Stability, growth, reform: WB

World Bank, Jakarta

Structural reforms under the Megawati administration have by and large remained on track. Reforms accelerated markedly after the Bali attack. Recognizing the importance of sending positive signals after Bali, the government renewed reform efforts on a wide front. Key steps taken in recent months include the passage of the Law on the Anti-Corruption Commission, the sale of an IBRA bank, and announcements of more sales. IBRA recovery targets were met, and even privatization receipts, although the original aim to sell stakes in 25 enterprises was not met by a long shot, amidst growing political opposition against privatization. The agreement on past liquidity credits reached between the government and the central bank, the restructuring of recapitalization bonds, and the start of treasury bonds auctions all underpin fiscal sustainability, and will contribute to a reduction in Indonesia's risk premium. Less encouraging were developments in trade policy, where a succession of tariff and non-tariff measures, from sugar, cloves to textile, signal a more protectionist stance. Particularly worrying are plans to further increase the tariff on rice, a measure that would hurt the poor, even the poor farmer, while achieving little for Indonesia's food security or term productivity.

Five years after the onset of the crisis, macroeconomic stability has gained much ground, thanks to the government's macroeconomic policies and supporting reforms. Now, aside from maintaining stability. the government needs to tackle those issues that hold back growth, employment, and poverty reduction. In many ways, these are the harder issues, and they must be addressed in a year before the elections. Improving the investment climate and restoring the rule of law in Indonesia will therefore require the same resolve and determination as the government has shown after the Bali bombing.

Maintaining Indonesia's hard-won macroeconomic stability requires the government to continue its prudent macroeconomic policies, maintain fiscal sustainability, and keep the pace of structural reforms.

Maintaining fiscal sustainability over the next few years will be particularly challenging. The Bali fiscal stimulus, while appropriate, will cause a slowdown n in fiscal consolidation, requiring a redoubling of efforts in the years beyond 2003. The government's plan for a 'second fiscal stimulus' by means of tax relief for businesses would add to budget pressures. And the government's desire not to seek further rescheduling under the Paris Club, together with the still large amount of recapitalization bonds due in 2004 and 2005 would require careful management of government debt and financing. The government should therefore:

* Continue to raise revenues by accelerating the reforms initiated in tax and customs administration.

* Cut waste and corruption by improving government procurement and financial management.

* Develop savings options by evaluating the effectiveness of existing programs and projects.

* Devolve more expenditure responsibilities by finalizing arrangements for offending to the regions, and expanding the DAK.

* Minimize debt financing of the budget through continued IBRA asset sales and privatization.

* Maximize the use of concessional aid funds by improving the disbursement on current existing commitments.

On structural reforms, the government should use the year ahead to speed up corporate restructuring, and tackle remaining reforms in the financial sector, by:

* Continuing IBRA's asset sales, and complete the sale of banks already selected.

* Improving the governance of state banks, and pursuing their announced sales.

* Further building a solid financial safety net through improvement in supervision, an orderly phase-out of IBRA, and a gradual transition to the new financial sector regulatory authority.

To accelerate growth and investment, the government must improve the country's investment climate. The formation of the National Investment Team announced in the aftermath of Bali is promising. It will need to be a focused, cabinet level team sufficiently empowered to address all of the key issues affecting the investment climate. The team will have its plate full, as government must:

* Reduce bureaucracy and red tape. From investment approval to tax and customs administration, regulations that are needlessly cumbersome and give rise to discretion and corruption should be cut.

* Ensure that labor regulations balance the interests of employers and employees, while maintaining labor market flexibility. The government should also consider how it could give more guidance to the regions in their decisions on minimum wages.

* Contain the downside of decentralization by clarifying the functions of levels of government, and by granting the regions a proper tax base, while limiting the type of taxes they can levy.

* Avoid a power crisis by investing in transmission, and restoring the financial viability of the sector.

Continue to hand over state assets to the private sector. Beyond revenues, privatizing enterprises in competitive or well- regulated sectors still has much scope to improve the country's productivity.

Perhaps the most effective way to improve the investment climate is to send a strong signal that the government means business in reforming the justice sector. There are no easy or quick solutions to the sector's deeply rooted problems, and all of its key institutions need major repairs, which cannot be expected overnight. Five years after the end of the New Order regime, many of the elements of a reform program have been identified, including the need for a national framework for legal reforms. The current "National Law Summit" process is a step in the right direction, but government must ensure that the outcome of the process leads to a clearly articulated long-term strategy for justice sector reform, and measurable progress towards the goals outlined in that strategy. This requires:

* Leadership at the highest levels off government on the issue of justice sector reforms.

* Preparation by the Attorney General's Office and the judiciary of comprehensive governance reform action programs for their respective institutions.

* A needs assessment for existing And new institutions in the justice sector to determine adequate funding and resources for them.

Making growth work for the poor requires a broad-based strategy comprising all elements of government policy. The government should be commended for embarking on a process to develop such a strategy. It is expected that at the time of the CGI the government will have published a roadmap for drafting such a strategy. As Indonesia moves forward to develop its full poverty reduction strategy, it will be important to focus on:

* Defining priority areas of policy and public action for equitable growth and poverty reduction, and create the analytical basis in these areas to come to the right policy decisions.

* Identifying national poverty reduction objectives, indicators, and targets. The Millennium Development Goals can serve as useful, guides in this respect, but the government should translate these to Indonesia's own circumstances.

* Mainstreaming the poverty reduction strategy in the government's core planning, policy and budgeting processes, and Propenas and Repeta.

If the government manages to maintain stability, and deepen reforms as spelled out in this report, it will be in a position to deliver a healthier economy with more growth and less poverty in 2004.

The above article is taken from the executive summary of World Bank Brief of the Consultative Group on Indonesia (CGI) titled Maintaining Stability, Deepening Reforms. The group will meet in Bali next week.