Latest letter of intent between Indonesia, IMF

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.