(Adds details from IMF report)
WASHINGTON, Feb 6 (Reuters) - The International Monetary Fund said Indonesia's annual economic growth will gradually rise to about 5.6 percent over the medium term, led by robust domestic demand, but it cautioned against building up too much debt in the country's drive to boost infrastructure investment.
The IMF, in its annual review of Indonesia's economic policies, released in Washington on Tuesday, projected annual inflation to remain at around 3.5 percent, with well-anchored inflation expectations. Indonesia's current account deficit is expected to remain at near 2 percent of gross domestic product due to firm commodity prices and robust exports, the fund said.
The IMF report projected Indonesia's 2018 gross domestic product growth rate at 5.3 percent, compared with 5.1 percent in 2017.
"Risks to the outlook remain tilted to the downside, including spikes in global financial volatility, uncertainty around U.S. economic policies, lower growth in China and geopolitical tensions," the IMF said.
While global growth and commodity prices could surprise on the upside, aiding Indonesia's outlook, the IMF said domestic risks include tax revenue shortfalls and larger fiscal financing needs due to higher interest rates.
The IMF's executive board urged Indonesian authorities to stay vigilant against risks including from volatile capital flows and said fiscal adjustment in 2018 should be gradual to protect growth and rebuild fiscal buffers.
The IMF directors said they welcomed Indonesia's progress in boosting infrastructure investment, but stressed that the pace should be aligned with available financing and the economy's ability to absorb new investment.
"Priority should be given to financing infrastructure with domestic revenue, as well as greater private sector participation, including foreign direct investment," the IMF board said in its assessment. "This would limit the build-up of corporate external debt and contingent liabilities from state-owned enterprises."
The IMF board also called for authorities to reduce state control and the role of state-owned enterprises in some sectors of the economy and to improve the level and quality of education spending. (Reporting by David Lawder; Editing by James Dalgleish and Leslie Adler)