Stephen Coates, Jakarta – The International Monetary Fund warned on Friday that Indonesia must make fighting corruption a priority if it wants to build on its progress as one of the world's best-performing economies.

Southeast Asia's biggest economy expanded by 4.5 percent in 2009, the third fastest in the Group of 20, and is poised for accelerated growth in the years ahead, the IMF said in an annual report.

But it said foreign investors who are needed to fund Indonesia's expansion into a regional powerhouse would be cautious until more is done to fight rampant corruption and improve the rule of law.

"A decisive and successful response, as well as a decade of sound policies and structural reform, helped Indonesia recover quickly from the 2008 global crisis," the report said.

"However, lingering concerns over weak enforcement of the rule of law, transparency, and governance issues, weigh on market perceptions. Addressing these weaknesses should be a priority."

The IMF praised Indonesia's "remarkable achievements" over the past decade, as it transformed from the Suharto dictatorship into a flourishing democracy and recovered from near-bankruptcy in the 1998-1999 Asian financial crisis.

Indonesia was forced into a 43-billion-dollar bailout from the IMF in 1998, and only exited supervision by the Washington-based organization in 2003.

But the Fund said Indonesia "still faces challenges to preserve financial stability and develop its financial system", especially in areas such as supervision and the development of the non-bank sector.

"Market participants view Indonesia as a country with great potential, supported by a large consumer base and rich in natural resources," the report said.

"Yet, Indonesian securities continue to trade at a discount relative to regional peers and many wealthy Indonesian individuals still prefer to place their savings offshore.

"The financial sector lags behind comparable countries in terms of depth and contribution to the economy. This is because weaknesses in the legal and governance framework undermine investor confidence."

It said one of the consequences of the legal uncertainty was that "large corporate borrowers have the economic clout to challenge contracts."

As a result banks focused more on lending to consumers and small- and medium-scale enterprises.