Reform programs to spur recovery later in the year
Reform programs to spur recovery later in the year
The following is the full text of the Supplementary Memorandum
of Economic and Financial Policies. The memorandum was the
outcome of a three-week negotiation between the government and
the International Monetary Fund.
1. The overall economic stabilization and reform strategy of
the Government of Indonesia remains as described in the
Memorandum of Economic and Financial Policies signed on Jan. 15,
1998. This supplementary memorandum updates the earlier document
to allow for recent changes in the macroeconomics situation and
outlook, and also describes areas where our strategy needs to be
modified, extended or strengthened. The main changes are
highlighted in seven attached appendices.
2. The economic situation has deteriorated since the beginning
of 1998. The depreciation of the rupiah in recent months combined
with a severe drought has resulted in a large increase in prices,
with the consumer price index rising by 6.9 percent in January
and 12.7 percent in February before slowing to 5.5 percent in
March. Because of the drought, food prices have risen
particularly sharply during the first quarter of the year. The
financial position of the domestic banking system has
dramatically deteriorated, as the crisis in the economy has
deepened. Bank Indonesia granted very large scale liquidity
support, creating additional pressure on the exchange rate and
international reserves. At the same time, foreign banks have cut
trade and other credit lines to Indonesian banks, and enterprises
are having difficulty in obtaining the imported inputs needed for
production. The rupiah strengthened briefly in February, but then
weakened again, fluctuating during the first half of March in the
region of Rp 10,000 per U.S. dollar. In the second half of March
the rupiah strengthened again to Rp 8,500 per U.S. dollar. After
declining by $5 billion during the first two months of 1998,
gross foreign exchange reserves stabilized in March at about $16
billion.
3. Our strategy is to (i) stabilize the rupiah at a level more
in line with the underlying strengths of the Indonesian economy,
including through a tightening of monetary policy, (ii)
strengthen and accelerate our strategy for restructuring the
banking system; (iii) strengthen the implementation of the
structural reforms that will create the foundations for a more
efficient and competitive economy; (iv) provide a framework for
comprehensively addressing the debt problems of private
corporations; and (v) restore trade financing to a normal basis,
thereby allowing domestic production and especially the export
sector to recover. The government expects that its bold policy
program will be reinforced by financial support from the
international community, including trade financing and the
provision of food and medical aid.
4. With the deterioration in the economic situation, inflation
will be higher and the economy weaker in 1998 than we had earlier
hoped. While it is difficult to be precise in current
circumstances about the macroeconomic outlook, the revised
program envisages that the exchange rate would strengthen rapidly
during the first quarter of 1998/99. We expect that the exchange
rate will eventually stabilize below Rp 6.000 per U.S. dollar. On
that basis, inflation would decelerate quickly, but would
probably still amount to over 45 percent during 1998 as a whole.
Given the disruption to production that has already taken place,
a decline in real GDP in 1998 of 5 percent is probably now
unavoidable. We expect the economy to start to recover in the
second half of 1998 and the decline in real GDP is predicted to
be 4 percent for the fiscal year. With the depreciation of the
rupiah and the weakening of the economy, the external current
account is expected to show a shift from a deficit of about 1
percent of GDP in 1997/98 to a surplus of about 3 percent of GDP
in 1998/99. With the projected increase in official external
concessional assistance, the cessation of private capital
outflows as the program takes hold, as well as the restructuring
of corporate debt, the overall balance of payments position is
expected to be manageable.
5. Monetary policy is being tightened in order to bring the
exchange rate to a more appropriate level and to reduce
inflation. The monetary program target has been shifted to net
domestic assets (NDA) of Bank Indonesia instead of base money as
agreed in October 1997. This change is being made because it is
essential to curb the expansion of central bank credit, which has
grown rapidly in recent months. This will require that liquidity
support to banks be brought firmly under control. Limits on NDA
and net international reserves will be performance criteria.
Because of uncertainties over monetary relationships, the
performance criteria for NDA and NIR will for the time being
established only one month in advance, within the context of a
rolling three month indicative framework. It is envisaged that
both NDA and NIR would be broadly constant during April-June
1998. This is consistent with the outlook for the balance of
payments. Bank Indonesia will publish key monetary data on a
weekly basis.
6. Within the month, should the exchange rate deviate from its
programmed path, NDA and interest rates will be adjusted as
necessary. Consistent with the implications of the performance
criteria for NDA and NIR, base money is projected to be
approximately constant during April to June. This reflects modest
growth in rupiah broad money combined with a decline in the
currency-deposit ratio resulting from improved confidence in the
banking system. We will establish indicative limits for base
money and liquidity credit to banks. The central bank will
appoint high level foreign advisors to assist in the conduct of
monetary policy.
7. To help reduce monetary growth and restore confidence in
the rupiah, interest rates in Bank Indonesia certificates (SBIs)
have been substantially increased, and Bank Indonesia has
publicly indicated its intention to adjust interest rates as
necessary to reduce inflation rapidly and strengthen the exchange
rate. Steps have also been taken to remove impediments to the
pass through of higher money market interest rates to deposit and
lending rates. In addition, new liquidity support facilities have
been introduced to make access to this support more restrictive
and costly. These changes are summarized in Appendix I.
Reflecting these measures, bank deposit interest rates increased
sharply.
8. Bank restructuring is being accelerated and the Indonesian
Bank Restructuring Agency (IBRA) strengthened. This is crucial
for stopping the flow of liquidity support to banks and regaining
monetary control. The most urgent priority is to effectively take
over seven large banks that account for the bulk of the liquidity
support that has been provided to the banking system. The action
plan for addressing the banking sector problems is described in
Appendix II. Implementation of this plan is a prior action. In
addition, a number of steps are being taken to strengthen IBRA
and ensure that it has the resources and independence to complete
the restructuring of the banking system effectively and to
maintain the highest standards of governance. These measures are
also described in Appendix II. Given the overall objective of
restoring quickly a credible and viable banking system, Bank
Indonesia is also intensifying its efforts to rehabilitate and
strengthen relatively healthier banks, including raising their
capital adequacy levels to international standards. The
implementation guidelines for the government guarantee program on
commercial bank obligations were issued on March 6, which should
help to further strengthen confidence in the banking system.
Coordination of work between BI and IBRA in strengthening the
banking system will be enhanced by maintaining a full and well
structured flow of information and data.
9. The total cost of bank restructuring, including the cost of
recapitalizing banks to an 8 percent capital asset ratio and of
repaying Bank Indonesia for the liquidity support provided to
banks taken over by IBRA, is tentatively estimated to be of the
order of 15 percent of GDP, on the basis of end-January balance
sheet data and the macroeconomic assumptions underlying the
revised program. Part of this cost will eventually be recovered
as recapitalized banks are sold by IBRA. The costs to the
government of bank restructuring will be recorded transparently
in the budget. It is envisaged that the repayment to Bank
Indonesia for the liquidity support will be implemented in the
first instance through the transfer of Rp 80 trillion (roughly
the stock of credit outstanding to the 54 banks taken over by
IBRA) of indexed bonds to IBRA from the Ministry of Finance which
will likely on-sell them to Bank Indonesia. Additional bonds of
perhaps Rp 75 trillion with market-related nominal interest rates
will be issued during the course of the year for restoring the
financial viability of banks taken over by IBRA. Including
allowance for the cost of running IBRA and managing the assets
that it takes over, the budgetary cost of bank restructuring in
1998/99 is estimated at about 1 1/2 percent of GDP. The budgetary
burden in subsequent years may be higher as amortization payments
begin, even after allowing for significant cost recovery, and
lower nominal interest rates.
10. The budgetary position in 1998/99 will come under severe
pressure as a result of the decline in economic activity, the
need for temporary subsidies to protect low income groups from
the impact of the depreciation of the exchange rate on the prices
of staple foods and other essential items, the large cost of
restructuring the banking system, and the decline in
international oil prices. Without offsetting measures, these
factors could increase the deficit to at least 6 percent of GDP.
However, the government intends to limit the deficit to about 3
1/2 percent of GDP, almost all of which can be covered by foreign
financing.
11. To achieve the program's budgetary objective the
government has taken the following steps: (i) subsidies remain
limited to a few items that have a large weight in the
consumption baskets of low income groups, and the subsidies are
being contained by large price increases for several food items,
petroleum products and electricity (Appendix III). In the present
environment, there is little or no scope to raise revenues by
increasing taxes. Subsidies will be substantially scaled down by
October 1. (ii) low priority development expenditures have been
reduced; and (iii) profit transfers from state enterprises,
including from Pertamina, will be increased as a result of
efforts to scale back state enterprise investment and accelerate
management reforms. The remainder of the budgetary gap will be
covered by divestiture proceeds. During the program period, we
intend to conduct a revenue review in conjunction with the Fund
that would aim to strengthen overall revenue performance and
improve tax administration. The first stage of this review will
be undertaken by end-September 1998.
12. A detailed state enterprise reform and divestiture plan
(Appendix IV) is being developed with the intention of improving
the efficiency of the enterprise sector as well as helping to
strengthen the public finances. Transparent procedures are being
developed for the sale of state assets. Over the longer-term, at
a minimum, all enterprises that operate in competitive markets
will be privatized, with the government retaining only selected
public utilities and strategic companies. For 1998/99,
divestiture receipts have been estimated conservatively because
of the uncertain market conditions.
13. The government remains fully committed to the structural
reforms set out in the January Memorandum of Economic Policies.
However, implementation has lagged in some areas and difficulties
with implementation encountered in others, notably the
elimination of certain restrictive marketing arrangements and the
operations of BULOG. The situation in these areas and the steps
that the government is taking to rectify any problems that have
arisen are set out in Appendix V. In particular, the government
will, by April 22, 1998, eliminate all restrictions on foreign
investment in wholesale trade and establish a level playing field
in the import and distribution of essential food items between
BULOG and private sector participants. Clove marketing has been
opened to private sector competition, with the government
ensuring that small holders are not disadvantaged; foreign and
domestic applications for investment in oil palm plantations are
being treated identically throughout the country; and the plywood
joint marketing body has been dismantled. Provincial and local
export taxes have been abolished. Transparent and competitive
bidding for the private provision of infrastructure is being
strengthened or improved.
14. The Executive committee of the Resilience Council will be
in charge of constant monitoring of the structural reforms. The
Executive Committee will be assisted in this task by the Asian
Development Bank, the World Bank and the Fund, and will employ
independent auditors as necessary to ensure effective progress in
this area. The auditors' reports will be made available to the
three institutions.
15. The government has already taken steps as part of its
economic restructuring program to improve competitive conditions
in a number of specific markets. In order to enhance the overall
efficiency of markets, the government will write and implement a
law on competition policy to establish guidelines for fair
business practices and to avoid anti-competitive behavior.
Competition policy will benefit consumers by making quality goods
available at the lowest possible prices; small scale enterprises
will benefit from improved access to the widest range of goods
and trade facilities. As a first step, the government will
implement by September 1998 the necessary regulations
establishing guidelines and clear procedures and mechanisms for
mergers, acquisitions, and exit which facilitate efficient
corporate restructuring while safeguarding against anti-
competitive or predatory behavior. The broader draft law will be
completed by December 1998.
16. The government will further strengthen and support the
development of small and medium scale enterprises and
cooperatives through various measures. In particular, the
government will ensure an adequate flow of credit to these
enterprises and cooperatives during the period of general credit
restraint. In the first instance, this will be done by improving
the targeting and implementation of existing schemes with
assistance from the Asian Development Bank and World Bank. If
necessary, additional budgetary resources will be made available
to these schemes. Over the medium-term, the government will
strengthen the overall institutional framework for enhancing
efficiency of the small and medium enterprises and cooperatives.
The government will develop a specific plan of action, with
assistance from the Asian Development Bank and the World Bank.
Such a plan will include measures to (1) strengthen the
capabilities of financial institutions involved in lending to
small and medium scale enterprises and cooperatives, especially
with regard to credit appraisal and project supervision; (2)
manage the risks and reduce the transaction costs associated with
such lending; (3) enhance access to trade financing and insurance
facilities; (4) develop technical skills and improve access to
appropriate technologies; and (5) improve provision of suitable
infrastructure and reduce administrative control.
17. Steps are being taken to strengthen the initiative for
addressing the external debt problems of private corporations,
where progress so far has been slow. Efforts to collect data from
corporations on their external obligations are being accelerated
and reinforced. In addition, the government-appointed private
external debt team is working on the development of a framework
for greater, though still limited, government involvement in
corporate debt restructuring, in order to help move the process
forward. This process should be well underway by mid-April. These
steps are described in Appendix VI. To strengthen the incentives
for corporations to participate in the corporate debt
restructuring scheme, and to improve the business environment
more generally, we are overhauling the bankruptcy system and are
establishing a special commercial court to provide for fair,
transparent and expeditious resolution of commercial disputes
(the activities of the court will initially be limited to
bankruptcy proceedings) (Appendix VII). We also intend to request
that foreign banks roll over interbank credits to domestic banks
and restore trade financing.
18. To help restart the normal provision of trade finance,
which has been severely disrupted, Bank Indonesia is putting in
place a facility to guarantee letters of credit opened by
participating foreign banks for the import of raw materials.
Beginning March 13, 1998, Bank Indonesia deposited $100 million
with each of seven foreign banks as backing for these banks'
confirmation of letters of credit issued by six state-owned
banks. Up to three more foreign banks are considering
participating, which would bring Bank Indonesia's commitment to
$1 billion.
19. Adequate financial support from the international
community will be essential for the success of the stabilization
strategy. We have been assured that assistance will be provided
by the Asian Development Bank and the World Bank once the program
review is completed. The provision of other assistance including
food aid and a restoration of trade credit exposure by foreign
commercial banks to domestic banks will need to be coordinated.
Additional bilateral financial support has been pledged.
20. It is imperative that the adjustment program does not
result in a worsening of the economic and social conditions of
the poor. Our policies stated previously on providing a social
safety net will be continued and strengthened. The government
also is broadening subsidized credit schemes for small and
medium-size enterprises where most of the non-agricultural labor
force is employed. In addition, community-based work programs are
being expanded, in cooperation with the Asian Development Bank
and the World Bank and to sustain the purchasing power of the
poor in both rural and urban areas, especially those households
suffering unemployment.