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 (BI, the central bank) will seek to "normalise" interest rates by gradually tightening monetary policy.
• The fiscal deficit will widen in 2011, to the equivalent of 1.3% 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 just under 1% 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

• The fallout from the conviction of a tax official, Gayus Tambunan, on bribery charges has deepened divisions within the ruling coalition, with one party, Golkar, now even more likely to resist reformist policy initiatives.
• An ugly incident of orchestrated violence against members of an Islamic sect, the Ahmadiyah, in February has heightened concerns about rising intolerance and the government's weakening commitment to religious pluralism.
• The government has indicated that it will postpone indefinitely its planned restriction of subsidised fuel supplies, owing to spiralling oil prices and rapid domestic inflation.
• According to Statistics Indonesia (BPS), strong economic growth of 6.1% in 2010 pushed GDP per head above US$3,000, the mark at which a country is officially accorded middle-income status by the World Bank.
• The country's largest commercial bank, Bank Mandiri, raised Rp11.7trn (US$1.3bn) through a rights issue that closed in mid-February, in what was the largest such issue yet by an Indonesian bank.
• Following a rise in policy interest rates in February, the rupiah strengthened to its highest level since June 2007, at around Rp8,800:US$1.

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. Mr Yudhoyono's current government has proved even less effective than the one that he led during his first term, owing to the conflicting views of its various member parties on a number of reform issues.

Divisions within the coalition have been most apparent in relation to the scandal surrounding a medium-sized local lender, Bank Century, which the authorities rescued from collapse in late 2008. Opponents of the most prominent reformer in the cabinet at that time, Sri Mulyani Indrawati, who was finance minister, used the ballooning cost of the bail-out as an opportunity to try to force her from her post. Despite being absolved of blame for the high cost of the rescue, Ms Mulyani left the government in May 2010, fuelling suggestions that Mr Yudhoyono had asked her to go (or at least did not request that she stay) in an attempt to repair relations with two major coalition parties, Golkar and the Prosperous Justice Party (PKS). Such speculation was heightened by the appointment soon after Ms Mulyani's resignation of Golkar's head, Aburizal Bakrie, as managing chairman of the coalition; Mr Bakrie, one of the country's richest pribumi (ethnic-Indonesian) businessmen, had been Ms Mulyani's chief opponent. Rivalry between the two escalated in late 2008, when Ms Mulyani refused to allow stockmarket rules to be manipulated in favour of companies owned by Mr Bakrie and his relatives, and began to investigate alleged tax evasion by mining firms owned by the Bakrie family.

Some commentators have argued that Ms Mulyani's resignation has made the coalition more stable by ending the in-fighting between two of the country's most powerful figures. The Economist Intelligence Unit is less sanguine. If, for the sake of coalition unity, the government abandons its efforts to hold vested interests to account, prospects for an improvement in standards of governance will worsen. If, however, Mr Yudhoyono and leading reformers in the government continue to confront such interests, it may be only a matter of time before conflict erupts again within the coalition. In January 2011 Mr Yudhoyono appointed the vice-president, Boediono, and Kuntoro Mangkusubroto, the head of a presidential taskforce on "judicial mafia" (bribery, blackmail, witness intimidation and other wrongdoing within the justice system), to take charge of efforts to eliminate tax evasion. The move followed the sentencing of a former tax official, Gayus Tambunan, whose trial exposed egregious examples of official corruption, to seven years in prison for bribery. The appointments appear to suggest that the president is indeed prepared to take a tougher line against vested interests.

Among the companies that Mr Tambunan has testified to taking "fees" from are three mining firms owned by the Bakrie family. Senior figures in the PD have suggested that an evaluation of the composition of the coalition will be launched, focusing particularly on Golkar and the PKS, although disregarding coalition stability and realigning the balance of power within the government would require Mr Yudhoyono to display hitherto unseen strength. However, his position was strengthened in February, when the DPR voted narrowly against a full-scale investigation of corruption in the tax department. It is likely that Golkar legislators were hoping to use such an investigation to discredit Boediono and his probe into the companies that are alleged to have paid bribes to Mr Tambunan, including the Bakrie-owned firms.

The opportunity also exists for Mr Yudhoyono to become more assertive in promoting religious tolerance. In the past year violence against religious minorities, such Christians and members of an unorthodox Islamic sect, the Ahmadiyah, has risen, characterised by incidents in which the police have done little to prevent persecution. The brutal murder of three Ahmadi in Java in February triggered only an impotent response from the government, not least because of the influence two powerful cabinet members, the religious affairs minister, Suryadharma Ali, and the justice minister and human rights minister, Patrialis Akbar, who are unsympathetic towards the Ahmadiyah. Only when faced with a growing backlash did Mr Yudhoyono promise to make efforts to disband organisations that advocate violence, but firm action has yet to be taken.

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.

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 Indonesian Democratic Party-Struggle (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. Speculation has increased recently that Ms Mulyani is considering a bid for the presidency, possibly in partnership with the PD chairman, Anas Urbaningrum. A contest between Mr Bakrie and Ms Mulyani would present voters with a clear choice between conservatism and reform. But it is not certain that Ms Mulyani will declare herself a candidate and, even if she were to do so, she is less popular at home than she is with foreign investors, making her victory far from assured.

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 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 1.3% 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, which was approved in October last year. Although the current finance minister, Agus Martowardojo, is continuing 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 remains a problem. Final results for 2010 have yet to be published, but in early January Mr Yudhoyono said that the fiscal deficit last year was equivalent to only 0.6% of GDP. The inability of ministries to spend all of the money allocated to them will continue to limit expenditure, and we therefore expect the fiscal deficit to shrink during the remainder of the forecast period, to stand at 0.3% of GDP in 2015. The public debt to GDP ratio is forecast to drop further in the next few years, 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, signals the start of the process of "normalising" interest rates. In previous recent meetings BI had left the rate at 6.5%, its 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). But consumer price inflation accelerated to 7% year on year, a 21-month high, in January and inflation has remained above BI's 4-6% target range since November. These factors convinced the bank's governors that raising the BI rate had become essential. Although BI waited until early February before raising 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. It has also announced a rise in the banking sector's US dollar reserve requirement to 8% from June 1st 2011, up from 1% at present. We expect the BI rate to average 7.3% in 2011 and 8.5% in 2012-15.

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Indonesia was affected less severely by the 2008-09 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 employment growth accelerates and the rate 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 a 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 then expand at an average annual rate of 10.4% a year in 2012-15. 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, as domestic prices responded to an increase in international prices for crude oil and non-oil commodities. Although BI has embarked on a process of normalising interest rates, inflationary pressures in 2011 will build as economic activity accelerates. Another factor exerting an inflationary influence will be a further increase in international commodity prices, notably for crude oil and grains. Although 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, price pressures are building. As a result, we expect inflation to average 6.9% this year, above BI's 4-6% target range. Nevertheless, the authorities' cooling measures are already taking effect: in February inflation slowed to 6.8%, thanks to the first year-on-year fall in food prices for four years. In 2012-15 inflation will slow to an average of 6.3%. The primary risk to our forecast comes from the possibility that high global oil prices could force the government to raise administered fuel prices domestically to keep the budget deficit under control, especially given that its assumption that international oil prices will average US$80/barrel this year looks unrealistic.

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 2.7% on average 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 US$36.1bn, and we forecast that the surplus will continue to grow in 2011-15, to stand at US$49.2bn 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 2011-15 will force more Indonesian workers to seek jobs abroad, 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 0.9% of GDP on average in the forecast period.

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The fallout from the conviction of a junior tax official, Gayus Tambunan, on corruption charges has revealed deep rifts in the coalition government led by the president, Susilo Bambang Yudhoyono. In January Mr Tambunan was sentenced to seven years in prison after a trial that uncovered deep and ingrained graft in the Directorate-general of Taxes (DJP). Following the sentencing of Mr Tambunan, the president ordered the investigation of companies that had allegedly conspired with Mr Tambunan to avoid their tax obligations. Among the firms from which Mr Tambunan claimed to have received bribes in exchange for favourable tax treatment are three mining firms, Bumi Resources, Kaltim Prima Coal and Arutmin, that are owned by the family of Aburizal Bakrie, the chairman of Golkar (one of the parties making up ruling coalition).

To counter this threat to his business empire, Mr Bakrie appears to have used his influence in the House of People's Representatives (DPR, the legislature) to launch a proposal for a formal enquiry into tax corruption, with the Prosperous Justice Party (PKS) joining Golkar in backing the plan. Although Golkar and the PKS are the second- and third-largest parties respectively in Mr Yudhoyono's coalition, their narrow interests frequently cast them in opposition to the president. On this occasion Mr Bakrie may have hoped that a full-scale parliamentary probe would discourage the government from pursuing investigations into his companies with due vigour and cause it to turn its attention elsewhere. An enquiry of this nature would have put severe pressure on Mr Yudhoyono's administration, drawing government ministers and senior officials into months of questioning. It would potential also mean that the president might ultimately be held accountable for his failure to deal with tax graft. A similar parliamentary enquiry into the bailout of a medium-sized lender, Bank Century, in late 2008 was used to harass the government and led to the resignation of a reformist finance minister, Sri Mulyani Indrawati.

Mr Yudhoyono's Democrat Party (PD) was opposed to the setting up of a special enquiry, and instead argued that oversight of ongoing tax-corruption cases should remain with a lower house committee, House Commission III for legal affairs. The PD's argument prevailed, and the proposal to establish a special enquiry was voted down narrowly in late February. Senior PD figures have now indicated that they will conduct an evaluation of the composition of the coalition, with Golkar and the PKS being subject to particularly close scrutiny. Mr Yudhoyono's consensual approach to politics, as well as the arithmetic of parliament, means that a major shake-up is unlikely. But the divisions between the coalition parties are now clearer than ever, with Mr Bakrie acting as a brake on reform, Golkar and the PKS functioning as a self-serving virtual opposition within the government, and Mr Yudhoyono being drawn closer to allies in the National Mandate Party and the People's Awakening Party, on which he depends (along with Golkar and the PKS) for a majority in the legislature. Furthermore, the divisions and the influence of vested interests over policymaking means that it is unlikely that any further substantial reform will emerge from Mr Yudhoyono's second-term administration.

An ugly incident of orchestrated violence against a religious minority has raised concerns about rising intolerance and the government's weakening commitment to pluralism. On February 6th three members of the Ahmadiyah, an unorthodox Islamic sect, were beaten to death by a mob orchestrated by a fundamentalist vigilante group, the Islamic Defenders Front (FPI), in Banten province, near the capital, Jakarta. Videos of the attack, aired widely on local and international news channels, show police standing aside as the mob attacked a house where Ahmadiyah members had gathered, killing the three men. On February 5th local Ahmadiyah followers, including the owner of the house, had sought police protection as a result of threats to attack them. But despite the fact that busloads of youths had assembled at the scene the following day, the authorities had declined to act.

The Ahmadiyah sect originated in India; its followers believe that its founder, Mirza Ghulam Ahmad, was Islam's last prophet. This contradicts orthodox teachings, which hold that Mohammed was the faith's last prophet. Ahmadiyah followers were denounced as apostates in a fatwa issued by the Religious Scholars' Council of Indonesia (MUI, the country's top clerical body) in 2005, and since then its adherents-of whom there are thought to be around 500,000 in Indonesia-have been persecuted by Islamic vigilante groups such as the FPI. The government has aligned itself to a degree with the MUI and the vigilantes, passing a joint ministerial decree in 2008 that prohibited the Ahmadiyah from worshipping in public and proselytising, and subsequently failing to protect Ahmadiyah members from frequent attacks.

However, the violence in February has taken such intimidation to new heights, and its wide and graphic dissemination has been met with an outpouring of public disgust and anger directed at the government for failing to protect minority religions. Mr Yudhoyono first commented on February 7th, when he expressed his regret at the incident but also called on the Ahmadiyah to respect the decree restricting their religious freedom. Two days later, in response to a growing backlash, he called for organisations that advocate violence to be disbanded. In retaliation, the FPI threatened to overthrow Mr Yudhoyono if he moved to disband any Islamic mass organisations, and on February 19th it staged a demonstration outside the presidential palace in Jakarta, calling on the president to disband the Ahmadiyah or resign.

Mr Yudhoyono has yet to respond to these taunts and threats, unlike previous occasions on which his authority has been challenged openly, and it remains unclear whether he will have the courage to curb the FPI and other, similar organisations. Past attempts to rein in the FPI have failed, with light sentences handed to leaders of the group found guilty of inciting violence and hatred. The FPI's leader, Rizieq Shihab, received an 18-month prison term after being found guilty of orchestrating an attack against a group advocating religious tolerance in 2008, while a local leader, Murhali Barda, who incited an attack in Bekasi last year in which Christians were beaten and stabbed, was sentenced to only five and a half months in jail for unpleasant conduct. This time around the cabinet is divided on the issue. The religious affairs minister, Suryadharma Ali, and the justice and human rights minister, Patrialis Akbar, are broadly sympathetic to the views of the FPI. In the aftermath of the attack Mr Ali defended the 2008 joint decree and denied that it had encouraged discrimination against the Ahmadiyah, while Mr Akbar refused to accept that the murders constituted a violation of human rights. The police have also been ineffective so far in pursuing the FPI. The national police chief, General Timur Pradopo, was reported as having been a founding member of the FPI in 1998 and said when he was appointed in 2010 that the vigilante group could play a role in maintaining security.

Internal politics within the coalition go a long way towards explaining the recent deterioration in religious tolerance in Indonesia. A local group that monitors religious tolerance, the Setara Institute for Democracy and Peace, recorded 75 violations of religious freedom in the country in 2010, up from 17 in 2008 and 18 in 2009. In February 2011 a further two cases were noted, in Temanggung, Central Java, where Muslim extremists perpetrated an arson attack on two churches, and at an Islamic boarding school in Pasuruan, East Java, which was pelted with stones because its clerics were suspected of being sympathetic to Shiite views rather than the Sunni doctrines that prevail in Indonesia.

The government has indicated that it will postpone indefinitely its planned restriction on supplies of subsidised fuel. In late February the co-ordinating minister for the economy, Hatta Rajasa, said that rocketing international oil prices as a result of growing political unrest in the Middle East, together with rapid domestic inflation, meant that now was not the right time to introduce the measure. DPR members had earlier called for the postponement of the restriction to prevent popular unrest, as rising global oil prices would have resulted in steep local price increases for non-subsidised fuel in the coming months. Under the proposed measure, fuel used in private cars would no longer be subsidised. The measure had originally been due to take effect in Jakarta from January 1st, but its introduction had already been postponed until end-March. The plan was that subsidies would be phased out slowly across the Indonesian archipelago in the period to 2013. Any delay in removing subsidies, which mainly benefit wealthier, car-owning households, will leave the government facing a larger bill this year. But the issue is politically explosive, and successive governments have failed to rein in this wasteful form of expenditure. As a result, fuel subsidies continue to divert funds away from healthcare, education, infrastructure and other development priorities. The current budget assumes a fuel subsidy bill of Rp95.9trn (US$10.9bn) for 2011, based on the assumption that international oil prices will average US$80/barrel. However, global crude oil prices (dated Brent Blend) stood at US$112/b at end-February, with grades imported for refining into fuel in Indonesia commonly being priced around US$5/b less.

Indonesia's commercial banks posted a strong performance in 2010 on the back of vigorous economic growth. Total net profits came to Rp57.3trn, up by 27% on the Rp45.2trn that was recorded in 2009, according to Bank Indonesia (BI, the central bank). Loan disbursements rose to Rp1,765.8trn, up by 23% on 2009, while third-party funds (borrowing by banks) rose by 18.5%, to Rp2,338.8trn. The total assets of the country's 122 banks were worth Rp3,008.9trn at end-2010, up by 20% compared with 2009, while the average capital-adequacy ratio stood at 17%. In 2011, according to BI, commercial banks plan to increase lending by 24%-above the central bank's target of 20-23%. As third-party funds are set to grow more slowly this year, by 15%, it appears that lending growth will be funded from banks' existing reserves of liquidity, as well as from new deposits. This would take the average loan to deposit ratio up to around 80%, from 75% at end-2010.

Accordingly, some banks are now taking steps to replenish their capital reserves. Indonesia's largest commercial bank, Bank Mandiri, raised Rp11.7trn through a rights issue that closed in mid-February, in the largest such issue ever by an Indonesian bank. The issue will lift Bank Mandiri's tier-1 capital adequacy ratio to around 14%, from slightly under 10% at present. Bank Mandiri's rights issue follows similar issues by Bank Negara Indonesia, Bank Kasawan and Bank Muamalat in recent months. Together, these three issues raised a total of Rp14trn, providing capital to support continued strong growth in lending in 2011.

According to Statistics Indonesia (BPS, the national data office), strong economic growth of 6.1% in 2010 pushed GDP per head above the US$3,000 mark at which a country is officially accorded middle-income status by the World Bank. (The Economist Intelligence Unit calculates that GDP per head last year was slightly lower, at US$2,909.) The middle-income classification may be arbitrary, but it underlines the economic progress that Indonesia has made in recent years. The World Bank's country director for Indonesia, Stefan Koeberle, said in February that "Indonesia is emerging as a self-confident, rising and dynamic middle-income country". Nevertheless, great inequalities in income distribution persist, meaning that tens of millions of people continue to live in poverty. Corruption, a weak and venal civil service and poor infrastructure greatly constrain the country's economic performance, and these obstacles to growth will now need to be tackled through difficult reforms-measures that the paralysed coalition government seems in no position to push through-if Indonesia is to fulfil its potential.

However, the era of middle-income status could herald an acceleration in development-other Asian countries have grown rapidly after passing this threshold. Indonesia's economic planners are not lacking in ambition: the National Development Planning Agency (Bappenas) has outlined an economic master plan that aims to lift the country to high-income status within 15 years. The vision was outlined in February by the minister for development planning, Armida Alisjahbana, and targets annual GDP growth of 7-8% from 2013. If this were to happen, Indonesia would become one of the world's ten largest economies by 2025. To achieve this target, annual investment of Rp2,417trn in infrastructure would be required for the next 15 years. This compares with private investment of Rp2,000trn, public infrastructure spending (only partially realised) of Rp95trn and a public works budget of Rp36trn in 2010.

The current account posted a surplus of US$1.2bn in the final quarter of 2010, down from US$1.3bn in the third quarter. The trade surplus rose to US$9.3bn, boosted by strong non-oil and gas exports. Rising commodity prices and strong global demand helped to lift the value of exports (not including oil and gas) to US$46bn. However, these gains were offset by increased payments for freight owing to higher demand for imports, as well as by the transfer of profits earned by foreign firms with investments in the local stock and bond markets. In 2010 as a whole the current-account surplus came to US$6.3bn, down from US$10.7bn in 2009, in part as a result of a weaker trade position. Imports grew by 51% to US$127.1bn in 2010, while exports rose by 32% to US$158.2bn.

The capital and financial account surplus rose to US$9.9bn in the fourth quarter, from US$6.5bn at the end of the third quarter. A strong macroeconomic outlook and bright prospects for future growth helped to lift net direct investment inflows to US$3.7bn, from US$2.5bn in the third quarter. Net portfolio investment inflows also continued to rise, reaching US$1.8bn at the end of the fourth quarter, owing to the fact that capital was attracted into the country by poor returns in developed markets and growing optimism regarding Indonesia's future growth prospects. Overall, net inward portfolio investment reached US$15.7bn in 2010, up by 52% on US$10.4bn in 2009.

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The net impact of the movements on the current account and the capital and financial account was a balance-of-payments surplus in the fourth quarter of US$11.3bn, up from US$7bn in the third quarter. In 2010 as a whole the surplus rose to US$30.3bn, from US$12.5bn in 2009. International reserves increased to US$96.2bn as a result of the strengthened balance-of-payments position, sufficient to cover seven months of imports and interest payments on official external debt.

International reserves fell to US$95.3bn in January 2011, as BI sold US dollars to stabilise the rupiah in the face of a sharp but limited withdrawal of foreign portfolio funds from stocks, bonds and central bank promissory notes. Investors withdrew funds after BI declined to raise the benchmark interest rate at its January policy meeting, giving rise to concerns that it was failing to act to curb rising inflation. However, the expectation and subsequent realisation of a rate increase in February set the rupiah on an upward trajectory, and by the end of the month the currency had risen to its highest point since June 2007, at around Rp8,800:US$1.

In early February 2011 BI announced further measures to reduce the risk of exchange-rate volatility in the face of surging inflows of foreign portfolio capital. The central bank revealed that it would end monthly auctions of its six-month BI certificates (SBIs), meaning that nine-month certificates will now be the shortest maturity now sold through auction. The auction of six-month SBIs will be replaced with a six-month term deposit, in line with BI's policy of using term deposits to replace SBIs as the primary instrument for absorbing excess liquidity from the financial system. Term deposits are non-tradable and must be held to maturity, reducing the potential for volatility through secondary-market sales. BI had previously introduced a 28-day minimum holding period for SBIs in June 2010, discouraging investors from investing in such instruments. Sales of three-month certificates were halted in November 2010, and one- and two-month term deposits were introduced at the start of 2011.

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Please see graphic below

Please see graphic below

Please see graphic below

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