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Indonesia: Eighth Review Under the Extended Arrangement and Request for Waiver of Performance Criterion

Author(s):
International Monetary Fund
Published Date:
December 2003
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I. Background and Performance Under the Program

A. Background

I. Much has been achieved over the past three years under Indonesia’s extended arrangement. Macroeconomic stability has been restored, international reserves have been rebuilt to a more comfortable level, the banking system has been strengthened, IBRA asset recoveries have advanced, and steps have been taken to enhance governance. Nevertheless, the investment climate remains weak and economic growth has been disappointing relative to original program targets (which had envisaged growth of 5–6 percent by now).

2. As Indonesia enters the final year of the EFF arrangement, the priority has shifted from macroeconomic stabilization to advancing the unfinished structural reform agenda. In addition to ensuring the maintenance of macroeconomic stability and further steps to enhance debt sustainability, the 2003 program focuses on strengthening the banking system, and legal and other reforms to enhance the investment climate.

3. While recent policy implementation has been generally favorable, there is a risk that support for reforms could diminish as the year unfolds. Political maneuvering is rising in advance of the 2004 elections, and President Megawati’s government has already come under pressure this year. This was apparent in January, when the government reacted to street protests by rolling back a scheduled increase in fuel prices that was intended to eliminate poorly targeted subsidies, and which had received parliamentary approval. Observers have noted that the protests were mainly politically motivated, with the aim of destabilizing the government. They have also emphasized that the authorities’ policy agenda is not well understood by the general public, suggesting that to ensure its credibility, the government will need to spare no effort in explaining its program to civil society as well as forcefully pressing ahead with policy implementation.

4. Indonesia’s post-2003 relationship with the Fund following the expiration of the extended arrangement has also become the focus of domestic political debate. A team has been commissioned by the President to study post-2003 strategic and financing options. The authorities have stated publicly their desire to graduate from exceptional financing when the extended arrangement expires at the end of the year.

B. Recent Developments and Performance Under the Program

5. Macroeconomic developments have evolved broadly as projected, and performance against end-2002 quantitative program targets was favorable (Table 2, MEFP Table 2, and Figure 1). While the October Bali attack has undoubtedly had an effect on tourism, indicators related to private consumption have held up better than expected, and the impact of the attack now appears less severe than originally feared:

  • The preliminary outturn for real GDP growth in 2002 was 3.7 percent, above the 3¼ percent projected at the last review, and within the original 2002 program range. However, investment has remained weak, and demand was led by private consumption (Box 1).

  • Inflation has continued to moderate, to 7.3 percent (12-month basis) in February (Figure 2), The recent decline has been somewhat steeper than expected, due to a fall in food prices. Still, core inflation continues to trend down, and now stands at about 8 percent.

  • The preliminary balance of payments outturn for 2002 is also somewhat more favorable than projected at the last review (Table 3). The current account surplus amounted to over $7 billion (4.2 percent of GDP), reflecting continued sluggishness in imports, and a better-than-expected services balance notwithstanding the sharp decline in fourth-quarter tourism receipts. On the capital account, official financing in 2002 was substantially lower than expected (mainly reflecting slow disbursement of project loans) and FDI inflows declined slightly; but this was offset by an improvement in portfolio flows. As a result, the end-December NIR target was met with a large margin, and reserves accumulation for the year amounted to $3½ billion, bringing gross reserves to $32 billion (equivalent to seven months of imports and sufficient to more than fully cover short-term debt).

  • Financial markets have maintained the positive trends recorded through much of 2002, rebounding from the effects of the Bali attack and so far being relatively unscathed by the ongoing geopolitical tensions (Figure 3). The rupiah has stabilized at below Rp 9,000 per dollar, and stock prices have recovered. Indonesia’s sovereign credit ratings have also been maintained, following the third quarter upgrade.

Stock Market and Exchange Rate Developments

Table 1.Indonesia: Schedule of Reviews and Purchases
Purchases
DateIn Millions of SDRIn Percent of QuotaConditions
Completed purchases
February 4, 2000260.0012.5Approval of extended arrangement
June 2, 2000281.5013.5First review completed by the Board
September 10, 2000309.6514.9Second review completed by the Board
September 10, 2001309.6514.9Third review completed by the Board
January 28, 2002275.2413.2Fourth review completed by the Board
April 26, 2002275.2413.2Fifth review completed by the Board
June 21, 2002275.2413.2Sixth review completed by the Board
December 5, 2002275.2413.2Seventh review completed by the Board
Total2,261.76108.8
Remaining purchases
March 24, 2003344.0616.5Eighth review and end-December 2002 performance criteria
May 15, 2003344.0616.5Ninth review and end-March 2003 performance criteria
August 15, 2003344.0616.5Tenth review and end-June 2003 performance criteria
November 15, 2003344.0616.5Eleventh review and end-September 2Û03 performance criteria
Total1,376.2466.2
Total3,638.00175.0
Table 2.Indonesia: Selected Economic Indicators, 1996/97-2003 1/
1996/971997/981998/991999200020012002

Est.
2003

Proj.
Real GDP (percent change)8.21.7−13.60.84.93.43.73.5-4
Domestic demand9.51.2−17.2−2.14.05.11.94.2
Of which:
Private consumption8.06.5−5.54.61.64.44.74.1
Grass fixed investment17.6−0.1−37.9−18.216.77.7−0.22.5
Net exports 2/−1.50.54.02.91.0−1.51.8−0.5
Errors and omissions 2/−0.5−2.4−1.5−0.9−1.1−0.5−2.40.0
Savings and investment (in percent of GDP)
Gross fixed capital investment29.829.222.720.121.821.820.220.0
Gross national savings26.428.027.124.227.226.724.422.2
Foreign savings3.41.1−4.5−4.1−5.3−4.9−4.2−2.2
Prices (12-month percent change)
Consumer prices (end period)4.735.846.52.09.312.510.09.0
Consumer prices (period average)5.711.364.820.73.811.511.99.0
Public finances (in percent of GDP)
Central government revenue 3/14.915.414.916.820.020.818.617.9
Central government expenditure13.816.717.218.321.124.520.319.7
Central government balance1.1−1.3−2.3−1.5−1.1−3.7−1.6−1.8
Central government debt22.961.566.688.6100.390.979.364.1
Money and credit (end of period)
Rupiah M227.439.439.917.013.813.67.912.7
Base money13.968.132.535.522.82.18.313.0
One-month SBI rate (period average)12.115.048.222.712.416.514.912.3
Balance of payments (in billions of U.S. dollars)
Oil and gas (net)7.65.74.25.98.66.45.15.5
Non-oil exports (f.o.b)39.345.941.141.050.344.845.34S.1
Non-oil imports (c.i.f)−45.7−42.9−30.7−29.0−37.1−31.3−29.8−33.5
Current account balance−8.1−1.74.65.88.06.57.24.7
Overall balance6.1−13.40.90.01.2−2.91.0−3.0
Grass reserves
In billions of U.S. dollars (end period) 4/25.810.720.324.329.428.032.033.0
In months of imports5.43.15.35.37.16.97.16.9
As a percent of short-term debt 5/77.124.460.378.184.392.6126.3155.5
External debt (medium- and long-term)
In billions of U.S. dollars127.4138.0149.9148.7141.7131.2128.1126.3
(In percent of GDP)54.292.9144.994.994.392.774.059.3
Exchange rate
Rupiah per U.S. dollar (period average)2,3644,6679,8497,8558,42210,2469,2959,000
Nominal effective exchange rate 6/99.371.62S.033.732.328.030629.8
Real effective exchange rate 6/97.874.649563.962.759.772.675.1
Memorandum items;
Indonesia oil production ((000 bepd)1,5231,5011,4761,4711,3881,3201,2601,200
Indonesian oil price (US$/bbl)20.716.911.917.428.123.623.524.1
Nominal GDP in trillions of rupiah5566931,0191,1001,2651,4491,6101,916
Nominal GDP in billions of U.S. dollars235149104140150141173213

Fiscal years from 1996/97 to 1998/99 (fiscal year starts April 1). Calendar years from 1999 onward, with the exception of public finances for 1999 and 2000 which are based on fiscal year 1999/00 and the 9-month fiscal year from April to December, respectively.

Contribution to GDP growth. Errors and omissions includes stock building.

Includes grants.

From 2002 onward reflects higher reserves reported in general ledger.

Short-term debt is on a remaining maturity basis before rescheduling and including IMF repurchases.

Period average (June 1997=100).

Fiscal years from 1996/97 to 1998/99 (fiscal year starts April 1). Calendar years from 1999 onward, with the exception of public finances for 1999 and 2000 which are based on fiscal year 1999/00 and the 9-month fiscal year from April to December, respectively.

Contribution to GDP growth. Errors and omissions includes stock building.

Includes grants.

From 2002 onward reflects higher reserves reported in general ledger.

Short-term debt is on a remaining maturity basis before rescheduling and including IMF repurchases.

Period average (June 1997=100).

Figure 1.Recent Macroeconomic Developments

Sources: Data provided by the Indonesian authorities; CEIC; Danareksa Research Institute; and Fund staff estimates.

Figure 2.Market Sentiment and Financial Indicators

Sources: Data provided by the Indonesian authorities: and Fund staff estimates.

1/ As of November 20132.

Table 3.Indonesia: Balance of Payments, 2000–03(In billions of U.S. dollars)
2000200120022003
ActualActual7th ReviewEstimateProjection
Current account8.06.95.57.24.7
Trade balance21.819.820.520.620.1
Exports (fob)65.457.457.357.361.0
Oil and gas15.112.112.212.112.9
Non-oil and gas50.344.845.245.348.1
Imports (cif)−43.6−37.5−36.8−36.7−40.9
Oil and gas−6.5−6.2−6.4−7.0−7.4
Non-oil and gas−37.1−31.3−30.5−29.8−33.5
Services (net)−13.8−12.9−15.0−13.4−15.4
Nonfactor services (net)6.57.1−7.9−7.3−9.1
Factor services−7.2−5.S−7.1−6.1−6.3
Capital account-6.9-9.8-6.0-6.2-7.7
Nonfinancial public sector−0.9−2.7−3.0−3.7−3.2
Disbursements4.02.93.22.43.4
Amortization−4.9−5.6−6.3−6.1−6.6
Banking sector (net)−1.70.10.50.2−0.5
Disbursements1.32.01.61.41.0
Amortization−3.0−1.9−1.1−1.1−1.4
Private sector (net)−4.3−7.2−3.5−2.8−4.0
FDI2.82.62.62.42.2
Other−7.0−9.3−6.1−5.1−6.1
Portfolio investment−1.9−0.20.91.10.0
Other private sector (net)−5.1−9.5−7.0−6.26.1
Overall balance1.2-2.9-0.51.0-3.0
Financing-1.22.90.5-1.03.0
NIR−3.50.0−3.0−4.5−0.5
Gross reserves−5.01.4−2.1−3.5−1.0
Reserve liabilities1.5−1.4−0.9−0.90.5
Public sector rescheduling 1/2.42.93.53.53.5
Memorandum items:
Gross reserves (c.o.p.) 2/29.423.030.132.033.0
In months of imports of goods and nonfactor services7.16.96.87.16.9
As a ratio to short-term debt0.840.931.011.271.56
Non-oil and gas exports, volume growth (percent)17.6−7.9−1.3−1.21.0
Non-oil and gas imports, volume growth (percent)28.9−13.1−4.3−6.57.8
Terms of trade, percent change10.0−1.40.20.20.6
Current account (in percent of GDP)5.34-73.04.22.2
Stock of public sector external debt (excluding state-owned banks)80.074.173.676.376.0
(In percent of GDP)53.252.440.144.035.7
Nonfinancial public sector debt service/XGNFS 3/12.417.619.618.616.7
Indonesian oil price28.123.623.523.524.1
GDP (in billions of U.S. dollars)1.50141184173213
Sources: Data are provided by the Indonesian authorities; and Fund staff estimates.

For 2003, debt relief of $3.1 billion has already been committed. Full interest resheduling would provide an extra $0.4 billion of financing.

Projections from 2002 onward reflect higher reserves reported in BI’s general ledger.

Before rescheduling and including IMF repurchases.

Sources: Data are provided by the Indonesian authorities; and Fund staff estimates.

For 2003, debt relief of $3.1 billion has already been committed. Full interest resheduling would provide an extra $0.4 billion of financing.

Projections from 2002 onward reflect higher reserves reported in BI’s general ledger.

Before rescheduling and including IMF repurchases.

Figure 3.Monetary and Inflation Developments

Sources: Dala provided by the Indonesian authorities; CEIC; and Fund staff estimates.

1/ Nonfood, excluding administered prices.

2/ Using core inflation.

3/ Using ratio of 5:1 on real SBI and REER.

4/ At constant exchange rate.

5/ Data adjusted to account for loan transfers to and from IBRA.

6. Base money has remained well within the program path, and the end-December performance criterion on NDA was met with a significant margin (Table 4). Following cuts totaling 300 basis points from April to November, BI’s overnight deposit facility rate (previously known as the rupiah intervention rate) was reduced by about 60 basis points in early March, and now stands at 11.5 percent; the one-month SBI rate has continued to ease, reaching 11.6 percent in mid-March.

Table 4.Indonesia: Monetary Survey, December 2000–December 20031/(In trillions of rupiah, unless otherwise indicated)
2000200120022003
Dec.Dec.Sep.Dec.Mar.Jun.Sep.Dec.
ActualActualProgramActualProjected
(End-of-period)
Monetary Survey
Net Foreign assets119.0141.9164.2163.0178.8186.71894192.1194.9
(In billions of U.S. dollars)17.020.323.523.325.526.727.127.427.8
Net domestic assets590.1651.6663.5734.1674.6686.8710.2734.0766.3
Net claims on government526.5539.3536.4569.7515.2519.3521.7511.8507.4
Claims or private sector263.4294.8343.3377.4369.0373.8391.9419.8454.9
Rupiah claims178.4224.2272.6306.7295.7301.2317.8344.3377.9
Foreign exchange claims85.070.770.770.773.372.674.175.577.0
Other items (net)−199.9−182.6−216.2−213.1−209.6−206.4−203.4−197.6−196.0
Broad money (M2)709.1793.5827.7897.0853.4873.4899.6926.1961.2
Rupiah broad money606.8689.3716.6779.3743.4760.2783.1806.2837.8
Currency72.476.372.885.280.778.181.183.794.2
Deposits 2/534.5612.9643.8694.0662.8682.1702.0722.5743.6
Foreign exchange deposits102.3104.2111.2117.8110.0113.2116.5119.9123.4
Bank of Indonesia
Net international reserves 3/124.5128.1145.1138.3155.1155.3155.4155.5155.6
Net domestic assets0.4−0.5−21.33.9−16.8−24.5−19.4−15.60.6
Net claims on government136.1166.8176.2197.3172.0189.0198.1195.9193.1
Claims on private sector7.77.88.37.88.38.38.3S.38.3
Claims on DMBs44.6−69.6−83.3−65.2−80.9−105.6−109.6−103.6−84.6
Open market operations−78.0−102.6−115.9−98.2−113.3−138.1−142.1−136.0−117.0
Other items (net)−98.7−105.5−122.4−135.9−116.3116.3−116.3−116.3−116.3
Base money 4/125.0127.7123.9142.2138.2130.7136.0139.9156.2
Currency outside banks72.476.372.885.280.778.181.183.794.2
DMBs50.749.649.653.955.951.053.254.560.4
Nonbank deposits2.01.71.53.01.61.61.61.61.6
Memorandum items:
Base Money test date 5/118.1124.7120.8138.2132.2129.3134.5138.1150.4
NIR of BI (billions USD)17.818.320.719.822.222.222.222.222.2
Motley multiplier (rupiah broad money)4.95.45.85.55.45.85.85.85.4
Base money velocity 6/10.811.413.212.211.714.314.014.012.5
Rupiah broad money velocity 6/2.22.12.32.22.22.42.42.42.3
Annual percentage change:
Broad money (constant exchange rate)10.011.911.213.17-610.510.911.912.6
Rupiah broad money13.813.611.413.17.911.611.912.512.7
Base money22.82.17.611.48.311.813.412.913.0
Private sector claims 7/5.217.920.228.023.624.522.622.323.3
Sources: Data provided by Indonesian authorities; and Fund staff estimates.

All foreign currency denominated components are valued at the program exchange rate.

Includes nonbank private sector deposits held at BI (Rp 1.6 trillion at December 2002).

From December 2002 (actual) based on general ledger.

Data on base money differ from those presented in Table 2 of the MEFP, which arc based on period averages rather than endpoint values.

Test date outcome based on 10-day average centered at end-month for 2000; 30-day average centered at end-month from 2001.

Calculated using end-period quarterly GDP, annualized.

Adjusted for transfers to and from IBRA. Projections make allowance for credit growth associated with IBRA bond-for-loan swaps, IBRA loan and asset sales, and privatization.

Sources: Data provided by Indonesian authorities; and Fund staff estimates.

All foreign currency denominated components are valued at the program exchange rate.

Includes nonbank private sector deposits held at BI (Rp 1.6 trillion at December 2002).

From December 2002 (actual) based on general ledger.

Data on base money differ from those presented in Table 2 of the MEFP, which arc based on period averages rather than endpoint values.

Test date outcome based on 10-day average centered at end-month for 2000; 30-day average centered at end-month from 2001.

Calculated using end-period quarterly GDP, annualized.

Adjusted for transfers to and from IBRA. Projections make allowance for credit growth associated with IBRA bond-for-loan swaps, IBRA loan and asset sales, and privatization.

7. The 2002 budget deficit outturn was also well within the program target (Table 5). The full-year deficit was only Rp 26.3 trillion (1.6 percent of GDP), compared with the program ceiling of Rp 42.1 trillion (2.5 percent of GDP). Overall revenues were broadly in line with expectations. Encouragingly, non-oil tax collections (mainly VAT and excise receipts) exceeded expectations in the fourth quarter, due in part to improvements in tax administration implemented during the year.1 Expenditure was significantly lower than expected, owing to a combination of factors, including savings on current expenditures (including lower external interest payments) and some lags in implementation of development projects.

Table 5.Indonesia: Summary of Central Government Operations, 2001–03
200120022003
Budget7th ReviewActualBudgetProj.
(In trillions of rupiah)
Revenues and grants301.1301.9300.6300.2336.2344.0
Oil and gas revenues104.174.284.377.271.081.1
Nun-oil and gas revenues196.5227.7216.3223.0265.2262.9
Tax revenues162.4203.9189.9193.7239.4237.1
Nontax revenues 1/34.523.726.429.225.825.8
Expenditure and net lending354.4344.0342.7326.5370.6378.4
Central government expenditure273.3246.0244.9228.0253.7260.0
Current expenditure226.1197.1205.0192.7195.8202.1
Personnel38.741.842.239.850.250.2
Subsidies77.441.643.840.025.532.8
Interest94.988.591.589.982.081.2
External28.929.027.725.426.826.0
Domestic66.059.563.864.555.255.2
Other15.025.227.523.133.137.9
Development expenditure 2/41.648.939.936.957.957.9
Statistical discrepancy5.60.00.0−1.60.00.0
Transfers to regions81.198.097.898.5116.9118.4
Overall balance−53.3−42.1−42.1−26.3−34.4−34.4
Financing53.342.142.126.334.434.4
Domestic46.526.031.624.022.522.5
Bank financing 3/7.20.00.0−21.8−11.5−11.6
Cash recovery of bank assets 4/28.043.643.643.326.026.0
Privatization of nonfinancial assets3.56.56.57.68.08.0
Other7.8−24.1−18.5−5.10.00.0
External6.816.110.52.412.012.0
(In percent of GDP)
Revenues and grants20.817.917.518.617.317.9
Oil and gas revenues7.24.44.94.83.742
Non-oil and gas revenues13.613.512.613.813.7137
Tax revenues11.212.111.112.012.3124
Nontax revenues 1/2.31.41.5l.81.31.3
Expenditure and net lending24.520.420.020.319.119.7
Central government expenditure18.914.614.314.213.113.6
Current expenditure15.611.711.912.010.110.5
Personnel2.72.52.52.52.62.6
Subsidies5.32.52.62.51.31.7
Interest6.65.35.35.64.24.2
External2.01.71.61.61.41.4
Domestic4.63.53.74.02.82.9
Other1.01.51.61.42.02.0
Development expenditure 2/2.92.92.32.33.03.0
Statistical discrepancy0.40.00.0−0.10.00.0
Transfers to regions5.65.S5.76.16.06.2
Overall balance−3.7−2.5−2.51.6−1.8−1.8
Financing3.72.52.51.61.81.8
Domestic3.21.51.81.51.21.2
Bank financing 3/0.50.00.0−1.4−Û.6−0.6
Cask recovery of bank assets 4/1.92.62.52.71.31.4
Privatization of nonfinancial assets0.20.40.40.50.40.4
Other0.5−1.4−1.1−0.30.00.0
External0.51.00.60.10.60.6
Memorandum items;
Primary balance2.92.82.93.92.52.4
Non-oil primary balance−4.3−1.7−2.0−0.9−1.2−1.8
Non-oil overall balance−10.9−6.9−7.4−6.4−5.4−6.0
GDP (in billions of rupiah)1,4491,6851,7161,6101.9401,916
Sources; Data provided by the Indonesian authorities: and Fund staff estimates.

Includes Rp 0.5 trillion in grants in 2001, and Rp 0.3 trillion in grants in 2002.

Excludes military expenditures, which are included in other current expenditure.

In 2003, includes Rp 7.7 trillion for issuance of government debt, Rp 21.5 trillion in domestic debt amortization, and Rp 15 trillion in debt buy-backs.

For 2002 and 2003, includes total IBRA receipts (rather than only the amount needed to finance the deficit).

Sources; Data provided by the Indonesian authorities: and Fund staff estimates.

Includes Rp 0.5 trillion in grants in 2001, and Rp 0.3 trillion in grants in 2002.

Excludes military expenditures, which are included in other current expenditure.

In 2003, includes Rp 7.7 trillion for issuance of government debt, Rp 21.5 trillion in domestic debt amortization, and Rp 15 trillion in debt buy-backs.

For 2002 and 2003, includes total IBRA receipts (rather than only the amount needed to finance the deficit).

8. Performance against the November and December structural benchmarks was satisfactory (Table 6). IBRA exceeded its annual cash recoveries target; enforcement actions were initiated against noncompliant former bank owners under their shareholder settlement agreements (see ¶33 below); further progress was made in the bank divestment program, with the launching of the sale of a majority stake of Bank Danamon in early December; the Anti-Corruption Commission (ACC) was established with the passage of its enabling legislation; and the government conducted a successful auction of government securities. However, the structural performance criterion on the implementation of the burden sharing agreement on Bank Indonesia liquidity credits (BLBI) between BI and the government was again not met. Implementation of the agreement awaits completion of parliamentary discussion, which was initiated in January (¶30). The benchmarks on the completion of the third round of audits of state enterprises and the quarterly reporting of local government finances were also not fully met. The former is now expected to be completed in July (¶43), and the latter (for which the reporting coverage was only 65 percent of regions, compared to the benchmark of 85 percent) is expected to be completed shortly.

Table 6.Indonesia: Structural Benchmarks for the Eighth Review
MeasuresStatus1
November 2002
  • Initiate legal and other enforcement actions against former bank owners issued final determination of noncompliance in relation to the shareholder settlement agreements.

  • Launch sale of a majority stake in Bank Danamon.

Completed in early December.
December 2002
  • Implement burden sharing agreement on BLBI between BI and government.2

Pending.
  • Complete third round of special audits of state enterprises and adopt corrective actions.

Expected in July.
  • Collect at least Rp 36.1 trillion in cash by IBRA (net of expenses).

  • Establish Anti-Corruption Commission.

  • Begin primary auctions of government securities.

  • Produce quarterly report on local government finances through June 2002 with coverage of at least 85 percent of jurisdictions.

Report prepared covering 65 percent of regions; actions underway to increase coverage to 85 percent by end-April.

A

indicates that the structural benchmark was met on time.

Performance criterion.

A

indicates that the structural benchmark was met on time.

Performance criterion.

9. Satisfactory progress was also made in other areas of the structural reform agenda. The annual privatization receipts target (Rp 6.5 trillion) was exceeded with the successful sale of the telecommunications company Indo sat. As already noted, good progress was also made in implementing tax administration reforms, particularly with respect to arrears collections and the expansion of tax audits.

II. Policy Discussions and the 2003 Program

10. The discussions focused on advancing the unfinished reform agenda, and strengthening the investment climate. Recent economic developments provided some indication that implementation of the government’s overall strategy was bearing fruit. Both economic activity and financial markets had shown an impressive resilience to the Bali attack. The staff therefore stressed the importance of adhering to the program, particularly given that the political environment for reform was becoming more difficult and in view of Indonesia’s desire to graduate successfully in 2004 from exceptional financing.

A. Macroeconomic Framework

11. The macroeconomic objectives for 2003 remain broadly unchanged from those presented at the seventh review. GDP growth is projected in the 3½—4 percent range, and inflation is expected to run at 9 percent.2 The program targets an increase in gross reserves of $1 billion, sufficient to raise the coverage of short-term debt to about 150 percent while keeping import cover broadly unchanged.

12. The main risks to the outlook stem from a slowdown in policy implementation and from exogenous shocks related to a war in the Middle East or global weakness. On the domestic front, a slowdown in policy implementation, combined with investor uncertainty ahead of the 2004 elections, could threaten the recovery. The risks of an external crisis, however, are relatively low given the flexible exchange rate regime and comfortable level of reserves (Box 2, and Tables 7 and 8). Moreover, the effects of a sharp rise in oil prices would be mitigated given Indonesia’s status as an oil exporter. A relatively low dependence on market financing would also act to limit vulnerability to global credit market events.

Table 7.Indonesia; Indicators of External Vulnerability, 1996/97-2003
1996/971997/981998/9919992000200120022003
Key economic and market indicators
Real GDP growth (in percent)8.21.7−13.60.84.93.43.73.5
CPI inflation (period average, in percent)5.711.964.820.73.811.511.99.0
Short-term (ST) interest rate (in percent)12.11548.222.712.416.514.912.3
EMBI plus secondary market Spread (bps, end of period)114508839458677479347
Exchange rate NC/US$ (end of period)2,4198,3258,6857,0859,59510,4008,9509,200
External sector
Current account balance (percent of GDP)−3.4−1.14.54.15.34.94.22.2
Net EDI inflows (percent of GDP)3.76.35.52.41.81.81.41.0
Export growth (US$ value, GNFS)9.76.8−15.41.826.5−10.9−0.54.8
Real effective exchange rate (1995 = 100)106.681.353.969.768.365.179.181.9
Gross international reserves (GIR) (in billions of U.S. dollars)25.810.720.324.329.428.032.032.6
GIR in percent of short-term debt at remaining maturity84.130.366.473.884.392.6126.3153.7
Net international reserves (NIR) (in billions of U.S. dollars)26.713.315.916.017.818.322.222.2
Total gross external debt in percent of GDP60.399.4156.9113.299.697.575.160.3
Of which: Short-term debt (original maturity in percent of GDP)6.16.512.16.95.34.71.20.9
Private sector debt (in percent of GDP)22.946.166.743.043.542.332.025.7
Total gross external debt in percent of exports of GNFS243.2237.1308.0285.0212.7220.2208.8196.6
Public sector1/
Overall balance (percent of GDP)0.8−1.6−2.2−1.5−1.1−3.7−1.6−1.8
Primary balance (percent of GDP)2.00.00.92.44.02.93.92.4
Debt-stabilizing primary balance (percent of GDP) 2/2.32.52.3
Public sector gross debt (in percent of GDP) 3/24.566.170.192.1104.194.281.565.5
Externa1 debt from official creditors (in percent of total)65.363.449.334.044.443.841.745.3
External debt from private creditors (in percent of total)28.229.622.613.30.60.50.10.0
Domestic debt linked to foreign currency (in percent of total)0.00.00.02.82.62.92.01.0
Domestic debt linked to ST interest rate or inflation (in percent of total)0.00.00.019.816.716.118.118.1
Public sector net debt (in percent of GDP)
Financial sector
Capital adequacy ratio (in percent) 4/5/6/11.89.2−52.2−8.121.718.523.4
NPLs in percent of total loans 4/6/11.350.932.915.012.18.7
Provisions in percent of NPLs 4/6/36.434.434.587.095.096.4113.1
Return on average assets (in percent) 4/6/−8.70.30.71.7
FX deposits (in percent of total deposits)22.231.525.919.220.820.218.2
FX deposits (in percent of gross international reserves)82.0123.772.965.630.852.549.0
FX loans (in percent of total loans)20.039.836.937.639.832.628.9
Financing requirements
Grass external financing requirement (GEFR) (in billions of U.S. dollars)25.340.429.722.714.818.99.512.8
Of which: Amortization of MLT debt, public (in percent of total GEFR) 7/40.820.142.443.853.349.6101.273.2
Amortization of MLT debt, private (in percent of total GEFR) 8/−29.451.731.238.747.551.554.247.9
Maturing ST debt (in percent of total GEFR)56.824.042.042.953.535.521.115.6
Current account balance (in percent of total GEFR)31.84.2−15.5−25.4−54.4−36.6−76-5−36.7
Gross public sector financing requirements (GPSFR) (in billions of U.S. dollars) 9/4.36.35.34.95.211.89.812.4
Of which: Amortization of MLT debt (in percent of total GPSFR) 10/143.962.456.655.217.330.147.738.9
Maturing ST debt (in percent of total GPSFR)3.21.41.71.3
Overall public sector deficit (in percent of total GPSFR)−43.937.643.444.824.743.929.030.8

Nonfinancial public sector (including state-owned enterprises). For 1999 and 2000, data are for FY 1999/00 and FY 2000, respectively.

Based on GDP growth of 2.4 percent (annual average for 1995/96-2002) and a real interest rate of 5 percent.

Medium- and long-term debt. Excludes IMF outstanding purchases.

From 1999 onward, top 15 banks only (which account for over 80 percent of total deposits).

Data for 1995/96, 1996/97 and 1997/98 are for December 1995, December 1996 and December 1997, respectively.

2002 column refers to end-September.

Includes banking sector amortizations and IMF repurchases.

Due to data deficiencies, this item represents net MLT capital flows to the corporate sector (which were positive prior to 1997/98) and net portfolio investment flows.

Includes ST debt (all external).

Based on fiscal data for external MLT amortization (net of rescheduling), domestic debt amortization, and IMF repurchases.

Nonfinancial public sector (including state-owned enterprises). For 1999 and 2000, data are for FY 1999/00 and FY 2000, respectively.

Based on GDP growth of 2.4 percent (annual average for 1995/96-2002) and a real interest rate of 5 percent.

Medium- and long-term debt. Excludes IMF outstanding purchases.

From 1999 onward, top 15 banks only (which account for over 80 percent of total deposits).

Data for 1995/96, 1996/97 and 1997/98 are for December 1995, December 1996 and December 1997, respectively.

2002 column refers to end-September.

Includes banking sector amortizations and IMF repurchases.

Due to data deficiencies, this item represents net MLT capital flows to the corporate sector (which were positive prior to 1997/98) and net portfolio investment flows.

Includes ST debt (all external).

Based on fiscal data for external MLT amortization (net of rescheduling), domestic debt amortization, and IMF repurchases.

Table 8.Indonesia: External Sustainability Framework, 1997–2010
ActualProjections
19971998199920002001200220032004200520062007200820092010
I. Baseline Medium-Term Projections
External debt/Exports of goods and services229282285213220209197175158144134127124122
External debt/GDP6816711210098756053474238363433
II. Sensitivity Analysis for External Debt-to-GDP Ratio
1. If interest rate, real GDP growth rate, U.S. dollar GDP deflator growth, non-interest current account, and nondebt flows (in percent of GDP) are at average of past 10 years6451454035312825
2. If interest rate in 2003 and 2004 is average plus two standard deviations, others at baseline6255494440383635
3 If real GDP growth rate in 2003 and 2004 is average minus two standard deviations, others at baseline6258524643403938
4, If U.S. dollar GDP deflator in 2003 is average minus two standard deviations, others at baseline9588827672706867
5. If non-interest current account (in percent of GDP) in 2003 and 2004 is average minus two s.d.s, others at baseline7073666157555352
6. Combination of 2–5 using one standard deviation shocks8484777268656362
7. One time 30 percent depreciation in year 2003 (-30% GDP deflator shock), others at baseline10597918581787776
Memorandum items: Key macro and external assumptions
Nominal GDP (rupiah trillion)6289561,1101,2651,4491,6101,9162,1562,4142,6862,9903,3283,7044,122
Nominal GDP (U.S. dollar billions)21695141150141173213226241259277297319341
Real GDP growth (in percent per year)4.5−13.10.84.93.43.73.54.05.05.05.05.05.05.0
Nominal GOP deflator (in U.S. dollars, change in percent per year)−9.1−43.146.82.8−8.918.218.82.01.82.22.12.02.12.0
External interest rate (percent per year)6.06.04.44.44.73.94.05.66.06.06.36.66.76.9
Growth of exports of goods and services (U.S. dollar terms, in percent per year)15.1−11.7−1.826.5−10.9−0.54.85.14.94.75.45.45.45.5
Growth of imports of goods and services (U.S. dollar terms, in percent per year)7.6−21.9−19.829.5−9.3−1.810.85.57.07.07.472767.2
Historical values for macroeconomic variables 1/
(Excluding 1997–98)(Including 1997–98)
Current account deficit, excluding interest payments (percent of GDP, average of past 10 years)−4.7−5.2
Current account deficit, excluding interest payments (percent of GDP, standard deviation of past 10 years)4.75.2
Net nondebt creating capital inflows (percent of GDP, average of past 10 years)1.81.3
Interest rate (average of past 10 years)4.95.1
Interest rate (standard deviation of past 10 years)0.70.8
Real GDP growth rate (average of past 10 years)5.53.5
Real GDP growth rate (standard deviation of past 10 years)2.76.3
GDP deflator, U.S. dollar terms (average of past 10 years)9.82.0
GDP deflator, U.S. dollar terms (standard deviation of past 10 years)16623.9

Historical values are based on the ten year (1992-2002) average excluding 1997–98, as those two years represented extreme outliers. The averages including 1997–98 are presented for information.

Historical values are based on the ten year (1992-2002) average excluding 1997–98, as those two years represented extreme outliers. The averages including 1997–98 are presented for information.

B. Macroeconomic Policies

Fiscal Policy

13. The authorities emphasized that they remain committed to their 2003 budget deficit target of 1.8 percent of GDP (MEFP, ¶7). The budget places an emphasis on raising non-oil tax revenues (from gains in tax administration and a broadening of the tax base) to finance an increase in priority development spending. Faced with popular pressure in January, the government introduced two temporary initiatives which, while being accommodated within the overall fiscal envelope, represent a departure from the original budget. These comprise: (i) tax relief measures, amounting to 0.3 percent of GDP;3 and (ii) a temporary rollback of the planned increase in fuel prices that would have eliminated subsidies (except on household consumption of kerosene) that are poorly targeted on the poor, and a suspension of the automatic fuel price adjustment mechanism. The rollback led to the increases being scaled back from 21 percent to 12 percent (on a weighted average basis).

14. The mission reviewed the budgetary impact of the tax relief and partial reintroduction of fuel subsidies. The mission agreed that these measures could be financed from additional oil revenues associated with the recent run-up in oil prices, and that even after the rollback, the fuel subsidy rate had been reduced from its level at end-2002. (Nevertheless, as a result of the measures the non-oil deficit is now projected to widen by an additional 0.6 percent of GDP compared to the original budget.) The mission expressed serious concern about the damage to the government’s credibility that such a reversal of policy might have (all the more so as scheduled increases in electricity and phone tariffs were also delayed.) The authorities stated that their decision was unavoidable given the widespread level of opposition, and emphasized that the price freezes were temporary, and that the monthly price adjustment mechanism—and elimination of fuel subsidies—would resume once international benchmark prices fell to more normal levels, which they anticipated would occur around mid-year.4 (Subsidies would fall automatically under such a scenario, bringing the non-oil primary balance back toward the original budget target.) Even if oil prices remained high, the overall budget target would be protected, as the net impact (on revenues and subsidies) would be positive.

15. The mission also expressed reservations about the composition of the tax package introduced in January. The staff noted that even though the budgetary impact of the reversal of the elimination of the VAT exemption on capital goods was small, it would weaken the overall structure of the VAT. The authorities explained that the decision was a temporary measure adopted in response to complaints from businesses about inefficiencies in the VAT refund system (particularly in the mining and gas sectors), and agreed to reevaluate this decision in the context of the next review.

16. The latest financing outlook for the budget is broadly in line with that envisaged at the last review. The outlook is for net domestic financing of 1.4 percent of GDP, and net external financing of 0.4 percent of GDP, compared to 1.2 percent of GDP and 0.6 percent of GDP, respectively, at the last review. The change is due to the impact on foreign financing of the recent decision by Paris Club creditors to reschedule only 50 percent of interest falling due in 2003.5

17. The program also includes fiscal reforms in the following areas:

  • Tax administration (MEFP, ¶8 and Annex A). The measures encompass revenue generation (intensifying tax payer registration, tax audits, and arrears collection), modernization, and governance initiatives (expanding the large taxpayer offices and the new electronic tax payment system, strengthening the VAT refund system, and advancing customs reform).

  • Public expenditure management (MEFP, ¶10). Plans are underway for an internal reorganization of the Ministry of Finance. The priorities include a restructuring of the budget preparation process and a strengthening of the government’s payment and receipts systems.

  • Fiscal decentralization (MEFP, ¶ 13–15). The program includes measures to: (i) strengthen the reporting of fiscal outturns from the regions; (ii) enhance central oversight of regional regulations; and (iii) improve the framework for regional borrowing (in the meantime, as noted at the last review, the government has extended the moratorium on local government borrowing for another year, covering all borrowing other than through the center).6 The government is also working with donors to develop a framework to enable on-lending of donor funds to regions through the central government (this issue has become a priority for donors with the devolution of expenditure responsibilities to the regions).

18. The mission updated its assessment of Indonesia’s medium-term fiscal sustainability (Table 9). This assessment continues to show that with further progress in fiscal consolidation, the public debt-to-GDP ratio should remain on a declining path, a conclusion that is robust to a variety of shocks (Text Figure). In addition, the short-term financing outlook has improved considerably following the successful reprofiling of the government’s domestic debt last year.

Public Debt Dynamics 1/

(In percent of GDP)

1/ The alternative paths assume the following cumulative shocks:

A: GDP growth of 3 percent per year for 2003–10

B: Interest rate 250 bps higher than baseline for 2003–10

C: Exchange rate 30 percent more depreciated than baseline for 2003–10

The alternative debt paths assume that the primary surplus is the same as in the baseline.

Table 9.Indonesia: Medium-Term Fiscal Projection, 2001–05
20012002200320042005
(In percent of GDP)
Fiscal accounts
Primary balance2.94.02.52.93.2
Interest 1/6.55.64.23.93.7
Overall balance−3.7−1.6−l.8−1.0−0.5
Financing
Gross requirements8.35.46.24.77.0
Deficit3.71.61.81.00.5
Amortization4.63.84.43.76.5
External3.33.12.52.32.2
Domestic 2/1.20.71.91.44.3
Sources8.35.46.24.77.0
External disbursements3.83.23.21.61.4
Privatization and asset recoveries2.13.21.80.60.4
Other domestic financing 3/2.4−1.01.32.55.2
Public debt
Total90.979.864.760.454.9
External 4/41.834.630.328.325.0
Domestic 5/49.145.234.432.129.9
Memorandum items:
Other domestic financing (in trillions of rupiah)34.0−15.524.954.3125.1
Deficit financing3.71.61.81.00.5
Net domestic financing3.21.51.21.81.3
Net external financing0.50.10.6−0.7−0.8
Key assumptions
Real GDP growth (annual rate)3.43.73.54.05.0
Domestic interest rate (short-term real)4.52.64.04.24.5
Sources: Data are provided by the Indonesian authorities; and Fund staff estimates.

Includes interest assumed on a new BLBI-related note, estimated at Rp 2 trillion (0.1 percent of GDP) in 2004, and Rp 5.2 trillion (0.2 percent of GDP) in 2005.

Excludes amortization on the stock of hedge bonds and BI indexed bonds, which are to be rolled over. In 2003, includes debt buy back of Rp 15 trillion; and IBRA debt redemption of Rp 8 trillion.

Includes domestic debt issuance.

Includes short-term debt.

In 2003 includes Rp 66.7 trillion for debt write-off related to BLBI resolution.

Sources: Data are provided by the Indonesian authorities; and Fund staff estimates.

Includes interest assumed on a new BLBI-related note, estimated at Rp 2 trillion (0.1 percent of GDP) in 2004, and Rp 5.2 trillion (0.2 percent of GDP) in 2005.

Excludes amortization on the stock of hedge bonds and BI indexed bonds, which are to be rolled over. In 2003, includes debt buy back of Rp 15 trillion; and IBRA debt redemption of Rp 8 trillion.

Includes domestic debt issuance.

Includes short-term debt.

In 2003 includes Rp 66.7 trillion for debt write-off related to BLBI resolution.

19. Discussions on the 2004 financing outlook focused on the implications of the authorities’ intention at this stage not to seek recourse to exceptional financing (including from the Paris Club). The authorities explained that they are considering a number of financing options in view of the substantial domestic and external amortization falling due. In addition to the issuance of domestic bonds, they are examining the scope for drawing down deposits at BI.7 From a macroeconomic perspective, the risk of crowding out is small given banks’ substantial liquidity position, but the feasibility of a potentially significant increase in bond sales would depend on the success of the government’s plans to foster the development of an active debt market.8 As for the option of using domestic deposits to repay external debt, the authorities would need to ensure that this did not lead to undue pressure on foreign reserves. The authorities plan to continue monitoring the 2004 financing outlook in close consultation with the staff as the year evolves.

Monetary and Exchange Rate Policy

20. The mission agreed with the authorities that the recent conduct of monetary policy had been appropriate, but urged caution with respect to the pace of further interest rate cuts. In recent months, interest rates had been reduced modestly, while the rupiah had remained stable. Indeed, with the appreciation of the rupiah, monetary conditions remained relatively tight (Text Figure). Thus, a further reduction in interest rates could be warranted, so long as inflation continued to decline in line with the program’s target. Consistent with this approach, interest rates were eased in early March. While the monetary program is consistent with the year-end inflation target of 9 percent, the authorities were optimistic that the inflation outcome could well be lower, if the rupiah continues to trade in a range of Rp 8,800-9,000 per dollar, as they expect.

Monetary Conditions Index

1/ Using core Inflation.

2/ Using ratio of 5:1 on real SBI and REER

Balance of Payments and External Financing

21. The balance of payments outlook has been updated to take into account the prospects of higher oil revenues but still weak external demand conditions. The current account surplus is expected to narrow in 2003, as higher export receipts are offset by weak tourism receipts (due to the Bali attack), and a rebound in imports from their currently compressed levels. Despite higher official disbursements, the capital account is also expected to show a modest deterioration reflecting higher payments falling due by the banking sector and lower expected net portfolio inflows. On this basis, NIR is projected to remain broadly unchanged. Gross external financing needs for 2003 are estimated at $5.3 billion (Text Table). In addition to Fund purchases, this is to be covered by official financing secured at the meeting of the Consultative Group on Indonesia (CGI) meeting (held last January in Bali) and rescheduling from the Paris Club.

External Financing in 2003(In billions of U.S. dollars)
Gross financing needs5.3
Current account deficit−4.7
Debt amortization8.1
IMF repayments1.3
Reserves accumulation0.6
Available financing5.3
Foreign direct investment2.2
Loan disbursements4.4
IMF purchases1.8
Other flows, net−6.1
Rescheduling3.1

C. Structural Reforms

22. The authorities agreed with the importance of maintaining momentum and forcefully addressing the unfinished structural reform agenda. In that regard, there is a need to advance reforms in the areas of bank divestment and restructuring, to continue the asset recovery process through further IBRA asset sales and privatization, and to improve the investment climate through legal, judicial, and other reforms. The staff stressed that the authorities’ commitment in these areas would be especially important for maintaining confidence as the Fund arrangement winds down, in the pre-election period.

Financial Sector Reforms

23. While the condition of Indonesian banks has stabilized, further progress is required to restore them to full health. Indicators of banking system soundness generally improved in 2002, with profitability rising and nonperforming loans continuing to decline (Text Figure). Nonetheless, the system remains vulnerable, especially as there are concerns that the quality of restructured loans--and hence part of the improvement in these indicators—may be overstated. Banks have resumed lending to the private sector, especially to consumers. However, despite the pickup in credit growth in 2002 (to 24 percent in nominal terms), bank credit to the private sector as a share of GDP remains low, and recapitalization bonds continue to represent almost one-half of banking system assets. Against this background, the discussions focused on measures to conclude the process of bank restructuring and improve the institutional framework for the financial sector.

Banking Indicators

(Top 15 domestic banks, in percent of average assets)

24. Ensuring the return of banks taken over during the crisis to private ownership is central to the strategy to revitalize the banking sector (MEFP, ¶23). The four banks still under IBRA’s control represent almost 15 percent of banking system assets. The immediate priority is to conclude the divestment of Bank Danamon, expected by end-April. This would be followed by the launch of the divestment of the government’s remaining majority stake in Bank Lippo.9 The sales of IBRA’s other banks, BII and Permata (formed through the merger of five smaller banks in October 2002), will be launched later in the year, with a view to completing the divestment process by the end of IBRA’s mandate in early 2004.

25. The program includes measures to strengthen state bank governance (MEFP ¶24). Progress in this area has lagged, with the government continuing to exercise weak control over the state banks (which together account for about 45 percent of banking system assets). With a view to improving oversight of the sector, the government is taking a number of measures to strengthen the monitoring and accountability of state bank activities.

26. The mission also agreed on the next steps in the restructuring and divestment of the state banks (MEFP, ¶25). The conditions for the sale of a stake in the largest state bank, Bank Mandiri, have been met, and the IPO of a minority stake is now envisaged to be concluded by June. The government then intends to develop a plan for the next phase of its divestment strategy. With respect to the other state banks, an IPO of a minority stake in BRI is to be launched in the second half of the year, and BNI will be reviewed as part of the fourth round of performance audits of state enterprises, with a view to strengthening its operations ahead of its eventual divestment. As for BTN, a restructuring plan is being developed, with a specific implementation schedule.

27. The authorities’ plans for the reform of the financial sector safety net are advancing (MEFP, ¶26-28; ¶30). A comprehensive plan is expected by end-March to ensure the coordination and proper sequencing of a number of new institutions and policies needed to safeguard the stability of the financial system. The first priority will be to establish a deposit insurance agency with powers to manage bank closures, with a view to having the agency in place when IBRA’s mandate expires. In addition, BI’s lender of last resort (LOLR) function needs to be strengthened to ensure that it has the capability to provide emergency liquidity support to banks encountering difficulties. The strategy also incorporates the development of the independent Financial Supervisory Agency (OJK). In order to ensure a smooth transition to the new agency, supervisory and regulatory functions will be transferred to it gradually, over a number of years. In the first stage, the OJK is expected to be responsible for supervising the nonbank sector, with bank supervision remaining at BI. In order to improve the efficiency and accountability of bank supervision ahead of the eventual transfer of these duties to the OJK, by end-September BI will complete a restructuring of its operations in this area.

28. The blanket deposit guarantee will be phased out gradually. The mission advised delaying its removal until the health of the banking system has improved further, and the major elements of the financial safety net described above are in place (in particular, the deposit insurance agency and BI’s enhanced LOLR function). The authorities agreed to move cautiously, and it is expected that the guarantee will be removed progressively.

29. The mission discussed a number of issues related to the reform of BI (MEFP, ¶29). Parliamentary discussions of amendments to the BI Law, designed to improve the oversight and accountability of the central bank while safeguarding its operational independence, have not yet concluded. However, the divestment of BI’s overseas subsidiary is advancing. Following the transfer of its impaired assets to a special purpose vehicle, the subsidiary (Bank Indover) will be offered for sale.

30. The resolution of the BLBI liquidity credit issue is nearing completion. A major concern in the program was a potential deadlock between the government and BI on their financial relations linked to this issue. Following the landmark agreement between the two parties in June 2002 based on the report of the independent panel of experts, the government in January took the important step of forwarding the proposed agreement to Parliament for its review. The discussion so far, as well as informal consultations with the Supreme Audit Agency, has not indicated any problems with the basic elements of the financial agreement. However, the discussion in Parliament is touching upon the broader issue of assigning responsibility for the decision to provide the liquidity credits during the crisis. The authorities are working to ensure the agreement’s expeditious approval, but the deliberations are yet to be completed. Given the sensitive nature of the discussions, the staff agreed with the authorities that it would be counter-productive to pressure Parliament to reach a quick conclusion on this matter, and concluded that a further rescheduling of the performance criterion would not be warranted. In the meantime, the financial operations of the budget and the central bank in 2003 are being conducted on the basis of the agreement; therefore the delay is not having a macroeconomic impact.

IBRA Asset Recovery

31. IBRA cash recoveries in 2002 amounted to Rp 38.1 trillion, exceeding the target of Rp 36.1 trillion (total asset recoveries, including bonds, amounted to Rp 45.6 trillion). Proceeds from the sale of loans accounted for nearly two-thirds of cash receipts (Rp 21.7 trillion), while divestment of government holdings in banks BCA and Niaga brought in a further 18 percent (Rp 6.7 trillion). (The remaining recoveries were under the shareholder settlement agreements with former bank owners.) To date, IBRA has disposed of over half of its total loan book.

32. The program for 2003 aims to maximize recovery from the remaining stock of assets ahead of the winding down of IBRA’s operations by February 2004 (MEFP, ¶31 and ¶ 34 and Table 10). IBRA’s Rp 26 trillion (1.4 percent of GDP) recovery target for 2003 is expected to be met primarily from sales of its remaining NPLs. While the majority of these loans are to be offered using IBRA’s well-tested auction mechanism, loans related to the Top 5 debtors will be offered on an individual basis in strategic sales (combining equity and debt positions). To ensure transparency, IBRA’s Oversight Committee is vetting the proposed sales mechanisms.

Table 10.IBRA Asset Recovery and Official Targets, 2002–03(In trillions of rupiah)
20022003
AnnualQ1Q2Q3Q4Total
ActualTargetTarget 1/
Total cash receipts (net of expenses)38.136.13.47.513.21.926.0
+ AMC (loans and non-core assets)26.824.53.03.29.30.115.6
of which loan sales21.715.5
+ AMI (industrial and other assets)5.09.70.41.32.91.96.4
+ BRU (bank equity)6.74.30.03.01.00.04.0
+ Other Income 2/0.7
− Total expenses1.12.4
Total bond receipts 3/7.57.5
Source: Finance and Accounting (IBRA).

Net of investment income and operational expenses. May also include receipts in the form of bonds, for which no separate target has been set for 2003.

Comprises investment income.

Received as payment in loan sales.

Source: Finance and Accounting (IBRA).

Net of investment income and operational expenses. May also include receipts in the form of bonds, for which no separate target has been set for 2003.

Comprises investment income.

Received as payment in loan sales.

33. The authorities are strengthening their strategy for asset recoveries under the settlement agreements with former bank shareholders (MEFP, ¶32-33). IBRA has launched formal enforcement actions against the shareholders who remained noncompliant with their agreements at the end-February deadline.10 For the 4 shareholders who have fulfilled their obligations under the agreements, the government is ceasing further legal actions. All industrial and other assets that had been pledged in settlement of outstanding claims are being transferred to IBRA; these assets will be offered for sale over the course of 2003. IBRA will also undertake forensic audits to identify any additional shareholder assets that could be used to meet outstanding obligations in cases (under the so-called MRNIAs) where the assessed value of the assets pledged initially was insufficient to meet the full obligation amount.

Legal Reforms

34. The mission reviewed the strategy and priorities for legal reform in 2003 (MEFP, ¶38-39). It was agreed that the key program objective in this area is to further the development of the commercial court system, as weaknesses in the implementation of the bankruptcy framework remained a significant impediment to enhancing the investment climate. The authorities noted that ongoing work to strengthen the operations of the Commercial Court would continue, and that an update of the blueprint for the associated reforms would be finalized by the middle of the year. Steps are also being taken to expedite the passage of (largely procedural) amendments to the bankruptcy law and to strengthen the Court by increasing the number of ad hoc judges. The authorities are complementing the work in this area with two new initiatives:

  • A financial needs assessment of the Commercial Court to place its finances on a sounder basis. The assessment will provide a comprehensive review of the facilities (and personnel) needed to operate an effective commercial court system.

  • The establishment of an independent Judicial Commission to strengthen the governance and administration of the judiciary. The government is working with the Supreme Court and the relevant parliamentary committees to finalize the enabling legislation for the commission by the end of the year.

35. The mission assessed progress in other areas of the legal reform agenda (MEFP, ¶40—41). The government is working to ensure that the Anti-Corruption Commission (ACC) starts work by end-2003, as required by the Anti-Corruption Law. The next step in this process will be to appoint the chairman and the four deputies for the Commission by July this year. Steps are also being taken to ensure that the wealth declaration process is not weakened once this function is taken over by the ACC.

36. Progress is being made in strengthening Indonesia’s anti-money laundering (AML) framework. The senior management of the financial intelligence unit, which has primary responsibility for administering the AML framework, has been appointed, and the unit now has 23 staff (including 2 international advisers). The government will also shortly table amendments to the AML law, to bring it into conformity with FATF requirements. Passage of these amendments is expected to pave the way to removing Indonesia from FATF’s list of non-cooperating countries.

Other Structural Reforms

Privatization

37. The government has approved a privatization program for 2003 designed to achieve the budget target of Rp 8 trillion (MEFP, ¶35). In order to ensure broader support for its program, the government will present its program to Parliament and seek approval for the larger divestments on an individual basis.11

Corporate debt restructuring

38. After several years of stagnation, financial restructuring of Indonesia’s heavily indebted corporate sector is advancing (Box 3 and MEFP, ¶36). IBRA’s sale of over Rp 100 trillion in NPLs in 2002 has significantly boosted the secondary market for distressed corporate debt, thus encouraging market-based restructuring, and further NPL sales this year are likely to provide an additional stimulus. With better prospects for market-based restructurings, the role of official intermediation in restructuring negotiations is likely to wane. As the Jakarta Initiative Task Force’s (JITF’s) mandate is set to expire at end-2003, the JITF will prioritize its mediation efforts on its remaining cases with the greatest chance of reaching resolution in 2003, while those unlikely to be resolved will be dismissed.12

Labor policies

39. The mission reviewed the status of the government’s strategy to modernize labor relations (MEFP, ¶42). This process, which was initiated in 1998 with the ratification of ILO conventions on worker rights and was followed in 2000 by a major reform of legislation governing rights of association and union activity, had stalled in the absence of a consensus on complementary legislation on labor protection and industrial dispute settlement, leaving investors uncertain about the shape of the key elements of the industrial relations framework (retrenchment, severance pay, dispute resolution). The government reported that good progress had been made in recent months. The legislation relating to labor protection has now been passed by Parliament, and the bill on industrial dispute settlement is expected to be enacted by the middle of the year.

40. The government also informed the mission that it intended to strengthen the framework for setting minimum wages (MEFP, ¶43). This has been another area of concern to investors, as minimum wages had been rising rapidly since being devolved to the regions in 2001. While the central government has only limited direct influence in this area, it had decided to convene a national tripartite council (comprising government, labor, and employers) to establish national standards to guide the minimum wage setting process in the regions. Such standards would be intended to foster a minimum wage setting process that was more orderly and predictable, and took into account the broader national interest.

Trade

41. Indonesia continues to maintain a relatively open trade regime (MEFP, ¶21). The simple average tariff (7 percent) compares favorably to other countries in the region, and trade barriers are relatively low.13 In response to concerns expressed by the mission about recent protectionist actions (with respect to sugar, steel, and textiles), the authorities reaffirmed their commitment to a liberal regime, and pointed out that such actions had been narrow in scope, and were consistent with Indonesia’s WTO commitments.14 The government is an ongoing participant of the Doha round of WTO negotiations, and will also take part in future trade negotiations under the ASEAN.

Public sector governance

42. The authorities intend to advance ongoing efforts to improve fiscal transparency (MEFP, ¶16). The priority in this area will be to continue the process of auditing and consolidating off-budget funds. Audits of the largest of the remaining funds—the Reforestation Fund and the two investment funds (RDI and RDA)—have been completed and their findings presented to Parliament. The focus going forward will be on ensuring that these funds are consolidated into the budget and brought fully under the control of the Ministry of Finance. Routine audits of government agencies will continue to prevent the emergence of new off-budget funds and all balances from previously identified off-budget funds will be transferred to the Treasury by June this year.

43. The mission also discussed measures to improve governance of the wider public sector (MEFP, ¶17-19). The program of performance audits of state enterprises has played a major role in strengthening the public sector. The first two rounds of performance audits uncovered sizeable efficiency losses (currently being addressed through corrective action plans).15 The third round of audits covering an additional five companies will be completed by July and a fourth round, which will start the process of auditing state banks, will be launched in June. Oversight of military and other foundations linked to public agencies will also be strengthened. To this end, the authorities are drafting amendments to the Foundations Law to ensure that the Supreme Audit Agency has clear powers to audit the activities of such foundations.

III. Program Monitoring and Financing

44. Quantitative program targets have been established through end-2003, consistent with quarterly purchases and reviews (MEFP Table 2). Performance criteria for end-March and end-June are proposed for NDA, NIR, the central government balance, and external debt, and indicative targets are proposed for end-September and end-December for these variables. The definitions and coverage of all program variables are unchanged from those set out in the technical memorandum for the 2002 program, except for the definition of reserves (including NIR), which has been clarified to be consistent with the general ledger concept (following the safeguard assessment’s recommendations).

45. New structural benchmarks have also been set through December 2003 (MEFP Table 3). These relate to key financial sector reforms, tax administration initiatives, IBRA asset sales and privatization, governance of state-owned enterprises and banks, financial reporting of local governments, and BI reforms. The authorities have requested a waiver for the nonobservance of the end-2002 structural performance criterion related to the resolution of the BLBI credit issue, which is expected to be implemented soon. The end-2002 structural benchmarks that were not met on time—relating to the completion of the third round of special audits of state enterprises and the reporting of local government finances—are not being reset, as the former is underway, and the latter is close to completion.

46. The authorities have made good progress toward finalizing their recent bilateral rescheduling agreements. Of the 18 bilateral agreements to be signed with Paris Club creditors eight have been concluded, and the others are being finalized. The authorities have requested an extension of the deadline for concluding agreements to end-May. Negotiations with non-Paris Club official creditors are ongoing, although some difficulties in securing comparable treatment have been encountered (in two of the five cases).

47. The mission discussed measures being implemented under the Fund’s safeguard assessments policy. The authorities agreed to the follow up on the recommendations endorsed by the Board at the seventh review concerning the mid-term review of BI’s reserves. In particular, (i) BI agreed to base its future reporting of NIR to the Fund on the general ledger concept; and (ii) BI is undertaking measures to address control weaknesses in its foreign reserves operations, and the Supreme Audit Agency will conduct an implementation review in the context of its annual 2002 audit. Discussions are underway with respect to the continued involvement of an independent accounting firm in BI’s external audit mechanism, and the staff will report on further developments as warranted.

IV. Staff Appraisal

48. Overall, good progress has been made over the past year in policy implementation under the program. Prudent fiscal and monetary policies have contributed to a reduction in inflation and an appreciation of the rupiah, which have facilitated a decline in interest rates in support of the economic recovery. At the same time, structural reforms have advanced in key areas, including bank divestment, IBRA asset recoveries, and privatization. The improvement in economic conditions and resilience of the economy to recent shocks, including from the tragic events in Bali last year, are indications that the program has been working to restore confidence and promote a durable recovery.

49. Notwithstanding these achievements, the reform agenda remains unfinished, and it is likely that program implementation will become more difficult in 2003. As Indonesia enters the final year of the extended arrangement, the authorities should make every effort to consolidate recent gains made under the program and address remaining reforms. The authorities’ program for 2003 appropriately focuses on maintaining macroeconomic stability, ensuring debt sustainability through further fiscal prudence and continued asset recoveries and privatization, strengthening the banking system, and enhancing the still-weak investment climate. Sustaining the pace of reform will be important for maintaining market confidence in the lead-up to the 2004 general elections, and will be crucial if Indonesia is to graduate successfully from exceptional financial support.

50. The 2002 fiscal deficit outturn was well within the program’s 2½ percent of GDP target. As overall revenues were broadly in line with expectations at the last review, this outcome was achieved primarily through lower than expected expenditure, on both current and development spending items. Encouragingly, tax collections picked up in the fourth quarter, with indications that the tax administration measures implemented earlier in the year are yielding results.

51. For 2003, the staff welcomes the authorities’ commitment to maintain their 1.8 percent of GDP budget deficit target. As noted at the last review, the target strikes an appropriate balance between ensuring consolidation to reduce public debt, and providing support for the economy. While the temporary rollback in January of the planned elimination of fuel subsidies (except on household kerosene) is regrettable, the authorities’ desire to smooth the domestic pass-through of the recent sharp increase in international oil prices is understandable. The staff welcomes the authorities’ intention to reintroduce the fuel price adjustment mechanism and eliminate subsidies once oil prices return to more normal levels. The staff also commends the authorities’ ongoing efforts to strengthen tax administration, improve public expenditure management, and implement a sound decentralization framework.

52. Bank Indonesia has continued to maintain a prudent monetary stance. In the period ahead, the authorities should proceed cautiously with respect to further easing of monetary conditions, to ensure that inflation remains in line with the program’s target, and that the rupiah’s stability is not compromised as investors assess the outlook ahead of the 2004 elections.

53. In 2002, IBRA made important strides in returning assets taken over during the crisis to the private sector, and recovering funds for the budget. For 2003, IBRA’s strategy is to maximize recoveries from loan sales and to complete the divestment of IBRA banks, in advance of its winding down early next year. In this regard, the staff welcomes IBRA’s detailed asset disposal plan, which contains important steps to enhance transparency and governance in the sales process, as well as the bank divestment schedule. Recent efforts to better enforce the shareholder settlement agreements are also welcome, in conjunction with steps to initiate legal actions against noncompliant former bank owners, and to discharge those who have fulfilled their obligations from further liability. It will be essential for the government to play an active coordinating role with the Attorney General’s Office and police to ensure that the enforcement actions are effectively implemented.

54. Financial sector reforms and the strengthening of the financial safety net remain core areas of the program. The staff urges the authorities to ensure close coordination among relevant agencies to ensure the development of a sound and comprehensive plan for the reform of the financial safety net. Key elements of the plan include the creation of a deposit insurance agency, the adoption of a strengthened lender of last resort function at BI, and the transition to an independent Financial Supervisory Agency. These reforms should be carefully sequenced, with a gradual removal of the blanket guarantee linked to the implementation of key elements of the financial safety net. The staff welcomes steps in the program to strengthen state bank governance through improved monitoring and accountability, as they are prepared for divestment. This is a priority given the state banks’ large size in the overall banking system.

55. Efforts in recent months to advance the structural reform agenda in other important areas have also met with some success. The 2002 target for privatization receipts was exceeded with the successful sale of Indosat. The authorities have made good progress to deepen the market for public debt, with the initiation of domestic bond placements. And steps have been taken to further judicial and legal reform, as well as to strengthen the governance of state enterprises; it will be critical to maintain progress in these areas under the 2003 program, in order to strengthen the investment climate.

56. The 2003 program is appropriately ambitious and, if fully implemented, should go a long way toward consolidating recent gains in Indonesia’s economic performance. The challenge moving forward will be to build on the progress made in policy implementation over the past year. As recent events have illustrated, this will not be an easy task, in what is likely to become an increasingly difficult environment for policy implementation ahead of the 2004 elections. Nevertheless, recent policy actions and the intentions outlined in the MEFP are an indication of the government’s commitment to meeting this challenge. The staff therefore supports the authorities’ request for a waiver for the nonobservance of the structural performance criterion on the end-December BLBI burden-sharing agreement, and the completion of the eighth review.

Box 1.Status of Economic Recovery

Indonesia’s GDP has finally recovered to its precrisis level. While GDP growth in recent years has been steady, in a range of 3—4 percent, it remains below the level required to absorb new entrants into the labor market and achieve a sustained reduction in poverty.

According to newly released GDP data, growth in 2002 rose to 3.7 percent, up from 3.4 percent in 2001. Despite this modest pickup, the recovery in Indonesia continues to lag other regional economies (Text Figure). Growth in 2002 was driven primarily by consumption, with net exports also contributing somewhat, due mainly to sluggish import growth. However, investment remains slack, and this remains a constraint on Indonesia’s growth prospects.

Real GDP, Seasonally Adjusted

(1997 Q1 = 100)

The impact of the terrorist attack in Bali was relatively mild, with a fourth quarter decline in output that was only slightly steeper than the usual seasonal pattern. Tourism has clearly been affected (arrivals in Bali were down 30 percent in the fourth quarter from the previous year), but other indicators of consumer and business confidence have held up well.

There has been a sustained strengthening of private consumption in recent years. Consumption growth is largely related to nonfood expenditures including durables (motorcycle sales have recorded strong increases in recent years). Household spending has been supported by an expansion of consumer credit, which banks considered to be relatively less risky than the corporate sector. This process is likely to continue, as household indebtedness remains relatively low—the ratio of such credit to GDP remains below 8 percent, compared with above 13 percent before the crisis.

Investment remains weak. After a strong recovery in 2000 and 2001 (following a precipitous decline after the crisis), investment has remained flat. The share of investment in GDP remains at about 20 percent in 2002, from above 30 percent before the crisis (Text Figure). The investment outlook in the near term remains poor, with foreign investment approvals in 2002 registering a 35 percent drop from the previous year. In 2002, some high-profile foreign investors wound down their operations in Indonesia, citing concerns over the legal environment and labor framework.

Gross Fixed Capital Formation

Some progress has been made in reducing unemployment, but the overall pace of poverty reduction slowed in 2002. Open unemployment declined from above 6 percent in 1999 to percent in 2001 (based on a consistent methodology).1 Underemployment experienced a similar decline, but remains very high at 28 percent in 2001. While formal wages have increased sharply in recent years, real wages in the informal sector remain depressed at below precrisis levels. In real terms, by mid-2002 formal sector wages were 35 percent higher than in 1996, while agricultural wages (a proxy for informal wages) remained 12 percent lower. As a result, improvements in poverty indicators have stalled. The core poverty headcount index, which had improved sharply through end-2000, recorded a small increase in early 2002.

1/ Official data report open unemployment of 8 percent in 2001, but this is based on an expanded definition of unemployment.

Box 2.External Vulnerability

Large current account surpluses and prudent macroeconomic policies have helped to reduce Indonesia’s vulnerability to external shocks. By end-2002, external reserves had risen to $32 billion, sufficient to cover seven months of imports and over 125 percent of short-term debt. External debt has also declined sharply, falling from a peak of 167 percent of GDP in 1998 to 75 percent in 2002, reflecting the return of output to its precrisis levels, as well as the recovery of the exchange rate. Nevertheless, Indonesia’s external debt remains comparatively high, as does its debt-service burden, which is running at around 30 percent of exports of goods and services.

Provided the economic recovery continues, Indonesia’s external vulnerability should continue to decline over the medium term. Under the staffs baseline scenario, the external debt-to-GDP ratio is projected to decline to around 47 percent by 2005 (Text Table). External reserves are also expected to remain at a comfortable level (6-7 months of imports), with an improvement in the coverage of short-term debt. A simulation of various macroeconomic shocks (through setting key parameters at their historical averages) still shows a declining trend in debt ratios over the medium term, although at a somewhat slower pace than under the baseline scenario.

Sensitivity of Total External Debt to Macroeconomic Shocks(In percent of GDP)
Projections
200220032004200520062007200820092010
Baseline debt-to-GDP ratio756053474238363433
Higher interest rate 1/6255494440383635
Lower real GDP growth 1/6258524643403538
Lower USD GDP deflator 1/9588827672706867
Weaker current account 1/7073666157555352
Combined shock 2/8484777268656362

Shocks represent two standard standard deviations from 1992–2002 average (excluding 1997–98).

The combined shock (all of the above) is based on one standard deviation.

Shocks represent two standard standard deviations from 1992–2002 average (excluding 1997–98).

The combined shock (all of the above) is based on one standard deviation.

The Indonesian government is relatively insulated from some of the external financing concerns that are prevalent in other emerging markets. Most of its debt is on concessional terms and only a negligible portion is short term. Government external debt-service payments are projected to average $8 billion per annum (20 percent of government revenues) over the next five years, which is expected to be manageable provided that there is a continued fiscal consolidation effort and a deepening of the domestic bond market.

This relatively benign outlook is dependent on a number of important assumptions, most notably exchange rate stability and a policy framework geared toward promoting exports and investment:

  • Stability in the real exchange rate. By way of example, if growth of the nominal GDP deflator were two standard deviations lower than its historical average (due to a sharp depreciation), debt ratios would increase by over 30 percentage points. For the private sector, an exchange rate shock would prolong its reliance on arrears accumulation, as it already faces a difficult debt-service burden.

  • Export growth. The baseline scenario envisages export growth of around 5 percent per annum over the medium term (somewhat more conservative than Indonesia’s past experience). Although such growth may not be realized in all products (the largest non-oil export sector, textiles, is for instance facing pressures from competitors), prospects for other key manufacturing sectors such as electrical appliances, machinery, and chemicals are promising; moreover, several major commodity exports (palm oil, rubber, copper) are expected to benefit from rising prices over the medium term.

  • Investment flows. The tentative recovery seen in 2002 for some components of the capital account (equity FDI, bond issues) will need to continue in the coming years. In fact, the medium-term projections assume a gradual recovery of FDI and a restoration of the private sector’s access to external loans and bond markets. Besides external factors, policy measures that improve the investment climate and strengthen the domestic financial sector will be critical for Indonesia’s success in this endeavor.

Box 3.Corporate Sector Developments

An assessment of corporate sector developments in Indonesia is impaired by data limitations. As relatively few Indonesian companies are publicly owned (at cnd-2002, only 257 nonfinancial companies were listed on the Jakarta Stock Exchange), financial indicators are available for a relatively small share of the corporate sector, thus making it difficult to draw conclusions regarding the performance of the sector as a whole. In addition, a quantitative assessment of the corporate sector’s financial condition is hindered by the fact that debt restructuring activity may not be fully captured by the official data on corporate debt.

Nevertheless, available indicators suggest that the financial health of the corporate sector has improved in recent years. The average debt-to-equity ratio (weighted by company equity) has fallen from roughly 6 at the end of 1998, to about 2 in early 2002.1 This decline in corporate sector leverage has resulted in part from the implementation of restructuring agreements for Rp 54 trillion in IBRA-held debt, involving 156 companies. A further $19.4 billion in external debt has been restructured through JITF mediation, involving 91 companies. IBRA’s loan sales should provide an additional stimulus to financial restructuring, by bolstering the development of the secondary distressed-debt market and thereby promoting market-based debt restructuring. Nevertheless, firms remain vulnerable to exchange rate risk due to the sizeable remaining stock of foreign exchange-denominated debt.

Although corporate financial restructuring should continue to accelerate with further IBRA loan sales during 2003, a more sustainable recovery of the corporate sector may be constrained by firms’ limited access to new financing. Foreign debt financing remains very low compared to precrisis levels (Text Figure). Indonesian issuers returned to the international bond market only in December 2001, when Bank Mandiri placed a $125 million Eurobond, and only a handful of corporate borrowers were able to follow suit in 2002 (total issuance of $800 million). Although access to external loan finance has become available to high-grade corporate borrowers, it remains severely limited (only $200 million last year). FDI flows to Indonesia, estimated at $2.4 billion in 2002, are still well below their pre-crisis peak of over $9 billion in 1997/98.

Corporate Sector External Borrowing

(In billions of U.S. dollars)

Access to domestic financing also remains limited, Bank credit to the corporate sector increased by only 7 percent in 2002 and 8 percent in 2001 (in nominal terms), as banks remain reluctant to lend to heavily-indebted corporates. Although activity in the corporate bond market picked up sharply in 2002, with Rp 7.6 trillion in new issuance (compared with a cumulative total of Rp 11.1 trillion during 1998–2001), access remains limited to the top corporate names. However, market analysts expect activity in this market to continue to increase this year, as it has in other Asian crisis countries, as corporate health improves and yields on other investments (notably government and central bank debt) fall. Issuance of new equity has remained very low, due to both low investor interest and shareholders’ reluctance to dilute corporate control.

These data are for positive-equity companies continuously listed on the JSX between 1998 and 2002.
Table 11.Indonesia: Indicators of Debt Service to the Fund, 2001–10(In billions of U.S. dollars)
2001200220032004200520062007200820092010
Debt service to the Fund
Charges0.480.270.260.260.230.200.170.120.080.06
Repurchases1.752.341.300.911.041.201.431.660.960.75
In percent of exports of goods and nonfactor services3.64.22.41.71.81.92.02.11.20.9
In percent of total nonfinancial public sector debt service20.322.514.411.411.511.914.515.59.87.6
In percent of reserves of Bank Indonesia 1/8.08.14.83.53.63.84.04.12.21.5
Outstanding Fund credit9.218.419.21S.337.316.114.683.032.061.31
In percent of GDP6.54.94.63.93.22.51.81.10.70.4
In percent of nonfinancial public debt12.411.012.111.410.59.37.55.13.62.4
In percent of reserves of Bank Indonesia 1/32.926.327.925.020.616.511.77.04.32.4
In percent of quota348.8313.5332.6300.0262.7219.6168.373.437.819.3
Total nonfinancial public sector debt service
In percent of exports of goods and nonfactor services17.618.616.714.815.315.613.813.812.111.4
In percent of GDP7.86.75.44.74.84.84.24.13.53.3

End of period reserves.

End of period reserves.

ANNEX I: Indonesia: Fund Relations

As of February 28, 2003

I. Membership Status: Joined February 21, 1967; Article VIII

II. General Resources Account

SDR MillionsPercent of Quota
Quota2,079.30100.00
Fund holdings of currency8,207.3394.71
Reserve position in Fund145.507.00

III. SDR Department

SDR MillionsPercent of Allocation
Net cumulative allocation238.96100.00
Holdings5.962.49

IV. Outstanding Purchases and Loans

SDR MillionsPercent of Quota
Stand-by arrangements275.1813.23
Extended arrangements5,998.31288.48

V. Financial Arrangements

TypeApproval DateExpiration DateAmountAmount Drawn
Approved(SDR Millions)
(SDR Millions)
EFFFeb. 04, 2000Dec. 31, 20033,638.002,261.76
EFFAug. 25, 1998Feb. 04, 20005,383.103,797.70
Stand-byNov. 05, 1997Aug. 25, 19988,338.243,669.12

VI. Projected Obligations to Fund (SDR Millions; based on existing use of resources and present holdings of SDRs):

IV. Outstanding Purchases and Loans

Forthcoming
20032004200520062007
Principal734.7678.1774.81,015.61,245.0
Charges/Interest111.2133.2115.795.869.3
Total845.9811.3890.51,111.51,314.3

VII. Exchange Arrangements

The rupiah has floated since August 14, 1997. The market exchange rate was Rp 8,881 per U.S. dollar on February 28, 2003. Indonesia has accepted the obligations of Article VIII, Sections 2, 3, and 4, and maintains an exchange system free of restrictions on payments and transfers for current international transactions. A multiple currency practice arising from the foreign exchange subsidy for food imports was abolished on December 31, 1998.

VIII. Article IV Consultation

Indonesia is on the standard 12-month consultation cycle. The last Article IV consultation report (EBS/02/65) was discussed by the Executive Board on April 26, 2002.

IX. Safeguards Assessments

Under the Fund’s safeguards assessment policy, Bank Indonesia (BI) is subject to the transitional procedures with respect to the EFF arrangement, approved on February 4, 2000 and scheduled to expire on December 31, 2003. The transitional procedures require a review of only BI’s external audit mechanism. This assessment determines whether BI publishes annual financial statements that are independently audited in accordance with internationally accepted standards. The assessment of BI’s external audit mechanism completed on March 15, 2002, revealed significant weaknesses and recommended remedial actions to address identified vulnerabilities. The recommendation concerning BI’s publication of audited financial statements has been implemented. A mid-year audit of BI’s foreign exchange reserves (conducted by the independent accounting firm of PricewaterhouseCoopers) was completed in late October. The report indicated that international reserves data reported to the Fund had been underestimated at June 30, 2002, due to timing issues and other compilation discrepancies. The audit also found control weaknesses in BI’s foreign reserves operations. The staff is continuing to discuss follow-up recommendations with the authorities.

ANNEX II: Indonesia: World Bank—IMF Relations1

The World Bank has a wide-ranging policy dialogue in Indonesia, covering traditional areas such as poverty reduction, fiscal and structural reforms, and extending to new areas such as corruption, justice reform, postconflict assistance, and social empowerment. This Annex focuses on topics that are pertinent to the Fund’s activities in Indonesia.

World Bank Policy Dialogue

Poverty alleviation and PRSP. After declining markedly since the crisis, poverty increased between 2001 and 2002 mainly as a result of a hike in rice price. Rice remains a very important determining factor for poverty. Adopting a strategy for future rice policy, including price and trade policy and productivity enhancing measures for farmers, is a trigger to achieve the high case lending in the Bank’s current Country Assistance Strategy (CAS). Such a rice policy strategy should avoid increases in rice tariffs and expansion in public marketing policies. Moreover, building human assets is essential in breaking the vicious cycle of poverty. An enabling environment that deals with corruption, conflict resolution, and access to justice is also required for poverty alleviation. The government has recently completed a draft interim poverty reduction strategy which lays out a roadmap for developing a national poverty reduction strategy paper (PRSP) by 2004. The Bank will continue to actively support this process, through analytical work aimed to help the government formulate policy options for poverty reduction.

Fiscal issues. While the Fund is in the lead in developing fiscal policy and overall fiscal targets, as well as on taxation issues, the Bank takes the lead in policy dialogue on: the development budget and sectoral allocation, fiscal decentralization, and civil service reform. The Bank also plays a significant role in capacity building for long-term debt management and public expenditure management.

Development budget and sectoral allocations. The postcrisis deficit reduction entailed cuts in operation and maintenance and development spending, especially in infrastructure where roads have deteriorated and the threat of power shortage is looming. These sectoral spendings are now largely responsibilities assigned to subnational entities; their implementation depends on putting in place adequate mechanisms to foster decentralization in each sector and redefining a new role for the center.

Decentralization. The 2001 Big Bang decentralization was successfully implemented with smooth transfer of civil service to the regions, adequate safeguards on aggregate local budgets, and improved perception of service delivery. However, the regions have inherited a social service delivery system suffering from years of under-investment and lack of clarity in tasks and responsibilities. The decentralization process is far from finalized as the government continues to struggle with the issue of devolution of responsibilities, regional imbalance, and revenue sharing. The ongoing debate on regional autonomy needs to clarify the functions of regional governments and the center, provide a stronger intergovernmental fiscal framework, and reinforce accountability at the local level. The Bank is closely monitoring the decentralization process through analytical work and is advising government on coherent implementation of decentralization laws 22 and 25. The Bank is also supporting the regions through its projects, such as governance at the kabupaten level and health services at the provincial level.

Civil service reform. Indonesia’s civil service size is at par with countries of similar per capita income. But there is an ongoing debate about whether civil service pay is appropriate, and whether it is linked to corruption in the public sector. The political will to embark on a major reform of the civil service has been lacking. The Bank is facilitating a process by which the central government develops and adopts an appropriate civil service model for a decentralized Indonesia, which is then implemented at the subnational level. The legal and institutional basis for greater flexibility to reforming regional governments will need to be put in place. In the medium term, a civil service reform agenda would need to comprise core elements such as a review of the administrative structures at the central and subnational levels based on the new role of the state.

Long-term debt management capacity building. Despite the progress achieved, the public debt remains high at 85 percent of GDP and requires careful management of both its level and vulnerability to shocks. Along with AusAID, the Bank is providing technical assistance and advice on building debt management capacity, including setting up an integrated debt management unit to establish a debt strategy and manage risk, implement an integrated debt reporting and risk management system that assesses vulnerability, risk, and cost in a sovereign liabilities portfolio, improve the “front, back, and middle-office” functions for public debt management, and monitor fiscal risks associated with the government’s contingent liabilities and incorporate them into debt management policy decisions. A new law on Government Securities was passed in September 2002, allowing the government to issue bonds and reprofile the existing bonds to smooth associated debt service payments. The Center for Government Bond Management within the Ministry of Finance has subsequently been established with the mandate to manage the country’s domestic debt, and eventually the entire public debt.

Public expenditure management. New legislation for budget formulation, treasury management, and auditing to increase transparency and accountability in budget preparation and execution was submitted to Parliament a year ago. In their current form, these draft laws are not adequate to meet the triggers on public financial management for the Bank’s high case lending. The Bank is providing advice on how to revise the three draft laws and how to improve government financial management—including strengthening linkages between planning and budgeting, and improving reporting to Parliament and financial accountability. The draft law on budget formulation is being revised and will be re-submitted to Parliament.

Financial Sector. Collaboration between the Fund and the Bank in the financial sector has been intense, given the extent of financial sector problems in Indonesia resulting from the crisis and its importance in the IMF program and the Bank’s CAS.

Division of labor between the Fund and the Bank. Early in the crisis, the Bank agreed with the IMF and AsDB to a division of labor wherein the Bank assumed primary or lead responsibility for the oversight of IBRA and three of the four state-owned banks; the IMF assumed oversight responsibility for the central bank and Bank Mandiri; and the AsDB for the pension, insurance, SME, capital market sectors, and more recently for the support of the introduction of the Financial Supervisory Authority (FSA) legislation. Bank staff have participated in many joint missions with the IMF, providing regular inputs to the authorities and frequent written contributions to the IMF Letter of Intent drafting process. Overall, the five-year old division of labor has remained in place.

Current situation in the financial sector. The banking sector is now in considerably better condition than it was at end-1997 as deposits, interest margins, earnings, and capital have all markedly increased, while the number of banks has decreased to 141 from 238. However, the four government-owned banks, comprising 45 percent of the sector, remain subject to the weak shareholder oversight and governance controls. Moreover, these banks remain vulnerable to external shocks, increased competition from foreign banks, or, in the case of the two largest state-owned banks, defaults from large domestic borrowers. In 2002, IBRA finally began in earnest to sell down its large NPLs and bank holdings: more than $10 billion equivalent (nominal value) of NPLs were sold, as were majority stakes in two nationalized banks.

World Bank financial sector program. Overall, the Bank’s financial sector assistance program will continue to aim at helping government improve the overall investment climate whilst supporting the authorities’ efforts to ensure that the poor and vulnerable share in the benefits of economic recovery and renewed growth. In particular, three remaining tasks are foreseen as Indonesia moves beyond the financial crisis.

First, the Bank will continue its policy dialogue with IBRA, aiming to largely and transparently dissolve the agency by early 2004 through sale of the agency’s remaining NPLs, bank and enterprise equity holdings, and resolution of the 39 shareholder settlement agreements. As a significant portion of IBRA’s assets may be unsold at the end of its mandate, the ownership, transfer, and management of the unsold asset stock remains a serious concern. To outline these issues and further a dialogue, a summary of possible disposition alternatives was recently provided to the authorities during the recent Bank-IMF mission. Regarding shareholder settlements, to minimize the effects of moral hazard, it is incumbent upon government to promptly exercise all available legal and administrative remedies toward recalcitrant former bank shareholders; vigorous prosecutions would serve as a deterrent to those prepared to honor their shareholder settlement agreements.

Second, regarding the three state-owned banks overseen by the Bank, the Bank is of the view that so long as these banks remain in the government’s control, neither corporate governance nor capital will be substantively improved. The best means of improving governance is to divest these banks, though state-owned asset sales of all types have proven to be amongst the most contentious public policy issues for successive governments. The Bank thus envisages supporting MoSOE in the near term through putting forward capacity and transparency strengthening measures to mitigate banking risks, and in the longer term through providing analytical work to enable government to reap the benefits of state banks divestment.

Third, following on from the paper on “Financial Sector Strategy: Issues and Options” delivered to government in September 2001, the Bank intends to continue to encourage government’s development of a comprehensive, medium-term Financial Sector Strategy which includes, inter alia: (i) development of a micro-finance institutional framework to increase access to finance for the poor; (ii) continuing public and private banks’ consolidation; (iii) sequenced establishment of a Financial Supervisory Authority; (iv) transition to a deposit insurance protection scheme; and (v) further capacity building for public debt management within government. A follow-up Bank paper, reflecting recent progress on the above components and providing further suggestions on the development of a financial sector strategy, will be prepared prior to end-April.

Private Sector. Both the Bank and the Fund have been heavily involved in voluntary debt workout through the Jakarta Initiative Task Force (JITF), with the Bank taking the lead. Working closely with the Fund, the Bank played a key role in the creation and fine tuning of the JITF mechanism and provided most of the financing for JITF through its Corporate Restructuring Technical Assistance Project, two Bank-executed technical assistance grants, and policy conditionality in two adjustment loans (PRSL I and II). Since JITF corporate restructuring was redesigned in 1999, corporate debt resolution accelerated and JITF targets have been consistently met. Restructurings through the JITF to date amount to more than $ 17 billion, accounting for almost one-third of Indonesia’s nonperforming corporate loans. Incentive measures to maintain the momentum of corporate debt restructuring until JITF’s closure in end-2003 were discussed recently between the government, the Bank, and the Fund.

Moreover, the Bank continues to support other reforms for the corporate sector, notably in the areas of corporate governance, competition policy, promotion of foreign direct investment, SME development policy, and legal and judicial reforms. The Bank is placing increasing emphasis on improving the investment climate, at the national and local level, particularly in simplifying regulations and levies, improving access to finance for investment and working capital, reducing corruption and improving local public sector governance, and developing business management skills and service for SMEs.

Trade. The trade agenda is becoming highly topical in Indonesia and the region. While Indonesia has a very open trade regime, it has recently issued some trade restrictions on the import of textiles, sugar, and steel. A recent increase in the rice tariff has been modest, but further increases are likely to be damaging for the poor. At the same time, agricultural exports, a potential growth market for Indonesia, are hampered by developed country trade restrictions and subsidies, but also by the lack of capacity of Indonesia to meet standards in health and quality. Moreover, infrastructure bottlenecks, ports and customs handling, and corruption are hampering better export performance. In addition, manufacturing industries, and textiles in particular, are suffering from increased competition notably from China. The Bank is collaborating with the Ministry of Trade and Industry on trade policy, trade performance, and export competitiveness.

Corruption, justice and legal reforms. The Bank and the Fund have been active in providing support to the legal and justice sector. The authorities realize that progress in this area is important, particularly as the investment climate continues to suffer from widespread recognition of judicial corruption and weaknesses in the legal framework. The Fund is providing technical assistance to the Supreme Court and, together with the Bank, is assisting in the reform of the commercial courts. For the Bank, justice sector reforms are an important part of a broader program of governance reforms. The Bank’s strategy in this area has three components: (i) leading the CGI members’ dialogue on justice sector reforms at the national level through support to the Governance Partnership’s efforts at enhancing dialogue within the justice sector and to the work of the National Law Commission which is now finalizing its recommendations for a long-term reform agenda for the sector; (ii) contributing to effective aid coordination; and (iii) supporting civil society reform efforts, both through the Partnership and through the Bank’s own project mechanisms, such as the Justice for the Poor program.

While the government has initiated a number of anticorruption measures, including passage of an anticorruption law, the establishment of the office of the Ombudsman, and the creation of a commission to audit the wealth of state officials, these efforts have been undermined by weak enforcement. The Bank has been working with the Governance Partnership in undertaking corruption diagnostic work (including an anticorruption survey) that led to a number of civil society initiatives to fight corruption and raised public awareness of the underlying policy issues. The Bank’s planned operations in subnational regions to improve governance have a strong anticorruption focus. Finally, the Bank is working with the government to reform key budgetary processes relating to procurement and financial management. Progress in these areas are triggers for Indonesia accessing the high case lending in the current CAS.

World Bank-Fund Overall Collaboration

Bank-Fund collaboration in Indonesia takes place at two levels: (i) through the lending program and conditionalities; and (ii) through analytical and advisory services.

Lending programs and macroeconomic issues. The Fund has taken the lead in assisting the government in maintaining macroeconomic stability and fiscal sustainability. There is a close link between the Fund program and the CAS triggers for the high case lending of the Bank. On the one hand, structural measures in the current Fund program are closely coordinated with the Bank, especially relating to IBRA, privatization, bank and corporate restructuring, and other financial sector reforms. On the other hand, compliance with appropriate policies and targets in the LOI, including macroeconomic stability, is one of the Bank’s triggers in the current CAS to reach the high case lending. Coordination between the two institutions has thus been crucial.

Analytical and advisory activities. Over the CAS period, the Bank’s analytical and advisory services have shifted from crisis response to longer-term development concerns, including work on governance, decentralization, financial sector development, and long-term development prospects. At the same time, the Bank continues its assistance in the development and implementation of the government’s broad-based poverty strategy.

Main World Bank’s Nonlending Services(Recently completed or ongoing)
IssueInstrument
Poverty alleviationPoverty report (2001); PRSP (ongoing)
Development spending and sector issuesHealth Strategy in a Post-Decentralizing Indonesia (2000); Education Sector Review; Infrastructure Strategy for Decentralized Indonesia; Public Expenditure Review
Long-term debt managementASEM trust fund on Building Debt Management Capacity
Public expenditure managementPublic Expenditure Review; Advice on three laws (CAS trigger); Country Financial Accountability Assessment (2001); and Country Procurement Assessment Review (2001)
DecentralizationRegional Public Expenditure Reviews
Civil service reformASEM trust fund on Civil Service Reform in Decentralized Indonesia
Financial sectorAdvice on IBRA and three state banks; Financial Sector Strategy
Corporate sectorSpecial Miyazawa technical assistance grants; Corporate Restructuring Technical Assistance project; Policy dialogue; Investment Climate Survey and Assessment
TradeASEM trust fund on Trade Performance and Competitiveness; Trade Diagnostics Study
Corruption, justice, and legal reformsSupport for Governance Partnership; Justice for the Poor program; Advice on procurement (CAS trigger)
Note: Services without a date are ongoing and will be completed in 2003.
Note: Services without a date are ongoing and will be completed in 2003.

Lending Operations

The main goal of the World Bank in Indonesia is to support efforts in reducing poverty and vulnerability in an open and decentralized environment. FY01 and FY02 achieved base case lending expectations averaging $400 million a year, and a similar trend is expected for FY03. But project implementation is slowing down due to changes arising from decentralization and, in particular, the lack of on-lending guidelines. Corruption continues to limit the effectiveness of development expenditures in Indonesia. The Bank is working with government to address corruption in Bank-financed projects and has outlined a strategy to help ensure that Bank funds are used for intended purposes. The Bank’s projects over the past three years fell into five categories: community development, infrastructure, human development, decentralization/governance reform, and environment.

Despite higher oil prices, oil and gas receipts were below expectations, as some overseas revenue was frozen pending resolution of a commercial dispute.

While the authorities have maintained a target for GDP growth of 4 percent, as a safeguard against downside risks to the outlook, the program’s quantitative targets have been based on a point estimate consistent with the staffs 3½ percent growth projection (at the upper end of the 3–3½ percent range forecast at the seventh review, owing to the smaller-than-feared impact of the Bali attack). Inflation is currently below the end-year target, due in part to base effects and other temporary factors.

The tax package included an exemption from income tax for minimum wage workers and a reduction in the rates of luxury tax on selected consumer items (largely to reduce smuggling). The package also reintroduced an exemption from VAT for capital goods, and postponed the removal of exemptions of a number of other items (electricity and toll roads).

For the purposes of this review, it was assumed that Indonesian oil prices would decline gradually to S24 per barrel by mid-year, compared with a price of $22 per barrel in the budget.

When Paris Club creditors agreed last April to reschedule eligible interest and principal falling due in 2003, they deferred a decision on the precise amount of interest rescheduling until the 2003 balance of payments need could be established. In the event, the amount granted—100 percent of principal and 50 percent of interest—was a little below the authorities’ request on which the budget was formulated.

The moratorium provides additional time to strengthen the budget reporting system and address weaknesses in the legal framework governing regional borrowing. Although the framework establishes a ceiling on the debt of local governments, it does not specify sanctions against regions which breach their debt limits. There is also a need to develop a resolution framework for regions that default on their debt.

The government holds substantial deposits (around Rp 80 trillion), partly reflecting earnings from “investment funds” that are generated by interest and principal payments received on donor (and other) funds previously on-lent to local governments. The balances on these funds are integrated into the budget.

The results of the government’s placement of domestic securities (Rp 2 trillion in 8-year bonds) in December were promising. The auction was 3½ times oversubscribed, with the bond yielding 14½ percent (the prevailing yield for 1-month SBIs was 13 percent).

Bank Lippo was jointly recapitalized in 1999 by the government and the original owners. A controversy has surfaced in recent weeks regarding the financial statements for the bank, linked to allegations that the former owners have been seeking to manipulate the reported value of the bank’s assets and share price to enable them to regain control. The government, as majority shareholder, is considering steps to address the situation, including changing the bank’s management.

Criminal cases have been launched against 5 shareholders, and are under preparation for a further 12. To strengthen this approach, IBRA will now include the original Directors and Commissioners of the banks, who in many cases are closely related to the noncooperative shareholders, in their legal actions.

A draft privatization law is currently before Parliament. The draft seeks to consolidate the legal basis for privatization into a single law, and thereby facilitate the privatization process.

To date, the JITF has mediated $19.4 billion in external debt restructuring; its remaining stock amounts to $10.4 billion.

Indonesia has been replacing nontariff barriers with tariffs since the mid-1990s; while licensing requirements exist for some sensitive goods (e.g., steel and textiles), they are implemented liberally, without quantitative restrictions.

Recent actions include an increase in steel tariffs (of 10–15 percentage points) and imposition of a licensing requirement for textile imports (mainly woven cloth). The authorities explained that the former is a temporary measure to address anti-dumping concerns, while the latter is narrow in scope, and does not impose quantitative restrictions.

The first two rounds covered major agencies such as the national oil company (Pertamina), the electricity company (PLN), and the rice procurement board (Bulog).

Prepared by World Bank staff.

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