Indonesia signs new letter of intent with IMF (2)

The following is the second and last part of the complete text of the new Letter of Intent signed by the Indonesian government and the International Monetary Fund on Thursday. Tables and annexes are not included.

Memorandum of Economic and Financial Policies Medium-Term Strategy and Policies for 1999/2000 and 2000 (continued)

54. Continued efforts will be needed to ensure that the newly recapitalized banking system is able to operate profitably on a sustainable basis. With these efforts, and the achievement of 8 percent CAR by end-2001, a sound banking system should be reestablished. The government intends, thereafter, progressively to limit the scope of the blanket guarantee, with a view to replacing it by 2004 with a limited deposit insurance fund financed by the banking system.

D. Corporate Restructuring, Legal Reform and Governance

55. The government has developed a strategy to give fresh momentum to corporate restructuring with the following key elements: (i) ensuring that IBRA plays an active role in the workout process with the ability to engage in various forms of debt restructuring; (ii) for non-IBRA-led cases, establishing a procedure under which the Government may direct cases to the Jakarta Initiative Task Force (JITF), and may refer to the Attorney General for the initiation of bankruptcy proceedings those debtors that refuse to negotiate in good faith in accordance with the principles and timetables established under the new JITF mediation procedures; (iii) strengthening the insolvency system; and (iv) more generally, improving the corporate governance framework, and subjecting companies to greater market discipline. In accordance with a Presidential Decree issued on Dec. 28, 1999, the Financial Sector Policy Committee (The FSPC) has been established to oversee bank and corporate restructuring. As indicated above, the FSPC, which reports directly to the President, consists of key ministers and will be assisted by a permanent secretariat. The FSPC will play a central role in the strengthened corporate restructuring strategy described below.

56. It is essential for IBRA, as a major creditor to the corporate sector, to be able to engage in a full range of commercially acceptable methods of debt restructuring, including debt-for-equity conversions and, where appropriate, debt reduction. To that end, the FSPC has announced -- and will approve before end-January -- a set of policies and procedures for IBRA that specify the conditions under which debt and debt- service reduction decisions may be taken. Under these policies and procedures, debt reduction will only be made available to cooperating debtors where: (i) it is in the best commercial interests of IBRA as a creditor and (ii) there is no evidence of criminal or fraudulent activity on the part of the debtor. Also by end-January, an FSPC decree will be issued that commits the government to provide the officers of IBRA and the members of the FSPC with personal legal assistance in cases where decisions consistent with the above mentioned policies and procedures are challenged.

57. Efforts are also underway to allow IBRA to make more effective use of the insolvency system. Specifically, in cases where debtors fail to enter into good faith negotiations with IBRA in accordance with the timetable agreed upon with the debtor, IBRA will, where appropriate, file insolvency petitions in the Commercial Court. Two test cases have been filed as of Jan. 20, 2000.

58. The government has also announced measures to strengthen procedures for restructuring through the JITF's collective negotiating framework. In accordance with a decree to be issued shortly, the FSPC will be able to direct cases that cannot expeditiously be led by IBRA (because, for example, IBRA is a minority creditor) for restructuring under the JITF. A first list of such companies will be referred to the JITF by end-January 2000. Any case being negotiated under the Jakarta Initiative framework (including those cases that have come voluntarily to the JITF and those directed by the FSPC) may be referred to the Attorney General by the FSPC for the initiation of bankruptcy proceedings against the debtor. The basis for such referrals will be a recommendation by the JITF that the debtor has failed to negotiate in good faith in accordance with the JITF meditation procedures. A Government Regulation will be issued establishing this referral authority before end-January, 2000. At the same time, the FSPC will approve new time-bound mediation procedures to be administered by the JITF that will provide the basis for the exercise of the referral authority. It is recognized that the leverage this authority provides to the JITF will also facilitate the sale of assets by IBRA, by giving greater assurance to the buyers that their claims can be enforced.

59. IBRA will take steps to ensure that it participates in the Jakarta Initiative framework when such participation is necessary for effective restructuring. The FSPC will be responsible for ensuring adequate coordination between lBRA and the JITF.

60. The above measures recognize that the JITF has a critical role to play in accelerating the pace of corporate restructuring. The government is committed to provide adequate resources and the necessary budgetary support to ensure that the JITF has the necessary institutional capacity and will be able to fulfill its strengthened mandate in a timely manner.

61. By end-January 2000, we will obtain the agreement of concerned ministries and agencies to the procedures for accelerated regulatory approval of restructurings and will adopt and publish them. By mid-February 2000, we will make these procedures fully operational under the Regulatory Facilitation Group ("one-stop shop") within the JITF.

62. The government recognizes that a key incentive for debtors to enter into negotiations with their creditors has been ineffective, namely the threat that creditors will initiate bankruptcy (including rehabilitation) proceedings against recalcitrant debtors. A primary problem in this area has been the capacity of the judiciary to implement the insolvency law, including the perception of governance problems. To this end, a number of measures are being implemented to strengthen the judiciary.

63. First, in accordance with recently enacted legislation, the President has submitted to Parliament a list of candidates to be appointed as members of the Independent Commission for the Audit of State Officials. The Commission includes a judicial sub- commission responsible for obtaining information and conducting investigations regarding the wealth of judges and referring evidence of corruption to the Attorney General for prosecution. Other sub-commissions will gather information regarding the wealth of state officials. The Commission will be fully functional by March 31, 2000, with an adequate budget and supporting infrastructure.

64. Second, the Attorney General will, in coordination with the Commission for the Audit of State Officials, give priority to the investigation and prosecution of any judges and members of the legal profession that have engaged in corrupt practices under the newly enacted Anti-Corruption Law. For this purpose, a Government Regulation is being issued establishing a Joint Investigating Team which will be coordinated by the Attorney General. The Attorney General will, in turn, issue shortly a policy directive indicating that the Joint Investigating Team will be initially charged with investigating and prosecuting corruption within the court system in accordance with procedures established under the Anti-Corruption Law. A number of reputable professionals, including representatives from civil society, will be appointed to this team and adequate budgetary resources will be appropriated to ensure that it has the capacity to pursue its mandate. The Joint Investigating Team plans to expand its investigations of corruption into other areas as its capacity increases.

65. Third, after considerable delays, transparent procedures were published on Dec. 10, 1999, regarding the method by which the appointment of ad hoc judges from the private sector by requested by involved parties. IBRA will request ad hoc judges for all future cases that are filed in the Commercial Court.

66. The government recognizes that the ineffectiveness of the bankruptcy system stems from problems in implementation rather than from the structure of the law itself. Thus, only procedural changes in the law are anticipated in the near future (e.g., guidance on prepackaged bankruptcy procedures), and substantive changes to either the liquidation or suspension of payments (rehabilitation) chapters of the existing law are not judged necessary.

67. Given slow progress in the past, the corporate restructuring strategy will be kept under continuous review. The Corporate Restructuring Advisory Committee (consisting of a representative group of debtors, creditors, IBRA and the JITF) has been consulted regarding the new mediation procedures to be adopted by the JITF and will continue to be consulted regarding the effectiveness of the strengthened strategy.

68. Finally, sustainable progress in this area requires the adoption and implementation of a new and enhanced corporate governance framework. Progress is being made in adopting and implementing such a framework. The high-level committee on corporate governance policy has made recommendations in a number of areas related to accountability, disclosure, enforcement, and oversight. Recommendations will be adopted by March 15, 2000 and implemented over the next six months.

E. Reform and Privatization of State-Owned Enterprises

69. The new government has been carefully reviewing the privatization program. We are in the process of examining all of the completed privatization transactions, to assess whether they were handled satisfactorily in accordance with current laws and regulations and in line with best practice procedures. Based on this review, we will decide, by end-January 2000, how procedures could be further improved. The government has also been reviewing the privatization schedule of the masterplan for state enterprise reform and privatization. Particular attention was given to the privatization transactions that were scheduled to be completed during the remainder of 1999/2000; those transactions that remain sound and feasible under current market conditions will be expedited. Overall, we expect privatization revenue to amount to Rp 8.6 trillion during 1999/2000.

70. Based on these reviews, and with the assistance of the AsDB, the government has prepared a soundly based privatization program for FY 2000, designed to yield Rp 5.9 trillion. The program will focus on enterprises -- including small enterprises -- operating in competitive markets where there is no compelling case for public ownership. The government is also preparing a liquidation plan for loss-making and heavily indebted enterprises that have no prospect of achieving commercial viability. This plan will be completed by end-March 2000 and fully implemented during FY 2000.

71. Among the larger enterprises, the two publicly listed telecommunications enterprises, PT Telkom and PT Indosat, are strong candidates for further rapid privatization. Toward this end, as well as to promote private investment in the sector, we will (i) adopt a new tariff policy (by March 2000) and adopt new network interconnection rules; (ii) finalize the implementing regulations for the new Telecommunications law (by June 2000); (iii) finalize modern, new licenses for major operators, and (iv) establish an agency to provide transparent and predictable regulation. By end-2000, the government will also strive to reduce Telkom's and Indosat's extensive cross-ownership in the sector, and to secure a mutually acceptable resolution of the issues concerning the revenue-sharing contracts between PT Telkom and its private partners (KSOs). This resolution will be consistent with the new Telecommunications Law, and promote competition by enabling both Telkom and Indosat to evolve into competing full service providers.

72. The government does not plan to establish holding companies for public enterprises, as such arrangements would dampen competition and slow privatization. Indeed, where appropriate, the government will unbundle monopolies and encourage effective competition. Plans for restructuring Pertamina and PLN are being prepared and will be accelerated. A strategy to improve the performance of other state monopolies, including ports, airports, telecommunications, and toll roads, will be prepared by end-March 2000 with assistance from the AsDB and the World Bank.

73. Concrete steps are being taken to require state enterprises to adhere to the same standards of corporate governance as required for listed companies. Accordingly, all state enterprises will be required to lodge their annual reports by June 2000. The government will also ensure that all audits of state enterprises are disclosed to the public. For a group of 30 state enterprises, the government is preparing a plan (with the AsDB) whereby their annual financial audits would be conducted by independent auditors, and completed by end-2000. This plan will be extended to a further 30 SOEs in 2001.

74. The government will continue the process of undertaking special audits for key enterprises and taking corrective actions in light of their results. Those with respect to Pertamina and Bulog were previously completed and their main findings made public. The audits for PLN and the Reforestation Fund have also now been completed and made public. A program of remedial actions for Bulog and the Reforestation Fund will be drawn up by January 2000, and implemented by mid-2000. Remedial actions for the problems identified at PLN and Pertamina will be addressed as part of the comprehensive restructuring of these enterprises. The remedial actions will include the initiation of more narrowly focused investigative audits where judged necessary. Claims of subsidy payments by Pertamina, PLN, and BULOG will be audited no later than June 30, 2000, and budgetary arrears will be eliminated by then. Any over-statement of subsidy claims will be investigated.

75. The government has identified a further list of major enterprises that will be subject to the next round of special audits which will also identify instances of corruption and other illegal practices. These enterprises include the national airline, the national toll road operator, the domestic telecommunications company, the public port corporations, and the major plantation companies. These audits will be conducted by international auditors and by completed by June 2000. Legal proceedings will be instigated in all cases where laws are revealed to have been broken and public losses incurred.

F. The Energy Sector

76. The government is firmly committed to continuing and accelerating the initiatives already underway to resolve the deep-seated problems that are impairing the performance of the electric power and oil/gas sectors.

77. In the electric power sector, the restructuring policy announced in August 1998 maps out the actions needed to restore commercial viability, improve efficiency, and attract private investment. The government's agenda for the coming year includes the passage of a new electricity law, establishment of an independent regulatory agency, and adoption of a tariff restructuring plan designed to restore tariffs progressively to commercially viable levels while limiting the impact on the poorer segments of society. Toward this end, the FY 2000 budget is based on an increase in the average tariff; however, we will shield the poor from this increase during FY 2000, and will not raise tariffs for households with a connection of less than 450V.

78. The government will also take steps to accelerate the corporate and financial restructuring of the electricity company, PLN. A new ministerial level PLN Restructuring and Rehabilitation Team was established on Dec. 31, 1999 to guide and oversee the implementation process, as well as PLN's renegotiations with independent power producers (IPPs). PLN is in the process of selecting international management consultants to assist it to implement the restructuring, and an appointment will be made by March 2000. The government will ensure that the implementation program incorporates appropriate corrective actions for problems identified by the recently completed special audit.

79. The government will take steps to accelerate efforts to negotiate solutions for reducing the massive financial burden imposed by the power purchase obligations. It is recognized that the handling of this issue will have ramifications that extend beyond the energy sector. Accordingly, the government will ensure that the new oversight team is adequately supported by competent legal, strategy, and other specialist advisors, and that PLN conducts negotiations on individual agreements within a soundly based and transparent policy and strategy framework. The oversight team will report progress to the World Bank, IMF, and AsDB on a monthly basis.

80. In the oil and gas sector, the government is firmly committed to the following actions: replacing existing laws with a modern legal framework; restructuring and reforming Pertamina; ensuring that fiscal terms and regulations for exploration and production remain internationally competitive; allowing domestic product prices to reflect international market levels; and establishing a coherent and sound policy framework for promoting efficient and environmentally sustainable patterns of domestic energy use.

81. The draft oil and gas law that was presented to the previous parliament will be reviewed and resubmitted with a view to its passage during 2000. This law will provide for the establishment of a special purpose agency to allocate acreage and supervise exploration and production contracts; the establishment of an independent agency to regulate monopoly elements of downstream businesses; the enabling of effective competition in the supply of fuels to the domestic market; and the transformation of Pertamina into a limited liability enterprise. In parallel, domestic fuel prices will be progressively increased so as to encourage more efficient energy choices and to phase-out the budget subsidy; toward these ends, an initial increase will be implemented for FY 2000. Low income households will be protected by targeted subsidy schemes that are being developed in close consultation with the World Bank.

82. The government remains committed to building a world class oil and gas industry in which a reformed Pertamina will continue to play a key role. The recent special audit and an earlier internal management review commissioned by Pertamina identify clearly where performance needs to be substantially improved. The government will require Pertamina to develop and publicize, by March 2000, a comprehensive restructuring plan that will include corrective actions in all problem areas identified by the special audit.

G. Other Structural Reforms

Competition and Investment Policy

83. In March 1999, the Law regarding Prohibition of Monopoly Practices and Unhealthy Competition (Competition Law) was enacted. By end-March 2000, we will fully establish the Commission for Business Supervision (CBS), which is designed to enforce the law this will include appointing the Commissioners, and issuing all necessary implementing regulations. After a short period to give training to CBS staff and to disseminate information about the law to the wider public, enforcement of the new law will begin by end-July 2000.

84. The government places the highest importance on improving the business environment and reviving foreign direct investment which declined precipitously during the crisis. We have completed a review of investment policies, with the assistance of the AsDB, and intend to reduce the number of sectors where foreign investment is prohibited by March 2000.

Agricultural Policy

85. Our focus in agricultural policy will be to maintain food security and promote efficient production, processing, and marketing of agricultural products.

86. A key aim of our rice policy framework will be to ensure food security by promoting competition in this sector. Accordingly, trade in all qualities of rice has been opened to general importers and exporters. However, with the strengthening of the rupiah and world price declines, domestic rice prices have been declining. Thus, there is a case for providing transitional protection to rice farmers through an import tariff, while balancing the impact on consumers. This tariff will be set at Rp 430 per kg and will apply only through August 2000, when we will review whether it is still needed. At the same time, we will also assess the BULOG procurement price, which acts as a floor price for rice.

87. We are also preparing a strategy for a broader reform of our food security approach. Until such strategy defines future directions, BULOG will focus on procuring rice for its special subsidized rice program (OPK) and for emergency stocks. We expect that BULOG will balance this procurement between domestic and international markets, so as to strengthen demand for domestic supply during the peak harvest period. We are also preparing a strategy for a phased restructuring of BULOG, to follow up on the recommendations of the recent special audit. This reform will aim at a more transparent accounting system and efficient operating structure for BULOG through, inter alia, a change in its legal status.

88. Agricultural input policy will emphasize competitive, private market delivery of fertilizers and rural credit. We will continue to liberalize fertilizer marketing by permitting general importers to engage in trade, by opening domestic marketing to new participants, and by preparing by end-February 2000 a plan for placing PT Pusri's domestic marketing capacity under autonomous management. Increased competition and a stronger rupiah should result in lower domestic fertilizer prices, and so no reintroduction of fertilizer subsidies is planned. However, for social reasons, we will continue with subsidies for transportation and fertilizers to remote areas, as identified by decree.

89. With a return to normal agricultural conditions, we propose to revert as quickly as possible to meeting farmers' credit needs through the commercial banking system. As an interim measure, 12 domestic banks have committed to financing KUT credits of Rp 1.9 trillion for the current planting season (through March 2000). This constitutes the ceiling under the scheme, and no new funds will be raised under this scheme. From April 2000, the working capital needs of farmers will be met by commercial banks only. Such banks will bear all the risks of nonrepayment of principal and will be given full independence in making credit decisions. All lending quotas and targets will be eliminated. In parallel, we will develop a strategy jointly with the AsDB and the World Bank to improve the rural credit system. Work on this strategy will be completed by end-June 2000 and implementation will begin on Sept. 1, 2000.

90. For sugar we will pursue a policy of restructuring the domestic industry by consolidating the number of sugar factories on Java and promoting private sector-led investment off-Java in new capacity. To achieve this, by end-January, we will replace the decree (expiring end-December 1999), that limits imports to selected traders, with a 25 percent tariff to be phased down over three years and, at the same time, open sugar trade to all general importers. We also are committed to closing a minimum of four sugar factories once the crushing season is completed in 2000. By June 2000, we will prepare, in consultation with the World Bank, a plan to consolidate the rest of the Java-based sugar industry; the plan will include detailed and time-bound factory restructuring, privatization or closure plans, as well as budget costs and implementation mechanisms. Firms implementing their restructuring plans according to schedule will be provided with adequate budgetary resources to subsidize operations and closing costs for a limited period. We also reiterate our commitment to farmers being free to make their own crop choices.

Forestry

91. On Nov. 9, 1999, the Ministry of Forest and Estate Crops (MoFEC) launched a strategic planning and consultative process to establish a National Forest Program. This process should provide the mechanism for stake holder participation in future policy and regulatory decisions by MoFEC. The initial design work for the process is being carried out by two groups of stakeholders, supported by the Consultative Group on Indonesian Forestry; preliminary results of these proposals are expected by end- February 2000. The government will ensure adequate support in implementing the consultative mechanism; thus, we will convene a high-level meeting on forestry on Jan. 26, 2000, and establish a ministerial working group to deal with forestry issues.

92. The project to determine where forests still exist is proceeding well, with updated maps of forest cover completed for Kalimantan, Sumatra, and Sulawesi. Making the results publicly available is an essential next step, to increase awareness of the perilous state of the forests and allow interested stakeholders make informed decisions. MoFEC has made the maps and statistics for Kalimantan and Sumatra available to the public on its website; it will add Sulawesi by Dec. 31, 1999 and the other provinces as they are completed. MoFEC continues to observe its moratorium on new forest conversion licenses. It will do so until transparent, rules-based procedures are developed to minimize further conversion of the remaining natural forest.

Environment

93. The government is committed to increasing urban air quality. A high-level Steering Group chaired by the Minister of Communications, and an Implementation Team chaired by the Director General of Land Transport, were formally established in June 1999 to coordinate Indonesia's conversion to cleaner vehicle fuels. In October 1999, the government tightened vehicle fuel specifications and mandated the elimination of lead in gasoline by January 2003. In moving toward that objective, we will continue with the earlier plan to convert to unleaded gasoline in a geographically-phased manner, with Jakarta the first priority.

94. We are also accelerating the implementation of the Environmental Management Law (Number 23 of 1999). Until now, only four of the 19 implementing regulations had been issued, but by Dec. 31, 2000 we will promulgate five new regulations, including the one for water pollution control. At least five additional regulations will be issued by Dec. 31, 2001, and the remainder will be issued in 2002. Finally, the Reforestation Fund will only be used for maintaining natural forests and for reforestation; transparent criteria and budgeting procedures to upgrade this Fund will be developed by the Ministry of Forestry and the MOF, in consultation with the World Bank, and will be implemented beginning April 1, 2000.

Small and Medium Enterprise Policy

95. The government is committed to empowering small and medium enterprises (SMEs). However, we recognize that many current SME support programs have failed to meet the needs of the SME community. We are thus committed to reevaluating government interventions so as to increase private sector involvement in SME support programs.

96. A government task force is preparing a medium-term SME strategy with the assistance of the AsDB and World Bank. An Action Plan is being developed, which provides for the following to be completed by March 30, 2000: (i) developing an institutional framework for SME policy implementation; (ii) making business development services more responsive to SME needs; (iii) expanding access to finance for SMEs; (iv) streamlining government regulations affecting small and medium businesses; and (v) monitoring and evaluation of government SME programs.

97. The role of BI in funding and administering SME credit schemes has been eliminated. The SME credit schemes have been transferred to BRI, PT Madani and BTN. By Dec. 31, 1999, PT Madani has finalized plans for consolidating SME credit lines to two, at most, and program parameters will be consolidated. Then new credit lines will be introduced on April 1, 2000, and will be based on commercial principles with full risks of nonpayments being borne by participating banks. Any interest rate subsidy will be supported by adequate provisions in the budget. In addition, by June 30, 2000, Bank Indonesia will announce a plan to phase out mandatory requirements on commercial bank lending to SMEs.

98. SMEs as well as larger firms need access to Trade Finance in order to compete in international markets. The government has created a new institution, Bank Expor Indonesia with the aim of expanding access to trade finance. By March 31, 2000, the government will present the Law on Bank Expor Indonesia to Parliament, establishing BEI as an independent Export Credit Agency for Indonesia.