Greg Earl, Jakarta – The World Bank has warned that Indonesia is failing to make use of a period of high foreign investment and economic growth to resolve economic challenges that threaten its long-term performance.

The bank's annual assessment of one of its largest borrowers says that deregulation has lost momentum, underlying inflation is still high, some tariff reductions have not been implemented and the banking sector remains weak.

Nevertheless, the report forecasts a continued strong short-term economic performance, with growth of about 7.8 per cent over the next three years and a current account deficit that will remain at about 4 per cent of gross domestic product over that time.

Non-oil export growth is projected at 12.8-13.8 per cent, which is an increase on last year but below Indonesia's long-term projections. Import growth is projected at above 8 per cent but below the unsustainable levels of 1994 and 1995.

The report was circulated to Indonesia's main aid donors yesterday ahead of an annual meeting in Tokyo next month.

The meeting is expected to agree to an aid package of about $US5 billion ($6.7 billion), which the World Bank says is still necessary despite booming foreign investment.

While the report contains the bank's regular mix of recommendations favouring market pricing and transparent government procedures, this year it is distinguished by a repeated warning that Indonesia is allowing its once strong commitment to economic reform to drift.

It says: "Unless momentum is restored to deregulation, Indonesia risks slower growth and deteriorating equity, which characterises many developing countries."

While Indonesia has made many changes to its banking and currency regime over the past year the report says there is continuing concern that "the financial system, in its present state, would not act as an adequate shock absorber in the event of some macro-economic shock".