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Document o f The World Bank
FOR OFFICIAL USE ONLY
ReportNo. 30418-IND
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
PROGRAM DOCUMENT
FOR A
PROPOSED FIRST DEVELOPMENT POLICY LOAN
IN THE AMOUNT OF US$300 MILLION
TO
THE REPUBLIC OF INDONESIA
NOVEMBER 23,2004
Poverty Reduction and Economic Management Unit East Asia and Pacific Region
This document has a restricted distribution and may b e used by recipients on ly in the performance o f their off icial duties. I t s contents m a y no t otherwise b e disclosed without W o r l d Bank authorization.
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CURRENCY EQUIVALENTS
(Exchange Rate Effective November 23,2004) Currency Unit = Rupiah (Rp)
U S $ l = 8,983
FISCAL YEAR
Until March 3 1, 2000: April 1 to March 3 1 Until December 3 1,2000: April 1 to December 3 1 From January 1,200 1 : January 1 to December 3 1
Vice President: Jemal-ud-din Kassum Country Director: Andrew D. Steer
Lead Economist: William Wallace Chief Economist and Sector Director:
Task Team Leaders:
Homi Kharas
Wolfgang Fengler / P. S. Srinivas
The operation was prepared by a World Bank team consisting of Wolfgang Fengler and P.S. Srinivas (Task Team Leaders), William Wallace (Lead Economist since November 2004), Bert Hofman (Lead Economist until September 2004), Yoichiro Ishihara, Amitabha Mukherjee and James Sheppard (EASPR); Susan Wong (EASSD); Robert Saum and Rajiv Sondhi (EAPCO); Yogana Prasta (EACIF); and Anthony Toft (LEGEA).
Contributions were received from Jehan Arulpragasam, Sudarshan Gooptu, Joel Hellman, Blane Lewis, Kathy Macpherson, Tariq Niazi, Kumya Roesad (EASPR); Djauhari Sitorus, Megawati Sulistyo (EASFP); Naseer Rana (EAPCO); Mohamad Al-Arief (EACIF); Renganaden Soopramanien (LEGEA); Rajashree Paralkar (EACIQ); and Lars Jessen (BCFBD). Rachel Susan Palmer (EACIQ); Nina Herawati, Indra Imawan, Sr i Oktorini, Christina Sukmawati, Retno Anna Widiana, Retno Widuri (EACIF); and Hedwig Abbey (EASPR) provided logistical support and document processing assistance.
The peer reviewers were Vikram Nehru (PRMDE) and Mark Thomas (LCCSA). Stefan Koeberle (OPCCE) provided overall advice. The team worked under the overall guidance of Homi Kharas (EASPR) and Andrew Steer (EACIF).
FOR OFFICIAL USE ONLY
ABBREVIATIONS AND ACRONYMS
ADB AG APBN AusAID
BCP BAKUN
BAPPENAS
BAPETAL BI BPK BPKP CAMEL
CAS CDD CEIC CFAA
CGI CIDA
CPAR
DG DGFI
DAK DPL DPR EPP EU FATF FDI FMRC
GDP GFMRAP
GTZ IBRA
Asian Development Bank Attorney General Central Govemment Budget Australian International Development Agency Business Continuity Plan T h e Agency for Govemment Accounts National Development Planning Agency Supervisor of Electricity Power Bank Indonesia Supreme Audit Board Government Intemal Auditor Bank Indonesia’s regulations on bank supervision Country Assistance Strategy Community Demand Driven CEIC Data Company Ltd. Country Financial Accountability Assessment Consultative Group on Indonesia Canadian Intemational Development Agency Country Procurement Assessment Report Director General Director General Financial Institutions Special Allocation Grants Development Policy Loan People’s Consultative Assembly Economic Policy Program European Union Financial Action Task Force Foreign Direct Investment Financial Management Reform Committee Gross Domestic Product Govemment Financial Management and Revenue Administration Project German Technical Cooperation Indonesian Bank Restructuring Agency
IDA IFC IMF KANWIL KAR KASIPA Keppres KKN KPPN KSAP
LDP LPEM
LTO MOF MOU MTEF NBFI NPPO OED PFM PPA PRSP RDA RDI RPJM
SA1 SARS SBI SME SOE SPAN STAR STPDN
TSA UNCTAD
UNDP USAid
VSL
Intemational Development Association Intemational Finance Corporation International Monetary Fund Local Accounting Offices Regional Accounting Offices Local Verification Offices Presidential Decree Corruption, Collusion, Nepotism Local Payment Offices Govemment Accounting Standards Committee Letter o f Development Policy Institute for Economic and Social Research, University o f Indonesia Large Taxpayers Office Ministry o f Finance Memorandum o f Understandings Medium-Term Expenditure Non-Bank Financial Institutions National Public Procurement Office Operations Evaluation Department Public Financial Management Participatory Poverty Assessments Poverty Reduction Strategy Paper Regional Development Fund Account Investment Fund Account Government’s Medium Term Development Plan Supreme Audit Institution Severe Acute Respiratory Syndrome Bank Indonesia Certificate Small and Medium Enterprises State-owned Enterprises State Treasury and Budget System State Audit Reform Project Public Administration Institute of the Ministry o f Home Affairs Treasury Single Account United Nations Conference on Trade and Development United Nations Development Fund United States Agency for Intemational Development Variable Spread Loan
This document has a restr icted d is t r ibut ion and may be used by recipients on ly in the performance o f their of f ic ia l duties. I t s contents may n o t be otherwise disclosed w i thout W o r l d Bank authorization. -
TABLE OF CONTENTS
I . INTRODUCTION AND STRATEGIC CONTEXT .............................................................................. 1 I1 . ECONOMY. INVESTMENT CLIMATE AND POVERTY 3
B . MEDIUM-TERM MACROECONOMIC PROSPECTS ...................................................................................... 10
SUSTAINABLE DEVELOPMENT ....................................................................................................... 13 A . CRISIS AND POST-CRISIS MANAGEMENT .................................................................................................. 13 B . WHITE PAPER” IMPLEMENTATION .......................................................................................................... 13 c . LOOKING FORWARD: AGENDA. OPPORTUNITY AND CHALLENGES OF THE NEW GOVERNMENT ......... 15
WORLD BANK SUPPORT FOR THE GOVERNMENT’S STRATEGY ........................................ 18 THE DEVELOPMENT POLICY LOAN PROGRAM ....................................................................... 22
A . DEVELOPMENT POLICY LOAN FRAMEWORK AND PROGRAM .................................................................. 22 B . THE FIRST DEVELOPMENT POLICY LOAN ............................................................................................... 22
OPERATION IMPLEMENTATION. .................................................................................................. 28 A . LESSONS LEARNED FROM PAST ADJUSTMENT LENDING ........................................................................ 28 B . DESIGN OF THE PROPOSED DPL ............................................................................................................... 28
E . LOAN ADMINISTRATION ............................................................................................................................ 30 F . POVERTY AND SOCIAL IMPACT ANALYSIS ............................................................................................... 31 G . ENVIRONMENTAL ASPECTS ...................................................................................................................... 31
................................................................. A . RECENT ECONOMIC AND SOCIAL DEVELOPMENTS ................................................................................... 3
I11 . THE GOVERNMENT’S POLICY AGENDA: FROM CRISIS MANAGEMENT TO
I V . V .
VI .
C . IMPLEMENTATION ARRANGEMENTS ........................................................................................................ 29 D . MONITORING AND EVALUATION .............................................................................................................. 29
H . BENEFITS ................................................................................................................................................... 31 I . RISKS ........................................................................................................................................................... 32
FIDUCIARY ASSESSMENT ................................................................................................................. 35 VI1 . ANNEX 1: LETTER OF DEVELOPMENT POLICY .................................................................................. 37 ANNEX 2: RESULTS FRAMEWORK . INDONESIA DEVELOPMENT POLICY LOAN .................... 44
NOVEMBER 2004 ......................................................................................................................... 47
ANNEX 5: FIDUCIARY ASSESSMENT FOR DEVELOPMENT POLICY LOAN ................................. 64
ANNEX 8: INDONESIA: STATEMENT OF IFC’S HELD AND DISBURSED PORTFOLIO ................ 78
ANNEX 3: ADDRESS OF THE PRESIDENT OF THE REPUBLIC OF INDONESIA . 17TH
ANNEX 4: INDONESIA: DEBT AND DEBT SUSTAINABILITY .............................................................. 60
ANNEX 6: STATUS OF BANK GROUP OPERATIONS ............................................................................. 75 ANNEX 7: FUND RELATIONS NOTE .......................................................................................................... 76
ANNEX 9: INDONESIA AT A GLANCE ....................................................................................................... 79
MAP: IBRD NO . 30904R5 .................................................................................... 81
INDONESIA PROPOSED FIRST DEVELOPMENT POLICY LOAN
Loan and Program Summary
Borrower:
Implementing Agencies:
Poverty Category:
Amount:
Terms:
Commitment Fee:
Front-end Fee:
Objective:
Description:
Republic o f Indonesia
Coordinating Ministry o f the Economy and Ministry o f Finance
No t Applicable
US$300 mi l l ion (Single Tranche)
Repayable in 20 years, including 5 years o f grace, at the standard interest rate for LIBOR-based variable-spread loans in U S Dollars.
0.75% per annum on undisbursed balances.
1% o f the loan amount, to be paid out o f loan proceeds.
The proposed First Development Pol icy Loan (DPL) has been designed to recognize past actions and support continued progress in Indonesia’s pol icy reforms during the transition between administrations and from stabilization to development. The loan supports the Government’s public pol icy statements and agenda in key economic areas with a specific focus o n maintaining macroeconomic stability, enhancing the investment climate, and improving public financial management and anti- corruption. In addition, i t provides vital financing at a critical stage and provides an effective vehicle for the Bank to engage the new administration.
I t i s anticipated that the proposed loan wil l be the f i rs t o f a series o f DPLs - in a programmatic framework - in support o f Indonesia’s medium-term growth and poverty reduction program. The expected results o f this approach include sustained macro stability, an improved investment climate, greater government accountability, and improved public services for the poor.
The proposed DPL supports the pol icy reforms in the fol lowing areas:
Macroeconomic stability and creditworthiness. The administration has indicated its commitment to build on the fiscal discipline achieved, and a willingness to address
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Benefits:
problematic issues in subsidies, tax compliance, and . inter- governmental fiscal transfers. In the medium term, continued progress in these areas would result in a sound fiscal position with low budget deficits, additional mobilization o f non-oil and gas revenues, and further upgrades to Indonesia’s international credit rating.
Investment climate. The administration has expressed i t s commitment to continued tax and customs reforms, given the problems in these areas. It wil l make hrther progress in financial sector reforms, rationalize regional government taxes and fees, focus on public private partnerships to develop infrastructure and improve pol icy toward SMEs. These reforms, over the medium term, are expected to result in a stronger financial sector and an increase in the share o f investment to GDP.
Public financial management and anti-corruption. The administration has committed to continuing fiduciary and budget reforms through, among other actions, issuing implementing regulations for several key laws, establishing a Treasury Single Account and strengthening the Inspector General’s office. By 2007, these reforms are expected to result in significant improvements to budgeting and transparency and accountability in public financial management.
The proposed DPL i s an appropriate instrument to simultaneously tackle several key issues at a time o f pol icy and political transition.
Endorsement of sound policy. The previous administration’s largely successful implementation o f the White Paper has contributed to reducing macroeconomic uncertainty - a key concern at the end o f the IMF-supported program in 2003. The White Paper made significant progress in important pol icy areas and the proposed D P L recognizes these past reforms.
Vehicle for ongoing and future policy dialog. The proposed D P L also provides a mechanism for early and intensive engagement with the Government o n forward looking pol icy actions to consolidate and deepen these reforms. The new administration’s public statements as we l l as the Letter o f Development Pol icy (LDP) indicate i t s commitments on a range o f issues. Within the context o f the proposed programmatic framework, Bank engagement on pol icy issues will be enhanced.
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Risks:
Enhanced partnership. Traditional adjustment lending in Indonesia has had uneven success and entailed considerable reputational costs for the Bank, both within the Government and c iv i l society. The DPL provides a unique opportunity for the Bank to change course and re-engage with the Government by basing financial assistance on completed actions derived from the Government’s own reform program and in line with the Government’s annual budget cycle. The proposed loan - coming in the f i rst few months o f the new administration - would also convey a strong positive signal to the financial markets and the intemational community to back up the encouraging pol icy agenda o f the new Government.
Meeting fiscal needs. The proposed loan would help meet the Government’s financing needs for the current fiscal year. Without the loan, Government wil l be forced to take actions - such as drawing down further on i t s deposits at the central bank, cutting development spending, or retuming to capital markets in an unanticipated manner - that could increase macro uncertainty.
The proposed operation faces several risks.
Political. Though the President won a decisive mandate, his party and coalition partners currently lack a stable majority in parliament. This could lead to pol icy divisions between the Government and the legislature. In addition, the majority o f local executives and legislative bodies are dominated by opposition parties raising r isks o f implementation difficulties in Indonesia’s largely decentralized pol icy environment. The proposed programmatic nature o f Bank engagement as wel l as the triggers laid out in CAS; mitigate the r isks to the Bank. Future operations wil l be undertaken only i f satisfactory progress is made on implementing the Government’s reform agenda.
Economic. Despite public commitment to fiscal discipline, there i s the risk that political pressures lead the Government to pursue an excessively expansionary fiscal strategy. Once r e f o m momentum slips Indonesia’s hard-won macroeconomic stability could be at risk. The Government also has large contingent liabilities - e.g. blanket guarantee on bank deposits, loss-making state owned enterprises (SOEs), and actuarial liabilities at public pension funds. Although there i s off icial ly no sovereign guarantee, the central government implici t ly faces
... 111
r isks from regional borrowing allowed under a recent law. There i s the risk that domestic fuelprices will not be raised as political pressures have delayed or forestalled increases in the past. State owned banks continue to pose r isks due to weak governance. The Bank continues to have a dialog with the Government o n state banks and i s working with the Government to assist the development o f NBFIs to provide alternate sources o f long-term finance. The investment climate remains poor and poses r isks to growth. The legal system, labor laws, decentralization, taxes and customs al l present significant constraints. The Government’s public commitment to maintain fiscal and macro stability, and pursue the reform agenda i s key to addressing a broad range o f economic risks. The Bank’s analysis and dialogue in these areas and the programmatic nature o f the loan also mitigate these risks to some extent.
,
Fiduciary and reputational. In the past, the Bank has been associated with Indonesia’s weak governance environment. Concerns have also been raised by c iv i l society groups about the.proper use o f donor funds. The Bank’s fiduciary assessment for the DPL concludes that since 2000-01, there have been considerable improvements in Indonesia’s public financial management systems. Despite these reforms, Indonesia clearly has an enormous public sector institutional reform agenda to implement. There remain concerns about the quality o f Indonesia’s public expenditure management system; however, the proposed loan would take place in an environment o f substantially improved public expenditure management.
Financing Plan: N o t applicable
Net Present Value: N o t applicable
Project ID Number: PO92663
iv
I. INTRODUCTION AND STRATEGIC CONTEXT
The proposed loan i s being prepared at an important time in Indonesia’s history. On October 20, Dr. Susilo Bambang Yudhoyono, the former coordinating minister for security and political affairs, took over as the f i rs t directly elected President in Indonesia’s history - having won a decisive mandate with 61 percent o f the vote. In more than 600,000 pol l ing stations across the country, more people voted in this election than in any other direct presidential election in any country in history. Indonesia’s electoral process with three national elections within six months has been remarkably peaceful.
Although the new administration has been in office for a short period, it has begun to articulate a clear vision and policy stance. In his inaugural address to the nation, President Yudhoyono highlighted poverty, unemployment, debt, and corruption as key challenges. The Government has also developed a 100-day plan that identifies actions to be taken by the administration o n the basis o f three broad themes: (i) creating a safe and peaceful Indonesia (ii) creating a just and democratic Indonesia and (iii) creating a prosperous Indonesia. Many o f the priorities aim to consolidate previous achievements, while others emphasize new areas, including resolving conflicts in Aceh and Papua. More recently, on November 17, the President again spoke to the nation and reconfirmed his commitment to the above themes. H e added detail on pol icy direction in economics, welfare, legal reform, politics and security. H e signaled a sound approach to policymaking that would maintain stability while increasing attention to the investment climate, corruption, education, and health among other areas.
This proposed single-tranche First Development Policy Loan (DPL) in the amount of US$300 million aims to support the new administration in its reform process. The DPL i s being designed during a time o f transition in Indonesia. In pol icy terms, the D P L supports a transition from a stabilization agenda to a development agenda that has begun. The DPL also aims to sustain the momentum o f reform across administrations in a time o f political transition and to provide vital financing and support to the new Government in its early months. The DPL recognizes past reforms and creates the basis for early engagement with the new administration o n key pol icy issues. The DPL also develops a forward - looking programmatic framework for Bank support o f Indonesia’s medium-term reform program.
The Bank’s Country Assistance Strategy (CAS) prepared the ground for programmatic lending. The CAS (Report No . 27108-IND) included the proposed DPL for the first ha l f of FY05 under an “Enhanced Base Case” scenario. Reaching the “Enhanced Base Case” required systematic implementation o f the “Whi te Paper” reforms, particularly in the areas o f (i) macroeconomic stability and creditworthiness, (ii) investment climate and (iii) public financial management and anti-corruption. It i s anticipated that the proposed loan will be the f i rs t o f a series o f DPLs to support reform efforts. Once Indonesia moves into the “High Case” scenario laid out in the Bank’s CAS - which would require a continuation o f reforms in DPLl areas as we l l as progress in justice sector reform and public service delivery - the Government could obtain further programmatic assistance from the Bank.
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Indonesia i s a prime candidate for development policy lending. With macro- economic stability regained and a new administration in place, Indonesia i s entering a new era which could allow i t to switch from a short-term crisis management mode to a longer term strategic development approach. At the end o f 2003 , Indonesia successfblly “graduated’ from the IMF-supported program. The Government expressed i t s commitment to a continued program o f economic reform through the adoption o f a comprehensive, time-bound package o f pol icy reforms until end-2004. The implementation o f the White Paper has helped to consolidate earlier macroeconomic achievements.
This loan forms part of the financial support for the implementation of the White Paper discussed at the last Consultative Group meeting. At the December 2003 meeting o f the Consultative Group on Indonesia (CGI) - held after the White Paper was issued - the intemational community agreed to provide up to U S $ 1 b i l l ion in program loans for 2004 to meet financing needs that the Government had identified, subject to firm implementation o f the White Paper. The C G I clearly understood that the Paris Club had provided exceptional financing in 2002 and 2003 - and with the end o f the IMF-supported program this would no longer be available. To help with the gross financing needs, fast disbursing program loans were to be made available. For 2004, the Bank offered potential support o f US$450 mi l l ion in program loans - with the proposed D P L o f US$300 m i l l i on being the core element o f this support. The remaining U S $ l 5 0 mi l l ion would have been the final tranche disbursement o f the Water Resources Sector Adjustment Loan (WATSAL), which has been recently cancelled.
The new Administration has strongly restated the request of the outgoing government that this loan i s provided before the end of 2004. I t has publicly articulated an init ial set o f economic policies and reaffirmed that fiscal discipline and macroeconomic stability would continue to be comerstones o f its policies. It has indicated i t s commitment to a substantive program o f actions through the L D P to the Bank and requested that the Bank continue to be a reliable development partner for Indonesia by providing the resources o f the proposed loan. The Bank would l ike be responsive to the Government’s needs.
The timing of the proposed loan presents opportunities and risks. The new administration took office very recently, and i t s policies are st i l l being finalized. Whi le this transition presents some risks, the Bank believes these are substantially outweighed by the opportunity for the Bank and the Government to engage early in a meaningfbl dialog on key policies and programs. Through the DPL, the Bank will also be able to convey an endorsement o f the new administration’s ini t ial pol icy statements and thus help promote appropriate market sentiment. Recognizing the r isks in the proposed timing o f the operation, the structure o f the proposed loan as a one-tranche operation provides the Bank with flexibility for future policy-based support.
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11. ECONOMY, INVESTMENT CLIMATE AND POVERTY
Indonesia’s economic fundamentals have improved markedly since 2001. Rising consumer demand increased economic growth f rom 3.8 percent in 2001 to 4.5 percent in 2003 (Figure 1). Growth is expected to reach 4.9 percent in 2004 and 5.4 percent in 2005, the highest level since the onset o f the economic crisis in 1997. Inflation f e l l f rom 13 percent in December 2001 to 6.2 percent in October 2004, and one month S B I interest rates fel l from 18 percent in December 2001 to 7.4 percent in November 2004. Despite this progress, growth has been insufficient to reduce unemployment, and interest rates remain high by regional standards. Investment demand has begun to rise, but at 18 percent o f GDP (2003) remains low, especially in light o f high capacity utilization.
The new government i s well positioned to take advantage of the election momentum to improve the investment climate and accelerate growth. A continued focus on macroeconomic fundamentals coupled with early and effective implementation o f important reforms would provide confidence to markets and investors. In particular, improving the investment climate i s key given that consumer demand and capacity utilization are already high. If the investment climate improves and investment increases, Indonesia’s growth could reach 6 percent-a level sufficient to reduce unemployment-by 2006.
However, macroeconomic and fiscal gains have been achieved in part by low levels o f public investment. Government spending, including o n infrastructure, health and education have been low, and overall service delivery weak. Looking ahead, the government’s main challenge is to expand public investment while keeping macroeconomic stabilization on track. There are a number o f options to increase public service resources including improved allocation o f expenditures, the reallocation o f subsidies, an increase in non-oil and gas tax revenues, and a re-profiling o f public debt.
A central challenge for the period 2004-2009 i s medium term government financing. Despite continued fiscal consolidation and relatively l ow deficits, financing remains a problem with limited opportunities for asset sales (an important source o f financing annual in recent years) and large amounts o f domestic and foreign debt coming due. Gross financing needs will remain in the 3 percent o f GDP (US$lO-11 billion) range until 2009. The government will need a diversified approach to meeting these financing needs including increased domestic and foreign borrowing, and better debt management to improve the maturity structure o f the portfolio (see also Annex 4).
A. RECENT ECONOMIC AND SOCIAL DEVELOPMENTS
Steady growth with signs of investment recovery. Growth o f 4.5 percent in 2003 was higher than expected in the wake o f the Ba l i bombing (October 2002), the Iraq War and S A R S . Economic performance was mainly driven by private consumption and increased regional government spending. Growth rose slightly in the first ha l f o f 2004 to 4.7 percent (yoy), and investment rebounded, growing by 8.3 percent, up from 1.9 percent in 2003 as a
3
whole. This turn around in investment activity is reinforced by a 35 percent increase in capital goods imports (yoy) between January and September 2004. Strengthening fundamentals, steady growth and successful elections, are reflected in positive market sentiment. The stock market index rose to over 900 in November 2004, a historic high, from 692 at the end o f 2003 and 425 at the end o f 2002 (Figure 2).
Despite these positive signs, Indonesia’s investment i s recovering from a low base and the investment climate remains weak. Between 1996 (pre-crisis) and 2002, investment as a share o f GDP declined from 30 percent to below 20 percent, where it remains today. Investment has been a problem for the entire region but Indonesia’s investment rate i s the lowest since the early 1970s and Indonesia has slipped wel l behind i t s competitors (Figure 3).
Export competitiveness remains under pressure. Indonesia has also lost market share in export sectors where i t competes with i t s neighbors. The weak investment climate and especially foreign direct investment, contributed to this disappointing performance (Figure 6). Exports in the f i rst six months o f 2004 were up only 2 percent from a year earlier, while exports from Thailand grew by 8.6 percent, Malaysia by 17.5 percent, the Philippines by 13 percent, and Korea by 27 percent. In light o f high capacity utilization and strong domestic demand, Indonesia wil l need additional investment to take advantage o f the global economic recovery.
Box 1. Revaluation of the GDP - Important Implications for K e y Indicators
In M a y 2004, the Indonesian government updated GDP estimates as part o f a exercise carried out every ten years to capture the change in the structure o f the economy. The GDP-components have been re-weighted and include new products (e.g. IT sector) based on the 2000 Input-Output Table. The result was an upward revision in the nominal level and growth rates compared to the previous 1993 base year (Box Table 1). For example, nominal GDP was almost 10 percent higher in 2000 and 18 percent higher in 2003. This change in nominal GDP affects key macroeconomic indicators including tax, budget deficits and debt to GDP ratio. In some cases, these ratios have declined sizably. For example, the government debt to GDP ratio in 2003 was 69 percent (1993 GDP base) but only 59 percent (2000 GDP base); the budget deficit ratio improved as well: in 2003 it was 2.1 percent (1993 GDP base) and 1.8 percent (2000 GDP base).
Box Table 1: Change in GDP between base year 1993 and 2000
Nominal GDP (Rp. Trillion) Real GDP (growth rate, percent) 1993 base 2000 base Percent change 1993 base 2000 base Percent change
2000 1,265 1,390 9.9 4.9 200 1 1,468 1,684 14.8 3.5 3.8 0.3 2002 1,611 1,898 17.8 3.7 4.3 0.6 2003 1,787 2,087 16.8 4.1 4.5 0.4 Source: BPS, World Bank staffestimates
Given the transition to the new GDP base i t i s important to highlight the base year for consistency purposes: The Government continues to present the 2005 budget in 1993 base GDP but explains the differences with the 2000 base. For consistency, the Government continues to use the 1993 base including in the attached Letter o f Development Policy. In 2005, al l government documents w i l l be based on the new 2000 base GDP as 1993 base GDP data w i l l no longer be available. In contrast, this document uses 2000 GDP for al l real and nominal calculations. The 2000 base GDP currently best reflects the real state o f the economy.
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This growth in the domestic market, combined with weak export performance, has increased demand for protection. Indonesia has a l o w average import tari f f o f 7.3 percent but poor coordination on trade pol icy has resulted in increasing non-tariff barriers, and export restrictions. A ban was placed on rice imports during the harvest season in 2004 and then extended to the end o f the year. Sugar and salt, plastic raw materials, and textiles al l now require special import licenses. O n the export side restrictions were continued or added on logs, rattan, leather and palm kernels; and cocoa i s under threat. On a positive note in early 2003, luxury taxes were reduced or eliminated on a wide range o f electronic and other goods. These were fostering smuggling and their elimination or reduction appears to have stimulated production and investment in Indonesia.
Box 2. Doing Business in Indonesia
The World Bank's Investment Climate Assessment and the World Bank's Doing Business Survey 2005 reflect difficulties in Indonesia's investment climate. These two reports highlight the importance o f policy and macroeconomic uncertainty for private sector investment decisions and point to the weak institutional environment businesses are s t i l l exposed to:
Investors continue to perceive the Indonesian macroeconomic situation as fragile and policy uncertainty as high (48 percent o f fm mention this). Less than 60 percent o f firms are confident that their property rights can be protected and 56 percent consider the interpretation o f regulations unpredictable (Box Table 2) In Indonesia, it takes 151 days to start a business, much longer than regional competitors such as Thailand (33 days) and Malaysia (30 days). Long periods to enforce contracts and go through insolvency reflect the weak legal environment (Box Table 2)
Box Table 2. Indonesia's investment climate in regional comparison
Indonesia Thailand Malaysia Philippines Vietnam China
151 33 30 50 56 41 Time to start business (days) Time to enforce contract (days) 570 390 300 380 404 24 1
6.0 2.6 2.3 5.6 5.5 2.4 Time to go through insolvency (vears) " ." I
Source: World Bank (Doing Business 2005) ~ ~~
Poverty has declined but Table 1. Change in poverty headcount index from 1996 to 2003 half o f the population still lives below US$2 a day. A steady growth rate together with lower inflation contributed to continuing poverty reduction. The 2003 SUSENAS household survey indicates that the poverty
96 99 02 03 National poverty l i ne 15.7 27.1 16.0 15.1 International poverty l ine 1 dollar a day 7.8 12.0 7.4 7.2 2 dollar a dav 50.5 65.1 53.4 52.9
Source: World Bank stafestimates
headcount ratio continued to decline from 16.0 percent in 2002 to 15.1 percent in 2003 well below i t s peak in 1999 at 27.1 percent and lower than the pre-crisis level o f 15.7 percent in 1996 (Table 1). However, non-income aspects o f poverty persist as particularly serious
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problems. Indonesia continues to under-perform i t s neighbors in access to quality health, education and other basic services. In February 2004 the Government issued i t s Progress Report on the Mil lennium Development Goals which highlights the challenges to improving social welfare, particularly with regard to health and education outcomes. For example, Indonesia’s maternal mortality rate i s twice that o f the Philippines and five times higher than that o f Vietnam.
Employment growth has been discouraging. Formal sector employment declined from 32 mi l l ion in 1999 to 26 mi l l ion in 2003, while informal employment increased from 56.9 mi l l ion to 64.2 million. Latest annual figures show that j ob losses in the formal sector were particularly severe in 2002-2003 with more than one mi l l ion jobs lost in manufacturing. As a result, the open unemployment rate reached 9.5 percent in 2003. L o w productivity, high wages, and increasingly rigid labor regulations drive these disappointing j o b numbers. Higher wage demands are the price o f an evolving collective bargaining system. But excessive wage growth i s also a product o f a flawed mechanism for minimum wages, which rel ies on debatable surveys to estimate the cost o f living used in the negotiations. Higher productivity will depend on sufficient skilled workers and flexible labor regulations, neither o f which are currently in place.
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A Snapshot o f Indonesia's Economic and Social Developments
7% -
6% -
5% -
4 % -
3% -
2% -
1% -
Figure 1. Steady Growth Continues (real GDP growth rate, percent)
,e*.*
a . * ' , .
- .. Q1 Q2 Q3 Q4 Q1 QZ Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2000 2001 2002 2003 2004
Source: BPS Figure 3. Indonesia's Investment i s Low in International
Comparison (Investment as a share o f GDP, percent)
.. 40%
35%
30%
25%
20%
15%
Thai I and
3
1996 1997 1998 1999 2000 2001 2002 2003
Source: CEIC, World Bank staff estimates
Figure 5. Interest rates decline but lending rate lags
Figure 2. Market Sentiment i s Strong (Rupiah exchange rate and JSX stock index (83=100)
RpmSS 83=100 9600 1 T 1000
I I
9200 9400 I stock index (RHS)
- 900
8800 90001+4 I .
800
700
600
500
8200 400
8000 4 I ' 300 Jan-03 Apr-03 Jul-03 Oet-03 Jan-04 Apr-04 Jul-04 Oet-04
Source: CEIC Figure 4. External Risks are Abating
(external debt as a share o f GDP)
180% 1 160% - 140% - 120% - 100% -
80% -
60% -
1993 base GDP
40% 2000 base GDP
20%
0% 1996 1997 1998 1999 2000 2001 2002 2003 2004
June
Source: BPS, Bank Indonesia, MOF, World Bank staff estimates
Figure 6. Export Performance i s lagging (Export index, constant prices)
9 6 4 0 0 220 -
Korea 200 -
180 ,
percent 21 1
Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-03 Jan-03 Jul-03 5811-04 Jul-04
120
100
80 1995 1996 1997 1998 1999 2000 2001 2002 2003
Source: CEIC Note: Indonesia number is based on the 1993 base national account; Source: CEIC, World Bank staff estimates
7
After five years o f prudent post-crisis economic management, Indonesia has achieved more fiscal consolidation than expected. Reducing budget deficits (Figure 7 ) and mobilizing non-debt financial resources (e.g. privatization, and BRA asset sales); together with steady economic growth have brought the debt to GDP ratio down rapidly. The government debt to GDP ratio declined from 80 percent in 2000 to 53 percent as o f June 2004, lower than the 60 percent threshold stipulated in the 2003 State Finance Law (Figure 8). These macroeconomic improvements have been reflected in Indonesia’s credit rating which - now at “By’ by S&P - has been upgraded three times since September 2002. Despite these substantial improvements, Indonesia’s credit rating remains five notches below the investment grade and trails neighbors such as the Philippines and Vietnam.
100% - 90% - 80% -
70% - 60% - 50% - 40% -
Figure 7. Budget deficit to GDP ratio
4%
-3%
-1%
-1%
0%
FYW FYOl FYOl FYOS FYM FYOS
Note: Ratio is based on I993 base GDP Source: MOF
Public investment has declined dramatically. Fiscal consolidation and disruptions caused by the transition to decentralization reduced public investment spending (Figure 9). Prior to the crisis total development spending (central and regional government combined) averaged above 9 percent o f GDP with the regional component being about a fifth o f this. At i ts low point in 2001, development spending fe l l below 5 percent o f GDP creating the infrastructure and other shortfalls. Since 2002 public investment has begun to recover and i s estimated to have reached 6.5 percent in 2003 with regional governments now accounting for approximately half.
Figure 8. Government debt to GDP ratio
2000 bue GDP I d
0% 4 1996 1997 1998 1999 2wO 2001 2002 Zoo3 2004
June
Source: World Bank staff estimates
Figure 9. Development Spending
Regional governments
FY94l95 FY96I97 FY9W99 FYOO FYOZ
Note: FY9495-FY02 actual, 2003 Regional development spending WB estimate Source: World Bank staff estimates
8
The 2004 budget i s the first for Indonesia without an IMF program. For the f i rs t t ime since the crisis the Government has had to find financing for US$3 billion o f debt previously rescheduled under the Paris Club. In the in i t ia l budget this increased financing need was met by a draw down in the government account with the central bank, continued privatization and asset sales, and most importantly increased domestic and foreign bond issuance (Table 3). The 2004 budget revision included an upward adjustment for both revenues and expenditures, though the budget deficit as a share o f GDP remained almost unchanged at 1.1 percent. The upward revisions were main ly due to the higher o i l and gas revenues and corresponding expenditures, especially subsidies. The net impact o f the oi l price change on the budgetary balance was almost zero. However, disbursements on program and project loans, and net bonds were reduced wh i le asset sales (BRA and PPA) and the draw down o f the government account were increased.
Financing i s on track to match the revised budget estimate. The Bank’s current estimate for 2004 financing i s presented in Table 3. Given current estimates with program loans o f US$ 400 million (including the DPL) financing needs would b e met. However, the 2004 budget defici t target m a y b e exceeded. Arrears on oi l and gas revenues are greater than o i l and gas expenditures. A s the government operates on a cash basis, a shortfall in net oi l and gas revenues would affect the deficit assuming compensating measures are not taken.
Table 3. 2004 Budget Financing (Rp. Trillion)
Revised Latest Budget Estimate Budget
1. Gross financing needs 24.4 26.3 26.3 2. Sources o f financing
Bank financing Privatization IBRA (PPA) asset sales N e t government bond Net foreign loans
Foreign program loans Foreign project loans
24.4 19.2 5 .O 5.0 11.4
19.7 8.5
-16.1
26.3 23.9 5.0 12.9 8.2
18.6 3.1
-23.8
26.2-26.6 23.9 3.5
14.7-15.1 8.2
-24.1 17.8 3.9 - - -
Amortization -44.5 -45.5 -45.8 ~~~~~~ ~~
Source: World Bank staff estimates
Sound management and oil price increases provide opportunities for needed development spending in 2005 The Bank projection for 2005 assumes that, in l ine with public statements, the government increases h e 1 prices and increases the deficit to around 1 percent o f GDP from the current 2005 budget target o f 0.7 percent. Fuel subsidies would then decline to 1.8 percent o f GDP from the current estimate o f 2.5 percent o f GDP in 2004. These resources would be reallocated to regional governments and development spending would rise to 3.7 percent o f GDP, 0.6 percentage points higher than 2004. Gross financing wou ld remain challen ing with financing needs projected at 3.6 percent o f GDP (equivalent to US$11 billion) . The contribution from asset sales by PPA (the asset management agency replacing BRA) and privatization are expected to b e small whi le foreign and domestic debt principal
F
Gross financing needs are the s u m o f budget deficits and debt principal repayments (domestic and extemal).
9
payments are very high. Meeting this financing demand will require an expansion in debt financing which will reach more than 80 percent o f gross financing needs in 2005.
B. MEDIUM-TERM MACROECONOMIC PROSPECTS
Improving the investment climate i s key to accelerating growth. In the past few years, consumers have been the key drivers o f economic growth supported by consumption credit. The Bank expects that with continuing macroeconomic stability and reforms to the investment climate, the investment rate wil l r ise and GDP growth could average 6 percent or more from 2006. Inflation i s expected to fall to 3 percent, built on a credible inflation targeting regime, even allowing for some pass through o f higher fuel prices and the current account to remain i s expected in small surplus (Table 4).
Table 4. Medium-Term Macroeconomic Framework (in percent, unless stated otherwise)
2003 2004 2004 2005 2006 2007 2008 2009 (Act.) (H1
act.) GDP growth 4.5 4.7 4.9 5.4 6.0 6.0 6.0 6.0 olw investment 1.9 8.3 9.0 10.0 11.0 12.0 11.0 11.0
Investment to GDP ratio 17.8 18.3 18.8 20.7 21.9 22.7 23.4 23.9 Consumer Price (average) 6.7 5.8 6.7 6.5 6.0 5.5 4.0 3.0 Budget deficit -1.8 -1.1 -1.0 -0.9 -0.8 -0.6 -0.4 Current account (US$ bln) 7.3 4.5 3.5 2.7 2.2 1.7 1 .o (percent o f GDP) (3.0) (1.8) (1.2) (0.9) (0.7) (0.5) (0.3)
Source: World Bank staffestimates
Recovery should lead to higher growth in taxes. Bank projections indicate that the ratio o f non-oil and gas tax revenues to GDP could increase by 0.3 percentage points o f GDP a year, offsetting a decline in oi l revenues o f approximately 0.15 percent per year. The increase in taxes i s slightly higher than the 0.2 percentage point per year gain between 2000 and 2003, but i s consistent with the President’s strong commitment to tax reform and higher compliance. The projection i s also based on higher economic growth and structural change (increased manufacturing and investment and a turnaround in formal sector employment) that would result in higher tax revenues. Finally, improvements in tax administration, building on ongoing tax office modernization (converting from a tax to a taxpayer orientation) and other tax administration reforms are assumed to contribute to increased revenues (Table 5).
10
Table 5. Indicative Medium-Term Fiscal Framework (2003-2008, percent of GDP)
2003 2004 2005 2006 2008 Revised Budget <--Projection---->
Actual
I. Revenues olw Non-Oil and Gas Tax olw Oil and Gas
11. Expenditures
111. Primary Balance IV. Overall Balance V. Financing (1+2)
olw Development Expenditures
1. Domestic (( 1)+(2)) (1) domestic bank financing (2) domestic non-bank financing
a. Asset sales for budget financing b. Domestic bonds
- New Issues - Amortization
2. Foreign (( 1)+(2)) (1) Gross Disbursement (2) Amortization
16.3% 10.1% 3.9%
18.2% 3.2% 1.5%
-1.8% 1.7% 1.7% 0.5% 1.1% 1.3%
-0.1% 0.5%
-0.7% 0.1% 0.9%
-0.8%
17.2% 10.4% 4.7%
18.4% 3.1% 1.6%
-1.1% 1.1% 2.1% 1 .O% 1.1% 0.8% 0.4% 1.4%
-1.0% -1.0% 0.9%
-1.9%
16.6% 10.3% 4.4%
17.6% 3.7%
-1.0% 1.0% 1.8% 0.0% 1.8% 0.2% 1.6% 2.4%
1.5%
-0.8% -0.8% 0.9%
-1.8%
16.8% 10.6% 4.3%
17.7% 4.6% 1.4 yo
-0.9% 0.9% 1.4% 0.0% 1.4% 0.2% 1.2% 2.1%
-0.9% -0.5% 1.2%
-1.7%
17.1% 11.2% 4.0%
17.7% 6.1%
-0.6% 0.6% 0.6% 0.0% 0.6% 0.2% 0.4% 1.5%
-1.1% -0.1% 1.3%
1.3%
-1.3% . , Gross financing needs (Rp. Trillion) 69.7 95.9 94.1 101.2 108.4 Gross financing needs (US$ billion) 8.1 10.8 10.9 11.3 11.4 Gross financing needs (“h o f GDP) 3.3% 4.1% 3.6% 3.4% 3.0%
Nominal GDP 2,087 2,342 2,629 2,954 3,642 Real GDP Growth Rate 4.5% 4.9% 5.4% 6.0% 6.0% GDP Deflator Growth Rate 5.2% 7.0% 6.5% 6.0% 4.0%
Government Debt to GDP ratio (“h) 59% 53% 47% 43% 37% Oil Prices (ICP, US$/bbl) 29 36 35 35 35
Note: 2003 - Preliminary actual, 2004 - Revised 2004 budget (APBN-P), 2005-2009 staflprojection, 2000 base GDP - Development expenditures are central government development expenditures. Regional governments also contribute to development expenditures, most of which come fvom central governments transfers -A constant real exchange rate is assumed
Fiscal consolidation would continue in the medium term, even as public investment rises. The medium term projections assume that the Government continues to focus on fiscal consolidation with deficits projected at no more than 1 percent o f GDP. This scenario (Table 5) results in a substantial decline in the debt to GDP ratio to 37 percent by 2008 (and 34 percent by 2009, not shown). Central government development spending increases by about three percent age points to 6.1 percent o f GDP by 2008. With the regions estimated to spend another 3 percent o f GDP, total development spending would be back to pre-crisis levels o f approximately 9 percent o f GDP. This increase in development spending i s
11
largely due to the reallocation o f fuel subsidies, a decline in domestic interest rates and increases in non-oil and gas tax revenues. Domestic fuel prices are projected to reach international levels by 2007, with international o i l prices at an assumed US$35 hbl.
Financing remains critical to Secure Indonesia’s budgetary needs. In 2005, gross financing needs (the sum o f budget deficits and debt repayments) amount to 3.6 percent o f GDP (about US$11 billion) and will remain in the 3-4 percent o f GDP (US$ll-12 billion) range until 2009 (Figure 10). For the past few years, debt and non-debt financing (including privatization, BRA asset sales and deposit withdrawals) have been used to meet around half o f financing
Management and Debt Sustainability). From Source: ~ u ~ k Indonesia. MOF. WorZd ~ u n k stufest. 2006-2009, contributions from non-debt financing are expected to be more modest. BRA’S unsold assets were transferred to PPA (asset management unit), but the quality o f remaining assets i s low.
Figure 10. Indonesia’s Gross Financing Profile
USS
12
‘ 4
2
needs. (See Annex 4 for more on Debt 2003 2004 1OM tCM 2W7 200% Z w 1
Debt financing concerns point to the importance of continued, reliable low-cost financing. The scenario assumes that gross external financing (including export credits) will average US$4 bi l l ion per year. This leaves gross domestic bond issuance as the residual at approximately Rp.60 trillion, or approximately US$6.5 bil l ion per year from 2006-2008. However, net issuance o f domestic debt would be much smaller at Rp.25 trill ion (or approximately US$3 billion). At these levels o f borrowing, total debt to GDP falls rapidly.
Factors Affecting Prospects. There are two key factors that could affect this medium-term macroeconomic prospect: (i) a slowdown in global economic growth and trade (due to high o i l prices), and (ii) domestic economic policies. The economic performance o f key trading partners such as the United States, Japan and China are especially important for sustained higher growth. However, Indonesia’s medium-term macroeconomic prospects depend most importantly on Indonesian policy, especially reforms designed to improve the investment climate. Encouragingly, Indonesia’s fiscal stability i s quite robust to different macroeconomic assumptions. For example, the IMF Article IV consultation indicates that: “A severe shock involving a 30 percent depreciation, a 250 basis point r ise in interest rates, and a slowdown in growth to 3 percent would raise the public debt ratio by 10 percentage points of GDP.”
12
111. THE GOVERNMENT’S POLICY AGENDA: FROM CRISIS MANAGEMENT TO SUSTAINABLE DEVELOPMENT
In policy terms, Indonesia i s in transition from a focus on crisis management and stabilization to a focus on sustainable development. After a difficult period o f crisis and post-crisis management, and the broadly successful implementation o f the “White Paper”, Indonesia has a new administration with the opportunity to implement a longer-term development agenda. The new government has articulated i ts vision to increase growth, create jobs and reduce poverty.
A. CRISIS AND POST-CRISIS MANAGEMENT
In the aftermath of the financial crisis, Indonesia’s first priority was restoring macroeconomic stability. The consecutive IMF-supported programs and concurrent World Bank and ADB programs supported fiscal consolidation, restoration o f a viable banking system, corporate restructuring, and, increasingly, legal and governance reforms. The reform progress was uneven and recovery from the crisis was slow, in part due to the political transition. Indonesia was the last East Asian country to graduate from IMF support at the end o f 2003, six years after the onset o f the crisis. Overall, reforms have been largely successful in restoring macroeconomic stability, although weaknesses remain in the banking system and corporate restructuring s t i l l remains unfinished. While governance reforms proceeded more slowly, inroads have been made on legal reform, notably in bankruptcy law, the strategic framework for court reform, and the development o f specific institutions to combat corruption (Le. the Commission to Eradicate Corruption and the Anti-Corruption Court).
At the same time, Indonesia transformed itself from one of the most centralized countries in the world to one of its more decentralized nations. Regions are now responsible for one-third o f all government spending, and half o f the development budget. Most spending on education, health and infrastructure i s local, and the regions employ three- quarters o f the c iv i l service. The rapid shift to a decentralized government was inevitably disruptive in the short term, and many challenges remain in i t s implementation, but was, in general, much smoother than anticipated. Decentralization has created new openings for governance reform, innovation and demonstration effects by shifting control over resources and public services to a level o f government closer to the client. And the introduction o f competitive elections for local executives - and more recently direct elections for local mayors and district heads - enhances the prospects for greater accountability at the local level.
B. “WHITE PAPER” IMPLEMENTATION
The implementation of the Government’s (‘White Paper’’ effectively bridged the “credibility gap’’ that could have emerged at the end of the IMF-supported program in an election year. At the end o f 2003, Indonesia “graduated” from the IMF-supported program and Paris Club rescheduling ended. In order to signal the continuation o f prudent
13
I
macroeconomic policies and economic reforms, the Government presented a comprehensive policy reform agenda (popularly called the White Paper) through end-2004.
Macroeconomic fundamentals improved markedly. Monetary policy remained consistent with macroeconomic conditions and inflation fell, whereas fiscal policy remained prudent, so as to achieve the debt to GDP ratio below 60percent as prescribed by the State Finance Law (Section II). The banking sector was put on firmer footing. The bank restructuring agency IBRA, set up during the crisis, sold-off most major assets and was closed on schedule in February 2004. The remaining assets were handed over to a new Asset Management Agency (PPA) which completed the sale o f the last “IBRA” bank in November 2004. The authorities issued a blueprint for the financial sector safety net and began implementation: a Deposit Insurance Law was passed by Parliament and the Central Bank law was amended to allow for a lender o f last resort. Minority Government shareholdings in two state owned banks - Bank Mandiri and BRI - were also sold to the public. Public financial management was improved. As highlighted in the fiduciary assessment (Section IV and Annex 5), Indonesia has made major headway in the difficult area o f public financial management. Parliament enacted the State Finance Law in 2003, followed by the State Treasury and Audit Laws in 2004. The reorganization o f the Ministry o f Finance was launched in September 2004, and wil l be completed by January 2005, to provide the required institutional basis for these reforms. The foundations for a better judicial system were established. Management o f the entire judicial system was shifted from the Ministry Justice to the Supreme Court according to a “one roof ’ model. The Supreme Court, in close collaboration with civil society, designed an impressive “blueprint” to guide reforms in all major aspects o f the court system and established an office to implement the blueprints and coordinate donor assistance. Specialized courts were set up to handle commercial cases and corruption cases. After a long delay, an Anti-corruption Commission was set up with the appointment o f five commissioners. The Commission has sweeping powers to investigate and prosecute corruption allegations and to undertake preventive and community outreach measures to tackle the roots o f corruption.
Despite significant progress in implementing the White Paper policy actions, the investment climate remains weak. Overall investment remains below 20 percent o f GDP and i s only recovering slowly (Section 11). Some o f the policy initiatives fe l l short o f the target, including the high level investment committee which had a minimal impact. Other developments, included some protectionist measures, (a ban on rice imports, an export ban on rattan), seemingly erratic and allegedly biased court decisions in a series o f high profile cases, and continuing discussions about merging state banks, all hampered investor confidence exacerbated by the substantial uncertainty associated with Indonesia’s prolonged elections and terrorism risks.
14
c. LOOKING FORWARD: AGENDA, OPPORTUNITY AND CHALLENGES OF THE NEW GOVERNMENT
The new administration has begun to articulate its vision and policy direction. In h is inaugural speech on October 20,2004, the new President Dr. Susilo Bambang Yudhoyono articulated his vision to reduce poverty. H e emphasized that “...the greatest challenge is to free our people from poverty, ignorance, backwardness, and all problems that prevent the growth of our people‘s abilities. ... the challenge of our era is to consolidate our democracy and accomplish our reform agenda.. . ”. More specifically, he stressed that h i s administration would adopt policies that would attract investment and that he would personally lead the anticorruption effort. On October 28, the new Cabinet was presented a “100-day plan”, a process that should begin to implement the vision outlined in the inaugural speech. This “100- day plan” i s organized along the following three broad objectives: (i) Creating a safe and peaceful Indonesia (ii) Creating a just and democratic Indonesia, and (iii) Creating a prosperous Indonesia. Many o f the actions o f the 100-day plan follow on fi-om the “White Paper”, while others emphasize new areas, such as resolving the conflicts in Aceh and Papua (Table 5).
Table 5: Measures from the “100-day plan”
Objectives Actions ....................................................................................................................................................... ............................ Expedite resolutio a, prevent
Creating a safe and peaceful Indonesia infrastructure)
escalation in Poso, Maluku, and North Maluku (e.g. rehabilitate
Increase measures to control illegal logging and fishing Provide full support for the operationalization o f the Commission and AntLConuption Court in terms o f authority, personnel, and
Accelerate the prosecution o f selected high profile corruption cases Create an independent oversight body and advisory staff to spur reform o f the Attorney General’s Office Improve regulations related to recruitment, wages, lay-offs and separation
Secure the 2004 budget - including intensification o f tax collection and divest remaining minority shareholdings in ex -BRA banks Review 2005 budget - while ensuring continued trend decline in the fiscal
Create a more business friendly tax system (accelerate depreciation schedule, investment allowances, extend loss carry-forward, reduce dividend
Complete a poverty reduction strategy Increase access to education (books scholarships, teacher competence) and health (increase staffing at Puskemas, Medical practitioners law, free service for poor at Puskesmas)
................................................................................................................................................................................................................................................................�� ..................................
Creating a just and finance democratic Indonesia
..................................................................................................................................................................................
Creating a prosperous deficit Indonesia
tax)
In his most recent address to the nation on November 17”, the President laid out a broad agenda in economics, people’s welfare, and justice (Annex 3). H e highlighted the efforts currently underway including; the formulation o f a Medium Term Plan by end-January 2005; establishing the ground rules for members o f the Government including a “contract o f accountability”; addressing pressing issues o f which he mentioned the burden o f fuel
15
subsidies explicitly; and an intensive program o f outreach to other state institutions especially Parliament.
In economics, the emphasis would be on improving investment and exports. H e focused on obstacles created by problems in law enforcement, corruption, policy uncertainty, infrastructure and security, among others. H e signaled support for a more active international role in trade negotiations, for increased rural expenditures including support for research and development and biotechnology. H e committed to energy and infrastructure strategies designed to address pressing problems in these areas.
In the area of people’s welfare the focus would be on education, health, housing and poverty. In education he emphasized improving quality and access, including for religious based schools. In health he reiterated the importance o f local health centers (puskesmas), affordability for the poor, eliminating TB and more attention on HIV/AIDS. Housing would be a priority and a new ministry would be created to increase the amount o f housing available. The Poverty Eradication Committee would be revitalized and poverty reduction goals established. Public services would be made more efficient, illegal fees abolished, and the disabled and elderly would get better services.
The President has made the fight against corruption one of his main priorities and emphasized collaboration with the Anti-Corruption Committee, including issuing a Presidential Instruction in December. H e has stressed that progress in this area this will be a yardstick by which the success o f h i s Administration will be measured. H i s cabinet appointments in the legal sector have reputations o f high integrity and strong reformist credentials. The new Attorney General, in particular, has taken a high profile role in the early days o f the Administration, proposing institutional changes to enhance oversight in h i s office and setting ambitious targets for the prosecution o f ongoing corruption cases. Among the earliest moves o f the new Government has been the requirement that all cabinet ministers (and further Echelon level I and I1 bureaucrats in many ministries) s ign a contract committing themselves to clear performance targets and to maintaining high standards o f integrity. All ministers were also compelled to submit and publish their personal asset declarations with the Anti-Corruption Commission. The President banned all government officials from the common practice o f accepting “parcels” (i.e. welcome or holiday gifts) from the public. New procedures have already been put into place to suspend government officials from their posts under investigation for corruption allegations. These measures, along with strong public statements by the President and key members o f the new Cabinet, have been designed to send a clear signal to the public that this administration marks a change o f tone with regards to corrupt practices widely thought to be deeply ingrained in the Indonesian public sector. More detailed measures to implement this anti-corruption drive have been promised in a Presidential Instruction on Combating Corruption to be issued in early December.
The electorate and investors will also be closely watching government policies in the areas of (i) trade, (ii) the financial sector, (iii) labor, and (iv) decentralization. All o f these are critical to improve the investment climate and to ensure continued macro stability.
16
Trade. Indonesia i s a very open economy, with an average tariff o f 7.3 percent. However, recent protectionist measures have hurt Indonesia’s reputation as an open economy. Indonesia needs an open trade regime to hold down costs and attract new foreign investment, particularly in the export sectors. The new administration seems to be taking a more progressive approach. Early announcements have included a decision to establish a uniform five percent tariff by 2010, and an immediate review o f all non- tariff import barriers and export restrictions.
Financial sector. Despite good progress in financial sector reform since the crisis, state owned banks continue to play a large role in Indonesia’s bank-dominated financial sector. The two largest banks in the country are state-owned and continue to pose risks to the overall financial system due to poor governance and weak internal controls. Recent proposals to assist SMEs by permitting state banks to restructure existing SME non-performing loans need carefil implementation to ensure that governance issues and moral hazard do not weaken the health o f the banks and undermine the overall environment for SME lending. The new administration plans to take a more proactive approach to developing the non-bank financial institutions in Indonesia - as articulated in i ts LDP. Sound measures in this area would help diversify the financial sector as well as provide an avenue to mobilize long-term domestic resources for development.
Labor. The Government has also addressed some o f the critical labor issues in i ts First 100 Days Agenda. Most o f the short-term actions within the next three months focus on providing better protection for Indonesia’s migrant workers. But some important actions to ensure a more flexible labor legislation are listed, among them the improvement o f regulations concerning recruitment, wage and dismissal procedures. If enacted, improved measures in these areas could help reduce rigidities in the employment laws, particularly with regard to minimum wage negotiations and severance pay allowances.
Decentralization. In October 2004, the parliament amended the two decentralization laws 22 and 25, which has provided some clarification, but some more changes are still needed before decentralization can work effectively. First, the functional responsibilities within sectors across levels o f governments need to be clarified. The revised law 22 establishes criteria for the decentralization o f responsibilities across levels o f government. The next steps are implementing regulations to operationalize the service assignment criteria. Second, several provisions in the new decentralization laws suggest that sub- national government borrowing i s likely to remain restricted to that from the central government, at least in the near-term. This suggests that the problems with central lending, in particular on-lending, need to be addressed in forthcoming new and revised government regulations.
17
IV. WORLD BANK SUPPORT FOR THE GOVERNMENT’S STRATEGY
The DPL i s a core part of the Bank’s CAS (2004-7)’ discussed by the Board in November 2003. The CAS highlighted the types o f reforms and policy improvements needed to reach the enhanced base case and high case scenarios. All o f these indicative measures were drawn from the Government’s own economic policy reform package (“White Paper”). The measures under the enhanced base case, under which this first DPL was programmed, represent a subset o f key White Paper measures.
The Bank’s assessment i s that sufficient progress has been made for Indonesia to become eligible for a DPL now. Progress in implementing the White Paper has been discussed above (Section 111). Progress in implementing measures corresponding to the enhanced base case i s outlined in Table 6. While not all White Paper targets have been achieved, and the impact o f many policy measures i s yet to be felt, the Government has made significant progress, particularly in the areas of macroeconomic stabilization and public financial management.
In addition to enhanced base case criteria, the Government can claim several additional significant achievements. Domestic government securities are being issued in monthly auctions in a regular and transparent manner. The 2005 budget i s now based on GFS- classification as mandated by the State Finance Law. Important reforms to decentralization laws have been enacted. The Bankruptcy law has been amended - and the permission o f the Minister o f Finance i s now required in the event o f a bankruptcy case against an insurance company. This was necessitated by a series o f well-publicized law suits exploiting a provision that allowed a creditor (policy holder) to sue under the previous interpretation o f the bankruptcy law.
18
Table 6. Progress in Achieving the CAS Enhanced Base Case
Result Status ....................................................................................................................................................... ........................................................................................................................ Outcome Area Reforms area Macroeconomic Reduction of government e Government debt to GDP ratio: 59% (end-2003) - stability and debt Achieved the 60% target in the State Finance creditworthy- Law ness Accessing intemational 0 Issued U S $ l bi l l ion global bond in March 2004
Public f i i n c i a l Revised Decree on public 0
capital markets .................................................................................................................................. .........................................................................................
management procurement State Treasury Law and 0
State Audit Law
Implementing regulations e o f the State Finance Law
e
Organizational reforms in 0
the Ministry o f Finance and establishment o f a Treasury Single Account
Operationalizing the e National Procurement Policy Office (”PO)
e
Presidential decree No.80/2003 issued in Nov. 2003 State Treasury Law enacted in Dec 2003 (N0.1/2004) State Au&t Law was approved (UU 15/2004) Three implementing regulations (N0.20,21, and 23) have been issued; two presidential decrees have been drafted (accounting standards, performance budgeting) Functional Reorganization o f MOF; establishment o f separate Treasury department and Debt Management Unit; f i rs t steps taken to automate treasury payment system and set up a Treasury Single Account by 2006 Presidential Decree on Government Procurement issued in September 2003 (Keppres 80/2003.
.\I
J
J
J J
J
......................................
J
J Expected early 2005
Set up o f NPPO in progress ................................................................................................................................................................................................................................................................�� Investment Establishing independent 0 Government regulation No.53/2003 climate regulator in the electricity
market
Effective functioning o f 0
the Investment Team
Progress in establishmg a 0
financial sector safety net
0
Progress in tax 0
administration reforms
Government has selected members o f the Expected supervisory authority (BAPETAL) and they early 2005 await fit and proper test at Parliament.
No. 87/2003) Improvement Effective functioning not yet observed
Parliament July 2004. O K (financial service authority) Law submitted to Parliament. Draft tax and tax administration law submitted to Cabinet Office. Large Taxpayers Office
Team established (Presidential decree J
LPS (deposit insurance) Law agreed by J
J
necessary
successfbl and expansion underway. Source: World Bank staffestimates, CAS 2004- 7 (Report N0.27108-IND)
Once Indonesia reaches the “High” case - as laid out in the CAS - the Bank could provide additional DPLs. Reaching the “High” case would require continuation o f reforms in the core areas supported by the proposed DPL as well as further progress in justice sector reform, decentralization and improved service delivery to the poor (Table 7). It i s expected that future DPLs would be synchronized with the Government’s budget cycle.
19
Table 7. Links between the DPL program and CAS policy framework
C
A
S
E
Decentralization Law 25 has been revised to increase equity in the intergovenunental system
d Justice sector and Established Anti-Corruption
court legal reform Commission and Anti-Corruption
Revisions to Law 34 to reduce nuisance and economically -1 taxes and charges Improving justice sector governance through effective Anti-Comption Commission and Court
CAS Pillar III: Making Services Work for the Poor
Service delivery
Poverty reduction strategy
d Switch f rom deconcentrated spending to increased conditional grants (DAKs) mandated under the revised law 25
d New draft PRSP presented in November 2004
Law needs to be implemented to improve service delivery to the poor by increasing transfers to support poor regions Improved poverty orientation o f development plans and public spending
&strong performance; Jadequate pe rformance;
PRSP preparations in Indonesia are well-advanced, involving government agencies, civil society and a broad range of stakeholders. A final draft i s expected by the end o f 2004, which would also coincide with the finalization o f the government’s medium- term plan (PJM). Whi le the respective roles o f the medium-tenn plan and the PRSP are s t i l l under discussion, the Bank has recommended stronger l inks or even a consolidation o f these important strategic documents.
The proposed DPL draws on the Bank’s extensive analytic work over many years. The Bank has been producing annual Development Policy Reviews in conjunction with the CGI meetings as well as semi-annual economic updates and bi-annual Public Expenditure Reviews. The Bank has also produced flagship reports on decentralization, combating corruption and trade, has just recently completed a set o f 18 policy briefs for the
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incoming government, and i s finalizing an investment climate assessment. Further details of analytical work supporting the DPL are provided in Section V.
The proposed loan also has strong synergies with other Bank operations. In particular, i t has close l inks to the Government Financial Management and Revenue Administration Program (GFMRAP) - which will also be presented for Board consideration in December 2004. GFMRAF’ embodies many o f the governance and fiduciary reforms at the Ministry o f Finance and measures proposed by the Government in the LDP. It also provides the technical assistance needed to implement the ambitious public finance management reform agenda. (See section V and GFMRAP documentation for further details).
During the preparation of this loan, the Bank has worked closely with the IMF, the Japanese Government, and the ADB. The IMF participated closely throughout the loan preparation process and provided important inputs into the macroeconomic analysis and the fiduciary assessment. The Bank will participate in and benefit from the I M F ’ s post-program monitoring missions on an ongoing basis. The Bank has also worked closely with the Government o f Japan - which i s considering providing a substantial amount o f co-financing to Indonesia - during loan preparation. The Bank and the Japanese Government held joint discussions with the Indonesian authorities and undertook joint appraisal o f the DPL. The Bank and the ADB have been working on burden-sharing arrangements with regard to support for the new administration. The ADB - which has three outstanding program loans with tranche disbursements that have been stalled for the past year - i s now likely to disburse about $125 mill ion this year.
The DPL design has benefited from inputs from civil society and other partners. The Bank’s CAS - where the framework for the proposed DPL was f irst presented - was widely discussed in several forums. Nearly 400 civ i l society representatives provided inputs - including for the benchmarks for the proposed DPL. The CAS document i s publicly available, has been widely disseminated and discussed. In addition, as part o f the preparation o f the DPL the Bank, together with an Indonesian economic research organization, LPEM, co-sponsored a Public Finance Day on October 21, 2004. This forum brought together experts, key policy makers, bilateral and international organizations to discuss public finance challenges o f the new administration. Participants emphasized that program loans by the international community can play a positive role in supporting the new administration’s reform program.
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V. THE DEVELOPMENT POLICY LOAN PROGRAM
The Government has requested the Bank’s support for implementing key elements of i t s overall program. The Letter o f Development Policy (LDP, Annex 1) outlines the Government’s commitments in the areas o f macroeconomic stability, investment climate, public financial management, decentralization, judicial and legal reform and anti- corruption, and public service delivery.
A. DEVELOPMENT POLICY LOAN FRAMEWORK AND PROGRAM
In response to the Government’s request, a programmatic approach to development policy lending has been designed. The proposed DPL i s part o f a series o f operations in support o f Indonesia’s medium-term program o f policy and institutional actions to advance substantially i t s growth and poverty reduction objectives (Figure 11). Over the next three years, the expected results o f this programmatic approach would include fiscal consolidation, an improved investment climate, greater government accountability, and improved services for the poor.
Figure 11: Overview of the Long-Term Programmatic Approach
DPL 1: Sustaining Reform DPL 2 and 3: Implementing
reduction program Momentum a sustainable poverty
Government Program: White Paper Government Program: 100 Day Program Medium term plan with
Focus Macroeconomic stability Maintain momentum in core
Investment climate Progress in addressing key Public financial risks identified in DPLl management and anti - corruption delivery to poor, judicial
and creditworthiness
CAS Enhanced base case December 2004
B. THE FIRST DEVELOPMENT POLICY LOAN
Objectives and Mediu Term Outcomes
Reduced debt burdl continued international capital market access Reduced transactio1 costs for businesses strengthened finant sector Increased governmt accountability and fiscal transparency Better services fort poor
The first operation in the series wil l focus on actions completed prior to Board presentation. The core reform areas supported by the proposed loan are macroeconomic stability, improvements in the investment climate, and public financial management & anti- corruption. Continuing the momentum o f reform in DPLl-core areas as well as progress in justice sector reform and public service delivery would move Indonesia into the high case o f
22
the CAS (Table 7). The results framework for the DPL program (Annex 2) spells out indicative benchmarks which would signal progress towards the medium-term results.
DPL CORE AREA I: SUPPORTING MACROECONOMIC STABILITYAND CREDITWORTHINESS
Government program and objectives. The Government’s main objectives are to reduce the debt burden and macroeconomic vulnerability as well as improve expenditure allocation including poorly targeted subsidies. In addition to careful attention to the deficit level, fiscal stability requires greater efforts at revenue mobilization and curbing inefficient spending.
Prior actions for DPL 1. The following set o f measures were completed prior to
Reduction o f government debt to GDP (2000 base) to below 60 percent (December 2003) was a major achievement and contributed significantly to the upgrade o f Indonesia’s credit ratings (see Chapter I1 and Annex 4); Issuance o f a U S $ 1 bil l ion international bond: In March 2004, Indonesia issued an international bond which was oversubscribed and at a lower spread than other countries o f the region that issued international bonds during the same period; Divestment o f maiority shares in al l BRA banks: This process, completed in November 2004, was an important step in overcoming the legacy o f the financial crisis.
Board presentation o f D P L l : 0
Next steps in the reform process. Over the coming months, the Government’s program in this area i s expected to include progress in reducing subsidies to the non-poor and developing and implementing a debt management strategy.
Expected Results of the DPL Program. By the end o f 2007, the DPL supported program i s expected to further improve Indonesia’s macroeconomic fundamentals. This would include a reduction o f public debt to GDP to below 40 percent (2000 base) as well as a re-profiling o f the debt, continued fiscal discipline supported by mobilization o f additional non-oil and gas revenues o f between 0.6 percent and 0.9 percent o f GDP. These improved macroeconomic fimdamentals would be reflected in an upgrade o f Indonesia’s credit rating to B+ or equivalent.
Analytic Work and Capacity Building support being provided by the Bank and other donors i s highlighted in Table 8.
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Table 8. DPL support for macroeconomic stability and creditworthiness
Prior Actions Next Steps in Reform Rationale for ESW / Technical (before DPL 1) Process Supporting Actions Assistance .................................................................. ........................... ...............................................................................................................................................
Reduction o f Continue fiscal stabilization Reduce fiscal a l ic Expenditure government debt to while addressing macroeconomic risk GDP to below 60 percent (Dec 2003) spending shortfalls
infrastructure and other Reviews, IPEA
Reviews
Crisis
Development Policy
Averting an Infrastructure ................................................................................................................................................................ ................................................ ” ..........................................................................
Issuance o f Developing and implementing orthiness Debt management capacity international bond ategy and diversify financing buildmg ........ Divestment o f majo ctor Reduce risks and restore Diagnostic on
........................................................... .......................................................................................................................................................
shares in al l IBRA Strengthening and private sector incentives of gate-Owned Banks in banks diversification Indonesia”
DPL CORE AREA 11: IMPROPTNG THE INVESTMENT CLIMATE
Government program and objectives. The Government’s ma in objectives are to reduce transaction costs for business, strengthen the financial sector, and encourage investment in infrastructure. In order to achieve this, reforms to improve services at tax and customs will b e continued. Decentralization and regional government fees and regulations have been a special problem for the investment climate and the Government i s committed to amending the relevant l aw to reduce nuisance and economically harmfbl taxes and charges. Working together with the private sector, the Government also plans to increase investments in infrastructure, and to develop an effective framework to support the development o f SMEs. The Government i s also committed to continued financial sector reforms - especially in the areas o f developing non-bank financial institutions.
Prior Actions for DPL 1. The fol lowing set o f measures to improve the investment climate were completed pr ior to Board presentation o f DPLl :
Deposit insurance law was passed and amendment issued to establish Bank Indonesia as lender o f last resort wh ich i s important progress towards establishing a financial sector safety net. A modern Large Tax pavers Off ice was further expanded in 2004 satisfying those businesses covered under the LTO and higher revenues.
Next steps in the reform process. Over the coming months, the Government’s program in this area i s expected to include regional tax reforms, further progress in the establishment o f a financial sector safety net, development o f a strategy to strengthen non- bank financial institutions, development o f a medium-term plan for infrastructure development that encourages public-private partnerships, and reforms aimed at developing SMEs.
Expected Results of the DPL Program. By the end o f 2007, the DPL supported program i s expected to make Indonesia a more attractive place to invest. This improvement in the investment climate wou ld b e reflected in an increase o f the investment rate by 3-5 percent
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o f GDP (to about 25 percent o f GDP), further strengthening o f the financial sector through reduced role o f state owned banks and an increase in the share o f financial assets at NBFIs.
Analytic Work and Capacity Building support being provided by the Bank and other donors i s highlighted in Table 9.
Table 9. DPL support for Improving the investment climate
Prior Actions Next Steps in Reform Rationale for Supporting ESW / Technical Process Actions Assistance .............. ..ibefore.DE! .. 11 ..................................................................... ............................................................
Progress in establishing Continue establishing Blanket guarantee needs to be Unlocking a financial sector safety financial safety net phased out to reduce moral Indonesia’s net (LPS (24/04), MoUs Domestic Financial hazard and NBFIs need to be (BI, MOF) Strengthen NBFIs strengthened to diversify Resources for
Development financing and extend maturity Financial Sector Innovation Facility
utch Trust Fund) Progress in tax Expand modem tax offices Increase in revenues and 0 Trade Diagnostics
...................................................
administration (e.g. revise Law 34 to move from Large Tax Payers negative to positive l i s t and Office) reduce nuisance and harmful
taxes and charges Develop a medium term plan for infrastructure that encourages private public partnership
Develop a medium term action plan and framework to coordinate the development o f SMEs
improvement o f the overall framework for taxation and tax administration
Decentralizing Indonesia
Shortfalls in infrastructure 0 Avertingan reduce growth potential but Infrastructure public resources are limited
SMEs account for the vast 0 Investment Climate
Crisis : A Framework for Policy and Action
majority o f employment in Assessment Indonesia and have high growth Investment potential, yet they operate in an uncertain and difficult business environment. Trust Fund)
Rapid Response Facility (Dutch
DPL CORE AREA 111: IMPROMNG PUBLIC FINANCIAL MANAGEMENTAND ANTI -CORRUPTION
Government program and objectives. The Government’s main objective i s to make a decisive impact on the extent o f corruption in Indonesia through measures to increase accountability and transparency in government financial management and public procurement and to reform the legal and judicial sector to enhance legal certainty and impartiality and ensure a more effective deterrent against corruption.
The Government’s main objectives are to increase accountability and transparency in government financial management and public procurement and to strengthen the institutional framework for addressing corruption.
Prior Actions for DPL 1. The following set o f measures were completed prior to Board presentation o f DPLl :
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0 State Treasurv and Audit Laws were passed and Implementing Regulations for State Finance Law issued. These laws contribute to modernizing the budget execution and resource management, and strengthening the state audit institutions. Organizational reforms in the Ministn, o f Finance, including the first steps toward establishing a Treasury Single Account were launched, laying the basis for a more efficient budget process and a reduction in corruption. A Presidential Decree on public procurement was issued that paved the way for streamlining public procurement through the establishment o f a National Procurement Policy Office and bringing Indonesia up to international procurement standards The Special Audit proDam for State Owned Enterprises has been continued and the results made public enhancing internal governance structures in enterprises highly susceptible to corruption. The Anti-Corruption Commission and Anti-Corruption Court were established and their members selected through an open and transparent recruitment process. Adequate state resources were allocated to these institutions in the state budget.
0
0
Next steps in the reform process. The Government i s committed to a substantial reform agenda in these areas including issuing the remaining implementing regulations for State Finance Law and Treasury Law. The Treasury Single Account within the new Treasury DG will begin to phase in according to a schedule worked out with the assistance o f the World Bank GFMRAP project. Oversight o f taxes and customs will be improved through increased support for the Inspector General function. As discussed above, the President has made fighting corruption one o f the highest priorities o f the Government. Measures outlined in the 1 00-day plan include reform the Attorney General’s Office, accelerated prosecution o f corruption cases, strengthened capacity o f the Anti-Corruption Commission and Anti- Corruption Court, and ratification o f a new Presidential Instruction on anti-corruption measures.
Expected Results of the DPL Program. By the end o f 2007, the DPL program i s expected to contribute to a more efficient, transparent and accountable management o f public resources. These improvements in public financial management would be reflected in the consolidation o f all core government cash operations into a Treasury Single Account, a 100 percent compliance o f government financial statements with new accounting standards, and a positive trend in investigations with successful outcomes by the Inspector General in MoF. Lower corruption indices, improvements in corruption spot checks, higher numbers o f corruption prosecutions, and improved investor and public perceptions o f the extent o f the problem would be indicators o f success in anti-corruption efforts. A key component o f th is progress will also be evidence o f substantial reform in the legal and judicial sector.
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Analytic Work and Capacity Building support being provided by the Bank and other donors i s highlighted in Table 10.
Table 10. DPL support for Improving public financial management and anti-corruption
Prior Actions Next Steps in Reform Rationale for supporting ESW / Technical Assistance ................................................. ................... @efore.DPL. ........ Process
Implementing regulations Budgeting in an MTEF for State Finance, framework, consolidate Treasury and Audit Laws accounts at the M o F as issued part o f Treasury Single
Account system and improve audit system .....................................................................................................................................................................
Organizational reform at Modemization strategies M o F at tax and customs, IT
programsand IG investigation unit operational
Implementing regulations are required to this loan operationalize treasury 0 GFMRAP support system, budgeting changes and audit rules
Fiduciary assessment for
............................................................................................................................................................................ Organizational change i s required to functionally align min is t ry with new roles and strengthen checks and balances
GFMRAP support Fiduciary assessment for th is loan
Presidential decree on NPPO established and Revisions required to 0 CPAR Procurement issued operational improve governance and
efficiency o f government services ................................................................................................................................................................................................................................................................#� ” ............................................
Special audit o f SOEs Continue audit procedures Improved govemance and Public Expenditure continued efficiency Reviews, IPEA
Establishment o f the Ensure adequate financial Anti-Corruption and personnel resources Commission and Anti- and effective capacity- Corruption Court building o f these
institutions. Extend reform process to Attorney General’s Office. Support implementation o f the blueprints for court reform.
Critical to strengthen the deterrent against Indonesia corruption.
Combating Corruption in
ASEM Grant to Support the Anti-Corruption Commission Netherlands-Indonesia Trust Fund for Legal and Judicial Reform Support to the Partnership for Governance Reform
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VI. OPERATION IMPLEMENTATION
A. LESSONS LEARNED FROM PAST ADJUSTMENT LENDING
Bank experience with traditional adjustment lending to Indonesia following the crisis i s mixed. The two most recent adjustment loans - the Social Safety Net Adjustment Loan (SSNAL) and the Water Sector Adjustment Loan (WATSAL) - have faced questions regarding the quality o f loan design and implementation. Despite the SSNAL’s significant achievements, i t was viewed as being too complex and detailed - especially because it attempted to achieve institutional change through conditionality. The SSNAL was closed in December 2000 without disbursing the second tranche o f US$300 million. The WATSAL shows a mixed record o f achievements and serious backtracking on reforms. Approved in May 1999, US$150 mill ion was disbursed in two tranches. However, the remaining third tranche o f US$l50 mill ion was not disbursed, as the Government backtracked on a reform to empower water users, particularly farmers. The Bank and the Government have agreed to close the loan.
The main lesson to be learned from the Bank’s past experience i s that classic ex- ante conditionality i s not very effective in Indonesia. This is broadly in l ine with the ADB’s experience also. Whi le conditions under past sector adjustment loans may have been effective and important in addressing sectoral challenges, their impact on the economy as a whole has not necessarily been significant. The DPL takes this into account.
In addition, the DPL also benefits from key messages from OED’s evaluations of adjustment loans Bank-wide in the 1990s. The main lessons from th is review are that multi-tranching tends to contribute to slow implementation, particularly if the operation becomes overly complex as a result. Traditional ex-ante conditionality based on promises o f future actions risks weakening reform ownership. Conditionality becomes unrealistic if institutional capacity does not correspond to technical demands o f the loan. In addition, rapidly changing policy environments are difficult to anticipate in loan design.
B. DESIGN OF THE PROPOSED DPL
The design of the DPL takes into account lessons learned from past adjustment lending as well as the latest thinking on development policy lending’. The loan also draws heavily on the experience gained in Brazil, where the first programmatic loan was prepared during a transition o f governments and was aimed at consolidating reforms o f one administration while obtaining commitment from the next administration to continue the reform process3.
* World Bank 2004. Programmatic Adjustment Lending Retrospective, and World Bank 2004: Good Practice Note: Designing Development Policy Operations (OPCS website).
First Programmatic Human Development Sector Reform Loan. Report No. 25351-BR, January 2003. 3
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The underlying principles of this Indonesia DPL operation are the following: Upfront action instead o f ex-ante conditionalitv. T h i s loan i s based on actual performance rather than promises, as i t recognizes the successful implementation of the “White Paper”. Building on these accomplishments, the new government has demonstrated i ts commitment to continue and consolidate the reform process. Support o f reform program - based on the Government’s track record. The DPL and the programmatic approach will support a broad government reform program and will predicate future Bank support on progress against a set o f anticipated prior actions. Given the medium-term nature o f the reform process, progress may not always be even across all areas. As long as the overall reform program remains on track, slow progress in a specific area may be compensated with actions in others.
(iii) Results-orientation and streamlined conditions. Prior actions for the DPL are focused on a small set o f actions that are critical for achieving medium-term results. Similarly, a limited set o f triggers for subsequent operations provide an indicative basis for the Bank’s decision to proceed with lending in support o f key results.
(iv) Aligning program loans with budnetarv cvcle. Over time, the proposed programmatic approach i s designed to be closely aligned with the Government’s annual budget cycle, to become a predictable source o f financing for the Government. Working in partnership. The Government o f Japan i s likely to provide substantial co- financing in the proposed DPL and the Bank i s working to identify other partners in follow-on operations.
(i)
(ii)
(v)
C. IMPLEMENTATION ARRANGEMENTS
As all the actions supported by the proposed loan have been completed prior to Board presentation, implementation arrangements are only relevant within the context of the overall programmatic framework of support. The Bank and the Government have agreed to maintain a close and continuing dialog on future policy actions. The signing o f the Letter o f Development Policy jointly by the Minister o f Finance and the Coordinating Minister o f Economic Affairs i s a clear indication that the Government considers implementation o f the future reform agenda a joint responsibility across economic ministries. The Government has also set up a coordinating committee under the leadership o f the Ministry o f Finance and BAPPENAS. It comprises all the implementing agencies responsible for carrying out the future program - and this committee will meet bi-monthly. The Bank will coordinate with this committee on an ongoing basis and will also leverage i ts other activities in Indonesia in support o f the reform agenda.
D. MONITORING AND EVALUATION
The design of the DPL recognizes the criticality of monitoring and evaluation as well as stakeholder participation for the operation’s success4. The Government and the Bank will take advantage o f several important data sources to assess progress for the DPLs.
World Bank 2004. Programmatic Adjustment Lending Retrospective, and World Bank 2004: Good Practice Note: Designing Development Policy Operations (OPCS website).
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These include: (i) post program monitoring missions o f the IMF to assess the macroeconomic framework, (ii) central and regional government budget monitoring; (iii) Bureau o f statistics (BPS) reports, (iv) Investment climate surveys and assessments; (v) financial sector reports and updates; (vi) Ministry o f Finance reports (from GFMRAP and other MoF periodic reports), (vii) reviews and analyses o f laws and implementing regulations from the Bank and other stakeholders, (viii) financial audits, and (ix) reports from advisory and working groups. Current baseline information i s already available regarding the various actions and triggers. I t i s expected that the Ministry o f Finance wil l establish a detailed time schedule and implementation plan for meeting the high case scenario and indicative triggers for subsequent operations.
The Bank will also consult with an array of stakeholders during the formulation, monitoring and evaluation of DPLs on an ongoing basis. The public finance expert forum - PEA - i s an example o f a vehicle to ensure continued engagement by multiple stakeholders in monitoring DPL performance. Looking forward, PEA plans to sponsor workshops, roundtable discussions, and working groups to discuss progress on the specific reform benchmarks and advise on progress, impact, implementation capacity and timing. The DPL provides an opportunity to engage key experts and stakeholders in discussing issues o f public finance and economic governance and contributing to more informed public decision-making.
E. LOAN ADMINISTRATION
Borrower and Credit Amount. The Borrower i s the Republic o f Indonesia and this operation is a single-tranche loan o f U S $ 300 million. The loan proceeds would be made available to the Borrower upon loan effectiveness, as all policy actions supported by the loan have been completed prior to Board presentation.
Disbursement and Reporting Arrangements. The loan will be disbursed in a single- tranche and will follow the standard disbursement procedures for Development Policy Lending. The loan amount will be disbursed into a foreign currency account o f the Borrower at Bank Indonesia that forms part o f Indonesia’s official foreign exchange reserves. The equivalent Rupiah amount will immediately be credited to the general treasury account o f the Borrower that i s used to finance budget expenditures- as the loan i s intended to be used to support the general government budget5. The Borrower would provide to the Bank a confirmation that this has been done, and any other relevant information relating to these issues that the Bank may reasonably request. Disbursement will not be linked to any specific purchases, except that the Borrower i s required to comply with the standard negative l i s t o f excluded items that may not be financed with Bank loan proceeds. Ongoing discussions with the Government on the overall reform program being supported by the proposed series o f DPLs will form the basis for reporting on substantive policy issues.
As discussed earlier and in more detail in Section VI1 and Annex 5, the Bank i s satisfied that Indonesia h a s made satisfactory progress on i t s fiduciary environment for the proposed operation.
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F. POVERTY AND SOCIAL IMPACT ANALYSIS
Most of the specific policy measures that are supported by this loan are not expected to have any significant distributional impact that either warrant or are amenable to specific PSIA. Bank PSIA also confirmed that regained macroeconomic stability - one o f the three core areas o f this DPL - has contributed substantially to poverty reduction after 2000 through price stability and growth. The Bank, in partnership with the Government and other stakeholders, has been leading poverty and social impact analysis in numerous key policy areas, including trade policy, local government policies, and subsidy policies. The Bank and i ts partners will continue to carry out PSIA o f key policy areas, which will feed into the dialogue on the new Government’s medium t e r m plans, including i ts PRSP. These analyses would also underpin follow-on loans, particularly if they entail the reallocation o f public expenditures, the reduction o f transaction costs for business and the reassignment o f regional taxes.
G. ENVIRONMENTAL ASPECTS
The proposed loan wil l not support specific measures that are likely to have significant effects on the environment. W h i l e the loan supports sustainable economic growth, the environmental sustainability o f the growth depends on the effectiveness o f Indonesia’s framework for managing economic expansion and transformation o f the economy. In this context, key aspects are sound environmental policy as well as the institutional framework and capacity to safeguard and sustainably manage environmental resources and impacts. The Bank‘s ongoing and proposed activities support environmental governance, and forest law enforcement as well as decentralization and reform o f AMDAL. The Bank i s helping to assess and strengthen the institutional and policy framework for environmental impact review process in provinces and districts, and support governments in improving and strengthen their ability to use environmental impact assessment effectively.
H. BENEFITS
The proposed DPL i s a means to endorse sound policy. The largely successful implementation o f the White Paper has contributed to reducing macroeconomic uncertainty - a key concern at the end o f the IMF-supported program in 2003. The White Paper made significant progress in key areas such as macro stability, investment climate, and public financial management. The proposed DPL recognizes these past reforms.
The proposed DPL i s also vehicle for ongoing and future policy dialog. The proposed DPL also provides a mechanism for early and intensive engagement with the Government on forward looking policy actions to consolidate and deepen these reforms. The new administration’s public statements thus far as well as the Letter o f Development Policy (LDP) indicate i ts commitments on a range o f issues. Within the context o f the programmatic framework for future Bank support, the level o f Bank engagement on policy issues will be further enhanced.
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The DPL creates a basis for enhanced partnership with the Government and other stakeholders. Traditional adjustment lending in Indonesia has had uneven success and entailed considerable reputational costs for the Bank, both within the Government and among civil society partners. The DPL provides a unique opportunity for the Bank to change course and re-engage with the Government in a more innovative way by basing financial assistance on completed actions derived from the Government’s own reform program and in l ine with the Government’s annual budget cycle. The DPL also offers the possibility o f a new level o f Government ownership o f the Bank’s assistance strategy and a higher degree o f reliability o f the Bank’s partnership. The proposed loan - coming in the first few months o f the new administration - would also convey a strong positive signal to the financial markets and the international community to back up the encouraging policy agenda set out by the new Government.
The proposed loan contributes to meeting vital fiscal needs. The proposed loan would help meet the Government’s financing needs for the Government’s current fiscal year. Without the loan, Government wil l most likely be forced to take actions - such as drawing down further on i ts deposits at the central bank, cutting development spending, or returning to capital markets in an unanticipated manner - that could increase macro uncertainty.
I. R I S K S
Political. Though the President won a decisive mandate, his party and coalition partners currently lack a stable majority in parliament. This could lead to policy divisions between the Government and the legislature. The President has crafted a cabinet that includes a very diverse range o f political parties with an eye towards building a workable coalition in the legislature under different political scenarios. However, this leads to the potential for r isks to policy coherence and consistency within the cabinet, though a set o f strong Coordinating Ministers have been put in place to mitigate such risks. In addition, the majority o f local executives and legislative bodies are dominated by opposition parties raising risks o f implementation difficulties in Indonesia’s largely decentralized policy environment. The programmatic nature o f proposed Bank engagement as well as the triggers laid out in CAS, mitigate the risks to the Bank. Future operations will be undertaken only if satisfactory progress i s made on implementing the Government’s reform agenda.
Economic. The Government’s commitment to maintain fiscal and macro stability, and address subsidies i s key to addressing a broad range o f macroeconomic risks discussed below. From the Bank’s perspective, appropriate timing o f the subsequent DPLs - and delaying them if necessary until the overall reform program i s on track - would mitigate some o f these risks.
Despite public commitment to fiscal discipline, there i s the r isk that political pressures lead the Government to pursue an excessively expansionary fiscal strategy. Once reform momentum slips Indonesia’s hard-won macroeconomic stability could be at risk. A deterioration in the macroeconomic situation through slower growth directly affects the fiscal situation though lower tax revenues. Interest and exchange rate movements also pose risks, given the structure o f government debt.
0
0
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0 The Government also has large contingent liabilities - eg: blanket guarantee on bank liabilities, loss-making state owned enterprises (SOEs), and actuarial liabilities at public pension funds. The recently approved law for a comprehensive social security system for all Indonesians could further add to the liabilities unless designed carefully. Although there i s officially no sovereign guarantee, the central government implicitly faces risks f iom regional borrowing allowed under a recent law. The Bank and other development partners are working with the Government on measures to mitigate these r isks including sound implementation o f the financial sector safety net, developing a strategy to address public pension fund reforms, and reform and restructuring of SOEs. Despite public statements indicating a reduction o f subsidies to the non-poor (largely fuel prices), there i s the r i sk that domestic fuelprices will not be raised as political pressures have delayed or forestalled increases in the past. There i s also the r isk that low investment in the oil and gas sector will continue - despite some recently announced incentives - and that actual production will fall short o f the budget projections, thereby reducing revenues.
0 State owned banks continue to pose risks due to weak governance and recent proposals to permit state owned banks to restructure SME bad loans need careful implementation in this context. The Bank and the IMF continue to have a dialog with the Government on state banks. The Bank i s working with the Government to assist the development o f NBFIs to provide alternate sources o f long-term finance. The investment climate remains poor with the legal system, labor laws, decentralization, taxes and customs all presenting constraints to growth. The Government’s public commitment to maintain fiscal and macro stability, and pursue the reform agenda i s key to addressing a broad range o f economic risks. The Bank’s analysis and dialogue in these areas and the programmatic nature o f the loan also mitigate these risks. Indonesia’s continued presence on the OECD’s Financial Action Task Force (FATF) on Money Laundering l i s t o f Non-Cooperative Countries and Territories (NCCT) exposes it to the r isk o f counter-measures by the FATF. Several donors are working with the Government in this area.
0
Fiduciary and reputational. In the past, the Bank has been associated with Indonesia’s weak governance environment. Concerns have also been raised by civ i l society groups about the proper use o f donor funds. The Bank’s fiduciary assessment for th is DPL concludes that since 2000-0 1, there have been considerable improvements in Indonesia’s public financial management systems (Section VII). The Government proposes to lock in many o f these reforms with support from donors, under the umbrella o f the World Bank- financed GFMRAP. Despite these reforms, Indonesia clearly has an enormous public sector institutional reform agenda to implement. There remain concerns about the quality o f Indonesia’s public expenditure management system; however, the proposed loan would take place in an environment o f substantially improved public expenditure management.
Social. Ongoing conflicts and social unrest continue to pose risks. These would adversely affect the investment climate and Indonesia’s ability to attract foreign investment. O f particular concern are armed conflicts in the Moluccas, Dyaks, and Madureses in Central
33
Kalimantan, and separatist movements in Aceh and Papua, wh ich have a l l been cited in the ASEAN Free Trade Area (AFTA) as a deterrent to the free-trade system. The new administration has made it clear very early o n that resolving these conflicts i s a key area o f focus.
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VII. FIDUCIARY ASSESSMENT
In 2000-2001, the fiduciary environment was considered weak. In-depth reviews by the Bank and donor partners emphasized the lack o f efficiency, transparency and accountability in the management and use o f public resources.6 These fiduciary problems were compounded by fragmented and overlapping Ministry o f Finance (MoF) structures, leading to inadequate focus on aggregate fiscal discipline, appropriate resource allocation and reliable fiscal reporting.
Since then, however, improvements in Indonesia’s Public Financial Management (PFM) systems have been significant and consistent7. A 2003 White Paper on Financial Management Reform laid out the key principles and a road map for reforming Indonesia’s PFM system. These included specific actions aimed at macroeconomic stability, financial sector reform and restructuring, and increasing investment, exports and employment opportunities. The Government subsequently implemented the core o f a new legal framework for PFM. A troika o f laws (on State Finances, State Treasury and State Audit) passed in 2003 and 2004 now provide an adequate architecture to modernize public resource management and oversight.
A new budget preparation process i s being introduced from fiscal 2005. Following the 2003 State Finances Law, the 2005 draft budget has introduced functional and program classifications, presenting information using the international standard GFS200 1 classification. For the f irst time in i ts history, Indonesia has presented to Parliament a national budget with identifiable sectoral allocations. Budget allocations have begun to be based on sector strategies and programs rather than historical expenditures. Movement has begun towards output- and performance-based, and away from input-based, budgeting. One-year forward estimates are another first step towards a medium-term expenditure framework (MTEF).
Budget execution and public resource management are being modernized. The new legal framework for comprehensive management o f public resources will allow the Government to manage i ts financial assets, debt and cash more efficiently and effectively. The establishment o f a Treasury, introduction o f a Treasury Single Account (TSA) and automation o f the treasury payment system are key.
A functional reorganization of the MOF i s under way. This will strengthen accountability, eliminate overlap and duplication o f functions, and enable the Ministry to focus more effectively on i ts core functions. The consolidation o f budget development activities in a new DG Budget and Fiscal Balance, and consolidating budget execution functions (including cash management and fiscal reporting) in a new DG Treasury, has
These include the 2001 Country Financial Accountability Assessment (Report no. 21824-IN), the 2000 Public Expenditure Review (Report no. 19845-IN), Indonesia: Reforming the Public Procurement System (Report no. 21 823-IN), and IMF: Indonesia - Action Plans to Improve Public Expenditure Management, October 2002.
See Annex 5. Whi te Paper - Reform o f Public Financial Management Systems in Indonesia: Principles and Strategy, 2003. 8
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clarified mandates and strengthened accountability. The complementary ongoing reengineering o f business processes i s envisaged to introduce checks and balances, and diminish the potential for rent-seeking that hitherto characterized virtually all stages o f budget formulation and execution in Indonesia.
The BPK - the supreme audit institution - now has a stronger mandate. The BPK has independence in determining the scope o f audits. I t can audit all government entities and operations as it deems appropriate. In addition, public disclosure o f all BPK audit reports i s now mandatory.
Indonesia still has an enormous public sector institutional reform agenda to implement. The next phase in public sector institutional reforms i s expected to focus on deepening the existing reforms and widening the scope o f the reform agenda. This entails significant changes in processes and practices, as well as technological change. The implementation and mainstreaming o f the institutional reform agenda will require a more professional civil service, underpinned by merit-based recruitment and promotions, objective performance appraisal, effective integrity systems, and adequate and transparent ,
compensation. Key elements o f the upcoming public sector institutional reform agenda include:
Expanding the scope, depth and reach o f anti-conuption efforts - through more effective operation o f the Anti-Corruption Commission and Anti-Conuption Court; Enhancing judicial capacity and credibility through an effective Judicial Commission; Ensuring greater integrity and more effective execution o f public expenditures through implementing regulations for the State Finances and Treasury laws, a Treasury Single Account, an automated treasury payments system, a government financial management information system, streamlined public procurement and adoption o f govemment accounting standards; Strengthening public expenditure oversight by enhancing the technical capacity o f the Supreme Audit Institution ( S A I ) capacity, strengthening legislative capacity for oversight of budget execution, and eliminating the overlap in internal audit entities’ mandates; Increasing revenue collection and eliminating revenue leakages through governance- and accountability-enhancing reforms to the tax and customs administrations; and Strengthening civ i l service management, incentives, integrity and effectiveness.
The Government proposes to lock in many o f these reforms with donor support, under the umbrella o f the World Bank-financed GFMRAP.
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Annex 1 : Letter of Development Policy
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Annex 3: ADDRESS OF THE PRESIDENT OF THE REPUBLIC OF INDONESIA
17TH NOVEMBER 2004
“Recognize the problems, determine the agenda and the direction”
Assalamu ’alaikum Wr. Wb Good wishes for all o f us
My dear fellow citizens and compatriots, wherever you may serve and wherever you may be at the moment, First o f all in the atmosphere o f Lebaran allow me on behalf o f the government and also personally to wish a Happy Idul Fitri lSt Syawal 1425 Hijriyah, to al l those o f the Muslim faith. Minal ‘aidin wal faidzin, forgive us for our misdoings physically and spiritually. May the blessings o f Ramadhan accompany us in our struggle to build a better future for Indonesia.
As a nation we also have reason to say thanks because after successfully carrying out the general elections in 2004 peacefully and democratically, the present national climate from the political, social and security aspects i s in general in a good condition. The Lebaran situation this year also developed properly, including managing the gulf o f Indonesian workers coming home from Malaysia in significant numbers.
However, in the midst o f our happiness and gratefulness, we are truly concerned with the violent actions in Poso, and the natural disaster on Alor, East Nusa Tenggara. We condemn and are angry with the bombing performed by irresponsible persons who have tom up the human values in Poso, resulting in the death and injuries o f some o f our innocent brothers. The Coordinating Minister o f Politics, Justice and Security, the Minister o f Internal Affairs, the TNI Commander, the Chief o f Police and the Deputy Head o f Public Guidance have left for Poso in order to immediately control the security situation, to prevent further violence including measures for early detection, to be followed by the right measures o f enforcing the law.
As an expression o f our sympathy and as a quick response o f the government, the Coordinating Minister o f People’s Welfare together with the Minister o f Social Affairs, the Minister o f Health, the Minister o f Communications and the Minister o f Public Works have visited Alor for a review and to provide the necessary emergency aid. I have also communicated with the Governor o f NTT to prepare and carry out regional rehabilitation and reconstruction in connection with said natural disaster.
Today the government under my leadership i s 4 weeks old. I feel that this f i rs t month o f our administration i s the beginning o f the start o f rebuilding Indonesia, after our people have begun to get out o f the crisis. In accordance with the mandate and the message that I have received from the people, I will continue the management o f the administration and the national development o f my predecessors. In essence, development consists o f continuity and change.
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What was achieved by the government o f President Megawati Soekamoputri, such as the economic growth that has occurred and the successfbl achievement o f macro economy stabilization we naturally must maintain. Meanwhile what has not yet been fully realized in the past, such as the s t i l l high levels o f unemployment and poverty, and the s t i l l insufficient growth o f investment and the real sector, naturally wil l be the task and duty o f the present government to be continuously resolved and improved.
Practically everybody i s talking about the Program o f 100 Days. The mass media, including television broadcasts are never without a discussion o f the government’s program o f 100 days. There are even some who use this 100 days program as a measure o f the government’s success.
I do not wish to argue about this issue; what i s clear i s that the government’s 100 days program is not meant to and will not solve all problems. I t i s also impossible to be able to carry out all activities, including to measure the success o f the present government who God willing s t i l l has to work hard in the next 5 years.
We have been taught that to find a simple solution o f a problem, f irst o f all we must understand the roots and causes o f that problem, and only then we remove and overcome the cause o f such a problem. Thus, what the government i s going to do during these 100 days, in particular in this f irst month, I might call: “Recognize the Problem, Determine the Agenda and the Direction.” Naturally this will also be accompanied by actual steps and measures.
There are at least 10 steps that the government undertakes now.
First, consolidate the administration. The Ministers, except for the three Ministers who also served in the Gotong Royong Cabinet, i.e. the Minister o f Foreign Affairs, the Minister o f Energy and Mineral Resources, and the Minister o f Social Affairs, need to carry out orientation, adaptation and take their initial steps. I, too have to quickly study the policies o f President Megawati, particularly those o f a fundamental and actual character.
Second, the government needs to immediately position and study all issues, starting with the political, economic, social, cultural, legal, human rights, defense and security aspects. This includes commitments and problems that have not yet been finalized in the past, in the sense that they are s t i l l continuing.
Third, specifically the government needs to study and review a number o f important policies, such as the fiscal, industrial and agricultural policies, the education and health policies, steps to eradicate corruption, the policy o f solving the issues o f Aceh, Papua and Terrorism, the policy o f infrastructure development on a national scale, investment and trade policies, and the foreign policy.
Fourth, after having gained sufficient insight o f the problems and reviewed the policies that are effective, the government must determine the direction, the agenda and the development priorities and the administration management for the next 5 years.
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Fifth, in accordance with the L a w o f the Republic o f Indonesia No. 25 o f the year 2004 on the National Development Planning System, said agenda and priorities must be laid down in a Medium Term Development Plan (RPJM ) that must be finished within 3 months. In order that during these first 100 days there should also be a correct direction, concept and plan in what the government is doing, the government has already stipulated the Agenda o f the First 100 Days o f the Unif ied Indonesian Cabinet.
Sixth, in order that the government management may truly take place effectively, as the President I have already stipulated the Rules o f the Game and the Code o f Conduct for all rank and files o f administration or executive institutions, both at Cabinet level (intemal), Central Government level as wel l as Regional government level. In fact th i s i s a contract o f accountability o f the executive ranks that must be held high. I want the government ranks to work seriously, responsibly, performing properly, and to be free o f corruption and deviations.
Seventh, during these 100 days the government needs to show determination and a high commitment in carrying out its tasks, including applying a shock therapy. That is why during the first week I have visited four important institutions o f whom the State and the people expect that they will carry out their task properly, with a high performance and not to the contrary carry out deviations including acts o f KKN. These four institutions are the Office o f the Attorney General, the Indonesian Police, the Directorate General o f Taxes and the Directorate General o f Customs & Excises. I have clearly told these servants o f the State that we will carry out the principles o f reward and punishment even more firmly in the future.
Eighth, the government must be able to handle the actual problems that exist during these 100 days, namely the management o f the celebration o f Lebaran, Christmas and New Year, and the management o f the repatriation o f Indonesian workers from Malaysia. The Government must be able to manage the stability o f the nine basic commodities prices, public transportation, the availability o f fuel, health services and security during these Holidays. The retum o f workers f rom Malaysia in hundreds of thousands must also be carried out smoothly. A s the leader I must review and check directly al l those public services so that there wil l be no big and serious problem.
Ninth, during these 100 days the government must also settle and find a solution for several critical problems that were not yet settled before, such as a pol icy solution on the high o i l price on the international market, which places a heavy burden on the State Budget due to the large fuel subsidies. A solution in respect o f settling the Karaha Bodas case, the review o f the 2005 State Budget including the stipulation o f the budget deficit figure, and a review o f the assumed o i l price. I need to point out that the choice is often not easy, and even bitter. However, whatever is the case the government must make a choice and take a decision. Because this problem i s closely related to the existence o f our people, the government naturally will seriously discuss the matter with the Parliament and the Regional Representatives Council (DPD).
Tenth, as o f this year 2004 the system and practice o f our State has experienced many changes. This is in accordance with the message o f the 1945 Constitution that has already experienced four amendments.
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We all know that aside from the Supreme Court we have the Constitutional Court. Aside from the People’s Representatives Council there i s the Regional Representatives Council. The People’s Advisory Assembly which in the past was the Supreme State Institution, has now become a State Institution which no longer elects the President and stipulates the Broad Outlines o f the Nation’s Direction. O f course this needs adjustments and adaptations from the aspect o f paradigms, mind set, mechanism and even the political culture in which we all find ourselves. And therefore during this first month I have carried out communications and consultations with those high state institutions so that we will mutually understand our respective roles, function, authorities and tasks, in accordance with the Constitution and the laws that are in force.
In connection with the relations o f the government with Parliament that have been strained in the past, particularly before the work meetings between the Government and the Parliamentary commissions could begin, naturally these were not designed or the wish o f the government or the Parliament. I am thankful that the problems that concem these horizontal relations have relatively been solved and both institutes have been able to carry out their role and function in accordance with the message o f the Constitution. Clearly the government naturally wishes to receive control from Parliament so that the decisions and public policies will truly be right, and also in accordance with the expectations o f our people.
Dear fellow compatriots whom I love, At this opportune occasion, at the beginning o f implementing the tasks o f the
government that I lead, it would be good for me to refresh and bring up the vision and mission that I have pointed out during the past elections. This i s important so that aside from achieving consistency, said vision and mission can also be understood as a whole and free from inaccurate manipulations.
I have repeatedly said that the Indonesia towards which we are heading i s an Of course such Indonesia that i s safer, fairer, more democratic and more prosperous.
conditions we have to build in phases, through togethemess and hard work.
In the time range o f 5 years forward there are a number of fundamental issues that we must handle seriously, so that our aim to build a better Indonesia will be accomplished.
In the economic field we must work hard so that our economy will grow at a target o f an average 6.5% per year. We want the state revenues to continue increasing, both from taxes as well as non taxes. We also want unemployment to decrease to the rate o f 6% or even lower by the year 2009. We must lower the poverty rate. On the other hand, we need to carry out serious efforts to be able to increase investments and to develop our infrastructure nation wide.
In the field o f people’s welfare, our main agenda will be to enhance the quality o f education and health. Aside from that we must also encourage religious l i f e fill o f harmony and tolerance. The protection and empowerment o f women must be carried out continuously.
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In the f ield o f justice, the priorities must be assigned to sustainable justice sector reforms, law enforcement, eradication o f KKN in a more effective and serious way, and the settlement o f large scale legal cases.
In the field o f politics, we need to continue reforms and democratization. Respect for c iv i l r ights needs to be enhanced, in line with the enhancement o f freedom in the political system that i s stable and orderly.
And in the field o f security, the main agenda i s directed at settling the separatism issue in Aceh and Papua, the eradication o f terrorism, and thorough settling the communal conflict in Poso and in Ambon.
The accomplishment o f above mentioned five agendas, namely the problems in the economic field, people’s welfare, justice, politics and security, naturally needs the right strategy, policy and plans. The steps and actions from the government during these first 100 days, too, cannot be disengaged from the context o f the agenda 5 years forward. It goes without saying that in 100 days what the government can do i s to determine the strategy, the fundamental policy and action plan, including also to lay the foundation for the subsequent phases. However, both symbolical as well as concrete the government must already work according to the correct direction and aim. The government wants to carry out effective and systemic administration management, and also be able to measure its progress.
Dear people, I will explain, briefly and in broad lines, the 5 Year Agenda and 100 Days Action,
field by field, for a more complete understanding o f the vision, mission, plan and action o f the government forward.
I will begin with the economic field. I will use the phrase TripZe Strategy in the national economic development forward. The first strategy i s to boost growth through enhanced investments and exports. The second strategy, to revive the real sector in order to create more extensive employment opportunities. And the third strategy i s to revitalize agriculture and rural economy to diminish poverty. So, actually the triple strategy i s nothing other than a “Pro-Growth, Pro-Employment and Pro-Poor,’ strategy.
We do have to carry out economic growth and enhanced quality output. If during the transition period o f the past six years growth was stimulated more by consumption, naturally for the fbture we wil l endeavor that the pillars o f growth will be investment and exports.
For investment, domestic as well as foreign, to continue to increase and grow, we need an increasingly conducive national climate. I agree with the results o f the survey coordinated by the Intemational Business Chamber in Jakarta in August 2004 last, that according to its ranking the factors that influence investment including i ts barriers are law enforcement, corruption, taxes, bureaucracy and inconsistent policies or regulations, manpower, crime and security, infrastructure and regional autonomy. I also agree with the identifications by Kadin that the critical factors related to industrial expansion in our country are problems in the field o f law, taxes, manpower, infrastructure and regional autonomy and
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industrial strategy and policy. In fact those factors, identified by the International Business Chamber o f Jakarta and by Kadin, constitute the agenda and priority o f putting order in the investment climate in the next 5 years. Actually, during the first 100 days, the government again has begun to touch and handle these factors. Personally, as the President, I too have given it my utmost attention.
From the export side, the government will try hard to enhance international economic cooperation more aggressively, to find access to wider markets for agricultural products in developed countries, including negotiations o f tari f fs that are profitable for us in the WTO forum. In this first month I have already held substantial discussions, naturally in the macro context, relating to more extensive economic cooperation with the Malaysian Prime Minister Abdullah Badawi, the Singaporean Prime Minister Lee Hsien Loong, the special envoy o f the President o f the PRC Hu Jintao the State Councellor Tang, the special envoy o f the Emperor and the Prime Minister o f Japan Fukuda and the Leader o f Nippon Keidanren, and the Australian Prime Minister John Howard. In this context I have also held communications and discussions with the U S Chamber o f Commerce in Washington D C through a video conference in Jakarta.
God willing, during the APEC meeting this weekend in Chile, I will continue the discussions with other world leaders. The Coordinating Minister o f the Economy and the Minister o f Trade have been specifically assigned by me to hold more operational discussions with their respective counterparts in the ASEAN countries as well as APEC.
The activation o f the real sector must be done more aggressively in the next 5 years. The manufacture and services sector must get up and grow, including the expansion o f SMEs. We have a stake in diminishing unemployment significantly, through the revival o f the real sector. Why must the manufacture industry survive? mainly those that face certain challenges such as the textile industry, so that there will not be a wave o f lay-offs, that will only worsen the figure o f open unemployment which now numbers about 10 mill ion people.
Revitalization o f agriculture and the rural economy must be undertaken. Agriculture and rural infrastructure must be developed. We must also increase government spending on agricultural development, because this can decrease the poverty figure o f which 68% i s in the agriculture and rural sector. The expansion o f agribusiness also should not marginalize the farmers who are getting increasingly marginalized. I encourage research and innovation in the agriculture sector, including biotechnology as have successfblly been accomplished in Thailand. The IPB [Bogor Agricultural Institute] for example as one o f the centers o f excellence could become a pioneer in revitalizing agriculture and rural economy.
The energy sector must also be encouraged seriously. The demand for energy will continue to increase, including electricity by first stipulating the medium and long term energy strategy. Meanwhile the government needs continuously to stipulate the fue l subsidy policy and the correct price policy. This f irst month I have officially opened the gas production and processing o f f shore Natuna. I have also officially opened 3 gas electric power stations in South Sumatra, including the development o f electric interconnection in the
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Sumatra area. I even agree and encourage the wish o f the regional government and the people o f South Sumatra to turn their province into the storage o f energy.
Infrastructure development i s very pressing for us to be undertaken. The need for new investment in the infrastructure sector is estimated to reach US$72 bil l ion for the next five years, for which naturally we greatly expect contributions from the private sector. During these f i rst 100 days the government wil l compile a blueprint o f the infiastructure development plan nationwide and integrated. This includes the aspect o f the necessary financing, which naturally must be integrated between regional and central financing, including contribution from the private sector. Bearing in mind the big investment in the infrastructure development, the choice and decision must be exactly right. The cost-benefit considerations must also be correct. As an example, the plan o f developing the Dumai sea port I consider to be right because the CPO volume which will be carried from that port will increase from 3 mill ion tonnes in 2004 to become 6 mill ion tonnes in the year 2006. With the same objective, the sea port development plan in Pangkalan Bun, Central Kalimantan is also right. The development o f a subway and monorail in Jakarta in order to solve the increasingly worsening traffic jams, will o f course be a need that should be understood.
So that the hture economic development will be even more successful, we need proper synergy and synchronizing. This synergy and synchronizing involves the national policy and the regional policy, monetary policy and fiscal policy, as well as the joint role o f the government and the business community.
I have held discussions with the BI Governor regarding how to harmonize the role o f BI and the government into a correct policy integration. Likewise the Government has communicated i ts vision and national economic policy for the next 5 years, to the leaders o f banks in Indonesia. I support the effort o f BI in the frame o f strengthening monetary stability and the increasingly credible banking system. Periodically I want to hold meetings with the BI Governor. Likewise I will also hold periodical meetings with Kadin and the business community. We must bear in mind, that in fact i t i s the business community that creates economic growth and employment, and not the government. Naturally the government has the obligation to encourage the compilation o f a correct economic development strategy (SBY uses EngZish phrase: a government driven development strategy).
Bearing in mind the increasingly stronger relationship between countries in the global economy, and also realizing the need for overseas investment to expand the national economy, international economic cooperation whether with countries or international organizations must be carried out properly. During the first 30 days I have held substantial discussions with international institutions such as the World Bank, CGI elements and others, to continue cooperation, naturally continuing to be oriented on our national interest. Learning a lesson o f Indonesia’s cooperation with IMF in the past, for the future we should play a bigger role in formulating the strategy, policy and road map o f our economic development, and not others.
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Dear people, Following I will present the 5 Year Agenda, 100 days action in the field o f People’s
Welfare. For the future we must increasingly fulfill the people’s basic rights, such as food, clothing, housing, the sense o f security, education, health and others. These are the measures o f their welfare, our people. Meanwhile, the concept o f the prosperous family needs to be revitalized. The prosperous family can become the stronghold and supervisor o f many things, including the threat o f narcotics, alcohol and students fights against our children. This i s where the role o f BKKBN, Puskesmas becomes important, also Primary School, Junior High School and Senior High School.
In the education sector we do have to work very hard to enhance the quality o f our education. We need to continuously increase the education budget in line with our economic growth. The quality and welfare o f teachers must also be enhanced. I know for the weak economy group it i s difficult to finance their children’s schooling. That i s why the govemment i s looking for an effort to lessen the education costs, including the costs o f buying textbooks. The Reform and structure o f national education also covers the structure and improvement of religious education, such as pesantren that are distributed throughout Indonesia. In order to lighten the education burden I urge that aside from using the government budget through the State Budget, perhaps the parents who can afford i t and the private sector could also make a contribution. I invite donors to develop our human resources, our human capital to become competitive in the future.
A few moments ago I had a video conference with ITS and Unair Surabaya. I challenged these two universities to become centers o f excellence in the education community. We must fight so that at one time in the future there will be a university from Indonesia included in the 100 best Universities in Asia, or the 500 best Universities in the world.
In the health sector we want an increasingly better level and quality o f people’s health. The quality of l i fe o f the people i s often measured from the level o f health, education, and income per capita. And in this context Indonesia must work very hard to improve the quality o f l i fe o f i t s people.
In the future, the government wants to improve the condition o f the puskesmas that are distributed throughout Indonesia, including hospitals. The quality o f health services must also be improved. In the dialogues that I held with the people, in particular in rural areas, they complained about medicines being too expensive. The Minister o f Health i s studying how to make the price of drugs more affordable to the small people. Including how the poor can be exempted from payment at hospitals. The government also needs to stipulate the correct policy in health treatment o f the senior citizens, particularly for the less well-to-do. In my dialogues with the doctors joined in ID1 and the extended family o f other health communities, I did challenge “when will Indonesia be really free o f malaria, dengue fever and tuberculosis.” I t i s the same as the question o f when will the world find a cure for HIV/AIDS and cancer. When meeting me a few moments ago, I asked the organization for the prevention and solving o f HIVIAIDS in Indonesia to continue conduct an aggressive national campaign against the spread o f HIV/AIDS that i s getting more worrisome in our
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country. particular o f the nation’s younger generation.
The same campaign also against narcotics hat is also threatening our lives, in
In the structure o f the Unified Indonesian Cabinet I have revived the State Minister for People’s Housing. The ownership o f reasonable housing i s one o f the basic r ights o f the people. We don’t want more luxury houses in this country, shopping malls and public facilities alone, but also people’s housing that are adequate and increasingly affordable.
In the f i rst 100 days the government wishes to compile a housing development plan for the next five years concretely and realistically. The construction o f housing on a large scale will be able to move the real sector, and absorb large numbers o f manpower.
A war that we must fight in peace time is the war against poverty and backwardness. The government needs to integrate all efforts to solve poverty, including increasing the performance o f the Poverty Eradication Committee. What i s expected o f our brothers who are s t i l l poor i s quite simple, to have food each day, a house to sleep, to be able to send their children to school, and when they are sick to get medical treatment.
One aspect o f social l i f e that is important i s religious l i fe. We most position religion as a value, and then as behavior, and not as a symbol. Frankly, during the six years o f the transition period there has been a drop in the harmony and tolerance in our life, including the relations between the religious communities. We must strengthen brotherhood, harmony and tolerance.
On the other hand there are many complaints concerning the management o f the Hajj pilgrimage, both at the level o f the Department o f Religion as well as service in the field, in Indonesia as well as in Saudi Arabia. In these 100 days the Minister o f Religion i s carrying out a restructuring in the Hajj pilgrimage management with as target economizing, preventing corruption and improved quality o f services for the hajj pilgrims.
We know that a developed nation i s a nation that has good morals and personality, physical and mental health, and that masters knowledge and technology. These are the competitive elements of a nation. Our homework will be to continue building the character, attitude and behavior o f our nation - which we often call character building. I welcome the social movement lead by AA Gym, called Gema Nusa or the Movement to Build the Conscience o f the Nation as a manifestation o f character building.
St i l l concerning people’s welfare, I really want to try hard to improve the quality o f public services, or the service o f our society, including protection o f safety and security. At nearly all occasions when I meet the people, I always ask whether the State, in this case the government, has provided them with adequate protection and services. The answers are varied. Beginning from those who are satisfied to those who are not satisfied. When I met Governors, Bupatis, Mayors and al l the ranks o f the administration, amongst others in Tanjung Pinang, Dumai, Pekanbaru, Palembang, Bengkulu, Pangkalan Brandan and in Jakarta too, during these first 30.daysY I always emphasize and I order them to improve their service to our people. Although the major part o f people’s income i s s t i l l low, but if the
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government provides proper service, naturally they will feel more comfortable. For the future, our people must feel more secure wherever they are, during the day or at night, free from the intensive fear o f various crimes. T h i s i s a challenge for our police. And th is I have said when I visited Police Headquarters, including my briefing for all Chiefs o f Regional Police through a video conference, that the protection o f the people fkom crimes will be increased. In particular threats fkom street crimes.
Likewise an easy, quick service free fkom illegal levies in handling documents, including licensing, registration as government officials, TNI and Police members, or applying for any job, health service, transportation services etceteras. The government through the Department o f Social Affairs, the Department o f Health and the ranks o f the Regional Governments i s considering how to perform services for the deformed and the elderly in the public area in the right manner.
Dear people, The aspect o f l i f e that i s currently being focused on much i s that o f law and justice.
Everybody wants the face of the law in our country to be totally improved. Although, I need to remind, there i s no short cut for reform in the field o f the law, which in reality i s very complicated at the moment. What the government will do in the future, i s a systematic and intensive effort to make reforms in the field o f law and law enforcement. In fact, especially for fighting the crimes o f corruption, the government in cooperation with other state institutions and civil society elements will continue to carry out more serious measures.
The major agenda in enforcing the law i s to fight corruption, to prevent and to take action against serious crimes against human rights, eradicate smuggling, illegal logging and illegal fishing, and controlling crimes o f narcotics and street crimes. During the f i rs t 100 days steps into that direction will be taken.
In the fight against corruption the government has and i s studying all aspects and knots that have caused corruption to continue in this country. The government also holds intensive and continuous consultations with the KPK [Corruption Eradication Committee] to establish coordination, synchronization and synergy in fighting corruption. Early December next, God willing a Presidential Instruction on the Eradication o f Corruption will be issued, including i ts mechanism and institution. After that, periodically and incidentally evaluations will be made of corruption eradication measures, including the obstacles and the results achieved. At cabinet level, once a month a Special Meeting will be held on corruption eradication, which I will chair directly.
The Attomey General i s undertaking an accelerated process to bring corruption cases to court. I have issued an instruction that priority should continue to be assigned to large scale corruption cases that are detrimental to the state in large amounts and that bother the sense o f justice. I have and will continue to accelerate giving permission for government officials, from the central as well as the regional government, to undergo investigation by the police on the suspicion o f a crime of corruption. I invite the participation and contribution fkom non-government organizations that are active in “corruption watch”, for this effort to eradicate corruption. As Head o f the State, I hope that all institutions and sub-systems o f the
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corruption eradication can function properly and correctly, namely the Government and i t s BPKP [Agency for the Supervision o f Finances and the Development], BPK [Supreme Audit Board], KPK, the Police, the public attorney’s office, Courts, Attorneys, NGOs and also the general public.
So that the eradication o f corruption can be carried out effectively I ask the leaders to really lead and to set an example. I repeat my statement when I installed the Unified Indonesian Cabinet that those state officials in the ranks o f the administration who are involved in corruption to resign immediately and subsequently receive the proper legal sanction.
The crime o f illegal logging i s also causing a lot o f concern. Not long ago I reviewed directly the National Park at Tanjung Putting which i s in a condition that causes great concem, damaged due to theft and illegal logging. The same situation also occurs in other regions. My instruction i s brief and clear. Save our forests, punish the illegal loggers and wood thieves. In Central Kalimantan I said that there i s no one in this country who i s untouchable because o f the forest looting. I will evaluate the performance o f our law enforcers in eradicating this illegal logging.
The smuggling cases s t i l l occur in our country. Since I have already given a very clear instruction to the police and the Directorate General o f Customs and Excises, we will see their implementation and perfonnance. The State loses hundreds o f billions from these crimes o f smuggling. An amount that i s very significant to help the poor, including to improve education and health and teachers’ welfare, civil servants, soldiers and also the welfare o f fanners, fishermen, laborers and other weaker economy categories.
Dear friends, Talking about the 5 year Agenda, the 100 days Action in the field o f politics naturally
will not be in such plain view as the steps for law enforcement or infrastructure development for example. I t i s clear that we want the democratization process to proceed properly. The success story o f the 2004 general elections, that has shown that our people are able to carry out democracy peacefully, although we s t i l l have to improve its quality, needs to become a historical benchmark to further expand our democratic l ife.
Several important agendas in the national political development are the strengthening o f the political institutions, an increasingly transparent and accountable political process, an increasingly extended political participation and the reform o f the TNI, the Police and other state institutions to take a neutral attitude, and not to engage in practical politics.
Frankly we must admit that al l state institutions must learn a lesson from the past 2004 General Elections, to truly free oneself from any political interest. All sides must really understand the values, norms, rules o f the game and ethics in democratic l i f e so that the fairness and justice o f democracy will not be disturbed.
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In the field o f security we also must work extra hard to maintain a good national security level. With national security I am talking about extemal defense, internal security as well as public security.
We must be able to find a good solution for the issue o f security in Aceh and Papua. Especially for the settlement o f Aceh, today the government has held a Consultation Meeting with the Parliament to discuss the policies and follow up measures in the Aceh settlement. While continuing to preserve the momentum and the sustainable recovery o f security in Aceh, the government also held an approach and new measures in order to end the conflict in a more dignified, fair and peaceful manner. W h i l e we work hard and must endeavor to really end the conflict peacefully, the integrated operations that are s t i l l going on currently can really be carried out with better quality, so that its results can be felt by the people o f Aceh even more concretely. Together with Parliament, the government i s preparing to grant amnesty and economic reconstruction if the conflict really ends, which will be marked by the rejoining o f GAM into the greater family o f the Indonesian people.
The settlement o f Papua i s also being undertaken more intensively, with special autonomy as the pillar o f settlement. Some time ago I have met the Governor and the leaders o f Papua, to take concreter steps in settling the Papua issue.
The eradication o f the crime o f terrorism also constitutes an important agenda. This has the objective to protect the safety and the security o f the Indonesian people i tse l f f iom terrorist acts performed by irresponsible parties. For the future, the major measure o f the government i s to increase the capacity to be more able to carry out prevention and action against terrorism, increase operational activities o f intelligence and the police, including increasing cooperation with friendly countries, since it i s a fact that terrorism currently has a global network.
Our intelligence and police continue to work to reveal the terrorism actions in the Kuningan, Jakarta area in September 2004 last. The Chief o f Police has reported a number o f progresses in this effort. But the people o f Indonesia naturally hopes that the legal measures on the terrorist can be carried out concretely and wisely. This i s a challenge for our Intelligence and Police during the first 100 days.
The solution o f the communal conflicts in Poso and Ambon also has priority. The Intelligence, the Police and the TNI, with the support o f the general public must really be able to prevent the occurrence o f new violence in Poso as well as in Ambon. The government also has undertaken quick measures so that the horizontal conflict in Mamasa does not develop further and a peaceful solution can be found.
As President, I also pay attention to the welfare o f the soldiers and their families, the same as my concem for teachers, civil officials, farmers, fishermen, laborers and other weaker economy classes. The officers have a high assignment fiequency, amongst others the assignment to Aceh, to Poso, to Ambon, to North Maluku, to Atambua, to Papua and other assignments. The families le f t behind often have problems o f life, such as just enough wages, the costs needed to send their children to school, or costs for medical care. Not to mention
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when the soldiers are killed or injured in action, while we know that the insurance i s not too big. This needs serious thinking and efforts to improve their welfare. This i s also applicable to the Seroja widows who were le f t behind by their husbands who were killed when in action in East Timor. In line with the economic growth and the increased state revenues, we need to consider their improved welfare.
Dear brothers and compatriots, One o f the government’s agendas i s to enhance international cooperation to support
our national interests. In the era o f globalization and the continued development o f geopolitics and geo-economy, international cooperation i s a must. We want to continue to develop a wide and constructive cooperation network, whether bilateral , multilateral or regional. The ASEAN cooperation remains the major pillar. Other cooperations where we play a role are the cooperation in the frame o f APEC, OKI and Asia-Africa.
The extension o f the cooperation agenda i s being undertaken with Malaysia, Singapore, Japan, the PRC, Australia, the USA and the Near East countries. At the least this i s what the government i s doing during this first month. In accordance with my discussions with the leaders o f said countries, within the period o f 100 days it i s expected that there will be progress and more certain plans, involving the cooperation that we will increase, in particular in the economic field, including investment and trade. I feel there i s a desire from friendly countries to increase th is cooperation and therefore I invite everyone, including the business community, not to neglect this opportunity and momentum.
In my journey home from Cairo, Egypt, where I attended the procession o f President Yaser Arafat’s funeral, I had a meeting with the Indonesian Ambassadors for the Emirate Arab union, for Iran, for Qatar and for Kuwait. In the 2-hours meeting in the early morning, which was also attended by the Chairman o f MPR RI and the Speaker o f the Indonesian Parliament I asked each o f the Ambassadors to present possible opportunities for cooperation with the countries o f the Middle East, in particular in the economic field. I st i l l see that there are opportunities if we really endeavor this seriously.
Dear friends, What I am presenting i s my report to the Indonesian people on what the government
has done during the first 30 days. Naturally the government cannot do everything. But it i s clear that what the government does naturally has a clear direction and aim, settling the problems that the Indonesian people will face in the next 5 years and then carry out the redevelopment o f Indonesia towards better conditions.
In closing I wish to underscore that “the spirit o f change towards a better direction” continues to burn in the hearts o f us all. Yet we must remember that these changes cannot only be desired or dreamt of. We must plan this “Change”, we must reflect i t in our political behavior, we must practice it in our measures, and we must solder it firmly into our administration, and we must preserve it in. the medium term and in the long term.
Thank you. Wassalamu ’alaikum Wr. V%.
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Annex 4: Indonesia: Debt and Debt Sustainability
A. Government Debt Management
The level o f government debt in Indonesia, while on a falling trend, i s s t i l l high by international comparison (Table 1). Also, the structure o f the debt implies substantial risks. A depreciation o f the Rupiah and/or an increase in domestic short term interest rates will have a substantial and immediate impact on the Government's budget.
Efforts by the Government at formulating and communicating a credible debt management strategy to market participants and continued responsible macro-economic management would greatly contribute towards keeping risk spreads low and yield curves relatively flat.
Table 1. Indonesia: Central Government Debt, Billion Rupiah
1999 2000 2001 2002 2003 ................... .................................................................................................................................................................... ............................ Domestic 5 10,117 653,821 659,023 650,433 623,941
49% 48% 48% 49% 48% ..................................................................... External
52% 51% 52% Total 1 048 737 1 372 640 1 401 354 1,317,902 1 267 349 Debt to GDP 95% 80% 77% 68% 59%
............................... ................... ................................................................ .? ........... ? ............................... .? ........... ? ............................... 2 .......... 1 ........................................................................... 2 ........... ? ...................
Note: Nominal outstanding exchange rate as of end ofyear. External debt includes BI debt to the IMF Debt to GDP ratio: for 1999 base GDP; for 2000-2003: 2000 base GDP Source: BI, PMON
External debt
At the end o f 2003, hal f o f the government's debt was denominated in foreign currency. A very high share o f the external debt i s non-commercial, and the currency composition i s dominated by U S dollars and Japanese yen (Table 2). Most o f the external debt i s long term, and a substantial part (around 70 per cent) has fixed interest rates, indicating that the main r i sk on the external debt is exchange rate risk.
Table 2. Indonesia: External Debt
1999 2000 200 1 2002 2003 ................................................................................................................................................................................................................................................................�� ............................. 741,802 666,003 678,038 External debt, Rp billion 537,619 718,579 ...................... ....................... ............................ ................................ ...................
Creditors Commercial 3% 3% 6% 3% 4% Non-commercial 97% 97% 94% 97% 96% Currency composition U S Dollar 43% 45% 49% 45% 45% Japanese Yen 39% 3 6% 33% 35% 35% Euro 10% 11% 14% 15% 16% Other 8% 7% 4% 5% 4%
................................................................................................................................................................................................................................................................��
Note: Nominal outstanding, exchange rate as of end ofyear. Source: EI, PMON
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Domestic debt
The total domestic debt as o f end 2003 was Rp 624 trillion, with Rp 390 tril l ion o f th is being in a tradable form. The Government has been making significant changes to the profi le o f i ts tradable domestic debt over the last few years, to smoothen the maturity profile and lengthen the duration o f the debt (see Chart 1 and Table 3), thereby reducing the risk to the government's budget.
Chart 1. Debt Profile, Tradable Domestic Debt end 2000 and 2003. Billion Rupiah
Redenptlon Profile, Tradable Domestlc Debt, End 2003 _ _
04 05 08 07 08 09 10 11 12 13 14 15 16 17 18 I 9 20 21
Table 3. Indonesia: Risk Indicators, Domestic Tradable Debt
.................................................................................................................. ............... ............. , Rp bi "
Risk Average Time to maturity (years) 7.0 5.9 5.0 7.3 7.5
Debt falling due within 2 years 0% 1 Debt falling due within 1 year 0% 0% 1% 4% 6%
Interest Rate Risk Duration (years) 1.2 2.1 1.8 2.0 1.9 Average Time to Re-fming (years) 1.9 2.9 2.5 3.0 2.7 Share with Re-fixing within 1 year 80% 55% 56% 59% 60%
.................................................................................................................................................................... ...................
Note: Nominal outstanding. Source: PMON
Managing roZlover or refinancing risk has been the main objective for the management o f the domestic debt, and currently the focus i s o n how to further smooth the redemption profi le to smoothen the hump in 2008 (Chart 1). I t i s clear that the government has been successful in reducing rollover risk with the share o f debt falling due within 1 and 2 years, being relatively low.
The risk indicators point in the direction that the main risk o n the domestic debt i s interest rate risk, Le., the r isk that the cost o f the debt will increase due to an increase in market rates. With 60 per cent o f the debt having its interest rate re-set within 12 months, an increase in market rates will have immediate and substantial effect in the form o f an increase in the cost o f the domestic debt. The main reason for the high interest rate risk i s a high share o f variable rate debt that i s linked to the 3 month S B I rate.
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Impact of the proposed DPL on the overall debt
Government debt management i s centered on the trade-off between cost and risk. From a pure r i sk perspective, a loan in domestic currency compared to a loan in foreign currency i s attractive, as it will insulate the government’s budget to changes in the loan payments due to changes in the exchange rates. Similarly, a fixed rate loan i s attractive compared to a variable rate loan, as changes in market interest rates will have no effect on the loan payments, and therefore the government’s budget. However, a low-risk choice typically comes at the price o f higher cost. A loan in domestic currency under current market conditions will come at a higher interest rate, and a fixed rate loan will normally have a higher interest rate than a variable rate loan.
The choice o f structure for specific loans, and therefore eventually the overall r i sk profile o f the debt, will depend on the strategy for government debt management. Taking into account that the total central government debt i s approximately US$ 140 billion, a US$ 300 mill ion equivalent loan will only marginally change the overall r i sk profile o f the portfolio. Furthermore, as Indonesia does not, at th is time, have a comprehensive and formalized strategy for debt management in place, the choice o f loan structure should focus on the costs with due account taken to current borrowing practices, and at the same time ensure the future flexibility o f changing the r isk characteristics o f the loan to make sure that it f i t s into the overall strategy for debt management.
The Government has indicated that i t would l ike the proposed DPL to be a US-dollar denominated LIBOR-based variable spread loan. At prevailing rates, there i s about a 250 basis point difference between the interest rates on the Bank’s proposed loan and the yield on the 10-year Indonesian global bond issued in March 2004. (This does not account for the fact that the maturity o f the Bank’s loan i s twice the maturity o f the global bond). Assuming that the alternative to borrowing from the Bank i s to borrow from international capital markets, this implies that, borrowing from the Bank would result in a saving in interest payment - at prevailing rates - o f about US$7.5 million per year on a loan amount o f US$300 million. This would help reduce the debt burden o f the Government.
Debt Sustainability
Figure 1. Public Debt Dynamics consultation report issued in June 2004, the IMF has conducted a debt sustainabilitv /u \
(Inper‘.&,fGDp) 90 w 901
In i ts most recent Article IV I
analysis for Indonesia (Annex IV o f the IMk 70 - ExbemeShock I/
Staff Report)’. The main conclusion i s that ’-. .._ ..... .....
..... both external and public debt dynamics are 60 - robust to possible shocks in exchange rates, Alternative 21
- 80
- 70
- 60
interest rates, and GDP growth.
projected to decline by from i ts 2003 level to under 40 per cent o f GDP by 2009. Even in a
In the baseline scenario, the debt to GDP ratio i s
2002 1003 2004 2005 2006 2W7 2008
IMF Country Report No. 04/188.
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extreme shock scenario - up to a 30 per cent depreciation in the exchange rate, a 250 basis point r ise in interest rates, and slow down o f GDP growth to 3 percent - the public debt ratio would increase by 10 percentage points o f GDP, but the debt ratios would s t i l l be sustainable, and the path o f consolidation would be expected to continue.
The assumptions underlying the analysis are that real GDP growth i s projected to pick up to between 5-6 percent during 2007-09, the investment ratio to increase by about ?4 percent o f GDP annually, reaching 22 percent by 2009, export growth to gradually r ise to around 6 percent per annum, inflation to decline further to around 3 percent, the real exchange rate i s to remain broadly stable at i t s present level, and real interest rates at approximately 3 percent. Continued fiscal consolidation i s projected with primary surpluses remaining in their current range o f around 2% percent o f GDP under the baseline scenario - implying a steady improvement in the non-oil primary balance o f about % percent o f GDP annually. In addition to the extreme shock scenario, the IMF report also identifies n intermediate “muddle through” scenario with weaker output growth, lower improvements in capital flows, and an overall weaker macroeconomic environment. The debt profile in this altemate scenario i s also projected to improve over the medium term.
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Annex 5: Fiduciary Assessment for Development Policy Loan
A. Fiduciary Challenges in Indonesia
Years o f rapid economic growth, economic and social gains and a stable political environment had obscured the real situation in which aggregate fiscal discipline was weak, resource allocation poor, public expenditure plagued by corruption and fiscal reporting unreliable. The crisis exposed the weakness o f the New-Order style o f managing state resources and forced the government - squeezed by high levels o f debt, an erosion o f government revenue and a more unstable macroeconomic environment - to be more efficient in i ts operations.
The Government o f Indonesia (GOI) together with i t s development partners (World Bank, JMF, and ADB) have conducted a series o f in-depth PFM diagnostics, including a joint GOI-Bank-ADB Country Financial Accountability Assessment (CFAA) and Country Procurement Assessment Review (CPAR), both published in 2001 lo.
The analyses emphasized the following problem areas: The legal and institutional environment was outdated. Indonesia’s management o f government financial operations had been based on outdated laws. The legal framework from the colonial period - the 1925 Indische Comptabiliteitset Stbl -was complemented by a series o f decrees which were not adequate in addressing the requirements o f modem public financial management. This PFM system allowed for systematic and pervasive corruption, collusion and nepotism o, because assignments were unclear, transparency was low, and enforcement was poor. Fragmented and overlapping structures in the MOF reflected the deficiencies o f PFM in Indonesia. The division o f budgeting and treasury functions between a number o f directorates and agencies made it difficult to assure aggregate fiscal discipline, to allocate resources efficiently and to report reliable fiscal data. The budget formulation process was opaque and inefficient. In the past, i t was difficult to quantify basic components o f the budget, e.g. total public investment or sectoral allocations. This led to enormous inefficiencies because it was difficult to evaluate government programs. There have also been major gaps in budget coverage owing to the prevalence o f significant numbers o f off-budget funds. Finally, the budget framework was split: while the routine budget was prepared and managed by the MOF, the development budget was prepared and managed by the planning agency (BAPPENAS), although it included deliberation with the MOF. Budget execution was open delayed and monitoring arrangements were weak Currently, delays and inefficiencies in the treasury payment system raise the cost o f supplies to government and are the source o f significant governance-related problems. In addition, the highly detailed nature o f the budget allocations implies tight control in theory. However, in reality, the MOF was overburdened implementing the budget.
lo Indonesia: Country Financial Accountability Assessment, April 27, 200 1 (Report No.2 18244”); Indonesia: Country Procurement Assessment Report, March 27,2001 (Report No. 21823-IND). See the attachments to t h i s Annex for a compilation o f the main recommendations and the current status o f their implementation.
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Spending uni ts were - and st i l l are - often unable to get full or timely access to their budget allocations during the course o f the budget year. When spending units do obtain their allocations, their management systems have been unable to disburse them with efficacy. Procurement processes were prone to corruption and collusion. Corrupt and collusive practices are deeply entrenched in public procurement. A multiplicity of legal instruments continues to regulate different aspects o f public procurement and limit competition. No single agency has a clear mandate for formulating procurement policy, monitoring compliance, and ensuring clear and enforceable sanctions. The lack of capacity in working level staff o f the tender committees makes them vulnerable to undue and improper influence. Accounting and reporting were fragmented and not always reliable. Several agencies within MOF are involved in financial accounting and reporting. Fragmentation has meant that none o f the systems are able to produce a reliable and reconcilable set o f accounts. The lack o f segregation o f key accounting duties in spending units, and lack o f oversight o f these functions either by spending ministry or M O F staff, i s a serious weakness. The financial controllership function i s non-existent at the spending ministry/agency level. Ex-post reviews o f payment orders are compliance-oriented, limited to checking arithmetical accuracy and sufficiency o f supporting documentation. Treasury and cash management functions are not well coordinated: thousands o f bank accounts are maintained by spending units, many o f which are unauthorized bank off-budget funds. There i s a redundant and uncoordinated proliferation of stand-alone computerized government accounting systems. The mandates of government audit entities were not clearly defined The internal and external audit bodies in Indonesia have been characterized by unclear roles, responsibilities, authority, funding, reporting, and accountability. Furthermore, the boundaries o f responsibility between external and internal audit, between the BPK and BPKP, and the BPKP and the Inspectorate Generals respectively have not yet been clearly defined. These agencies are also under-resourced in terms o f budget, staff and facilities.
B. The Reform Process
Since 2002, the Government o f Indonesia has made substantive progress in improving the institutional, legal and regulatory environment o f PFM. These improvements have been part o f a broader reform process, accelerated by the implementation o f the EPP (or “White Paper”). A breakthrough has been achieved with the enactment o f the Laws on State Finances, State Treasury and State Audit during 2003-2004. The implementing regulations are currently being drafted. These laws create an adequate legal underpinning for modernizing Indonesia’s PFM systems and oversight, and provide the basis for anchoring future reforms. Complementing these i s the ongoing structural transformation o f the M O F around i t s core functions - in particular those o f budget development and treasury management - in line with good international practice.
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The new legal framework i s the culmination o f many years o f hard toil. In November 2001 , the Financial Management Reform Committee (FMRC, Komite Penyempurnaan Munujemen Keuangun) presented a first draft o f a White Paper on PFM reform. This PFM White Paper was completed in May 2003 and outlined a twin track approach: first, improving the legal and regulatory framework to sustain the government’s fiscal position and build public confidence; and second, investing in efficient and transparent systems to manage these functions and promote accountability and integrity. The reform agenda outlined in the White Paper i s a critical component o f the Government’s long-term goal o f macroeconomic stability. This was clearly evident with the inclusion o f a number o f the White Paper’s key objectives in the 2003 EPP.
The State Finances Law (Law No.17/2003). The State Finance Law, while at a high level o f generality, provides for the first time a modem and coherent framework for Indonesia’s PFM system, on which the reform agenda can build. I t provides for such basic components as developing a macro-economic and fiscal framework for the budget, the budget cycle, the information to be presented to Parliament with the draft annual budget law, and the reporting standards to be used in preparing the budget. The major changes currently being implemented are the following:
Integrating the hitherto separate development and routine budgets; Introducing a formal economic and fiscal framework early in the budget process, to be considered by Parliament and to guide the development o f the detailed budget; Introducing a multi-year focus, through the development o f a MTEF, to ensure that the annual budget i s developed with consideration o f i t s impact on future years; Increasing the performance focus of the budget, through the development o f ministry and agency work plans and an overall government work plan setting out strategies, objectives and targets. In the past the budget dialogue has been largely a discussion about perceived needs for inputs (salaries, supplies etc) with l i t t le or no explicit focus on the desired or expected outputs or outcomes o f these expenditures; Improving budget classification by changing the sectoral classification o f expenditures to accord with the functional classification in GFSM2001 and to amend the Budget Administration Code to align it with the GFS economic classification; Expanding the scope o f the budget to include some o f the significant off-budget fiscal activities. The Housing Fund and the Petroleum Account (both operated by the MOF), and the on-lending operations o f the RDI (to state owned enterprises) and RDA (to sub-national governments), should be included in the regular budget reporting process.
With these measures, the new State Finance Law will also improve fiscal transparency. Budget documents will become more comprehensive and informative. This will include among others: (i) the new economic and fiscal framework (including MTEF), (ii) clearer expenditure classification, including the integration o f routine and development budgets, and (iii) enhanced ex post fiscal reporting through the provision o f comprehensive financial statement, including a balance sheet, cash flow statement and the budget execution report to Parliament within six months o f the end o f the fiscal year.
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Planning and budgeting functions have also been clarified. Recently promulgated regulations operationalize the Law on State Finances. Planning and budgeting have been integrated by formally linking ministerial work plans with budgets. The respective roles o f BAPPENAS and MOF in budget preparation have been clarified, with BAPPENAS assuming full responsibility for the planning process (including preparation o f the work plans) and M O F having the leading role in the formulation o f the annual budget (see Figure 1).
Figure 1 : The Planning and Budgeting System - Then and Now
I P L A N N I N G 1 1 Development I Expenditure Recurrent I
BAPPENAS @y-
A conceptual framework for gradual introduction o f performance concepts in the budget process has been laid down, requesting ministries to specify outputs and outcomes in their work plans and report on their performance at the end o f the year. Fiscal discipline has been enforced by imposing hard budget ceilings on ministries in the formulation o f their budget proposals. A “bottom-up” approach to budget preparation has been introduced: spending units are requested to fill in budget submission forms specifying their budget bids at the most detailed level o f the functional, program and economic classification.
State Development Planning System Law (Law No.25/2004). The State Development Planning System (SPPN) Law now provides the legal basis for the national development planning process, linking planning with budgeting. There are a number o f plans outlined in the law spanning a period of 20 years and each connecting up with one another: a 20 year long term development plan; a 5 year medium term government development plan; a 5 year ministry medium term developmenthtrategic plan; an annual government work plan; and an annual ministry work plan.
The longer term strategic vision o f the government coincides well with the reform o f Indonesia’s planning and budgeting system. The State Finance Law (2003) and the Planning Law (2004) now provide the legal basis for the public financial management and planning respectively, with the MOF and BAPPENAS playing complementary roles. Both laws stress the importance o f linking planning with budgeting. The Planning Law now also provides the legal foundation for the Government’s Medium Term Development Plan (RPJM). The RPJM i s intended to be an elaboration o f the administration’s five-year program. Following Indonesia’s first direct Presidential election, the f i rs t RPJM (scheduled to be finalized by January 2005) i s expected to reflect the priorities and platform o f the new President and h i s
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Cabinet. The FWJM i s to set out the national development strategy, general policies and program priorities, and the macroeconomic and fiscal framework.
State Treasury Law (Law No.1/2004). The Law on State Treasury i s the cornerstone for modernizing the budget execution and resource management functions. The MOF reorganization created a new DG Treasury by transfer o f the treasury functions previously handled at the DG Budget, DG Financial Institutions (DGFI), the Secretary General, the State Financial Accountancy Agency (BAKUN), and the many field offices o f the DG Budget and BAKUN delivering payment, verification, and accounting functions. The treasury reforms are focused on ending the extensive proliferation o f independent bank accounts, inefficient use on banking intermediation for payment processes, and the absence o f any strategy for making temporary cash surplus remunerative. The new Treasury law provides an appropriate legal umbrella for moving forward. The regulations are under process . 11
Central government accounting will be based on international standards. The government i s gradually moving towards the introduction o f full accrual accounting standards by 2008. Eleven government accounting standards regulating the preparation o f government financial reports on a modified accrual basis (budget implementation reports and cash flow statements), including information on accounts payable and receivable were issued in December 2003. The regulations also provide for the elaboration o f a government balance sheet, albeit based on unverifiable information on line-Ministries' assets and liabilities. This i s the work o f the Government Accounting Standards Committee (Komite Standar Akuntasi Pemerintah - KSAP) established in 2002. The KSAP comprises representatives o f all stakeholders, including the accounting profession and the academic community. The organizational structure and processes have been established to develop and review the accounting standards.
Procurement Decree (Keppres 80/2003)'2 introduces many improvements in the procurement regime in Indonesia and lays out a timetable for establishing a policy formulation and oversight agency by January 2005. An omnibus procurement law i s envisaged for consolidating, clarifying and simplifying the numerous procurement rules and regulations.
State Audit Law (Law No.15/2004). The State Audit Law lays out the broad legal framework for BPK to operate as the country's SAI, as envisaged under the Constitution. The administrative aspects o f i t s functioning, including the appointment and tenure o f BPK Board members, are regulated by Law 15/1973. While the central issue o f overlap o f internal audit function (between BPKP and others) has not been resolved, there i s repeated reference to the need for BPK to refer to the audit findings o f Yntemal Comptrollers" o f the government and also on the option to utilize resources from Internal Auditors/Comptrollers in carrying out BPK's work where they do not have sufficient resources.
'' Key regulations under the State Treasury Law include those on (i) Accounting Standards; (ii) Budget Execution; (iii) Cash Management; (iv) Asset Management; (v) Debt Management; (vi) Financial and Performance Reporting; (vii) Procurement; (viii) Special Purpose Agencies; and (ix) Internal Controls. l2 Presidential Decree No. 1812003.
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The SA1 now has a stronger mandate under the State Audit Law. I t has independence in determining the scope o f audits and can audit all government entities and operations as it deems appropriate. In addition, i t now has to disclose publicly all audit reports.
MOF Reorganization. The organizational structure and responsibilities o f the M O F departments have been reformed by a series o f Presidential and Ministerial decrees signed between May and June, 200413. The budget and treasury functions have been consolidated and separated into distinct Directorates in l ine with international good practice. The checks and balances introduced by this separation o f roles and functions increase accountability and transparency, effective budgeting, debt management and financial reporting. The physical movement o f offices and personnel i s to be completed at MOF headquarters in the regions prior to the commencement o f the 2005 budget year.
The effects o f the reorganization process wil l be visible throughout the country. The MOF structure has been altered considerably to allow it to organize around the key functions o f a modern ministry o f finance. The consolidation o f treasury functions within the DG Treasury will see substantial rationalization o f relevant distributed services. In particular, the regional accounting offices (KAR) and local verification offices (KASIPA) will be merged into local M I L S and KPPNs, which will now form part o f the DG Treasury. Local payment offices wil l now take on an internal verification function, and be renamed KPPN. The main elements o f the MOF-reorganization are shown in Figure 2.
The organization and responsibilities o f the MOF departments have been reformed by three Presidential Decrees signed on May 10, 2004: Decree #35 on MOF tasks and responsibilities; #36 on Echelon-I units o f the MOF; and # 36 on central and regional offices o f the DG Treasury in the MOF.
13
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Figure 2: The significance of the MOF reorganization
C. Moving Forward
Although commendable progress has been made in PFM reform during the last several years, an enormous agenda remains. The next phase in PFM reforms will require equally undivided attention. Key measures o f the upcoming reform agenda include: (i) effective and monitorable implementation o f recent laws and corresponding regulations; (ii) establishment o f an integrated financial management information system including, as a first step, an automated State Treasury and Budget System (Sistem Perbendaharaan dan Anggaran Negara - SPAN); (iii) the progressive consolidation o f government bank accounts into a TSA located in the BI14; (iv) adoption o f Government Accounting Standards; (v) establishment o f a National Public Procurement Office ("PO); and (vi) strengthening BPK capacity and removing functional overlaps between internal audit entities. Together these could constitute the basis for processes and practices which could facilitate efficiency, transparency, and accountability.
A modernized State Treasury and Budget System (SPAN) would be the central
0 Include core h c t i o n a l requirements for the execution components o f government budget through an integrated accounting system. In general, th is would include recording o f revenue collections, appropriations, commitments, verifications, and
element o f fmancial management and accounting operations in Indonesia. The SPAN will:
l4 The treasury operates about 60 bank accounts at BI headquarters. As a f i rs t step, the balances in these accounts w i l l be consolidated for investment pufposes. This can be done by either converting these accounts into TSA sub-accounts with provision for daily sweeping o f the balances into TSA, or closing these accounts and replacing them by ledger accounts at the treasury, so that their separate identity can be maintained, if required.
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fund allocations leading to payment (covering accounts payable, accounts receivable, general ledger operations, and report generation); Record and process all state budget transactions and incorporate aggregate data from other elements o f general government as rapidly as possible; Record all relevant stages o f the payments and receipts processes and enable reports to be made on key variables, such as commitments, funds available, bills outstanding and payments and receipts (both cash and accruals basis); for individual agencies and at various levels o f aggregation; Incorporate controls on any specified variables as necessary, for instance to ensure that commitments do not exceed available funds; Generate standard monthly reports and provide query facilities to determine the budgetary position o f agencies, the state budget and the general government budget; Maintain data according to the budget classification for as many past years as required, and allow projections o f up to three years; Facilitate reconciliation between treasury system accounts and banking data by generating chronological l is ts o f transactions in a form comparable to those generated by the banks; and Ensure compatibility o f the system with other systems, such as those for tax and customs administrations. The treasury system will also support the budget preparation process.
To support these reforms, the Government o f Indonesia has prepared two projects: the World Bank-financed GFMRAPl’ and the ADB-financed State Audit Reform (STAR) Program. The GO1 believes that both projects will support the implementation o f the overall reform program, and eliminate overlap and duplication between donor-financed programs and projects.
The GFMRAP i s envisaged by the M O F as the umbrella for sequencing PFM and revenue administration reforms, and for donor coordination“. GFMRAP-I (2004-2008) focuses on improving PFM. I t supports strengthening policy capacity in the M O F and Bappenas, budget policy and formulation, budget implementation and treasury modemization, public procurement reform, and implementation o f public sector accounting standards. I t also pilots activities supportive o f revenue administration reforms (such as the establishment o f an investigations unit and making the Tax Court more transparent and efficient), and strengthening o f legislative oversight o f budget formulation and execution. GFMRAP-11 (2007-2010) i s envisaged to strengthen the tax and Customs administration and trade facilitation, and improve integrity, transparency and accountability systems in tax and customs. I t will also address PFM issues such as SPAN extension and further strengthening
l5 The World Bank and the IMF, at the Government’s request, have jointly assisted the Government to prepare the project. The GFMRAP builds on several years of analytical work by al l three partners. Id In designing and implementing the overall reform program, the GO1 has been receiving technical support from multilateral partners such as the Asian Development Bank (ADB), the IMF, the UNDP, UNCTAD and the World Bank, and from bilateral partners such as the Australian Aid Agency (AusAid), the Canadian International Development Agency (CIDA), the European Union (EU), GTZ and the United States Agency for International Development (USAID).
71
legislative oversight capacity. GFMRAP-I11 (2009-2012) may likely address residual PFM and revenue administration issues.
The ADB-financed STAR Program aims to strengthen the legal and institutional framework for internal and extemal audit in Indonesia. I t provides support for strengthening the S A I , as well as for clarifylng internal and external audit roles and responsibilities, strengthening audit capacity and infrastructure.
Several GFMR4P-I project indicators focusing on PFM, macroeconomic stability and
0 Submission and endorsement by the GO1 o f the f irst MTEF, and presentation o f the first set o f forward estimates to the DPR (House o f Representatives);
0 A TSA system functioning with acceptable parameters (with all on-budget central government bank accounts and own-revenue bank accounts o f l ine ministries and spendin units brought into the TSA system), while the consolidated management reports produced by the DG Treasury include financial assets and liabilities, and cash-based reports o f extra-budgetary funds; The DG Customs and Excise has (a) adopted a comprehensive Modernization Action Plan with inputs from stakeholders; (b) institutionalized an annual survey o f stakeholders, and annually publishes a summary o f the results; and (c) implemented Web-based filing for about 75% o f trade transactions; The DG Tax has adopted a Results-oriented Modernization Strategy and Plan with measurable performance indicators, aimed at the eventual redesign o f processes along single taxpayer account lines and based on the results o f the pilot re-engineering o f one representative district offices; Annual surveys o f stakeholder satisfaction with Tax Court administration and case management established, an action plan adopted to address systemic weaknesses, and Tax Court decisions publicly accessible through the Tax Court website; An investigation unit established and fully operational in the IG MOF, including being vested with the legal powers to fully investigate allegations o f corruption against any MOF staff, including tax and customs officials.
the investment climate i s relevant for future program loans:
I$
0
Overall, therefore, while the fiduciary environment remains fragile, and r isks remain, there has been consistent and significant progress on reforms. It i s desirable to lock in these governance-, accountability- and transparency-enhancing reforms. The G F W and STAR programs together provide adequate, broad yet flexible support for the policy and institutional reforms to be addressed by this first and subsequent DPLs.
Consolidated central government financial reports would continue to be prepared on a cash basis. 17
72
ATTACHMENT: STATUS OF CFAA KEY RECOMMENDATIONS (OCTOBER 2004)
CFAA Status October 2004
Laws have been legislated as separate laws. Finance Law (No. 17/2003) and Treasury Law (No. 1/2004) passed. Implementing regulations for these laws are bei Gove onor support. Parliament continues to use an existing Budget
Committee o f the Parliament Committee. The Commission IX was closest to performing h c t i o n s s imi lar to that o f a PAC. However, the composition o f DPR Commissions i s undergoing a major change in the new DPR. To address the issue o f weak technical support to the Budget Committee and Commissions, grant-based technical assistance o f US$2 mi l l ion i s provided in
Not yet developed, except a limited one for the auditing sector. There i s sufficient scope and flexibility within the GFMRAP program design to achieve this.
R w " m i a t i o n .................... ...........................................................................................................
1. Enact a modem Budget Law by proposed State Finance and Treasury Laws.
combining the
................. ............... ..................................................... atute a Public accounts and Audit
GFMRAP-I. papub .................................................................................................................................................................................................... auditing
stream within a professional c iv i l service.
Reform the Government Budget System .................................................................................................................................................................................................. basedon Implementation wil l start in budget for FY 2005, as
mandated by State Finances Law. of the Implementation started in budget FY 2003. From
political input into the budget preparation FY2005 the budget process i s envisaged to process. progressively provide for greater political input into the
budget process. GFMRAP provides grant-based TA for strengthening DPR capacity. Implementation started in budget FY 2003.
..................................................................................................................................................................................................
............................................................................................................................................................................................................................................... nue estimates including
customs, tax and other revenues within a macro Eramework. ...................................................................... ^ ........................ ................................................................................................
7. Introduction o f performance start in budget FY 2005, as mandated under Finance Law No. 17. However, t h i s i s a long process and it i s advisable for the government to
forward gradually. ..................... ................................................................................................................................................ Strewthen Financial Management 8. Appoint an Accountant General (AG) wihn the
Ministry o f Finance at the level o f Director General.
......................................................................................................................................................................................................................................................... As part o f the ongoing MO DG Treasury has been created to oversee accounting and treasury functions and separated from DG Budget and Fiscal Balance. There i s n o position o f Accountant General, but a Directorate for Systems, Accounts and Reporting has been created within DG Treasury.
these concerns. Consolidation o f accounting will be supported by the treasury modernization component
10. Establish a financial controllership fimction The M O F reorganization plan envisages shifting greater responsibility for financial control to l ine ministr ies starting 2005.
.............................................................................................................................................................................................................................................................. 9. Establish streamlined Government accounting The MOF Reorganization 20
under AG by consolidating functions currently carried out by KPK.N, KTUA, KAR, BAKUN and PPDIA. o f the GFMRAP-I.
withm sector ministries to coordinate planning, budgeting, accounting and reporting.
................................................................................................................................................................................................................................................................B�
73
1 1. Issue Treasury management guidelines and consolidate cash management under AG.
The implementing regulations for the State Treasury Law will address this. Cash and asset management have been consolidated under the DG Treasury.
12. Establish quarterly and annually, payments
13. Forecasting o f cash needs including receipts. and commitments.
Develop an IT strategy and a practice statement for public sector agencies.
Th is will be covered by the implementing regulations for the State Treasury Law, passed 2004. A beginning has been made with the M O F - the DG Customs has promulgated an ICT policy statement as a precursor to a more detailed I C T Strategy. The ongoing SPAN design and implementation initiative i s another examle o f ICT amlication driven bv business needs. .. .................................................................................................................................................................................................................................................................�
14. Develop integrated financial management T h e design and implementation o f the SPAN system i s the f i rst step in the eventual implementation o f an IFMIS.
Public Sector FM Reform plan addresses these concerns.
information system to serve central government needs.
systems to support the enhanced role o f financial controllers at sector min is t r ies.
16. Standardize form and content o f Annual Reports to be prepared by the Government agencies.
17. Design form and content o f the Government's Annual Report to the Parliament.
......................................................................................... ................................................................................................................................................................................................... 15. Develop financial manage
............................................................................................................................................................................................... ..................... Public Sector FM Reform plan includes development o f government accounting standards.
Public Sector FM Reform plan includes preparation of"'" government annual report.
................................................................................................................................................................................................................................................................�� .......................
Strenpthen Government Auditing 18. Revise the current Audit Law No. 5 o f passed in August 2004, providing clear
.............................................................................................................................. .....................................................................................................................................
incorporate features o f a modem public accounting and auditing law.
reconstitute the Supreme Audit Agency to be responsible for a l l external audits o f budgetary funds o f national and sub-national
mandate for B P K as Supreme Audit Institution.
Provided in new ........................................................................................................................................ tment o f the above law,
.................................................................................................................................................... 20. Under the new law, redefme the functions o f
2 1. Develop and implement a comprehensive
State Audit Law provisio
Limited progress. W B - f i n c e d B P K Modernization"' Project has supported capacity building (limited to BPK).
n sector ministries. .................................................................................................................................................
professional development plan for both external and internal auditors.
74
Annex 6: Status of Bank Group Operations
BETWEEN
ACTUAL DISBURSEMENTS
Frm Project Name IBRD IDA GRANT Cancel. Undisb. Ong. Rev,d
ACTIVE PROJECTS ORIGINAL AMOUNT IN US$ MILLIONS EXPECTED AND
Project ID
PO40061 PO7 13 18
PO71 3 16 PO03701 PO79156
PO74290
PO59930 PO36049 PO40578 PO68051 PO73970 PO73772 PO63913 PO64728
PO68949 PO76271 PO49545 PO49539 PO04026 PO36956 PO73025
PO41895 PO401 96 PO03993 PO72852 PO40528 PO59477 PO59931
ID-BENGKULU REGIONAL DEVELOPMENT ID-CORAL REEF REHAB AND MANAGEMENT I1 ID-CORAL REEF REHAB AND MGMT PROG I1 ID-ODS I- UMBRELLA ID-THIRD KECAMATAN DEVELQPMENT PROJECT ID-2ND EASTERN INDONESIA REG. TRANSPORT ID-DECNT. AGRICULTURAWORESTRY EXT ID-EARLY CHILD DEVELOPMENT ID-EASTERN INDONESIA REGION TRANSPORT ID-GEF-W. JAVA ENVT MGMT
ID-GLOBAL DEV LEARNING (LIL) ID-HEALTH WORKFORCE & SERVICES (PHP 3) ID-JAVA-BAL1 PWR SECTOR & STRENGTH ID-LAND MANAGEMENT &POLICY DEVT PROJECT ID-LIBRARY DEVELOPMENT PROJECT - LIL ID-PPITA ID-PROVINCIAL HEALTH I ID-PROVINCIAL HEALTH I1 ID-RAILWAY EFFICIENCY ID-SAFE MOTHERHOOD ID-2ND KECAMATAN DEVELOPMENT PROJECT ID-SULAWESI BASIC EDUC. ID-SUMATRA BASIC EDUCUATION ID-SUMATRA REG'L RDS ID-UPP2 ID-W. JAVA ENVMT MGMT ID-WSSLIC I1 ID-WATER RESOURCES & IRR. SECTOR MGT PROG
20.5
33.2
45.5
200
13 21.5 200
2.66 31.1 141
32.8
17.1
63.2 105
42.5
208.9 47.9 54.5 234 29.5 11.7
45
23
45.5
5
74.5
32.8 4.15
38 40
111.3 15.9 20.1
70.5 5.75 77.4
25
5.00
7.5
36.55
10.65
3.11
47.33 9.15
50.00
7.64
7.50 56.20 20.17
92.48
198.00 3.95 1.96
7 1.48 2.75
1.75 105.65 139.59
64.59 1.53
14.64 18.70 91.78
1.99 2.20
131.25 18.03 5.91
11.22 91.51 11.76 55.54
70.09
12.64 7.64
0.05
0.17 0.62 5.49
0.08
1 .oo 3.34
12.63 12.63
20.48 7.41 1.04
-4.31 -1.41
3.01 0.79 4.61 1.09 -2.12
59.37 49.31 -0.08 11.35 5.35
-203.37 18.79 6.55
61.22 0.56 19.90 8.41
-27.74
12.33
Total: 1600.6 588.9 47.16 122.13 1,299.87 79.35 29.47
75
Annex 7: Fund Relations Note Indonesia: Assessment Letter for the Asian Development Bank and World Bank
November 19,2004
This note provides the IMF staffs current assessment o f Indonesia's macroeconomic conditions and outlook for the coming period, ahead o f the staffs next Post-Program Monitoring mission to Jakarta in early December.
Economic Conditions
Real GDP growth in the 4%-5 percent range is expected for 2004, driven mainly by consumption, although investment and non-oil exports show some signs o f recovery. Following a pickup in April-July, inflation has edged back down, to 6.2 percent (year-on-year) by October, with the swings in inflation mainly reflecting an unusual pattem in food prices and fluctuations in the rupiah.
Financial markets have strengthened since mid-year, driven initially by increasing prospects o f a peaceful election, and more recently by an overall positive reaction to the election outcome. The exchange rate has recovered from i ts lows in early June and i s currently trading at around Rp 9,000 per U.S. dollar. The stock market has recently reached new highs.
Data through October are consistent with an annual 2004 fiscal deficit o f 1 ?4 percent o f GDP, down from 2% percent last year. In recent months, non-oil revenue performance has improved, and so have o i l revenues, the latter reflecting high oi l prices. At the same time, spending has also accelerated, including both payments o f fuel subsidies and development expenditures.
With regard to monetary policy, Bank Indonesia, in response to exchange market pressures that reflected concems about political uncertainty and higher global interest rates, as well as some concems about the inflation outlook, raised reserve requirements in July. At the same time, BI managed liquidity in domestic money markets to prevent short-term interest rates fiom continuing to decline. However, base money growth remains strong and credit to the private sector, especially consumer loans, has picked up.
Further progress has been made toward a sound banking system, and with the completion o f the sale o f Bank Permata, all banks taken over during the crisis have been returned to private ownership. The passage o f the deposit insurance law sets the stage for gradual phase out o f the blanket guarantee scheme. However, high ratios o f compromised assets and low liquidity ratios at state banks st i l l pose a significant risk.
The balance o f payments position remains sound. Despite a surge in imports o f raw materials and capital goods, Indonesia continues to enjoy trade surpluses reflecting high oi l prices and a recent upturn in non-oil exports. Intemational reserves, at some US$35 billion, remain comfortable at 150 percent o f short-term debt.
76
In September/October, the outgoing government passed several laws that were outstanding from i ts White Paper. The law establishing the Judicial Commission and amendments to the Bankruptcy Law address some key concems about the investment climate. However, the social security bill leaves the actual content o f reforms vague and could potentially create unfimded liabilities, while the laws on decentralization, state finances, auditing and Treasury all require implementing regulations to become effective.
Outlook and Policy Challenges
The outlook will depend importantly on policy choices that the new government makes in formulating i ts economic program. In this context, a preliminary assessment o f the government’s 100-day plan announced on November 17 indicates that the underlying economic strategy i s aimed at improving the investment climate, reducing corruption, improving infrastructure, all within the framework o f a stable macroeconomic environment. However, several measures need better specification while others could have fiscal implications. Discussions with the authorities in the context o f the Fund PPM mission will provide an opportunity to discuss this plan and form a better assessment.
Having said that, the government’s stated objective to maintain macroeconomic stability, including only a limited revision o f the deficit to accommodate i t s objectives are welcome. Successll implementation o f a policy package that maintains the current positive market sentiment by signaling commitment to macroeconomic stability and strengthened structural reforms to improve the investment climate, could help generate high growth rates, and reduce further unemployment and poverty.
Status of IMF Relations
0 Indonesia’s Extended Arrangement with the Fund ended in December 2003. The Fund remains engaged in a close policy dialogue with the authorities through post-program monitoring (PPM) and extensive technical assistance activities. The 2004 Article N consultation and first PPM were completed on May 3. There was a staff v is i t in July 2004.
0 The next PPM mission i s scheduled for December 1-9, and technical assistance missions from Fiscal Affairs Department, Monetary and Financial Systems Department, and Statistics Department will be in the field during November-January.
Contact person: Ms. Nita Thacker (nthacker@,imf.org, 623-7464)
77
Annex 8: Indonesia: Statement of IFC's Held and Disbursed Portfolio (As o f 9/30/2004 - In U S Dollars Millions)
Held Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic
2003 1999
1985 2002 1989 1997
1989/94/03
1995 2/4/2000
1997 1993196
2004
1991/95/99/01/03 1992196
1995 1997 2000 1998 1993 2004 1993 1997 2001
1995104 1997 2003 2001 2003 2004
Buana Bank ITCF LYON-MLF-Ibis Manulife P.T. Gawi PT Agro Muko PT Alumindo PT Astra PT Astra Graphia PT Astra Otopart PT Bakrie Pipe PT Bank NISP PT Berlian PT Bina Danatama PT Ecogeen PT Grahawita '
PT Indo-Ram PT K IA Keramik PT KIA Serpih PT Kalimantan PT Mako PT Megaplast PT Nusantara PT Prakars (PAS) PT Samudera PT Sayap PT Sigma PT Viscose PT Wings SMM Sunson Verdaine Wilmar
0 40
2.01 0
11.5 0
8.47 0 0 0
23.71 35
0 4.41
30 0 5
1.65 4.5 15 0
5.25 7.63
35 0
4.17 0
9.5 3.62
12 12.41
14 20
12.16 0 0
0.32 0
2.2 0
1.24 2
1.07 0 0
13.96 1.73
0 0 0 0 0
15 2.61 2.5
0 0 5 0 3 0 0
' 0 0 0 0
0 0 0 0 0 0 0 0 0 0
9.53 0 0 0 0 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
0 0 0 0
2.01 2.01 0 0
10 5.35 0 0 2 8.47 0 0 0 0 0 0 0 23.71 0 35 0 0
8.19 4.41 0 30 0 0 0 4.88
53.49 1.65 49.5 4.5
0 15 0 0 0 5.25
5.93 7.63 10 24.12 0 0 0 4.17 0 0 0 0 0 3.62 0 9
7.85 12.41 0 14 0 0
12.16 0 0
0.32 0
2.2 0
1.24 2
1.07 0 0
10.61 1.73
0 0 0 0 0
15 2.61 2.5
0 0 5 0 3 0 0 0 0 0 0
0 0 0 0 0 2.01 0 0 0 4.65 0 0 0 2 0 0 0 0 0 0
9.53 0 0 0 0 0 0 8.19 0 0 5 0 0 0 0 53.49 0 49.5 0 0 0 0 0 0 0 5.93 0 6.88 0 0 0 0 0 0 0 0 0 0 0 0 0 7.85 0 0 0 0
Total Portfolio: 304.8 62.79 14.5 149 215.2 59.44 14.5 141
Approvals Pending Commitment Loan Quity Quasi Partic
2005Astra Otoparts 2 24 0 0 0 48 0 0 0 2004Indorama Captive
2005NISP Bussan 22.75 0 0 0
Total Pending Commitment: 94.75 0 0 0
78
Annex 9: Indonesia at a Glance
214 3 810
1x3 5
1 3 1 2
17 43 86 47 25 76 10
111 122 110
m 3 153 0 1 3 I 8 a 3 a# *4 3 2 8
P 4 33338
2m2
3 T 2 2
4.6
Past *ala & PaMe
1 ,855 1 ,om 201%
1!3 1 1
40 89 32 i s as I D
111 112 111
2aar 173.0 20 3 35 8 28 8 23 4
4 5 2 7
78 5 a 4 79 B
221 5
ma 4 4 2 6 4 0
20Qf 208.3
29 7 31.2 26 3 28.4
3 8 2Q
64 5 340
4 1 91 3 9
Life expectancy
I
Access to improvsd %vat8 SOUIW
monomie ratlca"
Trade
I T
STRUCTURE ob the ECONOMY
~~~~
4 ricu kun Industry
s?Nices Privirta mumpt i cm General govemrnent consumpikn lmpoh of go& and sewices
Man ufaciwlng
a983 I933 z(w2 2009
22.9 17.9 17.1 16.8 39.8 3 . 7 44.2 43.6 12.7 P . 3 25.4 24.7 37.3 42.4 38.7 39.9 a . 9 59.5 fi5.0 86.6 10.4 5.0 8 2 9.2 27.R 23.8 251.3 25.7
5983.m dB9393 am2 83003 trwwge ~~~1~~~ & ncw nu n 3 8 1 7 2 0 2.5 Industry 9 0 2 8 3 5 34
Msnukduriflg 116 3 7 3 4 33 %sIwces 7 0 1 3 4 6 6 6
Pnvate msumptlcm 4 8 4 2 3 8 4 0
Gmss domesbc inwstrrmnt 102 -1 3 0 2 1 4 General pcwemmont eonsumpiion 5 1 1 5 128 ga
Imporb of goods and wwiem 4 8 0 5 -50 2 0
Note 2003 data are preliminary enimabs GDP based on 1993 prices *The diemondsshmvfour b y indicsbxf in thecountry (in bold) compcueel wW Its income-group average If data are missing, the diamondwili
be incomplete
79
11.8 9.6 14.3 8.9
.. 16.8
.. 3.5 18.5 19.1 7.4 0.4 -1.1 -2.1
1w 1493
.. 38,823
.. 9,745
.. 859
.. 16,699
. 20,328
.. 1,342
.. 2,155
. 12,158
.. 112
.. 102
.. 110
18,2?8 40,5836 22,037 30,222 2,0m 2,344 .w52 -4,987
114 537
-5,338 -2,106
6,521 2,700 -183 .&Q4
4.814 12,355 809.3 2.0B7.1
$ 1 3 t993
30.2B 88,172 2,133 11,283
7%3 796
3,741 14,089 m4 1,620
I O 24
104 219 1,180 2,344 2,961 3,3#7
2w 2,004 0 2,452
1,210 924 1,195
FX? 782 451 413
2BEi 448 in ae?i
2062 3
57,159 81,058 12.138 13,700 1.238 1.191
19,119 19,680 31,289 32,651 2,052 3,121 8,658 7,684 8,BOS 7.100
139 161 59 64
237 237
2ao2 2003
w , w 17,440 51,019 65,629 13,575 11,iJil
8,081 -6.123 1.129 1,564 7,823 1,252
-3.000 -2,96)5 4,023 -4,257
31,013 36,170 9,311.2 8,517.0
k 9,779 132264 134,320 '10,729 8.779
794 880 G 24.300 E: 880
17,364 21.323 1,905 2,003
33 33
L Clop76
r E61.281
E - Blataal % I %!: 0-Otbrrnullilatatal F - P r M s 1.0835 1,294 G - short-!" 698 -886 873 142
-1519 -1,628
The World E& Gmp: This Wle was prepsrod by arrntry unit sW. figure3 may differ frcm other Wcrld published data. 9izom
80
F
INTERNATIONAL MONETARY FUND
December 20,2004
To: Mi-. Andrew Steer World Bank Jakarta Office
Subject: Indonesia: Assessment Letter
Please find attached an updated letter of assessment of Indonesia’s macroeconomic policy based on the findings of the mission that visited Jakarta during December 1-9. In keeping with the guidelines, this letter will not be transmitted by the IMF Board, and so you should consider this as the formal transmission. The letter will be circulated to our Board.
Odd Per Brekk Mission Chief for Indonesia (HQ 3-202, ext. 623-9892)
U
P
Indonesia: Assessment Letter (Update)
This note updates the IMF Assessment Letter dated November 19,2004. The update is based on the findings of the IMF staff mission to Indonesia during December 1-9.
Economic developments remain favorable. Fund staff estimates indicate that real GDP growth could reach 5 percent this year, with end-year inflation now projected at 6 percent. Financial markets have remained strong, with the stock market continuing to reach new highs. However, the budget deficit for the year is now expected to be somewhat higher than targeted, due to lower income tax collections and higher fuel subsidies and shortfalls in profit transfers from Pertamina (state-owned oil company) as a result of higher oil prices. On the external front, despite a surge in imports, the current account is expected to register a surplus of 3.3 percent of GDP in 2004, reflecting strong export growth. International reserves have edged up to about US$36 billion and remain comfortable at 150 percent of short-term debt.
The mission was encouraged by the new government’s determination to build on the progress so far, including its emphasis on maintaining macroeconomic stability and moving ahead forcefully with structural reforms to improve the investment climate.
With sound economic policies, the outlook is promising. Growth is projected at 5.5 percent and inflation to remain in the 6 percent range. The authorities intend to pursue further fiscal consolidation, and aim to limit the budget deficit to about 1 percent of GDP in 2005. The government is moving to improve the business climate, including by resolving some long- standing investor disputes, taking visible actions to address corruption, and improving the flexibility of the labor market.
Nevertheless, risks remain. The government’s intention to provide a tax amnesty could result in revenue losses if not complemented by appropriate measures to enhance tax compliance. The government also faces the politically difficult decision of eliminating fuel subsidies, which will be important to make room for spending in high-priority areas such as infrastructure. Asset quality at state banks remains weak and governance, including internal controls and risk management, needs to be further improved. Finally, early and demonstrable actions to address corruption and improve governance in the public sector (including in tax administration), and to strengthen the judicial and regulatory system to ensure creditor rights and sanctity of contracts, will be key to attracting investment and generating growth and employment.