JAKARTA - The International Monetary Fund has recommended Bank Indonesia (BI) limit its 2022 direct purchases of government bonds to periods of market dysfunction, as Southeast Asia's largest economy begins to unwind pandemic-era economic stimulus.

In a report published on Wednesday, the fund also recommended BI allow greater flexibility in the rupiah IDR= exchange rate if the economy is faced with adverse spillovers from global monetary tightening.

"The IMF team supports the authorities' commitment to exit from monetary budget financing by the end-2022 target date, and further recommends confining further primary market purchases under the market mechanism this year only to periods of severe market dysfunction," Cheng Hoon Lim, the IMF's Indonesia Mission Chief, said in a press briefing for its so-called Article IV.

BI has cut interest rates by 150 basis points and injected tens of billions of dollars since 2020 to help Indonesia weather the economic impact of the COVID-19 pandemic.

Some of the liquidity support has come in the form of government bond purchases in auctions and through private placement, to limit the government's debt interest expenses.

BI will raise by 300 bps the reserve requirement ratio for banks from March to September in a first step towards rolling back monetary stimulus, it said last week.

IMF's Lim said Indonesia was in a good position to normalise policy and BI's liquidity absorption measure will help anticipate the U.S. Federal Reserve's monetary tightening.

"If and when the Fed tightens, we do not anticipate the need for significant capital outflows because the current account is strong, so we expect an orderly adjustment in the monetary policy for BI," Lim said, pointing to Indonesia's improving external balance on the back of high commodity prices.

In the case of capital outflows, BI should preserve its monetary policy space by allowing the rupiah to absorb the shock first, Lim said.

The IMF downgraded Indonesia's 2022 economic growth forecast to 5.6% in 2022, from 5.9% in its October report, which Lim said was due to the spread of the Omicron variant and slower global economic growth. The fund sees GDP growth of 6% in 2023.

(Reporting by Gayatri Suroyo Editing by Ed Davies) ((gayatri.suroyo@thomsonreuters.com; +622129927609; Reuters Messaging: gayatri.suroyo.thomsonreuters.com@reuters.net))