RI's 3rd memorandum of economic and financial policies

RI's 3rd memorandum of economic and financial policies

This is the full text of Indonesia's Third Supplementary
Memorandum of Economic and Financial Policies attached to the
letter of intent to the Managing Director of the International
Monetary Fund, Michel Camdessus in Washington. The letter was
signed by Indonesian Coordinating Minister for Economy, Finance
and Industry Ginandjar Kartasasmita on Sept. 11 in Jakarta.
However, five matrixes on the policy action target dates are not
included in this text.

1. The government of Indonesia's economic program, most recently
described in the Memorandum of Economic and Financial Policies
(MEFP) of July 29, 1998, remains on track. In particular, the
rupiah has strengthened considerably since mid-July, reflecting
strong policy implementation and growing confidence in the
program. Monetary policy has been in line with the program, and
the fiscal balance is well within the program limit. Important
structural policy measures taken in recent weeks in several
areas, especially bank restructuring and corporate debt, have
also contributed to increasing market confidence. Although
inflation was high in July and August, it is expected to decline
substantially in the period ahead, given the strengthening of the
rupiah and the measures being taken to improve the food
situation. In these circumstances, while major changes to the
program are not envisaged at this stage, we have further
developed some aspects of the program, as described below. An
updated matrix of structural policy commitments is attached to
this memorandum. The revised program has been worked out jointly
with the IMF, World Bank and Asian Development Bank.

2. To help ensure that inflation is reduced quickly and that the
rupiah continues to strengthen, we intend to continue to
implement a firm monetary policy, consistent with the monetary
targets already established as part of our program. As inflation
declines, and provided the rupiah remains in line with the
program path, we expect that interest rates will decline
gradually, easing the pressure on the corporate and banking
sectors. At the same time, we are taking steps to ensure that
fiscal policy is as supportive of recovery as programmed. In
particular, development expenditures, including those for the
social safety net, which have been running below the programmed
level, are to be stepped up in line with budget targets.

3. Increases in food prices, especially for rice, have been a
major factor behind the pickup in inflation in July and August.
For rice, a disappointing second harvest and some panic hoarding
have contributed to the sharp run up in prices in recent weeks.
As a result, domestic market prices are currently close to
international prices. This has made it even more urgent to
shelter the poor from the effect of high rice prices. Therefore,
our program for providing rice at very subsidized prices to poor
families, which has already been extended to over two million
households, will be extended further to at least seven-and-a=half
million poor families by October. In order to stabilize and
reduce market prices paid by the general public, BULOG is
increasing substantially the quantity of rice released into the
market at below market prices, and will maintain a higher level
of releases until the main harvest. Also, for the first time in
thirty years, we will allow private traders to import rice. These
steps are part of the seven point strategy adopted by the
government as an immediate response to the rice situation (see
annex). In addition, we will continue to provide physical
protection to traders and for warehouses and transportation of
supplies. Even with these steps, however, recent developments
have proved that maintaining domestic prices substantially below
prices in international markets is not feasible.

4. As an additional step to improve the food situation, we have
eliminated the BULOG monopoly on wheat, sugar, and soybeans, and
we intend to turn over their importation to the private sector.
We have also recently decided to eliminate the subsidies on wheat
and sugar and to gradually phase out the subsidy on soybeans.
While it would have been desirable to maintain the subsidies for
the time being, as had been foreseen in our program, their
benefit to consumers was being eroded by the difficulties to
prevent illegal exporting and higher markups of traders. The
decision of the government to eliminate these subsidies was thus
dictated by the reality of market participants' behavior, and was
not made as a commitment under the program. For the same reasons,
subsidies for the importation of soybean meal, fishmeal, and corn
have also been eliminated. For all these commodities, relevant
import duties have been removed. In the case of sugar, it is
expected that these measures will not lead to upward pressure on
the domestic price, which has recently been above international
levels. For the other commodities, significant price increases
are not expected, reflecting increased competition and
efficiency, and also the removal of import duties. The removal of
subsidies on these commodities means that existing export bans
(except for rice) are no longer relevant, and these will be
eliminated by Sept. 21.

5. In coming weeks, we will be working closely with the World
Bank and the Asian Development Bank on additional steps to
improve the targeting of remaining subsidies, and consideration
will be given to selective increases in administered prices.
Subsidies on aviation fuel will be eliminated by Oct. 1, 1998. A
mechanism for regular adjustments to administered prices to be
introduced for 1999/2000 will also be developed. In addition,
also in collaboration with the World Bank, we will develop a plan
for the longer-term role and the corresponding restructuring of
BULOG.

6. The government is fully committed to moving ahead with
privatization and a master plan for privatization is nearing
completion, including provision for the sale of majority stakes
in state enterprises over the medium term. The privatization
program for this year, however, has been proceeding more slowly
than originally hoped, because of the weakening of the domestic
economy, and an adverse shift in investor attitudes toward
emerging markets generally. Procedural difficulties, including
with respect to regulatory and legal changes required in some
cases, and concerns about selling assets when prices are very
depressed have also been factors. While in these circumstances
our privatization efforts in the near term will need to be more
selective than originally envisaged, we have been working closely
with the World Bank, and preparations in a number of suitable
cases are well advanced. These include cement, some areas of
telecommunications, mining, plantations, and infrastructure. On
the basis of current plans, achievement of the program target for
privatization receipts for 1998/1999 is still possible. However,
given the exceptionally unfavorable environment and inevitable
uncertainties related to privatization, especially as regards
timing, a shortfall from the program revenue target is now
likely. This should not jeopardize the achievement of the overall
target for the fiscal deficit, given the savings on subsidies now
in prospect.

7. On Aug. 21, the government announced a major bank
restructuring package that covered banks accounting for almost
half of banking system assets. As immediate steps to implement
this plan, we intend by Sept. 21, 1998 to complete negotiations
with the former owners of large intervened banks for the
repayment of Bank Indonesia liquidity support. We also intend by
Sept. 30, 1998 to (i) prepare a final plan for the restructuring
of Bank Danamon, (ii) finalize the strategy for recapitalizing
and privatizing two other banks, PDFCI and Tiara, and (iii)
finalize the plan for recapitalizing and rehabilitating Bank
Central Asia In addition, the legal requirements for the merger
of four state banks are to be completed and an initial action
plan for the operational merger of those banks drawn up by end-
September. Full details of the plan for the recapitalization of
stronger banks, announced on Aug. 21, will be developed by end-
September. We intend to proceed quickly with the issuance of
government bonds needed to finance bank restructuring operations.
The five members of the Independent Review Committee of IBRA will
be appointed by end-September 1998, and a first meeting will be
held by end-October 1998. The government recently submitted to
parliament a set of amendments to the banking law that would
enhance IBRA's legal powers, allowing the speedy transfer of
assets to its asset management unit; reform bank secrecy laws,
and eliminate the legal restrictions on foreign ownership of
listed banks. We hope that these amendments can be passed into
law by Oct. 20.

8. As outlined in the MEFP dated July 29, the government is
establishing a framework designed to promote the voluntary
restructuring of corporate debt, which is essential for a broad-
based recovery of output. This framework, called "The Jakarta
Initiative", was announced on Sept. 9, 1998. The initiative,
which is intended to complement the newly amended bankruptcy law
and the INDRA scheme, establishes principles to guide and
streamline out-of corporate restructuring. These principles
cover, importantly, the provision of interim financing during
workouts, which is essential for preserving viable corporations,
and the provision of adequate information by debtor corporations,
which is necessary for creditors to be able to evaluate viability
and business plans. A Task Force, including representatives of
relevant ministries and agencies, is being established by the
Private Debt Team to oversee the Initiative, and will be staffed
and funded over the next two weeks so as to ensure that the
Jakarta initiative is operational by end-September 1998. To
provide advice on the implementation of the initiative, an
advisory group, consisting of representatives of domestic and
foreign creditors, and domestic corporations will also be
established, and will meet regularly. The Task Force will receive
initial technical assistance from the World Bank and the Asian
Development Bank, and the government is exploring with the World
Bank a more comprehensive funding program. Attention will be
given to supporting the restructuring efforts of small and medium
sized enterprises. Following initial discussions with debtors and
creditors, it is envisaged that the first restructuring
negotiations will take place shortly after the Jakarta Initiative
becomes operational. Other steps being taken by Sept. 30, 1998 to
promote corporate restructuring include: (i) issuance of
regulations that remove the impediments and disincentives to
debt-equity conversions; and (ii) issuance of a decree to remove
tax disincentives to the merger and restructuring of companies,
and that also facilitates debt forgiveness and debt-equity swaps
by limiting the current taxation of any related income. By end-
October, the Task Force will have established a forum for "one-
stop" facilitation of regulatory filings made in connection with
corporate restructuring.

9. Regarding bankruptcy reform, the Special Commercial Court
opened as scheduled on Aug. 20 and has received and registered a
number of bankruptcy petitions. As required by law, the court
hearings for the adjudication of bankruptcy are scheduled to take
place within 30 days of the date of registration. Supported by
technical assistance provided by the Fund and other contributors,
procedures are being introduced to ensure that court proceedings
are efficient, transparent and predictable. To further enhance
the capacity of the Special Commercial Court, special court fees
-- the modalities of which are being worked out -- are being
introduced that will generate resources on a transparent basis
for the operation of the court system.
10. To guide financial policies during the fourth quarter of
1998, we have established indicative targets for end-October and
end-November for base money, the net domestic assets of Bank
Indonesia, the net international reserves of Ban Indonesia,
liquidity support to banks, and the overall government balance,
as shown in the attached table. As the program is on track, these
are all in line with the respective indicative targets and
performance criteria for end-September 1998 and the indicative
targets for end-December 1998 established earlier, and set out in
the MEFP of July 29, 1998.

Indonesia -- Food Subsidies

* Under the influence of recent developments, the government is
changing subsidy policy in two important aspects:

(1) the prices at which some subsidized commodities are released
to the market are being increased closer to market prices, and
other subsidies are being eliminated.

(2) targeted delivery of rice -- the most important staple -- at
substantially below market prices to poor families is being
expanded.

* Untargeted food subsidies have proved ineffective in holding
domestic prices for sustained period substantially below world
market prices, as commodities released at low prices have been
increasingly either exported or hoarded by traders, and consumers
no longer benefited from the subsidy.

* Because of higher market prices for the general public, it has
become even more urgent to supply low-priced rice directly to
needy families. This program is being rapidly expanded with the
help of provincial governors. It may ultimately cover 15 million
families.

* The removal of the subsidy on sugar will not increase the
price, given that sugar imports by the private sector are now
allowed, and the world price is currently below the domestic
price.

* The impact of the removal of the subsidy on wheat flour will be
cushioned by the opening of flour imports to private traders and
the removal of the import tax (so far, there were only wheat
imports by the government which were processed at high cost).

* The reduction of untargeted food subsidies at this time has
nevertheless, added to the hardship of the population. But the
government's decision was made inevitable by the reality of
market participants' behavior and the government's inability to
enforce the bans on exports of subsidized committees. It was not
a government decision to create budgetary savings nor was it a
commitment under the program agreed with the IMF.

* Besides improving and expanding targeted subsidies, the
government must continue policies that will have a lasting
alleviation of people's suffering by bringing down inflation and
laying the groundwork for a durable recovery. These are the basic
objectives of the economic program agreed with the Fund.

Seven Point Strategy for Rice

1. BULOG will release large quantities of medium grade rice (a
mixture of the second and third qualities) into the market, in
coming days.

2. This rice will be released into the market at a less than the
market price.

3. BULOG will increase direct deliveries of low quality rice to
retailers and cooperatives.

4. To put further downward pressure on prices, VAT on rice (and
also other essential commodities) will be suspended.

5. The program for delivering rice at prices well below market
prices to poor families will be expanded as quickly as possible,
with the help of provincial governors.

6. BULOG will actively seek new import contract for rice to
ensure that stocks remain adequate.

7. Private traders will be freely allowed to import rice.

Window: As inflation declines, and provided the rupiah remains in line
with the program path, we expect that interest rates will decline
gradually, easing the pressure on the corporate and banking
sectors.