Outlook for 2011-15

• The president, Susilo Bambang Yudhoyono, has a strong mandate to pursue his reformist policy agenda, having won re-election comfortably in July 2009, but his reforms are encountering resistance from vested interests.
• Indonesia will elect a new president to succeed Mr Yudhoyono in 2014. A requirement of the election law means that the next president is likely to be the nominee of one of the country's three main political parties.
• Bank Indonesia (the central bank) will seek to "normalise" monetary policy by gradually raising interest rates.
• The fiscal deficit will widen in 2011, to the equivalent of 1.4% of GDP, but it will then narrow during the remainder of the forecast period, owing to a rise in revenue.
• The Economist Intelligence Unit forecasts that real GDP growth will accelerate to an average of 6.3% a year in the forecast period, driven mainly by private consumption and fixed investment.
• We expect the current account to record an average surplus equivalent to 1.5% of GDP in the forecast period. The income account will stay in deficit, owing to the repatriation of earnings by foreign-owned companies.

Monthly review

• Members of the Golkar party and Prosperous Justice Party (PKS) have retained their posts in Mr Yudhoyono's cabinet, despite defying the president by voting for a full-scale parliamentary investigation into tax corruption.
• One of Mr Yudhoyono's sons is to marry a daughter of Hatta Rajasa, the chairman of the National Mandate Party (PAN), something that will unite two of the country's foremost political families.
• Despite the fiscal risks posed by a recent increase in global oil prices, officials have again postponed plans to restrict the sale of subsidised fuel products.
• Proposed revisions to the legislation that established the Anti-Corruption Commission (KPK) could weaken the watchdog's ability to prosecute those suspected of graft.
• Japan is one of Indonesia's most important trade and investment partners. The earthquake and tsunami that struck Japan on March 11th could negatively impact the Indonesian economy this year.
• Inflation slowed in March, with consumer prices rising by 6.7% year on year, down from a rise of 6.8% in February, according to the national data office, Statistics Indonesia. On a month-on-month basis consumer prices fell by 0.3%.

After successfully guiding Indonesia through the 2008-09 global financial crisis, the president, Susilo Bambang Yudhoyono, showed that he had retained the backing of voters by winning a second term in the July 2009 election. However, he has since lost some of that support. Too often Mr Yudhoyono has chosen to side with conservatives rather than reformers, in an apparent attempt to preserve the unity of the governing coalition in the House of People's Representatives (DPR, the legislature). Mr Yudhoyono's Democratic Party (PD) performed well in the April 2009 parliamentary election, becoming the largest party in the DPR, but it fell short of an overall majority. Given these circumstances, the president followed his natural instinct to rule by consensus, building a six-party coalition that controls two-thirds of the seats in parliament. But Mr Yudhoyono's current coalition has proved even less effective than the one that he led during his first term, with various member parties routinely voting against the president on reform issues, calling into question the advantages of his consensual approach.

Recently divisions within the coalition have been most apparent in relation to calls by two coalition parties, Golkar and the Prosperous Justice Party (PKS), for a full-scale parliamentary investigation into corruption at the tax department. The calls followed the conviction in mid-January of a former tax official, Gayus Tambunan, whose trial for bribery and other offences had exposed sensational examples of official corruption. Among the companies that Mr Tambunan confessed to taking "fees" from were three mining firms owned by the family of Aburizal Bakrie, the Golkar chairman and one of the country's richest pribumi (ethnic-Indonesian) businessmen. Far from seeking to clean up the tax department, calls by Golkar and its allies for an investigation by the legislature are widely seen as an attempt to discredit leading reformers within the government, notably the vice president, Boediono, and the head of a presidential anti-corruption taskforce, Kuntoro Mangkusubroto. Only days before the calls for a parliamentary investigation, Mr Yudhoyono had announced that he was placing Boediono and Mr Mangkusubroto in charge of the government's efforts to eliminate tax fraud. The announcement appeared to signal that the president had at last resolved to confront those with a vested interest in preserving the corrupt status quo.

It is not the first time that Golkar has tried to use parliamentary investigations to discredit reformists who have challenged vested interests. In May 2010 the leading reformer in the cabinet at that time, Sri Mulyani Indrawati, resigned from her post as finance minister following an investigation by the DPR into a scandal surrounding the bail-out of a medium-sized local lender, Bank Century. Despite being absolved of any blame in relation to the ballooning cost of the bail-out, Ms Mulyani stepped down to take up a senior position at the World Bank, fuelling suggestions that Mr Yudhoyono had asked her to go (or at least had not asked that she stay) in an attempt to repair relations with Golkar and the PKS. Such speculation was heightened by the appointment soon after Ms Mulyani's resignation of Mr Bakrie as managing chairman of the coalition. Mr Bakrie had been Ms Mulyani's chief opponent.

In the event, parliament voted narrowly in late February against Golkar's calls for an investigation into corruption at the tax department. But the episode has brought the ruling coalition to the brink of collapse, with Mr Yudhoyono said to have been ready to replace Golkar and PKS cabinet ministers with members of two opposition parties, the Indonesian Democratic Party-Struggle (PDI-P) and the Great Indonesia Movement Party (Gerindra), only to change his mind at the last moment because of difficulties in concluding a power-sharing agreement with the leader of the PDI-P, Megawati Soekarnoputri, who is also the previous president. If Mr Yudhoyono and leading reformers in the government continue to confront vested interests, it may be only a matter of time before conflict erupts again within the coalition. If, however, the government abandons its efforts to hold such interests to account for the sake of coalition unity, the prospects for an improvement in standards of governance will worsen. The Economist Intelligence Unit believes that the most likely scenario is a succession of messy compromises between conservatives and reformists in the coalition.

The threat of separatist violence in Indonesia's northernmost province, Aceh, has diminished in the past few years, with a peace accord signed with the separatist Free Aceh Movement (GAM) in 2005 and orderly local elections taking place in 2006. However, separatist tensions continue to simmer in the eastern province of Papua. Most importantly for foreign investors, the terrorist threat will remain severe. Indonesia suffered a series of bombings in 2002-05 that specifically targeted foreigners. The first major attack in almost four years, at the JW Marriott and Ritz-Carlton hotels in the capital, Jakarta, in July 2009, killed nine people, demonstrating that the threat of large-scale bombings persists. Violence is increasing against religious minorities, such as Ahmadi Muslims and Christians, with the police often protecting the perpetrators of the hate crimes rather than the victims.

Book bombs signal rising religious tensions

Indonesia is no stranger to terrorist bombings. The country has been hit by five major attacks since 2002, the latest of which occurred in the capital, Jakarta, in July 2009, when suicide bombers killed nine people and injured more than 50 others at two five-star hotels. It is therefore tempting to dismiss as relatively trivial what has all the hallmarks of being the terrorists' latest campaign: four small parcel bombs delivered to separate addresses in Jakarta on March 15th.

The damaged caused by the explosive-packed parcels was minor compared with past attacks. Only one of the bombs exploded, no one was killed and only one person was injured seriously (a policeman had a hand blown off as he attempted to defuse one of the devices). But there are fears that the bombs could signal a violent escalation of the debate on religious freedom that has gripped the world's most populous Muslim-majority country since early February, when a religious mob beat to death three members of the Ahmadiyah, a controversial Islamic sect.

Although no one has claimed responsibility for posting the parcels, there is circumstantial evidence that points to the involvement of religious extremists. After examining the design of one of the devices, police detectives named a bomb-maker, Upik Lawang, as their prime suspect. He led a militant group involved in the religious strife that erupted on Sulawesi in the mid-2000s.

The targeting of the parcel bombs also points to an extremist agenda. The one parcel that did explode was sent to a moderate Muslim scholar, Ulil Abshar Abdalla, a founder of the Liberal Islam Network, which advocates religious freedom. Bomb-disposal experts defused a similar parcel addressed to General Gorries Mere, a Christian and former leader of Densus 88, the police's anti-terrorism unit, along with devices sent to a musician of Jewish descent, Ahmad Dhani, and to the leader of Pemuda Pancasila (a youth movement), Yapto Soerjosoemarno. All but one of the parcels contained hardline Islamic or anti-Semitic books. The other parcel, sent to Mr Soerjosoemarno, contained a book entitled Is Pancasila Dead? Pancasila refers to Indonesia's five founding principles, which some Muslims have criticised for being too secular.

That the terrorists appear to have been reduced to posting parcel bombs could be interpreted as a sign of the success of the counter-terrorism campaign. Indonesia has arrested or killed hundreds of suspected militants since the deaths of 202 people in two suicide bombings on Bali in October 2002. However, the authorities have been much slower to act in condemning the pedlars of religious hatred who are responsible for inciting such violence, such as the attack on Ahmadi Muslims, along with church-burnings and other hate crimes. The president, Susilo Bambang Yudhoyono, has failed to defend Indonesia's long-established traditions of tolerance in the face of legislation-sponsored by his own coalition partners-that has been so vaguely worded as to permit religious vigilantes to persecute minorities. At times, the police have appeared to protect the perpetrators of religious violence, not its victims.

If the parcel bombs were intended to stoke religious tensions and silence those who speak out against extremists, they have certainly succeeded in creating a climate of fear. The police are said to be "exhausted" by calls to inspect more suspicious devices, all of which have turned out to be harmless. Encouragingly, several prominent Muslim leaders have since spoken out in defence of religious freedom. Indonesia's moderate Muslims are still a long way from being gagged by fear of violent reprisals.

Indonesia will elect a new president to succeed Mr Yudhoyono in 2014. Parliamentary elections will also be held in that year and will have an important bearing on the outcome of the presidential poll. According to the election law, only political parties (or groups of parties) that win at least 20% of seats in parliament or 25% of the vote in the legislative election are eligible to nominate presidential candidates, meaning that the next president is likely to be the nominee of one of the country's three main parties-the PD, Golkar and the PDI-P. Mr Bakrie is a strong contender for the Golkar nomination, but he would be a controversial choice owing to the possibility of conflicts of interest arising from his extensive business empire. Despite losing to Mr Yudhoyono in both the 2004 and 2009 elections, the PDI-P is again expected to nominate its own leader, Ms Soekarnoputri. The news in late March that one of Mr Yudhoyono's sons is to marry a daughter of the chairman of the National Mandate Party (PAN), Hatta Rajasa, has led to speculation that the ruling party may nominate Mr Rajasa as its candidate for either president or vice-president. Such a move would reduce the possibility of a reformer, such as Boediono or the chairman of the PD, Anas Urbaningrum, securing the party's nomination in 2014.

Indonesia has become more prominent in international organisations in recent years, serving as a non-permanent member of the UN Security Council in 2006-08 and taking a seat at meetings of the G20 group of the world's major economies. There is an opportunity for warmer relations with the US, given that the US president, Barack Obama, spent several years in Indonesia as a child. Ties with China are also likely to strengthen. Chinese businesses have become major foreign investors in a variety of sectors in Indonesia. Moreover, owing to the likelihood that the world's advanced economies will grow relatively slowly in the forecast period as they recover from the 2008-09 global recession, Indonesia will rely increasingly on China as an export market. However, there will be opposition to closer economic ties with China, as demonstrated by the backlash among local manufacturers against the free-trade agreement between that country and the Association of South-East Asian Nations (ASEAN) that took full effect in January 2010. Indonesia's foreign policy will continue to be influenced by the principle of non-alignment, and the government will resist becoming too closely associated with either the US or China. There will be intermittent disputes with Malaysia and Singapore over a range of long-standing issues. At the start of 2011 Indonesia took over the chair of ASEAN for one year.

Reforms aimed at addressing the shortcomings of Indonesia's business environment will move forward in a stop-start manner, reflecting the conflicting views on reform that exist within the governing coalition. The anti-corruption drive will continue, but the Anti-Corruption Commission (KPK) will face constant opposition, as will other statutory bodies charged with tackling graft. Several changes, including reform of the country's restrictive labour laws and removal of energy subsidies, may not prove politically feasible. Reform of the inefficient civil service, which was cited by Mr Yudhoyono as a priority for his second term, is making only slow progress. The government has, however, submitted draft legislation to parliament on land acquisitions. If passed, the measure will make it easier for the state to acquire land for development purposes, thus removing a major bottleneck obstructing much-needed improvements to infrastructure.

As a consequence of the inability of the civil service to spend fully the funds allocated to it, the Indonesian government generally fails to operate an effective counter-cyclical fiscal policy, and macroeconomic management therefore has to be achieved primarily through monetary policy. Bank Indonesia (BI, the central bank) will tighten policy by raising interest rates in 2011 in an attempt to contain the inflationary pressures generated by strong economic growth. In February BI tightened restrictions introduced in June 2010 on foreign purchases of short-term central bank bonds in order to maintain the stability of the rupiah. Although the authorities remain eager to attract long-term foreign investment, the potential for instability to be generated by sudden changes in investor sentiment was judged too great a risk to be ignored.

We expect the fiscal deficit to widen to the equivalent of 1.4% of GDP in 2011, from an estimated 0.8% in 2010. This compares with the target of 1.8% of GDP in the 2011 budget. Although the finance minister, Agus Martowardojo, has continued with the carrot-and-stick system introduced by Ms Mulyani of increasing the budgets of government ministries that meet their spending targets and reducing allocations to those that miss them, underspending will remain a problem. A recent rise in global oil prices poses the main risk to our forecast. Despite the fact that fuel subsidies mainly benefit Indonesia's middle class, the governments has baulked at proposals to free the prices of petrol, diesel and other fuel products to rise and fall in line with market trends. With the international price of oil (dated Brent Blend) trading at around US$115/barrel at present, well above the 2011 budget assumption of US$80/b, spending on subsidies this year could easily exceed the expected Rp187.6trn (US$21.6bn). In 2012-15 the fiscal deficit will shrink. As a result, government debt is forecast to drop further in relation to GDP, and this could mean that Indonesia's sovereign debt rating improves to investment grade, making it cheaper for the government to raise funds in international markets.

Monetary tightening will continue during the remainder of 2011, following BI's decision on February 4th to raise its main policy interest rate, the BI rate, by 25 basis points, to 6.75%. The rate rise, the first since October 2008, signalled the start of the process of "normalising" monetary policy. Previously BI had left the rate at 6.5%, the lowest level since it was introduced in 2005, owing to concerns about the effect that a widening interest rate differential with major global economies would have on capital inflows (given that rates in such countries are likely to remain low). Continued concerns about capital inflows, as well as signs that government intervention has succeeded in stabilising inflation, mean that BI's governors will raise interest rates only slowly. Although BI waited until February to raise rates, it began to tighten monetary policy in September 2010, when it increased the commercial banking sector's primary rupiah reserve requirement to 8%, from 5% previously. In March 2011 BI raised the banking sector's US dollar reserve requirement to 5%, from 1% previously. A further rise, to 8%, is scheduled for June. Interest rates will continue to rise in 2012 before stabilising in 2013-15.

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Indonesia was affected less severely by the 2009 global recession than many neighbouring economies, largely because exports account for a relatively small proportion of the country's GDP. Moreover, economic growth accelerated in 2010, with real GDP expanding by 6.1% in the year as a whole and by 6.9% year on year in the fourth quarter, its fastest quarterly pace of growth for six years. The economy will grow by 6.1% in 2011, and will then expand at an average annual rate of 6.4% in 2012-15. Private consumption will remain a major driving force behind GDP growth in 2011-15, expanding by an average of 5.6% a year as the unemployment rate falls and that of real wage increases picks up. Fixed investment will meanwhile expand by 8.7% a year on average, supported by strengthening demand conditions. Exports of goods and services grew at double-digit rates in 2010, largely because of healthy Chinese demand for Indonesia's commodities, but growth in overseas sales will slow in 2011, in line with a weaker global economy. Exports will expand at an average annual rate of 10.2% a year in 2011-15. Owing to healthy import demand, the external sector will make only a modest contribution to GDP growth in 2011-15.

Some downside risks to our forecast remain. The most serious concern is that fiscal austerity programmes in Western economies might lead to a rapid slowdown in global economic growth. In addition, the loose monetary policy stance adopted by Western central banks has caused strong flows of capital into Asian countries, creating concerns that asset price bubbles could develop in these economies. Such bubbles create risks, particularly if assets are used to back higher levels of borrowing; in such circumstances, the bursting of bubbles can trigger a process of deleveraging that hurts a country's real economy. Indonesia was a recipient of strong flows of foreign finance in 2010, and it will continue to attract substantial inflows in 2011. As a result, asset prices are likely to rise. However, Indonesian companies and households are not highly leveraged, and a period of strong lending growth could benefit the economy, particularly if funds are invested in productive areas, such as improvements to infrastructure.

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On an annual average basis, consumer price inflation accelerated to 5.1% in 2010, from 4.8% in 2009. Although the central bank has embarked on a process of normalising interest rates, inflationary pressures will build again this year as economic activity accelerates. A sharp increase in the international price of oil and non-oil commodities, notably grains, will also exert upward pressure on domestic prices. However, the rupiah's continued appreciation against the US dollar and the government's decision in January to suspend import duties on a range of goods (notably foodstuffs) will limit inflation. After accelerating in January to 7% year on year, the fastest pace for 21 months, inflation slowed in February and again in March, to 6.7%. We expect inflation to average 6.2% this year, slightly above BI's 4-6% target range. Inflation will slow to 5.9% in 2012, before accelerating to 6.3% on average in 2013-15. The primary risk to our forecast comes from the possibility that high global oil prices could force officials to raise domestic fuel prices to keep the budget deficit under control, especially given that their assumption that oil prices will average US$80/barrel this year looks unrealistically low. But there is little sign that the government is contemplating raising prices. In fact, it has repeatedly postponed plans to end the sale of subsidised fuel products to owners of private cars on Java.

The rupiah appreciated by 14.4% against the US dollar on an annual average basis in 2010, and by the end of the year it had reached Rp8,991:US$1, more than regaining the ground lost since late 2008, when the currency plunged as international investors fled risky emerging markets. Interest from international investors in carry trades (whereby speculators borrow in countries where interest rates are low, such as the US and Japan, to purchase assets in countries with higher rates, such as Indonesia) has been an important factor in the rupiah's appreciation. Healthy domestic economic growth has been another factor encouraging foreign investment in Indonesian assets. Substantial capital inflows are expected in 2011, when Indonesia's GDP growth performance and interest rates will compare favourably with those of Western economies, but BI will continue to intervene to prevent the currency from appreciating too sharply. The rupiah is forecast to strengthen by 3.5% in 2011, before weakening slowly in 2012-15. The currency will remain vulnerable to sudden swings in sentiment.

A recovery in merchandise exports, led by commodities, caused the trade surplus to rise in 2010, to an estimated US$36.3bn, and we forecast that the surplus will continue to grow in 2011-15, to stand at US$61.7bn in 2015. The deficit on the income account widened in 2010, in part owing to a rise in interest and dividend payments. The income account will remain in the red throughout the forecast period, as foreigners continue to repatriate earnings while Indonesian investments abroad still earn relatively meagre returns. Limited employment opportunities at home in the next five years will force more Indonesian workers to seek jobs overseas, leading to an increase in inward remittances and thus pushing up the surplus on the transfers account. We expect the current account to record a surplus equivalent to 1.5% of GDP on average in the forecast period.

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Speculation of a cabinet reshuffle intensified in early March, when the president, Susilo Bambang Yudhoyono, accused a couple of parties of violating the terms of the agreement that established the ruling coalition. Mr Yudhoyono was referring obliquely to the Golkar party and the Prosperous Justice Party (PKS), both of which have frequently opposed the government, despite being members of the coalition. Recently the two parties had defied the president and his Democratic Party (PD) by attempting to launch a full-scale parliamentary enquiry into corruption at the tax office-a move that would have dragged the cabinet and its reformist ministers through months of highly politicised investigation by the House of People's Representatives (DPR, the legislature). The coalition agreement, signed in late 2009 as Mr Yudhoyono began his second term of office, binds together six parties: the PD, Golkar, the PKS, the National Mandate Party (PAN), the National Awakening Party (PKB) and the United Development Party (PPP). Signatories of the agreement are meant to support the government in the legislature as well as in the executive until the end of the DPR's term, in 2014.

Following Mr Yudhoyono's statement, senior members of the PD began to brief the media that a reshuffle was imminent. Discussions were opened with two opposition parties, the Indonesian Democratic Party-Struggle (PDI-P) and the Great Indonesia Movement Party (Gerindra), to assess their willingness to join the ruling coalition. According to press reports, the PDI-P wanted three ministerial portfolios, while Gerindra wanted two. The agriculture minister, Suswono, and the communications minister, Tifatul Sembiring, both of whom belong to the PKS, were said to be at greatest risk of replacement, along with the Golkar co-ordinating minister for public welfare, Agung Laksono, and the independent minister for state-owned enterprises, Mustafa Abubakar. The social affairs minister, Salim Segaf Aljufri, and the research and technology minister, Suharna Surapranata, both of whom are also members of the PKS, also faced speculation about their futures.

The PDI-P would be a natural coalition partner for the PD, as both parties share a secular-nationalist political philosophy. But the PDI-P chairwoman, Megawati Soekarnoputri, who is also the previous president, has held an irreconcilable grudge against Mr Yudhoyono ever since he resigned from her cabinet and then defeated her in the 2004 presidential election. Gerindra would be a more awkward partner for the PD. The populist party is little more than a personal political vehicle for its founder, Prabowo Subianto. A son-in-law of the former authoritarian president, Soeharto, Mr Subianto is alleged to have committed serious human-rights abuses during his military career.

It appears that Ms Soekarnoputri's intransigence, as well as Mr Yudhoyono's conciliatory political instincts, have combined to bring the coalition back from the brink of rupture. Given that a power-sharing deal with the PDI-P was proving elusive, Mr Yudhoyono embarked on a series of private meetings with most coalition party leaders. Mr Yudhoyono appears to have reached some form of rapprochement with Golkar, after that party's chairman, Aburizal Bakrie, emerged from a one-to-one meeting with the president to promise continued support for the coalition. In late March Mr Yudhoyono told the cabinet that reshuffle speculation was not constructive and that he would make changes only when left to do so without pressure from interested parties. But the president snubbed the PKS, refusing to meet with that party's chairman, Luthfi Hasan Ishaaq, leaving the party to look increasingly isolated.

The isolation of the PKS within the ruling coalition comes at a time of intense in-fighting within the party's senior ranks. In March a co-founder of the party, Yusuf Supendi, reported Mr Ishaaq and the party's secretary-general, Anis Matta, to the Anti-Corruption Commission (KPK) for allegedly stealing party funds. Mr Matta is alleged to have embezzled Rp10bn (US$1.2m) earmarked for the gubernatorial election in the capital, Jakarta, in 2007, while Mr Ishaaq is alleged to have embezzled donations from the Middle East during the 1999 national poll campaign. Allegations of corruption within the senior echelons of the party follow the conviction on fraud charges of a prominent PKS legislator, Misbakhun, in November 2010.

The internal splits may prevent the PKS leadership from focusing on restoring its standing within the coalition. The scandals may also damage the party's support among the public. The PKS's success to date has been built on a platform of clean governance and strict Islamic morality. The party was a leading proponent of an anti-pornography passed in 2008-which was recently used to imprison a popular singer after he appeared in an Internet sex video-making the PKS seem hypocritical in the light of the allegations against the secretary-general. Unless it can shake off the scandals, along with the growing perception that it is misusing its position within the coalition to further its own narrow interests, the PKS may face a rapid reversal of the gains in popularity it has made in recent years.

The misfortunes faced by the PKS have to some extent benefited the PAN, which has emerged as Mr Yudhoyono's most reliable coalition partner, with a pivotal position in the legislature. This alliance and the close personal relationship between Mr Yudhoyono and the PAN chairman, Hatta Rajasa, looks set to be strengthened further by the marriage of Mr Yudhoyono's youngest son, Edhie Baskoro Yudhoyono, who is commonly known as Ibas, and one of Mr Rajasa's daughters, Siti Ruby Aliya Rajasa. The marriage will unite two of the country's foremost political families. This suggests that Mr Rajasa, the co-ordinating minister for the economy, will become more influential within the government. Mr Rajasa and the PAN take an economic-nationalist stance on many issues and are less supportive of market-oriented reforms. The PAN chairman also has an indifferent track record on reform and clean governance, with questions raised over his performance as transport minister in 2004-07. His close relationship with Mr Yudhoyono may further diminish the influence of economic reformers within the cabinet.

The cost of fuel subsidies is set to rise sharply in 2011 after the DPR approved a government proposal to postpone indefinitely planned restrictions on the sale of subsidised fuel. In postponing the measures, the DPR cited fears of stoking unrest and fuelling inflation. The decision was made despite rising oil prices (dated Brent Blend) and a looming shortfall in domestic production. The budget currently assumes an average oil price of US$80/barrel this year, with Rp95.8trn (US$11bn) earmarked for fuel subsidies. However, social and political unrest that is spreading across the Middle East and North Africa have pushed up oil prices towards US$120/b in early April, while disruptions at major domestic production facilities reduced domestic oil output to 917,000 barrels/day in March, according to the country's oil and gas regulator, BPMIGAS, well short of the 970,000 b/d assumed by the 2011 budget.

The Ministry of Finance estimates that the fiscal deficit increases by around Rp800bn for every US$1 that the price of a barrel of oil exceeds the price set out in the budget. Officials have indicated that the oil price used in the budget may be revised upwards, with the country paying US$100/b in January and US$104/b in February on average for imported oil. Nevertheless, the finance minister, Agus Martowardojo, remains confident that the overall budget deficit will remain below the equivalent of 2% of GDP, with the rupiah's stronger exchange rate against the US dollar helping to offset the impact of higher international fuel prices.

Fuel subsidies mainly benefit Indonesia's wealthier car-owning households, introduce considerable potential liabilities into the public finances, and contradict the government's stated aim of reducing poverty and improving social welfare. According to the World Bank, the richest 10% of the population receive Rp135,000 (US$15.50) of fuel subsidy per head annually, while the poorest 10% receive only Rp23,000 per head. Nevertheless, the issue is politically explosive, and successive governments have failed to rein in wasteful spending on fuel subsidies.

The KPK is facing renewed threats to its independence and effectiveness as a result of proposed revisions to anti-corruption laws. The justice and human rights minister, Patrialis Akbar, has proposed revisions to the 1999 corruption law that could compromise the commission's ability to prosecute its own cases and to seek proportional punishment for those convicted of corruption. Meanwhile, revisions to the 2003 law establishing the KPK, currently under consideration in the DPR, would weaken the commission's ability to gather evidence through wire-tapping-a crucial means of building cases. A local anti-corruption watchdog, Indonesia Corruption Watch, has warned that the proposed revisions would severely weaken efforts to combat graft.

Many powerful interests are threatened by the KPK's investigations. In March the commission arrested a senior official at the transport ministry, Soemino Eko Widodo Saputro, in relation to allegations that he marked up the shipping costs for railway carriages imported to Indonesia in 2006-07. Mr Saputro has said previously that he was acting on the instructions of Mr Rajasa, who at the time served as the transport minister. As the PAN chairman, Mr Rajasa is the party superior of Mr Akbar, who is preparing the amendments to the 1999 law on corrupt crimes. Meanwhile, the DPR's moves to revise the 2003 law on the KPK follows the arrest by the commission of 25 past and present legislators from Golkar, the PDI-P and the PPP on charges of accepting bribes in exchange for approving the appointment of Miranda Goeltom as a senior deputy governor of Bank Indonesia (BI, the central bank) in 2004. The commission successfully prosecuted a further four politicians in relation to the case in 2010.

A coalition of non-governmental organisations (NGOs) has launched a campaign against attempts by the government to reform the procedures governing land acquisitions. The complex rules surrounding the acquisition of privately owned land for infrastructure projects deemed to be in the public interest have hampered investment in recent years. Partly as a result of this Indonesia's infrastructure remains hopelessly inadequate, posing a significant obstacle to economic growth. A draft law on land acquisition aims to clarify the rules. The National Development Planning Agency (Bappenas) hopes that the bill, once passed into law, will support investments exceeding US$100bn in a range of infrastructure projects, from roads and railways to power generation and transmission. However, an alliance of NGOs has raised objections to the bill, on the grounds that it would legalise land seizures and forced evictions. The alliance, which organised a protest against the bill outside the presidential palace on March 25th, says that the definition of public interest used in the bill is ambiguous, leaving it open to abuse. NGOs campaigning against the bill include Walhi, an outspoken environmental group, the Legal Aid Foundation (YLBH) and the Committee for Missing Persons and Victims of Violence (Kontras), a human-rights watchdog.

A slowdown in the Japanese economy following an earthquake and tsunami that struck Japan on March 11th may have a temporary, negative impact on trade and investment flows with Indonesia. However, reconstruction efforts could increase demand for Indonesian goods, services and labour in the second half of the year. The 9.0-magnitude earthquake and the resulting tsunami have claimed more than 12,000 lives, with thousands still missing. The disaster has also destroyed important infrastructure, including roads, railways, ports and power stations, and has threatened to cause a meltdown at the Fukushima Daiichi nuclear power plant. The damage has also disrupted manufacturing supply chains.

Japan is Indonesia's third-largest export market after the EU and China. In 2010 Indonesia's exports of goods excluding oil and gas to Japan were equivalent to US$16.2bn, or 12.5% of the total, according to BI. (Indonesia's export dependence on Japan is even greater if oil and gas exports are included.) Meanwhile, in 2010 Japan was Indonesia's second most important supplier of imports. Indonesia imported goods excluding oil and gas from Japan worth US$16.8bn, equivalent to 15.7% of the total. Disruptions to trade in both directions will affect importing and exporting firms across Indonesia. Producers of primary commodities, including coal, timber and gas, will lose orders, while some smaller industries may also face difficult times. Balinese small- and medium-sized enterprises, which export a range of goods to Japan, including fish, marine products, handicrafts, silver and textiles, were anticipating a 10% fall in trade as a result of the disaster. At the same time the Association of Indonesian Automotive Manufacturers (Gaikindo) reduced its sales forecast for this year to 800,000 units, from 850,000 previously, owing to a shortfall in the availability of component parts supplied to local manufacturers by Japanese firms. Tourism will also be disrupted, as Japan constitutes the fourth-largest market for visitors to Indonesia. However, post-tsunami reconstruction is likely to create new demand for Indonesian goods, services and labour, and a reappraisal of the safety of nuclear power may lead to Japan increasing its reliance on coal- and gas-fired power plants, creating a deeper market for Indonesian exports of coal and liquefied natural gas (LNG).

Japan was also the largest source of foreign direct investment in Indonesia in 2010, with direct investment totalling US$3.7bn, according to BI. The Japanese government is a major donor, and so the viability of public and private investment projects that depend on Japanese capital is likely to come under some doubt in the coming months, as Japanese capital is drawn into the reconstruction effort that is now getting underway. Japan's current commitments to infrastructure in Indonesia exceed US$50bn, with projects now at risk including Jakarta's mass rapid transit system, as well as coal and geothermal power plants. The Fukushima nuclear disaster has also prompted renewed debate about the wisdom of plans to construct Indonesia's first nuclear power plant. Indonesia is one of the world's most earthquake-prone countries, with a poor record on health and safety. Despite strong local opposition at the proposed sites, the government plans to construct a nuclear plant by 2019.

Inflation slowed in March, with consumer prices rising by 6.7% year on year, down from a rise of 6.8% in February, according to the national data office, Statistics Indonesia. On a month-on-month basis consumer prices fell by 0.3% in March. The slower pace of annual inflation was mainly the result of slower growth in food prices, which rose by 13.6%, compared with an increase of 14.8% in February. The main domestic rice harvest began in March, resulting in lower prices for the country's staple food. The government's decision to waive import duties on imports of rice, along with some other foodstuffs, also contributed to the slower pace of inflation. So too did an appreciation of the rupiah against the US dollar. On a month-on-month basis food prices fell by 1.9% in March, following a fall of 0.3% in February. A recent decision by the government to postpone indefinitely restrictions on the supply of subsidised fuels will also help to manage inflationary pressures in coming months. However, BI now believes that it is back on course to achieve its 4-6% inflation target this year. Core inflation, which excludes volatile food and fuel prices, rose to 4.5% year on year in March, up from 4.4% in February, highlighting the risks of price pressures in these two categories spreading out to affect the prices of other goods and services. The central bank has said that it expects core inflation to accelerate to an annual average of around 5% in 2011.

In early April the rupiah appreciated to around Rp8,690:US$1-its strongest level against the US dollar in around four years-after the central bank confirmed it plans to allow the currency to appreciate to control inflation. The rupiah has appreciated by more than 3% against the US dollar so far this year, making it one of Asia's strongest performing currencies. Factors contributing to the rise include strong demand for Indonesia's major export commodities, such as coal and palm oil, as well as strong inflows of portfolio investment. An interest rate increase in February and confidence in recent measures to curb inflation, including postponing planned restrictions on the sale of subsidised fuel, have also contributed to Indonesia's attractions. The strong inflows of capital also helped to boost foreign exchange reserves to a record high of US$101.8bn in early March, according to BI. The central bank now expects reserves to rise to US$110bn-120bn by the end of the year.

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Land area

1,904,443 sq km

Sea area (exclusive economic zone)

3,166,163 sq km (before deductions for sea area now under the control of Timor-Leste)

Total area

5,070,606 sq km

Population

240m (US Census Bureau 2009 estimate)

Main towns

Population in '000 (2000 census)

Jakarta (capital): 8,385 Medan: 1,792

Surabaya: 2,589 Palembang: 1,442

Bandung: 2,142 Semarang: 1,345

Climate

Tropical

Weather in Jakarta (altitude 8 metres)

Hottest months, April-May, 24-31°C (average daily minimum and maximum); coldest months, January-February, 23-29°C; wettest months, January-February, 300 mm average rainfall

Languages

Indonesian (Bahasa Indonesia), as well as some 250 other regional languages and dialects. English has replaced Dutch as the main second language and is widely spoken in government and business circles

Measures

Metric system

Currency

Rupiah (Rp). Average exchange rate in 2010: Rp9,088:US$1

Time

Western Zone 7 hours ahead of GMT, Central Zone 8 hours ahead, Eastern Zone 9 hours ahead

Fiscal year

January 1st-December 31st (since 2001)

Public holidays

New Year, January 1st; Chinese New Year, February 3rd; Mouloud, February 15th; Hindu New Year, March 5th; Good Friday, April 22nd; Waisak Day, May 17th; Ascension Day, June 2nd; Lailat Al Miraj, June 29th; Independence Day, August 17th; Eid al-Fitr, August 30th-31st; Eid al-Adha, November 6th; Islamic New Year, November 27th; Christmas Day, December 25th

Official name

Republic of Indonesia

Form of government

Power has historically been concentrated in the hands of the president, but recent constitutional amendments have given the legislature an expanded role

Executive

The presidency is the highest executive office, with authority to appoint the cabinet

Head of state

The president, Susilo Bambang Yudhoyono

National legislature

The People's Consultative Assembly (MPR) consists of a 550-member House of People's Representatives (DPR) and a 128-member Regional Representatives' Council (DPD)

National elections

April 2009 (DPR); July 2009 (presidential). Next elections: 2014 (DPR and presidential)

National government

Mr Yudhoyono's second-term government contains representatives of the Democratic Party (PD), Golkar, the National Mandate Party (PAN), the Prosperous Justice Party (PKS), the National Awakening Party (PKB) and the United Development Party (PPP)

Main political organisations

There are three nationalist secular parties: the PD, Golkar and the Indonesian Democratic Party-Struggle (PDI-P). The other main parties-the PPP, the PKB, the PAN and the PKS-have an Islamic orientation

President: Susilo Bambang Yudhoyono

Vice-president: Boediono

Key ministers

Agriculture: Suswono

Co-ordinating minister for the economy: Hatta Rajasa

Co-ordinating minister for people's welfare: Agung Laksono

Co-ordinating minister for political, security & social affairs: Djoko Suyanto

Culture & tourism: Jero Wacik

Defence: Purnomo Yusgiantoro

Education: Muhammad Nuh

Energy & mineral resources: Darwin Saleh

Finance: Agus Martowardojo

Foreign affairs: Marty Natalegawa

Forestry: Zulkifli Hasan

Health: Endang Rahayu Sedyaningsih

Home affairs: Gamawan Fauzi

Industry: M S Hidayat

Justice & human rights: Patrialis Akbar

Manpower & transmigration: Muhaimin Iskandar

Public works: Djoko Kirmanto

Religious affairs: Suryadharma Ali

Social affairs: Salim Segaf Aljufri

Trade: Mari Pangestu

Transport: Freddy Numberi

Central bank governor

Darmin Nasution