Government embarks on monetary, judicial reform

Government embarks on monetary, judicial reform

The followings are the seven appendixes attached to the text
of the Supplementary Memorandum of Economic and Financial
Policies.

APPENDIX I: Monetary and Interest Rate Policy

* The main monetary policy target has been shifted to NDA
instead of base money. Within the month should the exchange rate
deviate from its programmed path, NDA and interest rates will
adjust as necessary. For monetary policy to be effective,
interest rates across the spectrum should be permitted to respond
to changes in NDA.

* Interest rates on Bank Indonesia certificates (SBIs) were
sharply increased on March 23, when the rate on one month SBIs
was raised from 22 percent to 45 percent (effective annual yield
of 55 percent), with overnight SBI interest rates at 40 percent
(effective annual yield of 49 percent). A positive yield curve
over this range is necessary to allow a lengthening of maturities
of outstanding Bank Indonesia instruments.

* Commercial bank deposit rates for all maturities also rose
substantially, following the increase in SBI rates. In order to
prevent weak banks from taking advantage of the guarantee,
individual bank deposit rates will not be allowed to exceed the
average of deposit rates for a group of strong banks.

* Bank Indonesia intends to adjust interest rates as
necessary to strengthen the rupiah and reduce inflation.

* New Bank Indonesia liquidity support facilities have been
introduced, with the interest rates on these facilities now set
at levels designed to provide a disincentive to resort to support
from BI, but not so high as to force banks experiencing temporary
liquidity difficulties into insolvency:

- a key lending facility with an interest rate at 150 percent
of JIBOR, renewable monthly with increasing prudential sanctions,
including ultimately transfer to IBRA;

- initial high penalty rates of interest on required reserve
shortfalls or negative balances -- 400 and 500 percent of JIBOR
respectively -- in order to induce banks to monitor their
liquidity and apply to BI for the leading facility at an early
date; and

- flexibility to BI to determine the pace of imposition of
sanctions, including transfer to IBRA, after special on-site
examination and reporting to management.

APPENDIX II: Banking sector developments

* On Jan. 27, the government announced guarantees for all
depositors and creditors of locally incorporated banks, as well
as the establishment of the Indonesian Bank Restructuring Agency
(IBRA).

* On Feb. 14, IBRA intervened in the 54 banks that had
emergency borrowings from Bank Indonesia greater than 200 percent
of capital, or that had capital, on adjusted December 1997
figures, less than 5 percent of assets. On Feb. 16, some 250
examiners were placed in these banks, to monitor the banks'
compliance with additional prudential restrictions on, for
instance, new credits, and payments of dividends.

* On April 4, IBRA suspended the rights of the owners and
management of the seven banks that have borrowed more than Rp 2
trillion from BI, comprising 75 percent of total BI lending to
the banking system. IBRA-appointed managers began operating the
banks pending portfolio reviews and possible disposals of assets
and liabilities. At the same time, IBRA took control of seven
banks that have borrowed more than 500 percent of their capital
and 75 percent of total assets from BI with a view to effecting
an immediate transfer of their assets and liabilities to other
banks. IBRA also intensified its control over the remaining IBRA
banks through issuing governance contracts with these banks and
preparing to remove their foreign exchange licenses.

* The government will establish an Asset Management Company
(AMC) to focus on the debt recovery of troubled assets. Once
established, the AMC will take the assets of the seven small
banks being intervened on April 4, as well as subsequently the
troubled assets of other IBRA banks.

* The government is proceeding with the merger of state-owned
banks, as announced in October 1997. Bank Bumi Daya and Bapindo
will be merged first. After a review of their portfolios, by June
1998, the troubled assets will be transferred to the AMC. A
healthy entity will be created out of the remainder of the bank.

* Any further state bank mergers, including any involving Bank
Dagang Negara and Bank Exim, will be determined later, in the
light of the conditions of the banks at that time and assessment
of the preferred strategy to attract strategic investors into
these banks.

* In order to finance IBRA, the government is issuing IBRA
with an initial tranche of Rp 80 billion of bonds which IBRA is
expected to sell in the first instance largely to BI. Additional
bonds of perhaps Rp 75 trillion will be issued during the course
of the year for restoring the financial viability of banks taken
over by IBRA.

* On Feb. 27, BI promulgated new classification and loan loss
provisions based on international standards to help restore and
maintain the soundness of the banking system in the future.

* The minimum capital requirement for locally incorporated
banks has been set at Rp 1 trillion for the end of 1998. However,
given the substantial loan loss provisions required by the
central bank, a modified minimum capital requirement is necessary
and will be set at Rp 250 billion for end of 1998. Banks will be
informed that they should work on the basis of the Rp 250 billion
minimum standard. Subsequent increases will be determined at a
later date in light of the condition of the banking sector.

* By June, the government will introduce into parliament a law
eliminating existing restrictions on foreign ownership of banks.
At the same time, the government is appointing a review
committee, including foreign experts, over IBRA to ensure high
levels of governance.

APPENDIX III: Budgetary Support for Vulnerable Groups

* The government intends to provide subsidies in 1998/99 to
limit reductions in the welfare of the poorest sectors of the
population. Targeting mechanisms will be adopted in order to
minimize their distortive effects on the efficiency and growth
potential of the economy. All subsidies will be transparently
provided through the budget.

* Food. Drought and the rupiah depreciation have recently
pushed up the prices of rice and other basic foodstuff. The
government intends to continue importing and providing staple
foodstuffs through the State Logistics Agency (BULOG). Subsidized
prices for rice and soybeans which constitute a large part of the
consumption basket of the poorest households, will be increased
by Oct. 1, 1998. Prices of sugar, wheat, flour, corn,
soybeanmeal, and fishmeal will be increased on April 1, 1998. On
Oct. 1, 1998, prices will be increased further in order to
eliminate subsidies on these commodities. The subsidy on soybeans
will be eliminated when the exchange rate has stabilized at the
expected level.

* Fuel. The government will increase domestic fuel prices
gradually in the fiscal year 1998/99. The price increase will be
smaller for kerosene, which is consumed mainly by low-income
households. These increased prices will still imply a budgetary
subsidy, which will be gradually phased out by the combined
effects of the expected appreciation of the rupiah, and if
necessary, by additional price increases.

* Electricity. The government will increase electricity prices
during fiscal year 1998/99. However, an affordable supply of
power to low income households and remote rural areas will be
ensured through targeted low tariffs for the first 250 kilowatt
hours per month, compared with 100 kilowatt hours at present.

* Other subsidies. The government intends to introduce a
budgetary subsidy to the importation of basic inputs for the
provision of generic medicines to help provide adequate health
services to the poor. Interest subsidies for low-cost housing,
farmers, and rural cooperatives and villages will be maintained.

* Employment programs. The government will undertake
additional labor-intensive public works and temporary employment
programs that are targeted to the poorest households suffering
unemployment, mostly financed by the Asian Development Bank, the
World Bank, and bilateral foreign assistance. Budgetary
allocations have been increased for these programs. In addition,
to sustain employment, subsidized credit schemes are being
expanded for small and medium-size enterprises.

APPENDIX IV: Enterprise reform and privatization

* The authorities are accelerating state enterprise reform in
order to strengthen profitability and increase budgetary transfer
receipts in 1998/99 and beyond. This will partially offset the
deterioration in the public finances this year caused by lower
tax revenue, higher subsidies than originally budgeted, and the
costs of bank restructuring.

* A Minister for State Enterprises has been appointed with the
task of managing the 164 firms in the public sector, including
financial enterprises. This approach involves the transfer of
management responsibilities from various line ministries, with
the objective of strengthening policy supervision, avoiding
conflict of interest and more closely monitoring performance to
improve efficiency and profitability. A presidential decree will
be issued giving the new minister full responsibility and
accountability for the state enterprises.

* Enterprises have been grouped into three broad categories of
firms: those operating in a competitive market environment;
public utilities; and strategic industries. Appropriate
performance indicators, including profitability and liquidity,
are being established in consultation with the World Bank for
each group, with focus on better management, planning and cost
reduction.

* Action plans will be completed for every corporation by end-
September 1998. A format has already been developed for this
exercise. Explicit criteria are being developed to monitor the
performance of each enterprise and encourage increased efficiency
including through the formation of joint ventures; sales, inter
alia through management buy-outs and direct placements; mergers;
restructuring; and closures of non-viable enterprises.
Performance indicators will be included in the action plans. The
government will appoint reputable management audit companies to
undertake periodic performance reviews.

* Sales are planned within the present fiscal year of
additional shares in some of the six state enterprises that are
already listed on the stock exchange and are operating in a
competitive environment, including PT Telkom (domestic
telecommunications), PT Indosat (international
telecommunications) and PT Semen Gresik (cement production). This
divestment plan will be announced before April 24, 1998.

* A target of seven new enterprises are to be identified for
privatization in fiscal year 1998/99 and the list will be
announced before April 24, 1998. This could include enterprises
in plantations, infrastructure, mining and manufacturing,
including PT Pelindo II (ports infrastructure and management), PT
Perkebunan Nusantara IV (palm oil plantation) and PT Jasa Marga
(toll roads). A list of five additional enterprises is to be
identified and prepared for listing by June 30, 1998.

* Transparent procedures will be established by June 30, 1998
for divestiture and privatization, in collaboration with the
World Bank. These procedures will allow for open bidding or other
market mechanisms, including full participation by foreign
investors. A blueprint for privatization over the medium term is
to be completed by end-September 1998.

* The World Bank is providing technical assistance, in the
context of the public expenditure review that is precisely
underway, to benchmark the performance of state enterprises in
comparison with similar firms in other countries.

APPENDIX V: Structural Reform

* Domestic Trade. The Government eliminated all restrictions
on foreign investment in retail trade in January 1998. All
restrictions on foreign investment in wholesale trade will be
removed by April 22, 1998. These actions will compress
distribution margins and strengthen competition.

* Food distribution. Government regulations were issued in
January 1998 abolishing the monopoly of the state trading agency,
BULOG, over the importation and distribution of essential food
items so that it now faces private sector competition. However,
private sector participation in these activities has been
inhibited by subsidies granted only to BULOG. The government's
action to extend subsidies to all market participants by mid-
April and the removal of restrictions in importing activities
will effectively provide the opportunity for full private sector
participation.

* Plywood. The government issued a decree in January 1998
establishing the rights of plywood producers to market
independently and ship with any carrier of their choice and a
statement has been issued by the ministry of industry and trade
confirming the dismantlement of the joint marketing body. The
government plans by mid-April 1998 to impose resource rent
royalties that are linked to international prices and the cost of
efficient extraction, and that are independent of end-use.
Royalty rates will be revised every six months to reflect price
and cost changes and to maintain an appropriate level of public
revenue from forestry. The government has provided a timetable
for the phased reduction of export taxes on logs and sawn timber
to 10 percent ad valorem. To provide plywood producers with some
time to adjust in the face of depressed international prices,
export taxes will be reduced on an ad valorem basis to 30 percent
by April 22, 1998, 20 percent by end-December 1998, 15 percent by
end-December 1999 and 10 percent by end-December 2000. By end-
June 1998, the restriction that only those with wood processing
facilities can hold forestry concessions will be removed and the
transfer of concessions by sale will be allowed.

* Cloves. In February 1998, the sale and transport of cloves
across district and provincial boundaries were completely freed.
Buyers, traders and factories are now free to buy, sell and
transport cloves at unrestricted prices. In particular, producers
are free to join any cooperative or to sell directly through a
trader. The ministry of cooperatives is helping cooperatives to
improve services offered to members, including providing basic
forward purchase contracts, in ways which encourage and maintain
open competition between buyers and sellers at all levels.

* Oil palm investment. Restrictions on foreign investment in
oil palm plantations were removed in January 1998 for all 27
provinces, so that foreign investors are treated the same as
domestic investors. Remaining locational restrictions, based on
environmental and spatial planning considerations, will be made
clear and publicly available by April 22, 1998. Procedures for
the appeal of decisions will be established by end-June 1998.
Quantitative restrictions on palm oil, olein and stearin exports
will be replaced by an export tax of not more than 40 percent by
April 22, 1998. The level of the export tax will be reviewed
regularly for possible reduction, based on market prices and the
exchange rate, and reduced to 10 percent by end-December 1999.

* Provincial export taxes. Provincial and local taxes on export
commodities were prohibited in a January 1998 decree, and strict
implementation is now being coordinated by the ministry of
industry and trade and the ministry of home affairs.

* Infrastructure contracts. The government issued a decree in
January 1998 designed to facilitate private participation in the
provision of public infrastructure. Details of the procedures are
being clarified with the World Bank. Needed changes to the decree
and implementing regulation will be established by June 1998.

* The Executive Council will monitor the implementation of
structural reforms, with the assistance of Asian Development
Bank, the World Band, and the Fund. Independent auditors will be
employed as necessary to oversee progress. The auditors' reports
will be made available to the three institutions. Other steps to
strengthen implementation will include ministerial statements,
and newspaper advertisements to explain official decisions, and
procedures to deal with public complaints.

APPENDIX VI: Corporate debt restructuring

* The initial meeting between the steering committee of
foreign bank creditors, and the Contact Group of debtors and the
Private External Debt Team (PED) was held on Feb. 26, 1998.
Technical support is being provided by the Fund, Asian
Development Bank and World Bank to enhance the coordinating
function of PED.

* Efforts to collect data from corporations on their external
obligations and arrears are being accelerated. A presidential
decree will be issued requiring compliance with requests for data
by BI, with noncompliance or the provision of incorrect data
possibly resulting exclusion from schemes with government
involvement in the restructuring process. A revised report form
is being completed by enterprises, so that a first estimate can
be made of the amount of debt that may need to be restructured.

* With the assistance of outside advisors, and in consultation
with the Contact Group of debtors, the Steering Committee and IMF
staff, the Asian Development Bank, the World Bank and interested
governments, the PED is preparing a framework for the
restructuring of private corporate debt. This framework will
adhere to the following principles: (i) participation in the
scheme will remain voluntary with the precise terms of any
restructuring to be worked out between creditors and debtors;
(ii) commercial risk will remain with the creditors; (iii) the
maximum potential cost to the government will be capped at a
manageable level; (iv) the government support would only be
provided in return for the restructuring of obligations on
specified minimum terms; and (v) negotiations between debtors and
creditors should begin as quickly as possible.

* In further meetings, the Steering Committee and the PED will
seek agreement on the basic features of a scheme, and credible
progress towards this aim will be in place by mid-April.

APPENDIX VII: Bankruptcy and Judicial Reforms

* Reforms are being introduced to overhaul the bankruptcy
system and establish a court system that will provide for fair,
transparent and expeditious resolution of commercial disputes.
Specifically:

* The existing bankruptcy law is being updated in a number of
important respects. First the law will allow for qualified
professionals from the private sector to act as receivers and
administrators in the management of the estates of companies in
bankruptcy or reorganization. Second, procedural rules are being
introduced to ensure certainty and transparency in the
proceedings, especially to prevent unjustifiable delays in the
adjudication of bankruptcy. Third, a number of substantive rules
are being updated. For example. there will be greater protection
against insider and fraudulent transactions taken by a debtor
prior to the adjudication of bankruptcy. Moreover, to enhance the
possibility of reorganizations, limitations are being imposed on
the ability of secured creditors to foreclose on their collateral
during the proceedings (as is provided for in the bankruptcy laws
of most other countries), with the requirement that adequate
compensation and protection be provided to such creditors during
that period.

* An improved bankruptcy law will have little impact unless it
is enforced by an effective judiciary. To that end, a Special
Commercial Court is being created (in the courts of general
jurisdiction) that will have jurisdiction over bankruptcy
proceedings and general commercial disputes (jurisdiction over
the latter will be exercised once the court's capacity is
sufficiently developed). The special Commercial Court will be
staffed by specially trained judges, will ensure that rules
regarding summary proceedings are strictly applied and will
render written decisions that provide the legal basis for the
ruling in question. Appeals of decisions rendered by the Special
Commercial Court will go directly to the Supreme Court.

* The amendment of the existing bankruptcy law and the
establishment of the special Commercial Court will be effected
through the issuance of a government regulation in lieu of law
(requiring subsequent ratification by Parliament), which will be
enacted in mid-April and will go into effect 120 days thereafter,
so as to give adequate time for the creation of the necessary
institutional infrastructure. The Fund's staff, in consultation
with other organizations, will assist in providing the external
technical assistance that will form a necessary part of this
process.