Ensuring aid effectiveness

Ensuring aid effectiveness

The Consultative Group on Indonesia (CGI) predictably approved
on Thursday US$2.8 billion in new loans and $600 million in new
grants to help the government plug part of the big hole in its
budget.

It is roughly similar to the pledges made by the creditor
group last year, but the sum is less than half of the $7.2
billion the government has to transfer overseas in debt service
payments this year.

On top of these pledges, the creditor consortium also
committed $1.7 billion in soft loans and grants especially for
the rehabilitation and reconstruction of Aceh.

Since 2003, the government's annual debt service payments
overseas have been more than twice as large as its new foreign
borrowing, because the government is no longer entitled to a debt
rescheduling facility from its sovereign creditors and more debts
are now maturing.

However small the new pledges may seem, compared to the annual
interest charges and debt amortization, the new aid commitments
will nonetheless help greatly, especially now as the fiscal
burdens have sharply increased after the cataclysm in northern
Sumatra.

The terms and conditions of CGI loans are concessional in that
their interest rates are way below what the government can obtain
from the international financial market and their maturity
extends to as long as 40 years, including a 10-year grace period.
More than one-fifth of the pledges consist of grants.

For example, the $1.07 billion in new pledges made by Japan,
Indonesia's largest sovereign creditor, carry annual interest
rates of only between 0.4 to 1.3 percent a year, as compared to
the more than 10 percent, which the government has to pay for its
ten-year global bonds that were floated last year. Even the
interest rates charged by the World Bank and Asian Development
Bank, which raise their lending resources from the capital
market, are more than 5 percentage points lower than the
government's borrowing costs.

Moreover, the CGI loans are used entirely for sectors, which
promise high productivity and high economic returns, but which
are not attractive to private investors, such as basic
infrastructure like roads, ports and water networks, as well as
education and health facilities.

However, as past experiences have shown, what is more
important is not the amount of pledges, but how well the soft
loans are used. Tens of billions of dollars in past CGI loan
commitments had been cancelled due to long delays in their
disbursement, caused mainly by problems on the part of the
government: lack of counterpart funds, poor project preparations
and some confusion in the division of responsibility between the
central and local governments.

On top of these problems, the long delay in the establishment
of a national public procurement office has undermined project
implementation. Analysts can only scratch their heads and wonder
why such an important agency, which can simply be set up with a
presidential decree, is taking so much time to establish, while
public procurement of goods and services has long been a main
source of corruption both at government institutions and state
companies.

No wonder good governance practices are the primary condition
to which creditors tie their aid pledges. Almost all major donors
reiterated last week the importance of corruption eradication.
The primary reason, as ADB Vice President Joseph Eichenberger
noted, is quite obvious: The donors have to prove to their own
taxpayers (in the case of government creditors) and their
shareholders (in the case of multilateral donors) that the money
is used for the purposes intended.

This condition makes a lot of sense because the creditors
would simply waste their money and make the new debts completely
unsustainable if the government did not improve governance
practices and implement projects according to schedules.

In fact, problems related to bad governance practices and poor
infrastructure have been cited as the main barriers to private
investment. Various surveys have found that costs associated with
policy and regulatory uncertainty and unreliable infrastructure
amounted to as large as 20 percent of company sales.

President Susilo Bambang Yudhoyono personally reemphasized the
vital role of good governance and good quality infrastructure in
his address at the CGI meeting, and economic ministers elaborated
on key reforms that were planned to improve the investment
climate.

The market and investors, which have often been disillusioned
with false starts in reform programs, expect immediate, concrete
implementation of these promises, lest even the Susilo
government, supported by a strong political mandate, would not be
able to seize upon the emerging cyclical upturn so the economy
would grow faster.