Indonesia signs new Letter of Intent with IMF<\/p>\n
The following is the first part of the complete text of the
\nnew Letter of Intent signed by the Indonesian government and the
\nInternational Monetary Fund on Thursday. The second part of the
\ntext will appear on Friday.<\/p>\n
Jakarta, Indonesia<\/p>\n
January 20, 2000<\/p>\n
Government of Indonesia and Bank Indonesia<\/p>\n
Memorandum of Economic and Financial Policies Medium-Term
\nStrategy and Policies for 1999\/2000 and 2000<\/p>\n
I. INTRODUCTION<\/p>\n
1. With the completion of Indonesia's political transition, and
\nthe election of a government with a wide popular mandate,
\nIndonesia now has an historic opportunity to join its neighbors
\nin a strong recovery and enhance the wellbeing of the Indonesian
\npeople.<\/p>\n
2. Much was achieved under the previous extended arrangement when
\nIndonesia made significant progress in restoring macroeconomic
\nstability, dealing with the financial crisis, advancing
\nstructural reforms, and assuring food security. The macroeconomic
\nachievements include the elimination of inflation, the
\nstabilization of the rupiah, and recovering foreign exchange
\nreserves. The financial sector has begun to stabilize, interest
\nrates have fallen below pre-crisis levels, and bank restructuring
\nand recapitalization have started.<\/p>\n
3. However, much remains to be done to revive the real economy
\nand lay the foundation for a sustained recovery that would
\nincrease employment, reduce poverty, and assure equality of
\nopportunity. These challenges constitute the principal agenda of
\nthe State Policy Guidelines that have been approved by
\nIndonesia's democratically elected Parliament. Based on these
\nguidelines, the government has now adopted a comprehensive
\neconomic program that would accelerate the restructuring of
\nIndonesia's economy and meet these challenges.<\/p>\n
II. MEDIUM-TERM ECONOMIC STRATEGY<\/p>\n
4. The medium-term strategy has four main planks. First, to make
\nthe macroeconomic policy mix fully supportive of recovery while
\nentrenching basic price stability. Second, to reinvigorate bank,
\ncorporate, and other restructuring policies, which are crucial to
\nsustaining an economic recovery accompanied by lasting poverty
\nreduction. Third, to rebuild key public institutions, thereby
\nstrengthening Indonesia's capacity to implement economic and
\nsocial policies with popular support, transparency, and good
\ngovernance. Fourth, to improve greatly natural resource
\nmanagement, arrest the long-term deterioration in the
\nenvironment, and ensure the sustainable use of natural resources
\nfor future generations.<\/p>\n
A. Medium-Term Macroeconomic Framework<\/p>\n
5. The strategy envisages restoring a growth rate of 5-6 percent
\nover the medium term, and Bank Indonesia (in the context of the
\nnew Central Banking Act) has adopted a target of keeping
\ninflation below 5 percent annually. Although the external current
\naccount would weaken over the next several years, as investment
\npicks up, official financing and improvements in private capital
\nflows (including the return of flight capital) should readily
\noffset the decline in the current account surplus. We are
\nconfident that the need for exceptional balance of payments
\nfinancing would be eliminated by the end of the program period,
\nwhile the import coverage of liquid reserves would be maintained
\nat about six months. The government debt-to-GDP ratio should
\ndecline from its recent peak of about 100 percent to about 65
\npercent by 2004, helped by falling interest rates and IBRA's
\nasset recovery.<\/p>\n
6. Key to attaining these objectives will be a range of fiscal
\nreforms, affecting both revenues and expenditures. These reforms
\nwill be introduced concurrently with implementing fiscal
\ndecentralization by June 2001, consistent with the Regional
\nGovernance and Fiscal Balance Laws, and without increasing the
\nGeneral Government deficit.<\/p>\n
B. Restructuring Policies<\/p>\n
7. Financial and corporate reforms lie at the heart of the
\nprogram, and the government is resolved to carry these forward in
\nan integrated and coherent way. The strategic objectives of our
\nbank restructuring program are four-fold: (i) capitalize all
\nbanks to at least 8 percent CAR by end-2001, as a precondition to
\nthe eventual replacement of the comprehensive guarantee by self-
\nfinanced deposit insurance; (ii) ensure that the banking system
\nis restructured at minimum public cost; (iii) enhance supervision
\nand instill much improved governance in the banking sector; and
\n(iv) deepen bond and equity markets, allowing dependence on bank
\nfinance to be reduced.<\/p>\n
8. In tandem with bank restructuring efforts, corporate
\nrestructuring needs to move ahead with much greater momentum in
\norder to restart credit flows that are needed to sustain the
\nrecovery. This will require changing the incentive structure
\nfaced by corporate debtors and strengthening the institutional
\nstructure for corporate restructuring.<\/p>\n
The government intends to do this by giving new political
\nleadership and direction to the corporate restructuring strategy,
\nimproving the implementation of the bankruptcy law, enhancing the
\ngovernance framework in the judiciary, instructing IBRA to
\nintensify implementation of its sequenced strategy toward its
\ncorporate debtors, and strengthening procedures for non-IBRA-led
\nrestructuring.<\/p>\n
9. To ensure that the benefits of economic recovery are widely
\nshared among the Indonesian people, the strategy includes a wide
\nrange of structural measures. Thus, reforms to strengthen
\nagriculture, increase the opportunities to the small scale
\nsector, improve targeted spending programs, and upgrade the human
\ninfrastructure will help ensure that recovery is accompanied by
\nsustained poverty reduction. They will be supported by measures
\nto deepen competition in the economy, inter alia, through the
\nrestructuring and reform of the state-owned enterprises,
\nespecially in the energy sector.<\/p>\n
10. In particular, the program for the reform and privatization
\nof the state-owned enterprises represents a central element of
\nthe government's broader strategy for improving the performance
\nof the public sector, and enhancing overall corporate
\ncompetitiveness. While privatization is expected to generate
\nconsiderable revenues over the coming years, and support public
\ndebt reduction, this is not seen as its sole objective. Rather,
\nthe ultimate objective of the privatization program is to create
\nefficient and viable enterprises. In all instances, privatization
\nwill be undertaken transparently using best practice procedures.<\/p>\n
C. Rebuilding Economic Institutions<\/p>\n
11. There is widespread consensus in Indonesian society that key
\neconomic institutions need to be rebuilt or strengthened in order
\nto command the trust of the people and allow the smooth
\nimplementation of the medium-term policy agenda. Insufficient
\nattention to institution building over a long period led to a
\nsteady erosion in the governance framework for economic and
\nsocial activities, contributing to the depth of Indonesia's
\nfinancial crisis, and burdening the recovery process.<\/p>\n
Reversing this situation will not be easy; our early
\npriorities will be in the public sector (fiscal management and
\ncivil service reform), financial sector (IBRA, the state-owned
\nbanks, and the regulatory and supervisory institutions), the
\njudiciary, and the institutions responsible for corporate
\ngovernance.<\/p>\n
12. The task of improving governance in fiscal management is vast
\nand complex, and crucial to regaining public confidence as well
\nas sustaining fiscal adjustment and public debt reduction. The
\ntax system needs to be reformed to ensure that it is broad-based,
\nnondistortionary, equitable, and transparent. Tax administration
\nhas to be overhauled to ensure that regulations are implemented
\nfaithfully and in an even-handed manner.<\/p>\n
The governance of spending programs must be greatly improved
\nand the allocation of funds redirected toward poverty alleviation
\nto promote interregional equity and increase efficiency in the
\nprovision of public goods. Fiscal transparency needs to be
\nenhanced by identifying and auditing off-budget activities and
\nbringing them under the consolidated budget. Wages to public
\nservants need to be increased, in line with improved governance
\nand within the government's fiscal capacity, so as to create a
\nmore professional civil service with high standards and
\nintegrity.<\/p>\n
13. Implementing fiscal decentralization will require new
\ninstitutions which will need to work in close consultation with
\nregional authorities and civil society. A Consultative Regional
\nAutonomy Council will be established shortly to oversee
\nimplementation of decentralization. A grants administration (a
\nFiscal Balance Secretariat) will be established to design the
\nrules for transfers. The Ministry of Finance has been designated
\nas the lead agency for implementing all fiscal aspects of
\ndecentralization, in consultation with the Fiscal Balance
\nSecretariat. A full-time fiscal decentralization advisor is being
\nappointed to the MOF. The accountability of lower levels of
\ngovernment will need to be developed, and the regional tax base
\nincreased; toward these ends, a review of tax legislation and
\nadministration has been launched, and regulations for regional
\nfinancial management will be developed by June 2000. A central
\ndatabase for regional government financial information will be
\nestablished to support central policy formulation.<\/p>\n
14. The newly independent Bank Indonesia (BI) has a great
\nresponsibility to support the recovery, by maintaining price
\nstability, rebuilding bank supervision, and ensuring a high level
\nof disclosure of banking activities. Prudential supervision of
\nthe financial system needs to be carried as quickly as possible
\nto international standards. Effective oversight of BI will be
\nexercised through regular reporting to Parliament.<\/p>\n
15. Improving public confidence in the integrity of the judiciary
\nand in the efficacy of the legal process is a vital objective of
\ninstitutional reform and key to economic restructuring. Thus, we
\nhave adopted a comprehensive agenda of legal and judicial reform
\nwith four key programs aimed at good governance in the legal
\nsystem and administrative law reform; improved administration of
\njustice; legal education, testing and discipline; and improved
\nlegislative capabilities. The program includes measures to reduce
\nthe opportunities for corruption (by improving the transparency
\nand speed of legal proceedings) while, at the same time, creating
\npowerful disincentives for corrupt practices (including
\nprosecutions of the parties that engage in such practices). We
\nalso intend to enhance the role of the Attorney Generals Office,
\nreform the court system, and seek: parliamentary confirmation for
\nall appointments to the Supreme Court. The IMF, World Bank, and
\nAsDB will assist in mobilizing financial and expert assistance to
\nthe Attorney General's Office.<\/p>\n
16. IBRA is crucial to meeting the objectives of restoring a
\nsound banking system as well as promoting corporate restructuring
\nand asset recovery to reduce the public debt. To accomplish these
\ntasks, IBRA needs to be protected from narrow political
\ninterests; it also needs to be administered by professionals in a
\ntransparent manner, and have an unassailable governance
\nstructure, including a strong oversight body. The government is
\ncommitted to assuring these conditions, and establishing a fully
\neffective governance structure in consultation with the IMF, the
\nWorld Bank, and the AsDB. We expect that IBRA will largely
\ncomplete its work in restructuring financial institutions and
\nrecovering asset value during the period of the program.<\/p>\n
17. The governance structures of other economic institutions are
\nalso being reviewed and improved to upgrade corporate governance.
\nThis will include adopting a new code of corporate governance,
\nstrengthening capital market regulation at the Securities and
\nExchange Commission (BAPEPAM), and improving the oversight of
\nnonbank financial institutions at the Ministry of Finance.<\/p>\n
D. Improved Natural Resource Management<\/p>\n
18. Indonesia's natural environment has continued to deteriorate
\nduring the crisis. Weak policy implementation and weak market
\ninstitutions have combined to undermine Indonesia's base of
\nnatural resources. We recognize the key role natural resources
\nplay in the Indonesian economy and are determined that our
\npolicies and programs ensure their sustainable use for the
\nbenefit of this and future generations.<\/p>\n
19. Our policy and institutional framework for natural resource
\nmanagement will focus on three key objectives. First, we will
\ninclude greater consultation and stakeholder participation in
\ndecisions affecting our natural resources, particularly in the
\nformulation of new policies, and the location and selection of
\npublic investments. To ensure that these decisions are based on
\ngood information, we propose to expand and improve environmental
\nmonitoring of Indonesia's air, water, forests, and marine
\nresources. Second, we will move towards a pricing structure for
\nnatural resources that better reflects their true value. And
\nthird, we will pay special attention to improving forest
\nmanagement and ensuring a sustainable production of goods and
\nservices from our forest resources.<\/p>\n
III. MACROECONOMIC POLICIES FOR 1999\/2000 AND 2000<\/p>\n
20. Consistent with the medium-term framework, our near-term
\nmacroeconomic policies are based on growth being in the 1-2
\npercent range in l999\/2000, strengthening to the 3-4 percent
\nrange during FY 2000. Low single-digit inflation will be
\nentrenched. The external reserve position will be further
\nstrengthened. Fiscal, monetary, and external policies have been
\nformulated to contribute to these outcomes, and will be regularly
\nreviewed to address risks that may materialize.<\/p>\n
Fiscal Policy and the Social Safety Net<\/p>\n
21. The fiscal deficit for 1999\/2000 is currently estimated at
\nabout 3 3\/4 percent of GDP. Inclusive of the settlement of
\narrears, the budgetary financing need is estimated at about 5
\npercent of GDP. This is below the original program because of
\ndevelopment spending shortfalls in the first half of the year
\n(associated with the political transition), and higher oil prices
\nand revenues. An ongoing recovery in development spending should
\nensure positive fiscal stimulus during the second half of the
\nfiscal year. The financing need will be fully met by
\nprivatization receipts, asset recovery, and foreign financing.<\/p>\n
22. We have established clear principles for the FY 2000 budget
\nwhich was submitted to Parliament today. First, to strike a
\ncareful balance between supporting the economic recovery and
\nstarting the process of reducing government debt. Second, to
\ncontinue to avoid domestic bank financing. Third, to initiate a
\nrange of structural tax reforms, whose full impact will accrue
\nover-the medium term. Fourth, to start the process of gradually
\nreducing untargeted subsidies, while protecting small household
\nusers from their impact, and strengthening targeted poverty-
\nalleviation programs. Fifth, to begin to restore public sector
\nwages, especially for the most senior officials, concurrently
\nwith administrative reform and stringent penalties on corruption.
\nOn this basis, we expect that the FY 2000 budget deficit will be
\n5 percent of GDP, financed about equally from domestic (asset
\nrecovery and privatization) and foreign sources.<\/p>\n
23. The wage differential with the private sector is very high;
\nparticularly at the top echelons, and correcting this
\ndifferential is an integral part of civil service reform, and
\nwill be accompanied by anti-corruption efforts. With these key
\nobjectives in mind, we have decided to raise the basic wages of
\npublic employees in two installments of 10 percent each, to be
\nimplemented on April 1 and Oct. 1, 2000, thus achieving a total
\nwage increase of 2.0 percent during the year. Larger increases
\nwill be given to higher civil service echelons, including state
\nofficers and the judiciary. With these increases, total personnel
\nexpenditure is projected to increase by 16 percent to Rp 45.7
\ntrillion.<\/p>\n
24. There are three main elements to our social spending: the
\nsocial safety net (SSN); poverty alleviation programs; and
\ntargeted fuel and energy subsidies. Overall social spending is
\nprojected to be Rp 8.5 trillion in FY 2000. Of this total, SSN
\nprograms are projected at Rp 2.7 trillion and have the following
\nprincipal components: (i) the rice distribution (OPK) program;
\n(ii) a health component; (iii) specific employment programs,
\nincluding to enhance women's employment; (iv) a program to
\nprovide funds directly to communities; (v) scholarships to needy
\nstudents and block grants to targeted schools; and (vi) poverty
\nalleviation. These programs have enhanced monitoring provisions
\nand other safeguards to prevent abuse and protect implementation,
\nincluding frequent reporting on key performance indicators'
\nindependent verification, and close involvement by NGOs and civil
\nsociety. They are being supplemented by the new poverty-
\nalleviation programs which are projected at Rp 4.5 trillion in FY
\n2000, and are being designed also in close consultation with the
\nWorld Bank and the AsDB. The new programs will be implemented
\nwith the same monitoring provisions and safeguards. The proposed
\nmechanisms aimed at protecting low income households from the
\nenergy tariff increases are projected at Rp 1.3 trillion in FY
\n2000.<\/p>\n
Monetary and Exchange Rate Policies<\/p>\n
25. Firm base money control, combined with a flexible exchange
\nrate policy, have anchored prices and strengthened the rupiah,
\nand there will be full continuity of these policies. Although the
\nuncertainties of August-October interrupted the process of making
\nmonetary policy fully supportive of recovery, the declining trend
\nof money market interest rates has now resumed. Given the absence
\nof inflation, there remains room to guide interest rates down
\ncautiously further, as in the other Asian countries.<\/p>\n
26. The monetary program for the remainder of 1999\/2000 results
\nin a base money increase for the fiscal year as a whole of about
\n9 1\/2 percent, to Rp 86 trillion. Compared with the previous
\nprojection, this program is based on a slightly higher level of
\nnet BI reserves. An indicative monetary program for 2000 has also
\nbeen formulated to accommodate anticipated higher growth. With
\nimproved confidence reducing currency demand, base money is
\ntargeted to increase to about Rp 92 trillion by end-December
\n2000. This base money program provides for the recovery of bank
\ncredit to the private sector, and will be reviewed periodically
\nto ensure that it remains fully supportive of recovery and
\nresponsive to unanticipated capital inflows.<\/p>\n
Balance of Payments and External Policies<\/p>\n
27. The external current account surplus in 1999\/2000 is
\nprojected to reach about $5billion (3.1 percent of GDP), about
\n$2.5 billion above previous projections because of the reduced
\nfiscal expansion and stronger oil export prices. Liquid reserves
\nare now projected to be $25 billion by the end of the fiscal
\nyear, or about 6 months of imports; its coverage of short-term
\ndebt will improve to over 70 percent.<\/p>\n
28. With the onset of recovery and a strengthened currency, we
\nexpect the current account surplus to decline in 2000, consistent
\nwith the pattern experienced in the other Asian countries.
\nCurrent projections point to the current account surplus falling
\nto about $2 billion in FY 2000. Export volume growth should
\nstrengthen, although this is expected to be outweighed by a
\nrecovery of imports (which will still remain well below the pre-
\ncrisis level). In the capital account, private capital flows
\nshould improve, but new-pressures are expected from at least two
\nsources: (i) corporate reschedulings are likely to be associated
\nwith prepayments on account of arrears; and (ii) banks are
\nexpected to make payments consistent with contractual obligations
\nunder the first exchange offer.<\/p>\n
29. Consequently, we expect an external financing gap to emerge
\nagain in FY 2000, of about $4.3 billion, linked closely to the
\nfiscal deficit. We are confident that the full amount of official
\nexternal financing will be available. We have requested another
\nprincipal rescheduling from The Group of Official Creditor
\nCountries of Indonesia for the 24-month period through March
\n2002; estimated relief during FY 2000 is about $2.1 billion. We
\nhave been in touch with our multilateral creditors (especially
\nthe World Bank and the AsDB) and bilateral creditors (especially
\nJapan) and have received assurances that the remaining amount of
\nfinancing should be available from these sources during FY 2000.<\/p>\n
IV. STRUCTURAL REFORMS<\/p>\n
A. Fiscal and Trade Policy Reforms<\/p>\n
30. A range of structural fiscal reforms is being implemented to
\nunderpin the increased efficiency, transparency, and institution
\nbuilding planned for the public finances. Policies governing tax
\nholidays and free trade zones are being rationalized to keep the
\ntax system from being used to promote or discourage specific
\nsectors, industries, or regions, thus reducing abuse and evasion.
\nThe efficiency of the value-added tax (VAT) is being improved by
\nphasing out unnecessary exemptions. Concrete steps are being
\ntaken to improve tax and customs administration, improve the
\ntargeting of large taxpayers, and combat fraud. An audit of the
\ntax office is expected to be completed by March 2000. Two new
\namendments to tax laws (the VAT law and the Tax Procedure law)
\nare being prepared for submission to Parliament by February 2000
\nto strengthen the auditing and refund procedures and broaden the
\ntax base. A reform plan is also being implemented to rationalize
\nexcise taxes on cigarettes. We will complete an audit of the
\nagricultural credit program (KUT) by March 2000 to improve its
\nefficiency and clarify its future role.<\/p>\n
31. The Ministry of Finance intends to complete two reviews aimed
\nat delivering much increased fiscal transparency by end-March
\n2000. The first review aims at consolidating information on all
\nbank accounts controlled by government agencies. The second
\nreview takes stock of off-budget funds. Based on these reviews,
\nwe will consolidate off-budget accounts and funds, where
\nappropriate, by June 30. Any funds remaining outside the budget
\nwill be subject to annual audit. In addition, we have instructed
\nthe State Audit Board (BPKP) that any future internal audits of
\nfinancial operations of all government agencies take full account
\nof all extrabudgetary sources of support. This will begin in 2000
\nand will include the military.<\/p>\n
32. We recognize that quasi-fiscal activities may also arise from
\nthe operations of foundations and we intend to bring their
\nactivities and accounts under government review and audit. The
\nMinistry of Law and Legislation will form a working group to make
\npolicy recommendations and to draft legislation on foundations to
\nbe submitted to Parliament by end-April 2000. The legislation
\nwill require foundations to file a public statement of
\nactivities, including audited accounts.<\/p>\n
33. We reaffirm our commitment to maintain a liberal trade
\nregime, avoid introducing any new trade barriers, and remove
\nremaining distortionary elements in the trade structure. As part
\nof the 1995 tariff reduction plan, we recently reduced the import
\ntariff on a number of items from 10 percent to 5 percent and, by
\nend-2003, we will establish a three-tiered tariff structure (0,
\n5, and 10 percent) for all goods except alcohol and automobiles.
\nDuring the program period, we will eliminate all exemptions to
\nimport tariffs (except those which are part of international
\nagreements), and remove all existing non-tariff barriers (except
\nthose for health and safety reasons). As a step toward replacing
\nall export taxes and levies by resource rent taxes, the maximum
\nexport tax on logs, sawn timber, and minerals was reduced to 15
\npercent by end-December 2000. This will be followed by a review
\nof forestry sector taxation policy starting January 200O, in
\nconsultation with the World Bank. At the same time we will ensure
\nthat the forest resource royalty rate (PSDH) captures at least 60
\npercent of the economic rent from logs and, thereby, protect
\nIndonesia's forests. Finally, we will eliminate all other export
\nrestrictions (e.g., licensing requirements or government approval
\non logs, coffee, and wood products), by end-2000, with the
\nexception of those needed under the multi-fiber agreement.<\/p>\n
B. Fiscal Decentralization<\/p>\n
34. The government is committed to implementing fiscal
\ndecentralization according to the approved legal framework. The
\ndecentralization framework specifies principles for sharing
\nnatural resource-based government revenue, notably of oil
\n(devolution of 15 percent of onshore nontax revenue), gas (30
\npercent of onshore nontax revenue) and forestry (80 percent of
\nrevenue? to regional authorities, and establishes a General
\nAllocation to regional authorities (at least 25 percent of total
\ndomestic revenue). Implementation of these principles would
\ndouble transfers and shared revenues to 6 percent of GDP by 2002,
\nin step with the decentralization of most administrative and
\nsocial welfare functions. As a result, the share of regional
\ngovernment spending is expected to double, to about 40 percent of
\ntotal spending by 2002, by which time it should total 7 percent
\nof GDP. We will ensure that fiscal transfers to the regions
\npromote equity by taking regions' revenue capacity and spending
\nneeds into account; this will be the task of the grants
\nadministration.<\/p>\n
C. Banking System Reforms<\/p>\n
35. Banking reforms lie at the heart of the economic program, and
\nan ambitious agenda for the year 2000 has been adopted. In many
\nareas, strong measures have already been taken to signal the
\ngovernment's determination. The Financial Sector Policy Committee
\n(FSPC), which reports directly to the President, has been
\nestablished to give clear political leadership and direction in
\nthe areas of banking and corporate restructuring. The FSPC is
\nheaded by the Coordinating Minister for Economy, Finance, and
\nIndustry, and includes the Minister of Finance, the Minister for
\nInvestment and State-Owned Enterprises, the Minister of Trade and
\nIndustry, and the Chairman of BAPPENAS. The Governor of Bank
\nIndonesia will be invited to attend meetings. The FSPC is in the
\nprocess of establishing a secretariat, including a coordinator to
\nliaise with IBRA and the JTTF.<\/p>\n
Improved Governance in Banking<\/p>\n
36. The government has taken a strong set of measures to reassure
\nthe public, as well as markets, that the Bank Bali investigation
\nis being credibly advanced, and that systems and procedures have
\nbeen strengthened to prevent any recurrence. The Attorney General
\nis undertaking an investigation into the corruption aspects of
\nthe Bank Bali matter, assisted by PwC, and has so far made one
\nindictment in the case; additional actions are expected to be
\nforthcoming as the investigation proceeds.<\/p>\n
37. We are taking steps to ensure that future settlements under
\nthe guarantee scheme are made expeditiously and that the process
\nis not compromised in any way. Thus, an international accounting
\nfirm contracted by IBRA completed a preliminary examination of
\nall pending interbank claims in mid-December 1999, allowing a
\nfirst round of eligible claims to be paid at end-December. Based
\non this examination, and in close collaboration with the IMF, the
\nWorld Bank, and the AsDB, IBRA will publicize new and fully
\ntransparent procedures for processing claims under the guarantee
\nin February 2000. The eligibility of the remaining claims is
\nexpected to be determined during February through a further
\nreview conducted with the full cooperation of BI. All of the
\nclaims deemed eligible in that review will be settled promptly
\nthereafter.<\/p>\n
38. A comprehensive study, in collaboration with the World Bank,
\nhas been launched to develop a strengthened governance and
\noversight framework for IBRA, and an interim report is expected
\nduring February 2000. On the basis of this report,
\nrecommendations will be developed and final decisions taken no
\nlater than March 31, 2000. Meanwhile, a number of essential steps
\nhave been taken to strengthen IBRA: (i) the government has
\nreconfirmed IBRA's status as the sole publicly funded entity in
\ncharge of asset recovery; (ii) the President has issued an
\ninstruction clarifying that IBRA will report to his office on all
\npolicy issues; (iii) IBRA is finalizing its accounting policies
\non the basis of advice from international auditors; (iv) the
\nfirst audited accounts of IBRA's operations, covering its
\nposition as of December 1999, will be publicized by end-April
\n2000, followed by regular quarterly and annual audited financial
\nstatements; and (v) an Ombudsman's office will be established
\nwithin IBRA by end-January, 2000 to respond to all inquiries from
\nthe public. The Independent Review Committee continues to
\nexercise oversight over IBRA.<\/p>\n
Loan Collection and Asset Recovery<\/p>\n
39. The institutional framework and sequenced strategy for loan
\ncollection and asset recovery, focused on the largest borrowers,
\ncontinues to be implemented. The strategic objectives for March
\n31, 2000 are to complete restructuring MOUs for about 50 percent
\nof the loan value of IBRA's cooperating Category A debtors; and
\nto complete the valuation of the assets of at least 50 percent of
\nloan value of cooperating Category B borrowers. We are resolved
\nto take timely and evenhanded action against all noncooperating
\ndebtors (Categories C and D). Their loan obligations and payment
\nrecords have already been made public, and IBRA's Legal
\nDepartment is now pursuing a strategy to ensure these accounts
\nare settled in an expeditious manner. The first round of formal
\nlegal actions were taken in December 1999. In addition, all
\nstate\/BTO banks and IBRA will start in February releasing
\nquarterly reports on recovery performance on loans in categories
\n3, 4, and 5.<\/p>\n
40. IBRA is on track with its recovery schedule aimed at
\ncollecting at least Rp 17 trillion in cash by March 2000; and had
\nalready recovered Rp 7.9 trillion by Nov. 30, 1999. IBRA has
\nadopted a minimum cash recovery target of Rp l6.3 trillion for FY
\n2000, including sales of assets and companies from its AMI (Asset
\nManagement Investments) and recoveries on loans from its AMC
\n(Asset management Credits). In addition, IBRA is launching a
\ntransparent process of outsourcing and\/or sale of its smaller
\nloans (less than Rp 50 billion), with the first such disposition
\nscheduled to take place by end-March 2000. IBRA publishes
\nfrequently, through the press, a schedule of auctions of noncore
\nassets, as well as transparent procedures for all asset sales.<\/p>\n
41. IBRA has also made decisive progress toward completing
\ndiscussions with, and transferring shareholder assets from,
\nformer owners or i998 and 1999 BTOs (banks taken over) and BBOs
\n(banks closed). With regard to the 13 1998 BTO and BBO banks that
\nhad violated prudential regulations, the asset transfers from
\nseven bank owners are to be completed by Dec. 31, 1999; those
\nfrom two further bank owners are expected to be completed by
\nApril 2000. The cases of the noncooperating shareholders of the
\nremaining four banks will be publicized in February 2000 and, if
\nnot resolved, referred for prosecution to the Attorney General,
\nwho will initiate court proceedings during March 2000. We expect
\nto finalize negotiations with the 46 1999 BTO\/BBO banks by May
\n2000, and complete all associated asset transfers by end-October
\n2000.<\/p>\n
State and BTO Bank Restructuring<\/p>\n
42. State bank restructuring is being implemented under the
\noversight of an interdepartmental Restructuring Committee, and
\nwith the following safeguards. All state banks have been required
\nto prepare business plans will the help of international
\nadvisors, and to contract with international banks for their loan
\nwork-outs. The Ministry of Finance is establishing a fully funded
\nand staffed monitoring unit to ensure compliance of the state
\nbanks with their performance contracts. The monitoring unit has
\nensured that all state banks have transferred to IBRA all of
\ntheir category 5 loans (as well as any loans with provisions of
\nmore than 50 percent), as of Sept. 30, 1999, together with all
\nloan documentation. Henceforth, all state banks will be subject
\nto an annual audit by international accounting firms, beginning
\nwith their end-l999 positions.<\/p>\n
43. Progress is most advanced in Blank Mandiri. Two branches of
\ncapital have now been injected into the bank, the latest one (for
\nRp 75 trillion) on Dec. 28, 1999, bringing the total bonds
\nprovided to Rp 178 trillion. As a result, the bank's CAR has been
\nraised to above 4 percent, based on the December position
\nestimated by an international accounting firm. Any difference
\nwith the:he final audited end-1999 accounts will be met by (or
\nrepaid to) the government in early 2000, as soon as these
\naccounts become available.<\/p>\n
44. At the same time, Bank Mandiri is taking decisive actions to
\nimprove its operational performance in line with operational and
\nfinancial1 targets specified in the interim investment and
\nmanagement performance agreement signed on Dec. 28, 1999. Efforts
\nare underway to improve services by hiring additional line
\nmanagers, and outsourcing the information technology system at
\nheadquarters. To improve financial management, the bank has
\nestablished special teams to secure full information on the
\nbank's daily cash flow, and to complete the reconciliation of
\ninterbranch items inherited from its component banks by Feb. 29,
\n2000. To improve transparency, the bank is publicizing the terms
\nand conditions of all its loan restructuring deals.<\/p>\n
45. Concerning BNI, we intend to follow a similar restructuring,
\nstarting with a management review. Following an international
\nexecutive search, a new management team will be appointed
\nfollowing the shareholders'meeting. The government and the new
\nmanagement will sign performance contracts by Feb. 29, 2000.
\nThereafter, the new management will finalize agreement with an
\ninternational firm to enter into a twinning\/management agreement
\nby March 31, 2000 to implement the full business plan, with
\nspecial emphasis on governance, risk management and the workout
\nof non-performing loans. The first tranche of recapitalization
\nwill be provided only upon completion of the preceding actions,
\nexpected by March 31, 2000. The remaining tranche will follow the
\ncompletion of the end-1999 financial audit, and implementation of
\nthe business plan, expected by June 30, 2000.<\/p>\n
46. BRI's financial plan, refocusing the bank on its traditional
\nactivities of retail banking and microfinance, has been reviewed
\nby an international consultant and the full business plan is
\nexpected to be reviewed and approved by the Restructuring
\nCommittee in February 2000. Management is being reviewed and new
\nmembers recruited through an international executive search. We
\nexpect that a new management team will be in place by February
\n15, 2000. BRI will begin in March to divest its corporate loans
\nexcept for certain traditional customers that will constitute a
\nmaximum of 20 percent of its total portfolio. The process of
\ndivesting corporate loans will be completed by end-2000. The
\nfirst tranche of recapitalization is expected to be provided by
\nApril 15, 2000, upon completion of the preceding actions; the
\nremaining tranche will be provided following the completion of
\nthe end-1999 financial audit and satisfactory implementation of
\nthe business plan, expected by June 30, 2000, including the
\nfuture roles of BTN and of the housing credit program.<\/p>\n
47. We intend to achieve majority privatization of BCA in 2000.
\nToward this end we intend to launch BCA's initial public offering
\nof shares in March 2000; as a first step, a filing will be made
\nwith BAPEPAM by-end January.<\/p>\n
48. Danamon's divestment process will be delayed until its
\nmergers with eight BTO banks can be completed. One bank (PDFCI)
\nwas merged into Danamon in late-December 1999, following approval
\nof the merger by BI; the remaining mergers should be completed by
\nSeptember 2000. We have provided Danamon with a strong management
\nteam, which was approved by Bank Indonesia on Dec. 15, 1999, and
\nbusiness plans and a management contract were in January 2000. On
\nthis basis, in May 2000, Bank Danamon will be provided with
\nrecapitalization bonds of about Rp 30 trillion to allow it to
\nfinance the remaining mergers. A timetable for achieving majority
\nprivatization in 2001 will be drawn up by September 2000.<\/p>\n
49. Steps are also being taken to resolve two banks-Bank Bali and
\nBank Niaga--which were taken over when their owners failed to
\ncome up with the funds necessary to participate in the private
\nbank recapitalization scheme. We plan to sell both banks by open
\ntender during the first half of 2000.<\/p>\n
Private Bank Restructuring<\/p>\n
50. BI is determined to ensure the soundness of the 73 A-category
\nbanks. All owners and managers of these banks have been subject
\nto fit and proper tests, and those who failed have been replaced.
\nBI further required owners of banks whose capital fell below 4
\npercent to raise capital to that level by Jan. 20, 2000, and it
\nwill take corrective actions against those banks where the owners
\nfail to comply with the requirement. Banks whose business plans
\nneeded revision or correction to ensure compliance with the
\nrequirement to achieve CARs of at least 8 percent by end-2001
\nhave now submitted revised business plans, and these have been
\nreviewed. All A-category banks will be monitored on a quarterly
\nbasis to ensure they comply with their business plan; BI will
\ntake appropriate corrective actions in all cases where these
\ntargets are not being achieved. Performance of the private banks
\njointly recapitalized with the government will also be subject to
\nquarterly monitoring by IBRA and BI, and any substantial
\ndeviations will be reported to the Ministry of Finance for
\nappropriate resolution.<\/p>\n
Legal, Regulatory, and Supervisory Framework<\/p>\n
51. The first audit of Bank Indonesia under the new central bank
\nlaw, conducted by the Supreme Audit (BPK) with the assistance of
\nan international accounting firm, was completed and sent to the
\nParliament on Dec. 31, 1999. In response, BI has adopted a
\ntimebound program of follow-up actions, aimed at addressing the
\nissues raised by the audit, which will be implemented in
\ncooperation with the BPK during the coming year. The action
\nprogram comprises a range of measures to clarify BI's financial
\nposition, improve the bank's internal controls, and strengthen
\nits supervision standards.<\/p>\n
Special audits are being commissioned to verify and revalue
\nBI's financial and tangible fixed assets, and assess the bank's
\noff-balance sheet positions by end-April 2000. Should this work
\nreveal the bank has a capital shortfall, the government will
\nprovide an immediate injection of funds so that the bank meets
\nstatutory requirements. At the same time, BI will take steps to
\ndivest its financial subsidiaries, and to tighten internal
\ncontrols and strengthen information systems. The overall aim
\nwould be to obtain an unqualified auditor's opinion for the end-
\n2000 financial accounts.<\/p>\n
52. The authorities are adopting a comprehensive approach to
\nachieve and maintain the soundness of the overall financial
\nsector. Bank Indonesia will provide the IMF with monthly bank-by-
\nbank data beginning with end-December 1999. The Board of Bank
\nIndonesia has approved a master strategy for enhancing bank
\nsupervision.<\/p>\n
The strategy to be assisted by the IMF will guide
\nimplementation of the reforms necessary to bring supervisory and
\nexamination activities up to international standards, fully
\nconsistent with the Basle Committee's Core Principles, and ensure
\nthat technical assistance projects on bank supervision are
\neffectively coordinated.<\/p>\n
It is envisaged that BI will maintain substantial on-site
\nsupervisory presence at each state bank. Similar master plans
\nwill be developed by end-March 2000 for the oversight of the
\nnonbank financial sector (pension funds, insurance companies, and
\nfinance companies), and securities markets by the Ministry of
\nFinance, with the assistance of the World Bank and the AsDB. We
\nwill also review and strengthen the law on pension funds during
\n2000.<\/p>\n
53. We have issued additional bonds for bank capitalization and
\nare taking steps to develop a government bond market. The
\nMinistry of Finance, with the assistance of AusAid, has
\nestablished a unit to manage the public debt. Our progress and
\nplans in this area include the following:<\/p>\n
As of end-December 1999, the government has issued bonds,
\ntotaling about Rp 500 trillion rupiah, for the capitalization of
\nBank Mandiri, the private and BTO banks, and to compensate BI for
\nits past liquidity support and the settlement of interbank
\nclaims. It is expected that some Rp 140 trillion in additional
\nbonds will need to be issued by mid-2000, principally to complete
\nthe recapitalization of the state banks. The interest burden on
\nthe budget of these bonds is projected to peak at about 4.7
\npercent of GDP in FY 2000 before declining in subsequent years.<\/p>\n
A portion of the capitalization bonds for banks with net open
\nforeign currency positions will be in the form of foreign
\nexchange-linked (rupiah-denominated) bonds, to enable these banks
\nto close their positions in an orderly manner.<\/p>\n
A number of steps have been taken to begin secondary market
\ntrading of government bonds over the next year. A committee is
\nbeing formed with participation from the Ministry of Finance and
\nBI to facilitate development and regulation of the market, and a
\nbook-entry system is now operational within Bank Indonesia for
\nrecord-keeping and transfers of government bonds in paperless
\nform.<\/p>\n
Regarding the tradability of the recapitalization bonds, banks
\nhave (since Dec. 9, 1999) been permitted to transfer up to 10
\npercent of their bonds into a \"trading portfolio.\" Initially,
\nthese bonds may be used as collateral for borrowing. Starting in
\nFebruary 2000, banks will be permitted to trade these bonds in
\nthe secondary market. The portion of bonds in the trading
\nportfolio will thereafter be increased progressively.<\/p>",
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"sponsor": "Okusi Associates",
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