Latest letter of intent between Indonesia, IMF

The following is the full text of the new Letter of Intent signed by the Indonesian government and the International Monetary Fund on Tuesday.

1. This memorandum builds upon the economic program described in the Memoranda of Economic and Financial Policies (MEFP) of Jan. 20, 2000 and updated on May 17, 2000 and Sept. 7, 2000, with particular emphasis on the 2001 program.

I. MACROECONOMIC FRAMEWORK AND POLICIES

2. Our macroeconomic framework for 2001 is reflected in the revised budget agreed with Parliament in June. This framework targets growth in the 3 percent - 3.5 percent range in 2001 and aims to bring 12-month inflation well within the 9 percent - 11 percent target range by the end of the year (Table 1). This framework reflects our intention to sustain and build upon the recent recovery in market confidence in the latter part of the year. Supporting macroeconomic policies are described below.

3. Monetary policy is being set consistent with the inflation objective, and aims to keep real interest rates at adequate positive levels. Bank Indonesia (BI) has adopted a target path for gradually reducing base money growth to 12.5 percent (12- month basis) by March 2002, and is implementing policies consistent with the achievement of this objective. The monetary program aims at keeping NIR broadly unchanged over 2001, and excludes any bank financing of the budget. The Government of Indonesia (GOI) and BI remain committed to maintaining a flexible exchange rate regime and an open capital account, and BI does not plan to implement any new restrictions on capital flows.

4. The GOI is committed to a strong, independent and accountable central bank. In line with this objective, we are developing a set of amendments to the central bank law that will preserve its independence while increasing its accountability. To this end, we have sought the views of an independent panel of experts, and we generally support the panel's recommendations. We have also consulted other experts. However, the GOI, in consultation with Parliament, has decided that more time is needed -- at least six month-- to study the options for revision of the law. During this period, the GOI intends to work in close consultation with Parliament, as well as with the IMF, to ensure that any revisions are mutually acceptable.

5. The GOI reached agreement with Parliament on June 16 on a package of measures that will maintain the original 2001 budget deficit target of 3.7 percent of GDP. The package included: (i) raising fuel prices for nonindustrial users by just over 30 percent; (ii) raising electricity prices for large consumers in two phases by an average of 17.5 percent (with the second increase to be completed in October); (iii) reducing the nonneutrality of fiscal decentralization; (iv) selective cuts in lesser priority development spending; and (v) a range of administrative revenue measures. These measures are now fully in place. In particular, the GOI has put in place the specific modalities for achieving the targeted savings in decentralization and these measures will be ratified with the Regional Autonomy Supervisory Board by end-August (Section II). The budget revisions include measures to compensate low-income households for the increase in fuel prices, among them, an increase in the amount of subsidized rice (OPK scheme). BPKP will audit the 2001 compensation scheme by March 2002.

6. Ahead of the planned November meeting of the Consultative Group for Indonesia (CGI), the GOI will review with the IMF and the World Bank by mid-October the implementation of the 2001 budget and the framework for the 2002 budget. This review will allow a further assessment to be made of the course of the 2001 budget and its financing, and whether additional measures are needed to keep them on track. In particular, there is still room to rephase lesser priority spending and to strengthen revenue mobilization in 2001.

7. The GOI is taking all necessary measures to achieve this year's budget financing targets, including revenue from IBRA asset sales and state enterprise privatization. The GOI is committed to expediting the privatization program that has been developed in consultation with Parliament. The privatization program for 2001 was published on August 6 and is expected to yield Rp 6.5 trillion. From the published list, the GOI will now focus on a subset of enterprises in the areas of telecommunications, manufacturing, transportation, and agriculture. IBRA's recovery targets are given in Section IV. The GOI will not seek any commercial external financing for budgetary or extra budgetary operations, including through the securitization or forward sale of receipts from natural resources.

8. The GOI has recently submitted for Parliamentary consideration its 2002 annual development program (REPETA). The proposed program is designed to promote medium-term fiscal sustainability and reduce dependence on exceptional external financing. The draft program includes measures that would strengthen non-oil tax revenues, lower untargeted subsidies, and improve implementation of fiscal decentralization. The draft program also includes continued wage restraint and envisages the introduction of a civil service reform incorporating mechanisms to guarantee performance. The draft program for 2002 envisages a deficit in the range of about 2 percent - 3 percent of GDP, which needs to be discussed further with Parliament. Following the approval of this program, the GOI will finalize the 2002 budget in line with the approved development program, and consistent with the 2002 macroeconomic framework.

9. The GOI is working to develop a comprehensive legal and institutional framework for public debt management and a liquid government securities market, and to this end, will submit in the coming weeks a draft Sovereign Debt Securities Law to Parliament. The GOI will seek Parliament's support for the early approval of this law, and within three months of this approval, will begin primary auctions of (6 and 12 month) treasury bills, with the proceeds in 2001 to be used mainly to buy back existing recapitalization bonds. Banks will also be allowed to exchange some of their longer-term fixed-rate bonds for new variable rate bonds to facilitate their sale in the secondary market.

II. FISCAL DECENTRALIZATION

10. To ensure that fiscal decentralization is carried out in an orderly fashion, the GOI has put in place a number of safeguards, especially: (i) local governments are not permitted to borrow in 2001, except through the center; (ii) the 2001 budget includes a contingency fund for local governments with funding shortfalls; (iii) regulations have been issued to ensure that transferred personnel are paid from shared and transferred revenue; and (iv) the GOI has issued regulations for local governments to submit quarterly financial reports. The full quarterly reporting system (consistent with GFS) will be in place from the beginning of 2002, but the GOI will produce an estimate of local government finances for 2001 Q1 by end-September 2001.

11. As indicated above, the GOI has taken the following steps to implement the savings in fiscal decentralization that were part of the revised 2001 budget. Toward this end: (i) the GOI has accelerated the transfer of staff to the regions, such that a total of 2.1 million civil servants will be transferred by end- 2001, reducing the central government payroll to 1.6 million; (ii) the GOI has reached agreement with Parliament to base FY2001 transfers from the General Allocation Fund (DAU) and natural resource revenue sharing on the original budget estimates; (iii) after assessing requests from the regions to use the decentralization contingency, the GOI will limit outlays under the contingency to within the revised allocation of Rp 3 trillion agreed with Parliament; (iv) the GOI is finalizing the modalities to absorb at least Rp 0.9 trillion of revenue transfers by issuing bonds to surplus regions in the last quarter of 2001; and (v) to help monitor fiscal decentralization and ensure macroeconomic control, BPKP will complete audits of the allocations of the contingency fund by December 2001, and of central government lending operations to local governments by March 2002.

12. The GOI is currently reviewing certain of the decentralization laws and related regulations. In light of our operational experience in implementing these laws, the GOI plans to propose revisions to Parliament in 2002 to strengthen the decentralization program. The GOI will refine the DAU formula for FY2002, in consultation with Parliament, by end-September 2001 to minimize mismatches between transferred revenue and expenditure and ensure that the formula is equalizing across regions.

III. BANDING SYSTEM REFORMS

State Bank Restructuring

13. The GOI has announced its plan to privatize Bank Mandiri, with an initial primary share issue for up to 30 percent expected to be launched by the end of 2001 and completed by the first quarter of 2002. The GOI is also examining the privatization of the remaining state banks and will announce its plan in consultation with Parliament by December 2001. An independent study for Bank BTN will be completed during this period. The state bank governance unit is closely monitoring the banks and will play an important role in advancing risk management, avoiding any directed lending ensuring, and progress toward state bank privatization.

Supervisory and Regulatory Framework

14. The main objectives regarding the supervisory and regulatory framework are: (i) BI examiners are undertaking during 2001 risk- focused examinations of all systemically important banks as part of the strategy to ensure that all banks meet more stringent prudential standards by end-2001; (ii) to enhance transparency, BI will begin publishing key individual bank financial data on a monthly basis by end-2001; (iii) for the GOI to set a realistic timetable by December 2001 for the establishment of the new integrated Financial Sector Supervisory Institution; (iv) for the GOI to adopt an action plan by December 2001 to strengthen the supervisory, regulatory, and governance structures of the nonbank financial institutions (with the assistance of the AsDB); (v) for BI to aim to complete by end-December 2001 all outstanding issues related to its 1999-2000 audits, especially the divestment of all subsidiaries; and (vi) for the GOI and BI to work closely with Parliament to expedite the final resolution of BLBI. credits, which is critical to both BI and IBRA audits, before end-2001.

15. The GOI remains fully committed to the current Government Guarantee Scheme for depositors, and, in consultation with Parliament, is in the process of replenishing the guarantee fund. This process is expected to be finalized by the first week of September. In order to minimize demands on the scheme, BI is intensifying its special surveillance procedures to ensure that banks meet their prudential targets. Procedures have already been established for banks that do not meet their targets for transferring the bank to IBRA for resolution. To promote the development of the economy, the GOI and BI continue to support the orderly consolidation of the banking industry. In order to facilitate this process, BI, IBRA, and the Ministry of Finance have jointly agreed on procedures for providing short-term support to banks as provided for under the law.

16. Regarding the resolution of the solvency situation of Bank BII, the Ministry of Finance, IBRA, and BI, in consultation with Parliament, have begun to implement the following agreed strategy. On July 13, responsibility for BII was transferred to IBRA, it was declared a BTO bank, and new management was put in place. BII's impaired assets (mainly its exposure to the Sinar Mas group) will be removed and replaced with government bonds (including hedge bonds) by mid-September. Bank Mandiri has indicated its intention to acquire BII, as part of its strategy to strengthen its retail position, and a rights issue is expected to be completed by end-November. Sufficient safeguards have been put in place for Mandiri and to ensure that BII meets all its commitments until the acquisition is completed.

IV. IBRA ASSET RECOVERY AND RESTRUCTURING

17. The role and performance of IBRA remain crucial to fiscal sustainability and increasing investor confidence. The GOI remains committed to maintaining IBRA as an independent and professional organization and intends to keep its current institutional structure intact, including the respective current roles of the FSPC and the Oversight Committee, while intensifying IBRA's activity.

18. During 2000, IBRA intensified its operations with net cash recoveries of Rp 18.1 trillion, close to the program target of Rp 18.9 trillion. Toward this end, IBRA published a schedule of quarterly revenue targets and asset sales consistent with the 2001 target on Aug. 12, 2001. The Ministry of Finance and IBRA are working, in consultation with Bank and Fund staff, on detailed procedures and safeguards governing all exchanges of IBRA's loans for sovereign bonds and these will be published by mid-September.

19. IBRA will continue to improve its governance and, to this end, the FSPC published on April 4, 2001 a set of principles designed to promote economically viable restructurings of distressed companies through a transparent process that aims to maximize recoveries for the GOI (Attachment I). These principles, which are being applied to all work by IBRA on large restructuring cases, also constrain IBRA from extending any future guarantees.

20. IBRA's Oversight Committee (OC) will help ensure independent review of IBRA's adherence to these principles. The FSPC will consider and publish the results of these reviews along with the GO['s rationale for any deviations between the proposed restructurings and the principles within one month of their submission to the FSPC. Reviews of those restructurings of IBRA's top 21 obligers that have not yet legally closed are well underway. The results of the first round of OC reviews of four large restructurings were published by the FSPC on Aug. 24, 2001, and the GOI response to the findings will be finalized by mid- September. The results of the next round of 10 reviews will be published by mid-October 2001. In line with the principles, newly submitted restructuring proposals to the FSPC by IBRA will henceforth be accompanied by independent reviews by the OC.

21. IBRA's recently established audit committee has reviewed IBRA's internal controls and audit framework, so as to ensure a clearer delegation of authority and greater transparency in asset sales and restructuring. IBRA has also begun implementation of a corrective action plan (CAP) to address the issues raised in IBRA's 1999 and 2000 audit reports. To this end, IBRA has amended disclosure of its cash flows on the basis of operating, investing, and financing activities, and disclosed the fair value estimates of its major assets in its 2000 financial statements. In line with the new CAP, IBRA proposes to further develop its reporting to achieve greater transparency.

Asset Management Credits (AMC) Operations

22. IBRA has continued to make progress with the restructuring of its largest debtors. For the 21 largest obligers, most restructurings with cooperating debtors have reached the MOU stage. IBRA's strategic objective is to subject these MOUs to independent review by the OC and reach legal closure on them in 2002.

23. IBRA has also intensified the disposition of the AMC's other loans: (i) the sale of the smallest loans (under Rp5 billion) and outsourcing of the medium-sized loans (Rp 5 billion- Rp50 billion) will be completed by December 2001; and (ii) targets have been set for completing the restructuring (legal closure stage) and/or sale of about half of the loans above Rp 50 billion by mid-2002. To add impetus to asset disposals, IBRA intends to launch the sale of unrestructured loans through an open and transparent process in the fourth quarter. All loan sales to banks and investors will continue to take place through public auctions or other transparent and competitive bidding mechanisms. A key safeguard will be FSPC approval for all large loan sales.

24. For noncooperating debtors, IBRA is initiating legal actions. So far, it has filed legal actions against 48 noncooperating debtors (total debt of over Rp 13 trillion) of the top 21 obligers. Additional filings against the remaining 20 noncooperating debtors (total debt of over Rp 5 trillion) are expected during the second half of 2001.

Asset Management Investments (AMI) Operations

25. For 2001, the AMI aims to raise about Rp 10.7 trillion in cash. To achieve this goal, the AMI is preparing the sale of nearly 40 companies from 4 holding companies and from former bank shareholders. The AMI's sales schedule is based on implementing existing MSAA/MRA agreements with cooperating former bank owners. IBRA has obtained written commitments from former owners for the sale of their assets in 2001, and international advisory firms have been engaged for all enterprises scheduled for sale. At the same time, IBRA has referred eight cases of noncooperative bank shareholders to the Attorney General, and legal action is underway. Successful resolution of these cases will allow the AMI to expand its program of asset sales.

IBRA-Led Bank Resolutions (BRU) Operations

26. The GOI is fully committed to majority privatization of banks BCA and Niaga in 2001. The sale process is largely taking place through private placement to strategic investors so as to ensure that both banks attract strong partners. A 10 percent stake in BCA was sold through public offering in July, and the GOI is discussing with Parliament its intention to offer a further 5l percent for sale to a strategic partner by end-year. A strategy for the majority sale by December 2001 of Niaga will be finalized by end-September.

27. In consultation with Parliament, IBRA intends to privatize the remainder of its bank holdings by 2003. A comprehensive divestment plan will be drawn up and presented for Parliamentary approval in the coming months. IBRA is preparing for the divestment of its shares in banks BCA and Niaga in 2002.

V. CORPORATE RESTRUCTURING AND LEGAL REFORM

28. Total JITF-mediated debt for which a term sheet or MOU has been signed totaled about $12 billion as of end-June 2001, representing the debt of 54 companies. The JITF has adopted the strategic objective of restructuring (MOU stage) a cumulative total of $14 billion to $15 billion by end-2001. Recognizing the importance of moving expeditiously from the MOU stage to legal closure, the JITF will monitor progress toward development and approval of final restructuring agreements, and has begun to incorporate deadlines for final restructuring agreements into the mediation schedules for its cases. JITF will continue to publish a quarterly survey of corporate debt and progress in debt restructuring.

29. Excluding the restructured cases mentioned above, the JITF's caseload as of end-June 2001 contained 61 cases with total debt of almost $8 billion. The GOI remains committed to referring strategically important cases to the JITF, including companies to which state banks have significant exposure. By December 2001, we expect FSPC referrals of debt to reach a total of around $10 billion to $11 billion.

30. In addition, the GOI has provided a supportive regulatory framework for JITF-led restructuring. This includes the introduction of tax relief for a broad range of restructuring transactions, and regulatory protection at the Jakarta Stock Exchange to prevent delisting for cooperating companies. The GOI remains firmly committed to imposing sanctions against parties that refuse to cooperate in JITF-led negotiations, including referral to the Attorney General for bankruptcy proceedings. The FSPC intends to consider expeditiously the question of providing indemnification to JITF personnel and agents in connection with the good faith exercise of their duties.

31. The GOI recognizes the importance of legal certainty and the rule of law. With regard to specific measures, the Commercial Court has now assigned a total of 13 ad hoc judges to deal with cases pending before it. An amended version of the bankruptcy law, which will clarify and strengthen the coverage of the current law and provide a statutory basis for the publication of dissenting opinions by Commercial Court judges, is being finalized and will be submitted to Parliament by December 2001. In addition, a comprehensive blueprint for reform of the Commercial Court has been finalized.

32. The GOI has implemented a number of measures to improve court governance. The Independent Commission for the Audit of the Wealth of State Officials has already begun to receive financial reports and forms, and assess the wealth of judges and other high ranking officials. In light of the recent Supreme Court ruling declaring unlawful the special Joint Investigating Team (JIT) responsible for investigating and prosecuting court system corruption, the Anti-Corruption Commission will take over this important task. This Commission will become fully elective in the coming months after the appointment of its members by Parliament. In the interim, the Attorney General's office has been handling the Prosecution of cases that had been investigated by the JIT.

VI. PUBLIC SECTOR AND OTHER STRUCTURAL REFORMS

Public Sector Governance

33. Several initiatives to improve public sector governance are being carried forward: a law for the oversight and audit of private foundations has been approved by Parliament; the BPKP plans to conduct in 2001 special audits to identify remaining off-budget funds that were not reported last year and to impose sanctions; and the Reforestation Fund and two Investment Funds (RDI and RDA) have been included in the 2001 Budget. The BPKP audit of the Reforestation Fund will be completed by end-year, with corrective actions adopted by March 2002; the BPKP audits of the two investment funds and the adoption of corrective actions will both be completed by June 2002.

34. Key government agencies have been audited as previously envisaged: After their audits by the BPKP, the KUT program has been replaced by a new scheme (KKP) under which default risks are assumed by banks and insurance companies. The results of the audit for the tax office will be published by end-September and corrective actions will be announced by October.

BPK completed audits of eight military foundations (two from the Ministry of Defense, three from the Army, and one each from the TNI headquarters, the Navy, and the Airforce) as well as one State Police foundation. The implementation of corrective actions in all cases will be publicized on a regular basis.

The performance audits of key enterprises (Garuda, Pelindo II, Jasa Marga, Telkom, PT PN-IV) have now been completed. Their results will be published and corrective actions announced by end-September, and their progress will be announced regularly. Also, by end-September, the GOI will announce companies to be included in the third round of performance audits.

Other Structural Reforms

35. The World Bank and AsDB are taking the lead on sectoral policies. The GOI will work closely with both institutions to pursue structural reforms and sectoral policies aimed at strengthening medium-term growth and delivering high case lending scenarios. Key policy areas in this regard include improvements in public sector procurement and financial management policies, rice policies, state-owned enterprise reform, civil service reform, and poverty reduction.