Five myths about the CGI

By Vikram Nehru

JAKARTA (JP): The Consultative Group on Indonesia -- or CGI -- meets each year to discuss Indonesia's external financing needs from the international donor community.

Each time it does so, there is enormous press coverage and considerable speculation as to whether Indonesia will receive its target level of foreign aid.

Commentators argue back and forth whether the money is needed or not, or whether or not the new debt can be afforded. But most lack a real understanding of what the CGI is about or what it does.

And myth is often peddled as fact. Here I list five common myths about the CGI and try to debunk them with some simple facts.

Myth No. 1: The CGI lends Indonesia money.

This myth is most common. It assumes the CGI is a single financial institution -- which, of course, it is not. As its name clearly implies, the CGI is a group (of 30 bilateral and multilateral donors) -- who consult with government and each other on Indonesia's development priorities and the external financing the country needs to meet those priorities.

The key objective of the group is to better understand Indonesia's development policies and programs, and to improve coordination between donors and government, and among donors themselves, so that external aid is used as effectively as possible and in the nation's best interests.

The CGI meets formally once a year at a time designed to be most helpful to the government in its budget formulation process. Since the government moved to a calendar year budget, the CGI meeting is held every October. This allows the draft budget (prepared in September) to inform the CGI proceedings, and at the same time allows the CGI pledges to inform parliament when finalizing the budget in November.

Each CGI member pledges in accordance with the policies of their institution or nation. Some pledge more than others. Of the total pledge at the Tokyo CGI held in October 2000, three members -- Japan, the ADB, and the World Bank -- accounted for almost 90 percent. Note that the IMF does not pledge at the CGI, because it lends its money to Bank Indonesia, not the government.

Since the crisis broke in 1997, pledges have been based on estimates of disbursements -- that is, the amount of money that donors actually expect to release to the Indonesian government.

In the last two years, actual disbursements have been much less than pledged disbursements. This year they are expected to be less than half.

Many factors account for this -- project implementation has been slower than expected, policy reforms were delayed (thereby holding up program loans -- see below), or the government did not need the money (thanks to higher-than-expected oil prices).

So adding the total pledges in each year does not give any indication of the buildup in debt. Some commentators have done this, saying the consequent increase in debt is intolerable. In fact, the increase in external debt is appropriately calculated by adding actual (not pledged) disbursements and then subtracting amortization. This is a much, much smaller amount than the pledge.

Myth No. 2: External finance from CGI members is expensive.

This is also not true. First, a small but growing share of external funds received through CGI members is in the form of grants -- free money requiring no repayment. But even loans from CGI members are cheaper and of longer maturity than anything Indonesia could find in the commercial markets.

True, Indonesia bears the risk of appreciation in the value of the Japanese yen, but these risks can be hedged. Official loans to Indonesia that cost the most are from the ADB and the World Bank, but even these are some 500 basis points below what the Indonesian government could raise in international capital markets and have much longer maturities.

Moreover, both the ADB and the World Bank are providing increasing amounts of "soft" money which is repayable over 35 years and bears no interest.

Myth No. 3: Indonesia does not need loans and grants from CGI members.

Whether the Indonesian government borrows or not is, of course, entirely of its own choosing. Borrowing makes sense when the resources it generates are put to good use and yield high economic and social returns.

In Indonesia's present situation, the government fully recognizes that its debt has grown recently to mammoth proportions, thanks largely to the huge cost of bank restructuring.

This increase in debt, most of it in the form of domestic bonds, has imposed a huge cost on the budget in the form of increased interest payments. Adding to this would be foolhardy at this point, as the emphasis should now be on reducing the debt burden to sustainable levels.

Similarly, lenders would also not be particularly interested to lend to a government already deeply in debt unless they felt it served an important development purpose.

So, why is the Indonesian government still borrowing from CGI members? The reason is simple. It must finance a development budget that has already been cut by a third in real terms. Indeed, the development budget is already low by historical standards.

Any further cuts would hurt programs such as education, health, and basic infrastructure that help the poor -- and lead to an unacceptable deterioration in the country's physical infrastructure.

Of course, the extent of reliance on external borrowing could be reduced if the government raised more in taxes, sold yet more IBRA assets, and accelerated the privatization program.

But it is finding it hard enough to reach its current targets in these areas, let alone exceeding them.

It is, however, likely to raise higher-than-targeted oil revenues, thanks to high international oil prices. Much of this bounty will be absorbed by higher domestic fuel subsidies (which also rise as international oil prices rise).

But if it is able to capture the net benefits, it should use the windfall gain to curb increases in government debt and indeed try to lower that debt if it can -- rather than fritter it away in increased spending.

The government committed to the CGI members in Tokyo that to the extent it could raise higher-than-expected net oil revenues, it would lower its foreign borrowing. This was welcomed by the international community.

The government also committed to use these resources wisely -- by ensuring they would support programs that help the poor and by making certain that funds were used for the purposes intended and did not "leak".

The international donor community, for its part, emphasized the importance of good financial management, improved public procurement processes, effective anti-corruption measures, and transparent budget preparation and implementation, and many made their pledges contingent on improved government performance in this critical area.

Myth No. 4: The CGI imposes conditions on the Indonesian government.

The CGI meeting does not impose any conditions on Indonesia. But the purpose of the CGI meeting is for donors to assess whether the government's policies are conducive for development and thus warrant international financial support.

So there is undoubtedly pressure on the government to meet these expectations. This is a good thing, because these expectations are raised in an international forum and can be tempered or even altered in dialogue with government representatives.

On its part, the government can make its priorities and expectations clear to the international donor community. It can also request enhanced cooperation from donors -- as it did in Tokyo recently when asking for increased flexibility in donor- financed projects.

While the CGI meeting itself does not impose conditions on the Indonesian government, individual lenders or grantors may very well link their financial support to certain government actions.

The World Bank and the Asian Development Bank, for example, regularly link their project aid to effective implementation, and require key policy reforms before disbursing their adjustment loans. These conditions are negotiated in advance -- and are designed to ensure that the funds are used to meet the development priorities of the country.

Myth No. 5: The CGI is an exclusive club of lenders.

To be effective, CGI meetings have to walk a fine line between being transparent (so that the public knows what is discussed and why) and being candid and spontaneous (to facilitate frank interchange between donors and government).

The press is, therefore, not invited into the meetings themselves, although there is a full press conference convened immediately afterwards at which the chairman's closing remarks are circulated.

Furthermore, the various statements of CGI delegates are posted on the World Bank's Indonesia website (www.worldbank.or.id) a day after the meetings close.

Finally, civil society groups were represented as observers at the CGI for the first time in February, 2000 (in Jakarta). Five civil society groups were represented in Tokyo and made a joint presentation to CGI members. These steps are indicative of a rapid trend toward increased openness going forward.

In the latest CGI meeting in Tokyo in October, the donors emphasized the importance of corporate restructuring, poverty reduction, good governance (with forestry as a vivid example), and sound financial management.

At the same time, they appreciated the difficulties faced by the government -- notably the complexity of the issues, most of which are a legacy from the past and a burden on the future.

To assist Indonesia in resolving these issues, the members of the CGI pledged financial and technical assistance as they have done in years past.

The total pledge (in terms of estimated disbursements) going through the budget came to about US$4.8 billion and grants and technical assistance outside the budget amounted to US$660 million (see table for details).

The government vowed not to draw on these resources if it did not need them -- for example, if average international oil prices exceed the budget assumption as happened this year -- because the priority at this stage is to bring down government debt and ensure that external borrowing is undertaken only to finance high priority expenditures that cannot be financed from domestic sources.

The writer is lead economist of the World Bank Office in Jakarta.