Memorandum of economic and financial policies

Memorandum of economic and financial policies

The government signed a new letter of intent with the
International Monetary Fund (IMF) on Wednesday May 17, 2000. The
agreement is expected to free US$400 million in blocked IMF
support funds by early June. Following is the full text of the
agreement (the text with tables and boxes of the agreement are
available at The Jakarta Post website: www.thejakartapost.com).

I. Introduction

1. The government remains committed to the macroeconomic
framework and structural reforms set out in the Memorandum of
Economic and Financial Policies (MEFP) of Jan. 20, 2000. At this
first review, the focus has been on elaborating aspects of the
approved fiscal year (FY) 2000 budget, and carrying forward
banking and corporate sector reforms.

II. Macroeconomic policies

2. Recent developments have been broadly consistent with the
program's macroeconomic framework. Growth in the final quarter of
1999 (5.8 percent annual rate) exceeded expectations, and the
economic recovery has been sustained in the first quarter of
2000. We now expect 2000 growth to be at the top end of the
targeted 3-4 percent range. End-period inflation should be well
within the targeted 5-6 percent range.

3. The fiscal deficit in 1999/2000 -- at 1.5 percent of GDP --
was below the targeted level. The spending program was achieved,
while tax revenues -- including from higher oil prices -- were
larger than expected. The FY2000 budget, approved by Parliament
on March 2, is in line with the January MEFP. Some modifications
were agreed with Parliament whose net effect is a slightly
reduced deficit target of 4.8 percent of GDP, compared with the
original budget target of 5 percent of GDP. In three key areas
energy -- tariffs, subsidies, and wages -- consensus was reached
as follows:

* Electricity tariffs for large and industrial users were
raised by an average of 29 percent on April 1, with no increase
this year for households using up to 900 voltage ampere (VA).

* Petroleum product prices were agreed to be raised by an
average of 12 percent, but their full implementation has been
delayed in order to better prepare the people for this increase,
as well as to finalize measures to protect the poor. We are
working toward a mechanism involving a lumpsum cash transfer to
targeted households, and using the safeguards established for the
social safety net program, in consultation with the World Bank.

* Regarding the wage increase, the original budget provided
for a 20 percent base wage increase, to be implemented in two
equal installments (implying an average increase in total
personnel expenditure of 16 percent during FY2000). During the
budget debate, parliament decided to allocate sufficient
resources for a base wage increase of 30 percent. However,
agreement was only reached on an initial increase of 15 percent
in the base wage on April 1. The size of any wage increase to be
implemented on Oct. 1 will be decided later in the fiscal year.
That decision will be made in light of macroeconomic developments
and the state of the recovery.

* On April 1, the allowances payable to a small number of
state officials and upper echelon civil servants were also
increased, thereby significantly narrowing the pay gap with the
private sector, as part of the government's anti-corruption
strategy.

* By Oct. 1, 2000 a plan for civil service reform will be
developed by an interministerial task force led by the Minister
of State Apparatus, and in consultation with the World Bank. The
task force will also include the Chairman of the National Civil
Service Board.

4. We also agreed with Parliament on higher Indonesian Banking
Restructuring Agency (IBRA) cash recovery and privatization
targets for FY2000 totaling Rp 25.4 trillion (2.8 percent of
GDP). On this basis, foreign financing of the FY2000 budget is
expected to be Rp 18.7 trillion (2.0 percent of GDP), within the
range of commitments made by donors at the recent meeting of the
Consultative Group for Indonesia, and consistent with the April
12 Paris Club meeting. We also plan an early meeting of the
London Club to restructure certain obligations falling due to
commercial banks on comparable terms to the Paris Club
rescheduling.

5. Other aspects of the financial program for 2000 are being
broadly maintained (Table 1). Bank Indonesia will begin to
publish during May foreign exchange data on reserves consistent
with the SDDS standards.

III. Structural Fiscal Reforms

6. The fiscal reform agenda is being implemented as envisaged.
Consistent with the approved budget, we expect Parliament to
approve the amendments to the Value Added Tax (VAT) law, the Tax
Procedure law, and certain other tax laws by July 2000. Other tax
reforms affecting the tax privileges for the Integrated Economic
Development Zones (KAPETs); the rationalization of import tariffs
on capital goods; and the imposition of a flat 5 percent duty on
all exempted goods with non-zero rates have been implemented.
Regarding the collection of VAT from Batam island, we have
deferred its implementation to ensure that the necessary
institutional framework for tax collection is in place, and to
secure a wide consensus for this measure.

7. We remain committed to delivering the increased fiscal
transparency that is part of the program: (i) a performance
audits of the Tax Office by the Development Finance Comptroller
(BPKP) will begin in June and is expected to be completed by end-
November; (ii) the special audit of the credit for farmers (KUT)
program has been initiated and is expected to be completed by
October; however, corrective actions will begin in June based on
the results of Eastern and Central Java audits; (iii) BPKP and
the Supreme Audit Agency (BPK) have initiated steps to take
account of all extrabudgetary funding in its audits of public
institutions, including the military; (iv) a draft law bringing
private foundations under government review and audit has been
finalized and sent to the President for approval before
submission to Parliament in May; (v) a Presidential instruction
was issued in early May to improve compliance with the ongoing
review of remaining off-budget accounts -- this review is now
expected to be completed by end of June, and specific measures in
light of this review will be taken in the context of the next
(second) program review; and (vi) the Minister of Finance has
established a task force headed by the Director General for the
Budget to improve treasury management procedures, consolidate the
number of bank accounts of government agencies, and ensure
consistency between monetary and fiscal data, and a timetable for
this work will be established by the next program review.

8. We have intensified preparation for implementing fiscal
decentralization in 2001 within the framework of Laws 22 and 25,
and will be guided by the following key principles: (i) revenue
transfers to sub-national governments will be consistent with
expenditure responsibilities; (ii) expenditure responsibilities
will be devolved in keeping with the capacities of the sub-
national governments; (iii) specific mechanisms will be developed
to ensure that any borrowing by sub-national governments is kept
within strict limits. In this way, we are determined to preserve
fiscal neutrality while implementing decentralization.

9. The decentralization process is being led by the recently
established Regional Autonomy Advisory Council (RAAC) and the
Coordinating Team (CT). The Minister of Finance is taking the
lead in all fiscal aspects of decentralization. A full-time
decentralization expert has been appointed to the Ministry of
Finance. A working group under the Ministry of State Apparatus
has been appointed to resolve any impediments to the transfer of
civil servants. A firm timetable for implementation of fiscal
decentralization will be prepared by the time of the next review,
in consultation with the forthcoming IMF/World Bank fiscal
decentralization technical assistance mission.

IV. Banking System Reforms

Governance

1O. IBRA has concluded its evaluation of all outstanding
interbank claims under the guarantee scheme. Settlements have now
been made in all cases, except for very small claims under
litigation. IBRA and BI are implementing plans to ensure that
those banks whose claims were deemed ineligible remain adequately
capitalized. During the second half of May, the Ministry of
Finance will issue a new decree on the government guarantee
scheme, and strengthened procedures for the processing and
evaluation of new claims will be published.

11. We remain committed to a professional IBRA, free from
political interests and transparent in its operations. With the
assistance of an international consulting firm, and in
collaboration with the World Bank, we are developing a new
governance and oversight framework for IBRA. Interim
recommendations have been received, with final proposals by end-
May, slightly behind schedule because of delays in appointing the
consulting firm A new governance framework for IBRA, including an
independent governing body, will be established by end-June.

12. Meanwhile, we have taken steps to improve IBRA's
transparency. IBRA has commenced regular publication of its
activities, which includes monthly reports of sales and
collection activities, progress in loan restructuring, and
disposal of industrial assets, in addition to quarterly financial
reports by the BTO banks. IBRA will publish the audit reports of
its end-1999 accounts by June 2000, with the assistance of an
international accountancy firm. Also, IBRA will issue its first
comprehensive annual report during the third quarter.

IBRA loan collection and asset recovery

13. IBRA's net asset recoveries totaled Rp 17.1 trillion in
1999/2000, with Rp 4.2 trillion in the form of the redemption of
outstanding bonds. In FY2000, the net cash recovery target is Rp
18.9 trillion.

Asset Management Credits (AMC) operations

14. On April 3, state banks completed the legal transfer to
IBRA of all category 5 loans in excess of Rp 5 billion as of
Sept. 30, 1999 (including other loans with provisions exceeding
50 percent). Virtually all physical documentation has now been
transferred to IBRA; remaining loan documentation will be
transferred shortly.

15. IBRA is implementing its sequenced approach to restructure
its loans, with particular attention to the 21 largest
conglomerate obligers (as of end-April 2000), who account for
about 36 percent of IBRA's total loans (about $12.4 billion) and
represent about 340 individual company debtors. IBRA's strategic
objective is to reach the stage of finalizing restructuring term
sheets, or initiating legal actions against uncooperative
debtors, for at least 35 percent of the nominal loan value of
these obligers by June 2000, and for all the-21 obligers by end-
2000. Progress will be monitored on a monthly basis, and the
effectiveness of the strategy assessed at the next (second)
program review. All noncooperating debtors will be subject to
automatic sanctions, involving public disclosure, insolvency
petitions, or other legal actions. Legal actions were taken on
April 3 against five noncooperating debtors, and we will take
further actions as necessary. Restructuring agreements for
debtors whose nominal value of debt exceeds Rp 1 trillion will be
reviewed by the Financial Sector Policy Committee (FSPC), with
the assistance of outside consultants where necessary, to ensure
they incorporate operational restructuring on the part of debtors
and maximize value for the government. The threshold for FSPC
approval may be adjusted once IBRA's new governing body is in
place (paragraph 11 above).

16. IBRA has launched a tender to outsource about Rp 30
trillion of its commercial loans (from Rp 5 billion to Rp 50
billion in value per obliger) through an open system of
competitive bidding. We expect to complete the outsourcing of
these loans by end-June 2000. All loans, once restructured, will
be offered for auction to all banks. IBRA intends, by September
200O, to offer for sale by open tender, under similar procedures,
all its loans under Rp 5 billion.

Asset Management Investments

17. IBRA is also accelerating efforts to sell its listed
assets through the transparent disposal of shares in the capital
market. In particular, the agency sold its 39.5 percent stake in
Astra in March in an open, competitive process. Key future sales
include plantations, shipping, tyres, and forestry companies.

18. By end-June, IBRA expects to conclude final settlement
agreements with all cooperating shareholders from the fourteen
1998 BTO/closed banks. Asset transfers from five of these
shareholders have already been completed, and the remaining three
transfers should be concluded by end-September, 2000. Four
noncooperating shareholders were referred to the Attorney General
for prosecution on March 28, 2000. Negotiations with the
shareholders of the 1999 BTO/closed banks will be concluded by
September 2000.

l9. IBRA has completed an investigative audit into deposit
guarantee payments that were made by closed Bank Putera. The
audit was conducted by an independent accountancy firm.
Withdrawals by connected parties (about $3 million) will be
recovered through settlements with the Conner shareholders of the
bank, expected to be concluded by end-September.

Mechanism for resolving recalcitrant debtors and shareholders

20. We will establish by end-May through a Presidential Decree
a new body to coordinate the government's response to
uncooperative debtors and former bank shareholders. This
Committee, entitled the Committee for Resolving the Cases of
Recalcitrant Debtors, is chaired by the Attorney General, with
the Coordinating Minister for the Economy, and the Chief of
Police as the Vice Chairmen. The Finance Minister, the Chairman
of the Development Finance Comptroller (BPKP), the Chairman of
IBRA, and the Minister of Law are members of the Committee.
Henceforth, all IBRA's noncooperative debtors and bank
shareholders, not resolved through IBRA's special legal powers,
will be referred to the Committee for resolution. If cases are
not resolved within 90 days after referral, the Attorney General
will take appropriate legal actions.

State and Bank Take Over (BTO) bank restructuring

21. The Ministry of Finance has established a governance and
oversight unit for the state-owned and recapitalized banks. This
unit is responsible for overseeing the stakeholders' interest in
these banks and ensuring compliance with their business plans.
With technical assistance from donors, and in consultation with
the World Bank, the Ministry of Finance will assign new staff and
international consultants, and make the unit fully operational by
June 30.

22. Bank Mandiri's restructuring remains on track, and its
branch, staff, information and technology rationalization
programs are proceeding on schedule. The international audit of
Bank Mandiri's end-1999 accounts was completed in March.
Mandiri's final performance contract has now been signed and its
capitalization has been formally completed.

23. There has been progress in restructuring and
recapitalizing Bank BNI, the second largest state bank. Since
February, a new President Director and two Commissioners have
been appointed; an interim performance contract has been signed;
BNI has received the first tranche of recapitalization bonds (Rp
30 trillion) after approval by the Restructuring Committee; BNI
has entered into contracts with an international bank and two
consultancy firms to help implement operational restructuring and
prepare for privatization. In addition, BNI plans to sign a
contract for credit risk management and loan workouts by June.
The second and final recapitalization tranche is expected to be
provided by end-June, upon the completion of a financial audit
(as of March 31, 2000), and verification by an international firm
of its compliance with its interim performance contract.

24. Progress is also being made in the restructuring of BRI
and BTN, in close consultation with the World Bank. A new roster
of commissioners and management has been installed. BRI has begun
to divest its corporate loans, and intends to reduce their stock
to no more than 20 percent of its total portfolio by end-2000.
During 2000, no new loans will be authorized for corporate
borrowers, with the exception of a small number of traditional
clients closely linked to the bank's microfinance activities. The
first tranche of recapitalization is expected to be provided by
about end-May, upon review and approval of the Restructuring
Committee of the business plan, conclusion of an interim
management contract with the new management team, and progress
with the above reforms. The remaining tranche will follow the
completion of the mid-year financial audit and satisfactory
implementation of the business plan, expected by about September.
As nor Bank BTN's future role, the Ministries of Finance and
Housing have formed a working group with other stakeholders to
develop a new housing finance strategy during the second quarter
of 2000. The recapitalization of BTN will be based on the housing
strategy adopted.

25. We have launched an IPO for Bank BCA and expect to sell up
to 30 percent of IBRA's share in Bank BCA during May. It remains
our objective to achieve majority privatization of Bank BCA
during 2000 through seeking a strategic partner or private
placement. Niaga will be the next BTO bank to be recapitalized in
May. The strategy for its privatization will be finalized during
the second half of the year. We expect to complete the resolution
strategy of Bank Bali as soon as the current legal hurdles are
overcome.

26. Danamon will serve as a platform bank for resolving the
eight remaining BTOs; their legal merger with Danamon will be
completed during the second quarter of 2000, and the operational
mergers concluded by end-September. On this basis, Danamon will
be provided with about Rp 30 trillion in recapitalization bonds,
in step with the legal merger, and after approval by Parliament.
The bank will be prepared for majority privatization in 2001.

Supervisory and regulatory framework

27. Bank Indonesia is implementing a comprehensive Master Plan
to upgrade hank supervision and comply with international
regulatory norms by end-2001, assisted by international experts.
A quarterly cycle will be maintained for forward-looking
monitoring of the business plans and financial condition of all
private banks, including the seven banks that were recapitalized
with the support of public funds. BI has initiated a permanent
supervisory presence at each state bank; a full on-site
inspection of Bank Mandiri has begun and will be completed by
end-August. The Master Plan will also focus on improving the
quality and timeliness of offsite reporting data on all banks and
on making operational a program of special surveillance for
systemically important and problem banks.

28. Bank Indonesia is also upgrading its regulatory framework.
It is developing a set of corrective measures that supervisors
will use as it becomes apparent that a bank is falling into
difficulty; to this end, BI issued a decree on March 30, setting
out the conditions under which it will transfer banks to IBRA,
when this becomes necessary.

29. Nonbank financial institution reform is also on the
agenda, to strengthen the regulatory and governance structure of
the pension and insurance industries, finance companies, and
capital markets. These reforms are being designed with assistance
from the Asia Development Bank (AsDB). By end-September, a time-
bound plan for bringing the supervisory structure and regulations
into line with international standards of governance and
transparency will be drawn up.

Bank Indonesia audit

30. BI has been implementing in a timely way measures aimed at
addressing the issues raised by the Supreme Audit (BPK) report to
Parliament on Dec. 31, 1999 and clarifying BI's financial
position, as outlined in the January MEFP. By end-June, BI will
publish an audited statement of its financial accounts for end-
1999. Over the coming months, BI, in consultation with BPK, will
take steps to address remaining audit issues, including flee full
divestment of financial subsidiaries, as well as the aggressive
strengthening of management information systems, financial and
operational controls, and accounting policies to reflect best
practices. A due diligence of all BI's subsidiaries will be
completed by June 2000 ahead of their planned disposition to be
substantially completed by end-2000.

Bond market

31. We have begun the development of a domestic bond market in
Indonesia by making an initial share (10 percent) of the bonds
issued for bank recapitalization eligible for leading. A debt
management office (DMO) in the Ministry of Finance has become
operational, with the assistance of advisors from AusAid. The DMO
will coordinate future bond issues and the development of a debt
management strategy in consultation with Bank Indonesia. Bank
Indonesia has established a book-entry system to record transfers
of title of the bonds and a system to ensure delivery against
payment. We are examining -- with technical assistance being
provided through the IMF -- further ways to strengthen the
institutional framework for debt management and to enhance the
prospects for secondary market trading. The government will also
submit to Parliament a draft law on debt management which will
ensure automatic appropriations of debt-service payments for all
government bonds issued.

V. Corporate Restructuring, Legal Reform, and Governance

32. The enhanced corporate restructuring strategy described in
the January MEFP has now been put fully in place, after
consultation with market participants. All enabling regulations
and decrees have been issued, including those related to the
FSPC's referral of strategically important cases to the Jakarta
Initiative Task Force (JITF) and the use of time-bound procedures
for negotiations under the JITF; debt and debt-service reduction
by IBRA and legal protection of IBRA's staff in connection with
such transactions; and the authority of the Attorney General to
file "public interest" bankruptcy petitions against uncooperative
debtors. In addition, a permanent secretariat has been
established to assist the FSPC in overseeing bank and corporate
restructuring.

33. The JITF is being strengthened in its staffing and
resources in order to carry out its mandate more effectively.
Specifically: (i) the FSPC has issued a decree placing the JITF
under the FSPC and giving it broad powers to engage in activities
related to corporate sector restructuring; (ii) a new Chairman
and full-time Chief Operating Of ricer have been appointed for
the task force; (iii) the Chairman of the JITF will be an invited
member of the FSPC; (iv) the JITF has retained a core group of
staff members and facilitators; and (v) new budgetary and
disbursement arrangements have been adopted, with the approval of
the Ministry of Finance, that will ensure that the JITF can meet
its future obligations in a timely manner.

34. As of April, the FSPC has directed the cases of three
companies to the JITF, under a recently issued FSPC decree, and
these companies and their creditors are expected to start
negotiations under the JITF's new time-bound mediation procedures
immediately. We expect to direct additional companies to the JITF
by end-June. If the JITF determines that a debtor or creditor is
not negotiating in good faith, then the FSPC may take certain
actions against the uncooperative party. Such actions include
publishing the names of uncooperative debtors and creditors,
requesting the Attorney General to file a civil suit or
bankruptcy petition against an uncooperative debtor, and/or
requesting the relevant government agencies to revoke or refuse
to extend licenses, concessions and other facilities previously
granted to uncooperative parties. However, if the JITF determines
that a debtor or creditor is negotiating in good faith, it will
qualify the cooperative parties for agreed tax and capital market
regulatory incentives. In addition, the FSPC has issued
procedures for accelerated processing and approval of
restructuring-related applications under the JITF's One-Stop
Facilitation Group; all Ministries and agencies responsible for
handling such applications are required to observe the new
procedures.

35. We will keep under review the scope for expanding the
corporate restructuring strategy and providing additional tax and
other regulatory incentives for debtors and creditors to
accelerate restructuring.

36. The JITF will undertake periodic surveys to assess
progress in corporate restructuring and gather information on key
restructuring parameters. The first such survey will be conducted
by July 200O, and quarterly thereafter.

37. Key reforms have also been put in place to address
governance problems in the court system. The Chairman of the
Joint Investigating Team (JIT) has been appointed and the JIT
will become fully operational during May. The JIT will function
under the direction of the Attorney General, focusing on complex
corruption cases and the court system. The JIT is retaining a
core group of staff members to facilitate its work, and we have
made available adequate budgetary and infrastructure support for
it. External technical assistance is expected from the
Netherlands and other donors to assist the efforts of the Team.

38. The Independent Commission for the Audit of State
Officials (including its judicial subcommission) is expected to
be appointed by Parliament during the current quarter and to
become fully operational shortly thereafter, as a key part of our
anticorruption efforts.

39. We are giving high priority to resolving the issues that
delayed the appointment of ad hoc judges in recent Commercial
Court cases where they were requested. The Supreme Court has
expanded the class of professionals who can serve as ad hoc
judges to include private practitioners that do not have a
conflict of interest; and the President is expected to appoint
shortly a new slate of ad hoc judges that can be assigned to
cases in the Commercial Court.

40. The strategy for corporate governance reform proposed by
the National Committee on Corporate Governance has been adopted.
The strategic objective is to amend the Company Law, and the
Company Registration Law within the next 12 months, thereby
strengthening key aspects of corporate governance, especially
monitoring and disclosure rules. Meanwhile, we have strengthened
the enforcement of existing regulations in these key areas. The
AsDB is providing technical assistance for implementing the
corporate governance framework and coordinating the activities of
other donors.

VI. Reform of State-owned Enterprises and Other Key Structural Reforms

Privatization

The government has updated its masterplan for state enterprise
reform and privatization for the period 2000-2002. This
masterplan, which is to be published by end-May 2000, promotes
fast-track privatization for enterprises in competitive
industries, and deals with loss-making enterprises that have no
prospect of returning to commercial viability. The planned
privatization transactions for FY 2000 are expected to yield Rp
6.5 trillion. The Ministry for Investment and State Enterprises
is also preparing to issue shortly guidelines on improved
privatization procedures, drawing on a review of completed
transactions, these guidelines have been prepared with the
assistance of international consultant.

Other enterprise reforms

42. The masterplan accords very high priority to moving ahead
quickly with privatization of the telecommunications sector.
Toward this end, we remain firmly committed to transforming the
telecommunication sector into a fully competitive business
environment. In preparing for their privatization, Telkom and
Indosat will rationalize their holdings in other
telecommunications enterprises and divest stakes in non-core
businesses during 2000. In parallel, the government will, by June
2000, and in consultation with the World Bank, finalize the
implementing Government Regulations for the 1999
Telecommunications Laws and complete the other related actions
listed in the January 2000 Letter of Intent. To ensure effective
coordination, we will establish an interministerial team, headed
by the Deputy Minister of Restructuring and Privatization to
guide and oversee the sector's restructuring and privatization.
This team will be responsible for preparing a detailed and
comprehensive faction plan by June 2000.

43. The government also remains committed to the reforms of
the energy sector outlined in the January MEFP. Management
changes have interrupted progress in some areas but we expect to
achieve all the strategic objectives of regulatory reform during
2000, including a plan for medium-term energy pricing reforms.

44. The MISOE, assisted by AsDB, will soon issue corporate
governance guidelines for all SOEs. Strategies to improve the
governance and efficiency of state infrastructure monopolies in
ports, airports, and toll roads will be prepared and phased-in
during 2000 by the Ministry of State-Owned Enterprises (MISOE) in
coordination with the respective line ministries. As part of a
two-year restructuring program, assisted by the AsDB, 32 state
enterprises have been identified to have their accounts audited
by independent auditors by end-2000; this plan will be extended
to a further 30 state enterprises in 2001.

45. We have begun implementing corrective actions for the
findings of the recently completed special audits of the National
Logistics Agency (Bulog), the state-run electricity firm PLN, the
state-run oil company Pertamina, and the Reforestation Fund.
Commencing in June 2000, the Coordinating Minister for the
Economy will require publication of quarterly reports on the
implementation of the corrective actions related to the audit
reports. We are also commissioning special audits, to be
conducted with the help of international firms, for five
additional state enterprises (the national airline, the national
toll road company, the domestic telecommunications company, the
largest public port corporations, and a plantation company).
These new special audits will be completed and the results
publicized by end-2000. Progress in other structural reform areas
is summarized in Box 1.

Independent Power Producers

46. The ministerial-level PLN restructuring and rehabilitation
team, supported by legal and technical advisors, has invigorated
the process of resolving contractual disputes with independent
power producers (IPPs). Legal actions filed by PLN and the
developer of one plant have been withdrawn, and a number of
interim agreements have now been concluded. The ministerial-level
team has met with representatives of six Export Credit Agencies
(ECAs) with IPP exposures, and a joint working team has been
established to formulate a common basic framework within which
long-term commercial solutions for individual IPPs will be
negotiated.