Policy report

Indonesia faces one of the most difficult outlooks in Asia amid the economic pandemic unleashed by COVID-19. The principal economic problem is not the old one of capital flight, but about funding the fiscal response necessary to address a massive once-in-a-lifetime shock. With little on offer from the international system, Indonesia is rightly looking to find its own way, including by having taken the unorthodox step of allowing the central bank to directly finance part of the budget deficit. To enable this, the central bank could establish a clearly defined policy of yield curve stabilisation — buying government bonds in the primary and secondary markets to stabilise bond yields close to ‘normal’ market rates, while providing a readily scalable amount of budget financing. This would provide a clearer policy framework than both the current approach and alternatives presently under consideration in Indonesia. It would, however, carry some risks. Indonesia could therefore also look to bilateral partners, notably Australia, to provide a large-scale standby loan facility as a complement to the budget backstop being provided by Bank Indonesia.

Key findings:

  • The principal economic problem facing Indonesia amid COVID-19 is financing the budget deficit needed to respond to a once-in-a-lifetime shock.
  • In a world of self-help, Indonesia has been right to turn to Bank Indonesia, which could establish a clear policy of yield curve stabilisation as a basis for providing a readily scalable amount of deficit financing.
  • Key bilateral partners, such as Australia, could complement this by providing a large standby loan facility to help reduce some of the inherent risks of Indonesia relying on its central bank.
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