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Inflation in Indonesia to decline to 6%-7% and GDP growth to moderate by year-end

Jakarta | | Media Releases APAC

Indonesian inflation rate would decline gradually to between 6% and 7% by the end of 2006. Interest rates, which have already peaked, are expected to be cut during the third quarter of 2006. The 3-month SBI rate is expected to decline to 10% by end of 2006. However economic growth would be weaker in 2006 given the adjustment process after the one-time inflation shock in late 2005, according to Christa JANJIC, Senior Economist, Southeast Asia, UBS Investment Bank, who is in Jakarta for meetings.

"Based on current macroeconomic condition and challenges going forward, we estimate a 5.3% economic growth by the end of the year. We also expect that the monetary policy to ease during the second half of 2006. We are currently positive on Indonesian bonds, both local and foreign currency denominated," said Janjic. The report also highlighted the improvement of Indonesia's government debt to GDP from around 70% in 2002 to 50% in 2005. UBS estimates the ratio to further decline to 40% by 2007.

"Although we have seen positive inflows of foreign direct investment (FDI) for the past year and a half, we think Indonesia should be able to attract higher level of FDI as long as the government continues with its reform programs especially those that were outlined in the recent investment policy package. That would include passing and implementing new investment law, improving labor market flexibility, civil service and legal reforms and transparent and accountable tax system," she added. Investment rate as a share of GDP has increased to around 22% by end of 2005, although still below the level pre-1997 financial crisis of between 28% and 30%.

Indonesia will also be affected by the economic trend in the Asia Pacific region. In his latest report, Jonathan ANDERSON, Asia Chief Economist at UBS Investment Bank shared four key themes for China and posed eight major questions about Asia. The four themes for China were recovery in domestic spending, the end of the "China threat", the coming profit recovery and fade of pressures on the Reminbi (Chinese currency). China's growth in 2006 is expected to reach 9.0% in 2006, down from 10.9% in 2005, but domestic spending is expected to increase. Net contribution of domestic demand to real GDP growth in China is expected to reach 10% in 2006, up from 8% in 2004.

"The first key question for Asia is China helping or hurting Asian economies? Rising domestic demand, recovery in infrastructure spending and continued high level of Asian exports to China should be positive for Asia. The second key question for Asia is to what extent can Asia take over as the global growth driver? Whilst the Asian domestic recession is over, corporate spending in Asia ex-China and Japan remains weak and even Japan's recovery has been slow. We see China and India offer great hope for Asia given the two countries' high domestic demand," said Anderson. Domestic demand contribution to GDP growth in China and India are above 7%, highest among all Asian economies.

With regard to high oil price, the report said that the strong demand by Asia itself was the main driver for oil price. But the worst might be over in terms of oil price. Another question for Asia was whether India is to be the next China. India's gross domestic savings rate as a share of GDP has increased to more than 25% by 2005, or closer to the rate of Asia high-growth economies. India's export of goods and services as a share of GDP has continued to increase in the past 25 years to reach more than 15%. India is expected to grow by 7.9% in 2006 compared to 8.1% in 2005 and 7.5% in 2004. However, Anderson cautioned to be aware of the cycle in India. India has had negative current account balance since 2004 despite the country's accumulation of foreign currency reserves.

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Jakarta, 20 March 2006
UBS