates and SBN yields will intensify market risk for banks, which will, therefore, need to strengthen risk management and reserves for possible losses that may arise. Likewise, credit risk to banks may increase due to the possibility of an economic slowdown before restructuring comes to an end. In this regard, KSSK coordination continues to be strengthened by conducting stress-tests on the financial sector individually and as the system against such risks. The results of these tests serve as the basis for the formulation of the policy and supervisory response required by each institution, namely the Ministry of Finance, Bank Indonesia, OJK, and LPS, in accordance with their respective authorities. In in 2023. Bank Indonesia will continue to strengthen synergy and coordination with the government and KSSK to revive bank intermediation to businesses to strengthen national economic resilience and recovery. KSSK policy coordination and supervision continues to be strengthened to maintain financial system stability, including in formulating joint efforts to mitigate the spillover effect of global turmoil. As noted, financial system stability is predicted to remain strong and the bank intermediation Graph 26. Stronger Financial System Stability and Resilience Index Financial Stability Index (FSI) 2.4 1.9 1.4 0.9 0.4 -0.1 -0.6 -1.1 Efficiency Intermediation Index Resilience FSI Financial System Vulnerability Index 1.0 0.8 0.6 0.4 0.2 - -0.2 -0.4 -0.6 -0,44 I II III IV I II III IV I II III IV I Balance Sheet Channel Source: Bank Indonesia II III IV I II III IV Risk Taking Channel I II III IV I II III IV I II III IV I II III Financial System Vulnerability Index addition, coordination in systemic surveillance within the framework of the Integrated Banking Supervision Forum between Bank Indonesia, OJK and LPS is routinely carried out. In addition to macromicroprudential policy synergy, Bank Indonesia and OJK continue to strengthen coordination in the provision of Short-Term Liquidity Loans and Sharia Short-Term Liquidity Financing (PLJP and PLJPS) by Bank Indonesia. Bank Indonesia and LPS also continue to coordinate to strengthen readiness to handle problem banks or bank resolution by LPS if required. The various measures taken to strengthen policy coordination and inter-authority supervision under the auspices of KSSK is the basis for further strengthening of prevailing laws and regulations. direction of payment system policy remains based on the implementation of Indonesia Payment System Blueprint (BSPI) 2025. Advancement of the national digital economy and finance has thus far provided opportunities and challenges to develop rapidly in the future, with a clear vision, strategy and actual digitalization program for the payment system in BSPI 2025, which is fully supported by the active participation of the industry through the digitalization of financial services and payments to consumers as well as accelerating public acceptance of fast, convenient, affordable, secure, and reliable digital payment transactions (Scheme 10). Nevertheless, we needs to remain vigilant about a number of challenges, including the rapid development of digital technology, which necessitates high investment costs, the scarcity of human resources, and cyber risks, as well as the rapid penetration of global financial digital players and the demands of international cooperation. In this regard, payment system policy in 2023 will continue towards accelerating and strengthening the integration of the national economic-financial digital ecosystem according to the first vision of the BSPI 2025, namely to be stronger and more competitive in international Payment System Policy Direction Payment system policy in 2023 will continue to be directed towards accelerating payment system digitalization for further integration in the national economic-financial digital ecosystem, developing Digital Rupiah, as well as expanding cross-border payment system cooperation. The Scheme 10. Payment System Policy Direction in 2023 NATIONAL DIGITAL FINANCE AND ECONOMY : OPPORTUNITIES AND CHALLENGES CLEAR VISION AND POLICY ON THE DIGITALIZATION OF THE NATIONAL PAYMENT SYSTEM ACTIVE INDUSTRY PARTICIPATION IN THE DIGITALIZATION OF FINANCIAL SERVICES AND PAYMENTS TO CONSUMERS ACCELERATION OF PUBLIC ACCEPTATION OF FAST, CONVENIENT, AFFORDABLE, SECURE, AND RELIABLE DIGITAL PAYMENT TRANSACTIONS DIGITAL TECHNOLOGY SPACE VS HIGH INVESTMENT COSTS, HUMAN RESOURCE SCARCITY, AND CYBER RISK PENETRATION OF GLOBAL DIGITAL FINANCE PLAYERS, THE NEEDS FOR INTERNATIONAL COOPERATION “Pro-Growth” Payment System Policy: National Digital Economic-Financial Integration, Digital Rupiah POLICY TRILLEM PAYMENT SYSTEM SOUND, COMPETITIVE, AND INNOVATIVE PAYMENT SYSTEM INDUSTRY PAYMENT SYSTEM INDUSTRY SOUND, EFFICIENT, AND FAIR 3I (INTEGRATED, INTEROPERABLE, INTERCONNECTED), SAFE, AND ROBUST MARKET PRACTICE PAYMENT SYSTEMS INFRASTRUCTURE Initiatives Indonesia Payment System Blueprint 2025 TARGET ACCELERATION OF NATIONAL DIGITAL ECONOMIC-FINANCE INTEGRATION, RUPIAH DIGITAL DEVELOPMENT, INTERNATIONAL PAYMENT COOPERATION Strong, Competitive, and Innovative of Payment System Industry Acceleration of regulatory reform and end-to-end consolidation of the payment system industry to build Indonesian unicorns that are strong, competitive, innovative, and ready to become Digital Rupiah “wholesalers” 3I Payment System Infrastructure (Integrated, Interoperable, Interconnected) Development of 3I (Integrated, Interoperable, Interconnected) retail and wholesale payment system infrastructure to accelerate national digital economic-financial integration and Digital Rupiah issuance Efficient, Healthy, Transparent of Payment System Pricing Policy Efficient, pro-business, and transparent payment system Pricing Policy in accordance with payment service clusters to support national interests, consumers, and industrial competitiveness nationally and regionally 3. BANK INDONESIA-OJK: STRENGTHENING OF ITSK REGULATION AND SUPERVISION (DIGITAL FINANCIAL INNOVATION) Digital Rupiah Design, Process, & Technology Finalization of conceptual design, development of business models and wholesaler participants, development of the Digital Rupiah technology platform 4. BANK INDONESIA-INTERNATIONAL: INTERNATIONAL PAYMENT COOPERATION AND DEVELOPMENT OF CBDC SYNERGY AND COORDINATION 1. BANK INDONESIA-GOVERNMENT: ELECTRONIFICATION OF SOCIAL ASSISTANT AND GOVERNMENT FINANCE 2. BANK INDONESIA-INDUSTRI: IMPLEMENTATION OF BSPI 2025 AND RUPIAH DIGITAL DEVELOPMENT BSPI Open Banking Retail Payment System Financial Market Infrastructure Data Regulatory, Licensing, and Supervisory Source: Bank Indonesia cooperation based on national interests according to the fifth vision of the BSPI 2025. Befitting the Youth Pledge of 28 October 1928, the policy direction was intended as the embodiment of “One Country, One Nation, and One Language” in the integration of the national economic-financial digital ecosystem. The aim is to optimize three goals, namely: (i) a healthy, competitive, and innovative payment system industry; (ii) 3I payment system infrastructure (integrated, interoperable, interconnected); and (iii) safe, efficient, and fair market practices. The optimization of the national economic-financial digital ecosystem is still based on accelerating banking digitalization according to the second vision, in collaboration with fintech and e-commerce according to the third vision, and encouraging innovation balanced with cyber security and consumer protection according to the fourth vision of the BSPI 2025. In its implementation, diversity in the capacity of participants, infrastructure, services, and payment instruments is still considered by prioritizing national interests in accordance with the principle of “Bhinneka Tunggal Ika” within the framework of the Republic of Indonesia. Payment system policy in 2023 will be instituted through 5 (five) main strategies that mutually strengthen national economic-financial digital ecosystem integration. First, the collaborative development of national standards as “One Language” of payment system services in collaboration between Bank Indonesia and the industry, as well as acceptance campaigns and their use by consumers in the public. Second, acceleration of regulatory reform and consolidation of the national payment system industry as “One Nation” in an end-to-end manner to build healthy, competitive, and innovative Indonesian unicorns, both nationally and internationally, and in the future ready to become a “wholesaler” in the issuance and circulation of Digital Rupiah. Third, further development of payment system infrastructure (retail and wholesale) with 3I (integrated, interoperable, interconnected) as “One Homeland” to accelerate the integration of the national economic-financial digital ecosystem and in the future as one of the prerequisites for the issuance of Digital Rupiah. Fourth, pricing policies and market practices of the national payment system industry that are safe, Scheme 11. Configuration of National Economic-Financial Digital Ecosystem in the Future Integr ated Financial Sector BI-RTGS WHOLESALE DIGITAL RUPIAH BI-SSSS SEK Industry BI-FAST UR ITA S BI-APS RETAIL DIGITAL RUPIAH IPT Retail & Institutional Investor E-Commerce & Fintech Source: Bank Indonesia Interopera bl e Retail Cross-border Payment efficient, and fair to support national interests, consumers, and industry competitiveness nationally and globally. Fifth, further development of Digital Rupiah as legal Central Bank Digital Currency (CBDC) in Indonesia through the finalization of conceptual design, development of business model including preparation of “wholesaler” participants, and development of technology platforms required for future issuance and circulation of Digital Rupiah (Scheme 11). The following is a further detailed explanation of the five main strategies. First, the development of national standards for national digital payment services in accordance with international best practices collaboratively between Bank Indonesia and the industry, and its public acceptance campaign will be expanded to accelerate integration of the national economicfinancial digital ecosystem. The success of Bank Indonesia collaboration with the industry in the preparation and use of QRIS as the only national QR standard in Indonesia will continue to be expanded both for public acceptance and the types of service. In 2023, QRIS payment service features will be expanded from QRIS Merchant Presented Mode (MPM), QRIS Customer Presented Mode (CPM) and QRIS Without Face-to-face (TTM), to QRIS Transfer Withdraw Deposit (TTS) and expansion of QRIS between countries as planned. The QRIS user target will be increased from 30 million to 45 million. Following the successful implementation cooperation with Thailand, the cooperation on QR code, Fast Payments, and Local Currency Transactions will be expanded, starting with the implementation of interoperability with Malaysia, a trial phase with Singapore, and preparations phase with the Philippines. Cooperation with other ASEAN countries will also be expanded as one of the achievements for Indonesia’s ASEAN Chairmanship in 2023, in addition to other countries, such as India and Saudi Arabia. The successful implementation of the Open API Payments National Standard (SNAP) in 2022 will continue to be expanded in 2023 and beyond. The number of participants which has currently reached 15 providers and payment services which has reached 324 types, will be augmented to all payment service provider (PJP) and 2,194 types of services towards becoming “One Language” in various payment services in Indonesia. Bank Indonesia will also collaborate with industry to develop national payment data management to support the national economic-financial digital ecosystem, while respecting data confidentiality and privacy. Such data management, includes the development of payment identification numbers (Payment ID), classification of data into public data, contractual data and/or with consumer consent, as well as confidential and/or personal data, as well as technology for the necessary data center. Second, Bank Indonesia will continue to encourage end-to-end consolidation of the national payment system industry to form healthy, competitive and innovative Indonesian unicorns, both nationally and internationally. As stated above, the rapid global financial digital penetration into various countries, including Indonesia, is happening, as well as the profileration of crypto currency and the dominance of digital technology by BigTech. The demand for cross-border payment cooperation has also increased in accordance with the agreement on the “cross-border payment roadmap” of the G20 countries as one of the concrete achievements of Indonesia’s G20 Presidency in 2022. Therefore, consolidation of the national payment industry is critical so that Indonesia is better prepared to face foreign penetration and to fulfill international commitments. With this regard, Bank Indonesia carried out regulatory reforms for the national payment system industry by appointing Payment System Infrastructure Providers or PIP (6 systemic PIPs and 3 critical PIPs) and granting licenses to three types of Payment Service Providers (PJP), namely systemic (10 PJPS), critical (20 PJPK), and general (350 PJPU), according to the criteria of size, interconnectedness, complexity, and substitutability (Figure 19). With similar criteria, participation in BI-FAST is also grouped into Direct Participants (21 PL) and Indirect Participants (56 PTL) considering the technology investment necessary. Bank Indonesia also encourages cooperation (business and/or ownership), both inter-PJPs and with e-commerce Figure 19. National Payment System Industry Classification The classification of Payment System Provider (PJP) and Payment System Infrastructure Provider (PIP) based on criteria in Bank Indonesia regulation concerning Payment System Article 34 which consists of 4 indicators namely size, interconnectedness, complexity, and substitutability Size Transaction performance/exposure to economic and financial activities Interconnectedness Interconnectedness among providers and its impact on payment system and financial system stability Complexity Complexity of activities and its impact on financial system stability and economy Substitutability Substitutability of PJPs/PIPs roles and its impact on financial system stability and economy Source: Bank Indonesia Source: Bank Indonesia companies, to form an end-to-end national economic-financial digital ecosystem, namely the digitalization of the digital payment services provided by banks, nonbank institutions and e-commerce to consumers. Consolidation of an integrated payment industry will create Indonesian unicorns that are healthy, competitive, and innovative, both nationally and internationally. Moreover, the arrangement and consolidation of the payment system industry is also very important going forward for Bank Indonesia to determine which PJPs meet the requirements to become a “wholesaler” in the circulation of Digital Rupiah. Third, the development of payment system infrastructure with 3I (integrated, interoperable, interconnected) will continue to accelerate and strengthen the national economic-financial digital ecosystem. Like toll roads, it is necessary to develop an urban ring road infrastructure for vehicle access from the city center to various destinations, and vice versa. Therefore, an end-to-end 3I payment system infrastructure is required, from wholesale (BI-RTGS) for deposit access to accounts at Bank Indonesia through retail infrastructure (BI-FAST, GPN, and SKNBI) to industry-developed payment channels according to the business model and public preference (Scheme 12). In addition to the convenience, speed, and security of payment services to and from consumers, the need for 3I is to strengthen the “unity in diversity” of the national payment system to support the revival of the national economy in the digital era going forward. The main focus of development in 2023 is on 3I retail payment system infrastructure (BI-FAST, SKNBI, GPN) and wholesale infrastructure (BI-RTGS). The initial phase of development will be carried out in 3I between BI-FAST and BI-RTGS, followed by 3I between BI-FAST, BI-RTGS and GPN. In addition, a study of the development of the Integrated Payment Interface (IPT) for interconnection between payment channels within the industry will be continued for implementation in the following year. Progress on 3I between the payment system infrastructure above is one of the prerequisites for the future issuance of Digital Rupiah. Fourth, pricing policy and market practices will continue to be developed to realize a sound, efficient, and fair national payment system industry. Amid increasingly widespread and complex digital payment system services, the current price scheme in the industry is significantly varied between the types of instruments, services, and PJPs. The pricing scheme even extend to various infrastructures and instruments. Pricing policies and strategies implemented by incumbent PJPs and new players has potentially lead to to unfair competition. These Scheme 12. The Future of Payment System Infrastructure Interconnection FRONT END Consumer Acquiring Services Merchant Payment Channels Cheque/BG ATM/Debit Card Nonbank EM Digital Payment Cash Payment Bank Notes and Coins IPT4) QR 1) Mobile & Internet including QR (static & dynamic) Settlement National Retail SP Infrastructure Proxy Address & ID Repository Digital Payment ID Clearing SKNBI ATM E-Wallet Switching Aggregator 2) API Consumer3) Debit Transfer Public Infrastructure EDC / POS Credit Card Bank Electronic Money (EM) Credit Transfer Data Hub Center of Retail Payment Services Payment Aggregator Agent (i.e. LKD, Laku Pandai) Flow of funds in the management of BI-FAST settlement funds CeBM via BI-RTGS National Payment Gateway Switching Services Institution International Payment System Network Provider (i.e. Visa, Master Card, WechatPay)5) Central Bank Industry 1) Quick Response Indonesia Standard (QRIS) 2) As long as IPT and BI FAST are not ready to process based transactions mobile then the processing of card and mobile transactions will go through the GPN 3) Includes individuals, corporations, and governments BI-FAST Simple Authentication Instrument Retail Payment BACK END Single Interface End User MIDDLE Industry Arrangement Settlement Bank Global Player 4) Integrated Payment Interface 5) Cross Border transaction data will be passed through the Integrated Payment Interface before to the International Payment System network provider in the context of capturing data Source: Bank Indonesia various factors cause payment services in Indonesia to be inefficient and the industry is less competitive, thus creating a burden to the public. It is necessary, therefore, to reform the payment system pricing policy in Indonesia to serve the national interest and the consumers, while still encouraging business continuity, competitiveness, and innovation nationally and globally (Scheme 13). To that end, the pricing policy will be pursued through three pillars. The first pillar will be regulator-led policy of Bank Indonesia, particularly for systemically important payment system with the infrastructure provided by Bank Indonesia, national interest and the people, including for government programs. Scheme 13. The Direction of Payment System Pricing Policy CHALLENGES 1. DIGITAL PAYMENT SYSTEM SERVICES ARE BECOMING MORE FRAMEWORK PRICING PAYMENT SYSTEM POLICY END STATE WIDELY USED AND COMPLEX • National Interest PRICING POLICY PILLARS AND NEW PLAYERS POTENTIALLY • Consumer Interests • Regulator-led Pricing Policy LEAD TO UNFAIR COMPETITION • Business Continuity 2. PRICING POLICY STRATEGIES APPLIED BY INCUMBENT PJPs GENERAL PRINCIPLES • Transparency 3. THE PRICING SCHEME EXTENDS TO VARIOUS INFRASTRUCTURES • Collaborative Pricing Policy • Industry-led Pricing Policy POLICY STRATEGY • Determination of Payment System Pricing Scheme EFFICIENT, • Oversight of Payment System Pricing Implementation AND FAIR AND INSTRUMENTS THE SCOPE OF PAYMENT SYSTEM PRICING REGULATION MANDATE OF BANK INDONESIA REGULATION CONCERNING PJP & PIP Bank Indonesia sets will determine the general principles of payment system pricing scheme which must be complied by PJPs and PIPs SOUND, • Report of Payment System Pricing Scheme • Fund Transfer Fees • Transaction Fees • Administrative Fees MARKET PRACTICES IN PAYMENT SYSTEM INDUSTRY MAINTAINING THE HARMONY OF TRILEMMA: NATIONAL, CONSUMER, AND INDUSTRY INTERESTS Source: Bank Indonesia Fifth, Bank Indonesia will continue to develop the Digital Rupiah as the only legal digital tender in Indonesia for various digital economic and financial transactions. Considering the advancement in 2022 in Indonesia and internationally, including through cooperation in the G20 forum, IMF, and BIS, the Digital Rupiah development plan in 2023 will cover the following three aspects. First, the conceptual design, which is currently in the finalization stage, will soon be published as a consultative paper for inputs from the industry and public (Scheme 14). In addition, Bank Indonesia is planning to build a technology platform for the Digital Rupiah Vault or “Khazanah Digital Rupiah (KDR)”, Distributed Ledger Technology (DLT) or blockchain technology for its issuance, as well as establish several banks and nonbanks qualified as “wholesalers” that will be appointed to be able to circulate Digital Rupiah for the public. We view the selection of the Digital Rupiah “wholesaler” business model as more appropriate for Indonesia, as Bank Indonesia will focus more on its authority as the central bank for the issuance and distribution of Digital Rupiah. The second pillar will be determined by Bank Indonesia in collaboration with industry associations (collaborative regulator and industry policy), particularly on inter-industry payment services that require technology investment costs. Third pillar will be determined by industry associations themselves (industry-led policy), namely on payment services from the industry to consumers that require innovation and marketing costs. The three pillars of the pricing policy will be implemented in accordance with similar payment service clusters to simplify, harmonize, and simultaneously reduce transaction costs in digital payment systems. Therefore, the pricing scheme needs to continue providing attractive and profitable incentives for the industry to continue investing and innovating, without burdening the consumer. Strengthening risk management and payment systems supervision will also continue to be pursued, particularly in the implementation of cyber security and resilience, as well as strengthening compliance with the principles of Anti-Money Laundering and Prevention of Financing of Terrorism (AML/CFT). Scheme 14. The Direction of Future Digital Rupiah Development CENTRAL BANK BI-RTGS WHOLESALE PLATFORM BI-FAST BANK INDONESIA One-tier Digital Rupiah Issuance Rupiah Digital Issuance wholesaler to member Redemption Issuance of Digital Rupiah directly to end users (future development) DAD* Cash Ledger Securities Ledger Two-tier Digital Rupiah INTERMEDIARY (BANK AND NONBANK) Distribution and Collection of retail Digital Rupiah through: 1. wholesaler – end user 2. wholesaler – retailer – end user NBFI BANK NBFI BANK Transfer Digital Rupiah transaction validation & settlement is carried out through web platforms, applications, and wallets (both online and offline transactions) NBFI BANK RETAILER Cash Ledger : Digital Rupiah ledger component that END USER records on the cash side Source: Bank Indonesia Securities Ledger : Digital Rupiah ledger component that RETAIL PLATFORM records on the securities side Cash Ledger Consumers Merchants Businesses * DAD = Digital Asset Depository Meanwhile, its utilization for various “retail” digital economic and financial transactions by the public will be left to the banks and nonbanks appointed as “wholesalers”. Second, the availability of a 3I (integrated, interoperable, interconnected) payment system and money market infrastructure, particularly at and among the large banks and nonbanks that will be appointed as Digital Rupiah “wholesalers”. This is substantial as the “wholesalers” form a network through DLT technology or blockchains with Bank Indonesia and among themselves so that they can play a role in “retail” distribution to the public. Third, the selection of a technology platform that is compatible with a number of platforms currently being developed by central banks and international institutions. This is because in the end, the Digital Rupiah must also be able to connect with Central Bank Digital Currency (CBDC) issued by other central banks with the mechanism of determining the exchange rate through digital technology. Several technology platforms are currently being developed under international cooperation, such as the Dunbar project by BISIH Singapore, MAS, BNM, RBA, and SARB, and the mBridge project by BISIH Hong Kong, HKMA, BOT, PBoC, and CB-UAE. Ultimately, the interconnection of CBDCs between countries requires policy and regulatory agreements between participating central banks, among others related to the mechanism for determining exchange rates, managing foreign capital flows, monitoring both transactions and operational technology, including resilience to cyber attacks. Today, we are launching the Digital Rupiah “white paper”, which we named “Project Garuda”, as a step to preserve the sovereignty of the Rupiah in digital ecosystem. This “white paper” contains the fundamental premise and roadmap to be taken (Figure 20). The Garuda Digital Rupiah Project will be implemented in several phases. The first phase will start with “wholesale-Digital Rupiah” for the use cases of issuance, redemption, and interbank fund transfer. In the second phase, the wholesaleDigital Rupiah will be expanded with use cases that support monetary operations and financial market development. The third stage we will develop an integrated end-to-end interaction between wholesale and retail-Digital Rupiah. Collaboration and synergy on national and international level is critical to the development of Digital Rupiah. Figure 20. Digital Rupiah Development Roadmap R-CBDC wholesaler to retailer R-CBDC direct from the central bank interbank fund transfer Digital Rupiah DIGITAL RUPIAH Digital Securities Bank Indonesia Digital Rupiah W-CBDC platform Bank Indonesia Digital Rupiah 3I Converter with RTGS W-CBDC platform Bank Indonesia Digital Rupiah and Digital Securities 3I Converter with FMI (multimatching CCP) 3I Standard for BI-APS, BI-RTGS Gen3 and BI-SSSS Gen3 Appointed wholesaler to share node with Bank Indonesia (no node) Appointed wholesalers by sharing nodes with Bank Indonesia or to use their respective nodes Digital Rupiah Bank Indonesia Digital Securities ASSET INFRASTR ITAL UCT DIG UR E Interbank money market and monetary operation are connected to CCP SE CA H IA R UP GE R L ED ITA L IG SH -D CA W Issuance & redemption SE U AH PI ES RU RITI ER L G ITA CU D IG SE LE -D H & W S CA D TE D RA -EN H G TE TO PIA C IN D- RU BD ENTAL R-C I IG TO -D C W CBD Distribution, Collection & P2P W Non Bank Indonesia Digital Securities W-CBDC Bank Indonesia platform for other use cases 3I standard for all FMI (seamless connection) R-CBDC Platform 2 tier & 1 tier BI DLT Gateway Wholesalers and/or retailers to prepare distribution mechanisms to retailer users IN D U ST RY 3I standard setup for other FMI infrastructures IMMEDIATE STATE INTERMEDIATE END STATE Source: Bank Indonesia In addition to the five main strategies, Bank Indonesia will also continue to strengthen synergy and coordination with the Government (central and regional), banks, and associations in the payment system, fintech and e-commerce. Coordination with the Government (central and regional) is primarily directed at expanding the electronification of regional government financial transactions by strengthening Task Force for Acceleration and Expansion of Regional Digitalization (TP2DD), encouraging the distribution of Government to Person (G2P) 4.0 social assistance program, and expanding electronification and integration between transportation modes. Likewise, the digitalization of MSMEs and tourism will be intensified through Proud of Indonesian Product National Movement Synergy with banks, payment system associations, fintech associations, and other associations continues to be strengthened both in expanding various existing payment system digitalization programs, such as QRIS, SNAP and BI-FAST, as well as expanding services to the wider community. It has become a principle of Bank Indonesia that payment system policies, regulations and supervision are formulated and implemented together with the industry (industry-friendly policy). (Gernas BBI) and Proud Travelling #DiIndonesiaAja (BWI) movement in various regions and at the main tourism destinations, as determined by the Government. The synergy and coordination of regulation and supervision of the digitalization of payment system by Bank Indonesia with the digitalization of financial institutions by OJK will be further strengthened, including for crypto asset transactions, sandbox development, the Financial System Technology Industry, digital financial literacy and consumer protection, as well as cyber security. effectiveness of monetary policy operations and transmission, which will be increasingly integrated with the creation of a modern and efficient money market, as efforts to support financing for the national economy. The direction of money market deepening remains consistent with the goals and programs in the Money Market Development Blueprint (BPPU) 2025, namely to build a modern and international-standard money market, and support the transformation of monetary management that is integrated with the money market (Scheme 15). The Money Market Deepening Policy The money market deepening policy in 2023 will continue to be directed at strengthening the Scheme 15. The Policy Direction of Money Market Deepening in 2023 STRENGTHENING INTEGRATED MONETARY OPERATION STRATEGY OPTIMIZATION OF FOREIGN EXCHANGE RESERVE ASSET MANAGEMENT MONEY MARKET AND FOREIGN EXCHANGE MARKET DEEPENING SINERGY & COORDINATION Money Market Deepening Policy “Pro-Growth” : Integrated, Modern, Efficient MAIN INITIATIVES Promote Digitalization & Strengthening of Financial Market Infrastructure Trading Venue/BI-ETP Repo Central Counterparty IndONIA dan JIBOR Develop Economic Financing Sources & Risk Management Long Term Hedging BI-SSSS Overnight Index Swap BI-RTGS DNDF Retail Investor LCS Asset Securitization COORDINATION FORUM FOR DEVELOPMENT FINANCING THROUGH FINANCIAL MARKETS (FK-PPPK) TARGET PARTICIPANT Consolidation of monetary operation participants and market participants having classification primary dealer (PD) into systemic, critical, and general in line with SIFIs, cross-border and future “wholesalers” 1. Stabilization of Financial Market PRODUCT Accelerating the development of strategic money market instrument for effective monetary policy instrument, rupiah stability, hedging and short term financing 2. Development of Economic Financing Instruments PRICING Developing efficient market mechanism to support interest rate structure formation (IndONIA and Repo), exchange rate (DNDF), and hedging (interest rate swap and exchange rate) 3. Financial Literacy and Consumer Protection INFRASTRUCTURE Infrastructure of monetary operation, money market and payment system which are 3I (integrated, interoperable, interconnected) as pre-requisite for CBDC Sustainable and Green Financing Trade Repository Source: Bank Indonesia Strengthen Effectiveness of Monetary Policy Transmission BPPU INTEGRATION OF MODERN AND EFFICIENT MONEY MARKET WITH MONETARY MANAGEMENT TO IMPROVE MONETARY OPERATION TRANSMISSION AND ECONOMIC FINANCING (Rupiah and foreign exchange) and bond market stability, particularly the derivative instruments, such as DNDF, repo as well as exchange rate and interest rate swaps, without compromising the development of other financial instruments. Fourth, strengthening efficient market mechanisms in the formation of interest rate structures (IndONIA and Repo), exchange rates (DNDF), and hedging (interest rate and exchange rate swaps) to strengthen monetary policy transmission and financial market stability. development focus will remain on three aspects of an efficient money market (3P), namely products, participants, and pricing, as well as 3I infrastructure (integrated, interoperable, interconnected) between the money market and the payment system. More emphasis will be placed on the 3I aspect between infrastructure, participants, and instruments in supporting the integration of Bank Indonesia monetary operations with money market deepening. With this in mind, the money market development policy in 2023 will be focused on the following four main programs. First, the 3I development between Bank Indonesia’s monetary operations infrastructure with money market infrastructure to further strengthen monetary policy transmission effectiveness and accelerate the modernization of First, 3I (integrated, interoperable, interconnected) development of Bank Indonesia’s monetary operations infrastructure with the money market infrastructure to further strengthen monetary policy transmission effectiveness and accelerate the modernization of the Indonesian money market. In this regard, Bank Indonesia will continue to finalize the Conceptual Design (CD) for the development of 3I money market infrastructure with the payment system, including BI-APS, BI-SSSS, BI-RTGS Gen-3, and Trade Repository (Scheme 16). Bank Indonesia will prioritize infrastructure development for the modernization of monetary operations, the BI-APS, the Indonesian money market. Second, consolidation of monetary operation participants where money market players will be classified into strategic, critical, and general according to the criteria of systemically important financial institutions (SIFIs), in line with the classification of the payment system industry (SIPS). Third, the development of money market instruments to support money market Scheme 16. 3I Development Direction for Money Market Infrastructure, Monetary Operations, and Payment Systems Moving Forward BANKING SYSTEM Customer FOMOBO/Swift Multimatching System Intervention: Spot, DNDF BANK BANK Order Nonbank Rp Member Bank OIS Forex BANK IRS Repo SBN Swap DNDF Forward Spot MO Rupiah: Repo, RR-SBN Agent Bank • Issuance auction of SBN/SBSN/SUKBI, others REFINITIV Member Bank Bloomberg 360T Monetary Operation (MO) & other auction • MO FX: FX Term Deposit, FX SBBI • Issuance auction: SBN /SBSN FX BANK Data/Information Flow • Standing Facilities: DF & LF Member Bank Nonresident Transaction Flow MO FX : FX Swap BI BANK BANK BANK BANK Call money Repo OIS IRS Other Money Market Spot DNDF Forward FX Swap Other FX Market Market Info: • Market Rate • Market liquidity Benchmark Price & Monetar Operation Result: • Volume & Repo o/n rate • Volume & rate OIS • JISDOR CCP: DNDF, Repo, OIS, IRS Trade Repository Secondary SBN auction o.b.o. BI-APS Government Monetary Operation (MO) BI the Gov't: • Buyback • Debt switching BI RTGS BI SSSS Omni Data Repository (INDRA) ANTASENA Source: Bank Indonesia which will be followed by other infrastructure, particularly the modernization of the BI-SSSS, which facilitate the use of SBN as underlying for repo transactions and other money market derivative products. Regarding money market infrastructure, Bank Indonesia strengthen collaboration with the industry in developing a Central Counterparty (CCP) for SBNT (interest rate and exchange rate) derivative market on a netting basis (CCP SBNT), in addition to expanding money market transactions through ETP Multimatching both for the Rupiah and foreign exchange money markets. Bank Indonesia emphasizes the need for 3I between monetary operations infrastructure, BI-APS, and money market infrastructure, CCP SBNT and ETP Multimatching due to several considerations. First, this will enable Bank Indonesia to become a participant in money market transactions, without compromising Bank Indonesia’s ability to carry out direct monetary operations as it has thus far. Bank Indonesia participation in the market will clearly increase transactions and the depth of the money market in Indonesia. Second, effectiveness of the policy rate transmission to the money market and SBN market will be strengthened by Bank Indonesia participation and the increasing number of money market transactions, including the formation of the interest rate structure arising from these transactions. Money market efficiency will increase. Third, 3I monetary operation and market infrastructure will also be one of the prerequisites for the issuance and circulation of Digital Rupiah as described previously. Thus, in the future, monetary operations and transactions in the money market will be carried out either through the existing transfer mechanism between bank accounts, or directly through the Digital Rupiah. Second, Bank Indonesia will consolidate monetary operations and money market participants by grouping them according to the size and the importance in accordance with systemically important financial institutions (SIFIs). To the date, participants in monetary and money market operations are heterogeneous in terms of transaction size, institutional capability, and risk management. This has potential to create money market segmentation, resulting in underdeveloped transactions and inefficient market mechanisms due to the magnitude of risk, including liquidity risk, market risk, credit risk and operational risk. The classification of participants into systemic, critical, and general based on 4 (four) main criterias in accordance with the BIS, namely: size, interconnectedness, complexity, and substitutability, therby consistent with international standards, similar to the determination of systemic banks. Similiar approach has been applied by Bank Indonesia in classifying the PJPs into systemic, critical, and general PJPs as well as determining direct and indirect participants in BI-FAST. The fourmain criteria approach, will also be applied to the classification of Primary Dealers (PDs) as participants in monetary operations and money market players. Moving forward, there will be convergence in the classification of financial institutions as systemic banks and as participants in monetary operations, payment systems and money markets, namely into systemic, critical, and general. This convergence of participants is critical not only to accelerate the consolidation of money market and payment system players, but also for Bank Indonesia in terms of conducting supervision with approaches and criteria that comply with international standards. Moreover, the classification is also very important for Bank Indonesia moving forward when determining which participants meet the requirements to become wholesalers in the issuance and circulation of Digital Rupiah. Third, the development of money market instruments that support money market (Rupiah and foreign exchange) as well as bond market stability without compromising the development of other financing instruments. Currently, the underdeveloped short-term money market drives high liquidity risk, market risk (exchange rate and interest rate), and credit risk in the financial market. Despite the development of derivative instruments in the foreign exchange market, such as DNDF and swaps as exchange rate hedging instruments, transaction volume remains limited and mostly dominated by Bank Indonesia monetary operations with limited tenors of up to 3 months. The volume of swaps, as an interest rate hedging instrument, is still also limited. The volume of repo transactions with underlying SBN in the money market remain limited, as are short-term securities, such as Commercial Papers (SBK). Therefore, Bank Indonesia will focus more on developing instruments and increasing the volume of money market transactions, thus more efficient to nurture (portfolio and FDI) investment and simultaneously strengthen the effectiveness of monetary policy transmission in Indonesia. Meanwhile, the development of economic financing instruments for the economy will also continue to be strengthened through three policy strategies, namely: (i) developing asset securitization through the asset-backed securities-collective investment contracts (KIK-EBA) and asset-backed securities-participation note (EBA-SP) programs; (ii) developing retail investors and financial literacy on a regular basis; and (iii) strengthening coordination and communication in the development of the Sustainable Green Finance (SGF). These various financial market deepening policies will certainly be supported by a close synergy between Bank Indonesia, Ministry of Finance, OJK, and LPS within the Coordination Forum for Development Financing through Financial Markets (FK-PPPK). In this regard, various programs continue to be improved to increase the use of Local Currency Transaction (LCT) framework in facilitating trade and investment with partner countries, by strengthening synergy and coordination with other relevant authorities. The LCT campaign continues to be broadly expanded for the use of LCT Appointed Cross Currency Dealers (ACCD) to banks, corporations, and other potential users, in collaboration with relevant agencies at home and in partner countries. Included in this program is the implementation of the non-USD/IDR reference rate for the development of derivative instruments within the LCT framework. In addition, Bank Indonesia will also strengthen transaction regulations in the foreign exchange market by simplifying and integrating regulations to encourage market deepening and support financial system stability. Money market regulatory reform will simplify provisions according to a principle-based approach to increase implementation flexibility and effectiveness for market participants. Inclusive and Green Economic-Financial Policy Bank Indonesia continues to strengthen its MSME development program to promote MSME as the pride of Indonesia, Go Export and Go Digital. Bank Indonesia consistently implements MSME development programs to create a value added contribution in controlling inflation and in increasing foreign exchange from exports. The MSME development programs are implemented through 3 (three) policy pillars, namely corporatization, capacity building, and financing in order to enhance MSME’s competitiveness. The corporatization is carried out through the strengthening of formal institutions, the expansion of partnerships, as well as the development of business models for the creation of new entrepreneurs. Capacity building is focused on creating end-to-end capacity building supported by digitalization to increase production, enhance financial management and expand of market access. Market access is unlocked through product certification and curation, promotion of international trade, and fostering interconnections with the local value chain (LVC) and global value chain (GVC). The Karya Kreatif Indonesia (KKI) event, which encourages MSME to Go Export and Go Digital, continues to be improved, as well as synergy with the Goverment in the successful Gernas BBI and Bangga Berwisata #DiIndonesiaAja (BWI) movement involving all 46 Bank Indonesia representative offices. Meanwhile, MSME access to financing is facilitated to support compliance with inclusive financing regulations, among others through mapping the trends of MSME financing via multiple e-commerce channels and partnerships, as well as facilitating business matching. Bank Indonesia will also support the green MSME campaign, beginning with studies and pilot projects to hone existing practices. Bank Indonesia continues to support the growing role of the sharia economy and finance as a new source of economic growth. Implementation of a halal value chain ecosystem, both locally and internationally, is being expanded in terms of the participants, institutions and supporting infrastructure. Halal value chain ecosystem development will continue to prioritize the leading sectors of halal food and modest fashion. In terms of sharia finance, sharia money market deepening is pursued through, among others, development of foreign exchange transaction instruments and the Inclusive BI Sukuk. Support to increase the optimization of sharia social finance as an alternative source of financing for the major sectors of the sharia economy continues to be encouraged, especially through productive waqf. In addition, business linkages through a series of Sharia Economic Festival (FESyar) events in three regions (Java, Sumatra, Eastern Indonesia) and the international Indonesia Sharia Economic Festival (ISEF) event will continue to be facilitated. The center of excellence for the sharia economy and finance is also being improved continuously through higher education as an important part of implementing strategies for increasing public literacy. To that end, Bank Indonesia continues to strengthen synergy with various parties, both within the National Sharia Economy and Finance Committee (KNEKS) as well as with Islamic boarding schools (pesantren), the Sharia Economic Community (MES), business associations, banks, as well as scholars, academics and the wider community. Bank Indonesia strengthen policy synergy with the Government to support a sustainable economy characterized by a stable, inclusive, and green financial system. In response to the future challenges associated with climate change, which could threaten economic stability, and as Bank Indonesia’s active contribution in achieving the low-carbon target, Bank Indonesia carry out a comprehensive transformation by strengthening green finance policies. Bank Indonesia continues to conduct studies on green macroprudential policies to support sustainable finance, while accelerating financial market deepening through the development of green money market instruments. The manifestation of a green and inclusive economy and finance continues through, among others, the development of a circular economy business model, green farming, and green financial reports for MSMEs and sharia economic players. In addition, Bank Indonesia continues its institutional transformation, encompassing governance, risk management, strategies, and green performance indicators. In its development and implementation, Bank Indonesia will continue to synergize and coordinate closely with KSSK, ministries/institutions, and relevant stakeholders. International Policy Following, the success of Indonesia’s G20 Presidency in 2022, Bank Indonesia commits to support the success for Indonesia’s ASEAN Chairmanship of Indonesia in 2023 in close synergy with the Government, with focus on financial integration track. In this regard, Bank Indonesia will fully support the continuation of the 6 (six) priority agendas in the Finance Track of the 2020 G20 Indonesia’s Presidency, with the theme “Recover Together, Recover Stronger” for the priority agenda of ASEAN Financial Integration, under the Chairmanship of Indonesia in 2023 with the theme “Recovery-Rebuilding, Digital Economy, Sustainability”. In the first pillar “RecoveryRebuilding”, the G20 priority agenda “Addressing Exit Policy Spillovers and Scarring Effects” will be the agenda for the ASEAN Chairmanship in 2023 with High-Level Policy Dialogue and Technical Level Discussion on Exit Policy Spillovers, Scarring Effects, and the Macroeconomic Policy Mix (IMFIntegrated Policy Framework and BIS-MacroFinancial Policy Framework). In addition, increasing ASEAN cooperation in the application of the Local Currency Transaction (LCT) Framework is carried out by, among others, strengthening authority support/incentives, relaxing regulations, financial market infrastructure, and LCT linkages with crossborder payments. For the second pillar, the “Digital Economy”, Bank Indonesia will raise the G20 agenda Scheme 17. ASEAN Payment System Connectivity Moving Forward ASEAN-5 Payment Connectivity VISION: ASEAN PAYMENT CONNECTIVITY General understanding for infrastructure interlinkage Mission General understanding for regulatory and supervisory framework on cryptoasset & data policy STRATEGY SYNERGY AMONG CENTRAL BANKS Widening of QR payment partnership Enablers Interlinking Fast payment Standardizing API RTGS interlinking Data framework Data framework ACCD-based Local Currency Settlement (LCS) Local Currency Bilateral Swap Agreement (LCBSA) Source: Bank Indonesia “Advancing Payment Connectivity and Promoting Digital Financial Inclusion and Literacy” in ASEAN. In this regard, Bank Indonesia will focus on Advancing ASEAN Payment Connectivity with the CrossBorder Payments Linkage collaboration, namely QR and fast payment connectivity with LCT, which was inaugurated by the President of the Republic of Indonesia at the G20 Leaders’ Summit in Bali on 14 November 2022 (Scheme 17). In addition, there will be a High-Level Policy Discussion to support CBDC Initiatives, Promote Digital Financial Inclusion and Literacy to strengthen Digital Financial Literacy in ASEAN, including implementation of the Digital Financial Inclusion Festival, a High-Level Regulatory and Supervisory Discussion on Crypto Assets and Cybersecurity and the implications for WC-ABIF Guidelines to Incorporate Digitalization. Policy Discussion and Seminars addressing Climate Related Risk are also scheduled. In addition to the ASEAN Chairmanship in 2023, Bank Indonesia continues to pursue active participation in various international cooperation forums to support national economic recovery. Strengthening international cooperation is also continuously carried out at the multilateral, regional and bilateral levels in relation to the International Financial Safety Net, Local Currency Transactions (LCT), Payment Systems and Digital Financial Innovation, Anti-Money Laundering and Prevention of Terrorism Financing, as well as Structured Bilateral Cooperation with central banks and other international institutions. Bank Indonesia continues to increase the positive perception of investors and rating agencies through more proactive engagement activities. We also continue to play an important role in facilitating the promotion of trade and investment in priority sectors through support from the Investor Relations Unit (IRU) at the regional, national, and international levels. Bank Indonesia will carry out a massive campaign to encourage and expand the use of LCT, including through outreach activities to potential business actors in collaboration with the overseas and domestic Bank Indonesia representative offices, and other strategic partners. Institutional Transformation Policy monetary management integration with money market deepening in accordance with BPPU 2025, as well as optimizing the management of adequate reserve assets. Macroprudential policy transformation emphasizes strengthening macro-financial linkage modeling, an integrated macroprudential policy response with systemic surveillance, developing macroprudential policy instruments for bank lending/financing to the business sectors, as well as the readiness of shortterm liquidity assistance/sharia short-term liquidity assistance if necessary. Meanwhile, payment system policy transformation will remain focus on continuing payment system digitalization in accordance with BSPI 2025 and further development of the Digital Rupiah. Bank Indonesia will continue to undertake comprehensive institutional transformation to build a credible central bank, with excellent performance, good governance and transparent. The policy, organizational, human resources and digital transformation, which have been initiated since 2018, will be strengthened further and hones to realize the vision of become the foremost digital central bank that creates a tangible contribution to the national economy and the best amongst emerging market countries towards Advanced Indonesia. To improve the policy mix response in terms of strengthening economic resilience, recovery, and revival from the impact of global turmoil, policy transformation is focused on strengthening the Bank Indonesia policy mix framework, macroeconomic and financial system modeling, and striking an optimal policy mix response. Strengthening monetary policy transformation emphasizes the formulation of an optimal interest rate policy response, exchange rate stabilization and twist operations, along with Organizational transformation is directed at strengthening the implementation of a framework for institutional excellence and strengthening the digitalization of policy and institutional work processes. The existing implementation of assessments underlying the institutional Scheme 18. Bank Indonesia Digital Business Process Reengineering Illustration: Generic Business Process Reengineering Board of Governor (BoG) Monthly Meeting Drafting of Department Level Material (Hybrid) Layer 1 Layer 2 Recommendation Approval IK N Initial Coordination Meeting The Committee meeting minutes (Policy decision recommendation points) Follow-Up and Monitoring Coordination for follow-up actions using Digital Workplace Assignment Management featuring Committee Meeting BoG Members, Policy Departments, material drafting team, relevant Departments Data Gathering -Assessment -Formulation of Recommendations Decision Points BoG BoG Meeting NFT/TES Drafting of material and executive summay of RDG 1. Meeting Minutes of RDG 2. Policy Decision Items MEMORANDUM Assigment Report JS </> {. ..} Data Gathering E-Doc: Meeting Minutes Approved by the Head of Department Policy Departments Related Departments Main Policy Department Source: Bank Indonesia Follow-up actions report (Memorandum) L XM RINGKASAN EKSLUSIF + C+ Digital Workplace Collaborative work of main policy Departments: 1. Monetary Sector 2. Macroprudential Sector 3. Payment System Sector Consolidation of material and main policy formulation by policy coordinator Department Approval of the Executive Summary by the relevant BoG member 1. Communication, collaboration, & productivity 2. Meeting management 3. Document management 4. Assignment management 5. Email 6. Data analytics 7. Virtual meeting platform Executive Summary proposed to the BoG Drafting of policy decision items and minutes meeting of RDG Assignments to follow-up Data Center Bank Indonesia Policy Mix Committee Board of Governor Meeting and Follow-up Action policy response based on Effective, Efficient, and Governance (2EG) through the quarterly Board of Governors Meeting on Institutions will be strengthened with methodologies for measuring the effectiveness of the correlation between performance indicators and work processes, the efficiency of important budget items with the achievement of performance indicators, strengthening future strategic risk measurement and mitigation as well as internal audits. Strengthening of work processes, risk management, and the management of major projects continues for both information system projects and physical projects. Meanwhile, the implementation of Digital Business Process Re-engineering (Digital BPR) in the formulation of the policy mix that has been successful in the departmental level to the Board of Governors Meeting will be expanded with Digital BPR within the departments by creating “digital collaborative work”, which will start from the policy formulation department, strategic management, and human resources (Scheme 18). With Digital BPR, the work process has been shortened from eight stages to four from work units at the departmental level to decision-making at the Board of Governors Meeting. Hybrid work will also be maintained as it is more effective and efficient in managing resources and achieving performance. Digital transformation for policy and institutional work processes will be accelerated based on the Master Plan for Digital Innovation in Bank Indonesia (RIVIBI) towards the vision of becoming the foremost central bank. Digitalization of Bank Indonesia includes three important interrelated and mutually strengthening parts (Scheme 19). First, the digitalization of work processes, including policies and institutions as described above. Digitalization of work processes allow work collaboration to be faster, more effective and efficient, and allows working virtually from home or different other places. Second, data digitalization to enable users to experiment and innovate on their own (customer experience) for instant, interactive, and multidimensional uses for policy analysis and formulation. End-to-end data digitalization and innovation, starting from structured data inputs and big data technology, Scheme 19. Digital Transformation at Bank Indonesia Configuration of IT Use Case(s) for Core Policy and Institutional Business Process EXTERNAL OMNIDATA INTELLIGENCE EXTERNAL PLATFORM Customer Platform Omni Repository Omni Analytic Data - Customer Portal - Customer Apps - Social networks Information Factory Analytics Workbench Master data - API Marketplace - Partner Apps - Partner - Run Ecosystem Reports Model Metadata Ecosystem Platform Al Engine Connect Alerts Data Base Datasets Interactive Dashboard Data Science laboratory Omni Integration Collect INTERNAL Insight Prediction Stories Forecats Advanced Analyst Optimization Decisions Recommendations Conversations Audio Analyse Text Analyse Complex Decisions Image Analysis Video Analysis INTERNAL PLATFORM loT Platform - Connected Things loT Platform - Connected Things Employee Platform - Employee collaboration and workplace - Back - office system - Core system Technology & Security Information Governance (Metadata Management, Master data Management) Source: Bank Indonesia metadata processing, storage in data lakes, data analytics and management of data scientists, to the use of applications that drive the customer experience and innovation in analysis and policies. Third, development of a technology platform that enables data digitalization and innovation as well as digitalization of the policy and institutional work processes, as well as an omni-technology platform that allows several core applications to be interconnected and integrated with the support of adequate cybersecurity. To realize digital transformation, organizational improvements have been made by reorganizing the existing work units into three new departments, namely the digital development and innovation department, the digitalization and data innovation department, and the digital services and cybersecurity department. The planned, programmed, and transparent transformation of human resources continues to strengthen leadership with integrity, competence, professionalism, agility, and ethics at Bank Indonesia. Many human resources (HR) transformations have been successfully achieved since 2018 with mature merit-based HR planning, clear and transparent career management, rigorous selection of the talent pool in accordance with person-to-job fit, tiered leadership programs from nonofficers to officers and the top management, education and training programs for technical competency development as well as master’s and doctoral scholarships, all of which are supported by the provision of competitive remuneration, welfare facilities, and post-employment benefits that are competitive with the market. In addition to further strengthening these programs, future HR transformation will be more focus on strengthening visionary leadership characteristics with the ability for strategic foresight leadership who are agile towards change, as well as ethical behavior according to national and spiritual values and their respective religion. Strengthening competencies is emphasized with the ability to adapt to digitalization, including technical competencies relating to data analytics and data scientists as well as aspects of behavior and mindset, while strengthening leadership exposure through coordination and assignments to other institutions at home and abroad. Strengthening the employee value proposition and the BI-Achievement, BI-Innovation, BI-Digital, and BI-Religi work culture programs emphasize building pride, creativity, recognition, and incentives for achievements and collaboration as leaders and employees of Bank Indonesia. Equally important is the development of an atmosphere, relationships and work facilities that are more supportive of digitalization and also the behavior of millennial employees, including hybrid work processes that will be maintained. Moving Forward with Optimism and Vigilance: Strong, Recover, and Revival Towards Advanced Indonesia Synergy and innovation have been the key factor for Indonesia to survive the impact of the Covid-19 pandemic and global turmoil, and further optimism for the ongoing recovery and economic revival in 2023 and beyond. Optimistic that economic stability will be maintained, and the economic recovery will continue to accelerate. Vigilant of the possibility that the global turmoil could persist, with all its adverse impacts to the national economic performance. Therefore, the synergy between Bank Indonesia, the central and regional government and Financial System Stability Committee will be improved to strengthen the resilience, recovery, and revival of the national economy moving forward. Bank Indonesia will also continue and maintain the strong synergy with the House Representatives of the Republic of Indonesia, particularly Commission XI, the banking industry, businesses, academia, the media, and other strategic partners. An innovative monetary, macroprudential and payment system policy mix will be deployed in pursuit of striking an optimal policy response to the dynamic global economy, thereby maintaining national economic resilience, recovery momentum, and revival. In closing, let us move forward with optimism and vigilance, by continuously strengthening synergy and innovation. Through synergy and innovation, Indonesia’s economic outlook will improve. Strong synergy in the national economic policy mix, fiscal-monetary coordination, acceleration of the real and financial sectors transformation, as well as innovation and acceleration of the digital economy and finance. To that end, let us continue strengthening synergy and innovation for economic resilience, recovery, and revival moving forward. Let us continue working, together we raise and spread hope, confidence, and optimism for the recovery of the national economy towards Advanced Indonesia. May Allah subhanahu wa ta’ala, God Almighty, always provide guidance, convenience, perfection and blessings to Indonesia, our nation and all of us. Thank you Wassalamualaikum warahmatullahi wabarakatuh, Jakarta, 30 November 2022 Perry Warjiyo Governor Bank Indonesia
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Speech by Mr Perry Warjiyo, Governor of Bank Indonesia, at Bank Indonesia's Annual Meeting 2024, Jakarta, 29 November 2024.
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TABLE OF CONTENT I. Global Economic Performance and Outlook: Slowing Growth, High Uncertainty II. National Economic Performance and Outlook: Maintained Stability, Rising Growth III. Bank Indonesia Policy Mix 2024: Maintaining Stability, Supporting Sustainable Growth • • • • • • • • Conception of the Bank Indonesia Policy Mix Monetary Policy Macroprudential Policy Payment System Policy Money Market and Foreign Exchange Market Deepening Development of the Sharia Economy and Finance and MSMEs International Policy Bank Indonesia Transformation IV. Synergy of Policy Mix for National Economic Transformation: Strengthening Stability, Driving High Growth • • • • • • Policy Mix Synergy for Stability Policy Mix Synergy for Domestic Demand Policy Mix Synergy for Economic Capacity Policy Mix Synergy for Financial Sector Deepening Policy Mix Synergy for Accelerating Digitalization Medium-Term Economic Outlook for Indonesia V. Direction of Bank Indonesia Policy Mix in 2025: Maintaining Stability, Driving Sustainable Growth • • • • • • • Direction of Monetary Policy Direction of Macroprudential Policy Direction of Payment System Policy Money Market and Foreign Exchange Market Deepening Policy Inclusive and Green Economy-Finance Policy International Policy Institutional Transformation Policy VI. Moving Forward with Optimism and Vigilance: Stability and National Economic Transformation toward the 2045 Golden Indonesia (Indonesia Emas 2045) SYNERGY TO STRENGTHEN STABILITY AND NATIONAL ECONOMIC TRANSFORMATION Remarks of the Governor of Bank Indonesia BANK INDONESIA ANNUAL MEETING Jakarta, 29th November 2024 We are honoured to welcome, The President of the Republic of Indonesia, Gen (Ret.) Prabowo Subianto With respect to the honourable, • Leaders and Members of DPR and DPD RI, • Leaders of State Institutions, • Excellencies, Ambassador of friendly countries, • Ministers of the Red and White Cabinet, • Chairman and Members of the OJK and the LPS Board of Commissioners, • Former Governors and fellow Members of the Board of Governors of Bank Indonesia, • Regional Governors, Mayors and Regents from throughout Indonesia, • Leaders of the National Banking Industry, Corporate Sector, and National Media, • Recipients of the 2024 Bank Indonesia Awards, • Esteemed guests. Assalamu’alaikum Warahmatullahi Wabarakaatuh, Peace and prosperity be upon us all, Syalom, Om Swastyastu, Namo Buddhaya, Greetings of virtue, First of all, let us express our gratitude for the presence of Allah Subhanahu Wa ta’ala (SWT), God Almighty, for His mercy and blessing that allow us to gather at the 2024 Bank Indonesia Annual Meeting this evening. With all humility, we would like to express our utmost gratitude to the President, for his presence, along with all distinguished guests, and for providing direction to strengthen policy synergy to enhance stability and national economic transformation moving forward. We extend our congratulations to the banks, corporations, and individuals that received Bank Indonesia Awards 2024, totaling 51 (fifty-one) recipients in 5 (five) areas and 20 (twenty) categories in the fields of monetary stability management, macroprudential, payment system, MSMEs development and the sharia economy, as well as supporters of Bank Indonesia policy. The awards are presented annually in conjunction with the Bank Indonesia Annual Meeting as a form of appreciation and national recognition to our partners that have supported the implementation of Bank Indonesia’s tasks. On this auspicious occasion, allow me to present the evaluation of Indonesia’s economic performance for 2024, the economic prospects and policy direction of Bank Indonesia in 2025, which summarized under the theme Synergy to Strengthen Stability and National Economic Transformation. We should be grateful that Indonesia’s economy performed well in 2024. Economic growth was relatively high with maintained stability. This performance was achieved amidst highly dynamic global economic uncertainty. Strong synergy of national economic policy mix between Government and Bank Indonesia is the key aspect of achieving robust national economic performance. This policy mix synergy must be enhanced to strengthen stability and national economic transformation toward the 2045 Golden Indonesia (Indonesia Emas 2045) vision. I will deliver my presentation in 5 (five) main parts. First, an evaluation of global economic performance and the outlook, which are full of dynamics, risks and uncertainties. Second, an evaluation of domestic economic performance and the outlook, which has demonstrated resilience and continued recovery. Third, a report and evaluation of the policy mix implemented by Bank Indonesia in 2024 to maintain stability and support sustainable economic growth. Fourth, synergy of national economic policy mix between the Government and Bank Indonesia to strengthen stability and national economic transformation moving forward. Fifth, Bank Indonesia’s policy direction in 2025 to strengthen stability and foster sustainable economic growth. This explanation also serves as the fulfillment of Bank Indonesia accountability and transparency as mandated by Bank Indonesia Act. I. Global Economic Performance and Outlook: Slowing Growth, High Uncertainty European Union and the UK, which could spur retaliation from these countries. Strict immigration policies will also be introduced against illegal foreign workers, while foreign policy toward NATO, Russia-Ukraine and the Middle East could reshape the global geopolitical landscape. To stimulate domestic economic growth, the new US Administration is predicted to cut corporate tax and personal income tax, thereby increasing the fiscal deficit from 6.5% to 7.7% of GDP in 2025 and raising US government debt going forward. The result of the US Presidential Election undermined global financial market conditions in the fourth quarter of 2024 and is anticipated to trigger global economic slowdown moving forwards along with the growing risk of trade and investment fragmentation. Global economic dynamics changed rapidly accompanied by heightened uncertainty. At the beginning of 2024, geopolitical tensions remained high given the ongoing conflict between Russia and Ukraine. After a brief respite, geopolitical tensions have marked another round of escalation, triggered by Israeli attack on Palestine. Toward the end of 2024, the re-election of President Trump in the United States (US), with his America First policy, could lead to a significant change in the geopolitical landscape and world economy moving forwards. Initial assessments indicate the possibility that the new US Administration under President Trump will impose high tariffs on countries maintaining a large trade surplus with the US as part of its international policy (Figure 1.). Such countries could include China, Mexico, Japan, and Vietnam, and several European countries. For instance, high tariffs may be imposed on imports of machinery/electronic goods and chemicals from China as well as imports of iron, aluminium, and motor vehicles from the Volatile geopolitical dynamics have shaped global economic and financial market performance throughout 2024, and are expected to persist in 2025 and beyond. Overall, global economic growth in 2024 is expected to moderate to 3.2%, from 3.3% in 2023, with a further slowdown projected to 3.1% in 2025 and 3.0% in 2026 Figure 1. Initial Assessment of the Impact of Trump’s Victory on the US and Global Economy 1. IMPACT ON THE US ECONOMY Tax cuts increase domestic demand TAX CUTS Personal tax cut: approximately a 3% reduction in each income bracket Migrant restrictions tighten the labor market Tax cuts increase demand-pull inflation Extending the tax cut policy set to expire in 2025, including: Corporate tax cut: a flat rate of 21% FISCAL DEFICIT 2026, it increases from 6.0% to 8.8% of GDP FISCAL DEFICIT WIDENS FISCA L AINA BILIT Y SUST Bond issuance increases 2025, it increases from 6.5% to 7.7% of GDP TARIFFS (Effective in Semester II-25) IMMIGRATION Euro Area/United Kingdom, China GEOPOLITICAL TRADE FRAGMENTATION: SUPPLY DISRUPTION: TRADE WAR, SANCTIONS ENERGY DOMINANCE: OIL SUPPLY DEMAND FFR FOR ASSET The USA, China, Mexico, Canada, Euro Area/the United Kingdom TRADE DIVERSION: ASEAN, Latin Amerika Reducing immigration, tightening customs Deportation of illegal immigrants UST YIELD RISES Commodity market: 25%: steel, aluminium, motor vehicles from the Euro Area/UK, followed by retaliation 25%: machinery/electronics and chemicals from China. China retaliates with 10% Increasing penalties for illegal entry and overstaying INFLATION RISES RISK EXPORT COMMODITY PRICES OIL PRICES (2025-26) GLOBAL INFLATION (2025-2026) GLOBAL GDP GROWTH Ensuring NATO members meet the requirements for fiscal spending of 2% of GDP on defense Cut aid to Ukraine. Ending the conflict in Ukraine through negotiations with Russia Settling the conflict in the Middle East SMALLER CUTS IN THE FFR, UST YIELDS RISING UST YIELD RISES Notes: FLOWS INTO U.S. - Trade tariffs (supply shock) have a negative impact on GDP USD STRENGTHENS FINANCIAL ASSETS and a positive impact on inflation. - Tax cuts (demand shock) have a positive impact on both GDP and inflation EXCHANGE RATE DEPRECIATION AND FOREIGN PORTFOLIO INVESTMENT OUTFLOWS FROM EMEs Source: Bank Indonesia, adapted from various sources SMALLER CUTS IN GLOBAL INTEREST RATES GEOPOLITICAL CONFLICT MAIN POLICIES: Tariffs increase import prices 2. IMPACT ON THE GLOBAL ECONOMY THE DIRECTION OF TRUMP'S POLICY Table 1. Global Economic Growth Performance and Outlook (%) 2024* 2025* 2026* World 3.5 3.3 3.2 3.1 3.0 Advanced Economies 2.6 1.7 1.8 1.7 1.8 United States 1.9 2.9 2.7 2.1 2.3 Euro Area 3.4 0.4 0.8 1.2 1.3 Japan 1.0 1.9 0.0 1.2 0.6 4.1 4.4 4.2 4.1 4.0 China 3.0 5.2 4.8 4.5 3.9 India 6.8 7.7 7.0 6.7 6.7 ASEAN-5 5.5 4.0 4.8 4.8 4.8 Latin America 4.2 2.2 2.1 2.4 2.5 Emerging Economies Note: *Bank Indonesia’s Projection Source: WEO-IMF, Bank Indonesia (Table 1.). Divergence in growth patterns across countries continues, accompanied by increasing global economic and trade fragmentation. The US economy, which is expected to moderate in 2024, is forecasted to rebound in 2025, although the risk of economic overheating looms with the widening fiscal deficit and growing government debt. GDP growth in China and Euro Area are expected to moderate in response to persistently sluggish domestic demand and the potential impact of high trade tariffs imposed by the new US Administration. Economic growth in Indonesia, India, and several other emerging market economies (EMEs) remain relatively Graph 1. Global Inflation Trends %, yoy 0 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 Global Inflation AEs Inflation EMEs Inflation strong on the back of domestic demand despite export constraints as a corollary of economic moderation and global trade fragmentation. Global inflation eased from 6.2% in 2023 to 5.2% in 2024 and 4.5% in 2025, yet is projected to rise to 4.8% in 2026 amidst potential trade war between the US and several of its key trading partners, coupled with global supply chain disruptions (Graph 1.). Geopolitical and global economic dynamics have a substantial impact on the monetary policy of central banks and global financial market developments. Financial market uncertainty remained elevated in the first half of 2024 due to geopolitical tensions between Russia and Ukraine as well as the Israeli attack on Palestine. Sovereign risk premia in EMEs, as reflected by Emerging Market Bond Index (EMBI) spread, increased sharply from 270 in April 2024 to 380 in August 2024 (Graph 2.a.). Similarly, global financial market volatility (VIX) and Credit Default Swap (CDS) in Indonesia also tracked upward trends (Graph 2.b.). In the third quarter of 2024, as geopolitical tensions eased and the global disinflation process continued, central banks began lowering monetary policy rates, including the Federal Reserve which eventually started reducing the Federal Funds Rate (FFR) in September 2024. Monetary policy easing had a positive impact on global financial markets. The US dollar index against global currencies (DXY), which hit 105 at Source: Bloomberg, IMF the beginning of 2024 subsequently retreated to around 101 in September 2024, along with a similar downward trend observed in EMBI spread (Graph 2.a.). Nevertheless, the results of the US Presidential Election and unresolved geopolitical tensions in the Middle East adversely affected financial markets and the monetary policy direction of central banks. Smaller reductions in the FFR and other monetary policy rates are expected moving forward. The US dollar faced sharp, broad-based appreciation, with the DXY index recorded at 107 recently (Graph 2.a.). Similarly, US Treasury yields, which had tracked a downward trend in line with the lower FFR, rebounded strongly across all maturity periods. Sovereign risk premia in EMEs and global financial market volatility saw a renewed increase. Such developments triggered a reversal of portfolio flows and exchange rate depreciation in EMEs, forcing a stronger national policy responses to address the adverse impact of deteriorating global economic dynamics. The US economy exhibited slight softening in 2024 yet is expected to rebound moving forward given the policies of the incoming Administration. US economic performance remained comparatively solid until the middle of 2024, yet subsequently slowed down and is projected to moderate to 2.1% in 2025. However, US economic growth could potentially rebound with the policies of the incoming Administration. The primary source of economic growth is domestic demand, particularly the services sector and investment in information technology and financial services. Incrementally milder inflationary pressures have prevailed, with disinflation moving toward the medium-term target of approximately 2%. Such developments prompted a 50bps cut in the Federal Funds Rate from 5.5% to 5.0% in September 2024, with a further 25bps decrease to 4.75% in November 2024 and a similar 25bps reduction expected in December 2024, bringing the FFR to 4.5% at the end of 2024. FFR cuts are expected to persist with another 50bps adjustment to 4.0% anticipated in 2025 (Graph 3.a.). The downward FFR trend spurred lower US Treasury yields on short-term maturities, contrasting the upward trend of mediumlong-term US Treasury yields due to the widening fiscal deficit and massive debt burden of the US Government (Graph 3.b.). Notwithstanding, the reelection of President-elect Trump, complemented by Republican victories in the Senate and House, could change US economic dynamics significantly in the near future. Economic growth in the US could regain momentum on higher demand for investment and domestic consumption given the proposed cuts to corporate tax and personal income tax. Likewise, external sources of growth will also increase due to lower imports caused by high tariffs imposed on countries maintaining a large trade surplus with the US. On the other hand, inflationary pressures are Graph 2.a. Trends in the US Dollar and EMEs Risk Premium Graph 2.b. Trends in Global Financial Market Volatility Index Index US Dollar Appreciation vs Major Currencies bps Index EMBI Spread Note: *Data as of 18 Nov’24 Source: Bloomberg 11* US Dollar Index (rhs) Credit Default Swap (CDS) Indonesia Note: *Data as of 18 Nov’24 Source: Bloomberg Volatility Index (VIX) rhs Graph 3.b. Structure of the US Treasury Yield Graph 3.a. Projection of the Federal Funds Rate (FFR) % 5.5 % 0.8 0.6 5.0 0.4 0.2 4.5 Yield -0.2 4.0 -0.4 -0.6 3.5 % 6 8 10 12 2 6 8 10 12 2 Actual 6 8 10 12 2 6 8 10 12 2 6 8 10 12 Projection 3.0 -0.8 MONTH MONTH Δ '24 - '23 ytd (rhs) YEAR YEAR Tenor Dec’23 YEAR YEAR Oct’24 YEAR -1.0 *Nov’24 Note: FFR uses the lower bound. Projections use the Taylor and Yellen Rules. Source: FRED, Bank Indonesia’s Calculation Note:*Data as of 15 Nov’24 Source: Bloomberg expected to return as a result of increasing domestic demand, higher import prices due to higher tariffs, and rising wages given highly stringent immigration policy. Furthermore, the US economy will be overshadowed by the risk of economic overheating in response to the widening fiscal deficit and growing government debt. The impact of US economic dynamics is already perceptible in the financial markets, as reflected by higher US Treasury yields for all maturities, sharp and broad-based US dollar appreciation, as well as smaller FFR reductions than previously expected. inflation deceleration process toward the 2% inflation target in the medium term. Nonetheless, as mentioned previously, the results of the US Presidential Election are expected to spur economic moderation and a build-up of inflationary pressures in Europe due to the possible imposition of trade tariffs by the US Administration, resulting in smaller reductions expected by the ECB to its key interest rates. Meanwhile, a sluggish economic recovery is lingering in the Euro Area. Growth in 2024 is expected to remain below the historical average at 0.8%, and is forecasted to reach 1.2% in 2025. Weak growth stemmed from subdued consumption in line with the saving and investment preferences of households that prioritise financial assets for investment. Consequently, Euro Area registered a faster disinflation process than the US, with the European Central Bank (ECB), therefore, cutting its policy rate earlier and deeper than the US Federal Reserve. Hitherto, the ECB has lowered its policy rate by 75bps from 4.00% to 3.25%, with a further reduction of around 25bps to 3.00% expected at the end of 2024 before decreasing another 100bps to 2.00% by the end of 2025 in line with the ongoing In the Asian region, China’s economy is in a declining trend. Economic growth in China is expected to decelerate from 5.2% in 2023 to 4.8% in 2024, with a further decline to 4.5% in 2025. Inflation in 2024 is lower than projected, however, at just 0.4%, which is expected to remain low at approximately 1.7% in 2025 on the back of weak domestic demand. Domestic economic moderation is resulted from muted consumption in response to deteriorating consumer confidence and low exports given declining manufacturing performance globally and the ongoing trade tensions with the US (Graph 4.a.). A slowdown has been experienced across nearly all economic sectors, particularly the ongoing decline in the property market, accompanied by slower manufacturing and services growth. Monetary and fiscal stimulus from the central bank and government have, thus far, been insufficient to offset economic decline. The People’s Bank of China (PBoC) has introduced monetary stimulus by lowering interest rates on housing loans and reducing the minimum statutory reserve requirements, while providing swap facilities with property shares as collateral. On the other hand, the Chinese Government has introduced fiscal stimulus by raising social assistance for public consumption and allocating funds to regional governments, among others. Looking ahead, the fiscal stimulus could potentially be increasingly constrained due to large fiscal deficit in both onbudget and off-budget, which are projected to reach 3.1% and 10.0% of GDP, respectively (Graph 4.b.). As stated previously, the results of the US Presidential Election could intensify pressures on economic moderation in China with the possible imposition of trade tariffs by the incoming US Administration. The economic recovery in Japan remains weak. Japan’s economy in 2024 is expected to be stagnant, with growth of 0.0%, down from 1.9% in 2023, primarily dampened by a manufacturing and export downturn in line with the global economy, while consumption has remained solid owing to real wage improvements. Inflation in 2024 remains high at approximately 2.2% due to rising wages and a weaker yen exchange rate, which is projected to fall to 2.0% in 2025. The inflation trend has compelled the Bank of Japan (BoJ) to raise interest rates and continue tightening monetary policy to %, yoy Index 2.4 3.4 3.2 3.6 85.7 -15 II III IV I II III IV I II III IV I II III IV I II III IV I 2019 2020 2021 2022 2023 Retail Sales Export Source: Bloomberg, NBS -5 -10 I II III Amidst the broad-based economic moderation, the Indian economy has performed well and supported global economic growth. India’s GDP in 2024 and 2025 is projected to remain high at 7.0% and 6.7%, respectively, despite moderating from 7.7% in 2023 in response to the global economic downturn. Consumption has maintained robust growth, underpinned by urban and rural labor absorption. Private investment, including building and non-building investment, and the service sector are projected to improve in line with domestic consumption. Meanwhile, export performance weakens, consistent with the global slowdown, which subsequently leads to a slowdown in manufacturing expansion (Graph 5.a.). Economic easing in 2025 will also stem from the direction of fiscal consolidation implemented by the Graph 4.b. Fiscal Consolidation of China Graph 4.a. Domestic Demand of China -20 bring inflation back to its medium-term target. From a fiscal perspective, the election of a new Prime Minister in Japan will sustain gradual fiscal consolidation until 2026. Fiscal and monetary policy coordination in Japan is expected to boost national economic performance, with inflation projected to fall to 2.0% and GDP growth to accelerate to 1.2% in 2025. Nevertheless, the impact of the US Presidential Election will demand vigilance in terms of the trade relationship between Japan and the United States. 5 6 7 8 9 % GDP -2 -2.8 -3.7 -2.8 -3.1 -3.1 -3.1 -3.0 -9.1 -10.1 -10.0 -9.9 -13.0 -13.2 -13.1 -12.9 2025* 2026* -3.9 -4 -6 -8 -9.0 -9.7 -10 -10.6 -13.3 -12 -14 -16 -18 -12.1 -12.5 -13.4 -17.0 Consumer Confidence Index (rhs) Fixed Asset Investment Activity Index On-budget fiscal balance Off-budget fiscal balance Augmented fiscal balance Note: *IMF Projection (Article IV 2024) Source: Ministry of Finance of China, IMF Volatile global economic dynamics and high uncertainty have forced EMEs to strengthen economic resilience in order to sustain economic recovery over the next two years. As mentioned, the re-election of President-elect Trump in the US is expected to bring significant changes to the geopolitical landscape and global economy moving forwards. The impact has been seen in the increased global financial market uncertainty in the fourth quarter of 2024 after improving in the previous period. The US dollar experienced sharp, broad-based appreciation, accompanied by higher US Treasury yields across all maturities as well as increasing sovereign risk premia in EMEs. The convergence of monetary policy rate cuts, including the FFR, which previously bolstered global financial market stability in the third quarter of 2024, could shift direction in the future. Further reductions to the FFR and monetary policy rates by other central banks are expected to be smaller. Volatile global financial market dynamics since the US Presidential Election could also trigger a portfolio rebalancing among global investors toward US in pursuit of high US Treasury yields and the strong US dollar. Consequently, the high fluctuation of portfolio inflows to EMEs throughout 2024, affecting bonds and shares (Graph 6.a.), is expected to intensify in the coming period, alongside the growing risk of a sudden capital reversal. Furthermore, sharp US dollar appreciation since the US Presidential Election spurred widespread depreciation among Graph. 5.a. Domestic Demand of India Graph. 5.b. Fiscal Consolidation of India Government, with the fiscal deficit narrowing from 5.6% to 4.9% of GDP, coupled with lower subsidies and increasing capital expenditures (Graph 5.b.). Inflation peaked at 5.1% in the middle of 2024 due to rising food prices and the impact of El Niño, which is expected to fall to 4.4% at the end of 2024 and 4.1% in 2025 given the response of the Reserve Bank of India (RBI) to hike its policy rate to 6.5%. In response to low inflation, however, the RBI is expected to lower its monetary policy rate in the future. Similarly, economic performance in the ASEAN-5 region (Indonesia, Singapore, Malaysia, Thailand, and the Philippines) points to higher growth. Economic growth in ASEAN-5 is projected to accelerate from 4.0% in 2023 to 4.8% in 2024 and 2025. Inflation also decreases from 3.5% in 2023 to 2.3% in 2024 and 2025. Overall, such developments indicate solid economic resilience in ASEAN-5 against the impact of global spillovers, and achieving economic growth. In particular, the results of the U.S. Presidential Election need to be closely examined for its impact on the trade relations between ASEAN countries and the U.S. going forward, especially for Vietnam, which has a large trade surplus with the U.S. Index % GDP 9.6 5.6 4.9 3.6 3.6 3.2 3.4 9.1 Manufacturing 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 Services 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 1.5 Total Receipt Fiscal Deficit 2021 2022 2023 2024 2021 2022 2023 2024 Manufacturing PMI New Orders Index Services PMI New Export Orders Index Output Index New Export Orders Index New Orders Index Future Activity Index Source: IHS Markit 1.3 Fiscal Year 2024-2025 Interest Payment Subsidies Capital Fiscal Year 2024-2026 Source: Reserve Bank of India several currencies in advanced economies and EMEs in the fourth quarter of 2024 (Graph 6.b.). high tariffs imposed by the US along with inwardlooking trade policies in other countries. Global spillovers have compelled many EMEs to prioritize the mix of national economic policies on stability, which limits the policy space for driving growth. First, central banks must reassess the plans to lower interest rates in order to boost growth, and instead, must focus monetary policy on maintaining exchange rate stability and preventing another build-up inflationary pressures, which have been painstakingly managed thus far. Second, the space available for fiscal policy to stimulate economic growth is more limited given the need to manage deficits for fiscal consolidation and reduce the risk of larger debt financing caused by high global interest rates, particularly higher US Treasury yields after the US Presidential Election. Third, the impact of global spillovers require authorities to focus on maintaining financial system stability and resilience, thereby limiting the room available to institute pro-growth policies. And fourth, EMEs governments must become more proficient to boost domestic demand, including consumption and investment, and accelerate structural reforms to increase aggregate supply capacity for economic growth. This is important, considering the space for increasing exports may be constrained due to global economic moderation, together with increasing trade fragmentation and the growing possibility of Over the next five years, the global economy is expected to be characterized by high dynamics and challenges. There are at least 5 (five) challenges that demand vigilance as follows: Graph 6.a. Portfolio Flows to EMEs Graph 6.b. Depreciation of EMEs Currencies Post-US Election Results USD Million -10 Equities, Korea and Taiwan (Province of China) Equities, EMEs exclude China Local Currency Bonds, EMEs exclude China Source: IMF, Global Financial Stability Report, October 2024 First, high geopolitical risk and ongoing world trade fragmentation. General elections in more than 50 countries in 2024 have altered political preferences and the economic policies of incoming administrations. In the US, the incoming Administration is expected to cut corporate tax and personal income tax, which implies a ballooning fiscal deficit and government debt to stimulate the domestic economy. In many countries, populism and expansionary fiscal policy are becoming more prevalent, thereby expanding fiscal deficits and government debt. This tendency is increasing competition in terms of financing fiscal deficits and government debt, which is projected to edge up interest rates globally, thus increasing portfolio flows to advanced economies and the fiscal burden borne by EMEs. Meanwhile, inward-looking trade policies will exacerbate the current increasingly fragmented world trade pattern. Specifically, the new US Administration has conveyed plans to impose high trade tariffs to all % -20 i. THB MYR JPY NZD BRL AUD PHP EUR KRW SGD ZAR IDR CNY TRY INR -4.0 -2.49 -2.87 -2.12 -2.86 -1.70 -2.58 -1.10 -2.39 0.61 -2.38 -0.77 -2.30 -2.72 -1.19 -2.10 -1.92 -1.14 -1.96 -1.61 -2.50 -1.36 -1.43 -1.68 -1.34 -0.85 -1.11 -0.67 -0.35 -0.37 -0.36 -3.0 -2.0 Point to Point Nov'24 Vs Oct'24 Note: Data as of 19 Nov’24 Source: Reuters, Bloomberg -1.0 Average Nov'24 Vs Oct'24 1.0 countries maintaining a large trade surplus with the US. Consequently, world trade and economic fragmentation is expected to worsen. Multilateral trade will gradually be replaced by bilateral trade, with the growing risk of international trade wars. Such inauspicious conditions could disrupt world trade distribution channels and global supply chains, which have been centered in China. ii. Second, a spatial rebalancing in the centers of world economic growth. Economic growth in the US is expected to rebound despite the risk of economic overheating due to high interest rates and government debt burden. Meanwhile, economies in Europe and China face the risk of slowdown. Notwithstanding, economic growth in Indonesia, India, and several other EMEs, which is supported by domestic demand, is projected to remain solid (Graph 7.a.). In addition to increasing trade fragmentation and unresolved global geopolitical tensions, economic growth will also be determined by the issues associated with an aging population along with strong calls in advanced economies for an immediate transition toward the green economy. iii. Third, high interest rates and debt risk. Overcoming the deleterious impact of the Covid-19 pandemic incurred massive fiscal burdens and higher government debt in many countries. The latest dynamics indicate that the Presidential Election in the US and general elections in various other countries, which have heralded a shift toward inward-looking policies and populist politics, will increase fiscal deficits and government debt moving forward. This trend will increase international competition to finance fiscal deficits and government debt in the global financial markets and, therefore, push up interest rates globally. Consequently, portfolio inflows will be attracted to advanced economies, particularly the US, which will intensify pressures on external resilience and increase the fiscal burden for EMEs. The adverse impact of global spillovers will make it increasingly difficult for EMEs, not only in terms of monetary policy to maintain exchange rate stability, but also in terms of fiscal policy to stimulate economic growth. iv. Fourth, persistent uncertainty and a shift in the pattern of global financial investment. As mentioned previously, a rebalancing in the portfolio investment preferences of global investors toward the US due to high US Treasury yields will complicate EMEs’ capacity to attract portfolio inflows and, therefore, challenging EMEs’ economic stability. The ability to attract foreign direct investment (FDI) will also be affected. Investors will apply more selective investment strategies due to high risk premia globally, thus favouring EMEs that have been successful in terms of real sector transformation and maintaining macroeconomic stability. An investment-friendly environment, government policy assurance, and investment project feasibility will become prerequisites for investment. Furthermore, political and economic fragmentation will also necessitate a country’s ability to establish bilateral trade and investment cooperation with the US and other economic trade partners. v. Fifth, the rapid pace of cross-border digitalization and increasing operational risk (cyber). Rapid digital technological advancement will continue to accelerate innovation, preferences, and the efficiency of various digital economic and financial transactions. In addition, digitalization will continue to propagate globally with rapidity due to the persistent march of technology and digital innovation. Various forms of international and cross-border cooperation, particularly between central banks, will also accelerate digital cross-border payment system transactions. Consequently, digital-based service transactions, including financial services, corporate services, and other intermediary services, domestically and exported to other countries, will increase exponentially. The positive digitalization outlook will unlock compelling opportunities to drive economic growth in countries that can accelerate its economic and financial digitalization programs Graph 7.a. Global GDP Projections for 2025-2030 %, yoy Index, 2010=100 6.6 6.7 7.0 7.0 6.0 3.9 3.9 4.3 4.1 0.3 0.6 0.7 0.8 1.0 1.7 2.3 2.1 2.0 1.5 1.8 2.0 1.9 2.7 3.3 3.2 4.0 3.4 4.2 4.8 5.0 3.0 Graph 7.b. Digitalization and Service Exports 0.0 Global AEs EMEs United States Euro Area Japan China India 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 Digitally Delivered Services Exports Goods Exports Source: Bank Indonesia’s Projection (Graph 7.b.). Digital globalisation will play an increasingly significant role, thereby replacing the decline of trade globalization and change the pattern of financial digitalization, which will be a key characteristic of the world economy in the new era ahead. The dynamics and direction of the global economy in 2025-2026 and for the upcoming five years will have massive implications for the Indonesian economy, thereby necessitating anticipatory measures through optimal national economic policy mix responses. There are at least 5 (five) important aspects that must be considered. First, the importance of maintaining macroeconomic and financial system stability as the first and main line of defence against volatile global economic and financial dynamics replete with uncertainty. Second, the need to increase domestic sources of growth, particularly consumption and investment, while expanding exports through international trade cooperation. Third, accelerating real sector transformation to increase competitiveness and productivity in terms of capital, labor, innovation and efficiency. Improving the investment climate to compete and attract inward FDI, driving growth of capital- and labor-intensive sectors, as well as increasing skills and professional certification, are becoming even more important. Fourth, the need to increase financial market deepening as a source Other Service Exports Source: Citi Research of national economic financing by attracting foreign capital inflows in the form of portfolio investment and FDI. Fifth, the need to accelerate digitalization of the payment system and financial sector, while fostering innovation in various national and cross-border economic and financial transactions. Digitalization will drive economic growth as the financial and intermediary services sector develop while simultaneously increasing national economic efficiency and productivity. II. National Economic Performance and Outlook: Maintained Stability, Rising Growth Indonesia’s economy has demonstrated strong resilience in mitigating the impact of global spillovers, with its economic performance being recognized internationally. First, Indonesia’s economic performance is considered one of the best among emerging market economies (EMEs), maintaining macroeconomic stability alongside robust growth. Moreover, Indonesia effectively averted an economic crisis precipitated by the Covid-19 pandemic and has continued its economic recovery to this day. Second, strong macroeconomic policy coordination, particularly the fiscal policy of the Government and the monetary policy of Bank Indonesia, has been the key pillar in maintaining national economic resilience by striking an optimal balance between stability and growth. Furthermore, Indonesia is firmly committed to economic transformation, including improving the investment climate, developing infrastructure, and downstreaming natural resources. And third, Indonesia has demonstrated strong leadership in international cooperation. Indonesia’s highly successful G20 Presidency in 2022, during a time of escalating global conflict, was recognized as ‘making possible the impossible’. Indonesia successfully advocated for several important agendas, including the need for close fiscal-monetary coordination, cooperation to address global health challenges, resolutions to the debt issues plaguing poor countries, as well as cooperation for cross-border payment system digitalization. Additionally, Indonesia’s leadership was widely praised for its successful ASEAN Chairmanship in 2023. Covid-19 pandemic was relatively shallow compared to other countries. Macroeconomic and financial system stability have been maintained, inflation remains low (averaging less than 3% from 20182023), and Rupiah stability has also been maintained, supported by Bank Indonesia’s strong monetary policy commitments. The fiscal deficit was well managed at less than 3% of GDP, except during the peak of the Covid-19 pandemic in 2020 and 2021, which was immediately resolved through prudent fiscal consolidation by the Government. Moreover, the current account deficit remained manageable and even recorded a surplus in 2021 and 2022, primarily driven by the downstreaming of natural resources. These developments reflect Indonesia’s increasingly strong external economic resilience. Similarly, the stability of the financial system was preserved, with the banking industry maintaining a high Capital Adequacy Ratio (CAR) above 20%. Loans disbursed by the banking industry recorded high growth, significantly contributing to financing economic growth. These positive economic achievements were accompanied by the rapid digitalization of the payment system, which helped drive inclusive economic growth through the continued expansion of the national digital economic and financial ecosystem. Developments over the past five years have shown that Indonesia’s economic performance is among the best in Emerging Market Economies (EMEs), maintaining stability alongside relatively high growth. Since 2018, economic growth has been maintained above 5%, except during the pandemic (Table 2.). In fact, the economic contraction triggered by the Table 2. Indonesia’s Economic Performance: 2018-2023 Indicator Unit Economic Growth % 5.17 5.02 -2.07 3.70 5.31* 5.05** Current Account %GDP -2.94 -2.71 -0.42 0.30 1.00 -0.16* Fiscal Deficit %GDP -1.82 -2.20 -6.14 -4.57 -2.35 -1.61 CPI Inflation % 3.13 2.59 1.68 1.87 5.51 2.61 IDR/USD (average) 14,246 14,139 14,525 14,296 14,873 15,247 BI-Rate % 6.00 5.00 3.75 3.50 5.50 6.00 Bank Lending % 11.75 6.08 -2.41 5.24 11.35 10.38 Banking Capital (CAR) % 22.89 23.31 23.81 25.67 25.63 27.66 Rupiah Exchange Rate Source: BPS, Bank Indonesia Note: *Preliminary figure. **Very preliminary figure Indonesia’s positive economic performance from 2018-2023 was the result of close synergy between the Government and Bank Indonesia. Fiscal policy was oriented toward economic stimulus through capital expenditures to nurture investment as well as social protection programs to encourage private consumption. Bank Indonesia prioritized a prostability monetary policy to mitigate the impact of global spillovers, while macroprudential policy and payment system policy aimed to foster sustainable economic growth. Several sectoral transformation programs were implemented during the 2018-2023 period. Infrastructure development remained a priority through various national strategic projects (PSN) for transportation, irrigation, housing, telecommunications, and others. The investment climate was also improved through the enactment of Act Number 6 of 2023 concerning Job Creation, while financial system stability was strengthened through Act Number 4 of 2023, namely the Financial Sector Development and Strengthening Act (P2SK Act). Moving forward, the synergy of national economic policy mix must be strengthened and expanded to continue maintaining stability and strengthening national economic transformation. Indonesia’s numerous economic achievements provide a strong foundation for solidifying national economic performance. The synergy of the policy mix will be further strengthened to address emerging issues and anticipate the highly dynamic opportunities and challenges of the global economy. Policy synergy will also drive national economic performance toward the ultimate goal of the Golden Indonesia Vision 2045 - Indonesia Emas 2045 Vision for the prosperity of the Indonesian people. The economic recovery process has remained intact in Indonesia throughout 2024, as reflected by solid growth that is expected to persist in 2025 and 2026. In the third quarter of 2024, economic growth remained robust on the back of domestic demand, despite moderating from 5.11% in the first quarter of 2024 to 5.05% in the second quarter of 2024 and 4.95% in the third quarter of 2024 (Table 3.). Investment has remained solid, particularly building investment, supported by the completion of various national strategic projects (PSN). Household consumption, particularly among the upper-middle class, has been maintained. Non-oil and gas exports remain comparatively high despite global economic moderation and lower international commodity prices. Meanwhile, imports have increased to meet export needs and fulfill domestic demand, which has contributed to a slowdown in economic growth. In the fourth quarter of 2024, solid economic growth is projected, primarily underpinned by higher investment and maintained household consumption, accompanied by increasing government spending toward the end of the year. Overall, Bank Indonesia projects economic growth in 2024 in the 4.7-5.5% range before accelerating in 2025 and 2026 to 4.85.6% and 4.9-5.7%, respectively. Moving forward, Table 3. Indonesia’s Economic Growth by Expenditure (%, yoy) Component 2022* 2023** 5.31 - Private Consumption 2024P 2025P 2026P 4.95 4.7-5.5 4.8-5.6 4.9-5.7 4.93 4.91 4.7-5.5 4.5-5.3 4.8-5.6 19.90 1.42 4.62 7.0-7.8 4.6-5.4 3.7-4.5 4.40 3.79 4.43 5.15 4.2-5.0 4.4-5.2 4.7-5.5 16.23 1.32 1.44 8.18 9.09 4.1-4.9 4.8-5.6 5.7-6.5 15.00 -1.65 1.46 7.79 11.47 4.0-4.8 5.1-5.9 5.5-6.3 I II III 5.05 5.11 5.05 4.94 4.82 4.91 - Government Consumption -4.47 2.95 - Investment 3.87 - Exports - Imports Economic Growth Source: BPS, Bank Indonesia 2024*** Note: *Preliminary Figure. **Very Preliminary Figure. ***Very Very Preliminary Figure; PBank Indonesia’s Projection By sector, domestic economic growth has primarily been supported by capital-intensive economic sectors and therefore, labor-intensive sectors must receive more attention moving forward. This trend is reflected in the comparatively high growth of export-oriented sectors and sectors associated with the downstreaming of natural resources, such as mining and quarrying, as well as the manufacturing industry (Table 4.). Sectors related to infrastructure development and connectivity, such as construction, transportation, and storage, various efforts to revive economic growth must be continued from both the demand and supply sides. To that end, Bank Indonesia is strengthening its pro-growth policy mix in close synergy with the fiscal stimulus of the Government. On the supply side, structural reform policies must be continuously strengthened to promote economic sectors that can increase labor absorption. This must be supported by optimizing macroprudential policy stimulus and accelerating the digitalization of payment transactions by Bank Indonesia. Table 4. Indonesia’s Economic Growth by Sectors (%, yoy) Sector 2022* 2023** 2024*** I II III 2024P 2025P 2026P Economic Growth 5.31 5.05 5.11 5.05 4.95 4.7-5.5 4.8-5.6 4.9-5.7 Agriculture, Forestry, and Fisheries 2.25 1.30 -3.5 3.2 1.7 0.2-1.0 4.8-5.6 5.1-5.9 Mining and Quarrying 4.38 6.12 9.3 3.2 3.5 5.2-6.0 4.9-5.7 5.4-6.2 Manufacturing Industry 4.89 4.64 4.1 3.9 4.7 3.6-4.4 4.2-5.0 4.3-5.1 Electricity and Gas 6.61 4.91 5.3 5.4 5.0 4.4-5.2 2.3-3.1 3.9-4.7 Water Supply, Waste Management, Waste and Recycling Management 3.23 4.90 4.4 0.8 0.0 2.1-2.9 3.8-4.6 4.3-5.1 Construction 2.01 4.91 7.6 7.3 7.5 6.9-7.7 5.9-6.7 6.2-7.0 Wholesale and Retail Trade, Motor Vehicle and Motorcycle Repair 5.53 4.85 4.6 4.9 4.8 4.2-5.0 4.4-5.2 4.5-5.3 Transportation and Warehousing 19.87 13.96 8.7 9.6 8.6 8.8-9.6 8.9-9.7 10.1-10.9 Accommodation and Food Services 11.94 10.01 9.4 10.2 8.3 8.3-9.1 5.5-6.3 5.8-6.6 Information and Communication 7.73 7.59 8.4 7.7 6.9 7.5-8.3 8.4-9.2 10.2-11.0 Financial and Insurance Services 1.93 4.77 3.9 7.9 5.5 6.3-7.1 6.6-7.4 7.0-7.8 Real Estate 1.72 1.43 2.5 2.2 2.3 1.7-2.5 1.6-2.4 2.8-3.6 Business Services 8.77 8.24 9.6 8.0 7.9 8.9-9.7 7.1-7.9 5.6-6.4 Public Administration, Defense, and Mandatory Social Security 2.51 1.50 18.9 2.8 3.9 9.0-9.8 -1.7--0.9 4.0-4.8 Education Services 0.57 1.78 7.3 2.4 2.5 4.3-5.1 3.5-4.3 7.1-7.9 Health Services and Social Activities 2.75 4.66 11.6 8.6 7.6 7.1-7.9 4.4-5.2 4.5-5.3 Other Services 9.47 10.52 8.9 8.9 9.9 7.3-8.1 5.1-5.9 6.5-7.3 Source: BPS, Bank Indonesia Note: *Preliminary Figure. **Very Preliminary Figure. ***Very Very Preliminary Figure; PBank Indonesia’s Projection have also supported national economic growth. In addition, sectors associated with higher private consumption and digitalization, including wholesale and retail trade, accommodation and food service activities, as well as information and communication, have also posted stronger growth. Similarly, various service sectors, such as insurance and financial services, corporate services, as well as human health and social work activities, have also recorded gains. Sectoral performance in Indonesia highlights a solid post-pandemic economic recovery, ranging from sectors recovering from the scarring effects of the Covid-19 pandemic in 2021-2022 to exportoriented sectors in 2022-2024, as well as those driving future domestic demand. Moving forward, the development of agriculture, retail trade, accommodation and food services, information and communication (digitalization) and various service sectors must be accelerated, not only in pursuit of sustainable growth but also to increase labor absorption. Such growth that balances capital-intensive and labor-intensive sectors must be increased and expanded to strengthen resilience and drive national economic transformation moving forward. Spatially, economic growth across nearly all regions of Indonesia performed solidly. In 2024, economic growth in the Bali and Nusa Tenggara (Balinusra) region is expected to improve to approximately 5.5% from 4.0% driven by tourism and mining exports. Economic performance in Kalimantan also improved from 5.4% in 2023 to around 5.5% in 2024 in response to the development of the new Nusantara Capital City (IKN) and mining exports. Similarly, economic growth in the Sulawesi, Maluku and Papua (Sulampua) region accelerated from 6.5% in 2023 to approximately 6.9% this year, supported by manufacturing and mining investment related to the downstreaming of natural resources. In the Java region, growth is projected at 4.9%, driven by manufacturing and trade activity, in contrast to the Sumatra region, where economic growth is expected to moderate from 4.7% to 4.5% due to slower manufacturing and mining activity (Figures 2.). In 2025, economic growth in Java and Sumatra is expected to rebound on the back of trade activity Figure 2. Indonesia’s Regional Economic Growth (%, yoy) SUMATRA 4.79 I KALIMANTAN 4.90 II 4.49 4.59 III IV 4.24 I 4.48 4.48 II III 5.82 5.60 I II 4.83 III 5.48 IV 6.17 I SULAMPUA 5.22 5.20 II III 5.58 6.50 7.15 6.80 II III IV I 7.97 6.74 I 5.91 II III Aceh 5.17 North Kalimantan 4.79 North Sumatra 5.20 Riau 3.46 West Sumatra 4.33 Riau Islands 5.02 Bangka Belitung Islands 0.13 Jambi 4.01 South Sumatra 5.04 Lampung 4.81 Bengkulu 4.57 Gorontalo 3.98 East Kalimantan 5.52 West Kalimantan 4.87 West Sulawesi 2.16 Central Kalimantan 4.64 South Kalimantan 5.23 North Sulawesi 5.21 North Maluku 4.42 Central Sulawesi 9.08 Southeast Sulawesi 5.24 West Papua 19.56 Papua 1.66 Maluku 6.23 South Sulawesi 5.08 Jakarta 4.93 West Java 4.91 Banten 4.93 Central Java 4.93 DIY 5.05 JAVA East Java 4.91 Bali 5.43 West Nusa Tenggara 6.22 East Nusa Tenggara 3.66 BALINUSRA 5.18 4.96 I II Source: BPS 4.84 4.86 4.83 III IV I 4.92 4.92 II III 4.75 Q3'24>Q2'24 Q3'24=Q2'24 Q3'24<Q2'24 I 3.04 3.43 II III 4.80 5.11 IV I 6.84 II 5.28 III and plantation crop exports. Conversely, economic moderation is anticipated in the Sulampua and Balinusra regions due to reduced mining activity, as well as in Kalimantan due to reduced activity in the new Nusantara Capital City (IKN). Indonesia’s external stability has been maintained, accompanied by a solid Balance of Payments (BOP). Overall, the BOP is expected to maintain a surplus supported by a low current account (CA) deficit and growing capital and financial account surplus. A manageable current account deficit has been maintained within the 0.1-0.9% of GDP range, supported by a non-oil and gas trade surplus which was recorded at USD36.0 billion in the third quarter of 2024 (Graph 8.a.). Indonesia’s non-oil and gas exports, including manufacturing, agricultural, and mining exports, maintained robust growth despite global economic moderation. Mining exports of downstream natural resources have continued tracking an upward trend, particularly nickel and copper (Graph 8.b.). Meanwhile, portfolio investment inflows up to the third quarter of 2024 were recorded at a high level of USD11.0 billion, amid heightened uncertainty in the global financial markets (Table 5.). The largest portfolio inflows were attracted to Bank Indonesia Rupiah Securities (SRBI), along with (domestic and global) government securities (SBN) and shares. A high position of reserve assets at the Graph 8.a. Indonesian Non-oil and Gas Exports USD Billion The stability of the Rupiah has been maintained, supported by Bank Indonesia’s firm monetary policy commitments. As mentioned, highly dynamic geopolitics and global financial markets, accompanied by high uncertainty, have pushed up US Treasury yields and strengthened the US dollar, with significant implications on portfolio inflows and exchange rates in EMEs, including Indonesia. In the middle of 2024, the DXY index experienced a broad-based increase, rising to 105.2 in June 2024 from 102.7 at the end of 2023 (Graph 9.a.). Following to a clear policy direction and subsequent FFR reductions, the DXY index decreased to around 101.0 in September 2024. Notwithstanding, the US dollar experienced further appreciation as geopolitical tensions began escalated in the Middle East, coupled with Graph 8.b. Exports of Downstream Mineral and Coal Mining Products USD Million end of October 2024 was recorded at USD151.2 billion, equivalent to 6.6 months of imports or 6.4 months of imports and servicing government external debt, which is well above the international adequacy standard of around 3 months of imports. In 2025, Indonesia’s BOP is projected to remain sound, with a manageable current account deficit in the 0.5-1.3% of GDP range. Furthermore, the capital and financial account surplus is expected to widen, primarily driven by portfolio inflows, thereby supporting a healthy BOP and external economic resilience in Indonesia moving forward. 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 Export Non-Oil and Gas Source: DJBC Agriculture Mining Manufacturing Bauxite Nickel Copper Tin 2023 2024* Total Note: *Data as of Sept’24 (Cumulative) Source: DJBC Table 5. Indonesia’s Balance of Payments (USD Billion) 2023* Component I II III IV Total l* II* III** Current Account -4.4 3.5 13.2 2.8 -2.5 -1.2 -1.3 -2.1 -2.5 -3.2 -2.2 A. Goods 28.3 43.8 62.7 14.8 10.0 10.2 11.4 46.3 9.3 10.0 9.3 Exports, fob 163.4 232.8 292.5 66.8 61.6 63.5 65.9 257.7 61.7 62.1 67.2 Imports, fob -135.1 -189.0 -229.9 -52.1 -51.6 -53.3 -54.5 -211.4 -52.4 -52.0 -57.9 a. Non-oil and Gas 30.0 57.8 89.8 19.0 15.2 16.0 17.7 67.8 15.1 15.2 14.8 b. Oil and Gas -5.4 -13.0 -24.8 -3.9 -4.7 -5.4 -5.9 -19.9 -5.5 -4.6 -4.4 B. Services -9.8 -14.6 -20.0 -4.5 -4.6 -3.9 -4.8 -17.8 -4.1 -5.1 -4.2 C. Primary Income -28.9 -32.0 -35.3 -8.9 -9.3 -8.7 -9.1 -36.0 -8.9 -9.6 -8.9 D. Secondary Income 5.9 6.3 5.8 1.4 1.4 1.3 1.2 5.4 1.3 1.5 1.6 Capital and Financial Account 7.9 12.5 -9.2 4.2 -5.1 -0.6 11.0 9.5 -2.1 3.0 6.6 1. Direct Investment 14.1 17.3 18.1 4.5 4.0 2.7 3.4 14.6 4.6 2.1 5.2 2. Portfolio Investment 3.4 5.1 -11.6 3.0 -2.6 -3.0 4.9 2.2 -1.8 3.2 9.6 3. Other Investments -9.6 -10.2 -15.6 -3.5 -6.3 -0.2 2.6 -7.4 -4.5 -2.8 -8.6 Overall Balance 2.6 13.5 4.0 6.5 -7.4 -1.5 8.6 6.3 -6.0 -0.6 5.9 Reserve Assets 135.9 144.9 137.2 145.2 137.5 134.9 146.4 146.4 140.4 140.2 149.9 (In Months of Imports and Official Debt Repayment) 9.8 7.8 5.9 6.2 6.0 6.0 6.5 6.5 6.2 6.1 6.4 Current Account / GDP (%) -0.4 0.3 1.0 0.8 -0.7 -0.3 -0.4 -0.2 -0.7 -0.9 -0.6 Memorandum: Source: Bank Indonesia the results of the US Presidential Election, thus nudging the index up to 106.3 recently. Broadbased US dollar appreciation triggered a build-up of depreciatory pressures on global currencies, including the Rupiah. At the end of 2023, the value of the Rupiah against the US dollar was recorded at around Rp15,500 per US dollar before depreciating to Rp16,328 in June 2024 and subsequently regaining lost value to around Rp15,319 in September 2024. Recently, however, global turmoil has intensified pressure on the Rupiah, which depreciated to around Rp15,800 per US dollar. To mitigate the adverse impact of global spillovers, Bank Indonesia intensified its monetary policy efforts to stabilize the Rupiah exchange rate by intervening in Note: *Preliminary figure. **Very preliminary figure the spot and DNDF markets, and purchasing SBN in the secondary market. The monetary operations (MO) strategy using SRBI instruments was also stepped up, which successfully attracted portfolio inflows and, therefore, strengthened the stabilization of the Rupiah exchange rate. Overall, the Rupiah has depreciated by 2.74% (ptp) or 3.63% (average), as of 19th November 2024, compared to the end of 2023 (Graph 9.b.). The magnitude of Rupiah depreciation is on par with or less severe than that of several peer currencies, including the Philippine peso, Korean won, Mexican peso, Brazilian real, Japanese yen and Turkish lira. Moving forward, the Rupiah exchange rate is expected to remain stable and tend to appreciate, in line with Indonesia’s positive economic Graph 9.a. Rupiah and US Dollar Exchange Rates IDR/USD Graph 9.b. Exchange Rates of the Rupiah and Other Currencies against US Dollar Index 16,600 16,400 16,200 16,000 15,800 15,600 15,400 15,200 15,000 %, ytd TRY JPY BRL KRW IDR PHP TWD MXN THB CNY INR NZD AUD MYR EUR ZAR SGD -14.38 -26.76 -8.81 -15.57 -6.84 -7.53 -6.25 -5.83 -3.78 -2.74 -3.63 -5.26 -15.61 -2.65 -2.61 -2.36 -1.33 -1.43 -1.93 -1.37 -1.40 -1.11 -6.88 -4.29 -0,84 -0.16 2.71 -0.16 -4.18 0.56 1.71 0.70 -1.32 -30.0 -25.0 -20.0 -15.0 -5.0 -10.0 0.72 0.0 5.0 Spot NDF1M DNDF1M Point-to-point DXY (rhs) Average Note: Data as of 19 Nov’24 Source: Reuters, Bloomberg Note: Data as of 19 Nov’24 Source: Reuters, Bloomberg fundamentals, including attractive yields, low inflation, and increasing economic growth, as well as Bank Indonesia’s firm monetary policy commitments. inflation to remain stable, supported by anchored inflation expectations within the target range, ample economic capacity to accommodate domestic demand, controlled imported inflation in line with Bank Indonesia’s Rupiah stabilization policy, as well as the positive impact of growing digitalization. VF inflation is expected to remain under control, supported by the close synergy in inflation control efforts between Bank Indonesia and both the central and regional governments. Bank Indonesia remains firmly committed to strengthening monetary policy effectiveness to manage inflation in 2025 and 2026 within the target set by the government at 2.5±1%. Price stability has been maintained through consistent monetary policy by Bank Indonesia and close coordination with government policy. Consumer Price Index (CPI) inflation has declined in 2024 and remains within the 2.5±1% target corridor. CPI inflation was low in October 2024, recorded at 1.71%, with all components showing similarly subdued inflation (Graph 10.). Low core inflation was recorded at 2.21% (yoy), while volatile food (VF) inflation fell to 0.89% (yoy). Core inflation has been successfully managed through consistent monetary policy by Bank Indonesia to anchor inflation expectations to the 2.5±1% target corridor, while considering the state of economic growth. The Rupiah stabilization policy has also helped control imported inflation. The decline in VF inflation has been supported by an increase in food supply during the ongoing harvesting season, together with close synergy with the Central and Regional Government Inflation Control Teams (TPIP and TPID), and further reinforced by the National Movement for Food Inflation Control (GNPIP), as well as the base effect of high food prices. Moving forward, Bank Indonesia is confident that headline inflation will remain under control and within the target range. Furthermore, Bank Indonesia also expects core Graph 10. CPI, Core, VF and AP Inflation %, yoy 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.21 1.71 0.89 0.77 2.0 -2.0 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 CPI Core Volatile Food Administered Prices Source: BPS As mentioned, Bank Indonesia consistently implements monetary policy to anchor and manage inflation expectations, guiding projections for the upcoming two years to the 2.5±1% target corridor set by the Government. The US dollar experienced a sharp appreciation in the first half of 2024, triggering a build-up of depreciatory pressures on the Rupiah that were expected to exacerbate imported inflation. Consequently, in addition to strengthening the Rupiah stabilization policy, Bank Indonesia also decided to raise the BI-Rate by 25 bps from 6.00% to 6.25% at the monthly Board of Governor’s Meeting (RDG) in April 2024. After the Fed provided clarity concerning the direction of FFR policy and the strengthening of the Rupiah Exchange rate, the Bank Indonesia Board of Governors decided at the RDG meeting in September 2024 to lower the BI-Rate by 25 bps back to 6.00%, while acknowledging room for further reductions provided Rupiah stability is maintained with an appreciatory trend. Monetary policy consistency is supported by clear public communication to anchor inflation expectations and to ensure effective monetary policy transmission. The IndONIA money market reference rate is still moving within the BI-Rate range, recorded at 6.20% on 19th November 2024 (Graph 11.a.). SRBI rates remain attractive to support foreign capital inflows at 6.79%, 6.85% and 7.07% for tenors of 6, 9, and 12 months, respectively, as of 15th November 2024. SBN yields on tenors of 2 and 10 years increased to 6.44% and 6.86%, respectively, as of 19th November 2024, in line with higher US Treasury yields. The 1-month term deposit rate and lending rate were recorded at 4.73% and 9.16%, respectively, slightly lower than the previous month (Graph 11.b.). Adequate liquidity and improved banking efficiency in pricing, supported by the transparency policy of the Prime Lending Rate (PLR), have had a positive impact on maintaining stable bank interest rates. Graph 11.a. BI-Rate and IndONIA Graph 11.b. Bank Interest Rates bps % 1.0 6.4 0.8 6.2 0.6 6.0 0.4 5.8 5.6 0.2 5.4 Spread IndONIA - BI Rate (lhs) Source: Bank Indonesia 30 Oct’24 19 Nov’24 10 Oct’24 30 Aug’24 IndONIA 20 Sept’24 12 Aug’24 3 Jul’24 23 Jul’24 11 Jun’24 20 May’24 25 Jun’24 25 Apr’24 5 Mar’24 27 Mar’24 13 Feb’24 2 Jan’24 5.2 22 Jan’24 -0.2 6.6 BI-Rate Bank Indonesia continues optimizing various pro-market monetary instruments to support the strengthening of interest rate policy and foreign exchange interventions aimed at stabilizing the Rupiah exchange rate and achieving the inflation target. Bank Indonesia continues optimizing the full range of monetary instruments available, including Bank Indonesia Rupiah Securities (SRBI), Bank Indonesia Forex Securities (SVBI) and Bank Indonesia Forex Sukuk (SUVBI) instruments, to enhance the effectiveness of monetary policy transmission, accelerate money market and foreign exchange market deepening, and attract foreign capital inflows. As of 18th November 2024, the respective positions of SRBI, SVBI and SUVBI instruments stood at Rp968.82 trillion, USD3.39 billion and USD387 million (Graph 12.a.). SRBI issuances have attracted portfolio inflows to Indonesia and strengthened the Rupiah exchange % 9.16 8.72 5.28 4.73 0 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 Lending Rate Deposit Rate Source: Bank Indonesia Working Capital Lending Rate 1 Month Deposit Rate Graph 12.a. SRBI Position: Banks, Nonresidents and Nonbank Residents % IDR Trillion 25.82% 1,100 -100 Total Bank Nonresident Share (lhs) Nonresident Nonbank Resident Note: Data as of 18 Nov’24 Source: Bank Indonesia rate, as reflected by significant non-resident holdings of SRBI totaling Rp250.18 trillion (25.8% of total outstanding). The implementation of Primary Dealers (PD) since May 2024 has also increased SRBI transactions in the secondary market along with repurchase agreement (repo) transactions among market players. The participation of primary dealers in SRBI transactions on the secondary market increased from an average of 55% in April-May 2024 to 89% in October 2024 (Graph 12.b.), thereby strengthening the effectiveness of monetary instruments that support Rupiah exchange rate stability and help to control inflation. Moving forward, Bank Indonesia will continue optimizing various innovative pro-market instruments in terms of volume and attractive yields to further deepen the money market and strengthen the effectiveness of monetary policy transmission. Supported by solid economic fundamentals, this will maintain portfolio inflows to domestic financial markets and further strengthen Rupiah stability. Bank liquidity remains ample in line with Bank Indonesia policy, while economic security is consistent with real sector activity. Liquidity can be measured by the amount of liquidity in the banking sector and that circulating in the economy. Usually, money supply is used as a measure of economic liquidity, including narrow IDR Trillion 1,300 Graph 12.b. Role of Primary Dealers (PD) in SRBI Transactions on Primary and Secondary Markets Pre-PD (Average 16 Apr'24-16 May'24) Total Primary Market Post-PD (Average Oct'24) Secondary Market Source: Bank Indonesia money (M0) for consumption purposes, as well as broad money (M1 and M2), which includes deposits. Consequently, economic liquidity reflects the level of economic growth in nominal terms. In October 2024, growth of the M0, M1, and M2 aggregates stood at 7.3%, 7.1%, and 6.7%, respectively, reflecting a nominal level of growth at approximately 6.7%, comprising real GDP at 4.9% and CPI inflation at 1.7% (Graph 13.a.). Economic liquidity will increase if real economic growth accelerates. Meanwhile, bank liquidity represents liquid activity excluding new loan disbursements, which is held in the form of cash and invested in securities as part of the bank asset portfolio strategy. Typically, this is measured in terms of the Ratio of Liquid Assets to Third-Party Funds, the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). Liquid assets originate from the accumulation of funds collected from deposits, the issuance of securities, and foreign loans. As an accumulation of funds not disbursed as loans, measurement is also possible using the Loan-to-Deposit Ratio (LDR) but not deposit growth. As of October 2024, the ratio of liquid assets to third-party funds and the LDR ratio stood at 25.58% and 87.50%, respectively, indicating loose liquidity conditions in the banking industry (Graph 13.b.). The liquidity condition of each specific bank is determined by the level of bank prudence in terms of managing liquidity and disbursing loans. Graph 13.a. Economic Liquidity Graph 13.b. Bank Liquidity %, yoy 6.7 7.3 7.1 7,3 87.50% 25.58% M0 M1 M2 Average Ratio of Liquid Assets to Third-party Funds 2018-2019: 20.18% -20 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 -10 % % 6.74% 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 2018 2019 2020 2021 2022 Liquid Assets to Third Party Funds 2023 2024 Growth of Third Party Funds (year-on-year) Average Ratio of Liquid Assets to Third-party Funds 2018-2019 Loan-to-Deposit Ratio (rhs) Source: Bank Indonesia Source: Bank Indonesia Loans disbursed by the banking industry have maintained solid growth to support economic financing and maintain the stability of the financial system. In October 2024, credit growth was recorded at 10.92% (yoy). By segment, growth of working capital loans, consumer loans and investment loans stood at 9.25% (yoy), 11.01% (yoy) and 13.63% (yoy), respectively (Graph 14.a.). Shariacompliant financing posted 11.93% (yoy) growth, while MSME loans grew 4.76% (yoy). New loan disbursements are influenced by bank’s appetite to lend on the supply side as well as corporate demand for loans. On the supply side, solid credit growth has been supported by strong bank’s appetite to lend, ample liquidity and the reallocation of liquid assets to credit, together with Macroprudential Liquidity Incentive (KLM) Policy introduced by Bank Indonesia. As of October 2024, Bank Indonesia has disbursed KLM incentives totaling Rp259 trillion to the banking industry, including state-owned banks (Rp120.92 trillion), national private commercial banks (Rp110.85 trillion), regional government banks (Rp24.66 trillion), and foreign bank branches (Rp2.56 trillion). The KLM incentives are disbursed to banks extending loans/ financing to priority sectors, namely downstream Mineral and Non-mineral, the Automotive sector, Electricity, Gas and Water Supply, and Social Services, Housing, Tourism and the Creative Economy, ultra-micro enterprises as well as inclusive and green finance. On the demand side, loan growth is supported by robust corporate demand. By sector, credit growth remains high in most economic sectors, particularly the Manufacturing Industry, Mining, Trade, Transportation, and Corporate Services. Loans disbursed to capitalintensive sectors recorded higher growth at 13.17% (yoy) compared to labor-intensive sectors at 9.43% (yoy) - (Graph 14.b.), indicating that economic growth in the post-pandemic recovery period is dominated by capital-intensive sectors, which are typically oriented toward international exports. Moving forward, as demand for credit grows, particularly household consumption, Bank Indonesia projects credit growth to be 10-12% in 2024 before accelerating to 11-13% in 2025. Financial system stability remains solid, supported by strong capital adequacy and low credit risk. The Capital Adequacy Ratio (CAR) remained high in September 2024 at 26.78%, thereby absorbing risk and supporting credit growth effectively (Graph 15.a.). Meanwhile, nonperforming loans (NPL), as a proxy for credit risk, were also low in September 2024, as indicated by NPL ratios of 2.21% (gross) and 0.78% (net). Mitigated credit risk was also reflected in the downward Loan at Risk (LaR) ratio. In general, the banking industry has allocated adequate Graph 14.a. Credit Growth by Segment: Investment, Working Capital and Consumer Loans %, yoy Graph 14.b. Credit Growth to Capital Intensive Sectors, Labor Intensive Sectors and Consumer Loans %, yoy 13.63 11.01 10.92 9.25 -5 -5 -10 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 -10 11.01 13.17 9.43 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 2023 2024 Growth of Working Capital Loans Growth of Total Loans Growth of Investment Loans Growth of Consumer Loans Aggregate Capital Intensive 2023 2024 Labor Intensive Consumer Loans Source: Bank Indonesia Source: Bank Indonesia provisions for impairment losses to mitigate credit risk. The results of the stress-tests indicate that the resilience of the banking industry in Indonesia is solid, as reflected by a resilient Capital Adequacy Ratio (CAR) above 25% across various scenarios. Capital and liquidity resilience in the banking industry are also supported by maintained corporate repayment capacity (Interest Coverage Ratio, ICR) and profitability (Graph 15.b.), as confirmed by the latest stress tests. Moving forward, the stability of the financial system will be maintained as national economic performance improves. Meanwhile, Bank Indonesia will continue strengthening synergy with the KSSK to preserve financial system stability. Graph 15.a. CAR and NPL in Banking Industry Graph 15.b. Interest Coverage Ratio (ICR) 4.0 % % % % 3.0 26.78 3.5 25.0 3.0 2.5 2.21 2.0 20.0 10.0 1.0 0.78 0.5 5.0 42.2 Gross NPL Net NPL 2023 2024 CAR (rhs) 2.0 1.5 1.0 20.6 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 2.5 15.0 1.5 30.0 Digital economic and financial transactions remain solid, supported by secure, seamless, and reliable payment systems. On the wholesale or high-value side, BI-RTGS transactions in October 2024 increased by 21.1% (yoy) to reach Rp16,683 trillion. On the other hand, the volume of retail transactions processed through BI-FAST increased by 54.23% (yoy) to 339 million transactions. The volume of digital banking transactions was 0.5 12 ICR 12 Months (Median) 6* 9** 12*** Debt at Risk (rhs) % Corporation ICR < 1.0 (rhs) Source: OJK, Bank Indonesia Source: OJK, Bank Indonesia recorded at 1,960.8 million, growing 37.1% (yoy), while electronic money transactions grew 27.0% (yoy) to reach 1,365.4 million. The volume of cardbased payments using ATM/debit cards retreated by 11.4% (yoy) to 558.8 million transactions, while credit card transactions increased 19.6% (yoy) to reach 39.7 million. QRIS transactions saw an impressive 183.9% (yoy) growth, with QRIS users and merchants totaling 54.21 million and 34.7 million, respectively. In terms of Rupiah currency management, total currency in circulation grew by 11.8% (yoy) to Rp1,070.6 trillion in October 2024. Payment system stability has been maintained, supported by a stronger structure and resilient infrastructure. In terms of infrastructure, Bank Indonesia maintains a seamless and reliable payment system. Regarding the structure of the payments industry, payment system interconnection and the digital economy and finance ecosystem continue to expand. Table 6. Indonesia Payment System Projections Growth (%) Component Transaction 2023 2024* 2025* 2026* 2024* 14.1 19.6 48.7 48.0 59,411.1 71,038.0 105,664.5 156,365.9 38.6 43.5 52.3 51.6 25,331.0 36,346.9 55,351.1 83,884.6 33.3 47.1 53.6 52.2 16,647.8 24,486.8 37,612.9 57,256.8 38.7 47.1 53.6 52.2 13,979.0 20,561.3 31,583.2 48,078.0 7.5 8.1 46.1 45.5 41,969.9 45,389.3 66,293.0 96,444.2 29.6 8.1 46.1 45.5 2,190.3 2,368.8 3,459.7 5,033.3 44.5 46.4 51.4 51.5 793.4 1,161.9 1,758.6 2,664.9 40.8 46.4 51.4 51.5 9,161.7 13,416.8 20,308.2 30,773.4 126.3 145.8 14.7 17.6 226.3 556.3 638.2 750.3 166.2 145.8 14.7 17.6 2,138.2 5,256.2 6,030.1 7,089.4 8.3 57.9 34.1 17.7 6,236.5 9,846.6 13,205.3 15,539.9 226.6 57.9 34.1 17.7 2,112.3 3,335.0 4,472.6 5,263.3 9.5 17.3 9.4 8.0 106,835.7 125,285.0 137,057.0 148,070.0 -2.5 17.3 8.0 8.0 9.8 11.5 12.4 13.4 Nominal (IDR Trillion) -0.3 8.4 7.7 7.7 8,255.3 8,947.7 9,637.1 10,379.6 Volume (IDR Million) 5.1 8.7 7.7 7.7 10,611.3 11,532.3 12,420.8 13,377.7 Nominal (IDR Trillion) 7.3 6.7 5.4 5.2 1,101.7 1,175.9 1,239.0 1,303.6 2025* 2026* I. Cashless 1. Digital Payment a. Mobile Banking b. Internet Banking c. UE Server Based 2. QRIS 3. BI-FAST 4. BI-RTGS System 5. Card-Based Payment Instruments Nominal (IDR Trillion) Volume (IDR Million) Nominal (IDR Trillion) Volume (IDR Million) Nominal (IDR Trillion) Volume (IDR Million) Nominal (IDR Trillion) Volume (IDR Million) Nominal (IDR Trillion) Volume (IDR Million) Nominal (IDR Trillion) Volume (IDR Million) Nominal (IDR Trillion) Volume (IDR Million) II. Cash Currency in Circulation Source: Bank Indonesia Note: *Projection Payment transactions based on the National Open API Payment Standard (SNAP) continue to grow as SNAP adoption expands among various industry players. Meanwhile, Bank Indonesia continues to ensure the adequate availability of Rupiah currency fit for circulation in suitable denominations throughout all regions of the Republic of Indonesia, including frontier, outermost, and remote (3T) regions. Positive domestic economic performance is the result of close policy coordination between the Government and Bank Indonesia to maintain stability and revive growth. Closer fiscal and monetary policy coordination to maintain macroeconomic stability is an important pillar of nurturing economic growth. Prudent fiscal policy, with a fiscal deficit in 2024 projected at just 2.7% of GDP, indicates that the post-pandemic Covid-19 consolidation process is progressing well. Bank Indonesia’s monetary policy is directed toward ensuring that inflation now and over the next two years remains within the target range of 2.5±1% set by the Government. Policy synergy to control inflation between Bank Indonesia and the (central and regional) Government through the Central and Regional Government Inflation Control Teams (TPIP and TPID) is also being strengthened through the National Movement for Food Inflation Control (GNPIP) in various regions. In pursuit of sustainable economic growth, fiscal policy in 2024 is oriented toward providing economic stimulus through social protection programs for private consumption, spending allocation for general and local elections, as well as capital expenditures for ongoing investment in national strategic projects (PSN), including the development of the new Nusantara Capital City (IKN). The downstreaming program for the mineral and mining sector continues to improve and evolve, accompanied by fiscal incentives to foster priority sectors that drive economic growth. On the other hand, Bank Indonesia has disbursed Macroprudential Liquidity Incentive (KLM) totaling Rp259 trillion to banks extending loans/financing to priority sectors, namely downstream Mineral and Nonmineral, the Automotive sector, Electricity, Gas and Water Supply and Social Services, Housing, Tourism and the Creative Economy, ultra-micro enterprises as well as inclusive and green finance. The Government and Bank Indonesia are also collaborating in close synergy to develop the national digital economy and finance, which includes the electrification of social aid program (bansos) disbursements and (central and regional) government financial transactions. The close coordination within the KSSK between the Ministry of Finance, Bank Indonesia, the Financial Services Authority (the OJK), and the Indonesia Deposit Insurance Corporation (the LPS) also aims to maintain the stability of the financial system and increase economic financing from the financial sector. The close policy coordination between the Government, Bank Indonesia, and the KSSK to maintain macroeconomic and financial system stability has been recognized internationally as an important pillar of national economic performance and, therefore, must be strengthened continuously moving forward. III. Bank Indonesia Policy Mix 2024: Maintaining Stability, Supporting Sustainable Growth The Bank Indonesia Policy Mix in 2024 was oriented toward strengthening stability and supporting sustainable growth in close synergy with the national economic policy mix. As mentioned at the Bank Indonesia Annual Meeting in 2023, monetary policy in 2024 was focused more on maintaining stability (pro-stability), while macroprudential and payment system policies remain directed toward fostering economic growth (pro-growth). This stance strikes an optimal balance between maintaining stability against the adverse effects of global spillovers and sustaining recovery momentum of the economic and financial cycles, which are currently expanding. This monetary policy objective aims to manage Conception of the Bank Indonesia Policy Mix inflation within the target corridor set by the Government, namely 2.5±1% in 2024, as well as maintain Rupiah exchange rate stability against the impact of global turmoil consistent with inflation control policy, while underpinning macroeconomic and financial system stability. Meanwhile, to support sustainable national economic growth, accommodative macroprudential policy sought to revive bank lending to priority sectors, while maintaining the stability of the financial system. Similarly, Bank Indonesia continued accelerating payment system digitalization to support inclusive economic growth through the expansion of the digital economy and finance, particularly among retailers and micro, small and medium enterprises (MSMEs), the electronification of government financial transactions as well as strengthening financial system stability. Bank Indonesia’s policy mix, consisting of monetary, macroprudential, and payment system policies, was further supported by strengthened efforts to deepen the money market and foreign exchange market, development programs for MSMEs, the sharia economy and finance, as well as international policy. In accordance with the Bank Indonesia Act, which has been amended several times and most recently by the Financial Sector Development and Strengthening Act (P2SK Act), the overarching goal of Bank Indonesia as the central bank of the Republic of Indonesia is to achieve Rupiah stability, maintain payment system stability and contribute to preserving financial system stability in support for sustainable economic growth. Rupiah stability is measured by achieving the inflation target set by the Government and maintaining Rupiah exchange rate stability to achieve the intended inflation target and for the economy overall, supported by adequate reserve assets (Figure 3.). Payment system stability is reflected in the velocity of money, including banknotes, account-based money and digital money, in line with economic needs, a healthy and efficient structure of the national payment system industry as well as the availability of secure and reliable payment system infrastructure. Meanwhile, financial system stability is reflected in the optimal disbursement Figure 3. Bank Indonesia Policy Mix MONETARY AND MACROPRUDENTIAL POLICY MIX MONETARY POLICY: FLEXIBLE INFLATION TARGETING FRAMEWORK MACROPRUDENTIAL POLICY: MACRO-FINANCIAL STABILITY FRAMEWORK PRICE STABILITY OPTIMAL CREDIT/FINANCING + π EXCHANGE RATE STABILITY Rp Fx CAPITAL FLOW MANAGEMENT AND FX RESERVE ADEQUACY FINANCIAL SYSTEM STABILITY PAYMENT SYSTEM POLICY PAYMENT SYSTEM POLICY: DIGITALIZATION OF ONE HOMELAND, ONE NATION, ONE LANGUAGE CONVENIENT AND AFFORDABLE RETAIL AND WHOLESALE PAYMENT SYSTEM TRANSACTIONS AND VELOCITY V HEALTHY AND COMPETITIVE STRUCTURE OF THE PAYMENT SYSTEM SERVICES INDUSTRY Source: Bank Indonesia S I PAYMENT SYSTEM INFRASTRUCTURE OF BANK INDONESIA AND THE INDUSTRY THAT IS “3i” AND STABLE INCLUSIVE AND GREEN ECONOMY AND FINANCE PERTUMBUHAN SUSTAINABLE EKONOMI ECONOMIC YANG BERKELANJUTAN GROWTH of loans/financing, mitigated risk in the financial system as well as a financial and economic inclusion. To that end, Bank Indonesia also maintains financial system stability through macroprudential policy in the banking sector and in terms of macroeconomicfinancial linkages, considering that financial system stability is a shared responsibility of the Ministry of Finance, Bank Indonesia, the OJK and the LPS within the Financial System Stability Committee (the KSSK). Those three aspects of Bank Indonesia’s stability objectives are crucial and, therefore, oriented toward supporting sustainable economic growth. In pursuit of its goals, Bank Indonesia is mandated with three main duties that are concurrently oriented toward achieving the three aforementioned aspects of stability to support sustainable economic growth. In accordance with the Bank Indonesia Act, the three tasks and targets are as follows: (i) determining and implementing monetary policy sustainably, consistently and transparently to achieve Rupiah stability; (ii) regulating and maintaining a seamless payment system to preserve payment system stability; and (iii) determining and implementing macroprudential policy to maintain financial system stability. Thus, Bank Indonesia’s support for sustainable economic growth is pursued through these three duties, which can be elaborated as follows. First, through monetary policy, achieving the inflation target and Rupiah exchange rate stability is very important for the growth and development of various economic and financial activities by the government, financial sector, businesses, and the public. Low inflation increases the purchasing power of the public and strengthens certainty for businesses. Similarly, Rupiah exchange rate stability is very important for controlling inflation, maintaining financial system stability, stability of the government securities (SBN) market and government fiscal financing, and maintaining certainty for businesses. Second, through payment system policy, innovative payment instruments, seamless transactions, a healthy industry and stable payment system infrastructure determine the velocity, efficiency, and productivity of various economic and financial activities, including account-based and digital. Similarly, the circulation of currency to ensure the availability of banknotes of sufficient quantity and quality is essential for the community, including outermost, frontier, and remote (3T) regions. Third, through macroprudential policy, optimal growth of bank credit/financing, supported by maintained banking system stability with close synergy within the KSSK, plays an important role in promoting sustainable economic growth. To support the implementation of these three duties, Bank Indonesia is also given authority in money market deepening and international policy, in addition to participating in the development of MSMEs and the sharia economy and finance. When formulating its duties and authority, Bank Indonesia institutes an optimal policy mix to strike a balance between maintaining stability and supporting national economic growth, while taking into consideration the impact of the global economy. The policy mix is based on Bank Indonesia’s assessments, projections, and simulations of movements in the national economic and financial cycles. In this case, accomodative policy mix stance is applied when the cycle is contracting and below potential economic capacity (stagnation or recession) and, alternatively, a tight policy stance is adopted when the cycle is expanding above potential capacity (boom period or overheating). For example, the economic and financial cycles in Indonesia have recently tracked expansionary trends yet remain below potential economic capacity (Graph 16.). This is reflected in low core inflation, a narrow current account deficit, and economic growth that has not yet spread to most economic sectors. Conceptually, therefore, Bank Indonesia has been inclined to maintain an accommodative policy mix stance to strike an optimal balance between stability and sustainable economic growth. However, as a country with an open economy, the impact of global spillovers influences national economic stability and resilience. As explained previously, the impact of global turmoil primarily manifests as Graph 16. Indonesia’s Economic and Financial Cycles monetary policy transmission was strengthened by a pro-market monetary operations strategy through optimization of Bank Indonesia Rupiah Securities (SRBI), Bank Indonesia Forex Securities (SVBI) and Bank Indonesia Forex Sukuk (SUVBI) to attract portfolio inflows and maintain Rupiah stability, while simultaneously deepening the money market and foreign exchange market. Inflation control, particularly food prices, was supported by close coordination with the (central and regional) Government through the Central and Regional Government Inflation Control Teams (TPIP and TPID) and the National Movement for Food Inflation Control (GNPIP) in all regions of the Indonesian archipelago. % -1 -2 -3 -4 -5 -6 -7 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Financial Cycle Economic Cycle Source:: Bank Indonesia instability in terms of Rupiah exchange rates and portfolio inflows due to high interest rates and a strong US dollar. These considerations underlie the posture of the Bank Indonesia policy mix in 2024, namely pro-stability monetary policy, coupled with pro-growth payment system and macroprudential policies, and supported by money market deepening policy as well as economic and financial inclusion programs. Based on the current stance of the Bank Indonesia policy mix, the following policy instruments were implemented in 2024. i. In terms of monetary policy, inflation control and Rupiah stability were achieved through a consistent and well-calibrated policy rate, underpinned by foreign exchange market intervention, a pro-market monetary operations (MO) strategy, and adequate reserve assets. This was pursued to optimize the monetary policy trilemma, namely maintaining price stability, exchange rate stability, and adequate reserve assets. To that end, Bank Indonesia consistently orients BI-Rate policy toward achieving the inflation targets in 2024 and 2025. Meanwhile, Rupiah stabilization efforts aim to dampen shortterm volatility and control the impact on imported inflation through triple intervention in the spot, Domestic Non-Deliverable Forward (DNDF) and SBN markets as required. The effectiveness of ii. In terms of macroprudential policy, Bank Indonesia increased the liquidity incentives and loosened all macroprudential instruments to revive bank lending/financing and maintain financial system stability. The three targets of the macroprudential policy trilemma, namely optimal credit, financial system stability and financial inclusion, were aligned and strengthened. Additional liquidity incentives were provided to banks through implementation of the Macroprudential Liquidity Incentive (KLM) Policy to revive bank lending/financing to priority sectors, including downstream sectors (mineral and coal mining, agriculture, plantation crops and fishing), housing (including public housing), tourism and the creative economy, as well as increasing financial inclusion (MSMEs, people’s business credit program (KUR), ultra-micro), and the green economy and finance. The flexibility of liquidity management in the banking industry was also enhanced by loosening the Macroprudential Liquidity Buffer (MPLB). Likewise, all other macroprudential policy instruments remained loose, including the Countercyclical Capital Buffer (CCyB), Macroprudential Intermediation Ratio (MIR), Loan/Financing-to-Value (LTV/FTV) ratio for property loans/financing and downpayment requirements on automotive loans/financing. Macroprudential and money market surveillance of the banking system was also strengthened to help maintain financial system stability in close coordination with the KSSK. iii. In terms of payment system policy, Bank Indonesia continued accelerating payment system digitalization and ensuring adequate currency in circulation for seamless, efficient and productive economic and financial transactions. Digitalization was implemented through the innovation of various instruments and expansion of digital payment services, while strengthening the structure of the industry and stability of payment system infrastructure, including integration of the national digital economy and finance ecosystem. To that end, the three targets of the payment system policy trilemma, namely velocity, industry structure and infrastructure stability were aligned and strengthened. Implementation of the Indonesia Payment System Blueprint (BSPI) 2025 since 2019 has successfully accelerated digital transformation nationally and achieved various milestones, encompassing the standards, regulations and infrastructure, such as greater acceptance of Quick Response Code Indonesia Standard (QRIS), BI-FAST, and National Open API Payment Standard (SNAP), which have become popular with the public. Seeking to increase transaction value and the velocity of digital payments, Bank Indonesia in 2024 enhanced QRIS by expanding the user base and participating merchants, while extending the 0% Merchant Discount Rate (MDR) for micro merchants. The structure of the payment system was strengthened by expanding SNAP for greater interconnection of payment services and strengthening the surveillance of payment system providers, including monitoring for illegal transactions and enhancing cyber security. BI-FAST acceptance and stability were improved as retail payment system infrastructure that has become increasingly popular with the public. Similarly, the electronification of social aid program (bansos) disbursements and government financial transactions increased, particularly to accelerate and expand local regional digitalization (P2DD) and increase acceptance of the Indonesia Credit Card (KKI) for the government segment. In addition, Bank Indonesia also expanded cross-border payment cooperation through implementation of the Regional Payment Connectivity (RPC) initiative in the ASEAN along with several other important economic partners of Indonesia. Monetary Policy The policy rate in 2024 was set at each monthly Board of Governors Meeting (RDG) as a forwardlooking and pre-emptive measure to steer inflation forecasts for the upcoming two years toward the 2.5±1% target in 2024 and 2025 set by the Government. As explained in the previous section, dynamic world geopolitics and global financial market uncertainty edged up US Treasury yields and strengthened the US dollar, which prompted portfolio outflows and currency depreciation in emerging market economies (EMEs), including Indonesia. In the middle of 2024, the DXY index experienced a broad-based increase to 105.2 in June 2024 from 102.7 at the end of 2023. At the end of 2023, the value of the Rupiah against the US dollar was recorded at approximately Rp15,500 per US dollar before depreciating to Rp16,328 in June 2024. Persistent depreciatory pressures on the Rupiah triggered imported inflation and posed the risk of inflation exceeding the upper bound of the 2.5±1% target in 2024. In response, Bank Indonesia in April 2024 hiked the BI-Rate 25 bps to 6.25% (Graph 17.a.). The increase aimed to strengthen Rupiah stability against the adverse impact of global spillovers as a pre-emptive and forward-looking measure to ensure inflation in 2024 and 2025 remain within the 2.5±1% target corridor. Furthermore, the BI-Rate also succeeded in re-anchoring inflation expectations within the target range (Graph 17.b.). After the Fed provided clarity concerning FFR policy and subsequently lowered the Federal Funds Graph 17.a. BI-Rate and IndONIA Graph 17.b. Inflation Expectations % %, yoy 6.8 6.2 6.0 2.7 2.8 2.4 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 Deposit Facility Rate Lending Facility Rate BI-Rate 2.2 Inflation Target IndONIA Survey period Note: Data as of 20 Nov’24 Source: Bank Indonesia Rate, the US dollar experienced depreciation in September 2024, as indicated by DXY index of 101.0, and the Rupiah regained some lost value to around Rp15,319 in the same period. As the global turmoil eased, one day before the Fed’s decision to lower the FFR in September 2024, Bank Indonesia decided to reduce the BI-Rate by 25 bps to 6.0%. The BI-Rate reduction was consistent with the pre-emptive and forward-looking measures to ensure inflation in 2024 and 2025 remains under control and within the 2.5±1% target corridor. Bank Indonesia also acknowledged space for further reductions in line with low inflation and the need to foster sustainable economic growth. Further decisions concerning the BI-Rate will be determined at future RDG meetings based on global and domestic economic dynamics (data dependent). Rupiah stabilization policy was implemented to dampen short-term volatility and control the direction of future movements in line with achieving the inflation target as well as macroeconomic and financial system stability. Fundamentally, Rupiah exchange rate movements are determined by market mechanisms. Under conditions of market distress, however, particularly the impact of global spillovers, Rupiah volatility tends to be excessive and could disrupt monetary, financial market and financial system stability. Inflation Realization 5.3 Aug'24 Sept'24 Oct'24 Source: Consensus Forecast World geopolitical dynamics and global financial market uncertainty led to high US Treasury yields and a strong US dollar and, therefore, heighten the volatility of foreign portfolio inflows and intensify currency pressures in EMEs, including Indonesia, throughout 2024. The DXY index strengthened from around 102.7 at the end of 2023 to 105.2 in June 2024 before sliding back to 101.0 in September 2024 and recently rebounding to 106.3 given geopolitical tensions in the Middle East and the results of the US presidential election. The build-up of currency pressures and portfolio investment volatility had a massive impact on liquidity risk, market risk and credit risk in the financial market and financial sector, as well as the SBN market and fiscal financing. In addition, persistent currency pressures on the Rupiah also impacted inflation control measures through imported inflation. Those two primary considerations underlie foreign exchange market intervention by Bank Indonesia as an integral part of the monetary policy instruments available to achieve Rupiah stability as mandated by the Bank Indonesia Act. Bank Indonesia’s foreign exchange interventions are carried out through spot transactions, DNDF, and the secondary market for the government securities (SBN), commonly referred to as triple intervention, to strengthen Rupiah exchange rate stability. Intervention primarily seeks to dampen short-term Rupiah volatility and provide signals concerning the direction of Rupiah movements to remain in line with economic fundamentals. Intervention in the government securities (SBN) market is necessary considering that Rupiah pressures typically coincide with foreign portfolio investment outflows from SBN. Therefore, such intervention is an integral part of close monetaryfiscal coordination to stabilize the Rupiah and support Government fiscal financing. Through firm commitment by Bank Indonesia to stabilize the Rupiah, the currency, which slumped to Rp16,328 per US dollar in June 2024, regained lost value to reach Rp15,319 in September 2024 and has remained relatively stable despite depreciating to Rp15,800 recently. It is important to note that Bank Indonesia intervention is implemented symmetrically, namely by selling (or buying) foreign exchange during periods of excessive Rupiah depreciation (or appreciation), which has implications on lower (or higher) forex reserves. Bank Indonesia constantly maintains adequate reserve assets in accordance with international standards. The position of reserve assets was recorded at USD151.2 billion at the end of October 2024 to support the servicing of government external debt and Rupiah stabilization policy. Interest rate policy and Rupiah stability were strengthened through a pro-market monetary operations strategy to reinforce monetary policy independence from the impact of global spillovers, to increase the effectiveness of monetary policy transmission and simultaneously to accelerate money market and foreign exchange market deepening. As explained at the Bank Indonesia Annual Meeting in 2023, Bank Indonesia issued 3 (three) innovative pro-market monetary operation instruments, namely SRBI, SVBI, and SUVBI. There are at least 3 (three) advantages of using such innovative monetary instruments developed by Bank Indonesia. First, all three instruments can be traded on the secondary market, thereby accelerating money market and foreign exchange market deepening, strengthening monetary policy effectiveness, and facilitating more flexible liquidity and investment portfolio management by the banking industry and investors at home and abroad. Second, the three monetary instruments can be traded by non-residents, thus indicating their effectiveness as instruments to manage foreign portfolio flows and Rupiah stability against the impact of global spillovers on the domestic economy. Third, strengthening the independence of monetary policy by Bank Indonesia from the interest rate policies of central banks in advanced economies in terms of directing the BI-Rate and Rupiah stability consistently in line with the domestic goals of controlling inflation and supporting sustainable economic growth. Close monetary and fiscal policy coordination between Bank Indonesia and the Government has been maintained, which includes coordination between issuances of monetary instruments and SBN for fiscal financing. Close coordination between monetary and fiscal instruments began with the plan to issue SBN at the beginning of the year, including implementation from month to month, and even week to week, particularly during highly dynamic global financial market conditions. In terms of SBN issuances, coordination covers the total, timing, target market (domestic or global) and even the fairness of yield performance in the market. The current developments are also reported at the quarterly the KSSK meeting as part of the assessment and coordination of policies to maintain financial system stability. Since the first issue in September 2023, the three instruments have played an increasingly important role in strengthening monetary policy transmission and deepening the money market and foreign exchange market nationally despite the deleterious impact of global spillovers. As mentioned in the previous section, as of 18th November 2024, Bank Indonesia has issued SRBI, SVBI and SUVBI instruments to the tune of Rp968.82 trillion, USD3.39 billion and USD387 million. SRBI issuances support efforts to increase portfolio inflows and strengthen the Rupiah, with significant non-resident holdings of SRBI totaling Rp250.18 trillion (25.8% of total outstanding). The implementation of Primary Dealers (PD) since May 2024 has also increased SRBI transactions in the secondary market along with repurchase agreement (repo) transactions between market players. The composition of SRBI is dominated by 12-month tenors at Rp791.51 trillion, with tenors of 6 and 9 months totaling Rp123.33 trillion and Rp53.97 trillion, respectively, as of 18th November 2024 (Graph 18.a.). The current composition of SRBI is consistent with the preferences of the banking industry, market participants and investors against a backdrop of lower interest rates, in addition to the convenience provided in terms of liquidity management through a deeper secondary money market. SRBI yields are moving in line with market mechanisms, particularly US Treasury yields, specifically 2-year tenors, considering the spread between yields in Indonesia and other EMEs. Consistent with the inverted US Treasury yield, where yields on 2-year tenors are higher than the benchmark 10-year tenor, and high-risk premiums in response to increasing global financial market uncertainty, SRBI yields on 12-month tenors also tracked an upward trend from 6.90% at the end of 2023 to 7.26% at the end of July 2024 (Graph 18.b.). In the subsequent period, given a flattening of US Treasury yields on tenors of 2 years due to clarity from the Fed concerning the direction of FFR policy and the subsequent The three aforementioned instruments of monetary policy, namely the BI-Rate, Rupiah stabilization policy and the pro-market monetary operations strategy, are supported by adequate international reserves and foreign exchange flow management. Bank Indonesia constantly maintains adequate forex reserves in accordance with international standards to support the servicing of government external debt and Rupiah stabilization policy. At the end of October 2024, the position of reserve assets was recorded at USD151.2 billion, equivalent to 6.6 months of imports or 6.4 months of imports and servicing government external debt, which is well above the international adequacy standard of around 3 months of imports. Bank Indonesia is confident that the current level of reserve assets can maintain external sector resilience, as well as macroeconomic and financial system stability. In terms of forex flow management, Bank Indonesia also issued an innovative MO instrument in the form of Foreign Currency Term Deposits (TD Valas) to retain the foreign exchange proceeds of natural Graph 18.a. SRBI Performance Graph 18.b. SRBI Rate by Tenor 6, 9, and 12 months IDR Trillion 1.200 1.000 921 928 399 405 6 Month Note: Data as of 18 Nov’24 Source: Bank Indonesia 961 969 9 Month 12 Month FFR reduction, SRBI yields also tracked a downward trend. For example, the yield of 12-month tenors decreased to 7.00% in October 2024. SRBI yields subsequently rebounded in line with US Treasury yields as a corollary deepening geopolitical tensions in the Middle East and the results of the US presidential election. 7.8 7.6 7.4 7.2 7.0 6.8 6.6 6.4 6.2 6.0 5.8 5.6 % 7.3 7.0 6.9 6.9 6.8 6.8 7.4 7.5 7.3 7.17 7.0 7.0 6.9 6.8 6.4 6 Month Note: Data as of 15 Nov’24 Source: Bank Indonesia 9 Month 12 Month resource exports through banks to Bank Indonesia at competitive rates. The TD Valas instrument is one of 7 (seven) alternative foreign currency asset placement instruments based on Bank Indonesia Regulation (PBI) No. 7 of 2023 as implementation of the requirements to retain the foreign exchange proceeds of natural resource exports (DHE SDA) in accordance with Government Regulation (PP) No. 36 of 2023. The latest developments indicate that exporter interest in the TD Valas instrument continues to grow. As of 19th November 2024, outstanding TD Valas reached USD1.55 billion, dominated by 3-month tenors (Graph 19.a.). In addition, TD Valas also represent an alternative investment instrument that is attractive to exporters and the banking industry, as reflected by the stable level of placements in nostro accounts abroad (Graph 19.b.). Bank Indonesia continued strengthening coordination with the Government to control inflation and bolster the external resilience of the national economy. As discussed previously, close policy coordination encompasses the fiscal policies of the Government and policies of Bank Indonesia. In terms of controlling inflation, particularly volatile food (VF) inflation, close coordination with the (central and regional) Government in the Central and Regional Government Inflation Control Teams (TPIP and TPID) through the National Movement for Food Inflation Control (GNPIP) is fully supported by Bank Indonesia at head office and 46 regional offices throughout Indonesia. Coordination to control food inflation is implemented in accordance with the 4K strategy, namely price affordability (Keterjangkauan Harga), supply availability (Ketersediaan Pasokan), uninterrupted distribution (Kelancaran Distribusi), and effective communication (Komunikasi Efektif). Bank Indonesia support for the success of the GNPIP movement, including food security programs, self-sufficient food cultivation, interregional cooperation, food distribution facilitation, operating affordable markets, data digitalization, as well as ongoing coordination and communication with the public (Table 7.). In terms of coordination, the Government ensures the availability and distribution of food supply nationally, particularly for rice, including social assistance for food, observing food inflation control measures by regional governments, as well as providing awards and fiscal incentives to local governments that are successful in managing food inflation. The success of inflation control measures through the GNPIP movement was reflected in low food inflation throughout 2024. Meanwhile, coordination to maintain macroeconomic stability against the impact of global turmoil involved monetary and fiscal policy coordination between Bank Indonesia and the Government, including domestic and global SBN issuances by the Ministry Graph 19.a. Foreign Currency TD DHE Graph 19.b. Foreign Currency TD vs Nostro USD Billion USD Billion USD Billion 2.5 1 Month Note: Data as of 19 Nov’24 Source: Bank Indonesia 3 Month 6 Month Foreign Exchange Time Deposit 4 Nov’24 19 Nov’24 10 Nov’24 29 Oct’24 23 Oct’24 5 Oct’24 11 Oct’24 17 Oct’24 29 Sept’24 23 Sept’24 17 Sept’24 5 Sept’24 30 Aug’24 11 Sept’24 24 Aug’24 18 Aug’24 12 Aug’24 31 Jul’24 25 Jul’24 06 Aug’24 7 Jul’24 19 Jul’24 1 Jul’24 13 Jul’24 19 Jun’24 25 Jun’24 7 Jun’24 1 Jun’24 13 Jun’24 26 May’24 20 May’24 9 Oct’24 29 Oct’24 19 Nov’24 7 Aug’24 28 Aug’24 18 Sept’24 5 Jun’24 17 Jul’24 26 Jun’24 3 Apr’24 24 Apr’24 15 May’24 31 Jan’24 21 Feb’24 13 Mar’24 10 Jan’24 20 Dec’23 8 Nov’23 18 Oct’23 29 Nov’23 6 Sept’23 16 Aug’23 0.5 27 Sept’23 5 Jul’23 26 Jul’23 1.0 14 Jun’23 3 May’23 12 Apr’23 1.5 24 May’23 1 Mar’23 22 Mar’23 2.0 Nostro (rhs) Note: Data as of 19 Nov’24 Source: Bank Indonesia Table 7. Bank Indonesia’s Support in GNPIP for Inflation Control in 2024 GNPIP Flagship Program Target Achievement % Implementation a. Optimization of Good Agriculture Practices 163.1% b. Replication of Best Practices 102.6% c. Food Downstreaming 91.0% Self-Sufficient Food Cultivation 149.2% Interregional Cooperation 143.9% Food Distribution Facilitation 177.4% Affordable Markets 13,800 11,933 86.4% Data Digitalization 81.6% a. Institutional Coordination 130.7% b. TPID Capacity Building 136.6% c. Managing Inflation Expectation 114.1% d. Food Diversification and Processing 88.8% Food Security Coordination and Communication Source: Bank Indonesia of Finance to finance the budget deficit in the State Revenue and Expenditure Budget (APBN), as mentioned earlier. Bank Indonesia coordination to maintain financial system stability with the Ministry of Finance, the OJK, and the LPS was also implemented under the auspices of the Financial System Stability Committee (the KSSK). Macroprudential Policy To further encourage bank lending/financing to priority sectors, Bank Indonesia in 2024 expanded the scope of liquidity incentives for the banking industry through implementation of Macroprudential Liquidity Incentive (KLM) Policy. As mentioned at the Bank Indonesia Annual Meeting in 2022 and 2023, innovative and accommodative macroprudential policies have been implemented by Bank Indonesia since Data as of 11 Nov’24 March 2022 as part of the Bank Indonesia policy mix to support sustainable growth, specifically the economic recovery process from the adverse impact of the Covid-19 pandemic. Liquidity incentives are provided to banks in the form of a return of the Minimum Reserve Requirement (GWM) to foster credit/financing growth to businesses. Bank Indonesia views the return of GWM in the form of KLM liquidity incentives as more productive for the economy, compared to reducing the GWM requirement for all banks which may be used for exchange rate speculation or other uses rather than credit/financing for businesses. Based on this consideration, Bank Indonesia regularly reviews KLM implementation concerning the scope of sectors and size of incentives and strengthens its effectiveness in terms of encouraging the banking industry to disburse loans/financing (Graph 20.). Regarding the scope of priority sectors, KLM policy was initially provided to support the recovery of sectors experiencing the Graph 20. Evolution of Macroprudential Liquidity Incentive (KLM) Policy Nominal Incentive Realized Incentive Rate (rhs) Maximum Total Incentive 400 bps IDR Trillion 3.42% Maximum Total Incentive 100bps 0.56% 0.58% 36.5 39.8 -40 1.27% 1.33% 3.44% 2.29% 2.27% 1.49% 1.49% 108.4 108.2 87.5 95.7 104.7 3.5% 2.5% 1.88% 1.47% % 3.0% Maximum Total Incentive 280 bps Maximum Total Incentive 200bps 3.44% 137.7 163.3 165.0 255.8 256.1 2.0% 1.5% 1.0% 0.5% 38 Priority Subsectors and Inclusive Finance Expanded to 46 Priority Subsectors and Inclusive Finance Refocusing on 46 Priority Sectors, Inclusive and Green Finance Downstream Mineral and Coal Mining and Non-Mineral, Housing, Tourism, Inclusive and Green Finance 0.0% Expansion: Downstream Mineral and Coal Mining and Non-Mineral, Public Housing, Tourism, Automotive, Trade, Electricity, Gas and Water Supply and Social Services, Inclusive and Green Finance Source: Bank Indonesia scarring effect of the Covid-19 pandemic, which was subsequently expanded to sectors with high leverage for economic growth. The scope of priority sectors was expanded in line with the Government’s program to downstream the mineral sector and mining. Furthermore, Bank Indonesia also increased the size of the KLM incentives, namely from 1.0% to 2.8% of third-party funds (TPF) in April 2023, while the scope was expanded beyond the 46 priority subsectors to also include MSMEs and the green economy. In October 2023, Bank Indonesia decided to again increase the size of the incentives to 4.0% of third-party funds, while expanding the scope of priority sectors to downstream sectors (mineral and coal mining, agriculture, animal husbandry, plantation crops, and fishing), housing (including public housing), tourism (including hotels, restaurants and cafeterias), as well as enhancing economic inclusion (MSMEs, KUR, ultra-micro), and the green economy and finance. The utilization of KLM liquidity incentives by banks has continued to increase in line with the rise in loan/financing growth aimed at supporting sustainable economic growth. As mentioned in the previous chapter, as of the end of October 2024, Bank Indonesia disbursed KLM incentives totaling Rp259.0 trillion to the banking industry, including to state-owned banks (Rp120.92 trillion), national private commercial banks (Rp110.85 trillion), regional government banks (Rp24.66 trillion), and foreign bank branches (Rp2.56 trillion). In total, 123 banks have received KLM liquidity incentives. Of these, 49 banks received amounts equivalent to 3–4% of their thirdparty funds (DPK), and 44 banks received amounts equivalent to 2–3% of their DPK (Graph 21.a.). In terms of the priority sectors, as illustrated in Graph 21.b, most KLM incentives have been disbursed for loans/financing extended to the downstream mineral and non-mineral sector (Rp64.41 trillion), followed by inclusive financing obligations for MSMEs (Rp55.39 trillion) and ultra-micro enterprises (Rp19.86 trillion) in accordance with fulfilling the Macroprudential Inclusive Financing Ratio (RPIM), the automotive, trade, electricity, gas and water supply, and social services sector (Rp39.76 trillion), tourism and the creative economy (Rp31.78 trillion), the green economy (Rp25.96 trillion), and housing (Rp21.82 trillion). Therefore, the provision of KLM liquidity incentives is considered effective in encouraging Graph 21.a. Number of Banks Receiving KLM Incentives Graph 21.b. KLM Disbursements by Priority Sector Number of Banks IDR Trillion 300.0 250.0 0% (No Insentives) >0%-1% >1%-2% Regional Development Bank National Private Commercial Bank 150.0 >2%-3% 200.0 >3%-4% State-Owned Enterprise Foreign Bank Branch 100.0 50.0 25.96 55.39 Green 19.86 RPIM Tourism and Creative Economy 21.82 Housing 39.76 Automotive, Trade, Electricity, Gas and Water Supply Downstream 31.78 64.41 Nominal Ultra-micro Enterprises Housing Ultra Micro Enterprises Total Incentives IDR259.00 T Number of Banks Green RPIM Tourism and Creative Economy Downstream Automotive, Trade, Electricity, Gas and Water Supply Source: Bank Indonesia Source: Bank Indonesia the banking industry to extend loans and financing in pursuit of sustainable economic growth. Moving forward, Bank Indonesia will regularly assess the scope of priority sectors to remain in line with government programs, including sectors that create jobs. Indonesia should banks require short-term liquidity (Graph 22.a). In October 2024, all banks maintained a MPLB ratio above 5% of TPF, with 73 banks exceeding 20% and 28 banks with a MPLB ratio in the 10-20% range (Graph 22.b.). Nearly all securities used to meet the MPLB ratio were held by the banking industry and only a small portion were used in repo transactions with Bank Indonesia. This demonstrates loose liquidity conditions in the banking industry to support lending/ financing for the economy. As mentioned in the previous section, the banks tended to place the excess liquidity in securities as an alternative instrument amid sluggish demand for credit from businesses that meet the lending standards. Moving forward, as the national economy continues to recover, the growth of credit/ financing extended by the banking industry is expected to accelerate. Bank Indonesia continues to maintain the adequacy of banking liquidity, including a flexible Macroprudential Liquidity Buffer (MPLB), to support lending while simultaneously maintaining financial system stability. As discussed previously, loose liquidity conditions in the banking industry are reflected in the ratio of liquid assets to third-party funds and the loan-to-deposit ratio (LDR), which were recorded at 25.58% and 87.50%, respectively in Oktober 2024. (Graph 22.a.). The loose liquidity conditions in the banking sector for credit/financing distribution are also reflected in the fulfillment of the Macroprudential Liquidity Buffer (MPLB) ratio requirement, which obliges banks to allocate a portion of their liquid assets in high-quality securities, such as the SBN. As outlined in the Bank Indonesia’s Annual Meeting 2023, to enhance banks’ flexibility in managing their liquidity, Bank Indonesia has reduced the MPLB ratio by 100 bps to 5% for Conventional Commercial Banks (BUK) and 3.5% for Sharia Commercial Banks/Sharia Business Units (BUS/UUS). Additionally, the flexibility of the designated securities allows them to be used in repo transactions with Bank In addition to the KLM liquidity incentives and MPLB flexibility, Bank Indonesia extended all other accommodative macroprudential policy instruments to maintain financial system stability to support sustainable economic growth. Bank Indonesia maintained various accommodative macroprudential policy instruments, including a Loan/Financing-toValue (LTV/FTV) ratio of 100% for all residential property types (including public housing) and a 0% downpayment requirement for automotive loans, which was initially set to end on 31 December 2023 but has been extended to 31 December 2024. Graph 22.a. Macroprudential Liquidity Buffer (MPLB) Graph 22.b. Distribution of the Macroprudential Liquidity Buffer (MPLB) % Number of Banks 68 69 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 Non-Repo Securities Flexible Repo Securities <5% 5-10% Sept'23 Macroprudential Liquidity Buffer Dec'23 10-20% Mar'24 >20% Oct'24 Source: Bank Indonesia Source: Bank Indonesia Similarly, Bank Indonesia maintained a Countercyclical Capital Buffer (CCyB) of 0%, and a Macroprudential Intermediation Ratio (RIM) of 84–94% to provide liquidity flexibility and revive bank lending and financing. Additionally, the Macroprudential Inclusive Financing Ratio (RPIM) was implemented to support an inclusive economy and finance, specifically for MSMEs, along with the prime lending rate (PLR) transparency policy to bolster the effective transmission of monetary and macroprudential policies. on assessing the three risks arising from transactions and the interconnectedness of large banks in the money and foreign exchange markets. In addition to risk assessments, macroprudential and market surveillance also focus on the capabilities of human resources, risk management, and the technology used in large banks. Both forms of surveillance are mandated by the Financial Sector Development and Strengthening Act (P2SK Act), which enhances Bank Indonesia’s mandate in macroprudential policy, as well as in deepening the money and foreign exchange markets. The results of macroprudential and market surveillance serve as important considerations for formulating Bank Indonesia’s policy mix and are an integral part of bilateral supervisory coordination with the OJK, as well as broader coordination to maintain financial system stability within the KSSK. Bank Indonesia continues to strengthen macroprudential and money market surveillance of the banking system to maintain financial system stability. Macroprudential surveillance focuses on the macroeconomic-financial linkages of large banks, which play an important role in lending/financing, and maintaining financial system stability. The surveillance assesses liquidity risk, market risk (interest rates and exchange rates) and credit risk, which can arise from domestic and global macroeconomic dynamics. Risk assessment is conducted on individual large banks as well as interlinkages within the banking system, both in the near term (cross-sectional) and dynamically over the next two years (forwardlooking). The three aspects of risk are also stresstested based on macroeconomic projections in Indonesia as well as the impact of global economic dynamics. Meanwhile, market surveillance focused Bank Indonesia continues to strengthen policy synergy with the KSSK to maintain financial system stability. In 2024, the KSSK held quarterly meetings as well as ad hoc meetings as required. First, coordination to conduct joint assessments of conditions and policy coordination to maintain financial system stability. Overall, financial system stability was preserved, demonstrating resilience against global and domestic pressures. Bank Indonesia maintained financial system stability and Rupiah stability, optimal credit/financing growth, surveillance of large banks focusing on liquidity and market risks, as well as payment system stability. Joint stress-tests of financial system stability were conducted along with coordinated simulations to prevent and manage the possibility of a crisis. Second, coordination to follow up on regulations and provisions that must be issued as part of P2SK Act implementation. To that end, Bank Indonesia has issued 12 of 17 Bank Indonesia Regulations (PBI), with the remainder to be completed within the timeframe specified. Third, coordination in the implementation of the Financial Sector Assessment Program (FSAP) by the IMF and World Bank to assess the progress of financial sector development and supervision in accordance with international standards. This year was the third time the FSAP had been conducted after successful assessments performed in 2010 and 2017. In general, the assessment found that the economy and financial sector in Indonesia are healthy, accompanied by strong, stable, and resilient growth in the face of external shocks. The assessment looked at aspects of financial system stability with a focus on vulnerabilities (systemic risk analysis), the regulatory and supervisory framework for the financial sector, crisis management, financial system safety nets, and aspects of financial sector development. The FSAP positively assessed the P2SK Act as an important factor in increasing resilience, strengthening financial sector safety nets and the crisis management framework, as well as fostering financial sector development in Indonesia. Indonesia’s achievements were the result of close synergy and the contributions of the Ministry of Finance, Bank Indonesia, the OJK, the LPS, and other relevant authorities, as well as business players in the financial services sector. Payment System Policy Bank Indonesia has continued to accelerate payment system digitalization through innovation in instruments and the expansion of digital payment services to strengthen integration of the national digital economy-financial ecosystem (EKD). The use of Quick Response Code Indonesia Standard (QRIS), as the only national QR standard for EKD transactions in Indonesia, has been expanded continuously through a broad acceptance campaign, coupled with innovative ease and convenience features for the public. A wide-ranging campaign to expand QRIS acceptance in 2024 was implemented nationally and in various regions through the 46 representative offices of Bank Indonesia. Bank Indonesia innovated QRIS features in conjunction with the Indonesia Payment System Association (ASPI) in the form of national standards for QRIS Withdrawal, Transfer and Deposit (TUNTAS), thereby facilitating users to withdraw, transfer and deposit cash. To further increase digital payment transactions for the people’s economy, Bank Indonesia in 2024 continued providing incentives in the form of a 0% MDR for QRIS micro enterprises. As of October 2024, QRIS users totaled 54.2 million of the 55 million target along with 34.7 million merchants, dominated by MSMEs. Spatially, most QRIS users are in the Java region, totaling 37.2 million, followed by Sumatra (9.4 million), Sulawesi, Maluku and Papua (3.0 million), Kalimantan (2.7 million) and Bali-Nusa Tenggara (1.9 million). Meanwhile, QRIS transactions accelerated, with transaction volume increasing 183.9% (yoy) and transaction value growing 184.5% (yoy), supported by 34.7 million merchants (Graph 23.a.). QRIS transaction value was dominated by spending on food and beverages, followed by transportation and communication, restaurants and hotels as well as other consumer spending (Graph 23.b.). The increasing popularity of QRIS among the public indicates the growing benefits of faster payment system digitalization by Bank Indonesia to support sustainable and inclusive economic growth. The expansion of acceptance and stability of BIFAST has been enhanced as the retail payment system infrastructure increasingly favored by the public. As is known, BI-FAST was introduced in late December 2021 as nationally driven retail payment system infrastructure, with real-time features operating 24/7, to meet the rapidly growing needs of retail transactions. Bank Indonesia also offers several benefits, such as open participation, the option for independent or shared infrastructure, a Graph 23.a. QRIS Performance: Users, Transaction Volume and Value Graph 23.b. QRIS Transaction Value by Segment Million IDR Trillion TOTAL Oct 2024 QRIS Users 45,777,525 54,213,807 QRIS Merchants 30,411,888 34,679,784 687.71 Million 184% (yoy) Rp71.02 Trillion 185% (yoy) 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 Volume IDR Trillion Value (rhs) Food and Beverages, excluding Restaurants Apparel, Footwear and Services Others Restaurants and Hotels Health and Education Transportation and Communication Housing and Household Appliances Source: Bank Indonesia Source: Bank Indonesia transaction limit of Rp250 million per transaction and competitive pricing up to a maximum of Rp2,500 per transaction for consumers and Rp19 per transaction paid by the participants to Bank Indonesia. In total, BI-FAST participation currently includes 122 banks, 2 nonbank payment system service providers and the Indonesian Central Securities Depository (KSEI), accounting for 94% of retail payment system transactions. Participation in BI-FAST services can be direct or indirect, depending on participants’ technological capabilities, risk management, and human resource capacity. As of October 2024, the volume of retail payment system transactions below Rp250 million via BI- FAST reached 2.7 billion transactions with a value of Rp7,114 trillion, accounting for 72.8% and 64.0% of retail payment transaction volume and value, respectively (Graph 24.a.). The value of BIFAST transactions is relatively small, namely below Rp500,000 per transaction, accounting for 58% of transactions. Among these transactions, services provided by Non-Main PSPs accounted for 69.8%, compared to 53% by Main PSPs (Graph 24.b.). These developments indicate that BI-FAST is increasingly capable of providing inclusive digital payment services to the public, while nurturing cooperation Main PSPs and Non-Main PSPs. As public acceptance grows, Bank Indonesia is strengthening service Graph 24.a. BI-FAST Transaction Volume vs Other Retail Payments Graph 24.b. BI-FAST Transaction Volume by Transaction Value Bracket Million Transactions % 10.4% 12.2% 13,7% 11 12 BI-FAST Source: Bank Indonesia Online Transfer SKNBI BI-RTGS 4.7% 1.6% 5.8% 3.8% 9.1% 9.0% 12.3% 11.3% 13.3% 69.8% 58.0% 53.0% Main PSP Non-Main PSP All Participants <500k 500k - <1m 1m - <2m 2m - <5m 10m - <50m 100m - <250m 50m - <100m 5m - <10m 250m Source: Bank Indonesia stability end-to-end, from the stability of payment system infrastructure in Bank Indonesia to the technology and risk management in PSPs, and the services provided by PSPs to the public. The main concerns of Bank Indonesia policy and supervision include aspects of consumer protection, security against illegal transactions and the reliability of cyber security technology. Digital payment system services offered by the banking industry and nonbank PSPs have increased rapidly given the increasing interconnection of services. As explained in the previous chapter, digital payments in 2024 are projected to reach 36.3 billion transactions with a value of approximately Rp71.0 trillion. Most digital payments are serviced through mobile banking, totaling 20.6 billion transactions with a value of Rp24.5 trillion, followed by electronic money, totaling 13.4 billion transactions with a value of Rp1.2 trillion, and internet banking, totaling 2.4 billion transactions with a value of Rp45.4 trillion (Graph 25.a.). Such rapid growth indicates increasing public acceptance and preference for digital payment services, which provide greater convenience in the form of fast, simple and cheaper economic and financial transactions. To further facilitate digital payments for the public and simultaneously strengthen the structure of the payment industry, Bank Indonesia has expanded implementation of the National Graph 25.a. Digital Payment Transaction Volume Million Transactions 30,000 25,000 20,000 15,000 10,000 5,000 2023 2024* Mobile Banking UE Server Based Internet Banking Digital Payment Digital Payment Growth (rhs) Note: * Projection Source: Bank Indonesia 35,000 Bank Indonesia continued strengthening policy synergy with the (central and regional) Graph 25.b. Composition of Transaction Volume among SNAP Participants %, yoy 40,000 Open API Payment Standard (SNAP) to support interconnected digital banking services between banks and the FinTech industry. After SNAP implementation for the first movers and second movers in 2022 and 2023, respectively, Bank Indonesia in 2024 expanded PSP participation to further accelerate the digital economy and finance in synergy with the Indonesia Payment System Association (ASPI). As a result, SNAP participation currently involves 10 first movers, 71 second movers and 32 new participants in terms of SNAP interconnection. SNAP adoption for interconnected payment services by the payment system industry has increased significantly, currently accounting for approximately 73% of payment transaction volume (Graph 25.b.). To strengthen a healthy, efficient and stable PSP industry structure, Bank Indonesia continues strengthening payment system surveillance in terms of HR competencies, risk management and the reliability of the technology deployed. The results of the surveillance are used as the basis for determining the health and classification of PSPs participating in BI-FAST and the payment services offered to the public, which includes coaching if required. % 27% 73% SNAP Volume Source: Bank Indonesia Proprietary Volume Government in the electronification of social aid program (bansos) disbursements and government financial transactions. Seamless social aid program (bansos) disbursements to Beneficiary Families (KPM) were maintained through coordination/facilitation, socialization/education and monitoring involving all Bank Indonesia representative offices. The implementation and acceptance of the Indonesia Credit Card (KKI) for the government segment was further expanded to support government financial transaction efficiency, inclusive finance and economic recovery. Launched in August 2022, the KKI for the government segment is a national credit card scheme for domestic purposes, beginning with transactions in the government segment. After the success of integrating QRIS features into the KKI for the government segment, Bank Indonesia in 2024 focused on efforts to expand use of the KKI for the government segment in order to boost acceptance. Given the various benefits and consistency of Bank Indonesia in synergy with the Indonesia Payment System Association (ASPI) to strengthen implementation and acceptance of the KKI for the government segment, the number of regional governments participating has increased. Likewise, KKI transactions continue to rise both in volume and nominal value, dominated by transactions by Regional Governments through the QRIS feature. Most KKI transactions are made in the transportation and accommodation sectors. Implementation of the Regional Government Transaction Electronification (ETPD) program was also expanded in conjunction with the Task Force for Accelerating and Expanding the Electronification of Central and Regional Government Transactions (P2DD), including the TP2DD Championship Program at the National Coordination Meeting (Rakornas) for P2DD held in September 2024. In addition, synergy with government ministries/agencies and other authorities was maintained through the Indonesia Digital Economy and Finance Festival (FEKDI), which was hosted in conjunction with Karya Kreatif Indonesia in August 2024. Bank Indonesia continued expanding cross-border payment cooperation through implementation of the Regional Payment Connectivity (RPC) initiative in the ASEAN region along with several other important economic partners of Indonesia. QRIS cross-border payments have been implemented between Bank Indonesia and the Bank of Thailand (BoT), Bank Negara Malaysia (BNM) and Monetary Authority of Singapore (MAS). The latest developments indicate that more and more residents in both countries are using QR to facilitate transactions, particularly retail transactions for tourism. For example, QR cooperation between Bank Indonesia and Bank Negara Malaysia (BNM) is facilitated by 8 PSPs in Malaysia and 57 PSPs in Indonesia, with 181,000 transactions recorded in Indonesia to the tune of approximately Rp43.6 billion (Graph 26.a.). Furthermore, cross-border QRIS cooperation will be expanded to other partners, including Japan, India and South Korea, to nurture faster, cheaper, more transparent, and more inclusive cross-border payments, particularly for MSMEs. This initiative is expected to foster economic activity, including the tourism sector, as well as encourage the use of local currencies and bilateral transactions within the local currency transaction (LCT) framework. As of October 2024, LCT totaled USD12.2 billion (with share to total trade amounting to 9.5%), averaging USD1,222 million per month, increasing 133.3% from an average of USD524 million per month in 2023. Most local currency transactions were between Indonesia and China, followed by transactions with Japan, Malaysia, and Thailand (Graph 26.b.). Bank Indonesia also continues to develop the Digital Rupiah through Project Garuda to ensure the Rupiah remains the sole legal tender in Indonesia in the digital era. This is in accordance with implementing the mandate pursuant to Act Number 4 of 2023 concerning Financial Sector Development and Strengthening (P2SK Act), which stipulates Bank Indonesia as the only institution authorized to issue Rupiah currency in Indonesia. After receiving feedback from the industry and associations, government ministries/agencies, academics, and the public, Bank Indonesia is currently in the process of experimenting with technology Graph 26.a. Cross-Border QRIS Transactions between Indonesia and Malaysia Transactions 200,000 Graph 26.b. Local Currency Transactions (LCT) IDR Billion Inbound Volume 180,977 transactions Inbound Value IDR43.60 Billion 180,977 43.6 150,000 57 PSP 1,400 100,000 Inbound Volume 9 10 11 12 9 10 1,000 Launch 1,200 50,000 1,600 8 PSP USD Million Inbound Value (rhs) 1,222 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 Malaysia Thailand Japan China Monthly Average Volume Source: Bank Indonesia Source: Bank Indonesia through the proof of concept (POC) with a focus on issuing and circulating the Digital Rupiah. Alternative technological solutions are currently being tested by Bank Indonesia, namely the choice between centralized and decentralized solutions considering the speed and security of issuing Digital Rupiah moving forward. The POC output will underlie the subsequent process, namely prototyping and piloting/sandboxing during the immediate phase, which focuses on issuing and circulating the Digital Rupiah from Bank Indonesia to banks appointed as wholesalers as the starting point of the intermediate phase that focuses on using the Digital Rupiah for digital financial securities. Indonesia strengthened the capabilities of the Rupiah Currency Management Command Center through the development of a currency distribution application along with dashboard analytics for near real-time monitoring as well as to project and monitor currency stock levels at all cash-related work units. Bank Indonesia continued optimizing currency distribution through cash deposit services, while increasing cash services in remote regions, including currency exchange services in frontier, outermost and remote (3T) regions through the Sovereign Rupiah Expedition (ERB) to ensure the equitable distribution of currency fit for circulation in the community. Bank Indonesia also began initiating the application of green Rupiah currency management through collaborative research with strategic partners, especially to study the development of a green waste processing network for the Rupiah currency. In terms of Rupiah currency management, Bank Indonesia continued the transformation of Rupiah currency management, based on the Rupiah Currency Management Blueprint (BPPUR) 2025. The implementation of this transformation has been carried out by increasing the efficiency of the currency distribution system and premium cash services in frontier, outermost and remote (3T) regions. Bank Indonesia optimized the distribution routes by leveraging better regional connectivity infrastructure to increase efficiency in the distribution process, human resources and costs. Synergy with strategic partners was also improved to extend the reach, timeliness, and security of currency distribution throughout all regions in the territory of the Republic of Indonesia. Furthermore, Bank Money Market and Foreign Exchange Market Deepening Bank Indonesia continued accelerating the deepening of modern, efficient and advanced money and foreign exchange markets referring to international best practices. This is in accordance with P2SK Act implementation, which mandates Bank Indonesia with regulating, deepening, and supervising the money market and foreign exchange market. The implementation of various programs refers to the Money Market Development Blueprint (BPPU) from 2020-2025, covering 4 (four) aspects, namely the financial market products, pricing, participants, and infrastructure. Regulatory strengthening was continued oriented toward accelerating the development of modern, efficient, and advanced money and foreign exchange markets in close synergy with the Government and the KSSK, as well as involving the industry, namely banks and market participants. In accordance with P2SK Act implementation, Bank Indonesia promulgated Bank Indonesia Regulation (PBI) No. 6 of 2024 concerning the Money Market and Foreign Exchange Market, which regulates general provisions, the regulatory framework, market development and supervision, market products, pricing, market participants, financial market infrastructure, market transactions, licensing, data and information, potential principles, risk management and governance, consumer protection, transitional regulations, and closing provisions. Bank Indonesia is confident that modern, efficient and advanced money and foreign exchange markets are critical to strengthen operational effectiveness and monetary policy transmission, financial system stability, fiscal financing, as well as financing for businesses and the economy. Since BPPU 2025 implementation, money market and foreign exchange market transactions in Indonesia have developed rapidly, particularly repurchase agreement (repo) transactions in the money market. In terms of product development, for instance, average daily repo transaction value has increased 34-fold since initial BPPU 2025 implementation in 2020. Data as of October 2024 indicates that average daily repo transaction value reached Rp14.9 trillion in 2024, up 36.7% from Rp10.9 trillion in 2023 and more than a twofold increase on the Rp7.3 trillion recorded in 2022 (Graph 27.a.). This indicates that repo transactions are helping market participants manage bank liquidity in terms of the securities (specifically SBN and SRBI) held as collateral for repo transactions without the need to resell. This also benefits the SBN market in terms of liquidity and yield and, therefore, lowers the cost of fiscal financing for the Government. On the other hand, transactions in the foreign exchange market are increasing at a slower pace. Average daily foreign exchange transactions as of October 2024 were recorded at USD9.1 billion, up 19.7% from USD7.6 billion in 2023 and 40.0% from USD6.5 billion in 2022 (Graph 27.b.). The foreign exchange market is dominated by spot transactions, with DNDF transactions increasing more slowly. Moving forward, Bank Indonesia will continue developing money market and foreign exchange market Graph 27.a. Daily Average Repo Transactions Graph 27.b. Daily Average Foreign Exchange Transactions IDR Trillion USD Billion 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 Daily Average Repo Volume Daily Average Annual Repo Volume 2023 Note: Data as of Oct’24 Source: Bank Indonesia Daily Average Annual Repo Volume 2022 Daily Average Annual Repo Volume 2024 Spot Swap Forward DNDF Option Cross-Currency Swap Source: Bank Indonesia products by deepening repo and DNDF transactions, while expanding other products, such as interest rate swaps (IRS) and cross-currency swaps (CCS). In terms of the pricing mechanism, Bank Indonesia publishes IndONIA as the daily reference rate for the money market and JISDOR for the foreign exchange market referring to international best practices. In addition, Bank Indonesia will publish regulations concerning overnight index swaps (OIS) as a reference for the formation of the interest rate structure in the money market for tenors of 2 weeks to 12 months. Similarly, FX swaps with longer tenors will be developed as hedging instruments for the banking industry, market participants and corporate sector, particularly exporters, importers and foreign direct investment (FDI) companies. Bank Indonesia continued strengthening market participants and the role of associations in terms of accelerating money market and foreign exchange market deepening to be more modern, efficient, and advanced. The structure of market participants is determined through the selection of Primary Dealers (PD) based on transaction value, interconnected transactions with other participants, human resources capacity, risk management, and the reliability of the technology used. The four selection criteria are also applied when determining the structure of the payment system industry. According to Bank Indonesia Regulation (PBI) No. 6 of 2024, PDs are required to operate as marketmakers, remain active in Bank Indonesia monetary operations, actively transact in the money market and foreign exchange market and fulfill other obligations set by Bank Indonesia in terms of money market and foreign exchange market activity. As of October 2024, Bank Indonesia has approved 20 banks as PD, with the opportunity still open for other banks to become PD providing they meet the prevailing regulations. All PDs are evaluated regularly by Bank Indonesia based on the four criteria mentioned, with coaching offered for any requirements that must be improved. As of October 2024, average daily transactions by PDs accounted for around 56% of the money market (Graph 28.a.) and approximately 72% of the foreign exchange market (Graph 28.b.). Gradually, this structure of market participants will ensure direct transactions in the money market and foreign exchange market and monetary operations transactions with Bank Indonesia will be limited to and between PDs, while other market participants will transact through the PDs. Strengthening the structure of market participants intends to accelerate future money market and foreign exchange market deepening with larger transactions and more efficient pricing. Bank Indonesia will continue to provide standing facilities, including a deposit facility and a lending facility, for all banks to manage their daily liquidity. Meanwhile, market associations will be strengthened Graph 28.a. Primary Dealer Transactions in the Money Market Graph 28.b. Primary Dealer Transactions in the Foreign Exchange Market % IDR Trillion 56% 10,000 8,000 USD Million % 12,000 % 72% 4,000 2,000 Total Source: Bank Indonesia Primary Dealer Primary Dealer Share (rhs) 6,000 Total Source: Bank Indonesia Primary Dealer Primary Dealer Share (rhs) through the formation of the Indonesia Money Market and Foreign Exchange Market Association (APUVINDO) as the only association representing the industry in coordination with Bank Indonesia to develop and deepen the money market and foreign exchange market. With the formation of APUVINDO, Bank Indonesia will focus more on principle-based regulations, while the actual implementation will be carried out through the APUVINDO association. The work program of APUVINDO, therefore, is similar in operation to Bank Indonesia’s programs contained in BPPU 2025. Money market and foreign exchange market development in Indonesia made history with the operation of the Central Counterparty for Interest Rate and Exchange Rate Derivatives (CCP-SBNT) on 30th September 2024. Modern and advanced money and foreign exchange markets facilitate large volumes and adequate liquidity, a variety of participants, as well as stability and efficiency, supported by interconnected infrastructure. To that end, in synergy with the OJK, Indonesia Stock Exchange (IDX), Indonesia Stock Market Clearing House (KPEI), and banking industry, Bank Indonesia created and developed CCP-SBNT for the money market and foreign exchange market in Indonesia. The central counterparty (CCP) was launched to fulfill the mandate of the P2SK Act, which mandates Bank Indonesia with regulating, developing, and supervising the money market and foreign exchange market, including financial market infrastructures (FMIs). The CCP launch also aimed to fulfill the G20 Over the Counter (OTC) Derivatives Market Reform commitments as an integral part of BPPU 2025 implementation. The CCP is a systemic financial market infrastructure responsible for clearing and novation the transactions of its members (Figure 4.). At the initial stage of CCP implementation, eight banks are participating with the IDX as existing shareholders of the KPEI, namely Mandiri, BRI, BNI, BCA, CIMB Niaga, Permata, Danamon, and Maybank. Bank Indonesia conferred the status of Qualifying CCP (QCCP) after fulfilling international standards, namely the Principles for Financial Market Infrastructures, while also accommodating settlement through close-out netting. Initially, the CCP will focus on DNDF and repo instruments, with the products Figure 4. Money Market and Foreign Exchange Market Transactions Before and After Novation through the Central Counterparty (CCP) Current Conditions (before Novation): Bilateral Trading and Bilateral Clearing Future Conditions (after Novation): Bilateral Trading and Multilateral Clearing Over-the-Counter (OTC) Bilateral Netting, Counterparty Risk, Liquidity Risk, Market Risk 1:N Relationship Central Counterparty (CCP) Multilateral Netting with CCP as Central Clearing and Guarantor 1:1 Relationship A F A B F B CCP E C E C D D Credit Risk and Interconnected Risk Netting and Unconnected Source: Bank Indonesia expanded gradually based on transaction volume and market readiness, including the infrastructure. CCP implementation is expected to increase average daily repo transactions in the money market to Rp30 trillion and DNDF transactions in the foreign exchange market to exceed USD1 billion in 2030. Money market and financial market deepening was also strengthened by the pro-market monetary operations strategy applied by Bank Indonesia. This strategy was deployed by issuing SRBI, SVBI, and SUVBI instruments to replace monetary operations based on repo and reverse repo (RR) auctions using SBN as the underlying. Since issuing SRBI, Bank Indonesia has discontinued SBN RR auctions for monetary operations across all tenors, excluding the 1-week tenor for the operationalization of the BI-Rate in the money market and some of the 3-month tenors as a reference for calculating burden sharing with the Government in accordance with the Joint Decree (KB) concerning State Budget (APBN) financing by Bank Indonesia during the Covid-19 pandemic. This pro-market monetary operations strategy aims to ensure that more SRBI are traded in the secondary market, thereby accelerating money market and foreign exchange market deepening in Indonesia. Its development is truly impressive, as reflected in the rapid increase of SRBI transactions in the secondary market. Average daily SRBI transactions in the secondary market in the second IDR Trillion IDR Trillion 10.25 7.99 % 47% 0.00 0.00 Semester II Semester I Overnight 3 month Source: Bank Indonesia Semester II 2-4 day 6 month 1 week 9 month 2 week 12 month 1 month Total 2.98 8.53 Bank Indonesia continued strengthening synergy with the Government and the KSSK for financial market development in terms of financial education and literacy, as well as enhancing sources of economic financing. Synergy through the Coordination Forum for Development Financing through Financial Markets (FKPPPK) continued by following up various regulations as mandated by the P2SK Act. Furthermore, FK-PPPK synergy was also directed at expanding the retail Graph 29.b. Primary Dealer Transactions in Monetary Operations with Bank Indonesia Graph 29.a. SRBI Transactions in the Secondary Market by Tenor semester of 2023 reached just Rp3 trillion before increasing rapidly to Rp10 trillion as of October 2024 (Graph 29.a.). This indicates that SRBI issuances have effectively deepened the money market and foreign exchange market by significantly increasing transactions in the secondary market, while also demonstrating the ability of the banking industry and other market participants to manage their liquidity and investment portfolios, which previously depended upon monetary operations with Bank Indonesia. Furthermore, the rapid proliferation of SRBI transactions in the secondary market has successfully reduced PDs transactions in the money market and foreign exchange market, which currently account for approximately 47% of Bank Indonesia’s monetary operations (Graph 29.b.). Such positive developments are inextricably linked to Bank Indonesia policy to restructure market participants through the selection of PDs to boost transactions and interconnections between participants in the money market and foreign exchange market. Total Source: Bank Indonesia Primary Dealer Primary Dealer Share (rhs) investor base through the LIKE IT financial literacy campaign. In 2024, the financial education and literacy program targeted the younger generation to increase their participation in terms of investment in the financial market as part of their financial planning education and simultaneously how the investment will subsequently play an important role in terms of increasing the savings and financing of the national economy. The ease of investing in the financial market is also supported by faster payment system digitalization and retail investment innovation, which the banking industry and securities companies continue to develop and offer. In addition to the younger generation, the financial literacy program also targeted businesses in the MSMEs sector, piloting sustainable finance and derivative transaction instruments (environmental, social and governance, or ESG). In addition, synergy and strengthening were both used to harmonize tax regulations in the money market, supporting the development of money market instruments as a source of national economic development financing. Development of the Sharia Economy and Finance and MSMEs Bank Indonesia continued strengthening synergy to accelerate development of the green and inclusive economy and finance in pursuit of sustainable economic growth. In this regard, MSME development is carried out through three strategic pillars, as follows: (i) inclusive economic and financial empowerment; (ii) development of the green economy and finance; and (iii) synergy and collaboration. Inclusive economic and financial empowerment is achieved through programs to level up MSMEs, increase the subsistence level, expand market access, expand access to finance, and increase financial literacy. Meanwhile, development programs for the green economic-finance aim to increase green financial literacy, strengthen the green economy and finance ecosystem, and increase access to green finance. Both programs extend beyond studies and reviews to include the development of business models, pilot projects, replication efforts for business expansion, entrepreneurship education as well as the expansion of access to markets and finance. Implementation is conducted through MSMEs development programs at all 46 Bank Indonesia representative offices across Indonesia. The products of MSMEs under the mentorship of Bank Indonesia, including fabrics and modern fashion as well as food and beverages, including coffee, are recognized as national flagship products that have been marketed internationally. In implementing these inclusive and green economicfinance programs, Bank Indonesia collaborates in close synergy with the Government and the OJK, and play an active role nationally and internationally. The synergy between Bank Indonesia and ministries/agencies, as well as all other strategic partners, continues to be strengthened to promote the development of competitive MSMEs. Bank Indonesia has consistently supported the National Movement of Promoting Pride in Indonesian-made Products and the Proud to Travel in Indonesia (BBI and BBWI) to increase the use of quality MSME products throughout the community. Bank Indonesia has proactively and consistently initiated various programs and activities at all regional Bank Indonesia representative offices, including business matching for financing and exports, MSMEs onboarding and MSMEs capacity building. Close synergy in MSMEs development also manifested in the Karya Kreatif Indonesia (KKI) 2024, which was held in conjunction with the Indonesia Digital Economy and Finance Festival (FEKDI) in August 2024. Through close synergy between Bank Indonesia, government ministries/agencies, associations, the industry, and potential buyers/aggregators, the KKI exhibition in 2024 performed impressively. Nearly 27,000 visitors attended the event in person and approximately 123,000 visited the event virtually, with MSMEs revenue and business matching increasing by 28% to reach Rp576 billion (Figure 5.). The success of the KKI event in 2024 is expected to motivate MSMEs to increase their creativity, innovation, and spirit of growth to become Indonesian MSMEs that can level up, being digitally savvy, and go global, thereby supporting sustainable economic growth. Figure 5. Karya Kreatif Indonesia (KKI) 2024 Achievements at a Glance #HamajuonNagari Festival Ekonomi Keuangan Digital dan Karya Kreatif Indonesia KKI ACHIEVEMENTS 2024 Joko Widodo VISITORS Perry Warjiyo President of the Republic of Indonesia 26,990 123,290 Governor of Bank Indonesia Implementation of BSPI 2019 - 2025: 1 Rapid acceleration of national digital transformation. Three main points: Opportunities for economic and digital financial growth. The importance of digital transformation and the role of MSMEs in the digital economy and finance. The need to strengthen consumer protection and financial literacy in the digital economy sector. IDR123.1 Billion Online IDR98.4 Billion ( 36% ) ( 35% ) Offline IDR24.7 Billion ( 31% ) Tenun Sutera Isam IDR1.29 Billion Perada Batik Batik Dwihadi IDR1.12 Billion IDR1.04 Billion Online Visitors IDR576 Billion 28% (YoY) 140.0 Offline MSMEs FASHION AND READY TO WEAR Total MSMEs Revenue and Business Matching KKI Total Revenue (IDR Billion) EXHIBITORS 2 The acceleration of national payment digitalization will be focused on 5 (five) key initiatives of BSPI 2030: Modernization of retail, wholesale, and data payment infrastructure. Consolidation of the national payment industry. Digital innovation and acceptance. Expansion of international cooperation. Development of Digital Rupiah. 3 The importance of synergy among all government elements, authorities, associations, industries, and the public to strengthen national digital transformation synergy in advancing the national Digital Economy and Finance (EKD). TOP 3 Revenue of MSMEs (Offline) Total MSME Revenue Offline Visitors Online MSMEs BI Regional Office, Ministry/Agency 123,1 120.0 91.2 100.0 98.4 80.0 72.4 60.0 HOME DECOR 40.0 ACCESORIES 20.0 PROCESSED FOOD 0.0 TEA AND COFFEE 16.5 IDR2.64 Billion 251 MSMEs 23 Potential Buyers 12 Countries ( | Exhibition of Leading MSMEs | | Wastra | Ready to Wear | Kriya | | Home Decor | | National Tea and Coffee | | National Culinary and Snack | Top 3 Revenue of BI Regional Office (Offline) West Java IDR2.93 Billion Tegal IDR Rp 2,47 2.47 MILIAR Billion Solo IDR2.36 Billion 180 MSMEs 15 Financial Institutions 452.9 Countries 350.0 358.3 282.2 300.0 207.2 200.0 27% ) 264.7 210.0 170.6 16.5 150.0 100.0 ( 450.0 400.0 IDR2.47 Billion Offline 500.0 26% ) BUSINESS MATCHING FINANCING Online Business Matching Trend (IDR Billion) 250.0 ACTIVITIES 24.7 18.8 Total Revenue BUSINESS MATCHING EXPORT 33.9 12.4 12.4 111.6 50.0 148.38 188.19 0.0 Total Business Matching Export Business Matching Financing Source: Bank Indonesia Bank Indonesia continued to develop an inclusive and green national sharia economy and finance. The development was implemented through 3 (three) strategic pillars as follows: (i) strengthening the halal product ecosystem (halal value chain); (ii) strengthening Islamic finance; and (iii) strengthening application of the halal lifestyle. In 2024, strengthening the ecosystem for halal products remained focused on halal food and beverages, as well as modest Muslim fashion. The development of halal food and beverages was pursued through coordinating the development of community-based food commodity business models, including pesantren communities, and assisting in the acceleration of halal product certification processes. Meanwhile, the development of modest Muslim fashion was pursued by strengthening synergy between Bank Indonesia with designers and curators to use flagship MSME products under the mentorship of Bank Indonesia to be featured at various prominent fashion shows, such as the Indonesia International Modest Fashion Festival (IN2MOTION) held in conjunction with the 11th Indonesia Sharia Economic Festival (ISEF) in 2024. Meanwhile, Bank Indonesia has strengthened Islamic finance through KLM liquidity incentives targeting sharia banks to nurture financing to more inclusive and green sectors. The digitalization of zakat, infaq, sadaqah and waqf (ZISWAF) was supported by further development of the halal certification process and Satu Wakaf Indonesia (SWI) application that was launched in 2023. Strengthening the halal lifestyle, Bank Indonesia was fully committed to hosting Sharia Economic Festivals (FESyar) in three regions, namely Java, Sumatra and Eastern Indonesia, as part of the ‘road-to’ activities for the 11th ISEF in 2024, held in Jakarta. The close synergy of all stakeholders in the development of Islamic economics has successfully supported the flagship programs FESyar and ISEF 2024. Solid synergy between Bank Indonesia and the National Islamic Economy and Finance Committee (KNEKS), relevant government ministries/agencies and other strategic partners, including international organisations, such as the Islamic Development Bank (IsDB), International Islamic Financial Market (IIFM), International Islamic Liquidity Management Corporation (IILM) and Islamic Financial Services Board (IFSB), again realized a successful series of FESyar and ISEF activities in 2024 Figure 6. Achievements of the 11th Indonesia Sharia Economic Festival (ISEF) 2024 INDONESIA SHARIA ECONOMIC FESTIVAL 2024 Synergy to strengthen the resilience and revival of the global sharia economy TOTAL EVENTS IN2MOTION FEST events INTERNATIONAL AND NATIONAL DESIGNERS: 218 designers TOTAL VISITORS PARADES: 20 parades OFFLINE: 1,363,645 ONLINE: 74,747 LOOKS: 1,622 looks BUSINESS TRANSACTIONS IDR1.94 Trillion FINANCING COMMITMENT AND REALIZATION: IDR641 Billion TRADE COMMITMENTS AND REALIZATION: IDR295 Billion TOTAL EXHIBITORS 5,143 exhibitors revenue IDR115 Billion TOTAL COMPETITION TOTAL COMPETITIONS: competition types COMPETITORS: 6,573 participants ISLAMIC FINANCE ECOSYSTEM COOPERATION COMMITMENTS: IDR1 Trillion Source: Bank Indonesia for the 11th consecutive year. In 2024, a total of 71 ISEF activities attracted nearly 1.5 million visitors, 5,143 businesses that realized revenue totaling Rp115 billion, as well as 218 designers putting on 20 parades and 1,622 looks at the IN2MOTION Festival (Figure 6.). Total transaction value during the ISEF increased to Rp1.9 trillion, consisting of Rp641 billion in financing commitments and realization, Rp295 billion in trade commitments and realization, and Rp1 trillion in the form of Islamic finance ecosystem cooperation. Bank Indonesia expressed its utmost appreciation to all parties that collaborated in synergy to support the success of the flagship FESyar and ISEF program in 2024 and advance the Islamic economy and finance in Indonesia. International Policy Bank Indonesia continued implementing international policy in close synergy with the Government to strengthen macroeconomic stability and resilience in pursuit of Indonesia’s economic interests on the international stage. Against a backdrop of persistently high global uncertainty, cooperation with international partners through the Global Financial Safety Net (GFSN) continues to be strengthened. In 2024, the Local Currency Bilateral Swap Arrangement (LCBSA) with Bank Negara Malaysia (BNM) was strengthened by increasing the value of the facility to MYR24 billion or Rp82 trillion for the upcoming five-year period. In addition, the LCBSA and Bilateral Repo Agreement (BRA) with the Monetary Authority of Singapore (MAS), and the Bilateral Swap Arrangement with the Bank of Japan (BoJ) were also extended. In synergy with ASEAN+3 members, Bank Indonesia also agreed the settings of the new Regional Financing Arrangement (RFA) in the form of Rapid Financing Facilities (RFF). Such cooperation has strengthened the external resilience buffer in Indonesia that was previously developed through cooperation with the Federal Reserve and Bank for International Settlements (BIS). Bank Indonesia continues to highlight three important aspects at various international forums in response to the rapid changes in global uncertainty dynamics as follows: (i) emphasizing the importance of a central bank policy mix to maintain macroeconomic stability; (ii) emphasizing the important role of international financial institutions in providing guidance to emerging markets and developing economies using the policy instruments available; and (iii) encouraging the strengthening fiscal and monetary policy coordination as well as structural reforms. Bank Indonesia also continued expanding agreements and promoting the implementation of local currency cooperation to support efforts to maintain exchange rate stability. Bank Indonesia has expanded LCT cooperation with the Reserve Bank of India (RBI) and Central Bank of the United Arab Emirates (CBUAE), following previous agreements with China, Japan, Malaysia, Thailand, South Korea, and Singapore. In September 2024, LCT cooperation with the Bank of Korea (BoK) entered a new phase with the commencement of LCT implementation stages. Businesses, therefore, have the option to settle their cross-border payment transactions based on direct exchange rate quotations provided by Appointed Cross Currency Dealers (ACCD). LCT cooperation also works in synergy to facilitate QR transactions with partner countries. Moreover, Bank Indonesia initiated the preparation of an ASEAN LCT Framework as a follow-up action to Indonesia’s ASEAN Chairmanship in 2023. The framework will serve as guidance in the implementation and promotion of LCT as well as mitigating exchange rate stability risk in the ASEAN region. Domestically, the role of the National Task Force (Satgas) LCT, established since 2023, has also been strengthened to accelerate LCT implementation. Bank Indonesia actively enhanced bilateral nonfinancial corporation to accelerate central banking capacity and nurture cooperation in the payment system space. Bilateral cooperation with partner central banks in the area of Structured Bilateral Cooperation (SBC) continues to be implemented by focusing on various central banking duties (monetary, macroprudential, payment system) and other specific areas, such as the sharia economy and finance, green economy, anti-money laundering (AML), combating the financing of terrorism (CFT) and financing the proliferation of weapons of mass destruction (WMD). Since initiation in 2015, Bank Indonesia has implemented SBC cooperation with 12 partner central banks, including the Federal Reserve (the Fed), Bank of England (BoE) and People’s Bank of China (PBoC). SBC is cooperation is essential as it enhances Bank Indonesia’s capacity in central banking and reflects Bank Indonesia’s institutional leadership role among regional central banks. Cooperation in the field of payment systems is also continuously strengthened to increase cross-border payment connectivity. In 2024, bilateral payment system corporation was strengthened with the BoK and CBUAE to establish cross-border payment connectivity. At the regional level, Bank Indonesia and other ASEAN members expanded RPC cooperation. RPC was initially signed in November 2022 by ASEAN-5 central banks (Bank Indonesia, Bank Negara Malaysia, Monetary Authority of Singapore, Bank of Thailand, and Bangko Sentral ng Pilipinas). RPC members now total eight countries after the State Bank of Vietnam, Brunei Darussalam Central Bank and Bank of Laos joined the initiative. Central banks from ASEAN-5 countries and the Bank for International Settlements Innovation Hub (BISIH) also achieved progress by completing in-depth studies on fast payment connectivity in phase 3 of the NEXUS project. Cross-border payment connectivity must be nurtured to encourage faster, cheaper, transparent, and inclusive cross-border payments. Bank Indonesia has consistently strengthened synergy with government ministries/agencies in managing positive stakeholder perception toward the Indonesian economy. Synergy has been achieved through intensive engagement and communication with rating agencies and international stakeholders. In addition, Bank Indonesia strengthened trade and investment promotion in 2024 through outreach activities for portfolio investors through targeted, thematic, and transparent strategies. Such strategies supported Indonesia in terms of maintaining its sovereign credit rating at one level above investment grade with a stable outlook from Moody’s (Baa2), Standard & Poor’s (BBB) and Fitch (BBB). Indonesia has even maintained a rating two levels above investment grade (BBB+) with a positive outlook from the R&I rating agency in Japan. Bank Indonesia’s increasingly strong international reputation was reflected in its chairmanship in several international cooperation forums. Bank Indonesia served as Chair of the BIS Asian Consultative Council (ACC), EMEAP Deputies Meeting, ASEAN Senior Level Committee (SLC), as well as IILM and IFSB Islamic forum. Three priority agendas of Bank Indonesia’s Chairmanship of BIS are as follows: (i) Policy Mix/Integrated Policy Framework/Monetary and Financial Stability; (ii) Artificial Intelligence (AI) and cross-border payment innovations; and (iii) Sustainable finance. Discussions at the BIS ACC emphasized the need for structural reforms to increase productivity and the importance of monitoring market volatility that could be triggered by non-traditional factors, such as artificial intelligence (AI) and cross-border payment innovations. At the ASEAN SLC, Bank Indonesia led discussions on the progress of financial integration in the ASEAN region, which covers banking integration, the payment system, trade, financial inclusion, financial market development and capital flow liberalization. Bank Indonesia also served as Chair of the SLC Task Force on Sustainable Finance, which discussed the ongoing green agenda of ASEAN, including the ASEAN Taxonomy on Sustainable Finance and ASEAN Green Map. At the IILM and IFSB Islamic forum, specifically in terms of the organizational transformation and business strategy agenda, Bank Indonesia’s Chairmanship was oriented toward institutional strengthening and nurturing efforts to accelerate development of the sharia economy and finance in Indonesia. The various milestones accomplished by Bank Indonesia have further increased international recognition for Bank Indonesia as the best central bank, as reflected in the number of international awards received in 2024. The Central Banking Award presented an award for money circulation policies to 3T areas through the Sovereign Rupiah Expedition (ERB). Bank Indonesia also received the Global Islamic Finance Award in recognition of its development initiatives and leadership for the sharia economy and finance. Building on the successes of the previous year, the Bank Indonesia contact center in 2024 received various awards, including the Contact Center Award Asia Pacific (3 Gold and 1 Silver medals), and the Global Top Ranking Performers Award (2 Gold and 2 Silver) from the Contact Center World. In recognition of consistency for receiving the awards for three consecutive years, the Contact Center World presented three Certified World-Class Contact Center Awards in the categories of Helpdesk, Customer Service and Employee Wellness. Awards were also presented by HR Asia as the Best Company to Work for in Asia 2024, thereby reflecting international recognition for HR management as one of the best companies to work for. The trove of international awards received have strengthened Bank Indonesia’s image as the best central bank among emerging markets. Bank Indonesia Transformation Bank Indonesia continued implementing comprehensive transformation, which began in 2018, as a commitment in carrying out the mandate stipulated by the Bank Indonesia Act, which has been amended several times, most recently by the Financial Sector Development and Strengthening Act (P2SK Act). Transformation aims to create a credible, professional, accountable, and transparent central bank with good governance. In the policy area, Bank Indonesia continued strengthening its Main Policy Mix (BKU) framework to ensure integration of the monetary, payment system and macroprudential policy frameworks, underpinned by supporting policies to achieve Bank Indonesia’s goals. Bank Indonesia strengthened its BKU framework by revisiting and amending Bank Indonesia regulations (PBI), including the PBI concerning the Bank Indonesia Policy Mix and regulations on supporting policies. Strengthening the policy framework was accompanied by business process re-engineering (BPR) to create simpler, streamlined, and standardized business processes. Policy transformation at Bank Indonesia focused on various policy functions, including development of a blueprint framework, instruments, and infrastructure. In terms of monetary policy, transformation entailed reformulating money market and foreign exchange market regulations, optimizing the implementation of integrated pro-market monetary operations, as well as forming the institutional arrangements and developing the CCP. Macroprudential policy transformation focused on strengthening instrument regulations, developing inclusive and green finance, and developing supervisory technology (SupTech). Payment system policy transformation was implemented in accordance with BSPI 20252030, covering infrastructure development to support the digital economy and finance ecosystem, strengthening industry competitiveness, fostering innovation, and expanding acceptance, developing cross-border payment system connectivity, and developing the Digital Rupiah. The transformation in the institutional area focused on 4 (four) strategic areas. First, organizational and work process transformation focused on strengthening the institutional policy mix framework and improving institutional regulations as a followup to the P2SK Act, supported by streamlining the digital-based business processes and work processes (Figure 7.). The strengthening of the Figure 7. Institutional Policy Mix Framework Source: Bank Indonesia institutional policy mix framework aimed to integrate all institutional policies in order to achieve Bank Indonesia’s goals. The achievement of these goals is reflected in Bank Indonesia’s strategic targets through effective organizational support with the efficient use of resources and good institutional governance operationally. In its implementation, the stages of each Institutional Policy Mix (BKK) process continues to be refined and supported by the gradual implementation of digital business process re-engineering (Digital BPR) in line with the dynamic needs of the digital era. Furthermore, Bank Indonesia has also issued several regulations concerning the Bank Indonesia’s Institutional Report, regulations concerning the organization, work procedures, and budget of the Bank Indonesia Supervisory Board (BSBI), as well as regulations concerning the security of information systems and cyber resilience. Second, strengthening of organizational functions to support the effective, efficient, and compliant execution of Bank Indonesia’s duties and achievement of its goals. Bank Indonesia strengthened its organizational function by focusing on the strategic framework in each area, maintaining organizational continuity with the business processes of all work units at Bank Indonesia, current best practices as well as the infrastructure and technology support required based on the 3S Principles of Simplification, Standardization, and Systematization. In 2024, Bank Indonesia assessed its strengthening efforts in terms of organizational functions in accordance with the mandate of the P2SK Act and Bank Indonesia’s efforts to promote an inclusive and green economic-financial development nationally in pursuit of sustainable economic growth. In addition, Bank Indonesia continued strengthening its organizational functions for coordination and operational support of task implementation as well as Bank Indonesia’s jurisdiction in the new Nusantara Capital City (IKN). Third, improving digital-based business process re-engineering (Digital BPR) in formulation of the Bank Indonesia’s policy mix and institutional policy mix. Bank Indonesia continued refining the Digital Workplace platform to strengthen the decisionmaking process from the work unit level to the committee level and RDG level, ensuring aspects of effectiveness, efficiency, and compliance. This effort aimed to strengthen the Bank Indonesia’s policy mix and institutional policy mix formulation and decisionmaking process, including the reformulating the RDG materials. In 2024, Bank Indonesia continued refining the Digital Workplace by identifying the needs, design, testing, and incremental development to support digitalization of the decision-making process. Fourth, Digital BPR implementation was also supported by strengthening the people aspect by improving leadership, developing new capabilities and strengthening the employee value proposition (EVP). HR transformation was carried out by applying a new flagship ‘work in the digital era’ system, supported by various elements, such as physical and digital facilities to achieve optimal organizational performance by increasing work effectiveness, efficiency, and productivity. The new work system in the digital era is expected to improve Bank Indonesia’s employee value proposition (EVP) and, ultimately, improve Bank Indonesia efforts to attract and retain the best talent. In 2024, Bank Indonesia’s optimized the human resources management strategy, underpinned by the Digital Business Process (DBP) to create professional future leaders based on the 3-Smart aspects, namely competency (book smart), experience (street smart), and noble behavior (spiritual smart). In addition, human resources fulfillment transformation improved the recruitment strategy and strengthened employee career management, which aims to provide employees with solid leadership capabilities to work optimally in the digital era. Furthermore, Bank Indonesia continued strengthening its human resources capabilities through various development programs to support central bank task implementation in the digital era. Bank Indonesia’s digital transformation will continue to be strengthened in the future to support policy and institutional transformation in pursuit of Bank Indonesia’s vision of becoming the foremost digital central bank. The digital transformation is undertaken through 4 (four) strategies as follows: (i) developing digital business platforms to support the policies and institutional arrangements; (ii) developing data centers to build innovative and sophisticated data analytics and create a data-driven institution; (iii) using data and artificial intelligence to drive business process transformation; and (iv) increasing the capabilities and capacity of technology infrastructure and security end-to-end. In 2024, Bank Indonesia was undertaking various development initiatives for payment system digitalization, including the development and expansion of BI-FAST features as well as the digitalization of work processes through digitalization of the Decision-Making Process (DMP). Bank Indonesia also continued the end-to-end development of its data centers by continuing to enrich content and data flow automation to support data analytics use cases in the policy and institutional area. The use of artificial intelligence (AI) and machine learning was expanded to the analysis of various monetary, macroprudential, and payment system indicators. This was done concurrently with the strengthening of data flow automation using straightthrough processing (STP). Finally, Bank Indonesia continued improving the capabilities of technology infrastructure to support task implementation. Overall, broad institutional transformation will be strengthened to establish Bank Indonesia as the foremost digital central bank with strong governance, significantly contributing to the national economy and being the best central bank among emerging markets. IV. Synergy of Policy Mix for National Economic Transformation: Strengthening Stability, Driving High Growth The positive milestone of Indonesia’s strong national economic policy mix over the past decade serves as a solid foundation for maintaining stability and accelerating higher economic growth moving forward. As mentioned in previous chapters, Indonesia’s economy has maintained strong resilience, accompanied by sustainable growth. Macroeconomic and financial system stability have been maintained despite the deleterious impact of the Covid-19 pandemic and unrelenting global spillovers. Indonesia’s economic growth is considered one of the best among emerging market economies (EMEs), with expansionary economic and financial cycles. These positive economic milestones in Indonesia are the outcomes of strong synergy within the national economic policy mix. Maintained stability and solid economic resilience are a corollary of close fiscal and monetary policy coordination between the Government and Bank Indonesia as well as policy coordination within the Financial System Stability Committee (KSSK). Structural transformation remains an ongoing priority to improve the investment climate, infrastructure development, mineral and mining downstreaming, as well as social protection programs for low-income earners. Close synergy within the national economic policy mix must be further strengthened to enhance national economic performance. Moving forward, several global and domestic challenges must be anticipated to sustain higher national economic growth. Globally, there are at least 5 (five) challenges that demand vigilance. First, escalating geopolitical tensions and trade fragmentation could potentially trigger a trade war and disrupt international distribution channels and supply chains. Second, a geographical shift in global economic growth to the US and India given moderation in China and the European Union, accompanied by persistently high international commodity price volatility. Third, high interest rates, debt risks, and US dollar appreciation in global financial markets, which could burden EMEs heavily in terms of fiscal policy to promote economic growth and monetary policy to maintain stability. Fourth, a rebalancing of investment in global financial markets toward advanced economies, thus restraining portfolio investment and foreign direct investment (FDI) in EMEs. Fifth, the rapid pace of digital globalization that is unlocking compelling export opportunities for digital services exports and cross-border payment system cooperation, accompanied by increasing operational risks (cyber risks), which must be mitigated. At home, there are at least 5 (five) domestic challenges that demand an optimal response in the national economic policy mix agenda to strengthen resilience and accelerate national economic performance moving forward (Figure 8.), as follows: i. First, the importance of maintaining macroeconomic and financial system stability. As mentioned above, the dynamics of the global economy and finance will continue to change rapidly and remain full of uncertainties. Against such an inauspicious backdrop, macroeconomic and financial system stability, which has remained a pillar of resilience and economic advancement in Indonesia, must remain a top priority in the national economic policy mix moving forward. Therefore, a close fiscal and monetary policy coordination between the Government and Bank Indonesia, and coordination within the KSSK, which have remained solid, must be strengthened on an ongoing basis. ii. Second, the importance to continue expanding domestic sources of growth, particularly consumption and investment, while still promoting exports underpinned by international trade cooperation. Household consumption has been more reliant on the upper-middle income groups, therefore consumption among lower-income groups need to be further increased. Economic growth has also been predominantly driven by capital-intensive sectors, while labor-intensive sectors need to be further improved, not only to support growth but also to create jobs. This can be achieved through fiscal stimulus that strike an optimal balance between productive social programs and capital spending. From Bank Indonesia’s perspective, macroprudential policy will remain oriented toward accelerating bank lending to priority sectors which are drivers of growth as well as job creation. iii. Third, the importance to accelerate transformation policies in the real sector to increase competitiveness and productivity, including capital, labor, as well as innovation and efficiency to achieve higher economic growth. Investment and capital must be increased by improving the investment climate, developing physical and digital connectivity infrastructure, as well as implementing development programs targeting priority sectors that support economic growth. Enhacing the quantity and quality of labor absorption must be pursued by fostering growth in labor-intensive sectors, providing fiscal stimulus for labor-intensive programs, and offering vocational education and training along with entrepreneurship. iv. Fourth, the importance to accelerate financial market deepening to increase sources of national economic financing and continue attracting foreign capital inflows. Economic financing, which has relied on bank lending, must be expanded through financing from the capital market including stocks and bonds. Improving the investment climate along with bilateral trade promotion and cooperation with Indonesia’s main economic partners must be intensified to attract FDI to Indonesia. Money market and financial market deepening are also critical, not only for increasing liquidity, developing hedging instruments, and lowering interest rates, but also for attracting portfolio inflows Figure 8. Five Agendas of the National Economic Transformation Mix FIVE GLOBAL ECONOMIC RISKS Macroeconomic and Financial System Stability FIVE NATIONAL ECONOMIC TRANSFORMATION POLICY AGENDAS High geopolitical risk and trade fragmentation Synergy in strengthening macroeconomic and financial system stability Rebalancing of center and sources of growth Synergy in driving domestic growth (consumption and investment) High interest rates and sovereign debt risk Synergy in increasing productivity and national economic capacity Financial and investment uncertainty Synergy in deepening financial markets for economic financing Acceleration of digitalization in services and payment systems Synergy for digitalization of the payment system and service sector Economic Growth Job Creation Source: Bank Indonesia and maintaining Rupiah exchange rate stability. To that end, close coordination within the KSSK Committee is vital. v. Fifth, the importance to accelerate digitalization of the payment system and financial sector as well as innovative services transactions nationally and internationally. Indonesia has become one of the fastest countries in digitalization, particularly digitalization of the payment system, banking and financial services, as well as retail economic and financial transactions, which must be accelerated moving forward. Similarly, the digital innovation capabilities of Indonesia’s younger generation continue to flourish and show great potential. Therefore, the development of digital-based service enterprises in various segments, including trade, micro, small, and medium enterprises (MSMEs), office and intermediary services, telecommunications and information, hotel and restaurant, and tourism, must be expanded to drive national economic growth. Moreover, programs to develop digital services transactions have significant export potential to advanced economies. Existing cross-border cooperation in digital payment systems must also be expanded moving forward. Policy Mix Synergy for Stability Moving forward, strengthening the macroeconomic and financial system policy mix must be continued to maintain stability in achieving sustainable economic growth. The risks posed to national economic stability and resilience stemming from the adverse impact of global spillovers are expected to increase. A strong US dollar, coupled with high US Treasury yields and risk premiums in global financial markets will intensify pressures on Rupiah exchange rate stability and prompt potential capital reversal of portfolio inflows. The external resilience of Indonesia’s economy could also be disrupted by a wider current account deficit or narrower capital and financial account surplus in the balance of payments (BOP). In terms of internal stability, inflationary pressures particularly from imported inflation, are expected to rise in line with higher international commodity prices and Rupiah depreciation amid increasing domestic demand. Fiscal deficit financing could be undermined by high SBN yields and restrained portfolio inflows to Indonesia. Similarly, the adverse impact of global spillovers could exacerbate market risks (exchange rates and interest rate), liquidity risks, and credit risks in Indonesia’s financial system. Close fiscal and monetary policy coordination between the Government and Bank Indonesia must be strengthened to maintain macroeconomic stability. Fiscal policy must remain prudent by maintaining a manageable deficit of not more than 3% of gross domestic product (GDP), which has been a legacy of Indonesia’s economic credibility at the international level. To that end, the fiscal deficit in the 2025 State Budget (APBN) remains prudent at just 2.53% of GDP, indicating sustainability, strengthening, and acceleration during the transition to a new government administration, while setting a solid foundation toward the 2045 Golden Indonesia (Figure 9.). State revenues in 2025 increases by 7.2% from 2024 to Rp3.005,1 trillion, supported by higher tax revenues and non-tax state revenues (PNBP). State expenditures will increase by 8.9% in 2025 to Rp3,621.3 trillion, striking an optimal balance between budget allocations for social programs and capital expenditure as well as balance between stability and economic growth. Similarly, budget financing for the fiscal deficit totaling Rp616.2 trillion will be pursued sought by optimizing program loans and issuing SBN in domestic and global financial markets. Meanwhile, monetary policy will remain focused on achieving the inflation target set by the Government at 2.5±1% in 2025 and 2026. Rupiah exchange rate stability will be maintained to achieve the inflation target and to sustain macroeconomic and financial system stability, to develop business, as well as to drive national economic growth. Fiscal and monetary policy coordination is reinforced in the formulation of realistic macroeconomic assumptions in the 2025 APBN, balancing between stability and growth targets, with economic growth set at 5.2%, inflation within the 2.5±1% target corridor, average benchmark 10-year SBN yield at 7.0%, Figure 9. State Budget (APBN) in 2025 State Budget (APBN) in 2025 Foundation toward the 2045 Golden Indonesia (Indonesia Emas 2045) Effective transition Sustainability, Strengthening, and Acceleration STATE REVENUE 2025: IDR3,005.1 T 2024:IDR2,802.3 T TAX REVENUE STATE EXPENDITURES 2025: IDR3,621.3 T 2024: IDR3,325.1 T CENTRAL GOVERNMENT EXPENDITURE 2025: IDR2,490.9 T 2025: IDR2,701.4 T 2024: IDR2,309.9 T 2024: IDR2,467.5 T NON-TAX STATE REVENUE (PNBP) Healthy State Budget REGIONAL TRANSFERS 2025: IDR513.6 T 2025: IDR919.9 T 2024: IDR492.0 T 2024: IDR857.6 T DEFICIT (% OF GDP) BUDGET FINANCING 2025: IDR616.2 T (2.53%) 2025: IDR616.2 T 2024: IDR522.8 T (2.29%) 2024: IDR522.8 T APBN Source: Ministry of Finance and an average exchange rate of Rp16,000 per US dollar. Close policy coordination is also important in government bond issuance policy (domestic and global) for budget deficit financing, as well as to serve as consideration for monetary policy in inflation control and exxchange rate stability, based on global financial market conditions. This close coordination is carried out in annual planning and its monthly implementation, covering the amount, interest rates, and timing according to the dynamics in the domestic and global financial markets. Monetary and fiscal policy coordination between Bank Indonesia and the Government is also close in terms of inflation control, particularly in managing administered prices and volatile food inflation through the Central and Regional Government Inflation Control Teams (TPIP and TPID). Policy synergy within the KSSK is oriented toward strengthening financial system stability to ensure a greater resilience against the impact of global spillovers and to increase economic financing, including inclusive and green finance. The KSSK meetings (Ministry of Finance, Bank Indonesia, the OJK, and the LPS) are held on a quarterly basis to assess the condition of financial system stability in Indonesia and institute the necessary coordinated policy measures. The focus of policy coordination is oriented toward five critical aspects, namely: (i) coordination of economic financing; (ii) coordinated macroprudential and microprudential supervision; (iii) coordination of financial market deepening as well as financial education and literacy; (iv) coordination of operational risk and cyber attack surveillance; (v) coordination of resolution for financial institutions (Figure 10.). To that end, monetary and fiscal policy synergy between Bank Indonesia and the Government to maintain financial system stability is oriented toward inflation control, Rupiah exchange rate stability, SBN rates and issuances for budget financing against the negative impact of global spillovers. In preserving the stability of the banking system, close coordination is maintained between the macroprudential supervision policy of Bank Indonesia in terms of macro-financial linkages among large banks and the microprudential supervision policy of the OJK to maintain the health of all individual banks. The OJK is also strengthening its supervision of nonbank financial institutions, the capital market, FinTech industry, and consumer protection in financial services. The LPS continues Figure 10. Policy Coordination within the KSSK Maintains Financial System Stability MACROFINANCIALPROCYCLICALITY OF FINANCING Excessive optimism Promoting excessive credit Accumulation of risks in the financial sector MACROPRUDENTIALMICROPRUDENTIAL Economic growth decreases Worsening confidence, overoptimism, and risk taking Credit lowers Capital Outflows Interest rate spread increases Expansion Systemic Banks NBFI The emergence of shocks can occur in any phase of the financial cycle, the materialization of risks occurs without going through the build-up phase Better confidence, overoptimism, and risk taking Capital Inflows Non-Systemic Banks Financial Market • Excessive pessimism • Reluctant to disburse credit because high risk • Risk averse Asset prices hike Credit improvement Collateral rises FINANCIAL MARKETS, LITERACY AND CUSTOMER PROTECTION Company and bank deleveraging Contraction Economic growth increases Company and bank leverage increases Asset prices drop ONLINE GAMBLING CRISIS IN INDONESIA FINANCIAL SYSTEM STABILITY COMMITTEE (KSSK) POLICY COORDINATION RESOLUTION MECHANISM FOR FINANCIAL INSTITUTIONS DIGITALIZATION, CYBER, AND OPERATIONAL Types of Cyber Attacks KSSK Ransomware Man in the Middle Attack Malware Zero-day Exploit KSSK Phishing DNS Tunneling SQL Injection S O DD Net 1 Regulation and Supervision of Financial Services Institutions Net 2 Central Bank as Lender of the Last Resort Net 3 Bank resolution by industry Net 4 The presence of the state through the use of APBN DoS and DDoS Attack Social Engineering XSS Attacks Cryptojacking Source: Bank Indonesia strengthening deposit guarantees and bank resolution in close coordination with the OJK and Bank Indonesia in accordance with respective authority and jurisdiction. The simulation of coordination readiness among the four KSSK institutions, as well as bilaterally in handling issues in the financial sector, continue to be enhanced. Furthermore, the KSSK coordination is enhanced to complete all regulations in accordance with the P2SK Act. Overall, P2SK Act implementation is bolstering the development and the strengthening of financial sector, to support financial system stability and economic financing for sustainable economic growth moving forward. Policy coordination between the Government and Bank Indonesia will also be intensified in the management of foreign exchange flows to strengthen external resilience against the impact of global spillovers in line with national goals for economic stability and growth. In principle, Indonesia implements a free foreign exchange regime, allowing residents to obtain, hold, and use foreign currencies freely. As a member of the International Monetary Fund (IMF), Indonesia is also required to maintain free movement of foreign exchange originating from international trade and investment. As an EME with an open economy, such a foreign exchange regime influences macroeconomic and financial system conditions in Indonesian. Therefore, external resilience to the adverse impact of foreign exchange flows is strengthened through prudent fiscal and monetary policy coordination between the Government and Bank Indonesia. Macroeconomic policy is also accompanied by the trade and investment policies of the Government. If the macroeconomic policies instituted by the Government and Bank Indonesia are no longer effective in mitigating the negative risks posed by foreign exchange flows leading to potential macroeconomic and financial system instability, further administrative regulations and policies may be adopted, including taxes, mandatory retention and repatriation of foreign exchange as well as restrictions on foreign exchange. The Government may issue policies to optimize the foreign exchange proceeds of natural resources exports, as implemented in Government Regulation Number 36 of 2023 concerning the Foreign Exchange Proceeds of Exports and the Exploitation, Management and/or Processing of Natural Resources (PP DHE SDA). The implementation of this Government Regulation has several advantages, which include retaining a larger amount of foreign exchange in the domestic banking industry for economic financing and financial market deepening. It is important to note that this regulation only applies to the export activities of residents in terms of natural resources and remains consistent with the foreign exchange regime adopted by Indonesia. Policy Mix Synergy for Domestic Demand National economic policy mix synergy must be strengthened to drive domestic demand, both consumption and investment, to pursue higher economic growth prospect. As elucidated in chapter two, economic performance in Indonesia is considered one of the best among EMEs. Nevertheless, consumption growth has remained below 5% and, thus, requires stronger economic policy synergy to stimulate consumption. This was also reflected in the Bank Indonesia Consumer Survey, indicating that economic growth has relied on high-income earners (upper income group). The survey shows that the current income index among this income group is supported by job availability. Notwithstanding, their future expectations of income are expected to moderate, leading to a higher propensity to place savings in financial assets for investment, specifically SBN. Regarding the middleincome group, the survey points to an improving current income index yet declining job availability index and income expectation index (Graph 30.a). In the lower income group, the current income index is moderating despite an improvement in the farmers’ terms of trade (NTP), accompanied by a decline in the job availability index and income expectation index (Graph 30.b). This heterogeneous consumption trend explains how corporate sales activities increasingly rely on food and basic services to meet essential needs. This has led to weaker residential and commercial property investment (Graph 31.a). Similarly, the Purchasing Managers Index (PMI) in new orders, including exports, is also moderating (Graph 31.b). Such developments demonstrate the need for national economic policy synergy to drive private consumption, particularly among the lowermiddle income groups, by ensuring job availability and thereby increasing incomes in the future. National economic policy mix synergy is also required to expand sectors driving economic growth in the future. As explained in chapter two, economic growth since the Covid-19 pandemic has not fully recovered and continues to rely on export and consumption from upper-middle income groups. This condition is reflected in the growth contribution of sectors such as mining, manufacturing industry, Graph 30.b. Survey of Consumer Expectations in Lower Income Group Graph 30.a. Survey of Consumer Expectations in Middle Income Group Index Index I II III IV I II III IV I II III IV I II III IV 2021 2022 2023 2024 Job Availability Index 8 10 12 2 Income Index 8 10 12 2 8 10 Income Expectation Index I II III IV I II III IV I II III IV I II III IV 2021 2022 2023 2024 8 10 12 2 Job Availability Index 8 10 12 2 8 10 Income Index Income Expectation Index Source: Bank Indonesia Source: Bank Indonesia Graph 31.a. Investment Growth in Construction and Property Sector % %, yoy -20 -40 Graph 31.b. Purchasing Managers Index (PMI): Export and Domestic Orders 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 Index -2 -4 -6 -8 -10 I 2017 2018 2019 2020 2021 2022 2023 2024 III I III I III I III I III I III 2019 2020 2021 2022 2023 2024 Building Investment Growth (rhs) Construction Growth Based on BCI* Commercial Property Growth Contribution Residential Property Growth Contribution Infrastructure Growth Contribution New Orders Index 9 11 1 9 11 1 New Export Orders Index PMI Index Note: *Data as of Oct’24 Source: Building Construction Information (BCI), BPS Source: PMI Markit wholesale trade, and construction (Graph 32.a) with relatively low labor absorption (Graph 32.b). Meanwhile, labor-intensive sectors, such as agriculture, accommodation and food service activities, the manufacturing industry, retail trade, information and communication, and other service sectors have not fully recovered due to the lasting scarring effect from the pandemic. As a corollary of effective downstream mineral and coal mining policy, for example, the growth contribution of the mining sector recorded a threefold increase to 0.39% in 2022-2023, from 0.13% in 20112019 period. Notwithstanding, labor absorption in the mining sector remains comparatively low and unchanged since the pre-pandemic period at 1.16% of the national total. In the same period, the agricultural sector has in fact experienced declines in terms of growth contribution (from 0.52% to just 0.22%) and labor absorption (from 32.35% to 28.41%). Absorbing 14.0% of the national workforce, the growth contribution of the manufacturing industry has fallen from 1.01% to 0.98% due to a reliance on large-scale industries. Similarly, trade sector growth, with labor absorption of 19.17%, has not fully recovered, as indicated by a slightly lower growth contribution of approximately Graph 32.a. Growth Contribution by Sectors Graph 32.b. Labor Composition by Sectors % yoy -2 -4 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Agriculture Trade Source: BPS % Construction Accommodation and Food Services Information and Communication Manufacturing Transportation and Storage Mining Others Agriculture Trade Source: BPS Construction Accommodation and Food Services Information and Communication Manufacturing Transportation and Storage Mining Others 0.68% as most labor is still absorbed in the wholesale trade subsector. Absorbing 6.44% of the labor, the construction sector has experienced a significant decline in growth contribution from 0.63% to just 0.34% in the same period. Likewise, growth of accommodation and food service activities as well as the others sector must be accelerated due to the sectors’ ability to absorb 7.41% and 18.34% of total labor, respectively. The Asta Cita government program contains several priority programs formulated to develop economic sectors that can create job opportunities. This program is expected to simultaneously increase private consumption lower-middle income groups. The priority sectors include downstream agriculture and fishery, housing (public housing), micro, small and medium enterprises (MSMEs), tourism and the creative economy. More specifically, downstreaming the food subsector is a priority government program based on three important considerations. First, food downstreaming can further accelerate agricultural sector growth, create massive job opportunities and, therefore, increase private income and consumption. Second, food downstreaming would strengthen price stabilization and inflation control policies, which are critical for macroeconomic stability nationally, public purchasing power and prosperity. And third, food downstreaming would Table 8. Major Food Imports from 2018-2023 Graph 33. Harvest Area and Agricultural Productivity in Java Region In Thousand Tons Commodity Rice Wheat Kernels Maize 444.5 10.7 356.3 10.3 410.4 11.4 429.2 9.5 2024* 3,062.85 3,227.75 10.9 also lower the need for food imports, which have tracked an upward trend over the past five years, conserve foreign exchange, and thus strengthening external economic resilience in Indonesia against international commodity price shocks (Table 8). The main challenge is that harvest area and productivity are declining, thereby requiring an agricultural downstreaming program to overcome these economies-of-scale issues. Therefore, an agricultural downstreaming program is required with integrated end-to-end business models from cultivation by the farmers supported by the provision of inputs and technology, to post-harvest management, processing into downstream products to increase value added, and marketing at the consumer level (Graph 33). Furthermore, the food downstreaming program must be implemented in the form of business models based on the core concept of parent business entities for subsidiary farmer groups with unambiguous rules and regulations. Implementable business models are needed that fulfill business and financial feasibility requirements to ensure access to finance from the banking industry and other sources. The use of digital technology can be applied from the cultivation process to post-harvest management and marketing to consumers (Figure 11.). It is important to note that Bank Indonesia has already developed a small-scale food downstream business 9.5 Thousands hectare 57.2 57.0 6,000 56.7 5,000 56.6 56.4 3,000 56.0 56.2 55.8 2.000 1,016.68 869.87 996.00 1,094.22 1,235.84 1,220.40 2,670.64 2,475.48 2,489.17 2,325.06 2,274.95 2,162.23 55.6 1,000 55.4 2018 2019 2020 2021 2022 2023 2024* Harvest Area Note: *Data as of Sept’24 Source: BPS 56.8 4,000 Soybean %, yoy 7,000 55.2 Productivity (rhs) Note: *Data as of Sept’24 Source: BPS Figure 11. Generic Food Downstreaming Business Model UPSTREAM DOWNSTREAM CULTIVATION POST-HARVEST AND DOWNSTREAMING CULTIVATION TECHNOLOGY RICE PRODUCERS AGROINPUT SEEDS AND OTHER AGRICULTURAL PRODUCTION FACILITIES UPSTREAM DIGITAL PLATFORM POST-HARVEST TECHNOLOGY MILL/DISTRIBUTION CENTER MODERN RICE MILLING PLANT OF INDONESIAN BUREAU OF LOGISTICS - BULOG MARKETING Traditional Markets Aggregators/ BUMD/ BUMDES Industry MILLED PRODUCTS MARKET (BULK/PACKAGED) Modern Retail/ Cafe, Restaurant, Hotel Downstream Digital Platforms CONSUMERS Source: Bank Indonesia model based on this concept for commodities high contribution to inflation, namely rice, shallots, and various chili varieties at several regional representative offices. The Government has oriented fiscal policy toward supporting several priority programs to improve public welfare and accelerate agricultural downstreaming. In the 2025 State Budget (APBN), for example, Rp71.0 trillion has been allocated to the free nutritious meal program through the formation of a National Nutrition Board. This program is expected to improve public welfare, particularly for expectant and breastfeeding mothers, toddlers, and students from preschool to secondary school. The Government has also allocated Rp20 trillion to the school renovation program to rehabilitate classrooms, furniture, and sanitation facilities, in addition to Rp2 trillion for the Integrated Flagship School program to develop and build flagship schools in four locations. In terms of agricultural downstreaming, the Government has earmarked Rp15 trillion for the national, regional, and village food reserves program through agricultural intensification and extensification (Figure 12.). In addition to public prosperity programs, the Government has also directed fiscal policy toward nurturing priority sectors with high job creation through fiscal incentives to improve financial feasibility and obtain funding/financing from the banking industry. Such policies can also be applied to development programs targeting MSMEs, the creative economy, tourism industry as well as downstream agricultural and fishing sectors. This will require clear business models as well as business and financial feasibility to meet the financing requirements of the banking industry through fiscal incentives. Fiscal and macroprudential policy synergy between the Government and Bank Indonesia must be strengthened in the implementation of priority programs to foster economic sectors that create job opportunities and simultaneously increase private consumption. To that end, the Government must design concrete programs with clear business models to meet the business and financial feasibility requirements to apply Figure 12. New Government Quick Wins Program 2025 New Government Quick Wins Program 2025 to be implemented by government ministries/agencies Free Nutritional Free Health Checks School Renovation Food IDR71.0 Trillion IDR3.2 Trillion IDR20 Trillion Provide lunches for expectant mothers, breastfeeding mothers, toddlers and students at all education levels (preschool, primary and secondary, including public, vocational and religious education) Free health checks for 52.2 Million residents, including hypertension, blood sugar and x-rays to screen for catastrophic illnesses Development of Quality Regional Hospitals IDR1.8 Trillion Improving Type-D hospitals to Type-C hospitals, including infrastructure and medical equipment National Nutrition Board Ministry of Health Source: Ministry of Finance for loans/financing from the banking industry and/or other financial institutions through fiscal incentives in the form of subsidized interest rates and/or other incentives. Meanwhile, Bank Indonesia can orient Macroprudential Liquidity Incentive (KLM) Policy toward encouraging banks to offer loans/financing to priority sectors that meet the requirements in line with prudent credit disbursement rules. Such fiscal and macroprudential policy coordination between the Government and Bank Indonesia has already been applied to MSMEs and the housing sector, specifically public housing. In terms of KUR disbursements, for instance, the Government can set which sectors are eligible for financing, the requirements, and fiscal incentives in the form of subsidized interest rates. For the public housing program, the Government provides fiscal incentives in the form of subsidized interest rates and assistance for the administration costs, which are adjusted based on the type of residence to be financed. Meanwhile, Bank Indonesia provides KLM to banks extending KUR and loans/financing to the public housing sector in accordance with government regulations. Such fiscal and Renovating classrooms, furniture, and bathroom facilities Ministry of Public Works and Housing will coordinate with Ministry of Education, Culture, Research and Technology and the Ministry of Religious Affairs concerning the location ofschools to renovate Integrated Flagship Schools IDR2 Trillion National, Regional, and Village Granaries IDR15 Trillion* Ministry of Public Works and Housing IDR7.5 Trillion Ministry of Agriculture IDR7.5 Trillion • Intensification of 80,000 ha • Extensification of 150,000 ha Development and Construction of flagship schools at four locations Ministry of Public Works and Housing, Ministry of Education, Culture, Research and Technology, Ministry of Religious Affairs Ministry of Public Works and Housing Ministry of Agriculture Note: *Excluding Extensification by State-Owned Enterprises and Other Appointed Institutions macroprudential policy synergy can be expanded to other sectors that create job opportunities and, therefore, increase private income and consumption in pursuit of sustainable economic growth. Policy Mix Synergy for Economic Capacity Broad-based synergy in terms of national economic transformation policy is required by the Government to achieve high growth without triggering instability. The current level of economic growth achieved by Indonesia, at around 5%, predominantly stems from the contributions of capital, labor, and productivity, which remain relatively low. According to the Ministry of National Development Planning/National Development Planning Agency (PPN/Bappenas), total factor productivity (TFP) to GDP growth from 2011-2019 averaged just 1.37% and, consequently, must be increased threefold to 3.61% from 2025-2029 to achieve economic growth of around 8% in 2029 (Graph 34). This is an enormous task as it requires increased investment, productivity, and economic Graph 34. Sources of Growth: Contribution of Capital, Labor, and Productivity % -2 Average TFP contribution 2011-2019: 1.37% -4 Capital Labor Productivity End-to-end implementation of a comprehensive national economic transformation policy is required in terms of increasing capital, job creation, and productivity. This is important for achieving high economic growth and creating job opportunities sustainably (Figure 13.). Transformation policy must be directed toward improving the investment climate, accelerating investment realization, and fostering investment in capital-intensive sectors to increase the value of investment and ratio of capital to GDP. Programs must be implemented to increase mean years of schooling (MYS), the availability and quality of vocational education, which includes expanding professional certification, as well as investment and growth in labor-intensive sectors to create job opportunities and simultaneously nurture private consumption. Meanwhile, various policies are also required to increase economic 2029* 2028* 2027* 2026* 2025* 2024* 2025-2029: 3.61% Economic growth Note: *Projection Source: Ministry of National Development Planning/National Development Planning Agency (PPN/Bappenas) efficiency in Indonesia. Regarding productivity, the contribution of TFP to GDP since 2000 tracked a downward trend before turning a corner in 2022, primarily due to progress in terms of downstreaming mineral and coal mining (Graph 35.a). Furthermore, efficiency and investment are also low, as reflected by a high trending Incremental Capital Output Ratio (ICOR), which restrains the contribution of capital to GDP growth (Graph 35.b). In addition, the value of FDI in Indonesia is relatively low, resulting in a ratio of capital to GDP of less than 20%, which is far below Malaysia, Thailand and Vietnam, which have reached approximately 50% of GDP Graph 35.a. Total Factor Productivity (TFP) % 7.5 7.0 6.5 6.0 -1 -2 5.5 -3 -4 Note: *Projection Source: Bank Indonesia 2024* 2024* Note: *Projection Source: Bank Indonesia 4.5 5.0 -5 -6 % Graph 35.b. Incremental Capital Output Ratio (ICOR) -6 Average TFP contribution (Graph 36.a). Compared to Vietnam, the value of inward FDI to Indonesia, specifically from South Korea, Japan, and Taiwan to the textiles industry, electronics, retail trade, as well as consumer goods and services, is also low (Graph 36.b). Investment in these labor-intensive sectors is required to strike an optimal balance with capital-intensive sectors for high growth by increasing national economic capacity or, on the demand side, boosting consumption and investment. Graph 36.a. Ratio of FDI Stock to GDP: Indonesia vs Peers Graph 36.b. Foreign Direct Investment: Indonesia vs Vietnam % Waves 1st Textile 2nd Electronic 3rd USD Billion Retail, Consumer, Service Invest in 1988-2016 5k 700k South Korea Company Job South Korea Singapore Japan China Malaysia-Thailand Indonesia Malaysia Philippines Thailand Taiwan The United States of America-Europe USD Billion Vietnam Vietnam Indonesia Note: Cumulative Data 2013-2021 Source: Indonesian Investment Coordinating Board, Vietnam Ministry of Planning and Investment Source: United Nation Conference on Trade and Development (UNCTAD) productivity, namely accelerating the development of physical and digital connectivity infrastructure, strengthening national supply chains to global markets, accelerating economic and payment system digitalization as well as developing digital financial and intermediary services, while increasing the research and development (R&D) capabilities of universities and large corporations. Those three sources that can expand national economic capacity must be supported mutually for further improvement in pursuit of higher economic growth. Within the Asta Cita program, the Government has formulated 40 strategic projects which are expected to increase high economic growth, while maintaining macroeconomic stability. Within the concept of increasing national economic capacity, these projects can accelerate economic growth L CAPITAL Improving the investment climate Accelerating investment realization Nurturing investment in capital-intensive sectors LABOR Increasing average years of schooling Increasing the availability of vocational education, which includes expanding professional certification Increasing investment in labor-intensive sectors R A IC GRO OM BO W H A T Figure 13. Transformation Policy to Increase National Economic Capacity BSORP O N O N TI EC PRODUCTIVITY Accelerating infrastructure and strengthening national supply chains to go global Accelerating economic and payment system digitalization as well as developing digital financial and intermediary services Increasing Research and Development capabilities Source: Bank Indonesia Figure 14. Impact of 40 Government Strategic Projects on Increasing National Economic Capacity ENERGY RESILIENCE (13, 14) Green fuel derived from sugarcane and palm oil (19) Pertamina Long-Term Plan: Sustaining Capital Expenditure (20) PLN Long-Term Plan Power Station Development (21) PLN Long-Term Plan Transmission Development (22, 24) Mamberamo and Kayan hydroelectric power plants (26) Masela Block gas Field INFRASTRUCTURE (12) Development of affordable housing (16, 17, 18) Giant sea wall (29) Sunda Strait Bridge (31) Waste management infrastructure (34, 35) PIK 2 and BSD City STRUCTURAL REFORM (37) Jakarta – Surabaya high-speed rail link (38) West Jakarta MRT (39) Nusantara Capital City (IKN) (40) 20 priority cities CAPITAL INTENSIVE (11) Increasing tax administration bureaucratic reform DIGITALIZATION (23, 25) Mamberamo Industrial Estate and Kayan Data Center (28) National Data Center LABOR INTENSIVE HUMAN CAPITAL FOOD DOWNSTREAMING AND FOOD SECURITY (2) Food reserves and price stability (3) Village Granary (4) National Granary (5) Milk self-sufficiency (30) Advanced downstreaming–EV (36) New Freeport Smelter in Gresik Free nutritious meals 20 international flagship schools Flagship schools in each regency Renovation of damaged schools Fully equipped hospitals in each regency (10) Eradication of tuberculosis (TBC) and strengthening family plan (15) Strengthening the social protection card (27) Capture fisheries to exceed 1 million tons (32) Borobudur (largest Buddhist temple) (33) Empowering 1.000.000 migrant workers Source: Ministry of National Development Planning/National Development Planning Agency (PPN/Bappenas), Bank Indonesia in terms of increasing investment and capital, as well as job creation and higher productivity. The Government has designed 12 infrastructure projects and 8 energy resilience projects to increase investment and capital (Figure 14.). Regarding job creation, the Government has prepared 6 downstream and food security projects as well as 10 projects for HR empowerment. Meanwhile, 3 projects on digitalization and 1 project on structural reform are expected to increase national economic productivity. The impact of the 40 government projects on increasing national economic capacity and accelerating economic growth will depend on the speed and accuracy of implementation. From these various programs, the Government has planned policies to increase investment for higher capital in the economy. The Government will improve the investment climate by streamlining the licensing process through Online Single Submission (OSS), simplifying the regulations, as well as central and regional regulatory harmonization. The Government will also strengthen international and bilateral cooperation. Fiscal incentives must also be provided for export-oriented industries, including tax holidays and tax allowances for investment in priority sectors and specific regions. The implementation of government projects will also be prioritized to increase foreign direct investment (FDI) and domestic direct investment (DDI) as well as sources of finance for the manufacturing industry, mining, information and communication, agriculture, and services. Attractive special economic zones (KEK) are also needed, as well as supports for green and sustainable investment, which includes issuing Green Bonds and Green Sukuk to fund environmentally friendly projects. Meanwhile, investment in capital-intensive sectors will be increased through mineral and food downstreaming to enhance value addition and strengthen the structure of these industries, while maintaining investment in the tourism sector and the creative economy. Overall, there are 40 priority government projects to stimulate economic growth in areas such as infrastructure, energy resilience, food downstreaming and security, digitalization, and education. The Government has also planned policies to increase job creation through education, vocational training and by accelerating growth in laborintensive sectors. Programs designed to increase public access to education will be expanded, including the Bidikmisi-Smart Indonesia Card (KIP), endowment funds for education and scholarships, as well as free education programs up to secondary education in all regions. Vocational education programs will be expanded based on industry needs, including the Independent Vocational Campus Program (Program Kampus Merdeka Vokasi), while expanding job training centers (BLK) and vocational high schools (SMK). BLK revitalisation and the vocational curriculum will be improved in line with industry needs. Fiscal incentives will be provided to corporations contributing to vocational education. Labor absorption will be increased by expanding export markets for priority sectors and micro, small and medium enterprises (MSMEs) to absorb more labor. Similarly, the Pre-Employment Card program will be continued to enhance work competencies as well as facilitate traineeships and job matching platforms, particularly in the manufacturing industry, labor-intensive tourism, and food security. In addition, worker rights protection will be addressed by encouraging companies to provide good working conditions, which will increase worker productivity and labor retention. Meanwhile, productivity will be increased through the development of infrastructure, digitalization, and R&D. Infrastructure development includes expanding 4G networks, operating the SATRIA Multifunction Satellite, developing government data centers, developing 5G networks, and continuing to develop connectivity infrastructure to improve the efficiency of logistics costs along with infrastructure to support tourism at priority tourism destinations. Digitalization to increase agricultural and labor-intensive industrial productivity, particularly in the textile and textile product industry, will involve applying digital technology and automation in the production process, including smart-farming and the Making Indonesia 4.0 initiative. The Government will also develop the digital economy and finance (EKD) by accelerating the development of digital infrastructure, while providing tax incentives for digital technology companies. State budget support to prepare digital spatial planning and priority investment areas includes implementation for business licensing, procurement (e-catalogue), as well as mineral and coal mining management (Mineral and Coal Information System – Simbara). In terms of R&D, the Government will allocate subsidies and other fiscal support to process technology imports for the manufacturing industry as well as simplify the application process for fiscal incentives for R&D, while strengthening digitalization as well as science and technology through collaboration with the private sector and foreign parties for new technologies through investment, particularly for of education. Furthermore, national resilience against cyber-attacks through R&D will also be increased. Government policies to stimulate economic growth by increasing capital, labor, and productivity require policy support and synergy with Bank Indonesia. Most importantly, Bank Indonesia must continue to maintain macroeconomic stability, particularly regarding inflation, exchange rates, adequate liquidity, and adequate reserve assets. Through macroprudential policy, Bank Indonesia can allocate liquidity incentives to the banking sector for extending loans/financing to the Government’s priority sectors. Bank Indonesia will also accelerate payment system and financial sector digitalization to increase the productivity and efficiency of economic and financial transactions in pursuit of sustainable economic growth. Bank Indonesia will expand electronification of the social protection program and the electronification of (central and regional) government financial transactions. Digital innovation programs in payment services and financial services will also be developed, while strengthening consumer protection and cyber security. Bank Indonesia will also improve the investment climate and external financing by: (i) promoting trade and investment in priority sectors, (ii) managing the positive perception of international stakeholders, and (iii) facilitating efforts to optimize/internalize international trade/investment cooperation. Policy Mix Synergy for Financial Sector Deepening Policy synergy between the Government, the KSSK, and Bank Indonesia must be strengthened to explore domestic and external financing sources to meet the massive investment needs for high economic growth moving forward. Bank Indonesia’s (optimistic) initial estimate indicates the total additional need for investment in the 2025-2030 period is approximately Rp56.9 thousand trillion (Graph 37.a). This estimate assumes that all national economic transformation programs implemented by the Government to increase investment, labor and productivity, as mentioned above, are successful in terms of increasing TFP, lowering ICOR, and optimizing investment needs. In accordance with the existing sources of finance, approximately 63.1% or Rp35.9 thousand trillion will originate from internal funds, including retained earnings or paid-up capital. The next source of financing is in the form of additional bank loans/financing at approximately 13.4% or Rp7.6 thousand trillion, and from external financing in the form of FDI or foreign loans at approximately 11.8% or Rp6.7 thousand trillion. Meanwhile, sources of finance from the Government in the form of capital expenditures in the State Budget or capital investment account for approximately 7.5% or Rp4.3 thousand trillion (Graph 37.b). Therefore, the mobilization of financing from Graph 37.a. Projected Total Investment and Sources of Finance: 2025-2030 the four main sources mentioned, namely internal funds, the banking industry, FDI, and government budget, must be optimized to achieve high growth in the next five years. The preparation process, licensing, and feasibility studies are the most decisive stages in the realization of investments, and therefore, also critical for achieving high economic growth. This is the case for both government projects and private FDI and DDI. Thus, it is important to improve the investment climate and implement bureaucratic reform, which are key to achieving high economic growth, alongside streamlined new business registration and licensing procedures, while minimizing the cost of starting a business. To that end, however, Indonesia is still less competitive than other countries in the region and, therefore, serious measures are needed to improve the investment climate and implement bureaucratic reform centrally and regionally. According to the Business Environment Index issued by the United Nations - World Intellectual Property Organization (UN-WIPO), for example, Indonesia received the low score of 82.1, which must be improved to at least 87.6 or higher. Several important measures need to be taken immediately as follows: resolving the technical constraints impeding the digitalization of OSS licensing, including the data input, verification, payment, and validation processes, expanding integrated one-stop licensing services (PTSP) to all Graph 37.b. Projected Composition of Sources of Investment Financing: 2025-2030 1.68% IDR Trillion 14,000 12,000 7.52% 13.40% 10,000 2.52% 8,000 11.78% 6,000 63.10% 4,000 2,000 Foreign Financing Retained Earnings and Other Financing Banking Industry Government NBFI Capital Market Source: Bank Indonesia Source: Bank Indonesia regions and incentives to reduce licensing costs, as well as central and regional regulatory harmonization and between sectors, while strengthening legal assurance. The effectiveness of government programs that specifically support new and emerging entrepreneurs must be ensured, including direct government support in the form of tax incentives, subsidies, or reductions to certain costs related to entrepreneurship. Improvements to the investment climate and bureaucratic reform will facilitate the preparation of new business models and feasibility studies for investment projects and, therefore, in the calculation and mobilization of financing sources as required. The feasibility of green projects must also receive special attention due to increasingly stringent requirements from investors for projects associated with the green economy and finance. In addition to improving the investment climate, bureaucratic reform, and project feasibility, concrete measures from the (central and regional) Government are required to increase FDI and DDI investment realization from around 6.75% of GDP currently to at least 8.0% of GDP, particularly in priority sectors, such as agriculture, manufacturing, mining, information and communication, services (health and education), construction, electricity, water and gas supply, as well as tourism. The focus is on investment realization, not on FDI and PMDN approval. Policy synergy between the Government, Bank Indonesia, and the KSSK must be strengthened to increase economic financing from the financial sector. Such coordination is an integral part of refining the national financial market development and deepening strategy by optimizing the Coordination Forum for Development Financing through Financial Markets (FK-PPPK), involving the Ministry of Finance, Bank Indonesia, the OJK, and the LPS. In this case, the focus of coordination covers four salient aspects, namely: (i) an optimal structure of project financing, (ii) appropriate financing sources, (iii) liquidity and hedging needs, and (iv) financial education and literacy. Investment project feasibility will determine the optimal financing structure. More profitable investment projects will facilitate a broader financing structure from the private sector, including bank loans/ financing, issuances of bonds and other securities in the domestic capital market, or loans from foreign investors. Numerous projects fulfill these requirements, including infrastructure projects, downstreaming natural resources, the manufacturing industry, electricity gas and water supply, as well as construction. Several other projects, however, such as downstreaming agriculture and fishery, tourism, MSMEs, and the creative economy, require fiscal incentives and/or other policies to meet feasibility requirements for financing sources, including favorable tax rates, subsidized interest rates and government policy assurance, particularly in providing a grace period from the construction phase until initial operational phase. To reiterate, feasibility studies, improving the investment climate, and bureaucratic reform are critical. Synergy within the FK-PPPK forum (Ministry of Finance, Bank Indonesia, the OJK, and the LPS) to coordinate the mobilization of financing sources to meet investment needs will support high economic growth. To that end, Bank Indonesia will continue collaborating in synergy with the three institutions in the KSSK to formulate joint measures to fulfill the sources of finance required. Bank Indonesia will continue optimizing Macroprudential Liquidity Incentive (KLM) Policy to revive bank lending to priority sectors supporting growth and job creation. In addition to macroprudential policy and microprudential supervision coordination to optimize credit and mitigate risk in the banking system, the coordination between Bank Indonesia and the OJK also includes regulatory harmonization concerning bond issuances and transactions as well as commercial securities, while harmonizing financial market licensing, such as inter-market infrastructure and supporting professions in the financial sector. In addition to fiscal, monetary, and macroprudential policy coordination, as explained previously, policy synergy between Bank Indonesia and the Ministry of Finance relates to government bond market deepening (government securities - SBN) as well as tax harmonization for financial transactions in the capital market, money market, and foreign exchange market. Financial market deepening synergy within the KSSK and with government ministries/ agencies, authorities, and market participants will be continued to develop innovative economic financing and hedging instruments, such as debt securities, as well as interest rate and exchange rate swaps, and optimizing local currency transactions (LCT). Policy Mix Synergy for Accelerating Digitalization The digitalization of the Indonesia’s economicfinance and services sectors has massive potential to drive higher economic growth through increased investment and productivity. According to the latest e-Conomy SEA 2024 report published by Google, Temasek, and Bain & Company, Indonesia’s digital economy will achieve gross merchandise value (GMV) totaling USD90 billion in 2024, a 13% increase compared to 2023, which is the largest GMV in Southeast Asia. In the next five years, the digital economy in Indonesia will increase to approximately USD200-360 billion by 2030 (Graph 38.a). Rapid advancement primarily stems from prolific digitalization of economic and financial transactions through e-commerce in 2024, reaching USD65 billion and expected to increase to USD150 billion by 2030 (Graph 38.b). Digitalization is also Graph 38.a. Indonesia’s Digital Economy Performance and Outlook USD Billion ~150 ~200-360 +13% +6% +11% +1% Source: e-Conomy SEA 2024 Government policies are required to accelerate economic digitalization in Indonesia moving forward, specifically digitalization of the services sector, the creative economy, MSMEs, corporate services, and tourism. To that end, infrastructure development for digital connectivity must be continued by expanding 4G networks and operating the SATRIA Graph 38.b. Indonesia’s E-Commerce Performance and Outlook USD Billion accelerating through transportation and food services, online travel, and online media. Digitalization has accelerated even faster through the payment system and financial sector. The latest e-Conomy SEA 2024 report also projects digital payment transactions in Indonesia to reach USD404 billion in 2024, before rapidly increasing to approximately USD900 billion by 2030 (Graph 39.a). In the same period, digital loan transactions from the banking industry will accelerate even faster from approximately USD9 billion in 2024 to USD40 billion by 2030 (Graph 39.b). The digitalization of other financial services, such as wealth management and insurance, is also developing quickly, though its value remains below that of the payment system and bank loans. Rapid acceleration of the digital economy and finance in Indonesia is the result of digitalization programs launched by Bank Indonesia in accordance with the Indonesia Payment System Blueprint (BSPI) and in close synergy with the Indonesia Payment System Association (ASPI), providing a compelling opportunity to support high and inclusive economic growth moving forwards. Source: e-Conomy SEA 2024 Graph 39.a. Indonesia’s Digital Payments Performance and Outlook Graph 39.b. Indonesia’s Digital Lending Performance and Outlook USD Billion USD Billion 1,000 ~900 +19% +19% ~40 +27% +45% Source: e-Conomy SEA 2024 Source: e-Conomy SEA 2024 multifunction satellite along with the development of government data center infrastructure and 5G networks. Policies to support the digital economy and finance (EKD) can be implemented by accelerating digital infrastructure development and providing tax incentives to digital technology companies. Policies to increase productivity in the agricultural sector and labor-intensive industries, particularly in the textile and textile product (TPT), can be implemented by applying digital technology and automating the production process, including smart-farming technology and the Making Indonesia 4.0 initiative. In terms of fiscal policy, the Government can provide State Budget support to establish digital spatial planning in priority investment areas, which includes implementation for business licensing, procurement (e-catalogue), as well as mineral and coal mining management (Mineral and Coal Information System – Simbara). payment services and financial productivity for the economy, which includes strengthening the role of MSME digitalization through MSME transformation to Go Digital and Go Export. Bank Indonesia will also establish a Digital Innovation Center to strengthen public digital literacy and acceptance. Payment system electronification in social program disbursements and government financial transactions will also be expanded. Likewise, bilateral and international cooperation in cross-border payment systems will also be expanded not only among ASEAN-5 countries but also with Japan, China, South Korea, and India. Bank Indonesia will continue accelerating payment system digitalization to support the realization of compelling opportunities in the national digital economy and finance in pursuit of high and inclusive economic growth. This will be achieved through programs in the Indonesia Payment System Blueprint (BSPI) 2030 for developing payment infrastructure (retail, wholesale, and data), strengthening the industry, fostering innovation, and international cooperation. Bank Indonesia will accelerate payment system and financial sector digitalization as leverage to increase Medium-Term Economic Outlook for Indonesia Overall, the programs formulated by the Government are expected to accelerate higher economic growth, while maintaining macroeconomic stability. The extent to which economic growth can be increased will depend on the speed, accuracy, and effectiveness of the programs. To that end, three scenarios can be simulated. First, a “Baseline” scenario, where the government programs are implemented on schedule, in addition to preparing projects by strengthening the synergy between capital-intensive and laborintensive sectors. Financing will primarily be sourced from the State Budget (APBN) as well as the domestic banking industry and foreign financing for projects that are ready to proceed. Bank Indonesia will also maintain development programs for the digital economy and finance in accordance with BSPI, while deepening the money market and foreign exchange market in line with the Money Market Development Blueprint (BPPU) 2030. Second, an “Optimistic” scenario, which is the baseline scenario with additional strategies to accelerate the preparation and implementation of government and private projects that meet business feasibility requirements with moderate financing needs. Business climate improvements are accelerated in terms of implementation at the central and regional levels, with fiscal incentives in the form of lower licensing costs and other fiscal incentives to strengthen business feasibility and financing requirements. Financial market development policy will also be further implemented to increase financing capacity for the implementation of feasible government and private projects from the domestic banking industry, FDI, and foreign loans. Third, a “Super Optimistic” scenario, which is the optimistic scenario with additional government and private projects with massive financing needs that have met business feasibility requirements. The business climate is stronger due to legal assurance and faster settlement procedures. Greater expansion of financing capacity is achieved through the development of from nonbank financial institutions and the capital market in the form of shares, securities, insurance, and others, including inclusive, green, and Islamic finance. Graph 40.a. Projected Productivity Growth: 2024-2030 Graph 40.a. Projected ICOR Decline: 2024-2030 % yoy The three scenarios outlined above can accelerate economic growth outlook to different degrees. The key lies in the speed and effectiveness of the implementation of various government and private programs and projects to drive growth, in terms of consumption and investment demand as well as increasing the capacity of the national economy. The five national economic transformation policy agendas are interrelated and support higher investment in capital, labor absorption and private income, as well as increasing economic productivity and efficiency. This will be reflected in upward productivity growth (TFP), with the largest gains achievable under the Super Optimistic scenario (Graph 40.a). This implies that with the same level of capital investment and labor absorption, economic growth will be higher. To achieve higher economic growth, an optimal balance must be struck between capital-intensive sectors to increase economic capacity (aggregate supply side) and labor-intensive sectors to increase income and consumption (aggregate demand side). Likewise, ICOR will decrease most under the Super Optimistic scenario (Graph 40.b). With a lower ICOR, the national economy will be more efficient because achieving higher growth will require lower investment. % Baseline Note: *Projection Source: Bank Indonesia Optimistic Super Optimistic 2024* 2025* 2026* 2027* 2028* 2029* 2030* 2024* 2025* 2026* 2027* 2028* 2029* 2030* Baseline Note: *Projection Source: Bank Indonesia Optimistic Super Optimistic Higher TFP and lower ICOR from the implementation of the national economic transformation policy mix will simultaneously accelerate higher economic growth, while maintaining macroeconomic stability. Economic growth, which in 2024 is projected at around 4.7-5.5%, is forecast to accelerate to 4.8-5.6% in 2025 and 4.9-5.7% in 2026. With implementation of the national economic transformation policy mix, however, the projected economic in 2030 under Baseline scenario at 5.3-6.1%, will increase to 5.86.6% for the Optimistic scenario, and 6.7-7.5% for the Super Optimistic scenario. Price stability will be maintained with inflation controlled within the 2.5±1% target corridor, accompanied by a narrow current account deficit of approximately 1.1-1.9% of GDP in 2030 (Table 9). Internal and external economic stability in Indonesia will be maintained due to sufficient increases on the aggregate supply side to meet increasing demand through implementation of the national economic transformation policy mix. Loans/financing disbursed by the banking industry will maintain optimal growth of approximately 11-13% per year. The fiscal deficit will also be maintained at below 3% of GDP in line with Indonesia’s credibility on fiscal discipline. As explained previously, additional financing to support higher investment and economic growth will come from internal funds given broader business opportunities, accompanied by a stable and conducive investment climate, and higher growth. Simulations of economic performance due to implementation of the national economic transformation policy mix must be evaluated continuously based on emerging dynamics and the necessary policy mix responses. Several assumptions underlie the simulations. First, world economic growth is assumed to increase from 3.2% in 2024 to 3.4% in 2030, with stable global inflation and international commodity prices and a decline in the US monetary policy rate from 4.5% to 3.5%. These assumptions could change with the policies of the new US Administration under President Trump. US economic growth could accelerate, contrasting lower growth in China, the European Union, and several other countries. US inflation could increase, thereby delaying further FFR reductions yet leading to higher UST yield in line with higher US government debt, and a strong US dollar. Volatile geopolitics and global economic dynamics will potentially disrupt economic stability and growth in Indonesia. Trade and investment policy in Indonesia, therefore, must be calibrated to strengthen bilateral cooperation with global sources of economic growth, such as the US, India, and Saudi Arabia. Second, in addition to government programs and projects to stimulate growth, the role of the private sector, including large companies, MSMEs, the creative economy, the digital economy and financial services, as well as tourism, is critical to drive economic growth and job creation. Improving the investment climate, developing infrastructure, and providing business assurance are key to economic growth and job creation. Maintaining macroeconomic and financial system stability is also crucial, which have established credibility in Indonesia in terms of economic performance that is recognized internationally. To that end, close policy coordination Table 9. Indonesia’s Economic Projections: 2024-2030 Indicator Unit Economic Growth % 4.7–5.5 4.8–5.6 CPI Inflation % 2.5 ± 1 Current Account % PDB Credit Growth % Baseline Optimistic Super Optimistic 4.9–5.7 5.3-6.1 5.8-6.6 6.7-7.5 2.5 ± 1 2.5 ± 1 2.5 ± 1 2.5 ± 1 2.5 ± 1 -0.1 to -0.9 -0.5 to -1.3 -0.6 to -1.4 -0.5 to -1.3 -0.9 to -1.7 -1.1 to -1.9 10–12 11–13 11–13 11-13 11-13 11-13 Source: Bank Indonesia’s Projection between the Government, Bank Indonesia, and the KSSK is a prerequisite in the face of volatile geopolitical and global economic dynamics and will serve as a solid foundation for the success of the national economic transformation policy mix in achieving higher and sustainable economic growth toward the 2045 Golden Indonesia. V. Direction of Bank Indonesia Policy Mix in 2025: Maintaining Stability, Driving Sustainable Growth The Bank Indonesia policy mix in 2025 will continue to be directed at maintaining stability and fostering sustainable economic growth, in close synergy with national economic policy. Considering the dynamics of the global and national economies over the next two years, Bank Indonesia’s monetary policy in 2025 will be aimed at balancing stability and growth (pro-stability and growth), while continue to examine further room to support economic growth. The objectives are to achieve the inflation target and Rupiah exchange rate stability, particularly against the adverse impact of global spillovers (Figure 15.). Meanwhile, macroprudential policy and payment system policy remains directed toward driving sustainable economic growth (progrowth). Bank Indonesia will hold an accommodative macroprudential policy stance to stimulate bank lending/financing to priority sectors aiming for supporting economic growth and job creation, MSMEs development, economic inclusion and green finance. Bank Indonesia will continue accelerating payment system digitalization in accordance with Indonesia Payment System Blueprint (BSPI) 2030 to strengthen the payment service industry and support national digital economy and finance, in addition to expanding cross-border payment system cooperation and ongoing development of the Digital Rupiah. The policy mix of monetary, macroprudential, and payment system will continue be supported by accelerating money market and foreign exchange market deepening in accordance with the Money Market Development Blueprint (BPPU) 2030 to strengthen the effectiveness of monetary policy transmission, develop a modern secondary market in line with international standards, and develop instruments of economic financing. Programs to develop inclusiveness for MSMEs and sharia Figure 15. Direction of Bank Indonesia Policy Mix in 2025 PRO-STABILITY AND GROWTH PRO-GROWTH EM ST SY Y IT Source: Bank Indonesia FIN A N STA CIA BI L L RY ETA ON ILITY M TAB S ECONOMIC GROWTH MONETARY MACROPRUDENTIAL PAYMENT SYSTEM MONEY MARKET DEEPENING INCLUSIVE AND GREEN ECONOMY AND FINANCE economic and finance will also be expanded, including the use of digitalization, as well as expansion of market, both in domestic and exports. Bank Indonesia will continue to strengthen synergy and coordination with the Government and the Financial System Stability Committee (KSSK), as well as with the financial industry, businesses, and industry associations to strengthen stability and drive national economic transformation toward the 2045 Golden Indonesia (Indonesia Emas 2045). The above-mentioned policy mix also serves as an implementation of Bank Indonesia’s mandate in accordance with Act Number 4 of 2023 concerning Financial Sector Development and Strengthening (P2SK Act), which strengthens the goals and duties of Bank Indonesia. According to to the P2SK Act, the goal of Bank Indonesia is to achieve Rupiah exchange rate stability, maintain payment system stability, and contribute to financial system stability to promote sustainable economic growth. This is achieved through three main duties: (i) setting and implementing monetary policy in a sustainable, consistent, and transparent manner; (ii) regulating and maintaining a seamless payment system; and (iii) regulating and implementing macroprudential policy. As mentioned previously, Bank Indonesia’s support for sustainable economic growth through the following measures. First, through monetary policy, contained inflation and Rupiah exchange rate stability, which serve as a prerequisite to ensure the development of economic and financial activities by the Government, banking industry, businesses, investors, and the public. Second, through payment system digitalization, the expansion of transaction value and volume in the digital economy-finance are nurtured to increase payment velocity and efficiency in the productivity of various economic and financial activities, supported by the development of a healthy national payment service industry. Third, by increasing bank lending/financing, which is essential for promoting economic financing, supported by maintained financial system stability. Supporting the three policies in terms of maintaining stability and sustainable economic growth, Bank Indonesia also pursues money market and foreign exchange market deepening policy, international policy, and supporting MSME and sharia economy-finance programs. Direction of Monetary Policy Bank Indonesia’s monetary policy direction in 2025 will be oriented toward achieving the inflation target and maintaining Rupiah exchange rate stability, while supporting national economic growth. As explained in the first section, geopolitical tensions and global economic uncertainty will remain high in 2025 and 2026. Specifically, the re-election of President Trump, supported by the Republican victories in the US House of Representatives and Senate, could trigger major changes in the global geopolitical landscape and global economic risk. The imposition of high tariffs, trade wars, and supply chain disruptions will lead to a decline in global economic growth and raise global inflation, thereby delaying further potential monetary policy rate reductions by central banks, including the Federal Funds Rate (FFR) in the US, which may not be as large as previously anticipated. In the US, to drive economic growth, the widening fiscal deficit through tax cuts and higher government debt has edged up US Treasury yields across all maturities and triggered a significant and broad-based US dollar appreciation. Such a shift in the global geopolitical landscape will prompt higher global uncertainty, portfolio outflows from EMEs to the US and a build-up of currency pressures globally, including on the Rupiah. Therefore, Bank Indonesia’s monetary policy will remain focused on Rupiah exchange rate stability to mitigate the adverse impact of global spillovers on higher inflation, macroeconomic and financial system stability, and the national economic recovery process. Consistent and calculated monetary policy will be applied to achieve the inflation target and support economic growth in 2025 and 2026. Striking a balance between stability and growth (pro-stability and growth) will be the monetary policy direction pursued in 2025. The direction of monetary policy in 2025 for stability and economic growth will be pursued with four primary instruments (Figure 16.). First, forward looking and pre-emptive interest rate policy to achieve the inflation target set by the Government, while remain vigilant and continue to examine room to support economic growth. Second, Rupiah exchange rate stabilization policy will remain in line with achieving the inflation target and supporting external economic stability from the impact of global spillovers. Third, promarket monetary operations to enhance the effectiveness of Bank Indonesia monetary policy transmission, the portfolio inflows, the Rupiah exchange rate stability, as well as money market and foreign exchange market deepening. And fourth, maintaining adequate reserve assets to support Rupiah exchange rate stabilization policy and government external debt repayment, supported by foreign exchange flow management in accordance with international rules. Policy coordination with the Government will be strengthened for macroeconomic stability and with the KSSK for financial system stability. First, Bank Indonesia’s interest rate policy will be continued to be directed in a forward-looking and preemptive manner to achieve the Government’s inflation target of 2.5±1% in 2025 and 2026. Low inflation and the need to support economic growth provide room for further BI-Rate reductions, following a 25 bps cut to 6.00% in September 2024. This is considering the core inflation pressure, which is expected to remain controlled in line with anchored inflation expectations and the economy’s output capacity that can still meet increasing demand. However, the risk of inflationary pressures stemming from global turmoil, specifically the impact of Rupiah depreciation on imported good prices (imported inflation), requires continued vigilance. Accordingly, the near-term focus of monetary policy aims to stabilize the Rupiah against the effects of global shocks. Therefore, policies to leverage room for further BI-Rate reductions will be based on assessments of data and evolving conditions (data dependent). Meanwhile, coordination with the (central and regional) Government through the Central and Regional Government Inflation Control Teams (TPIP and TPID) to control inflationary pressures on volatile food and administered prices will be strengthened through the National Movement for Figure 16. Direction of Bank Indonesia Monetary Policy in 2025 MITIGATING THE IMPACT OF GLOBAL SPILLOVERS MODERATING GLOBAL GROWTH – LONGER DISINFLATION PROCESS HIGHER UST YIELDS, SMALLER FFR AND POLICY RATE REDUCTIONS SUPER STRONG US DOLLAR AND DEPRECIATION OF GLOBAL CURRENCIES PORTFOLIO OUTFLOWS FROM EMEs TO THE US Pro-Stability and Growth Monetary Policy: Forward Looking, Pre-emptive, Coordinative MONETARY POLICY TRILEMMA INTEREST RATE FOR INFLATION AND GROWTH ACHIEVING THE 2.5±1% INFLATION TARGET IN 2025 AND 2026 TARGET TOGETHER WITH RUPIAH STABILITY FOR SUSTAINABLE ECONOMIC GROWTH BI-RATE 2.5±1% inflation target in 2025 and 2026, while observing further room Source: Bank Indonesia RUPIAH EXCHANGE RATE STABILIZATION maintain economic stability through foreign exchange market intervention through PRO-MARKET MONETARY OPERATIONS effectiveness of Bank Indonesia's policy transmission, attract foreign portfolio inflows, FOREIGN RESERVES ADEQUACY COORDINATION WITH THE GOVERNMENT Forward-looking and pre-emptive to achieve the for lowering the BI-Rate based on conditions (data dependent) RUPIAH RESERVE ASSETS STABILITY ADEQUACY AND FOR IMPORTED FOREIGN EXCHANGE INFLATION FLOW MANAGEMENT Rupiah exchange rate stabilization to control imported inflation and spot interventions, DNDF, and SBN transactions in the secondary market Pro-market monetary operations using SRBI and SVBI/SUVBI to strengthen the and deepen the money and foreign exchange markets Increasing reserve assets, expanding the placement of export proceeds from natural resources (DHE SDA), and managing foreign exchange flows in accordance with international standards 1. CONTROLLING INFLATION THROUGH TPIP/TPID AND GNPIP 2. FISCAL-MONETARY COORDINATION 3. DEVELOPING PRIORITY SECTORS Food Inflation Control (GNPIP) involving all 46 Bank Indonesia representative offices. Second, Rupiah exchange rate stabilization policy will continue to focus on mitigating the impact of global spillovers on achieving the inflation target, while maintaining macroeconomic and financial system stability to support national economic recovery momentum. From fundamental perspective, the Rupiah exchange rate should track a stable appreciating trend, in line with low inflation, attractive return on domestic financial assets, and comparatively high economic growth. Nevertheless, elevated US Treasury yields and the strong US dollar intensify pressure on the risk of portfolio outflows from emerging market economies (EMEs) and weaken various global currencies, including the Rupiah. Consequently, Rupiah exchange rate stability must be maintained to control imported inflation and sustain Indonesia’s external economic stability. Rupiah stability is also crucial to sustain fiscal performance, particularly in terms of preserving the attractiveness of SBN yields for State Budget financing. In addition, Rupiah stability will also determine financial system stability, particularly the exchange rate risk posed to balance sheets in the banking and corporate sectors, and its importance in ensuring business and public confidence. To that end, Bank Indonesia will continue to maintain its presence in the market and implement Rupiah exchange rate stabilization policy through foreign exchange market intervention with spot and Domestic NonDeliverable Forward (DNDF) transactions, as well as purchasing government securities (SBN) in the secondary market. Third, Bank Indonesia will continue refining its promarket monetary operations strategy to enhance monetary policy effectiveness, including attracting portfolio inflows and maintaining Rupiah exchange rate stability. To that end, Bank Indonesia will continue issuing Bank Indonesia Rupiah Securities (SRBI) with tenors of 6, 9, and 12 months, as well as Bank Indonesia Forex Securities (SVBI) and Bank Indonesia Forex Sukuk (SUVBI) with tenors of 1 and 3 months. The pro-market monetary operations strategy implemented by Bank Indonesia has provided many benefits for the national economy. First, a deeper money market and foreign exchange market, with higher transaction volume and liquidity, more participants and more efficient interest rate and exchange rate price formation in the market. Second, the SRBI, SVBI, and SUVBI instruments can be owned and traded on the secondary market by both residents and non-residents and, therefore, attract portfolio inflows. Third, more flexible liquidity management in the banking industry and larger investment portfolios by investment managers with the introduction of SRBI, SVBI, and SUVBI instruments that are actively traded in the secondary market. And fourth, the pro-market monetary operations strategy, using the three aforementioned policy instruments, has further improved the effectiveness of monetary policy transmission to the financial sector, as well as maintaining market and financial system stability. Fourth, Bank Indonesia will maintain adequate reserve assets to support Rupiah exchange rate stabilization policy and service government external debt, strengthened by capital flow management consistent with international principles. Bank Indonesia will continue improving the adequacy of reserve assets, through a surplus balance of payments and foreign exchange monetary operations, as well as optimizing reserve assets management. In this regard, Bank Indonesia will continue optimizing reserve assets management through the application of Strategic Asset Allocation (SAA) in pursuit of optimal returns on investment and meeting liquidity needs to service government external debt and implement Rupiah exchange rate stabilization policy. Bank Indonesia will also expand instruments to retain foreign exchange proceeds of natural resource exports (DHE SDA) as mandated by Government Regulation Number 36 of 2023. International cooperation will also be strengthened multilaterally with the Bank for International Settlements (BIS) for foreign exchange management, as well as through bilateral swap arrangements with several central banks, including the US, Japan, China, and ASEAN, and regionally with ASEAN+3 (Japan and South Korea) under the Chiang Mai Initiative Multilateralization (CMIM) framework to strengthen Regional Financial Arrangements (RFA) in Asia. Implementing the P2SK Act, Bank Indonesia has issued Bank Indonesia Regulations (PBI) on foreign exchange flow management to bolster Indonesia’s external economic resilience, consistent with a free foreign exchange system and international principles in accordance with guidelines published by the IMF. The regulations cover the management of foreign exchange flows under normal, distress, and crisis conditions, as well as the coordination mechanism between Bank Indonesia, the Government, and the KSSK to maintain macroeconomic and financial system stability. Policy coordination between Bank Indonesia and the Government will be strengthened to bolster external resilience against global turmoil, to control inflation and to drive sustainable economic growth. Strengthening external resilience against global shocks, monetary and fiscal policy coordination between Bank Indonesia and the Government in the area of managing aggregate demand to maintain macroeconomic stability, as well as issuance of government bond in the domestic and global markets related to annual planning and its implementation. Controlling volatile food inflation, Bank Indonesia also collaborates in close synergy with the Government through the Central and Regional Government Inflation Control Teams (TPIP and TPID) as well as through the National Movement for Food Inflation Control (GNPIP), implemented on a large scale across various regions. Meanwhile, coordination to foster priority sectors will be strengthened through Bank Indonesia support in assessing the latest developments and issues emerging centrally and regionally, while providing national economic policy recommendations as needed, including from the results of the Regional Economic and Financial Review (KEKR) conducted by various Bank Indonesia regional offices. Direction of Macroprudential Policy Bank Indonesia will continue strengthening accommodative macroprudential policy in 2025 to support sustainable economic growth, while maintaining financial system stability. Bank Indonesia will maintain accomodative macroprudential policy stance to support growth (pro-growth) based on three key considerations. First, Indonesia’s financial cycle in 2025 and 2026 is expected to remain below its optimal financing capacity during the expansionary phase, which is projected to peak in 2028 (Graph 41.a.). This is associated with national economic growth in Indonesia that remains below its potential output, primarily due to sluggish consumption and investment demand, as well as slower exports due to slowdown in global economy. Consequently, an accommodative macroprudential policy is required to boost bank lending/financing, especially targeting sectors that can create growth and jobs. Second, real sector policies from the Government to increase growth and job opportunities are vital to improve the demand for bank lending. Various programs have been planned by the Government to foster specific sectors, such as agriculture downstreaming, public housing, MSMEs, the creative economy and tourism, accompanied by fiscal incentives as required. Therefore, synergy between Bank Indonesia’s macroprudential policy and the Government’s fiscal policy along with structural reforms is crucial to address the significant constraints on credit demand from businesses and households (Graph 41.b.). Third, such accommodative macroprudential policy is also consistent with the importance of maintaining financial system stability from the vulnerabilities that could emerge from global and domestic economic dynamics. As mentioned, global spillover effects exert pressure on the Rupiah exchange rate, increase SBN yields, tightening liquidity due to capital outflows, and reducing business activity. Close synergy is required, therefore, between the accommodative macroprudential policies and enhanced banking system surveillance undertaken by Bank Indonesia and the microprudential supervision Graph 41.a. Indonesia’s Financial Cycle 6.0 Graph 41.b. Credit Demand Constraints % %, yoy Trillion Rupiah 2.000,00 2.000 4.0 1.500 1.500,00 2.0 1.000 1.000,00 500,00 -2.0 0- -4.0 -1.000,00 -1.000 -8.0 -6.0 -500 -500,00 1 5 91 5 9 1 5 91 5 9 1 5 9 1 5 91 5 9 1 5 91 5 9 1 5 9 1 5 91 5 9 1 5 9 -10-10 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Indonesia’s Financial Cycle Excessive Threshold Optimal Threshold Credit Demand Constraints Kendala Permintaan Kredit Credit Growth (rhs) Pertumbuhan Kredit - Skala Kanan Source: Bank Indonesia Source: Bank Indonesia conducted by the OJK. Coordination between the two authorities is important to mitigate market risk (exchange rate and interest rate), liquidity risk, and credit risk to ensure the stability of the financial system is preserved. Close coordination in the KSSK will also be strengthened to maintain financial system stability, while strengthening the implementation of financial sector reforms as mandated by the P2SK Act. Incentive (KLM) Policy and other macroprudential policy instruments to accelerate bank lending/ financing, particularly to priority sectors that support economic growth and create job opportunities. Second, accommodative liquidity policy through the Macroprudential Liquidity Buffer (MPLB) and other macroprudential policy instruments to maintain financial system stability against the downside of global spillovers. Third, strengthening systemic surveillance of the banking industry resilience in the face of market risk, liquidity risk, and credit risk stemming from global and domestic economic dynamics to maintain financial system stability. Policy coordination with the Government and the KSSK is also strengthened to increase loans/financing to the real sector, bolster the resilience of financial system stability against global shocks and continue financial sector reforms as mandated by the P2SK Act. The easing of all macroprudential policy instruments is directed toward achieving credit/financing growth of 11-13% in 2025 and 2026, while maintaining financial system stability. The direction of macroprudential policy is based on striking a balance between three targets, namely optimal credit growth, maintained financial system stability, as well as economic and financial inclusion, in line with the current expansionary trend observed in the financial cycle (Figure 17.). The three targets must be optimized to maintain conducive macro-financial linkages, including the credit supply capacity of banks, the demand for credit from priority sectors, adequate liquidity, and mitigating financial system stability risk that can emerge from high Rupiah exchange rate volatility and higher SBN yields. The accommodative macroprudential policy stance, therefore, is implemented through the following three principal instruments. First, increasing the effectiveness of Macroprudential Liquidity First, enhancing the effectiveness of Macroprudential Liquidity Incentive (KLM) Policy and easing other macroprudential policy instruments to revive bank lending/financing to priority sectors in the national economy. This is the manifestation of Bank Indonesia’s firm commitment to support sustainable economic growth. Commencing in January 2025, KLM policy will be oriented toward reviving bank lending/financing to sectors that can increase economic growth and job creation, namely: (i) agriculture, trade, and the manufacturing Figure 17. Direction of Macroprudential Policy in 2025 ACCELERATING LENDING, MAINTAINING FINANCIAL SYSTEM STABILITY INCREASE THE SUPPLY OF CREDIT FROM THE BANKING INDUSTRY INCREASE THE DEMAND FOR CREDIT IN PRIORITY SECTORS MAINTAIN LOOSE LIQUIDITY CONDITIONS MITIGATE FINANCIAL SYSTEM STABILITY RISKS DUE TO EXCHANGE RATES AND HIGHER SBN YIELDS Pro-Growth Macroprudential Policy : Optimal Credit Growth, Financial System Stability, Economic and Financial Inclusion MACROPRUDENTIAL POLICY TRILEMMA OPTIMAL CREDIT GROWTH TARGET 11-13% CREDIT GROWTH IN 2025 AND 2026, MAINTAINED THE RESILIENCE OF FINANCIAL SYSTEM STABILITY AGAINST RISKS MACROPRUDENTIAL INCENTIVES FOR LOAN DISBURSEMENTS Macroprudential Liquidity Incentive (KLM) Policy for priority sectors and easing all macroprudential policy instruments to increase lending/financing LOOSE MACROPRUDENTIAL LIQUIDITY FINANCIAL SYSTEM STABILITY ECONOMIC AND FINANCIAL INCLUSION MACRO-SYSTEMIC SURVEILLANCE OF FINANCIAL SYSTEM STABILITY Liquidity easing through the Macroprudential Liquidity Buffer (MPLB) ratio aims to stimulate credit/financing growth while maintaining financial system stability amidst global spillovers effects FINANCIAL SYSTEM STABILITY COMMITTEE (KSSK) COORDINATION 1. INCREASING CREDIT/FINANCING TO PRIORITY REAL SECTORS 2. STRENGTHENING THE RESILIENCE OF FINANCIAL SYSTEM STABILITY AGAINTS GLOBAL SPILLOVERS 3. IMPLEMENTING FINANCIAL SECTOR REFORMS IN ACCORDANCE WITH P2SK ACT Strengthening systemic surveillance of loan/financing disbursements and banking resilience to maintain financial system stability in close coordination with KSSK Source: Bank Indonesia industry; (ii) transportation, storage, tourism, and the creative economy; (iii) construction, real estate, and public housing; (iv) MSMEs; (v) ultra-micro enterprises (UMi); and (vi) green economy. The size of the liquidity incentives will also be increased from Rp259 trillion in October 2024 to Rp282.81 trillion starting January 2025 (Table 10.). The incentives are largest for the trade sector, agriculture, and manufacturing industry at Rp115.95 trillion, which absorb a 57.68% share of the labor market, followed by the transportation sector, tourism and creative economy with a value of Rp26.91 trillion and 23.94% share, and the construction sector, including public housing, with a value of 21.77 trillion and a 6.64% share. The MSME sector, UMi, and green sector will receive the same KLM incentives, totaling Rp118.18 trillion. More banks will also receive larger incentives, with 102 banks receiving KLM incentives above 3% of third-party funds (Graph 42.). Bank Indonesia will periodically assess the effectiveness of KLM liquidity incentives to further encourage bank lending/financing disbursement to priority sectors. In addition, all macroprudential policy instruments will remain accommodative to support loan/financing disbursements and maintain financial system stability for sustainable economic growth. To that end, Bank Indonesia has extended the period for other accommodative macroprudential policies to the end of December 2025. The Loan/Financing-to-Value (LTV/FTV) ratio will be held at 100% to revive property/ housing loans as well as 0% downpayment requirements on automotive loans. The Macroprudential Intermediation Ratio (MIR) will also be held at 84-94% considering that the MIR position was recorded at 85.69% in October 2024. Similarly, the Countercyclical Capital Buffer (CCyB) will be held at 0% and will not be increased before December 2025. Furthermore, Bank Indonesia’s prime lending rate transparency policy will be continued and its effectiveness be further strengthened. Second, Bank Indonesia will maintain an accommodative liquidity policy through the Macroprudential Liquidity Buffer (MPLB) to safeguard financial system stability against the impact of global spillovers. As explained in the previous section, there is ample liquidity in the banking system in line with the accommodative liquidity policies instituted by Bank Indonesia. Among others, this is reflected in the relatively high ratio of liquid assets to third-party Table 10. KLM Incentive Value by sectors KLM Sector Share of Labor (% of Total Labor) Graph 42. Number of Banks Receiving KLM Incentives Incentive Value (IDR Trillion) Number of Banks 102 banks receiving 58 KLM Incentives Trade, Agriculture and Manufacturing Industry 57.68% 115.95 Transportation, Tourism and Creative Economy 23.94% 26.91 Construction, including Public Housing 6.64% 21.77 MSMEs 69.2 Ultra-micro Enterprises 19.63 Green 29.35 Total 282.81 above 3% Incentive>0% Incentive>1% Incentive>2% Incentive>3% Incentive 4% Existing KLM Refocusing KLM Source: Bank Indonesia Source: Bank Indonesia funds in the banking industry at 25.58% in October 2024. This accommodative liquidity policy will be maintained in 2025. To provide greater flexibility in liquidity management in the banking industry, Bank Indonesia has extended MPLB policy to conventional commercial banks and shariah commercial banks/ sharia business units at 5% and 3.5%, respectively, until the end of December 2025 with the flexibility that all instruments can be used as collateral in repurchase agreement (repo) transactions with Bank Indonesia for bank liquidity management. Bank Indonesia expects the banking industry to utilize this liquidity flexibility to further encourage credit/financing disbursement so that economic growth can be higher. Bank Indonesia will continue monitoring overall liquidity conditions in the banking industry to strengthen the policy response as required. This accommodative liquidity policy will also be implemented through monetary operations by Bank Indonesia. Such policies are expected to strengthen the resilience of financial system stability, which includes mitigating the risks posed by global spillovers. of macroprudential supervision, focuses on large banks in terms of the macro-financial linkages, which are deemed influential in determining loan/ credit disbursements and financial system stability overall. There are several key aspects of Bank Indonesia’s systemic surveillance, including loan/ financing performance, resilience to liquidity risk, market risk (exchange rates and SBN yields), and credit risk, as well as interconnectedness in terms of funding, money market, and payment systems. In its implementation, Bank Indonesia closely coordinates with the KSSK to jointly manage financial system stability and bilaterally with the microprudential supervision conducted by the OJK. In this regard, policy coordination and the KSSK supervision are continuously strengthened to increase economic financing and maintain financial system stability, including from the impact of global turmoil. As mentioned previously, the impact of global spillovers can create excessive pressures on Rupiah exchange rates, increase SBN yields substantially, tighten liquidity due to capital outflows, and reduce business activity. Consequently, Bank Indonesia will strengthen synergy between the macroprudential surveillance of the banking and the microprudential supervision conducted by the OJK in accordance with the well-established coordination mechanisms. This type of coordination is critical to mitigate market risk (exchange rate and interest Third, strengthening systemic surveillance on credit/financing disbursement and banking resilience to help maintain financial system stability, in close coordination with the KSSK. Systemic surveillance by Bank Indonesia, as an integral part rate), liquidity risk, and credit risk to ensure the stability of the financial system. Strengthening close coordination within the KSSK is also necessary to maintain financial system stability and strengthen implementation of financial sector reforms as mandated by the P2SK Act. Direction of Payment System Policy Digital payment systems are key to accelerating the growth of digital economy and finance in the future. The volume of retail fund transfers originating from fast payment transactions is expected to grow exponentially and record 10.05 billion transactions in 2030, representing a 14-fold increase compared with the numbers in 2022. Rapid growth of digital transactions is driven by Millennials, Gen Z, and Generation Alpha, who will be the dominant driver of the digital economy. This is also supported by the promising economic outlook for Indonesia, with economic growth projected to accelerate toward 2030, including MSMEs and the creative economy. Payment technology innovation is expected to advance rapidity toward a cashless, cardless, and contactless transaction focusing on consumer need and preference (consumer centric), and incorporating the use of Artificial Intelligence (AI). On the other hand, the rapid pace of digital innovation must be balanced with adequate consumer protection and literacy, as well as security against cyber attacks and personal data protection. In addition, while digitalization of the banking industry is progressing rapidly, it has not been accompanied by strong linkages between banks and nonbank players (FinTech). Bank Indonesia has updated its roadmap to accelerate the national digital economy and finance for the next generation in the Indonesia Payment System Blueprint (BSPI) 2030, which was launched at the Indonesia Digital Economy and Finance Festival (FEKDI) on 1st August 2024. BSPI 2030 is designed to create an Indonesian payment system that support integration of the digital economy- finance nationally, ensuring safeguarding the central bank functions in currency circulation, monetary policy, and financial system stability. BSPI 2030 is a continuation of BSPI 2025 and, simultaneously, the manifestation of Bank Indonesia’s commitment to fulfill its mandate in accordance with the P2SK Act. That mandate is realized through 3 (three) policy objectives. First, the Velocity of payment system transactions, namely fast, simple, and affordable in retail and wholesale transactions to ensure greater efficiency in economic and financial transactions and, ultimately, increase productivity and support sustainable economic growth. Second, Structure in the form of a healthy, competitive, and innovative payment service industry with solid risk management, as well as efficient and fair market practices. Third, stable, modern, and secure Infrastructure in line with international standards and 3i principles (interconnection, interoperability, and integration), for both infrastructures managed by Bank Indonesia and the industry. The vision of BSPI 2030 will be achieved through 5 (five) initiatives, namely Infrastructure, Industry, Innovation, International, and Digital Rupiah (4I-RD), which simultaneously serves as the main strategy (Figure 18.). First, strengthening and modernizing retail and wholesale infrastructure as well as payment system data. Second, consolidating and restructuring the industry. Third, expanding innovation and digital acceptance. Fourth, expanding interconnection and international cooperation. Fifth, developing the Digital Rupiah. These five main strategies have been translated into flagship programs, along with a timeframe for completion. Payment system policy in 2025, as the first year of BSPI 2030 implementation, will accelerate the existing progress of digitalization to support sustainable economic growth. As previously shown in Table 6 of section 2, the target is to increase digital payment transactions through mobile banking, internet banking, and server-based electronic money from 36.4 billion transactions with a value of Rp71,038.0 trillion in 2024 to 55.4 billion transactions (52.3%) with a value of Rp105,664.5 Figure 18. Five Initiatives of Indonesia Payment System Blueprint (BSPI) 2025-2030 INDONESIA PAYMENT SYSTEM BLUEPRINT 2030 INITIATIVES Payment System Blueprint INFRASTRUCTURE INDUSTRY INNOVATION INTERNATIONAL DIGITAL RUPIAH RETAIL WHOLESALE DATA SP TIKMI Innovation QR Payment Cash-Ledger BI-Payment Clear ISO 20022 Payment Info Membership Settlement Engine Multicurrency Capturing Activity Reclassification Literacy and Acceptance Fast Payment SecuritiesLedger Private Fast Payment 3i Features Payment ID Regulatory Reform Consumer Protection Wholesale Cross-Border 3S PRINCIPLE (STANDARDIZATION, SIMPLIFICATION AND SYSTEMIZATION) ONE HOMELAND, ONE NATION, ONE LANGUAGE Source: Bank Indonesia trillion (48.7%) in 2025. QRIS transactions are expected to increase from 5.3 billion in 2024 to 6.0 billion transactions (14.70%) in 2025, with the number of users increasing to 58 million along with 40 million merchants, dominated by MSMEs. BIFAST services are projected to increase from 3.3 billion transactions in 2024 to 4.5 billion transactions (34.1%) in 2025, while Bank Indonesia – Real Time Gross Settlement (BI-RTGS) system transactions are expected to increase from 11.5 million with a value of Rp125,285.0 trillion in 2024 to 12.4 million transactions (8.0%) with a value of Rp137,057.0 trillion (9.4%) in 2025. This direction of payment system policies in 2025 will be implemented to support growth (pro-growth) through five key measures (Figure 19.). First, in terms of payment system infrastructure, Bank Indonesia will develop New BI-FAST and fast payment industry, modernize BI-RTGS, and integrated payment data infrastructure with 3i (interconnection, interoperability, and integration) for policy formulation, business development, and public interest. Second, in terms of industry consolidation, Bank Indonesia will strengthen payment system digitalization in the banking industry as the dominant institution and encourage interlinked digital payment services between banks and FinTech, while implementing regulatory reform for payment system industry consolidation based on TIKMI (Transactions, Interconnection, Capacity, Risk Management, and Information Technology) to create a stronger and more competitive industry. Third, in terms of innovation and digital acceptance, Bank Indonesia will collaborate with the Indonesia Payment System Association (ASPI) to nurture innovation and expand acceptance of digital payments while balancing this with consumer protection through the Bank Indonesia Digital Innovation Centre (BIDIC), campaigns to expand QRIS, as well as public education and literacy. Fourth, in terms of payment internationalization, Bank Indonesia will expand international cooperation on retail payment systems (QRIS and BI-FAST) bilaterally and multilaterally through development of the Nexus project with several other Asian countries. And fifth, in terms of Digital Rupiah development, Bank Indonesia will continue the advanced experimentation stage with a focus on issuing and circulating wholesale Figure 19. Direction of Bank Indonesia Payment System Policy in 2025 ACCELERATING THE NATIONAL DIGITAL ECONOMY FOR THE NEXT GENERATION EXPONENTIAL GROWTH OF DIGITAL TRANSACTIONS WITH GENERATION Y-Z AS THE MAIN PLAYERS RAPID TECHNOLOGICAL INNOVATION AND DIGITAL TRANSACTIONS AND CONSUMER CENTRIC INTERLINK BETWEEN FINANCIAL AND PAYMENT SERVICES BETWEEN BANKS AND FINTECH INTERLINKING ECONOMIC TRANSACTIONS AND DIGITAL PAYMENT BETWEEN COUNTRIES CYBERCRIME AS THREAT AND THE IMPORTANCE OF CONSUMER PROTECTION Pro-Growth Payment System Policy : Accelerating and Integrating the National Digital Economy, Digital Rupiah PAYMENT SYSTEM POLICY TRILEMMA FAST AND AFFORDABLE TRANSACTION VELOCITY HEALTHY AND COMPETITIVE INDUSTRY STRUCTURE STABLE AND RELIABLE INFRASTRUCTURE TARGET ACCELERATING THE INTEGRATION OF THE NATIONAL DIGITAL ECONOMY AND FINANCE, DEVELOPING THE DIGITAL RUPIAH, CROSS-BORDER PAYMENT COOPERATION RETAIL AND WHOLESALE INFRASTRUCTURE, DATA Developing the New BI-FAST system and private fast payment, modernizing BI-RTGS and payment data infrastructure based on 3i principles for policymaking, business development in the industry and in the public interest HEALTHY AND COMPETITIVE INDUSTRY CONSOLIDATION Strengthening banking digitalization as the main institutions, encouraging bank and FinTech interlinkages, and implementing regulatory reform for payment system industry consolidation based on TIKMI to create a stronger and more competitive industry INNOVATION AND DIGITAL ACCEPTANCE Bank Indonesia collaborates with ASPI to drive innovation and balanced digital payment acceptance while ensuring consumer protection through the Bank Indonesia Digital Innovation Center, QRIS expansion campaigns, and public education-literacy programs INTERNATIONAL PAYMENT Expanding cooperation in retail payment systems (QRIS and BI-FAST) both bilaterally and multilaterally through the development of Nexus with several Asian countries DIGITAL RUPIAH Advanced experimentation stage with a focus on issuing and circulating wholesale digital Rupiah and developing digital financial assets between Bank Indonesia and several selected banks SYNERGY AND COORDINATION 1. BANK INDONESIA-GOVERNMENT ELECTRONIFICATION OF SOCIAL AID PROGRAM (BANSOS) AND GOVERNMENT FINANCIAL TRANSACTIONS 2. BANK INDONESIA-INDUSTRY IMPLEMENTATION OF BSPI 2030 AND DIGITAL RUPIAH 3. BANK INDONESIA-OJK STRENGTHENING REGULATIONS AND SUPERVISION OF DIGITAL FINANCIAL INNOVATION 4. BANK INDONESIA-INTERNATIONAL CROSS-BORDER PAYMENT COOPERATION AND CENTRAL BANK DIGITAL CURRENCY DEVELOPMENT Source: Bank Indonesia Digital Rupiah and developing digital financial assets between Bank Indonesia and several selected banks. First, the development of retail and wholesale payment system infrastructure, and data will be oriented toward the interconnection, interoperability, and integration (3i) of payment transaction digitalization, industry consolidation, innovation, and acceptance as well as internationalization of the national digital economy-finance (Figure 20.). In terms of the retail payment system, Bank Indonesia will develop New BI-FAST in anticipation of future digital transaction needs regarding stability and scalability with the development of modular system architecture within the application for processing payment enquiries, clearing and settlement. The modular system architecture is considered to be more capable of responding to the development of service features in line with the needs of the public and businesses. Bank Indonesia will also nurture the development of fast payment infrastructure by the industry that is interconnected, interoperable, and integrated (3i) with BI-FAST, in terms of business and governance to ensure more effective synergy. To that end, BI-Payment Clear will be developed to maintain secure payment transactions against the risk of fraud by strengthening risk management capacity in the industry. Through BI-Payment Clear, the integrity of online retail payment transactions can be curated in advance in terms of validity and security prior to settlement in the fast payment infrastructure. Industry players can flag and reject suspicious transactions suspected of fraud. In terms of wholesale payment system infrastructure, Bank Indonesia is modernizing the RTGS system with the adoption of ISO 20022, the development of multicurrency features and other features that strengthen 3i principles with financial market infrastructure end-to-end. The multicurrency feature will enhance the effectiveness of foreign currency transaction settlements, including domestic and cross-border transactions. The adoption of ISO 20022 aims to make Rupiah and foreign currency transactions more efficient by providing greater seamlessness and granularity. Risk management will be strengthened through the Liquidity Figure 20. Direction of Retail and Wholesale Payment System Infrastructure and Data Development in BSPI 2030 PAYMENT SYSTEM INFRASTRUCTURE STRENGTHENING INFRASTRUCTURE STABILITY GO STRENGTHENING RISK MANAGEMENT OD SM FINA NCIA ARK ET L MA BI-RT GS RKE T TRX >1 B LIMIT: ILLIO N INDUSTRY TRX <1 B LIMIT: ILLIO N TAR G Private Fast Payment TAR G ETE COR D MA POR RKET ATE : EAR CRIT HIGH-V ICA ALU L TR E ANSA CTIO T CL MEN ETE IND D MA IVID RKE UAL T: Y BI PA N STA HIG BILIT Y HF R LOW EQUE -VA NCY LUE RETAIL PAYMENT SYSTEM 3i RISK PAY M ENT NT EME AG MAN SN AP ISO ISO ID 3i OPTIMIZING DATA UTILIZATION DATA CENTER BI P AY M EN P SNA STA BIL ITY NT ME E AG AN M ISK R WHOLESALE PAYMENT SYSTEM T IN FO Source: Bank Indonesia Saving Mechanism (LSM) feature, including fraud management/endpoint security. Bank Indonesia will also begin development of data centers to ensure end-to-end payment system data flows from the consumers to merchants and banking industry to nonbanks, as well as settlement in the Bank Indonesia payment system infrastructure. This is important to safeguard the continuity of central bank tasks in terms of maintaining price stability, financial system stability, and payment system stability. This payment system data infrastructure will be developed to strengthen transaction integrity and policymaking through development and optimization of Payment ID and Payment Info. Payment ID will function as a payment unique identifier, thereby facilitating the system to collect and process granular digital data for the purposes of policymaking, business development within the industry and public services. The processed data will be uploaded to the BI-Payment Info platform as public infrastructure from Bank Indonesia that provides processed data products of the digital payment system for the national interest. Second, Bank Indonesia will orient payment system industry structure policy toward strengthening a healthy and competitive industry structure, while safeguarding the currency circulation function of the central bank. This will be achieved through three strategies, namely: (i) strengthening banks as the primary institutions; (ii) nurturing interlinks between banks and FinTech; and (iii) regulatory reform (Figure 21.). As the primary institution providing payment services, banks function as the axis of money supply in an effective monetary system and financial system. Nonbanks are encouraged to establish interlinks with the banking industry in two key aspects, namely technical aspects through National Open API Payment Standard (SNAP) and business aspects through contractual standards concerning the technology, business, and ownership. This consolidation and strengthening of the industry aim not only to enhance end-to-end integration of payment services within the national digital economy-finance ecosystem, but also to increase the competitiveness and efficiency of payment services for the public. To that end, Bank Indonesia Figure 21. Direction of Payment System Industry Consolidation in BSPI 2030 INDUSTRY CONSOLIDATION STRENGTHENING BANKS AS PRIMARY INSTITUTIONS NURTURING BANK AND NONBANK INTERLINK REGULATORY REFORM Money BANKING DIGITALIZATION SNAP ISO 20022 General Public Consumer and Merchant TIKMI SNAP ISO 20022 Commercial Bank Primary PSP and Non-Primary PSP TECHNOLOGY SNAP BUSINESS COLLABORATION Contractual Enhancing Risk Management SNAP ISO 20022 ply Sup P cess ro Consumer Protection KYC OWNERSHIP Fintech/ Non-Commercial Bank Bank Indonesia DEGREE OF INTERLINK LOW MEDIUM HIGH ENTRY POLICY ACCESS POLICY EXIT POLICY Promoting interlink between banks and fintech REGULATORY REFORM ENHANCING SUPERVISION Source: Bank Indonesia has formulated several criteria that measure the level of contribution and risk management of industry players, consisting of Transactions, Interconnection, Competency, Risk Management, and Information Technology (TIKMI). TIKMI assessments of industry players are evaluated periodically as a reference in the licensing requirements, structuring the line of business, evaluating the license and developing activities, products and/or business cooperation, as well as a reference for Bank Indonesia supervision. For instance, direct access to BI-FAST is only granted to Primary Payment System Providers (PSP) that meet the minimum parameters in terms of Competency, Risk Management, and Information Technology (KMI) within TIKMI, as set by Bank Indonesia. This assessment is undertaken to ensure operational risk, liquidity risk, and credit risk mitigation are in accordance with the recommendations contained in the Principles for Financial Market Infrastructures (PFMI) for individual PSPs and the industry. Non-Primary and Primary PSPs that fail to meet the KMI criteria are directed toward participation in the private fast payment. In addition, Bank Indonesia is also committed to supporting the development of competent human resources in the payment system through competency certification programs implemented in collaboration with the Indonesia Payment System Association (ASPI). Third, Bank Indonesia will continue collaborating with the industry to foster innovation and digital payment system acceptance while balancing it with consumer protection, integrity, stability, and healthy business competition. This will be achieved through three main policies, namely: (i) fostering innovation of payment services; (ii) strengthening digital literacy and acceptance of the public; and (iii) strengthening risk management and consumer protection (Figure 22.). The three main strategies will be implemented collaboratively between Bank Indonesia and the Indonesia Payment System Association (ASPI). Bank Indonesia will foster the innovation of payment services in a corridor of healthy business competition that guarantees end-to-end integration in the digital economy and finance. Standardization of payment methods in terms of payment instruments and delivery channels will focus on the types of innovation with potential for massive adoption based on the one language principle. In addition to preventing the risk of unhealthy competition, standardization also aims to maintain the continuity of end-to-end integration in the digital economy-finance as the ultimate goal of BSPI 2030. An effective collaborative process with industry players will be optimized through the establishment of the Bank Indonesia Digital Innovation Centre (BIDIC). BIDIC will be developed on 3 (three) pillars of functionality: (i) in-depth sandboxing or effective innovation testing environment; (ii) market intelligence or monitoring industry developments; and (iii) design thinking or iterative processes, including research/assessments in collaboration with the industry and involving experts in their field. The implementation of these functions will accommodate efforts to safeguard aspects of consumer protection, stability, including risk management, integrity or compliance, and healthy competition. Meanwhile, digital acceptance, which has progressed effectively over the past few years, will be continued and strengthened through digital literacy programs. QRIS acceptance in 2025 is targeted to achieve 58 million users and 40 million merchants, dominated by MSMEs. This program will be implemented through socialization, education, and campaign activities to accelerate adoption balanced with fulfillment of risk management and consumer protection principles, particularly on the user side. The Jelajah Nusantara QRIS program will be held regularly with a broad scope and organized collaboratively with the industry and other relevant stakeholders to optimize the achievement of educational and literacy goals. Similarly, consumer protection will be strengthened through enhancing the regulatory framework and designing mechanisms that can bridge the needs of all elements (public, businesses, payment system industry players). Public awareness of their rights and responsibilities as consumers of payment services will also be strengthened through various digital literacy programs. Fourth, Bank Indonesia will expand international cooperation for cross-border payment system connectivity to support regional economic integration, particularly in the ASEAN region. International payment connectivity is critical to assist cross-border economic and financial transactions, maintain stability and build sustainable economies, while prioritizing national interests. This initiative will be realized through Figure 22. Direction of Innovation and Digital Payment System Acceptance in BSPI 2030 DIGITAL INNOVATION AND ACCEPTANCE FOSTERING INNOVATION OF PAYMENT SERVICES C LITERA STRENGTHENING DIGITAL LITERACY AND ACCEPTANCE Y Services Services Data Public ECONOMIC TRANSACTION DATA RISK CONSUMER PROTECTION Data INDUSTRY Bank - Nonbank PAYMENT SERVICES INNOVATION MARKET INTELLIGENCE DESIGN THINKING SNAP INSTRUMENT CHANNEL DATA CENTER SANDBOX PAYMENT SERVICES QRIS Bank Indonesia DATA AS A SERVICE KYC AML-CFT CYBER FRAUD UNFAIR COMPETITION BI-DIGITAL INNOVATION CENTER Industry & BI Collaboration PAYMENT INFO BI Led PAYMENT CLEAR SUPERVISORY TECHNOLOGY - REGULATORY TECHNOLOGY REPORTING - REGULATION - SUPERVISION Source: Bank Indonesia two programs, namely: (i) expanding the scope of cross-border QRIS cooperation; and (ii) preparing national payment system infrastructure that is ready to connect internationally (Figure 23.). Existing QRIS cooperation between Indonesia and Malaysia, Thailand, and Singapore will be expanded to Japan, South Korea, India, United Arab Emirates (UAE) and Saudi Arabia. Cross-border payment connectivity will also be driven through interconnected payment system infrastructure channels, both bilaterally and multilaterally. On the retail side, Bank Indonesia is pursuing BI-FAST interconnection multilaterally through project Nexus with Malaysia, Thailand, Singapore, the Philippines, and India with the involvement of the Bank for International Settlements (BIS). Bank Indonesia is actively involved in the Stage III development of project Nexus by preparing a roadmap for multilateral interconnection between five ASEAN member states and India for the use case of remittances. In terms of wholesale payment system infrastructure connectivity, the BI-RTGS modernization, as previously mentioned, is being prepared from the outset to anticipate and meet future cross-border interconnection demand. RTGS interconnection has also become a G20 agenda promoted through the initiative of enhancing cross-border payments, which needs to be anticipated early, considering Indonesia’s position as a G20 member. Fifth, Bank Indonesia will continue Digital Rupiah development in the advanced experimentation stage with a focus on replicating the function of the wholesale market and financial market deepening. This will be achieved through three main programs as follows: (i) experimentation in terms of issuance, transference, and redemption of the securities ledger; (ii) experimentation in terms of using digital securities for the use cases of monetary operations and other financial transactions; and (iii) exploration in terms of exploiting the advantages of programmability, composability, and tokenization for financial market deepening (Figure 24.). The exploration initiative for the design of Indonesia’s Central Bank Digital Currency (CBDC), or Digital Rupiah, is under the umbrella of Project Garuda, with the aims of: (i) maintaining Rupiah sovereignty as mandated by the Currency Act and P2SK Act; (ii) strengthening its role internationally; and (iii) accelerating national integration of the digital economy and finance. Figure 23. Direction of International Payment System Connectivity in BSPI 2030 INTERNATIONAL PAYMENT SYSTEM CONNECTIVITY REGIONAL PAYMENT CONNECTIVITY EXPANDING THE SCOPE OF QRIS CROSS-BORDER FAST PAYMENT CROSS-BORDER (NEXUS) INDONESIA-THAILAND INDONESIA-PHILIPPINES THAILAND N PHILIPPINES INDONESIA-SINGAPORE MALAYSIA N N SINGAPORE INDONESIA-MALAYSIA INDONESIA Source: Bank Indonesia N WHOLESALE CROSS-BORDER Figure 24. Direction of Digital Rupiah Development in BSPI 2030 DIGITAL RUPIAH WHERE WE ARE WAY FORWARD STAGE 1 STAGE 2 CASH LEDGER DIGITAL SECURITIES Interbank Money Market Monetary Operation SSB CCP Issuance, Redemption Interbank Fund Transfer MONETARY INSTRUMENT SSB INFORMATION CCP Connection CROSS-BORDER USE CASE NATIVE SSB PROOF OF CONCEPT STAGE 3 SECURITIES LEDGER GOVERNMENT SECURITIES MONEY SUPPLY PROCESS KDR KDS SMART CONTRACT EXPLORATION PROGRAMMABILITY COMPOSABILITY TOKENIZATION Source: Bank Indonesia Through this project, Bank Indonesia will develop the most accurate Digital Rupiah design to ensure its function as: (i) digital legal tender in the territory of the Republic of Indonesia; (ii) a core instrument for Bank Indonesia to discharge its mandate as a central bank in the digital era; and (iii) a means to support financial inclusion and innovation as well as driving end-to-end efficiency. The implementation of Project Garuda is divided into three stages. In the first stage (immediate), development began with the w-Digital Rupiah for the use cases of issuance, destruction, and transfers, which was completed in 2024. In 2025, as part of the advanced experimentation stage between Bank Indonesia and several selected banks, the focus is on replicating the function of the wholesale market and deepening the financial markets. In the subsequent phase (intermediate), the use cases for w-Digital Rupiah will be expanded to include additional use cases that support financial market transactions. In the final stage (end state), the concept of end-to-end integration of w-Digital Rupiah with r-Digital Rupiah will be tested. In addition to the five programs mentioned above, Bank Indonesia will also continue strengthening synergy and coordination with the (central and regional) Government as well as payment system industry. Coordination with the (central and regional) Government will primarily be oriented toward expanding the electronification of regional government financial transactions by strengthening the Regional Digitalization Acceleration and Expansion Team (TP2DD), fostering social aid program (bansos) disbursements and expanding the use of the Indonesia credit card (KKI) for the government segment. Similarly, digitalization of MSMEs and the tourism industry will be amplified through the National Movement promoting pride in Indonesian-made products (GBBI) and Proud to Travel in Indonesia National Movements (GBWI) in various regions. Synergy and coordination in terms of regulation and supervision of payment system digitalization by Bank Indonesia with the digitalization of financial institutions by the OJK will be strengthened as mandated by the P2SK Act, which encompasses crypto assets and the Financial System Technology Industry (ITSK), digital financial literacy and consumer protection, as well as cybersecurity. Synergy with the banking industry, payment system association, FinTech association and other associations will also be strengthened constantly by expanding various existing payment system digitalization programs, such as QRIS, SNAP, and BI-FAST, as well as expanding services to the public. Bank Indonesia abides by the principles of industry-friendly policy, where payment system policies, regulations, and supervision are formulated and implemented together with the industry. Money and Foreign Exchange Market Deepening Policy Money and foreign exchange market deepening plays an important role in the effectiveness of Bank Indonesia policy transmission, financial system stability, as well as fiscal and economic financing. Significant progress has been achieved through the implementation of the Money Market Development Blueprint (BPPU) 2020-2025. In the money market, for example, average daily repurchase agreement (repo) transactions have increased from merely Rp0.5 trillion in 2020 to Rp14.9 trillion as of October 2024. Similarly, average daily SRBI transactions in the secondary market have reached approximately Rp10 trillion per day. In the foreign exchange market, average daily transactions have increased from USD4.8 billion to USD9.1 billion, although Domestic Non-Deliverable Forward (DNDF) transactions have only reached USD143.80 million per day. In terms of the market participants and infrastructure, as explained in the third section, the Indonesian Money Market and Foreign Exchange Association (APUVINDO) has been established, and the Central Counterparty for Interest Rate and Exchange Rate Derivatives (CCP-SBNT) has also been operational. Such progress serves as a foundation to accelerate money and foreign exchange market deepening and close the gap with Malaysia, Thailand, and South Korea. Money and foreign exchange market deepening in terms of the products, pricing, participants, and infrastructure (3P+I) is critical for effective interest rate and exchange rate policy transmission as well as Bank Indonesia’s pro-market monetary operations to influence the financial system and economy. Liquidity and asset portfolio management by the banking industry and investors will also become more efficient and flexible and, therefore, support financial system stability. The SBN market will also improve and facilitate government fiscal financing. Similarly, a deep and efficient money and foreign exchange market will facilitate liquidity management and hedging needs against interest rate and exchange rate risks for businesses and economic financing. Bank Indonesia today launched the Money Market Development Blueprint (BPPU) 2030 as a continuation of BPPU 2025. BPPU 2030 is a clear roadmap to navigate the direction of money and foreign exchange market deepening to create modern and advanced money and foreign exchange markets in the 2025-2030 period, thereby supporting monetary policy transmission, financial system stability and national economic financing as well as implementation of Bank Indonesia’s mandate and authority in accordance with the P2SK Act. Money and foreign exchange market deepening focuses on 3 (three) aspects, namely 3P+I: products, participants, and pricing, as well as 3i market infrastructure (integrated, interoperable, interconnected) between money and foreign exchange market and the payment system. The direction of money and foreign exchange market transformation in BPPU 2030 is a strengthening of BPPU 2025, particularly in terms of integration with the pro-market monetary operations (MO) strategy, the strategic 3P+I targets, the development of money and foreign exchange market infrastructure based on 3i principles and data digitalization, as well as underscoring money and foreign exchange market regulation, and supervision based on best principles and practices. Product development prioritizes increasing repo and DNDF transactions, with average daily targets of Rp30 trillion and USD1 billion, respectively, as the benchmark for derivative product development, including Interest Rate Swaps (IRS) and FX Swaps. The pricing aspect is oriented toward creating an efficient term structure for money and foreign exchange market product prices from tenors of 2 weeks to 12 months, interconnecting larger and more active transactions between Primary Dealers (PD) and other market participants, supported by CCP-SBNT infrastructure that is ‘3i’-connected with the electronic trading platform (ETP) in the markets, the ETP and BI-SSSS in Bank Indonesia, as well as the BI-FAST and BIRTGS payment system infrastructure as previously explained. Money market deepening policy in 2025 will remain focused on pro-growth through the development of a modern money market based on international standards, while strengthening the effectiveness of Bank Indonesia policy mix transmission and supporting financing for sustainable economic growth (Figure 25.). Money market and foreign exchange market deepening policy in 2025 will focus on 5 (five) main programs as follows. First, product development to increase transaction volume and liquidity in the secondary market for Bank Indonesia Rupiah Securities (SRBI), Bank Indonesia Forex Securities (SVBI) and Bank Indonesia Forex Sukuk (SUVBI), supported by issuances of Interest Rate Swaps (IRS) and Foreign Exchange Swaps (FX Swaps) for effective monetary transmission, Rupiah stability, hedging and short-term liquidity management. Second, strengthening efficient market mechanisms to create an effective term structure for interest rate (IndONIA, OIS and repo), exchange rate (Domestic Non-Deliverable Forwards, DNDF) and hedging instruments (IRS and FX Swaps). Third, strengthening the consolidation of market participants through the implementation of Primary Dealers (PD) and establishment of the Indonesia Money Market and Foreign Exchange Market Association (APUVINDO) as key partners of Bank Indonesia in terms of implementing the monetary operation strategy and money market deepening. Fourth, infrastructure development for the money market, monetary operations and payment system that is ‘3i’ mutually as a prerequisite for the future issuance of Digital Rupiah. Fifth, synergy and coordination in terms of economic financing to support the formation of money and foreign exchange market with good governance. First, product and pricing development will be aimed at increasing liquidity, nurturing product innovation and strengthening efficient and credible pricing formation (Figure 26.). In the money market, Figure 25. Direction of Money Market and Foreign Exchange Market Deepening Policy in 2025 BANK INDONESIA MANDATE FOR RUPIAH AND FOREIGN EXCHANGE MONEY MARKETS DEEPENING PRO-MARKET MONETARY OPERATIONS STRATEGY, SURVEILLANCE, DIGITALIZATION OF PAYMENTS P2SK ACT IMPLEMENTATION FOR FINANCIAL SECTOR REFORM SYNERGY AND COORDINATION WITH THE GOVERNMENT, KSSK AND INDUSTRY Pro-Growth Money Market Deepening Policy: Integrated, Modern, Efficient MONEY MARKET AND FOREIGN EXCHANGE MARKET POLICY TRILEMMA INCREASING TRANSACTION VOLUME AND LIQUIDITY TARGET MODERN AND ADVANCED MONEY AND FOREIGN EXCHANGE MARKETS, INTEGRATED WITH MONETARY MANAGEMENT FOR BANK INDONESIA POLICY MIX TRANSMISSION AND DEVELOPMENT FINANCING PRODUCT AND PRICING The development of products and pricing is aimed at liquidity improvement, encouraging product innovation, and strengthening the efficient and credible price formation PARTICIPANTS AND INFRASTRUCTURE Development of competent and professional market participants with integrity, accompanied by market development with the latest technology to strengthen stability and reliability by fulfilling 3I principles and international standards SYNERGY AND PARTICIPANTS Synergy and coordination in economic financing are oriented toward supporting the creation of well-governed money and foreign exchange markets with a "pro-market" operational strategy, digitalization of payment systems, and coordination within the KSSK for economic financing FINANCIAL SECTOR DEVELOPMENT COORDINATION FORUM (FK-PSK) 1. FINANCIAL MARKET STABILITY 2. DEVELOPMENT FINANCING INSTRUMENTS MARKET AND PRICE EFFICIENCY AND INFRASTRUCTURE MARKET CONDUCT STABILITY 3. FINANCIAL LITERACY AND CONSUMER PROTECTION Source: Bank Indonesia Figure 26. Direction of Product and Pricing Development in BPPU 2030 INCREASING LIQUIDITY AND INFLOWS Repo, OIS, BI instruments (SBM/SRBI/SVBI, etc) Secondary transaction: SRBI, SVBI, SUVBI, SBM DNDF, FX Swap IndONIA JISDOR, Non-USD/IDR Reference Rate Smart Contract OIS Curve FX Forward Curve Digital Currency Other Products (including ESG, Structured Product, Retail) Price Discovery Standardization Product Features Close Out Netting FOSTERING VARIOUS PRODUCT INNOVATION STRENGTHENING THE EFFICIENT AND CREDIBLE PRICE FORMATION International Standard Digital Securities Market Making ITSK Innovation Center Transparency Integrated with Digital Rupiah Development Omni Channel Market Info and Data Industry and BI Collaboration [OM PRO MARKET] BI Led SUPERVISORY TECHNOLOGY - REGULATORY TECHNOLOGY REPORTING – REGULATION – SUPERVISION – COORDINATION Source: Bank Indonesia product development will focus on increasing transaction volume for repo and Overnight Index Swap (OIS) liquidity, accompanied by efficient and credible pricing based on the IndONIA and OIS Curve as reference to form the term structure for tenors from 2 weeks to 12 months. In the foreign exchange market, product development will focus on increasing transaction volume for DNDF and FX Swap (OIS) liquidity, accompanied by efficient and credible pricing for JISDOR and non-USD/IDR reference rates to form the term structure for tenors from 2 weeks to 12 months. Bank Indonesia will integrate product and pricing development in the money market and foreign exchange market with the pro-market monetary operations strategy to increase liquidity for SRBI, SVBI and SUVBI transactions in the secondary market by developing Money Market Curve and FX Forward Curve prices based on BISBM (Floating Rate Certificate) issuances as floatingrate notes to form the OIS Curve as a reference for market prices. Bank Indonesia will increase repo and DNDF liquidity in the money market and foreign exchange market by strengthening the role of primary dealers as market-makers, developing features and standardizing products, as well as expanding the investor base in coordination with relevant authorities and financial market associations. Second, the development of competent and professional money market and foreign exchange market participants with integrity, accompanied by market infrastructure development using the latest technology to strengthen stability and reliability by fulfilling 3i principles and international standards (Figure 27.). Bank Indonesia will collaborate with the Indonesia Money Market and Foreign Exchange Market Association (APUVINDO) to develop the money market and foreign exchange market, which includes enhancing the quality of human resources. Competencies will be developed through mandatory treasury competency certification issued by registered providers with Bank Indonesia. The application of market code of ethics will be initiated by Bank Indonesia issuing a Market Code of Conduct (MCoC) and Islamic Financial Market Code of Conduct (ICoC) as ethical guidelines for market participants. Meanwhile, strengthening money and foreign exchange market infrastructure consists of 3 (three) aspects: front-end, middle-end, and back-end. Figure 27. Direction of Market Participant and Infrastructure Development in BPPU 2030 THE INTERCONNECTION 2 INCREASING BETWEEN MONEY MARKET AND IMPROVING THE QUALITY, COMPETENCY, AND INTEGRITY OF MONEY MARKET AND FX MARKET PARTICIPANTS FX MARKET PARTICIPANTS BY STRENGTHENING PRIMARY DEALERS IN TERMS OF LIQUIDITY REDISTRIBUTION OPTIMIZING THE ROLE OF MONEY MARKET AND FX MARKET SRO TO SUPPORT MONETARY POLICY EFFECTIVENESS AND MARKET DEVELOPMENT SIC-S DAN TIKMI COMPETENCY STANDARDIZATION AND INTEGRITY ENHANCEMENT GENERAL MEMBER OF CCP SKKNI & KKMI MARKET MAKING MARKET CONDUCT COMPETENT INTEGRITY PROFESSIONAL INFLOWS LIQUIDITY REDISTRIBUTION Trustee Securities company Nonresident, NBFI Corporation MARKET STANDARD EXIT POLICY TECHNICAL PROVISION SURVEILLANCE SURVEILLANCE SUPPORTING PROFESSION Notary Individual BPIK ENTRY POLICY LITERACY TRANSACTION PARTICIPANTS Bank APUVINDO BANK INDONESIA PRIMARY DEALER Public Accountant Legal Consultant SUPPORTING INSTITUTION Securities Company Trustee Bank MONEY MARKET AND FX MARKET INDUSTRY REGULATORY REFORM INTEGRATED SURVEILLANCE CONSUMER PROTECTION Source: Bank Indonesia First, the front-end will be strengthened through enhancement of trading venues, consisting of the Bank Indonesia-Electronic Trading Platform (BI-ETP) and market operators (MO). Second, the middle-end will be strengthened by developing a clearing system that utilizes the CCP-SBNT. Third, the back-end will be strengthened through strategies targeting the Securities Settlement System/Central Securities Depository (SSS/CSD) through development of the Bank Indonesia – Scripless Securities Settlement System (BI-SSSS), payment system through development of the Bank Indonesia – Real Time Gross Settlement (BI-RTGS) system in accordance with BSPI 2030, and the development of reporting focused on establishing a Trade Repository (TR). Money and foreign exchange market infrastructure development will also apply ISO 20022 international messaging standards to increase transaction efficiency, transparency and security, while simultaneously preparing for the future money and foreign exchange market digitalization process. Third, synergy and coordination in economic financing will be oriented toward supporting the creation of money and foreign exchange market with good governance (Figure 28.). Synergy with the pro-market monetary operations strategy and macroprudential surveillance will be oriented toward increasing transaction liquidity in the money market and foreign exchange market, market stability and infrastructure, as well as efficient pricing in accordance with market conduct. An integration strategy will be implemented in terms of products and price development, market participants and infrastructure, as well as regulatory harmonization between monetary operations, money and foreign exchange market deepening, and monetary and macroprudential market surveillance to support financial system stability. Digitalization synergy for money and foreign exchange market deepening in accordance with the BSPI 2030 initiative aims to strengthen infrastructure and data digitalization. This will commence with the alignment of money and foreign exchange market unique identifiers with payment ID, followed by the development of data capturing and data analytics infrastructure, and extending their application across various use cases. Infrastructure will be harmonized with the Figure 28. Direction of Development of Synergy and Coordination of the Money and Foreign Exchange Markets in BPPU 2030 SYNERGY AND COORDINATION IN PRO-MARKET MONETARY OPERATIONS AND SURVEILLANCE Product and Pricing Monetary Operation, Money and FX Markets Repo and OIS Participants and Infrastructures SYNERGY AND COORDINATION IN DIGITALIZATION END TO END PROCESS DATA ANALYTICS Parameters of SICS, Rights and Obligations DNDF MONEY MARKET AND FX MARKET, IPK PD Evaluation Liquidity Money Market Foreign Exchange Market Regulation Supervision Alignment with other authorities Integrated Monetary Operation-Money and FX Market Monitoring Tools Integrated DSRS Alignment with BKU Alignment with best practices and global regulations Regulation Evaluation and Review IDCB SURVEILLANCE MONETARY-MACROPRUDENTIAL-MARKET Price TSSB TSNT PAYMENT SYSTEM BI SSSS Gen 2 - Gen 3 Monetary Operations Regulation, Money and FX Market Implementation, Surveillance OM PRO-MARKET Payment ID Money and FX Markets and Payment System IPK: CCP, BI-ETP, ETP MO, BISSSS TIKMI Evaluation Metadata SYNERGY AND COORDINATION IN ECONOMIC FINANCING BI-OJK Coordination FK-PPPK Coordination SNPPPK LIKE IT! Licensing Regulation Alignment (including CCP) 3-ID Integrated Digital Payment System dan Finance Market Risk KSSK FK-PPPK Interconnectedness Among Participants Liquidity Risk Interconnectedness Money Market Integrated Digital Technology Integrated Digital Central Bank Financing Source: Bank Indonesia ISO 20022 message format, including: (i) BI-RTGS Generation III; (ii) BI-SSSS Generation III; (iii) Trade Repository; and (iv) Central Counterparty. Synergy in terms of maintaining financial system stability and economic financing will be implemented through regulation and supervision in accordance with international principles through bilateral coordination between Bank Indonesia and the OJK. Meanwhile, synergy within the Financial Sector Development Coordination Forum (FKPSK), as implementation of Article 11 of the P2SK Act, between the Ministry of Finance in developing the Government bond market for development financing, Bank Indonesia in money and foreign exchange market deepening, and the OJK in capital market development. Synergy within the Sustainable Finance Committee (KKB), as mandated by Article 224 of the P2SK Act, for coordinated development of sustainable finance for the green economy and achieving the Sustainable Development Goals (SDGs) is carried out between the Ministry of Finance in financing government projects and programs, Bank Indonesia in formulating macroprudential policies, deepening money market and foreign exchange market, and the OJK in financing through the banking industry and capital market. The formation of FK-PSK has strengthened financial sector development synergy and efficiency to comprehensively (end-to-end) cover the various forms of financing required in the economy. Inclusive and Green EconomyFinance Policy Bank Indonesia will continue expanding and strengthening development programs targeting the inclusive and green economy and finance to support sustainable economic growth (progrowth). In this regard, MSME development programs will be oriented toward supporting the downstreaming of agriculture and fishing to help control inflation, developing MSMEs specializing in traditional fabrics (wastra nusantara) as the pride of Indonesia along with “Go Export” and “Go Digital” MSMEs, and development to support tourism as a source of national foreign exchange. Program implementation involves the role of 46 Bank Indonesia offices in various regions as well as international offices. The MSME program to control inflation focuses on downstreaming production, the development of integrated business models from market to consumer as well as interregional cooperation, particularly for major inflationcontributing food commodities, such as rice, various chili varieties, shallots, beef, chicken, and fish. Implementation is performed in synergy with the National Movement for Food Inflation Control (GNPIP) and the (central and regional) Government. Similarly, the development program for MSMEs specializing in traditional fabrics, assortment of food products, and tourism emphasizes its value to support inflation control, increase foreign exchange, and ameliorate public prosperity. Bank Indonesia will increase access to markets and financing by facilitating product certification and curation, trade promotion and business matching through the annual Karya Kreatif Indonesia national event, and international MSME exhibitions in various countries in cooperation with the local embassy of the Republic of Indonesia. Enabling financial institutions to fulfill inclusive and green financing obligations, Bank Indonesia will also provide Macroprudential Liquidity Incentive (KLM) Policy to banks extending MSME loans, People’s Business Loans (KUR) and ultra-micro (UMi) loans. facilitating business matching with international business partners. Bank Indonesia will also continue supporting government programs to implement halal certification in synergy with the Halal Certification Agency (BPJPH) and Indonesian Council of Ulema (MUI) centrally and regionally, including through supporting of the automation of halal certification services. In terms of Islamic commercial finance, Bank Indonesia will continue sharia money market deepening policy to support sharia-based financing by expanding BI Sukuk (SUKBI) and Bank Indonesia Forex Sukuk (SUVBI) transactions in the money market and providing Macroprudential Liquidity Incentive (KLM) to banks extending sharia-based and inclusive financing. In addition, Bank Indonesia will continue hosting the series of activities associated with the Sharia Economic Festivals (FESyar) in three regions (Java, Sumatra, and eastern Indonesia) and the international Indonesia Sharia Economic Festival (ISEF) in Jakarta to showcase the development progress of the sharia economy and finance, while also featuring local businesses, facilitating business matching and providing education and literacy for the public. Bank Indonesia constantly strengthens synergy with various parties, including the National Sharia Economy and Finance Committee (KNEKS) and pesantren, Sharia Economic Society (MES), business associations, the banking industry, ulema, academics and the general public. Bank Indonesia will continue strengthening its role as a pioneer and driver of the sharia economy and finance as a new source of economic growth, while establishing Indonesia as one of the major players globally. Halal value chain ecosystem development will remain focused on flagship sectors, namely halal food, modest fashion, Muslim-friendly tourism and the green economy. Bank Indonesia will accelerate halal ecosystem implementation end-to-end in terms of the participants, institutions, and supporting infrastructure through economic development programs targeting “pesantren” (Islamic boarding schools) and MSMEs through 46 Bank Indonesia offices in various regions, strengthening the Pesantren Economy and Business Association (Hebitren), and International Policy Bank Indonesia will continue collaborating in close synergy with the Government to strengthen Indonesia’s position in bilateral relation, within Asian region, as well as globally. International policy aims to support the national interest in strengthening economic resilience against global impacts, while expanding cooperation to support sustainable economic growth. In accordance with its authority, the international policy of Bank Indonesia covers various aspects of the central bank and national economic policy mix, cross-border payment system cooperation, and the expansion of Local Currency Transactions (LCT), in addition to aspects of the green and inclusive economy and finance as well as promoting trade and investment in synergy with the Government and the KSSK. In 2025, international policy will focus on 3 (three) main aspects. First, strengthening and expanding bilateral cooperation with key partner central banks in the areas of central banking, payment systems, LCT, and Bilateral Swap Arrangements (BSA). Second, expanding regional cooperation, particularly ASEAN Financial Integration, ASEAN Payment Connectivity (APC) and strengthening the Chiang Mai Initiative Multilateralization (CMIM) as a form of regional financial cooperation among ASEAN+3 countries. Third, Bank Indonesia’s active participation in championing the national interest in various economic, monetary and international financial agendas, including the G20, IMF, Financial Stability Board (FSB) and Bank for International Settlements (BIS), as well as in terms of sharia-based finance in the Islamic Financial Services Board (IFSB) and International Islamic Liquidity Management Corporation (IILM). In addition, Bank Indonesia will continue improving positive perception management among investors and rating agencies, while promoting trade and investment through the Bank Indonesia Investor Relations Unit, nationally (IRU), regionally (RIRU) and globally (GIRU) by further empowering and leveraging the network of Bank Indonesia offices in various regions and abroad. Bank Indonesia will also continue enhancing institutional leadership and international recognition in terms of the policy mix, research, innovation, institutional arrangements, leadership, payment system digitalization and currency circulation. Bank Indonesia will continue strengthening cooperation with other main partner central banks in the formulation of a monetary and macroprudential policy mix as well as payment system cooperation, LCT and BSA. Existing structured bilateral cooperation (SBC) and MoUs with central banks in Malaysia, Thailand, Singapore, Japan, China, South Korea, US, UK, and India will be expanded to other countries. Payment system cooperation through QR interoperability and fast payments with Malaysia, Thailand, and Singapore will be expanded to Japan, South Korea, China, India, UAE, and Saudi Arabia. Similarly, the bilateral use of local currencies through LCT with Malaysia, Thailand, Japan, South Korea, UAE, China and Singapore will be expanded in terms of the partner countries and scope of transactions that include trade and investment, portfolio investment and payment transactions, as well as in terms of the number of appointed participating banks. To ease the aforementioned LCT, Bank Indonesia is conducting the cooperation under Local Currency Bilateral Swap Arrangements (LCBSA) with Bank Negara Malaysia (value of MYR24 billion or Rp82 trillion), Bank of Korea (value of KRW10.7 trillion or Rp115 trillion), People’s Bank of China (value of CNY250 billion or Rp550 trillion), Monetary Authority of Singapore (value of SGD9.5 billion or Rp100 trillion) and the Reserve Bank of Australia (value of AUD10 billion or Rp100 trillion). In addition, Bank Indonesia will maintain bilateral cooperation to strengthen reserve assets in the face of global turmoil through a bilateral swap agreement (BSA) with the Bank of Japan (value of USD22.76 billion) and bilateral repo agreement (BRA) with the Monetary Authority of Singapore (MAS) (value of USD3 billion). Institutional Transformation Policy Bank Indonesia will continue implementing comprehensive institutional transformation policy to build a credible, professional, well-governed, and transparent central bank institution. Transformation of the policy mix, institutional governance, organization and work processes, and human resources as well as digital transformation, which began in 2018, will be strengthened and refined. In addition to being more capable of safeguarding the national economy from the impact of global turmoil and strengthening the duties and authority of Bank Indonesia in the digital era, strengthening institutional transformation is also an integral part of implementing Bank Indonesia’s mandate in accordance with the Bank Indonesia Act, as amended several times and most recently by the P2SK Act. In addition to transformation of the Bank Indonesia policy mix, as described in section three and four previously, strengthening institutional transformation will focus on 3 (three) main agendas. First, strengthening the central bank policy governance and institutional governance systems based on the principles of independence, consistency, coordination, accountability, and transparency (IKKAT). Second, digitalization of the policy and institutional work processes with clear outputs and division of labor, streamlined processes and collaborative work, supported by the development of data centers as well as artificial intelligence (AI) capabilities, specifically utilizing data analytics and data science. Third, strengthening Bank Indonesia’s professional leadership with high competence (book-smart), strong experience (street-smart), and noble character (spiritual smart) through the “Aku Bangga BI Bermakna (AB3)” work culture program. Bank Indonesia will also continue to strengthen institutional accountability to the Indonesian House of Representatives (DPR-RI) and maintain an unqualified opinion (WTP) on financial reports from the Indonesian Supreme Audit Agency (BPK-RI), and enhance public transparency. In its implementation, institutional transformation will still consider the principles of 2EG (effective, efficient, and governance) to strike a balance between effective duties and authority, efficient resource management, and professional and strong governance. First, strengthening the central bank policy governance and institutional governance systems based on the principles of independence, consistency, coordination, accountability and transparency (IKKAT). In line with Bank Indonesia’s mandate in the Bank Indonesia Act and P2SK Act, Bank Indonesia has strengthened its vision, which has now become “the Foremost Digital Central Bank with Strong Governance that makes Tangible Contributions to the National Economy and the Best among Emerging Markets toward Indonesia Maju.” That vision is implemented by strengthening 7 (seven) missions as implementation of the main policies in monetary, payment system, and macroprudential policies, supported by money market and foreign exchange market deepening, inclusive and green economy-finance policy, international policy, as well as digitalization, strengthening governance along with organizational and human resource management. To that end, Board of Governors Regulations (PDG) have been issued to regulate the Bank Indonesia governance system as a central bank and institutional entity. As a central bank, prevailing laws afford Bank Indonesia independence to discharge policy duties and authority along with the policy budgeting to achieve the inflation target set by the Government. Strengthening Bank Indonesia’s credibility, the policy governance system regulates aspects concerning policy consistency, coordination with the Government, as well as transparency to the public. In this regard, policymaking in Bank Indonesia is discussed at various levels through committees for each policy before being discussed jointly within the Main Policy Mix Committee (KBKU) and then submitted to the Board of Governors Meeting (RDG) for approval. Meanwhile, the Bank Indonesia institutional governance system covers planning process and work program consistency, approval of the operational budgets by DPR-RI, and institutional performance accountability to the President and DPR-RI. Bank Indonesia has already submitted its quarterly and annual institutional performance reports to the President and DPR-RI as a part of P2SK Act implementation. Internally, the institutional performance of Bank Indonesia as an entity is discussed at the Institutional Governance Committee (KTKK) on a quarterly basis and submitted to the Board of Governors Meeting (RDG) for approval. Bank Indonesia will continue strengthening its Institutional Policy Mix (BKK) framework based on effective , efficient, and governance. BKK aims to strengthen the institutional performance of Bank Indonesia and support the achievement of Bank Indonesia’s goals in accordance with its legal mandate through sound and professional institutional performance. To that end, Board of Governors Regulations (PDG) are formulated for end-to-end BKK implementation, integrated with the salient aspects of institutional governance, namely strategic planning and performance evaluation, business processes and organization, financial and human resource management, and the control function in terms of legal aspects, risk management and strengthening the internal audit. These measures aim to ensure the rules are aligned and accentuating the principles contained in the Bank Indonesia’s Governance System. will digitally become input for institutional and human resources processes to measure institutional and individual employee performance (Figure 29). Conversely, the output of digitalized institutional and human resources processes will serve as input to improve policy work processes. Bank Indonesia has begun DWP development to digitalize the work process and decision-making process for the monetary, macroprudential, and payment system policy mix from the work unit to committee level and then to the monthly RDG that fulfills the aspects of effectiveness, efficiency, and governance. The DWP work process, which previously required 8 (eight) stages, has been streamlined to just 4 (four) stages from the department level up to the decision-making level at the RDG meeting. The decision-making process, which entails initiation, verification, recommendations, and approval, is facilitated within an integrated end-to-end digital platform to which all employees and leadership have access in accordance with their access rights and authority. DWP and IDCB development will be further improved in 2025 and expanded to other policy, institutional and human resource processes. Second, Bank Indonesia will accelerate the digitalization of policy and institutional work processes toward achieving the vision of becoming the foremost digital central bank with strong and professional governance that contributes tangibly to the national economy. Bank Indonesia will continue the development of integrated digital business platforms within the Integrated Digital Central Bank (IDCB) program, supported by the Digital Workplace Platform (DWP) for digitalization of the policy, institutional and human resource business processes with integrated input-output interconnection. Through IDCB, for example, the output of policy processes Figure 29. Direction of Digital Transformation at Bank Indonesia OUTPUT ck dba Fee AI d n an atio alu Ev nput e I c an ing rm nn rfo Pla Pe DMP INSTITUTIONAL Collaborative work includ ing POLICY Collaborative work OUTPUT AI Digital Business Process Di Bus gital Pro iness ces s TECHNOLOGY-DRIVEN SECURITY Input 4P including individual performance evaluation Feedback I npu indi vidu t4 al p P erfo rm an ce eva lua tio n ital Dig ess in s Bu cess Pro INFRA AND NETWORK SOFTWARE DATA AND AI Source: Bank Indonesia Fee db ack DMP OUTPUT AI DMP HUMAN RESOURCE Collaborative work IDCB and DWP development is supported by the aspects of processes, people, and technology that are aligned with the seven guiding principles of one input, one process, multi-purposes as follows: (i) good governance; (ii) collaborative works; (iii) digital; (iv) streamlined; (v) agile; (vi) data-driven; and (vii) green. Therefore, to support the above IDCB and DWP, the development of omni data centers and data digitization is carried out for end-to-end data management and innovation, from data input to the utilization of Big Data in metadata processing and storage in an omni data lake. Bank Indonesia is enhancing the digital capabilities of human resources through education and training for using data analytics and data science in analysis, projections, and formulating policy recommendations. In addition, the development of omni-technology platforms, which allow data digitalization and innovation as well as policy and institutional digital BPR with several core applications that can mutually connect and integrate with the support of cybersecurity. With such implementation of digital transformation, the effectiveness and efficiency of work processes and decision-making at Bank Indonesia will be strengthened by eliminating redundancies and streamlining the processes, while still prioritizing governance together with work process collaboration between work units, supported by secure end-to-end information systems. Third, strengthening highly competent and professional leadership with strong experience and integrity through the “Aku Bangga BI Bermakna (AB3)” work culture program. Since 2018, the human resouce transformation program has been extremely successful with mature merit-based human resouce planning, clear and transparent career management, stringent selection from the talent pool in accordance with person-to-job fit, a tiered leadership program from non-officer to officer and the highest leadership levels, education and training programs to develop technical competencies and scholarship programs for master’s and doctorate degrees, all of which are supported by competitive remuneration, welfare facilities and post-employment benefits. In addition to further strengthening these programs, future human resource transformation will remain focused on enhancing visionary leadership character with “strategic spiritual leadership” capabilities, combining high competence (book-smart), strong experience (street-smart), and noble character (spiritual-smart). This is critical to build leadership character that is innovative and creative, agile to change, highly motivated and perseverance, as well as morals in accordance with the national values and individual spiritual beliefs. Competency enhancement will also emphasize adaptability to digitalization, including technical competencies in Artificial Intelligence (AI), as well as behavioral and mindset aspects. Strengthening the Employee Value Proposition (EVP) and “Aku Bangga BI Bermakna (AB3)” work culture program also emphasizes leadership character that is book-smart, street-smart, and spiritual-smart through 9 (nine) programs across three pillars namely leadership, family, and well-being. Equally important is the development of a modern office atmosphere, relationships, and work facilities that better support digitalization and the behavioral traits of millennial employees. VI. Moving Forward with Optimism and Vigilance: Stability and National Economic Transformation toward the 2045 Golden Indonesia (Indonesia Emas 2045) Synergy is the key to Indonesia’s economic resilience, whether from crisis threats due to the Covid-19 pandemic and global turmoil, or from current conditions in strengthening optimism with vigilance for enduring economic revival into 2025 and beyond. Optimism that economic stability will be maintained and sustainable economic growth will accelerate by strengthening the national economic policy mix. We must remain vigilant of the dynamic global turmoil that could persist and evolve rapidly with all the negative spillover effects on national economic performance. Therefore, synergy between Bank Indonesia, the (central and regional) Government, and the KSSK will continuously be improved to strengthen national economic stability and future transformation. Bank Indonesia will also strengthen synergy with DPR-RI, specifically Commission XI, the banking industry, business community, academia, media and various other parties. In response to global dynamics, Bank Indonesia will continue developing innovation in monetary, macroprudential, and payment system policy mix, supported by money market deepening policy, international policy, and development programs for the inclusive and green economy, to strengthen stability and national economic transformation. In closing, let us continue the collaborative synergy as we move forward with optimism and caution. In the interest of national economic resilience and revival toward the 2045 Golden Indonesia. May Allah SWT, God Almighty, always provide guidance, ease, perfection, and blessings to the Indonesian nation and state, and to all of us. Thank you, Wassalamualaikum warahmatullahi wabarakatuh, Jakarta, 29th November 2024 Perry Warjiyo Governor of Bank Indonesia
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Text of the Dr. Harold Walter Siebens Lecture delivered by the Governor of the Bank of Canada, Mr. Gordon G. Thiessen, to the Fraser Institute in Vancouver on 6/3/97.
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Mr. Thiessen discusses monetary policy and the Canadian economy in a changing world Text of the Dr. Harold Walter Siebens Lecture delivered by the Governor of the Bank of Canada, Mr. Gordon G. Thiessen, to the Fraser Institute in Vancouver on 6/3/97. The performance of the Canadian economy is a popular topic these days. Canadians wonder why our economy seems to have been struggling recently, turning in a lacklustre performance that has left the unemployment rate high and a significant margin of our production capacity unused. When people focus on the recent record of the Canadian economy, they point in particular to the contrast with the United States where the economy has been operating at close to full capacity over the past couple of years. The United States is by far our most important trading partner. And in the past, economic developments in Canada have tended to follow reasonably closely those in the United States. Naturally, people want to know what is different this time. The fact that the Canadian economy has not been expanding at a strong pace is also worrying to governments trying, as they are, to address budgetary problems. They are concerned that fiscal cutbacks may weaken the economy further. Of course in all of this, questions are also raised about the role of monetary policy. I would like to take this opportunity today to discuss the factors that have affected the recent performance of the Canadian economy, to explain the role that monetary policy has played, and to conclude with some comments on our future economic prospects. The Canadian economy in a changing world environment The world economy has been going through profound changes. Many developing countries have embraced open markets and international trade as a means of accelerating their economic progress. Deregulation and privatization initiatives have been undertaken by both developing and industrial countries, typically as part of structural adjustment programs to improve economic performance. Technological changes have reduced the cost of capital relative to labour, encouraging businesses to use more physical capital, in particular more computers and computer-based equipment. And there has been an accompanying shift in the demand for labour away from unskilled workers. These technological innovations, along with reductions in transportation and communications costs, have also made possible a wider geographic dispersion of the production process -- not just nationally but internationally. And to ensure access to foreign markets, countries have been pursuing multilateral and regional trading arrangements. As a result, all nations have been adjusting to the new reality of heightened international competition and to the accompanying substantial shifts in the location of production of many goods. Such shifts have not been limited merely to the diversion of the production of goods requiring unsophisticated techniques to the developing countries. Indeed, some developing nations, particularly in Asia, are establishing themselves as important suppliers of a wide range of internationally traded products, including high-technology manufactured goods. At the same time, industrial economies are moving more towards the export of services, as a result of improvements in communications and information technology. All in all, these changes are to the good, in that they should result in expanding international trade, more rapid increases in productivity and, hence, improved living standards everywhere, but especially in developing countries. However, these ongoing globalization trends and adjustments to new technology do imply changes in the structure of national economies. Canada and other industrial countries are having to cope with these changes. But change is never easy and is often stressful. Even in the large U.S. economy, there has been considerable concern over the uncertain job prospects, especially for unskilled workers, in light of the changes in technology, production and trade trends that I have just described. However, the process of adjustment in the United States to these developments began early, and their economy has been operating successfully at full capacity. Why is it that in Canada we seem to have had a more difficult time of it? There are a number of reasons for this. But, in my view, one of the most important is the fact that in Canada we started adjusting later and, as a result, we were further behind. Why was that? The depreciation of the Canadian dollar in the mid-1980s, by easing the pressure from foreign competition, blunted the urgency to adopt more efficient production processes. And through much of the second half of the 1980s, because many Canadians were still acting on expectations of accelerating inflation, we were devoting a good part of our energies and resources to speculative activities, rather than investing in improvements in productivity and competitiveness. Rising government deficits, which were absorbing increasing amounts of domestic savings, were not helping either. Thus, with poor productivity growth, rapidly rising wages and generally weak cost control, Canadian businesses and exporters found it increasingly difficult to compete, especially at the end of the 1980s, when the Canadian dollar had reversed its earlier depreciation. For a nation that is highly dependent on foreign trade, Canada certainly was doing all the wrong things to get ready for the new world of changing technology and increasing global competition. It was not until the early 1990s that many Canadian businesses realized that they had to undertake major adjustments. They had to restructure, invest in new technology and implement tight cost control. And they had to do it quickly if they were going to position themselves to take advantage of the Free Trade Agreement with the United States, the subsequent North American Free Trade Agreement and then, more generally, the multilateral agreement on trade liberalization. Adjustments of this magnitude are never easy. They are often disruptive and stressful, generating a great deal of uncertainty about the future for both individuals and businesses. But because the adjustment process was delayed in Canada, it ended up being more far-ranging and more intense than in the United States. For many businesses, restructuring has meant downsizing. But the business sector has not been the only area of the Canadian economy in need of an overhaul. There has also been an urgent need for fiscal adjustment. Here again, that adjustment was late in coming. As a result, the cutbacks and downsizing necessary to restore fiscal health have been more sweeping and more disruptive than if action has been taken much earlier. Thus, we have had two major structural adjustments vital to our economy taking place back to back. Indeed, over the past year, these adjustments have been overlapping, and that may continue for some time. And while a good deal of the restructuring in the private sector has already occurred, the adjustment in the public sector still has some way to go. This restructuring has affected the unemployment rate as more people move between jobs, taking time to retrain and upgrade their skills. And the related uncertainty among workers has been reflected in low consumer confidence and an unwillingness to spend. As a result, the recovery of the Canadian economy has been slower than it might otherwise have been. However, what we must not forget is that restructuring in both the private and public sectors was absolutely necessary, and it will have significant payoffs for the Canadian economy in terms of productivity gains, competitiveness and an improved standard of living. The role of monetary policy What has been the role of monetary policy in all of these developments? Should monetary policy have been following a different course to ease some of the difficulties that our economy has encountered? During the last half of the 1980s, monetary policy sought to prevent excessive demand pressures from fuelling an accelerating trend of inflation. The intention was to put inflation on a gradual downward trend once the demand pressures subsided. In February 1991, the Bank of Canada and the federal government made a formal commitment to price stability as the objective of monetary policy. To make the path to price stability more explicit, the Bank and the government agreed on specific targets for inflation control. The targets aimed at bringing inflation (as measured by the consumer price index) down from about 5 per cent at the end of 1990 to 2 per cent by the end of 1995. Inflation decelerated sharply between 1991 and 1992 -- much more than the Bank had anticipated or indeed was aiming for. This was mainly the result of the sharper-than-expected downturn of the Canadian economy in 1990-1991 and the subsequent slow recovery. Our economy had to cope with both the economic distortions caused by past high inflation and with the large and overdue adjustment needed to respond to the changes in technology and the more open and competitive world markets that I have been describing. When I reflect on the view expressed by the Bank’s critics that the 1990-1991 recession, the slow recovery and the sharp deterioration in our fiscal situation were all caused by an excessively tight monetary policy in the late 1980s, I find it useful to ask what would have happened if monetary policy had in fact been less anti-inflationary in the late 1980s. I believe that such a policy would have led to even greater inflation-related distortions in our economy, an even more pronounced recession afterwards and still greater problems for businesses trying to adjust to the new technology and the more competitive international environment. Moreover, higher inflation would have led to higher interest rates and more expensive debt-servicing costs for governments and other debtors. Indeed, with the benefit of hindsight, if there is a lesson in this experience, it is that the Bank should have pursued a tighter monetary policy earlier in the second half of the 1980s. A tighter monetary policy earlier on might have moderated some of the speculative activity and debt accumulation that subsequently weighed so heavily on our economy. The other lesson is that fiscal policy, too, should have been tighter during that period. With a tighter fiscal policy, some of the buildup of public debt that governments are now having to contend with would have been avoided. More fiscal restraint during the second half of the 1980s would also have moderated the excess spending demands on the economy, removing some of the upward pressure on interest rates and the Canadian dollar at the time. Since the sharp deceleration of inflation in 1992, the role of monetary policy has been to keep inflation low. In doing so, monetary policy has provided Canadian businesses with a more stable, lower interest rate environment in which to undertake the investments and cost controls necessary to adjust to the new competitive reality I have described. Looking to the future So, where is the Canadian economy now, and what are the prospects for the future? I believe that Canadian business has gone through a remarkable transformation in the last few years. There has been substantial investment in machinery and equipment, particularly in computer-based technology, to improve productivity. And strict cost control is now the norm. As a result, Canadian businesses have become much more competitive, both at home and internationally. The low Canadian dollar has, no doubt, also been helpful in this respect. But businesses are using the low exchange rate to help them get into new world markets and expand their market share rather than needing it to offset uncontrolled costs and poor productivity. The benefits from this restructuring can already be seen in the success that Canadian businesses have had over the last few years in exporting their products and in competing with imports within Canada. Indeed, exports are likely to remain the main locomotive for economic expansion in the period ahead. The restructuring process for the public sector is not that far advanced as yet. As I noted earlier, most governments in Canada took major steps last year to reduce their fiscal deficits. However, public debt levels remain high in relation to our total national income. Evidence of investor concerns about these debt levels, and about political uncertainty, can be seen in the persistence in Canada of medium and longer-term interest rates that are high relative to similar rates in the United States. These high interest rates have the potential to discourage some of the investments that will be needed to keep the Canadian economy productive and competitive in the future. In order to reduce these interest rates, Canadian governments must stay the course of fiscal consolidation, and bring down the levels of public debt in relation to national income. The largest part of economic activity in our country revolves around the spending by Canadian households on consumer goods of all kinds and on housing. This has been the area most affected by the stresses and uncertainty of the restructuring. As I said before, a good deal of the restructuring in the private sector has already occurred. And private sector jobs have been increasing -- by 3.5 per cent in 1994 and 1.5 per cent in 1995. We now need to reduce some of the anxiety associated with public sector restructuring by getting on as quickly as possible with the fundamental decisions needed to put government programs and their funding on a sustainable basis. As for monetary policy, our good inflation performance and the fiscal measures taken so far have given the Bank of Canada some room to ease monetary conditions in Canada. I believe there is now substantial monetary stimulus in the economy, which should help counteract some of the concerns that affect the confidence of Canadians, as we work our way through this crucial period of restructuring the Canadian economy.
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Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Canadian Association for Business Economics and the Ottawa Economics Association in Ottawa on 21/3/97.
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Mr. Thiessen elucidates why he is optimistic about the prospects for a stronger Canadian economy Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Canadian Association for Business Economics and the Ottawa Economics Association in Ottawa on 21/3/97. Anyone who has read our last Monetary Policy Report, the winter issue of the Bank of Canada Review, or our just-released Annual Report knows that the Bank has been positive about Canada’s economic outlook. Basically, we are looking for a solid pickup in the pace of economic expansion in coming months, with inflation remaining low. And, with improvements in the basic foundation of our economy, we see the potential for sustained good economic performance over the medium term. Not everyone is as upbeat as we are. Some analysts are rather sceptical, especially of the fairly strong recovery that we foresee in household spending. They see Canadian households carrying too much debt, a personal savings rate that is already too low, and an unemployment rate that is too high to sustain much of an increase in spending. Others seem to have difficulty reconciling an optimistic outlook on the rate of economic expansion with a scenario of continued low inflation. In this group, some are afraid that the Bank will react too quickly to an acceleration of inflation, frustrating the economic recovery. Another camp is worried that the Bank will let inflation get away, with all the costs that that would entail. Today, I would like to use this opportunity to address some of these issues. I believe that I can offer good reasons -- and monetary policy is one of them -- why we in Canada should be upbeat about our economic future. Why is the Bank optimistic about an expanding economy? The Canadian economy has been undergoing extensive transformation. And clearly we are not out of the restructuring woods yet. This restructuring has been spawned by rapid technological advancements, increasingly open and competitive world markets, the decline of inflation in Canada from the high levels of the past, and the need to reverse an unsustainable trend of debt accumulation, particularly by Canadian governments. But over the last few years, Canada has made great strides in dealing with these issues. As a result, I believe that we now have a much more efficient and competitive private sector. We also have a fundamentally improved macroeconomic policy situation. Fiscal policy has been successful in reducing deficits, and governments have been moving towards less vulnerable debt positions. Inflation is low and relatively stable within the Bank’s inflation-control target range. Together, these improvements in our basic economic circumstances have facilitated the major decline that we have seen in domestic interest rates over the past year or so. Many interest rates in Canada are now at their lowest levels since the 1960s. And for maturities of up to 10 years, they are also below comparable U.S. rates by the widest margins we have seen in many years. Some of the gloom about the economy during the past year had to do with the perception that the stimulus to economic activity from the decline in interest rates was taking a long time to have its effects on spending and employment. There are, of course, lags in the impact of monetary policy actions on the economy that are widely believed to be of the order of 12 to 18 months. However, what may not have been widely appreciated was that the reductions in short-term rates that began in the spring of 1995 initially just reversed the runup in rates that occurred after the Mexican currency crisis and before the 1995 federal budget. The real easing in monetary conditions relative to 1994 effectively started only in late 1995, following the Quebec referendum, and continued for one year to late 1996. Therefore, it is not surprising that signs of the response to that easing have only been apparent quite recently. Because of the lags involved, the contribution of the easier monetary conditions to a stronger expansion in output and employment should continue for some time. Thus, we expect the economy to expand at rates in excess of the growth in potential output through 1997 and 1998. In other words, we anticipate that the margin of unused capacity in our economy will shrink substantially over the next couple of years. As I noted, there are those who view this outlook with scepticism. For them, it is not a question of lags. They argue that the current very low interest rates will not do enough to encourage additional household spending, given high debt levels, a low savings rate, and high unemployment. I will not tell you that these factors cannot temper the response to low interest rates. Of course they can. But I do not believe they are sufficiently important to offset it. Let me take the arguments in turn. First, household debt levels. Yes, they are high relative to personal disposable income -- over 90 per cent. But the burden of servicing this debt represents only 8 per cent of disposable income -- well down from the peak in 1990 -- and is expected to continue to fall as debt is rolled over, or new debt taken on, at lower interest rates. In addition, over three-quarters of household debt is in mortgages, which have financed the purchase of houses. Households have also been accumulating financial investments. In fact, the net worth of the household sector has been rising, although, of course, the assets and debts are not equally distributed across households. The important point I want to make is that, if you take the household sector as a whole, it is not buried under a mountain of debt, with high servicing costs, no assets, and no spending power. Second, the personal savings rate. In this case, there are valid concerns that we have been underestimating savings by ignoring capital gains, particularly on investments in stocks, given the rise in the stock market. If we look at the conventional measure of personal savings, the savings rate of 3¼ per cent in the fourth quarter of 1996 is indeed low. But this does not mean that it could not remain low for a time (or even go lower temporarily) while the economy is recovering. This is, in fact, what we would expect to happen if significant numbers of households decided to cash in some of their accumulated financial assets in order to spend. Third, the high unemployment rate. This argument sounds like a "Catch 22": the high unemployment rate discourages people from spending, which keeps unemployment high, which discourages spending still more. I believe that this grim picture overstates the problem, given that over 90 per cent of the workforce is employed. And yes, there are still cutbacks and layoffs, especially in the public sector. However, private sector employment continues to expand. Since the beginning of 1996, the private sector generated some 210,000 net new jobs, six times as many as were lost in the public sector. Undoubtedly, employment concerns remain, but the quickening of output growth that began in the second half of last year should lead to sustained growth in private sector employment over the course of 1997, and to improved consumer confidence. You can see that I did not find the arguments against a strong comeback in consumer spending persuasive. Moreover, these negative influences must be weighed against the size of the easing in interest rates that has taken place since late 1995. Short-term rates are down by about 3 percentage points, medium-term rates by 2 percentage points and longer-term rates by 1½ percentage points. Another indicator of the extent of easing in monetary conditions is the growth of the narrowly-defined monetary aggregate, M1. This aggregate, which provides advance information on the near-term expansion of the real economy, has recently accelerated to a year-over-year growth rate of over 15 per cent. But, of course, in the end, it is the recent evidence from the interest-sensitive sectors of the economy that is the most telling. As the economic results for the second half of 1996 show, and the more recent monthly indicators confirm, there have been substantial increases in spending on housing, motor vehicles and other consumer durables. Sales in these sectors have picked up in response to the lower interest rates, just as expected. All things considered, I believe there are good reasons to expect solid economic expansion in coming months. What are the risks that inflation will accelerate? Let me now turn to the inflation implications of this scenario. If the economy grows at the above-potential rates that the Bank foresees, won’t inflation accelerate? As I noted, this question seems to lead to two, quite opposite, concerns. One group of commentators fears that the Bank will respond, either too quickly or unnecessarily, to an acceleration of inflation and cut off the economic expansion. Another group worries that the Bank will let inflation get away, resulting in another cycle of boom and bust. There seems to be a certain confusion around this issue. Some people apparently assume that it is the speed at which the economy is growing that determines whether inflationary pressures will increase or decrease. While the rate of growth is not irrelevant, what really matters is the level of economic activity relative to the production capacity of the economy -- in other words, the margin of slack or the output gap in the economy. The size of the output gap, interacting with inflation expectations, is the principal force behind increased or decreased inflationary pressure. Thus, one would expect inflation to start accelerating only after a period in which the level of aggregate demand had exceeded the economy’s capacity to produce on a sustained basis. That is by no means the situation we face in Canada today. In fact, we have a fairly large margin of spare capacity. Even with the more rapid pace of expansion we experienced in the second half of 1996, we estimate that the level of real GDP was still, on average, about 3 per cent below the level of potential output. This means that the Canadian economy should have room for strong, above-potential rates of growth in output and employment in coming quarters, without a resurgence of inflation. But what about the current rapid rates of money growth? Are they not inflationary? The 15 per cent year-over-year growth of the M1 aggregate that I mentioned a moment ago is certainly high, and if it persisted for very long, it would not be consistent with preserving low inflation. But there are currently some special factors in the picture which suggest that a temporary period of rapid M1 growth would not be inflationary. These are the recent changes in the nature of business chequing accounts and the need for an adjustment in the stock of money held for transactions purposes, in response to the low levels of interest rates and the move of the economy towards full capacity. Moreover, the recent evolution of the broader monetary aggregates continues to point to low inflation. The important role of inflation-control targets I believe that the role of inflation-control targets in the Bank’s conduct of monetary policy provides additional credibility to this scenario of non-inflationary economic expansion. First of all, with the success we have had in meeting these targets and their growing credibility, inflation expectations appear to have diminished. That makes our job easier these days. In the past, when inflation was high, any signs of demand or price shocks would worsen inflation expectations and add to upward pressures on inflation. Inflation-control targets are also important in dealing with possible changes in the growth potential of the economy. Such changes can result, for example, from additions to the capital stock and increases in productivity. Potential output growth in Canada is expected to increase over the next few years, with the cyclical rebound in productivity and with improvements from ongoing restructuring and investments in technology. There is also a debate going on, particularly in the United States, as to whether there has been a structural change in the way an economy operates. Have more open and competitive international markets effectively increased the capacity of the economy to expand without generating inflation pressures? The Bank tries to take all these considerations into account when forming a view about the inflation outlook. But estimates of potential output are difficult to make, and they have a wide margin of error around them. A monetary policy focused on inflation-control targets ensures that the Bank will not inadvertently make systematic misjudgments over time about how fast the economy can grow. How does that work? An unforeseen improvement in potential will tend to put unexpected downward pressure on inflation. That will encourage the Bank to ease monetary conditions to support a faster expansion in output and employment and to prevent inflation from falling below the bottom of the target range. The reverse would be the case if potential was growing more slowly than we realized and inflation was tending to rise. Moreover, by responding to the trend of inflation relative to the target range, as I have described, monetary policy will also act as an important stabilizer for the economy over the medium term in the face of cyclical fluctuations. The targets effectively call for the Bank to tighten monetary conditions when demand in the economy approaches unsustainable levels, pressing against capacity. But they also call for easier monetary conditions when demand is weak, leaving slack in the economy. Monetary policy targets focused on inflation were initially developed to help reduce persistent high inflation in an orderly manner. But I believe that such targets continue to provide the best framework for the conduct of monetary policy, even at low rates of inflation. Concluding comments In recent years, Canada has made significant progress in restoring the credibility of its macroeconomic policies and making the adjustments necessary to lay the foundation for a more efficient, prosperous economy in the future. We are now beginning to see the payoffs from this economic transformation. The best contribution the Bank of Canada can make to sustaining these positive trends is to foster a monetary environment of confidence and stability. And that is what we intend to deliver with our commitment to targets for inflation control.
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| 1,997 | 4 |
Remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the FOREX '97 Conference held in Toronto on 30/5/97.
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Mr. Thiessen looks at flexible exchange rates in a world of low inflation Remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the FOREX ’97 Conference held in Toronto on 30/5/97. There is a good deal of discussion these days about Economic and Monetary Union (EMU) in Europe -- about the benefits and difficulties of organizing such a union. However, today I would like to examine a somewhat different issue, one that is at the other end of the spectrum; namely, How is the international system of flexible exchange rates working these days? This is not to denigrate or deny the importance of the challenges surrounding the EMU initiative, nor its relevance for those who will be directly or indirectly affected by its debut. But while many European countries have operated under a fixed exchange rate regime during the post-Bretton Woods period, most other industrial economies have chosen to operate under a flexible currency arrangement. The three major currencies, those of the United States, Japan, and Germany, float against one another. So I thought what I might do this morning is focus on flexible exchange rates and discuss, in particular, how they have performed over the past few years. The main message I would like to convey to you is that, when all is said and done, the flexible exchange rate system has not done badly over the past 25 years. And in the last three or four years, it has done rather well in an environment characterized by low inflation and improved fiscal performance across the major industrial countries. Exchange rates have, for the most part, moved in the “right direction.” And short-run exchange rate volatility has diminished, notwithstanding some evident cyclical swings of the U.S. dollar. Why are the major currencies floating? The initial reason for adopting floating exchange rates was more a matter of circumstance than a considered choice. The Bretton Woods system, which was established shortly after the Second World War, collapsed in the early 1970s, forcing most industrial countries onto a flexible exchange rate regime as an “interim measure.” Attempts to rescue the Bretton Woods system in the summer of 1971 and the fall of 1973 proved unsuccessful. The reputed reasons for the collapse of the system were the inflationary macropolicies pursued by the United States during the late 1960s and early 1970s and the unwillingness of other countries either to inflate their economies to the same extent or to allow the U.S. dollar to devalue. But the true reasons for its demise were more deep-seated. This system, which had been viable, although prone to periodic crises, throughout the 1950s and 1960s, was clearly unable to cope in a world of liberalized trade and international capital mobility. The Bretton Woods system, while laudable in concept, proved to be flawed in practice. The main problem was that the imbalances that the system was supposed to address, through discrete changes in the parity value of the affected currencies vis-à-vis the U.S. dollar and gold, proved to be much larger and more intractable than the architects of the system had ever envisaged. Moreover, countries were reluctant to adjust their currencies, even when the problems were shown to be fundamental. Thus, authorities would often subvert domestic economic objectives, such as price stability, economic growth and full employment, in order to protect outdated parities. As a result, the system was in disequilibrium more often than not. And its adjustable nature did not prove flexible enough to help countries deal with the shocks that regularly hit the international financial system. While the adoption of floating exchange rates may have been more a matter of necessity than choice, floating rates did promise greater independence in the conduct of monetary policy and better insulation from external shocks. Advocates of a floating regime, partly influenced by Canada’s favourable experience with such a system in the 1950s, suggested that exchange rates would automatically adjust to correct external imbalances in an orderly and continuous manner. And this would give domestic policymakers greater freedom than under the pegged rate system as well as obviate the need for official intervention and large international reserves. Experience with the floating rate system Needless to say, experience under the floating rate system has not been problem-free. Events did not unfold quite as its proponents had suggested, and the past 25 years have been characterized by volatile short-term movements and sizable long-term swings in most of the major currencies. The magnitude of these currency movements and our evident inability to explain them in a comprehensive, precise manner, led many observers to presume that such movements were driven by market speculation and that they were largely disconnected from economic fundamentals. There is no simple way to resolve this issue. Nonetheless, it is possible to identify some of the forces that have influenced exchange rates through this period, either by shaping their broad movements or, at times, by contributing to uncertainty and hence to excessive volatility in these rates. I would stress, in particular, the uncertainty over the future course of monetary and fiscal policies, which made it difficult for financial markets to cope with the macroeconomic pressures of the day. What forces am I talking about? In the 1970s, we had the two oil shocks, one at the beginning and one at the end of the decade. These may have been precipitated by political developments in the Middle East, but the initial shock was encouraged by the pursuit, among the major industrial countries, of higher output and employment through monetary ease and a willingness to tolerate increased inflation. Subsequently, the monetary accommodation of the price effects caused by the oil shocks added to the turbulent environment that followed. The 1970s and early 1980s turned out to be a period of high and variable inflation in many countries. High inflation, balance-of-payments difficulties arising from the oil shocks, and the large fiscal transfers necessary to support economic activity in energy-dependent countries, were the catalyst for much of what followed in the 1980s. Excessive government spending and rising public indebtedness were coupled with tighter monetary policy, as authorities struggled to maintain social services, restore full employment, and dampen the inflationary pressures that had been allowed to grow in the 1970s. The effects of this uncomfortable policy mix hit the major industrial countries with varying severity and triggered a debt crisis in the developing world. Success on the inflation front was mixed, adding to the strains that the exchange rate system was expected to cope with. While the problems in the industrial countries were generally less severe than those in the developing world, they nevertheless caused serious dislocations. Because of differences in the mix of fiscal and monetary policies in the United States compared with Germany and Japan, the U.S. dollar appreciated sharply against the deutschemark and the yen through the first part of the 1980s. In turn, these developments led to an accumulation of very large current account imbalances among these three major countries. In these circumstances, the flexible exchange rate system did not perform as well as it might have. But it is not obvious that any other alternative would have been practicable, and I doubt very much that a fixed exchange rate system for the U.S. dollar, the mark, and the yen could have survived these strains. The three major currencies were not the only ones subjected to tensions. Uncertainty about whether and how fiscal imbalances might be corrected, and considerable cross-country differences in actual and expected inflation contributed to major exchange rate pressures among other currencies in the 1980s and early 1990s. By 1992-93, these pressures had reached the breaking point in continental Europe and the United Kingdom, putting extreme stress on the Exchange Rate Mechanism (ERM). As well as causing the United Kingdom and Italy to leave the arrangement, the situation necessitated a widening of the ERM intervention bands. What is the current situation? Although it is still early days, conditions in exchange and asset markets have improved considerably since 1993. Short-term exchange rate volatility, and even the trend movements in bilateral rates, while still significant, are much smaller than those of the previous two decades. I believe that this improved perfomance has a lot to do with the convergence we have seen in recent years towards low and stable rates of inflation among the major industrial countries. But progress on the fiscal front has also been essential, helping to reduce risk premiums and stabilize expectations, both with regard to the long-run viability of the fiscal track in many countries and the prospects for continued low inflation. Thus, I would argue that consistently low inflation and improved fiscal positions have brought about more stable, “better behaved” exchange rates, just as theory would have predicted. This is not to say that exchange rates have remained absolutely stable over the past four years. They have not. But movements have been more orderly, unlike those of the earlier periods, and most of the observed trends can be explained by the different cyclical positions of countries, the different monetary and fiscal responses, and by changes in world commodity prices. Exchange rate movements have, at times, appeared to contribute to trade imbalances or exacerbate existing ones. But this should not be interpreted as evidence that markets are pushing rates in the wrong direction. Indeed, imbalances often reflect the fact that economies are at different points of the business cycle. For example, Japan has, until very recently, seen the value of its currency decline, on balance, against the U.S. dollar, even though the country is running a large and growing trade surplus. It is obvious that much of the recent movement in the U.S. dollar/yen exchange rate has been driven by the different cyclical positions of the two countries. Thus, the relatively low yen has been helping to rejuvenate demand in Japan. Meanwhile, a strong U.S. dollar has been helping the United States to counter inflationary pressures that would otherwise require stronger doses of interest-rate medicine. Of course, it is possible for exchange rates to overreact, even in the benign environment I described a moment ago. But the chances of a serious misalignment are much lower when markets are operating in a climate of greater predictability, provided by a monetary policy grounded in domestic price stability. When exchange rates are not anchored by a credible commitment to price stability, it is difficult, if not impossible, for markets to perform the tasks that are expected of them. The operation of the flexible exchange rate system in Canada As you know, Canada has been one of the strongest proponents of a flexible exchange rate system. We were the only major industrial country to operate under such a system in the 1950s and early 1960s, and we were the first major country to adopt it again in the 1970s. As a medium-sized open economy that relies on exports of primary commodities more than our principal trading partners, we are vulnerable to external shocks and appreciate the ”shock absorber” effect provided by a flexible exchange rate. Let me tell you briefly how the Canadian economy has performed under the flexible exchange rate system and describe the main forces that have been acting on our exchange rate. The most significant trend movement occurred over the 1976 to 1986 period, when the Canadian dollar experienced a large depreciation vis-à-vis the U.S. dollar, falling from roughly parity to a low of 69 cents (U.S.) in February 1986. During this time, annual inflation rates in Canada exceeded those in the United States by about one per cent, on average. While on a yearly basis this may not sound like much, cumulatively the differential was rather significant and can explain most of the trend depreciation in the Canada-U.S. exchange rate over this period. As for the cyclical swings that accompanied the trend depreciation of the Canadian dollar, they reflected a number of factors. Among these, the most significant has been the variability in the world prices of primary commodities, which remain an important component of our exports. But the most worrisome factor during the 1980s and 1990s was the growth of the fiscal deficit and the destabilizing effect that this had on financial markets, including the foreign exchange market. Rising public debts and deficits contributed importantly to the risk premiums in interest rates on Canadian dollar assets and were the catalyst, if not the cause, of unsettling episodes in 1986, 1992, and 1994. Fiscal policy concerns, at times coupled with political uncertainty, proved to be a volatile mix and led to serious financial market turbulence and speculative pressures, complicating the task of monetary policy. Fortunately, the situation has recently improved considerably. Inflation in Canada is stable, at its lowest level in decades. And it has been somewhat below that in the United States since 1992. This implies a potential appreciation of the Canadian dollar vis-à-vis the U.S. dollar over time, if the inflation differential persists. But other factors also tend to favour a stronger Canadian dollar. First, deficit reduction by Canadian governments has eased the uncertainty that had pervaded financial markets, thereby shrinking risk premiums in interest rates and reversing the currency weakness caused earlier by these premiums. Second, Canadian industries are in a stronger competitive position than they have been for years, and this has contributed to a sharp reduction of the persistent deficit in the current account of our international balance of payments. Third, primary commodity prices are firm and likely to move higher with the pickup in global economic activity. In light of all this, it is not surprising that several analysts, as well as the Bank of Canada, expect a stronger Canadian dollar in the future and think that the currency is currently undervalued relative to its longer-term fundamentals. Why, then, has the Canadian dollar not been stronger? The explanation lies mainly in the different cyclical positions of the Canadian and U.S. economies. The more accommodative monetary conditions pursued in Canada during the past two years have been consistent with the needs of an economy characterized by considerable excess capacity and an inflation rate that has tended to be in the lower half of the current 1 to 3 per cent target range. Thus, lower interest rates and a relatively low Canadian dollar have been temporarily appropriate for economic reasons. While no central bank ever wishes to have a weak currency, since late 1995, the Bank of Canada has encouraged easier monetary conditions -- conditions that, at times, have taken the form of lower interest rates and a somewhat softer dollar. Put another way, the Bank did not purposely push the dollar lower, but simply aimed for the path of monetary conditions that seemed appropriate given sluggish domestic economic conditions. The particular mix of interest rate and exchange rate adjustments necessary to achieve the desired path of monetary conditions is not under the direct control of the Bank of Canada. It is essentially determined by the markets. However, the Canadian economy has been gathering momentum lately, and prospects are good for continued robust expansion through 1997 and into 1998, in response to the substantial past monetary easing. With the margin of excess capacity in the economy still fairly wide, there is ample room for strong growth in coming quarters without a resurgence of inflation. However, as the slack is absorbed, the Bank will need to pursue less stimulative monetary conditions, consistent with a durable, low-inflation economic expansion. In other words, for cyclical as well as for more fundamental reasons, the prospects are good for a stronger Canadian currency. *************** In summary, I would say that the exchange market for the Canadian dollar has worked rather well in recent years, interpreting and responding to both the fundamental trends in our economy and the cyclical differences between Canada and the United States. I believe that fiscal discipline and a credible commitment to low inflation are key ingredients of that good performance.
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| 1,997 | 6 |
Remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to 'La Chambre de commerce et d'industrie du Québec métropolitain', Quebec City, Quebec on 19/6/97.
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Mr. Thiessen discusses the challenges and prospects for the Canadian economy Remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to “La Chambre de commerce et d’industrie du Québec métropolitain”, Quebec City, Quebec on 19/6/97. Once a year, the Bank of Canada’s Board of Directors meets outside Ottawa, alternating among the provinces. I am delighted that this year’s out-of-town meeting has brought us to the beautiful and historic city of Quebec. I would like to take this opportunity to talk to you about recent developments in our economy. But first, let me take a moment to bring you up-to-date on some of the Bank’s recent initiatives to strengthen its regional contacts. As part of this effort, we have just set up new representative offices in Calgary and in Halifax, and are expanding our existing offices in Montreal, Toronto, and Vancouver. What is behind all this? We have learned from experience that both the economy and monetary policy work better when Canadians are well informed about the major economic issues of the day and about the focus of monetary policy. That is why in the last few years we have been trying to increase public awareness and understanding of these matters, by regularly providing more information on the economy and explaining what monetary policy is up to and why. But to do our job well, we at the Bank must also be on top of what is happening in the economy, from one end of this country to the other. We also need to listen to the views and concerns of Canadians about the economy and monetary policy. The Bank has always kept in touch with the regions and has monitored all the available regional economic data. What we are now aiming to improve is our ability to interpret these data. For this, we need to increase our contacts with businesses, governments, associations, economic analysts, and the public -- in all parts of Canada. We expect that our new and expanded regional representative offices will help us do just that. While the central focus of the regional offices will be on the economy and monetary policy, we also expect our representatives to play a broader role in communicating with the public on all aspects of the Bank’s responsibilities. This would include, for example, our increased efforts to ensure that Canadians are aware of the anti-counterfeiting features in bank notes. Public awareness is an important deterrent to counterfeiting activities. Our representative offices will also oversee the new arrangements for the distribution of bank notes to financial institutions. They will ensure that these arrangements are carried out efficiently and that the currency system continues to provide good service to Canadians. The city of Quebec was the site for our second pilot of the new system for bank note distribution. Bank notes are now moving directly from financial institutions with surplus notes to those that need them. Notes are now returned to the Bank of Canada only to be destroyed when they are no longer fit for use. I hope that we can count on your help to make the new regional initiatives work. I would especially like to encourage you to contact our two senior representatives for the province of Quebec in Montreal -- Louis-Robert Lafleur, Economics Representative and Lorraine Laviolette, Operations Representative -- to obtain information, express your point of view, or get in touch with the Bank in Ottawa. As I said earlier, it is important for Canadians to be well informed about the economy and about monetary policy. Thus, I welcome the attention that economic issues have been receiving in the last few years. There are three questions related to monetary policy that are raised frequently and that I would like to discuss with you today. First, why is the Bank still preoccupied with controlling inflation when it is so low and does not seem to be a threat any longer? With this continued focus on inflation, isn’t there a risk that monetary policy will fail to provide the support necessary for incomes and employment to grow? Second, if low inflation is good for the economy, why have we not seen more of its dividends in our economic performance? Third, the Bank has taken a rather optimistic view of Canada’s economic prospects for this year and next. What is the basis for this, when we are still undergoing economic restructuring and have been experiencing its effects on consumer confidence? Is the commitment to inflation control still appropriate? Over the past five years, inflation in Canada has averaged less than 2 per cent a year. Why, then, is the Bank of Canada still so focussed on its target range for inflation control? Why not put more emphasis on economic growth and employment? My response to the first question is simply this: a commitment to low inflation is the best contribution monetary policy can make over time to a well-functioning economy -- an economy that delivers growth in output and employment. Why? Because such a commitment gives Canadians confidence that the value of their money will not be eroded by inflation. Low inflation generally means less uncertainty about the future, which allows people to make sounder economic decisions. And, as uncertainty about inflation diminishes, interest rates go down. In contrast, high inflation makes it difficult to interpret price changes and encourages speculative rather than productive investments -- all of which tends to increase economic inefficiency. We know from past experience that this leads only to painful boom-and-bust cycles and not to a stable economy. But what about the concern that this focus on inflation control may conflict with the achievement of full economic recovery and job creation? In fact, when the Bank takes action to keep inflation inside the target range, monetary policy operates as an important stabilizer for the economy, helping to maintain sustainable growth over time in output and employment. How does this work? When the economy is expanding at an unsustainable pace, pushing hard on the limits of production capacity and threatening to send the trend of inflation through the top of the target range, the Bank will tighten monetary conditions to cool things off. But the Bank will also respond when the economy is sluggish, and inflation is likely to fall below the bottom of the target range, by easing monetary conditions. This is what we did from late 1995 to late 1996. Now, I do not want to leave the impression that your central bank can somehow “fine-tune” the economy. We can’t, because it takes time for the effects of monetary actions to work their way through the economy. However, this approach to policy provides monetary support which, over time, will help output and employment to grow at their potential. So, by focussing on the inflation-control targets, the Bank is doing the right thing for the economy. As you can see, there are good reasons why we must remain committed to our inflation-control targets. Of course, the targets were introduced to help reduce a high inflation rate. But I believe that they continue to be the best basis for the conduct of monetary policy even now that inflation is low, and the aim is to keep it low. Why have the benefits of low inflation been slow to emerge? With all the good news on the inflation front over the past five years, why has Canada not fared better in terms of overall economic performance? I believe that this has a lot to do with the magnitude and complexity of the transformation that our economy has been going through in recent years, in response to two major challenges. First, there has been the global challenge, stemming from rapid technological advancements and increasingly open and competitive world markets. Second, there is the domestic challenge, arising from the need to unwind the economic imbalances and excesses of the 1970s and 1980s. I am referring here to rapidly rising production costs, speculative activity (particularly in the real estate sector), the large budgetary deficits of Canadian governments, and accumulating public indebtedness. To be sure, the restructuring process has been difficult and stressful. It has meant layoffs -- both in the private and, more recently, the public sectors -- causing a great deal of uncertainty. Moreover, in 1994 and early 1995, investor nervousness about our fiscal and political situations led to temporary sharp increases in domestic interest rates in the wake of turbulent global financial markets. All of this left Canadians anxious about the future and cautious about spending. In these circumstances, is it any wonder that the benefits of low inflation have been slow to materialize, and the recovery from the recession of the early 1990s has been more gradual than expected? There is no getting around the short-run costs to Canadians of these difficult, yet absolutely necessary, structural adjustments. But neither should we lose sight of the impressive, longer-term improvements that have been taking place in our economy. I have already mentioned our favourable inflation performance. The sharp decline in inflation from the high levels of the 1970s and 1980s has contributed to lower interest rates, more effective cost control by businesses, and a more stable economic environment overall. Canadian firms have been investing in new technology and streamlining their operations to become more efficient and productive. With this, and a more outward-looking focus, they have been able to take advantage of a competitive exchange rate to break into new world markets and expand their market share. Considerable progress has also been made in restructuring the public sector. Deficits have been reduced substantially, and governments have been moving towards less vulnerable debt positions. The ratio of government debt outstanding relative to the size of our economy is expected to fall this year, and should continue to do so in the years ahead. This is very good news, since a decline in this ratio is essential to fully restore our financial health. But that is not all. With our success in exporting and with the reduced budgetary deficits of Canadian governments, the persistent deficit in the current account of our international balance of payments has been sharply reduced. This means that, as a nation, we are no longer rapidly building up foreign debt. As is the case elsewhere in Canada, people in Quebec are all too familiar with the stresses and strains of adjusting to changing economic realities. A large number of Quebec businesses have undergone extensive restructuring in this decade, involving the acquisition of new high-tech equipment, the rationalization of activities, and the upgrading of labour skills. The public sector has also begun its own adjustment process recently. Such restructuring is by no means easy. But the changes that have taken place have made a number of Quebec’s industries (telecommunications, office equipment, aircraft, construction) highly competitive. And all of these changes should provide this province with the base for a better economic future. I believe that the emphasis of Canadian monetary policy on low inflation, which has contributed to greater economic stability and low interest rates, is supporting the adjustment process in the Quebec economy. Why is the Bank optimistic about Canada’s economic prospects? The difficulties associated with the economic transformation in Canada have no doubt acted as a drag on output and employment. But I believe we are now at the stage where the payoffs from these necessary adjustments have begun to outweigh the difficulties. One of the major benefits has been the marked decline in our interest rates since late 1995. Many interest rates in Canada are now at their lowest levels since the 1960s. And for maturities of up to 10 years, they are appreciably lower than comparable U.S. rates. This decline in interest rates represents a substantial stimulus to domestic spending. However, it takes considerable time -- one to two years -- for monetary policy actions to have an effect on the economy. So, it is only recently that we have seen unmistakable signs of the response to these lower interest rates. This explains some of the gloom during the past year regarding Canada’s economic prospects. Recent evidence, particularly from the interest-rate-sensitive sectors of the economy, is very encouraging. The economic results for the second half of 1996 and the first quarter of 1997 confirm that, much as expected, there have been significant increases in household spending on housing, motor vehicles, and consumer durables. And businesses continue to increase their capital spending. Moreover, after a slow start to the year, growth in private sector employment has resumed. Given the lags involved, the substantial past easing of interest rates should continue to support robust growth in domestic spending for some time. And with strong U.S. demand for our exports, the Bank feels that there is good reason to expect a solid economic expansion in the period ahead. What then are the implications for inflation? Because there is still a fairly wide margin of spare production capacity in the economy, there is room for strong growth in coming quarters, without too much concern about a flare-up in inflation. But as slack in the economy is taken up, we won’t need as much monetary stimulus as we have now to keep the economy on a sustainable, low-inflation growth path. Put another way, it is only by maintaining Canada’s low rate of inflation that monetary policy will help to consolidate a durable economic expansion. And this is the type of expansion that delivers improved economic conditions and benefits for Canadians. What is my message to you today? Canada has been through a difficult period of major economic changes, some of which are still unfolding. But we have also made remarkable progress in restoring the credibility of our economic policies and laying the foundation for a more efficient, prosperous economy in the future. We are now in better shape than we have been in years to face the economic challenges of the future.
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Notes for remarks by Mr. Gordon Thiessen, Governor of the Bank of Canada, to the New England-Canadian Business Council in Boston, USA, on 16/9/97.
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Mr. Thiessen looks at the recent economic record in Canada and the challenges ahead for monetary policy Notes for remarks by Mr. Gordon Thiessen, Governor of the Bank of Canada, to the New England-Canadian Business Council in Boston, USA, on 16/9/97. It has been a little over two years since my last public speech to an audience in the United States. During this time, a lot has happened in terms of economic developments in our two countries. One thing that continues to impress me is the remarkable performance of the U.S. economy, which has achieved six years of steady economic expansion, with high rates of job creation and low inflation. As a neighbour and major trading partner, Canada has certainly benefited from the strong U.S. economy. But I think that what is happening in the United States is relevant to Canada in other ways. First, it offers a yardstick that we Canadians often use to judge the performance of our own economy. Second, as the unused capacity in the Canadian economy is gradually absorbed, monetary policy in Canada will be facing challenges similar to those that the Federal Reserve has had to confront in trying to steer the U.S. economy on a path of durable, non-inflationary expansion. The recent U.S. experience in this area is, therefore, particularly interesting for us. Today, I would like to discuss the recent economic record in Canada and the challenges ahead for monetary policy. In doing so, I will emphasize the Bank of Canada’s continued commitment to explicit targets for keeping inflation low. Along with their other benefits, these targets help anchor market expectations about future movements in the exchange rate. The role of the exchange rate in the operation of Canadian monetary policy is another topic I will discuss today. The recent economic record in Canada Let us first take a quick look at how the Canadian economy has performed in the recent past, in comparative terms. In terms of economic growth and job creation, there is no doubt that Canada has not done as well as the United States in the 1990s. And even though, in my view, there are good explanations for this, the fact remains that Canada has some catching up to do in this regard. Why has the growth in output and employment been more modest in Canada than in the United States in recent years? I believe that the reasons lie in the major transformation that the Canadian economy has been going through since the beginning of this decade. This transformation has been in response both to the universal forces of globalization and technological change, and to the need to unwind the domestic excesses and imbalances that had built up in the 1970s and the 1980s. Let me remind you that, through that period, high actual and expected inflation had led to escalating production costs, speculative activity, and the accumulation of debt by households, by businesses, and by Canadian governments. Our foreign indebtedness was also rising rapidly, as were the risk premiums in our interest rates, leaving us in a very vulnerable position indeed. By the late 1980s, the situation had become untenable. Canada had to adjust. Of course, the United States also had to cope with many of these changes. Why has the restructuring been more intense and disruptive in Canada? In my view, the most important reasons are that the distortions arising from high inflation were more severe in Canada and that the adjustments to globalization and technological change were slow in coming. As a result, Canada had to do more and do it faster. The short-run disruptions associated with the economic restructuring have been significant. Plant closings, cutbacks in major government programs, and layoffs in both the private and public sectors caused a great deal of uncertainty among Canadian households. And it did not help that interest rates rose sharply in 1994 and early 1995 as investor nervousness about Canada’s fiscal and political situation increased in the wake of turbulence in global financial markets. All of this left Canadians anxious about the future and cautious about spending, which acted as a drag on output and employment. But there have also been some particularly encouraging results from the restructuring. Canada has made rather dramatic economic adjustments in recent years, and as a result has emerged with a much sounder economic foundation. Inflation has averaged just under 2 per cent during the past five and a half years -- well below that in the United States. With the benefit of low inflation and low interest rates, Canadian businesses have been investing in new technology and streamlining their operations to become more efficient, productive, and internationally competitive. Canadian governments have taken steps to reduce their deficits and to move towards less vulnerable debt positions. And, with our success in exporting and these improved fiscal positions, the persistent large shortfall in the current account of our international balance of payments has narrowed markedly. These improvements in Canada’s economic fundamentals have not been lost on financial markets. They are the reason why risk premiums demanded by investors on Canadian dollar assets have declined sharply over the past two years. They are also the reason why the markets today see a potential for upward movement in the Canadian dollar over time, thus allowing interest rates on maturities up to 30 years to remain below comparable U.S. rates. This is a view of the Canadian dollar that we at the Bank of Canada share. These low Canadian interest rates represent a substantial stimulus to domestic spending. Because of the lags involved, it has taken households and businesses some time to respond. But now we have strong evidence, particularly from the interest-rate-sensitive sectors of the economy, that the consumer is back. And businesses continue to increase their capital spending. Moreover, the latest surveys of consumer and business confidence point to continued expansion in domestic spending in coming months. What is particularly heartening is that total employment growth has picked up recently, despite the cutbacks in the public sector, and that the number of full-time jobs has increased significantly. Altogether, it seems to me that the Canadian economy has the potential for a long period of sustained growth in output and employment, with rising productivity and improving living standards. The challenge ahead What does monetary policy need to do to help realize this potential? With the economy gathering momentum, the challenge for monetary policy in the period ahead will be to encourage monetary conditions that preserve Canada’s good inflation performance, because low inflation is a prerequisite for a durable economic expansion. Experience has taught us that monetary stimulus which pushes too hard on the economy’s capacity limits for too long inevitably leads to rising inflation and painful boom and bust economic cycles of the kind we suffered in Canada from the 1970s to the early 1990s. Concern about inflation risks at this stage may seem misplaced. But monetary policy actions have their full effects on the economy with relatively long lags. So what we must be concerned with is not the current rate of inflation but rather what may happen in 1998 and beyond. To maintain a low and stable rate of inflation in the period ahead, we must conduct monetary policy in a forward-looking, pre-emptive manner. This means that we should be ready to take action early to ensure that, as slack is absorbed, the pace of economic activity converges smoothly with the path implied by potential output -- that is, the economy’s capacity to produce on a sustained basis. It is our view that the Canadian economy should indeed absorb the existing unused capacity over the course of the next couple of years. Thus, there will be a need to move to less-stimulative monetary conditions in the period ahead. Taking timely, measured steps in that direction is the recipe for avoiding the more substantial, and potentially more disruptive, tightening that would be required later if monetary policy actions were unduly delayed. As the Canadian economy approaches full capacity, we will have to contend with the considerable uncertainty that surrounds the estimation of potential output. The recent experience in the United States, where despite a high level of resource utilization there has been no sign yet of generalized inflationary pressures, raises the possibility that past relationships have been altered by structural changes at both the national and international levels. It is possible that technological innovations have increased the flexibility and efficiency of production processes. Heightened global competition and low inflation worldwide may have led to a reduction of inflation expectations and to a change in price- and wage-setting behaviour. Monetary policy must somehow find a way to take all of these factors into consideration in order to avoid systematic misjudgements on potential output and the risk of inflation. I believe that Canada’s inflation-control target provides a useful framework within which to do that. Let me explain. Our target, set jointly with the Government of Canada, calls for inflation to be held within a range of 1 to 3 per cent. One attraction of an explicit inflation-control target is that it allows a ready assessment of macroeconomic performance by looking at the trend of the inflation rate relative to the target range. If it looks as though the trend of inflation will push through the top of the target range, this implies that demand in the economy has been unsustainably strong. Conversely, if it appears that the trend of inflation is about to fall through the bottom of the range, this suggests weak demand and a persistent margin of unused capacity. Moreover, if we somehow continually misjudge the economy’s capacity to produce, we will in all likelihood witness an unexpected trend in the inflation rate. For example, if the rate is persistently lower than would have been expected in the past at the current levels of aggregate demand, and it is tending to press the bottom of the target range, chances are that the economy has more room to absorb higher levels of demand than previously thought. Thus, the targets provide a check on systematic errors in estimating potential output. However, if monetary policy is going to take account of such signals, the central bank had better make sure that its inflation-control strategy is a credible one. Why? Because only if it is widely accepted that the central bank will keep inflation under control, will businesses and individuals not respond immediately to signs of strong demand pressures by seeking to raise prices and wages. The recent U.S. experience attests to this. Indeed, strong credibility has been a key factor that has enabled the Fed to take account of the possible changes in economic structure that I mentioned earlier and to steer the U.S. economy successfully towards levels of aggregate demand and employment that in the past would have been thought incompatible with maintaining low inflation. It is by conducting monetary policy prudently during the economic upswing that we at the Bank of Canada will have the credibility needed when our economy begins to operate at levels that test its potential to produce. The role of the exchange rate I would now like to take a moment to underscore the important role that the exchange rate plays in the conduct of Canadian monetary policy and to explain what I meant earlier when I used the term “monetary conditions”. In a medium-sized, open economy, like Canada’s, a good deal of the impact of monetary policy actions is channelled through the exchange rate. But because financial markets do not always respond to events in completely predictable ways, we do not know exactly how interest rates and the exchange rate will move and interact. That is why we at the Bank have found it useful to construct an index of monetary conditions to help us keep track of the combined effect of these two variables on aggregate demand in Canada. To understand how we use monetary conditions in practice, let us look at the recent situation where cyclical differences have meant that the Canadian economy has been weaker than the U.S. economy. In these circumstances, the need for accommodative monetary conditions in Canada required the Bank of Canada to take action to lower interest rates. But the magnitude and timing of those interest rate reductions depended, to an important degree, on the exchange rate response. With the Canadian dollar roughly stable between late 1995 and late 1996, the easing in monetary conditions could take place through measured declines in interest rates. The strengthening Canadian dollar through the latter part of 1996 accelerated the decline in interest rates, as the Bank of Canada sought to maintain the degree of monetary ease achieved in the autumn of 1996. With the economy gathering momentum since then, persistent weakness in the Canadian dollar through June 1997 prompted a small increase in interest rates in order to offset an undesired further easing in monetary conditions. I might add that, since cyclical differences have required interest rates in Canada to be below those in the United States, there has been -- rightly -- a strong market perception that the relative weakness of the Canadian dollar is temporary and that a future appreciation will compensate investors for the lower yields on Canadian dollar assets. But experience has taught us that this process of exchange rate/interest rate interaction works well only if there are no concerns in the markets about Canadian economic policies. As we found out in 1994-95, when there were concerns about fiscal policy, a decline in the value of the Canadian dollar can generate a loss of confidence and expectations of further depreciation of the currency, not of subsequent appreciation. The upshot of all this is that, with a floating currency, market participants need a consistent and credible policy framework to help anchor their expectations about future movements in the exchange rate. Such a framework rests, above all, on a firm undertaking by the authorities to preserve the domestic purchasing value of the currency. I believe that our inflation-control targets, by giving a clear, precise view of this commitment, provide a strong underpinning for the external value of the Canadian dollar. What is my main message to you today? Canada is in better shape now than it has been for many years to face the economic challenges of the future and to reap the benefits of changing technology and an increasingly integrated world economy. But, for this scenario to unfold, there will have to be continued commitment by the authorities to prudent, credible economic policies. As far as monetary policy goes, this means a pledge to maintain Canada’s good inflation performance. That is a pledge I can give without reservation.
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Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Vancouver Board of Trade in Vancouver, British Columbia, on 7/10/97.
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Mr. Thiessen discusses some important issues and challenges facing monetary policy in Canada in the period ahead Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Vancouver Board of Trade in Vancouver, British Columbia, on 7/10/97. The challenges ahead for monetary policy Today, I would like to talk about some of the important issues and challenges facing monetary policy in the period ahead and how the Bank of Canada proposes to deal with them. This is not an unusual topic for me since the business of central banking is seldom without challenges. But what a difference the past two years have made to the challenges we face! Let me remind you that it was in late 1995, when investors’ concerns about Canada’s fiscal and political problems finally began to recede, that the Bank of Canada was able to take action to provide substantial monetary support to the economy. This action, which continued over the next year or so, was designed to offset both the direct impact on the economy of fiscal restraint and the effects on consumer confidence of the difficulties and uncertainties arising from the major restructurings that were necessary in both the private and public sectors. In response to the monetary stimulus, the economy has gathered momentum and finally seems to have pulled free from the difficulties associated with the restructuring. Indeed, economic activity has accelerated this year and has expanded by about 4 per cent over the course of the past 12 months. With the economic momentum expected to continue at a solid pace in the period ahead, monetary policy now faces new challenges. Over the next year or two, as the remaining slack is absorbed and we move towards full use of the economy’s capacity to produce, the issue for monetary policy will be to try to ensure that this process goes smoothly and that inflationary pressures do not re-emerge. Further down the road, we will also have to concern ourselves with the conduct of monetary policy as the economy operates under conditions of full capacity. With all the structural changes that have taken place in Canada and around the world in recent years, one important issue will be to gauge just how rapidly our economy can grow on a sustainable basis -- that is, without generating inflation pressures -- and what this implies for the employment picture in Canada. The challenge for monetary policy at that stage will be how best to deal with the uncertainty surrounding estimates of the economy’s potential to produce. The conduct of monetary policy through the economic upswing and then under conditions of full capacity are the two topics I would like to discuss with you today. Returning to full capacity Let me start with the immediate challenge for monetary policy -- to promote monetary conditions that will preserve Canada’s good inflation performance through the current economic upswing, thereby helping to make this economic expansion a long-lasting one. As I mentioned, monetary conditions in Canada have been very stimulative for over a year. With growing evidence that economic activity was expanding smartly, the Bank of Canada began reminding Canadians that, as slack in the economy is taken up, there would be a need to move to less-stimulative monetary conditions. We took a step in that direction last week when we raised our Bank Rate by ¼ of a percentage point to 3¾ per cent. This kind of action can set off alarm bells in the minds of some people. They may wonder why the Bank of Canada is “slamming on the brakes” when the economy has only just begun to pick up and the unemployment rate is still high. I would like to respond to any such concerns by explaining what Canadians can expect from their central bank in the period ahead and why. But before I do so, I would like to remind you that, when we at the Bank talk about how stimulative monetary conditions have been, we are not just looking at short-term interest rates (which are still near their lowest levels in decades and well below comparable U.S. rates). Monetary conditions also take into account the effects on the economy of changes in the exchange rate for the Canadian dollar. For example, the relatively low value of our dollar has been a major source of stimulus for Canada’s export sector. So a proper assessment of the degree of monetary ease in the economy has to consider both our low interest rates and the relatively low Canadian dollar. Now, what about the perception that any move by the Bank of Canada to less-stimulative monetary conditions means “slamming on the brakes” for our economy? Let me stay with the automobile analogy for a moment. To get the economy moving, the Bank has been pressing hard on the monetary accelerator. But once the economy picks up speed, just as with a car, you need to ease off gradually on the accelerator and steady your cruising speed at a safe level. If you press hard on the accelerator for too long, you will reach speeds that are unsafe. You risk losing control and getting into serious trouble. The same holds true for the economy. Too much monetary stimulus can lead to an exhilarating temporary burst of economic activity. But it will almost certainly also lead to inflation-related distortions that undermine both the expansion and the economy’s efficiency over the longer term. The end result, as we know only too well from past experience, is high interest rates, punishing debt loads, recession, and higher unemployment. A further complication is that it takes between a year to a year and a half for the economy to fully respond to changes in the degree of monetary stimulus. In this sense, the economy is like a car that doesn’t respond immediately when you ease off on the accelerator but only a mile or so further down the road. With such a car, you want to be able to look a long way ahead to see what is coming, and you want to take action early to ensure that your speed is appropriate. This is why monetary policy must focus on the future, rather than the present, and why the Bank must act in a forward-looking, pre-emptive manner. In other words, if we want our economy to reach full capacity relatively smoothly, without the risk of repeating the painful, inflation-related boom and bust cycles of the past, we must be ready to take timely action. If we wait to act until the economy is going flat out and pressing hard on the limits of its capacity to produce, we will have waited too long. Thus, some combination of a further rise in short-term interest rates and an increase in the value of the Canadian dollar will likely be necessary in coming months. I hasten to add that such a rise in short-term rates is the best way to preserve medium- and long-term rates at low levels. And it is these longer-term rates that are so important for the investments in new technology and other initiatives to increase productivity that Canadian businesses need to stay competitive. Let me reassure you that we are not talking about anything like the short-term interest rate increases that we saw in the 1970s and 1980s, or even in 1995. In an environment of low inflation and improved fiscal health, interest rates should not have to get that high again. You will not be surprised that I cannot give you in advance precise information about any further action the Bank may take to reduce the amount of monetary stimulus in the economy. What I can tell you is that it is the strength of the momentum of demand, and thus how quickly the economy approaches the limits of its capacity to meet that demand, that will determine the timing and extent of our response. Close monitoring of the strength of demand in the economy, and timely, measured steps in the right direction, will help us avoid the more substantial, and potentially more disruptive, tightening that would be required later on if monetary policy actions were unduly delayed. Moreover, the magnitude of the increase in short-term interest rates will be influenced by the extent of the exchange rate response. I hope this makes it clear that what the Bank of Canada has in mind, and is aiming for, is a “gradual easing off on the accelerator” in the months ahead, so that there will be no need to “slam on the brakes” later on. Making the most of the economy’s production potential Next, let me say a few words about the challenges that await us further down the road. One of the more remarkable international economic developments of the past few years has been the performance of the U.S. economy. That economy has had six years of solid economic expansion, with high rates of job creation and low inflation. In the late 1980s, when the U.S. unemployment rate dipped below 6 per cent, there were strong inflationary pressures. Compare this with the present situation: the U.S. economy has been expanding at an average rate of about 3½ per cent for 8 quarters, current levels of demand are above most estimates of its capacity to produce, and the unemployment rate has been at or below 5 per cent for several months. Yet inflation has remained well behaved. What is happening? Are we operating in a different environment? There are, of course, some temporary factors -- such as the appreciation of the U.S. dollar, the decline in energy prices, and the slack in overseas economies -- that are currently helping to suppress inflationary pressures in the United States. However, a number of observers are suggesting that other, more permanent factors may also be contributing. One possibility, which has been rather widely discussed recently, is that all the structural changes that have taken place in the United States have raised the production capacity of the economy and reduced the risk of inflation. I believe that another important factor in this success story has been the strong credibility of monetary policy in the United States. By persuading Americans that it is determined to maintain low inflation, the U.S. Federal Reserve has given itself room to test the potential of the economy without triggering the quick response in wages and prices from worried workers and businesses that we saw during the years of high inflation. How does this U.S. experience relate to Canada? Can we also look forward to an improvement in the longer-term performance of our economy? Unfortunately, it is not possible to make that judgement in advance, given the complexity of the factors affecting economic performance. How rapid growth can be and still be sustainable, and how low our unemployment rate will go, will ultimately depend on the flexibility, efficiency, and productivity of Canadian enterprises. I am referring here to the effective use of new technology; the skills, training, and adaptability of our labour force; our ability to control costs; and the initiative and ability of Canadian businesses to find and develop new and expanded foreign markets for their products. The contribution that monetary policy can make towards realizing this potential is to ensure that the pace of economic expansion remains sustainable. This essentially means encouraging monetary conditions that will allow the economy to test the limits of its capacity to expand, but without setting off inflation and the costly boom and bust cycles of the past two decades. As in the United States, the problem in Canada is that there is considerable uncertainty regarding the level of economic activity that can be accommodated by our capacity to produce and how rapidly this capacity will expand over time. This is where the Bank of Canada’s inflation-control target should prove useful as we try to steer the economy along a sustainable growth path. That target is to hold inflation inside a range of 1 to 3 per cent. One of the advantages of such an explicit target is that it provides a ready measure of the state of the economy by comparing the actual trend of inflation against the target range. If the trend of inflation looks as though it will be pushing through the top of the target range, this implies that demand in the economy has been unsustainably strong, and monetary conditions must be tightened. But if inflation is persistently lower than past history and the existing levels of demand would suggest, and it is tending to press the bottom of the range, chances are that there is more room for the economy to expand than previously thought, and monetary conditions can be easier. However, if the Bank of Canada is going to respond to such signals, we must ensure that our inflation-control strategy is a credible one. It is by conducting monetary policy in a prudent manner during the economic upswing that the Bank can provide Canadians with assurance that inflation will remain under control when the economy begins to operate at levels that push against the limits of capacity. If businesses, individuals, and investors are persuaded that inflation will stay low, they will not respond immediately to signs of strong demand pressures by seeking to raise prices and wages and by pushing up interest rates. Such an environment provides the flexibility necessary for the economy to test the limits of growth and employment without immediately putting the economic expansion at risk. Concluding remarks In conclusion, let me just say that the period ahead will be an exciting one. At no time since the 1960s have we had in place the conditions that would permit the Canadian economy to fully realize its potential. With inflation under control and increasingly favourable fiscal positions, we now have an opportunity to see what our economy is capable of delivering, in terms of sustained growth in output and employment and improving standards of living. The Bank of Canada’s role is to make sure that monetary policy provides the right background -- a stable, low-inflation environment.
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Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Canadian Club of Toronto in Toronto, on 1/12/97.
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Mr. Thiessen’s remarks to the Canadian Club of Toronto Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Canadian Club of Toronto in Toronto, on 1/12/97. What can monetary policy do to help the economy reach its full potential? Today, we meet against a backdrop of some uncertainty in the international economy. I would like to begin my remarks with an assessment of what the recent financial and economic events in Asia could mean for Canada. The nervousness and uncertainty that spread around the world in the wake of the problems in Southeast Asia highlight the growing interactions among national economies and financial markets. The events in Asia also underscore how crucial prudent macroeconomic policies and sound financial sector management are to good economic performance. The measures that have been taken, mainly through the International Monetary Fund, are important first steps for the affected Asian economies in dealing with their problems. I believe that these measures have helped to contain at least some of the potential spillover effects to other countries and, thus, they are helping to settle global financial markets. Canada’s direct trade links with Southeast Asia are not large. However, those with Japan and Korea are more important to us, and there are also potential effects on our other trading partners that need to be taken into account. The problems in Asia and their possible implications for the world economy are probably the source of some of the recent softening in world commodity prices. Because of the importance of commodities to Canada, this softening has been a factor behind the recent weakness in our currency. Our judgment at this stage is that the overall impact of these recent developments on Canada does not look likely to be large. However, we are sensitive to the fact that some industries and regions will be affected more than others. I can assure you that we will continue to monitor the situation very closely, in view of the uncertainty that remains about the likely outcome of events in Asia. Even with this uncertainty, however, recent suggestions that there is a risk of worldwide deflation strike me as being very pessimistic. Developments in Asia will slow somewhat the pace of global economic expansion. But as long as the world’s largest economy, the United States, is pressing against its capacity limits, with the possibility of upward pressure on its inflation rate, the risk of worldwide deflation looks rather remote. Certainly, from Canada’s perspective, the U.S. economy is by far the most important influence. I would now like to turn from these recent events and talk about the Bank of Canada’s longer-term strategy for monetary policy. In any discussion of strategy, the place to start is with the objective. In conducting monetary policy, the Bank of Canada’s ultimate objective is to help the Canadian economy achieve its full potential. And that means more jobs and rising standards of living. I am sure that all Canadians would agree that this is an appropriate objective. The Bank pursues this objective through a policy aimed at keeping inflation low and stable. Today, I would like to explain why such a policy is the best way to achieve Canada’s full economic potential and to extend the current expansion. In this connection, I will review the recent U.S. experience in this area -- an experience that I find both relevant and instructive. On the road to full economic potential The performance of the Canadian economy over the past 25 years has been rather disappointing. The economy has suffered from recurring bouts of boom and bust, and unemployment has been very high. The growth of productivity and, thus, the improvement in our standard of living have been very gradual. Canada is not unique in this respect. Most industrial countries have shared this experience to varying degrees. And that includes the United States. Since the early 1990s, however, the U.S. economy has performed remarkably well and substantially better than other industrial economies. That country has enjoyed a solid, six-and-a-half-year-long economic expansion. Over that period, employment growth has averaged 2 per cent per year. The unemployment rate has declined from a peak of 8 per cent to under 5 per cent. Household incomes have risen by 2½ per cent a year (after correction for inflation). U.S. businesses have become highly competitive, even in areas where prospects did not look all that good at the end of the 1980s. What’s more, inflation has been on a declining path, albeit with some help from temporary factors (such as an appreciating U.S. dollar, declines in energy prices, and the slack in overseas economies). Why has the U.S. economy done so well? Are there any lessons here for Canada? Lessons from the U.S. experience There are, undoubtedly, a number of factors behind this striking U.S. performance. But, to me, there are at least two that seem to have been particularly important: the early adjustment of that economy to changing technology and globalization; and the credible, low-inflation policy pursued by the U.S. central bank. The Americans started adjusting in earnest in the 1980s to the new realities of heightened global competition and rapidly changing technology. As a result, they are ahead of most other industrial countries on that score. And, with improving productivity and highly competitive enterprises in a wide range of sectors, the U.S. economy has been able to expand rapidly and to support rising employment on a sustained basis. But taking full advantage of that improved potential for economic growth has required a climate of confidence in monetary policy. Bringing inflation down in a credible manner has helped to create that climate. And because of this, the U.S. monetary authorities have been in a position to encourage the economy to test its full capacity to produce, to create jobs, and to support rising incomes. This would not have been possible in an environment of high inflation and high inflation expectations. In such an environment, businesses, workers, and investors respond swiftly to any signs of demand pressures by pushing up prices, wages, and interest rates. And this has the effect of undermining the sustainability of the economic expansion. What precisely did the U.S. Federal Reserve do? In the early 1990s, problems in the banking sector were restraining the economic recovery in that country by limiting access to financing and undermining confidence. To counter these “headwinds”, as Alan Greenspan called them, the Fed responded by providing a high degree of monetary stimulus. Then, in early 1994, when it became evident that the economy had started to pick up steam and move ahead on its own, the Fed began withdrawing the excess monetary stimulus. This timely, pre-emptive action to moderate monetary stimulus accomplished two things. First, it sent a strong reassuring signal to investors, businesses, and consumers that the Fed would not let inflation break out as the economy surged ahead. Indeed, after short-term rates went up in 1994-95, long-term rates declined, as investors became more confident that the economic expansion would remain non-inflationary and, thus, sustainable. Second, the pre-emptive action helped avoid the need for stronger, more disruptive, tightening later on. The less-accommodative monetary conditions that have prevailed since then certainly have not stopped the U.S. economic expansion dead in its tracks, as some had feared at the time. On the contrary, the expansion has continued at a healthy pace. And with widespread belief in the Fed’s commitment to low inflation, there has been some room to explore the possibility that capacity has improved. As a result, the Fed has been able to set monetary conditions that have encouraged output and employment to expand at rates that in the past could not have been sustained. And both unemployment and inflation have come down at the same time. To be sure, with tightening labour markets, there is some risk of an increase in inflation pressures in the United States. Thus, one cannot rule out the possibility that the Fed may have to raise interest rates somewhat further at some point. But any future increases in interest rates should not have to be large and may be conditioned by the implications of the recent international developments I mentioned earlier. What parallels can we find in all this for Canada? The recent Canadian experience The adjustment in Canada to the forces of technological change and globalization has run behind that in the United States. Because the restructuring was delayed, Canada had to respond in a more dramatic fashion. We had to do more and do it faster. More importantly, our fiscal situation was more precarious and required stronger medicine. As a result, we ended up with more pronounced short-run disruptions and more catching up to do in terms of output and employment. These difficult but necessary adjustments in the private and public sectors of our economy were Canada’s parallel to the U.S. headwinds. To compensate for the direct impact of these adjustments, as well as for their indirect effects on consumer confidence, the economy needed a substantial amount of monetary support. The Bank of Canada was able to provide such support once investor concerns about Canada’s fiscal and political problems began to subside in late 1995. We did that by systematically reducing interest rates over the next year or so. As in the United States in 1991-92, short-term rates in Canada were brought down during 1995-96 from over 6 per cent to about 3 per cent -- their lowest level in over 30 years. At the same time, the Canadian dollar has been relatively low, providing support to the export sector. When we put interest rates and the exchange rate together -- as we must in order to correctly gauge the amount of monetary stimulus -- it is clear that monetary conditions in Canada have been exceptionally stimulative for well over a year. This was entirely appropriate while our economy was still struggling against the headwinds of private and public sector restructuring. To return to my automobile analogy of recent speeches, we needed to put the “pedal to the metal” to buck those headwinds and get the economy going. The monetary stimulus has done its job. The economy has been gathering speed and absorbing unused capacity. We now expect it to have expanded by about 4 per cent from the end of 1996 to the end of 1997. The diminishing effects of fiscal restraint, along with evidence of continued strong demand, output, and money growth, suggest another year of healthy expansion in 1998. Thus, in terms of the economic cycle, we are about where the Americans were in 1994. What should the role of monetary policy be in the period ahead? As we move towards full capacity over the next year or so, the task for monetary policy will be to try to ensure that this process goes smoothly and that inflationary pressures do not re-emerge. I want to make it clear that the Bank does not see an overheated economy at this point, nor a threat of inflation lurking around the corner. There is still unused capacity and, thus, room for strong expansion for some time yet. But, with monetary policy actions taking between one to two years to have their full effects on the economy, we always have to look ahead. And we have to ask, What sort of monetary support will the economy need at that point? The measures -- especially the fiscal measures -- needed to restructure our economy will be largely in place by then. Thus, monetary policy will no longer need to compensate for these sources of restraint on demand. By gradually easing off on the monetary gas pedal, we can steady our economy at a safe cruising speed down the road. As we look still further down the road, we will face other important issues. How well will our economy perform once it reaches full capacity? How rapid can growth be and still be sustainable? And how far can we reduce our unemployment rate? Given the complexity of the factors affecting economic performance, it is not possible to make precise predictions on these matters. Much will depend on the flexibility, efficiency, and productivity of Canadian enterprises; on how effectively new technology is used; on the skills, training, and adaptability of our labour force; on our ability to control costs; and on the initiative and ability of Canadian businesses to develop new products and new and expanded foreign markets for those products. Still, I believe that the restructuring that has taken place in the Canadian economy provides good reason to think that our potential to grow and create jobs is the best we have had in years. I also believe that continued credible fiscal and monetary policies have an important role to play. The best contribution monetary policy can make towards achieving that potential is to ensure that the economic expansion remains sustainable over the medium term. As we have learned over the past 25 years, a sustained expansion is not possible unless we can avoid a resurgence of inflation and the painful cycles of boom and bust that go with it. Thus, the challenge for monetary policy will be to set monetary conditions at levels that allow the economy to expand at a pace that makes full use of its production capacity and at the same time preserves low inflation. It is by conducting monetary policy prudently during the upswing that the Bank can assure Canadians that inflation will not break out when the economy begins to operate at levels that push against capacity limits. If we succeed in providing that confidence, we will then have the flexibility that will allow us to carefully explore the limits of growth and employment without immediately putting the economic expansion at risk. Concluding remarks Let me summarize my main messages to you today. The extraordinary monetary stimulus of the recent past has accomplished its task. It has supported the economy through a period of difficult but necessary restructuring. As the impact of this restructuring subsides and our economy enters a phase of self-sustaining expansion, we will no longer need the same amount of monetary stimulus. Because the economy takes time to respond to monetary policy actions, the Bank has to focus on the future. This means taking steps early to ensure that we will reach full capacity at a sustainable cruising speed. Of course, projections of future economic trends need constant reassessment. And that is particularly true at a time of nervous financial markets and uncertainty about the implications that events in Asia may have for the world economy. As I said earlier, the Bank continues to monitor the current global situation carefully. Aside from any complications that could arise from a prolonged period of international instability, the Canadian economy in the next year or so should absorb the unused capacity that we now see. At that point, we will begin to see concrete evidence of the kind of payoffs we are going to get from the economic restructuring process we have been through. With low inflation and a sound fiscal position, the Canadian economy is now in a better position than it has been for years to weather the impact of unexpected international developments and to make progress in generating higher incomes and employment.
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Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, in Saint John, New Brunswick on 5/2/98.
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Mr. Thiessen discusses international developments and the prospects for the Canadian economy Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, in Saint John, New Brunswick on 5/2/98. A year ago, in early 1997, prospects for global economic growth were very promising. World economic activity had strengthened and was expected to accelerate further, with the benefit of low inflation, reduced fiscal imbalances, and stable or declining interest rates. In Canada too, output and employment growth had picked up. And the economy was expected to gain momentum in 1997, supported by strong US demand and the lowest domestic interest rates in many years. Low inflation and a dramatic improvement in our fiscal situation had made those low interest rates possible. Today, the views about the global economy are more mixed. The buildup of events in Asia since last summer has cast a cloud over the economic picture. The International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) have scaled back their projections for world economic growth this year. In early December, they suggested that global output growth could be ¾ to 1 percentage point slower in 1998 than previously expected. But the news on the external side is certainly not all negative. There have also been some positive surprises recently. For example, the underlying economic momentum in our major trading partners, other than Japan, looks to be stronger than expected a few months ago. And longer-term interest rates have been declining in most industrial countries, which should help underpin global economic expansion. Today, I would like to give you an update on the Canadian economy and discuss the prospects for the period ahead in light of the latest international developments. My conclusion and main message is that, even with the current uncertainties on the external horizon, Canada’s economic outlook remains positive. An important basis for this conclusion is that the underlying foundations of the Canadian economy are sounder than they have been for many years. Thus, we are in a better position to weather the impact of unexpected international developments and to make progress in generating higher incomes and employment. How did we do in 1997? Let us start with a quick look at our economic performance in 1997. Based on the most recent information available, the Bank of Canada estimates that the Canadian economy expanded at a rate of about 4 per cent from the fourth quarter of 1996 to the fourth quarter of 1997. Exports were the mainstay of the economic recovery until mid-1996; but since then the expansion has become more broadly based. Over the past year and a half, spending by Canadian households on consumer goods and by businesses on investments in technology and new equipment has been the driving force in the economy. The strong pickup in economic activity has also contributed to a substantial increase in employment. Over 380,000 new jobs were created in the private sector last year, offsetting many times over the 13,000 jobs lost in the public sector because of restructuring. Even more encouraging is the fact that a good part of this increase in employment represented full-time jobs. Moreover, the unemployment rate fell to 8.6 per cent by year-end from 9.8 per cent at the end of 1996. Inflation has remained low, and within our target range of 1 to 3 per cent for most of 1997, although it did end the year somewhat below target. Some of the factors that contributed to this recent greater-than-expected slowing in the trend of inflation are of a temporary nature and are expected to unwind in coming months. But some of the other dampening influences at work may be more persistent than seemed likely earlier. So, although we see the trend of inflation moving back inside the target range in the near future, on balance it will probably be somewhat lower in 1998 than previously expected. I would also like to underline the additional progress made during the year in the area of public finances, where government deficits have been further reduced. More importantly, the ratio of public debt relative to the size of our economy is finally falling. This is a major contribution towards the sounder economic foundations that I mentioned earlier. Altogether then, 1997 turned out to be a good year for the Canadian economy. Prospects for 1998 and the ’Asian factor’ But what about prospects for the current year? How important are the latest international events when viewed from a Canadian perspective? And what is their likely impact on our economy? There is no doubt that what started as financial turbulence related to difficulties in Thailand has become a more widespread problem than anyone would have thought likely some months back. An erosion of market confidence led to strong downward pressure on exchange rates and to sharply higher interest rates in the affected South-East Asian countries and, subsequently, in South Korea. These market difficulties in turn uncovered and exacerbated financial and economic weaknesses that had been plaguing these countries for some time. The international community, including Canada, has taken steps, primarily through the IMF, to help these countries deal with their problems. Some of the initial uncertainties involved in setting up and getting these IMF adjustment programs going have been resolved. And there are now some encouraging signs of improved confidence and financial stability in the region. Among the industrial countries, Japan is the one most affected by the spillover effects from its Asian trading partners. Not only are its trade links with them important, but this external shock comes at a time when the Japanese domestic economy is much less buoyant than was anticipated earlier. Substantial loan exposure by Japanese banks to the Asian region has also weakened an already ailing financial sector in that country. But it is important to note that Japan has the financial wherewithal to deal with its banking difficulties and that a series of measures to combat these problems and to strengthen the economic recovery have already been taken. Additional financial sector and fiscal measures were announced recently. At this stage, the situation in Asia is still evolving, and, while prospects have improved, we cannot be sure just how quickly and effectively the South-East Asian, Korean, and Japanese economies will respond to the adjustment measures that have been taken. What about the potential effects of all this on Canada? Since our trade with Asia, including Japan, makes up less than 10 per cent of our total exports, the direct effects will be relatively modest. But we must also take into account the indirect effects that work through our other major trading partners and through the prices of some of the products we sell abroad. Indeed, the implications of the Asian crisis for global economic growth and for primary commodity prices on world markets will probably have a more important impact on Canada than the reduction of our exports to Asia. The fallout from Asia will no doubt have a dampening effect on Canadian output growth for the current year. But there are also other, more positive, developments that could well work to mitigate this effect. As I said before, economic performance in our major trading partners in the West, particularly the United States, has been somewhat stronger than anticipated. And even though our short-term interest rates have risen, Canadian longer-term rates have been falling, along with their counterparts in the United States and Europe, reflecting declining inflation and lower inflation-risk premiums. These longer-term rates are an important element in both business investment decisions and household spending on consumer durables and housing. The Bank continues to monitor the situation carefully and to appraise the overall effect of these positive and negative influences on our economy. It is clear, however, that economic growth in 1998 will not be as robust as appeared likely last fall. And some Canadian regions and industries, particularly those with heavier reliance on primary commodities and exports to Asia, will no doubt feel the impact more than others. As well, there are the economic effects of the recent ice storm in Eastern Ontario, Quebec, and the Maritimes to consider. But I want to stress that, for the economy as a whole, the outlook is still favourable for continued expansion in output and employment, and for a further gradual reduction in the margin of unused capacity. Recent developments in international financial markets Next, I would like to say a few words about recent developments in world financial markets. The key feature of these developments has been the sharp appreciation of the US dollar. Measured against all major currencies, the value of the US dollar has risen by about 4 per cent since late September. Two main factors have combined to push the US dollar up. The first is the remarkable strength of the US economy relative to the economies of its major trading partners. Indeed, the US economy has been expanding more rapidly and operating at higher levels of capacity than were thought to be sustainable in the past. The second factor is the attraction that the large, efficient, and liquid US financial markets hold for nervous investors in search of a safe haven because of the events in Asia. The dampening effect of the Asian problems on expectations for primary commodity prices has also been a factor behind movements in the currencies of countries, like Canada, that are important producers and exporters of such products. With all this going on, the Canadian dollar has declined by just under 5 per cent against the US dollar since late September. Because other major currencies have also fallen against the US dollar during this period, the Canadian dollar has declined much less against these currencies. Nonetheless, given the importance of our trade with the United States, the effective value of the Canadian dollar, measured on a trade-weighted basis against all the major G-10 currencies, has declined significantly in recent months. This decline in the value of our currency led to a further substantial easing of monetary conditions. But, as I said before, even with the effects of the Asian crisis, the Canadian economy is on track to continue expanding and moving towards full use of its potential. In these circumstances, the extent of the recent further monetary easing was not appropriate. That is why we moved last week to re-balance monetary conditions, and to provide support for the Canadian dollar, by raising the Bank Rate by ½ of a percentage point to 5 per cent. It is probably too early to be drawing conclusions and lessons from this latest episode of world financial turbulence. Still, when it comes to Canada, it is worth noting the different reaction in domestic financial markets this time compared with our experience during the Mexican currency crisis of early 1995. Back then, the international financial turmoil had the effect of focusing market attention on Canada’s fiscal problems, causing investors to demand higher risk premiums. And this led to sharply higher longer-term rates in Canada. This time, as I mentioned, domestic longer-term rates have been falling, along with comparable rates in the United States and Europe, to their lowest levels in 30 years. What this tells me is that it pays to have one’s house in order. Now we can see more clearly the importance of the remarkable progress that has been made since 1995 in fiscal deficit reduction. A declining ratio of public debt relative to the size of our economy will help to further reduce our vulnerability to international shocks. From a monetary policy perspective, the best contribution your central bank can make to helping the economy cope with external shocks is to ensure that inflation remains under control. Nothing is as important to investors, especially during turbulent times, as the assurance that comes from the protection that low and stable inflation provides for the value of money. Concluding remarks In closing, let me reiterate that, in view of the uncertainties involved, it is difficult at this time to make precise assessments of the likely effects of the Asian crisis on the Canadian economy. But in making judgments about our economy, we must also consider the positive influences of the economic momentum in many of our major trading partners, as well as the prospects for domestic demand in Canada. The main factors at play in the outlook for domestic demand suggest that business and household spending should continue to grow. In particular, monetary conditions are very stimulative, providing considerable encouragement for expansion. All in all, the economic outlook remains positive. And with our low inflation rate and greatly improved fiscal position, the Canadian economy is now in better shape to withstand the impact of the Asian crisis and to continue to make headway in improving the well-being of Canadians.
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Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Canadian Club of Winnipeg, in Winnipeg on 25/3/98.
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Mr. Thiessen reports on the future performance of the Canadian economy Notes for remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the Canadian Club of Winnipeg, in Winnipeg on 25/3/98. It can take anywhere from one to two years for monetary actions to have their full effect on the economy. Because of this, the conduct of monetary policy must be based on a view of what the economy will be like -- not tomorrow, not in a month -- but rather in one to two years’ time. That is why in speeches in Vancouver and Toronto last year I spoke about where the Canadian economy might be heading in the future; what this might imply for our economic performance over the medium term; and what should the contribution of monetary policy be. Understandably, these important issues can get pushed aside because of the public focus on the current economic situation and on recent movements in short-term interest rates and in the external value of the Canadian dollar. Today, I would like to use this opportunity to revisit these medium-term issues. In doing so, I will be underlining the crucial role played by productivity improvements in our economic performance. The best place to start is with a brief review of the recent record. Recent economic performance As we approach the end of the decade, we can take satisfaction in the good economic performance of the past two years and in the notable improvements in our economic fundamentals. The Canadian economy has expanded at an average annual rate of 4 per cent since mid-1996 and, even with the dampening effects of the Asian crisis, it is expected to continue to grow at a healthy pace this year. This should contribute to further gains in employment and reduce the amount of unused capacity. Inflation is low, and we are committed to keeping it low. Last month, together with the federal government, we announced that we would extend our target of holding inflation inside a range of 1 to 3 per cent to the end of 2001. Moreover, government deficits have virtually disappeared, and the ratio of public debt relative to the size of our economy is finally on a downward path -- for the first time in about 25 years. Low inflation and improved fiscal health represent major contributions towards the sounder economic fundamentals I mentioned a moment ago. They are no doubt the main reason why our interest rates have been below US rates. The other key area where there have been important improvements in recent years is in the private business sector. Since the early 1990s, Canadian businesses have taken up the challenge of structural adjustment, which their US counterparts had started several years earlier, in response to the gathering momentum of technological change, globalization, and heightened competition. With the benefit of low inflation and low interest rates, Canadian businesses have been investing in new technology and streamlining their operations to enhance productivity. Their success in doing so will be crucial to our future economic performance. ˝ The importance of productivity growth Why this emphasis on improving productivity? Whether viewed from the perspective of an individual firm or of the economy as a whole, it is almost impossible to overemphasize the importance of rising productivity for overall performance and prosperity. Productivity growth is what allows firms to hand out real wage increases, while holding their production costs down and remaining profitable. From a broader perspective, productivity growth is a key element that determines economic welfare and the general well-being of a society. At any point in time, our perception of how well we are doing economically is probably influenced by where we happen to be in the cyclical fluctuations that affect any economy. But over the longer term, the trend in productivity growth for the economy as a whole is the basis for growing incomes and rising standards of living. Now, I know that for some people any discussion of the need to increase productivity can be rather unsettling. They tend to associate improvements in productivity in an individual company with downsizing and layoffs. And from there it is only a short step to the belief that strong economy-wide productivity gains can only mean a more difficult job market and higher unemployment. But the history of industrial economies shows that growth in productivity has actually gone hand in hand with improved overall employment conditions. This is borne out by the experience of countries like Japan in the 1980s and, more recently, the United States and the United Kingdom. That was also our experience in Canada during the 1950s and 1960s. Canada’s productivity record So how has Canada fared in the productivity department since the 1950s and 1960s? Not all that well, I’m afraid. After a relatively strong showing from the end of the Second World War to the early 1970s, our productivity performance became rather lacklustre. Productivity growth is estimated to have slowed from an average rate of about 2 per cent in the 1950s and 1960s to less than 1 per cent in the 1980s and 1990s, although it has picked up recently with the recovery in economic activity. I should note that economists do not fully understand why productivity growth in Canada (and, indeed, in other industrial countries) has slowed so sharply since the mid-1970s. I do not propose to try to untangle this puzzle today. Nonetheless, there are a few points I would like to make with respect to the Canadian situation. The sharp rise in the world price of oil in the 1970s no doubt dealt a major shock to Canadian industry. Because of our climate and because of the importance of primary commodity production in our economy, we are major users of energy. Adapting to higher energy costs certainly took considerable time. ˝ In my view, two other important factors inhibited productivity improvements through much of the 1970s, 1980s, and early 1990s: large fiscal deficits and high inflation. Government deficits through the 1980s and early 1990s tended to crowd out private sector investment by appropriating an ever-increasing share of Canadian savings. It was, of course, possible for businesses and governments to get foreign financing. But the accumulation of a large public sector debt and the rapid buildup of foreign indebtedness eventually resulted in appreciable premiums being built into our interest rates. High inflation through the 1970s and 1980s had a similar effect on interest rates. For these reasons, interest rates were high, even after adjusting for inflation. This discouraged some of the investment that would have contributed to gains in productivity. Moreover, because high inflation increases uncertainty about the future, businesses and individuals seek protection from its ravages or try to profit from it. Either way, scarce economic resources were diverted from productive investments towards hedging and speculative investments. I do not mean to suggest that the factors I have mentioned here explain all of our productivity problems. But they no doubt worked against the investment that was needed to help us adjust to both the oil price shocks of the 1970s and the global forces of the past two decades, and to make headway in terms of productivity growth. Let me now turn to the question of what we can expect in terms of productivity in the future. Future productivity trends and Canada’s economic potential Increases in productivity do not just happen. We need to work hard to achieve them. In a world of rapid technological change and intense international competition, there are opportunities and incentives for productivity gains -- provided we do what is necessary to take advantage of the possibilities. Productivity comes from the interaction of business investment in new capital equipment, a skilled labour force, and the adoption of new technology. It takes entrepreneurship and innovation to pull it all together. Typically, this interaction works best when businesses operate in a stable, low-inflation economic environment and when markets are competitive. Producers are then under pressure to perform in terms of price, quality, and service. With low inflation, a balanced fiscal position, and low interest rates, the economic policy environment is better now than it has been for over 25 years. This should provide the underpinnings for solid economic growth and increased savings and investment in the future. With this support from improving economic policy conditions, business investment has indeed been buoyant, particularly since mid-1996, and notably in high-technology equipment such as computers. As well, more and more businesses, led by high-tech enterprises, are reported to have introduced new production technologies. Progress has also been made in learning new skills, ˝ removing labour market rigidities, and improving the adaptability, flexibility, and efficiency of our labour force. But more undoubtedly needs to be done in this area. It is likely that these trends will continue in the future, and will spread to sectors that have been lagging behind. With ongoing technological change, deregulation, trade liberalization, and intensified global competition, the pressures and incentives are certainly there for further productivity gains. Thus, the trends are positive, and the direction of our economy is clear. What is not clear is just how much our economic performance will improve. We cannot attach precise estimates to future growth in productivity. Neither can we judge the end results of the major structural changes that have taken place in the private sector of the Canadian economy. Because of this, we need to take a somewhat agnostic view about the production potential of the Canadian economy and about the lowest unemployment rate that can be sustained over time. Monetary policy response -- making the most of the economy’s production potential What are the implications of all this for the conduct of monetary policy? When we at the Bank look one to two years into the future to set a course for monetary policy, we must take into account changes in the trends that affect the potential of the economy to produce over time. At the same time, we must recognize that our ability to predict that potential is restricted by the many uncertainties involved. In these circumstances, the best way for monetary policy to help the economy realize its potential is to focus on encouraging a sustained economic expansion over time. How do we do this? By keeping inflation low. As we move towards full capacity over the next year or so, it will be important to set monetary conditions at levels that forestall a resurgence of inflation and the painful boom and bust cycles that go with it. A responsible, credible monetary policy will allow us to explore the limits of the economy’s capacity to produce, to create jobs, and to support rising standards of living. The recent US experience amply demonstrates the advantages and benefits of such a policy. I believe that the recent extension of the inflation-control targets and the increasing credibility of those targets give monetary policy more scope to test the limits of our economic potential than at any time since the 1960s. Now that I have discussed the rationale behind the Bank of Canada’s medium-term strategy, let me explain our recent actions to raise the Bank Rate. As I said earlier, the underlying momentum of the Canadian economy remains positive. Despite the problems in Asia, Canada’s external environment is still favourable, given the strength in our major non-Asian trading partners, particularly the United States. In addition, the ˝ dampening effects on domestic demand from the fiscal consolidation efforts of the past four years are diminishing. And monetary conditions continue to support the economic expansion. Given these circumstances, the persistent decline in the external value of the Canadian dollar through December and January implied a further easing in monetary conditions that looked to us to be excessive. Moreover, the speed of the decline in the currency risked undermining investor confidence in Canadian dollar assets. That is why we took action. Concluding thoughts Let me conclude by summarizing my main points today. For much of the period since the 1960s, we have not had conditions in place that would allow the Canadian economy to fully realize its potential. With low inflation and a sound fiscal position, we now have the foundation that should permit us to move towards full capacity and to explore what our economy can deliver in terms of sustained growth in output and employment and better standards of living. Canada’s private sector has been responding to the universal challenges of rapid technological change, globalization, and heightened competition by undertaking major restructuring initiatives to become more efficient, productive, and competitive. Although we do not know for sure just how much more productive we are going to be as a result of these initiatives, there is good reason for optimism. The best contribution the Bank of Canada can make to this process is by continuing to provide a stable, low-inflation environment. With an eye to the medium term, this will require setting a course for monetary policy that will ensure that the Canadian economy reaches full capacity smoothly and then continues to grow over time at a non-inflationary and therefore sustainable pace. The longer economic growth is sustained, the more benefits we will see in terms of improved incomes and employment. ˝
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Notes for remarks by Governor of the Bank of Canada, Mr. Gordon Thiessen, before La Conférence de Montréal, in Montréal, on 27/5/98.
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Mr. Thiessen reports on globalized financial markets and monetary policy Notes for remarks by Governor of the Bank of Canada, Mr. Gordon Thiessen, before La Conférence de Montréal, in Montréal, on 27/5/98. Globalization - that is, the growing integration and interdependence of national economies - is changing dramatically the economic landscape. Countries are trading more goods and services, an increasing number of firms now operate across national borders, and savers and borrowers have greater access than ever before to global financial markets. Over the past decade, world trade has grown twice as fast as world output, foreign direct investment three times as fast, and both currency trading and share trading about ten times as fast. Not everyone agrees that all this is good for individual national economies or for the world community at large. Among those who take a dimmer view of globalization, one concern is that the increased influence of international financial markets is eroding the ability of national governments to set their own macroeconomic policies. They also worry that powerful financial markets may be the main cause of crises such as those in Mexico in 1994-95 and in Southeast Asia in 1997. You will probably not be surprised to hear that I do not share these negative views. And today, I would like to discuss one particular aspect of globalization - how national monetary policies work in an environment of globalized financial markets. I will draw heavily on Canada’s own experience to support the view that monetary policy can continue to function effectively in this increasingly integrated world. Canada has a long history of being open to global markets for goods, services and capital. This interaction with the rest of the world has proven very successful, in my view, and has benefited Canadians and our foreign partners enormously through the years. With open international markets, Canadians have been able to sell their products and services abroad and to enjoy a wide variety of imported goods, some of which could not readily be produced at home. And we have been able to set up businesses and pursue investment opportunities abroad. Even more importantly, we have been able to use foreign savings to finance the large investment projects that were necessary to develop our industrial infrastructure and to increase our production potential, especially in the resource and manufacturing sectors. We have also had access to technological innovations and processes developed elsewhere. This has allowed us to combine new capital equipment and a skilled labour force more efficiently, thereby improving productivity and, thus, our incomes and standards of living. Nonetheless, there are concerns in Canada, as well as elsewhere, about the rapid increase in international financial flows and the implications thereof. How does the free movement of capital affect the conduct of national monetary policies? Capital mobility and the implications for monetary policy The growing integration of national financial markets, as evidenced by the dramatic growth in the volume of cross-border capital flows since the early 1970s, has no doubt changed the environment in which national economic policies are conducted. Globalization tends to bring such policies under closer market scrutiny and to uncover and draw attention to any deep-seated economic problems that may exist. But I would not conclude from this that we have become captives of the markets and that we have lost control of our national monetary policies, as some argue. First, let us be clear as to what “having control” over one’s own monetary policy actually means. When people talk about an independent or autonomous monetary policy, they often take it to mean the ability of a central bank to set domestic interest rates without being influenced by developments outside national borders. This is not realistic - unless of course a country is completely cut off from the rest of the world! The moment a country wants to make use of foreign savings, or invest a portion of its domestic savings abroad, a link between domestic and foreign interest rates is inevitable. As a major user of foreign capital, Canada has long lived with interest rates that are closely related to those in the United States and other foreign financial markets. But even with integrated financial markets, there is still room for monetary policy independence via exchange rate movements. Thus, monetary policy autonomy requires a flexible exchange rate regime. With a fixed exchange rate, the national authorities essentially adopt the monetary policy of another country - the country whose currency serves as the anchor. If interest rates go up in the anchor-currency country, interest rates will also have to rise sufficiently in the country with fixed exchange rates to ensure that the peg is maintained. Thus, if monetary policy is focused on a fixed exchange rate, the central bank cannot at the same time pursue a domestic objective. In the case of the European Union, where member countries have decided to adopt a single currency - the euro - they have essentially opted to give up the potential for an independent national monetary policy and to transfer the policymaking power to a supranational agency - the European Central Bank (ECB). Of course, the ability of the ECB to follow an independent European monetary policy will require that the euro float against other major outside currencies, such as the US dollar and the Japanese yen. Thus, in a world of open and integrated financial markets, the exchange rate is a major channel through which monetary policy actions are transmitted to the economy. Moreover, it is movements in the exchange rate that permit domestic interest rates to diverge from their foreign counterparts for a period of time. For example, an increase in official interest rates by the central bank, in response to demand and inflation pressures in the economy, leads to a stronger currency, which also works to restrain those pressures. At the same time, the appreciation of the currency creates the conditions for other domestic rates to follow the rise in official rates, to levels that may now be above those prevailing abroad. This is because the exchange rate is now seen to be above its expected value and is thus likely to decline in the future. Under these circumstances, financial markets will bid up domestic interest rates to compensate for the anticipated decline in the external value of the currency. Having clarified the issue of monetary policy independence, I would now like to discuss the effects of increased capital mobility on the conduct of monetary policy. A higher degree of capital mobility enhances still further the role of the exchange rate in the monetary transmission process. This is not a bad thing. It just means we have to ensure that we always take the exchange rate into account when considering the monetary policy stance that is appropriate for our domestic economic circumstances. That is why in Canada we have developed the concept of “monetary conditions” to keep track of the combined effect on the economy of movements in both interest rates and the exchange rate. With a flexible exchange rate system, the increased role of the exchange rate in the monetary transmission mechanism also means that it is crucial that investors’ expectations of future currency movements are firmly anchored by clear and credible domestic macroeconomic policies. Thus, the central bank must have a strong commitment to preserving the internal value of the currency by keeping inflation low. That is why in Canada we have adopted explicit targets for inflation-control. But this is not enough. The fiscal situation must also be seen to be under control. Otherwise, as fiscal deficits and debts keep accumulating, investors will come to fear that inflationary policies will be used in the future to reduce the burden of debt. Canada’s experience during the Mexican currency crisis of 1994-95, and more recently through the Asian problems, is very instructive in this regard. The Mexican crisis focused the spotlight on our fiscal problems at the time, consequently driving risk premiums in our interest rates sharply higher. During the recent Asian crisis, however, with our public finances in better shape, and with clear, strong policy commitments by both the fiscal and monetary authorities, financial markets have been more stable and our longer-term interest rates have been falling. Of course, pressures on the exchange rate can also be triggered by so-called “real shocks”. In Canada, such shocks are frequently associated with swings in world prices of primary commodities. In cases like these, a flexible exchange rate can act as a “shock absorber”, allowing some of the necessary adjustments to the shock to take place through movements in the value of the currency. Canada’s long-standing preference for flexible exchange rates has been driven largely by the benefits such rates offer in facilitating adjustments to external shocks. This is an important consideration for us, given our strong reliance on international trade and foreign savings. As a major exporter of primary commodities, Canada has often been hit by sharp swings in the world prices of these products which, in turn, have caused large capital movements. Indeed, the decisions to float our exchange rate in 1950 and again in 1970 (after a short period of fixed exchange rates), were related to strong inflows of foreign capital associated with a surge in commodity prices. In both cases, we chose to allow the Canadian dollar to float up, rather than try to maintain a fixed exchange rate and risk a destabilizing inflationary monetary expansion. Overall, I am persuaded that a flexible exchange rate regime is the best way for a country to take advantage of today’s integrated capital markets and to deal with the external shocks that arise from time to time. Exchange rate fluctuations: Is taxing currency transactions the solution? Some critics have argued that integrated international financial markets have given rise to large, short-term speculative flows of capital that can cause unwarranted exchange rate pressures. Such speculative transactions, they say, disrupt domestic macroeconomic policies, result in temporary misallocations of resources, discourage trade, and encourage further unproductive financial transactions as businesses and individuals seek to protect themselves. Based on these arguments, some people have resurrected the idea of discouraging currency transactions using a tax similar to the one proposed by Professor James Tobin in the 1970s. The case for taxing global financial transactions rests on the notion that such a tax will discourage short-term flows, which are viewed as destabilizing, without affecting longer-term flows that are presumed to be desirable and based on fundamentals. But short-term flows are by no means all undesirable and destabilizing. And there is no way of discriminating between useful flows and destabilizing speculative ones. For example, because foreign trade and investment inflows and outflows are not always fully offsetting, short-term capital flows are typically needed to balance out a country’s external accounts. These capital flows occur in response to actual and anticipated movements in the exchange rate, and thus serve to smooth out exchange rate fluctuations. Because such flows are often driven by small differences in perceived rates of return at home and abroad, they could well be discouraged by a transactions tax. On the other hand, speculative flows that actually “bet” on a sharp movement in a currency, have rather large expected returns and are unlikely to be discouraged by the tax. In the end, a transactions tax would likely increase, rather than decrease, exchange rate volatility, as well as reduce market liquidity and raise the cost of capital. Needless to say, where financial market fluctuations reflect changes in domestic macroeconomic policies that put investors at greater risk than before, the tax would be aimed at treating the symptoms rather than the cause of the problem. In all, I find the case for a tax on currency transactions completely unconvincing. Promoting greater financial market stability If a tax is not a good idea, how else can we promote greater stability in international financial markets and reduce potential disruptions to domestic policymaking? I have already talked about the value of a flexible exchange rate system in facilitating adjustment to “real” shocks and allowing national authorities to pursue an independent monetary policy. Flexible exchange rates can also be helpful in moderating the size of, and aiding in the adjustment to, capital flows. In addition, governments are increasingly coming to the realization that the issue of international financial stability is best addressed not by retreating into isolation or by falling back on distorting, costly restrictions, but rather through sound and transparent domestic economic policies. International co-operation can also help. It can help by encouraging countries to pursue national policies that lead to economic stability, thereby reducing the risk of sudden changes in market sentiment and sharp exchange rate fluctuations. And it can help by setting widely accepted standards for transparency and disclosure. Such standards should support more informed market judgments about the riskiness of investments, especially in emerging market economies, and thus help avoid the crises that can be triggered by the sudden uncovering of problems. Following the G-7 Halifax Summit in 1995, a series of international initiatives to improve the functioning of financial markets have been undertaken, mainly under the auspices of the International Monetary Fund and the Bank for International Settlements. These initiatives seek to enhance the transparency and disclosure of economic and financial data, strengthen the surveillance of national and global financial systems, develop mechanisms for support in times of crisis, and provide training in financial sector supervision. Recognizing the importance of these efforts, Canada has recently proposed the creation of a new international process to provide “peer review” of national financial regulatory and supervisory systems. Efficient and prudently managed national financial systems can reduce the risks, and maximize the benefits, of international capital flows. In this regard, national supervisory authorities need to ensure that financial institutions have appropriate risk-management systems in place to help minimize risks, particularly with respect to mismatching of maturities and currencies. This would make it easier to cope in the event that short-term inflows switched to outflows. One of the main problems in Asia was that domestic financial institutions were borrowing short-term, in foreign currency, to invest in illiquid domestic assets. Concluding thoughts To summarize, globalization has been broadly beneficial to the world economy. International financial markets have facilitated access by borrowers to a larger pool of global savings and have enhanced investment opportunities for savers worldwide. Yes, international capital flows have at times disrupted national financial markets. But such episodes more often than not were caused by unsustainable domestic policies and pointed to the need for adjustment. In view of the overall benefits of greater access to global capital markets, it would not serve us well to restrict the free flow of funds. The best way to maximize the benefits of financial globalization and reduce the risks of disruptions to national macroeconomic policies is to ensure that these policies are sound and sustainable. In addition, financial systems need to be prudently managed and supervised - both nationally and internationally. Here in Canada, we are following this advice in our domestic macroeconomic policies. And we are also strongly supporting and contributing to global initiatives designed to promote financial market stability worldwide.
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bank of canada
| 1,998 | 6 |
Remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the St. John's Board of Trade in St. John's, Newfoundland on 23/9/98.
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Mr. Thiessen discusses global uncertainties and the Canadian economy Remarks by the Governor of the Bank of Canada, Mr. Gordon Thiessen, to the St. John’s Board of Trade in St. John’s, Newfoundland on 23/9/98. I am delighted to have been invited to speak to the Board of Trade on this occasion when the Bank of Canada’s Board of Directors is meeting here in St. John’s. This past year, we have had to deal with the implications for our economy and our currency of increased global uncertainty and pressures arising from the problems that originated in Southeast Asia. I am sure that the effects of these developments, especially on primary commodities, such as oil and nickel, are already very familiar to Newfoundlanders. To understand what is going on, we need to look at the nature of the forces that are currently affecting our economy. We also need to correctly identify cause and effect when it comes to the decline in the external value of our currency over the past 12 months. The commentary on this subject has not always been helpful. I would like to start my presentation with a quick review of international developments, focusing on the extent to which the problems in Southeast Asia have persisted and spread. Next, I will discuss the implications of these developments for the Canadian economy and give you the Bank’s latest assessment of the outlook. I can tell you now that I believe that the key trends in our economy remain positive. Lastly, I will talk about the decline in the external value of the Canadian dollar and about the response of monetary policy to that decline. The world around us For over a year now, volatility and uncertainty have been the main traits of the international environment in which Canada operates. The financial crisis started in Southeast Asia in the summer of 1997, then spread to South Korea, and in turn exacerbated the domestic economic difficulties that Japan was already facing. Recently, Russia has been added to the list of afflicted countries, and now some countries in Latin America are under pressure. As with the crisis in Asia, the financial problems in Russia have reverberated around the world through foreign exchange, stock, and bond markets, touching off concerns of still further contagion. It is certainly easier now, with the benefit of hindsight, to see the extent to which many investors from industrial countries were attracted to higher-yield investments in emergingmarket countries, without fully appreciating the risks involved. When investors suffered substantial losses in certain markets, they sought to reduce their exposure to emerging markets more generally. But this rapid withdrawal of funds brought to the surface areas of weakness in some of these economies, making investors still more nervous. The recent events in Russia are a prime example of this process. The apparently contagious nature of these developments has led to some pessimistic predictions of recession in the world economy. How concerned should we be about this? While the international environment has turned out to be more difficult than most people had thought earlier, let me reassure you that it is certainly not all negative. To be sure, the situation in Japan is worrisome - not only because of that country’s economic importance but also because of its strong trade and financial links with other troubled Asian economies. But, and this is an important but, Japan has the capacity and the financial wherewithal to turn its situation around. With resolute action to speed up the implementation of measures to deal with its ailing banking sector and to kickstart its domestic economy, the present concerns would dissipate. More importantly, economic activity in the United States has been very robust and is expected to remain healthy. In Canada, too, and in Europe the situation is positive. This is certainly not insignificant, for North America and Europe together account for more than half of world output. And recent declines in medium- and long-term interest rates to record low levels are helping to sustain domestic spending in all industrial countries. With this as background, I would now like to turn to the impact of these international developments, and of the associated uncertainties and pressures in financial markets, on Canada. How is our economy faring? The international developments of the past year have affected our economy more than previously anticipated. And there is no doubt that those Canadian industries and regions that depend on the production of primary commodities are facing considerable difficulties. To appreciate this particular link between recent international developments and the Canadian economy, let me point out that Asia, including Japan, absorbs between 30 and 35 per cent of the world output of certain key primary materials. So it is not surprising that world commodity prices have been hit hard by the Asian crisis. The recent events in Russia, which is a major commodity producer, have added to the uncertainty about the outlook for the world supply and prices of primary commodities. Because of all this, the US dollar prices of commodities that are important to Canada have fallen by about 15 per cent over the past 12 months. While commodities are less important to us than they used to be, they still make up about 30 to 35 per cent of our merchandise exports. Although Canadians have to deal with these difficulties coming from abroad, it is important to remember that, overall, our economy is still in good shape. This is, first and foremost, because some basic aspects of our economic situation have improved markedly in the last few years. We now have a low rate of inflation, a fiscal surplus, and a declining (though still high) public debt-to-GDP ratio. As well, Canadian businesses have undertaken major restructuring and investment initiatives to increase their productivity. Because of these fundamental strengths, we are now better positioned to weather sudden shocks. As for the near-term outlook, there are also a number of positive elements in the picture. Economic activity in the United States, our main customer, remains high. And here in Canada, the latest indicators suggest continued expansion in consumer spending and business investment, supported by higher employment and low medium- and long-term interest rates. This year, the Canadian economy will not repeat the 4 per cent growth experienced through 1997. But it may still expand by 2½ to 3 per cent (fourth quarter over fourth quarter). Clearly, a good deal of uncertainty surrounds any estimate at this juncture, given the international situation. For one thing, it is difficult to judge how quickly and effectively Japan will deal with its problems, and what this will mean for the rest of Asia. The extent of the impact from the recent spreading of the crisis to Russia and the pressures in parts of Latin America is also uncertain. But, at the same time, most forecasters have consistently underestimated the resilience of the US economy, and may still be doing so. Implications for the Canadian dollar One of the most talked-about economic events in Canada over the past year has been the decline in the external value of our currency. At its lowest point, in late August 1998, the Canadian dollar had depreciated by about 13 per cent against the US dollar and by more than 7 per cent against the German mark from its average value in the first half of 1997, before the Asian crisis erupted. Since that low point in late August, the Canadian dollar has recovered somewhat against the US dollar. What has caused these movements? Exchange rates will typically reflect developments in Canada and abroad. Thus, it is important to keep in mind that the recent movements in the Canadian dollar are the consequence of developments that have occurred over the past year. They are not the cause of the difficulties we are now facing, as some of the recent commentary seems to suggest. It is also important to note that our exchange rate is the price of the Canadian dollar expressed in terms of the currency of another country, usually the US dollar. So, the exchange rate will be influenced by events affecting both countries. If we are to correctly interpret movements in the Canada/US exchange rate, we must also look at what has been happening to the United States, not just to Canada. And that makes any interpretation more complex. Until very recently, the US dollar has been exceptionally strong against all currencies. In part, this reflected the buoyancy of the US economy. But in the difficult and uncertain global environment of the past year, the strength of the US dollar also came from its role as the major international currency. After the Asian crisis, and with renewed vigour in the days following the events in Russia, international investors sought shelter in US dollar assets. Indeed, the turmoil in financial markets in late August seemed to be the result of a worldwide reassessment of risks by investors following the announcement of the Russian debt moratorium. Thus, to the extent that the depreciation of our currency reflected the appreciation of the US dollar against all currencies, the cause was the global flight of funds into US assets. But that is not the whole story. The downward pressure on our currency over the past year was also related to events that were seen as affecting Canada more specifically. As I explained earlier, one important event was the marked decline in the prices of the key primary commodities we export. The drop in these prices has meant lower incomes and wealth for Canadians. The profit outlook for many of our resource industries has deteriorated and production and employment in those industries are likely to be affected. And the market value of companies in those sectors has reflected these developments. Moreover, lower net export earnings from our primary commodities imply, all else being equal, a larger deficit in our balance of international payments and a greater need for foreign borrowing than would otherwise be required. All these commodity-related developments have led to downward pressure on our exchange rate. And the lower dollar spreads the wealth and income effects of falling commodity prices across the economy. In effect, a lower Canadian dollar means higher domestic prices for all those goods that are imported and for many of the import substitutes we produce here. For a given level of income, these higher prices imply a decline in living standards for Canadian consumers. Retailers who feel unable to pass on these price increases to consumers will have to absorb them in lower profits which, in turn, will mean lower returns for their shareholders. The bottom line is that the decline in commodity prices has made us less well off than we were before. And we have to adjust to this reality. These effects are unavoidable, even if we were able to prevent the Canadian dollar from falling. In fact, if the currency were not allowed to move at all, the adjustment would be slower and more costly, taking place through reductions in wages which usually involve sharper fluctuations in output and employment. Under a floating exchange rate, the process is facilitated by some downward movement in the dollar which spreads the burden of adjustment. Over the years, this has been an important justification for a flexible exchange rate in Canada -- that adjusting through exchange rate movements to the shocks that periodically hit our economy makes for a generally smoother and fairer process than adjusting through reductions in output, employment, and wages. But I do not want to leave you with the impression that foreign exchange markets always know the appropriate value for a currency. They sometimes push too far once a trend is established in one direction or another. Indeed, I believe that during this latest episode of global financial turbulence, markets exaggerated the commodity connection of the Canadian dollar. For example, our exports of highly manufactured goods, apart from the important motor vehicle sector, have grown by nearly 20 per cent over the past 12 months, and now represent about 30 per cent of our merchandise trade. This development seems to have been largely overlooked. Monetary policy response So, what can and should the Bank of Canada do about the exchange rate in times of international financial turbulence and major external shocks? First of all, let me remind you that the objective of Canadian monetary policy is to hold the rate of inflation within a range of 1 to 3 per cent. This target, jointly agreed upon by the government and the Bank of Canada, reflects the conclusion that low inflation will contribute to a stronger, more stable economic performance over time. If we are to fulfill our commitment to keep inflation low and stable, monetary policy must remain focused on that objective. The exchange rate and interest rates are the channels through which monetary policy operates and they must be allowed to adjust to help achieve the inflation targets. But what if the momentum of currency movements pushes the Canadian dollar beyond any level that is justified on economic grounds? Judgments as to what is, or is not, justified are very difficult to make, but there are times when the good economic news gets lost in the face of a persistent currency decline. On those occasions, Canadian authorities need to remind investors of the positive trends in our economy. And to reinforce the message, the Bank may intervene, on behalf of the Minister of Finance, to support the currency by buying Canadian dollars in the foreign exchange market. But we do know that this kind of intervention will be effective only if a good number of investors share our belief that the currency movement has been overdone. The Bank can also respond to currency declines with Bank Rate changes. There are two sets of circumstances in which this would be appropriate. The first is when the magnitude of the currency decline threatens to push the economy off a sustainable, noninflationary growth path. Remember that a declining currency is a source of stimulus to the economy, because it encourages exporters and producers of import substitutes to expand their activities. That is why the Bank always puts the exchange rate and interest rates together in order to measure the amount of monetary stimulus in the economy. If a declining currency leads to monetary conditions that are persistently too easy and inconsistent with the inflation targets, the Bank will offset that with higher short-term interest rates. The second situation that would prompt a Bank Rate increase is when there is a potential loss of confidence in the Canadian dollar. If confidence is undermined, both Canadian and foreign investors will move out of investments denominated in Canadian dollars unless they are compensated with substantial premiums in interest rates. Higher premiums, which translate into higher medium- and long-term interest rates, are very costly for the economy. It was because of such concerns that the Bank responded strongly to the decline in our currency during the Mexican crisis in early 1995. The recent Bank Rate increase at the end of August was also designed to counter a potential loss of market confidence. In this case, investor nervousness was exacerbated by the financial crisis in Russia and was reflected in a sharp decline in our currency and rising mediumand long-term interest rates. Since the Bank Rate increase, the Canadian dollar has recovered and medium- and longer-term interest rates have come down. Concluding comments I have placed a great deal of emphasis on recent international developments in my remarks today because the implications of these developments for the Canadian economy and the exchange rate are important and complex. Let me summarize my main points. For the past year, our economy has had to cope with the fallout from the Asian crisis, which has turned out to be more widespread and prolonged than most of us had predicted. Although we are having to deal with these difficulties and with the ongoing global uncertainty and pressures, it is important to remember that there is still a significant positive element in Canada’s external environment coming mainly from a resilient US economy. And there is still considerable underlying buoyancy in our domestic economy. What’s more, the improvement in our basic economic foundations puts us in a better position than before to withstand the present adversity. In addition to pressure from the worldwide strength of the US dollar, some of the downward movement in the Canadian dollar over the past year was a reflection of the impact of lower commodity prices on our economic well-being. However, by early August, it appeared that investors were exaggerating the importance of these effects and losing sight of the overall positive fundamentals in our economy. The Bank intervened, buying Canadian dollars, to encourage market participants to pause and reassess their views of the Canadian economy. When that pause was overwhelmed by a new wave of nervousness precipitated by the events in Russia in mid-August, the Bank raised the Bank Rate to forestall a loss of confidence in the currency and thus reverse a costly increase that was taking place in medium and long-term interest rates. Since then, these interest rates have come down. Let me conclude by pointing out that, despite all the recent attention on the Canadian dollar because of exceptional external developments, the fundamental focus of monetary policy remains on keeping the trend of inflation in Canada inside a target range of 1 to 3 per cent. Low inflation is the best contribution the Bank of Canada can make towards improved overall economic performance over time. It also provides the best underpinning for a sound Canadian dollar in the long run.
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bank of canada
| 1,998 | 10 |
Text of the 1998 Gibson Lecture by the Governor of the Bank of Canada, Mr. Gordon Thiessen, at Queen's University in Kingston, Ontario on 15/10/98 (charts and references omitted).
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Mr. Thiessen discusses the Canadian experience with targets for inflation control Text of the 1998 Gibson Lecture by the Governor of the Bank of Canada, Mr. Gordon Thiessen, at Queen’s University in Kingston, Ontario on 15/10/98 (charts and references omitted). It is an honour to have been asked by the School of Policy Studies and the John Deutsch Institute to deliver the 1998 Gibson Lecture. As an economist who worked as a banker for most of his career, Douglas Gibson brought an interesting perspective to public policy issues, to the relationship between government and business, and to the contribution of outside economists to government policies. I noted with particular interest a comment by Gibson in his 1981 essay in honour of John Deutsch. He points out that few academic economists in Canada up to that time “appeared to appreciate the destructive influence of inflation on the economy and on society”.1 That comment provides a convenient link to my topic for this year's Gibson Lecture. What I propose to do is to reflect on Canada's experience using explicit targets aimed at low rates of inflation as the focus for conducting monetary policy.2 But let me first set the scene by putting the inflation targets in the context of various approaches to monetary policy. With the sharp rise in worldwide inflation in the 1970s, the costs of inflation became more and more evident. Consequently, central banks increasingly focused their attention on how to get inflation down and keep it down. One lesson that came out of this period was the importance of having some sort of “nominal anchor” to ensure that monetary policy does not lose sight of the objective of inflation control, given the long lags in the operation of monetary policy.3 The traditional nominal anchor for small countries has been a fixed exchange rate that links the currency of the small country to that of a larger trading partner that has been successful in controlling inflation. Among the larger countries, many central banks turned to monetary aggregates as an intermediate target for monetary policy around the mid-1970s as relatively high inflation became entrenched in the world economy. Subsequently, with inflation and inflation expectations persisting at uncomfortable levels in many countries during the 1980s, the policy innovation in the early 1990s was the introduction of explicit inflation-control targets in eight countries.4 The main factor that countries choosing to use explicit inflation-control targets have in common is a history of higher-than-average inflation. In some cases, they had previously used monetary aggregates and/or a fixed exchange rate without success or with only limited success. And, unlike countries with a history of relatively low inflation (such as the United Gibson (1981). Broad assessments of the experience to date with inflation targeting in industrial countries can be found in Almeida and Goodhart (1998) and Bernanke et al. (1998). Individual country experiences can be found in Leiderman and Svensson (1995). For an assessment of the potential advantages and disadvantages of inflation targeting in developing countries, see Masson et al. (1997). See Bouey (1982). New Zealand, Canada, the United Kingdom, Sweden, Finland, Australia, Israel and Spain adopted inflation targets in the first half of the 1990s. States, Germany and Japan), the history and consequent problems of policy credibility in inflation-targeting countries meant that they were unable to rely upon a general qualitative commitment to low inflation. The key objectives of Canada’s inflation targets, when they were originally announced in 1991, were to prevent inflation from accelerating in the short run in the face of the introduction of the new Goods and Services Tax (GST) and a sharp rise in oil prices and, in the longer run, to bring inflation down to a level consistent with price stability. Over time, the importance of other favourable characteristics of inflation targets as a permanent operating framework for monetary policy has become increasingly apparent to us at the Bank of Canada. The most notable of these characteristics are increased transparency, better accountability, improved internal decision-making, and a mechanism for responding to demand and supply shocks that reduces potential fluctuations in output. I would not argue that explicit inflation targets are the only way to achieve good macroeconomic results. Indeed, the worldwide reduction of inflation in the 1990s across countries with different frameworks for monetary policy clearly indicates that there are a number of ways to achieve low inflation. Rather, I will argue that explicit inflation targets bring a discipline to monetary policy that is helpful in providing a more stable and predictable environment for the economic decisions of businesses and individuals. Moreover, I believe that the benefits of the clear operating framework provided by such targets will make them increasingly attractive in democratic societies that demand accountable public institutions. I will begin this lecture with a brief history of inflation targets in Canada and go on to an assessment of the performance of the Canadian economy during the period in which inflation targets have been in place. I will then turn to a discussion of the favourable characteristics of inflation targets, over and above achieving a low rate of inflation. After examining the main criticisms of explicit targets for low inflation, I will offer some concluding remarks about the contributions that the targets have made to the conduct of monetary policy in Canada over the last eight years. A brief history of inflation targets in Canada In response to the persistence of high inflation during the 1970s, the Bank of Canada adopted a narrowly defined monetary aggregate (M1) as a target in 1975. When this aggregate became increasingly unreliable and turned out not to have been all that helpful in achieving the desired lessening of inflation pressures, it was eventually dropped as a target in 1982. Subsequently, the Bank embarked on a protracted empirical search for an alternative monetary aggregate target, but no aggregate was found that would be suitable as a formal target. Thus, from 1982 to 1991, monetary policy in Canada was carried out with price stability as the longer-term goal and inflation containment as the shorter-term goal, but without intermediate targets or a specified path to the longer-term objective. In February 1991, explicit targets for reducing inflation were introduced through joint announcements by the Bank and the federal government.5 These announcements confirmed price stability as the appropriate long-term objective for monetary policy in Canada and specified The government’s announcement came as part of its annual budget, while the Bank issued a press release and a background note setting out practical details regarding the operation of the targets. A discussion of some of the practical issues surrounding the operational use of the targets can be found in Freedman (1995). a target path to low inflation. The first guidepost was set for the end of 1992 at a target rate of 3 per cent for the 12-month increase in the consumer price index (CPI). This was to be followed by a reduction to 2.5 per cent for mid-1994 and to 2 per cent by the end of 1995. These targets had a band of plus and minus 1 percentage point around them. The announcements specified that after 1995 there would be further reductions of inflation until price stability was achieved. At the time the targets were announced, there was upward pressure on prices in Canada from two major shocks -- the sharp rise in oil prices following the Iraqi invasion of Kuwait and the effect on the price level of replacing the existing federal sales tax at the manufacturers’ level by the broader-based GST. These shocks had led the Bank and the government to be concerned about a deterioration of inflation expectations and the possibility of additional ongoing upward pressure on wages and prices. The fact that Canada had recently gone through a period of inflationary pressure induced by excess demand added to those concerns. By providing a clear indication of the downward path for inflation over the medium term, the key near-term aim of the targets was to help firms and individuals see beyond these price shocks to the underlying downward trend of inflation at which monetary policy was aiming, and to take this into account in their economic decision-making. In the longer term, the inflation-reduction targets were designed to make more concrete the commitment of the authorities to the goal of achieving and maintaining price stability. In addition, by providing information on the specific objectives to which the Bank’s monetary policy actions would be directed, the targets were intended to make those actions more readily understandable to financial market participants and to the general public. In this way, the targets would provide a better basis than before for judging the performance of monetary policy. In December 1993, on the occasion of the announcement of my appointment as Governor, the Bank and the Minister of Finance issued a joint statement on the objectives of monetary policy. In this statement, the newly elected government and the Bank recommitted themselves to price stability as the goal of monetary policy. It was also agreed that the 1 to 3 per cent target range for inflation would be extended through 1998, and that a decision on the definition of price stability would be postponed. There were two reasons for this extension. First, because it had been a long time since Canada had had low rates of inflation, it was felt that more experience in operating under such conditions would be helpful before a long-term objective was set. Second, since inflation had dropped rather dramatically and unexpectedly during 1991, it was unlikely that Canadians had completely adjusted to the improved inflation situation. More time was therefore needed to make that adjustment before announcing any further changes to the target. In February 1998, the government and the Bank announced that the 1 to 3 per cent target range would be extended again, this time to the end of 2001. This extension reflected the fact that the economy had not yet reached full capacity in the current cyclical upswing. It would, therefore, be helpful to have the economy demonstrate more fully its ability to perform well under conditions of low inflation before determining the appropriate long-run target consistent with price stability. The government and the Bank now plan to determine this long-run target before the end of 2001. Inflation targets and economic performance in Canada What did we expect in the way of economic performance from the inflation targets? First, we expected a lower rate of inflation and reduced inflation expectations. Second, the achievement of a lower inflation rate and the commitment embodied in the targets to maintain that lower inflation rate were expected to result in lower interest rates. Third, with lower inflation, we anticipated that the economy would function more efficiently and without the sharp fluctuations caused by inflationary booms and subsequent recessions.6 What has the outcome been thus far? Chart 1 shows the rate of inflation over the period of inflation targets. Following the initial announcement of the targets in February 1991 (when the 12-month rate of increase in the total CPI was at 6.8 per cent), inflation fell rapidly. Indeed, for much of 1992 it was below the bottom of the target range. Since then, with the exception of a brief period in 1995, the trend of inflation has been in the lower half of the target range. The speed of the decline in inflation during 1991 was surprising. It reflected a much more severe economic slowdown than either the Bank or most other forecasters had expected. In part, the depth of the 1990-91 recession was due to international factors, such as lower-than-expected growth in the United States and an unexpectedly sharp decline in raw materials prices. But in Canada, it also reflected the unwinding of distortions in asset prices and debt accumulations associated with the preceding period of inflationary pressures. It is unlikely that the 1991 announcement of the path for inflation reduction had a significant immediate impact on the expectations of individuals, businesses, or financial market participants. On balance, I think that it is the low realized trend rate of inflation in Canada since 1992 that has been the major factor in shifting expectations of inflation downwards. But the targets have probably played a role in convincing the public and the markets that the Bank would persevere in its commitment to maintain inflation at the low rates that had been achieved. Moreover, there are some recent indications that the 2 per cent mid-point of our target range is becoming an important anchor for current expectations and for long-range corporate planning. If we examine interest rates and the growth of output and employment over the period of inflation targets, the first point to note is that the recovery from the 1990-91 recession was less vigorous than typical in the post-war period. The growth of domestic demand, in particular, was subdued until mid-1996 (see Chart 2). Moreover, the economic expansion in Canada was considerably less robust than that in the United States. While some observers have attributed the sluggishness of the recovery to the adoption of inflation targets and the associated conduct of monetary policy, this criticism overlooks the major restructuring that took place in Canada in both the private and public sectors over this period.7 Whereas the United States had undergone a period of intense private sector restructuring starting in the mid-1980s, the corresponding Canadian restructuring did not take place until the first half of the 1990s. At about the same time, after two decades of continuous fiscal deficits and public sector debt accumulation in Canada, unprecedented corrective actions were required to put public finances onto a sounder path. See Bank of Canada (1991) on the benefits of price stability. This critique of Bank policy can be found in Fortin (1996). A detailed response can be found in Freedman and Macklem (1998). Both sets of actions were essential to move Canada towards a better-functioning economy. The short-run consequences, however, included a weak employment situation and an associated lack of consumer confidence. And these resulted in sluggish domestic demand and a weaker-than-expected recovery in the Canadian economy. Monetary conditions were easing through much of this period.8 However, for quite a long time the Bank was unable to provide as much monetary stimulus as it would have liked because of fiscal, political, and international developments that, at times, caused financial markets to be nervous and volatile. It was only after 1995, with improved credibility on the fiscal front and subsequent to the Quebec referendum campaign, that the Bank was able to achieve a durable reduction in short-term interest rates. As the credibility of both monetary and fiscal policy improved, Canadian interest rates across the maturity spectrum moved to levels below comparable interest rates in the United States. In response to easier monetary conditions, domestic demand in Canada recovered, with a strong expansion beginning in mid-1996 and continuing through 1997. One of the main conclusions that I would draw from the Canadian experience of the 1990s is that, while low inflation is necessary for good economic performance, it is not sufficient by itself. While monetary policy was able to achieve a rate of inflation that was within the target range for most of the period, other factors also played an important role in determining interest rate movements and output and employment growth. Does the important role played by non-monetary factors mean that the inflation targets and the low rate of inflation were not helpful? Not at all. The ability of businesses to undertake a major restructuring was greatly enhanced by the stable low-inflation environment. And while fiscal and political uncertainty resulted in appreciable financial market volatility, as well as vulnerability to external shocks in the period before 1996,9 I believe that the situation would have been considerably worse without the anchor provided by low inflation and the inflation targets. And, in conjunction with improved fiscal policy, they have facilitated better economic performance in the more recent period and have allowed us to weather the current international financial problems with fewer difficulties than before. Targets should continue to provide a sound foundation for good economic performance and for coping with the international shocks that are bound to hit us from time to time. Increased monetary policy transparency and accountability When the government and the Bank agreed on the initial targets in 1991, the main concern was to lay out a path for the reduction of inflation on the way to price stability. Despite the emphasis that the Bank had for some years placed on price stability as the objective of monetary policy,10 the period over which the objective was to be achieved was a source of uncertainty among the public. Thus, one of the key benefits of the targets was expected to be increased transparency with respect to the objective of monetary policy, leading to a reduction of public and financial market uncertainty. The concept of monetary conditions includes movements in short-term interest rates and in the exchange rate, the two channels through which monetary policy operates. See Freedman (1994) and Thiessen (1995). Clinton and Zelmer (1997). See Bank of Canada (1987) and Crow (1988). The announcement in 1991 also noted that the targets should provide a better basis for judging the performance of monetary policy. Criticisms of monetary policy had often implicitly assumed that the Bank should be pursuing policy objectives other than price stability. By setting out a clear objective, and with the commitment of the government to that objective, the Bank hoped that future public assessments of monetary policy performance would focus more clearly on its record of achieving price stability. There is no question that explicit targets for inflation control make the objective of monetary policy more transparent and provide a better basis than before for holding the central bank accountable for its conduct of monetary policy. I have not tried to pull together evidence that, with a clearer objective, public commentary on monetary policy since 1991 has involved fairer assessments of the performance of the Bank of Canada. And it is difficult to demonstrate conclusively that, overall, financial and economic uncertainty in Canada have been less than they would have been without targets. Nonetheless, it is my qualitative assessment that those improvements have taken place. And the targets have certainly had a major impact on the Bank itself. With respect to transparency, we found that explicit targets provided a strong incentive that encouraged us to become more forthcoming about how we would operate to achieve those targets. As I have discussed elsewhere,11 we have taken initiatives to explain more fully our assessment of economic developments and our outlook for output and inflation. We have clarified how we make judgments about the actions needed to achieve the inflation target, and how we operate in markets to implement those judgments. Moreover, the Bank’s senior staff now spends much more time than before on public explanations and discussions across the country about monetary policy and central bank operations. All these initiatives were designed to make the implementation of monetary policy and the achievement of the targets more effective. Explanations and discussions are also part of the process whereby the Bank is accountable to the public for its actions. Accountability implies that the central bank must either achieve the target or explain what unanticipated events caused it to miss the target and what it is doing to rectify the situation. Thus, we have a strong incentive to ensure that the public is well informed about the circumstances that could affect our achievement of the objective. It is not surprising that in some countries inflation targets and increased autonomy for the central bank have gone hand in hand. An autonomous central bank has traditionally fitted somewhat awkwardly into a democratic society.12 However, once targets are set and the central bank is charged with achieving those targets, it is much more feasible for Parliament and the public to hold the managers of monetary policy to account for their performance. Thiessen (1995). See Rasminsky (1966). In Canada, no new arrangements for central bank accountability have been put in place since 1991. But in fact the existing arrangements have adapted quite well to an inflationtargeting environment. The Bank of Canada Act gives the Bank’s Board of Directors the responsibility for ensuring that the institution is well run.13 This includes assessing the performance of the Governor and of the other members of the Governing Council, who are responsible for managing the Bank.14 The inflation targets have made those performance assessments more straightforward. When it comes to monetary policy -- the Bank’s most important responsibility -there is now a clear measure of what constitutes successful performance. The second part of the accountability arrangement for the Bank of Canada is the directive power given to the Minister of Finance under Section 14 of the Bank of Canada Act. With the new practice of agreed targets between the Bank and the Minister, the directive power, which has never been used, now seems even less likely to be used. Nonetheless, if there were a fundamental disagreement on the targets when they came up for renewal, the Minister could impose his will via a directive. That would likely lead to the Governor’s resignation and a new Governor, who was prepared to accept the desired targets, would have to be chosen.15 As long as no directive is in force, the Bank must take full responsibility for its monetary policy actions. However, this directive power implies that the Minister must also take a broad, ultimate responsibility because he has the power to change monetary policy. Quite evidently, this is a power to be used only in extreme circumstances. Nevertheless, this arrangement defines the nature of the Bank’s relationship to the Minister of Finance in the area of monetary policy. In today’s world, the accountability of public institutions goes beyond traditional legislated arrangements. In democratic societies, the general public now demands much more information and accountability for performance from public institutions. Here again, by establishing a clear performance objective, the inflation-control targets have made it easier for the Bank to account for its stewardship to Parliament and the general public. Improved internal decision-making The explicit target for policy and the associated increase in transparency and accountability of the Bank of Canada have also had an impact on our internal decision-making processes. Other central banks that have adopted inflation targets have also noted the improvement in the process of internal decision-making that has resulted.16 The improved The directors of the Bank are appointed by the government for three-year terms. By tradition, there are two directors from Ontario, two from Quebec and one from each of the other provinces. The Governing Council is composed of the Governor, the Senior Deputy Governor and the four Deputy Governors. In addition, if the Minister decided that the actions that the Bank was taking to achieve the agreed targets were inappropriate, he could use the directive power. Once again, this would be an expression of no confidence, which would probably lead to the Governor’s resignation and replacement. Haldane (1995). decision-making can be attributed largely to the focus on a clear objective and the consequent need to develop a robust framework that maximizes the likelihood of realizing that objective in the light of the long lags between monetary policy actions and their effects on inflation. The inflation-targeting framework typically has a number of components -- a procedure for projecting the future rate of inflation, a set of quantitative estimates of the relationships that link the central bank actions and the rate of inflation, and the development of information variables that provide early warning to the authorities that economic and financial events are, or are not, proceeding in line with the inflation outlook. In Canada, the policy process works as follows. The Bank makes a projection of inflation one to two years ahead. This is based in large part on our assessment of international and domestic economic developments and their implications for the path of real output in the Canadian economy relative to potential output. In this framework, minimizing the difference between the projected rate of inflation six to eight quarters in the future and the target rate becomes the effective intermediate objective for monetary policy.17 A full projection is undertaken every quarter, reassessed mid-quarter and carefully monitored in between. The idea is to re-examine the scenarios on which policy actions are based as new information becomes available. In this context, I would note that we are very aware of the uncertainty surrounding both the projection and the transmission mechanism that links our actions to demand and inflation.18 While it is still early to offer any definitive judgments, I would suggest that so far one of the most important results of the targets has been an increase in the internal discipline of the policy-making process. The Bank’s commitment to the targets and the need to explain and justify any inability to meet the targets have resulted in a better-focused internal debate on the appropriate policy actions to take and has probably reduced the likelihood that decisions to take such actions will be put off. The response to demand and supply shocks under inflation targeting In addition to their positive effects on transparency, accountability and decision-making, the inflation targets also provide a mechanism that helps monetary policy to deal with demand and supply shocks in a way that reduces economic fluctuations. If the inflation forecast suggested that aggregate demand was expanding at an unsustainable rate and would be pressing on capacity so that the trend of inflation would likely go through the top of the target range, the Bank would tighten monetary conditions to offset the demand and inflationary pressures. Conversely, if demand was weak relative to capacity and the trend of inflation looked likely to move below the bottom of the range, the Bank would ease monetary conditions, thereby providing stimulus to the economy and reducing the downward pressure on inflation. By operating in this way, the Bank effectively reduces the magnitude of the fluctuations in real output and income that are inherent in a market-based economy. Because of Svensson (1997). For a detailed discussion of the Canadian framework for making policy, see Duguay and Poloz (1994) or Longworth and Freedman (1995). See Haldane (1995) for descriptions of the policy frameworks of those countries using inflation targeting as the basis of their policy. For a discussion of the uncertainty surrounding the transmission mechanism, see Thiessen (1995). this economic-stabilizer characteristic of targets in response to demand shocks, and the helpful role of the top and bottom of the range in communicating the way in which the Bank responds to such shocks, the Bank has recently been giving more emphasis to the target range than was the case initially. Moreover, to the extent that explicit targets and their successful achievement give Canadian monetary policy more credibility, the Bank of Canada has more potential room for manoeuvre in dealing with demand shocks. For example, following an upward demand shock, policy credibility can give the Bank more room to see how large and how long-lived the shock is likely to be and how much pressure it seems to be putting on the economy’s capacity to produce. The Bank will have this greater latitude only insofar as inflation expectations are more firmly anchored by the targets and are not dislodged by a delay in responding to a shock.19 Inflation targets have also turned out to be helpful in dealing with certain types of supply shocks. For temporary shocks to food and energy prices, our operational focus on a core rate of inflation (the CPI excluding food, energy and the effect of changes in indirect taxes) makes it clear that the focus of monetary policy is on the trend of inflation and not on such temporary fluctuations. Removing indirect taxes from our core measure of inflation implies that the Bank will accommodate first-round effects of tax changes on the price level. However, we have also made it clear that we would not accommodate any ongoing inflation effects that might come from attempts to adjust salaries and wages to seek compensation for tax increases. Another type of supply shock that may become relevant in the period ahead is the possibility that the widespread restructuring that we have seen in the Canadian economy, along with new technology and high levels of business investment, will lead to growth rates and levels of potential output higher than currently estimated on the basis of past experience. In such an event, the economy will be able to expand faster and operate at higher levels of output than previously thought without generating inflation pressures. A credible inflation target can help the Bank probe to find out where the limits of potential output really are. Consider a case where inflation remains under downward pressure even as the economy operates at levels of activity that the Bank believes to be consistent with full capacity. The risk of having inflation go below the target, and the accountability issues that this would raise, should ensure that the Bank will not make persistent errors in underestimating potential output.20 This operational framework should help to make clear to Canadians that a monetary policy focused on inflation targets does not ignore fluctuations in employment and output, or result in a persistently underperforming economy. Some criticisms of targeting low inflation See Freedman (1996). The ability of the US monetary authorities to adopt a wait-and-see position in response to shocks in recent years is closely related to the very high degree of credibility that the Federal Reserve has achieved. Thiessen (1997). - 10 - Let me now turn to the main criticisms that have been levelled at the Bank’s targets for low inflation. They are: the possibility of downward rigidity in nominal wages; the floor of zero on nominal interest rates; and a concern about deflation. You will note that none of these criticisms is directed at inflation targeting as such, but at the choice of a target for inflation control that is very low. Wage rigidity Are wages rigid to the degree that they would be slow to decline even in the face of slack in the labour market? And what are the implications of such a situation for the working of the economy and for monetary policy? In other words, is some level of inflation needed to “grease the wheels” of the economy and eliminate the potential effect of such rigidity?21 The evidence thus far, although still fragmentary, suggests that wages can and do decline. It is also worth emphasizing that, with positive productivity growth, the average wage will normally rise over time even in an environment of stable prices. In such circumstances, unchanged nominal wages will enable a decline in unit labour costs equal to the rate of productivity growth, if such a decline is needed. Furthermore, the resistance to downward adjustments of nominal wages that built up during the period of high inflation is likely to lessen as the public becomes accustomed to low inflation. Given that the behaviour of nominal wages adjusted to the period of high inflation starting in the 1970s, I see no reason why it will not adjust equally to the current period of low inflation. Indeed, there is now some evidence, in Canada and in other low-inflation countries, of an increase in the relative importance of variable pay schemes (bonuses, etc.) as opposed to increases in base wage rates.23 If sustained, this development would help to increase wage flexibility. As I have said in the past, I have a great deal of difficulty with the idea that wage earners in Canada are subject to a permanent money illusion that can, and should, be exploited by the monetary authority.24 How can monetary policy be eased when inflation is very low and interest rates are close to zero? One of the criticisms of the goal of price stability, or a very low inflation rate, is that it rules out using negative real interest rates (i.e. interest rates lower than the rate of inflation) to provide stimulus to the economy should this become necessary. This line of argument implies that one should avoid targeting a very low rate of inflation because of the added flexibility that the possibility of having negative real interest rates gives to policy-makers at a time of economic weakness. See Fortin (1996) and Akerlof et al. (1996). See Crawford and Harrison (1997). Crawford and Harrison (1997). See Thiessen (1996-97). - 11 - In assessing this criticism, it is important to remember that the achievement of price stability is likely to lead to a lessening in the amplitude of business cycle fluctuations. In the post-war period, deep recessions (of the sort that might, in extreme cases, call for negative real rates) have typically been preceded by periods of strong inflation pressures. These pressures resulted in significant economic distortions, which, in turn, affected the depth of the subsequent downturn. In the absence of such inflationary distortions, the downturns are likely to be much milder. Hence, there is less likelihood that a period of negative real interest rates would ever be called for. Moreover, while nominal short-term interest rates cannot be less than zero, it is worth underlining that a near-zero nominal rate will still imply a real interest rate that is appreciably below its equilibrium value and will provide considerable stimulus to the economy. Finally, in a small open economy with a flexible exchange rate regime, monetary conditions can become easier as a result of both interest rate and exchange rate movements. Even if there were only limited easing possible via the interest rate, there could still be a sufficient adjustment of monetary conditions to support a recovery and avoid having inflation persistently below the target range. Is there a “deflation” problem? Some critics have suggested that targeting a low inflation rate, such as the present 1 to 3 per cent range, raises the potential problem that a negative shock could readily push Canada into deflation. The first point to clarify is that what is relevant here is a decline in the general level of prices of goods and services, not in asset prices as some people seem to think. Furthermore, the use of the term “deflation” to describe a small decrease in prices for a short period of time, rather than a period of sustained price declines, can be very misleading. In Canada, the term deflation is associated in the public mind with the depression of the 1930s, when prices fell more than 20 per cent over a four-year period. The concerns about persistent deflation are that households will decide to defer consumption expenditures in the expectation that prices will be significantly lower in the future than at present and that the economy will enter into a debt-deflation spiral. Such responses are highly unlikely in the case of small price declines over short periods of time. The fact that under inflation targeting the authorities are committed to bringing the rate of change in prices back inside the target range would reduce even further the likelihood that deflationary expectations would take hold in such circumstances. I would contend that inflation and deflation are equally to be avoided. Both imply increased uncertainty for economic agents, and both have negative implications for economic performance. That is why the Bank treats the risk of inflation moving above the top or below the bottom of the range with equal concern. Concluding remarks It is too early to be able to draw very strong conclusions about the impact of inflation targets on actual economic performance in Canada. We really do require a longer period of time for targets to demonstrate their ability to deal successfully with the peak of an economic upturn without the trend of inflation moving persistently outside the target range. - 12 - Nonetheless, some conclusions can be drawn at this point. In Canada, inflation has remained within the target range for most of the period in which targets have been set. Because of this, the outlook for inflation has, in recent years, been more stable and predictable than at any time since the 1960s. And, consequently, most nominal interest rates have been lower than at any time since the 1960s. It would appear that business investment in Canada has been encouraged by the low interest rates and stable inflation outlook. Among individuals, stable inflation has encouraged both savers and borrowers to move further out along the maturity curve. This provides greater security for these individuals -a benefit that is particularly important for those who are not expert in, or do not wish to devote a great deal of time and energy to, financial matters. A common criticism of inflation targets in Canada is that the United States has managed to achieve better output and employment performance since 1991, with an inflation rate that is currently only 1 percentage point higher than in Canada. However, as I have argued in this lecture, there have been a number of factors at work that account for differences in economic performance between Canada and the United States, of which the most important probably were fiscal policy and the resulting higher public debt levels in Canada. I would add that monetary policy credibility has been less of a problem in the United States than in Canada. To an important extent, this reflects the somewhat lower average US inflation rate from the early 1970s to the beginning of the 1990s. It also reflects the fact that the US dollar is the major international reserve currency, and for that reason there is strong ongoing demand to hold US dollar denominated assets that does not exist for Canadian dollar assets. In these circumstances, the commitment provided by inflation-control targets will be far more useful in attracting and holding investors to a relatively small, open economy like Canada’s than to the United States. However, I would argue that the transparency and accountability of monetary policy and the resulting discipline in central bank decision-making that the targets encourage would be good for any country. And the greater predictability of the inflation outlook under a targeting regime should contribute to good long-term economic performance everywhere. Moreover, the automatic-stabilizer feature of targets should reassure those who worry that the central bank is overly concerned about inflation to the exclusion of the real economy. Finally, I would argue that transparency and accountability give autonomous central banks legitimacy in a democratic society. Since I am persuaded that central bank autonomy provides the strongest guarantee of having a low-inflation monetary policy over time, I believe that it is important to ensure that such autonomy remains acceptable in democratic societies. Only with explicit performance targets will accountability arrangements be truly effective. Inflation-control targets are by no means a miracle solution for monetary policy. But I believe that they provide a framework that leads to better policy decisions, better economic - 13 - performance over time, and a more accountable, and therefore more sustainable, position for autonomous central banks.
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Speech by the Governor of the Bank of Canada, Mr Gordon Thiessen, to the Greater Victoria Chamber of Commerce in Victoria, British Columbia on 7/12/98.
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Mr Thiessen reviews the Canadian economy and monetary policy in unsettled times Speech by the Governor of the Bank of Canada, Mr Gordon Thiessen, to the Greater Victoria Chamber of Commerce in Victoria, British Columbia on 7/12/98. When the Asian crisis erupted in the summer of 1997, few observers anticipated that international financial markets would still be under its influence more than a year later. Most expected that the crisis would be contained and resolved relatively quickly. But then who could have foreseen a year ago that the Japanese situation would deteriorate as much as it has; or that Russia would declare a debt moratorium, jolting markets everywhere, and increasing financial pressure on parts of Latin America? All these unexpected developments have slowed world economic activity. Canada’s very open economy has not been immune to these forces. The sharp decline over the past year in the demand for, and the prices of, the key primary commodities we produce has taken its toll. British Columbia has been particularly hard hit because it produces and exports a larger share of such goods than other Canadian provinces. These developments have been reflected in the value of our currency, which has declined substantially against the U.S. dollar. All this seems to have provided fertile ground for some pessimistic scenarios. Indeed, some commentaries have raised the spectre of global recession and deflation, implying a consequent downturn for Canada. Are such concerns justified, or are they an overreaction to events? I believe that the pessimistic commentary has been overdone. Given the global uncertainty and financial market volatility of the past year, Canada has been coping relatively well. It is normal for people to feel queasy and to fear the worst when caught in the kind of stormy seas we have encountered in the past year. But the important thing to remember is that these days Canada is better positioned to ride out the storm. And we will feel much better if we can keep our eyes on the horizon – for there are signs that the sky is clearing. What I would like to do this morning is to put the recent changes in the global economic and financial environment in perspective. Next, I will look at the implications for the world economy and for Canada in particular. I will finish with a discussion of the Bank of Canada’s response to the international turbulence. Global financial problems in perspective I will spare you the detailed chronology of the past year’s events. You are probably already too familiar with it. Rather, I intend to focus on what has made this latest episode of global financial turbulence more troublesome than others in recent history. This should help us see recent developments in the Canadian economy and in monetary policy in a clearer light. It should also provide some insight on what needs fixing in the international financial system and what mistakes to avoid in the future. So, why has the 1997–98 financial turmoil been more widespread and long-lasting? The way I see it, there were two main reasons. First, with the benefit of hindsight, it is clear that too many incautious international portfolio investments were made in the wake of the growing globalization of capital markets. Second, it has taken Japan much longer than expected to deal with its serious economic and financial problems, problems that long predated the Asian crisis. –2– Let me explain why I think these factors have had such an impact this time around. First, the matter of incautious international investment practices – what was the problem here? With the opening up of financial markets and with the decline in interest rates in industrial countries, a growing number of investors were attracted to higher returns abroad. “Abroad” often meant the so-called emerging market countries, particularly those in Asia. With their rapid rates of economic growth year after year, these countries seemed to have great investment potential. But foreign investments, especially in emerging markets, are far more complex than domestic ones. And assessing these investments can be very tricky. For one thing, investors are dealing with companies operating far away, in a very different economic and political environment. For another, financial regulatory and supervisory practices in some of these countries are less welldeveloped and transparent. In addition, investors may have felt rather well “protected” from risks – for a couple of reasons. First, past assistance packages by the International Monetary Fund (IMF) and other international agencies may have led them to believe that the international community would always come to the rescue if worst came to worst. Second, many investment advisers evidently were not terribly fussed about the exchange rate risk because most Asian currencies were fixed to the U.S. dollar. It is all too easy to forget that having a fixed exchange rate is not in and of itself a guarantee that a currency will not decline in value – which in fact is what many of these currencies have done. In the end, huge amounts were placed in emerging markets in the 1990s by mutual funds, pension funds, financial institutions, and their clients, evidently without full appreciation of the risks involved. Moreover, many banks in these emerging markets were also taking large risks. They were borrowing short term from foreign banks, in U.S. dollars, at relatively low rates, and lending out long term, in domestic currency, at high rates – often to domestic real estate developers. When pegged exchange rate systems in Asia broke down under pressure, because they were fixed at levels that had become incompatible with changing economic fundamentals, both local and foreign investors rushed for the exits. And as exchange rates tumbled and interest rates soared, a host of other long-standing problems, especially related to weak banking systems, were unearthed. Investors that got burned in Southeast Asia tried to reduce their exposure to all emerging markets. Initially, emerging countries outside Asia managed to withstand the pressure – until the outbreak of the Russian crisis. That Russia was running into serious fiscal difficulties had been well known for some time. But its decision to declare a unilateral moratorium on its debt last August shook markets everywhere, and even the most sophisticated investors became very agitated. The resulting global reassessment of risk, and the greater weight placed by investors on security, led to a movement of funds out of emerging market bonds and corporate bonds into more secure U.S. Treasury bonds. Interest rates rose in the markets for riskier securities, and liquidity tightened – hence, the concerns through the autumn about a global “credit crunch” and recession. The second factor that has exacerbated the global financial turbulence this time is the surprising severity and intractability of Japan’s long-standing economic and financial problems. Remember, Japan is the second largest economy in the world. Most of us expected that, once the Japanese recognized the seriousness of their problems, they would move quickly and decisively to fix –3– them. A stronger Japanese economy would have made a significant difference to the outlook for the world economy. And it would have helped to speed up the turnaround in Southeast Asia – much as a strong U.S. economy facilitated the adjustment in Mexico, following the 1994–95 crisis in that country. The deterioration of the Japanese economic and political climate in the spring and early summer of 1998 was an important factor in the intensified market pressures that precipitated the Russian crisis last August. What to do about the global turmoil? So what are we to conclude from all this? The last thing we should do is retreat behind national borders and start placing restrictions on the free flow of international capital. That would be very unfortunate. Even though capital flows may sometimes prove difficult to handle, especially for small countries, there is much to be gained from access to world savings – provided those savings are used prudently and productively. What we must do is find ways to minimize the costs, without giving up the benefits. The Bank of Canada believes that a flexible exchange rate is very useful in this context. Under such a system, borrowers and lenders are constantly aware of the exchange rate risk, and the kind of pressures that built up behind the fixed exchange rates in Asia last year are much less likely to emerge. I should also note that a good deal of work has already been done by the international community to strengthen the global financial system and reduce the risk that these recent problems will recur. In their October communiqué, the Finance Ministers and Central Bank Governors of the G-7 countries outlined a series of initiatives. These are designed to: increase the transparency of the international financial system; promote international standards of good practice; strengthen incentives to meet such standards; provide assistance to developing countries to reform and reinforce their economic and financial systems; and put in place a process for crisis management that envisages the involvement of private lenders at an early stage. But all this, you may say, is to improve the international navigation and radar systems in the future. Meanwhile, we are still in difficult seas, wondering what’s up ahead and worrying what may hit us next. How worried should we be about the world economy and the outlook for Canada? Keeping our eyes on the horizon I can tell you that there are positive factors in the picture as we look ahead. Let me elaborate, starting with the global environment. Perhaps the most reassuring element is that the economic expansion in the main industrialized countries, except Japan, is still well sustained. Remember that these countries account for more than half of world output. The U.S. economy, in particular, remains strong, growing much faster than anticipated in the third quarter. So even if it slows, that economy – Canada’s main export market – will still be operating at relatively high levels. The major European economies, as a group, are also expanding moderately. And a number of industrial countries, including the United States, the United Kingdom, and many countries in continental Europe, have lowered their interest rates to help sustain domestic spending. –4– Japan is still the main uncertainty at this point. But the recent legislation to rehabilitate its banking sector, which is at the core of Japan’s problems, and other measures proposed to stimulate the economy are grounds for cautious optimism. If these are implemented in a sensible, systematic fashion, the world economic outlook will brighten considerably. Another factor that added to the pessimism through the early autumn was the concern about a “credit crunch” in the United States that could spread elsewhere, including here in Canada. However, the recent interest rate reductions by the U.S. Federal Reserve have eliminated the worst scenarios envisaged at the time. Some of the rise in interest rates on “less-than-prime” debt, which occurred during the autumn because of concerns in global markets about risk and liquidity, has reversed. And the availability of credit is slowly improving. This is not to say that we are completely out of trouble yet; or that there is no longer considerable uncertainty out there. But, for the reasons I have discussed, I certainly do not believe that the scenarios of worldwide recession and deflation are very likely as we look ahead. As for Canada, it is true that we have been hit hard by the more than 15% decline in commodity prices over the past year. It is also true that those lower prices, together with the slowing world economy, are affecting our export industries – a fact that this audience probably knows only too well. It is also evident that the nervousness and volatility in financial markets have made some Canadian consumers and businesses less confident, affecting domestic spending plans. As a result, the Canadian economy has expanded much more moderately this year than in 1997, when it grew by more than 4% (fourth quarter over fourth quarter). As we look ahead to 1999, the considerable degree of global uncertainty that is still lingering makes all economic forecasts more tentative than usual. Because financial stability is so important for household and business confidence, the expansion of our economy will be influenced by how quickly global financial markets stabilize. Still, with accommodative monetary conditions and recent solid employment gains, spending by Canadian households and businesses, while slowing, should continue to contribute to an expanding economy. And, based on the Bank’s current assessment of the world economic outlook and Canada’s improved competitiveness, our exports should continue to grow. The monetary policy response to the international turbulence Let me now turn to monetary policy. You will not be surprised to hear that throughout this period, the conduct of policy has been influenced by these exceptional international developments. The sharp drop in commodity prices has inevitably meant lower incomes and wealth for Canadians. And we have had no choice but to adjust. Because we are on a floating exchange rate, much of the adjustment has taken place through a decline in the external value of the Canadian dollar. Had we been on a fixed exchange rate, we would still have had to adjust. But the adjustment would have been more difficult, since it would have had to come mainly through downward pressure on output, employment, and wages. The depreciation of the Canadian dollar since the fall of 1997, while distressing, had for the most part been relatively orderly before the Russian crisis in August. At that point, pressure on our currency intensified because of a frantic worldwide capital flight to more secure U.S. assets and –5– an exaggerated sense internationally of the importance of commodities for Canada. The move out of “commodity currencies” was intensified by fears that Russia would start dumping commodities on world markets. As the decline in the Canadian dollar accelerated through August, medium- and long-term interest rates, including mortgage rates, began to rise sharply at a time when comparable U.S. rates were falling. We took this as a signal of potential loss of confidence in Canadian dollar investments that could prove very costly for the economy. To head that off, we raised the Bank Rate by one percentage point in late August. Our action, and the subsequent return of some stability to markets in the United States and elsewhere, helped to restore confidence in Canadian dollar assets. And medium- and longer-term interest rates came back down. When the U.S. Federal Reserve lowered its target interest rate three times between September and November, because of concerns about a possible “credit crunch” and an expected slowing in their economy, we followed with similar reductions in our Bank Rate. These cuts were appropriate, given the importance of the U.S. economy to Canada, our continued low inflation rate, and the improving international financial climate. I know that the depreciation of the Canadian dollar has been a source of concern and dismay to many people. One concern is that a weak currency blunts the incentives to improve productivity in the export sector. I must say that this is more likely to be a problem if the weakness of the currency reflects an inflationary environment. But such is not the case in Canada today. Inflation is low and stable, and the Bank of Canada is formally committed to keeping it that way. At the same time, I most certainly agree that we should always be looking at our economic policies from the perspective of their likely impact on the growth of productivity. After all, productivity is what matters for a sound economic performance and for rising standards of living over time. Currently, the low Canadian dollar provides an opportunity for Canadian businesses to expand their presence in foreign markets. But they must also continue to work hard to increase productivity and to ensure that they stay competitive as our currency regains strength. What about monetary policy – what is it doing to further productivity? The focus of Canadian monetary policy is on domestic price stability. This means keeping inflation low and stable over time – currently within a target range of 1% to 3%. The Bank aims to avoid both inflation and deflation. And if we are successful, we will have provided Canadians with greater predictability, fewer cyclical fluctuations, and sustained low interest rates. I believe that a monetary policy that seeks to provide this kind of environment is the most conducive to productivity growth over time. Concluding remarks To conclude, let me just say that Canada cannot escape the uncertainties that have clouded the global economic outlook. The pace of economic expansion in Canada is not as robust as it was a year ago. But our economy should continue to grow over the next year, supported by accommodative monetary conditions and sustained U.S. demand. –6– Although it may be difficult to see while we are still battling the waves of global instability, the fact is that we are coping better this time around because our economy is in sounder shape. And this gives me reason to remain rather positive about our economic future. * * *
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Remarks by the Governor of the Bank of Canada, Mr Gordon Thiessen, to the Canadian Club of Ottawa in Ottawa, Ontario on 20/1/99.
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Mr Thiessen discusses the euro: its economic implications and its lessons for Canada Remarks by the Governor of the Bank of Canada, Mr Gordon Thiessen, to the Canadian Club of Ottawa in Ottawa, Ontario on 20/1/99. We have just witnessed the dawn of a new era in Europe. Beginning this month, 11 of the 15 member countries of the European Union have joined in a currency union. And they are using the euro as their common currency. The currency union is yet another step on the road to greater economic, social, and political integration in Europe – a vision some 50 years in the making. To be sure, this is a remarkable achievement. Especially when you think that not too long ago many observers were still very sceptical that these countries would be prepared to give up their national currencies. Or, indeed, that they would be able to meet the requirements for participation. The launching of the euro has naturally piqued public interest in Canada, leading some commentators to suggest that we should consider a similar type of monetary arrangement as a follow-up to the North American Free Trade Agreement (NAFTA). Today, I would like to talk about some of the economic implications of the European currency union. I also intend to examine whether this common currency model has any relevance for North America. Should Canada be thinking of a new monetary arrangement along similar lines? A common currency for Europe The introduction of the euro no doubt qualifies as an economic event of historic proportions. And some of the commitments required of the participating countries have, indeed, been momentous. This month, 11 European countries permanently locked in their exchange rates, adopted a common currency, and effectively ceded the conduct of their national monetary policy to a supranational institution – the European Central Bank (ECB). To some degree, the national central banks of the participating countries are now like the regional federal reserve banks in the United States. To understand how this major change in European monetary arrangements came to be, it is important to keep in mind that profound political forces started the process and have provided the impetus for action through the years. Indeed, one could argue that had this been a strictly economic initiative it might not have materialized. The impetus essentially stemmed from the belief that greater economic integration would foster permanent reconciliation, and thus peace and stability, among European nations. And with a shared currency, the economic integration would become much more difficult to reverse. The history leading up to the adoption of the euro is fascinating, with roots extending back to the years immediately following World War II. I will not go through the steps that led to the introduction of the euro. Suffice it to say that the process has been a major political, administrative, and technical feat. Imagine the logistics of transposing monetary values from national currencies – German marks, French francs, Italian lire, etc. – into euros during the first weekend of 1999. And apparently this conversion was carried out without any major hitches. But the process of conversion is not yet complete. New euro notes and coins are not actually circulating yet, and will not be until January 2002. While financial market transactions must be –2– carried out in euros, for all other transactions the use of the euro is optional over the next three years. The euro can now be used for purchases by credit or debit card, cheque, or traveller’s cheque. Companies may do their accounting and pay their workers’ salaries in euros. But, on the whole, most Europeans are unlikely to notice much change right away in their daily lives, other than that prices in stores may be quoted in both euros and the old domestic currency. What is crucial, however, is that the conversion rates of the national currencies in the monetary union are now irrevocably fixed against the euro and against each other. In this sense, the national currencies now exist only as price measures and as temporary subdivisions of the euro. Just as the Canadian dollar is composed of 100 cents, you can think of the euro as being temporarily composed of 6.56 French francs or 1.96 German marks. What are the economic implications of the euro? What does it mean for these 11 countries to be sharing a common currency? First, you may have noticed that, as much as the launching of a common currency across these countries (collectively referred to as euroland) was a major event, it did not have a dramatic initial financial or economic impact. This is because of arrangements that have been in place for some time. For example, all currencies in the system had been effectively pegged to the German mark since May 1998; and some for much longer. With pegged exchange rates, interest rates in participating countries have tended to move together, in line with German interest rates. And over the past year, short-term official interest rates in all 11 countries gradually converged to the current single rate of 3%. Moreover, with an effective common market already operating in Europe, a common trade policy and more integrated internal markets have been in place for some time. Just what does the arrival of the euro change, then? A shared currency undoubtedly brings a number of economic benefits to the euro-zone countries. The main benefit comes from eliminating the costs of conversion from one currency to another in the 11 member countries. Thus, the flow of goods, services, and capital across national borders is no longer complicated by the use of different currencies. Comparisons of prices among suppliers throughout the euro zone are easier to make, which should spur greater competition and efficiency. And there is no need for hedging to protect buyers or sellers against the risk of currency movements. On the whole, there is greater certainty about the future when the risk of exchange rate fluctuations is eliminated among countries that have highly integrated trade and investment. The migration to the euro has required a major investment in time, resources, and technology by financial sector institutions to prepare for the conversion. But over time, euroland is likely to end up with deeper and more liquid bond and stock markets. And that has the potential to enhance Europe’s share of the global financial industry and the euro’s attractiveness as a major international reserve currency. Of course, this will not happen overnight. It will take time. As for economic policy, the main change that comes with the euro is the shifting of responsibility for monetary policy from national central banks to the European Central Bank. Beginning this month, a single monetary policy applies across all euroland countries – just as here in Canada we have the same monetary policy right across the country. The responsibility for monetary policy decisions for the euro zone is now in the hands of the Governing Council of the ECB. The –3– council consists of six members of an Executive Board plus the governors of the 11 national central banks. The ECB is an autonomous institution with a mandate to achieve price stability. Under these new arrangements, member countries give up that part of their national sovereignty which relates to monetary policy. In effect, individual countries no longer have the option to pursue an independent national monetary policy. What is the significance of this? Over the longer term, monetary policy has its effects only on the rate of inflation. So if all euroland countries were already aiming at price stability, the loss of sovereignty involved in not being able to choose a national inflation target may not seem all that important. Nonetheless, there can be differences of opinion about the appropriate definition of price stability or how quickly to return to the target inflation rate when unanticipated events cause a deviation from the target. More importantly, with a common currency, individual countries can no longer benefit from having their national currency operate as a buffer in the event of an economic shock. Take the case of a sharp rise in world energy prices. In this instance, an energy-producing country would experience rising incomes, expansionary demand pressures, and perhaps increased capital inflows. Countries that are heavy users of energy would experience the opposite effects. Exchange rate movements can help smooth the economic adjustment to such a shock, through a rise in the currency of the energy-producing country and a decline in the currency of the energyimporting country. Where exchange rate movements are not an option, as within the current euro area, greater price and wage flexibility or greater worker and capital mobility between national economies will be needed in response to the shock. Otherwise, the adjustment will be more painful and costly, involving greater fluctuations in national output and employment. Europe is still characterized by significant wage and price rigidities and by low worker mobility, which could make the adjustment to shocks more difficult. Evidently, the hope is that participation in the currency union will act as a catalyst for action to reduce or eliminate these rigidities. The economic case for a common currency in Europe rests mainly on a judgment that buffering differential shocks in the partner countries will be a less important consideration than the benefits from lower transactions costs and from the greater economic certainty because of reduced currency risk. This presumes that the economic structures of these countries are sufficiently alike that any shocks will be felt by all of them at roughly the same time and to a similar degree. A good number of the euro countries probably fall into this category. Those that do not may find themselves having to adopt measures to increase price and wage flexibility, as well as encourage worker and capital mobility, to take the place of adjustments in the exchange rate. What are the implications and relevance of the European currency model for Canada? Canada’s trade links with Europe are relatively modest. Only 4% of our exports go to euroland countries and about 7% of our imports come from there. So the direct economic effects on Canada from any developments in Europe related to the move to a common currency are likely to be rather limited, at least in the short run. Of course, should the new monetary union lead to changes in world trade and finance over time, Canada would feel an impact, like any other country. But it is difficult to assess the likelihood and extent of any such changes. In the meantime, I hope that Canadian businesses trading with Europe have made the adjustment to the new currency and are seeking to benefit from the lower costs of operating in Europe that go with it. –4– One thing that the launching of the euro has done in Canada is to generate discussion of the notion that we should be thinking of a North American monetary union with the United States (and perhaps Mexico). The decline in the external value of the Canadian dollar over the past year has, no doubt, heightened interest in the issue. Before I get into the arguments, let me remind you that we are talking about a currency union, not just a fixed exchange rate. Fixed rates that can be adjusted (that is, devalued or revalued) do not eliminate exchange rate uncertainty. Indeed, as we have seen recently in Asia, in Mexico in 1994, and in Europe in 1992, when adjustments are resisted, fixed exchange rates can become unsustainable. To obtain the economic benefits that I described earlier, a currency union, not just a fixed exchange rate, is required.* But, as I have also noted, even with a currency union the economic benefits come at a price. And that price is the loss of a degree of political and economic autonomy and flexibility. Just how significant would that price be for Canada? It is important to remember that, in the case of euroland, the monetary union is a considered, conscious choice that fits into the long-envisioned larger plan of greater economic, social, and political integration. But in North America, there are no parallels to these profound political forces. Nor does NAFTA entail the degree of economic integration involved in the European Union. Moreover, for Canada, any monetary union one might imagine with the United States would not only result in a loss of autonomy over monetary policy but would work very differently from the European monetary union. In Europe, there are three large partners of roughly comparable size and eight other medium- and smaller-size participants. Any North American monetary arrangement would most likely mean that Canada would have to adopt the US currency. For Canada, the other major problem with a single North American currency is that we would be giving up the buffer that a flexible exchange rate provides in dealing with shocks that affect us differently from the United States. An important contrast between Canada and the United States is the distinctly different impact that fluctuations in the world prices of primary commodities have on our two economies. To a significant degree, Canada is still an important producer of primary commodities. And we are major net exporters of such commodities, while the Americans are small net importers. Thus, Canadian and US terms of trade (the ratio of export to import prices) move in opposite directions when there is a sharp movement in world commodity prices. Take the past two years or so: with a decline of over 25% in such prices, our terms of trade deteriorated by about 6% while the US terms of trade improved by 5%. When the terms of trade turn against us, it means that, on average, we receive less attractive prices for the goods we sell abroad compared with the prices we pay for the products we import. As a nation, we become less well off compared with our trading partners. That is reality, and we have to adjust to it, whether we are on a floating or a fixed exchange rate or even in a currency union. The value of the Canadian dollar reflected that reality by moving lower last year. This helped to smooth the process of adjustment. If the exchange rate is not allowed to move, then the * Another arrangement that would involve greater commitment to exchange rate stability than just a fixed exchange rate is a currency board. With a currency board, there is a legislated commitment to convert local currency into the currency used as an anchor, say the US dollar, at a fixed exchange rate. And enough reserves would be held in US dollars to cover all the local currency issued by the currency board country. But, as the recent pressures on the currency boards of Argentina and Hong Kong demonstrate, even then, exchange rate uncertainty is not completely eliminated, especially at times of major global nervousness and volatility. –5– adjustment would have to take place primarily through declines in prices and wages and the movement of labour and capital. And if those did not readily occur, the adjustment would take longer and cost more in terms of losses in output and employment. It is precisely for these reasons, and not by accident, that the Government of Canada has, for the better part of the past 50 years, operated a floating exchange rate. Concluding remarks The introduction of the euro ushers in an exciting new era for the Europeans, and we should all wish them well. But the euro is not a blueprint for a North American monetary union. The political objectives that motivated monetary union in Europe do not have a parallel in North America. More importantly, Canada has a very useful economic safety valve in its floating exchange rate. Because movements in the Canadian dollar reflect external shocks as well as any domestic economic difficulties we may face, there is sometimes a tendency in Canada to blame such movements as the cause of our problems. In fact, these currency movements are a consequence, not a cause. Exchange rate flexibility has served us well over time. Why would we want to give it up? ***
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Text of the Tony Hampson Memorial Lecture by Gordon G Thiessen, Governor of the Bank of Canada, at the C D Howe Institute, Toronto, Ontario, on 11 March 1999.
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Mr Thiessen discusses the change in views on the role of monetary policy since the Porter Commission Text of the Tony Hampson Memorial Lecture by Gordon G Thiessen, Governor of the Bank of Canada, at the C D Howe Institute, Toronto, Ontario, on 11 March 1999. A. TONY HAMPSON AND THE PORTER COMMISSION Tony Hampson made a number of outstanding contributions to Canadian public life as well as having a successful business career. Many in this audience will be familiar with the fact that for a number of years he was Chairman of the C.D. Howe Institute’s Policy Analysis Committee. Early in his career, he worked on the Royal Commission on Canada’s Economic Prospects (the Gordon Commission) and, most prominently, served as secretary of the Royal Commission on Banking and Finance (the Porter Commission). His colleagues, on these Commissions as elsewhere, remember an engaging personality, an ambitious and demanding manager, a clear-headed analyst, and a thorough and helpful editor. He was also a superb communicator and writer. Let me quote the acknowledgement in the Porter Report: “Our greatest debt has been to Mr. H. A. Hampson, the Secretary of the Commission. His intellect, organizing ability and energy proved invaluable in the planning of our work, the development of our views and the drafting of our entire report.”1 The hearings and analysis undertaken in the early 1960s by the Porter Commission, together with its Report and the discussions it generated, were events of major importance for the Canadian financial system and for the Bank of Canada. Indeed, I will suggest in this lecture that the Porter Report contained the seeds of a major reorientation of thinking about financial structure and monetary policy. Its emphasis on competition, and on the use of market mechanisms in the implementation of monetary policy, clearly showed the way ahead. It also foresaw many of the subsequent changes in financial institutions and markets. Moreover, the Commission underlined the necessity for inflation control at a time when the view that inflation could be traded off for lower unemployment was gaining in popularity. The Commissioners themselves, chaired by Chief Justice of Ontario Dana Porter, were people of experience and insight. They assembled an extraordinarily talented young research staff, and Tony Hampson proved to be an admirable team leader. The Commission believed in markets. This was not such a popular stance at the time. Extensive government controls, a legacy of the post-World War Two period, were still in place in many advanced economies, and they were widely thought to be necessary, if not desirable. In contrast, the Porter Commission felt that the somewhat more liberal financial regime in Canada was by and large working effectively. The financial system had played a central role in the post-war expansion, especially in the smooth financing of the tremendous wave of investment in the 1950s. Moreover, at the time it was undergoing considerable change, in response to the evolving demands in the financial markets of households, firms and governments. On the basis of this encouraging experience, the Porter Report came out strongly in favour of increased competition and deregulation. It was aware that this might entail some risks, but thought they were worth taking. Porter Commission Report, p. 572. This advice was followed in the revisions to federal financial legislation of 1967, notably in the following measures:2 removal of the 6 per cent ceiling on bank loan rates; permission for banks to enter conventional (i.e. non-government-insured) mortgage lending; prohibition of interbank agreements on interest rates and of interlocking directorates; and the reduction of the burden of cash reserve requirements on chartered bank deposits. These measures have stood the test of time and have served Canada well. For example, the liberalization of interest rates allowed financial institutions to adapt appropriately to the requirements of the more volatile financial environment of the decades that followed. Canada was spared the systemic weaknesses caused elsewhere by ceilings on administered interest rates. In the United States, for example, such ceilings were a major factor encouraging the unbalanced portfolios of the thrift institutions, which in the 1980s would be revealed as a fatal flaw. In more philosophical terms, Porter’s arguments on financial liberalization and competition were ahead of their time, and still read very well today. I cite all this to underline that the Porter Commission made an important difference to our financial landscape. But financial reform, important and topical though it may be, is not the central theme of my lecture. Instead, I will focus on the Commission’s work on the conduct of monetary policy. First, I will set out a broad characterization of the view of monetary policy in the Porter Report. I have not tried to provide a thorough description of the Commission’s analysis of monetary policy. Rather, I have focused on a few general policy issues that strike me as important. Next, I will present the general approach to policy that is taken today. Comparison of the two, you will see, reveals some striking differences, but also some common themes. These themes lead me to the view that the Porter Commission Report and the surrounding debate were a key step in the evolution towards the current monetary policy framework in Canada.3 B. THE PORTER COMMISSION VIEW OF MONETARY POLICY 1. The basic framework The Porter Report in most respects adopted a standard 1960s view of monetary policy. It was the heyday of Keynesianism, in official circles as well as in the universities. Although Milton Friedman and his collaborators had begun their restoration of the quantity theory with some The main revisions were to the Bank Act and the Bank of Canada Act. While the Commission had recommended a comprehensive definition of banking, the legislation did not go so far as to eliminate distinctions between different kinds of financial institutions. Moreover, the Commission was against government-backed deposit insurance, which was nevertheless enacted in 1967, following a run on a trust company. The Commission also dealt with the issue of central bank governance. It recommended formalizing the agreement on dual government-Bank of Canada responsibility that Louis Rasminsky had drawn up before accepting his appointment as governor. In consequence, the Bank of Canada Act was amended in 1967 to provide the Minister of Finance with the right to issue a directive to the Bank if the government disapproved of the Bank’s policy. Thus, the government is ultimately responsible for monetary policy, but if no directive is issued the Bank has full responsibility for designing and implementing monetary policy. impressive, if controversial, empirical work,4 theirs was very much a minority view in the early 1960s. There were four key tenets in the standard view of monetary policy at the time.5 First, monetary policy was seen as just one element of macroeconomic policy, which in its entirety has multiple objectives (high employment and output, low inflation, rapid economic growth, external balance, etc). And it was argued that monetary, fiscal and debt management policies should be coordinated in pursuit of these objectives. These propositions reflected a strong focus on the short run. While there is no doubt that monetary policy and fiscal policy both affect real variables in the short run, it was less clear at the time that the effects of monetary policy on the demand for goods and services did not extend into the longer run. Given its short time horizon, it was not surprising that macroeconomic analysis in the 1960s focused on stabilizing output and employment. Second, monetary policy on its own was viewed as not very effective. Large movements in credit conditions or interest rates might in theory have a large economic impact, but they had to be avoided because of harmful side effects (instrument instability, financial instability, balance of payments repercussions, etc.). The changes in credit conditions that were feasible had a comparatively limited effect. Third, the credit channel was thought to be the main source of impact of monetary policy on the economy. Conventional monetary policy instruments (open market operations, bank reserve management, and Bank Rate changes) were said to affect credit flows by changing the liquidity positions of financial institutions. This credit channel embodied the effects of both the availability and the cost of borrowing. However, its overall influence was complex and typically slow; and the impact of an easing of credit was considered to be especially weak – “you can’t push on a string.”6 Fourth, a need was seen for moral suasion or formal controls on lending in difficult short-run situations, such as balance of payments crises. The Commission recognized the defects of such measures: arbitrary discrimination, economic distortions, and eroding effectiveness over time. However, the general view at the time was that such controls were helpful when quick effects were urgently needed. 2. The relationship between inflation and economic activity In 1958, A.W. Phillips published the analysis of the relationship between wage increases and unemployment in the United Kingdom that now bears his name, and researchers in the United States soon found a similar relationship.7 By the early 1960s macroeconomists were regarding See, for example, Friedman (1956). These ideas were also to be found in similar inquiries of that time in the United Kingdom (the Radcliffe Report) and in the United States (the Commission on Money and Credit). However, there were some differences in the argumentation of the three reports. For example, Radcliffe was most interventionist while Porter was the strongest advocate of market mechanisms. Porter Commission Report, p. 434. Phillips (1958), Samuelson and Solow (1960). the Phillips curve as a description of a policy trade-off between inflation and unemployment. By accepting more inflation, it seemed possible to reach a higher level of output. A seminal study of the policy implications of the Phillips curve was in a Royal Commission Working Paper by Grant Reuber.8 The Porter Commission accepted this line of reasoning and argued that a balance had to be struck between the goals of price stability and maximizing output, and that neither should be pursued to the exclusion of the other. At the same time, however, the Commission was aware that inflation could have very negative longer-run consequences for the economy. “The objective of stable prices..., while desirable for its own sake, is also important as a means to a wider end.... rising prices can weaken real economic growth by undermining the system of fixed value contracts on which efficient business is founded, by generating a fear of long-term saving and lending commitments, and by diverting real resources into unproductive and inefficient channels ....”9 In a similar vein, the Report rejected the argument for mild inflation to lubricate real wage adjustment, after noting that productivity was increasing at 2 per cent a year, so that a considerable degree of adjustment was possible without real wage declines, and that measures to increase market flexibility were a better solution. The Report also described inflation as acting “like a drug whose dose must be continually increased to get the same effect: if the authorities permitted the economy to become addicted, the inevitable return to reality would bring about very painful withdrawal adjustments.”10 These passages were prescient in the light of what was to happen over the next 20 years. However, the Report struggled to reconcile its advocacy of multiple targets with its vivid warnings about inflation. The tension between the two, we can now see, stemmed largely from a lack of clarity about relevant time horizons. The multiple targets approach to monetary policy focused on the short-run trade-off between inflation and unemployment. It did not recognize that this trade-off disappears over time as inflation expectations adjust to changes in the rate of inflation. The idea of a vertical long-run Phillips curve, which was implied by the adjustment of inflation expectations, was developed only later in the decade.11 At the same time, the Report did recognize the likely damage that inflation could cause in the longer run to the productive capacity of the economy. In the end, the Report did not recommend the firm guideline for monetary policy that its spirited advocacy of price stability would, in retrospect, seem to have justified.12 Despite this ambivalence, the Commission was more far-sighted in its concerns about inflation than the See Reuber (1962, 1964). Porter Commission Report, pp. 399-400. Porter Commission Report, p. 419. The main authors were Milton Friedman (1968) and Edmund Phelps (1967). The Submissions of the Bank of Canada also pointed to the importance of restraining inflation (II, paragraph 59): “Central banks feel a particular obligation for seeing that in the consideration given to the proper ‘mix’ of public policies adequate emphasis is at all times placed on price stability... being in a position to exercise an influence on the volume of money, they must inevitably be concerned with its value.” consensus of economists of the day, which was that the Bank of Canada had been investing too much in fighting inflation.13 3. The scope for monetary policy under a fixed exchange rate Canada had been on a floating exchange rate regime when the Porter Commission was appointed in October 1961, but the government adopted a fixed exchange rate in May 1962. Given the degree of asset substitutability between Canada and the United States, Canadian interest rates were thereafter tightly constrained by the objective of maintaining the dollar at the parity of 92.5 U.S. cents.14 With respect to longer-run policy objectives, as we know today, the fixed exchange rate implied that monetary policy in Canada would be mainly determined in the United States. However, the prevailing opinion among economists, reflected in the Porter Report, was that Canadian monetary policy could nevertheless serve a constructive short-run purpose with respect to the range of macroeconomic policy objectives, as long as the currency was fixed at a reasonable value and the government had an adequate reserve of foreign exchange. At the time, most policy-oriented economists did not draw the sharp distinction we now do between fixed and floating exchange rate regimes. To understand this, we have to recognize three factors. First, under Canada’s floating exchange rate regime of the 1950s – which was the only post-war experience in the industrialized world to go by – variations in the exchange rate had been quite modest, as had the movements in Canada-U.S. interest rate differentials. That is, in practice, the float did not appear to be very different from a fixed rate regime. Second, with their focus on short-run output and employment, policy-makers tended to neglect the possible inconsistency between the objective for domestic inflation and the fixed exchange rate. Third, the theory of monetary policy in an open economy was in a fairly rudimentary state.15 The severe constraints that a fixed exchange rate imposes even on shortrun monetary policy choices in a world of high asset substitutability were not fully appreciated at the time. In the case where a conflict might materialize between domestic objectives and the fixed exchange rate for the dollar, the Commission recommended that domestic considerations should prevail, and that the exchange rate parity be allowed to change. But it did not reopen the debate over the exchange rate, which had been a topic of heated political controversy earlier in the decade. By 1964, at the time the Report was published, the view of the Canadian authorities was very much that the fixed exchange rate system was appropriate, and that the existing parity was in the right range. In part these views stemmed from theories of inflation that emphasized non-monetary factors, e.g. cost push, union or seller power, demand shift, struggle for income, and so on. Exchange controls had been eliminated in the early 1950s. The Canadian dollar would remain fixed until June 1970. Robert Mundell was at that very time making the contributions that would form the standard modern model for open-economy policy analysis. See Mundell (1961, 1962, and 1963). 4. Monetary policy instruments and the transmission mechanism Both the Porter Commission and the Bank in its submissions described the transmission of monetary policy actions in terms of their effects on credit conditions. By credit conditions they meant “the whole range of terms and conditions affecting borrowing and lending and the purchase and sale of financial assets.”16 This would include, most importantly, interest rates, but also standards of creditworthiness, collateral, repayment periods, and other terms and conditions. In general, whereas the Bank of Canada17 stressed the importance of availability effects, the Porter Report was more inclined to give a central place to interest rates. One of the reasons why the Bank of Canada put so much emphasis on credit availability at that time was because, even apart from the 6 per cent bank loan rate ceiling, it believed that wide fluctuations in interest rates were not feasible. Indeed, historical experience was of a quite narrow range of interest rate movements. For example, the prime lending rate of the chartered banks, a key rate in the transmission mechanism, had never been lower than 4.5 per cent, while the maximum legal rate was 6 per cent – a range of 150 basis points. There simply had not been much scope for borrowing costs to vary. As outlined by the Commission and the Bank, there were a number of possible reasons for this belief that wider movements in interest rates were not feasible: the possibility of instrument instability (with interest rates swinging abruptly), the potential effect of sharp changes in security prices on the stability of financial institutions, adverse public opinion, and the external constraint posed by the fixed exchange rate. While the Commission agreed with some of these concerns, it nonetheless argued that such considerations should not stand in the way of a vigorous monetary policy. The Porter Report accepted, however, the description put forward by the Bank of Canada of the way that monetary policy affected the operation of chartered banks. The provision of cash reserves by the Bank of Canada would bring about changes in chartered bank holdings of liquid assets, which over time would affect the banks’ willingness to make loans. However, when quick results were deemed necessary, the Bank felt that resort to direct limits on bank lending would be justified. On the several occasions that moral suasion had been employed in the 1950s, it had seemed to work. The Commission showed little enthusiasm for such intervention. It argued that controls impaired market efficiency, were discriminatory, and were of diminishing effectiveness over time. There was also a concern about their clumsiness, especially the delays in making instructions effective in bank branches across the country, and possible misinterpretation of their eventual withdrawal. Despite all that was said and done about the credit conditions approach to monetary policy, empirically any significant effects seem to have been confined to a few brief periods of moral suasion and the impact on residential construction of the lags in changing the administered NHA mortgage rate and the interaction between this rate and the 6 per cent bank lending rate ceiling. The available empirical evidence did not indicate that changes in credit conditions systematically had much effect on aggregate demand. Econometric tests reported in the Commission’s Working Papers show no significant effects on consumption and investment Bank of Canada Submissions, II, para. 11. Bank of Canada Submissions, II, paras. 13 and 14. spending from interest rate or credit variables.18 This seems to have been because monetary policy actions had not been very aggressive. These results confirmed the conventional belief that ordinary monetary policy actions were not very effective. And this was a major reason for the insistence on policy packages with the right mix of fiscal and monetary policy, plus coordinated debt management policy, and on the possible need for moral suasion and/or some sort of direct controls on bank lending. 5. The role of debt management I have noted that the package of macroeconomic policies advocated during the 1960s tended to include debt management policy along with fiscal and monetary policies. Certainly, central bankers of the day regarded debt management policy as an integral part of macroeconomic policy. The Porter Report had some sympathy with this notion. There were three discernible lines of thinking here. First, monetary policy is itself a kind of debt management with an open market operation switching one public sector liability (central bank deposits) for another (e.g. treasury bills). Second, changes in relative supplies of debt could affect the liquidity of the banks and hence their willingness to lend. Third, debt management might directly alter the term structure of interest rates. These notions may have had greater plausibility at the time, when there were some indications of segmented markets. But over time, market segmentation diminished in importance as both lenders and borrowers became increasingly willing to adjust the maturity of their commitments in response to interest rate differences across the term structure. Moreover, in the years following the publication of the Porter Report, evidence accumulated supporting the expectations theory of the term structure of interest rates. According to this theory, long-term rates are the average expected value of future short-term rates, plus a liquidity risk premium. Although in principle the latter could vary systematically as the composition of debt changes, in practice such effects, if they exist at all, are of too short duration to have any macroeconomic impact. C. THE CANADIAN POLICY FRAMEWORK IN THE 1990s 1. The basic propositions Between the 1960s and the 1990s, informed opinion about the appropriate role of central banks shifted radically. The current mainstream view can be briefly summarized in the following four propositions. First, the main objective of monetary policy is to preserve the value of money, in other words to achieve a very low rate of inflation over the long run. Other economic objectives are not ignored, however, because price stability is the best contribution that monetary policy can make towards high employment and, more generally, towards a prosperous, growing economy. Second, an independent monetary policy, or, more precisely, a domestically set objective for inflation, logically requires a floating exchange rate. Third, markets, and price mechanisms, work efficiently and thus provide effective channels for the transmission of Johnson and Winder (1962) and Reuber (1962). monetary policy through short-term interest rates and the exchange rate. Fourth, short-term interest rates must be adjusted as much as required to meet the monetary policy objective. Most of the present policy framework is, I hope, reasonably familiar to you. So I will spare you further detail. Instead, I would like to underline the magnitude of the revision that has taken place in accepted thinking about monetary policy since the Porter Commission, and to speculate on the reasons for the shift. 2. Contrasts in views about policy objectives The sharpest apparent contrasts between the ideas and practices I have sketched for the two periods concern the objectives of monetary policy. Nowadays we focus the job of the central bank squarely on the single objective of price stability. In the 1960s, that would have been looked upon by most observers as an extreme and partial view of the role of monetary policy.19 What has been learned from the experience over the years is that high and variable inflation can be very costly for the economy and that aiming at low and stable inflation is the best contribution that monetary policy can make to achieving, over time, the multiple economic objectives espoused by Porter. Desirable economic outcomes can never be guaranteed, but chances of achieving them are best when inflation is low and stable. That is, low inflation is an indispensable asset for the achievement of the other economic goals.20 Consider, for example, the accepted view during the 1960s that there was an exploitable tradeoff between inflation and unemployment. Along with the short-term perspective of policymakers, this view led to excessively easy monetary and fiscal policies in most industrial countries. In Canada, we found ourselves confronted by an enormous and destructive inflation, with peaks in the mid-1970s and the beginning of the 1980s, and another bout of upward pressure in the late 1980s. Moreover, the high rates of inflation were accompanied by an economic slowdown in the 1970s (reflected in the coining of the term “stagflation”) and were followed by unusually sharp economic recessions in the early 1980s and early 1990s. The idea of an exploitable long-run trade-off between inflation and unemployment was effectively demolished by this experience. And the lesson was reinforced by the success of the firm stance in favour of price stability taken by the German and Japanese central banks in the late 1970s. The Bank has long had a concern about restraining inflation. What was lacking in the past was the support from theory and experience to make that focus more precise and explicit. Public milestones in the evolution of the Bank’s views were three lectures by my predecessors: the 1966 Per Jacobsson Lecture by Louis Rasminsky on the objectives of monetary policy and the mechanisms through which it operates; the 1982 Per Jacobsson Lecture by Gerald Bouey, which highlighted the need for a “place to stand” or, in other words, for a “nominal anchor”; and the 1988 Hanson Lecture of John Crow, which singled out price stability as the objective of monetary policy in Canada. Also, I would draw attention to Gerald Bouey’s final Annual Report, for 1986, which emphasized the costs of inflation and the difficulty of reducing it once entrenched. For a fuller explanation of the relation between price stability and other economic objectives, see Thiessen (1998-1999). The inflation of the 1970s and early 1980s demonstrated just how costly inflation was and how difficult it was to eradicate once rooted in expectations. These experiences were key factors underlying the shift in views about monetary policy. They also were central to the acceptance of the expectations-augmented Phillips curve in place of the simple Phillips curve as part of the analytic framework underlying monetary policy. This is not just theory or central bank ideology. As we look around the world and over history, we see that countries that achieve high standards of living and sustained strong output growth have also maintained low rates of inflation. 3. Understanding the role of the exchange rate in monetary policy As I explained earlier in this lecture, when the Commission was preparing its Report, neither the then current economic theory nor the Canadian experience of the 1950s provided strong evidence for the crucial role that exchange rate flexibility plays in the operation of monetary policy in an open economy like Canada’s. When we floated our exchange rate in 1950 and again in 1970, it was because we were pushed off our pegged rate by the pressures of rising commodity prices and associated strong inflows of capital. The notion of a national monetary policy with an independent inflation target did not feature in these decisions. As we now see it, a floating exchange rate plays two key roles. In the first place, in the long run a floating currency allows the central bank to pursue a national inflation target, regardless of the behaviour of foreign inflation. In the second place, variations in the currency allow the real exchange rate, and hence the economy, to adjust more smoothly to international shocks to relative prices. It was only after currency and capital controls began to be removed (or were increasingly bypassed) in the post-war period, and domestic financial markets became more deregulated in a number of countries, that economists came to appreciate fully the interaction of domestic interest rates and exchange rates. In open economies with unhindered capital flows, it is only when the real exchange rate moves to levels where it is widely expected to appreciate or depreciate that domestic real interest rates can temporarily move away from their international counterparts. Furthermore, what we understand much more clearly these days is that movements in the real exchange rate are a major part of the process whereby an economy returns to a sustainable growth path after being hit by a shock. For example, it is well known that a drop in world commodity prices reduces the real equilibrium value of the Canadian dollar. If this is brought about by currency depreciation, the overall domestic price level need not deviate from its target path. In contrast, with a fixed exchange rate, domestic prices would have to fall below that path, and perhaps fall absolutely, to bring about the required decline in the real exchange rate. It is clear that real exchange rate adjustment works much more smoothly when the nominal exchange rate can adjust. However, for the benefits of exchange rate flexibility to be realized, expectations about nominal exchange rates must be anchored by a monetary policy that is focused on maintaining low and stable inflation over the medium term. 4. Increased confidence in the resilience and efficiency of markets It would have been unthinkable in the 1960s to have suggested that the central bank’s influence over interest rates was, in and of itself, enough to enable it to keep the rate of inflation low and stable. The view at the time was that there were narrow bounds on how far interest rates could be moved, and that these severely limited what the central bank could accomplish by varying them. As a result, moral suasion to affect bank lending policies or direct controls were seen as important additional instruments for central banks. A key reason for the change in attitude today is an increased confidence in markets. Certainly, at central banks, we are more confident than we were in the 1960s of the ability of financial markets to absorb changes in interest rates. At the same time, we have accumulated strong evidence to support the view that market mechanisms transmit monetary policy actions effectively. In the 1960s the Porter Commission was ahead of the Bank, and of conventional wisdom, in this. It envisaged a monetary system that in key respects would function much as it does today – driven by market forces, flexible, and frequently undergoing rapid change. In its recommendations for reform, the Commission was looking forward to a world in which monetary policy would be increasingly reliant for its effectiveness on appropriate movements in financial market prices. In line with this view, the Porter Report maintained that institutions and markets were well able to withstand substantial shocks and warned against letting the conduct of monetary policy be excessively influenced by an undue concern for the stability of asset values. It saw that the aversion to significant interest rate movements expressed at the time by the Bank of Canada put at risk its ability to achieve its macroeconomic objectives. In one of its more colourful phrases, the Report warned that “the authorities must not be restrained by excessive tenderness.”21 However, the present confidence in markets is not just a question of philosophy. Since the 1960s, a variety of legislative and structural changes have made the financial sector still more resilient and flexible. This has made the transmission of monetary policy more efficient and has eliminated residual concerns about the inability of the markets to cope with the effects of central bank actions. D. CONCLUDING REMARKS Even though the Porter Commission had some remarkable insights, there is no doubt that there has been a major change in views since the 1960s with respect to the objective of monetary policy and the mechanisms through which policy works. Two factors stand out in trying to understand the change. The first is the simple accumulation of experience that has exposed some of the shortcomings in earlier thinking about macroeconomic policy. The second is the advances in the analytic framework available to policy-makers to help them analyze the workings of the economy and of monetary policy. These are not independent factors, of course, since economic analysis does change in response to experience. In this case, it was the inability of the previous framework to provide a satisfactory explanation of the developments in the second half of the 1960s and the 1970s that led to changes in the framework for analyzing the macroeconomy. Porter Commission Report, pp. 477-478. Experience of good and bad outcomes has thus played a major role in the development of views about monetary policy. The theory dominating the views of Tony Hampson and his colleagues was developed in response to the Great Depression of the 1930s. However, the views of my generation of central bankers have been coloured by the great inflation that marked our professional years. This brought back to the fore the fundamental truth about inflation being a monetary phenomenon that had become temporarily obscured in the 1950s and 1960s. I want to make sure, however, that I do not leave you with the impression that views on monetary policy are mere creatures of circumstance. Our belief in the objective of price stability has a more solid foundation than that. A vast range of historical evidence as well as a large body of economic theory have long supported this objective as a necessary factor for good performance with respect to output, employment, and growth. I would like to end this lecture by drawing attention to the area in which central banking has probably changed most dramatically quite recently. This is the move, particularly during the 1990s, towards much greater transparency and public accountability in monetary policy and in the operations of central banks generally. Here again, the Commission was insightful but did not make strong recommendations for greater transparency.22 Since 1991, the use of explicit low-inflation targets as the objective of monetary policy has been the most prominent aspect in Canada of this broader development. We now believe that our actions are likely to be more effective and more credible to the extent that they are more clearly understood and more predictable. Therefore, today we provide the public with large amounts of data and commentary on monetary policy, in our regular publications, on the internet, and in response to specific requests. We also try to give information on the outlook for the economy and monetary policy in our Monetary Policy Reports, in speeches by Bank of Canada officials, and in the extensive informal contacts of our regional offices across the country. In our Technical Reports and Working Papers and annual economics conferences, the Bank makes its latest research available in a timely fashion. This is a two-way street, by the way, since feedback and criticism are essential to good research. There has been a similar move to openness with respect to the process of policy implementation. Since 1994, the Bank has announced its operating band for the overnight interest rate, which is now tied to the Bank Rate. And since 1996, press releases providing an explanation of the Bank’s actions have accompanied each change in the Bank Rate.23 Much of this is quite a break from the past, since traditionally central banks liked to retain a strong element of mystery about their conduct of policy and at times liked to have the capacity to surprise the market with shifts in the supply of reserves to move the overnight rate. “Mystery leads to misinformation, and monetary policy needs informed public opinion to function effectively and acceptably. As the Governor pointed out, much of this information must be backwardlooking, but we believe it need not all be.” Porter Commission Report, p. 555. For a detailed discussion of the movement to greater transparency, see Thiessen (1995). Public opinion has been an underlying driving force in this movement towards transparency. People expect much more than they used to with respect to the accountability of public institutions. The great expansion in higher education over the past 40 years, and with it the rise in sophistication about financial and economic matters, mean that the public is more apt to raise questions about economic policies. The amount and the quality of the information that we provide has had to keep in step. Also, the great inflation, which has had a lasting effect on perceptions about the value of money, has led to a heightened interest in the conduct of monetary policy. Expectations are not held as firmly as they were in the 1950s and early 1960s. People have had to be convinced in recent years that price stability is a credible objective. They still do not take the present low inflation completely for granted. Each action of the central bank is liable to be scrutinized for any sign of backsliding. For example, the volatility of bond and foreign exchange markets, which persists despite almost a decade of low inflation, can partly be attributed to lingering uncertainties with respect to future price movements. At the Bank of Canada, we have taken the position that these concerns are best confronted by making clear statements about the objective and strategy of monetary policy, by releasing our economic analysis to outside examination, and by publishing all relevant data. It is possible that some future governor of the Bank of Canada will want to give a lecture looking back at monetary policy in the 1990s. I believe that this future governor will be particularly impressed by the influence that demands for transparency and public accountability have had in shifting the culture of central banks and their approach to monetary policy in the 1990s. References – 1999 Hampson Lecture Bank of Canada. 1962. Submissions by the Bank of Canada to the Royal Commission on Banking and Finance. Ottawa: Bank of Canada. ---------------. 1987. Annual report of the Governor to the Minister of Finance and statement of accounts for the year 1986. Ottawa: Bank of Canada. Bouey, Gerald K. 1982. “Monetary Policy – Finding a Place to Stand.” The Per Jacobsson Lecture, University of Toronto, Toronto, September 5. Crow, John. 1988. “The Work of Canadian Monetary Policy.” The Eric J. Hanson Memorial Lecture, University of Alberta, Edmonton, January 18. Friedman, Milton. 1956. “The Quantity Theory of Money – A Restatement,” in Studies in the Quantity Theory of Money, edited by Milton Friedman. Chicago: University of Chicago Press. --------------. 1968. “The Role of Monetary Policy,” American Economic Review, Volume LVIII, Number 1, (March): 1-17. Johnson, Harry G. and John W. L. Winder. 1962. “Lags in the effects of monetary policy in Canada,” Working Paper prepared for the Royal Commission on Banking and Finance. Mundell, Robert A. 1961. “Flexible Exchange Rates and Employment Policy,” The Canadian Journal of Economics and Political Science, Volume 27, Number 4, (November): 509-517. ---------------. 1962. “The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability,” IMF Staff Papers, Volume IX, Number 1, (March). ---------------. 1963. “Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates,” The Canadian Journal of Economics and Political Science, Volume 29, Number 4, (November): 475-485. Phelps, Edmund S. 1967. “Phillips Curves, Expectations of Inflation and Optimal Unemployment Over Time,” Economica, Volume XXXIV, Number 135, (August): 254- 281. Phillips, A. W. 1958. “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957,” Economica, Volume XXV, Number 100, (November): 283-299. Porter Commission Report. 1964. Report of the Royal Commission on Banking and Finance. Ottawa: Queen’s Printer. Radcliffe Report. 1959. Committee on the Working of the Monetary System. Report. (August). London: Her Majesty’s Stationery Office. Rasminsky, Louis. 1966. “The Role of the Central Banker Today.” The Per Jacobsson Lecture, Altieri Palace, Rome, Italy, November 9. Report of the Commission on Money and Credit. 1961. Money and Credit: Their Influence on Jobs, Prices and Growth. New Jersey: Prentice-Hall. Reuber, Grant L. 1962. “The objectives of monetary policy,” Working Paper prepared for the Royal Commission on Banking and Finance. ---------------. 1964. “The Objectives of Canadian Monetary Policy, 1949-61: Empirical “Trade-offs” and the Reaction Function of the Authorities,” The Journal of Political Economy, Volume 72, Number 2, (April): 109-132. Samuelson, Paul A. and Robert M. Solow. 1960. “Analytical Aspects of Anti-inflation Policy,” American Economic Review, Volume 50, (May): 177-94. Thiessen, Gordon G. 1995. “Uncertainty and the transmission of monetary policy in Canada.” The HERMES-Glendon Lecture, York University-Glendon College. Bank of Canada Review (Summer 1995): 41-58. ---------------. 1998-1999. “The Canadian experience with targets for inflation control.” The Gibson Lecture, Queen’s University. Bank of Canada Review (Winter 1998-1999): 89-107.
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Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Mennonite Savings and Credit Union Kitchener, Ontario 22 March 1999.
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Mr Thiessen reports on the future of the Canadian financial sector, the economy and monetary policy Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Mennonite Savings and Credit Union Kitchener, Ontario 22 March 1999. I am delighted to be with you this evening to celebrate the 35th annual meeting of the Mennonite Savings and Credit Union. On this occasion, I propose to speak about the Canadian economy and monetary policy. But given this audience, I thought I might start with some remarks on the future of the Canadian financial sector – a subject that has certainly grabbed its share of headlines over the past year! In December 1996 the Minister of Finance appointed a Task Force to assess the current situation and the future prospects of the Canadian financial services sector, and to make recommendations for change. In early 1998, while this inquiry was still on, four of Canada’s six largest banks announced plans to merge. The Task Force submitted its report (the MacKay Report) last September. In December 1998 the Minister of Finance, having taken into account that report as well as assessments of the proposed mergers by the Office of the Superintendent of Financial Institutions and the Competition Bureau, decided not to allow the mergers. The Government is now examining the issues facing the financial services sector and, in the course of 1999, it intends to present its proposals for modifying the relevant regulatory framework. The Bank of Canada is one of several agencies in Ottawa that provide advice to the Minister of Finance on the appropriate legislative framework for the financial industry. Because of this, I am not in a position to comment on specific proposals for change. But what I can do is offer some general comments on the broad issues involved in ensuring an efficient and sound financial industry in Canada as we strive to adapt to ongoing worldwide changes in the provision of financial services. Potential reforms of the Canadian financial system Canadian financial institutions are among the best providers of financial services in the world. These days, they are operating in an intensely competitive global marketplace, teeming with change spawned by rapid advances in technology and innovative new financial products. These powerful forces have transformed the way financial institutions around the world operate and the way they market and deliver their services. Globalization creates both opportunities and challenges. We must make sure that Canadian financial institutions can compete effectively in both domestic and international markets, and that they can offer Canadians innovative, world-class financial services. The MacKay Task Force says this means we should enhance competition in the financial services industry. How? Primarily by reducing restrictions on existing providers of those services and by encouraging new players to enter the field. Members of this audience know that one of the proposals for strengthening the position of existing participants is to give credit unions the option to form cooperative banks. More generally, provided prudential concerns can be resolved, the Task Force suggests that the regulation of credit unions be re-examined to encourage them to become more active, dynamic competitors within the financial industry. We would all agree that consumers of financial services are best served when there is effective competition among financial institutions. A strongly competitive financial industry will provide customers with the best deals for loans, deposits, insurance, and so on. Such an industry would also be more innovative and should provide a wider range of services. But the appropriate legislative framework for financial services cannot be one that simply maximizes competition without regard for the safety and soundness of the industry. Why all this concern about safety? And why do we regulate this particular industry more closely than virtually all others? There are two main reasons. First, the financial industry is the repository for the wealth of a large number of small savers. For most of these savers, it is very difficult and costly to make a personal judgment of the risks involved in doing business with a particular bank, credit union, or insurance company. The second reason has to do with what we call systemic risk, or contagion. This refers to the risk that problems in one particular financial institution will be transmitted to others. Contagion can occur when depositor nervousness about one institution spreads to others. As well, since the payments system links financial institutions closely together, the failure of one institution can potentially lead to serious losses for others. Governments have addressed safety concerns by imposing capital requirements on financial institutions, restricting their ability to engage in risky activities, supervising their adherence to riskreducing practices, and setting up deposit insurance. To limit contagion, central banks have the power to make liquidity loans to financial institutions in the payments system. And most central banks in industrial countries have been involved in initiatives to minimize the potential for systemic risk in their payments systems.1 When depositors feel ‘protected’, however, they are less inclined to monitor the riskiness of financial institutions. Thus, governments feel a greater need to regulate to reduce the risks of institutional failure. This tends to have side effects which could potentially restrict competition. What then is the scope of increasing competition, by encouraging new players and by reducing restrictions on existing ones, without undermining the safety and stability of the system? Clearly, there can be a tension between the goals of fostering greater competition within the financial sector and of preserving safety and stability. To find a balance between the twin objectives of efficiency and safety has always been a challenge for governments when they examine proposals to change the regulatory framework for the financial system. I do not mean to make this sound like an impossible task. There are bound to be some changes that can help promote competition without adding substantial risk to the system. More generally, though, I believe that we need to examine ways that could ease the tension between efficiency and safety. For example, if we are to encourage the entry of new financial institutions as a means of promoting greater competition, perhaps we should also consider a more formal, explicit policy of ‘early exit’ when an institution runs into trouble. One possible approach would be that when institutions reach some minimum level of capital, they would be required to recapitalize themselves or find a merger partner within a short period of time. Otherwise, and well before they became insolvent, they would be sold or wound up by the regulatory authorities. Such an approach might help reduce risks to depositors, to the deposit insurance system, and to other creditors of financial institutions. This is not a new idea. The United States has already moved in that direction and so have we in Canada, to a certain extent. But there may be room to move further down this path and, in so doing, to provide managers of financial institutions with stronger incentives to avoid getting into financial difficulties. To summarize, I agree with the MacKay Task Force that encouraging new participants and reducing restrictions on existing players in the financial industry would benefit customers through improved service and lower costs. But this may have the potential to increase risks for the financial system. So we need to look at ways to avoid having these risks add to the costs of deposit insurance and to the In Canada, under the Payment Clearing and Settlement Act, the Bank of Canada has been given formal oversight responsibility for ensuring that appropriate arrangements are in place to manage and control systemic risk in major clearing and settlement systems. costs for other users of financial services. One approach, as I mentioned, is to move further towards ‘early exit’ arrangements for troubled financial institutions. Such arrangements might not be easy to implement. But if we could move in this direction, there might be more scope to benefit from enhanced competition without exposing users of financial services to unacceptable risks or compromising the stability of the system. I would now like to turn to our economic situation and monetary policy. The state of our economy The past year has been a trying one, both for the world economy and for Canada. Still, considering the seriousness of the global difficulties we have been facing, the Canadian economy has coped much better than expected, and certainly better than in the past. This is because it is in sounder shape now than it has been for many years. Canadian businesses have been investing in new technology to increase productivity and efficiency. Governments are no longer draining national savings to finance huge budget deficits. And with the Bank of Canada’s commitment to inflation control targets, inflation is low and stable. But what about our economic prospects as we look ahead? Let me start with the financial climate. Global financial markets have been calmer recently compared with the turbulence last autumn after Russia declared a debt moratorium. Cuts in official interest rates around the world since then, and the success of some emerging market economies in addressing their problems, have clearly helped. International investors’ fears have abated, and markets seem to have regained a sense of their ability to assess risks and discriminate among borrowers. When it comes to the world economic environment, there is still uncertainty out there. But there are also positive elements in the picture. One area of uncertainty is the financial problems in Brazil and the extent of related economic weakness in Latin America more generally. If the Brazilians follow through on their fiscal adjustment program and limit the inflationary fallout from the depreciation of their currency, financial market pressures should ease, and growth in Brazil should resume next year. But the foremost uncertainty in the outlook continues to centre on Japan, where the economy remains in a slump. Nevertheless, if present efforts at bank reform continue, and if stimulative macroeconomic initiatives are pursued systematically, the Japanese economy should begin a gradual recovery, perhaps by late 1999. The economic expansion in the other industrial countries, which together account for about half of world output, should remain relatively well sustained. In Europe, economic activity has softened, but interest rate cuts since the autumn and the easing of global financial strains should help support confidence and domestic spending in coming months. The most positive element, certainly from a Canadian perspective, has been the remarkable performance of the United States. That economy ended 1998 on a much stronger note than had been expected, growing at an annual rate of 6% in the fourth quarter of 1998. Thus, its underlying momentum going into 1999 is much greater than most had supposed. This is confirmed by some of the advance data for early 1999. So even if growth slows, as expected, the US economy should continue to operate at high levels. There are also signs that the sharp economic downturns in some of the Asian countries most affected by the financial crisis are bottoming out. The economy of South Korea has started to expand, and in Thailand economic activity seems to have stabilized. However, a broad-based recovery in the region has yet to take hold and will depend, to an important degree, on economic conditions in Japan. Here in Canada, the impact of the global turbulence since the summer of 1997 was felt mainly through the lower demand for the key primary commodities we produce and the 20% decline in their prices between mid-1997 and end-1998. But consumer and business confidence were also affected, and that dampened domestic spending. Consequently, the Canadian economy expanded by just under 3% through 1998 (fourth quarter over fourth quarter) compared with over 4% in 1997. However, after some weakness through last summer and early autumn, our economy showed renewed strength recently. Helped by buoyant US demand, easing global financial strains, and the rebound from major labour disruptions, economic activity grew at an annual rate of 4.6% in the final quarter of 1998. And this was accompanied by robust, broad-based employment gains through the closing months of 1998 and into early 1999. With world economic and financial conditions still fragile and the timing of a firm recovery in primary commodity prices uncertain, projections for 1999 remain tentative. But with recent healthy employment growth, domestic spending should continue to contribute to an expanding economy. And sustained US demand, coupled with our improved competitiveness, should continue to bolster our exports. Altogether, we are looking at a somewhat more positive scenario than seemed possible last autumn. The response of monetary policy to international turbulence Let me now say a few words about how the Bank responded to the exceptional global events of the past couple of years. As commodity prices tumbled, we became less well-off as a nation. Distressing as that is, it is a reality Canada had to face. And our currency moved downwards, reflecting – not causing – the drop in our economic prosperity and the need to adjust. When shocks like this hit us from time to time, movements in the external value of the Canadian dollar help ‘buffer’ the shock and smooth the process of adjustment. If the currency is not allowed to move, the adjustment will drag out and cost more in terms of losses in output and employment. However, the relatively orderly depreciation of our currency through to July 1998 accelerated following the Russian crisis last August. And Canadian longer-term interest rates rose sharply at a time when comparable US rates were falling. To us at the Bank, this signalled a potential loss of confidence in Canadian dollar assets, which we moved to head off by raising the Bank Rate by 100 basis points. In so doing, we sought to limit the harmful effects of financial volatility on confidence by temporarily placing particular emphasis on calming markets. The situation has improved since then. Interest rates have been cut in all major industrial countries, and a measure of stability has returned to world financial markets. With this, concerns in Canadian markets have diminished, allowing us to unwind three-quarters of last August’s increase in the Bank Rate. Calmer financial markets should now make it possible for the Bank to refocus attention on its medium-term policy objective of keeping the underlying trend of inflation inside the target range of 1% to 3%. In conclusion, let me say that, given the financial market volatility and the global economic slowdown of the past couple of years, our economy has coped relatively well. And we begin 1999 on a positive note. This is testament to Canada’s improved basic economic foundation these days. And it gives me reason to remain positive about our future despite lingering international uncertainties.
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Remarks by Gordon G Thiessen, Governor of the Bank of Canada, to the 'Chambre de commerce de la région sherbrookoise' in Sherbrooke, Quebec on 4 May 1999.
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Mr Thiessen discusses the effect on the Canadian economy of recent global financial turbulence Remarks by Gordon G Thiessen, Governor of the Bank of Canada, to the “Chambre de commerce de la région sherbrookoise” in Sherbrooke, Quebec on 4 May 1999. Global financial turbulence and the Canadian economy The world economy and Canada have had to navigate some difficult straits in the past couple of years. But we have made it through. And considering the tide from the Asian financial crisis that washed around the world, the Canadian economy has coped better this time around than in the past. With the clouds of international uncertainty gradually lifting, Canada’s solid economic foundations are providing good reason to remain positive about the outlook for our economy. Today, I would like to talk about recent economic developments and the prospects for Canada. But since much of what has been happening here recently has been heavily influenced by external events, I would also like to discuss some of the measures the international community is contemplating to prevent, or at least reduce the severity of, any future crises. Recent developments in the Canadian economy The financial crisis that began in Southeast Asia in mid-1997 turned out to be much more persistent and serious than anyone had expected. During 1998, the turmoil spread to Russia and Brazil, causing a great deal of nervousness and volatility in markets everywhere. This led to large outflows of capital from many emerging-market economies, rising interest rates, tighter credit conditions, and a marked slowdown in economic growth worldwide. Canada has not been insulated from these forces. Many of our industries, including those in Quebec, have been hard hit. The most immediate impact on our economy has been the lower foreign demand for the key primary commodities we produce and a 20 per cent drop in their prices between the middle of 1997 and the end of 1998. These developments were reflected in the value of our currency, which declined sharply against the U.S. dollar. As the turmoil in markets increased following the Russian debt moratorium last August, the Bank of Canada moved to head off signs of a potential loss of confidence in Canadian dollar investments, by raising the Bank Rate one full percentage point. The confidence of households and businesses in Canada was also affected by market nervousness and volatility, and this dampened domestic spending. Consequently, the Canadian economy expanded by just under 3 per cent through 1998 (fourth quarter over fourth quarter) compared with over 4 per cent in 1997. Considering the seriousness of the external disturbances, this is not a bad economic outcome. And for this, we can thank our sounder fiscal position and low and stable inflation, which have helped us weather the international instability better this time around. These same factors, coupled with calmer financial markets, have allowed the Bank to lower the Bank Rate four times since the autumn (fully reversing last August’s increase), and to refocus attention on the medium-term objective of keeping inflation within the 1 to 3 per cent target range. Currently, inflation is just inside the bottom of the range. The economic outlook As I said before, the world economic horizon is now clearer. Interest rate reductions around the world -- most recently across the euro area -- have helped to rebuild investor confidence and to calm global financial markets. This includes markets in the troubled Southeast Asian economies, where progress is being made on structural reforms and the outlook for a turnaround this year and next has improved, especially in South Korea, but also in Thailand and Malaysia. There are also signs that the financial situation in Brazil, which looked precarious in late 1998, is now stabilizing with the adoption of measures to address imbalances in the country’ s fiscal and external accounts. What is less clear is the extent of short-term economic weakness one can expect in Latin America because of the difficulties in Brazil. There has also been a slowdown in the pace of economic expansion in Europe. But easier monetary conditions -- that is, lower interest rates and the lower value of the euro -- should help offset some of the economic weakness there. And these lower interest rates are a positive element for the international economy as a whole. The main question mark in the outlook continues to be the Japanese economy, which has been in recession since late 1997. Even if stimulative macroeconomic policies are pursued systematically, and progress continues on banking sector reform, it is rather unlikely that there will be much of a recovery there before the year is out. In contrast, the U.S. economy continues to flourish, consistently outperforming expectations and with no sign of inflationary pressures. That economy ended 1998 on a much stronger note than had been expected. And the momentum of U.S. economic activity in early 1999 is greater than most forecasters had predicted. From a Canadian perspective, this is the most positive element in the current external economic environment, as anyone who sells to U.S. markets can confirm. Strong U.S. demand for Canadian products and the rebound from major labour disruptions in Canada led to renewed vigour in our economy in the fourth quarter of 1998 which, by all indications, carried into early 1999. And this has been accompanied by healthy employment growth. As we look ahead, steadier financial markets, employment gains, and accommodative monetary conditions should bolster spending by Canadian households and businesses. All this, coupled with sustained U.S. demand and our improved competitiveness, should continue to contribute to an expanding Canadian economy. Since world economic and financial conditions are still fragile and since the timing of a firm recovery in primary commodity markets remains uncertain, I cannot be more specific about how strong our economy will be. But we are now looking at a somewhat more positive scenario than seemed possible last autumn -- both for the world economy and for Canada. What to do about future crises As much as we are all anxious to put this latest episode of global financial turbulence behind us, I hope that in one respect, at least, we won’ t soon forget it. The fact that things are getting better should not distract us from devising strategies to reduce the risks of similar crises in the future. And should there be any, we need to be better prepared to handle them and to minimize their economic fallout. So what are some of the issues, and what is being done about them? It would be all too easy to blame globalization and unhindered, large, cross-border capital flows for the recent financial problems, and to suggest that we retreat behind national borders and place restrictions on the flow of capital. But it would be unwise. For even though capital flows may sometimes be difficult to manage, especially for small countries, the benefits from access to a bigger pool of world savings are substantial -- when those savings are used prudently and productively. What we must do is find ways to minimize the risks, without surrendering the benefits. There are three main areas towards which international efforts are currently directed: strengthening financial systems; ensuring that countries follow responsible macroeconomic and financial policies; and developing effective processes for managing crises when they arise. Let’s look at these three areas. First, there is the need to encourage sound financial systems -nationally and internationally. Some of the things being addressed here are accounting and disclosure standards, supervisory and regulatory frameworks, and bankruptcy procedures. Why do we need to strengthen these practices? Widely accepted accounting standards are the key to communicating reliable information about a company’s financial health and to making its operations more transparent. Disclosure of accurate and timely information strengthens confidence and helps markets to make more informed judgments about the riskiness of investments. Recall that one of the main problems behind the recent difficulties was the huge amounts of funds placed in some emerging markets in Asia by investment advisers from industrial countries and by their clients, evidently without adequate information or appreciation of the risks involved. History shows than when concerns arise, lack of information causes investors to expect the worst and run for cover. There is also a need to improve the effectiveness of regulation and supervision of banks and other financial institutions, especially in emerging-market economies. Banks are important intermediaries for moving funds around at home and abroad. But they will perform this role most effectively and soundly if they are properly supervised and if they have reason to control risk. In countries where banks have strong links to industry and/or to government, their ability to make objective credit judgments may suffer. And sometimes these relationships include provisions that protect banks from failure but do not encourage prudent behaviour. Plans to improve global financial rules also involve strengthening bankruptcy procedures. Welldefined bankruptcy codes are important. They can provide debtors and creditors with a clear understanding of the rules for resolving defaults. And they would enable the private business sector to continue to function even in the event of a financial crisis. So far, I have talked about institutional improvements that international bodies, like the International Monetary Fund, are helping to design and put in place through a code of “best practices”. Let me now turn to economic policies and their role in promoting greater financial stability. One important lesson we have learned from experience -- including our own in Canada -- is that countries must, above all, follow sound and credible macroeconomic policies. This means a fiscal policy that avoids unsustainable public sector deficits and debts, and a monetary policy aimed at low and stable inflation. But the question of a country’ s exchange rate policy is also very relevant. Recent experience highlights the importance of ensuring that financial markets have the right incentives to make sound decisions and to avoid excessive exposure to risks. When a government pegs its exchange rate to another currency, pledging to do whatever it takes to ensure that the peg holds, domestic and foreign investors tend to minimize the exchange rate risk, as long as things are going well. The problem with a fixed, but adjustable, exchange rate is that it does not guarantee that a currency will not decline in value. Should it come under pressure, because it is fixed at a level that is inconsistent with changing fundamentals in the economy, and should markets begin to question the authorities’ pledge to the peg, domestic and foreign investors would likely rush for the exits, triggering a crisis. When you think of recent crises in Southeast Asia and in Brazil, the first thing that strikes you is that they all occurred in countries with fixed exchange rates. I would argue that, in most of these cases, greater exchange rate flexibility would have helped to make borrowers and lenders more aware of exchange rate risks. And so I find it encouraging that some of the crisis-afflicted emerging countries have since moved towards more flexible exchange rates. Let me now say a word about the need to devise processes for the effective management and resolution of future crises, should they occur. Right now, the International Monetary Fund is the main provider of emergency assistance to a country that runs into financial difficulties, while its private creditors are not always involved. The main, and somewhat contentious, issue here is to ensure that private lenders have the incentive to participate in crisis prevention and that they bear their fair share of the financial burden of dealing with crises. Progress in this area has been slow, but a number of proposals are being examined that would encourage debtor countries and their creditors to work out financial problems in a cooperative manner. Let me conclude. Thanks to a stronger foundation these days, the Canadian economy has thus far weathered the financial volatility and the global economic slowdown of the past couple of years reasonably well. And having started 1999 on a strong note, we are looking for sustained economic expansion this year. The situation in world financial markets has improved. And the international community has been hard at work, seeking ways to strengthen the international financial architecture. There is no single, simple solution to prevent crises. Today, I have discussed some of the measures planned to provide a degree of comfort. None of them is dramatic, and much remains to be done. But I believe that these changes should help reduce future risks. Canada has a stake in building a stronger, more stable international financial system, and strongly supports global initiatives designed to achieve this.
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Opening statement of the Governor of the Bank of Canada, Mr Gordon Thiessen, before the Standing Committee on Finance of the House of Commons on 26 May 1999.
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Mr Thiessen’s statement on the Bank of Canada’s Monetary Policy Report Opening statement of the Governor of the Bank of Canada, Mr Gordon Thiessen, before the Standing Committee on Finance of the House of Commons on 26 May 1999. It is always a pleasure to appear before your Committee following the publication of our Monetary Policy Report. We released our ninth Report last Wednesday. The Bank of Canada began publishing these Reports on a semiannual basis four years ago, as part of our effort to increase the transparency and accountability of the Bank’s conduct of monetary policy. The main focus of every Monetary Policy Report is how well Canada is doing in managing inflation. But controlling inflation is not an end in itself. The objective of monetary policy is to help create and maintain a monetary climate that favours good economic performance, an economy where growth and employment are strong and Canadians feel prosperous. The Bank feels strongly that the best thing that monetary policy can do to help long-term growth in the economy is to preserve low and stable inflation. Indeed, I believe the low and stable inflation rate we have had in Canada in recent years has helped us through some difficult times. However, I am also happy to report that the global financial system is much more stable than it was at the time of my last appearance before you six months ago. The shock from the financial crisis in Southeast Asia, which began almost two years ago, was compounded last August by Russia’s default on its external debt. The turbulence that followed has now largely subsided and investor confidence is being restored. As a result, the outlook for the world economy has become more positive than it was last November. Financial markets have steadied in Southeast Asia, and prospects are good for a gradual recovery there. In Brazil the authorities have taken major steps to address their difficulties. Overall, global financial markets now seem better able to assess risk. Interest rate cuts by central banks in all major countries have helped restore investor confidence. Most importantly for Canada, the US economy has continued to outperform expectations with strong growth and, as yet, no definitive sign of inflation pressure. Nonetheless, there is still a fair degree of uncertainty about the overall external environment, given the divergent performance of the major economies. Japan is still in recession and Europe has been slowing down. Because of this, we are expecting only a slow recovery in world commodity prices this year. In Canada, the recent driving force in our economy has been exports. The strong demand in the US economy, the relatively weak Canadian dollar and increasingly competitive Canadian manufacturers are allowing us to sell into the United States very successfully. What we are expecting to see now, however, is an increase here at home in consumer and business spending. We believe that the improvement in business and consumer confidence that we have seen in the last few months, the better employment picture and recent reductions in interest rates will all help support domestic spending. To be more specific, compared with six months ago, we at the Bank have raised our projection for growth in the economy in 1999 to between 2¾ and 3¾ per cent. We have such a wide range because of the international uncertainties that I mentioned a moment ago. The high end of this range is well above the latest consensus among private sector forecasters. If the economy does grow at the higher end of this range, it is likely to be because of stronger exports and more substitutions of Canadian goods for imports due to Canada’s good price and cost performance. Our economy should continue to expand next year at a broadly similar pace. On the basis of these growth forecasts, we would expect the trend of inflation to rise modestly over the next 18 months but remain in the lower half of the Bank’s 1 to 3 per cent target range for inflation. There is an increasing level of confidence, both at home and abroad, that Canada’s inflation will remain stable. Another source of uncertainty for the Bank at the present time is in estimating the margin of unused capacity in the economy. If economic activity expands as forecast, the traditional way of measuring these things tells us that the current margin of economic slack should be taken up in the second half of next year. However, the economy seems to have undergone some significant changes during the 1990s, and the traditional estimates of slack may no longer be accurate. As a result, the Bank will be placing increased weight on a range of indicators to assess the degree of pressure on the economy’s production capacity. What we have in mind are such things as movements in inflation relative to expectations, growth of money and credit, wage pressures, evidence of supply bottlenecks and the information provided to our regional representatives from their business contacts. We will not know just how much the Canadian economy has changed until its capacity limits come under more pressure. While the confidence of Canadians in ongoing low inflation allows monetary policy more room to accommodate demand pressures that test the limits of capacity, it will be very important for the Bank to be vigilant in following the array of indicators I have mentioned. We must not undermine the solid basis of low inflation and low interest rates that has been established in Canada.
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Address by the Governor of the Bank of Canada, Mr Gordon Thiessen, before the Canada Club in London on 2 June 1999.
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Mr Thiessen evaluates the performance of the Canadian economy at the end of the 20th century Address by the Governor of the Bank of Canada, Mr Gordon Thiessen, before the Canada Club in London on 2 June 1999. As the curtain comes down on the twentieth century and we move on to the next millennium, it is difficult to resist the temptation to be both retrospective and prospective. Ask Canadians to think back and many will tell you that the economy and they, as individuals, have been through some difficult times. Those with longer memories, however, will recall the remarkably positive climate between the end of the Second World War and the early 1970s. Canada came out of the war with a relatively strong economy compared with the ravaged European countries. Moreover, there were sizable and sustained gains in productivity through the 1950s and 1960s. These reflected the revolution in agriculture and the forced modernization and expansion of Canadian industry during the war as well as the rapid changes in technology and industrial processes that followed. All this led to a substantial rise in Canadian standards of living instead of the post-war depression that many had feared. And despite the exodus of workers from agriculture, the overall unemployment rate remained low. At the same time, rapid economic growth generated rising tax revenues that governments could spend on an increasingly wider social safety net without taxpayers feeling much of a pinch. Compared with this post-war prosperity, our economic performance over the subsequent quarter century has been the source of some disappointment and concern. Various explanations have been advanced for this less-favourable record since the early 1970s. There are four trends in particular that I would highlight in this regard: high inflation in the 1970s and 1980s; large and rising fiscal deficits from the mid-1970s to the mid-1990s; a slowdown in productivity growth; and a decline in the prices of primary commodities. Tonight, I propose to comment on these four trends and their effect on the economy over the past 25 years. Much of the sense of economic disenchantment that Canadians have been feeling in the 1990s has been related to the difficult process of reversing these trends or adjusting to them. Fortunately, considerable progress has been made on several fronts. Hence, there are grounds for optimism regarding Canada’s economic future. The harmful effects of high inflation The rate of inflation which, after getting through some of the post-war bottlenecks, averaged just over 2 per cent in the period to 1972, more than tripled over the next two decades. This pickup in inflation was not a uniquely Canadian phenomenon. In many countries, monetary policy had become too expansionary during the late 1960s. This partly reflected a misconception among policy-makers that, by fine-tuning the economy and taking advantage of a perceived trade-off between employment and inflation, overall economic well-being could be improved. One of the initial consequences of this accumulating worldwide monetary stimulus was a sharp rise in the prices of oil and other primary products in the early 1970s. Countries, like Canada, which are major producers of such commodities, experienced a surge in income and wealth. But they also faced strong demand pressures and rising inflation. In Canada, the surge in inflation was especially dramatic, reaching 12 per cent in 1974. Once inflation had risen to those levels, it was very difficult to reverse. With each passing year, expectations of ongoing high inflation became increasingly entrenched. High inflation exacts a heavy toll on an economy by making the future particularly uncertain. Long-term financing becomes less available and more costly as interest rates go up because of inflation and the higher risk premiums that lenders demand as compensation for the increased uncertainty. Inflation diverts resources away from productive investments into speculative ventures in real estate and other financial assets. And in its interaction with the tax system, high inflation encourages businesses to increase debt. These are the very types of excesses that lead to, and indeed aggravate, the economic busts that inevitably follow. During the 1970s and 1980s, Canadians had first-hand experience with such complications. The impact of persistent government deficits and rising debt High inflation was also partly responsible for the move towards larger government deficits in Canada that began in the mid-1970s. Initially, inflation tended to generate increased revenues for governments, and this encouraged additional spending. When the effects of inflation became more evident, however, public pressure led to the indexation of the personal income tax system and the growth in government revenues slowed. Unfortunately, this was not offset by a tighter grip on spending. For the government sector as a whole in Canada, on a national accounts basis, total program expenditures (not counting debt-servicing costs), rose from 37 per cent of gross domestic product (GDP) in 1975 to a peak of 43 per cent in 1992 (a year of recession). Over the same period, the budget deficit more than tripled to 8 per cent of GDP. And the ratio of outstanding net debt-to-GDP soared from less than 10 per cent to 60 per cent, and by the mid-1990s it had climbed to 70 per cent. Increasingly, through the late 1980s and early 1990s, the growth in government spending raised concerns about whether this represented the most efficient use of the economy’s resources. From a policy perspective, the greatest concern was that persistent large deficits were pushing Canada’s debt-to-GDP ratio to unsustainable levels and driving up risk premiums in our interest rates. The economic costs of Canada’s rising indebtedness became very clear after 1991, when our inflation rate came down quickly, but medium- and longer-term interest rates were slow to respond. One important reason for that was the persistence of high risk premiums because of fears that governments might be tempted to reduce the debt burden through inflation – in effect, by printing more money. Canada’s vulnerability to such concerns became particularly evident during the Mexican currency crisis. High interest rates meant that we had to pay more of our income to foreign holders of our public and private sector debt. This made us poorer as a nation. And these high rates discouraged investment which, to some extent, relates to the third “disappointing” trend of the past quarter century – the slowdown in productivity growth. The slowdown in productivity growth Productivity has been at the centre of many public discussions in Canada recently. For good reason, too, since productivity is critically important to growing incomes and rising standards of living over time. Unfortunately, such discussions are complicated by the fact that there is more than one measure of productivity, and there often seems to be some difficulty in distinguishing between the growth and the level of productivity. Things become even more complicated as one gets into cross-country comparisons. After a strong showing from the end of the Second World War to the early 1970s, our productivity growth became lacklustre. Output per worker slowed from an average rate of about 3 per cent in the 1950s and 1960s to 1 per cent in the 1980s and 1990s. Productivity growth also slowed in other industrial countries, including the United States, over this period. Indeed, average gains in labour productivity in the Canadian and U.S. business sectors have been roughly similar in the past 25 years. This means that the gap in productivity levels in favour of the United States has not really widened; but neither has it narrowed. Moreover, growth in U.S. productivity seems to have picked up strongly in the last year or so. I do not have a complete explanation for the productivity slowdown in Canada. But I am prepared to assert that high inflation and the large fiscal deficits through most of the past 25 years were not conducive to productivity growth. They led to high interest rates and considerable uncertainty about the future – both of which discourage the investment in technology and new equipment that helps to advance productivity increases. Declining primary commodity prices The final factor on my list is the decline in the prices of the key primary commodities that Canada produces. Calculated from the early 1970s to the present, this decline amounts to some 45 per cent when the international prices of these commodities in U.S. dollars are adjusted for the increase in the general price level during this period. A drop of that magnitude in the prices of some of Canada’s major exports is bound to have a significant effect on our standard of living. To look at the past 25 years in isolation, however, tends to magnify the extent of the decline and leaves one with an exaggerated sense of the associated economic consequences. This is because commodity prices jumped to historical peaks at the beginning of the period, in response to the worldwide monetary stimulus that I mentioned, and remained generally high for nearly a decade or so, before reversing. To put things in perspective, we need to focus on the longer-run behaviour of commodity prices. For only then does it become clear that these prices were exceptionally high through the first decade of this 25-year period, and that a good part of the subsequent downward movement represented a return to more “normal” levels. Indeed, between the late 1960s and the late 1980s, the level of inflation-adjusted commodity prices showed little change overall. We should also keep in mind that part of the decline in commodity prices has reflected new discoveries of raw materials, more efficient ways of extraction, and reduced production costs. Otherwise, we would have seen a much larger reduction in the importance of commodities, and in the profits and share prices of Canadian resource industries. When one allows for some of these factors, the downward movement in commodity prices in the past 25 years is not as dramatic as it appears at first. But I can certainly appreciate that the sharp drop in these prices in 1997-98, associated with the Asian financial crisis, has had an especially strong impact on many Canadians’ sense of well-being. Adjusted for inflation, commodity prices hit a new post-war low during this period and led to a substantial depreciation of our currency. What does the future hold? So far, I have argued that high inflation, large government deficits, slower productivity growth, and lower commodity prices have tended to complicate Canada’s economic situation over the past 25 years. But as I said at the beginning, much of the greater sense of difficulty and concern that Canadians have felt in the 1990s has to do with the after-effects of the strong medicine we have had to take to turn our economic performance around. The success we have had so far in this regard bodes well for our future. Canada’s inflation rate has come down dramatically, averaging less than 2 per cent since 1992. And there are now agreed targets between the Bank of Canada and the Government of Canada to keep inflation low and stable in the future. More importantly, Canadians have come to expect continued low inflation and to build that expectation into their plans. The federal government and most provincial governments now have balanced budgets or are running surpluses. The total government debt-to-GDP ratio, which peaked at 70 per cent in 1996, has since fallen to 63 per cent. With present prudent fiscal policies, it should continue to decline steadily. Future gains in productivity are difficult to predict. Certainly, our improved inflation and fiscal situation, together with the low interest rates that they have made possible, provide the best climate for fostering productivity that we have had in a long time. Moreover, Canadian businesses have undergone major restructuring during the 1990s in response to increasingly competitive world markets. Business investment has been rising smartly recently and more firms have been adopting new production technologies. It is also interesting to note that, after eight years of economic expansion, productivity growth in the United States has picked up, rather than falling off as usually happens at this stage of the cycle. Tight labour markets seem to have encouraged a record level of investment in that country and more efficient use of technology than before. While the pickup in Canadian investment in machinery and equipment has lagged somewhat behind that in the United States, new technology is not the exclusive preserve of our U.S. neighbours. So I hope that in Canada, too, we will see a similar payoff from the adoption of new technology and a comparable improvement in productivity. As for commodity prices, there has already been some turnaround this year, but a firmer recovery requires a strengthening world economy – in particular, a turnaround in Japan and the rest of Asia. The other point to note in this connection is that the relative importance of commodities in the Canadian economy has declined. The share of primary products in total Canadian exports has fallen from about 60 per cent in the 1970s and 1980s to about half as much presently. I should also add that our flexible exchange rate system has been playing the role that it should in helping us adjust to lower commodity prices. The decline in the value of the Canadian dollar in 1997-98 was mainly a response to the impact of the Asian crisis on commodity prices. A weaker currency has helped to cushion the negative effect on our resource sector. But, more importantly, it has helped to stimulate demand for other Canadian exports and import substitutes, particularly of manufactured goods. In turn, this is encouraging a shift in production from commodities towards other tradable goods. While I believe that this shift is exactly right for the Canadian economy, I do not agree with some recent suggestions that we should somehow force the pace of the movement out of primary products and into the so-called more modern, knowledge-based industries. If commodity prices do not recover from their current low levels and profits are squeezed as a result, this will happen naturally. But for now, primary products are still an important source of Canada’s wealth and high standard of living, and they are likely to remain so for some time. To conclude, the past 25 years have not been easy. And they have been less prosperous overall than many Canadians had come to expect, based on the experience of the 1950s and 1960s. But, as we stand on the threshold of the next century, we can take comfort from the remarkable progress we have made recently in strengthening the foundations of our economy. This gives me reason to be positive about our capacity to improve our economic performance and to meet tomorrow’s challenges with confidence.
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Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Chamber of Commerce Regina, Saskatchewan on 23 September 1999.
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Mr Thiessen gives an update on the Canadian economy and on the state of Year 2000 readiness in the Canadian financial sector Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Chamber of Commerce Regina, Saskatchewan on 23 September 1999. * * * It is always a pleasure to return and speak to people in my home province. This time, we are here for a meeting of the Bank of Canada’s Board of Directors. Once a year, our Board meets outside Ottawa, in a different part of the country. This year, we are delighted to be in Regina. Today, I would like to give you an update on the Canadian economy – its recent performance and its prospects. I would also like to brief you on the state of Year 2000 readiness in the Canadian financial sector. The recent performance of the Canadian economy Here in Saskatchewan, you know only too well that the last couple of years have been difficult for the Canadian economy, especially for producers of primary commodities. But there is reason for optimism as we look ahead. To fully appreciate why, we need to understand the international shocks that have buffeted our economy since mid-1997 and how we have dealt with them. The global financial crisis, which started in Southeast Asia in mid-1997 and spread to other countries during 1998, led to a sharp decline in the world prices of primary commodities. By this time last year, the average price (in US dollars) of key commodities produced in Canada had fallen by about 20% over the course of the previous 18 months. And when Russia declared a standstill on the servicing of its debt in August 1998, the effects were felt far and wide. Conditions tightened in financial markets everywhere. Many highly rated corporate borrowers in the industrial countries were faced with a reduction in the availability of credit and with higher borrowing costs – the same conditions that faced governments from emerging-market economies. Nevertheless, the Canadian economy has fared surprisingly well over the past year. Of course, we have not experienced booming conditions. Indeed, some of our primary sectors, such as farming, continue to struggle with low prices. Grain prices, in particular, have been plagued by ample global supplies and weak demand. But, on the whole, the economy has performed well. I expect that when the numbers for the third quarter of this year are out, they will show that output has grown by about 4% since the third quarter of 1998. This compares with growth of only 2½% over the same period the year before. To be sure, the economic impact of the Asian crisis on Canada has been moderated by the strength of the US economy and by the prompt response of major central banks, particularly the US Federal Reserve, to the global financial difficulties. And the efforts made by emerging-market economies in Asia to deal with their problems have helped to gradually repair confidence and improve world economic conditions. Although these positive developments are certainly important, it is also true that we have coped better with this crisis than in the past because our economy is now operating from a firmer base than it has for some time. This reflects a number of fundamental improvements in our economic structure. I would highlight three in particular: • first, our low-inflation record and the Bank of Canada’s commitment to keeping inflation low; • second, the virtual elimination of government deficits and the beginning of a downward trend in the high level of public debt to the size of our economy (as measured by the ratio of public debt to GDP); • third, the major restructuring of Canadian businesses during the 1990s in response to stronger global competition and to technological change. It has not, of course, all been smooth sailing. You will recall that throughout the summer of 1998 our currency kept losing ground in reaction to the sharp fall in commodity prices, which was made worse by the fallout from events in Russia. And with signs of a potential loss of confidence in Canadian dollar assets, the Bank of Canada moved to raise short-term interest rates significantly in August 1998. But once we got through that period of unusual global turmoil, we were able to reverse that increase rather quickly. Consequently, Canadian interest rates for all maturities fell back to levels below those in the United States, consistent with Canada’s lower inflation rate. The downward movement in the Canadian dollar, besides softening the impact on our resource sector, encouraged a rather prompt increase in exports of manufactured goods. This helped to compensate for the reduction in receipts from commodity exports. With this shift of economic activity out of the resource sector and into manufacturing, conditions in the labour market did not deteriorate as one might have expected. In fact, the unemployment rate has continued to decline over the past 12 months – from 8.3% to its current level of 7.8%. And despite the loss of jobs in the resource sector, close to 350,000 net new jobs have been created across the economy over this period. The three factors I mentioned earlier – low inflation, reduced budget deficits and debts, and business restructuring – have provided a sound base for the Canadian economy during this turbulent time. They have also helped smooth the process of exchange rate and economic adjustment that I have been describing. Because of our good inflation record in recent years, achieved through the Bank’s commitment to inflation targets, inflation remained subdued, even as our currency was falling and causing prices of imported goods to rise. Low inflation and a much improved fiscal position have helped to keep interest rates down. At the same time, because of restructuring, many more Canadian firms have been in a strong position to take advantage of the low Canadian dollar and increase their sales abroad. Low interest rates have also made it easier for businesses to finance investments so that they can expand production capacity and increase their foreign sales. The outlook for the Canadian economy The fundamental improvements in our economic foundation and the way that Canada has coped with these recent external financial difficulties give us good reason to be optimistic about the future. The export sector has been an important source of strength for the Canadian economy for some time now. Recently, the stimulus from spending by Canadian households and businesses has also been growing. Indeed, with the waning of last autumn’s global strains, consumers have regained the confidence to go out and buy a new car, a house, or furnishings. And businesses have revived their plans for investment in machinery and equipment (including continued buoyant spending on computer upgrades, partly related to Year 2000 readiness). With improved confidence, relatively low interest rates, and gains in employment, these trends should continue. Clearly, conditions outside Canada remain crucial to our economic outlook. In Europe, prospects for stronger growth now look better than they did a few months back. Even for the troubled Japanese economy, next year should be brighter. Forecasts for a number of emerging-market economies, particularly in Asia, have also been revised up. And with these improved global prospects, the prices of a number of our key commodities – especially energy, base metals, and minerals – have risen. Of course, for Canada the external influence that matters the most is the US economy. That economy has turned in an amazing performance in the past seven years – robust output growth, low unemployment, and low inflation. But with US consumers and businesses continuing to spend strongly, and labour markets tightening further, some signs of cost pressures have emerged recently. This has rekindled concerns about a pickup of inflation down the road. And it has prompted the US Federal Reserve to reverse part of last autumn’s easing, by raising interest rates twice this summer, in an effort to return the economy to a more sustainable, non-inflationary pace. The Fed’s success in preventing the US economy from overheating and bringing it down to a “soft landing” is critical for the world economy and especially for Canada. The worst case for us would have been for the Fed to have delayed action and risked another inflationary boom. Not only would this require more drastic tightening by the Fed down the road, but it could well lead to a recession – another episode of boom and bust. The Bank of Canada did not follow the two interest rate increases made by the Fed this summer. While there is no reason that changes in US interest rates should automatically trigger similar movements here, neither is it the case that such developments are irrelevant for us. Canada is closely integrated into the world economy and international financial markets. Developments in the United States, the world’s largest economy, will always have a major global impact. When it comes to Canada, the central bank must carefully assess the economic and financial circumstances in the United States that are behind any move by the Fed and their likely implications for our economy. Sometimes this will mean that the Bank of Canada will respond to a Fed move and sometimes it won’t. The interest rate actions taken by the Fed this summer improve the odds of continued, non-inflationary economic expansion in the United States. This is good news for all concerned. But it also means that we cannot count on the US economy to provide the same strong stimulus for Canadian exports in the future as it has in the recent past. Thus, the improved outlook for Europe and the firmer markets for primary commodities are particularly welcome developments for Canada. These external factors, along with the relatively low domestic interest rates and improved employment conditions that I mentioned, bode well for sustained economic expansion in Canada. Altogether, our economy should continue to grow at a healthy pace and take up slack in production capacity. Core inflation is expected to stay low over the next year, in the bottom half of the Bank’s 1% to 3% target range. But as the economy begins to produce at full capacity, monetary policy will have to be mindful of the potential for price pressures. However, there is a lot of uncertainty and imprecision in our estimates of the economy’s capacity to produce. For example, we do not know to what extent large investments in new technology and in machinery and equipment during the 1990s may have raised production capacity. Consequently, the Bank will be putting more emphasis on, and carefully watching, a range of indicators to assess the degree of pressure on capacity and on inflation. The interpretation of developments on this front will be an important challenge for monetary policy in the period ahead, one that will require a great deal of careful analysis. The Year 2000 changeover in the financial sector With the end of the millennium approaching, any review of near-term economic developments would be incomplete without a word on the efforts by financial sector participants and public sector agencies, including the Bank of Canada, to deal with the implications of the Year 2000 date change. As part of its commitment to Canadians, the Bank seeks to promote the safety and soundness of our financial system. With this in mind, we have for some time now been working closely with various Canadian and international organizations to minimize any effects on our financial sector as we head into the year 2000. Today, I can tell you that the Canadian financial sector has done its homework. It has been passing its Year 2000 tests. And contingency plans have been made. So, at the dawn of the new year, the Bank expects that it will be “business as usual,” but we will also be ready if anything unusual happens. Efforts to identify and fix potential Year 2000 problems in the Canadian financial sector started early. And they have been exhaustive, with expenditures in the billions of dollars. Operators of systems shared by the financial sector have made the necessary changes and fully tested them. For example, last June, the Canadian Payments Association and its members participated in a Global Payments Systems test to verify the ability of financial institutions around the world to send and receive international payments. Domestic clearing and settlement systems have also been tested, as have all systems used by the markets for transactions involving Canadian debt and other securities. They are ready to operate in a Year 2000 environment. At the same time, virtually all individual financial institutions have completed and tested changes to their critical systems, including those that support automated banking machines, credit and debit cards, and telephone banking. And major Canadian deposit-taking institutions have guaranteed the safety of their clients’ accounts and records from any Year 2000 computer-related disruptions. The Bank of Canada has given the same guarantee for Canada Savings Bonds records. Of course, the Bank of Canada’s own critical computer systems have also been reviewed, upgraded as necessary, and tested. And they are Year 2000 ready. An important issue for the financial sector is the state of preparedness of providers of infrastructure services (e.g. electricity, telecommunications). These, too, are reporting that they are Year 2000 ready. With all the effort, time, and resources devoted to the task, it is not surprising that a number of knowledgeable Year 2000 commentators have singled out the Canadian financial sector, especially the banking sector, as one of the world leaders in Year 2000 preparedness. That is a strong vote of confidence, which should help reassure Canadians. Still, we cannot afford to be complacent and relax our efforts. Computer systems will continue to be monitored and retested right up to the end of the year. There is also a need for ongoing clear, responsible communication to keep the public well-informed and confident in a smooth Year 2000 transition. At the same time, increasing attention is rightly being paid to contingency plans. In this connection, the Bank of Canada has recently announced a number of arrangements to provide an additional measure of confidence to financial institutions and the general public. We are putting in place a special line of credit to assure these institutions and the users of financial services that if there is any unusual demand for liquidity around the turn of the year, it will be met. And the Bank is prepared to accept a wider-than-normal range of collateral to support any liquidity loans it provides. We have also made arrangements to counter any unusual pressures on money market interest rates during this period. All this should be enough to reassure the vast majority of Canadians that the safest place to keep their money is with their financial institutions. In fact, they should prepare for the century-changeover weekend much as they would for any other long weekend. Nevertheless, there will be some who still feel that they need to take further precautions. Those who prefer a little extra reassurance in the form of additional cash can rest easy – it will be readily available. The Bank has increased considerably its inventory of bank notes. And it has been working with financial institutions to ensure that the system can meet an increase in demand for cash across Canada. But let me reiterate that there is no reason for Canadians to feel that cash is the only way they can pay for goods and services over the New Year’s weekend. Overall, the Bank of Canada and other financial sector participants have every confidence that Canadians can plan on it being “business as usual” in the financial sector heading into the year 2000.
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Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Greater Charlottetown Area Chamber of Commerce, Charlottetown, Prince Edward Island, on 2 November 1999.
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Mr Thiessen reviews the challenges for Canadian monetary policy in the Year 2000 Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Greater Charlottetown Area Chamber of Commerce, Charlottetown, Prince Edward Island, on 2 November 1999. * * * Monetary policy actions take a relatively long time to affect the economy and inflation - anywhere between 12 to 24 months. Because of this, central banks must always look ahead and must put in place today the monetary conditions that are needed to help keep the economy on a sustainable path down the road. By “sustainable” I mean a situation where economic growth and job creation are not at risk from rising inflation. It is in this forward-looking context that I would like to talk to you today about the challenges that may face Canadian monetary policy in the Year 2000. First, of course, is the turn of the century itself. So let me start by saying a few words about Year 2000 readiness in the Canadian financial sector. Year 2000 preparations As I said in Regina a little over a month ago, the Canadian financial sector has done its Year 2000 homework - and, I might add, done it very thoroughly. The Bank of Canada and providers of financial services are confident that Canadians can expect “business as usual” in the financial sector as we head into the Year 2000 and beyond. The critical systems of financial institutions, including those systems that support automated banking machines, credit and debit cards, and telephone banking, have been modified where necessary and tested. Providers of infrastructure services to the financial sector (for example, electricity and telecommunications) have also reported that they are Year 2000 ready. And major Canadian deposit-taking institutions have guaranteed the safety of their clients’ accounts and records from any Year 2000 computer-related disruptions. The Bank of Canada has given the same guarantee to holders of Canada Savings Bonds. Even so, retesting of systems and contingency planning will continue right up to, and including, the New Year’s weekend. Right now, the Canadian financial sector is so well prepared that the major issue is no longer one of potential technical problems. Rather, it is a matter of dealing with a possible overreaction to Year 2000 fears that could be more disruptive than the Year 2000 problem itself. With this in mind, the Bank of Canada has built up a large inventory of banknotes. This is not because we think that Canadians will actually experience widespread problems using means of payment other than cash, such as credit and debit cards, over the New Year’s weekend. Not at all. Rather, this larger-than-normal inventory, together with the preparations made by the Bank and by private sector institutions that are responsible for distributing banknotes, is intended to reassure Canadians that, should some people decide to stock up on cash, the financial sector will be able to respond. By taking these actions, and by publicizing them, we hope to ease any public concerns in this area and so reduce the likelihood that we will actually need to use these extra banknotes. We have also made contingency arrangements to ease potential liquidity concerns in the business and financial sectors. Of course, the primary responsibility for contingency plans to meet possible liquidity needs rests with financial institutions. In addition to these private sector preparations, the Bank of Canada has set up a special liquidity facility to address any worries financial institutions may have about being hit with extraordinary demands for liquidity from their customers. And we are widening the range of collateral they can use to secure loans from the Bank. We have also announced arrangements to prevent any unusual liquidity demands from putting upward pressures on money market interest rates in Canada around the end of the year. So, there should be no reason for any material Year 2000 risk premium in Canadian interest rates. In summary, the Canadian financial sector is well-prepared for the century changeover. All participants, including the Bank of Canada, have made contingency arrangements. Should unexpected glitches develop, these arrangements will provide a quick, effective response to minimize any disruptions. More importantly, they should bolster the confidence of Canadians in the financial sector’s ability to operate normally. And this should ease Year 2000 fears and reduce the likelihood of an overreaction. I would like to reiterate what I have said before: when it comes to financial matters, I see no reason why Canadians should prepare for this coming New Year’s weekend any differently than for any other long weekend. I would now like to turn to the economy and monetary policy. The current economic situation The Canadian economy has bounced back from the global financial crisis of 1997–1998 and its negative impact on the prices of the key commodities we export. Indeed, when the numbers for the third quarter of 1999 are out, I expect that they will show that output has expanded by over 4% since the third quarter of 1998. And the unemployment rate has continued to fall over the past 12 months - from 8.3% to its current level of 7.5%. A number of factors have contributed to this economic rebound. Commodity prices have turned around, responding to the ongoing strength in North American demand and improved economic prospects in Europe as well as in Japan and the other Asian countries most hurt by the financial crisis. While energy prices have shown the sharpest recovery so far, prices for base metals, potatoes, shellfish and forest products, all of which are important in Atlantic Canada, have risen as well. Still, the prices for certain other key commodities, such as grains and oilseeds, remain soft, plagued by large global supplies and weak demand. Another factor that has been supporting economic activity in Canada is the amazing strength of the US economy, our major export market. That economy has had a remarkable eight-year-long expansion, marked by vigorous growth in production, strong gains in employment, and low inflation. Inflation has been held down by improvements in productivity as well as special factors such as a strong US dollar, low commodity prices and intense global competition. Stronger domestic demand has also been instrumental in Canada’s economic pickup. Indeed, the stimulus from spending by Canadian households and businesses has been growing recently in response to high levels of confidence, rising employment and relatively low interest rates. Behind all this, of course, has been our environment of low and stable inflation, which has helped our economy perform well despite the global financial difficulties. But what about the outlook for the Canadian economy over the next year? How does it shape up? Let me begin with the US economy. We currently expect that growth there will slow to a more sustainable pace next year. This will reduce the risk that US inflation pressures will intensify. Although the US market will no longer provide the same strong stimulus for our exports, we are now beginning to see stronger economic activity in Europe and Japan that should partly offset a slowing in US demand. As for domestic spending in Canada, the recent momentum is likely to continue. With respect to inflation, the total consumer price index has risen recently. But that is mainly the result of the recent increases in world energy prices passing through to retail prices for gasoline and natural gas. Those increases now seem to be coming to an end. There has also been upward pressure on prices from the effects of the earlier depreciation of the Canadian dollar. The core rate of inflation (total CPI, excluding food, energy, and the effects of changes in indirect taxes) is currently near the middle of our 1% to 3% target range. Overall, this is a positive economic picture as we go into 2000. But as I said earlier, monetary policy must be forward-looking. So central bankers are always peering into the future, looking for potential concerns. After all, it is our job to worry! And there are some rather significant risks to this positive economic scenario to worry about. Potential challenges for Canadian monetary policy There are a number of challenges that the Canadian economy and monetary policy may have to face in the coming year. Today, I would like to highlight two that are particularly important. The first challenge concerns the implications for Canada of the ongoing strength of the US economy. The second relates more to our own domestic situation as the Canadian economy begins to operate at what is estimated to be full production capacity. Let me start with the issue of the prolonged vigorous expansion of the US economy. This extraordinary performance presents the US monetary authorities with the difficult task of ensuring that it does not lead to overheating and rising inflation. The Americans have already raised interest rates twice over the summer. What would be the implications for Canada if the US economy does not start to slow and the US central bank has to raise interest rates further? In these days of close global integration, developments in the United States - the world’s largest economy - are bound to have a major effect on national economies everywhere. This is especially true for Canada. Our proximity and strong economic ties with that country mean that the state of the US economy and any associated monetary policy actions will certainly affect us. But there is no automatic rule as to how the Bank of Canada should respond if the US Federal Reserve raised interest rates. We would have to examine carefully the strength of the economic expansion in the United States and the associated price pressures behind such a move by the Fed. The challenge for the Bank would be to assess the implications for our economy and for financial markets. If it looked as though these developments would have a significant effect on Canada and lead to upward pressures on prices here, our objective of keeping inflation within the target range might be jeopardized. In that case, the Bank of Canada would certainly respond. Let me be as clear as I can on this - our current healthy economic expansion will continue only if we sustain a low and stable inflation environment. A more difficult scenario for Canadian monetary policy would be an actual outbreak of inflation in the United States next year. Let me hasten to add that I think this is rather unlikely, given the past success of the US monetary authorities in keeping inflation under control and their resolve to continue to do so. Nonetheless, it is important that we be prepared for all contingencies. The first thing the Bank of Canada would have to do in such a case is to ensure that the US inflation psychology did not cross our borders. That would mean making it absolutely clear that we would strongly resist movements in the underlying rate of inflation in Canada that risked taking it outside our target range. Once it became evident that the US inflation rate was persistently rising relative to ours, the Canadian dollar should start to rise in value against its US counterpart. Indeed, with such an adjustment in the Canadian dollar, our floating exchange rate would be playing its proper role in providing an important element of insulation for Canada from those rising US prices. And monetary policy should be ready to encourage that process, if necessary, to prevent a spillover of inflation. You would be right to gather from what I have said so far that the best news we can all hope for is a “Goldilocks” US economy - not too hot, not too cold. This basically means an economy that slows down to a steady, sustainable pace of expansion that keeps it off the boom-and-bust roller-coaster. The second challenge I want to talk about today is how Canadian monetary policy should operate as our economy gets close to the full use of its production resources. Whether because of persistent US demand for our exports or strong momentum in spending by Canadian households and businesses, we will very soon reach levels of economic activity that, based on typical measures of our production potential, appear to be at full capacity. Ideally, we want to see the economy operating at a level that is as close as possible to full potential. At this level, the economy can deliver a low and stable rate of inflation - one that is neither rising nor falling persistently. And economic activity is expanding at as rapid a pace as is sustainable over time. Unfortunately, in practice, it is very difficult to estimate precisely where this ideal operating level is. And this gets to be even trickier after a period of business restructuring, rapid technological change, and strong business investment in plant and equipment. This is what happened in Canada during the 1990s. And it may have raised our economy’s production capacity, although we cannot be sure by how much. Given the current momentum in our economy and the high levels of activity that we are seeing, and because of the uncertainty surrounding the conventional estimates of potential output, monetary policymakers must be on guard. In other words, we are at the point in the economic cycle where the Bank of Canada will have to be very alert to early warning signs of accumulating price and cost pressures. And we will have to respond promptly and firmly if any such signs emerge. The Bank will deal with this risk by closely monitoring a wide range of indicators that can help it to assess the extent of present and future pressures on capacity and on inflation. These indicators include unanticipated movements in current inflation, changes in expectations of future inflation, the growth of money and credit, and information gathered from the Bank’s regular contacts with businesses across Canada. In conclusion, let me say that you can be assured that the Bank is very sensitive to the increased risks of inflation that are coming from continued buoyant growth in the United States, improved economic prospects in Europe and Japan, and the increased momentum of domestic spending here in Canada. In facing the various challenges that may arise over the next year, it will be crucial to ensure that the Bank continues to deliver a trend of inflation that is inside our target range of 1% to 3%. It is only when Canadians can count on inflation staying low and stable that our economy performs best.
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Remarks by Gordon Thiessen, Governor of the Bank of Canada, to The Fraser Institute in Vancouver, British Columbia, on 6 December 1999
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Mr Thiessen clarifies some points regarding the economy, productivity and standard of living in Canada Remarks by Gordon Thiessen, Governor of the Bank of Canada, to The Fraser Institute in Vancouver, British Columbia, on 6 December 1999 * * * Over the past couple of years, there has been considerable debate about productivity and our standard of living in Canada. For the most part, the discussion of these issues has been useful, but at times it has been somewhat confusing. There are so many different facets to productivity and the standard of living that they cannot all be covered in one speech. My objective today is relatively modest - to try and clarify some of the basic ideas and measures and to explain where monetary policy fits in this debate. I will start by focusing on the relationship between the standard of living and productivity. Next, I will talk about some of the different measures of productivity. I will finish with a few words on how monetary policy can contribute to rising productivity and rising standards of living. The connection between the standard of living and productivity A country’s standard of living and its productivity are not the same thing, although over the long run they are closely linked. This distinction has not always been made clear in some of the commentary I have seen. When we speak of a society’s standard of living, we are typically referring to the individual well-being of its citizens. In principle, our standard of living should reflect both economic welfare and social (“quality of life”) elements, such as a clean environment, a low crime rate, freedom of expression, etc. But because the social elements are difficult to assess and to weigh properly, the focus is usually on measures of our economic well-being. There are a number of different indicators of our economic welfare. The most common one measures how much output is produced in our economy, on average, for every man, woman and child in Canada (real gross domestic product per capita). There are also various measures of real income per person, before and after taxes (such as gross national income per capita and personal disposable income per capita). If we look closely at any one of these measures, it is clear that productivity is a critical factor in the determination of our standard of living. But it is not the only factor. And when there are changes in any of the other elements that influence our economic welfare, our standard of living can, for periods of time, change in ways that appear to be disconnected from trends in the growth of productivity. As an example, let us look at the simplest yardstick of living standards - output per capita. Clearly, this is closely related to the output produced per worker - which is the most common measure of productivity. But it also depends on the number of people employed relative to the total population. Through the 1960s, 1970s and 1980s, output per capita in Canada increased more rapidly than productivity. But over the past 10 years, it has fallen behind the growth in productivity. Canada’s lacklustre standard-of-living performance in the 1990s, which we have heard so much about, has less to do with slower productivity growth than with the fact that the proportion of the population that is actually employed has not been increasing. This is in contrast to the rising trend of the previous three decades, when an increasing number of women and baby boomers were entering the labour market. During the 1990s, trends in employment rates in Canada also diverged significantly from those in the United States, contributing to an increased gap in living standards between the two countries. This weak employment growth in Canada partly reflects the extensive and difficult restructuring that our private and public sectors had to undergo in a relatively short time compared with the United States, where the process started earlier and was spread over a longer time period. If we measure our standard of living in terms of how much of the national income goes to each and every Canadian, then we are not just talking about the volume of goods and services we produce. We are also talking about the world prices we receive for what we sell abroad relative to the prices we pay for imports - that is, our terms of trade. During the 1970s, world prices for the primary commodities that Canada exports soared relative to prices in general. And they remained high through to the early 1980s. Since then, however, commodity prices have typically been on a downward trend. And, of course, they fell sharply in the wake of the Asian crisis in 1997-98, before partly recovering in 1999. We have to take this into account when we examine what happened to our standard of living in the 1990s compared with earlier decades. We also need to look at what has happened to personal income after taxes. From the mid-1970s to the early 1990s, tax revenues did not cover government spending and we were getting deeper and deeper into debt. In other words, we were living beyond our means. During the 1990s, taxes rose and government transfers and other expenditures were cut back relative to the size of our economy to reduce the burden of those large public debts that had accumulated during the previous two decades. Measures of after-tax income in the 1990s reflect that sobering reality. So these are some of the factors that have weakened the link between productivity and living standards in recent years. In the long run, however, productivity is, without a doubt, the key element contributing to our prosperity. Productivity growth is the foundation for real income growth - it allows businesses to pay higher real wages and still keep costs down and remain profitable. There is one important difference between productivity and the other factors that influence our living standards. The difference is that there are no constraints on productivity and its ability to contribute to improvements in our welfare on a sustained basis. The other factors are constrained by physical, institutional, and legal limitations. For example, there is a limit to the proportion of the population that can, and will, engage in economic activity. Similarly, there are limits on the length of the work week. On the other hand, there does not seem to be an upper bound on capital accumulation over time or on the growth of human knowledge or on the degree to which both can result in higher productivity. Productivity: the Canadian record But I have been talking about productivity without defining it properly or describing how we measure it. Measures of productivity tell us how much output we can produce from the effective use of various inputs - skilled workers, capital equipment, technological innovation, and managerial and entrepreneurial know-how. Increases in productivity trace improvements over time in our ability to boost output by finding new and more efficient ways to use these inputs. The most commonly used, and best-understood, measure of productivity is labour productivity. It tells us how much output is produced per worker or per hour worked. Of course, labour productivity is affected by experience and education as well as by the amount of capital equipment (notably machinery and equipment) that is available to workers. So, ideally, we would prefer to use the measure that combines labour with all these other inputs - what we economists call total factor productivity. In practice, however, it is very difficult to measure the amount of physical capital in the economy. Also, it is not clear how best to take account of improvements over time in the quality of the various inputs. And, of course, measurement problems are worse in the services sector, where output is also notoriously difficult to estimate. Because of these difficulties, analysts usually focus on the more straightforward measures of labour productivity. This has the added advantage of being closer to measures of standards of living and more directly comparable across countries. With that as background, let me now turn to the “facts” on productivity in Canada, as best we can measure them, and see how they compare with those for the United States. We should, of course, keep in mind that the relevant statistics for the two countries, while similar, are not always comparable. For example, there are differences in the way some prices are measured, particularly for high-tech equipment, as well as differences in adjusting for changes in the quality of inputs. Moreover, last month, the Americans revised their productivity figures upwards, following revisions to their national accounts going back to 1959. To a significant extent, these revisions reflect a definitional change that now treats computer software as an investment (instead of a business expense as before), and therefore as part of the country’s gross domestic product. These definitional changes probably make the U.S. productivity figures less comparable with ours than before. So one should be careful not to draw strong conclusions from comparisons that focus too narrowly on these data. Nevertheless, we can still comment on the broad trends. Through the 1950s and 1960s and into the early 1970s, labour productivity in the overall business sector in Canada grew rapidly. It averaged close to 4 per cent per year - somewhat higher than in the United States. From the early 1970s to the mid-1990s, productivity growth slowed sharply in both countries - to less than half that rate. It has picked up in the latter half of the 1990s, especially in the United States, where an investment boom has given U.S. workers substantially greater amounts of capital equipment to work with. Some commentators have paid particular attention to productivity growth in the manufacturing sector, even though manufacturing accounts for less than 20 per cent of total economic activity in both countries. They believe that the measures for this particular sector are more reliable and more relevant for international competitiveness. Since the 1980s, labour productivity in the Canadian manufacturing sector has risen at a significantly slower pace than in the United States. To a large extent, this stronger showing by the U.S. manufacturing sector reflects the remarkable performance of two industries - electrical and electronic products and commercial and industrial machinery. These industries have benefited the most from dramatic advances in computer technology, and they have a much larger weight in the U.S. economy than here in Canada. As a last comment on the facts about our productivity performance, I would like to stress the need to distinguish clearly between the rate of growth and the level of productivity. While this may seem selfevident, there has been a certain confusion on this score in some of the recent public commentary. The rate of growth in our productivity has certainly slowed since the early 1970s, as it has in most industrial countries, for reasons that are still not fully understood. But the level of our productivity has been rising, not falling. And it cannot be blamed for the decline in some measures of our living standards during the 1990s. However, there is a significant gap in levels of productivity between Canada and the United States ours is below theirs. Since access to ideas and technology is international, we would have expected that gap to narrow, as it did during the 1950s and 1960s. But it hasn’t. For this to happen, productivity in Canada has to grow at a faster pace than in the United States. This is the challenge we Canadians face if we are to bring our standard of living closer to that of our southern neighbours. How can monetary policy support productivity growth? Economists have not been particularly successful in explaining differences in rates of productivity growth over time or across countries. As a result, there is no widespread agreement on what can be done to bring about faster productivity growth on a sustained basis. Nonetheless, I would like to make some comments on what would be helpful in this regard. And I would certainly emphasize that we should always scrutinize our economic policies for any potential impact on productivity. When it comes to monetary policy, there is an increasing international consensus that the contribution central banks can make to encourage growing productivity and higher standards of living is to provide a low-inflation environment. Low and stable inflation reduces uncertainty about future price movements, lowers the incidence of boom-and-bust cycles in the economy, and helps to keep interest rates down. All of this encourages investments in equipment and new technology that should lead to productivity gains. When I look at the impressive productivity record of the United States over the past couple of years, I am struck by the exceptionally large investments in machinery, equipment, and technology that have taken place there. I know that the depreciation of the Canadian dollar through late 1997 and 1998 has kindled some concerns that a weak currency blunts the incentives for export industries to improve productivity. And that has led to some suggestions that Canadian monetary policy, rather than targeting low inflation, should set targets for the Canadian dollar. Or that perhaps our currency should be pegged to the U.S. dollar. It is true that in a period of high, and potentially rising, inflation, a depreciating currency adds to the confusion about what is happening to relative prices and contributes to an attitude that any cost increases can be passed on. Thus, businesses may not be as concerned about improving productivity as a cost-cutting measure. But that is not the case in Canada today - inflation is low and stable, and the Bank is committed to keeping it that way. Businesses know that they will generally not be able to pass on cost increases, and so they focus on cost control. The argument that a depreciated currency tends to discourage productivity improvements also ignores today’s powerful global competitive forces and the strong drive of businesses to increase their market share and their profits as well as raise the prices of their stock. In my judgment, our floating exchange rate works well. It absorbs the impact of, and facilitates the adjustment to, extraordinary shocks that hit our economy from time to time, such as the sharp drop in primary commodity prices in 1997-98. As part of that adjustment, the low Canadian dollar has encouraged businesses outside the primary industries to expand their presence in foreign markets. But they can maintain those gains only if they continue to work hard to increase productivity and to ensure that they stay competitive as our currency regains strength. Concluding thoughts To conclude, it is almost impossible to overemphasize the importance of rising productivity as the fundamental long-term factor contributing to healthy economic performance and prosperity. Over time, gains in productivity are the basis for growing incomes and rising standards of living. Compared with the strong performance of the 1950s and 1960s, Canada’s productivity record since the early 1970s has been rather disappointing. Even though the level of our productivity has been rising, we have not made any headway in bringing it closer to that of the United States. Recent developments in Canada, however, offer some promise of improvement. Productivity growth has picked up in the past couple of years in response to the cyclical recovery and the structural changes in our economy. And investment in machinery, equipment, and technology has increased sharply in the past three years, much the same way as it did in the United States some years earlier. But there is no room for complacency. Increases in productivity do not just happen. These days, good productivity performance seems to be related to changing technology - an openness to adopting it and a flexibility in adapting to it. That is what we must strive for in Canada. We will also need to maintain a stable macroeconomic environment that combines low inflation and a prudent fiscal policy. This will help foster a climate conducive to initiatives in innovation, risk-taking, and investment that can contribute to sustained productivity gains. I can assure you that the Bank of Canada will continue to do its part, by keeping inflation low and stable.
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Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Metropolitan Halifax Chamber of Commerce, Halifax, Nova Scotia, on 27 January 2000.
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Mr Thiessen discusses accountability and transparency in Canada’s monetary policy and assesses recent economic developments Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Metropolitan Halifax Chamber of Commerce, Halifax, Nova Scotia, on 27 January 2000. * * * Accountability and transparency in Canada’s monetary policy Public sector institutions have been undergoing significant changes over the past decade. One of the most important changes has been the move to greater accountability. Public institutions are now required to be more open and to provide more information about their operations. Or, to use the word currently in vogue, to be more “transparent.” Nowhere has this move towards greater transparency been more dramatic than among central banks in the major industrial countries. Traditionally, central banks had been rather closed, almost mysterious, institutions. This reflected the view that financial markets needed to be “surprised” if monetary policy was to have a significant effect. In recent years, the philosophy behind monetary policy in Canada, and in most major countries, has been moving in the other direction. Not only does this reflect the need for accountability, but also the fact that central banks have come to appreciate that transparency can actually lead to better policy outcomes. Today, I would like to tell you about some of the steps we have taken to increase transparency in the conduct of Canadian monetary policy. In keeping with this theme, I will also take this opportunity to bring you up to date with the Bank’s view of recent economic developments at home and abroad and tell you how the outlook shapes up. I will also discuss what monetary policy is doing to keep the current economic expansion in Canada on a sustainable course. Accountability and transparency in monetary policy I would suggest that what is absolutely crucial for the accountability and transparency of public institutions is clear objectives. This is certainly true for monetary policy. In Canada, a major step towards greater openness was the adoption in 1991 of specific targets for inflation reduction. Inflation was quickly brought down and, since 1994, the objective has been to keep it low and stable - within a range of 1% to 3%. This explicit target is a precise yardstick for measuring the Bank’s success or failure and, thus, provides the basis for our accountability to the public. But as I have said many times in the past, low inflation is not an end in itself. We focus on low inflation because it contributes to a more productive, stable, and prosperous economy. So ultimately, our accountability must be seen in terms of inflation control as a means to better overall economic performance. Interestingly, once a central bank has adopted an explicit inflation target, as we have, and is held to account for it, the move towards greater transparency is speeded up. For it quickly becomes apparent that monetary policy will be more successful in meeting the target if both the public and financial markets understand the factors affecting inflation as well as the central bank’s assessment of those factors and its likely response. Here in Canada, we found that, as we consistently met our targets, public expectations about future inflation changed - the more credible the Bank’s commitment to the targets became, the more Canadians formed their plans on the assumption that the future trend of inflation would stay inside the target range. Over time, a credible commitment to inflation control also sets other positive developments in motion. As credibility rises, uncertainty about future inflation diminishes. Interest rates are lower than otherwise and investment in machinery, equipment, and technology increases, leading to stronger economic growth in the longer run. But that is not all. As Canadians become more confident that inflation will be controlled, they are less quick to react to unexpected disturbances that could affect inflation. This contributes to greater economic stability and gives the Bank of Canada a bit more time to assess the extent and persistence of such disturbances. Greater public confidence thus gives the Bank more latitude to explore the limits of the economy’s capacity to produce and to create jobs without setting off inflation pressures that undermine the sustainability of the economic expansion. Transparency and accountability in monetary policy require effective communication. At the Bank, we have undertaken a series of initiatives to improve our communications with the public. Five years ago, we redesigned our Annual Report to make it a more reader-friendly yearly account of how we have managed the Bank and how effectively we have carried out our main responsibilities. At that time, we also introduced a Monetary Policy Report, which is published every six months - in May and November. This Report describes our management of monetary policy and gives the Bank’s assessment of recent economic information as well as our outlook for the economy and inflation. After the release of each Monetary Policy Report, we meet with media as well as with business economists and financial analysts. In addition, I appear before a parliamentary committee to discuss the Report’s contents. Both of these initiatives are important parts of the accountability process. Six months, however, has been proven to be rather a long time between Monetary Policy Reports, especially for market participants and economists who follow monetary policy closely. That is why next month we will issue an Update to the Monetary Policy Report from the Bank’s Governing Council. It will appear in the Winter 1999-2000 issue of the Bank of Canada Review. These Updates will be published regularly, every February and August, between issues of the Monetary Policy Report. Because Canada is such a large country with so many diverse economic regions, it is important that the Bank maintain contacts with the public that are country-wide and that involve two-way communication. We need to hear first-hand what is happening to the economy in every corner of Canada. That is why, in 1997, we set up five regional offices, including one here in Halifax for the Atlantic region. Our representatives are in frequent contact with various local associations, businesses, community groups, government officials, colleges, and universities to give and receive information and to exchange views on the economy and monetary policy. To supplement these contacts, my senior colleagues and I frequently travel across the country to talk to groups, like this, to respond to questions, and to listen to comments and concerns. That way, we ensure that we are heard and also that we hear what is going on from one end of this country to the other. For those of you who surf the Internet, I should mention that there is also a tremendous amount of information on the Bank of Canada’s Web site. All of our recent publications, speeches, and press releases are there. You will also find short, straightforward notes explaining various aspects of monetary policy as well as information on interest rates and exchange rates. In addition, our site features a rather neat inflation calculator, which allows you to find out what inflation has done to the value of your money over any period during the past 85 years. This can really bring home just how inflation eats into the buying power of money over time. These are just some of the things we have done to become more open, understandable, and accountable to the Canadian public. I would now like to give you my reading of where the Canadian economy is, where we are headed, and what it all means in terms of the outlook for inflation and monetary policy. The Canadian economy - recent record and outlook 1999 turned out to be a very good year for Canada. Our economy rebounded strongly from the global financial crisis of 1997-98 and its negative effects on the prices of the key primary commodities we export. When the numbers for the final quarter of 1999 are out, I expect that they will show that the Canadian economy has expanded by close to 4% since the fourth quarter of 1998. And employment has been growing strongly, taking the national unemployment rate down to an 18-year low of just under 7%. Nova Scotia’s economy has also done well this past year, both in terms of output and employment growth. Indeed, when it comes to job creation through the year (that is, December 1999 over December 1998), Nova Scotia has done better than the national average. A number of factors have supported the economic upswing in Canada. On the external side, we have greatly benefited from an amazingly strong US market. A pickup in growth in Europe and a recovery in some of the Asian economies that were most hurt by the financial crisis have also helped. Another important factor has been the turnaround in primary commodity prices, in response to firmer world economic activity. Stronger domestic spending in Canada, reflecting growing confidence, rising employment, and relatively low interest rates, has also been instrumental in boosting the rate of economic expansion. When I talked about our economic prospects in Charlottetown in early November and again when our Monetary Policy Report was released shortly after that, I indicated that the Bank expected a positive picture for 2000. This meant continued healthy growth and an underlying rate of inflation (as measured by the Consumer Price Index, excluding food, energy, and the effects of changes in indirect taxes) near the middle of our 1% to 3% target range. Information received since then suggests that in the future there may be more upward momentum of demand in Canada than we thought because of greater strength both in the world economy, especially in the United States, and in global commodity markets. So we may be looking at a somewhat faster pace of economic expansion for this year - in the upper half of the 2¾% to 3¾% range that we suggested in the autumn. I also pointed out last November that there were inflation risks in the outlook for Canada that the Bank was sensitive to, and should be ready to face, given that monetary policy must be forward-looking. I highlighted two risks in particular: a potential buildup of inflation pressures in the United States that could spill over to Canada; and the possibility of a much stronger momentum of demand in this country from both domestic and foreign sources. Economic developments since November continue to point to these risks. And they underline the need for the Bank to be vigilant and ready to act in a timely fashion to safeguard Canada’s low trend of inflation. For let us make no mistake: a resurgence of inflation would undermine our chances of a durable economic expansion. Of course, the challenge for monetary policy is to assess carefully just when action is needed. Ideally, we would want our economy to operate at a level that is as close to full production capacity as possible. At this level, inflation will stay low and stable, and the economy can expand at as rapid a pace as is sustainable over time. It is when persistently strong demand pushes the economy to operate well above capacity over a period of time that inflation pressures develop. This is what monetary policy must seek to avoid. Unfortunately, in practice, it is very difficult to estimate exactly where that sustainable operating level for the economy is. And this is even harder after a period of major restructuring, such as we have experienced in Canada in the 1990s. While conventional measures suggest that the economy may now be operating at capacity, it is quite likely that structural changes have raised the output potential of our economy. But we are not sure by how much. That is why the Bank closely monitors a wide range of indicators that can help it assess the extent of current and future pressures on capacity and inflation. Some of the elements going into this assessment are: unexpected movements in actual inflation; changes in expectations of future inflation; other measures of pressures in product and labour markets; the growth of money and credit; and information gathered by our regional representatives from business contacts across Canada. Because of the current strong momentum of demand and high levels of economic activity, and because of the uncertainty about Canada’s production potential, the Bank must continue to be on guard. It must continue to watch for leading signs of future price and cost pressures and stand ready to respond promptly if such signs emerge. To conclude, the Bank of Canada has taken a number of steps to become more open, transparent, and accountable about the conduct of monetary policy. Through a regular flow of reports and speeches like this, we intend to continue telling you where the economy is and where we think it is going, what risks we see out there, and what monetary policy can do to reduce them. These days, the Bank is sensitive to the increased risks of inflation coming from a more synchronized expansion of the world’s major economies. Not only does a buoyant US economy continue to bolster the demand for Canadian products, but firmer commodity prices are boosting our national income and adding to the impetus of domestic spending in Canada. The Bank remains committed to delivering a trend of inflation that is inside the target range of 1% to 3%. Because the long and the short of it is that low and stable inflation is a crucial ingredient for a durable, healthy economic expansion.
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Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Canadian Society of New York, New York, on 9 March 2000.
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Mr Thiessen converses on the conduct of monetary policy in Canada under a floating exchange rate system Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Canadian Society of New York, New York, on 9 March 2000. * * * The conduct of monetary policy when you live next door to a large neighbour Both in Canada and elsewhere, much ink has been spilled over the past year on the pros and cons of different exchange rate regimes and the implications for monetary policy. Interest in the subject was piqued by the difficulties experienced in 1997-98 by a number of emerging-market economies in Asia - difficulties that had a lot to do with unsustainable exchange rate arrangements. As well, the formation of a large single currency area in Europe, just over a year ago, focused attention on monetary unions. Canada’s floating exchange rate system has itself been the subject of debate, particularly while our economy was adjusting to the effects of falling world commodity prices. There have been a number of changes in exchange rate regimes recently. Several Asian countries have abandoned their fixed exchange rate arrangements for more flexible systems. Last year, Brazil also moved to a floating exchange rate. Conversely, Argentina was seriously debating giving up its currency board arrangement and adopting the US dollar. And of course this past January, Ecuador embarked on the road to “dollarization” in an effort to restore political and economic stability there. In a world of increasingly open markets for goods and services, burgeoning international trade, and massive global capital flows, what can we say about the appropriate exchange rate arrangements and the scope for independent monetary policies in individual countries? I believe that Canada is well placed to offer some useful insights, living next to a much bigger neighbour, with whom we have forged very close economic and financial links over the years. And so today, I would like to talk about the conduct of monetary policy in Canada under a floating exchange rate system. I will end with a brief summary of the state of the Canadian economy. Economic and financial links between Canada and the United States No two other countries share as much as the United States and Canada - and I do not just mean hockey, baseball, or the longest undefended border in the world! Let us look at some basic economic facts. The value of goods and services that cross the Canada-US border every year amounts to about US$370 billion - 40% of our gross domestic product. Canada accounts for nearly one-fifth of US international trade in goods and services, while the United States accounts for close to four-fifths of ours. With the Free Trade Agreement (FTA) of 1989 and the addition of Mexico in 1994 to form the North American Free Trade Agreement (NAFTA), tariffs between Canada and the United States have been eliminated on a large number of goods. Financial flows between our two countries have also generally been free of controls since shortly after the Second World War. Today, the United States accounts for two-thirds of our net international liability position and for approximately half of all Canadian gross international assets and liabilities. With this much economic and financial integration between our two nations, it is not surprising that there are people who believe that Canada should be in some type of monetary union with the United States (and perhaps Mexico) or that it should peg its currency to the US dollar. Instead, the Canadian dollar has been floating against the US dollar for all but eight of the last 50 years - the longest time that any industrial country has been on a floating exchange rate system. Indeed, this coming September will be the 50th anniversary of our first move to a floating rate. Canada’s floating exchange rate regime The main reason for choosing to float is that economic shocks affect our two countries differently. Even when Canada and the United States are hit by the same shocks, the impact on our economies can vary. Movements in the world prices of primary commodities are a classic example. Although the share of primary products in total Canadian exports has fallen by nearly half since the 1970s - to about 30% - primary-producing industries are still important to us. In the United States too, the primary sector is significant. But, unlike Canada, the United States is not a net exporter of commodities. Indeed, it is a net importer. So, when world commodity prices tumbled in 1997-98 in the wake of the Asian crisis, this actually helped a vigorously expanding US economy, by reducing input costs and dampening upward pressure on the general level of prices. In Canada, however, lower commodity prices caused a deterioration of our terms of trade - the prices we receive for our exports relative to the prices we pay for imports. Between mid-1997 and the end of 1998, the US terms of trade rose by about 3%, while ours fell by close to 5%. This had a negative effect on both our national income and the profitability of our primary sector. When something like this happens, our floating exchange rate helps us to absorb the consequences. This is not to say that it eliminates the effects of a decline in commodity prices. But it does cushion them, and it facilitates the necessary adjustments in the economy. In this instance, the external value of the Canadian dollar fell by about 12% between mid-1997 and late-1998, reflecting a drop of some 20% over the same period in the average world price (in US dollars) of the key primary commodities we produce. Because of this movement in our currency, the price of these products in Canadian dollars fell by less than their world price in US dollars, thus reducing the negative impact on our exporters of commodities. Even more important was the incentive that the lower exchange rate provided to Canadian producers and exporters of non-commodity goods and services to expand their sales abroad. With the exchange rate moving in response to the commodity-price shock, the negative effects were spread out more evenly across the economy and were less pronounced overall than they might otherwise have been. Yes, real GDP growth slowed from 4% in 1997 to 3% in 1998. But it picked up again to 4¼% in 1999. Moreover, employment has been rising, and unemployment has continued to fall since 1997. And in response to the acceleration in economic activity and rising commodity prices, the Canadian dollar has strengthened over the past year. The other important characteristic of a floating exchange rate is that it allows us to have a monetary policy that is separate from that of the United States. Typically, economists express this independence as the ability to choose one’s own national objective with respect to inflation. I do not find this to be a particularly useful way of looking at autonomy. And I most certainly would not want to suggest that there are serious shortcomings with the present objectives and approach of US monetary policy that would justify pursuing a fundamentally different policy in Canada. In fact, the objectives of monetary policy in our two countries are very similar. Monetary policy affects the level of aggregate demand in the economy which, in turn, leads to an ultimate effect on prices and the inflation rate. The real essence of pursuing a separate monetary policy is having the option and the ability to respond to fluctuations in demand that are unique to our economy. Let me give you an example from recent Canadian history. It goes back to the sharp fiscal tightening that we had to implement in 1995 in order to turn around our large public sector deficits and mounting indebtedness. Of course, fiscal deficits also had to be reduced in the United States during the 1990s, but the relative tightening has been much less than in Canada. In any event, the dampening effect on aggregate demand of this dramatic change in Canadian fiscal policy called for easier monetary conditions. As progress was made in restoring fiscal credibility, the Bank of Canada was able to lower its policy rate during 1996-97, to levels well below the comparable US Federal Reserve rate. Both market interest rates and the exchange rate moved down in response, helping to stimulate foreign and domestic demand and so moderate the effects of fiscal restraint on economic activity. For all these reasons, a flexible exchange rate has an important role to play in an open economy like Canada’s. Let me now turn to the framework for monetary policy that the Bank of Canada has adopted. Inflation-control targets The objective of Canadian monetary policy is to keep inflation low and stable. The Bank of Canada pursues this objective by means of an explicit target for inflation control. This target has been the main feature of our monetary order since the beginning of 1991. The current goal is to hold inflation inside a range of 1 to 3%. However, the Bank of Canada could not have targets for inflation control and be held accountable for achieving them without the flexibility provided by a floating exchange rate regime. But it is also true that a floating exchange rate system is more effective and reliable when there is a firm commitment to targets for inflation control. And our ability to have short-term interest rates for monetary policy purposes that are different from US rates is greater in those circumstances. The Bank of Canada’s success in meeting the targets over the past nine years has helped to increase public confidence that inflation will stay inside the target range. And this has been true even during periods of turbulence and relatively wide fluctuations in the external value of the Canadian dollar. Moreover, this increased confidence in the Bank’s commitment to low inflation has, in turn, helped the operation of financial markets by providing a strong underpinning to the valuation of the Canadian dollar. This is a relatively new phenomenon for Canada. During the years of high inflation - the 1970s and 1980s - a depreciation of the exchange rate would, all too often, raise fears of still higher inflation, which would then lead to further depreciation and higher interest rates. Needless to say, it is only when expectations of inflation and of the future value of the Canadian dollar are well anchored that an independent monetary policy is possible. For only then will movements in the exchange rate permit adjustments in real (after-inflation) interest rates in Canada that are different from those in the United States. Put another way, monetary policy actions cannot bring about Canadian real interest rates that remain below US rates for any significant length of time, unless markets have a fair amount of confidence in Canada’s commitment to prudent macroeconomic policies, and unless there is a reasonable expectation of a real appreciation of our currency in the future. In this context, I strongly believe that, without our inflation-targeting framework, we could not have had interest rates in Canada generally below those in the United States, as we have in the past four years. But I should add that neither would this have been possible without the remarkable progress made by Canadian governments during the second half of the 1990s to reduce budget deficits and to bring down the amount of public sector debt relative to the size of our economy (debt-to-GDP ratio). Now, you may ask, how important can inflation-control targets really be if the United States has consistently turned in a strong economic performance and low inflation without their benefit? The key element here is monetary policy credibility. And credibility is not necessarily tied to inflation targets. As US experience shows, a strong commitment to low inflation can do the job. But, where past price performance has not been particularly favourable, inflation targets can help to strengthen confidence in the central bank’s commitment to low inflation. From the early-1970s to the early-1990s, on average, Canada had a somewhat higher inflation rate than the United States. Other factors that matter are the size and importance of the US economy as well as the fact that the US dollar is the pre-eminent international reserve currency. All this incites considerable investment interest and greater market confidence in the US dollar compared with any other currency, especially during turbulent times. The Canadian economy, by contrast, is much smaller and more open. Because of these considerations, we in Canada have had to affirm our commitment to a more concrete monetary policy objective in the form of explicit inflation targets. The importance of credible macroeconomic policies In summary, I would suggest that our experience with a floating exchange rate system and a “made-in-Canada” monetary policy, despite high economic and financial integration with our much larger US neighbour, provides an interesting example for those exploring the gamut of exchange rate and monetary policy options. As I look at Canada’s exchange rate experience over the past few decades, however, one thing is very clear to me. And that is the importance of credible domestic macroeconomic policies. Without a sound fiscal policy and without a strong explicit commitment to inflation control, exchange markets will not have full confidence in the underlying value of the currency. And the ability of a flexible exchange rate to respond to shocks and to facilitate the interest rate movements needed for an independent monetary policy will be seriously compromised. This in the end says it all. No exchange rate system is going to bail you out of bad economic policies. And that is equally true of a floating exchange rate system, as it is of the alternatives - a fixed exchange rate or indeed a monetary union, even if that monetary union is with the world’s largest, strongest economy. In today’s rapidly changing, increasingly open world economy, there is an even greater need for flexibility than before. I believe that a flexible exchange rate regime continues to serve Canada well in dealing with the challenges of this new economic reality. The current economic situation in Canada Let me finally say a few words about the current economic situation in Canada. The Canadian economy had a good year in 1999. Our export industries benefited from the strong US economy. And with global economic conditions generally improved, primary commodity prices rebounded. The resulting gains in incomes and employment in Canada led to higher levels of domestic spending. Recently revised statistics now show stronger economic growth in Canada during 1999 than previously estimated. And we continue to see strong momentum in our economy so far this year. Indeed, by some calculations, we could be operating at full capacity. However, as has been the case in the United States for some time, Canada has also recently experienced an increased level of investment in machinery, equipment, and technology. This should lead to improvements in productivity and in our economy’s production capacity. But we cannot be sure by how much. In light of this uncertainty, the Bank of Canada has been concerned about our economy picking up too much speed. There is a risk that we could hit the capacity ceiling too hard, causing supply bottlenecks and shortages that could lead to an ongoing increase in inflation. To reduce this risk, the Bank of Canada increased its Bank Rate twice, in November and February, following similar rate hikes by the US Federal Reserve. The latest data indicate that the external demand for Canadian output, especially from the United States, is stronger than previously expected. Under these conditions, it is essential for the central bank to be vigilant. Moreover, in view of the uncertainty about the production potential of our economy at this time of structural change, the Bank is now monitoring a wide range of indicators for early-warning signs of pressure on capacity and prices. Up to now, our inflation performance has been somewhat better than we had expected. While the increase in the total CPI over the past 12 months to January was 2.3%, our core rate of inflation (excluding food, energy, and the effect of changes in indirect taxes), at 1.3%, remains in the bottom half of the 1 to 3% target range. This good inflation performance bodes well for the continued expansion of the Canadian economy. But what remains to be seen is whether this expansion will bring with it strong productivity gains for Canada similar to those witnessed in the United States. One thing is clear. The job of the Bank of Canada must be to keep inflation in Canada low and stable. Without that, we will be risking both the economic expansion and the potential productivity gains.
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Opening Statement by Mr Gordon Thiessen, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, on 6 April 2000.
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Gordon Thiessen: Update on economic and monetary developments in Canada Opening Statement by Mr Gordon Thiessen, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, on 6 April 2000. * * * I very much appreciate the opportunity to appear regularly before your Committee. I would like to use this particular occasion to update you on economic and monetary developments as well as to discuss any issues that you may want to raise. Let me first give you an overview of the developments in the past year. When I appeared before you last April, there was still a high degree of uncertainty in the global economy related to the 1997-98 financial crisis in emerging markets and the associated fall in world commodity prices. And because of these difficulties, the pace of economic activity in Canada had slowed. But by mid-1999, our economy had regained its momentum, supported by buoyant US demand, a rebound in commodity prices, and a pickup in domestic spending. Over the four quarters of 1999, output expanded by about 4¾% and 425,000 new jobs were created, taking the national unemployment rate down to 6.8% by this February - its lowest level in 23 years. At the same time, the underlying rate of inflation remained low. Why has Canada rebounded so quickly from the external shocks of 1997-98? I believe it is because Canada’s economic policy foundation is stronger today than it has been in several decades. This foundation has two cornerstones. One is the improved fiscal positions of governments that have led to a declining ratio of public sector debt relative to the size of our economy. The second is an environment of low and stable inflation that is expected to persist because it is anchored by the Bank of Canada’s target for inflation control. Since the early-1990s, Canadian monetary policy has been based on a commitment to explicit targets for inflation control. This commitment has helped to moderate fears of a resurgence of inflation, has assisted the Bank in taking timely action in response to changing economic and financial conditions, and has improved our public accountability. A crucial part of our monetary policy regime is our floating exchange rate. Without that, we could not have Canadian inflation targets. A good measure of the success of our monetary policy framework based on inflation targets and a flexible exchange rate is that Canadian interest rates have remained lower than comparable US rates, apart from the period of turbulence in 1998. These lower rates reflect Canada’s lower inflation rate, and the expectation that low inflation will continue. In the past, a depreciation of our currency has frequently fed fears of inflation and has led to interest rate increases. The difficulties of the past couple of years also illustrate the value of a flexible exchange rate as a shock absorber. The downward movement of the Canadian dollar from mid-1997 to the end of 1998 was largely a response to the sharp decline in world prices of the primary commodities that Canada exports. Our economy had to adjust to this reality; the exchange rate decline facilitated a shift in activity from the primary sector to manufacturing and other export sectors. It also provided an additional incentive for these sectors to take advantage of a strong US economy. Because of these adjustments, the Canadian economy continued to expand during 1998 and recorded a substantial upswing in 1999. When I last appeared before this Committee, Mr Chairman, there were a number of questions about Canada’s rate of productivity growth and about the gap in productivity levels with the United States. I am happy to report that there have been some positive developments over the past year. Not only have we had better productivity gains through 1999, but purchases of machinery and equipment climbed 18% during the course of the year. This continues the increase in investment in machinery, equipment and technology that began in 1996 and that mirrors the increase in investment that began somewhat earlier in the United States. While we are certainly heartened by the better productivity outlook in Canada, we are not sure how large these gains are likely to be, how long they will last, or by how much they will eventually enhance our economy’s production capacity. This uncertainty raises an important issue for monetary policy, especially since, by some measures, the Canadian economy is currently operating at or above full capacity. On the one hand, our low-inflation environment and the Bank of Canada’s commitment to maintaining it give us more room than we have had for some time to explore the economy’s full potential. However, because of the current strong momentum of the economy and the high levels of activity, the Bank must be careful to avoid approaching capacity limits too rapidly. We do not want to trigger bottlenecks and shortages that can put unnecessary pressure on inflation. Because of the time it takes for monetary policy to have its full impact on the economy, we can best achieve and maintain full potential if we approach capacity constraints gradually and carefully. We had these considerations in mind when we increased the Bank Rate in November, February and March. These increases followed similar rate hikes by the US Federal Reserve. The US actions provided additional evidence of the likely further spillover of US demand to our export sector. Altogether, this suggests an overall demand for Canadian output that is stronger than previously expected. Under these conditions, it has been essential for the Bank of Canada to be vigilant. As I said before, our inflation performance, up to now, has been good - in fact, somewhat better than we had expected. While the 12-month rate of increase in the total CPI moved up to 2.7% in February because of sharply higher energy prices, when one looks through those developments at the underlying trend of inflation, our core CPI measure (which excludes food, energy, and the effect of changes in indirect taxes) was at 1.6% in February. This is within the lower half of the 1 to 3% inflation-control target range. When it comes to the surge in energy prices, let me just say that the Bank of Canada will be watching closely to ensure that the recent increase in energy prices does not show up in higher expectations of inflation. We expect that the recent decline in world energy prices will persist, bringing the rate of increase in the total CPI down, closer to the centre of our target range by late this year. I cannot stress enough the importance that we at the Bank of Canada place on keeping the future trend of inflation in Canada low and stable. This is the best contribution that monetary policy can make to the continued expansion of the Canadian economy and to further productivity gains.
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Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Chambre de commerce régionale de Sainte-Foy, Sainte-Foy, Quebec, on 26 April 2000.
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Gordon Thiessen: The Canadian economy - charting a course for the future Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Chambre de commerce régionale de Sainte-Foy, Sainte-Foy, Quebec, on 26 April 2000. * * * The 1990s was a difficult period for Canada and the Canadian economy. From the beginning of the decade, it was clear that we had to grapple with the problems that had been hampering our economic performance through most of the 1970s and 1980s. Thus, the Bank of Canada set out to lower inflation. Canadian businesses began to restructure their operations to become more productive and internationally competitive. And governments started the process of cutting public deficits and lowering debt burdens. Dealing with these problems was certainly painful. And, in some cases, it took us a good part of the decade to overcome them. But we have now made some crucial improvements to our economic foundation. And as we step into the new century, we are beginning to see the benefits. The Canadian economy has been expanding solidly for some time now. In fact, if we look through some temporary monthly declines, we are in our nineteenth quarter of positive growth. This is the longest uninterrupted economic expansion in Canada since the mid-1960s. And throughout, inflation has remained low and stable. The advantages of this expansion are now showing up in gains in employment and incomes. This is all very heartening. To maximize these benefits, we must build on - not be complacent about - our new-found economic vitality. We must avoid the boom-bust cycles of the past. This is one issue I would like to discuss today - how to minimize economic fluctuations. Not eliminate them altogether, that is just not possible. In today’s globalized markets, there will still be times when Canada’s very open economy will be hit by external shocks. And sometimes there will be surprises on the domestic side too. In the past, though, some of our economic ups and downs were aggravated by outbreaks of inflation. The question is, what can we do now to keep our economy moving along on a sustainable growth path? There is also the question of longer-term economic performance. For example, how low can our unemployment rate go on a sustainable basis? Will we succeed in narrowing the gap between our standard of living and that of our US neighbours? What choices should we be making today that will improve our economic performance in the decade ahead? This sounds like a tall order! So before I raise expectations too much, let me say that I do not have answers for all these questions. There are, however, several important steps we can take that would increase our chances of preserving the current economic expansion and help improve our performance over the long run. Let me start at the beginning - with sound economic policies. ... keep inflation low and stable I see low and stable inflation as an essential building block of a strong economic structure. Is this just my bias as a central banker? Perhaps, but there are good reasons for it. Inflation carries with it costs that are more profound and widespread than is commonly recognized. Inflation magnifies uncertainty about the future: when prices are rising, the rate of inflation is rarely stable or predictable. Inflation distorts and confuses the information and incentives that consumers, entrepreneurs, savers and investors rely on to make their economic decisions. And it causes households and businesses to spend time and money to try to shield themselves, or to benefit, from the effects of rising prices by turning to speculative assets (such as real estate) and away from productive investments. We saw a lot of this during the high-inflation days of the 1970s and 1980s. We also saw our interest rates rise higher and higher to compensate savers for expected higher inflation and for the risks caused by uncertainty about future inflation. And we saw economic booms turn into busts. So the focus of central banks on price stability these days is neither accidental nor whimsical. It is deliberate. And it has to do with reducing the toll that inflation takes on the economy and minimizing economic ups and downs. Put another way, if the goal of economic policies is a productive, well-functioning economy, capable of creating new jobs and delivering higher standards of living over time, then low and stable inflation is a crucial means to that end. That is why the Bank of Canada and the Government of Canada have agreed to an explicit target for inflation control, which currently aims to hold inflation inside a range of 1 to 3%. There are already signs that this commitment is paying off in helping to reduce the fluctuations in our economy. In the nine years that the inflation targets have been in place, not only has the underlying rate of inflation been much lower than in the previous two decades, but the pace of economic activity has been less variable from one quarter to the next. ... keep public finances under tight control Fiscal prudence is the other crucial part of sound economic policies. Why does tight control over government budgetary positions matter so much? As I said before, governments have made remarkable progress in recent years in reducing deficits and bringing down the national debt relative to the size of our economy - the debt-to-GDP ratio. But this ratio is still high. Because of this, we remain vulnerable to unexpected developments, such as international financial crises, which can push up the risk premiums in our interest rates. There is no objective economic analysis that can tell us exactly what is the right debt-to-GDP ratio to aim for. But as long as our national debt ratio is higher than that of most other large industrial countries, we are at risk of being singled out by investors the next time there are international problems. I hesitate to make any comment on the current debate about tax rates. But it is important for a well-functioning economy to find the level of taxes and government services that would deliver the right balance of incentives and public support programs. Finding this balance is even more important these days. In today’s environment of rapidly changing technology, there can be increased uncertainty and insecurity about the future; however, there can also be great rewards. Let me now turn to this issue of technological change and to some of the other challenges we must deal with if we are to prosper in the future. ... keep abreast of, and continue to invest in, new technology I do not believe that anyone would disagree with the importance of keeping up with the times. We are in the midst of a global technological and information revolution that is transcending national borders, pushing at new frontiers every day, and transforming our economies. This is the brave new world of microchips, fibre optics and the internet - a world more closely connected than ever before, where opportunities abound, competition is intense and survival is synonymous with innovation. As a nation, Canada is probably better positioned than most to seize the opportunities presented by this new technological revolution. Canada is a large country that has been a pioneer in telecommunications, and we are well ahead of many countries in the use of personal computers and the internet. Our colleges and universities turn out graduates that are highly skilled. And, in general, our population is well-educated. But to make the most of potential opportunities, we must ensure that we keep pace with the best in the global race to take full advantage of accelerating technological change. To appreciate the benefits of moving quickly to exploit the full potential of new technologies, we have only to look at the stellar performance of our next-door neighbour. The “strong growth-high productivity-low inflation” record of the United States over the past nine years has much to do with the systematic efforts of US businesses since the 1980s to restructure their operations and invest heavily in machinery, equipment and software that embody the latest technologies. Business spending on machinery and equipment as a percentage of that country’s gross domestic product (GDP) rose from 6% in 1992 to 11% last year. Canadian businesses have also substantially increased their purchases of machinery, equipment and technology - especially since 1996. As a percentage of GDP, such investment has risen from 6% to 9% in 1999 - which leaves us where the United States was three or four years ago. There is no doubt that gains in productivity require more than just investments in technology. The entrepreneurial application of technology in new areas and employees skilled in the use of new practices and equipment are also key elements in this process. But because we are going through a period of major change in applied technology, the spotlight is naturally on investments in technology and on the need to intensify our efforts on this front. I believe that Canada has what it takes to make the most of this “new economy”. ... the importance of being globally competitive More Canadian businesses also need to understand that globalization is irreversible - they must plan to operate on the basis that markets of all sorts will become increasingly globalized. Despite the problems that the World Trade Organization ran into in Seattle, the move towards freer trade is inevitable as more emerging-market economies recognize that opening up to international trade and investment is the best means of raising productivity and improving living standards. And while it may not always seem to be the case, this increased openness in world trade will be good for Canada too, especially if we are adept enough to take full advantage of it. A freer world trade environment opens up new vistas so that our companies can increase their global reach. Of course, it does the same for our competitors. And they will be out there, going after a bigger slice of the world market. The way to stay ahead of the game is by developing and maintaining a competitive edge. This means improving productivity and finding more efficient, less costly ways, of delivering the products that foreign customers want. And it goes beyond innovation and investment in new technologies. It also means strengthening our educational system and making sure that the workplace environment in Canada is ready to respond to the technological and market changes as they unfold. ... the importance of flexibility, training and development Dealing with rapid change is always difficult. When people are not certain how their lives will be affected by it, they tend to be fearful and resistant. So what will be needed, to an even greater extent than ever before, is a sense of partnership between employers and employees in developing strategies to deal with the challenges of change. In my view, there are two important elements to such strategies: we need to foster a greater degree of flexibility in adapting to change and we need to increase training so that employees have the necessary tools to operate confidently with advanced technologies and to get the most out of them. Flexibility is important because job requirements will change more frequently, along with evolving technology. We must be prepared to accept and adjust to these changes as well as to the possible need for greater movement between jobs, employers and even regions. When it comes to training, the main point I would like to make is that human skills are essential to innovation. What is the sense of spending heavily on state-of-the-art technology and equipment that ends up idle or inefficiently used because of a lack of trained personnel? The partnerships that are being formed between industries, on the one hand, and colleges and universities, on the other, are going to be even more important in the future. And I expect that all businesses, especially smaller ones, are going to have to devote more time and resources to training staff. ... the importance of an efficient and innovative financial sector The final item on my list today is the importance of an efficient and innovative financial sector. There is considerable evidence that the degree of financial development can have a marked impact on economic growth. A highly developed financial sector helps channel savings into investments and allocates that capital more efficiently. In these times of rapid technological change, many of the new and innovative applications of technology are going to take place in small, often new start-up, companies. Financing the growth of these companies presents a challenge for the financial sector because it requires an ability to assess the risk involved and then put the right price on that risk. And when concentrations of risk become too high for individual investors and lenders, the financial system must be flexible enough to allow them to shift their risks and rebalance their loan and investment portfolios. One of the factors behind the recent extraordinary performance of the United States has been the flexibility and innovation of its financial system. We will need to ensure that in Canada too, the financial sector responds to the challenges of today’s changing financing needs. Concluding thoughts Let me summarize my main points today. Canada has made remarkable progress over the last decade in strengthening its economic foundation. Starting from that firmer base, we are now in a position to move forward and reap some of the potential gains in employment and incomes from the technological revolution that is now sweeping the world. Monetary policy can support this process by providing a low and stable inflation environment. This will minimize economic fluctuations and allow our economy to perform at its best. Fiscal policy can help by keeping public finances under control and continuing to reduce Canada’s debt burden. The right balance of taxes and government services is also important. A stable, innovative financial sector can also help, by ensuring that financing flows efficiently to where it is needed the most. All this will go a long way towards providing an environment in which Canadian companies can go about their business confidently in a world of rapid change. It is the business community, however, that must take the innovative, and sometimes risky, decisions that are necessary to improve productivity and competitiveness, in order to meet the challenges and realize the gains of proliferating technologies and increasingly open world markets. There is no reason why we in Canada cannot meet these challenges and build a better economic future for ourselves.
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Opening Statement by Mr Gordon Thiessen, Governor of the Bank of Canada, before the House of Commons Standing Committee on Finance, Ottawa, on 16 May 2000.
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Gordon Thiessen: The economic situation in Canada and the prospects for inflation Opening Statement by Mr Gordon Thiessen, Governor of the Bank of Canada, before the House of Commons Standing Committee on Finance, Ottawa, on 16 May 2000. * * * Mr Chairman, and members of the Committee: it is always a pleasure to appear before you. Since other Parliamentary business precluded my appearance before you last fall, I especially welcome this opportunity to discuss the economic situation in Canada and the prospects for inflation. Last week, we released our 11th Monetary Policy Report. Since our November Report, the Canadian economy has outperformed expectations. Bolstered by vigorous external and domestic demand, Canada’s economic expansion strengthened in the second half of 1999 and into early 2000. The buoyant US economic picture, combined with Canada’s high levels of business investment and solid employment gains, augurs well for continued strong growth in Canada. Given the strong momentum of demand, the Bank of Canada has raised its projection for growth in 2000 to a range of 4 to 4.5%. The trend of inflation in Canada over the past six months has been lower than expected and is among the lowest in the industrial countries. Nevertheless, pressures on capacity will likely intensify through the year. Consequently, we expect the trend of inflation, as measured by the consumer price index excluding food, energy, and indirect taxes, to rise gradually to close to the middle of our 1 to 3% inflation-control target range. To keep this core rate of inflation steady near 2%, some deceleration in economic expansion or a more rapid increase in productivity and production capacity will be required during 2001. When it comes to the production capacity of the economy, there is currently even more uncertainty than usual. The lower-than-expected rate of core inflation would suggest that conventional measures may be underestimating the economy’s capacity to produce goods and services without adding to inflationary pressures. While the conditions that would permit an increase in productivity growth and in capacity have improved substantially in recent years, there has so far been no significant hard evidence of such an increase. This makes judging the balance between aggregate demand and supply in the economy an even greater challenge than usual for monetary policy. The other main risks to Canada’s economic outlook include the possibility that the momentum of aggregate demand from the US economy will continue to be stronger than expected and the likelihood of a buildup of inflationary pressures in the United States spilling over into Canada. The US economy has continued to steam ahead. There is a clear need for the pace of expansion in the United States to slow as we progress through this year and into 2001. Prudent monetary management dictates that we in Canada do not underestimate the upside risks for inflation, especially given the strong growth of aggregate demand in Canada, the United States, and elsewhere. Because of a lag of some 18 to 24 months in the effect of monetary policy on prices, the Bank is always trying to anticipate inflationary pressures one to two years ahead. Productivity growth is the only way to achieve long-term gains in incomes and living standards. The technological revolution that is currently sweeping the world provides Canada with a golden opportunity to improve its productivity. The best contribution monetary policy can make to enhancing productivity is to provide a low-inflation environment. Low and stable inflation reduces uncertainty about future price movements, lowers the incidence of boom-and-bust cycles in the economy, and helps keep interest rates down. All of this encourages investment in the equipment and software needed to take advantage of the new technology. Canada’s inflation-control target and the Bank’s commitment to maintaining that target, should ensure that monetary policy fosters a climate conducive to continued improvement in the performance of our economy.
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Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Kelowna Chamber of Commerce, Kelowna, British Columbia, on 15 June 2000.
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Gordon Thiessen: The Canadian economy - finding the right balance Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Kelowna Chamber of Commerce, Kelowna, British Columbia, on 15 June 2000. * * * With the technological revolution that is currently sweeping the globe, dealing with change is a growing challenge for businesses these days. This revolution is erasing national frontiers, intensifying competition, and transforming economies everywhere. The rules of the game are constantly being rewritten, and the issues facing businesses are multiplying rapidly. To survive and prosper in today’s world, businesses need to keep abreast of global technological trends, be ready to innovate and apply new technologies to both their production processes and the development of new products and services for their clients. From a broader perspective, in order to have a vibrant, dynamic economy, we count on the business community to take the initiatives that increase productivity and competitiveness so that we, as a nation, can benefit from rapidly changing technologies and increasingly open global markets. What business people need, in turn, in order to go confidently about their affairs and take the innovative, and sometimes risky, initiatives we expect of them, is a supportive economic policy environment. Today, I would like to talk about what monetary policy is doing to foster such an environment. Low and stable inflation is good for business Now, more than ever, businesses are operating in a changeable and uncertain world. The Bank of Canada has been doing what it can by removing one major cause of uncertainty - high and variable inflation. Low and stable inflation is good for business, good for the consumer, and good for the economy as a whole. This is not just a trendy central bank mantra. The emphasis that central banks are placing on price stability these days is neither fanciful nor unstudied. It is pragmatic. And it has to do with reducing uncertainty about the future, eliminating the inefficiencies caused by inflation, and minimizing economic ups and downs. The future is always uncertain. But it is even more so when inflation is rising because the pace at which prices rise is rarely stable or predictable. This uncertainty distorts and confuses the information that consumers, entrepreneurs, savers, and investors rely on to make their economic decisions. Not only that. Businesses and individuals end up spending more time and money either protecting themselves against inflation or trying to benefit from it. And interest rates rise to compensate savers and lenders for expected higher inflation and for the risks caused by uncertainty about future inflation. None of this encourages productive investment. In the high-inflation days of the 1970s and 1980s, a lot of economic resources were instead devoted to hedging and speculative purchases. And inflationary booms - here and elsewhere - inevitably turned into busts. We must not let this happen again. That is why the Bank of Canada and the Government of Canada have agreed to an explicit target for inflation control. This target aims to hold inflation inside a range of 1 to 3%. Inflation-control targets also ensure that monetary policy works to moderate fluctuations in output, employment, and incomes. In the nine years since the targets were first adopted, not only has underlying inflation been lower than in the previous two decades, but economic growth has strengthened and has shown less short-term variability. As we move ahead, we must ensure that this situation continues and that we avoid the boom-bust cycles of the past. Granted, we will not be able to wipe out fluctuations completely. External shocks will still buffet Canada’s very open economy every now and then. And we will get economic surprises on the domestic front too. But in the past, our economic ups and downs were often amplified by outbreaks of inflation. Keeping the economy on an even keel So how is the Canadian economy performing these days and what is the Bank of Canada doing to help keep it on an even keel? Our economy has been expanding solidly for some time now - even through the Asian financial crisis of 1997-98 - creating the conditions for the healthy gains in employment and incomes that we are now seeing. Since mid-1999, the economy has outperformed expectations - growing in excess of 5% at annual rates and with an underlying rate of inflation that, excluding fluctuations in energy prices, has remained in the bottom half of our 1 to 3% target range. The Bank has raised its projection for growth in 2000 to a range of 4 to 4.5% because of stronger demand for Canadian products from both domestic and foreign sources. When it comes to foreign demand, this stronger momentum reflects faster-than-expected growth in several parts of the world, including Europe and the emerging-market economies that were in the eye of the Asian storm. Even in Japan, where the outlook continues to be uncertain, economic conditions should improve this year. But by far the greatest source of this stronger external stimulus is the tremendous buoyancy of demand in the United States - a market that absorbs over 80% of our exports. Demand in that country continues to steam ahead and to push hard against the limits of production capacity. And signs of price and wage pressures have become more visible. That is why the US Federal Reserve has raised interest rates six times in the past 12 months to cool down the economy. The Bank of Canada has also been concerned that the greater-than-expected US demand for our exports, along with the strong momentum of spending by Canadians, could lead to undue pressure on our production capacity and consequently on future inflation in Canada. With US monetary actions reinforcing our view about the risks of a buildup of demand and inflation pressures in that country - a buildup which could spill over into Canada - we have raised interest rates four times since last November. In this connection, I would like to highlight a couple of important points that sometimes get lost in the public commentary. Monetary policy actions aim at future inflation First, monetary policy is concerned with future inflation pressures. Monetary policy works with relatively long lags. It takes between 18 and 24 months for a change in interest rates to work through the economy and have an effect on inflation. For this reason, any actions taken by the Bank of Canada today must be based largely on considerations about the economy and inflation 18 to 24 months down the road - not on what is happening now and not on the current rate of inflation (except to the extent that these factors colour our view of the future). So, even though the underlying rate of inflation has been in the lower half of the 1 to 3% target range, the Bank has to consider what is likely to happen to prices in the future. Monetary policy actions are based on economic prospects here at home The next point I would like to stress is that Canadian monetary policy decisions focus, first and foremost, on the economic outlook here in Canada. So, the critical element is the Bank’s assessment of the balance of forces at work in the Canadian economy, and what this means for future inflation. If domestic demand here in Canada was not particularly strong, greater-than-anticipated US demand for our products would be a compensating element and hardly an issue. But if domestic demand was already rising rapidly, and the Canadian economy was operating at high levels, the spillover of strong US demand would have the potential to strain our production capacity and lead to higher inflation in the future. The important judgment that your central bank must make - every step of the way - is how these domestic and external forces add up. When the Canadian economy is generally in sync with that of the United States, and interest rates in our two countries are moving in the same direction, I can appreciate that Canadian monetary policy may be difficult to interpret. Some people may be persuaded to think that the Bank of Canada never has any choice but to follow the US Federal Reserve. Or, for that matter, that the Bank must have a target for the Canadian dollar that requires interest rates here to move in lock-step with US rates. But that is just not so. When US monetary authorities raise interest rates, the Bank of Canada has to look carefully at the reasons behind the move and decide what it means in terms of our ongoing assessment of the prospects for total demand and inflation in Canada. Developments in the US economy will always be important to Canada. And moves in US interest rates will always influence rates around the world, including ours. But that does not mean that we cannot have different interest rates in Canada and that the Bank always follows the Fed. Sometimes we do, and sometimes we don’t. It all depends on what we think is necessary to keep the Canadian economy on a non-inflationary, and thus sustainable, growth path. As I have already noted, in the past 12 months, we raised our interest rates four times while the Americans have raised theirs six times. On those four occasions, including the most recent increase in May, the Bank, after careful consideration, decided that the implications of US developments for our economy justified higher rates here as well. It is also important to remember that Canadian interest rates are still below comparable US rates for all maturities - as they have been for the last few years. This basically reflects the fact that we have a lower rate of inflation than our US neighbours and that our economy has not been pressing as hard against its capacity limits as theirs. We need to keep demand and supply in balance Through this discussion, I have talked mostly about total demand, but have not said much about our economy’s ability to supply goods and services - except to suggest that a rapidly rising demand could lead to pressures on capacity and inflation. For the most part, we can be reasonably confident about assessing the various sources and strength of demand in the economy. But estimates of the production potential of our economy, are much more uncertain these days because of major ongoing structural changes. We know that in recent years, and especially since 1996, Canadian businesses have been investing heavily in machinery, equipment, and software, much of which embodies the latest technologies. This should raise productivity in Canada and allow our economy to grow faster than it otherwise would. But, at this point, it is difficult to tell by how much, whether some of the gains are already in, or whether most are still to come. So far, our statistics yield little direct evidence of a substantial pickup in productivity growth, although recent historical revisions to the National Accounts show somewhat larger gains than before. Because of this uncertainty, the Bank is taking a cautious approach to projecting a permanently higher rate of growth in our economy’s capacity to produce. But we certainly do not want to dismiss this possibility either. That is why we are following closely a wider-than-usual range of indicators that could tell us what is happening on the supply side and give us early-warning signs of pressure on capacity and prices. For example, we watch for unexpected movements in the underlying trend of inflation and for changes in expectations of future inflation. We also look at commodity prices, wage settlements, reports of shortages in product and labour markets, the growth of money and credit, and information from the Bank’s business contacts across Canada. Take, for instance, our best estimate of the trend of inflation - what we call core inflation. This is a measure that takes out of the consumer price index the fluctuations caused by the very volatile energy and food components and the effects of changes in indirect taxes. By this measure, inflation has been somewhat lower than we had expected since late last year. This very favourable price performance suggests that our economy has not been pressing as hard against capacity as we had thought. It gives us some more room to explore where the limits of that capacity really are. And this should give businesses a greater opportunity to exploit their new equipment and technology to the fullest. Nonetheless, we must not be lulled into thinking that the threat of inflation has disappeared. Given the strong momentum and high levels of activity in our economy, and given the time that it takes for monetary policy actions to affect output and prices, the Bank must remain vigilant. Nothing will bring the present expansion to an abrupt halt more quickly than an outbreak of inflation. Assessing the balance between total demand and supply in the economy and the implications for inflation will be an ongoing challenge for monetary policy. I can assure you that the Bank is fully committed to the task - because keeping inflation low and stable will help to provide an environment in which the Canadian economy can enjoy solid growth and achieve its full potential.
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Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Calgary Chamber of Commerce, Calgary, on 14 September 2000.
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Gordon Thiesssen: The outlook for the Canadian economy and the conduct of monetary policy Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Calgary Chamber of Commerce, Calgary, on 14 September 2000. * * * Today, I would like to bring you up to date on the Bank of Canada’s views about the outlook for the Canadian economy. Prospects for the period ahead are generally very favourable. But, as is often the case, there are also uncertainties that the Bank will have to deal with as it pursues its objective of keeping the economy on a sustainable, non-inflationary track. Dealing with such uncertainties presents a constant challenge for the Bank in its job of conducting monetary policy. Another part of our job involves always looking at ways to enhance the effectiveness of policy - by reducing uncertainty about our actions, by increasing transparency and accountability, and by broadening public awareness of how monetary policy works. Today, I want to outline some new procedures for announcing changes in official interest rates that we plan to introduce later this autumn. We believe that these procedures should help improve the effectiveness of monetary policy in Canada. But first let me give you an update on the current economic situation. Economic update The Canadian economy has been expanding strongly for some time now, and particularly since mid-1999. Indeed, between mid-1999 and mid-2000, it grew by about 5¼%. Through much of that 12-month period, economic growth outstripped expectations. In part, this can be attributed to the spillover of greater-than-anticipated demand from the United States. The rapid growth of the American economy has been confounding observers for quite some time now. And, as might be expected, buoyant US demand has been pressing against that economy’s capacity to produce. One safety valve that has helped to relieve the pressures on US capacity has been the inflow of goods and services from abroad. Canada’s export industries have benefited greatly from this spillover of excess demand from the United States. Not only have these exports contributed directly to the rapid economic expansion in Canada, they have been a source of encouragement that has added to the surge in purchases of machinery and equipment by Canadian businesses. And, of course, the recent gains in employment and incomes in the export sector have strengthened the momentum of spending by Canadian households. Together, buoyant exports, strong investment by domestic businesses, and robust household spending have led to a surprisingly strong demand for Canadian goods and services. What is remarkable under the circumstances is that pressures on the basic trend of inflation in Canada have been minimal. Now, I know that the 12-month rate of increase in the total consumer price index has risen to around 3% because of the sharp rise in energy prices. Although these higher prices have boosted activity for Canada’s energy producers, they are also raising living costs for most Canadians. The Bank remains fully committed to preserving an environment of low and stable inflation. But monetary policy can control only the future trend of inflation - not the temporary ups and downs caused by movements in the prices of very volatile items such as energy and food. Of course, if there was evidence that higher energy prices were beginning to feed into prices of other goods and services, or into expectations about the future trend of inflation, that would be different. But so far, this has not been the case. In order to get a better fix on the underlying trend of inflation, we should look at the Bank’s core measure of inflation - the measure that excludes fluctuations in energy and food prices and the effects of changes in indirect taxes. This core measure has remained in the bottom half of the 1 to 3% target range we have set for controlling inflation. This is somewhat lower than we had expected. It suggests that total demand, although stronger than anticipated, may not have been putting as much pressure on our economy’s production capacity as we had thought at the beginning of the year. The economic outlook Let me now shift to the Bank’s view on the outlook for the economy. When it comes to monetary policy, “looking ahead” is very important. Why? Because the actions that your central bank takes today will not have their full effect on the economy and on prices for another 18 to 24 months. That is why the Bank must always base its decisions on a judgment about future economic growth and future inflation. The Bank’s latest projection for economic growth in 2000 (published in the August Monetary Policy Report Update) is within a range of 4¼ to 4¾% - somewhat higher than we had expected in the spring. This projection assumes a slowing through the balance of the year from the very rapid pace of the first half. But, even then, output will probably be growing faster than production capacity; and so pressures on capacity are likely to increase. Because of this, we are predicting that the core measure of inflation will move up to 2% - the centre of the Bank’s 1 to 3% target range - by early next year. At the same time, if world crude oil prices stabilize, we expect that the rate of increase in the total CPI will gradually come down and eventually converge with our core measure of inflation. But, as I said before, there are a number of uncertainties attached to this projection. The most important uncertainties revolve around future developments in the US economy. Will that economy slow to a more sustainable pace? Or will there be another surprising spillover of US demand into our exports? Right now, it looks as if the growth of spending by US households is moderating. What if the American economy does not slow fast enough to prevent a rise in US inflation? Will that have a significant adverse effect on expectations of inflation in Canada? This is where the Bank’s commitment to keeping the trend of inflation within the target range really comes into play. Our role is to reassure Canadians, by seeing to it that inflation here remains low and stable even if US inflation rises. Another major area of uncertainty has to do with our economy’s capacity to produce. As I said earlier, our remarkable inflation record to date suggests that there was probably still some excess capacity in the economy in the early part of this year. Although our projection assumes that pressures on capacity will contribute to an increase in the underlying trend of inflation - from around 1½% now to 2% next year - there is, in fact, a significant margin of uncertainty around these numbers. It is possible that the investment boom we have witnessed in Canada since 1996 will increase productivity growth and capacity more quickly than we are allowing for. There is a good deal of anecdotal evidence that some of the American experience (burgeoning investments in technology leading to robust productivity gains) is being replicated in Canada. Until recently, there had been little evidence of this in our official, economy-wide productivity statistics. But there was a significant gain in productivity in the data for the second quarter of this year that were released recently. Of course, it remains to be seen whether this will continue. Monetary policy response How has monetary policy responded to all this? Because of the surprisingly strong momentum of demand in Canada since mid-1999, and because of the likelihood that this could lead to inflation pressures in the future, the Bank of Canada raised interest rates four times - by a total of 1¼ percentage points - between November 1999 and May 2000. These four interest rate increases followed similar actions by the US central bank. The Federal Reserve’s assessment that interest rate increases were necessary because the growth of demand in that country continued to outstrip the growth of supply, was an important factor in our decision to match those moves. The reason was that this implied a continued spillover of US demand into Canada, which would add to the already buoyant growth in spending by Canadian households and businesses. This additional external demand for our products, at a time when domestic demand here was already brisk, essentially increased the risks that we would run into capacity constraints and pressures on inflation. Clearly, US economic and financial developments will always be relevant for Canada. After all, we do over 80% of our foreign trade with that country. And US financial markets have an important influence on interest rates worldwide, including ours. But that does not mean that the Bank of Canada must always follow the Federal Reserve, or that interest rate levels here and in the United States must be the same. The job of Canadian monetary policy is to respond to trends in our own economy. Naturally, because of the close ties between Canada and the United States, economic trends in the two countries are often similar, and may require similar policy responses. But this is not always the case. Since mid-1999, the Americans have raised their interest rates on six occasions. We have raised ours four times. Moreover, Canadian interest rates continue to be below US rates because inflation here has been lower and our economy has not been growing as quickly, or for as long, as theirs (so that the risks of pressures on capacity and inflation in Canada are not as intense). Still, I can appreciate that, when our economies move together, people may find Canadian monetary policy difficult to interpret - particularly when the Bank has moved immediately to match increases in US policy rates. On those occasions, there has been a tendency to conclude that either the Bank does not have much choice but to follow, or that it must have targets for the Canadian dollar that require interest rates here to move in lock-step with US rates. Neither of these assumptions is correct. When US monetary authorities take a policy action, the Bank looks carefully at the reasons behind the move and at what it all means for our ongoing assessment of the outlook for total demand and inflation in Canada. Our job is to do what we think is necessary to keep our economy on a non-inflationary, and thus more sustainable, growth path. New procedures for announcing monetary policy actions I would now like to turn to another aspect of the way we conduct monetary policy in this country. As I said at the outset, the Bank is constantly searching for ways to enhance the effectiveness of monetary policy. Over the past couple of years, we have been looking at how other major central banks go about announcing changes in official interest rates, and we have been assessing whether our current arrangements could be improved. We have noted that most foreign central banks announce their decisions on interest rates only on certain dates that are set well in advance. In the United States, this has been the practice for some time. And now it is also the case in the other major economies (Japan, the euro zone and the United Kingdom) as well as in a number of smaller industrial countries (eg Sweden, Australia and New Zealand). After carefully considering all the relevant issues, we have concluded that pre-set dates for announcing interest rate actions would improve the implementation and effectiveness of Canadian monetary policy. We have decided that eight specified dates per year would be appropriate in the Canadian context. The scheduling of these eight dates would be based on the timing of the flows of economic information that the Bank relies on to gauge the economic situation in Canada, to make projections, and to assess the need for monetary policy action. Each of these eight dates would be separated from US policy action dates by a week or more. In preparing to move to this new system, we will be consulting interested parties on the most appropriate day of the week and time of day for announcing interest rate changes. The way we see it, this new approach has several advantages over the existing arrangements, advantages that should contribute to a more effective monetary policy. I would like to briefly highlight some of these benefits. To begin with, the new arrangements should reduce uncertainty in financial markets about the timing of policy actions. Under the current system, the Bank can move interest rates on any business day (Monday to Friday), at 9 am because market participants are not sure exactly which day a change in interest rates may be announced, trading can slow in the early morning, for several days, when there is an expectation that the Bank may move. Removing this uncertainty should improve market efficiency and liquidity. We also believe that the new system will help to focus public attention more closely on economic trends here in Canada, and on the appropriate monetary policy response based on those critical trends. Let me explain. On each of the eight pre-set dates for interest rate action, the Bank would issue a press release that would give a brief assessment of the economic situation in Canada and explain why we chose either to change interest rates or to leave them unchanged. This would also give us an opportunity to link the latest developments more directly to the underlying economic trends in the medium term - the 18 to 24 months over which the effects of monetary policy actions are spread. Integrating the information in these eight press releases with our other key monetary policy statements throughout the year would provide a more regular, frequent, and continuous account of our views on the Canadian economy. In the end, if the Bank does its job of keeping people well informed, we expect that economic analysts, market participants, and the public generally will be clearer about the factors that influence monetary policy and will be in a better position to anticipate the direction of policy. This has certainly proven to be the case in the United States, the euro zone, and the United Kingdom. There could, of course, be extreme cases that might call for an immediate policy response from the Bank rather than waiting for the next scheduled announcement date. The new arrangements would not preclude such an option. It would be used very infrequently, however, and only under extraordinary circumstances. Details of this new approach to announcing interest rate changes will be issued next Tuesday and will be posted on the Bank’s Web site, along with an invitation for comments from the public. We plan to implement this system in the autumn, with the first date for interest rate action set for November 2000. Concluding remarks To conclude, let me return to my main points regarding our economic situation. The Canadian economy has been performing very well in recent years and the Bank expects that it will continue to do so. The task for monetary policy is to ensure that the economy stays on an expanding but non-inflationary path. Monetary policy faces some challenges in the period ahead - challenges arising from several uncertainties surrounding the economic outlook. The key uncertainty is the future performance of the US economy and the implications for Canada. From this perspective, what matters most is that the US monetary authorities succeed in bringing their high-flying economy onto a more sustainable track. Another important challenge for monetary policy will be to keep demand and supply here at home in balance at a time when the application of new technology may well be transforming Canada’s economy and moving it onto a higher growth path. But we are not sure of that yet. While the recent productivity gains are encouraging, it is too early to tell if this is the beginning of a sustained improved performance on this front. Because of this, the Bank will be closely watching all indicators that could provide early signs of such an occurrence. But we must be careful not to let our hopes run ahead of reality and take risks with inflation. A flare-up in inflation and the higher interest rates that would go with it would discourage investments, especially those in high-tech equipment and software, that enhance productivity and are so crucial to improved economic performance in the future. The outlook for the Canadian economy is very promising. The best contribution the Bank can make to realizing this economic potential is to preserve the present environment of low and stable inflation. For this is what fosters sustained solid economic growth and improved standards of living over time. I can assure you that the Bank of Canada remains fully committed to the task.
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Lecture by Gordon Thiessen, Governor of the Bank of Canada, to the Faculty of Social Science, University of Western Ontario, on 17 October 2000.
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Gordon Thiessen: Can a bank change? The evolution of monetary policy at the Bank of Canada 1935-2000 Lecture by Gordon Thiessen, Governor of the Bank of Canada, to the Faculty of Social Science, University of Western Ontario, on 17 October 2000. * * * I would like to thank the Faculty of Social Science here at the University of Western Ontario for inviting me to deliver this lecture. The Department of Economics within the Faculty is known for its long-standing interest in monetary economics, as well as its appreciation of economic history. I thought that it would be appropriate, therefore, to combine these two elements and use this occasion to reflect upon the dramatic changes that have taken place in the theory and practice of monetary policy in Canada during the Bank of Canada’s 65-year history. Over this period, there has been a fundamental transformation in the way monetary policy is conducted in Canada and in most other industrial countries. While globalization and technological change have played an important role in this area, as in so many others, they have not, to my mind, been the principal driving force behind this transformation. Far more important has been the interaction of experience and economic theory. The puzzling and, at times disappointing, performance of the economy has often served as the catalyst for major theoretical advances and policy innovations. Although the evolutionary process set in motion by these forces has not always been smooth or painless, it has, without question, deepened our understanding of how the economy works. It has also taught us valuable lessons about how monetary policy should be conducted. One of the most important lessons that monetary authorities have learned through this process of analysis and experimentation is that there is no virtue or advantage in vague policy objectives and complex operating procedures. Simpler and more straightforward approaches have generally turned out to be better. Monetary policy does not need to be cloaked in secrecy or artificial intricacies to be effective. What is needed to get the job done is one clear objective and one simple instrument. My career in central banking - of just over 37 years - covers more than half of the period since 1935 that I am going to review today. I do not intend, however, to describe every policy development since the early 1960s, when I first joined the Bank, nor all those from the preceding period. Instead, what follows is a selective overview of certain events that I believe were critical to the evolution of monetary policy in Canada. While the conduct of monetary policy will always involve a great deal of uncertainty and imprecision, the steps that we and other central banks have taken to make it simpler and more transparent have, in my opinion, improved its effectiveness and contribution to economic welfare. 1. The beginning: establishing the Bank of Canada The Bank of Canada was established in 19351 during the Great Depression. Public confidence in the behaviour of markets, and the financial system in particular, had all but disappeared. Traditional remedies and the natural re-equilibrating forces of the capitalist system did not seem to be having much effect, and there was growing sympathy for more radical solutions. The Bank of Canada Act was actually passed in July 1934, but the Bank did not begin operations until March 1935. Still, many observers questioned whether the creation of a central bank would be the answer to Canada’s problems. Other countries that had established central banks much earlier had suffered the same collapse in economic activity and were experiencing similar difficulties trying to extricate themselves from the situation. Keynes’ General Theory2 would not be published for another year, but there was already widespread scepticism about the likely effectiveness of a more aggressive approach to monetary policy. Interest rates were at historically low levels, and the provision of extra reserves was seen as only adding to the surplus liquidity that already existed in most commercial banks. Nevertheless, excessive credit creation in the period immediately preceding the Depression, and the severe liquidity problems that many borrowers had experienced once it was underway, were generally viewed as important contributors to the collapse, if not the primary cause. Perhaps a central bank, learning from past experience, could reduce the likelihood of a similar occurrence in the future. Doubts about the usefulness of monetary policy in stabilizing output did not prevent the legislators who drafted the original Bank of Canada Act from giving the Bank a broad and ambitious mandate. According to the preamble of the Act, which is the only description that we have ever had of its basic functions, the Bank was expected to: . . . regulate credit and currency in the best interest of the economic life of the nation, to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of the Dominion.3 While the legislators seemed to appreciate that not all of these objectives were mutually consistent or even attainable with a single policy tool,4 they may have assumed that the Bank would have more than one instrument at its disposal. Indeed, moral suasion, interest rate ceilings and various other means of directly influencing the volume and composition of credit had already been used extensively in Canada. The segmented nature of our financial system, in which banking, insurance, trust and securities activities were all carefully segregated from one another, combined with the high levels of concentration that existed in most of these industries, contributed to the “success” of such an approach. In any event, according to the new Keynesian orthodoxy that was soon to take hold, most of the heavy lifting associated with economic stabilization would be performed by fiscal policy. To ensure that the new central bank would not be subject to undue influence from either the government or the financial sector, the architects of the Bank of Canada made it a privately owned corporation with widely distributed shares. Neither the shareholders nor senior officers of the Bank were allowed to work in the financial sector, and the only formal representation that the government was permitted was through the Deputy Minister of Finance, who was expected to serve as a non-voting member of the Board of Directors. The Bank’s accountability and reporting requirements were limited to the publication of weekly financial statements and an annual report. Even though Parliament in 1935 was prepared to allow greater public regulation of the economic life of the nation, it realized that some separation of money creation from the government’s spending activities was probably important. Subsequent legislation reversed some of this separation by eliminating private equity holdings and making the government the exclusive owner of the Bank’s shares. Other restrictions, however, on the government’s ability to participate in Board meetings and influence the daily conduct of monetary policy remained in place. The issue of whose will would prevail if there was ever a major disagreement between the Minister of Finance and the Governor of the Bank of Canada was not explicitly addressed until much later. Keynes, J M (1936): The General Theory of Employment, Interest and Money, MacMillan, London. Bank of Canada Act, 1934, c. B-2, Preamble. Note the words “so far as may be possible within the scope of monetary action”. The contrast between the policy environment in 1935 and that of today could not be more dramatic. Diffuse policy objectives, uncertain reporting lines, interventionist policy measures and a distrust of financial markets have given way to clearly defined inflation targets, improved governance and accountability, simple operating procedures and a more open approach to policy formulation and implementation. We now have a single long-run objective - price stability - and a single policy instrument - the overnight interest rate. The targets for our objective and our instrument are both publicly announced, and our actions are subject to constant scrutiny and review. The story of how this profound transformation was brought about is the subject of the rest of my lecture. 2. How did we get here? The changes that I am about to describe did not happen overnight or in any continuous way. They were the result of a long, and sometimes painful, process of experience, experimentation, academic investigation and market pressures. At times, Canada was able to trade on the experience of other countries, but on other occasions it had to find its own way. The challenges and problems that we encountered were often unique or unprecedented. Our proximity to the United States, coupled with our smaller size and openness, forced us to confront many of the issues associated with globalization long before the term became fashionable. We have always been the archetypal small open economy. 2.1 The early years: 1935 to 1950 The Great Depression may have been exacerbated or even caused by monetary policy errors in Canada and elsewhere, but the newly created Bank of Canada had limited means of dealing with it. Financial markets were not very well developed in the 1930s and the monetary policy instruments at the Bank’s disposal did not appear likely to be effective.5 Interest rates, as noted earlier, had reached historically low levels and commercial banks, with few exceptions, had more than enough liquidity. No serious effort was made, therefore, to mount an aggressive countercyclical policy. Various fiscal initiatives were undertaken prior to the outbreak of the Second World War, but not much progress had been made in reducing unemployment or restoring industrial output to its pre-Depression levels. Most of the Bank’s activities from 1939 to 1945 were directed towards financing the war effort. This involved extending cash advances to the government and overseeing the sale of Victory Bonds. Determined not to repeat the economic mistakes made during the previous war, the government tried to finance most of its expenditures through taxes and new bond issues. Consequently, the Bank’s main responsibility immediately after the war was to keep interest rates as low as possible, to facilitate the rollover of the massive public debt that had accumulated. In the event, the reconversion of wartime production facilities and the absorption of decommissioned military personnel into the domestic labour force were much easier than many had imagined.6 By the late 1940s and early 1950s, however, inflationary pressures had started to build. The Bank and the government tried to suppress them by imposing temporary controls on certain types of bank financing. Some of this was accomplished through explicit legislation, the rest through private conversations between the Governor of the Bank and the presidents of the 10 chartered banks. These actions proved to be insufficient, however, in the face of rising world commodity prices, a booming US economy, large foreign investment inflows and increased defence expenditures to support the war effort in Korea. All of these factors put upward pressure on the Canadian dollar and made it difficult to control the domestic monetary expansion. With some reluctance, the government was forced to undertake a more decisive and, at the time, revolutionary action. Although Canada was no longer on the gold standard and might have used an exchange rate depreciation to help stimulate the economy, it had a large amount of foreign debt outstanding and a high priority was put on maintaining a stable exchange rate. Watts, G S (1993): The Bank of Canada: Origins and Early History, edited by T K Rymes, Carleton University Press, Ottawa. On 30 September 1950, Douglas Abbott, the Minister of Finance, announced that: Today the Government, by order in Council under the authority of the Foreign Exchange Control Act, cancelled the official rates of exchange which, since September 19th of last year, had been calculated on the basis of a 10 percent premium for the United States dollar in Canada. It has been decided not to establish any new fixed parity for the Canadian dollar, at this time, nor to prescribe any new official fixed rates of exchange. Instead, rates of exchange will be determined by conditions of supply and demand for foreign currencies in Canada. With this announcement, Canada abandoned the Bretton Woods system of pegged exchange rates, which had been established at the end of the Second World War, and allowed its currency to float freely in international markets. The resulting appreciation would hopefully discourage some of the inflow of funds, defuse the inflationary pressures that the economy had been experiencing, and obviate the need to pick a new, more sustainable value for the dollar. The flexible exchange rate was expected to remain in place only until markets had settled and a more reasonable value for the dollar had been determined. In fact, the experiment lasted for almost 12 years and had far greater significance than anyone could have imagined. Canada was the only major country in the world operating under a flexible exchange rate through the 1950s and early 1960s, and was regarded as something of a renegade in international circles. By the end of 1951, we had also eliminated all remaining controls on foreign exchange transactions and most, if not all, controls on foreign investment inflows. Canada’s financial markets were now open and exposed to external shocks. Our experience during this period would serve not only as a model for other industrial countries after the Bretton Woods system collapsed, but also as the catalyst for a revolutionary advance in the theory of international finance. Few students of Canadian economic history know that Milton Friedman played a role in Canada’s decision to float. In 1948, Friedman, then a young Associate Professor at the University of Chicago, participated in a radio debate with Donald Gordon, Deputy Governor of the Bank of Canada, and William Mackintosh, a Professor at Queen’s University and an adviser to the Department of Finance.7 One of the topics that they were asked to discuss was whether Canada should move to a flexible exchange rate. The Bank of Canada and the Department of Finance were both strong supporters of fixed exchange rates, as were most governments at the time. Friedman, as you might expect, spoke with great conviction about the advantages of a flexible exchange rate. Indeed, many of the arguments that he presented would later appear in his classic essay, “The Case for Flexible Exchange Rates”.8 Although the debate did not have any noticeable effect on policy for the next two years, Friedman’s ideas seem to have influenced official thinking in Ottawa. A number of secret memos were written within the Bank beginning in 1948, reviewing the feasibility and even desirability of his proposal.9 2.2 Monetary policy under a floating exchange rate: 1950 to 1962 In June 1954, Graham Towers, the first Governor of the Bank of Canada, retired after 19 years of service and was replaced by James Coyne, one of the authors of the secret memos. Like many Canadians at the time, the new Governor had become increasingly concerned about the level of foreign ownership in Canada and was anxious to increase national savings as a means of reducing our dependence on foreign capital inflows. Another concern, which was not as widely shared, involved the Friedman, M, D Gordon and W A Mackintosh (1948): “Canada and the Problems of World Trade”, transcript of a University of Chicago Roundtable radio discussion broadcast in cooperation with the National Broadcasting Company, The University of Chicago, Chicago, 18 April 1948. Friedman, M (1953): “The Case for Flexible Exchange Rates”, in Essays in Positive Economics, University of Chicago Press, Chicago, pp 157-203. See, for example, “A Method of Combining a Free Exchange Rate With the Present System of Exchange Control in Canada”, Memorandum, 31 January 1949, Bank of Canada Archives. domestic rate of inflation. Canada had experienced a sharp escalation in consumer prices during the Korean War, and inflationary pressures had persisted for some time after. While domestic spending had faltered in 1954, the subsequent recovery pushed inflation well above the level that the Bank implicitly associated with price stability. Coyne was convinced that the solution to both problems - low savings and high inflation - was a tighter monetary policy. Higher interest rates would reduce domestic demand and help raise national savings. Although a rudimentary money market had started to form in Canada, with the active encouragement of the Bank, it was not well developed. Popular wisdom, in any case, suggested that traditional monetary policy mechanisms were unlikely to be effective, even when they involved tightening monetary policy.10 As a result, Coyne decided to combine reductions in the supply of bank reserves with healthy doses of moral suasion, much as his predecessor had done in earlier periods. The Bank continued with this restrictive monetary policy stance through most of the late 1950s and into the early 1960s. In the face of rising unemployment and weakening economic activity, inflation dipped below 1% by the spring of 1961. Relations between the Bank and the Minister of Finance had deteriorated sharply, and numerous government ministers had demanded a change in policy direction. However, any desire to remove James Coyne and replace him with a more sympathetic Governor ran up against the ambiguous nature of the legislation regarding the government’s powers vis-à-vis the Bank. The academic community also became involved in the dispute and circulated a pamphlet entitled “The Economists versus the Bank of Canada”.11 A W Phillips had just published his famous paper on unemployment and the growth of money wages in the United Kingdom, and shown how higher (wage) inflation was typically associated with lower rates of unemployment.12 Not surprisingly, Phillips’ work found a receptive audience in Canada, and researchers soon replicated his results with North American data. Much of the commentary in the popular press during this period was also critical of the Bank’s policies, and reflected the widespread view that a little more inflation was not such a bad thing - provided it could bring higher employment and stronger output growth. James Coyne remained unconvinced, however. While he had no formal model or elaborate regression results to put forward in his defence, his instincts seem to have told him that any attempt to improve the economy’s performance by targeting a higher inflation rate was misguided and could only end in difficulty: There are those who sometimes set out the false alternatives of either full employment with inflation, or stable prices with a high level of unemployment. They say the nation must choose between unemployment and inflation. No person in any position of responsibility could possibly subscribe to that doctrine. It is false. Full employment and stable prices are not only compatible, they are in the long run inseparable.13 Doubts about the effectiveness of monetary policy were usually related to the presumed difficulties associated with stimulating the economy (ie “Pushing on a string”). Policy tightening was also thought to be ineffective during this period, however, since large interest rate increases were regarded as “unacceptable” and probably destabilizing. See the Bank of Canada’s testimony before the Porter Commission (Porter Commission Report (1964): Report of the Royal Commission on Banking and Finance, Queen’s Printer, Ottawa). Thirty prominent Canadian economists also signed a letter to the Minister of Finance calling for the dismissal of Governor Coyne. See Gordon, H.S. (1961): The Economists versus the Bank of Canada, The Ryerson Press, Toronto, pp v-vi. Phillips, A W (1958): “The Relation between Unemployment and the Rate of Change of Money Wages in the United Kingdom, 1861-1957”, Economica 24, no 100, November, 283-99. Coyne, J E (1961): Remarks to the Annual Conference of the Business Paper Editors Association, Ottawa, Ontario, 18 January 1961. The pathbreaking work of Milton Friedman and Edmund Phelps on the vertical Phillips curve would not be published until 1968, but their results were anticipated by Coyne in many of his speeches.14,15 He was convinced that there was no long-run trade-off between unemployment and inflation, except possibly in the sense that lower inflation might actually lead to higher output and employment. Experience and the new theory of rational expectations that would emerge 10 years later confirmed this result and showed that any positive employment effects associated with higher inflation were likely to be shortlived. There was one critical area, however, where Coyne and many other policy analysts, both within and outside the Bank, appear to have been misguided. Those who had questioned the effectiveness of monetary policy in earlier years had failed to appreciate that it was likely to be much stronger than fiscal policy under a flexible exchange rate system, especially when capital was highly mobile. The large capital movements triggered by any change in interest rates would put significant pressure on the exchange rate, amplifying the effects of monetary policy while undercutting the effects of any opposing fiscal policy. Coyne did not realize that, for similar reasons, it was unlikely that a tighter monetary policy would ever raise national savings or reduce foreign investment inflows. Robert Mundell, in his article on “The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability”, was the first economist to explain this apparent reversal of Keynesian theory.16 Mundell’s article was published in 1962, one year after Coyne had resigned in response to mounting criticism and ongoing efforts to remove him. The timing of Mundell’s work was no coincidence. According to Mundell,17 the inspiration for his work on policy effectiveness under fixed versus flexible exchange rates was a conversation he happened to overhear while working at the International Monetary Fund (IMF). Wynne Plumptre, Canada’s Executive Director at the IMF, was talking to another official in the elevator about a problem that the authorities back home had been wrestling with. The Bank of Canada had been pursuing a restrictive monetary policy in an apparent effort to reduce domestic spending, increase saving and limit the flow of capital into Canada. While economic activity had slowed, very little progress had been made on improving the trade balance or reducing foreign investment, owing to Canada’s strong dollar and high interest rates. Efforts by the Department of Finance to counter the negative effects of the Bank’s monetary policy through fiscal stimulus and to return the economy to full employment had thus far been unsuccessful. Government analysts were at a loss to explain why. The rest, as they say, is history. Mundell had written a number of papers on international capital flows as part of his PhD thesis, and this chance encounter seems to have been something of an epiphany. Suddenly, many of the ideas that he had been working on were transformed into a coherent model of the way the global economy worked in the presence of capital mobility. 2.3 Downward-sloping Phillips curves and the dash for growth: 1962 to 1970 The controversy surrounding James Coyne’s departure in 1961, together with publicly expressed government concerns that the value of the dollar was too high and that a nationalist program was needed to reduce foreign investment, put downward pressure on the Canadian dollar. It fell from a slight premium vis-à-vis the US dollar to roughly 95 cents (US) within a few months. Efforts to halt the decline through aggressive intervention in the foreign exchange market were unsuccessful. On 2 May 1962, the government decided to return to the Bretton Woods system and fix the value of the Friedman, M (1968): “The Role of Monetary Policy”, American Economic Review 58, March, 1-17. Phelps, E (1968): “Money-Wage Dynamics and Labour Market Equilibrium”, Journal of Political Economy 76, July/August, 678-711. Mundell, R A (1962): “The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability”, International Monetary Fund Staff Papers 9, March, 70-76. As told by R Mundell to J Murray, Bank of Canada. Canadian dollar at 92.5 cents (US). Unfortunately, it took some time for academics and policymakers to appreciate the full implications of Mundell’s work. Indeed, there is nothing that I am aware of in the official documents written over the next few years that would indicate whether the Bank or the Department of Finance fully appreciated that, by returning to a pegged exchange rate system, the government would effectively neutralize whatever independent influence monetary policy might have on the macroeconomy. With domestic fiscal policy on a strong expansionary track, and monetary policy constrained by the new exchange rate peg, the Bank of Canada would have no way of resisting the inflationary pressures that were gradually building in the second half of the 1960s. Government expenditures in Canada were growing at an accelerating rate with the new health care and unemployment insurance systems that had been introduced. Similar pressures were emerging in the United States in response to the Vietnam War and President Johnson’s program for a Great Society. With a fixed exchange rate, these pressures would inevitably spill over into Canada. Few serious concerns about inflation, however, were expressed outside central banking circles. Phillips and his followers had shown how a little bit of inflation might be beneficial, and monetary authorities were encouraged to be more forgiving. “Reasonable price stability” was touted as a preferred policy objective by the Economic Council of Canada, and “inflation-unemployment trade-off zones” were dutifully reproduced in many of its publications.18 Another development during this period is also worth noting. It concerns the clarification of the roles and responsibilities of the government and the Bank of Canada with regard to monetary policy. Louis Rasminsky, who had succeeded James Coyne as Governor in May 1961, had insisted as a condition of his appointment that the government’s powers regarding monetary policy be clearly defined.19 The Bank of Canada Act was amended in 1967 to allow the government to issue a directive to the Bank in the event there was a serious disagreement over the conduct of monetary policy. Under this amendment, the government would have the right to override the Bank’s policy decisions. To do so, however, the Minister of Finance would have to publish the reasons for his (her) dissatisfaction, indicating both the new measures that the Bank was supposed to undertake as well as the period during which they were to apply. It was generally agreed, I believe, that such a “nuclear weapon” would only be used when there was a fundamental disagreement between the Governor and the Minister, and that following its use, the Governor would resign. In this way, the rights of a democratically elected government to determine policy were balanced against the needs of the Bank for operational independence. While governments must always have the final say in important policy matters, the Bank had to be protected from undue political influence in its day-to-day operations. A key element that was missing from this solution was a clear measure by which the government and the public could judge the Bank’s performance. 2.4 Stagflation and monetarism: 1971 to 1981 The early 1970s began much like the 1950s. Foreign capital was flowing into Canada at an unprecedented rate and the Bank of Canada was finding it difficult to resist the upward pressure on the Canadian dollar. Rather than guess where the new equilibrium exchange rate might lie, the government again decided to let the currency float. As in the 1950s, this move was regarded as a temporary measure. Within three years, however, the rest of the Bretton Woods system had collapsed. While Canada’s decision was in no way responsible for what followed, its positive experience with a floating exchange rate through the 1950s and the early 1970s did provide some assurance to other countries that the new regime was at least workable. See, for example, Economic Council of Canada (1966): “Prices, Productivity and Employment”, in Third Annual Review Queen’s Printer, Ottawa. Muirhead, B (1999): “Into the Breach”, in Against the Odds: The Public Life and Times of Louis Rasminsky, University Press, Toronto, pp 167-82. Canada was now able to pursue an independent monetary policy. The Bank’s efforts in the face of building international inflation pressures, however, proved to be insufficient. Outdated views about the Phillips curve, overly ambitious estimates of the natural rate of unemployment and a concern about letting the Canadian dollar appreciate much above US$ 1, contributed to the problem. The Bank of Canada was not unusual in this regard, and its performance did not differ noticeably from that of most other central banks. Economic thinking among the major industrial countries was very similar, and received wisdom was, for the most part, imported from the United States. Although Canada’s experience had, in effect, been providing the rest of the world with an example of how an open economy operates in the presence of near-perfect capital mobility, it went largely unnoticed. Closed-economy concepts continued to dominate most national policy discussions. While Mundell’s results were slowly filtering through the academic community, they had not yet reached the ranks of practising economists. Little recognition was given to the effects that market liberalization and different exchange rate arrangements might have on policy outcomes. In the meantime, the combination of generalized excess demand in the world economy and the OPEC oil cartel had sent inflation and unemployment soaring to postwar highs. Policymakers in Canada and elsewhere were having difficulty dealing with this stagflation and were initially confused by the twin phenomena of rising inflation and high unemployment. Within a short time, however, three things had become evident. First, higher inflation was not always associated with higher output and employment. The Phillips curve was not only vertical in the long run, but was probably upward-sloping. Second, efforts to fine-tune the real economy were likely to end in failure. Optimism about our ability to forecast and about the level of full employment introduced a strong inflationary bias to fiscal and monetary policies. Third, money mattered and was the ultimate source of all sustained inflation. Excessive government spending and other positive demand shocks could not generate ongoing inflation unless monetary policy was prepared to validate it. To avoid similar problems in the future, many central banks began to target the monetary aggregates. If, as Friedman suggested, inflation was always and everywhere a monetary phenomenon, a gradual deceleration in the rate of money growth would eventually squeeze it out of the system. Once this had been accomplished, money growth could be set just high enough to meet the legitimate needs of the economy - thereby ensuring long-run price stability. If the new money targets were publicly announced and fully credible, some monetarists argued, it might even be possible to achieve this disinflation without any significant loss in output. If this proved to be impossible, some deterioration in economic performance would have to be accepted. A “gradualist” approach, however, would ensure that this was kept to a minimum. While fixed money targets might not deliver the best of all worlds, they were regarded as the safest alternative in a second-best world. Trying to forecast the future and optimally adjust fiscal and monetary policy settings had proved not only to be impossible but also potentially destabilizing. Canada adopted a target for the narrow monetary aggregate, M1, in the autumn of 1975, a short time after the United States and Germany. For a while, the strategy appeared to be working. Inflation began to decelerate, and the economy began to recover from the 1974-75 recession. While some of this early success could be credited to the wage and price controls that the government had introduced in late 1975, proponents of the monetarist view believed that Canada would soon be on its way to price stability. Initial optimism over what the monetary targets could deliver soon gave way to frustration as inflation began to rise again in the late 1970s. A second oil shock and continued fiscal expansion added to the inflation pressures that were already in place. By the early 1980s, inflation had returned to doubledigit levels, and inflationary expectations were again beginning to accelerate. Research at the Bank revealed that one of the reasons for the weak relationship between the movements in M1 and subsequent changes in prices was the high interest elasticity of the demand for this narrow money aggregate. The modest changes in interest rates that were required in the short run to keep M1 within its target band were not enough to have much impact on real output or prices.20 Another, more serious problem in using M1 was the uncertain impact of financial innovation. Technological developments had allowed financial institutions to introduce a number of new products designed to help depositors protect themselves from high inflation by shifting their idle balances into daily interest savings accounts. This weakened the relationship between M1 and the other macroeconomic variables that normally influenced its behaviour, and made it difficult for the Bank to interpret its movements. 2.5 The search for a new nominal anchor: 1982 to 1990 In 1982, after several disappointments, the Bank of Canada reluctantly conceded that the monetarist experiment had not worked and that the Bank would no longer be targeting M1. Movements in the monetary aggregates would continue to be monitored for any information they might provide on future economic developments, but no aggregate appeared to be sufficiently reliable to serve as an intermediate target. Similar difficulties were experienced in other industrial countries that had adopted money targets and, one by one, they were forced to follow Canada’s example. Gerald Bouey, who had succeeded Louis Rasminsky as Governor of the Bank of Canada in 1973, probably summarized the situation as well as anyone when he said: “We did not abandon M1, M1 abandoned us.”21 The search for a new nominal anchor had begun well before the Bank announced it would no longer be targeting M1, but without much success. Alternative definitions of money were tested and found to be equally unstable. For a time, nominal income was used as a guide for the Bank’s internal forecasting exercise, but it was also deemed to be unsuitable as an intermediate target. While it included the two variables that macroeconomists cared about most - output and prices - precise judgments were still required about the state of the real economy in order to make it work. Moreover, explaining nominal-income targeting to the public would be difficult. Inflation and money growth were generally regarded as legitimate central bank objectives, but efforts to control the level of spending and income might be seen as too invasive and suspiciously close to trying to control the level of employment. Although conducting monetary policy without a clear objective posed certain problems, the eclectic approach that the Bank was forced to follow after it abandoned M1 did yield some results. The strong monetary policy medicine that Canada had applied in early 1981, following similar action in the United States, soon brought inflation down. And within a short period of time, output and employment also began to recover. Through most of the 1980s, inflation hovered in a range of 3 to 5%. While the decade as a whole was viewed by many as a time of prosperity and growing optimism, much of this apparent affluence was based on speculative activities focused particularly on the real estate sector. Expansionary fiscal policies and rising world commodity prices were again generating strong inflationary pressures, which monetary policy was trying to resist. These pressures were largely masked, however, by the sharply appreciating exchange rate. Without an explicit target for monetary policy, the Bank had difficulty explaining its policy actions. In addition, there was no obvious basis on which to judge its performance. One could use rough qualitative benchmarks such as strong growth, rising employment and the absence of high inflation as performance measures, but monetary policy needed a firmer place to stand. It was supposed to provide a nominal anchor for the economy, but seemed to be lacking an anchor of its own to help guide policy decisions and ensure accountability. As Gerald Bouey explained in 1982: Thiessen, G G (1983): “The Canadian Experience with Monetary Targeting” in Central Bank Views on Monetary Targeting, 100-104. Proceedings of a conference held at the Federal Reserve Bank of New York, May 1982, Federal Reserve Bank of New York, New York. Canada, House of Commons Standing Committee on Finance, Trade and Economic Affairs, Minutes of Proceedings and Evidence, No 134, 28 March 1983, p 12. Central bankers are always looking for more reliable guides to the conduct of monetary policy than they have had. Part of the reason is that they want to find a better place to stand against the constant pressures that arise from many sources - almost irrespective of economic conditions - for easier money and lower interest rates.22 From today’s perspective, explicit inflation targets might seem like an obvious alternative, but price stability had not yet been widely accepted as the pre-eminent objective of monetary policy. Graham Towers, James Coyne, Louis Rasminsky and Gerald Bouey had extolled the virtues of price stability and had regarded it as one of the Bank’s most important objectives. But it had never been defined and the extent of the Bank’s commitment to achieving it was not always clear. The major preoccupation of the 1970s and early 1980s had been to “get inflation down”. How far down was a question that could be postponed for a later day, once we were within striking distance of this nirvana. The problems that arose because there was no clearly articulated and credible objective or end point for monetary policy were most evident in financial markets. Changes in US interest rates or some other external shock would often produce exaggerated swings in Canadian interest rates and the exchange rate, and made it difficult for the Bank to control domestic monetary conditions. A sudden increase in US interest rates, for example, would put sharp downward pressure on the Canadian dollar, causing import prices to rise and raising concerns about the future course of inflation. Because inflation expectations were not firmly anchored, prices in other areas of the economy would also come under upward pressure, setting off a potential inflationary spiral. Investors, worried about the future value of their money, would start to demand much higher rates of interest. The end result was higher interest rates, a weaker dollar and much stronger inflation expectations than the domestic economic conditions alone would warrant. Any efforts to keep interest rates low and to support economic activity were often misinterpreted as signs that the Bank was, in fact, pursuing an inflationary policy and would only make matters worse. As a result, the Bank found itself having to follow the US lead on interest rates and resist downward movements in the exchange rate for tactical reasons. Failure “to defend the Canadian dollar” would produce even larger increases in domestic interest rates and inflict more serious damage on the economy. A major step towards dealing with this problem was taken in January 1988, when John Crow, the Bank’s new Governor, delivered his Hanson Memorial Lecture at the University of Alberta. Price stability was set out explicitly as the Bank’s prime objective and, realistically, the only thing that it could deliver with the tools at its disposal. The hard lessons that had been learned from past experience were reviewed, as well as the advantages that might be realized with the consistent attainment of this objective: What pace of monetary expansion is most helpful to the development of the Canadian economy? Theory and experience - much of this experience not overly cheerful but certainly instructive - both point to a very clear answer. Monetary policy should be conducted so as to achieve a pace of monetary expansion that promotes stability in the value of money. This means pursuing a policy aimed at achieving and maintaining stable prices.23 The Hanson lecture contained probably the strongest commitment to price stability that had ever come from the Bank of Canada. It was designed to convince people that the Bank would do whatever was necessary to achieve price stability. Businesses, households and the government were, in effect, put on Bouey, G K (1982): “Monetary Policy: Finding a Place to Stand”, The 1982 Per Jacobsson Lecture, University of Toronto, Toronto, Ontario, 5 September. Crow, J (1988): “The Work of Canadian Monetary Policy”, The Eric J Hanson Memorial Lecture, University of Alberta, Edmonton, Alberta, Bank of Canada Review, February, 3-17. notice - any investment and spending plans that were based on inflationary expectations were likely to end in disappointment. Price stability, although often referred to, was not, however, clearly defined. It was presumably much lower than the prevailing rate of inflation (which was hovering around 4% and under upward pressure), but this was not made explicit. In addition, the path that inflation was expected to follow on the way to price stability was not outlined. A desired inflation path was an important part of the Bank’s internal projection exercise, but it was not announced publicly. 2.6 Inflation targets: 1991 to 2000 All of this changed in February 1991, when the Bank of Canada, in a joint statement with the Minister of Finance, announced the introduction of inflation-reduction targets. Academic economists had not been advocating targets focused directly on inflation. They had, however, already built a strong case for some form of nominal anchor, arguing that an explicit commitment of this sort would improve central bank accountability, help shape expectations, facilitate the disinflationary process and allow central banks to avoid something known as the time-inconsistency problem. According to the time-inconsistency theory, monetary authorities were subject to a serious inflationary bias. If a central bank could initiate an unexpected easing in monetary policy, it might be possible to raise short-term output and employment. However, once businesses and households realized what had happened, they would quickly revise their inflation expectations, and output and employment would return to their original equilibrium levels. Because businesses and households knew that central banks were always subject to this temptation, they would assume that central banks might try to trick them (even when no monetary policy easing was being planned) and would raise their inflation expectations in anticipation. The end result was a kind of prisoner’s dilemma, in which inflation was higher than it would otherwise be, while employment and output remained unchanged. Without some form of credible commitment that would allow monetary authorities to foreswear such policy actions, society was trapped in an inferior equilibrium. Inflation targeting, though it had not been proposed by any of the time-inconsistency authors, might be a way to correct this problem. The public nature of announced targets would raise the costs associated with any failure to meet them and, hopefully, move the economy towards the preferred, low-inflation equilibrium. Central banks were quite skeptical about whether the time-inconsistency literature provided a useful or accurate description of the situation in which they found themselves.24 Even so, the idea of inflationreduction targets did have strong appeal, but central banks were still reluctant to adopt them. Their resistance can probably be credited to two things. First, central banks were worried about what would happen to their credibility if, for some reason, they failed to meet the inflation objectives. Second, they were concerned that the inflation targets might be too constraining. Their ability to deal with unexpected shocks, such as an oil crisis or a jump in other world commodity prices, would be severely restricted unless the target bands were quite forgiving. But if the inflation target range was wide enough to accommodate these sorts of disturbances, it was unlikely to provide much discipline or comfort in more tranquil periods. The answer to both problems is now clear. If central banks are unable to achieve and maintain their targets on a regular basis, this is something that should be shared with the public. Credibility is not enhanced by the absence of targets. Special exceptions can be made for commodity-price shocks and other unusual events, as long as the monetary authority has a plausible explanation. The advantage of inflation targets, even if they occasionally cannot be achieved, is that they provide a convenient basis from which policy actions and outcomes can be judged. Central banks believed that there was an inflationary bias in the system, but that the pressure came from governments rather than any desire on their part to boost output and employment through an unexpected jump in inflation. (See Howitt, P (2000): “Learning about Monetary Policy and Theory”, Brown University Working Paper, unpublished.) It was one thing to understand these points on a conceptual level, it was another to put them into practice. Canada was the second country in the postwar period to introduce inflation targets (New Zealand was first). Even then, it is unlikely that targets would have been adopted as early as 1991 if the government had not been planning to introduce a new goods and services tax (GST). The government actively supported the introduction of inflation targets because it was seen as a way of preventing the one-time jump in prices associated with the GST from becoming entrenched in inflation expectations. More specifically, it would help to reassure government employees who were subject to salary restraints, as well as other wage earners, that inflation would be held in check.25 The lower and upper bounds of the original inflation-reduction targets were set at 2% and 4%, respectively, with a midpoint of 3%. These bounds were to gradually decline to 1% and 3% by the end of 1995. At this point, a new inflation target was to be announced, consistent with long-run price stability and based on the experience of the previous four years. While the inflation targets have been renewed twice during the past nine years, neither the government nor the Bank were convinced on those occasions that the conditions were right for a final determination of where the long-run target should be set. The Bank decided that further research and experience with the existing targets were needed before committing itself in this manner. As I have pointed out elsewhere,26 inflation-control targets have had a major impact on the Bank and on the way it conducts monetary policy. Perhaps the most important influence has been to encourage greater transparency. With an explicit target for inflation and the central bank accountable for achieving that target, there is a strong incentive to be as forthright as possible about any trends in the economy likely to influence inflation, the decisions policymakers may have to take to achieve the targets, the shocks that may temporarily push inflation outside the target range, and the pace at which inflation can be returned to the target. As monetary policy has become more transparent, it has become evident that it works more effectively when financial markets and the public understand what the Bank is doing and why. We no longer regard surprise as an important element in monetary policy actions. We prefer to see private agents anticipate, rather than respond to, monetary policy actions. 3. Where are we now? Monetary policy has come a long way since 1935. It is now directed towards a single long-run objective: the attainment and maintenance of price stability. Monetary authorities in Canada and elsewhere have realized that this is the best contribution that monetary policy can make to economic welfare, and indeed the only one that they can deliver on an ongoing basis. There is no inherent conflict between price stability and most of the other objectives that are set out in the preamble to the Bank of Canada Act. Focusing on price stability helps us to guard against the sort of systematic errors that often occurred when we tried to aim directly at output and employment. Optimistic estimates of potential output and full employment in the early 1970s introduced a strong inflationary bias into the policy-formulation process and did not deliver any of the long-run improvements in real economic performance that the Phillips-curve literature had promised. Today’s monetary policy differs from past approaches in yet another important way. It is conducted in a far more open and less complicated manner. Secrecy and surprise are no longer critical elements of our modus operandi. The Bank tries to work with markets, rather than against them, to avoid surprising them with unexpected actions. Greater transparency facilitates the policy-transmission The Economic Council of Canada had also recommended that Canada adopt inflation targets in its 1990 report. Economic Council of Canada (1990): Transition for the 90s. Twenty-Seventh Annual Review, Supply and Services Canada, Ottawa. Thiessen, G (1998): “The Canadian Experience with Targets for Inflation Control”, The 1998 Gibson Lecture, Queen’s University, Kingston, Ontario, 15 October. process by conditioning market expectations and helps avoid unnecessary confusion about the reasons for our actions. Various techniques for manipulating domestic credit conditions and the external value of the currency by means of direct controls, moral suasion and active foreign exchange market intervention are no longer used. Globalization and market liberalization have eliminated many of the barriers that used to separate different segments of the domestic financial system and have subjected them to increased international competition. As a result, these techniques became both less effective and more costly in terms of their impact on market efficiency. Monetary authorities now have a clearer understanding of the limitations of alternative policy measures, as well as more sympathy for indirect, market-based solutions. Monetary policy is now implemented in a more straightforward manner. Today, policy adjustments are effected and signalled to the market mainly through announced changes in the Bank Rate and the target band for the overnight interest rate. Private agents are then free to determine how these changes will be transmitted through the rest of the financial system and the economy in general. The Bank simply issues a press release indicating what the new Bank Rate is, and this in turn anchors the short-term end of the yield curve. Central bank independence and accountability have also been more clearly defined. As I explained earlier, the 1967 amendments to the Bank of Canada Act allow the Minister of Finance, acting on behalf of the government, to issue a directive to the Governor if serious differences arise on the conduct of monetary policy that cannot be resolved. The directive must indicate the specific policy changes that the Bank is supposed to undertake. Ultimate responsibility for monetary policy, therefore, rests where it should in a democratic society - with the elected government. But because of the consequences of issuing a directive, it is likely to be used only in unusual circumstances. Thus, a high degree of operational independence has, nevertheless, been preserved to allow the Bank to maintain its medium-term focus for monetary policy without the short-run pressures that arise in the political process. Moreover, the explicit targets for inflation control in Canada have been set jointly by the Bank and the Minister of Finance. It is then the Bank’s responsibility to achieve the agreed target. An explicit objective, a clear assignment of responsibility for achieving it as well as the appropriate instrument and independence of action to do what is required to meet the objective, are crucial ingredients in an effective process of accountability. That is what we now have in place in Canada for monetary policy. *************** Where does all this leave us? We now have a much better understanding of what monetary policy should be asked to do, who should be responsible for it and how it should be conducted. But has the evolutionary process been pushed as far as it can go? Is the transformation of monetary policy coming to an end? The answer, of course, is no. But I will leave it to my successor to return at some point in the future and update you on the evolving path of monetary policy in Canada.
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Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Chambre de commerce du Montréal métropolitain, Montreal, Quebec, 4 December 2000.
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Gordon Thiessen: Why a floating exchange rate regime makes sense for Canada Speech by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Chambre de commerce du Montréal métropolitain, Montreal, Quebec, 4 December 2000. * * * Why a floating exchange rate regime makes sense for Canada As I near the end of my term as Governor, I find myself looking back more and more, focusing on the broad, longer-term trends in our economy and in financial markets and on what those trends may imply for the future. One of the issues that has often surfaced over the years is the exchange rate for the Canadian dollar. Indeed, over the past couple of years, it has been a topic of considerable public discussion. That discussion has revolved around such questions as: Should we continue floating, or should we peg our currency to the US dollar? In fact, should we even keep our own currency, or should we adopt the US currency? That there is such interest in our exchange rate is hardly surprising. Some of the more recent attention no doubt stems from public concern about the relatively low value of the Canadian dollar in comparison to the US dollar. But the fundamental reason for this interest is that the exchange rate is an important price in an economy, particularly in one as open as ours. Exports represent about 40% of total Canadian output. And if we add imports, this proportion doubles to 80%. In addition, more than 80% of this trade is with the United States. So the value of our currency in terms of the US dollar has always been particularly important for us. But we must be careful not to exaggerate this point, because when it comes to exports, we compete with many other foreign countries for a share of the US market. And so the exchange rates of those currencies relative to ours also matter a great deal. In 1950, after the Second World War, Canada became the first major country to adopt a floating exchange rate. In 1962, we went back to a fixed exchange rate only to float our currency again in 1970. In all, the Canadian dollar has floated for 42 out of the past 50 years. No other major country has had as much experience with a floating exchange rate. This does not mean that our floating exchange rate regime has somehow outlasted all its critics! For the most part, though, the debate over the years has been about the market value of the Canadian dollar - whether it has floated too high or too low, especially from the viewpoint of certain exporters and importers. More recently, however, and certainly here in Montreal, some of the discussion has focused more on whether a floating currency is the right exchange rate regime for Canada. This particular debate has been kindled by the advent of the euro and its adoption by 11 members of the European Union at the beginning of 1999. I entered that debate early in 1999, arguing that the introduction of the euro was a remarkable achievement, but that it did not provide a useful role model for Canada and for our position in North America. Since then, with increased interest in the subject internationally, there has been considerable discussion of exchange rate alternatives for Canada and for other countries. In Canada, the debate about exchange rate regimes has been mainly among academic economists. But, with the decline of our currency against the US dollar through the 1990s, the exchange rate has also been raised as a concern in the business community when comparing our less-impressive economic performance with that of the United States. Outside Canada, the debate on exchange rate regimes has also become more active, especially in parts of Latin America that have had a long history of high inflation and exchange rate crises. Indeed, in some of these countries, commentators have argued in favour of the outright adoption of the US currency. Today, I would like to return to the issue of the right exchange rate regime for Canada. Having again considered the advantages and disadvantages of our current arrangements, I can tell you at the outset that I remain convinced that a floating exchange rate continues to make sense for us at this stage of our history. I propose to examine the different sides of the argument with respect to a floating currency in as simple and straightforward a manner as possible. The transactions costs of a floating currency When the amount of cross-border trade and financial transactions is as large as ours is with the United States, the need to exchange currency raises the cost of such transactions. Moreover, if the currencies involved are floating, so that the future level of the exchange rate is uncertain, there is also a foreign exchange risk to consider and to hedge against. For example, investors and borrowers must take into account not only the level of interest rates in Canada and the United States, but also potential movements in the exchange rate over the term of their investment or loan. So, yes, there are certain transactions costs in having a separate currency. A fixed exchange rate between the Canadian and US currencies, such as we had from 1962 to 1970, does not do away with all these transactions costs. Conversions between the two currencies would still be required. Moreover, a fixed exchange rate does not eliminate currency risk. If there were any perceived risk of a future devaluation of the fixed rate for the Canadian dollar, the result would be persistently higher interest rates in Canada than in the United States to compensate for that risk. Even where countries have gone beyond a fixed exchange rate and have tied their currencies rigidly to the US dollar - as Hong Kong and Argentina have, through a currency board - the costs, in terms of risk premiums in domestic interest rates, have not completely disappeared. So, in fact, the only way to eliminate cross-border transactions costs with the United States and eliminate premiums in our interest rates for potential exchange rate risk is not through a fixed exchange rate but through some sort of currency union with the United States. In reality, this would mean “dollarization”. Dollarization versus monetary union But why not a common-currency arrangement, as in Europe? Wouldn’t that be better? On the face of it, of course, a currency union would be better than dollarization. Under such an arrangement, we would, in principle, still have some say in determining a North American monetary policy. Presumably, we would also be able to keep some of the revenue (or seigniorage) from issuing that common currency. But we must understand what a North American monetary union would mean in reality. The European experience is rather enlightening in this respect. Economic and monetary union in Europe is the product of 50 years of increasing political and economic integration. The recent adoption of a common currency, which was a further step on the road to European integration, was taken mainly for political, rather than economic, reasons. And when it comes to decision-making at the European Central Bank, the three large countries in the euro area (Germany, France, and Italy) have agreed to a “one country one vote” rule with their other eight medium- and small-sized partners. I do not see how we could possibly have similar arrangements in North America, given the clear dominance of the US economy. In effect, a monetary union with the United States could only mean that Canada would adopt the US dollar. The advantages of a floating exchange rate So far, I have been focusing on the costs of cross-border transactions and the exchange rate regimes that could reduce those costs. But that is not all that matters. The real world is a more complicated place, as I shall explain in a moment. And that is why a floating exchange rate regime makes sense for Canada. The case typically made for a floating rate for Canada is that it gives us the chance to run an independent monetary policy. That is true. But these days, there is really very little difference in the low-inflation objectives of industrial countries. The real value of a floating exchange rate for Canada is that it allows us to have different monetary conditions than the United States - monetary conditions appropriate to our own economic circumstances, even as we pursue the same general objective of low and stable inflation. The significance of having this option is our ability to respond to external economic shocks that affect us differently from our southern neighbours, or to respond to differences in domestic economic policies. Let me give you a couple of examples of economic shocks and policies that have reflected these differences. Fluctuations in world commodity prices are an important first example. Although our reliance on primary commodities has diminished substantially through the years, such goods still account for 30 to 40% of Canada’s exports. The United States, on the other hand, is a net importer of commodities. The Asian financial crisis of 1997-98, which led to a 20% decline in the prices of the key primary commodities that we export, was a major negative shock for Canada. In contrast, the United States benefited from these lower prices. The decline in the value of our currency against the US dollar at the time was in response to that economic shock. And it helped Canadian manufacturing and other non-commodity sectors to increase their exports to the United States. In this way, the impact of falling employment and incomes in our primary sector because of the lower commodity prices was largely offset by greater expansion in these other sectors. Another example involves the fiscal restraint measures that were undertaken by our federal and provincial governments, beginning in the mid-1990s, to deal with persistent deficits and the resulting unsustainable accumulation of public debt. The United States also had a budgetary problem. But the need for fiscal tightening was much greater here and so was the effect of the corrective measures on total demand in our economy. To help the transfer of resources from the public to the private sector and so support overall demand in Canada, we needed lower interest rates here than in the United States. These lower rates were maintained through most of the period from 1996 to the present. In today’s globalized financial markets, such persistent interest rate differences in the circumstances I have described are possible only with a floating exchange rate. In both these examples, the exchange rate acted as a shock absorber between the US and Canadian economies, helping to facilitate the needed adjustment in response to differing shocks and differing policy requirements. Even though our two economies are closely linked, they can move in different directions. And when that happens, the shock-absorber role of a floating exchange rate is invaluable. Although these recent examples involved downward adjustments in our currency, this has not always been the case. Indeed, there have been times when economic shocks and policy differences in the two countries have worked in the opposite direction, leading to increases in the value of the Canadian dollar. It is, of course, possible to cope with unexpected shocks and policy differences under a fixed exchange rate or a monetary union. But the adjustment process will take longer, will be more difficult, and will cost more overall. Imagine the adjustment in our economy that would have been required in 1997-98 in response to the fall in commodity prices, if the Canadian dollar had not been floating. To maintain a fixed exchange rate throughout that period, much higher interest rates would have been necessary to resist the downward pressure on our currency from the falling receipts for commodity exports. In effect, this would have meant a more serious economic slowdown to bring wages and salaries down to a level that would make other industries more competitive and allow them to increase their exports. Even under a common-currency arrangement, we would still have had to go through much the same adjustment over the longer term. But under such an arrangement, more of the short-term pain - in terms of declines in employment and incomes - would have been felt in the primary industries and in regions of Canada with a higher concentration of such industries. The bottom line is: There is no escaping the need to adjust to real economic shocks regardless of the currency regime. But a floating-rate regime does help to facilitate and smooth the adjustment process. Before concluding, I would like to quickly deal with a couple of common misconceptions about flexible exchange rates. The first one relates to the incentives for business to innovate and invest in new technology. If the argument here is that a low exchange rate gives exporting firms easier profits and blunts their motivation to innovate and become more efficient and competitive, I am inclined to say that this suggests a rather serious problem of corporate governance. Surely, the job of company directors is to ensure that management is doing everything necessary to maximize profits and stock values, no matter what the circumstances. Any company that does not operate this way will soon find itself losing to the competition. Another misconception is that a relatively low exchange rate puts a country at a disadvantage in terms of foreign takeovers. Here, I would say that if Canadian companies became more attractive in recent years to US corporate buyers, it was primarily because of high stock market valuations in the United States, not because of a lower Canadian dollar. High stock prices essentially provided US companies with very cheap financing for corporate takeovers in countries where market valuations were lower. We saw a similar process involving Canadian takeovers of foreign companies more recently, when stock market valuations hit very high levels in this country. Concluding thoughts Let me summarize my main points. In view of our close economic and financial links with the United States, I recognize the attractions of the reduced currency uncertainty and lower transactions costs that would be part of a fixed exchange rate arrangement with the US dollar. Nonetheless, I believe that for Canada, the macroeconomic advantages of a flexible exchange rate continue to far outweigh the lower transactions costs of a fixed rate. As long as we remain a major producer of primary commodities, and as long as we want to pursue separate economic policies that are suited to our own circumstances and that require differing monetary conditions, the shock-absorber element of a floating currency will serve us well. Does a floating exchange rate regime mean that we are likely to have a persistently weak currency? No, it does not. Through the second half of the 1990s, we have seen a US dollar that is strong against virtually all other currencies, reflecting the remarkable performance of the US economy. In the process, however, the United States has also built up a very large cumulative deficit in its transactions with the rest of the world. At some stage, this external deficit will have to be reversed, and a lower US dollar will be part of this adjustment. Here in Canada, after a slow start in the early 1990s, the fundamentals of our economy have improved. Growth has been more robust in recent years, employment and incomes have been rising, and inflation is low and stable. Government budget deficits have been eliminated, and the public debt relative to the size of our economy has been shrinking. Moreover, as part of a major restructuring effort by the private sector, businesses have been investing heavily in machinery, equipment, and technology. We may now be starting to see the payoff of these efforts, in the form of some larger productivity gains, which I hope will grow and continue, thereby providing the basis for improved standards of living for Canadians in the future. All in all, the prospects for our economy are very positive. If these prospects are realized, we will also see a stronger Canadian dollar over the medium term.
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Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Canadian Club of Toronto, Toronto, Ontario, 22 January 2001
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Gordon Thiessen: Canada's Economic Future - What Have We Learned from the 1990s? Remarks by Mr Gordon Thiessen, Governor of the Bank of Canada, to the Canadian Club of Toronto, Toronto, Ontario, 22 January 2001. * * * It was to the Canadian Club of Toronto that I gave my first speech as Governor of the Bank of Canada seven years ago. It is only fitting that I should be here again today, for my final public presentation before I retire. In early 1994, Canada's economic situation was not that favourable—our economy was facing some rather serious problems. Today, too, we face some challenges. But our overall economic and financial situation is much stronger now than it was seven years ago. What I intend to do today is to look back at Canada's economic performance during the last decade of the twentieth century and, with the benefit of hindsight, look at the factors behind that performance. I would also like to talk about the changes that have taken place in our economy over this period, and what these changes mean as we look ahead. The problems of the 1990s Let me take you back to the early 1990s. That is when the gravity of the problems that would dominate the Canadian economic landscape for much of the decade became clear. By 1990, the persistent inflation of the 1970s and 1980s had pushed the consumer price index (CPI) to a level nearly four times as high as in 1970. Inflation had come down through the first part of the 1980s, but, with an inflationary psychology still very much at work, it picked up again towards the late 1980s. During that whole inflationary period, many Canadians sought to protect themselves from the effects of inflation through indexed wage contracts and by investing in the housing market. Others saw an opportunity to benefit from high inflation by speculating in real estate or other assets. Since many of these transactions had been financed by borrowing, debt had risen to high levels. When the Bank of Canada's anti-inflationary policy actions in the late 1980s finally convinced Canadians that inflation would be brought under control, the inflationary excesses that had built up contributed to a severe recession in 1990–91. Partly because inflationary pressures in Canada were greater than in the United States, and the inflation psychology was more deeply entrenched, the recession here was more severe than in the United States. The effects of technological change, including a decline in communications costs, meant that, through the 1980s, national markets had become much more susceptible to international competition. In Canada, however, the relatively high inflation of the 1970s and 1980s had distracted Canadian firms: rather than focusing on product design and innovation, cost control, and productivity improvement, many of them had been looking for ways to take advantage of inflation. Thus, they had tended to postpone the adjustments needed to respond to a changing world economy. Meanwhile, U.S. companies that had earlier found themselves in strong foreign competition, especially against Japanese firms, had already begun the process of adjusting to globalization during the mid- to late 1980s. So, by the beginning of the 1990s, they were better placed than most to respond to the intensifying forces of technological change and global competition. By the early 1990s, the realities of the new world economic order were becoming clearer to Canadian companies too. Only at that time, they were also coping with the fallout from the high-inflation years, especially the sharp drop in the prices of speculative investments and the burden of servicing large debts, as well as with declining world commodity prices. Working their way out of these difficulties was disruptive and painful for Canadian businesses. Defaults, restructurings, and downsizings became the order of the day. With all this, unemployment took a long time to recover from the 1990–91 recession and, in many instances, wages and salaries were frozen or reduced. But whatever else one may say, through this period, our businesses responded to the challenge and did a remarkable job of restructuring their operations and adjusting to the new economic realities. Canada's other major economic problem in the early 1990s was large budget deficits—federal and provincial. Because of these deficits, public debt was accumulating at an unsustainable rate, and foreign and domestic investors were becoming very nervous about holding Canadian government bonds. As a result, significant risk premiums were built into our interest rates. By 1994, it had become clear that Canada could be facing a potentially very serious debt problem. If there was any doubt about that, it disappeared in early 1995, when Canada was sideswiped by the Mexican peso crisis. The Canadian dollar came under strong downward pressure, and interest rates rose sharply across all maturities as investors demanded even larger risk premiums. Just as I believe that the restructuring in our private sector in the 1990s was impressive, I also think that Canadian governments (federal and provincial) responded forcefully and effectively in the mid1990s to the need to cut fiscal deficits and slow down the accumulation of public sector debt. The overall government sector moved from a total deficit of close to $45 billion or 6 per cent of gross domestic product (GDP) in 1995, to a balanced position in 1997 and 1998, and to surpluses thereafter. Moreover, net public debt as a ratio of GDP fell from close to 104 per cent in the fiscal year 1995/96 to an estimated 80 per cent in 1999/2000. That is some adjustment! This fiscal restructuring, although essential, was difficult and disruptive. Like the private sector, the public sector too had to undertake significant downsizing and salary restraint. Overall, given the type and size of structural changes that had to be made, it is not surprising that, for much of the 1990s, unemployment rates in Canada remained high and incomes stagnated. The turnaround The economic problems of the 1990s that I have been recounting make for a rather sombre story. The next chapter of that story, however, is rather more cheerful. Although Canada was late in dealing with past economic imbalances, once our private and public sectors realized the extent of the problems, their response was prompt and effective. And our economic performance has improved materially as a result. Let me highlight some of the major improvements. I have already noted the influence of technology and globalization in changing the world economy during the 1990s. This influence continues and, if anything, is accelerating. Indeed, the world seems to be going through a real technological revolution—a revolution spawned by the increasing efficiency and declining costs of computers and fibre optics and their application to information processing and communications. The United States has been at the forefront of this revolution. But, as far as we can tell, Canada is not that far behind. Once Canadian businesses sorted out the required restructuring and reorientation of their activities in the first half of the 1990s, they quickly came to realize that they had to adopt and invest in the new technology to become more competitive. U.S. firms served both as a role model and a competitive prod in this regard. Investment in new machinery, equipment, and technology by Canadian businesses began to pick up in 1996 and, as a ratio of our GDP, has been rising continuously. This pattern looks remarkably similar to the one in the United States—only with a lag of about four years. In the United States, the investment in equipment and technology, which had begun early in the 1990s, started paying off around 1996, with rather impressive gains in productivity. Over the past five years, U.S. productivity growth (measured as output per person-hour) has averaged 3 per cent. Although it is still early days, there have been encouraging signs of a pickup in Canadian productivity growth this past year. I see no reason why Canada cannot benefit from a process similar to the one that has been at work in the United States. However, the extent of any future gains in our productivity is still difficult to gauge at this point. There is, of course, more to the recent favourable economic news in Canada than just the early signs of a pickup in productivity growth. For example, there have also been substantial gains in employment. The unemployment rate, which had reached 11 per cent in the early 1990s, dropped to below 7 per cent in 2000—its lowest level in over 25 years. Incomes, too, have been rising. Adjusted for inflation, personal disposable income has increased by an average of almost 3 per cent per year over the past four years. The fiscal restructuring has also figured importantly in our improved economic performance. The reduction in deficits and the subsequent move to surpluses, together with the declining debt levels of the government sector, have helped to eliminate the risk premiums in our interest rates that cost us so dearly in the early 1990s. Indeed, for much of the period from mid-1996 to late 2000, Canadian interest rates were lower than comparable U.S. rates. This has, no doubt, been an important factor behind the surge in business investment in Canada since 1996, which is so important if we are to take advantage of new technology and enhance our ability to compete internationally. Low interest rates have also encouraged households to buy houses, cars, and other major consumer goods—purchases they had tended to postpone earlier in the decade. The role of monetary policy I have left a detailed discussion of the role of monetary policy (and of the Bank of Canada) for last. To explain the role of monetary policy through the 1990s, I need to go back to the 1970s and 1980s. As I said before, this is when some of the serious economic policy problems in Canada, and elsewhere, really started. In the late 1960s and early 1970s, the world economy was booming. And the large U.S. military expenditures during the Vietnam war amplified the boom. OPEC took advantage of strong world demand to restrict the supply of crude oil and push prices up. In the face of these pressures, inflation went up everywhere, including here in Canada. It took monetary authorities around the world a while to realize that rising inflation was not just the product of a series of temporary special factors. By the time most central banks reacted, inflation had become entrenched and proved very difficult to bring down. The persistent inflation of the 1970s and 1980s undermined economic performance worldwide. Canada did not escape unscathed. Because inflation creates uncertainty, it makes it much more difficult for households and businesses to judge future prices and to make sound economic decisions. High inflation encourages speculation rather than productive investments. It raises interest rates. And, in the end, it exacerbates both the booms and the busts. Restrictive monetary policies in the United States and in Canada during the early 1980s finally brought inflation down from its double-digit levels. But fears of inflation lingered, encouraging continued debtfinanced speculation in real estate and other assets. By the late 1980s, inflation pressures were on the rise again. In Canada, those pressures, and the fears of ongoing inflation that had been undermining our economic performance, finally eased after the successful implementation of the inflation-reduction targets adopted in February 1991. Inflation promptly declined to around 2 per cent, and inflationrelated hedging and speculation gradually disappeared. I believe that the low-inflation environment that was firmly established in the first part of the 1990s contributed significantly to Canada's improved economic performance later in the decade. Since the early 1990s, there has been greater certainty about future prices. Investment and savings horizons have, consequently, lengthened. Interest rates have come down. And, in contrast to our experience during the Mexican crisis, Canada rode out the impact of the Asian financial turbulence of 1997–98 with only a limited slowdown in output and employment growth. The way ahead Partly because of the difficulties we experienced in the 1990s, many Canadians remain sceptical about our economic future. They look at the extraordinary performance of the U.S. economy through much of the past decade, and Canada's record looks lacklustre by comparison. But I believe that there are considerable grounds for optimism. I say that primarily because of the improvements in our economic fundamentals that I have described. Indeed, good economic performance starts with a foundation of prudent economic policies. In this regard, low and stable inflation, together with a declining public sector debt, now provides a stronger base for the Canadian economy than we have had in three decades. In addition, there is the shift in business attitudes towards greater focus on cost control, productivity, and international competitiveness. How well we do in the future will depend on us getting a number of things right. Above all, we must ensure that we sustain and build on the progress made on the inflation, fiscal, and business fronts. But other things are also important. We must find the level of taxation that offers scope for entrepreneurship and risk-taking, while also allowing a level of government services that gives Canadians the degree of social support that can help them accept, respond, and adjust to a rapidly changing world. We must also think about the skills Canada needs to be able to exploit fully the benefits of rapid global economic change. This means strategic partnerships between employers and employees to promote on-the-job training, and partnerships between industries and educational institutions to improve skills and to develop new ones, suited to today's advanced technologies. This is very important if we are to avoid skill shortages that could constrain the expansion of our economy. Conclusion To conclude, our economy has been expanding robustly over the past five years, inflation has remained low, employment and incomes have been rising. And we are now seeing encouraging signs of a productivity payoff from the restructuring of the past decade—a payoff which, if sustained, would provide the basis for rising standards of living for all Canadians in the future. Some of you may wonder if this conclusion is not overly optimistic in the face of a slowing U.S. economy. Since tomorrow is our next pre-set date for announcing changes in the Bank Rate, I hope you can appreciate that I cannot comment on the current economic situation. We will be doing that in tomorrow's press release. What I can say is that the points I have been making here today are about the improvements we have seen in the fundamental, longer-term trends in our economy. Because of these improvements, our economy is now in a better shape than it has been for some time to deal with all kinds of external shocks—including fluctuations in U.S. demand for our products. What I see ahead are challenges, but not the serious problems we were facing ten years ago. Today, we have an economy with sound foundations, well-placed to rise to these challenges and prosper.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Toronto Board of Trade, Toronto, Ontario, 20 February 2001
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David Dodge: The Bank of Canada and monetary policy: future directions Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Toronto Board of Trade, Toronto, Ontario, 20 February 2001. * * * It's a pleasure to be here today, in my home town of Toronto, for my first public speech as Governor of the Bank of Canada. And I am particularly pleased to be speaking to the Board of Trade. One of my great delights as a boy was when my father would bring me to the dining room of the Old Board of Trade for lunch in June, if I had done well in school that year! That was my first contact with the Toronto business and financial community—a valuable contact that I have sought to maintain over the years. And it is a contact that I hope to strengthen while I am at the Bank of Canada. The Bank is well respected both inside and outside Canada for the quality of its professionals and the work that it does. I am honoured to join it and to lead it over the next seven years. My task will be to ensure that we build on the Bank's record to date and that we strengthen and deepen the progress made so far in fulfilling our responsibilities to Canadians. There are three main issues I want to address publicly as I begin my term: the Bank's contribution to good economic performance; the Bank's contribution to promoting financial stability, both nationally and internationally; and the importance of open and frank dialogue with business, labour, and the general public. Today, I would like to focus my comments on the first and the third of those issues. I hope to address financial stability as part of my next public speech. And I will conclude with a few remarks on the current economic situation. The Bank's contribution to good economic performance As the country's central bank, the Bank of Canada has a commitment to contribute to the economic well-being of Canadians. Fundamentally, this means that we must conduct monetary policy so as to promote sustained economic growth, create conditions conducive to rising investment, employment, and incomes, and encourage a more stable macroeconomic environment. How can the Bank of Canada foster such an outcome? ...low, stable, and predictable inflation The best contribution that the Bank can make to good economic performance is to preserve confidence in the future value of money. In practical terms, this means that Canadians should not have to worry about the effects of inflation when they make everyday decisions as consumers, business people, savers, and investors. It means that they should be able to go about their affairs confidently, knowing that they can count on their central bank to do whatever is necessary to keep future inflation low, stable, and predictable. In this way, they will be able to make sounder economic decisions, which will lead to better overall economic performance and rising incomes. Over the past several years, the Canadian economy has experienced low and stable inflation and a strong rate of expansion. Moreover, economic activity has been less variable than in the 1970s and 1980s, even though we had to face some important economic shocks, such as the Mexican and the Asian crises. Employment and personal incomes have risen, and business investment in machinery, equipment, and new technology has increased very substantially, particularly since 1996. At the same time, low inflation has encouraged Canadian businesses to operate more efficiently and to focus on cost control and productivity improvements. That is quite a change from our experience in the 1970s and 1980s. That experience amply demonstrated what a terrible price the economy and the people pay for high, unstable, and unpredictable inflation. I am thinking here of the increased uncertainty about the future, the distortion of vital signals and information that people rely on to make important decisions, the ups and downs in output and employment, and the waste of valuable economic resources as they are diverted from productive investments to speculative activities. All of this should be enough to strengthen our collective resolve not to let inflation break out again. And it convinces me that the focus of Canadian monetary policy since the early 1990s on low and predictable inflation as an essential building block of a productive, well-functioning economy has been exactly right. While low inflation is a necessary condition for good economic performance, it is not sufficient by itself. Other factors are also crucial. Clearly, it is very important that we all continue to work to improve the structure of our economy and the skills of our labour force, and to ensure that our product and labour markets operate efficiently. It is also critical that over the next decade all levels of government continue to focus on reducing their net indebtedness to lessen Canada's vulnerability to external shocks and to prepare for the pressures we will face with the projected decline in our working-age population. Canada's monetary policy approach: inflation-control targets and a flexible exchange rate Let me now turn to the role of the inflation-control targets and the floating exchange rate in Canadian monetary policy. Explicit inflation-control targets were jointly introduced by the Bank and the Government of Canada in 1991. Since 1995, the target has been to hold the trend of inflation inside a range of 1 to 3 per cent, with a focus on the midpoint of 2 per cent. Inflation targets provide an anchor for policy and an anchor for people's inflation expectations. They supply the Bank with an effective mechanism for assessing and dealing with demand pressures in the economy in a way that reduces fluctuations in output. Here's how this ‘stabilizer' feature of the targets works—bearing in mind that monetary policy actions take anywhere from one to two years to have their full effects on the economy and prices. If total demand was pressing on the economy's capacity to produce, so that the future trend of inflation looked likely to move towards the top of the target range, the Bank would tighten in order to reduce demand and inflation pressures. Equally importantly, in a symmetric fashion, if demand was weak and inflation looked likely to move towards the bottom of the range, the Bank would ease, providing more room for the economy to expand to its production potential. Moreover, the focus on inflation control can help the Bank to gauge where the economy's capacity to produce really is, especially after periods of widespread restructuring that may have raised capacity above the levels estimated on the basis of past experience. By comparing actual inflation relative to what the Bank expected, we can draw inferences about the limits of capacity, which is important in setting monetary policy. The basic point here is that the focus on inflation control and the clarity of the targets provide the Bank with an effective mechanism for guiding monetary policy in a way that reduces output volatility and helps to assess the economy's production potential. What about the exchange rate, how does it fit in all this? If the inflation targets are the anchor of our monetary policy, we need a flexible exchange rate. That much is clear. But in addition, a floating exchange rate allows the economy to adjust to economic disturbances, including fluctuations in external demand for our products. A classic example of this is a sharp movement in the relative price of our exports compared with our imports. In cases like this, movements in the relative value of the Canadian dollar help our economy to adjust more quickly than if the exchange rate did not move. And when the currency does move in response to shocks, the inflation target serves to anchor expectations about its value, thus facilitating the adjustment process. All this is to say that, in my view, inflation-control targets and a flexible exchange rate have worked well and continue to make sense for Canada in the foreseeable future. Openness, transparency, and public communications So far, I have explained why I consider an ongoing commitment by the Bank to low and predictable inflation to be of paramount importance to sustained strong economic performance in Canada. I have also outlined why I think that the Bank should continue to pursue the objective of low inflation within the current framework of inflation targets supported by a floating exchange rate. All this is fine, you may say, but how will the Bank ensure that it continues to deliver a credible, effective monetary policy? In a world subject to all kinds of shocks, and with financial markets increasingly more open and globalized, there are no guarantees that monetary policy will be successful at all times and under all circumstances. Still, it helps if those who are affected by policy decisions — the financial markets and the general public — understand what their central bank is doing, and why. Put another way, central bank actions will likely be more successful if they are better understood and more predictable. Financial markets will then likely respond more effectively, and indeed anticipate, monetary policy actions. And the general public will be better able to take monetary policy into account when making plans for the future. Transparency actually leads to better policy outcomes. In Canada, the move towards greater openness, transparency, and accountability in monetary policy received a big boost with the adoption of the inflation targets in 1991. The targets established a clear objective for monetary policy. And they set a precise yardstick for measuring the Bank of Canada's success in meeting that objective. The Bank's explicit inflation target and our commitment to achieving it, have provided strong incentives for us to be as candid as possible about the external and domestic developments that are likely to influence inflation and the ability of monetary policy to respond to them. Under the stewardship of my predecessor, Governor Thiessen, who placed particular emphasis on encouraging greater openness and more effective two-way communications, the Bank made important strides in this area. Today, we provide large amounts of data and commentary on monetary policy in our regular publications and on our Web site. We also discuss the outlook for the economy, inflation, and monetary policy in the Monetary Policy Report, the Updates to the Monetary Policy Report, and in speeches by Bank officials. Our latest initiative to improve public understanding of the Bank's actions is the adoption of a system of fixed dates for the announcement of decisions on the Bank Rate. The press release that we issue on each of these dates gives our latest assessment of the economy and the rationale for changing or not changing the Bank Rate. Communication, however, goes both ways. The Bank also needs to understand what is happening in the markets and in all key sectors of the economy and across the regions. We need your input, your information, and your views. We can only formulate good policy if we are good listeners. So I encourage you to talk to us. The phone lines and doors at our regional offices, here in Toronto and across the country, are open. Recent economic developments Constructive two-way communication is particularly critical in times of increased uncertainty about the future. So let me now say a few words about how the Bank views the current economic situation. The Canadian economy began 2001 from a strong base—expanding by an estimated 5 per cent, on average, in 2000 and with solid growth continuing right through the second half of last year despite the slowdown of the U.S. economy. In our last Update to the Monetary Policy Report, which was prepared on 23 January and released on 6 February, we revised down our projection for economic growth in Canada this year to about 3 per cent, primarily because of the more abrupt weakening of U.S. economic activity. That projection assumed that the U.S. economy would expand by 2 to 2.5 per cent, on average, in 2001, with a weak first half followed by a relatively strong rebound in the second half. When we released the Update on 6 February, we pointed out that, on the basis of accumulating evidence, it appeared that U.S. economic activity in the first half of the year would be weaker than we had projected on 23 January, even though we still expected a reasonable rebound in the second half of the year. We noted that this posed some near-term risks for the Canadian economic outlook. But, as we also pointed out then, despite the near-term uncertainties, the Bank remains generally positive about Canada's economic prospects for the year, given productivity increases and rising disposable incomes aided by tax cuts that are working to sustain domestic demand growth. Of course, there are some sectors and regions of the country that will feel the effects of the U.S. slowdown more than others, for example, those with heavier concentration in the production of cars and equipment, notably equipment related to communications and information technology. Offsetting those, there will be generally solid growth in construction and services, and particularly strong growth in energy-related sectors. Canadian and international data that have become available since 6 February have not caused us to alter the views outlined at that time. The Bank will continue to monitor the evolving situation closely, and we will have more to say on the subject in the press release on our next fixed announcement date, 6 March. Concluding thoughts Let me now conclude by underscoring my two main messages today. First, low, stable, and predictable inflation is the best contribution that monetary policy and the Bank can make to a productive, well-functioning economy. Second, effective dialogue between the Bank, the markets, and the general public is vital to the success of monetary policy. On both counts, my colleagues and I are determined to carry forward the Bank's commitment to Canadians.
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Remarks by David Dodge, Governor of the Bank of Canada, to the Montreal Society of Financial Analysts, Montreal, Quebec on 20 March 2001
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David Dodge: The Bank of Canada and financial stability Remarks by David Dodge, Governor of the Bank of Canada, to the Montreal Society of Financial Analysts, Montreal, Quebec on 20 March 2001. * * * I am pleased to be in Montréal today. Last month, in my first public speech as Governor of the Bank of Canada, I talked about our contribution to good economic performance through low, stable, and predictable inflation. I also stressed the importance of frank dialogue with financial markets and the general public in helping the Bank formulate and implement monetary policy successfully, particularly at times of increased uncertainty. While monetary stability through low inflation is crucial to good economic performance, our economy cannot function properly unless it is also supported by an efficient and stable financial system. And as the world economy becomes increasingly interconnected, sound macroeconomic policies and sound financial systems across all countries are even more essential. Today, I would like to talk about the Bank's contribution to financial stability at home and abroad. I will also comment briefly on the current economic situation. Canada as an international player As an open economy, Canada is very much affected by what goes on in the rest of the world. So we have more than a passing interest in promoting a sound and robust international environment. Since more than 80 per cent of our foreign trade is with the United States, it is developments in that country that have the most profound impact on our economy. Recent experience, however, has shown that even events in faraway places can reverberate back home. The Mexican peso crisis of 1994–95 and the Asian financial crisis of 1997–98 are cases in point. In both instances, Canada was sideswiped by those events. If this somehow leaves the impression that globalization - the increasing integration of economies and financial markets - has been of questionable value, I hasten to add that this is not how I see it. On the contrary, I believe that globalization has been, and will continue to be, a source of opportunity and growth for Montréal, for Canada, and for the rest of the world. Recent episodes, however, have highlighted certain vulnerabilities in the global financial system. And we must deal with them, if the benefits of economic and financial integration are to be fully realized by everyone in today's "global village." Let me tell you what the Bank is doing to promote financial stability. The importance of sound financial systems In addition to pursuing monetary stability through a low-inflation policy, all central banks, including the Bank of Canada, have a responsibility to promote the stability and soundness of their country's financial system. A market economy, like ours, cannot function well without the support of a strong financial system. Sound financial institutions, a robust financial infrastructure, and efficient financial markets are necessary to facilitate transactions and to properly channel savings into investments. For an economy to perform well, individuals and businesses must be confident that money and financial claims can be reliably and efficiently created, held, transferred, and settled. Now, if the arrangements that are in place do not work properly, the financial system can turn into a channel through which shocks are amplified as they are transmitted from one part of the system to the next and also beyond national borders. Whether such shocks are of an economic nature or whether they originate in the financial system itself, they can end up having an important impact on the economy as a whole. So there are good reasons why countries should ensure that their financial systems work well and that they do not trigger or spread instability domestically and internationally. The Bank's contribution to domestic financial stability In Canada, the Bank shares the responsibility for financial stability at the federal level with three other entities - the Office of the Superintendent of Financial Institutions, the Canada Deposit Insurance Corporation, and the Department of Finance. Various provincial bodies also play an important role. The Bank focuses its attention mainly on macro financial stability issues, leaving the principal responsibility for micro issues to the other entities. The Bank's overriding concern is to ensure that the financial system is sound and that it works efficiently. In this context, we provide liquidity to the system, in both ordinary and extraordinary situations. We give policy advice to the federal government on the design and development of the financial system. Through our oversight of major clearing and settlement systems, we act to make sure that the failure of a participant does not lead to domino effects and to generalized instability. And we provide banking services to these systems and to their participants. Finally, we collaborate with other domestic and international bodies that work on financialstability issues. Thanks to the collective efforts of all those charged with the promotion of financial stability in Canada, we have a financial system that is efficient and robust. And, as recognized by the International Monetary Fund (IMF) in 1999, it complies with all major international standards. But the financial landscape is constantly changing. Under pressure from greater global competition, and with the benefit of new information technology, more sophisticated financial products are being developed, and new ways to deliver financial services are continually being devised. What does this mean in terms of the Bank's commitment to financial stability? It means that we, and the other federal and provincial agencies responsible for the health of our financial system, must monitor these developments and understand their potential implications for financial stability. And we must continue to strengthen the ability of our financial system to withstand shocks. Moreover, since, despite our best efforts, there will be rare occasions when difficulties will develop, it also means devising effective, cost-efficient ways of resolving problems. Because even if the probability of such difficulties is low, the consequences could be major. The bank's contribution to global financial stability Let me now turn to the ongoing efforts to reform the international financial architecture and tell you about the Bank's involvement in this area. In the aftermath of the financial crises of the 1990s, new international bodies have been created, and existing ones strengthened, to help identify and deal with weaknesses in the global financial system. The Bank of Canada has been an active participant in several international forums where issues of financial stability are debated. And we have worked closely with other members to develop frameworks for the prevention, management, and resolution of international crises. I would highlight in particular our participation in two new international groups formed in 1999 - the Group of Twenty and the Financial Stability Forum. The Group of Twenty, currently chaired by Finance Minister Martin, brings together national authorities from both industrial and major emerging-market economies to discuss key issues that are important for the proper functioning of the global economy. Such issues include exchange rate regimes, good practices on transparency in fiscal, monetary, and financial policies, and the role of the private sector in crisis resolution. The Financial Stability Forum is responsible for identifying system-wide vulnerabilities and has dealt with such issues as offshore financial centres, capital flows, and international financial standards and codes. The bank's focus in fostering global financial stability Given our expertise, the Bank's focus in international forums has been, and will continue to be, on three key issues - exchange rate regimes, financial-system infrastructure, and private sector involvement in crisis resolution. In light of our long experience with flexible exchange rates and our strong reputation in inflation targeting, a number of emerging-market central banks have asked for, and received, assistance from the Bank in developing and operating policy frameworks based on inflation targets. We expect this to continue in the future. In the area of financial-system infrastructure, parallel to our work on the oversight of major payments systems and the provision of liquidity in Canada, we have been studying these issues from a global perspective as members of various committees at the Bank for International Settlements. And we have been contributing to the development of standards for the sound operation of such systems. The Bank has also been closely involved in international efforts to reduce the risks associated with the settlement of foreign exchange and securities transactions. Finally, there is the issue of private sector involvement in crisis resolution. We all recognize that, even with the best prevention efforts, we will not totally eliminate the possibility that foreign economic and financial disturbances will affect national economies around the world. In the event of an emergency, the international community has agreed to new assistance facilities for distressed IMF member countries. IMF resources, however, are not limitless. So there is a need for the private sector to play a key role in the resolution of crises. Greater clarity about the size of available official assistance is essential to encourage private sector debtors and creditors to work together to find solutions in difficult circumstances. And although we hope that most situations could be resolved voluntarily, it is important to recognize that, under certain conditions, an orderly standstill (a temporary suspension of debt-service payments) may be appropriate to give a distressed debtor country some breathing space in which to take steps to address its problems. Broad international consensus on limits to official lending and on standstills is still lacking. So we will continue to work away at these issues. Before summing up my main points today, I would like to give you a quick update on the Canadian economy. Recent economic developments In assessing the near-term course of the Canadian economy, we are all facing a number of uncertainties. The most important relates to the abruptness and extent of the slowdown in the U.S. economy. The fact that the recent economic data for North America are mixed adds to this uncertainty. While these data confirm a slowing in the pace of activity, some have come in weaker, and some stronger, than expected. This is certainly the case here in Canada. But even in the United States there have been both negative and positive reports. In the United States, the number of positive indicators, while not decisive, provides some hope that the end of the slowdown may not be far off. We continue to believe that U.S. economic growth will rebound in the second half of the year, supported by the decline in interest rates and by the moderation in energy prices. The exact timing of the U.S. recovery, however, remains uncertain and will depend importantly on how consumer confidence evolves in that country. Here in Canada, the latest national accounts data, which incorporate revisions to the growth profile in the first three quarters of last year, show that the level of economic activity was not quite as high at the end of 2000 as we had estimated earlier. And, based on more recent indicators, the pace of economic expansion in the first quarter of 2001 will be slower than in the final three months of last year. We can see this clearly in the automobile industry, where there have been production cutbacks mainly in response to weaker demand and excess inventories in the United States. Electronic goods and telecommunications products are two other areas where activity has slowed - although from very high levels - and where world production has been running ahead of demand. All three are high-profile sectors. So naturally they attract a lot of attention, especially in parts of Canada where there is a heavy concentration of these industries. But to keep things in perspective, there is still considerable strength in a number of other areas that are important to our economy. For example, investments in the energy sector and orders in the aerospace industry here in Quebec are extraordinarily strong. Or take retail sales other than autos, or housing, or non-residential construction: in all those areas, and in most other service industries, the level of activity remains high. When we considered the balance of this evidence earlier this month, we concluded that there was, in the near term, room for greater monetary stimulus without putting pressure on capacity and inflation. Therefore, we lowered the Bank Rate by 50 basis points on 6 March, bringing the total decline since January to 75 basis points. In taking this action, we also considered the uncertainties attached to the timing and extent of the expected recovery in the United States and their implications for growth of total demand in Canada. The Bank continues to believe that the reduction in our interest rates and rising disposable incomes, bolstered by recent tax cuts, should help to support the expansion of domestic demand in Canada in the second half of the year. This additional stimulus to economic activity is consistent with keeping the core rate of inflation close to the 2 per cent midpoint of the 1 to 3 per cent inflation-control target range. As for total CPI inflation, we still expect it to move down to about 2 per cent in the second half of 2001, assuming world oil prices remain at about current levels. Thus, as we look ahead through this year and into the next, we remain positive about the prospects for the Canadian economy. But, given the uncertainties, we will continue to closely monitor developments at home and abroad. Concluding thoughts Let me now conclude. The growing interdependence of national economies, massive capital flows, and new sources of potential risks in a globalized environment have brought into full relief the importance of sound macroeconomic policies and robust and efficient financial systems. Canada's monetary policy approach of inflation targets, a flexible exchange rate, and policy transparency has proven its worth through the difficult times of the past decade. Canadians can also take pride in a financial system that is universally acknowledged as sound and efficient. To keep it that way, we must ensure that as financial markets evolve, those of us charged with financial stability evolve with them. The Bank of Canada will continue to work closely with its domestic and foreign partners to strengthen financial stability at home and abroad. For to paraphrase John Donne: these days, no country is an island!
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, 28 March 2001
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David Dodge: Update on economic and monetary developments in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, 28 March 2001. * * * I appreciate the opportunity to appear before your Committee for the first time since my appointment as Governor of the Bank. On this occasion, I would like to touch on the Bank's contribution to good economic performance, our emphasis on openness and transparency, and our role in promoting domestic and global financial stability. I will then comment on the Bank's view of current economic conditions and discuss any issues you may wish to raise. The Bank of Canada has a commitment to contribute to the economic well-being of Canadians. This means conducting monetary policy so that it fosters sustained economic growth, by creating conditions favourable to rising investment, employment, and incomes and by bringing about a more stable macroeconomic environment. The unique contribution that the Bank can make to good economic performance is to preserve confidence in the future value of money. This means that Canadians should be able to go about their business secure in the knowledge that their central bank will do whatever it takes to keep future inflation low, stable, and predictable. The cornerstone of our monetary policy approach is an explicit inflation-control target. The current target range of 1 to 3 per cent, with emphasis on the 2 per cent midpoint, was established jointly by the Bank and the government under an agreement that runs until the end of 2001. An announcement regarding a new agreement to extend beyond 2001 will be made well before the end of the year. In a world that is subject to all kinds of shocks and with financial markets increasingly more open and globalized, monetary policy actions stand a better chance of being effective if they are more predictable and better understood by the public. That is why the Bank emphasizes transparency and effective two-way communication. In this context, I would like to highlight our latest initiative to improve public understanding of the Bank's actions. We have adopted a system of eight fixed dates each year when we announce decisions to change or maintain the Bank Rate and explain the reasons for our action in a press release. For a market economy like ours to function well, there must be widespread confidence not only that money will retain its value, but also that Canada's financial institutions, markets, and infrastructure are sound and efficient. Individuals and businesses must be confident that financial claims can be reliably and efficiently created, held, and transferred. This is why the Bank of Canada works closely with other federal and provincial entities to promote financial stability. The Bank focuses its attention mainly on macro financial stability issues. Our contribution includes the provision of liquidity to the financial system, the oversight of major clearing and settlement systems, policy advice to the government on the overall framework for the financial system, and collaboration with other domestic and international bodies that work on financial stability issues. In an increasingly interconnected world, we also must — and do — work with other members of the international community to promote the development of robust national financial systems and to prevent or minimize the impact of global financial crises of the sort experienced in the 1990s. Canada has a financial system that is recognized worldwide as being sound and efficient. To keep it that way, we must ensure that as financial markets evolve we evolve with them. The Bank will, therefore, continue to work closely with its domestic and foreign partners to strengthen financial stability at home and around the world. Let me now give you a quick overview of the economy. Since last fall, most forecasters have marked down their projections of world economic growth for 2001, from just over 4 per cent to just over 3 per cent. While 3 per cent may not be a stellar performance, it would still be quite respectable. In the United States, positive developments in such areas as employment and housing provide some hope that the end of the slowdown may not be far off. The Bank continues to believe that the pace of economic expansion in that country will strengthen during the second half of 2001, supported by the substantial decline in interest rates, the moderation in energy prices, and the drawing to an end of the current inventory adjustment. The exact timing of the recovery is uncertain, however, and will depend importantly on how U.S. consumer confidence and business investment evolve. In Canada, somewhat slower growth had been foreseen for 2001 as the economy was beginning to press against capacity. In fact, growth eased in the fourth quarter of last year. And with data for the first three quarters revised, the level of economic activity at the end of 2000 was not quite as high as we had estimated. Based on recent indicators, growth in the first quarter of 2001 will be less than in the closing months of last year. The slowing is clear in the automotive sector, where there have been production cutbacks in response to weaker U.S. demand and excess inventories. Activity has also eased—from very high levels—in electronics and telecommunications, where world production has been running ahead of demand. These three high-profile sectors naturally attract a lot of attention, especially in parts of Canada with a heavy concentration in such industries. Weakness also continues in sectors that produce non-energy commodities. But we must keep a sense of perspective. There is still considerable strength in other important areas of our economy. The latest data show that investments in the energy sector are very strong. And, except for autos, retail sales are solid. In addition, activity in housing, non-residential construction, and most other service industries remains firm. When we weighed all of the evidence in early March, we concluded that there was, in the near term, room for more monetary stimulus without risking pressures on capacity and inflation. On 6 March, we cut the Bank Rate by another 50 basis points, bringing the total reduction since January to 75 basis points. These lower domestic interest rates and rising disposable incomes, aided by recent tax cuts, should help to support the growth of domestic demand in Canada in the second half of 2001. This additional stimulus to economic activity is consistent with keeping the core rate of inflation in Canada close to the 2 per cent midpoint of the inflation-control target range. We see total CPI inflation moving down to about 2 per cent in the second half of 2001, if world oil prices remain around current levels. All in all, as we look ahead through this year and into 2002, the Bank remains positive about Canada's economic prospects. The recent volatility in exchange rates, both here in Canada and in many other countries, has generated considerable public commentary, and I would like to say a word about that. What we have been seeing is a strengthening of the U.S. dollar against all major currencies despite the marked slowdown in U.S. economic growth. Since the exchange rate is a key price in the Canadian economy, the Bank recognizes that movements in its value can be a source of concern for Canadians. I want to reassure you that the Bank watches market developments closely and carefully assesses the effects of currency movements on aggregate demand and inflation in Canada. In closing, Mr. Chairman, let me emphasize two points. First, although we expect reasonable growth to resume in the second half of the year, there are risks and uncertainties attached to this projection. These risks stem from global and, especially, U.S. developments. Although a moderation of U.S. demand was needed to sustain non-inflationary growth over the medium term, the slowing has been more abrupt than anticipated. As we look ahead, the question is how quickly will the necessary adjustments in production and inventories be completed in North America. My second point is that Canada's economic fundamentals are sound—in fact, they are the best they have been in nearly 30 years. Canada continues to benefit from a climate of low, stable, and predictable inflation. Canadian governments are running budgetary surpluses. Canada is running a record trade surplus. Federal and provincial governments are reducing their public debts. Canada is reducing its net foreign indebtedness. And there has been a surge in investment in equipment and technology that is essential for rising productivity and improved standards of living. Canada's strong fundamentals should operate in favour of the Canadian dollar over time. Moreover, corporate balance sheets are strong, financial institutions are sound, and credit markets are functioning well. Although consumer debt loads have increased, with rising incomes and lower interest rates households are in a better position to service those debts. In sum, Mr. Chairman, I believe that Canada is well placed to weather this period of economic adjustment. Given the uncertainties, however, the Bank will continue to monitor developments closely with a view to maintaining the low inflation that helps our economy to achieve its full potential.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Vancouver Board of Trade, Vancouver, British Columbia, 20 April 2001
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David Dodge: The Bank of Canada's contribution to the economic well-being of Canadians Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Vancouver Board of Trade, Vancouver, British Columbia, 20 April 2001. * * * I am glad to have this opportunity to talk to the Vancouver Board of Trade. I know that you are anxious to hear the Bank's views on the current economic situation, and I will have some comments on that later. But first I would like to talk about how the Bank contributes to good economic performance and how we promote financial stability here in Canada and abroad. The Bank's contribution to the economic well-being of Canadians The Bank of Canada has a commitment to contribute to the economic well-being of Canadians. In other words, we must conduct monetary policy so that it fosters sustained economic growth. Fundamentally, this means creating conditions that favour rising employment and incomes, strong investment, and a more stable macroeconomic environment. Low, stable, and predictable inflation The best contribution the Bank can make to good economic performance is to preserve confidence in the future value of money. This means that Canadians should not have to worry about the effects of inflation when they make everyday decisions as consumers, business people, savers, and investors. It means that they should be able to go about their affairs confidently, knowing that they can count on their central bank to do whatever is necessary to keep future inflation low, stable, and predictable. In this way, they will be able to make sounder economic decisions, which will lead to better performance for the economy as a whole and to rising incomes. Since the early 1990s, inflation in Canada has been low and stable. And economic activity has been expanding solidly over the past several years despite some major global disturbances. Of course, a low-inflation policy by itself is not sufficient. It must be complemented by other policies: policies that seek to improve the structure of our economy; policies that seek to enhance the skills and flexibility of our workforce; policies that seek to make Canadian product and labour markets more efficient. In addition, all levels of government must continue to reduce their net indebtedness. This is extraordinarily important if we as a nation are to become less vulnerable to external shocks and to prepare for the pressures of a shrinking working-age population. Inflation-control targets and a flexible exchange rate Let me now talk briefly about the role of the inflation-control targets and the floating exchange rate in Canadian monetary policy. Explicit inflation-control targets were jointly introduced by the Bank and the Government of Canada in 1991. Since 1995, the goal has been to hold the trend of inflation inside a target range of 1 to 3 per cent, with emphasis on the midpoint of 2 per cent. Inflation targets provide an anchor for policy and an anchor for people's inflation expectations. They supply the Bank with an effective mechanism for assessing and dealing with demand pressures in the economy in a way that reduces fluctuations in output. Here's how this 'stabilizer' feature of the targets works. If total demand was pressing on the economy's capacity to produce, so that the future trend of inflation looked likely to move towards the top of the target range, the Bank would tighten in order to reduce demand and inflation pressures. Equally importantly, in a symmetric fashion, if demand was weak and future inflation looked likely to move towards the bottom of the range, the Bank would ease, providing more room for the economy to expand. The basic point here is that the focus on inflation control allows the Bank to support growth when the economy is weak and to prevent overheating when the economy is strong and is pushing against capacity constraints. The other important element of our monetary policy approach is a flexible exchange rate. A floating exchange rate allows our economy to adjust to economic disturbances such as a sharp change in foreign demand for our products or a sharp movement in the relative price of our exports compared with our imports. In cases like these, movements in the relative value of the Canadian dollar help our economy to adjust with less fluctuation in output and employment than if the exchange rate did not move. And when our currency moves in response to those shocks, the inflation target helps to anchor expectations regarding its value in world markets. So the inflation target and a flexible exchange rate work well together—indeed they reinforce each other—under our current monetary policy framework. Effective two-way communication In an increasingly interconnected world subject to all kinds of shocks and uncertainties, delivering a monetary policy that is credible and effective has become quite a challenge. The Bank believes that greater openness and clear, two-way communication are important ways in which it can influence the economy, particularly at times of increased uncertainty. Put another way, our actions will likely be more successful if those we seek to affect—the financial markets and the general public—understand what we are up to and why. The Bank has made considerable progress in this area, and efforts will continue. Today, we provide large amounts of data and commentary on monetary policy in our regular publications and in speeches such as this one. Very importantly, we have also developed an excellent Web site that contains more than 5,000 documents touching on every aspect of our operations. It includes economic and financial data, research and analysis, speeches, and even an inflation calculator. I strongly urge you to visit our Web site, at www.bankofcanada.ca. I also encourage you to stay in touch with our regional offices across Canada. Our latest initiative to improve public understanding of the Bank's actions is a system of eight fixed dates each year for the announcement of decisions on the Bank Rate. This system has been in place since last December. I believe that it is working well because it allows all of us here in Canada to focus on our own unique economic circumstances. The Bank's contribution to domestic and global financial stability As I said before, widespread confidence that money will retain its value is crucial to sound economic performance. But a market economy like ours cannot function properly unless it is also supported by a strong financial system—that is, sound financial institutions, efficient financial markets, and a robust financial infrastructure. Canadians should be able to count on financial claims being reliably and efficiently created, held, and transferred. If the financial system is not robust, it can turn into a channel through which the effects of shocks— financial or economic—are magnified as they are transmitted from one part of the system to the next, within a country or between countries. The experience of the 1990s with the Mexican and the Asian financial crises showed us how this can happen. The echo of those events reverberated around the world. And, in both instances, Canada was sideswiped by the disturbance. So there are compelling reasons why all countries have to ensure that their financial systems function well. Here in Canada, the Bank works closely with other federal and provincial entities to promote financial stability. Bodies such as the B.C. Securities Commission focus on individual markets. But the Bank of Canada focuses mainly on stability issues from a broad, system-wide perspective. We contribute to financial stability in a number of ways. The Bank provides liquidity to the Canadian financial system. It oversees major clearing and settlement systems. It gives policy advice to the government on the overall framework for the financial system. The Bank also collaborates with other domestic and international bodies that seek to improve national financial systems and to prevent or minimize the impact of global financial crises. Canada's financial system is recognized worldwide as being sound and efficient. To keep it that way, those of us charged with promoting financial stability will have to stay one step ahead of today's rapidly evolving financial markets. The Bank of Canada will continue to work closely with its domestic and foreign partners to strengthen financial stability here in Canada and around the world. This completes my brief overview of the Bank's role in promoting monetary and financial stability. I now propose to turn to the current economic situation. Recent economic developments Let me start with the external environment in which Canada operates. The sharp easing in the pace of economic expansion in the United States has caused most forecasters to scale back their projections of world economic growth for 2001. Compared with an average projection of just over 4 per cent last fall, we are now looking at something a little over 3 per cent—not spectacular, but still quite respectable. This forecast assumes that, after a weak first half, economic activity in the United States will strengthen in the second half. Some of the recent U.S. data (such as housing, motor vehicle sales, and industrial production) indicate that the economic situation there may be stabilizing. The Bank expects that, with stable or lower energy prices and with the inventory adjustment process well advanced, U.S. economic growth should strengthen during the second half of the year. The reductions in interest rates by the U.S. Federal Reserve should underpin this recovery. But of course, its exact timing and precise strength are difficult to predict. Here in Canada, our economy was, by last summer, beginning to press against capacity limits. Thus, somewhat lower growth was anticipated for 2001. But, with the abrupt slowing of the U.S. economy, growth in Canada began to slow significantly in the final quarter of 2000. And by mid-2001, the Canadian economy will probably be operating somewhat below potential—that is to say, below what it is capable of producing over the long run without adding to inflation pressures. This slowing in economic activity has not been uniform. Some high-profile sectors such as the automotive, electronics, and telecommunications equipment industries have been affected the most. And the prices for many non-energy commodities have been weak. It is this weakness that has had an important effect here in British Columbia. But to keep a sense of perspective, let us not forget that there is still considerable underlying strength in other areas of our economy. This is certainly true of the energy sector, where production and especially investments to increase capacity are in high gear. And retail sales have held up well. In addition, activity in housing, non-residential construction, and most other service industries remains firm in most parts of Canada. On balance, looking at the economy as a whole, the Bank concluded that there was room to provide additional support to total demand consistent with our objective of keeping inflation close to 2 per cent over the medium term. To return to my earlier point, this is exactly how the inflation target is working today to guide us in our actions to support growth at a time when total demand is weak. So last Tuesday (17 April), we cut the Bank Rate by a further 25 basis points to 5 per cent, bringing the total reduction in interest rates since January to 100 basis points. This means that the overnight rate here in Canada is now at 4 3/4 per cent. It is this rate that corresponds to the federal funds rate in the United States, which is now 4 1/2 per cent. Easier domestic monetary conditions, rising disposable incomes (boosted by recent tax cuts), continued business investment in new technology, and a pickup in U.S. growth should support a stronger economic expansion in Canada in the second half of 2001 and in 2002. Consistent with this profile for output growth, core CPI inflation will likely average somewhat less than 2 per cent over the remainder of this year, but move back up to 2 per cent towards the end of 2002. (Core CPI focuses on the CPI without its volatile food and energy components, and without the effect of changes in indirect taxes.) Total CPI inflation is still expected to move down to about 2 per cent towards the end of 2001, if world oil prices remain around current levels. The Bank's spring Monetary Policy Report, which will be coming out on 1 May, will provide more detail on the economic outlook. The increased uncertainty surrounding global economic prospects has been reflected in recent developments in financial markets. Despite the marked slowing in economic growth in the United States, the U.S. dollar has strengthened against all major currencies, at least partly because global investors have sought the safety and liquidity of U.S. financial assets at a time of market uncertainty. Although the Canadian dollar has remained firm against other major currencies, the decline in its value against the U.S. dollar has once again generated considerable public commentary in this country. Since the exchange rate is a key price in our economy, the Bank recognizes that movements in the external value of our currency can be a source of concern for Canadians. I want to reassure you that we watch market developments closely. And we carefully assess financial market sentiment towards the Canadian dollar and the implications of movements in its value for aggregate demand and inflation in Canada. In closing, let me leave you with two key messages regarding our economic prospects. First, the Bank continues to expect a pickup in growth in the second half of this year and further strengthening in 2002. However, there are uncertainties attached to this scenario, mainly stemming from external— especially U.S.—developments. For example, there is a risk that the slowdown in the United States could be more protracted than anticipated. The Bank will have to monitor developments in this area closely. My second message is that there are good reasons to be positive about Canada's economic prospects over the medium term. We have established a climate of low inflation. Most Canadian governments are running budgetary surpluses. As a nation, we have a large trade surplus with the rest of the world, and we are reducing our net foreign indebtedness. Moreover, there are no serious speculative excesses in the economy. Corporate and financial sector balance sheets are generally healthy. Credit markets are functioning well. And although consumer debt loads have increased, with rising incomes and lower interest rates households generally are in a good position to service those debts. All this gives us a more solid basis to stand on as we go through this period of economic adjustment. And it provides a platform for future growth. The Bank's role is to target low inflation and to work with others to promote financial stability. As I explained before, by targeting inflation the Bank is providing appropriate support for growth in output and employment at this time of increased economic uncertainty.
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Opening statement by David Dodge, Governor of the Bank of Canada, before the House of Commons Standing Committee on Finance, Ottawa, 1 May 2001
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David Dodge: Update on economic and monetary developments in Canada Opening statement by David Dodge, Governor of the Bank of Canada, before the House of Commons Standing Committee on Finance, Ottawa, 1 May 2001. * * * I am pleased to appear before this Committee for the first time since my appointment as Governor of the Bank, on the occasion of the release today of our spring Monetary Policy Report. Mr. Knight and I hope to be able to return on the day of, or shortly after, the publication of our Report every May and November. The Report provides our latest assessment of the outlook for economic growth and inflation in Canada. Before I give you a flavour of that assessment, I would like to say a word about the objective of Canadian monetary policy and how we go about achieving it. The Bank of Canada has a commitment to contribute to the economic well-being of Canadians. Thus, we must conduct monetary policy so that it fosters sustained economic growth by creating conditions that favour rising output, employment, and incomes, and a more stable macroeconomic environment. The unique contribution that the Bank can make to sound economic performance is to preserve confidence in the future value of money. Canadians should be able to go about their business fully expecting that their central bank will keep future inflation low, stable, and predictable. In this way, they will be able to make sounder economic decisions. And this will lead to better overall economic performance. The Bank pursues low inflation within a monetary policy framework based on an inflation-control target and supported by a flexible exchange rate. The current target is to hold the trend of inflation inside a range of 1 to 3 per cent, with emphasis on the midpoint of 2 per cent. Inflation-control targets help to anchor policy and to anchor people's inflation expectations. And they provide the Bank with an effective mechanism for assessing demand pressures. In this way, we can take action to prevent overheating when the economy is strong and is pushing against capacity limits, and to support growth when the economy is weak. At the same time, a flexible exchange rate allows our economy to adjust to disturbances, such as changes in foreign demand for our products or changes in the relative prices of our exports compared with our imports. And it helps us to adjust with less overall fluctuation in output and employment than if the exchange rate did not move. With this brief overview of Canada's inflation-control strategy, let me now turn to the economic situation. When my predecessor appeared before you in May 2000, our economy was growing vigorously, bolstered by strong domestic and U.S. demand. Indeed, with signs of emerging capacity pressures, and with the need to sustain non-inflationary economic growth in Canada, the Bank raised interest rates the day after our appearance before this Committee. These higher interest rates led to some cooling off in domestic demand in Canada. What we, and most other analysts, did not anticipate was the abrupt slowing in U.S. economic growth. This is the factor that has contributed to a greater-than-expected moderation in economic activity in Canada. Since February, the Bank has been saying that we expect growth in the first half of this year to be very modest. And we have indicated that, by the middle of 2001, the Canadian economy will probably be operating somewhat below potential. Overall, the information received to date is broadly in line with the Bank's expectations. The monthly numbers have been volatile: some have been weaker and some have been stronger than anticipated. But they are generally consistent with our view that the weakness in the first half will be mainly associated with inventory adjustments in markets facing soft demand—in particular, motor vehicles—and with adjustments in other industries—notably electronics and telecommunications equipment. The Bank continues to believe that, after very modest growth in the first half of 2001, economic activity in Canada will pick up in the second half and strengthen further in 2002. Let me explain what we are basing this on. Despite lower production in the three high-profile sectors I just mentioned, aggregate economic activity continues to grow, buttressed by underlying strength in other areas, including the energy sector, retail sales, housing, non-residential construction, and most service industries. Supported by recent tax cuts that boost disposable income, final domestic demand should continue to expand. And we expect a recovery in foreign demand in the latter part of the year, encouraged by the substantial reductions in U.S. interest rates. Nonetheless, there are uncertainties about the exact timing and strength of the pickup in U.S. growth. Here in Canada, we have lowered interest rates significantly to support growth in total demand in line with our objective of keeping inflation close to 2 per cent over the medium term. Since January, the Bank of Canada has cut rates by a total of 100 basis points, bringing the overnight rate—the rate that corresponds to the U.S. federal funds rate—down to 4¾ per cent. With this monetary easing and with the strengthening in the pace of economic activity in the second half of the year, we now project annual average growth of between 2 and 3 per cent in 2001. For next year, we see output expanding at a rate slightly above the Bank's estimate of potential output growth of 3 per cent. Consistent with the Bank's expected path of output growth, core CPI inflation will likely average somewhat below 2 per cent over the remainder of 2001, then move back up to 2 per cent by the end of 2002. Total CPI inflation is expected to be volatile over the next few months, before moving down to about 2 per cent by the end of the year if world energy prices remain close to current levels. I would now like to say a word about recent developments in financial markets. These developments have essentially reflected the increased concerns and uncertainty surrounding world economic prospects. In the circumstances, global investors have, once again, sought the safety and liquidity of U.S. financial assets. And this has led to an appreciation of the U.S. dollar against all major currencies despite the marked economic slowdown in that country. Although the Canadian dollar has remained firm against other major currencies, the decline in its value against the U.S. dollar until just recently has been the subject of much public commentary in Canada. Since the exchange rate is a key price in our economy, the Bank recognizes that movements in its value can be a source of concern for Canadians. I want to assure you that the Bank monitors market developments very closely. And we carefully assess the implications of currency movements for aggregate demand and inflation in Canada. In closing, let me reiterate that the Bank remains generally positive about Canada's economic prospects in the period ahead. We continue to expect a pickup in growth in the second half of this year and further strengthening in 2002. The main risk to this outlook is the timing and strength of the projected pickup in U.S. growth. Given this uncertainty, we will continue to monitor developments closely and we will respond appropriately.
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Remarks by Mr Paul Jenkins, Deputy Governor of the Bank of Canada, to the Ottawa Economics Association, Ottawa, Ontario, 22 May 2001
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Paul Jenkins: Communicating Canadian monetary policy: towards greater transparency Remarks by Mr Paul Jenkins, Deputy Governor of the Bank of Canada, to the Ottawa Economics Association, Ottawa, Ontario, 22 May 2001. * * * I want, first, to thank the Ottawa Economics Association for your invitation to speak to you today. I welcome this opportunity to talk about an important aspect of the work of the Bank of Canada in conducting monetary policy – communications. In the next few minutes I would like to discuss some of the factors that are central to monetary policy communications. I will touch on a few of the particular challenges we at the Bank of Canada face. And I’ll conclude with a few words on the Bank’s communications approach, including its role in the new system of fixed dates for announcing interest rate decisions. The trend to openness and transparency Let me begin with a brief backward glance. It is not so long ago that central banks did little to let people know what they were up to and why. Indeed, in the conduct of monetary policy, little emphasis was placed on trying to explain the objectives of policy because those objectives were not clearly defined. Without clear objectives for monetary policy, central bank actions were generally not predictable. And the conventional way of thinking among central banks was that it was best to say nothing and let actions speak for themselves. It is a different story today. Indeed, there has been nothing less than a sea change in the way central banks view the role of communications in monetary policy. What we have seen in recent years is a broad and continuing trend among central banks towards greater openness and transparency in the conduct of monetary policy. This trend has come about not because of any “fad” for public relations or for marketing a central bank’s image. It has occurred because of fundamental changes in the way monetary policy is approached and conducted and the corresponding recognition that the effectiveness of monetary policy is improved through greater transparency. And to be transparent requires proactive and well-planned communication. Why communications has become so important for monetary policy For the Bank of Canada, communications has become a strategic priority in supporting our goal of preserving a low and stable inflation environment. We believe that maintaining low, stable, and predictable inflation is the best contribution monetary policy can make to a productive, well-functioning economy. An important step towards increased transparency, and thus towards clear and focused communication, was taken in 1991 when Canada adopted explicit inflation-control targets. The announcement of the targets clarified the objective of monetary policy and provided a nominal anchor for economic and financial decisions. (As you know, last week the government and the Bank agreed to renew the inflation-control target of a 1 to 3 per cent target range and a 2 per cent target midpoint.) The greater transparency of inflation targets has also anchored the Bank’s approach to communicating what monetary policy is trying to achieve, our means of achieving it and our assessment of the state of the economy. While the targets continue to define our inflation objective, conditions in the economy are constantly changing. Both international and domestic developments can affect the economic outlook in Canada. The Bank has to continually assess these changes and their implications for future inflation. If required, we take appropriate policy actions that are consistent with achieving the inflation-control target over the medium term. The role of communications is, therefore, to explain how and why circumstances have changed and to relate the Bank’s actions to our inflation target and to the well-being of the economy. I’d like to suggest to you that there are at least three important and related ways that good communications can help monetary policy be effective. First, good communications helps put the Bank and financial markets on the same wavelength. That is very important because, generally speaking, monetary policy is more effective when financial markets understand how the Bank assesses economic developments in relation to our policy objectives. When we are all on the same wavelength, markets can anticipate, rather than simply react to, interest rate actions by the Bank. If the Bank does a good job of keeping market expectations broadly in line with the direction of policy, there tends to be less volatility in financial markets and a smoother, more rapid incorporation of any shifts in policy into interest rates and exchange rates. In other words, effective communications improves the monetary policy transmission process and leads to responses in the exchange rate and in the term structure of interest rates that are more consistent with the Bank’s intentions. This greater stability and predictability is in everyone’s interest. A second reason why communications has become so important has to do with the effect of public expectations and behaviour on the Bank’s ability to meet our policy objectives. Improving public understanding and acceptance of what the Bank is trying to do increases the chances of success in achieving the inflation targets with as little economic disruption as possible. It is largely a matter of the credibility of the Bank’s commitment to those targets. Let me be more specific. If consumers, investors, workers, businesses, and governments believe that action will be taken to ensure that inflation remains close to the target, then they are more likely to make economic and financial decisions accordingly. Pricing decisions by producers and suppliers will reflect inflation expectations consistent with our target. Wage bargains between employees and employers will tend to be in line with the inflation target. The net effect will be a more stable macro-economic environment and greater success in keeping inflation low. Keeping in touch with expectations also entails good two-way communication. The Bank consults Canadians in business, finance, and government across the country on a regular basis. By doing so we keep informed of economic developments and perspectives on the ground, and this contributes to our understanding of what is happening in the “real” economy. A third reason why communications is important is accountability. As a public institution with a high degree of autonomy for the conduct of monetary policy, the Bank of Canada bears an obligation to account to Canadians for how well it is doing its job. An explicitly defined and agreed upon inflation target provides a clear basis for accountability. This clear basis for judging the Bank’s performance is extremely important for credibility. But for the Bank to be fully accountable, it must provide the public with the information it needs to be aware of, and understand, the Bank’s policy objectives, the factors we take into account in making decisions, and our progress in meeting our objectives. That is the job of communications. Challenges in communicating monetary policy Recognizing and understanding the importance of good communications does not mean the job is easy. In fact, being more open and transparent has created a wide range of communications challenges. One of these challenges stems from the medium-term time frame in which monetary policy operates. When the Bank raises or lowers interest rates, it takes about 12 months for this change to have its peak impact on aggregate demand and about 18 to 24 months to fully affect inflation. In other words, when the Bank acts, it does so on the basis of assessing developments, gauging the impact on the economy and on inflation 1 to 2 years down the road, and taking action to achieve our inflation target over that horizon. If the public is going to make informed economic and financial decisions, then it needs to understand and take into account the time frame over which monetary policy has its effects. Yet there continues to be a tendency to view Bank actions only as a short-term response to immediate events rather than in the context of medium-term trends and objectives. Adding to this communications challenge is the fact that assessing economic trends in the future is not an exact science but rather a highly interpretive exercise. Unforeseen developments or “shocks” are always occurring, and there is always an element of uncertainty about the order of magnitude and persistence of these developments. Thus, what we say and communicate about the future has to be phrased in conditional terms. And if the picture looking forward is clouded by uncertainties, it is impossible for a central bank to provide financial markets and the public with a high degree of precision and certainty. A second key communications challenge could be formulated as a question something like this: In becoming more transparent, how can the Bank best ensure value in what we communicate? At the risk of sounding a touch glib, I would argue that, when it comes to monetary policy communications, “more” isn’t necessarily “better.” It is “quality” that is of greater importance in transparency than “quantity.” As I have already noted, monetary policy needs to be viewed from a medium-term perspective. Therefore, the Bank can provide substantive value by communicating what it sees as the key trends in the economy and inflation and how the conduct of monetary policy relates to these trends. Usually it is the accumulation of information that gives understanding to these trends. For that reason, the Bank cannot, and should not, comment on every piece of new economic data or information that becomes public. But by transmitting our view of the larger trends in the economy, the Bank can promote better anticipation of the direction of policy. Our concern about quality has also influenced how we approach the flow of information just prior to, and at the time of, our policy announcements. The Bank consciously refrains from making public comments on issues relating to monetary policy in the week before an announcement on official interest rates. This is a sensitive period, particularly for financial markets, and comments could easily be misinterpreted. The other point I would stress about the quality of information relates to how the Bank arrives at monetary policy decisions. The decision-making of the Bank’s Governing Council is a process of consensus building. Members of the Governing Council are full-time employees of the Bank who meet on a daily basis. In the two weeks prior to a policy announcement, there is a series of meetings at which information from several sources is presented by Bank staff and discussed. Out of this process a consensus is developed within the Governing Council on the appropriate policy decision. Therefore, what is of greatest value from a communications perspective is a clear statement of the substantive reasons for a policy decision. That statement is the press release announcing our decision. Four times during the year, the announcement is supplemented two weeks later with the publication of our semi-annual Monetary Policy Reports (in May and November) and Updates to the full Report (in February and August). These publications, which are finalized as of the policy announcement date, elaborate in greater detail the Governing Council’s assessment of the factors that shaped the interest rate decision. Another challenge revolves around the fact that the Bank`s communications are with different audiences that may have different degrees of interest in what the Bank says and does. The general public, for example, is generally interested in inflation, the value of the dollar, and whether or not interest rates are going up or down – those developments that have an impact on their daily decision-making. Financial markets, on the other hand, are intensely interested in both the direction and the intricacies of monetary policy and tend to be highly sensitive to any Bank action or comment bearing on these issues. They scrutinize Bank publications and speeches by senior Bank officials for any shade of meaning about where monetary policy might be heading. This makes communicating monetary policy a difficult task, because some of the subtleties and complexities related to the direction of monetary policy simply can’t be reduced to a few words. The challenge is in tailoring messages that communicate as clearly as possible the Bank’s assessment of the economy and the direction of policy, while bearing in mind the specific concerns and information needs of different audiences. This challenge is all the more difficult when it comes to the media, an audience that is instrumental in whether or not we communicate successfully. There are no two ways about it. The Bank relies heavily on the media to get our message to the public, whether it is via TV and radio, newspapers and magazines, or the various wire services that feed financial institution trading rooms as well as news outlets across the country. We also recognize that the media act as a filter for what we say and often determine which of our statements will be reported. It is part of the media’s job to interpret our decisions and perspectives and to comment on how they see the Bank executing its mandate. It is also their job to reflect the views of third parties on what we say and do. That is healthy for democracy, healthy for our accountability, and can be healthy for raising public awareness of monetary policy issues. In this rather complex communications environment, it is squarely in the Bank’s interests that the media cover monetary policy as fully and accurately as possible. And the chances of full and accurate reporting are enormously better if the media are well informed about monetary policy and the factors affecting what we at the Bank do. Bearing in mind my comments a few moments ago about the frequently complex and conditional nature of monetary policy, I don’t underestimate the challenge – either for us or for the media. For the Bank’s part, we have taken a number of steps in recent years to strengthen our relations with the media and to furnish them with the information necessary for high-quality reporting and commentary. We now provide not only more information than in the past but more occasions when we explain information directly to the media and respond to their questions. Thus, for example, we have instituted regular media briefings prior to the release of key Bank reports. We installed a special “lock-up” facility at the Bank to enable the media to read our releases and write their stories in advance of their official publication. We have increased the number of press conferences and media sessions given by the Governor and Deputy Governors. The media tell us these changes have been helpful. But I would suggest that there is still some progress to be made to ensure that Canadians receive the accurate and insightful coverage of monetary policy they have every right to expect. For example, the media might assess whether investing more time and intellectual capital could strengthen and deepen its reporting and commentary on monetary policy issues. And there may well be additional things the Bank could do to promote better understanding of monetary policy. Indeed, we have been looking at the greater use of the electronic media to reach the public, and our new Governor has already done a fair number of interviews on radio and television. Our goal here is to continue the move to greater openness in Bank communications while at the same time being careful to stay clear of any short-run, market-sensitive issues. We will continue to consult with journalists and reporters about this and other improvements that we might consider. The Bank’s communications strategy – an evolving process To this point, I’ve underlined why communications is important for effective monetary policy and some of the challenges we face in communicating a complex subject to a variety of interested audiences. Now I’d like to say a few more words about what we’ve been doing at the Bank of Canada to communicate monetary policy in an open and transparent way. As I’ve already indicated, our overriding objective is to focus attention, debate, and understanding on the Canadian economic and financial situation and what it means for keeping inflation low and stable. To do this, the Bank has taken a number of initiatives. In 1995, we introduced our semi-annual Monetary Policy Report, which in many ways has become the centrepiece of our communications strategy. It is the Bank’s fullest interpretation of recent developments in the economy as well as our outlook for the medium term, the horizon over which monetary policy has its effects. Between each Report, we publish an update of the Bank’s views. Interspersed between these releases are speeches and press conferences by the Governor, speeches by Deputy Governors, press releases, and regional outreach activities, which have greatly broadened our audience coverage. As part of our communications strategy, we have tried to schedule our publications and communications events throughout the year to achieve a regular, continuous, and integrated program of public communications. This permits us to communicate on a more continuous basis our evolving views on the economy and on the trend of inflation. On the operational side, in 1994, we introduced an operating band for the overnight rate of interest to give greater clarity to financial markets about the Bank’s desired rate setting. In 1996, we set the Bank Rate – the rate at which we lend to financial institutions – at the upper limit of the operating band. And in 1999, we set the target for the overnight rate as the midpoint of the band. Currently, we are moving to place more focus on the target for the overnight rate in our announcements since it is the appropriate policy rate for international comparisons. For example, our target for the overnight rate corresponds with the U.S. Federal Reserve’s target for the federal funds rate. We have also put a lot of emphasis on developing and maintaining our Web site. It gives the public at large direct access not only to our publications and speeches but also to more easily understandable information about the Bank and monetary policy. (By the way, I encourage you to take a look at our Web site at www.bankofcanada.ca. It was recently ranked second among 24 central bank sites reviewed by the London-based organization, Lombard Street Research Ltd.) Fixed announcement dates Our most recent innovation to our strategy, launched on 5 December last year, is a new system for announcing decisions on official interest rates. Any change to the target for the overnight rate of interest is now announced on eight pre-specified or “fixed” dates during the year. On each date, a press release is issued, indicating the Bank’s decision either to change rates or to leave them unchanged and giving a short explanation of the reasons for the decision. This approach replaces the former practice of only making an announcement if we changed interest rates and doing so without any warning to the public or to financial markets. The new, fixed-date approach is an extremely important step for the Bank in implementing monetary policy actions. From a communications perspective, it provides a number of important benefits. First, it gives the public, the media, and financial markets the certainty of knowing exactly when the Bank will make an announcement on interest rates. This allows them to plan more efficiently and make more orderly assessments as each announcement approaches. A second communications benefit of fixed dates is the increased emphasis they bring to the economic situation in Canada as the primary focus of Canadian monetary policy. We believed this would lead to increased commentary on Canadian economic circumstances and their implications for monetary policy during the period leading up to a fixed announcement date. That, in turn, would contribute to building public awareness of both economic developments in Canada and the role of monetary policy. A third benefit is that fixed dates provide the Bank with a regular opportunity to put the recent economic and financial developments into a medium-term perspective. As I said earlier, this is important because the effects of monetary policy actions are usually spread over 1 to 2 years. The press release on each fixed date, together with the Bank’s other communications vehicles such as the Monetary Policy Report and Updates, enables the Bank to position recent developments in terms of the underlying trends over this time horizon. If we communicate this successfully, there should ultimately be more public focus on the trends over time that are important to monetary policy and less reaction to near-term developments. Finally, the eight new fixed dates increase the number of opportunities for the Bank to communicate its views on the economy. Whether or not there is a change in our policy rate, the analysis in the press release should stimulate a more frequent and continuous dialogue with key audiences and should generate more regular commentary among analysts and the media. We now have the experience of four fixed announcement dates under our belts. While it is still early to draw conclusions, generally we are very pleased with the way fixed dates are working and with the positive reaction they have generated. We have already seen more focused public commentary on the Canadian economic situation, and that is extremely encouraging. With the benefit of further experience with the new approach and feedback from financial markets and the public, we will be able to assess what further improvements might be made. But we are more convinced than ever that this new approach will increase the effectiveness of monetary policy. Conclusion To conclude, I want to emphasize that the Bank will continue to look at ways to build on the progress we have made in increasing the openness and transparency of monetary policy. Communications will play an increasingly vital and strategic role in helping achieve this further progress. It is a role that we at the Bank are extremely serious about. For in the final analysis, monetary policy is most effective when it is effectively communicated. Thank you.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Edmonton Chamber of Commerce, Edmonton, Alberta, 26 June 2001.
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David Dodge: Canada’s monetary policy approach: it works for Canadians Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Edmonton Chamber of Commerce, Edmonton, Alberta, 26 June 2001. * * * I welcome this opportunity to talk to you today. In recent months, the debate over Canada's exchange rate system has heated up and calls for the adoption of a common currency with the United States have attracted a lot of attention. Today, I would like to revisit the issue of the appropriate exchange rate regime for Canada and to set out as clearly as possible the Bank's position. I propose to frame my discussion in terms of Canada's approach to monetary policy. I will conclude with some comments on the current economic situation. The goal of monetary policy and how to achieve it The Bank of Canada's commitment is to contribute to the economic well-being of Canadians. This means conducting monetary policy so that it fosters sustained economic growth – by creating conditions that favour rising output, employment, and incomes, and a stable macroeconomic environment. Low, stable, and predictable inflation Experience over time and across countries has taught us that the best contribution monetary policy can make to a sound economy is to preserve confidence in the value of money. Fundamentally, this means that Canadians should be able to count on their central bank to keep future inflation low, stable, and predictable. In this way, they can go confidently about their affairs, making sound economic decisions. This, in turn, should lead to better economic performance nationally. Seen in this light, the focus on low inflation is not an end in itself, but rather a means to an end – the end being the advancement of the economic well-being of Canadians. Of course, a low-inflation policy by itself is not sufficient to guarantee the best economic outcome for Canada. Fiscal prudence and other policies that aim to improve the structure and flexibility of the economy are also essential. But low inflation provides a crucial underpinning to a well-functioning economy. If the goal of monetary policy is to achieve and preserve low inflation, how would the central bank go about it? Anchors for monetary policy When a central bank raises or lowers its key policy interest rate, it sets in motion a series of events that starts with the financial markets, works through changes in spending, output, and employment, and ends with an effect on the rate of inflation. This series of events is known as the transmission mechanism of monetary policy. The problem is that the transmission process is lengthy. So it takes time for monetary policy actions to affect output and inflation. Some effects are felt relatively quickly. But the full effects are not felt for some time – 3 to 6 quarters in the case of output and 6 to 8 quarters in the case of inflation. This means that, as central bankers go about their day-to-day business of implementing monetary policy, they must look ahead and anticipate what is likely to happen down the road. They have to work with assumptions and make judgment calls about future economic developments and about the timing and final outcome of any monetary policy action they take. All of this involves considerable uncertainty. This being said, as we look around the world, there have been different ways to focus the conduct of monetary policy and to give people greater comfort that things are on track, thus helping to tie down or "anchor" inflation expectations. Most countries have now adopted some kind of explicit target or anchor for monetary policy. The major exception is the United States, where a statement of general intentions with respect to inflation has, in recent years, proven sufficient to anchor monetary policy, in light of the U.S. Federal Reserve's strong credibility. In terms of explicit anchors, there have been targets for monetary aggregates, fixed exchange rates, and inflation targets. . . . targeting monetary aggregates Most industrialized countries, including Canada, have in the past tried to target the rate of money growth. However, in both Canada and the United States, targets for money growth have not proven to be an effective monetary anchor. Deregulation and financial innovation have weakened the reliability of money measures, and the relationship between money growth and the rate of inflation has proven unstable. But we still look at money for its information content about current and future developments in output and inflation. For all practical purposes, then, there are only two options today in terms of explicit anchors for monetary policy: fixing the exchange rate or targeting inflation. . . . fixing the exchange rate For many countries, especially smaller ones, tying their currency to that of a larger neighbour or major trading partner with a history of low inflation is one way to achieve a low rate of inflation. There are, of course, different forms of fixed exchange rates. They can range from 'softer' systems – such as a peg – to 'harder' fixes that lie at the opposite extreme from a free floating currency. These harder fixes can be a currency board, the outright use of another country's currency ("dollarization"), or a full monetary union. Pegged exchange rates that can be adjusted (that is, revalued or devalued) have been the most widely used anchor since the Second World War. They were the prevailing order under the Bretton Woods system, which was established after the war and lasted until the early 1970s, when it finally collapsed in the face of increasingly open financial markets, large capital flows, and U.S. expansionary policies. The problem with a fixed, but adjustable, exchange rate is that it does not guarantee that the value of the currency relative to other currencies, and thus its purchasing power, will not rise or fall. For example, the currency could come under downward pressure if it is pegged at a level that is out of line with the country's economic situation (say, because of large and growing fiscal deficits and debts). Should the markets then begin to question the authorities' commitment to the peg, domestic and foreign investors would scramble to get out, triggering a currency crisis. There is no shortage of such examples in recent history: repeated episodes in Latin America since the 1980s, crises in Europe in 1992 and 1993, and in Southeast Asia and Russia in 1997–98. Because pegs have proven problematic, a more realistic approach would involve adopting one of the more rigid fixes. I will have more to say about this later. But let me move on now to the third option for an explicit monetary policy anchor – inflation targets. . . . targeting inflation Among a number of industrialized countries that, like Canada, are operating a floating currency, there has been a tendency over the past decade to adopt explicit inflation targets as the anchor for monetary policy. The same tendency is now evident among a growing number of emerging-market economies that have recently moved to flexible exchange rates following the collapse of their pegged rates. The objective is to consistently maintain low and stable inflation, while the flexible exchange rate helps the economy to adjust to shocks. Why inflation targets and how do they work to guide monetary policy? In such a framework, the central bank targets the rate of inflation – say, 2 per cent – several quarters ahead. Then, based on its judgment of the current and projected strength of demand relative to the economy's production capacity, as well as the implications for future inflation relative to the target, it will take action now – because of the long lags involved – to ensure that the target is achieved down the road. The value of the inflation target as an anchor: the Canadian experience In Canada, explicit inflation targets were jointly introduced by the Government of Canada and the Bank of Canada in 1991. Since 1995, the goal has been to keep the trend of inflation inside a target range of 1 to 3 per cent. In adopting the targets, the Bank expected that they would provide a useful framework within which to assure Canadians that inflation would remain low and stable, thus leading to less fluctuation in output and employment. We also expected that the targets would provide a precise goal against which to measure the conduct of monetary policy, thus helping to increase the Bank's public accountability. After a decade of experience, it is clear that inflation targeting has proven to be an effective way of keeping inflation low, and that an inflation target provides an anchor for inflation expectations. Moreover, that target has supplied the Bank with a mechanism for assessing, and dealing with, demand pressures on future inflation in a way that helps to keep the economy on a more even keel. Indeed, there is already some evidence that the pronounced ups and downs in economic activity, so typical of the past, have diminished. Here's how the target helps the Bank to ‘stabilize' the economy. When demand pushes against the economy's capacity to produce and seems likely to put upward pressure on future inflation relative to the target, the Bank will raise interest rates. This will help to moderate demand and reduce inflation pressures. Equally importantly, when demand is weak and seems likely to put downward pressure on future inflation relative to the target, the Bank will lower interest rates, thus providing more room for the economy to expand. In short, the emphasis on inflation control allows the Bank to support growth when the economy is weak and to prevent overheating when the economy is strong and is pushing against capacity constraints. Now, this goes back to what I was saying at the beginning – that monetary policy contributes to sound economic performance by means of its focus on low inflation. With a low-inflation climate encouraging further initiatives by Canadian businesses to improve cost control, efficiency, and productivity, and with marked fiscal progress by all levels of government, our economy has performed well over the past several years. And it has generated solid gains in employment and incomes. In light of the important economic and social benefits that low inflation and inflation targets have delivered, the federal government and the Bank of Canada recently agreed to retain the current target of 1 to 3 per cent. To increase the chances that inflation stays inside that range, the Bank will now be aiming expressly at the 2 per cent midpoint. Moreover, the new agreement runs for five years, instead of three, to the end of 2006. Both of these changes should help to increase predictability and to reassure Canadians that low inflation will be a continuing feature of the domestic economic scene. Now, let us see how the exchange rate fits in all this and why Canada needs a floating currency. Why do we need a floating exchange rate? If we want to set our own goal for inflation or, what's more relevant (since today all industrial countries pursue a similar low-inflation objective), if we want to run a monetary policy suited to our own distinct economic circumstances, we need monetary independence. Monetary independence can exist only within a flexible exchange rate system. The real value of a floating currency for Canada lies in helping our economy to absorb some of the impact of external shocks. A classic example would be a sharp movement in the value of our exports relative to our imports, such as occurred in 1997–98, when world commodity prices plummeted in the wake of the Asian crisis. In that instance, a downward movement in the value of the Canadian dollar helped offset some of the losses suffered by our commodity producers. More importantly, it strengthened the competitiveness of Canadian manufacturers. They, in turn, were able to expand production and offset some of the downward pressure on output and incomes from the decline in the commodity sector. In this way, our national economy was able to adjust more quickly, and with less overall fluctuation in output and employment, than if the exchange rate did not move. Consider what would have happened under a fixed exchange rate. With the exchange rate not allowed to move, domestic wages and prices would have had to decline to restore external competitiveness. And since neither wages nor prices are flexible enough to adjust quickly, much of that adjustment would have had to come through declines in output and employment. In a world where capital is free to move across national borders, a floating exchange rate can also help to absorb some of the pressures stemming from large capital flows and to facilitate any necessary economic adjustments. Indeed, I would remind you that the decision to float the Canadian dollar in 1950, and again in 1970, was taken in the context of large capital inflows (and rising commodity prices) that were causing concerns about their inflationary effects on our economy and were putting strong upward pressure on our currency. The key point in all this is that Canada cannot insulate itself from external shocks. Whether we are on a flexible or a fixed exchange rate, the reality is that those shocks require a domestic adjustment. And, in the end, that adjustment will be made – one way or another. But, without the flexibility a floating currency can provide, it will take longer, be more difficult, and cost more overall in terms of lost output and jobs. Now, when the exchange rate moves up or down, there has to be some way to anchor expectations about its value. Otherwise, the freedom of the currency to float could, in the context of a downward movement, undermine confidence in its value on world markets and at home. Under our approach to monetary policy, the domestic inflation target serves as that all-important anchor for the exchange rate. The inflation target and a floating currency work well together – indeed, they reinforce each other. And they both have very significant economic benefits for Canada. These days, the advantages of a monetary policy approach based on inflation targets and supported by a flexible exchange rate regime are being increasingly recognized by others around the world. And Canada is often held up as a model. Why then the calls in this country to go back to pegging our currency to the U.S. dollar or to enter into a currency union with the United States? Pegging would mean losing the macroeconomic benefits of a flexible exchange rate, without gaining the assurance that the exchange rate will not move in the future. So what people are talking about now is a currency union with the United States. On the face of it, the prospective gains from such an arrangement would seem to be attractive. After all, Canada is one of the most open economies in the world, exporting over 40 per cent of its output and importing about as much. Moreover, 80 per cent of this trade is with the United States. So, yes, by adopting the U.S. dollar, Canadians could save on the transactions costs of converting national currencies and hedging against currency movements. There could also be some other advantages linked to the improved efficiency that can result from reduced exchange rate uncertainty. The crucial question, however, is whether the savings from such an arrangement would compensate for the loss of monetary policy independence and for the loss of the buffer that a flexible exchange rate provides against economic shocks. Research by the Bank of Canada and by many outside analysts confirms that Canada benefits significantly from having a separate currency and a floating exchange rate. It is true that Canada and the United States share many characteristics. But when it comes to economic structure, there are many important differences. Not only is our economy far more open than that of the United States, but Canada is also more dependent on raw materials. Moreover, while we are net exporters of primary commodities, the Americans are net importers. Sharp swings in world commodity prices have a much greater impact on economic activity in Canada and, more importantly, they affect us differently than our neighbours. It is very clear that the structure of our economy is sufficiently distinct from that of the United States that a flexible exchange rate can play a key role in facilitating the domestic economic adjustment to such shocks. From a strictly economic perspective, it is always possible that, at some future time, the structures of our two economies could converge to a point that the benefits of a common currency could outweigh the macroeconomic costs of abandoning our flexible exchange rate. But it is also possible that those structures could diverge further (if more trade led to greater specialization). We simply do not know. I would emphasize, however, that the crucial factor here is not the extent of the integration between Canada and the United States, but rather how close or how far apart our economic structures are, or will be. Former Bank of Canada Governor Thiessen put it well last December when he said that "as long as we remain a major producer of primary commodities, and as long as we want to pursue separate economic policies that are suited to our own circumstances and that require differing monetary conditions, the shock-absorber element of a floating currency will serve us well." I fully associated myself with this view during my appearance last month before the House of Commons Standing Committee on Finance. I said: "it's quite clear that at this stage in our evolution, a floating currency for Canada vis-à-vis the United States . . . is a great advantage because the structures of our economies differ." Thus, one may not argue that, for all time and under all circumstances, a floating currency will be the right solution for Canada. But, what I can say is that, given the structure of our economy, for now and for as far into the future as I can see, the advantages of a flexible exchange rate, anchored by a domestic inflation target, clearly outweigh the benefits of a currency union. And they will certainly always outweigh those of a peg. I hope that I have made it clear today that Canada's monetary policy approach of a flexible exchange rate, anchored by an inflation target, works. There is no need to fix it. Let me now conclude my presentation by giving you our latest reading of the economy. Recent economic developments Since late last year, the pace of economic expansion in Canada has slowed substantially, mainly because U.S. demand for our products has been much weaker than anticipated. Canadian manufacturers, particularly of motor vehicles, electronic products, and telecommunications equipment, have had to make very significant adjustments. At the same time, final domestic demand in Canada has remained firm, buttressed by underlying strength in the energy sector, retail sales, housing, non-residential construction, and most service industries. National accounts data to the end of March and more recent indicators show that our economy has been expanding at a moderate pace since the last quarter of 2000. As we look ahead, we see domestic demand in Canada continuing to grow, supported by the easing that has taken place in monetary conditions, the recent tax cuts that are boosting disposable incomes, gains in employment, and the projected completion of the current inventory adjustment. We also continue to see U.S. demand growth picking up in the second half of 2001, given substantial reductions in interest rates, relatively high levels of consumer spending, the expected end of the inventory correction, and recently announced tax cuts (which include rebates beginning in July). But because of the ongoing weakness in U.S. capital investment, there is still uncertainty about the exact timing and strength of the projected pickup in U.S. growth in the second half of the year. While that uncertainty poses some risks for Canada, we continue to expect that the pace of economic expansion here will pick up in the second half of the year and strengthen somewhat further in the course of 2002. Total CPI inflation has recently been above the top of the Bank's 1 to 3 per cent target range because of rising energy prices, including higher electricity rates. Total CPI inflation will probably remain volatile over the next couple of months, before moving down to about 2 per cent by the end of the year, if world prices for crude oil and natural gas stabilize around current levels. The main risk to the Canadian economic outlook continues to be the possibility that the projected pickup in U.S. growth may be delayed. At the same time, even though the prices of crude oil and natural gas have eased from their recent peaks, the Bank will need to stay alert to any signs of energy costs spilling over into other consumer prices, and thus putting upward pressure on the trend of inflation. In light of these risks, the Bank will have to continue to monitor the situation very carefully. In sum, the Bank remains positive about Canada's economic prospects. We continue to expect that the economy will grow by between 2 and 3 per cent this year and return to a somewhat higher growth path in 2002. This judgment is based on recent evidence that is broadly in line with the Bank's expectations. And it is supported by the marked improvement in our economic fundamentals, which gives Canada a very good chance to weather the current economic difficulties.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, at the annual meeting of the Bank's Board of Directors, Ottawa, 21 September 2001.
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David Dodge: Current developments in the Canadian economy Remarks by Mr David Dodge, Governor of the Bank of Canada, at the annual meeting of the Bank’s Board of Directors, Ottawa, 21 September 2001. * * * For reasons explained in our media advisory of 17 September, the annual out-of-town meeting of the Bank’s Board of Directors that was to take place on 19 September in Moncton was held in Ottawa instead. A scheduled speech by Governor Dodge to the Moncton Chamber of Commerce was postponed. The following is the section of that speech dealing with current economic developments. Right now, last week’s tragic events in the United States are uppermost in people’s minds. Like millions of people around the globe, Canadians are very concerned about the situation. We all share in the sheer horror of what has happened. In circumstances like these, part of our job as Canada’s central bank is to respond by addressing the financial needs of the country. That is why the Bank of Canada, like other major central banks, moved swiftly last week to provide liquidity to ensure that financial markets continued to function effectively. In addition, the Bank of Canada and the U.S. Federal Reserve agreed to temporarily increase the amount of their existing swap facility to provide liquidity in U.S. dollars to Canadian banks, should they need it to settle their U.S. dollar transactions. And this past Monday, we took action to counteract potential effects on confidence in the aftermath of the extraordinary events in the United States, by lowering our key policy rate outside our normal schedule of announcement dates. Clearly, the events in the United States have increased the uncertainty surrounding global economic prospects in the short run. It is important, however, that we look through the short term to the longer-term trends and potential of our economy. The first decade of the twenty-first century will continue to bring to Canada and to the rest of the world important technological changes—changes that will transform our economies through the widening application of new information, communications, and other general-purpose technologies. This transformation can be expected to raise the potential of our economy to grow and to generate income gains in the decade ahead. Once the cyclical forces that are currently constraining investment and innovation are behind us, we should see productivity and income gains from past investments and adjustment. And the way will be clear for further innovation and growth. In addition, Canada has made great progress over the past decade in strengthening its economic foundations: low inflation has been firmly established; the fiscal health of governments has been largely restored; and Canadian businesses have undertaken major restructuring. Thus, the medium-term outlook for growth in output, employment, and incomes in Canada is very favourable. Let me now put the short term in perspective. Around this time last year, both the Canadian and the U.S. economies were pushing against, or through, their capacity limits. Because of that, some slowing was anticipated, and indeed was desirable, to keep inflation in check. However, the economic slowdown in the latter part of 2000 was more abrupt than had been foreseen, especially in the information and communications sectors. At the beginning of 2001, the Bank of Canada expected that the economic slowdown in this country would continue through the first half of the year and that inflationary pressures would therefore be reduced. Thus, we began to lower interest rates. We also expected that, as the process of adjusting inventories and excess capacity was completed in most industries, capital spending in the United States, which had been sharply curtailed, would begin to recover in the second half of 2001. With the pace of economic expansion thus picking up in the United States, we expected that growth in Canada would also rebound—to above the growth of the economy’s production potential—during the first half of 2002. Consequently, the small output gap that had opened in 2001 would begin to close. The economic data received through last winter and spring were broadly consistent with this scenario, and the pace of monetary easing was set accordingly. By mid-summer, however, evidence began to accumulate that the U.S. slowdown would be more protracted than anticipated and that economic activity outside North America would be much weaker. At the same time, there were indications that domestic demand in Canada, which had held up well through the first part of the year, was softening. In view of these developments, at the time of our last fixed announcement date, on 28 August, we revised down our expectations for economic growth in the period ahead. We projected that output growth in the second half of 2001 would be only slightly stronger than in the first half. The pace of economic expansion would then start to gain momentum in the first half of 2002 and would move above potential growth in the second half. This meant more economic slack going into next year than we had previously anticipated, and it would take longer to absorb. In these circumstances, the Bank lowered interest rates again, at the end of August, to support domestic demand growth and to keep inflation near the target of 2 per cent over the medium term. And in our press release of 28 August we indicated that, given the continuing uncertainties in the global economy, particularly the timing and strength of the recovery in investment in the United States, and the uncertainty surrounding domestic demand growth in Canada, we would continue to monitor developments closely. Last week’s tragic developments in the United States, and their reverberations around the world, obviously bring with them further uncertainty with respect to the timing and extent of a rebound in economic activity. Although it is too early to fully assess the likely consequences for our economy, the Bank’s initial efforts involve trying to estimate the direct effects of disruption in sectors such as transportation, finance, and tourism. The terrorist attacks on the United States will also affect consumer and business confidence worldwide, including here in Canada. It is precisely for this reason that we moved promptly this week to lower interest rates by one-half of one percentage point. This action, which leaves short-term interest rates 2 1/4 percentage points lower than at the beginning of the year, aims to provide further support for economic growth in Canada. The Bank also recognizes that a key factor in preserving the confidence of Canadians in the prospects of our economy is a financial system that continues to function effectively. That is why, as I said earlier, we took steps, together with the other G-7 central banks, to inject liquidity into the financial system to support its smooth functioning in the wake of the tragic events in the United States. We stand ready to do so whenever necessary. But it is encouraging that at this juncture, with each passing day, we seem to be moving back to a more normal state of affairs in the financial system. Right now, it is difficult to look too far ahead in terms of the economic implications for Canada of last week’s events. Nevertheless, economic growth in the third quarter will likely be close to zero or slightly negative, and we will continue to feel the adverse effects into the fourth quarter. With the economic slack that is opening up, we continue to see core inflation falling to about 2 per cent by year-end. We also project that total CPI inflation will drop to close to 2 per cent over the same period, assuming that energy prices remain near current levels. There is a risk that world oil prices could rise sharply, depending on the fallout from last week’s events. A more complete analysis of the impact of last week’s events on the Canadian economy, including the effects on output and inflation in 2002, will be carried out as we prepare for our next policy announcement on 23 October. This analysis will be presented in our November 2001 Monetary Policy Report. Clearly, there are adverse effects that need to be assessed, but there will also be offsetting factors, from such activities as rebuilding in the United States and a return to more normal operations in both Canada and the United States, that need to be considered. Given the uncertainties surrounding all these elements, there will be a wider-than-usual confidence band around the economic outlook for next year.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Greater Moncton Chamber of Commerce and the Conseil économique du Nouveau-Brunswick, Moncton, New Brunswick, 24 October 2001.
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David Dodge: The Canadian economy - current and future challenges Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Greater Moncton Chamber of Commerce and the Conseil économique du Nouveau-Brunswick, Moncton, New Brunswick, 24 October 2001. * * * It's a pleasure to be talking to you today, although I wish these were happier times. All of us at the Bank of Canada share a deep sorrow at the loss of so many lives in the 11 September terrorist attacks in the United States. Among those who died were innocent citizens of many nationalities, including Canadians. To their families, friends, and colleagues we extend our heartfelt sympathy. As we strive to come to terms with this tragedy and its implications for all of us, we are tremendously encouraged by the co-operation, solidarity, and determination that are abundantly evident both at home and in the international community. Through this time of anxiety and uncertainty, we at the Bank of Canada will continue to fulfill our responsibility to support the economic well-being of Canadians and to promote the stability of the domestic and international financial systems. As we all struggle to fathom the dimensions of this tragedy and to get a measure of its immediate economic effects, it is important that we look through the short term to the longer-term trends and the potential of our economy. If we are to solidify our economic performance in the years ahead, we cannot lose sight of the challenges we must meet as a nation. Those longer-term challenges are my main topic for today. Of course, in the current circumstances, there are also important near-term challenges for monetary policy. So I will conclude with a brief discussion of the current economic situation and the steps that the Bank is taking to support domestic demand in Canada. Longer-term challenges to good economic performance—progress so far Let me start with the longer-term challenges. The past decade was a watershed for the Canadian economy. Low inflation was firmly established, fiscal health was restored, and Canadian businesses undertook major restructuring. In short, we made remarkable progress in improving our economic performance. Let me quickly review that progress, starting with the achievement of a credible low-inflation record. . . . establishing a record of low and stable inflation Since the early 1990s, the focus of Canadian monetary policy on low, stable, and predictable inflation has helped to anchor inflation expectations and to reduce the ups and downs in economic activity. Canadians have been able to make spending, saving, and investment decisions with greater certainty, knowing that their central bank will hold the line on future inflation and that the economy will be more stable. . . . restoring fiscal health But low inflation, although essential to good economic performance, is not sufficient by itself. It has to go hand in hand with prudent fiscal management. Since the early 1990s, Canada has also taken action to put its fiscal house in order. And this is paying dividends. Wiping out deficits at all levels of government has helped to bring about low interest rates and relatively more stable financial markets. . . . undertaking business restructuring and embracing open markets Low interest rates and greater confidence about the future have, in turn, encouraged Canadian firms to undertake important restructuring initiatives to meet the challenges of sweeping worldwide technological change and intensely competitive global markets. Over the past decade, these restructuring efforts have taken place against a backdrop of sustained efforts to open up our economy even further. Indeed, building on the trade agreements that we forged in the late 1980s and early 1990s, such as the North American Free Trade Agreement (NAFTA), we have significantly increased our involvement with the world economy. Altogether, it is clear that, over the past decade, we in Canada have done a lot to strengthen our economic foundations. Because of this, we are now better positioned than we have been in a long time to weather economic turbulence and to take on new challenges. But, in a rapidly changing, increasingly competitive world, "they who stand still, fall behind." If we are to seize the opportunities out there in the global economy, we have to continue to move forward and make further progress. Longer-term challenges to good economic performance—the way ahead Before I focus on the new things we need to do to facilitate progress in the future, let me stress how important it is that we maintain the strong base on which everything else rests—sound macroeconomic policies. . . . sound macroeconomic policies Fostering a climate of low, stable, and predictable inflation is the best contribution monetary policy can make to good economic performance over the medium term. The Bank of Canada is carrying forward its commitment to preserve confidence in the future value of money—that you can bank on! On the fiscal side, it is critical that our public finances remain healthy and that all levels of government continue to reduce their net indebtedness over time. A declining public debt relative to the size of our economy will make us less vulnerable to external shocks. But I hasten to add that I do not mean to suggest that we should not let the "automatic stabilizers" work when faced with an economic shock. (These stabilizers are the built-in features of revenues and expenditures that work to offset economic fluctuations. For example, in an economic downturn, tax revenues automatically go down and some expenditures, such as employment insurance payments, automatically go up.) Let us remember, however, that it is because of the progress we have made over the past decade in restoring healthy public finances that we can now afford to let these automatic stabilizers work. Now, sound macroeconomic policies, while necessary, are not sufficient if we are to improve the structure and performance of our economy in coming years. I would like to think through with you what other policies and steps we might need. As we look ahead, the one thing we can be sure about is that world markets for goods, services, and finance will become more and more globalized and competitive. Canada, as a very open economy, must operate in full recognition of that fact. In particular, in light of the heightened security concerns in the United States, it is important that we all work to facilitate the continued flow of goods and services between our two countries. Beyond this issue, there are many challenges for all Canadians. But there are also new opportunities for our firms to increase their global reach and to reap the benefits of largescale production—provided they pursue new initiatives to enhance productivity and find more efficient ways to deliver products and services to domestic and foreign customers. This is where innovation enters the picture. . . . exploiting the potential of new technologies The world is in the midst of far-reaching changes—changes that are transforming national economies and societies around the world through the widening application of new information and communication technologies. And more change is on the horizon—change that will come from dramatic advances in biotechnology and nanotechnology. Technologies like these take time to spread and spawn new applications across a broad range of economic sectors—pretty much like the electric motor did in the past. But to realize the full potential of these new applications, major changes in the organization of a firm, of an entire sector or, indeed, of a whole economy, are often necessary. It is the combination of these applications and adaptations that leads to rising productivity and rising incomes. Like many other economists who have studied these issues, I am optimistic that, over the next couple of decades, productivity will grow significantly faster than it did from 1975 to 1995, although perhaps not as fast as in the high-growth years of the 1950s and 1960s. But while experience shows that innovations take time to diffuse widely, it is important to remember that the prime opportunities go to those firms and those economies that are quick to take advantage of the new realities. Through the first half of the 1990s, Canada lagged behind the United States in making the investments that are necessary to take advantage of new technologies. But since 1996, there has been a surge in such investments in Canada. And in the last couple of years, we were beginning to see the first signs of a productivity payoff. Once the prevailing global uncertainty and the cyclical forces that are now constraining output and investment growth in Canada dissipate, we will likely see more efficiency gains from those past investments and more capital spending on innovations. And once the necessary adjustments are made to deal with the need for heightened security, those innovations will mean rising standards of living for Canadians. . . . redesigning organizational structures and upgrading skills But, as I just said, to benefit fully from technology, changes and improvements in the structure of our economy and in the way we run our businesses are necessary. At the company level—and that applies also to government departments and to the Bank of Canada— this means organizational changes and changes in management and work practices. It also means upgrading skills. Simply installing state-of-the-art equipment will not be enough. And it will, most certainly, not deliver efficiency and productivity gains if organizational structures and management practices are outmoded and if workers do not know how to use the new technology to advantage. Some of these issues will no doubt sound familiar to many of you here in the Atlantic provinces, where considerable effort and progress have been made in recent years to diversify the regional economy and to move into areas that make greater use of new technologies. And this is especially clear here in Moncton where, over the past decade, you have enjoyed the strongest employment growth in the province—12,000 new jobs created since 1990—thanks to your ability to attract call centres and other information-technology companies. . . . enhancing productivity Now, the reason for adopting new technologies, revamping management and work processes, and upgrading labour skills is that we, as a nation, can become more efficient and more productive. Productivity growth is the key to rising real incomes and improved standards of living over the longer run. But, you may ask, how does monetary policy fit in all this? And what can the Bank of Canada do to promote higher productivity and rising real incomes? An increase in real incomes is a key component of the good overall economic performance that the Bank aims at through a policy focused on low inflation. The Bank supports initiatives to improve productivity by delivering a climate of low and stable inflation that encourages well-informed, long-term business decisions, including decisions to invest in new high-tech machinery, equipment, and software. . . . ensuring that Canada's financial system and markets work efficiently The Bank also concerns itself with another factor in supporting good economic performance—a sound, innovative, and efficient financial sector. A stable, highly developed financial sector helps to channel savings into investments and allocates capital efficiently. This is particularly important in these times of rapid technological change, when we want companies that plan to adopt new technologies to have access to proper financing. But of course, we also want to ensure that this is done in a way that preserves the stability of the financial sector. Appropriate safeguards and sound policies aimed at fostering financial stability improve overall economic performance. The Bank of Canada is helping to promote financial stability in a number of ways. Here at home, we oversee major payments systems and provide ordinary and emergency liquidity to the financial system. We also work with other federal entities and provincial securities commissions to ensure that financial markets function well. And through international organizations, such as the Bank for International Settlements and the International Monetary Fund, we work with other central banks and financial regulators around the world to promote global financial stability. There are other medium-term issues that we could usefully spend time discussing. But given that time is limited, I would now like to turn to the current economic situation and the near-term challenges for monetary policy. Current economic situation and near-term policy challenges Even before last month's events in the United States, evidence had begun to accumulate that the economic slowdown in that country would be deeper and last longer than had been widely expected. By mid-summer, economic activity outside North America had also begun to show more clearly the effects of weaker U.S. growth and of the ongoing global retrenchment in the information and telecommunications sectors. At the same time, there were signs that domestic demand in Canada, which had held up well through the first part of the year, was softening and that the inventory adjustment, particularly in the electrical and electronic sectors, still had some way to go. This evidence, which had been accumulating through the summer, led the Bank to scale back its previous expectations for economic growth during the second half of 2001 and the first half of 2002. Consequently, on 28 August, we lowered interest rates to support domestic demand growth and to keep inflation near the target of 2 per cent over the medium term. The events of 11 September, and their repercussions around the world, added a further major element of uncertainty to the near-term prospects for the global economy and for Canada. Because of this heightened uncertainty, the Bank took the exceptional step of lowering interest rates by one-half of a percentage point on 17 September, outside our regular schedule of fixed announcement dates. We also moved immediately after the attacks, as did other major central banks, to provide additional liquidity to the financial system to ensure its smooth functioning. At times like these, a key factor in preserving confidence in the prospects for our economy is a financial system that continues to work effectively. The ongoing economic effects of last month's shock are very difficult to assess. We know that there was a clear and immediate impact on certain sectors (such as air transportation and tourism) and on those industries that rely on cross-border, just-in-time delivery. But how large the total impact will be and how long it will last are very difficult to gauge. What is even more difficult to evaluate at this stage are the implications for consumer and business attitudes. The recent events are unlike anything we have ever experienced in North America. So it will take some time before we can fully understand their consequences. When we take into account the direct effects of the terrorist actions in the United States, their immediate negative impact on business and consumer confidence, and the adjustments necessary to deal with increased security risks, it is now clear that economic growth in Canada in the second half of 2001 will be close to zero or slightly negative. This means average growth for the year as a whole of about 1 ½ per cent. How quickly growth will resume will depend crucially on geopolitical developments and on how soon consumer and business confidence return to normal. By their very nature, geopolitical developments are not easily predictable, although they will likely be more turbulent than usual for some time. Also difficult to predict is the evolution of consumer and business confidence. One could think of a scenario where confidence would be restored quickly. In such a case, fairly robust growth could resume by the second quarter of 2002. On the other hand, consumer and business confidence in North America could stay weak for quite some time. In these circumstances, growth could remain anemic through most of 2002. While the timing of a rebound in economic activity is unclear, we are confident that, once the uncertainty stemming from terrorist actions dissipates, healthy growth in output, investment, and employment will resume, given Canada's sound economic fundamentals. Under either of these scenarios, there will be less pressure on capacity through the balance of this year and during 2002 than we had thought earlier. Indeed, by the end of 2002, the economy will still be operating below potential. With less pressure on capacity, core inflation is expected to move below 2 per cent in early 2002, and to stay below through the remainder of the year. As for total CPI inflation, it will likely drop to about 2 per cent by the end of 2001 and move below that during 2002, if energy prices remain at or below their levels of early September. Based on these considerations, yesterday, on our pre-set announcement date, we cut our key policy interest rate—the target for the overnight rate—by ¾ of a percentage point. It is now at 2 ¾ per cent— a full 3 percentage points lower than at the beginning of the year. This action aims to further support economic growth in Canada and to keep inflation close to our 2 per cent target over the medium term. I do not have to tell you that, because of the many unknowns in the global economic environment, and because of the uncertainty surrounding domestic demand in Canada, we will continue to monitor developments very closely. Concluding thoughts To conclude, as we in Canada find ourselves in the middle of economic difficulties, and especially as businesses, governments, and individuals struggle to come to grips with last month's tragedy, our main preoccupation is, naturally, with near-term issues. That is understandable. But, at the same time, it is critically important that we maintain a sense of perspective—that we step back and look past current developments, focusing also on the longer-term trends in our economy and its potential. Over the past decade, Canada has made remarkable progress in strengthening its economic foundations. This should stand us in good stead, no matter what economic turbulence and near-term uncertainties we face. And it gives us a firm basis to stand on as we embark on new initiatives to improve our longer-term economic performance and meet the challenges of the twenty-first century.
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the House of Commons Standing Committee on Finance, Ottawa, 7 November 2001.
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David Dodge: Brief outlook for economic growth and inflation in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the House of Commons Standing Committee on Finance, Ottawa, 7 November 2001. * * * We are pleased to appear before this Committee, on the occasion of the release today of our autumn Monetary Policy Report, which provides our latest assessment of the outlook for economic growth and inflation in Canada. Mr. Knight and I hope to be able to return for future issues of the Report, every six months. Right now, all national economies face difficulties—difficulties stemming from the further weakening of the world economy and from the terrorist acts in the United States. As businesses, governments, and individuals in Canada—and around the world—strive to come to terms with the implications of those acts, the main preoccupation is, naturally, with the near term. But, as I said in a speech in Moncton two weeks ago, at times like this, it is also very important that we step back and look past current developments, to the longer-term trends and potential of our economy. Viewed from this angle, the outlook is brighter. The progress that we have made over the past decade in strengthening our economic foundations is remarkable. And it should stand us in good stead, no matter what short-term turbulence and uncertainties we face. True, at the moment, we are beset by tremendous uncertainties. And I would like to turn to those now, as I discuss the economic outlook and the steps that the Bank is taking to support growth in Canada. When I appeared before you in May 2001, the incoming information was broadly in line with the Bank's expectations of a modest pickup in growth in the second half of 2001 and further strengthening in 2002. Among the factors that would bring this about, we counted the completion of the inventory adjustment, tax cuts, the easing in domestic monetary conditions, and a recovery in U.S. business investment. But, by midsummer, evidence began to accumulate that the expected rebound in U.S. investment would be delayed and that the economic slowdown there would be deeper and more protracted than previously expected. Economic activity outside North America had also begun to show more clearly the effects of weaker U.S. growth and of the ongoing global retrenchment in the information and telecommunications sectors. In Canada too, there were signs that domestic demand, which had held up through the first part of 2001, was softening and that the inventory adjustment, particularly in the electrical and electronic sectors, was less advanced than expected. Accordingly, we revised down our projections for the second half of 2001 and the first half of 2002. And, at the end of August, we lowered interest rates to support domestic demand growth and to keep inflation near the target of 2 per cent over the medium term. The terrorist acts in the United States, and their worldwide fallout, greatly heightened the degree of uncertainty, further dampening near-term growth prospects. To underpin confidence in the face of this uncertainty, we took the exceptional step of lowering interest rates by ½ of a percentage point on 17 September, outside our regular schedule of fixed announcement dates. The ongoing economic consequences of the terrorist acts are very difficult to assess. These developments are unlike anything we have ever experienced in North America, and it will take some more time to understand their full implications. If we consider the direct effects of the attacks, their immediate impact on consumer and business confidence, and adjustments to address increased security risks, the Bank expects that output growth in Canada will be close to zero or slightly negative in the second half of 2001. For all of 2001, this implies growth of about 1½ per cent. As we look to 2002, the timing and strength of a recovery will depend crucially on geopolitics and on how soon confidence returns to normal in North America. But once the uncertainty stemming from terrorist acts dissipates, I expect that healthy growth in output, investment, and employment will resume, given Canada's sound economic fundamentals. At present, one can envisage two scenarios with respect to confidence. In the first, confidence could be restored quickly, and robust growth could resume, supported by the substantial monetary and fiscal stimulus already in place. In the second, confidence could stay weak for some time and, consequently, growth would remain sluggish through most of 2002. Under either scenario, by the end of 2002, our economy would still be operating at levels that are below capacity. Core inflation is thus expected to fall to about 1½ per cent by the second half of 2002. Total CPI inflation is also expected to decline to about 2 per cent by the end of 2001 and to move below that during 2002, if energy prices remain at or below their early-September levels. Based on these considerations, on 23 October, we again lowered our key policy interest rate by ¾ of a percentage point. The cumulative reduction of 3 full percentage points since January aims to support growth and to keep inflation close to the 2 per cent target over the medium term. Given the many unknowns in the current environment, we will continue to monitor the situation very closely and adjust our outlook in the light of new information.
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, 29 November 2001.
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David Dodge: Monetary policy and inflation targets in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, 29 November 2001. * * * Malcolm and I are pleased to appear before this Committee. We hope that we will be able to do so, on a regular basis, in the future. Today, I would like to start our discussion by spending a few minutes explaining how we at the Bank of Canada go about setting monetary policy. The Bank has a commitment to contribute to the economic well-being of Canadians. This means that we must conduct monetary policy so that it fosters sustained solid economic growth. As I said to you last March, the unique contribution that monetary policy can make to good economic performance is to preserve confidence in the future value of money. When people can count on their central bank to keep inflation low, stable, and predictable, they can make sounder economic decisions. The Bank pursues low inflation within a framework based on an explicit inflation target, supported by a flexible exchange rate. The current target is to aim at the 2 per cent midpoint of a range of 1 to 3 per cent over the medium term. I say “over the medium term” because monetary policy actions take time to have their effects on the economy and on inflation. Some effects are felt fairly quickly. But the full impact on inflation can take up to 18 to 24 months. So, in setting monetary policy, we have to look ahead and make judgment calls about future economic developments and about the timing and final outcome of any actions we take today. Since their adoption in 1991, inflation targets have proven very effective in keeping inflation low and in anchoring people’s inflation expectations. They have also provided the Bank with a useful mechanism for assessing and dealing with demand pressures on future inflation in a way that helps to keep the economy on a more even keel. Let me explain how the inflation targets work to guide monetary policy and to allow the Bank to help stabilize the economy. At any point in time, there is a certain level of output that an economy can produce without putting either upward or downward pressure on inflation. Economists refer to that level of output as “potential output” or “production capacity.” The level of potential rises over time as more workers join the labour force; businesses increase their investments in new technology, machinery and equipment; policy measures are taken to make product and labour markets more flexible; and all of us become more efficient and productive in what we do. Because potential output depends on many factors and their interaction, it is not something we can measure precisely—either in level or growth terms. But we can roughly estimate it, by analyzing the trends in those factors. At the Bank, we estimate that potential output in Canada is likely to rise by about 3 per cent per year over the medium term (as shown in Chart 1). In estimating potential output, we find the emphasis on inflation control to be particularly helpful. It helps us to avoid systematic errors in assessing potential. For example, if inflation was coming in persistently below our expectations, it would be a strong signal that production capacity was higher than our estimate, and vice versa. Now, in terms of setting monetary policy, the key question is where the economy is likely to be relative to potential several quarters down the road, and how that will affect future inflation. If the economy is likely to be operating close to, or above, its capacity to produce, it is reasonable to expect that this will put upward pressure on inflation in the future (Chart 1). If this seemed likely to take inflation above target, the Bank would tighten monetary policy (that is, raise its key policy interest rate) to moderate demand and head off those pressures. On the other hand, if the economy is likely to be operating below potential, then there will be downward pressure on future inflation. If it looked that this would take inflation below target, the Bank would ease monetary policy to provide more room for the economy to expand. Thus, the emphasis on inflation control works symmetrically. It allows the Bank to take policy actions to prevent overheating, when the economy is strong and is pushing against its capacity limits, and to support growth when the economy is weak. Let me now try to relate this to our recent experience in Canada. If we go back to the fall of 1998, when the worldwide reverberations of the Asian and Russian financial crises were still very much with us, we can see from Chart 2 that our economy was operating below potential. Since this implied that there was a good chance future inflation would be below target, we eased monetary policy through the latter part of 1998 and the first part of 1999. Our economy rebounded strongly during 1999, and expectations were that it would continue to grow robustly— above potential—for some time, bolstered by strong domestic and U.S. demand. With signs of emerging capacity pressures, we then moved to gradually tighten policy in late 1999 and through the first part of 2000, to cool off demand and prolong sustained non-inflationary growth. The slowing of the U.S. economy that began in the second half of 2000 was welcome because that economy had been growing very rapidly for some time and it was in danger of overheating. But what we, and most other analysts, did not anticipate was the collapse in U.S. business investment, particularly in the information and telecommunications sectors. This led to a sharper slowdown than expected. When this became apparent early in 2001, the Bank’s assessment was that it would lead to a moderation in growth in Canada, which would leave our economy operating somewhat below potential by mid-year. But we also expected that the pace of expansion would pick up in the second half of 2001 and strengthen further in 2002, returning us to potential output levels. So, although we proceeded to loosen monetary policy, we did so at a measured pace. In the first half of the year, available economic information was broadly in line with the Bank’s expectations. By midsummer, however, evidence began to accumulate that the recovery in U.S. investment—a key factor in the expected pickup in growth in the second half of 2001—would be delayed and that the slowdown in that country would be deeper and last longer than anticipated. Economic activity outside North America had also begun to show more clearly the effects of weaker U.S. growth and of the ongoing global retrenchment in the information and telecommunications sectors. In Canada too, there were signs that domestic demand, which had held up through the first part of 2001, was softening and that the inventory adjustment was not as well advanced as expected. So we revised down our growth projections. The implication of this, as we looked out several months down the road, was that the economy would be operating substantially below potential and that inflation would be below target. That is why, at the end of August, we again lowered interest rates to support domestic demand growth. The terrorist acts in the United States, and their worldwide fallout, introduced a whole new layer of uncertainty into the global economic picture, further dampening near-term growth prospects. I do not have to tell you how difficult it is to assess the ongoing economic effects of those disturbances, which may have had a significant effect on the psychology of North American households and businesses. But, as I said before, because monetary policy is forward-looking, we have to make a best possible evaluation of likely developments several quarters ahead. As we look to 2002, the timing and extent of a recovery in economic activity will depend crucially on geopolitics and on how quickly confidence returns to normal. As we discussed in our November Monetary Policy Report, one can envisage two scenarios (Chart 3). In the first, confidence could be restored quickly, and robust growth could resume in early 2002, supported by the substantial monetary and fiscal stimulus already in place. In the second, confidence could stay fragile for some time, and growth would be anemic through most of 2002. Note that, under either scenario, the Canadian economy would still be operating at levels that are below capacity by the end of 2002. This means that inflation would continue to be below target through next year. How has the Bank responded to all this? To underpin confidence in the wake of the extraordinary uncertainty generated by the terrorist acts, we took the exceptional step of lowering our key policy interest rate by 1/2 of a percentage point on 17 September, outside our regular fixed announcement schedule. And we moved again to ease rapidly—by 3/4 of a percentage point, on 23 October, and by 1/2 of a percentage point, on 27 November. The cumulative reduction in policy interest rates since the beginning of the year amounts to 3 1/2 percentage points, of which more than half—2 full percentage points—occurring since late August. This substantial amount of monetary stimulus will work to support a resumption of healthy growth in output, investment, and employment, given Canada’s solid economic foundations. In view of the ongoing uncertainties, it is still too early to characterize the economic outlook with great assurance. Nonetheless, signs that the geopolitical situation may be stabilizing and that households and firms are beginning to adjust to the new environment, suggest a somewhat greater likelihood that the Bank’s more optimistic scenario may come to pass than was the case a month ago. In closing, let me stress that I have oversimplified how the Bank judges the performance of the economy relative to its potential. In addition, I have not mentioned all the factors that can influence the growth of potential or the future path of inflation. But I have provided the basic elements of the inflation-targeting approach that the Bank uses to help promote good economic performance. Mr. Chairman, in my remarks today I focused, appropriately, on the contribution monetary policy can make to sustained economic growth. But I want to emphasize that, while low inflation is essential in this context, it is not sufficient by itself. Other policies, both macro- and micro-economic, must continue to focus on enhancing productivity and raising our production potential over the medium term. This focus is extraordinarily important if we want to achieve sustained, solid economic growth and rising standards of living over time. We should not lose sight of it as we go through the current short-term difficulties.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, prepared for the Central Bank Governor¿s Panel on Inflation Targeting at a joint session of The American Economic Association and the North American Economics and Finance Association, Atlanta, 5 January 2002.
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David Dodge: Inflation targeting in Canada - experience and lessons Remarks by Mr David Dodge, Governor of the Bank of Canada, prepared for the Central Bank Governor’s Panel on Inflation Targeting at a joint session of The American Economic Association and the North American Economics and Finance Association, Atlanta, 5 January 2002. The references for the speech can be found on the Bank of Canada’s website. * * * Thank you, Andrew. I am pleased to be in Atlanta today to talk to you about the Canadian experience with inflation targeting. In the 1970s and 1980s we found—in common with many other countries—that high and variable rates of inflation created a lot of economic damage. And it took a long time and a lot of work with various monetary policy frameworks before we got back on track. I would point to two particular sets of arrangements for policy during that time that were both designed to lead to low inflation rates. The first was monetary targeting—specifically, targeting the narrow monetary aggregate M1, beginning in 1975. A close relationship between M1 growth and inflation held only over very long periods of time. Moreover, this relationship was subject to sizable downward shifts in the demand for money. Such shifts did indeed occur. Thus, after a period of disinflation between 1975 and 1978, inflation picked up again in 1979–82 despite the achievement of the M1 target. Because of the lack of longer-term success in bringing down inflation, this approach to monetary policy was unable to build confidence and understanding on the part of the public. The second policy approach took place from 1982-90, a period in which there was no clear monetary policy target. Rather, there was only a desire to bring inflation down and (particularly after 1987-88) to approach “price stability.” After the disinflation of 1982-84, there was no further progress in reducing inflation. And with no explicit target, there was still little understanding of monetary policy and no focus for inflation expectations. The economic boom at the end of the 1980s, together with an oil-price shock and the introduction of the goods and services tax, led to fears that inflation would again escalate and stay high. It was against this background that, in 1991, the Canadian government and the Bank of Canada agreed on targets for inflation reduction. Canada was the second country, after New Zealand, to set out formal, medium-term inflation targets. The Canadian experience: agreeing on a target I would now like to turn to the question of how we adopted inflation targets in the first place. The Bank of Canada operates under the Bank of Canada Act. The preamble to the act notes that the central bank is established “to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada.” In essence, this is like the broad mandate given to the U.S. Federal Reserve under U.S. legislation. Theory and empirical evidence suggest that there is no long-run trade-off between inflation and production levels. Indeed, there is evidence that a low-inflation regime supports higher productivity. Moreover, monetary policy has essentially only one instrument. Therefore, the best that monetary policy actions can do to promote the welfare of Canadians is to aim for low, stable, and predictable inflation with a medium-term target horizon, which will maximize sustainable production levels. This will have the important benefit of tending to mitigate fluctuations in production and employment. It is also the best way to protect the external value of the monetary unit under flexible exchange rates. The experience of the 1970s and 1980s left both the government and the central bank sensitive to the havoc wreaked by high and unstable inflation rates and thus moved them away from the notion of Freedman (1983) and Thiessen (1983) discuss various aspects of the Canadian experience with M1 targeting. Duguay and Longworth (1998) discuss the search for a new anchor during the 1980s. trying to directly fine-tune short-run output and employment levels. By 1990, there was therefore a growing shared desire to create a policy that would provide a better anchor for inflation expectations. It was important that both parties be involved. Since 1967, the Bank of Canada Act has granted a directive power to the government that allows it to openly instruct the Bank to carry out specific actions over a specific time period. This power has never been used. However, both it and the requirement in the act for regular consultations between the Governor and the Minister of Finance highlight the importance of consultations between the two parties on any major change in the objective of monetary policy. In a democratic society, the government must be comfortable with the overall direction of monetary policy. Moreover, for an objective to be credible, the government’s backing is required. And, because of the expertise that resides in the central bank, it is important that the Bank provide the research and analysis regarding the framework that can deliver the agreed objective. An agreement was indeed reached. It was announced in the form of a joint press release on the inflation-reduction targets at the time of the February 1991 budget. The Bank issued a detailed background document at that time elaborating on the framework it would use to achieve the targets. Given the empirical evidence for Canada, showing that the appropriate horizon for aiming at an inflation target was about 1 1/2 to 2 years, the first formal target was set for December 1992 at a rate of 3 per cent (plus or minus 1 per cent). The series of targets announced in the agreement was aimed at bringing the 12-month CPI inflation rate down to 2 per cent (again, plus or minus 1 per cent) by December 1995. The decline in inflation was achieved in fairly short order, indeed faster than was consistent with the targets. By January 1992, inflation was close to 2 per cent. The agreement with the government has been renewed three times; in each case, the midpoint of the inflation target range has been confirmed at 2 per cent. Through this period—and with two different governments—there has been a growing shared appreciation of what inflation control has been contributing to Canada’s good economic performance. This includes the recognition of the automatic stabilizing feature of inflation targeting in response to demand shocks—a point that I will come back to later. Overall, the government and the central bank are on the same wavelength in terms of the objective of policy. The successful implementation of a monetary policy aimed at low, stable, and predictable inflation and a fiscal policy aimed, in most circumstances, at running a small surplus with the goal of bringing about a significant decline in the debt-to-GDP ratio has enhanced the credibility of both policies. The major lesson that we at the Bank of Canada draw from our experience with inflation control is related to the advantages of establishing a credible anchor for monetary policy by focusing on the predictability of inflation. That will be the theme of the rest of my talk. Establishing a credible anchor by focusing on predictability When the original inflation-reduction targets were announced in early 1991, the Bank was not relying on a credibility effect to reduce inflation. And subsequent studies have shown that this was the appropriate assumption—there was no evident reduction in the cost of disinflation arising from credibility. What the Bank did say was that The purpose of setting out formal targets is to provide a clear indication of the downward path for inflation over the medium term so that firms and individuals can take this into account in their economic decision-making. . . . The inflation targets also provide information on the specific objectives to which the monetary policy actions of the Bank will be directed in the period ahead and through the medium term. This information should make the Bank’s actions more readily understandable not only to financial market participants but also to the general public and should provide a better basis than before for judging the performance of monetary policy. See Bank of Canada (1991). Bank of Canada (1991), pp. 10-11 Credibility, inflation, and inflation expectations After inflation fell to 2 per cent, the expectations of forecasters and businesses soon began to fall in line with the targets. At first this was for expectations at the 2-year horizon. This then lengthened to the 6- to 10-year horizon. Finally, long-term expectations of inflation in financial markets, as expressed by the difference between 30-year yields on conventional and index-linked bonds, fell in line with the 2 per cent target midpoint in 1997. What was particularly noticeable after just a couple of years of targeting was that expectations over a 2-year horizon or longer tended to be affected very little by what was happening to current inflation rates, whether for the total CPI or for a measure of core inflation. This was in marked contrast to earlier periods in Canadian history, in which expectations for the future had been fairly tightly linked to recently observed inflation rates. With the low inflation target becoming increasingly credible, the whole nature of the inflation process seemed to change. The short-run response of inflation to measures of excess demand and supply appears to have fallen during this period. And the response of inflation to relative price shocks, such as changes in the exchange rate and energy prices, also seems to have declined. These changes have had the effect of reinforcing the stability of the inflation process and, therefore, of inflation itself. Overall, it became increasingly evident through the last decade that the inflation target deals with expectational problems. Among close observers of the economy, as well as businesses and those bargaining over wages, it promotes a much greater degree of confidence and understanding than monetary targets or a vaguely expressed desire for price stability ever did. People care about inflation. Therefore, when the focus of policy is on inflation itself and when accountability is in terms of a specific measure of inflation, the public can see and interpret both what the central bank aims to do and what it actually accomplishes. Inflation expectations are important in exchange markets. Canada has chosen to operate in a flexible exchange rate regime mainly because of the asymmetric shocks that it faces relative to the United States, its major trading partner. It is thus extremely important that Canada have a credible anchor for its monetary policy. The inflation target has played this role admirably. Shocks to the exchange rate have not threatened domestic monetary stability. Credibility and the real economy Greater stability on the inflation front was also associated with fundamental changes in the real economy in the 1990s. The average duration of union wage contracts and financial contracts lengthened markedly. New types of long-term financial contracts were created. And there were fewer work disruptions. While other factors also played a part in these changes, low and stable inflation was an important contributing factor. The real economy also became more stable. Both the output gap and the unemployment rate have been less volatile over the past decade of successful inflation targeting than in the preceding 10 years. And in the last two years the unemployment rate has been at its lowest level in 25 years. How is it that the variability of both inflation and output has fallen? I believe there are two main reasons. First, the increased credibility of monetary policy has led to a more stable behaviour of the economy, as I have alluded to above. Second, policy itself has been improved by the forward-looking framework of inflation targeting, which has allowed Canada to avoid the major boom and bust cycles experienced in the period from the late 1960s to the early 1990s by reacting promptly to new information. In particular, when there are demand shocks, the inflation-targeting framework acts as an automatic stabilizer for the economy. For example, a negative shock to demand leads to interest rates being lower than they otherwise would have been. This has the effect of moving output back towards potential output and inflation back to its target midpoint. In this regard, it is important to note the role of Perrier and Amano (2000) discuss the credibility of Canadian monetary policy. Kichian (2001) provides evidence on this point. See Bank of Canada (2000). See Jenkins and O'Reilly (2001). symmetric responses to positive and negative shocks, facilitated by the emphasis on the target midpoint. In response to supply shocks, which take the form of inflation being higher than expected for a given level of demand, the focus on inflation 1 1/2 to 2 years ahead means that temporary shocks can be ignored as long as they do not feed into inflation expectations. As noted above, they typically no longer do so. Consider price shocks coming from volatile components, like energy or fruit and vegetable prices. As our operating guide, we use a core measure of inflation that excludes such components. This gives us and the financial markets some confidence that we are looking at the underlying trend of inflation. Thus, the interest rate response to what is perceived to be a temporary price shock can be minimal. As a result, there will be little movement in output. Output will therefore tend to be more stable than in a situation where a lack of firmly held expectations meant that the monetary authority had to react more strongly to price shocks, even if it believed that they would be fairly short-lived. As the public’s appreciation for the value of low, stable, and predictable inflation has grown, so has its predilection for discussing monetary policy choices in terms of the appropriate inflation-targeting framework. In the periods leading up to the renewal of the inflation-targeting agreement between the Bank of Canada and the Canadian government in both 1998 and 2001, the debate was about the appropriate level of the target (say, target midpoints of 1, 2, or 3 per cent) and some of the specific details, rather than about whether there should be a target for inflation at all. Refinements to increase predictability Our recent agreement in May of last year reaffirmed the target midpoint of 2 per cent. The Bank issued a background note describing the refinements in the way that it will implement the targeting arrangements. These refinements, which should increase the predictability of inflation over the longer term, are fourfold: first, extending the length of the agreement to five years from the three years of the previous two agreements; second, clarifying that the Bank aims at the midpoint of the 1 to 3 per cent inflation-target range; third, committing to give special attention in the Monetary Policy Reports and Updates to situations where CPI inflation persistently deviates from the target midpoint; fourth, modifying the definition of the measure of core inflation to better capture the underlying inflation trend. The benefits, in terms of predictability, of having a longer agreement are self-evident. The reinforcement of the message that the Bank aims at the 2 per cent target midpoint, combined with the special attention to be given to persistent deviations from that midpoint, is meant to make it clear that we are not indifferent to the various outcomes in the target range. Rather, we consistently aim to get back to 2 per cent over a horizon of 1 1/2 to 2 years. Following such a practice means that the average inflation rate over successively longer periods of time will tend to be increasingly close to 2 per cent. Until last year, the Bank of Canada used as its core measure of inflation the CPI excluding food, energy, and the effect of changes in indirect taxes. Volatile food and energy prices tend to reverse themselves fairly quickly. Therefore, since monetary policy actions affect inflation over a longer period, it would be inappropriate for monetary policy to try to offset the short-run movements in the total CPI caused by these fluctuations. Among food components, however, only fruit and vegetable prices are highly volatile. And among energy components, electricity prices have not been particularly volatile in Canada. Thus, our new measure of core inflation excludes only the volatile components of food and energy, as well as the three other most volatile components of the CPI: tobacco prices, intercity transportation prices, and mortgage interest costs. As before, the effect of changes in indirect taxes on the remaining elements is also excluded. Not only does the new measure of core inflation have a stronger statistical basis for its creation, it is historically a better predictor of future total CPI inflation than the old measure. Overall, we expect that these refinements will help to further increase the predictability of inflation in Canada in the years to come. This should add to the benefits that the Canadian economy has experienced from having a credible anchor in the form of the inflation-control targets. See Bank of Canada (2001). This is shown in Crawford (2001). Macklem (2001) provides further details on the new measure of core inflation and its properties.
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Remarks by David Dodge, Governor of the Bank of Canada, to the Saskatoon and District Chamber of Commerce Saskatoon, Saskatchewan, 29 January 2002.
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David Dodge: Inflation Targeting During a Difficult Year Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Saskatoon and District Chamber of Commerce Saskatoon, Saskatchewan, 29 January 2002. * * * Thank you for the opportunity to speak to you this morning. As you may know, the end of this week will mark the first anniversary of my appointment as Governor of the Bank of Canada. It was an honour to be appointed, and it has been a privilege to serve Canadians in this role. I have had the opportunity to work with an extraordinarily talented group of professionals at the Bank, as well as a supportive Board of Directors. Together, with input from Canadians across the country, we have worked hard to conduct monetary policy as well as we could during rapidly changing, and increasingly difficult, economic times. As I come to the end of my first year as Governor, it seems natural to look back and review some of the challenges and changes that have marked the past 12 months. The main economic concern of the past year was the slowdown that occurred not just here in Canada, but in most major economies. Compounding the economic concerns were the 11 September terrorist attacks in the United States. Inside the Bank of Canada, there were some major developments as well. Two things in particular stand out for me. We went through our first year with our new system of fixed announcement dates for interest rate decisions, and we renewed our inflation-control agreement with the federal government. Yesterday in Winnipeg, I spoke about our fixed announcement dates. Today, I'd like to talk to you about our inflation-control target system. Then I'd like to take a few minutes to review the current state of the economy and touch on Canada's economic outlook. Renewing the Inflation-Control Targets Last May, the Bank and the federal government jointly announced the renewal of our inflation-control agreement. This was an important decision. It strengthened a policy framework that has given our economy low, stable, and predictable inflation for the past decade. One of the main benefits of the targets is that they help the economy to run more smoothly when there are surprises in the level of demand for Canadian goods and services. Let me elaborate. Under the agreement, the Bank of Canada aims to guide total consumer price inflation towards the 2 per cent midpoint of our 1 to 3 per cent target range over the medium term. So when demand for goods and services leads the Canadian economy to push the limits of its capacity, and there is a risk of future inflationary pressures, the Bank will raise interest rates to cool off the economy. But importantly, inflation targeting also works the other way. When the economy is operating well below its production capacity and inflationary pressures are likely to ease, the Bank will lower interest rates to stimulate growth. This was the situation we found ourselves in during the past year, as signs of the slowdown emerged. By working in a symmetrical way, inflation targeting helps to level out the peaks and valleys of the business cycle. It promotes sound growth while tempering economic ups and downs. And this benefits everybody. But the benefits of this framework go beyond its usefulness in setting monetary policy. It also helps reduce uncertainty about future inflation, by giving Canada a credible anchor for its monetary policy. Let me explain what that means. Once the original agreement between the Bank and the Government came into effect in 1991, inflation quickly came down into the target range. But more importantly, measures of inflation expectations began to fall in line with the target range as well. At first, this applied to expectations of inflation over a 2-year period. But the time frame lengthened gradually, and since 1997, inflation expectations have been essentially anchored on 2 per cent for 30 years into the future. This is important, because when inflation expectations are well anchored, the real economy works better. Wage bargaining can become less contentious. And we have seen a trend towards fewer labour disruptions and a lengthening of collective bargaining agreements. With stable inflation expectations, investors can better assess the future value of their investments. At the same time, savers know the future purchasing power of their money will not be eroded by inflation. Supporting our inflation-control framework is our flexible exchange rate system. Although from time to time there may be excessive volatility in exchange markets, having a flexible exchange rate is important. This is particularly true for Canada because we are a small, open, and relatively specialized economy. The structure of our economy is different from that of the United States. Now, when we renewed the inflation-control agreement with the federal government last year, we strengthened the framework in four ways. We lengthened the term of the agreement to five years, which should reinforce its credibility. We clarified that we are aiming inflation explicitly at the 2 per cent midpoint of the target range. This emphasizes that we pay equal attention to the top and the bottom of the target range. We committed to providing an explanation in our key publications – the Monetary Policy Report and Monetary Policy Report Update – if inflation persistently misses the target. This increases our accountability to Canadians. Finally, we refined the way we measure core inflation. Refinements to Core Inflation I want to take a minute to explain what core inflation is, and why it is important. The Bank's inflation-control target applies to the annual increase in the total consumer price index. But we use core inflation as a guide to help us predict where overall inflation is likely to be in the future. In calculating core inflation, we exclude the prices of those goods and services that tend to be the most volatile; that is, subject to temporarily wide movements both up and down. Previously, we would strip out all food and energy items from the CPI basket of goods and services when we calculated core inflation. But not all components of food and energy are volatile. Similarly, there are other prices in the economy that are highly volatile. So we found it helpful to focus just on the volatile components in order to do a better job in predicting the future path of inflation. Let me give you an example that explains why core inflation is important. In late 2000 and early 2001, energy prices were shooting higher. Anybody who drives can remember paying a lot more at the gasoline pumps a year ago than now. Natural gas and heating oil prices were also rising sharply. These prices were being reflected in the overall inflation rate, which moved above 3 per cent for the first time in almost 10 years. This prompted some commentators to call on the Bank to raise interest rates. But the core rate of inflation was telling us that these higher energy prices were not significantly feeding into other prices. The core rate suggested that inflation would fall back around the midpoint of the target range, once the surge in energy prices either levelled off or reversed itself. In fact, this is exactly what happened. It would not have made sense for us to raise interest rates in the face of these temporarily very high prices for oil and gas. So even though total CPI inflation was high in the first half of 2001, the weakening economy indicated that downward pressure on inflation was coming. We expected core inflation to fall by the end of the year, as indeed it did, and to fall further in 2002. That led to our decision to lower, not raise, interest rates. In the last few months, we've seen rapid declines in volatile components, such as gasoline, fuel oil, and air fares. This means total consumer price inflation is now well below the core rate of inflation. And in such circumstances, it is equally inappropriate to base our policy actions on swings in total CPI inflation. The Slowing Economy in the Past Year Let me now look back at a rather difficult year for the economy. During 2001, we lowered interest rates at every fixed announcement date, in order to adjust to the changing economic circumstances. At the beginning of the year, our main concern was the impact that a slowing U.S. economy would have on Canada. Although domestic demand in Canada was holding up, against a backdrop of weaker foreign demand, we lowered our target for the overnight rate through the first half of the year. Both the old and new measures of core inflation also remove the effect of changes in indirect taxes. But by mid-summer, evidence began to accumulate that the U.S. slowdown would be more protracted than anticipated, and that economic activity outside North America would be much weaker. At the same time, there were indications that domestic demand in Canada, which had held up well through the first part of the year, was softening. So at our 28 August fixed announcement date, we said that we had revised down our expectations for growth. Then came the terrorist attacks of 11 September. Their immediate impact and subsequent fallout compounded the problems of the economic slowdown. And the attacks presented a pressing challenge to the Bank of Canada and other central banks: to keep the world's financial systems operating smoothly. One of the Bank's key functions is to promote financial stability in Canada. That means keeping markets functioning well, even in times of extreme stress, such as the days immediately following 11 September. The Bank of Canada, as did other central banks around the world, stepped in to provide financial markets with ample access to domestic liquidity. And we reached an agreement with the U.S. Federal Reserve that would have permitted us to provide extra U.S.-dollar liquidity to Canadian banks had it been necessary. In short, we made sure that the disruption did not turn into gridlock. If there was one positive thing to emerge from this terrible event, it was that the global financial system kept running as well as it did. But in the aftermath of these events, we were left with another challenge. That was to try to minimize the economic impact of the attacks. It was obvious that consumer and business confidence would suffer. We needed to do our part to help keep the loss of confidence as small as possible, which would help the economy recover as quickly as possible. That is why in the days following the attacks, we took the extraordinary step of lowering interest rates outside our fixed announcement dates. It then became clear that the economy would continue to operate below its capacity throughout 2002, with resulting downward pressure on inflation. So we sped up the pace of interest rate reduction at the next two fixed announcement dates. We wanted to support economic growth, which would help keep inflation within our target range of 1 to 3 per cent. The terrorist attacks created all sorts of uncertainties—economic, political, and military. So it was extraordinarily difficult last fall to be very certain about the future track of the economy. Now however, a clearer picture is beginning to emerge. The Current Economic Situation and Outlook One way for us to get that clearer picture is to actually get out across the country to see what is going on in Canada's regions. These opportunities to get away from the frenetic world of financial markets, and to see what is happening in the real economy, are extremely important to me, and to the Bank. Let me focus on this province for a moment. Here in Saskatchewan, the impact of a slowing world economy was felt mainly through a weakening in commodity prices. This hurt not just the agricultural sector, but the important mining sector as well. After posting very modest growth in 2001, Saskatchewan's economy is expected to show an improvement this year. A pickup in the global economy should boost commodity prices, which would be a big help to the province. Saskatchewan's agricultural sector would also be helped by a return to more normal weather patterns. There is an old farming saying that you can't lose a crop in January. But there is a clear critical need for more moisture in the soil and we all hope it comes soon. Of course my predecessor, Gordon Thiessen, has strong roots in this province and he understood well the difficulties faced by farmers year in and year out. But I want you to know that I too can relate to the trials of farming. I have a small cow-calf operation outside Ottawa, and I know how difficult this business can be. We can try to do something about the economy at the Bank of Canada, but sadly, we can't do anything about the weather. One clear positive for Saskatchewan has been the fiscal record of the provincial government, which is currently projected to post an eighth consecutive surplus. This strong fiscal record can only help the province deal with the sort of negative shock we experienced in the past year. In looking at the country as a whole, some sectors of the economy have recovered smartly from 11 September, but in other areas the adverse effects have persisted. Certainly air travel, both for business and tourism, continues to be weak. Last week, we published our Monetary Policy Report Update. In it, we said that the economy looked increasingly likely to find itself between the two extreme possibilities we had sketched out in last November's full Monetary Policy Report. On the plus side, geopolitical developments have been positive. Indeed, consumer confidence seems to be recovering in the absence of new terrorist attacks. But it is difficult to pinpoint the exact moment that the economy will begin to recover or precisely how strong that recovery will be. What I can say is that the conditions for strengthening world economic growth are in place. Excess capital stock is being worked out of the system, leading to expectations of greater investment ahead. And low commodity prices should rebound as global demand picks up. All told, we see Canadian growth in the first half of 2002 averaging between 1 and 2 per cent on an annualized basis. But growth should accelerate in the second half, with an average in the range of 3 to 4 per cent on an annualized basis. What does this mean for inflation? We saw total consumer price inflation dip sharply in November, then stabilize in December. At the same time, core inflation also fell during those two months. This is consistent with an economy operating below its capacity. With the economy growing more slowly than potential output through the first half of the year, excess supply will continue to build. So both total and core inflation are expected to remain near current levels for the next few months. But by lowering the target for the overnight rate, the Bank of Canada has taken vigorous action to stimulate domestic demand. We expect that as this excess supply begins to be taken up, both core and total CPI inflation should move back up close to our target of 2 per cent in about two years. Businesses of all kinds are still adjusting to the security risks that the events of 11 September have shown to us. In our view, this should be a one-time adjustment. But it probably means that there will be a small reduction in the level of our economy's potential output. I would now like to say a few words to reinforce our views about recent exchange rate developments that are a source of concern. Over time, exchange rates should reflect underlying economic and financial developments and prospects. But in the short run, there can be volatility as markets gauge those prospects. As I have already noted, it is becoming clearer that our economy will strengthen as we go through this year and into 2003. Recent data increasingly support the view that a recovery is taking hold. Household spending in Canada, particularly on interest-sensitive purchases, has been stronger than expected. The latest data on exports and manufacturing activity show signs of recovery. The inventory adjustment is progressing. And with early evidence of a revival in the U.S. economy, the world prices of non-energy commodities appear to have bottomed out. These signs of a pickup in economic activity in Canada are encouraging. But the recent movements in the Canada–U.S. exchange rate do not appear to have reflected those developments and the depreciation we saw over the last couple of weeks is not helpful for the economy. Economic recovery in Canada does not hinge on the current low levels of the Canadian dollar against its U.S. counterpart. * * * So to conclude, this past year has certainly been full of challenges. I know, however, that we have done the right things to get the economy growing strongly again, and that we are in good shape to take advantage of better times when they arrive. I feel confident in predicting that one year from now, when I'm looking back over my second year as Governor, I'll be looking back over a recovering economy, one that is much stronger than it is today.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, for a meeting with Canadian banks and the investment community, New York, 31 January 2002.
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David Dodge: Bank of Canada’s outlook for the Canadian economy Remarks by Mr David Dodge, Governor of the Bank of Canada, for a meeting with Canadian banks and the investment community, New York, 31 January 2002. * * * I am pleased to be here today and to have this opportunity to talk about the Bank of Canada's outlook for the Canadian economy and to update you on our monetary policy actions. This has been a very difficult year for all of us in North America, but especially for you here in New York City. The tremendous loss of human lives as a result of the 11 September terrorist attacks has been tragic. Among those who died there were family members, friends, and colleagues. And there were other innocent citizens of many nationalities caught in this tragedy, including Canadians. All of us at the Bank of Canada share a deep sorrow and extend our heartfelt sympathy. The immediate impact and the fallout from last September's events introduced new layers of uncertainty into the economic picture, compounding the effects of a deepening global economic slowdown that had become more evident during the summer. The Bank of Canada quickly responded to this extreme uncertainty by aggressively lowering interest rates in order to minimize the economic impact of the attacks and limit the loss of confidence. Since September, we have lowered our key policy interest rate by 200 basis points, bringing the total reduction since the beginning of 2001 to 375 basis points. This substantial monetary easing, together with measures taken by Canadian governments to reduce taxes and to strengthen national security, should support growth in domestic spending. On this basis, and with the improvement we have seen since the fall in the geopolitical climate and in consumer confidence, it is now clearer that the Canadian economy will gather momentum as the year unfolds. The timing and strength of the recovery will partly depend on how quickly business confidence and business investment, which remain weak in many countries, bounce back. Here, it is important to note that in Canada we did not have the same degree of overinvestment in fixed capital in the manufacturing sector during 1998-2000 as in the United States. So, the need for retrenchment and for adjustment of excess capacity in Canada would be less. The Bank of Canada's current view is that economic growth in Canada will be relatively modest in the first half of 2002—between 1 and 2 per cent, on an annualized basis—but that it will accelerate in the second half—to a range of 3 to 4 per cent—and strengthen further in 2003. This output profile means that there will be an appreciable amount of excess supply in the economy through 2002. Because of this, we see core inflation averaging just under 1 ½ per cent in the second half of 2002—below our 2 per cent target. Total CPI inflation should remain below the core rate until late 2002. With slack in the economy starting to be taken up in the second half of 2002, and expected to disappear by late 2003, inflation should move back up close to 2 per cent in about two years. I would now like to reiterate some of the comments I made on current developments last week, when we released our Update to the November Monetary Policy Report, and in two speeches I gave in western Canada earlier this week. It is now becoming clearer that the Canadian economy will strengthen as we go through this year and into 2003. Recent data increasingly support the view that a recovery is taking hold. Household spending in Canada, particularly on interest-sensitive purchases, has been stronger than expected. The latest data on exports and manufacturing activity show signs of recovery. The inventory adjustment is progressing. And with early evidence of a revival in the U.S. economy, the world prices of non-energy commodities appear to have bottomed out. These signs of a pickup in economic activity in Canada, and elsewhere, are encouraging. Over time, exchange rates should reflect economic and financial developments and prospects. But movements in the Canada–U.S. exchange rate do not yet appear to have reflected the recent developments in our economy. And to the extent that the recent depreciation of the Canadian dollar risks affecting consumer and business confidence in Canada, it is clearly not helpful for our economy. Furthermore, at this juncture, it is certainly the case that the economic recovery in Canada does not hinge on the current low levels of the Canadian dollar against its U.S. counterpart. Let me sum up. There is a good chance that when the final national accounts data for Canada come out, we will see positive, albeit modest, economic growth in both the last quarter of 2001 and the first quarter of this year. At this point, all available data suggest that final demand in the fourth quarter was stronger than we had anticipated. With production coming in at a much lower rate than final demand, the implication is that there has been a sharp rundown of inventories during the fourth quarter. This bodes well for the future, since it underpins the significant momentum we expect to see in economic activity as the year progresses. This is not to say that there are not uncertainties or risks in the economic outlook, or that the Bank of Canada will not remain alert to unfolding developments. But, overall, the prospects for the Canadian economy are looking up.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Society of New York, New York City, 20 February 2002.
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David Dodge: Canada’s experience with inflation targets and a flexible exchange rate: lessons learned Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Society of New York, New York City, 20 February 2002. * * * The Canadian economy has undergone a dramatic transformation over the past decade. And it has emerged as a low-inflation economy, with declining levels of public and foreign debt and a private sector that is more cost-conscious, productive, and efficient, thanks to restructuring and investments in new technology. There is little resemblance between this economy and the one many of us had to contend with in the 1970s and 1980s - one that was racked by high and variable inflation and by unsustainably large and rising public deficits and debt. Since the 1990s, Canada’s monetary policy framework, based on an explicit inflation-control target and a flexible exchange rate, has contributed importantly to putting the Canadian economy back on the right path to longer-term prosperity. This is the main theme of my talk today. I will conclude with a few remarks on recent developments and the outlook for the Canadian economy. The mark of the 1970s and 1980s: high inflation and fiscal excesses To put Canada’s inflation-targeting approach to monetary policy in context, a quick look into our economic history over the past three decades is in order. Through the 1970s and 1980s, Canada, like many other countries, found that high inflation, large fiscal deficits, and rising public debt exacted a heavy toll on the economy. Indeed, those of us who had to struggle with those unhappy times do not need to be reminded that high, variable, and unpredictable inflation increases uncertainty about the future. That it distorts the key signals and information individuals and businesses rely on to make important economic decisions. That it leads to exaggerated ups and downs in economic activity and employment. That it wastes valuable economic resources - resources that ought to be going into productive uses, but are instead diverted into hedging, as people seek protection from rising inflation. To make matters worse, through much of the 1970s and 1980s, Canadian governments were running large budget deficits. Those deficits were absorbing a major part of our national savings. The resulting accumulation of public debt meant high risk premiums in our interest rates. And these, in turn, discouraged the investments in equipment and technology that were necessary to improve productivity. To state the obvious, this was not a sustainable situation. Speaking for monetary policy, I can tell you that it took us a long time and a lot of work with different policy frameworks before we arrived at our current approach. By the late 1980s, it had become clear to the Bank that an explicit policy framework, which could be easily and clearly communicated to the public, was necessary to deal with the inflation problem. In January 1988, former Governor John Crow articulated a clear need to focus on achieving price stability. As the macroeconomic problems intensified through the late 1980s, it became evident that what we needed was an explicit commitment to a path for bringing inflation down. The Canadian experience: agreeing on targets for inflation control February 1991 marked a turning point in this process. At that time, the Bank of Canada and the Government of Canada, acting on a growing shared appreciation of the economic damage caused by high inflation, agreed to adopt explicit targets for inflation reduction. Subsequently, inflation came down quickly - indeed, faster than envisaged by the agreement. By January 1992, it had already fallen to close to 2 per cent. Now, I do not want to leave you with the impression that this was a quick and painless process. Far from it. Indeed, because of the magnitude of our imbalances, we had to take strong medicine and live with high interest rates for some time. This caused a lot of economic dislocation and pain in the short run. And even as interest rates came down, there was still an appreciable risk premium built into those rates that reflected, at least partially, our fiscal problems. But once the fiscal adjustment got underway, financial markets quickly took note of it and the risk premiums were reduced significantly. Thus, we were able to reap one of the key payoffs of low inflation. The original inflation-control agreement with the government has been renewed three times - most recently, in May 2001. The current agreement, which runs to the end of 2006, continues to aim at keeping inflation at the 2 per cent midpoint of a 1 to 3 per cent target range. The fact that we aim at the midpoint is of the essence, as I shall explain later. Through the past decade, and with two different governments, there has been increased shared appreciation among Canadian authorities of the important contribution that inflation control can make to good economic performance. I want to underscore that, in a democratic society, it is essential that the central bank and the government share the ultimate objective of a well-functioning economy. And that they both take action, and work co-operatively, to contribute to that common goal - hence my repeated emphasis today on words like “shared” and “agreement”. Based on the Canadian experience, I can tell you that the combination of a monetary policy aimed at low, stable, and predictable inflation and a fiscal policy aimed at bringing about a significant decline in the debt-to-GDP ratio works to reinforce the credibility of both policies. Low and predictable inflation provides a credible monetary policy anchor When the Bank of Canada and the Government of Canada jointly announced explicit inflation targets in 1991, the purpose was to provide a clear path for inflation over the medium term to help Canadians make better economic decisions. To make those better decisions, Canadians had to understand what their central bank was trying to do. At the Bank, we were expecting that the targets would help us communicate clearly the specific policy objectives down the road and, in that way, make our actions more understandable to everyone. The targets would also provide a better basis for judging the effectiveness of monetary policy. The importance of communication in monetary policy is also something I would like to return to later. Right now, let me tell you what we have learned from our experience with inflation targeting. One lesson we draw is that a credible monetary policy requires a credible anchor. Inflation targets fulfill that role successfully. They do so because they make inflation more predictable and firmly anchor inflation expectations well into the future. With inflation expectations solidly anchored, investors can better assess the future value of their investments. Savers can be more confident that the purchasing power of their money will not be unexpectedly eroded by inflation. Wage bargaining can become less contentious and labour disruptions decrease. The duration of wage and financial contracts can lengthen considerably because people are confident that inflation will not greatly exceed 2 per cent over the medium term. Nor are they unduly concerned about the risk of deflation. Altogether, the real economy works better and is more stable. Moreover, the significance of the increased credibility of the targets is that it changes the whole dynamic of the inflation process. For example, sudden temporary changes in energy prices, or movements in the exchange rate, do not feed into other prices in the economy and into wages the way they did in the 1970s and 1980s. Again, this is because inflation expectations are well anchored. A main benefit of a credible monetary policy based on inflation targets is that it has helped the Canadian economy avoid the boom and bust cycles of the past. This is because the forward-looking framework of inflation targeting acts as an automatic stabilizer for the economy. Let me explain how that works. When demand is too strong, pushing the economy against its capacity limits, and there is a risk that future inflation will move appreciably above the target midpoint, the Bank will raise interest rates to cool off the economy. But this works also in the other direction. When demand is weak, and future inflationary pressures are likely to ease, as was the case in 2001, the Bank will lower interest rates to stimulate the economy, absorb economic slack, and return inflation to the target midpoint. Let me stress here that the midpoint of our inflation target range is a target, not a cap. That is to say, we pay equal attention to any significant movement away from the 2 per cent midpoint - whether above or below. By working in a symmetrical way in response to surprises in demand, our inflation-targeting system helps to smooth the peaks and valleys of the business cycle and to promote sound, and generally less variable, economic growth. In this connection, let me emphasize that our mandate, as expressed in the preamble to the Bank of Canada Act, is not dissimilar from that of the U.S. Federal Reserve or from those of many other central banks. Our Act enjoins the Bank “to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada”. The symmetry of monetary action that goes with our inflation-targeting framework is the best way to achieve inflation control and thus the objectives of the Act with respect to output and employment. In addition, a monetary policy that consistently delivers low, stable, and predictable inflation is likely to provide the greatest contribution to sustained growth in output and employment. This brings me to a key point I noted earlier. It is vital that the central bank communicate with the public and with financial markets on the goals of monetary policy. Here too, inflation targeting can play an important role - both in making monetary policy actions more understandable and transparent, and in making it possible for an independent central bank to be held accountable by the public. It can also provide financial markets with a clearer view of how the central bank will operate over time. Finally, let us not forget that monetary policy actions affect inflation with a lag of six to eight quarters. Because of that lag, in setting policy, one wants to emphasize those changes in prices that affect the underlying trend of inflation and downplay temporary fluctuations in very volatile components of the consumer price index. That is why, unlike some other central banks, we have explicitly chosen to focus on the underlying trend of inflation and use a core rate as our operating guide. The core rate excludes the eight most volatile components of the consumer price index as well as the effects of changes in indirect taxes. But I should add that the central bank can downplay those temporary price changes only if there is good reason to believe that they will not feed into other prices in the economy and affect inflation expectations. The reason we have been able to do that is because the inflation targets have helped to establish monetary credibility and to anchor inflation expectations. Inflation targeting and a flexible exchange rate My review of Canada’s current monetary policy framework would not be complete without reference to its other key element - our flexible exchange rate. Monetary policy can pursue only one objective - keeping inflation low as a means to promote the economic well-being of Canadians. In pursuing that goal, we have chosen an inflation target as our anchor. And that means that we have to have a floating exchange rate. But I want to emphasize that Canada is a small and very open economy, with a structure of production and trade that differs significantly from that of the United States. A floating exchange rate is important because it facilitates the adjustment to economic disturbances, such as fluctuations in the world demand for, and prices of, our products. It also facilitates adjustment to changes in savings and investment flows. Over the last few years, more countries around the world have moved to flexible exchange rate systems and have adopted inflation targets as their monetary policy anchor. Today, I have given you a flavour of the Canadian experience in this area, and I have talked about some of the lessons we have learned over the past decade. I hope that this has provided you with some useful insights. Let me now turn to recent economic developments and the outlook for the Canadian economy. Recent economic developments and prospects in Canada The immediate impact and the fallout from last September’s tragic events here in New York, and elsewhere in the United States, led to a sharp increase in economic uncertainty around the world, exacerbating the effects of the global economic slowdown that had become more evident by last summer. In those circumstances, the Bank of Canada moved quickly and aggressively to lower interest rates. The aim was to minimize the economic effects of the terrorist acts and to limit the loss of confidence at home. Since last September, we have cut our overnight rate target by 200 basis points, bringing the total reduction since the beginning of 2001 to 375 basis points. The substantial monetary easing undertaken in 2001 will have its maximum impact as we move through this year and into 2003. In addition, tax cuts implemented at the beginning of last year continue to provide significant support to the Canadian economy. Further stimulus will also come from spending on enhanced national security. Thus, both monetary and fiscal policies are providing very significant support as we move forward. Moreover, with the improvement since the fall in the geopolitical climate and in consumer confidence in North America and Europe, there are increasing signs that the global economy has turned the corner and will firm as the year progresses. For these reasons, the Bank of Canada expects that the Canadian economy will gain momentum through 2002. After growing modestly in the first half - by 1 to 2 per cent, on an annualized basis - it should accelerate in the second half - to something like 3 to 4 per cent - and strengthen further in 2003. Once our economy starts expanding at rates exceeding the growth of potential output later this year, the considerable amount of slack that has built up over the past several months will begin to be absorbed. Still, it could be late 2003 before the actual level of output in the Canadian economy will again reach its potential level. This implies that core inflation will probably average just under 1 ½ per cent in the second half of 2002. Total CPI inflation is expected to stay below the core rate until late 2002, if energy prices remain near their current levels. Given the profile for output growth, the Bank expects inflation to move back up to 2 per cent in approximately two years. Recent economic indicators for Canada support the view that a recovery is starting. Household spending, particularly on interest-sensitive purchases, has been stronger than expected. Exports have lately shown signs of revival. The inventory adjustment is progressing. And with early evidence of a firming U.S. economy, the world prices of non-energy commodities appear to have bottomed out. Moreover, the national accounts data for Canada may well show slightly positive economic growth in both the last quarter of 2001 and the first quarter of this year. All available indicators suggest that final demand in the fourth quarter was stronger than anticipated. And the healthy employment data for January suggest that this strength is continuing. Also notable is the fact that production, especially in manufacturing, did not keep up with growth in final demand in the closing months of last year. So part of that demand was met by running down inventories. This bodes well for the coming months, because it means that production will likely begin to increase. This is another factor contributing to the momentum we expect to see in economic activity as the year unfolds. This is not to say that there are no uncertainties or risks in the economic outlook, or that the Bank of Canada will not remain alert to unfolding developments. While we expect fixed investment to begin to increase in the second half of the year, we are very much aware that this is conditional upon a recovery in business confidence, especially for large multinational enterprises. How quickly and how strongly profits and the confidence of those enterprises bounce back will have an important bearing on the strength and sustainability of the overall economic recovery. * * * To sum up, over the past decade, Canada has made major economic strides. We now have a solid anchor for monetary policy, and inflation expectations are well grounded. Fiscal health has been restored and, even in the short run, we will continue to make progress in bringing down our public debt-to-GDP ratio. And significant business restructuring has taken place, with more to come. Thanks to these improvements, Canada fared better in 2001 than many other countries. And with encouraging signs of a turnaround in the global economy and strengthening final demand at home, prospects for the Canadian economy are favourable. As we look past the current difficulties to the more positive longer-term trends and the potential of our economy, I expect that we will be moving forward with an enhanced sense of the importance and contribution of sound macroeconomic policies to good economic performance. I have talked at length today of how Canada has gone about fostering a climate of low, stable, and predictable inflation by means of a monetary policy framework based on an inflation target and a flexible exchange rate. The inflation target and a floating exchange rate work well together - indeed they reinforce each other. This approach has worked extraordinarily well for us over the last decade. And we expect that it will continue to provide the foundation for a prosperous future.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Chambre de Commerce France-Canada and Les Canadiens en Europe (France), Paris, 12 March 2002.
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David Dodge: Monetary policy choices: the Canadian experience Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Chambre de Commerce France-Canada and Les Canadiens en Europe (France), Paris, 12 March 2002. * * * It is a great pleasure to be with you today here in this wonderful and historic city. Canada and France share important links that cannot be weakened by time. There was, of course, a vibrant French presence in North America long before there was a country called Canada. The French contribution to Canada is not restricted to language alone. Canada's legal and political institutions, as well as our culture and way of life, retain a clearly visible French influence, and will continue to do so. Obviously, our economies and the economic links between our countries have come a long way over the years. The Chambre de Commerce France-Canada was established just after the Second World War. The Chambre has played an important role in reinforcing commercial ties between our two countries that reflect the historical and cultural links already in place. Les Canadiens en Europe is another organization that seeks to strengthen the many ties between us. Today, France and Canada are both members of the G-7–partners at the forefront of the global economy. The strong links between our two countries are also reflected in the close working relationship between the Bank of Canada and the Bank of France. Since becoming Governor of the Bank of Canada last year, I have been pleased to continue this relationship. I am happy to be working once again with Jean-Claude Trichet, the Governor of the Bank of France. Bank of Canada staff regularly attend the annual seminars hosted by the Bank of France. And I hope we will continue to strengthen the working relationship between our two institutions. Over the years, both Canada and France have had to make decisions about the framework guiding monetary policy. The authorities in the two countries have made choices that reflect the differences in our economies. Today I'd like to talk about some of these choices, and what they have meant for our countries. As well, I will give you a brief update on Canada's current economic situation and outlook. Inflation targeting In the early 1990s, most of the world's central banks found themselves facing a common problem. They needed to make sure that their economies did not return to the high and volatile inflation seen in previous decades. Further, they were looking for a way to keep inflation expectations under control. In general, central banks did a good job with this. Certainly the Bank of France was successful in the early 1990s in building credibility as an inflation-fighting central bank. At that time, the Bank of Canada and the Government of Canada had come to a shared appreciation of the damage that inflation can do. So they made an important decision in early 1991. They announced a joint agreement to adopt explicit inflation-control targets. The agreement has been very successful in giving Canada low, stable, and predictable inflation. It has been renewed three times— most recently for five years until the end of 2006. Today, both the Bank of Canada and the European Central Bank are working to strengthen the economies in their jurisdictions. We both want to promote stable growth and rising living standards. And, importantly, we agree that promoting low and stable inflation is the best means to those ends. There are similarities between our inflation-control systems. For example, we both focus on inflation, and we both aim for price stability over the medium term. But there are also some differences that I want to highlight for you today. The Bank of Canada aims for price stability through its inflation target of 2 per cent. On the other hand, the European Central Bank has an inflation ceiling of 2 per cent, as measured by the Harmonized Index of Consumer Prices. This may look like a subtle difference, but it is important. For the Bank of Canada, 2 per cent is the midpoint of our 1 to 3 per cent inflation-control target range. It is a target, not a ceiling. Our focus on that midpoint makes it clear that we run monetary policy in a symmetrical way. That is to say, we pay equal attention to any significant movement away from 2 per cent—whether above or below. When demand is strong, it can push the economy against the limits of its capacity to produce. This will tend to raise future inflation above its target midpoint. In these circumstances, the Bank will raise interest rates to cool off the economy, and return inflation to the target. But this process also works in the other direction. When demand is weak, as we saw in 2001, this means that future inflationary pressures are likely to ease. So the Bank will lower interest rates to stimulate the economy, absorb economic slack, and return inflation to the target. By working in a symmetrical way in response to surprises in demand, our inflation-targeting system helps to smooth the peaks and valleys of the business cycle. This promotes sound, and generally less variable, economic growth. In our experience, we have found that operating this way around our inflation target is an effective way to anchor inflation expectations. Indeed, in recent years, inflation expectations have become firmly anchored on the 2 per cent target. This is important for the economy. With inflation expectations solidly anchored, investors can better assess the future value of their investments. Savers can be more confident that their purchasing power will not be eroded unexpectedly by inflation. Similarly, debtors can better assess the real burden of their interest payments. Wage bargaining can become less contentious so labour disruptions decrease. The duration of wage and financial contracts can be lengthened considerably. All of this is possible because people are confident that inflation will neither greatly exceed, nor greatly fall below, 2 per cent over the medium term. In short, the real economy works better and is more stable. Moreover, the credibility of the targets has changed the whole dynamic of the inflation process. Sudden temporary swings in energy prices, or movements in the exchange rate, do not feed into other prices in the economy the way they did in the past. Again, this is because inflation expectations are well anchored. I should be clear that adopting the inflation targets was not the only thing that happened in the past 10 years to improve Canada's economy. The federal government, and the provinces, proceeded to clean up their balance sheets. Because of that, our public debt-to-GDP ratio is on a sustainable downward path, even during a period of economic slowdown. This improvement in the public sector balance sheet has led to a sharp increase in national savings. As a result, our net foreign indebtedness fell from a peak of 44 per cent of GDP in 1993 to about 20 per cent today. It is important that we continue to reduce our net foreign debt. In Canada, it is particularly important that we do this before the baby-boom generation retires. So, based on our experience, I can say that a monetary policy aimed at low, stable, and predictable inflation and a fiscal policy aimed at reducing the public debt-to-GDP ratio work well together. Prudent monetary and fiscal policies reinforce each other's credibility. The role of a flexible exchange rate Let me now turn briefly to the role of exchange rates. This is one area where our two countries have made different choices. France is one of a dozen European countries that have chosen a monetary union with a single currency. This remarkable effort reached a crucial milestone at the start of this year. After existing in electronic form for three years, the euro finally began to circulate as notes and coins. By all accounts, the transition went extremely smoothly. The European Central Bank, and the 12 national central banks, deserve a great deal of credit for handling it so well. Indeed, the completion of the process has rekindled the debate in Canada: If it is advantageous for France and 11 other European countries to form a monetary union with a common currency, would a similar arrangement for Canada and the United States also be advantageous? After analyzing the costs and benefits, in my view, a separate, floating currency continues to make the most sense for Canada for the foreseeable future. Let me take a few minutes to explain why. A floating exchange rate is beneficial for Canada, primarily because our production and trade structures are quite different from those of our major trading partner, the United States. Let me give you a couple of examples. Canada is a net exporter of primary commodities, while the United States is a net importer of commodities. And unlike the United States, Canada's auto industry is geared heavily toward exports. We produce two cars for every one that is sold in Canada. Because of the differences in our economic structures, major changes, such as large swings in relative prices, affect Canada and the United States differently. One way or another, the Canadian economy must adjust to these changes. A floating exchange rate is important because it helps the economy adjust to economic disturbances, such as fluctuations in world demand for, and prices of, our products. Equally importantly, it also facilitates adjustments to changes in savings and investment flows. It is true that the Canadian and U.S. economies are becoming more integrated. It is also true that by forming a monetary union, there would be some savings for Canadians in terms of the transactions costs of converting currencies and hedging against currency movements. So the question might well be asked: Since most of Europe has moved to a monetary union with a single currency, what about North America? From a Canadian perspective, there are at least three major arguments against monetary union in North America. First, in Europe you have single markets for goods, capital and labour. In North America, we do not have a single labour market. Second, the structures of the largest economies in the euro zone are more similar than the structures of the Canadian and U.S. economies. Finally, the euro zone is a collection of 12 countries. Although they differ in size, no single nation dominates the group. In contrast, in North America, the United States is dominant, both in terms of population and economic power. So yes, North American economies are becoming more integrated. But it does not necessarily follow that the structures of our economies are becoming more alike. As long as those structures remain different, the benefits of a flexible exchange rate will outweigh the associated transactions and risk costs. For Canada, our best choice is to have inflation targets as an anchor for our monetary policy, and a distinct, floating currency. As I have said before, this should remain the case for the foreseeable future. Now let me turn briefly to the current state of Canada's economy and the outlook for the future. Recent economic developments and prospects in Canada The immediate impact and the fallout from last September's tragic events in the United States led to a sharp increase in economic uncertainty around the world. This exacerbated the effects of the global economic slowdown, which had become more evident by last summer. In those circumstances, the Bank of Canada stepped up the pace of interest rate reduction that had begun earlier in 2001. The aim was to minimize the economic effects of the terrorist acts and to limit the loss of confidence at home. Since last September, we have cut the target for our overnight interest rate by 200 basis points. The total reduction since the beginning of 2001 has been 375 basis points. This substantial monetary easing will have its maximum impact as we move through this year and into 2003. In addition, tax cuts implemented at the beginning of last year continue to provide significant support to the Canadian economy. Further stimulus will also come from spending on enhanced national security. Thus, both monetary and fiscal policies are supporting our economy as we move forward. Moreover, there has been an improvement since last autumn in the geopolitical climate and in consumer confidence, both in North America and in Europe. Signs are increasing that the global economy has turned the corner and will firm as the year progresses. For these reasons, the Bank of Canada expects that the Canadian economy will gain momentum through 2002. While growth in the first half will be moderate, it should accelerate in the second half— to something like 3 to 4 per cent—and strengthen further in 2003. This means that later this year, our economy should start expanding at rates exceeding the growth of potential output. At that point, the slack that has built up over the past several months will begin to be absorbed. Still, it could be well into 2003 before the actual level of output in the Canadian economy will again reach its potential level. This implies that core inflation will probably average about 1 1/2 per cent in the second half of 2002. Total CPI inflation is expected to stay below the core rate until late 2002, if energy prices remain near their current levels. Given the profile for output growth, the Bank expects both total and core inflation to move back up to 2 per cent in approximately two years. Recent economic indicators for Canada show that the worst of the downturn is over. A recovery is underway. There were several positive signs in the fourth quarter national accounts data published last month, including strong household spending. Overall, Canada's economy grew at a 2 per cent annualized rate in the fourth quarter of 2001. In addition, there was a sizable reduction of inventories in the fourth quarter. This bodes well for the coming months, because the lower level of inventories will underpin future production. Data for the first two months of this year show that the Canadian economy has added 82,000 new jobs. Car sales are continuing to show strength, as is the housing sector. The Bank expects that fixed investment in Canada and the United States should start to pick up in the second half of the year. But we are very much aware that this depends on a recovery in business confidence, especially for large multinational enterprises. How quickly and how strongly profits and the confidence of those firms bounce back will have an important bearing on the strength and sustainability of the overall economic recovery. To sum up, Canada has made some difficult choices in recent years to face the challenges of today's globalized economy. We have found that our framework of a symmetrical inflation target and a floating exchange rate is appropriate for our economy. We have a solid anchor for monetary policy, and inflation expectations are well grounded. Fiscal health has been restored and we will continue to make progress in bringing down our public debt-to-GDP ratio. Thanks to these improvements, the effects of last year's global economic slowdown on Canada were not as pronounced as they might have been. And with encouraging signs of a turnaround in the world economy and a domestic recovery underway, prospects for the Canadian economy are favourable.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the National Association for Business Economics, Washington, D.C., 26 March 2002.
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David Dodge: The conduct of monetary policy in the presence of economic shocks Remarks by Mr David Dodge, Governor of the Bank of Canada, to the National Association for Business Economics, Washington, D.C., 26 March 2002. * * * Globalization - the trend towards greater economic integration around the world - has brought important benefits to us all. It has boosted world trade, opened up access to sources of global finance, and facilitated the diffusion of far-reaching technological advances in transportation, communications, and information processing. A more integrated world also tends to speed up the transmission of economic and financial disturbances across national frontiers and increase their spillover effects. Over the past decade, monetary authorities around the world have had to deal with a number of such disturbances. In 1994-95, we had the Mexican financial crisis. In 1997-98, we had the Asian and Russian crises. And last year we had the global economic slowdown, which was greatly exacerbated by the tragic events of 11 September in the United States. To be sure, the conduct of monetary policy has become more complicated and challenging - but not impossible or ineffective. In fact, I would argue that in most countries, including Canada, monetary policy has been very effective in mitigating the impact of global shocks on the domestic economy. Today, I would like to discuss how Canadian monetary policy has been conducted in the presence of economic surprises or shocks - both domestic and external. I would also like to add some thoughts on the issue of the appropriate monetary response, nationally and internationally, to common economic disturbances. Economic surprises and Canada's inflation-targeting approach to monetary policy To put things in context, let me start by providing a bit of background about Canada's inflationtargeting system. When it comes to conducting monetary policy, our formal mandate is not dissimilar to that of the U.S. Federal Reserve or to those of many other central banks. The preamble to the Bank of Canada Act enjoins the Bank "to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada." We have chosen to achieve the objectives of the Act through a policy focused on inflation control. This is because we believe that a monetary policy that consistently delivers low, stable, and predictable inflation is likely to be the greatest contribution that the central bank can make to sustained growth in output and employment. Since 1991, the Bank and the Government of Canada have agreed to pursue low inflation within a framework based on an explicit inflation target. The current agreement, which runs to the end of 2006, aims at continuing to keep inflation at the 2 per cent target midpoint of a 1 to 3 per cent range over the medium term. There are two elements I would like to underscore here - the emphasis we place on the 2 per cent midpoint as our target and the emphasis on the medium term. The significance of the first will become apparent in a moment. As for the focus on the medium term, it has to do with the fact that monetary policy actions take anywhere between one and two years to have their full effects on output and inflation. So, when setting monetary policy, we have to consider what will be the effect of actions we take today on the economy and on inflation several months down the road. In practice, setting monetary policy means raising or lowering interest rates to maintain a balance between the demand for goods and services and the economy's capacity to supply those goods and services. As long as there is a balance between demand and supply, inflation will remain stable. When we look at it this way, the rate of inflation is more than a number that tells us how the purchasing power of the average consumer is holding up. It is also a measure that the central bank can use to gauge how close to capacity the economy actually is. The presence or absence of inflationary pressures can tell us a lot about the balance between demand and supply. Our objective is to help the economy achieve potential output - that is to say, the maximum level of output and employment that can be sustained over the medium term without putting upward pressure on inflation. Over the past decade, a monetary policy based on an inflation target has helped us realize important economic benefits, particularly solid gains in output, employment, and incomes. It has also helped us to avoid the boom and bust cycles of the past, even in the presence of important surprises. This is because the forward-looking framework of inflation targeting works like an automatic stabilizer for the economy, with interest rates being raised or lowered in response to expected movements in future inflation relative to our 2 per cent target midpoint. For the most part, such movements reflect changes in the pressure of demand on potential output. Thus, our focus on the 2 per cent target midpoint allows us to operate monetary policy symmetrically in response to surprises in demand. And this helps to reduce the ups and downs of the business cycle and to promote sustained economic growth. The forward-looking framework of inflation targeting also allows us to handle temporary supply shocks, so long as these shocks do not feed into inflation expectations. The monetary credibility gained through our inflation-targeting system means that changes in volatile energy or food prices no longer feed into other prices and into wages the way they did in the past. That is why, unlike some other central banks, we focus on the underlying trend of inflation, and use as our operating guide a core rate that excludes the eight most volatile components of the consumer price index (CPI) and the effect of changes in indirect taxes on the remaining components. Such a measure of core inflation is a better predictor of future inflation than the total CPI. With this approach, monetary policy responds only to fundamental trends and does not turn temporary price shocks into something that can destabilize the economy. How the Bank of Canada deals with international disturbances So far, I have described how our monetary policy framework, based on an inflation target, helps us respond to, and deal with, important surprises that have an impact on our economy. I would now like to say a few words about how the Bank of Canada incorporates external economic shocks into its decision-making process. Canada is a small and very open economy. We export more than 40 per cent of what we produce and, in general, we are price-takers (that is to say, the prices of what we buy and sell abroad are largely determined in world markets). Thus, the external environment is extraordinarily important to us. As part of its decision-making process, the Bank has always followed world economic developments very closely. The Bank's Governing Council starts its deliberations by looking at changes in the external environment. In particular, we focus on economic prospects for the United States and the major overseas countries, as well as on world commodity prices. Then we look at the implications of all this for aggregate demand in Canada. Next, we focus on domestic demand, taking into account anecdotal information gathered by our regional offices, as well as trends in credit, money, and financial markets. All this feeds into our decision on interest rates. Let me try and relate this to recent experience. Take last year, for example. Through the first half of 2001, we moved to loosen monetary policy at a measured pace. This approach was based on a view that the economic slowdown in the United States, although sharper than initially expected, would lead to only a moderate slowing of growth in Canada. By midsummer, however, evidence had begun to accumulate that the slowdown in the United States and elsewhere would be deeper and last longer than anticipated. Because of this, and because of signs that domestic demand in Canada was softening, we came to the conclusion, as we looked ahead, that our economy would be operating substantially below potential for some time, and that inflation would fall below target. The extraordinary uncertainty introduced by the 11 September terrorist acts in the United States pushed the recovery further back, so that, even under a relatively optimistic scenario, our economy was expected to be operating at levels below capacity well into 2003. That is why, as of mid-September and through to the end of 2001, we stepped up the pace of interest rate reductions. As I said in my last speech in Paris earlier this month, more recently, there have been encouraging signs of a turnaround in the world economy, and the latest economic indicators for Canada show that a recovery is indeed underway. What should be the international policy response to common shocks? Having discussed how Canadian monetary policy has been conducted in the presence of economic shocks, I would now like to broaden the scope of my presentation somewhat by providing some thoughts on the appropriate international policy response to common shocks. Clearly, it is very important that individual central banks do their best to assess the implications of such shocks and that they respond promptly, within their respective monetary policy arrangements, to mitigate the effects on their own economies and on the world economy as a whole. But given the increasing interconnectedness of national economies, a legitimate question is whether there should not be greater policy cooperation, or even concerted action, in response to major common shocks. Here's how I respond to that question, and I will certainly be very interested to hear the views of others. First, let me note that we central bankers greatly value our bi-monthly meetings at the Bank for International Settlements, and our regular meetings at the International Monetary Fund, where we systematically discuss the world economic situation. So there is an important process in place for exchanging information on what is going on in our domestic economies as well as globally. Now, when it comes to policy action, I would argue that the best way to deal with common shocks, such as last year's global economic slowdown and the 11 September events, is prompt response by individual central banks. This response should be based on individual circumstances. But it should also take into account what is happening elsewhere and what fiscal and monetary authorities around the world are doing to deal with the situation. Otherwise, there is a risk that individual central banks will either under- or overreact, with potentially undesired consequences for the world economy. But the way that I and a number of my central bank colleagues around the world see it, prompt action does not mean concerted action. Indeed, to be clear, I would say yes to co-operation; yes to exchange of information; and yes to taking into account what is happening elsewhere. But I do not believe that formal coordination or concerted action are necessary. Provided that there is a good collective appreciation of the significance of certain global shocks, there is no reason why individual monetary authorities should not be the ones to take action tailored to their own domestic circumstances to deal with the implications. For example, in the days immediately after 11 September, there was no formal joint decision-making, although the major central banks did exchange information, leading to a shared appreciation of the grave risks for the world economy. And policy action was taken quickly—although not simultaneously and not by equal amounts. Judging from the signs of economic recovery we are now seeing around the globe, I would say that this process of international consultation and prompt policy action by individual central banks worked well to help us weather the very difficult circumstances we all faced last year. I would also like to highlight the significance of personal contacts among central bankers. Regular contacts build trust. And trust is very important when we have to act quickly, as we did last September to deal with the pressures faced by financial institutions, markets, and infrastructures immediately following the terrorist attacks. For example, in Canada, we were able to move very quickly and secure a temporary increase of our existing swap facility with the U.S. Federal Reserve. This arrangement was made to facilitate the functioning of Canadian financial markets and to provide liquidity in U.S. dollars to Canadian banks to settle their U.S.-dollar transactions, if the need arose. * * * Let me conclude. Last year, as in previous episodes over the past decade, Canada's inflation-targeting approach to monetary policy allowed the Bank to respond quickly and successfully to buffer the effects of worldwide shocks on our economy. In a very open and increasingly integrated world, it is important that individual central banks take prompt action, based on their own circumstances and needs, but taking also into account what is going on outside their borders. Such action has the best chance of mitigating the effects of global shocks on their economies and, by extension, on the international economy. When we all do what is right for our domestic economies, we are also most likely to do what is right for the world economy.
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The Donald Gow lecture by Mr David Dodge, Governor of the Bank of Canada, to the School of Policy Studies, Queen's University, Kingston, Ontario, 26 April 2002
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David Dodge: The interaction between monetary and fiscal policies The Donald Gow lecture by Mr David Dodge, Governor of the Bank of Canada, to the School of Policy Studies, Queen's University, Kingston, Ontario, 26 April 2002. Footnotes and references have been omitted; please see the Bank of Canada’s website for these. * * * Thank you for the invitation to give the Gow Lecture for 2002. Donald Gow had a great interest in public administration and in budgetary reform in the federal government. He was one in a long line of Queen's professors who have focused on various budgetary matters at the federal level. The late Doug Purvis was another. In 1998, when I was asked to give the Doug Purvis Memorial Lecture, I chose to talk about my "Reflections on the Role of Fiscal Policy." In that lecture, I discussed the past practice of fiscal policy in Canada and drew from that experience some lessons that might guide its future practice. In that context, I touched briefly on the interaction between fiscal policy and monetary policy. Today, after some experience on the monetary side of the fence, I would like to reflect more fully on this important interaction. In doing so, I will be restricting myself to the macroeconomic aspects of fiscal policy. Thus, I will be dealing with deficits and debts—both in terms of fiscal planning and in terms of the responses of fiscal policy to economic surprises. These are the key aspects of fiscal policy in terms of its interaction with monetary policy. To begin, I find it helpful to look back to May 1970 when Canada returned to a floating exchange rate. At that time, there was no formal anchor for monetary policy and therefore no anchor for nominal economic variables. Nor had much thought been given to a medium- to long-run goal for fiscal policy. Both policies had a rather short-run focus, and economic fine-tuning was still in its heyday. Unfortunately, the early 1970s soon brought a number of surprises that were damaging to an economy with no policy anchors—world energy prices skyrocketed, the underlying trend rate of productivity growth slowed, and revisions to the employment insurance system increased the longer-run equilibrium unemployment rate in the economy. By 1975, inflation had climbed above 10 per cent, and the general government budget had moved into a deficit of 3.5 per cent of GDP. In response to this rise in inflation, two policies were put in place. The Bank of Canada adopted targets for the growth of the narrow monetary aggregate M1, and the federal government established an AntiInflation Program in the autumn of 1975, which was in force until 1978. Although the controls aspect of this program was aimed at facilitating the transition to lower inflation, the fiscal and monetary policies under the macroeconomic aspect of this program were insufficiently restrictive to achieve permanently lower inflation. Overall, through 1982, M1 monetary targeting was not as effective in bringing down inflation as had been anticipated. The links between money growth and inflation over a policy-relevant horizon were not as tight as had been expected. The high interest rate elasticity of money demand meant that interest rates did not have to be raised by much to slow down money growth. And, at times, this problem was compounded by unexpected downward shifts in the desire to hold M1 balances. Thus, although the targets for the monetary aggregate were achieved, spending and inflation did not decline as much as had been hoped. In the 1970s, fiscal policy was concentrating on cushioning shocks in a discretionary manner and on expanding the amount of public goods and services. There was little realization that it was going off track when examined from a medium- to long-term perspective. This was partly because real interest rates were very low (and, indeed, often negative) throughout the decade. This situation could not last forever, and it did not. Once real interest rates returned to higher levels and the economy continued to experience lower trend growth rates, the vicious circle of debt dynamics set in. Overall, one can view the period since 1970 as one in which the authorities struggled to establish appropriate medium-term anchors for both monetary and fiscal policies. During this time, they learned about the appropriate interaction between those two policies in the context of economic stabilization and growth under a flexible exchange rate regime. In the rest of this lecture, I will deal with four interrelated topics: the appropriate goals for fiscal and monetary policy, building policy credibility, the appropriate stabilization role for the two policies, and policy co-operation. I will conclude with some thoughts about the future. The appropriate goals and focus for monetary and fiscal policies I will start with the topic of the appropriate goals for monetary and fiscal policies. In the 1970s, it was not only Canada, but most industrialized countries, that went off track in terms of their economic performance and budgetary outcomes. The global economic surprises that occurred during the course of the decade were partly to blame. But, more fundamentally, the problem was that central banks and governments had not yet established an appropriate macroeconomic framework for dealing with such surprises. This framework would have to operate in a world of floating exchange rates with high capital mobility and a high degree of substitutability between assets denominated in domestic currency and assets denominated in foreign currencies. Although Canada had been on a flexible exchange rate regime for most of the 1950s and into the early 1960s, it had operated on a fixed-rate regime from 1962 to 1970. Most other industrialized countries did not float their currencies until 1973 or later. And, although Canadian capital markets had historically been closely linked with those in the United States, the same could not be said for most other countries. Much of the academic literature around 1970 was focused on short-run stabilization, short-run changes in policy instruments, and static analysis. Not much attention was paid to changes in the stocks of assets and liabilities, which influence economic behaviour in the medium to longer run. Even though the large econometric models that were being constructed at that time did have dynamic behaviour and some limited role for asset accumulation, they were not typically used to look at alternative policy rules or regimes. Apart from the literature linked to the monetary aggregates, little had been written that dealt with a coherent medium-term policy. And there was also little or no concentration on the long-run effects of fiscal policy. Given all this, it was not surprising that we struggled to come to grips with our problems here in Canada. Short-run static analysis There was still an active debate in the early 1970s as to whether there was a long-run trade-off between inflation and unemployment. Those who believed that there was, were more willing to engage in a high level of fine-tuning the real economy. Models were used to mimic fine-tuning exercises, with interest rates or fiscal policy levers changed to get back quickly to desired output levels. Empirical models of the Canadian economy under flexible exchange rates were hampered by the fact that the experience was all from the 1950s—a time when the economic structure was much different from that of the 1970s and the exchange rate did not fluctuate very much. Not surprisingly, it proved difficult to develop an equation that explained exchange rate movements very well. Fortunately, there were some extremely powerful theoretical models of the short-run effects of monetary and fiscal policy, developed in the early 1960s by Robert Mundell and Marcus Fleming. The sharpest prediction of the early models occurred under the assumption of perfect substitutability between domestic and foreign assets and a fixed domestic price level. In a flexible exchange rate regime, only monetary policy (and not fiscal policy) would affect the level of output ("internal balance"). Expansionary fiscal policy would, however, lead to a sizable deterioration of the current account of the balance of payments. Conversely, in a fixed exchange rate regime, only fiscal policy (and not monetary policy) would affect the level of output, while monetary policy would affect the balance of payments through its implications for changes in official reserves. Mundell had used quite restrictive assumptions regarding prices and expectations of exchange rate changes and inflation in his simple models. It is important to note, however, that relaxing these assumptions, while maintaining a hypothesis of perfect asset substitutability, still leads to the conclusion that monetary policy has no effect on output under a credible fixed exchange rate regime (because it must be used to defend the fixed rate and therefore is endogenously determined). Moreover, with perfect asset substitutability, monetary policy has a more powerful effect on output— and fiscal policy has a less powerful effect on output—under a flexible exchange rate regime than a fixed exchange rate regime. This comes about because the domestic effects of monetary policy are augmented by its impact on the exchange rate, whereas the domestic effects of fiscal policy are reduced by exchange rate movements. Even though Mundell's models dated from the early 1960s, it is not clear that policy-makers had taken their implications into account for the change in exchange rate regime when Canada floated in 1970. Medium-run analysis Central banks, including the Bank of Canada, had long favoured a goal of price stability. And the Economic Council of Canada, founded in the mid-1960s, favoured "reasonable price stability" as one of its preferred policy objectives (but it did believe in "inflation-unemployment trade-off zones"). But by 1970, the only anchors for obtaining price stability or good inflation performance that were given prominence in the literature were monetary aggregates. The 1960s and 1970s saw a battle between the "monetarists," who favoured low and stable growth of a monetary aggregate, and the "Keynesians," who believed in fine-tuning and (in some cases) considered monetary policy to be ineffective. On the fiscal policy side, there was little analysis of medium- to long-run effects. In large part, this was because the federal debt-to-GDP ratio had been on a long downward trend since the end of the Second World War to 1974. It was only after this ratio had increased for a number of years that it became obvious that there was a problem with sustainability. As the Canadian economy moved into the 1980s, taking with it a legacy of problems from the 1970s, attention turned more and more to the importance of policies that would be sustainable over the long run, as well as to what policies should be expected to accomplish over the medium to long run under a floating exchange rate regime. Evolution of thought about monetary policy in the 1980s and early 1990s In 1982, and just before the Bank dropped its M1 target, Governor Gerald Bouey gave the Per Jacobsson Lecture. In that lecture, he discussed the "search for a better analytic framework within which monetary policy choices are made." Importantly, he noted that the Bank had found itself "taking a view of policy that is more forward-looking than one based solely on monetary targets on the grounds that it is wise to respond immediately to any potentially inflationary shocks rather than to wait until such shocks are reflected in higher inflation and higher money growth." In the 1982–86 period, the Bank looked for a target—monetary aggregate or other measure—that would provide · a nominal anchor as a medium-term guide to policy (that is, a target that would prevent cumulative policy error) · a place to stand that would be used to communicate policy to the public, and · an anchor that could potentially affect the formation of inflation expectations. Research failed to turn up a monetary aggregate that could fulfill these conditions. But to aid policy-making, Bank staff set out a desired path for inflation that would lead to price stability in the context of internal economic projections. In 1988, in his Hanson Lecture, Governor John Crow laid out the case for price stability as the best way that monetary policy could contribute to raising living standards. He also made it clear that, in his view, 4 per cent inflation was not price stability. It is important to review the case for low and stable inflation that the Bank has been making since 1988. The first key element in this case is that there is no long-run trade-off between inflation and output—a belief fully borne out by events. Moreover, low and stable inflation would be expected to actually increase output or economic welfare by · reducing uncertainty about the future (and thus aiding planning and investment) · reducing the costs of having to cope with inflation · increasing equity and fairness · leading to a more stable economy The government was also sensitive to the problems caused by volatile inflation and by inflation expectations that were not solidly anchored. Thus, by late 1990, there was a growing shared desire to have an explicit target that would provide a better anchor for inflation expectations. The fact that the credibility of monetary policy can potentially be frustrated by inappropriate fiscal policy—a theme to which I will return later—is one of the reasons that it is essential for both the government and the central bank to sign on to an agreement. In fact, an agreement was reached on specific inflation-reduction targets and was announced in a joint press release at the time of the February 1991 budget. You may recall that a series of targets was announced in that agreement, aimed at bringing the 12-month CPI inflation rate down to 2 per cent (plus or minus 1 per cent) by December 1995. The target has subsequently been extended three times, retaining the 2 per cent target midpoint. For ten years now, inflation has been low and stable, and households and businesses have increasingly come to believe in its predictability. The increased transparency of the Bank's conduct of policy and its enhanced communications strategy have played key roles in this success. An understanding of the appropriate medium- to long-run goals for monetary policy, both conceptually and quantitatively, was thus solidly in place in the early 1990s. Moreover, the quantitative targets were achieved in short order. It took longer, however, for medium- to long-run goals to be established and achieved on the fiscal side. The evolution of thought about fiscal policy in the 1980s and early 1990s While central bankers and monetary theorists had always kept at least one eye on price stability or low inflation, the fiscal authorities in industrialized countries had typically not had to deal with rising debtto-GDP ratios during peacetime. Therefore, it took a while before there was any recognition that there was a longer-run problem on the fiscal side. The recognition lag was exacerbated by an unexpected decline in the trend rate of productivity growth, now dated at around 1973, and a rise in the actual real interest rate to some longer-run equilibrium that occurred sometime in the early 1980s. In my Purvis Lecture, I noted that in the 1971–83 period, "Expansionary fiscal policy was used . . . as a substitute for appropriate structural policies." This was particularly true with regard to the response to the two oil-price shocks. Thus, the contribution that fiscal policy could make to savings and longer-run growth was largely neglected in discussions during that period. During the 1983–85 period, academic economists began to discuss the sustainability of public deficits and the appropriate role for fiscal policy. (Queen's professors Neil Bruce and Doug Purvis were key contributors to this discussion.) The sustainability problem really comes down to two things. First, the stock of government debt cannot grow faster than the economy indefinitely. Eventually, fiscal policy must be adjusted. Second, because of this, when the rate of interest on government debt exceeds the growth of the economy, a rise in the government deficit relative to the size of the economy today means that there must be a rise in tax rates or a cut in the ratio of government program expenditures to GDP sometime in the future. That is, there are important transfers among generations. Economists were also becoming more convinced that deficits and debts have significant real effects on the economy. These effects occur because, in practice, changes in private sector savings do not fully offset changes in government saving. That is, reduced government saving leads to some decline in overall national saving. In a small open economy such as Canada's, when the international substitutability of assets is very high, the most important effect of changes in government debt will be on foreign indebtedness. It works this way. A decrease in the deficit lowers domestic expenditures relative to domestic production and thus increases the current account balance. There is a corresponding decrease in net capital inflows and thus in foreign indebtedness. The decline in foreign indebtedness will lower the interest and dividend payments flowing abroad and thus raise domestic net income relative to gross domestic product. To the extent that domestic interest rates decline when the domestic government debt-to-GDP ratio falls, a decrease in government debt will tend to increase business investment and the capital stock. This is the second major effect of a decline in deficits and debts on the Canadian economy. Combining these two major effects, one can say that the appropriate longer-term goal for fiscal policy should be increased savings, investment, and output through an appropriately low debt-to-GDP ratio. A decline in the debt-to-GDP ratio can have additional favourable effects. First, to the extent that a lower debt-service burden leads to lower taxes, rather than higher expenditures, it leads to a reduction in the usual distortionary effects of taxes. Second, to the extent that it reduces the effect of a given change in interest rates on the government's balance, it makes fiscal planning much easier. Third, in situations of very high (and perhaps rising) debt-to-GDP ratios, markets may build a premium into interest rates to cover the perceived probability that debt will be monetized. Lower debt ratios reverse this effect. Finally, when the economy weakens, governments facing high debt ratios may feel that they have to override the automatic stabilizers to avoid making a bad situation even worse—as often had to be done in the 1990s. This effect will tend to disappear at lower debt ratios. I will come back to the last two points later in this lecture. In the mid-1980s, the Canadian federal government developed a plan to gradually deal with the rising debt-to-GDP ratio. But little progress was made, and thus more significant measures had to be taken in 1993 and 1994. It was not until the budget of February 1995, however, that the cumulative effects of all the measures taken were perceived to have put fiscal policy back on a sustainable track. Since that budget, the debt-to-GDP ratio at the federal level has fallen from 70 per cent to 50 per cent, and the provinces have, by and large, also put their fiscal houses in order. Largely as a result of these fiscal moves, the ratio of Canada's international indebtedness to GDP has been halved from 40 per cent to around 20 per cent. Differentials in nominal long-term bond rates between Canada and the United States have come down from over 2 per cent in 1990 to between 1/4 and 1/2 per cent over the past year. Canadian long-term interest rates in real terms have also declined. With lower government financing needs, Canadian corporations could more easily issue debt in Canada. All these changes have favoured increased business fixed investment in Canada, which rose from 10.3 per cent of GDP in 1992–95 to 12.4 per cent of GDP in 1996–2001. As for future objectives, it is plain that the federal government and many provinces clearly intend to pursue further significant declines in their debt-to-GDP ratios over the medium term. The federal government, for example, has a framework of targets and contingency reserves in each annual budget that reduces to low levels the probability of running a deficit. The usual nominal growth in the economy will thus reduce the debt-to-GDP ratio. While the objective in the fiscal area may not be as specific as in the monetary area, it is the most definitive and operational medium- to long-term objective that there has been for Canadian fiscal policy in recent memory. What medium- to long-term objectives accomplish Whether one is thinking about monetary policy or fiscal policy, there are two important results when medium- to long-term objectives are established and achieved. First, a sustainable situation is created over time. Policy instruments are forced to adjust to surprises—particularly permanent surprises— because there is a longer-run anchor. Second, in choosing long-term objectives, appropriate consideration is given to the type of policy framework that will raise our living standards over the longer run. The longer-run outcome should be more than the result of a series of ad hoc short-run decisions aimed at economic fine-tuning. As a by-product, the economy gets the appropriate "assignment" of policies: long-run "internal balance"—that is, low and stable inflation—is assigned to monetary policy and long-run "external balance"—wealth accumulation coming, at least partly, from an increase in net foreign assets—is assigned to fiscal policy. This should be taken as only a rough parallel to Mundell's results for shortrun policy under flexible exchange rates with perfect international asset substitutability. It misses the richness of the dynamic process through which both the capital stock and the stock of net foreign assets can be affected, as discussed earlier. The credibility of monetary and fiscal policies I would now like to turn to the credibility of monetary and fiscal policies. After establishing appropriate medium- to long-term objectives for monetary and fiscal policies, it is important to achieve them. This is not only because in a democratic system it is important to be accountable, but also because there are gains to be reaped from having credible policies. The short- to medium-run credibility of monetary policy was established quite quickly, as inflation fell to 2 per cent in early 1992, more than three years before the inflation-reduction target itself was slated to be 2 per cent. By early 1993, the inflation expectations of private sector forecasters and businesses for short-run horizons had fallen in line with the midpoint of the target range. It took a while for these same inflation expectations at a 6- to 10-year horizon to fall to 2 per cent. This occurred by about early 1996. And at a 30-year horizon, as measured by the spread between the yields on conventional and Real Return bonds, expectations remained above 3 per cent until late 1996, before falling quite sharply to around 2 per cent by late 1997 and staying there. The significant deviation of long-term expectations from the target was partly a result of concerns about pressures that could arise because of a fiscal situation that was still not perceived to be fully in control. That is, financial markets were concerned with "fiscal dominance" over monetary policy in that period. There are a couple of strands in the theoretical literature on the interaction between fiscal and monetary policy, which essentially assert that fiscal policy will eventually dominate in determining longrun monetary policy. Both these strands, however, require that the fiscal authorities will either eventually require the monetary authorities to monetize the debt or convince the financial markets that, ultimately, the fiscal authority will have the upper hand. These appear to be extreme assumptions because they depend on the view that fiscal authorities are unconcerned with any inflationary consequence of their actions and ignore the many legal and institutional separations that exist between fiscal and monetary authorities. Nonetheless, market concerns about the potential for fiscal dominance can potentially have significant effects in financial markets, particularly on longer-term bond rates. These concerns were definitely at play in Canadian financial markets in the early and mid1990s. As I noted earlier, it was only in February 1995 that the Government of Canada was perceived to have established an objective for fiscal policy that was specific enough to provide a basis for achieving a reduction in deficits to zero and setting the economy on a path that would reduce the debt-to-GDP ratio. This objective was regarded as a foundation on which to build credibility for fiscal policy. As in the case of monetary policy, credibility did not come immediately. It had to be earned. Considerable credibility was gained, however, over the 2- to 2 1/2-year period after the 1995 budget. The deficit-reduction milestones were more than achieved and successive budgets reinforced the intention to stay the course. It is important to note the supporting role that the credibility of monetary policy played in this process. In part, because the short- to medium-run credibility of monetary policy was high, short- to mediumterm interest rates on government debt had fallen significantly. Even long-term rates were much lower than in the early 1990s. These lower interest rates reduced the real cost of the existing government debt as it was rolled over. Thus, there was an interaction between the credibility of fiscal and monetary policies. The joint credibility of the two policies led to lower rates on long-term bonds as risk premiums related to the debt-to-GDP ratio and to inflation uncertainty fell. The spreads between Canadian and U.S. long-term bond rates even became negative for most of the period from mid-1997 to late 2000. Canada's experience in the 1990s thus strongly suggests that there are important spillovers in credibility between fiscal and monetary policies. Moreover, it is easier for everyone—policy-makers and the private sector alike—when the frameworks for both monetary and fiscal policy are clear and understandable. In discussing the establishment of credibility, I have so far put the emphasis on achieving the established objectives. This is certainly the most important factor. But communication has also played a key role—communication about the quantitative objectives and about the framework of the mechanisms that enable us to attain those objectives. Communication has been equally important for both monetary policy and fiscal policy. Policy credibility has led to important gains for the Canadian economy. The joint credibility of the two policies has lowered long-term interest rates in real terms, favouring business investment and, therefore, economic growth. The credibility of monetary policy has apparently led to a change in the nature of the inflation process itself. In the short run, inflation does not seem to respond as strongly to measures of excess demand and supply. As well, because inflation expectations have been well anchored near the 2 per cent target midpoint, the labour market today operates much more efficiently than it did during the high-inflation years. Union contracts have lengthened considerably and wages are rarely indexed to the cost of living. Moreover, there are no immediate reactions of wages to big changes in oil prices. Thus, relative wages are better anchored and tend to better reflect demand and supply conditions in particular markets. I regard all this as an extraordinarily important contribution, since I spent two years with the Anti-Inflation Board struggling to settle down a labour market that had become terribly distorted by high inflation in the early 1970s. Overall, credibility has stabilized the inflation process and, therefore, inflation itself. Moreover, effective monetary policy seems to have reduced the variability in the real economy as well. The credibility of fiscal policy has enhanced investment planning by the business sector since it has drastically reduced the risk of future increases in taxes stemming from a need to deal with fiscal problems. Thus, credibility has led to a more stable Canadian economy and one that is better positioned for future economic growth. Stabilization policy There is a connection between credibility and my next topic—stabilization policy. The achievement of policy credibility has meant that the automatic stabilizers in the economy—those features of macro policy that tend to stabilize output—can be allowed to work fully. When the monetary and fiscal authorities are attempting to establish credibility, there is a natural inclination—and sometimes a necessity—to err on the side of overachieving the targets. This means that explicit actions may have to be taken to prevent the automatic stabilizers from working, as was the case with fiscal policy in the 1990s. Moreover, the lack of a credible fiscal policy was one of the factors that seemed to hinder the Bank's ability to achieve the monetary conditions that it desired at certain points in the early- to mid-1990s. Thus, the stabilizing properties of monetary policy were not able to fully work at that time. Now that the credibility of both policies is very high, both the federal government and the Bank can allow the automatic stabilizers to do their job. Monetary policy and stabilization In the case of monetary policy, interest rates actually have to be changed to get the stabilizing result. Nonetheless, although judgments are made based on the special factors at play and the balance of inflation risks going forward, the changes in rates can be considered as more or less automatic in response to surprises in demand. Our 2 per cent inflation target limits our discretion. Changes in interest rates independent of those in the United States are made possible by our flexible exchange rate regime. Let me explain how monetary policy focused on an inflation target plays a stabilizing role when there are demand surprises. Suppose that the economy is operating at its production potential, and inflation is at the 2 per cent target midpoint. A downward shift in demand—coming from, say, a tightening in fiscal policy—would create excess supply in the economy, putting downward pressure on inflation. To bring inflation back to 2 per cent over an 18- to 24-month horizon, the Bank of Canada would lower its target for the overnight interest rate. This action, through its effect on market interest rates and the exchange rate, would increase the level of output in the economy towards its production potential. Inflation would therefore return to target shortly after the excess supply disappeared from the economy. Because the inflation-targeting framework operates symmetrically, the same process would occur in reverse in response to an upward shift in demand. Supply shocks—which take the form of higher (or lower) inflation than expected for a given level of demand—are always more difficult for policy-makers to deal with than demand surprises. Nevertheless, the Bank's framework for inflation-targeting allows temporary supply shocks to be largely ignored, so long as they do not feed into inflation expectations. The credibility that has been established means that they no longer do so. Consider price surprises coming from the most volatile components of the consumer price index—components such as fruit and vegetables or oil and gas. As our operating guide, we use a measure of core inflation that excludes such components. This gives us, and economic observers, some confidence that we are looking at the underlying trend of inflation. Thus, our interest rate response to price shocks that are perceived to be temporary can be minimal. As a result, there will be little effect on output. In other words, monetary policy does not turn temporary supply shocks into something that is destabilizing for aggregate output. Fiscal policy and automatic stabilization On the fiscal side, the automatic stabilizers are tax revenues and employment insurance payouts. When the economy weakens, tax revenues tend to fall, and employment insurance payouts tend to increase. This buffers the effect on personal disposable income of the decline in output and therefore tends to reduce the amplitude of the output shock. If households based their spending decisions on their expected permanent level of income, as opposed to current income, there would be little role for the automatic stabilizers. But the evidence shows that many households, particularly those with lower incomes, cannot borrow freely against future income and therefore are often significantly constrained by their current level of disposable income. Thus, automatic stabilizers on the fiscal side play a significant role. Some have argued that a significant rise in the propensity to import, which can act as an automatic stabilizer in the economy, has perhaps decreased the importance of the automatic fiscal stabilizers. While this is true at the aggregate level, its effect has not been uniform across shocks affecting various final expenditure categories. The greatest increases in the propensity to import have come on the export side, because of the growing importance of two-way trade. Components of domestic expenditure such as housing investment, non-residential construction, and consumption of services, however, still have very low marginal propensities to import. Comparing and contrasting the automatic fiscal and monetary stabilizers Some of the automatic fiscal stabilizers work almost immediately—for example, the personal income tax deducted by the employer. Others, such as employment insurance payments and social assistance payments, work with a fairly short lag. These types of fiscal stabilizers are very effective in dampening an output cycle. But they do not come close to fully offsetting the change in output. Other elements of the automatic fiscal stabilizers do not take hold until income tax is settled in the spring of each year. The lags in the effects of monetary policy mean that there is no contemporaneous dampening effect on output. While changes in monetary policy can have some impact in the very short run, the full impact on output is not normally felt for 12 to 18 months. It is largely because of these lags that the Bank aims to bring inflation back on target over an 18- to 24-month horizon. As I noted earlier, the automatic fiscal stabilizers at the federal level will no longer have to be offset. What difference does that make for monetary policy? The most important factor is that fiscal policy will be more symmetric and predictable. Discretionary stabilization policy While the automatic stabilization provided by monetary and fiscal policies is very desirable, the question remains whether there is a role for something further—a role for a discretionary stabilization policy. In the case of monetary policy, the nature of our response is the more or less automatic one described earlier. As I said earlier, judgment is key to the process. That is particularly true at times of great uncertainty, as existed last autumn. But our clear inflation target means that, in principle, our discretion is limited relative to that of fiscal policy. The arguments for and against discretionary fiscal policy as an important element in macroeconomic stabilization in an open economy tend to revolve primarily around lags, and around the effectiveness of short-run fiscal policy relative to monetary policy. If the timing was close to perfect, fiscal policy measures that lasted for two or three quarters could, in principle, and under ideal circumstances, shorten the time to move output back to its desired level. Thus, in principle, discretionary fiscal policy is an important tool. But, as a practitioner, I can tell you that the great problem here is that temporary measures are both difficult to start quickly when the need arises and extraordinarily difficult to stop once the need is past. Thus, as a practical matter, not a philosophical one, there are some severe limitations to the use of discretionary fiscal policy as a stabilizer. Policy co-operation Now let me turn to policy co-operation and coordination. I want to start by emphasizing that the inflation targets are joint targets. They are not just the Bank's targets—they are the targets of the Government of Canada as well. Put another way, "coordination" came through the joint agreement on inflation targets. With clear agreement on the medium-term policy objectives and an understanding of the policy framework, there is no need for coordination on the setting of interest rates or fiscal policy instruments. The economic literature on policy coordination tends to be about situations where the fiscal and monetary authorities have one or more of the following: very different views of economic welfare, inconsistent policy objectives, policy that is totally discretionary, or a tendency to get involved in gamelike behaviour with one another. None of these applies in Canada. Given the policy framework, when the government changes fiscal policy, it needs to think of how these changes will affect inflation and, consequently, interest rates. Similarly, the Bank needs to consider how changes in fiscal policy will affect demand and inflation, and thus its setting of interest rates. Therefore, it is to the mutual benefit of both parties to co-operate in the sharing of information and analysis as they set their policies. For example, it is important for the Bank to recognize that government policies can affect the production potential of the economy through their effect on sustainable labour utilization rates and the level of productivity. The Bank needs to consider this information when making its policy decisions. Co-operation between the Bank and the federal Department of Finance occurs on a number of levels. I have frequent discussions with the Minister and Deputy Minister. My colleagues on the Governing Council stay in touch with the associate and assistant deputy ministers who are their counterparts. And there are meetings at the staff level to share, for example, information from economic forecasts, surveys, and contacts with various groups and organizations. One of the key reasons for our regular discussions is so that each institution understands the details of the framework within which the other organization is pursuing its objectives and how this framework applies to current economic surprises. With our inflation-targeting regime, provincial fiscal authorities—especially those in large provinces— also know that the Bank will react to the effect that their policies could have on the course of future inflation. At the same time, we at the Bank are obligated to keep the provincial authorities informed of our views on future inflation. Some of you may be surprised that I have not said anything about the appropriate mix of monetary and fiscal policies when talking about coordination and co-operation. As you might remember, policy mix was a hot topic in Canada in the late 1980s. That was before we had explicit frameworks for our monetary and fiscal policies. With these frameworks in place, the whole issue of policy mix becomes moot. In particular, interest rates are not adjusted to deal with problems of deficits and debts, and taxes and fiscal spending are not adjusted primarily to achieve an inflation objective. This does not mean, however, that there are no implications for financial and policy variables as a prolonged fiscal tightening puts the economy on a course for a new longer-run equilibrium with a lower debt-to-GDP ratio. All else being equal, the fiscal tightening will initially lead to lower real interest rates and a temporary real depreciation of the Canadian dollar, so that interest-rate-sensitive components of GDP and net foreign demand can make up for the loss in domestic demand stemming from the tightening. But as Canadian net foreign assets rise, the wealth effect on consumption will become large enough to support demand and to allow the Canadian dollar to rise to a permanently higher real value than prior to the change in fiscal policy. Related to what I have said about the need for co-operation rather than coordination of policy variables domestically, I would argue that, if each major industrial country had clear medium-term objectives for monetary and fiscal policies, along with transparent frameworks for achieving those objectives, there would be no need or desire to have any strong form of international coordination. Again, it would be co-operation in terms of information-sharing that would be important. Overall, I believe that the clear longer-term objectives and frameworks of monetary and fiscal policies have created an environment where co-operation in the form of sharing information and analysis is most effective. Concluding thoughts Just over 25 years ago, in the absence of appropriate anchors, Canadian monetary and fiscal policies both went badly off course. It then took 15 to 20 years to establish the appropriate focus for those policies and to bring them back on course. Now there are clear monetary and fiscal objectives and clear accountability for meeting those objectives. The transparent framework that has been established will be extremely helpful in meeting the challenges that the future is sure to bring. Two of these challenges are already apparent—a possible increase in the trend rate of productivity growth and a slowdown in population growth combined with an aging population. Both these factors create uncertainty about the growth and level of production potential of our economy. Fortunately, this broad type of uncertainty is not new, either for the Bank of Canada or for the fiscal authorities. The medium-term frameworks that have been set up for monetary and fiscal policies mean that the required adjustments in the economy will take place against a relatively stable background. That is to say, the Bank will react so that inflation does not stray too far from 2 per cent, and the government will react so that the debt-to-GDP ratio remains on a downward trend. We have come a long way in the past 25 years in understanding the relationship between monetary and fiscal policies and what those policies can best accomplish. As we go forward, this will help to underpin strong economic growth and a more stable Canadian economy.
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, 30 April 2002.
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David Dodge: Update on economic and monetary developments in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, before the Standing Senate Committee on Banking, Trade and Commerce, Ottawa, 30 April 2002. * * * When Malcolm and I appeared before you at the end of last November, a heavy cloud of uncertainty hung over the outlook for the world economy and for Canada. Much of that uncertainty stemmed from the September terrorist acts in the United States, which came at a time when the global economy had slowed more than expected. To counter that uncertainty and bolster consumer and business confidence, the Bank of Canada moved aggressively to provide monetary stimulus. Between last September and January 2002, we lowered interest rates by 200 basis points, bringing the total reduction since January 2001 to 375 basis points. As it turned out, consumer confidence was not as badly shaken in the aftermath of those tragic events as had been widely feared. Indeed, confidence bounced back as perceived geopolitical and economic uncertainties diminished. The world economy has begun to strengthen. Here in Canada, a robust recovery appears to be underway. Growth in the fourth quarter of last year and the first quarter of 2002 was appreciably stronger than expected, so that the level of economic activity is now higher than we thought it would be six months ago. This momentum is reflected in the extraordinary number of new jobs created since the beginning of 2002. In terms of the two scenarios we had painted last November, clearly, we are into the more optimistic one, in which a recovery in consumer confidence leads to an early resumption of economic growth. What do we see now as we look ahead? The Bank projects that, in the first half of 2002, the Canadian economy will grow by between 3 1/2 and 4 1/2 per cent, at annual rates. And we expect that it will continue to expand in the second half of the year and in 2003 at a rate somewhat above that of its production capacity (or potential), which we estimate to be around 3 per cent a year. You may recall, Senators, that at our last visit I spoke about the concept of potential output. We set monetary policy so as to keep inflation low and stable, thus contributing to sustaining economic growth at its full potential. Six months ago, we assumed that our economy would be growing at a pace well below the rate of capacity growth in the fourth quarter of last year and the first quarter of this year. We thought that the gap between the actual level of economic activity and the level of potential would be widening throughout this period. Instead, growth has turned out to be much stronger than expected. This means that our economy is operating at a much higher level than we thought. So the output gap is smaller than we had predicted and is currently narrowing. Indeed, we expect that it will close in the second half of 2003. The output path that we are now projecting is consistent with core CPI inflation being at 2 per cent by about the end of next year. Total CPI inflation will probably continue to fluctuate in coming months as oil and natural gas prices move around. But, like core inflation, we expect it to be at the 2 per cent target midpoint by about the end of 2003. Although we no longer face the same degree of uncertainty as we did last fall, there are still important risks and uncertainties in the outlook—some of which are working on the upside and others on the downside. Given the amount of monetary and fiscal stimulus in the economy, output growth could be even stronger than projected. But it is also possible that some of the recent strength in spending on consumer durables was borrowed from the future, so that the growth of household expenditures will be weaker than expected. At the same time, there is still considerable uncertainty about the timing and strength of the pickup in business investment in North America, mainly because of the continued weakness in profits. Moreover, recent tensions in the Middle East could have implications for crude oil prices and the global economy. While we face many of the same risks as the United States, there are a couple of differences in our situations that are worth noting. First, as we pointed out in the Monetary Policy Report, we expect that in Canada final demand will make up a larger share of the growth in the first quarter, while inventory rebuilding will constitute a smaller share than in the United States. Second, while weaker-than-expected confidence among large businesses remains a risk for both countries, the sectors that face the biggest challenges, such as computer equipment and telecommunications, make up a larger share of the U.S. economy than of the Canadian economy. So what do recent economic developments in Canada mean from a policy perspective? As I mentioned, our economy is now operating at a significantly higher level than we had expected. So the amount of spare capacity is smaller, and is expected to be absorbed sooner, than we assumed last November. In these circumstances, our job will be to gauge the strength of the economy as it approaches its capacity to produce and reduce the amount of monetary stimulus in place in a timely and measured manner. We want to ensure that inflation stays close to the target so that, over the medium term, our economy can continue to grow at full capacity. What do we mean by "timely and measured"? "Timely" relates to the fact that there is always a lag between our policy actions and their effect on the economy. We must be timely and forward-looking because our actions take a year to 18 months to have their full effect on output, and 18 months to 2 years to have their full effect on inflation. "Measured" relates to the judgments that we will make as we approach full capacity. If the economic data going forward tell us that we are taking up excess capacity more quickly than expected, we would have to reduce monetary stimulus more quickly. But if the data suggest that the return to full capacity is going more slowly than we thought, we would then need to move more slowly. Allow me to close by using the familiar car analogy. Over the past year we put our foot on the gas to help us get up the hill of economic difficulties. The prudent thing now, as we return to more normal driving conditions, is to ease off on the gas—ease off, not slam on the brakes—to make sure that we continue our journey along the highway at a safe cruising speed. It is in line with this that we moved, on 16 April, to raise the target for the overnight interest rate by 25 basis points.
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Remarks by David Dodge, Governor of the Bank of Canada, at a luncheon at the Canadian Consul General's residence Chicago, Illinois, 9 May 2002.
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David Dodge: Review of Canada’s recent economic performance and prospects Remarks by Mr David Dodge, Governor of the Bank of Canada, at a luncheon at the Canadian Consul General's residence Chicago, Illinois, 9 May 2002. * * * Thank you for the invitation to this luncheon and for the opportunity to speak to you this afternoon. I want to take this time to review Canada's recent economic performance and prospects and to hear your views as to how you see things evolving in the U.S. economy. Canada's recent economic performance In Canada, the economic weakness that we experienced was really concentrated in the third quarter of last year, particularly in September. The terrorist attacks in September created a great deal of uncertainty, and so the Bank of Canada, like the U.S. Federal Reserve, provided an extraordinary amount of stimulus by aggressively lowering interest rates. But with the improvement in the geopolitical situation, consumer confidence recovered rapidly, and consumers responded strongly and quickly to the monetary stimulus. Interest-sensitive sectors, such as housing and automobiles, showed remarkable strength. As a result, we saw annualized growth of 2 per cent in the fourth quarter of last year, when many analysts were expecting the Canadian economy to continue to shrink. Canada's economic outlook In the Monetary Policy Report, which we published a couple of weeks ago, we forecast growth in the first half of this year of between 3 1/2 and 4 1/2 per cent at annual rates, although data released since then suggest that the first quarter may have been slightly stronger than we had thought. Second-half growth is expected to be in a range of 3 to 4 per cent. With growth at the end of last year and early this year being stronger than we had earlier assumed, the economy is operating at a higher level than anticipated. Indeed, this strength led us to sharply raise our forecast for average annual growth this year. In the Monetary Policy Report Update published in January, we pegged average annual growth for 2002 at just over 1 per cent. When we published our full Report in April, we raised that forecast to between 2 1/4 and 3 1/4 per cent. With the economy now operating at a considerably higher level, the gap between the actual level of economic activity and the level of potential output is smaller than we had predicted, and is currently narrowing. We now expect that the output gap will close in the second half of 2003. In these circumstances, our job will be to gauge the strength of the economy as it approaches its capacity to produce and to reduce the amount of monetary stimulus in place in a timely and measured manner. What do we mean by those terms? "Timely" relates to the fact that there is always a lag between our policy actions and their effect on the economy. We must be timely because our actions take a year to 18 months to have their full effect on output, and 18 months to 2 years to have their full effect on inflation. "Measured" relates to the judgments that we will make as we approach full capacity. If the economic data going forward tell us that we are taking up excess capacity more quickly than expected, we would have to reduce monetary stimulus more quickly. But if the data suggest that the return to full capacity is going more slowly than we thought, we would then need to move more slowly. There are still important risks and uncertainties in the outlook. Some are working on the upside and others on the downside. Given the amount of monetary and fiscal stimulus in the economy, output growth could be even stronger than projected. But it is also possible that some of the recent strength in spending on consumer durables may have been borrowed from the future, so that the growth of household expenditures may be weaker than expected. At the same time, there is still considerable uncertainty about the timing and strength of the pickup in business investment in North America, mainly because of the continued weakness in profits. Moreover, recent developments in the Middle East could have implications for crude oil prices and the global economy. The Canadian and U.S. situations On 16 April, Canada became the first G-7 country to raise interest rates following the most recent economic slowdown. Central banks should always tailor their monetary policies to their own circumstances. And while Canada faces many of the same risks as the United States, there are some differences in our situations that are worth noting. Although the first-quarter national accounts data are not yet out in Canada, we expect that final demand has made up a larger share of Canada's growth in the first quarter, while the contribution to growth from inventories constituted a smaller share than in the United States. It is always difficult to measure excess capacity with precision. However, it is clear that the Canadian economy is now nearer its level of potential than we expected it to be just a few months ago. The key issue facing both the U.S. and Canadian economies is business investment—when it will resume and how strong that pickup will be. In this context, I would certainly be very interested to hear your views on the situation here in the Midwest, and in the United States as a whole. As I recently said to our Parliamentary committees, we see two or three key differences in the Canadian and U.S. situations. First, it is clear that there was a tremendous buildup of capacity in the telecommunications and information technology sectors in recent years, and some analysts expect that it will likely be well into 2003 before we see any recovery in investment there. But I would note that these sectors represent a smaller proportion of the Canadian economy than the U.S. economy. The second issue we have noted is that small- and medium-sized firms tend to be more bullish about their outlook and investment intentions than large, multinational firms. I'd certainly be interested in hearing your perspective on this. But again, I'd point out that these smaller companies make up a larger share of the Canadian economy than of the U.S. economy. The final point I made to the committees has to do with the potential impact of higher oil and natural gas prices on investment. While higher oil and natural gas prices stemming from developments in the Middle East could hurt consumers, they could lead to much greater drilling and exploration activity in Canada. Of course, that sector remains a significant part of our economy.
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Speech by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Club of Ottawa and the Canadian Institute of International Affairs, Ottawa, Ontario, 14 May 2002.
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David Dodge: International financial architecture and the resolution of financial crises Speech by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Club of Ottawa and the Canadian Institute of International Affairs, Ottawa, Ontario, 14 May 2002. * * * I am pleased to be here today to talk about the Bank of Canada's contribution to international financial stability and the resolution of financial crises. The preamble to the Bank of Canada Act calls on us to promote the economic and financial welfare of Canada. In this context, we aim to foster good economic performance through monetary stability—that is to say, through low, stable, and predictable inflation. But no market economy can function properly unless it is also supported by an efficient and stable financial system. Sound financial institutions, a robust infrastructure, and well-functioning financial markets are necessary to facilitate transactions and to properly channel savings into investments. This is true for Canada's domestic economy. But in today's interconnected world, it is equally true for the global economy. Recent experience has shown that world events can have serious repercussions on national financial markets, including ours, and indeed on our entire economy. The Mexican crisis of 1994–95 and the Asian and Russian crises of 1997–98 are cases in point. In both instances, Canada was sideswiped. And while the recent acute economic and social problems in Argentina have not had a major economic impact beyond that country's borders, they have nevertheless had implications for Canadian banks operating in, or holding claims on, Argentina. So Canadians have more than a passing interest in a healthy global financial environment. Sound macroeconomic policies and sound financial systems across all countries are becoming even more important as the world becomes more and more integrated. The episodes of financial stress that the world has experienced in recent years have revealed weaknesses in the foundation of the international financial architecture. Those problems have to be addressed, and the foundation fortified, if we want to reduce the incidence and the impact of global financial disturbances. In the aftermath of the crises of the late 1990s, the international community has acted to identify and to begin to deal with financial vulnerabilities. Canadians have been actively involved in this work. And we at the Bank of Canada have played our part. The Bank participates in several international forums where issues of financial stability are being debated. And we work closely with others to strengthen the international financial architecture by developing frameworks for the prevention, management, and resolution of crises. Today, I would like to update you on some of the progress that has been made to date and on what remains to be done. But before doing that, it is important to briefly review the lessons we have learned, or ought to have learned, from recent financial disturbances. Crisis prevention—lessons and progress What are some of the factors that led to the serious problems experienced by Mexico, a number of Southeast Asian countries, Russia, Brazil, and, more recently, Argentina? In various combinations, there were large current account and fiscal deficits, heavy reliance on short-term borrowing, weak banking systems, poor risk management, overvalued exchange rates, and lack of transparency in fiscal, monetary, and financial policies. Moreover, the presumption that the international community would come to the rescue if things turned sour, appeared to offer some form of protection to emerging-market borrowers and lenders. This distorted market signals and encouraged overborrowing and overlending. So what has been done, and what can be done, to minimize the risks of future crises? A sound macroeconomic policy framework It is now broadly recognized that sound and credible macroeconomic policies are the best defence against financial crises. As we know from our own experience in Canada, this means a fiscal policy focused on keeping public sector deficits and debts on a sustainable track and a monetary policy focused on keeping inflation low and stable. A viable macroeconomic framework for growth requires that both fiscal and monetary policies be credible. But many emerging-market countries lacked credibility. To provide an anchor for their policy framework, they chose to peg their currencies to another major international currency or a basket of currencies. But a peg can only provide temporary credibility. And when countries fail to develop appropriate fiscal, monetary, and regulatory policies, even small economic shocks can put pressure on the peg. Markets can then begin to question the authorities' commitment to the peg, and domestic and foreign investors can rush for the exits, triggering a crisis. In fact, that is exactly what happened in those economies that ended up in trouble during the past decade. So, many of these countries were forced to abandon the peg as an anchor and had to opt for a flexible exchange rate. But an anchor is still needed. Otherwise, the freedom of the currency to float could undermine confidence in its value, both at home and on world markets. Targets for domestic inflation provide such an anchor for the currency. In the last few years, a growing number of emerging-market economies have moved to flexible exchange rate regimes, and have also adopted inflation targets. In several cases, Canada has played an important role in that process. Because of our long experience with flexible exchange rates and our strong reputation in inflation-targeting, several emerging-market central banks have asked for the Bank of Canada's assistance in developing and operating frameworks based on inflation targets. A robust financial infrastructure Another important lesson drawn from recent crises is the need for a strong financial infrastructure. Weak banking systems were at the heart of nearly every one of the recent financial crises. To perform well their important role of intermediating between lenders and borrowers, banks and other financial institutions need to work within a strong framework—a framework distinguished by clear accounting and disclosure standards, appropriate regulatory and supervisory practices, and well-defined bankruptcy rules. In many cases, these institutional arrangements were found wanting. The international community has done a lot to contribute to the strengthening of financial systems in emerging-market economies and to improve risk management in major industrial countries. International groups, such as the Bank for International Settlements (BIS), the International Monetary Fund (IMF), the Group of Twenty (G-20), and the Financial Stability Forum (FSF), have worked hard to establish globally accepted guideposts—codes and standards—for the sound operation of financial institutions and systems. But guideposts are not much use if they are not followed. So it was also essential to develop the means for assessing adherence to key standards and for public disclosure of important economic and financial information. If there is a lasting lesson in recent history, it is that we need greater transparency. Better and more timely data should lead to more informed judgments about how risky certain investments are. And this should help avoid the crises that can be set off by the sudden revelation of problems. As I said earlier, the Bank of Canada and the Government of Canada have fully participated in, and contributed to, many of these initiatives. I would highlight, in particular, our involvement with the FSF and with the G-20, until recently chaired by Finance Minister Paul Martin. The Office of the Superintendent of Financial Institutions and provincial securities commissions have also been working with the FSF and with the BIS to identify system-wide weaknesses and to develop worldwide financial standards and codes. The Bank of Canada, together with the Bank of England, has also been promoting the idea of clear, upfront limits on official lending (that is, lending from international financial institutions, such as the IMF) as a means of conditioning the expectations of creditors and borrowers and thus helping to prevent crises. I will have more to say about this in a moment. Before I move on, let me add that, in the context of assessments of how well countries are doing in strengthening their financial systems, Canada was the first industrial country to place its financial system under IMF scrutiny. And we passed with flying colours. Of course, this does not mean that we can afford to rest on our laurels. On the contrary, it is vital that we continue to look for ways to improve the efficiency and soundness of our national financial systems. Crisis management and resolution: a work in progress with lots still to do As you can see, important preventative actions have been taken to reduce the risk of future crises. But of course, even with the best preventative efforts, we will not totally eliminate the possibility that, from time to time, there will be a crisis in some part of the world because of one shock or another. As I said before, when there is a shock, national macroeconomic policies must be adjusted in response. But this takes time. And where policies are not particularly credible and markets are getting jittery, the prospect of adjustment down the road may not be enough to restore confidence in the short run. So domestic and foreign investors and creditors may have a strong incentive to pull their funds out of the affected country. This could precipitate a crisis. If creditors can be encouraged to stay put and to negotiate a solution in an orderly fashion, it would be in their collective interest as well as that of the whole international community. But how can this best be accomplished? This has proven to be a rather contentious issue, with the debate centered on the proper roles and responsibilities of the official and private sectors in crisis management and resolution. The key question here is how much emergency assistance should be presumed to be available from the official sector and how much should be left for private debtors and creditors to sort out by themselves. Traditionally, the IMF has been the main provider of emergency official assistance to a country that runs into financial difficulties. But IMF resources are limited. And when debtors or creditors presume that there will be large official bailouts, there is the possibility of "moral hazard"—debtors have less incentive to make adjustments, and creditors feel less pressed to use effective risk management. More importantly, with no limits on official money, there is less motivation for creditors to be careful with risk assessment when loans are made. And there is little motivation for early, serious discussions between a debtor and its creditors when problems begin to arise. In fact, the only serious motivation comes when the crisis is full-blown and official money runs out. Clear limits would encourage better risk assessment, earlier negotiations, and conceivably, a quicker and more orderly resolution of the crisis. Of course, one could eliminate official assistance altogether and leave debtors and creditors to work it all out on their own. But with no official lending, disorderly defaults could occur more frequently, resulting in unnecessary output losses and financial-system disruptions in the affected countries and elsewhere. Over the past couple of years, the Bank of Canada and the Bank of England together have developed a "middle ground" approach, designed to encourage private lenders to work closely with debtors to find timely, orderly solutions. In our joint work with the Bank of England, we set out a framework for the resolution of international financial crises. This framework has three basic elements. First, official assistance should be limited, and the limits should be well known in advance. (These limits are often referred to as the "presumptive limits.") The second key element of our approach is the possibility of exceptional official lending in the unlikely event that a crisis threatens global financial stability. But such lending would be based on explicit criteria and procedures. Third, it is recognized that, under certain conditions, an orderly standstill (that is, a temporary suspension of debt-service payments) may be appropriate to give distressed debtors some time to take steps, including debt rescheduling, to address their problems. In addition, the framework encourages greater use of what is known as "collective-action clauses." These clauses are intended to discourage "rogue" creditors from blocking or rejecting a reasonable offer for debt restructuring. Such a framework, by providing greater clarity upfront about the size and terms of the official assistance available, allows debtors and creditors to form more realistic expectations. In so doing, it helps to prevent crises; and, should they occur, it creates the right incentives for their timely resolution. In many international forums—IMF, G-20, G-7—Canada has been working hard to encourage the adoption of such a framework. And last month, G-7 finance ministers and central bank governors adopted an Action Plan that aims to address many of these issues. The current problems in Argentina have served as a catalyst to refocus the attention of the international community on what was needed "to increase the predictability and reduce the uncertainty about official policy actions in the emerging markets." The G-7 Action Plan identifies the key elements of a successful framework for crisis prevention and resolution, and how these elements fit together to help align incentives for debtors and creditors. First, it recognizes the need for limits on official lending. Second, it recognizes the need for rules in loan contracts to allow a cooling-off or standstill period and prevent small groups of creditors from blocking a reasonable restructuring deal. The Plan also encourages the IMF to continue its important work to find some mechanisms for sovereign debt restructuring analogous to domestic corporate bankruptcy procedures, such as Chapter 11 in the United States and the Companies' Creditors Arrangement Act (CCAA) in Canada. The G-7 countries have pledged to work with borrowers and creditors to make sure that these ideas can be effectively put into practice. Clearly, a lot more needs to be done, including work on operational and legal issues. But let us not lose sight of why this work is important. The Action Plan, by helping to reduce the incidence of financial crises and to better resolve them when they do occur, will create conditions that encourage sustained and sustainable growth of private investment in emerging-market countries, thus helping to raise their living standards. Concluding thoughts To conclude, considerable progress has been made in defining the elements of a strategy to reduce the incidence of crises in the future. When it comes to crisis management and resolution, the international community is still hard at work. Many issues on how to put in place a framework for promoting orderly debt restructuring remain outstanding. But significant progress is being made. The stakes are high—not only because of the economic costs, but because of the social costs and the human suffering caused by financial crises. And, in an increasingly integrated world, more than ever, we are all in this together.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Greater Halifax Partnership, Halifax, Nova Scotia, 11 June 2002.
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David Dodge: Trust, transparency and financial markets Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Greater Halifax Partnership, Halifax, Nova Scotia, 11 June 2002. * * * Thank you for the invitation to speak to you today. It is a pleasure to come to Halifax and see the exciting things happening in this city and this province. I’d like to congratulate the Greater Halifax Partnership for its role in community development. You have been recognized for your outstanding work in community economic growth, and your innovative approach makes this partnership a model for private and public sector co-operation. Financial market efficiency My remarks today will concentrate on two themes. Later on, I want to talk a bit about the Bank of Canada’s view of the economy. But first, I would like to address an important subject; that is, how to promote the efficient operation of Canada’s financial markets. Rather than approaching this topic in a detailed, technical way, I want to speak about two qualities that are essential to their efficient operation: trust and transparency. Let me take a few minutes to describe why these qualities are important to the Bank. I think this can provide a good illustration as to why these same qualities are equally important for the private sector, particularly in light of Enron, and related questions about corporate practices. I will start with a quick definition of what I mean by trust. It’s a term that’s closely related to two other very important words: confidence and credibility. Trust, as I will use the term today, is more than a simple belief in something or someone without supporting evidence. Trust is what develops when a group of people share an understanding that the rules for behaviour governing their system or society work well and make things better for everyone. With trust, less effort is expended in keeping tabs on others, so systems can run more efficiently. With trust, people can develop confidence that others will, in fact, do what they say they will do. And over time, as trust builds, so does the credibility of those who are trustworthy. I can tell you from our own experience that trust is an important enabler for all of the Bank of Canada’s key functions. And nowhere is this more true or more relevant than in the conduct of monetary policy. We have worked hard over the past decade or so to build up trust in our policy of explicit inflation targets. And this effort has been bolstered by our moves towards greater transparency. The economic benefits of establishing trust During the 1970s and 1980s, the Bank of Canada had ample experience with operating in an environment where Canadians had significantly less confidence in the Bank’s ability to safeguard the domestic value of the currency. Inflation was choppy and unpredictable, and the Bank of Canada was struggling to come up with an appropriate anchor for monetary policy. However, in recent years, Canadians have gained confidence that we will keep inflation low, stable, and predictable, thanks to our system of explicit inflation targets and our success in meeting them. This trust can be thought of as a kind of social capital—a shared asset that benefits everyone, including the central bank. This capital is very valuable and must not be squandered. What does this have to do with efficiency? Quite a bit. If you think back to the 1970s and 1980s, people spent a great deal of time and effort trying to hedge against inflation. Resources that should have been put to more productive uses were spent devising ways to protect the value of savings. Then, in 1991, the Government of Canada and the Bank agreed on a system of explicit inflationcontrol targets. As you may know, under the current agreement our target is the 2 per cent midpoint of a 1 to 3 per cent band for the total consumer price index. Since we adopted this inflation-control system we have been consistently successful in meeting the target. As a result, inflation expectations have fallen in line with the target and are now well anchored, not just for the near term, but well into the future. With this trust in place, this social capital earned, the list of economic benefits for Canada is long indeed. Less time, energy, and money is being spent on protecting oneself against inflation. Labour and financial contracts have lengthened, while the amount of time lost to strikes and lockouts has dropped. What is more, the dynamics of the inflation process have been changed, to the point that inflation itself has become much more stable and predictable. Inflation expectations are less vulnerable to swings in the external value of the Canadian dollar, and to changes in key energy prices. All this allows the Bank to conduct monetary policy more easily. And it allows financial markets and businesses to operate more efficiently. Of course, the economy has also undergone a number of other necessary changes, including a massive restructuring of the private sector and a restoration of fiscal health. Together, these changes have led to better economic performance. Transparency supports the system Before I move on, I want to say a few words about transparency. Like many other major central banks, we have embraced the notion that it is better for the conduct of monetary policy if people can understand what their central bank is thinking and why. The Bank of Canada has dramatically increased the number of opportunities for updating Canadians on the economic outlook. We use our four Monetary Policy Reports and Updates, as well our eight fixed announcement dates each year, to share our thinking on the economy. We want Canadians to have a good grasp of what our goals are and of the framework we use to achieve those goals. Our explicit inflation target gives Canadians a yardstick for measuring how their central bank is doing. In our view, the less flexible the yardstick, the better. It is one thing to have a goal of “low inflation” or “price stability.” But the Bank and the Government of Canada agree that it is much more effective to have an explicit target for inflation so people know if we are meeting our commitment. So the result of all this effort at increased transparency is to give people a clear yardstick they can use to measure performance. All of this enhances the Bank’s accountability and reinforces the trust we have fostered through inflation targeting. After all, it’s a lot easier to have trust in an institution if it is open about its goals and strategies, and if it offers a clear way to measure its performance. Trust and the private sector This is relevant not just to central banks but to the entire business and financial community. Trustworthy business standards are one of the most important forms of social capital. Trust is paramount to the efficient operation of financial markets. And financial markets are a key ingredient of a well-functioning economy. This trust includes confidence in the players involved—the people who run the companies, and those who watch them. It also includes trust that the information required to make sound investment decisions is disclosed fully and accurately. Moreover, the disclosure must be fair—there must be confidence that insiders are not trading on information not available to everyone. Only when all these components of trust are in place can we have healthy, efficient financial markets that benefit everybody. Generally speaking, these components are in place in Canada. But the Enron collapse in the United States reminds us here that we cannot be complacent about our own situation. So what is lost when something like Enron occurs? Skepticism sets in about the truthfulness of routine financial disclosures. Companies find it more expensive to raise funds because once trust is broken, fewer investors are willing to participate, and those who remain demand a premium for the increased risk of being misled. A lack of reliable information also leads investors to make poor investment decisions, so capital is misallocated. In short, financial markets operate less efficiently, with fewer benefits for everyone. Avoiding a widespread loss of trust requires a systematic and coordinated effort to fix the flaws and weaknesses that can undermine investor confidence. It is important that there be a set of reasonable rules—so that chief executives, boards, and their auditors truly and fairly disclose the financial position of public companies—and that the investing public can rely on the truth, fairness, and completeness of that disclosure. Now, in spite of the specific flaws that the Enron collapse has revealed, it has become clear that much of the public’s confidence in the efficient operation of financial markets remains intact. But we must continue to be vigilant. Restoring confidence Financial statements form the foundation on which financial markets operate. I have already spoken of the way that a clear yardstick has helped the Bank improve its transparency. The same idea holds true for financial statements. Clear and accurate corporate reporting, together with other reliable information for investors, are essential. Equally importantly, information must be presented in a straightforward manner. Earnings reports should be used to disclose information, not bury it. We can’t pretend that hundreds of complicated pages lead to the type of disclosure that facilitates efficiency. Next, confidence must be constantly earned by corporate managers and directors, auditors, analysts and investment advisors, rating agencies and regulators. Reputations have been threatened by events like Enron, and by the suspicion that some insiders have been feathering their nests at the expense of shareholders. Obviously, it is wrong for analysts who actively own shares in a firm to use their assessments to promote that firm. But there can be more subtle conflicts of interest that don’t involve illegal or fraudulent activity—for example, auditors who are not truly independent of the companies they audit. Risk assessment is another issue that needs more attention, particularly by companies outside the financial sector. This involves more than just listing in a financial filing all the things that could go wrong. Companies need to tell investors how they are handling both the external risks that they face and the risks they have chosen to take on as part of their business strategy. After all, investors are required to sign a form that tells their broker about their risk tolerance before they buy a stock. Surely then, the company issuing that stock should be able to give those investors some honest disclosure of their assessment of the risks involved in that investment. The fallout from Enron has prompted debate about the need for tougher financial market rules. If it is determined that new rules need to be written, they must not be picayune regulations that simply give the unscrupulous a roadmap to evade the spirit of the rules. It is the observance of the spirit as well as the letter of the regulations that we all must aspire to achieve. And when unscrupulous market participants or practices are revealed, authorities must come down on them with full force. To do otherwise is to do markets a disservice. Only strict reprobation will restore and maintain confidence that the rules are being enforced. Regulatory and supervisory bodies around the globe have begun to deal with the fallout from Enron and other high-profile bankruptcies. In the United States, the Financial Accounting Standards Board is looking at proposals to determine when so-called “special-purpose entities” should be consolidated on company balance sheets. The Securities and Exchange Commission has proposed new rules for more detailed and timely corporate disclosure. Here at home, the Canadian Institute of Chartered Accountants (CICA) has asked its Accounting Standards Oversight Council to closely monitor the accounting and financial reporting issues raised by Enron. The CICA is also looking at ways to boost auditor independence. I am also aware that the accounting profession and its regulators are working to develop an oversight body to promote highquality audits of public companies. The Toronto Stock Exchange has made changes to its guidelines for effective corporate governance. Parliamentary committees such as the Senate Banking, Trade and Commerce Committee have also launched their own investigations into the Canadian market post-Enron. The market is responding We have seen much self-evaluation by market participants in recent months. I am very encouraged by how seriously these issues are being taken. The market is enforcing its own discipline. Corporate boards are re-examining their roles and taking a closer look at what is being done in their companies. Investors are demanding greater reconciliation between pro forma financial statements and generally accepted accounting principles. Major firms, in response to those demands, are changing their corporate reporting methods. For example, some firms have announced plans to include, as an expense, the cost of executive stock options. And Standard and Poor’s has introduced new benchmarks for reporting corporate earnings. Those changes aim to more accurately describe the revenues and costs associated with companies’ primary businesses. We feel steps like these are helpful in advancing the debate about the most fair and accurate methods for reporting a company’s true financial state. These are all positive examples of participants working together to enforce the spirit—not just the letter—of the rules under which financial markets operate. In the end, everyone needs to have trust in the financial markets—to know that the right rules are in place and that those rules are being enforced. We must continue to build on that social capital, to promote the efficient operation of financial markets, and the benefits that those markets can bring to everyone in society. The current outlook for the economy Now, I would like to say a few words on the Nova Scotia economy. Like the rest of Canada, Nova Scotia’s economy has proven to be stronger than expected over the past year. Indeed, Statistics Canada reported last week that the province’s employment rate has returned to an all-time high in May. Nova Scotia was buoyed by strong offshore oil and gas production last year. The study commissioned by the Greater Halifax Partnership paints an exciting picture of the future impact of offshore development. The province has also been making important strides in building other sectors to diversify its economy, and this bodes well for the future. We’ve seen tremendous expansion in the information technology and life sciences sectors. That includes commercializing some of the excellent research being done at Nova Scotia universities and fostering technology companies to capitalize on the province’s telecommunications infrastructure. Turning to the outlook for Canada as a whole, the economy has been growing robustly—expanding at an annual rate of 6 per cent in the first quarter—well above expectations. And this has been reflected in the extraordinary number of jobs created since the beginning of the year. Employment has grown by almost a quarter of a million jobs in the past five months. Canada is demonstrating clear economic momentum. Consumer spending, particularly on interestsensitive items, continues to show strength. Business investment is no longer acting as a drag on growth, and there are signs of the beginnings of a recovery in investment in machinery and equipment. Corporate profits are rebounding, which should continue to support business investment. While this domestic performance bodes well, geopolitical uncertainties and weaker profits among large multinational firms may inhibit a strong rebound in investment around the world for a period of time. Let me sum up. Canada’s economy is growing at a faster pace, and is operating at a higher level, than had been anticipated. And this means that it is moving towards full production capacity more quickly than we had expected. Core inflation has also been running slightly higher than we anticipated, at 2.2 per cent in April. Against this backdrop, last week, the Bank raised its target for the overnight rate by 25 basis points to 2.50 per cent. This was the second increase in the target rate, aimed at withdrawing some of the substantial amount of monetary stimulus in the economy. With the domestic economy showing strong momentum, the Bank will take whatever action is necessary to keep inflation near its 2 per cent target over the medium term. And that is the best contribution the Bank of Canada can make to promoting a strong, sustainable economy for all of Canada.
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, on the release of the Monetary Policy Report Update, 24 July 2002.
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David Dodge: Economic and financial trends in the context of Canada’s inflation-control strategy Opening statement by Mr David Dodge, Governor of the Bank of Canada, on the release of the Monetary Policy Report Update, 24 July 2002. * * * Today, we published our Update to the April Monetary Policy Report, in which we discuss economic and financial trends in the context of Canada’s inflation-control strategy. Canada’s economic recovery, which began in the last quarter of 2001, gathered momentum in the first half of 2002. Over the period to the end of 2003, the Bank projects continued solid economic expansion at an annual rate of 3 to 4 per cent. This will result in growth of close to 3 1/2 per cent on an annual average basis in 2002 and in 2003. Both the total and core rates of inflation are projected to be slightly above 2 per cent in the second half of 2002, before steadying out at close to 2 per cent in 2003. Given that the Canadian economy grew at a faster pace than anticipated in the first half of 2002, there is now less excess capacity than was projected in our April Report. The economy is expected to be operating at full capacity in early 2003 - sooner than previously anticipated. In light of these developments, the Bank has continued to reduce the amount of monetary stimulus in the economy, raising the target for the overnight interest rate by 25 basis points on three occasions in April, June, and July - to bring the rate to 2 3/4 per cent. It remains the Bank’s view that the underlying economic situation will require further reductions in the amount of monetary stimulus. The timing and pace of policy adjustments will depend on the strength of the various factors at play and their implications for pressures on capacity, and thus on inflation. There are both upside and downside risks to the outlook for Canadian economic growth. On the positive side, growth of domestic demand could turn out to be stronger than projected because of the substantial amount of monetary stimulus still in place. On the negative side, there are the uncertainties associated with global corporate and financial market developments and their potential effects on confidence and world economic growth. At this time, the risks to our projected rate of growth of 3 to 4 per cent growth appear to be balanced. As we go forward, the Bank will remain focused on taking actions to achieve the 2 per cent inflation target. Keeping inflation low and stable is the best contribution that monetary policy can make to sustained economic growth in Canada.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, 31 August 2002.
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David Dodge: Macroeconomic stabilization policy in Canada Remarks by Mr David Dodge, Governor of the Bank of Canada, to a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, 31 August 2002. The references for the speech can be found on the Bank of Canada’s website. * * * What I propose to do on this panel today is to talk about stabilization policy and policy co-operation from the viewpoint of an industrial country that has a floating exchange rate and both an explicit inflation target for monetary policy and a clear objective for fiscal policy. While my perspective has been particularly influenced by my time as Deputy Minister of Finance and now as Governor of Canada’s central bank, the broad outlines of my conclusions are widely shared, not only in those two institutions, but in Canadian academic and public policy circles as well. Moreover, I believe that our experience and the lessons that can be drawn from it are applicable to all open economies with flexible exchange rates. In the 1990s, the Bank of Canada and the Government of Canada reached a series of joint agreements on inflation-control targets. As well, the government established a framework that greatly reduces the probability of running a fiscal deficit and thus puts the debt-to-GDP ratio on a clear downward track. Initially, the credibility of these policies was not high; so it was essential to demonstrate clearly our resolve to achieve greater fiscal prudence and lower inflation until credibility was gained. Thus, it was sometimes necessary to override the automatic stabilizers of fiscal policy in order to establish credibility. And for monetary policy it meant that we could not always implement the easing warranted by our inflation targets. But as the targets were achieved, the public’s trust that the authorities were going to do what they said they would do increased. That trust is tremendously important. Now that the credibility of both monetary and fiscal policies is firmly established, the stabilizers are able to do their job. I would like to begin by considering stabilization policy, then say a few words on policy co-operation. Stabilization Policy Monetary policy and stabilization In aiming to achieve a 2 per cent inflation target over an 18- to 24-month horizon, Canadian monetary policy plays an important role in stabilizing the economy in response to demand and supply shocks. When there are shifts in demand, the direction of changes in our policy interest rate is quite clear. Suppose that the economy is operating at its production potential and that inflation is at the 2 per cent target. A downward shift in demand would create excess supply in the economy, putting downward pressure on inflation. To bring inflation back to 2 per cent over a period of 18 to 24 months, the Bank of Canada would lower its target for the overnight interest rate. Through its effect on market interest rates and the exchange rate, this action would increase the level of output in the economy, moving it back towards production potential. Inflation would, therefore, return to the target shortly after the excess supply disappeared from the economy. An upward shift in demand would, of course, generate symmetric responses. While the theory is clear about the appropriate response to demand shocks, the magnitude and persistence of shocks—and hence the size and timing of interest rate adjustments—are always difficult to judge. This is where the art of monetary policy-making comes into play. It is even more difficult, of course, to gauge the appropriate monetary policy response to supply shocks—which take the form of higher (or lower) inflation than expected for a given level of demand. The interaction of fiscal and monetary policies is covered more fully in Dodge The Bank’s framework for inflation targeting allows temporary supply shocks to be largely ignored, as long as they do not feed into inflation expectations. The credibility that has been established means that they typically no longer do so. Consider price surprises coming from the most volatile components of the consumer price index—components such as fruits and vegetables or fuel oil and natural gas. As our operating guide, we use a measure of core inflation that excludes these components. This gives us, and economic observers, some confidence that we are looking at something close to the underlying trend of inflation. Thus, our interest rate response to price shocks that are perceived to be temporary can be minimal. As a result, there will be little effect on output. In other words, monetary policy does not turn temporary supply shocks into something that is destabilizing for aggregate output. A more difficult situation occurs when persistent increases or decreases in prices coming from the most volatile components of the consumer price index threaten to keep the total index away from the target for a significant period of time. Credibility helps here too, but the Bank must be particularly cautious that these movements in inflation do not feed into inflation expectations. Supply shocks that take the form of a change in the level, or growth rate, of potential output are often hard to recognize. Here, however, the key is for the central bank to return the trend of inflation to the target if it has moved away. Since the trend of inflation relative to the target is the best indicator of where demand is relative to potential output, this will be consistent with moving demand back into line with the new path of potential output over the medium term. Fiscal policy and automatic stabilization In Canada, the main automatic fiscal stabilizers are various types of tax revenues, as well as employment insurance payouts. Some of these fiscal stabilizers work almost immediately—for example, personal income tax deducted by the employer. Others, such as employment insurance payments, work with a fairly short lag. Comparing and contrasting automatic fiscal and monetary stabilizers Automatic fiscal stabilizers are very effective in dampening an output cycle. But they offset only part of the change in output. In contrast, monetary policy can fully offset a change in output, but it takes time to work, with the full impact on output normally felt only after 12 to 18 months. Discretionary stabilization policy While the automatic or quasi-automatic stabilization provided by monetary and fiscal policies is very desirable, the question remains as to whether there is a role for something further—a discretionary stabilization policy. In the case of monetary policy, the nature of the response is the more or less automatic one described earlier. As I implied then, judgment is key to the process. That is particularly true in times of great uncertainty, such as last autumn. But a clear inflation target means that, in principle, the discretionary choice for monetary policy-makers is limited relative to that of the fiscal authorities. The arguments for and against discretionary fiscal policy as an important element in macroeconomic stabilization in an open economy tend to revolve primarily around lags and around the effectiveness of short-run fiscal policy relative to monetary policy. If the timing were close to perfect, fiscal policy measures that lasted for two or three quarters could, in principle, and under ideal circumstances, shorten the time it takes to move output back to its desired level. Thus, in principle, discretionary fiscal policy is a useful tool. But, as a practitioner, I can tell you Some commentators have described inflation targeting as "constrained discretion," in the sense that there is a clear objective and a medium-term framework but no precise rule for varying the policy interest rate (Bernanke et al. 1999). That is, there are many possible paths back to equilibrium. At the Bank of Canada, we have decided that the best way to implement inflation targeting is to have an acceptable trade-off between the variance of inflation around its target and the variance of output around its production potential. Thus, we have chosen an 18- to 24-month horizon for achieving the inflation target. We take into account all the relevant information, but we have no simple rule for setting interest rates. that the great problem here is that temporary measures are both difficult to initiate quickly when the need arises and extraordinarily difficult to stop once the need is past. Thus, as a practical matter, not a philosophical one, there are some severe limitations to the use of 3 4 discretionary fiscal policy as a stabilizer. , My views about this have been reinforced by the way the business cycle in Canada has developed over the last 18 months or so. In early 2001, we were expecting that the slowdown in both the U.S. and Canadian economies would be modest. In Canada, an earlier announced tax cut was fortuitously coming into effect. It was not until the middle of last summer that it became evident that the Canadian economy was undergoing a more pronounced slowdown than we had expected. Between January and August 2001, we had lowered our policy interest rate by 175 basis points. Even the most ardent supporters of discretionary fiscal policy would not have thought about doing anything major until August. With the horrific events of 11 September, economic forecasters marked down their forecasts for 2001 and 2002 significantly. We, like other major central banks, accelerated the pace at which we were cutting interest rates—from September through January 2002, we lowered our policy interest rate by a further 200 basis points. Fortunately, the Canadian government added only a small amount to spending in its budget announcements in late 2001—and that consisted mainly of necessary spending for security and border issues. I say "fortunately" because, based on the national accounts published at the end of May 2002, growth in the Canadian economy actually rebounded in the fourth quarter of 2001 and accelerated to about 6 per cent in the first quarter of this year. Thus, with the benefit of hindsight, it is evident that there was more underlying strength in the economy than we expected. Combined with the large amount of monetary stimulus that was applied, this meant that the economy could recover rapidly. Therefore, added fiscal stimulus was not necessary to get the economy going. And the monetary stimulus provided is proving much easier to turn around. Since mid-April, we have raised our policy rate by 75 basis points. To be sure, other uncertainties have arisen and will continue to arise in the future. Our best judgment about these uncertain factors will continue to be taken into account. But, overall, this episode is clearly showing that monetary policy actions can be used more flexibly than fiscal policy actions. I would stress that discretionary fiscal policy can also get governments into trouble if it leads them to neglect their long-run fiscal anchor—particularly since discretionary action is more likely to be associated with an easing in policy than a tightening. This neglect would risk eroding fiscal credibility— the trust that the public has that the fiscal targets will be met. Policy Co-Operation and Stabilization Now let me turn to the issue of policy co-operation and policy coordination. Our inflation targets are joint targets. They are not just the Bank’s targets—they are the targets of the Government of Canada as well. Our view is that, essentially, "coordination" came through the joint agreement on inflation targets. With clear agreement on the medium-term policy objectives and with a shared understanding of the policy framework, there is no need for coordination on the setting of interest rates and fiscal policy instruments. The economic literature on policy coordination tends to be about situations where the fiscal and monetary authorities have one or more of the following: very different views of economic welfare, This is also the view of Cecchetti (2002) and Taylor (2000). For an opposing view, see Seidman (2001). Much earlier, Boulding (1969) summarized an academic session on recent experiences in the use of fiscal policy with a poem including the following lines, ". . . Policy may follow Fillip’s Law—Too little and too late, too much too soon . . . ." For the Canadian federal government, the limitation of discretionary fiscal policy as a stabilizer is compounded by the fact that Canadian provincial governments taken together represent a larger share of the economy than the federal government does, and their spending structure (which includes more spending on capital than the federal government) better lends itself to discretionary spending for stabilization purposes. That is, their "loss functions" are very different. inconsistent policy objectives, policy that is totally discretionary, or a tendency to get involved in gamelike behaviour with one another. None of these applies in Canada—and none should apply anywhere. Given our policy framework, when the government changes fiscal policy, it needs to think of how these changes will affect inflation and, consequently, interest rates. Similarly, the Bank of Canada needs to consider how changes in fiscal policy will affect demand and inflation, and thus its setting of interest rates. Therefore, it is to the mutual benefit of both parties to co-operate in sharing information and analysis as they adjust their policy settings. Co-operation between the Bank and the federal Department of Finance occurs on a number of levels. I have frequent discussions with the Minister and Deputy Minister. And there are meetings at the staff level to share, for example, information from economic forecasts, surveys, and contacts with various groups and organizations. One of the key reasons for our regular discussions has been to ensure that each institution understands the details of the framework within which the other one is pursuing its objectives and how this framework is being implemented with respect to current economic surprises. The Bank also keeps in close touch with provincial fiscal authorities. Thus far, I have not said anything about the appropriate mix of monetary and fiscal policies when talking about coordination and co-operation. Quite simply, with explicit frameworks in place for monetary and fiscal policies, the whole issue of policy mix becomes moot. The fiscal and monetary authorities are both adjusting their policy instruments to attain their respective objectives. There is no other mix of interest rates and fiscal thrust that the authorities will perceive as consistent with meeting the monetary and fiscal objectives. Concluding Thoughts Clear monetary and fiscal objectives, combined with clear accountability for meeting those objectives, provide the background for policy co-operation and stabilization in Canada. The monetary and fiscal policy frameworks have created an environment where co-operation in the form of sharing information and analysis is most effective. Fiscal and monetary credibility is high. In other words, economic agents trust that the monetary authorities and the fiscal authorities will maintain these frameworks. With trust in place and with expectations well anchored, the automatic fiscal stabilizers can be allowed to operate fully and monetary policy actions can be directed to achieving the inflation targets. In addition, when major shocks occur, with trust in place, there can be a temporary overshoot or undershoot of the fiscal or monetary targets without unhinging confidence in the framework or in expectations that the targets will be met over time. I believe that Canada’s experience and the lessons we have learned about having clear policy objectives and supportive, transparent policy frameworks have broad applicability in open economies with a flexible exchange rate.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, at the University of British Columbia, Vancouver, 18 September 2002
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David Dodge: Canada’s economic performance after an eventful year Remarks by Mr David Dodge, Governor of the Bank of Canada, at the University of British Columbia, Vancouver, 18 September 2002 * * * Good afternoon. I was delighted to accept your invitation to speak to you today. I’d like to spend some time reflecting on the evolution of the Canadian economy and what we as Canadians have achieved in the past few years. Then I will talk a bit about the outlook and the uncertainties facing the global economy, and how Canada’s successes on the fiscal and monetary fronts will help us weather those uncertainties. But first, I’d like to say how much I appreciate the chance to return to the University of British Columbia campus. Five years ago, I was here as a Senior Fellow in the Commerce Faculty. While my current job is different, there is one common thread that unites this institution and, indeed, all Canadian universities, with the Bank of Canada—a commitment to excellence in research. The Bank of Canada fellowship program Indeed, a strong research environment has long been a hallmark of the Bank. We also want to encourage research relevant to our business, especially with respect to monetary policy and financial system stability, at universities all across Canada. That is why I am very pleased to announce today that the Bank of Canada is launching a Fellowship Program to foster high-calibre research in crucial economic areas. The program will be open to professors at Canadian universities who have a record of high-quality research. The Bank fellowships will pay a salary stipend and provide funding for graduate research assistants and expenses. We plan to award two fellowships the first year, and one each year after that, for a total of six fellowships by 2007. We hope the program will expand the pool of leading-edge research conducted across this country and strengthen Canadian expertise in areas critical to our mandate, such as macroeconomics, monetary economics, international finance, and the economics of financial markets and institutions. Expanded research and a broader knowledge base will benefit the Bank of Canada, universities working to build strong economics departments and, indeed, all Canadians. And I am particularly pleased to be launching our Fellowship Program here, at a university that is committed to producing the type of ground-breaking analysis we hope to encourage. Improving the policy framework When I first arrived at UBC in the fall of 1997, Canada was completing a decade of struggle to get our economic policies right. During the period 1988 through 1997, we took some important steps towards improving both our monetary and fiscal policies. The Bank of Canada, responding to the high and unpredictable inflation rates of the 1970s and early 1980s, adopted at the end of the 1980s a monetary policy aimed at achieving price stability. To make this commitment more concrete, the Bank and the Government of Canada agreed in 1991 on a series of inflation-control targets aimed at bringing the 12-month CPI inflation rate down to 2 per cent - plus or minus 1 per cent - by December 1995. The decline in inflation was achieved in fairly short order - by January 1992, inflation was close to 2 per cent. The agreement has subsequently been extended three times, retaining the 2 per cent target midpoint. For almost ten years now, inflation has been well under control, and households and businesses now believe we will continue to achieve the inflation targets. Inflation expectations are well anchored, not just for the near term, but well into the future. Almost a decade of low inflation makes it easy to forget how difficult it was to achieve our inflation targets, and the economic price that was paid to achieve the tremendous benefits of low and stable inflation. Back when I was teaching here, federal and provincial governments were in the midst of the painful but necessary process of fiscal consolidation. The federal government had been working to curb the rising debt-to-GDP ratio, but it really wasn’t until 1995 that the government had done enough to tip the scales decisively toward deficit reduction. And it was 1997 before the cumulative effects of all those deficit-reduction measures put federal fiscal policy back on a sustainable track. The debt-to-GDP ratio at the federal level has since fallen to less than 50 per cent, from a peak of 71 per cent in 1995. And while some provinces are still struggling to maintain budget surpluses, all have taken important steps to put their fiscal houses in order. Governments and the Bank of Canada were working to get public policies - the fiscal and monetary framework - right. The private sector was also restructuring to take advantage of the opportunities provided by the Canada-U.S. Free Trade Agreement and to increase its productivity and competitiveness. It is not surprising that during those years of adjustment we had slower growth than the United States. But by the late 1990s, our economy was beginning to reap the benefits of those restructuring efforts. The end result of all this effort - the adoption of inflation targets, the fiscal improvement and the private sector restructuring - was that Canada’s economy became better able to weather major shocks such as the Asian crisis, or last year’s global slowdown. Indeed, over the period from 1997 to 2001, Canada averaged annual economic growth of about 4 per cent, while the U.S. average was about 3.5 per cent. And while the U.S. economy fell into recession last year, ours did not. Although the productivity growth of Canadian companies has not been as strong as that of firms in the United States, we have seen encouraging signs that investments in technology and training are leading to greater productivity gains here. Indeed, business sector labour productivity in Canada grew at an annualized rate of 2.0 per cent from 1997 to 2001, much higher than the 1.2 per cent average over the 1990-96 period, and only a bit below the revised 2.3 per cent rate of productivity growth recorded in the United States. As we look forward, we see positive signs for future productivity growth in Canada, thanks to the efforts of Canadian firms to adjust to new technologies and incorporate them into their business processes. The shocks of 2000-2001 Indeed, the economy has held up remarkably well when you consider that we have been hit with four major shocks during the past couple of years. First, there was the meltdown in the technology and telecommunications industries, which began in late 2000 and the effects of which are still being felt today. The second was the broader economic slowdown in 2001 that affected, to various degrees, the economies of most countries. Third, and overshadowing every other event last year, was the 11 September terrorist attacks. With the first anniversary just passed, this seems like an appropriate time to reflect on the extraordinary events that have buffeted the North American economies since that terrible day, and to review how the Bank of Canada responded to those events. Our most immediate responsibility was to keep Canada’s financial system functioning. Our next responsibility was to promote consumer and investor confidence. Therefore, the Bank of Canada took extraordinary monetary policy action. On 17 September last year, we reduced our key policy interest rate outside our scheduled announcement dates. Between September 2001 and January 2002, we lowered interest rates by a total of 200 basis points to help mitigate the impact of 11 September on an already-weakening economy. It turned out that consumer confidence in Canada was not as badly shaken as had been feared. As the immediate geopolitical and economic uncertainties diminished, consumers responded strongly and quickly to the monetary stimulus. Interest rate-sensitive sectors, such as housing and automobiles, showed remarkable strength. Indeed, in the fourth quarter of last year we saw annualized GDP growth of almost 3 per cent, when most analysts were expecting the Canadian economy to shrink. However, as we recovered from the 2001 slowdown and from 11 September, the U.S. economy was hit by a fourth shock - loss of confidence in the integrity of financial reporting and analysis as a result of Enron, WorldCom, and other accounting and corporate governance scandals. Unfortunately, the uncertainty caused by these problems in the United States has spilled over into other financial markets, including ours. This has created additional caution for businesses and appears to have delayed the expected recovery in investment worldwide. In spite of these four economic shocks, Canada’s economic performance has been, in comparison with other countries, rather good. Clearly, this has been a difficult year for the mining and forestry industries in British Columbia, for grains and oilseeds producers in the Prairies, and for the telecom industry across the country. But overall, our economy has consistently exceeded the average growth rates of the G-7 countries since 1997. And both the IMF and the OECD predict that Canada will post the strongest growth rate of the G-7 in both 2002 and 2003. I want to emphasize that Canada’s recent strong performance isn’t just good luck. It is the result of having a solid policy framework, both in terms of inflation and fiscal control. The benefits of this framework are well understood, not just by the government and the Bank of Canada, but by Canadians in general. We stuck to that framework during the recent economic turmoil, and we are now seeing a clear payback for the tremendous investment that Canadians made in opening this country to free trade, and in getting our macroeconomic framework right in the 1990s. That framework holds and will continue to serve us well. If anyone still needs convincing of that, Canada’s recent economic performance provides compelling evidence. Canada’s economic prospects Canada’s economic growth so far this year has exceeded expectations. Real GDP jumped by 6.2 per cent at annual rates in the first quarter of 2002 and rose by 4.3 per cent in the second quarter. The Bank of Canada believes that keeping inflation low, stable, and predictable is the best contribution monetary policy can make to strong and sustained growth in Canada. We run monetary policy in a symmetrical way. That is to say, we pay equal attention to persistent pressures that could move us away from our 2 per cent target - whether above or below. When strong demand pushes the economy against the limits of its capacity and threatens to raise future inflation above the target, the Bank will raise interest rates to cool off the economy and mitigate those inflation pressures. When demand is weak, as we saw in 2001, future inflation is likely to ease. So the Bank will lower interest rates to stimulate the economy, and absorb economic slack, consistent with keeping inflation on target. The significant easing of monetary policy during 2001 was a key factor behind the strong growth of household demand in the first half of this year. Let me now turn to the outlook. In our April Monetary Policy Report, we said that the recovery in the Canadian economy began sooner, and was considerably stronger, than anticipated. Consumer spending and residential construction were reflecting the stimulus from both monetary and fiscal policy. Canada’s export volumes had begun to grow once again, as the U.S. economy began to recover. By the time of our Monetary Policy Report Update in July, we were also seeing a rebuilding of inventories and an increase in spending on machinery and equipment. These were suggesting a broadening of the recovery across economic sectors. The July Update still reflects our view of the economy. As we said two weeks ago, domestic demand in Canada remains stronger than expected, bolstered by the substantial amount of monetary stimulus still in the economy. Canada’s record of job creation has been nothing short of remarkable, with almost 400,000 new jobs since the beginning of the year. This strong job growth is reinforcing the confidence of Canadian consumers. In addition, medium and small businesses continue to invest. All this paves the way for higher output and ongoing strong domestic demand. But at the same time, there are downside risks and uncertainties, mostly originating from outside Canada. Near-term prospects for growth in the United States and the major overseas economies appear to have weakened. Private and public sector economists have revised down their near-term growth forecasts for the United States, Europe, and Japan. This could imply that Canada’s exports, which were already slightly weaker than anticipated in the second quarter, could continue to be affected by slower growth in global demand. The geopolitical situation remains quite unsettled. Finally, in the United States and Canada, we are still working through the corporate governance issues that have contributed to this year’s financial market volatility. History has taught us that during periods of uncertainty, business and consumers tend to sit on their hands until the outlook is clearer. Let me conclude. It remains the Bank’s view that as the Canadian economy continues to expand and to approach capacity, further timely and measured reductions in the amount of monetary stimulus will be necessary. Let me remind you what I mean by “timely and measured.” “Timely” relates to the fact that there is always a lag between our policy actions and their effect on the economy. “Measured” relates to the judgments that we make at each fixed announcement date about the pace at which the economy is approaching full capacity, taking into account new information and data as they become available. Our current view is that the fundamental underlying strength of the Canadian economy has not changed since our July Monetary Policy Report Update. Domestic demand may well be stronger; at the same time, the external uncertainties bearing on the outlook appear to be greater than they were in early July. We will provide a detailed view of our outlook for the Canadian economy in our next Monetary Policy Report, on 23 October. ******************** This past year has certainly been full of challenges. Over the last decade, Canada has put in place the right macroeconomic policy framework to weather major shocks and take advantage of opportunities. We are confident that this framework will stand us in good stead in the future.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Chambre du commerce du Québec, Sherbrooke, Quebec, 5 October 2002.
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David Dodge: Dollarization and North American integration Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Chambre du commerce du Québec, Sherbrooke, Quebec, 5 October 2002. * * * Good morning, ladies and gentlemen. Thank you for inviting me to this Congress, and for choosing to spend part of your weekend listening to the discussion on this important topic. The question before us sounds straightforward: “should Canada adopt the U.S. dollar?” But the issues are complicated. I will not pretend that I can cover all the nuances of this topic in my allotted time. So I am running the risk that I may oversimplify matters. I should also say that I want to stick to economic facts and arguments. There is, of course, a big political dimension to the question, but I will leave that to the politicians. I want to confine my arguments today to the field of economics. Choosing an exchange rate regime In the years following World War II, many countries operated under an exchange rate regime that one might call “fixed until further notice.” This system, known as the Bretton Woods system, saw most countries peg the external value of their currencies to some other currency, most often the U.S. dollar. But for a number of reasons, this system of “fixed until further notice” exchange rates proved unstable. It has been abandoned by many countries in favour of one of two options - either a floating-rate regime or the use of another currency. Most have chosen a floating-rate regime. A few countries have decided to join some kind of monetary union or to use a foreign currency to replace their own. Canada was one of the first countries to adopt a floating-rate regime. It did so at the beginning of the 1950s and, generally, this regime has served us well. But with increasing integration of the Canadian and U.S. economies, the question now being asked is whether Canada might be better off giving up the Canadian dollar, either through dollarization or by entering into a monetary union with the United States. What I want to do today is to discuss the benefits and costs of a floating exchange rate versus dollarization at the present time, given the current degree of integration of the U.S. and Canadian economies. Then I will talk briefly about the implications for our floating exchange rate should the two economies become more integrated. Let me just add here that Canada is not being inevitably drawn into adopting the U.S. dollar, or being de facto dollarized, as some have claimed. Recent research conducted at the Bank of Canada shows clearly that, if anything, Canada is now less dollarized than it was two decades ago. We are not drifting towards dollarization. If we go down that road, it will be a deliberate choice. When choosing an exchange rate regime, it is crucial to remember that monetary policy needs to have a nominal anchor. In Canada, monetary policy is anchored by our use of an explicit inflation target. If a country chooses not to float its currency, it essentially adopts the monetary policy of the country to which it is tied. This may, or may not, provide an effective nominal anchor. Let me briefly explain how the floating exchange rate fits into Canada’s monetary framework. Our monetary policy aims to keep inflation at the 2 per cent midpoint of a 1 to 3 per cent target range. We protect the domestic purchasing power of our currency by keeping inflation low, stable, and predictable. By doing so, we support the conditions necessary for strong, sustainable economic growth. With a floating currency, our exchange rate acts as a mechanism that allows the Canadian economy to adjust to important economic changes, or what economists call “shocks.” These can include movements in relative world prices, changes in capital flows, or divergent economic conditions across countries. Consider commodity prices, for example. As you know very well, Canada is an important producer of commodities such as metals, paper, and chemicals. When the world prices of these goods rise, it means that Canadian producers receive more income. This rise provides a boost to the Canadian economy. When commodity prices fall, it means less income for Canadian producers. This has a negative impact on the economy. Changes in these sorts of relative prices are a signal to shift real resources out of some sectors and into others. The Canadian economy needs to respond to such signals. Under a floating-rate regime, movements in the currency help to smooth that process and attenuate the adjustments in output, employment, wages, and prices. Without a floating currency, the Canadian economy would still need to absorb the effect of changes in relative prices. But the burden would fall initially on output and employment and, eventually, on all wages and prices. This would be a far more difficult and costly process for many. There will always be economic shocks that require adjustments. But because the structures of the U.S. and Canadian economies are so different, the two economies often require very different adjustments to shocks. Canada’s floating exchange rate facilitates these adjustments by reducing the amount of lost income and output during the adjustment process. Weighing the costs and benefits Our empirical analysis shows that these adjustment benefits are quite large during periods of significant shocks. But there is no free lunch. There are costs involved in choosing a floating currency, and these could be avoided under dollarization. These include the costs of currency transactions and the need to mitigate currency risk - costs that can be considerable. At the present time, however, the adjustment benefits clearly outweigh the costs. This is an empirical statement, not a philosophical one. It is possible that, at some future time, the structures of our two economies could converge to the point that the reverse would be true. But for now, and as far into the future as I can see, the floating exchange rate is the best choice for Canada given the degree of integration of the Canadian and U.S. markets for goods and services and labour. The question can then be asked: “would further integration of Canadian and U.S. markets change this assessment?” The fact that the structures of the Canadian and U.S. economies are so different argues against using the same currency. But this could conceivably be overcome if there was much greater integration of all markets between Canada and the United States. It is this integration that could help us reduce the costs of adjusting to shocks that I described earlier. Specifically, the markets for goods and services, and particularly for labour, would need to become much more unified with those in the United States before it would make economic sense to adopt the U.S. dollar. Right now, our capital markets are fairly well integrated. Our markets for goods and services are supposed to be deeply integrated under NAFTA. But as any exporter will tell you, we are not quite there. There is always the threat that the United States could take a countervailing or antidumping action. In addition, NAFTA does not cover all goods and services. Still, by far the largest problem is the labour market. Wages tend to be “sticky”; that is, adjusting wages often takes time. So, under dollarization, the brunt of the economic adjustment to shocks would be borne by the labour market. This would create a huge problem if workers were not free to move across the border in both directions. At times it would create periods of much higher unemployment in Canada than would otherwise be necessary, and at other times it would lead to periods of labour shortages. One important feature of the U.S. labour market and, in my opinion, perhaps the most important source of the U.S. economy’s success, is that workers do, in fact, migrate easily - not just from job to job, but also from place to place within the United States. We would need to share in that flexibility. But clearly, Canada and the United States are a long way from integrating their labour markets, and further integration of markets for goods and services is proving difficult. If these markets - for labour, capital, and goods and services - became much more highly integrated, then the benefits from having a separate currency could decline enough to make considering the adoption of the U.S. dollar worthwhile. Here, the European experience is relevant for us. Some observers look at the successful launch of the euro and suggest that this shows that Canada could easily adopt the U.S. dollar. But the euro marked the end of a long process of political and economic integration, not the beginning. The countries in the euro zone undertook a massive effort to integrate their markets for goods and services, capital, and labour, and to harmonize their fiscal and regulatory policies. Only after all of this was in place did they move to launch the common currency. It would not have made economic sense to go through the process in reverse. It would not make sense in North America either. We would first need to more closely integrate trade in goods and services, and, particularly, our markets for labour. Only then would it make sense to deal with the currency issue. Concluding comments As I said at the beginning, this is an important topic for discussion and research. At the Bank of Canada, we have been contributing to this debate for some time by laying out the economic facts and by promoting the research needed to determine the facts and carry out our analysis. We will continue to do this. But right now, our analysis tells us that Canada derives a significant benefit from having a floating currency - a benefit that far outweighs the costs. This system helps the economy to adjust to economic shocks, and allows us to have a monetary policy accountable to all Canadians. The floating exchange rate system serves the interests of all Canadians very well.
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report, 23 October 2002.
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David Dodge: Economic and financial trends in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, at a press conference following the release of the Monetary Policy Report, 23 October 2002. * * * Today, we released our October Monetary Policy Report, in which we discuss economic and financial trends in the context of Canada's inflation-control strategy. The Canadian economy has been expanding strongly so far this year and is now operating fairly close to its full production capacity. Consumer price inflation has risen above the 2 per cent target and is expected to rise further before year-end because of high oil prices and a number of other relative price movements. What is important for monetary policy is that these one-off influences on specific prices not feed more generally into price and wage inflation. The Canadian economy has grown more rapidly than those of all other G-7 countries over the past year. Annualized growth exceeded 5 per cent in the first half of 2002—well above the growth of the economy's potential. We estimate that Canada's economy grew at an annualized rate of about 4 per cent in the third quarter. Thus, we have seen a significant reduction in the amount of excess supply in the economy so far this year. As we look ahead, global economic, financial, and geopolitical uncertainties are likely to moderate the rate of Canada's economic growth over the next three quarters. Growth should come in at the bottom of, or slightly below, the 3 to 4 per cent range that we anticipated in our last Update. Bear in mind that the output gap is very small. Assuming the uncertainties now clouding the outlook dissipate in the second half of next year, we expect growth to accelerate to above potential at that time, absorbing the remaining small amount of excess supply. The Bank's core measure of inflation is running above our earlier projections. This largely reflects sharp increases in home and auto insurance premiums and, in Ontario, electricity prices. Core inflation is also being pushed up by strong demand for housing. All told, core inflation is expected to peak at about 3 per cent by the end of this year. But, as the onetime influences that I just mentioned fade, core inflation is expected to decline in the second half of 2003, provided those one-time factors do not feed into price and wage inflation more generally. We must remember that the Canadian economy is now operating not far from its capacity. In order to sustain non-inflationary growth, we will need to continue to remove monetary stimulus before the excess supply in the economy is completely absorbed. The pace and extent of this action will depend on the balance of domestic and external developments and on their implications for pressures on capacity and inflation in Canada. Now Malcolm and I will be happy to take your questions.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Calgary Chamber of Commerce, Calgary, 18 November 2002.
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David Dodge: Promoting Canada's economic and financial welfare Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Calgary Chamber of Commerce, Calgary, 18 November 2002. * * * Good afternoon, and thank you for inviting me here today. It's been a difficult year for many sectors of the Alberta economy. Certainly, the severe drought hurt many western farmers, and investment in the energy sector was held back by low oil and gas prices. In addition, the slump in the telecom sector has affected Calgary. This said, we believe that the outlook is positive for the province's economy, and I would be very interested to hear your views about this in our discussion later. In a few minutes, I will spend some time talking about the Canadian economy and its prospects. But first, I want to discuss something that has preoccupied business leaders and public officials for most of this year – the need to restore trust in financial markets, in corporations that raise funds in these markets, and in the financial professionals who monitor them. Restoring confidence in financial markets Let me tell you why the Bank of Canada is concerned about these issues. The Bank is not a regulator of financial institutions or markets. But we do have a responsibility to promote financial stability and to oversee systemically important clearing and settlement systems. And we are the fiscal agent of the government, so we are actively involved in the functioning of fixed-income markets. Therefore, we have a keen interest in the efficiency with which financial markets operate. Confidence is key to the efficient operation of financial markets. In the United States, that confidence has been shaken by Enron, WorldCom, and other corporate and accounting scandals. Despite the fact that problems of that magnitude have not emerged in Canada, confidence in Canadian markets, and markets worldwide, has been affected by events in the United States. That is why we are watching closely the current efforts to restore confidence and trust in corporate reporting and in financial markets more generally. It seems that there have not been exactly the right incentives in place for corporate management, boards, and their auditors and investment bankers to disclose all relevant information and to always act in a manner that is fully conducive to fair and open markets. The market itself will provide some of the solutions to the problems currently undermining investor confidence. But others may best be dealt with by regulation. The market does impose its own discipline. It rewards firms that successfully maintain investor confidence, and punishes those that have abused investor trust or are not sufficiently transparent. I have been impressed by how seriously the private sector has responded to the challenges raised by the events of this year. Accounting bodies and regulatory agencies are also seeking ways to improve practices and restore confidence. They are re-examining the role and the responsibilities of external auditors to boards and shareholders – and how these can differ from other duties that auditors are sometimes asked to carry out by management. And they are asking if shareholders and boards have the tools and the power to hold management accountable. It's important that we continue to work on these issues and, moreover, that we are seen to be working on them. We live in a world where impressions matter and where capital markets are increasingly global. Canadian issuers will be judged not only against our own standards, but also against the worldwide standards for accounting, disclosure, and governance. At the same time, we must be careful not to impose an overly onerous burden of processes and paper on businesses, particularly on smaller firms, given their importance to the Canadian economy. Let me be clear: the same principles must apply to all public companies. While all businesses must abide by the spirit of the new standards, it may well be appropriate that larger, more widely held firms should face more detailed requirements than smaller firms whose shares are not as widely held. The challenge of developing an appropriate Canadian formula is made more difficult because we do not have a single lead securities regulator, as do the United States, the United Kingdom, and Australia. I'm not here to argue whether or not Canada should have a single lead regulator. The point is we need to improve our current system, and we need to do it now. If we don't, we risk damaging our reputation in world capital markets. In sum, the best way to restore investor confidence is to put in place a system of incentives that encourages managers and boards to always act in the best interests of shareholders. Disclosure is key. In every case, shareholders are best protected with full, fair, and accurate disclosure of information. To quote a recent C.D. Howe report, "if reforms cannot help investors distinguish good and bad investment prospects, there is no avenue for improving confidence." This brings me to an important issue for the Bank. We have a shared responsibility to promote a sound financial system – together with the Department of Finance, the Office of the Superintendent of Financial Institutions, the Canada Deposit Insurance Corporation, as well as provincial and other regulatory bodies. For years, the Bank has been conducting analysis and research related to the Canadian financial system, much of which has been published in the Bank of Canada Review, and in technical reports and working papers. We are now prepared to take a further step in the interest of making the information about our financial system more widely available. I am pleased to announce that the Bank of Canada will introduce a new semi-annual publication, The Financial System Review (FSR). We are planning for the first issue to be available late next month. In it, we will publish some of the Bank's ongoing work in monitoring financial system developments and analyzing the direction of financial sector policy. The FSR aims to promote knowledge of, and discussion about, changes and developments in the Canadian financial system. I would point out that we are not the only central bank to publish such a document. For example, the Bank of England, the Swedish Riksbank, and the International Monetary Fund also produce similar reports. Promoting economic welfare through inflation control While we work to promote financial stability in conjunction with other agencies, we alone are responsible for monetary policy. The foundation for that policy is the inflation-targeting system. How this system works may be familiar ground for some of you, but it is worth discussing again, especially during these uncertain economic times. The Bank of Canada Act calls on us "to promote the economic and financial welfare of Canada." We want strong and sustainable economic and employment growth. The best way we can help to achieve that is to promote confidence among Canadians in the future purchasing power of their currency. In other words, we want Canadians to be confident that inflation will remain low, stable, and predictable. For over a decade, following a joint agreement with the federal government, the Bank has operated with a system of inflation-control targets. Under the current terms of the agreement, the Bank aims to keep the trend of consumer price inflation at the 2 per cent midpoint of a 1 to 3 per cent range. Since we instituted the agreement, inflation expectations have become firmly anchored on our 2 per cent target. Well-anchored expectations promote economic growth and stability. Why? Investors can better assess the future value of their investments. Savers can be more confident that their future purchasing power will not be unexpectedly eroded by inflation. Debtors can better assess the real burden of their interest payments. Wage and financial contracts can be set for longer terms. All of this is possible because people are confident that inflation will stay around 2 per cent over the medium term. Inflation and the "Output Gap" Our inflation-targeting system also helps to smooth the peaks and valleys of the business cycle and to avoid the boom-and-bust pattern seen in earlier decades. We do this by acting in a symmetrical manner; that is, we pay equal attention to any significant movement in inflation away from the 2 per cent target, whether above or below. The crucial task in controlling inflation is to judge how the economy is performing relative to its economic potential. Economic potential is a very important concept, so I want to take a minute to describe it. Potential output, or production capacity, is the amount of goods and services that can be produced without putting pressure – in either direction – on inflation. When the economy is producing less than its potential, economists say there is an output gap. That gap tends to put downward pressure on inflation, so the Bank will ease monetary policy to stimulate growth. We do this by lowering our target for the overnight interest rate. When the economy is operating above its potential, excess demand builds. This puts upward pressure on inflation, and the Bank will tighten monetary policy to try to cool the economy, bring it back down to its level of production potential, and return inflation to the target. Keep in mind that changes in our policy rate work their way through the economy slowly. It takes up to two years for a change in interest rates to have its full impact on demand, output, and ultimately, on prices and inflation. So we have to be forward-looking in our interest rate decisions. At our fixed announcement dates, we are not trying to affect today's inflation. What we are aiming at is future inflation and acting pre-emptively to achieve a balance in supply and demand going forward. This may sound easy in theory, but the reality is complicated. For one thing, it is impossible to measure the economy's potential with precision. All economists can do is to make their best estimate – a highly educated estimate, I might add, but an estimate nonetheless – of the level of economic activity that represents full capacity. And since one cannot measure potential with precision, it is impossible to measure the exact size of the output gap or the amount of excess demand. So the Bank looks at a wide variety of indicators to assess how much pressure there is on capacity. We monitor Statistics Canada reports on how closely factories are operating relative to their capacity. We survey businesses across the country to see where firms are feeling production constraints. We look at data from the labour market, as well as figures on input costs and wages. We look at real estate market indicators. And, of course, we pay careful attention to financial market developments. We also measure inflation and inflation expectations. One key indicator is core inflation, which strips out the eight most volatile components of the consumer price index, along with the effects of changes in indirect taxes on the remaining components. We have found that this measure gives a good indication of the trend of future inflation. Indeed, it has done a better job of predicting the path of total inflation than the CPI itself. All of this gives us a comprehensive view of how the economy is operating relative to its capacity, now and in the future. And I should point out that on the Bank's Web site, you can now find the latest data on the indicators that we look at when we assess capacity pressures. Canada's current growth prospects Let me now turn to our economic outlook, and tell you how our views have evolved over the year. In last April's Monetary Policy Report, we projected that economic growth would be in a range of 3 to 4 per cent, at annual rates, from the second half of this year to the end of next year. Excess capacity in the economy was expected to be eliminated in the second half of 2003. And we noted that since we had taken our policy interest rates down to historically low levels in 2001, we would have to raise interest rates in a timely and measured way. So we began to tighten monetary policy, raising our target for the overnight rate three times between April and July, by a total of three-quarters of a percentage point. By late summer, however, uncertainties stemming from beyond our borders were beginning to mount. We noted that slower growth in demand in the United States was likely to hurt our exports in the short run. We also noted that global financial headwinds could affect spending by Canadian businesses and households. Finally, we said that concerns about corporate governance and the unsettled geopolitical situation could cause some firms and households to delay their spending. By October, the cumulative impact of slower global growth and the financial headwinds led us to reduce our near-term growth projection for Canada. In our latest Monetary Policy Report, we say that we expect growth to average slightly less than 3 per cent, at annual rates, through to the middle of 2003. But assuming that the financial headwinds and geopolitical concerns dissipate in the second half of next year, we should see a strengthening of domestic and foreign demand and the resumption of above-potential growth in Canada. It is interesting to note that our current view on the level of economic activity in Canada by the middle of next year is not far from where it was back in April, although the quarterly growth profile has changed. We still project that the small amount of excess supply remaining in the economy should be taken up as output growth moves above potential growth in the second half of 2003. Finally, let me say a few words on inflation. In our October Monetary Policy Report, we noted that core inflation over the next few months would likely be higher than had been previously anticipated. We cited some specific, one-off movements in relative prices, including insurance premiums and the effects of changes in the structure of Ontario's electricity market. We also said that core inflation would likely move still higher in the fourth quarter of this year, because of the "echo effect" of the price discounting that took place in 2001 following the 11 September terrorist attacks. But we said that core inflation should return to 2 per cent in the second half of next year. We are still of that view. However, because of the change in electricity pricing in Ontario, the monthly pattern of price movements will likely be different than earlier expected. In October, we had indicated that higher crude oil prices could continue to push total CPI significantly above the target range at the end of this year. But crude oil prices have moderated in recent weeks. Should this moderation continue, total CPI will likely peak at a lower level than we thought in October. We also continue to expect that the total CPI will converge with the core rate, around 2 per cent, in the second half of next year. However, we will continue to watch this closely, to make sure that the one-off influences I mentioned earlier do not feed into prices more generally. To conclude, let me repeat what we said in our last Monetary Policy Report. As we go forward, we will need to remove some of the monetary stimulus now in place before the economy reaches its level of full potential. The pace of this action will continue to depend on the balance of domestic and external developments and on their implications for pressures on capacity and inflation in Canada.
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Speech by Mr David Dodge, Governor of the Bank of Canada, during a panel discussion at the Banco de México, Mexico City, 12 November 2002.
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David Dodge: Staying the course Speech by Mr David Dodge, Governor of the Bank of Canada, during a panel discussion at the Banco de México, Mexico City, 12 November 2002. * * * The dramatic events of the last two years and growing concern about the near-term prospects for the global economy have created a climate in which policy-makers focus only on current economic developments and lose sight of longer-term goals. There's a natural tendency to focus on the here and now, and to use any tools that are readily at hand to deal with today's problems, without proper regard for their long-term consequences. It's easy to forget the hard-learned lessons of the past and overlook the longer-term fundamentals that are necessary to support a strong recovery and sustained positive economic performance over time. What are those fundamentals? Mr. Greenspan, in his opening remarks to this conference, talked about the importance of the fundamentals, going all the way back to Adam Smith. What's interesting is that things have not changed that much. But we don't have to reach that far in history for guiding principles. We can look at the four key principles that emerged as part of the OECD consensus during the 1980s. The first principle relates to monetary policy. It basically recognized price stability as the appropriate goal for monetary policy over the medium term. Policy-makers were advised to respond symmetrically, and in a forward-looking manner, to excess demand and supply so as to keep the economy on an even keel, thus achieving price stability and maximizing output over the medium term. The second principle applied to fiscal policy and the need for a more disciplined approach to managing the public purse. Rising debt levels and an aging population made it clear that concrete action was necessary to eliminate deficits and put the debt-to-GDP ratio firmly on a declining path. Automatic stabilizers should still be allowed to work during economic downturns. But in good times, surpluses would be generated that would help preserve the budget balance and keep the debt-to-GDP ratio on a downward trend. The third principle focused on the need for wide-ranging structural reform to reduce rigidities and inefficiencies. This meant removing burdensome regulations and legislative restrictions and eliminating wasteful government expenditures and distortionary tax and subsidy systems. The fourth, and final, principle called for trade liberalization. It was based on the premise that only through freer international trade can countries fully exploit the gains from increased specialization, enhanced productivity, and greater competitiveness. These four principles can be likened to the four legs of a chair. The chair is steadier when all four legs are the same length. Similarly, an economy is more stable when progress is made on all four policy fronts. But what should we be doing during periods of unexpected, pronounced economic turbulence? The latest worldwide economic slowdown has increased pressures on policy-makers to take action on a number of fronts. Some of them are being encouraged to erect trade barriers in order to protect favoured national sectors from foreign competition. But experience shows that such beggar-thyneighbour policies not only impose costs on the rest of the domestic economy, they also undermine global economic welfare. Other policy-makers are being advised to forget about structural reforms in the short term, for fear of exacerbating economic weakness. Unfortunately, this approach virtually guarantees suboptimal performance in the future and maximizes the long-term costs of dealing with the structural problems – in many cases, sowing the seeds of future crises. In many countries, weak economic growth, coupled with rising government expenditures, has recently led to a deteriorating fiscal position, reversing the hard-won gains made over the past decade. To the extent this result is driven by the automatic stabilizers in place, it is unavoidable and desirable in the short run. But policy-makers should be very careful about calls for more extensive, discretionary fiscal measures taken for stabilization purposes. Such measures typically take effect long after the need for additional stimulus has passed, and they are often difficult to reverse. In the end, they often simply weaken a country's structural budget position. Without a doubt, the most suitable tool for dealing with any short-term cyclical problems in the economy is monetary policy. It is flexible, easily reversible, and general in scope. If monetary policy is allowed to perform this function, then there will not be inordinate pressure on other, less appropriate, instruments and policies. But let me be clear: this is not to say that we should use monetary policy to allow us to avoid taking the necessary steps on the other three fronts. For example, it is inappropriate to erect trade barriers and then say we need more monetary stimulus. It is inappropriate to allow rigidities to build in the economy and then call on central banks to provide stimulus. The right thing to do is to continue working on steadying the other three legs of the chair and to use monetary policy appropriately. Central bankers must guard against turning monetary policy itself into a source of instability. So here too, the bottom line is to never lose sight of our longer-term objective of low and stable inflation. The prevailing worldwide economic weakness, together with geopolitical uncertainty and financial market volatility, has led to significant monetary easing in most countries. This easing has been broadly appropriate and, in some cases, indeed even more may be needed. But it is extremely important that the monetary authorities keep their eyes firmly on the economic horizon. By concentrating on developments 18 to 24 months ahead, not only will they ensure that the critical medium-term objectives are met, but the short-term needs of the economy are also addressed. Monetary policy-makers should also be wary of taking on too many additional responsibilities, such as trying to stabilize selective market assets. This is not to say that we should not pay attention to what is happening in financial markets. We certainly should. These markets can convey important information about future developments. And they exert direct and indirect influences on the real economy. But monetary authorities must resist the siren calls for active management of financial markets and the pleas for regular intervention to help stabilize asset prices. It would be unfortunate if we were to repeat costly past mistakes for the sake of near-term expediency. Canada, like most other countries, has committed itself to the four principles of sound economic performance: low and stable inflation, fiscal prudence, structural reform, and trade liberalization. As a country, we have made great progress on all four fronts in recent years. Of course, pressures have emerged which threaten to undermine those commitments. These pressures have been resisted vigorously. While particular interest groups are unhappy with this resistance, the Canadian public as a whole supports sound policies. Canadians remain convinced that the authorities will follow these policies; and that is why both household consumption and investment by SMEs continue to be strong. Even in the face of geopolitical and international economic uncertainties, sound medium-term policies are helping to maintain strong domestic demand. To conclude, the current uncertainties will dissipate, and stronger growth will resume, provided we continue to pursue sound macro, trade, and structural policies. What is important is to anticipate the institutions, structures, and policies that we want to have in place once this latest turbulence subsides, and not to focus too narrowly on the present. Although the near-term challenges that we face may seem daunting, it would be unfortunate if, in attempting to deal with them, we impaired the prospects for future growth and improved economic performance. Canada is committed to staying the course. The same is true, I hope, of all other countries gathered here today. We all have an important responsibility to make sure that the lessons we have learned, and our continuing strong commitments to prudent policies, are understood more broadly.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, at the Speakers Forum, Toronto, Ontario, 29 January 2003.
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David Dodge: Monetary policy - meeting the challenges of an uncertain world Remarks by Mr David Dodge, Governor of the Bank of Canada, at the Speakers Forum, Toronto, Ontario, 29 January 2003. * * * I want to talk today about some of the uncertainties surrounding Canada's economic prospects and how the Bank of Canada is dealing with them through its conduct of monetary policy. In particular, I'll discuss what's happening to prices in the economy and how Canada's macroeconomic policy framework protects it from the risks of persistent inflation or deflation. Finally, I will update our outlook for the Canadian economy. Two weeks ago, I was in Basel, Switzerland, for one of our regular meetings at the Bank for International Settlements. This meeting, as well as others during the past year, have been particularly interesting for Canadians. Other participants always ask us, "How come you Canadians are doing so well, when the rest of us seem to be struggling?" We have been telling them that one of the reasons why Canada has been less affected by the recent worldwide economic slowdown is that we made extraordinary efforts during the 1990s to get our macroeconomic framework—that is, our monetary and fiscal policies—right. We all know it was painful to adjust to free trade and to conquer inflation in the early 1990s, and to eliminate public sector deficits over that decade. Canada paid an economic price for those efforts during the 1990s. But they are now yielding clear economic dividends. Of course, we've also had some good luck. We are less exposed to sectors that are struggling the most. But Canada's economic strength during the past two or three difficult years for the world economy reflects, for the most part, the fact that Canada stuck to its basic policy framework. As we move forward, this underscores the importance of maintaining that framework—especially now, when the near-term world economic outlook is not strong, and the geopolitical climate is uncertain. With all this economic uncertainty, it is not surprising that we hear concerns these days about both the risks of accelerating inflation and the risks of deflation. I think it is important to place these concerns into some context, so that Canadians can better understand the risks and implications of price shifts in the economy. That is why I'm going to concentrate most of my comments today on this subject. After all, the goal of the Bank of Canada's monetary policy is to maintain low, stable, and predictable inflation. For over a decade, following a joint agreement with the federal government, the Bank has operated with a system of inflation targets. We aim to keep the trend of consumer price inflation at the 2 per cent midpoint of a 1 to 3 per cent range. Because we have managed to keep inflation inside the target range through most of the past decade, Canadians' expectations for inflation have become firmly anchored around the 2 per cent target. Right off the top, let me assure you that the Bank of Canada will continue to pursue a monetary policy focused on returning inflation to that 2 per cent target, should it deviate in either direction. Canada's inflation-targeting framework operates symmetrically; that is, we minimize the chances of both a sustained upward drift in inflation and the threat of deflation. Recently, rates of inflation in Canada have come in higher than expected. At the same time, a weak global economic environment, the huge drop in equity prices, and declines in the prices of some manufactured goods are raising fears of deflation in other countries. Let's look at both these risks. The upside risk: inflation First, let's consider the upside risk of accelerating inflation. It has been more than a decade since Canada has experienced prolonged high inflation. Since the targeting system was put in place, both the trend of inflation and inflation expectations have come down to near 2 per cent and stayed there. In recent months, CPI inflation has risen substantially, for several reasons. We've seen higher oil and gas prices, higher home and auto insurance premiums, higher tobacco taxes, and, in Ontario, higher electricity prices. There has also been the "echo effect" of temporary price discounting in late 2001, following the 11 September terrorist attacks. At the same time, stronger demand in Canada has been pushing up prices in some sectors, such as housing and some services. These pressures are starting to show up somewhat more broadly in the CPI data; and, without offsetting declines in other components of the CPI, these pressures are having an impact on all our measures of trend inflation. This suggests to us that demand conditions may be strong enough now to make it easier to raise prices and widen profit margins. The Bank's policy aims to maintain total CPI inflation at 2 per cent, or to return it to that point within 18 to 24 months. With that horizon in mind, we need to look through any short-term volatility—and there's been a lot of short-term volatility in recent months. Mostly, we do that by focusing on our measure of core inflation, which excludes the eight most volatile components of the CPI, as well as the effect of changes in indirect taxes on the remaining components. Of course, any measure of core or underlying inflation won't perfectly predict future inflation. We also look carefully at what is happening to individual CPI components, to gauge the size and persistence of any price changes. So, for example, recently we have spent a lot of time examining the factors driving the prices of electricity, insurance, and some foods. Many of the relative price movements churning the current inflation numbers will likely prove to be temporary. But the recent pattern of persistently higher-than-expected rates of inflation, together with other signs of capacity pressures, may be indicating that our economy is operating closer to capacity than the Bank had previously thought. The downside risk: deflation Let me now turn to the potential downside risks on the price front—deflation, which is a persistent decline over time in the average prices of goods and services. We have all heard a lot about the toll that deflation has taken on Japan. In some other countries, including the United States, concerns about deflation have also arisen because prices for goods have been falling. Their economies have been operating below capacity, and the resulting output gap is putting downward pressure on prices. Why is the possibility of falling prices so worrisome? Well, when North Americans think of "deflation," they usually think of the 1930s and the terrible economic and social consequences of the Depression. Back then, deflation was the result of a spectacular drop in demand. That kind of deflation can lead to a vicious circle of declining profits and share values, increased debt burdens, business bankruptcies, lower investment, and a further weakening of demand. The goal of macroeconomic policy should be to avoid this type of situation. It is precisely for this reason that Canada's inflation-targeting framework operates symmetrically. But weak demand isn't the only thing that may pull down prices. A drop in prices that is triggered by increased productivity would not harm an economy, because the higher productivity would boost profits, stimulate business spending, and improve real incomes. With that in mind, let's look at what has been happening to prices around the world. In many of the world's biggest economies—Japan being the exception—inflation has been averaging around 2 per cent. That's low by historical standards, but still well above zero. In some of these economies, as I've mentioned, the prices of goods are actually falling. But much of that drop has come about as a result of higher productivity. Productivity growth has been more concentrated in goods-producing industries. That is why we see sharp divergences in goods and services prices. In the United States, for example, over the past year, goods prices—based on the core measure of inflation—fell 1½ per cent, while services prices rose by about 3½ per cent, resulting in an overall core inflation rate of about 2 per cent. A similar scenario is playing out in the United Kingdom. If technological advances and productivity growth cause lower goods prices, profitability in the goods-producing industries will be preserved, wages and salaries can increase, and there will be no adverse effects on total employment and spending. In Canada, goods prices are rising more slowly than services prices. However, we're not seeing actual declines in the overall price of goods. Although this may have something to do with structural differences in our economy, fundamentally it reflects the fact that domestic demand in Canada is stronger than in the United States, and our economy is operating closer to capacity. Here is some of the evidence we have to date to support this view. Capacity utilization among Canadian goods producers is getting close to the point where production constraints start to emerge. In some sectors, businesses are reporting shortages of skilled labour. And profit margins for consumer-related industries trended up through the first three quarters of 2002. All of this suggests that most goods prices in Canada are not being discounted because of weak demand, as appears to be the case in the United States. Moreover, Canadian corporate balance sheets are improving and are, indeed, in relatively good shape compared with those in other countries. Symmetrical monetary policy minimizes the risk So, those are both sides of the price picture. I've laid out for you some of the factors that are moving prices at home and abroad. Now, I'd like to spend some time explaining how Canada's monetary policy framework reduces the risk of both persistent inflation and persistent deflation. As I said before, Canadian monetary policy acts in a symmetrical manner—that is to say, we pay equal attention to any significant movement in inflation, whether above or below the 2 per cent target. We respond to shocks that would push inflation trends away from that target. For example, following the 11 September 2001 terrorist attacks, we quickly and aggressively cut our policy interest rate to shore up confidence. Then, in the spring of 2002, evidence started to build that demand was growing faster than the economy's potential. So, even though this was not yet showing up in prices, we raised our key policy rate three times between April and July, by a total of three-quarters of a percentage point. Last fall, when inflation was rising, we refrained from raising rates because we expected that global economic weakness would restrain total demand for Canadian goods. As we go forward, the Bank will be acting to prevent the current high headline inflation rates from feeding into expectations and to return inflation to the 2 per cent target. We will also be assessing all measures of capacity pressures in the economy. The outlook for the Canadian economy And this brings me to the Bank's economic outlook for the next 18 months or so. While Canada's economy has outperformed those of our major trading partners, our prospects are still very much influenced by developments abroad. After all, we sell to the world. So let me start with the external outlook. Since last summer, we have been worried about financial headwinds and geopolitical uncertainty and their effect on global demand. In our Monetary Policy Report Update that we just published, we said that global economic prospects may have weakened further in the first half of the year. However, we continue to expect global economic growth to pick up in the second half of the year and into 2004. We also expect that risk premiums in financial markets will continue to decline, which should further improve the environment for business investment later this year. But on the geopolitical front, the possible outbreak of war in the Middle East remains the great uncertainty. Let me outline the implications of some of the scenarios we face. A negotiated early resolution of the standoff in Iraq, or even a short, decisive conflict, could reduce geopolitical tensions fairly quickly. But a prolonged war would make the world economic outlook even more uncertain and would hurt business and consumer confidence. In the case of a war, oil supplies might be disrupted, which would lead to higher oil prices, further restrain global economic activity, and raise total CPI inflation around the world. I would note, however, that higher oil prices would raise the value of Canada's oil and gas exports. Finally, a prolonged war could boost US government spending and, hence, US demand. Of course, we don't know how the situation in the Middle East will be resolved. So, we have made an assumption that the related uncertainties will dissipate in the second half of 2003. Our projections for the global and Canadian economies are based on this assumption. So, let me now turn to the Canadian outlook. After growing significantly faster than potential during the first half of 2002, Canada's economy slowed to a growth rate close to potential in the second half of the year. Even with this slowdown, the level of demand has remained near capacity since the middle of last year. As we look forward, we foresee below-potential growth in the first half of the year. But we anticipate increased demand pressures in the second half of 2003 and into 2004, as global uncertainties diminish. However, with an appropriate reduction in the amount of monetary stimulus, we see the level of output remaining close to capacity during 2003 and into 2004. As I said earlier, recent inflation rates have come in somewhat higher than expected. This reflects certain one-off price increases, such as higher insurance premiums, but also some broadening of price pressures as a result of stronger demand. The one-off factors will hold the core rate of inflation well above the 2 per cent target in the first half of this year. In the second half and into 2004, we expect the core rate to ease, as the effect of the one-off factors diminishes and the removal of monetary stimulus keeps demand pressures in check. The outlook for total CPI inflation this year will continue to be importantly affected by developments in crude oil prices. With oil and gas prices where they are now, we could see CPI inflation rates between 4 and 4.5 per cent in the first quarter. If oil and gas prices decline in the second half, as futures prices suggest they will, then total CPI inflation would move back down in line with core inflation. Let's remember that the stance of monetary policy remains stimulative. To return inflation to the 2 per cent target over the medium term, we will need to remove some of the stimulus. In other words, we will need to raise interest rates. A number of elements will come into play in determining the pace at which we will reduce monetary stimulus. Let me reiterate them. First, although much of the recent run-up in inflation was the result of special factors, we can't rule out the possibility that demand pressures are becoming more prominent. So, we will watch these pressures carefully. Second, the Bank must guard against the risk that inflation above the 2 per cent target might lead to an increase in inflation expectations. These, too, we will monitor closely. Third, the confidence of investors and financial markets has improved but remains fragile because of geopolitical and world economic uncertainty. We will be watching credit and financial market developments to gauge the climate for business investment. Fourth, the way in which events in the Middle East unfold could affect demand and inflation, globally and in Canada. * * * To conclude, let me repeat that this is not an easy time to predict the course of the global economy. But Canada's economy, while feeling the impact of world uncertainties, is showing sustained strength. That strength reflects the extraordinary work Canadians have done in creating and maintaining a sound macroeconomic framework. I can assure you that monetary policy, as a key part of that framework, will continue to serve Canadians well in meeting the challenges of an uncertain world. In December, core inflation moved down to 2.7 per cent, largely reflecting rebates for electricity in Ontario. But this is expected to be reversed in January. Indeed, what we take from the December numbers is a continuation of recent price trends. So, inflation is projected to be above the 2 per cent target for the rest of this year.
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Remarks by David Dodge, Governor of the Bank of Canada, to the Canada-UK Chamber of Commerce, London, UK, 12 March 2003.
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David Dodge: Meeting global challenges - the importance of sound economic policies Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canada-UK Chamber of Commerce, London, UK, 12 March 2003. * * * I am delighted to be in London to speak with you today. We are facing a time of great economic and political uncertainty. While economic activity is close to potential in Canada, most other countries are facing very weak demand and lacklustre economic prospects. And, of course, there is the overriding prospect of a war in Iraq. Voltaire said that "doubt is not a pleasant condition, but certainty is an absurd one." We policy-makers are rarely burdened with certainty at the best of times, and definitely not these days! In an environment as unsettled as this one, it is easy to become preoccupied with the here and now. But, during such times, it is even more important that we remain focused on the medium-term goals of macroeconomic policy. And that's what we're trying to do in Canada. Many of my colleagues at international meetings this year have commented on Canada's economic strength. It is true that we've had some good luck. But Canada's strong performance during the past two or three difficult years for the world economy primarily reflects extraordinary efforts made during the 1990s to get our macroeconomic framework - that is, our monetary and fiscal policies - right. Canada, of course, was not alone in making these efforts. During the 1980s, a consensus developed among OECD nations on the combination of policies most likely to deliver sound economic performance. The consensus grew out of the unhappy experiences of earlier policy experiments. And it was built around four key principles: trade liberalization, structural reform, fiscal prudence, and low and stable inflation. These four principles work like the four legs of a chair. The chair is steadier when all four legs are equally sturdy. Similarly, an economy is more stable when progress is made on all four policy fronts. And when one of the legs starts to weaken, the best way to restore stability is to build that leg back up, not to cut down the other three. Canadians spent a great deal of effort over the past decade or so putting the four elements of this policy framework into place. It involved considerable short-term economic pain. But the phrase "short-term pain for long-term gain" is more than just a cliché. Canada is now receiving the economic payoff from this effort. Since 1997, our economy has consistently exceeded the average growth rates of the world's most industrialized countries. And it is expected to do so again this year. The first principle: trade liberalization Let me briefly review those four principles and the progress that Canada has made on each. I'll start with the principle of trade liberalization. We all know that freer international trade helps countries to more fully exploit the gains that come from increased specialization and greater productivity and competitiveness. Canada's economy made some difficult adjustments to freer trade during the late 1980s and early 1990s. First, we signed the Canada-US Free Trade Agreement, which came into effect in 1989. Then, in 1994, Mexico joined the group through the North American Free Trade Agreement. Both of these agreements sparked a great deal of political controversy. And many Canadian companies were understandably anxious to avoid increased competition. As well, the Free Trade Agreement came into effect at a time when monetary policy was tight, to fight the high inflation rates of the day. Despite initial misgivings, Canadian companies rose to the challenge of increased competition. Some of the sectors that we used to protect the most - such as furniture, clothing, and wine - have since established a strong presence in international markets. Overall, Canadian exports have flourished under these agreements. And that strengthens our resolve to see freer trade extended beyond regional trading blocs. Canada is hoping to see meaningful progress at the World Trade Organization's Doha round of multilateral talks. Clearly, agriculture is going to be a major hurdle. The developed countries, including all of us in the G-7, have a considerable way to go in terms of liberalizing agricultural trade. And there are other sectors where major effort is required. This effort must be made so that the global economy can benefit. It won't be easy but, in the long run, it will be worth it. The second principle: structural reform Complementing trade liberalization is the second principle, which focuses on the need to improve the structure of national economies. The goal here is twofold: first, to increase the flexibility of our economies to adjust to changing world economic conditions; and second, to ensure the longer-run viability of our social - and income - security arrangements. Structural adjustments are always difficult because reforms will affect various groups in differing and often painful ways. Further, the economic benefits of increased flexibility may take a fairly long time to emerge. But these difficulties should not sway us from the task of reducing rigidities and increasing efficiency. Canada has made some progress on a number of fronts. For example, governments have taken steps to reduce distortions in the personal income tax system, and have implemented a goods and services tax to replace the outdated tax on manufacturers. Unemployment insurance benefits were also reduced and restructured to strengthen the incentive to work. Another important structural reform was to our public pension system. In 1996, Canadian federal and provincial governments agreed to changes that would put the Canada and Quebec Pension Plans on a sustainable footing. This meant some restructuring of benefits and a sharp increase in contributions moves that were as unpopular as they were necessary. The surpluses in the Canada and Quebec Pension Plans now represent almost 1 per cent of GDP. Furthermore, these surpluses are set aside in special funds that cannot be touched by governments for general use. The assets of the public plan are now managed by the Canada Pension Plan Investment Board, a body that is entirely independent of government. Its sole mandate is to invest the contributions in markets, in order to generate the best possible returns, consistent with prudence, over the long term. The third principle: fiscal prudence This leads me to the next principle, which relates to fiscal policy and the need for a more disciplined approach to managing the public purse. Fiscal policy must be guided by the principle of putting the ratio of public debt to GDP on a sustainable, downward track. In Canada's experience, this was a difficult hurdle to overcome. To be sure, the fiscal consolidation of the 1990s was painful. I was federal Deputy Minister of Finance at that time, and I can tell you that many difficult and unpopular decisions had to be taken. Equally important, the provinces had to make tough choices as they reduced their public spending and restored their fiscal health. But as difficult as those years were, waiting would only have made matters worse. Well, here's the good news: the vicious circle of rising deficits and debt has become a virtuous circle of balanced budgets and falling debt. Reducing the deficit in the 1990s helped Canada's international credibility. This led to a reduction in the risk premium demanded by international investors. The fiscal improvement meant that the Bank of Canada was able to lower interest rates more easily when economic circumstances warranted. Not only did lower interest rates reduce debt-servicing costs, they also stimulated economic growth, which brought in more revenues to the government. The extra revenues and lower debt-servicing costs, in turn, led to an even better fiscal position. At the end of 2002, Canada's total government surplus represented just over 1 per cent of GDP - not including the surplus in the pension plans. Last month, Finance Minister John Manley announced a fifth consecutive surplus in the federal budget and projected that the budget will continue to be in a balanced position or better for the next three years. The budget maintained the fiscal planning framework of previous years. That framework includes a $3 billion contingency reserve, which is used to reduce debt if it is not needed. It also includes $1 billion in the upcoming budget year for additional economic prudence, and $2 billion in the following year, as further assurance that Canada won't fall back into deficit. Canada is expected to have one of the lowest debt burdens in the G-7 this year. Not only have we reduced the debt-to-GDP ratio, but we have paid down almost $50 billion of federal debt. This has led to the restoration of Canada's Triple-A credit rating and has freed up about $3 billion of resources every year for the federal government. The main point is that while the initial work of fiscal consolidation is certainly difficult, it is necessary in order to enjoy the dividends later on. The fourth principle: low and stable inflation The fourth principle relates to monetary policy - the responsibility of the Bank of Canada. This principle recognizes that, over the medium term, monetary policy should work to keep inflation low, stable, and predictable. Let me explain how we do this. Since 1991, following a joint agreement with the federal government, the Bank of Canada has operated with a system of inflation-control targets. I don't plan to spend a lot of time explaining our system to this audience, because the United Kingdom adopted a system very similar to ours a couple of years after we did. We aim to keep consumer price inflation at the 2 per cent midpoint of a 1 to 3 per cent range. If the trend of inflation moves away from the target in either direction, the Bank will take action so that inflation returns to the target within 18 to 24 months. Canada's inflation-targeting framework works in a symmetrical way, minimizing the chances of both a sustained upward drift in inflation and the threat of deflation. Indeed, through most of the past decade, we have managed to keep inflation around the 2 per cent target midpoint. And so, Canadians' expectations for inflation have become firmly anchored around 2 per cent. This climate of low, stable, and predictable inflation has helped to smooth out the ups and downs in the economy and to create the best possible environment for longer-term economic growth in Canada. Inflation and the economic outlook Let me now give you the Bank of Canada's views on the state of the Canadian economy and the outlook. First, a bit of history. Following the 11 September 2001 terrorist attacks in the United States, the Bank of Canada, like other major central banks, moved quickly and aggressively to cut its policy interest rate to shore up confidence. That dramatic monetary policy action helped a great deal. By the spring of 2002, it became evident that our economy hadn't been knocked off track by the events of 11 September. Indeed, evidence was starting to build that the economy was growing faster than its production potential, taking up the remaining small amount of economic slack. So, we raised our key policy rate three times between April and July, by a total of three-quarters of a percentage point. But by late last summer, we were seeing the effects of financial headwinds, geopolitical uncertainties, and continued weakness in the global economy. These factors remained in play through the autumn. As a result, we refrained from raising interest rates, even though inflation was accelerating. Our initial analysis was that this increase in inflation would be temporary. However, both core and total CPI inflation remain well above target. This reflects the impact of higher-than-expected prices for crude oil and natural gas, continuing increases in auto insurance premiums, and price pressures in certain sectors, such as housing, food, and some services. The higher inflation also suggests an underlying firmness in the price-setting environment. In other words, relative price increases wouldn't be pushing up trend inflation if there was not sufficient demand. Indeed, final domestic demand - especially household spending - has remained robust. However, economic growth in Canada moderated in the final three months of 2002, largely because of weaker exports - most notably, a decline in automotive shipments to the United States. Even with this slowing growth in the fourth quarter, upward revisions for previous quarters leave the level of economic activity slightly higher than we had been monitoring. In fact, Canada's economy remains near full capacity. Let me list some of the indicators that support this view: high industrial capacity utilization; near record-high labour force participation rates; a record-high employment-to-population ratio; corporate profits at their highest level since early 2001; and, as I said a few moments ago, above-target trend inflation. While we continue to foresee growth somewhat below potential in the first half of this year, we expect increased demand in the second half of 2003 and into 2004, as global uncertainties diminish. But with an appropriate reduction in the amount of monetary stimulus, we see the level of output remaining close to capacity during this year and into 2004. So, in making our interest rate decision on 4 March, we weighed the following considerations: domestic inflation pressures, the expectation that Canadian economic activity will remain near potential in 2003 despite geopolitical uncertainties, the stimulative stance of monetary policy, and improved conditions in capital markets. Taking all of these factors into account, the Bank raised its key policy rate by one-quarter of a percentage point to 3 per cent. Even with this increase, the stance of monetary policy remains stimulative. Thus, over time, further reductions in monetary stimulus will be required to return inflation to the target over the medium term. But, as we have said, the timing and pace of increases in policy interest rates will continue to depend on a number of considerations. These include the strength of demand pressures; the evolution of inflation expectations; the impact on confidence of geopolitical and global economic uncertainties; and the way in which developments in the Middle East affect demand and inflation, both globally and in Canada. The Bank will continue to closely monitor all of these factors. *********************** Let me conclude. At the beginning of my talk today, I noted that, for over a decade now, Canada has followed a policy based on the four key principles: trade liberalization, structural reform, fiscal prudence, and inflation control. It's never easy to follow those principles, but, over the medium term, they do lead to better economic performance. Canada's recent economic record is evidence of that. We have maintained an enviable growth performance through what has been a very difficult period for the world economy. We remain optimistic - and so do others - that we will continue to do so. Both the OECD and the IMF predict that Canada's economy will outperform those of other G-7 countries this year. But these are difficult times. Significant geopolitical and global economic uncertainties continue to overhang the economic outlook for all countries. It is during times like these that policy-makers may be tempted to put the four principles aside and focus instead on short-term economic problems. In Canada, we have learned that it is by sticking to these principles that we create economic structures that can withstand turmoil. The four policy principles have proven to be the most effective tools for meeting the challenges of a very uncertain world.
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Remarks by David Dodge, Governor of the Bank of Canada, at the Website Awards Event, Central Banking Publications and Lombard Street Research, London, England, 12 March 2003.
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David Dodge: Central Bank Website of the Year Remarks by David Dodge, Governor of the Bank of Canada, at the Website Awards Event, Central Banking Publications and Lombard Street Research, London, England, 12 March 2003. * * * It is very gratifying to be here tonight to accept, on behalf of the Bank of Canada, this award for "Central Bank Website of the Year." It has become almost a cliché to point out that "Internet time moves faster than normal time." But I'm reminded of that observation as I accept this award - an award for achievement in a medium that barely existed ten years ago. For that matter, it was only eight years ago - in 1995 - that the Banco de México, the Bank of Canada, and a few other central banks launched their first Web sites. Back then, it would have been hard to imagine just how quickly the Web would evolve into the hugely influential medium it is today. It would also have been hard to imagine back then just how far central banks would move towards greater openness and transparency in their day-to-day operations. So it seems significant that these two trends - the push towards more open, transparent communications, and the unexpectedly rapid ascendance of the Web - should have coincided. At the Bank of Canada, our Web site has been an integral part of our communications strategy over the past eight years. The Web offers us a cost-effective global distribution channel for vast amounts of data, analysis, and commentary pertaining to our main functions - that is, the conduct of monetary policy, the promotion of financial stability, the supply of bank notes, and the provision of central banking services to the federal government. Our site also offers a growing amount of purely instructive material. Through the use of glossaries, "backgrounders", and other information, we have made a concerted effort to ensure that every document we publish provides enough context to help non-specialists read and understand it. This is no small challenge, given the admittedly dry and complex nature of much of the material a central bank deals with. We have also developed "inflation and investment calculators" so that our message about the benefits of low inflation is clear to the public. And we use a graphic presentation to explain the transmission of monetary policy. As well, we are currently developing a Web-based simulation game, designed to explain the intricacies of monetary policy to high school and undergraduate students. Based on our efforts to date, our hosts here this evening have decided that the Bank of Canada's Web site is the best among the two dozen central bank sites that they short-listed for this award. So the question you may be asking is, "How exactly did you do it? And what sets the Bank of Canada's Web site apart from those of other banks?" First, we did it ourselves. We didn't throw a lot of money at outside consultants. From the earliest days, we have been fortunate enough to have a small group of key people - editors, writers, programmers - who were excited by this new technology, and who were willing to dedicate their time to building and improving the site. I'd like to take a moment to mention a couple of those key people by name - although, as always, there are many others whose efforts have contributed importantly to the success of the site. Some of you may already know our senior Web consultant, Brent Eades, through his Web-related articles in central banking publications, and his presentations at various central bank Web conferences. Since 1998, Brent has had the principal responsibility for developing and expanding our site, and we are obviously very pleased that his efforts are receiving such a strong endorsement here tonight. I would also like to note the considerable contribution of Ken Kingsbury, a senior programmer on our staff, who has been responsible for perfecting many of the sophisticated data search tools on the site. Second, from the beginning, our attitude has been one of encouragement, rather than direction. We have been content to trust the planning and management of the site to staff who have the expertise to do the job right. Indeed, I think the fact that we have trusted the specialists in our various departments to decide how best to present their particular information has a lot to do with the success of our Web site. As we look to the future of our site, our plan is to continue to trust those with the necessary talent. Staff are already planning a variety of improvements to the site over the next year - a graphic redesign is in the works, as well as the simulation game I mentioned a moment ago. We also plan to fine-tune and reorganize the site's content to make it even more accessible than it is now. So this is a heads-up to our fellow central bankers that we don't intend to relinquish this award readily! *********************** Once again, I want to express my sincere thanks to Central Banking Publications and Lombard Street Research for the honour of this most prestigious award. This is a proud moment for the members of our staff who have put in endless hours developing a prize-winning site.
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Speech by Mr David Dodge, Governor of the Bank of Canada, to the Italian Bankers Association, Rome, Italy, 18 March 2003.
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David Dodge: The benefits of sound economic policies Speech by Mr David Dodge, Governor of the Bank of Canada, to the Italian Bankers Association, Rome, Italy, 18 March 2003. * * * It is truly a pleasure for me to visit this magnificent and historic city. I certainly appreciate the opportunity to speak to your association today. Canada and Italy share many similar characteristics. We both belong to the G-7, and we are among the smaller members of that group. Our two economies vary greatly from region to region, both in terms of structure and strength. Overcoming these regional disparities is one of the great challenges we both face. After the serious inflation problems of the 1970s and early 1980s, Canada and Italy are now enjoying the benefits of a low-inflation environment. And we both trade a great deal with a large partner - in our case, with the United States, in your case, with the rest of the euro zone. We in Canada and you in Italy have recently taken steps to overhaul our tax systems, and we both face the challenges of an aging population. Given our similarities, there is clearly much we can take from each other. What I would like to do today is talk about some of the lessons that we in Canada have learned about economic policy in recent years. The "four legs" of economic policy During the 1980s, a consensus began to take shape among OECD countries on a set of economic policies that would provide the strongest base for sustained economic growth. There are four principles involved in this consensus. I like to think of them as the four legs of a chair. Just as a chair is steadiest when all of its legs are the same length, policy-makers can get the best results by paying equal attention to all four principles. And when one of the legs starts to weaken, the best way to restore stability is to build that leg back up, not to cut down the other three. Over the past decade or so, Canadians spent a great deal of effort putting the four elements of this framework into place. It certainly was not easy. It involved a fair bit of short-term economic pain. But the phrase "short-term pain for long-term gain" is more than just a cliché. Canada is now reaping the economic benefits of this effort. Of course, part of the reason for our recent good performance is the basic structure of our economy. For example, the current global economic uncertainties are having their greatest effect on large, multinational firms. But Canada's economy consists more of small and medium-sized enterprises. As well, while the hard-hit technology sector has become an increasingly important part of the Canadian economy in recent years, it still represents a smaller share of our economy, compared with, for example, the United States. But good fortune is only part of the story. Without Canada's commitment to the OECD's "four legs" of sound economic policy, our recent performance would no doubt have been poorer. So, what are the "four legs" of the OECD consensus? The principles that I am referring to deal with monetary policy, fiscal policy, trade liberalization, and structural reform. I will spend a few minutes on each of these, drawing on Canada's experience in recent years. Let me start with the one that relates most directly to the Bank of Canada's primary responsibility monetary policy. The OECD consensus holds that price stability is the appropriate goal for monetary policy over the medium term. In Canada, we try to achieve this goal through an inflation-targeting framework. The Bank of Canada reached an agreement with the federal government and introduced this policy in 1991. Under that agreement, we aim to keep inflation, as measured by the consumer price index (CPI), at the 2 per cent midpoint of a 1 to 3 per cent target range over the medium term. We have found that this inflation-targeting system has been very effective in promoting low, stable, and predictable inflation in Canada. Following a period of higher and more variable inflation in the 1970s and 1980s, the inflation-control targets have helped to anchor monetary policy. After the agreement came into effect, inflation quickly fell into the target range. Subsequently, inflation expectations have become focused on the target, helping to promote sustained economic growth. Here in Italy, the inflation-targeting monetary authority is the European Central Bank (ECB). Italy's recent inflation record is certainly favourable. But there is a slight difference in the approaches of the ECB and the Bank of Canada that I will mention. At the Bank of Canada, we explicitly run monetary policy in a symmetric way around our 2 per cent target. The ECB's only explicit commitment is to keep inflation below 2 per cent. There are always challenges to operating a single monetary policy in a country with diverse regions. As I said earlier, Canada, like Italy, has several regions with different economic structures. The ECB faces the even more daunting challenge of conducting monetary policy for an entire continent! But the important point I want to make here is that both the ECB and the Bank of Canada are determined to keep price stability as the medium-term policy goal. That is the first of the four legs. The second leg of the consensus has to do with fiscal policy. In the years leading up to the mid-1990s, provincial and federal governments in Canada were in the habit of running budget deficits. These deficits built up as governments continued to borrow, primarily to finance current consumption. It was an unsustainable situation, made more serious by our aging population. Clearly, social spending had to be put on a viable long-term course. And so fiscal policy needed to be based on a plan for putting the ratio of public debt to GDP on a steady downward track. In Canada's experience, this was a difficult hurdle to overcome. The fiscal consolidation of the 1990s was painful. I was the federal Deputy Minister of Finance at the time, and I can tell you that many difficult and unpopular decisions had to be taken. Equally important, the provinces had to make hard choices as they reduced their public spending and restored their fiscal health. But as difficult as those years were, waiting would only have made matters worse. Now, here's the good news: the vicious circle of rising deficits and debt has become a virtuous circle of balanced budgets and falling debt. Reducing the deficit in the 1990s helped Canada's international credibility. And this led to a reduction in the risk premium demanded by international investors. The fiscal improvement meant that the Bank of Canada was able to lower interest rates more easily when economic circumstances warranted. Not only did the lower interest rates reduce debt-servicing costs, they also stimulated economic growth, which brought in more revenues for the government. The extra revenue and lower debt-servicing costs, in turn, led to an even better fiscal position. Canada's total government surplus at the end of 2002 represented just over 1 per cent of GDP, which does not include the surpluses in public pension plans. Last month, Finance Minister John Manley announced a fifth consecutive surplus in the federal budget and projected that the budget will continue to be in a balanced position or better for the next three years. The budget maintained the fiscal planning framework of previous years. That framework includes a $3 billion contingency reserve, which is used to reduce debt if it is not needed for other purposes. It also includes $1 billion in the 2003–04 budget year for additional economic prudence, and $2 billion in the following year, as further assurance that Canada won't fall back into a deficit position. Not only have we reduced the debt-to-GDP ratio, but the federal government has paid down almost $50 billion of debt. This has led to the restoration of Canada's Triple-A credit rating and has freed up about $3 billion of resources every year for the federal government. The main point is that while the initial work of fiscal consolidation is certainly difficult, it is necessary in order to enjoy the fiscal dividends later on. The third leg of the consensus deals with trade liberalization. Countries need freer international trade to exploit the gains that come from increased specialization, enhanced productivity, and greater competitiveness. Canada's recent experience in this area first involved signing the Canada-U.S. Free Trade Agreement, which came into effect in 1989. In 1994, Mexico joined the group through the North American Free Trade Agreement (NAFTA). Both of these agreements sparked a great deal of domestic political controversy. But they also opened markets and created tremendous opportunities. Canada's exports have flourished as a result. But freeing up trade means more than setting up regional free-trade blocs, such as NAFTA and the European Union. Canada is hoping to see meaningful progress at the World Trade Organization's Doha round of multilateral talks. Clearly, agriculture is going to be a major hurdle. The developed countries, including all of us in the G-7, have a considerable way to go in terms of liberalizing agricultural trade. And a number of other sectors will also require a major effort. This effort must be made so that the global economy can benefit. It won't be easy, but in the long run, it will be worth it. The fourth policy leg has to do with structural reform. These adjustments are always difficult because reforms will affect various groups in differing and often painful ways. Further, the economic benefits of the increased flexibility may take a fairly long time to emerge. But these difficulties should not sway us from the task of reducing rigidities and increasing efficiency so that our economies can better adjust to a rapidly changing world. Canada has made some progress in a number of areas. The federal government has made changes to its system of unemployment insurance, trying to base the program more on insurance principles and to improve the employability of labour. Canada has also taken steps to reduce distortions in the personal income tax system and has implemented a goods and services tax to replace the outdated tax on manufacturers. More recently, we made some major changes to our public pension system. The Canada and Quebec Pension Plans were established in 1966 using a "pay-as-you-go" system. But changing demographics put pressure on the plans, as they are doing in Europe. By 1996, the federal and provincial governments agreed to changes that would put the Canada and Quebec Pension Plans on a firmer footing. This meant some restructuring of benefits and a sharp increase in contributions - moves that were not popular, but they were certainly necessary. The Canada and Quebec Pension Plans now generate surpluses that represent almost 1 per cent of GDP. These are set aside in special funds that cannot be touched by governments for general use. Indeed, the federal and provincial governments agreed to set up the Canada Pension Plan Investment Board, an entirely independent body. Its sole mandate is to invest the contributions in markets, in order to generate the best possible returns, with due consideration for prudence, over the long term. I should also point out, because the Canadian and Italian systems are different, that all public sector employees in Canada belong to pension plans that are fully funded. I know that you in Italy are struggling with pension reform, and I know how difficult the issue is. But such reforms are important, and I wish you well in your efforts. The challenges you are facing serve to highlight the fact that implementing the fourth leg of the OECD policy consensus is not easy. But we must all continue to make progress and not lose sight of the four principles. The payoff that Canada is now seeing gives me confidence in the value of the OECD consensus. Despite the global economic slowdown, despite the collapse of the share prices of many technology firms, despite the effects of the September 2001 terrorist attacks against the United States, and despite the corporate governance and accounting concerns, Canada's economy has remained strong. And most forecasters expect us to lead the G-7 in economic growth again this year. Given all the uncertainty in the global economy, it is more important than ever that national authorities around the world stick to this policy framework. It is only by staying the course that we can establish a steady base for sustained growth over the long term. Canada's economic prospects Let me now give you the Bank of Canada's views on the state of the Canadian economy and the outlook. First, a bit of history. Following the 11 September 2001 terrorist attacks in the United States, the Bank of Canada, like other major central banks, moved quickly and aggressively to cut its policy interest rate to shore up confidence. That dramatic monetary policy action helped a great deal. By the spring of 2002, it became evident that our economy hadn't been knocked off track by the events of 11 September. Indeed, evidence was starting to build that the economy was growing faster than its production potential, taking up the remaining small amount of economic slack. So, we raised our key policy rate three times between April and July, by a total of three-quarters of a percentage point. But by late last summer, we were seeing the effects of financial headwinds, geopolitical uncertainties, and continued weakness in the global economy. These factors remained in play through the autumn. As a result, we refrained from raising interest rates, even though inflation was accelerating. Our initial analysis was that this increase in inflation would be temporary. However, both core and total CPI inflation remain well above target. This reflects the impact of higher-than-expected prices for crude oil and natural gas, continuing increases in auto insurance premiums, and price pressures in certain sectors, such as housing, food, and some services. The higher inflation also suggests an underlying firmness in the price-setting environment. In other words, relative price increases wouldn't be pushing up trend inflation if there was not sufficient demand. Indeed, final domestic demand - especially household spending - has remained robust. However, economic growth in Canada moderated in the final three months of 2002, largely because of weaker exports - most notably, a decline in automotive shipments to the United States. Even with this slowing growth in the fourth quarter, upward revisions for previous quarters leave the level of economic activity slightly higher than we had been monitoring. In fact, Canada's economy remains near full capacity. Let me list some of the indicators that support this view: high industrial capacity utilization; near record-high labour force participation rates; a record-high employment-to-population ratio; corporate profits at their highest level since early 2001; and, as I said a few moments ago, above-target trend inflation. While we continue to foresee growth somewhat below potential in the first half of this year, we expect increased demand in the second half of 2003 and into 2004, as global uncertainties diminish. But with an appropriate reduction in the amount of monetary stimulus, we see the level of output remaining close to capacity during this year and into 2004. So, in making our interest rate decision on 4 March, we weighed the following considerations: domestic inflation pressures; the expectation that Canadian economic activity will remain near potential in 2003 despite geopolitical uncertainties; the stimulative stance of monetary policy; and improved conditions in capital markets. Taking all of these factors into account, the Bank raised its key policy rate by one-quarter of a percentage point to 3 per cent. Even with this increase, the stance of monetary policy remains stimulative. Thus, over time, further reductions in monetary stimulus will be required to return inflation to the target over the medium term. But, as we have said, the timing and pace of increases in policy interest rates will continue to depend on a number of considerations. These include the strength of demand pressures; the evolution of inflation expectations; the impact on confidence of geopolitical and global economic uncertainties; and the way in which developments in the Middle East affect demand and inflation, both globally and in Canada. The Bank will continue to closely monitor all of these factors. * * * So, to conclude, these are certainly challenging economic times. But we in Canada remain convinced of the merits of the economic policy consensus reached at the OECD. To reiterate, these policies are: a monetary policy aimed at medium-term price stability; a fiscal policy aimed at reducing public debt-to-GDP ratios; trade liberalization; and meaningful structural reform. Canada's positive economic experience over the past couple of years, in the face of stressful times for the global economy, is strong evidence that this framework is the right one. In Canada, there is a determination to stick with these policies which, especially during these uncertain times, are demonstrating their value.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Council of Chief Executives, Washington, D.C., 7 April 2003.
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David Dodge: Focusing on the long term Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Canadian Council of Chief Executives, Washington, D.C., 7 April 2003. * * * Thank you for the invitation to join you this evening. It was exactly a year ago that I met with you in Montréal. It has not been an easy year. All of you have been running companies and making decisions under very uncertain conditions. You have had to deal with corporate and accounting issues. Markets have been volatile. And geopolitical events have shaken confidence. At times like these, it's easy to get caught up in trying to make one's way through current events that cloud the outlook. But the present uncertainties make it even more important to maintain a focus on strategies that will promote the health of businesses over several years—not just over the next few months or quarters. The same holds true for economic policy-makers. Failed experiments in previous decades have taught us that, in times of uncertainty, it is extremely important to stick to policies that will foster long-term economic growth. A longer-term focus Many of us in this room have reached a stage in life where we have at least two pairs of glasses—one for close-up, and one for distance. We're acutely aware that wearing glasses to focus on something very close makes us lose perspective on things further away. And if we focus only on the here and now, we can lose sight of the future. We need a set of economic bifocals, if you will, to see the impact of current events, as well as the best path to future prosperity. Tonight, I'd like to speak about that longer-term economic vision. Through more than a decade of macroeconomic reform, we Canadians have created a framework to meet both immediate and longer-term challenges. Even as short-term events have buffeted our economy, we have followed four key long-term policy principles: trade liberalization, structural reform, sound fiscal policy, and low inflation. Recent Canadian economic performance demonstrates the merit of continuing to set policies with a longer-term view. Short-term adjustments are sometimes unavoidable in the face of extraordinary events—and we've had more than our share of extraordinary events in the past few years! But, on the whole, these basic principles have stood Canada in good stead through the recent difficulties in the world economy. Let me talk about each one in a bit more detail. Trade Liberalization The first principle is trade liberalization, and our economic relationship with the United States has reflected that goal. As you and I discussed last year, the Canadian and U.S. economies made difficult adjustments to freer trade in the early 1990s. The Canada-U.S. Free Trade Agreement and the North American Free Trade Agreement exposed many Canadian companies to stiffer competition. But freer trade also opened up new markets. And Canadian companies have risen to the challenge. Some of the sectors that we used to protect the most—such as furniture, clothing, and wine—have established a strong presence in international markets. On the whole, Canadian industry has flourished with the competitive pressures generated by these agreements. And so has the trading relationship between Canada and the United States. As you can see from Chart 1, freer trade has clearly meant increased volumes of exports and imports. And now that we have made the adjustment, the more open trading environment is clearly helping to raise living standards for Canadians. That should strengthen our resolve to see freer trade extended both within and beyond North America. We need to continue to work towards reduced trade barriers, both within NAFTA and at the Doha round of multilateral talks. It won't be easy, but the long-term economic benefits will make our efforts worthwhile. Structural Reform The second principle focuses on improving the structure of national economies, to facilitate adjustment to changing economic conditions and to ensure the longer-term viability of social- and income-security arrangements. A number of initiatives have been undertaken in Canada, but I'm going to focus on only three. I am sure that you're familiar with them, and many of you have participated in the debate surrounding these reforms. First, Employment Insurance (EI) benefits were restructured to strengthen the incentive to work. With these changes, and with improved economic performance, EI payments as a share of GDP have declined significantly over the past decade, from more than 2 1/2 per cent to just over 1 per cent, as shown in Chart 2. Second, the Canada and Quebec Pension Plans were revamped, to put them on a sustainable footing. The reforms meant some restructuring of benefits and a sharp increase in contributions—moves that were necessary, if unpopular. The results are shown in Chart 3. The assets of the CPP are now managed by the independent Canada Pension Plan Investment Board, the mandate of which is to invest the contributions in markets, in order to generate the best possible returns. These changes mean that Canadians no longer have to worry about the sustainability of their CPP and QPP pensions. Third, governments have improved the efficiency of their tax and spending programs. I know that you are familiar with the major federal and provincial efforts to make direct government spending more efficient. Although more work always needs to be done, governments in Canada have also undertaken significant structural changes to our tax regime. They have reduced distortions in the personal income tax system and implemented the goods and services tax to replace the outdated manufacturers sales tax. Structural reform has also included changes to Canada's corporate tax regime—changes that, when completed, will eliminate the federal capital tax and reduce the average statutory corporate tax rate in Canada to a level that is below current U.S. rates. Of course, there are other structural improvements left to be made. I'm sure many of you have views and suggestions about how to make them. You have been discussing some of them here today. In my view, it is critical that Canada's private and public sectors continue to work together to further improve the structure of our economy and increase our ability to adjust to changing world economic conditions. Sound Fiscal Policy Now, the key to good economic performance is sound macroeconomic policy. The Bank of Canada is responsible for monetary policy. But monetary policy operates within a larger macroeconomic context. So, let me start with fiscal policy. For Canada, the commitment to the principle of sound fiscal policy has meant putting our public debt, as a proportion of GDP, on a sustainable downward track. Many of you remember the difficult and unpopular decisions that had to be taken by federal and provincial governments during the 1990s to achieve this goal. Those efforts are paying off. Today, not only does Canada have one of the lowest debt burdens in the G-7, but, as shown by the arrows in Chart 4, that burden is expected to continue to decline. The federal government has paid down almost $50 billion of its debt—bringing it down from a high of almost 70 per cent of GDP in 1996 to about 45 per cent in 2002, as illustrated in Chart 5. Thus, the vicious circle of rising deficits and debts of the 1970s and 1980s has become a virtuous circle of balanced budgets and falling debt. Program spending for all levels of government has dropped from 42 per cent of GDP in 1993 to 34 per cent last year, as you can see in the table. And debt-servicing costs have dropped from about 9 per cent of GDP to less than 6 per cent. Here's how Finance Minister Manley summed up this principle of fiscal discipline in his February budget speech: "Keeping a balanced budget, cutting debt and getting the best value for money are a constant challenge and a constant imperative. These are the bedrock of our fiscal and economic strategy." Low Inflation Complementing a sound fiscal policy is a monetary policy focused on keeping inflation low and stable—that's the fourth principle, and that is the Bank of Canada's responsibility. Canada's inflation-targeting framework works in a symmetrical way to keep consumer price inflation at the 2 per cent midpoint of a 1 to 3 per cent range. If the trend of inflation moves away from the target, in either direction, the Bank will take action to return it to the target within 18 to 24 months. Through most of the past decade, we have managed to keep inflation around the 2 per cent target midpoint, as you can see in Chart 6. As a result, Canadians' expectations for inflation have become firmly anchored around 2 per cent, as shown in Chart 7. That is extremely valuable for decision-makers in business, government, and households. This climate of low, stable, and predictable inflation has helped to smooth out the ups and downs in the economy and to create the best possible environment for longer-term economic growth in Canada. Let me now spend a few minutes describing the circumstances in which monetary policy is currently operating. Even though growth slowed in the fourth quarter of 2002, reflecting global economic and geopolitical uncertainties, our economy continues to operate close to capacity. As we said in our January Monetary Policy Report Update, a number of indicators support this view. They include high industrial-capacity utilization; a record-high labour force participation rate; a record-high employment-to-population ratio; corporate profits at their highest level since early 2001; and trend inflation that is running above target. Canada's inflation numbers continue to reflect the impact of higher-than-expected prices for crude oil and natural gas, further increases in auto insurance premiums, and price pressures in certain sectors, such as housing, food, and some services. This higher inflation also suggests an underlying firmness in the price-setting environment. Relative price increases wouldn't be pushing up trend inflation if there was not sufficient demand. So, in making our latest interest rate decision on 4 March, we weighed not only domestic inflation pressures and the expectation that Canadian economic activity will remain near potential in 2003, but also the stimulative stance of monetary policy and improved conditions in capital markets. Taking these factors into account, we raised our key policy rate by one-quarter of a percentage point to 3 per cent. Even with this increase, the stance of monetary policy in Canada remains stimulative. Thus, over time, further reductions in monetary stimulus will be required to return inflation to the target in the medium term. But, as we have said, the timing and pace of increases in policy interest rates will continue to depend on a number of considerations. These include: the strength of demand pressures; the evolution of inflation expectations; the impact on confidence of global economic uncertainties; and the way in which the war in Iraq affects demand and inflation, both globally and in Canada. The Bank continues to monitor all of these factors and will adjust monetary conditions to keep Canadian inflation low, stable, and predictable over the medium term. The Bank's next Monetary Policy Report, to be released on 23 April, will provide a full update of our assessment of the economy and of the outlook for inflation. Conclusion In closing, let me repeat that, in these trying times, it is tough indeed to maintain a clear view of the current economic picture. But, if we spend all our energy focusing on the near term, we risk losing sight of what's farther out. Your job is to build enterprises that will flourish over the longer term. And our job as policy-makers, whether on the monetary or fiscal side, is to create the best possible climate for sustained economic growth. In an uncertain world, the best thing we can do is to stick to sound economic policy principles. They have proven to be the most effective tools to deal with short-term turbulence and, at the same time, promote solid, sustainable economic growth and prosperity over the longer term.
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the House of Commons Finance Committee, Ottawa, 29 April 2003.
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David Dodge: The Bank of Canada’s views on the Canadian economy and inflation Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the House of Commons Finance Committee, Ottawa, 29 April 2003. * * * Good afternoon, Madame Chair and members of the committee. I would like to start by saying how much we at the Bank of Canada appreciate the opportunity to come here twice a year, following the release of our semi-annual Monetary Policy Report. We are very aware of the need to keep Members of Parliament and, indeed, all Canadians informed about what we're doing and why. It's important that we explain our views on the economy and on inflation. So, thank you for the opportunity. I'm going to spend a few minutes summarizing for you our most recent Monetary Policy Report. But, before I do that, I'd like to say a few words about my colleagues here with me today. I am delighted to introduce to you our newly appointed Senior Deputy Governor, Paul Jenkins. Paul has been with the Bank of Canada since 1972 and, for the past 11 years, he has served as a Deputy Governor. In that role, Paul has been responsible for the Bank's analysis of international economic and financial issues and for our liaison with related international bodies, such as the International Monetary Fund. He's also been in charge of the strategic direction and oversight of the Bank's public communications. Paul has a deep understanding not only of economic and monetary policy issues, but also of the Bank and its staff. I know he will provide energetic leadership in helping the Bank continue its tradition of excellence in promoting the economic and financial welfare of Canada. Also with me today is Deputy Governor Chuck Freedman. Chuck will retire in September, after almost 30 years at the Bank. He's been a Deputy Governor since 1988, and his leadership in the areas of monetary policy, financial institutions, and Canada's clearing and settlement systems has been invaluable. One of Chuck's most important contributions has been his tireless promotion of bilingualism at the Bank. I can't begin to say how much we will all miss him—especially those of us on the Bank's Governing Council—not only for his expertise, but also for his enthusiasm and keen wit and intellect. Last week, we released our spring Monetary Policy Report, in which we discuss economic and financial trends in the context of Canada's inflation-control strategy. I last testified before this committee in October, following the release of our autumn Monetary Policy Report. To place our recent experience in some context, let me go back a bit further than that. Following the 11 September 2001 terrorist attacks in the United States, the Bank of Canada quickly and aggressively cut its policy interest rate to shore up confidence and support domestic demand. By the spring of 2002, evidence had already started to build that demand was growing faster than the economy's production capacity. Monetary policy actions must always be forward looking. So, even though demand pressures were not yet showing up in prices, we raised our key policy rate three times between April and July 2002, by a total of three-quarters of a percentage point. When we met with you last autumn, inflation in Canada was on the rise. But we refrained from raising interest rates because of the prevailing geopolitical and financial uncertainties, high yield spreads and restricted access to funding for riskier corporate borrowers, and the expectation that global economic weakness would restrain total demand for Canadian goods. Since then, inflation has been above the 2 per cent target. The total year-over-year CPI inflation rate reached a peak of 4.6 per cent in February, falling back somewhat to 4.3 per cent in March. Key factors behind the jump in inflation are the sharp rise in oil and natural gas prices, increases in insurance premiums, and strong domestic demand. That demand has led to price pressures in certain sectors, such as shelter and some services. In this environment, some indicators of short-term inflation expectations have edged up. These include data from the survey taken by the Bank's regional offices and the average private sector consensus forecast. Longer-term expectations of inflation, however, remain around 2 per cent. To assess the future trend of inflation, the Bank uses a measure of core inflation, which strips out the eight most volatile items in the CPI basket, and the effect of changes in indirect taxes on the remaining CPI components. Core inflation now sits around 3 per cent. It should fall to about 2 1/2 per cent in the second half of this year, and to about 2 per cent by early 2004. Total CPI inflation will continue to be importantly affected by swings in crude oil prices. If oil prices were to settle at about $25 per barrel by mid-2003—as futures prices suggest—and if the Canadian dollar were to stay close to current levels, total CPI inflation would likely fall temporarily below the core rate in the first half of 2004, before steadying out at a rate close to core inflation. In view of the domestic inflation situation and the underlying momentum of domestic demand, we have raised our target overnight rate by 25 basis points on each of our last two policy announcement dates—in March and in mid-April—bringing it to 3.25 per cent. As I said before, economic, financial, and geopolitical uncertainty figured prominently in the global picture last October. Some of the geopolitical and financial uncertainty has lifted in recent months, and the Bank expects that it will continue to recede. However, weak domestic demand in some regions of the world is still a concern. So, over the near term, a degree of global economic uncertainty remains. Even with all this, the risks confronting the world economy now appear to be better balanced than they were last autumn. And, by year-end, we expect that business and household confidence levels should improve. In Canada, domestic demand has remained quite strong. There is uncertainty, however, about the possible economic impact of Severe Acute Respiratory Syndrome (SARS), particularly in the Greater Toronto Area. As I said last week, we expect that economic growth in the second quarter will be somewhat weaker than we projected in the Monetary Policy Report because of the impact of SARS. But it is too soon to make an assessment of the magnitude of its effect on economic activity. We continue to monitor the situation very closely. We expect that the Canadian economy will strengthen towards the end of 2003, partly thanks to a pickup in economic activity in the United States. Average annual growth in Canada is expected to be about 2 1/2 per cent this year. During 2004, our economy should strengthen further, expanding at a rate above its 3 per cent growth of potential. This means that most of the small amount of economic slack that is likely to open up in Canada during 2003 will have closed by the end of next year. For this reason, the Bank continues to believe that further reductions in monetary stimulus will be necessary over time to return inflation to its 2 per cent target and to sustain output levels close to capacity. The timing and pace of further increases in policy interest rates will depend on the strength of domestic demand, the evolution of inflation expectations, and the pace of economic expansion in the United States and in overseas economies.
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Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the Senate Banking, Trade and Commerce Committee, Otttawa, 30 April 2003.
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David Dodge: Monetary policy developments in Canada Opening statement by Mr David Dodge, Governor of the Bank of Canada, to the Senate Banking, Trade and Commerce Committee, Otttawa, 30 April 2003. * * * Good afternoon, Mr. Chairman, members of the committee. I would like to start by saying how much we appreciate the opportunity to meet with you following the release of the Bank’s semi-annual Monetary Policy Report. It’s important for us to be able to explain our views on the economy and on inflation. I’d like to spend a few minutes summarizing the key points of our most recent Report, which we released last week. But first, I’d like to introduce my colleagues—Deputy Governors Chuck Freedman and Pierre Duguay. Chuck will retire in September, after almost 30 years at the Bank. His leadership in the areas of monetary policy, financial institutions, and Canada’s clearing and settlement systems has been invaluable. We will all miss his expertise, his enthusiasm, and his keen wit and intellect. The last time I testified before this committee was in the spring of 2002, because we were unable to arrange our regular meeting last fall. You will recall that following the 11 September 2001 terrorist attacks in the United States, we quickly and aggressively cut our policy interest rate to shore up confidence and support domestic demand. By last spring, evidence had already started to build that demand was growing faster than the economy’s production capacity. Monetary policy actions must always be forward looking. So, even though demand pressures were not yet showing up in prices, we raised our key policy rate three times between April and July 2002. By the autumn, inflation was on the rise. But we refrained from raising interest rates because of geopolitical and financial uncertainties, high yield spreads and restricted access to funding for riskier corporate borrowers, as well as the expectation of weaker foreign demand for Canadian goods. Since then, inflation has been above the 2 per cent target midpoint. The total CPI inflation rate peaked at 4.6 per cent in February, falling back somewhat to 4.3 per cent in March. The jump in inflation reflected the sharp rise in oil and natural gas prices, increases in insurance premiums, and strong domestic demand that had led to price pressures in certain sectors, such as shelter and some services. In this environment, certain indicators of short-term inflation expectations have edged up—although longer-term expectations remain around 2 per cent. Core inflation, which strips out the eight most volatile items in the CPI basket and the effect of changes in indirect taxes on the remaining CPI components, is a better indicator of the future trend of inflation. It now sits around 3 per cent. But it should fall to about 2 1/2 per cent in the second half of this year, and to about 2 per cent by early 2004. Total CPI inflation will continue to fluctuate with swings in crude oil prices. If these prices settle at about US$25 per barrel by mid-2003—as futures prices suggest—and if the Canadian dollar stays close to current levels, total CPI inflation will likely fall temporarily below the core rate in the first half of 2004, before steadying out at a rate close to core. In view of the domestic inflation situation and the underlying momentum of domestic demand, we raised our target overnight rate by 25 basis points on each of our last two policy announcement dates. It now stands at 3.25 per cent—still relatively low by historical standards. Some of the geopolitical and financial uncertainty we saw last fall has lifted in recent months, and we expect that it will continue to recede. Economic uncertainty in some regions of the world is still a concern. But overall, the risks confronting the world economy now appear to be better balanced than last autumn. And business and household confidence should improve by year-end. In Canada, domestic demand has remained quite strong. But now there is uncertainty about the economic impact of Severe Acute Respiratory Syndrome (SARS), particularly in the Greater Toronto Area. Second-quarter economic growth will be somewhat weaker than we projected in our latest Monetary Policy Report because of SARS. But, while the developments of the past few days suggest the worst is behind us, it is still too soon to put a number on the effect of SARS on economic activity. The Canadian economy should strengthen towards the end of 2003, partly thanks to a pickup in U.S. economic activity. Average annual growth in Canada is expected to be about 2 1/2 per cent this year. During 2004, our economy should expand at a rate above its 3 per cent growth of potential. Therefore, most of the small amount of economic slack that is likely to open up this year will have closed by the end of 2004. For this reason, we still believe that further reductions in monetary stimulus will be necessary over time to return inflation to its 2 per cent target and to sustain output levels close to capacity. The timing and pace of further increases in the Bank’s target overnight rate will depend on the strength of domestic demand, the evolution of inflation expectations, and the pace of economic expansion in the United States and overseas.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Foreign Bankers¿ Association in the Netherlands, Amsterdam, 13 May 2003.
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David Dodge: Policies to sustain growth domestically and internationally Remarks by Mr David Dodge, Governor of the Bank of Canada, to the Foreign Bankers’ Association in the Netherlands, Amsterdam, 13 May 2003. * * * Good afternoon, ladies and gentlemen. I have been looking forward to coming to Amsterdam since Governor Wellink extended the invitation last year. I must say that when you consider what has been happening in the world economy, it is certainly an interesting time to be a Canadian at international meetings such as the BIS meeting I attended yesterday. My colleagues from other central banks have often commented on Canada’s relatively strong economic performance over the past two or three years. In response, I have told them that there is certainly an element of good fortune in that performance. But, fundamentally, it reflects the extraordinary efforts made during the 1990s to put a coherent economic policy framework in place, and I want to begin by talking about that framework. The four principles of economic policy Let me quickly add that this is not simply a Canadian story. The framework that I’m talking about emerged from international discussions and has relevance for all national economies. In the 1980s, a consensus was reached among OECD countries on a set of economic policies that would provide the strongest base for sustained economic growth. This consensus is based on four principles: trade liberalization, structural reform, fiscal prudence, and inflation control. I will spend a few minutes on each one of them, drawing on Canada’s experience in recent years. Let me begin with trade liberalization. Your own mission statement acknowledges the importance of the free flow of goods and services, as well as of capital and people, within the European community. Freer international trade allows countries to better exploit the gains made from increased specialization and enhanced productivity. Canada has promoted reduced barriers to multilateral trade since the Havana Conference of 1947, which launched the General Agreement on Tarriffs and Trade. In 1989, Canada signed a free trade agreement (FTA) with the United States. In 1994, Mexico joined the group through the North American Free Trade Agreement (NAFTA). Both of these agreements initially sparked a great deal of political controversy in Canada. However, they have opened up markets and created tremendous opportunities for Canadian entrepreneurs. Our exports have flourished as a result. But freeing up trade means more than setting up regional free-trade blocs, such as NAFTA and the European Union. Canada is hoping to see meaningful progress at the World Trade Organization’s Doha round of multilateral talks. Clearly, agriculture and a number of other sectors are going to require a major effort. This effort must be made so that the global economy can benefit. It won’t be easy, but in the long run, it will be worth it. The second principle in the OECD policy consensus has to do with structural reform. There are two goals here: one, to increase the flexibility of our economies in order to adjust to changing world economic conditions; and two, to ensure the longer-run viability of our social- and income-security arrangements. These adjustments are always difficult, because reforms will affect various groups in different, and often painful, ways. Further, the economic benefits of the increased flexibility may take a fairly long time to emerge. But these difficulties should not sway us from the task of reducing rigidities and increasing efficiency. Canada has made some progress in a number of areas. The federal government has made changes to its system of unemployment insurance, trying to base the program more on insurance principles and to improve the employability of labour. Canada has also taken steps to reduce distortions in the personal income tax system and has slashed industrial subsidies by roughly two-thirds. More recently, we made some major changes to our public pension system, to better prepare for the inevitable pressures that will develop as our population ages. This meant some restructuring of benefits and a sharp increase in contributions—moves that were not popular, but were certainly necessary. In addition, the federal and provincial governments agreed to set up the Canada Pension Plan Investment Board, an entirely independent body. Its sole mandate is to invest the contributions in markets, in order to generate the best possible returns over the long term, with due consideration for prudence. Demographic pressures are also being felt, perhaps even more strongly, in some European countries, where various governments have dealt with, or are struggling with, this issue. The third principle in the OECD policy consensus has to do with fiscal prudence and the need for a disciplined approach to managing the public purse. In the years leading up to the mid-1990s, provincial and federal governments in Canada ran large budget deficits. These deficits built up as governments continued to borrow, primarily to finance current consumption. It was an unsustainable situation, made more serious by our aging population. Clearly, social spending had to be put on a viable long-term course. And so fiscal policy needed to be based on a plan that would put the ratio of public debt to GDP on a steady downward track. This was a difficult hurdle to overcome, and the fiscal consolidation of the 1990s was painful. Now, here’s the good news. Since that time, the vicious circle of rising deficits and debt has become a virtuous circle of balanced budgets and falling debt. Reducing, and ultimately eliminating, the deficit in the 1990s helped with Canada’s international credibility. And this led to a reduction in the risk premium demanded by investors. The fiscal improvement meant that the Bank of Canada was in a position to lower interest rates more easily when economic circumstances warranted. The lower interest rates reduced debt-servicing costs, stimulated economic growth, and boosted government revenues, which led to an even better fiscal position. The main point here is that, while the initial work of fiscal consolidation is certainly difficult, it is necessary in order to enjoy the fiscal dividends later on. The final policy principle is the one that relates most directly to the Bank of Canada’s primary responsibility—monetary policy. The OECD consensus holds that price stability is the appropriate goal for monetary policy over the medium term. In Canada, we try to achieve this goal through an inflationtargeting system. The Bank of Canada reached an agreement with the federal government in 1991 to try to keep inflation, as measured by the consumer price index, at the 2 per cent midpoint of a 1 to 3 per cent target range over the medium term. Importantly, we take a symmetric approach to our inflation target. This means that we worry as much about the trend of inflation falling below the target as we do about inflation rising above the target. We have found that this symmetric approach has been very effective in promoting low, stable, and predictable inflation in Canada. Following a period of higher and more variable inflation in the 1970s and 1980s, the inflation-control targets helped to anchor monetary policy. Inflation quickly fell into the target range, and inflation expectations became focused on the target. This has helped to smooth out the ups and downs of the business cycle and, more generally, has led to stronger economic growth in the long term. Those are the four principles on which the OECD policy consensus is based: trade liberalization, structural reform, sound fiscal policy, and monetary policy focused on inflation control. Canadians spent a great deal of effort putting the four elements of this framework into place over the past decade or so. It certainly was not easy. It involved a fair bit of short-term economic pain. But the phrase “shortterm pain for long-term gain” is more than just a cliché. Canada is now reaping the economic benefits of that effort. In the face of all the negative shocks that hit the global economy in the past two or three years—war, terrorism, corporate governance and accounting concerns, and the collapse of the technology sector—our economy has proven resilient. With all of the uncertainty in the global economy, it is more important than ever that national authorities around the world stick to a sound economic policy framework. It is only by staying the course that we can establish a steady base for sustained economic growth over the longer term. I don’t want to leave the impression that the way Canada has implemented the OECD policy consensus is the only way to go. Nor do I want to suggest that we have achieved perfection. There is still work to be done in all four areas of the framework, particularly in relation to microeconomic policies. Policy-makers should always be looking for ways to improve economic performance. In that vein, I now want to return to the topic of monetary policy and talk briefly about the potential role of asset prices in monetary policy. Asset prices and monetary policy Let me emphasize that I believe that our monetary policy framework, based on an explicit inflationcontrol target and a floating exchange rate, is the best choice for Canada. Our floating currency helps facilitate the economic adjustments that will always be necessary when shocks occur. This is particularly important for a relatively small and open economy such as ours. All told, Canada has a coherent monetary policy regime that has proven its worth—one that gives us a solid base for sound long-term economic growth. But the recent dramatic fall in the share prices of so many technology firms—the so-called bursting of the tech bubble—highlighted the debate about the role of asset prices in the conduct of monetary policy. It somehow seems appropriate that I should talk about this question here in the Netherlands, the location of one of the most famous asset-price bubbles in history—the tulip bubble of the seventeenth century. This episode, where mass speculation led to the dramatic rise and subsequent collapse in the price of tulip bulbs, illustrates that asset-price bubbles can have serious repercussions for a country’s economy when they burst. There has been a tendency recently, particularly in the United States, to ask whether central banks “should try to pop bubbles when they see them, before they get too large”. Let me be clear: I do not believe that central banks should try to target asset prices in the same way that we target the inflation rate. And I do not believe that we should be in the business of popping bubbles. To do so would be unrealistic. It would presume that central bankers know better than anyone else what represents fair value for assets. We don’t. Instead, the real issue is, What is the role of asset prices in the setting of monetary policy? Central banks—and here I’m speaking about the Bank of Canada in particular—do take into account the information contained in asset prices in a number of ways. When we set interest rates, we look at costof-capital effects and wealth effects, as well as the impact of changes in asset prices on confidence. And there are some asset prices, expressed as the yield spread between high- and low-risk bonds, that give an indication of credit conditions in the economy, so we look at those too. Other asset prices, such as the cost of new houses, form part of the Bank of Canada’s core measure of consumer prices, and are therefore taken into account directly. So clearly, movements in asset prices do play a role and are taken into consideration when we set monetary policy. All of these ways of looking at asset prices provide some information about the future inflation environment within our 18- to 24-month horizon for inflation targeting. But the broader question is, Are there ways in which asset prices can give central banks information about price pressures beyond this medium-term horizon? If so, what should be done about it? Let me give you a more concrete example. Consider the following scenario for an inflation-targeting central bank. Let’s assume that inflation is near its target, but demand in the economy is weak, and the output gap is widening. This situation would normally call for an easing of monetary policy. But what if, at the same time, there was evidence that the prices of assets such as equities or real estate were rising well above historical norms, or that there was a real surge in credit issuance relative to historic levels, or evidence of speculative overinvestment? Should a central bank then adopt a somewhat tighter policy than it otherwise would? And if it did, would this be effective in limiting the rise in asset prices? Should the central bank run the risk of inflation falling below the target, to help guard against a much more serious disinflationary correction of financial imbalances later on? There are no easy answers to these questions, but we have to continue to think hard about them. The role of the exchange rate That hard thinking must equally be applied to what is, in effect, another class of asset prices. I am referring to the price of a country’s currency—the exchange rate. This is particularly true at times when we see large movements in exchange rates. So it is an issue that faces us all, given the recent sharp depreciation of the U.S. dollar against the Canadian dollar, the euro, the pound, the Australian dollar, and others. What does this movement mean for the Bank of Canada? As with other asset prices, the Bank does not have a target level for the currency. Its price is determined by the markets, and the floating exchange rate is an important part of our monetary policy system, as I mentioned earlier. Thus, in setting monetary policy in the context of this system, we do take into account these movements, and what they tell us about demand and inflation. Insofar as movements in the exchange rate do affect the prices of imported goods, we must take them into account because they bear directly on what we do target; that is, the inflation rate. However, we have found in recent years that the passthrough from exchange rates to prices has been less pronounced than in the past. We also try to ascertain the primary causes of the movements in exchange rates, and whether these movements are giving any information about factors that are affecting real economic performance. To the extent that movements in the Canadian dollar reflect fundamental factors at work in the Canadian economy, such as strong economic performance or higher prices and stronger demand for non-energy commodities, then we clearly need to take these into account. ***** Let me close by reiterating that aiming for low, stable, and predictable inflation is a crucial component of the OECD policy framework, along with sound fiscal policy, structural reform, and trade liberalization. In my view, the debate about the role of asset prices in monetary policy is not an argument for moving away from inflation targeting. But I hope that my discussion of the potential role of asset prices in monetary policy underscores the idea that we should never stop looking for ways to improve our economic policy framework, so that we can continue to promote sustainable economic growth and prosperity.
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Remarks by Mr David Dodge, Governor of the Bank of Canada, to the German-Canadian Business Club of Berlin-Brandenburg Berlin, Germany, 5 June 2003.
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David Dodge: How sound economic policies help during uncertain times Remarks by Mr David Dodge, Governor of the Bank of Canada, to the German-Canadian Business Club of Berlin-Brandenburg Berlin, Germany, 5 June 2003. * * * It is an honour and a privilege to address the German-Canadian Business Club of Berlin-Brandenburg at its inaugural meeting. Groups such as this one serve many important purposes, not the least of which is the development of trading links that help to strengthen the economies of both our countries. Creating and strengthening international trading links has been one of the keys to the success of the Canadian economy in recent years. But there is much more to the story. So what I propose to do today is talk about some of the economic policies that Canada has put in place in recent years and, in doing so, touch on some of the challenges we still face. Canada's monetary policy framework Let me start with the policy area for which we at the Bank of Canada are responsible - monetary policy. The preamble to the Bank of Canada Act calls on us to conduct monetary policy "in the best interests of the economic life of the nation," and "to promote the economic and financial welfare of Canada." We know that too much demand can lead to inflationary pressures, and that too little demand means that resources are being wasted. So our aim in conducting monetary policy, insofar as monetary policy can influence demand, is to have the economy operating very close to its level of potential output. Over time, we have found that the best contribution that monetary policy can make is to try to keep inflation low, stable, and predictable, in order to provide the best setting for strong and sustained economic growth. The question then becomes, What should a central bank target in trying to bring this about? Following Canada's return to a floating exchange rate system in 1970, the Bank of Canada tried to achieve a low-inflation environment by targeting the growth of money from 1975 to 1982. But the relationship between money growth and the rate of inflation proved to be unstable. So, in 1991, the Bank adopted an explicit inflation-targeting approach. Under a joint agreement with the federal government, we aim to keep consumer-price inflation at the 2 per cent midpoint of a 1 to 3 per cent range. If the trend of inflation moves away from the target, the Bank will take action to return inflation to the target within 18 to 24 months. Our framework is symmetrical. This means that we worry as much about inflation falling below the target as we do about it rising above the target. Through most of the last decade, we have succeeded in keeping inflation close to the target. And so, Canadians' expectations for inflation have become anchored around 2 per cent. All this has helped to smooth out the ups and downs in the economy and to create the best possible environment for longer-term economic growth. This framework may sound simple in theory. But it is quite complex in practice. Our monetary policy decisions are based on economic projections, which can always be thrown off by unforeseen events. Because monetary policy actions take time to have their full impact on the economy, we must aim these actions at where we see the economy sitting 18 to 24 months into the future. In doing so, we are always looking at what is called the output gap - the difference between the actual level of production in the economy and the level of potential output. If the economy is operating above its potential capacity and inflation appears likely to be above target in the future, then we would tighten monetary policy. This would cool demand and bring inflation back down to the target. On the other hand, if the economy is operating below its potential capacity and inflation appears likely to be below target in the future, we would ease monetary policy in order to stimulate demand, close the output gap, and bring inflation back to its target. This means that we are always looking at demand and supply in the economy and trying to bring them into balance. So, in carrying out our policy, a large part of the analysis we do is concerned with the many factors that can influence demand and supply. The most important factor is, of course, the strength of domestic demand. But Canada is a trading nation, and so the strength of world demand is also important to us. In particular, the United States is a major customer for Canadian goods, so we closely monitor the health of the U.S. economy. Economic activity is also affected by movements in exchange rates. As you well know, there has recently been a significant adjustment in the value of the U.S. dollar against major currencies, including the Canadian dollar. As always, we need to understand the causes of this movement, as well as its effect on the Canadian economy. Furthermore, movements in exchange rates have a direct effect on the prices of traded goods and services and, therefore, on inflation. However, our research has shown that, in economies such as Canada's, the effect of exchange rate movements on consumer prices has been less pronounced in recent years, when inflation was relatively low, than was the case in earlier years, when inflation was high. Many other considerations go into our monetary policy decisions. We hear from the Bank's regional offices across Canada, which are in constant contact with Canadian businesses. We look at the economic clues in the data on credit conditions, monetary aggregates, and some asset prices - though I should make it clear that we don't have targets for those aggregates or for asset prices. Finally, we look at the expectations of financial markets. All of this information goes into our decisions, which always have the goal of aiming inflation at the 2 per cent target over the medium term. And as I said earlier, we are convinced that keeping inflation low, stable, and predictable is the best way for monetary policy to contribute to a healthy economy with strong and enduring economic growth. The Case for Flexibility But more is needed to ensure economic health. A doctor will tell you that, besides strength and endurance, healthy bodies need to be flexible. The same is true of an economy. Financial policymakers not only need to encourage strong and sustainable economic growth, they also need to work on improving economic flexibility. At the outset, I spoke briefly about trade. Removing barriers to trade is one important way of making an economy more flexible. We all know that freer international trade helps countries to more fully exploit the gains that come from increased competition and specialization. It is true that adjusting to freer international trade is not always easy. Canada's economy had to make some difficult adjustments after the Canada-U.S. Free Trade Agreement came into effect in 1989 and after the North American Free Trade Agreement added Mexico to the group in 1994. Both of these agreements sparked a great deal of domestic political controversy. Many Canadian companies were understandably concerned about their ability to compete. But despite initial misgivings, Canadian companies rose to the challenge. Some of the sectors that we used to protect the most - such as furniture, clothing, and wine - have since established a strong presence in international markets. Overall, Canadian exports have flourished. The success we have had strengthens our resolve to see freer trade extended beyond regional trading blocs. Canada is hoping to see meaningful progress at the World Trade Organization's Doha round of multilateral talks. Clearly, agriculture is going to be a major hurdle. The developed countries, including all of us in the G-7, have a considerable way to go in terms of liberalizing agricultural trade. And there are other sectors where major effort is required. This effort must be made so that the global economy can benefit. It won't be easy, but, in the long run, it will be worth it. Improving economic flexibility can also require structural reform. Improving the structures of our economies should help us not only to adjust to changing world economic conditions, but should also ensure the longer-run viability of our social- and income-security arrangements. Clearly, most structural reforms are not easy to accomplish. Adjustments can be difficult because reforms often affect different groups in painful ways. Further, the economic benefits of increased flexibility may take a fairly long time to emerge, making it harder to muster the political will to carry out needed reforms. But these difficulties should not sway us from the task of reducing rigidities and increasing efficiency. In Canada, we have made progress on a number of fronts over the past decade or so. In the early 1990s, Canada began to reform its system of unemployment insurance, reducing and restructuring benefits with a view to strengthening the incentive to work. In the mid-1990s, industrial subsidies were slashed by roughly two-thirds. In 1996, Canada's federal and provincial governments agreed to changes that would put the Canada and Quebec Pension plans on a sustainable footing. This meant some restructuring of benefits and a sharp increase in contributions - moves that were not popular, but were necessary. In 2000, the federal government implemented a five-year, $100-billion tax-reduction plan that lowered personal and corporate tax rates. And in the last federal budget, the government announced that Canada's tax on capital is being phased out. I would be remiss if I did not also mention how Canada cleaned up its public sector balance sheets during the 1990s. Many difficult and unpopular decisions had to be taken, by both the federal and provincial governments. But Canada has turned a vicious circle of rising deficits and debt into a virtuous circle of balanced budgets and falling debt. Reducing, and ultimately eliminating, the deficit in the 1990s helped Canada's international credibility and led to a reduction in the risk premium demanded by investors. The fiscal improvement gave the Bank of Canada the flexibility to lower interest rates more easily when economic circumstances warranted. Not only did lower interest rates reduce debt-servicing costs, they also stimulated economic growth, which brought in more revenues for the government. The extra revenues and lower debt-servicing costs, in turn, led to an even better fiscal position. Earlier this year, Canadian Finance Minister John Manley announced a sixth consecutive surplus in the federal budget and projected that the budget will continue to be balanced this year and next, despite slower-than-expected growth. The federal government is committed to following a prudent path for its budget planning. Canada is expected to have one of the lowest debt burdens in the G-7 this year. Not only have we reduced the debt-to-GDP ratio, but we have paid down almost $50 billion of federal debt. This has freed up about $3 billion of resources every year for the federal government. The main point is that, while the initial work of fiscal consolidation is certainly difficult, it is necessary in order to enjoy the dividends later on. Concluding remarks These policies I've mentioned - fiscal consolidation; a monetary policy focused on low, stable, and predictable inflation; and improving flexibility through trade liberalization and structural reform - have all been difficult to implement. Putting Canada's strong economic policy framework into place involved short-term pain. But our economic performance in recent years is compelling evidence, in my opinion, that these policies are the right ones to follow. I don't want to suggest that we've achieved perfection in Canada. Far from it. There is much more to be done, particularly in regards to microeconomic policy. Nor do I want to suggest that the precise ways in which we've implemented these policies should be followed by every country. Instead, the messages I want to leave you with are: that these economic principles are important, and implementing them is difficult, but the economic payoff is ultimately worth the effort. In times of global economic uncertainty, there is a natural tendency to put off difficult reforms or to backtrack on hard-won policy gains. But it is precisely during these difficult times that it is most important to stay the course. Canada is committed to staying the course and to building a strong, vibrant, and flexible economy.
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Speech by Mr David Dodge, Governor of the Bank of Canada, to the Metropolitan Halifax Chamber of Commerce, Halifax, 18 June 2003.
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David Dodge: Recent economic developments and the conduct of monetary policy Speech by Mr David Dodge, Governor of the Bank of Canada, to the Metropolitan Halifax Chamber of Commerce, Halifax, 18 June 2003. * * * Good afternoon, and thank you for the invitation to speak with you today. It’s great to be back in Halifax, one of Canada’s most colourful port cities. It is the wonderful juxtaposition of the new with the old - Halifax’s modern focus with its rich maritime traditions - that makes this city special. It’s been a year since I last spoke in Halifax, and a lot has changed since then. We’ve witnessed some extraordinary events, both in Canada and around the world. On the whole, Canada’s economy has withstood the turmoil quite well. The impact of some more recent events is not yet clear. Still, I will try today to outline how our economy has evolved over the past year and to lay out the issues that we’ll be assessing as we prepare our July Monetary Policy Report Update. Watching conditions and demand pressures As we at the Bank of Canada set monetary policy, we watch all the events affecting our economy, including global geopolitical, economic, and financial conditions. We do this with a view to keeping domestic inflation near the 2 per cent midpoint of Canada’s inflation target range of 1 to 3 per cent. As we have often said, delivering an environment of low, stable, and predictable inflation is the best contribution that monetary policy can make to a strong, sustainable economy and rising living standards for Canadians. Such a low-inflation environment also helps keep our economy near its production potential over time. To achieve those goals, we keep a close eye on the factors influencing demand and production capacity - factors that will, in turn, influence inflation over the medium term. And we adjust monetary policy to keep the future trend of inflation near the 2 per cent target midpoint. Where we’ve been As I’ve said, it’s been a year since I last spoke in Halifax. But to place our recent experience in some context, I should go back a bit further than that - to the 11 September 2001 terrorist attacks in the United States. In the wake of that terrible event, the Bank of Canada quickly and aggressively cut its policy interest rate to shore up confidence and support domestic demand. This action, together with earlier reductions in our policy interest rate, meant that the Bank had injected considerable stimulus into the economy. By the spring of 2002, evidence had already started to build that demand was recovering more quickly than had been anticipated. So, even though demand pressures were not yet showing up in prices, we began to remove some of that monetary stimulus. We raised our key policy interest rate three times between April and July 2002, by a total of three-quarters of a percentage point. By last autumn, inflation in Canada was on the rise. But we refrained from raising interest rates any further at the time, because we judged that the pickup in inflation was mainly the result of one-off factors and would be reversed over the next year or so. As well, there was considerable geopolitical and financial uncertainty, which, combined with global economic weakness, pointed to restrained total demand for Canadian goods and services. Through the first quarter of this year, CPI inflation climbed well above the 2 per cent target. Much of the rise was the result of higher energy prices. We also saw a marked increase in our measure of core inflation, which strips out the eight most volatile items - including gasoline, heating oil, and natural gas - from the CPI basket, as well as the effect of changes in indirect taxes on the remaining CPI components. The rise in core inflation was exacerbated by further increases in automobile insurance premiums. But even allowing for the unusual and extraordinarily large increases in insurance premiums, inflation was well above target. This suggested that strong domestic demand was putting pressure on production capacity. In this environment, some indicators of short-term inflation expectations edged up, although longer-term expectations remained around 2 per cent. In view of these inflation developments, the momentum of domestic demand, the narrowing of interest rate spreads in credit markets, and diminishing geopolitical uncertainty, we raised our target overnight rate by 25 basis points in March and again in mid-April - bringing it to 3.25 per cent. In our April Monetary Policy Report, we stated that the risks confronting the world economy appeared to be more evenly balanced than they had been in the autumn. The Canadian economy was projected to strengthen appreciably towards the end of 2003 and to grow somewhat above its production potential during 2004, thanks to a pickup in economic activity in the United States and further improvements in business and consumer confidence. We concluded in April that although growth would likely remain somewhat below potential in Canada for the first three quarters of this year, most of the small amount of economic slack that would open up this year would have closed by the end of 2004. We projected that core inflation would likely fall to about 2 1/2 per cent in the second half of this year and to about 2 per cent by early 2004 as some of the special factors pushing up inflation ran their course. We also pointed out that total CPI inflation would continue to be importantly affected by swings in crude oil prices and that it would likely fall temporarily below the core rate in the first half of 2004 before steadying out at a rate close to core inflation. Factors influencing monetary policy In the April Monetary Policy Report, we listed a number of factors that we intended to watch closely as we set monetary policy. These factors are the pace of economic expansion in the United States and overseas, the strength of domestic demand, financial market conditions, and the evolution of inflation and inflation expectations. So, let me review how we have seen these factors evolving. I’ll start with the external environment. In Europe, domestic demand and economic growth have continued to disappoint. Japan’s economy has also remained weak. While demand growth in the rest of Asia has been strong, the outbreak of Severe Acute Respiratory Syndrome (SARS) is clearly going to slow growth in some countries. In the United States, domestic demand has not been recovering as quickly as expected, which has negative implications for Canadian exports, at least over the short term. Consumer spending continues to underpin economic activity in that country. However, business fixed investment has not yet picked up. Expectations as to when the U.S. recovery will occur have been pushed back until late this year when confidence levels should improve, and when the impact of very expansionary monetary and fiscal policies should begin to be fully felt. Now, let’s turn to the second factor - domestic demand in Canada. On the whole, demand has remained quite strong, supported by a healthy employment market, low interest rates, and a recovery in corporate profits. While growth in consumer spending slowed slightly in the first quarter, it was still quite strong, especially on housing. Governments and businesses both increased their spending. As a result of strong domestic demand, gross domestic product grew at an annual rate of almost 2 1/2 per cent in the first quarter, up from about 1 1/2 per cent in the final quarter of 2002. In Nova Scotia, we are seeing some fall-off in consumer spending. Business investment prospects have also been dampened by the postponement of natural gas projects. Still, most forecasters predict Nova Scotia’s economy will continue to grow at the Canadian average rate this year. A third factor on our watch list is the evolution of conditions in financial markets. Last autumn, we witnessed sharp increases in risk premiums because of uncertainty in financial markets. In recent months, these risk premiums have declined, and conditions in both debt and equity markets continue to improve. This reflects reduced uncertainty and bodes well for business spending going forward. Before moving on to the fourth factor, I’d like to mention several developments since April that have implications for the economic outlook. Together, these developments point to near-term growth in Canada that will be lower than we expected at the time of our April Monetary Policy Report. SARS is having a significant impact on the hospitality industry, not just in Toronto, but across the country - including here in Atlantic Canada. More recently, the closure of export markets because of the discovery in Alberta of an isolated case of Bovine Spongiform Encephalopathy (BSE) is having an impact on the beef and beef-processing industry. And, of course, problems in several important East Coast fisheries are affecting employment and production in this region. As you well know, since mid-April there has also been a further sharp adjustment in the value of the U.S. dollar against major currencies, including ours. The magnitude and speed of the Canadian dollar’s rise has been greater than anyone had anticipated and will have a dampening influence on aggregate demand later this year and next. We are working to understand all the factors behind these exchange rate movements. In setting monetary policy, we have to take into account the effects on aggregate demand of these factors, as well as the effect of the exchange rate movements themselves. Exchange rate movements also have a direct effect on the prices of traded goods and services and, therefore, on inflation. However, our research has shown that, in economies such as Canada’s, the effect of exchange rate movements on consumer prices has been less pronounced in recent years, when inflation was relatively low, than was the case in earlier years when inflation was high. The inflation picture This leads me to the fourth factor that we watch closely in setting monetary policy—the evolution of inflation and inflation expectations. Let me start with inflation. In the 3 June press release that announced our latest interest rate decision, we pointed out that inflation has declined more than expected. Some of this decline is due to transitory factors, most notably, the rebate on electricity prices in Ontario. Thus, we expect some temporary rebound in core inflation in the coming months, as these factors unwind. Nevertheless, it now appears that both core and total CPI inflation will return to the 2 per cent target somewhat earlier than the Bank had anticipated in April. This is, in part, because of some near-term softness in demand. Also, the appreciation of the Canadian dollar will somewhat dampen the rise in total CPI, although it is not expected to have as large a direct effect on core CPI. Now, a word on inflation expectations. As I mentioned, we were concerned in April that the sharp rise in CPI inflation last winter was starting to push up Canadians’ expectations of inflation. The recent easing in inflation is likely to act as a moderating influence on those expectations. We will be seeking evidence of this in our regular survey of businesses prior to our next fixed announcement date. ********************** Let me sum up. Today, I have outlined some of the recent developments that will influence the demand for Canadian goods and services. They include continuing weakness in the U.S. and global economies, and concerns about the economic impact of SARS and BSE. These developments likely mean a very weak second quarter and point to some continuing softness in the Canadian economy in the third quarter. Looking forward, it remains our view that growth in Canada’s economy will be underpinned by the strength of domestic demand and a rebound in the U.S. economy towards the end of 2003 and through 2004. However, the appreciation of the Canadian dollar against the U.S. dollar, which is an outcome of various influences at work in both the Canadian and global economies, will be a factor influencing aggregate demand. We will provide Canadians with a more considered and complete picture of our views on the economy in our next Monetary Policy Report Update, which will be published on 17 July. Ladies and gentlemen, Halifax is a city that has withstood some extraordinary events in its long history. The Canadian economy, too, has been buffeted by some remarkable winds this year - some fair and some foul. But we have weathered them well, and I believe we will continue to do so. I can assure you that the Bank of Canada will continue to provide monetary policy that contributes to a strong, stable, and sustainable economy.
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