Press Release No. 97/50

Press Release: IMF Approves Stand-By Credit for Indonesia

November 5, 1997

The International Monetary Fund (IMF) today approved a stand-by credit for Indonesia, authorizing drawings of up to SDR 7.338 billion (about US$10.14 billion) over the next three years in support of Indonesia’s macroeconomic stabilization and structural reform program. Of the total, SDR 2.2 billion (about US$3.04 billion) is available immediately, and a further SDR 2.2 billion will be available after March 15, 1998, provided that end-December performance targets have been met and the first review of the program, completed. Subsequent disbursements, on a quarterly basis, will be made available subject to the attainment of performance targets and program reviews. The stand-by credit is equivalent to 490 percent of Indonesia’s quota¹ of SDR 1,497.6 million (about US$2.07 billion) in the IMF.

In approving Indonesia’s request for the stand-by credit, the IMF made use of the accelerated procedures established under the Emergency Financing Mechanism (EFM), which was adopted in September 1995. The EFM strengthens the IMF’s ability to respond swiftly in support of a member country facing an external financial crisis and seeking financial assistance from the IMF in support of a strong economic adjustment program.

Background

Indonesia’s economic performance over the past several decades has ranked among the best in the developing world, with real GDP growth averaging about 7 percent annually since 1970. This success has been based on a consistent adherence to prudent macroeconomic policies, high investment and savings rates, and market-oriented trade and exchange regimes. Broad-based labor-intensive growth, together with sustained improvements in basic education and health services, has dramatically reduced the incidence of poverty--from over 60 percent in the late 1960s to 11 percent by the mid-1990s.

The strong overall performance, however, masked the emergence of a number of underlying structural weaknesses which made Indonesia vulnerable to adverse external developments. Long-standing rigidities in the form of domestic trade regulations and some import monopolies impeded economic efficiency and competitiveness. At the same time, less transparency in decisions affecting the business environment and data deficiencies increased uncertainty and adversely affected investor confidence. In addition, large capital inflows intermediated through a weak banking system exposed Indonesia to a shift in financial market sentiment. Thus, Indonesia’s banking sector was not prepared to withstand the financial turmoil that swept Southeast Asia starting in July. Similarly the corporate sector was vulnerable toadverse external developments. Prompted by large interest rate differentials between domestic and foreign interest rates, private companies had increasingly borrowed abroad to finance domestic operations, which in the context of a relatively stable exchange rate, were largely unhedged.

With the abrupt shift in market sentiment that has occurred since the middle of July Indonesia has had to contend with a major crisis of confidence. The rupiah depreciation and the fall in equity prices have been among the largest in the area. The downward pressure on the rupiah persisted, despite policy measures that were timely and broadly appropriate, including the floating of the exchange rate, followed by increases in interest rates and fiscal retrenchment. .

The Medium-Term Policy Strategy

The government’s three-year program that is supported by the stand-by arrangement has been set in the context of an unavoidable slowdown in economic growth and higher inflation over the next two years as a result of the current crisis. The policy package is designed to stabilize exchange market conditions, ensure an orderly adjustment of the external current account in response to lower capital inflows, and lay the groundwork for a resumption of sustained, rapid growth.

To achieve these objectives, the government has put in place a comprehensive package to restore confidence and stabilize the rupiah. First, the authorities will maintain tight fiscal and monetary policies, designed to stabilize financial conditions and narrow the current account deficit. Substantial fiscal measures have been put in place to keep the budget in surplus, despite the cyclical downturn, while monetary policy will be kept tight. Second, prompt and decisive action will be taken to restore the health of the financial sector, including closing unviable banks. Third, a broad range of structural reforms will be implemented, including liberalization of foreign trade and investment, dismantling of domestic monopolies, allowing greater private sector participation in the provision of infrastructure, and expanding the privatization program.

Fiscal management will be improved by increasing the transparency of public sector activities, and this should enhance the quality of governance. The government’s commitment to bring off-budget activities into the budget is also designed to permit a clearer assessment of the financial position of the wider public sector.

The Program for 1997/98 and 1998/99

The main objectives of the program are to limit the downturn in growth; to reduce the current account deficit to 2 percent of GDP, and maintain gross official reserves at about 5 months of imports.

To achieve these objectives, the program aims at a surplus equivalent to 1 percent of GDP in central government operations, or 0.5 percent of GDP including the carrying costs of the financial sector restructuring. This will require measures equivalent to 1 percent of GDP. On theexpenditure side, the government recently formulated concrete plans to postpone or reschedule major state enterprise infrastructure projects. Revenues will be enhanced through an increase in the excise taxes, removal of some tax exemptions and increases in non-tax revenues. Fiscal policy will be supported by tight monetary conditions.

Financial Sector Restructuring

A comprehensive restructuring of troubled financial institutions will also be key to the success of the program. Decisive action has already been initiated to deal with the problem. 16 unviable banks have been closed, and weak but viable institutions have been required to quickly formulate and implement rehabilitation plans. At the same time, steps are being taken to strengthen the legal and regulatory environment and establish strong enforcement mechanisms and clear exit policy.

These actions are part of the restructuring program that has been put together with technical assistance from the IMF, the World Bank, and the Asian Development Bank (ADB). The authorities are determined that only a small portion of the costs of the restructuring will be met from the public purse. The government will compensate small depositors only, and not private shareholders and creditors. The government will not guarantee any liabilities of private nonfinancial companies, domestic or foreign.

Structural Policies

Since 1995, Indonesia has been implementing a comprehensive tariff reform. A key element of the medium-term program is a further reduction of tariff barriers, including those on a number of items previously excluded from tariff reductions, such as chemicals, steel/metal products, and fishery products. Over the next three years, remaining nontariff barriers other than those warranted for health, safety, environmental, or security reasons be phased out. The government has also indicated that it will implement ahead of schedule the WTO dispute panel ruling on the special tariff preferences given to the "National Car" should the judgement on this case be decided against Indonesia. Export taxes will also be reduced and more sectors will be open to foreign investment.

Domestic competition will be further enhanced through deregulation and privatization. The Government intends to phase out import and marketing monopolies and price restrictions (with the exception of rice and refined sugar) over the next three years, starting with the immediate elimination of import restrictions covering three key agricultural commodities.

Deregulation of domestic markets will be complemented by expanding the role of the private sector in providing infrastructure. The fundamental prerequisite for this strategy is the establishment of a clear framework to guide decision making, to level the playing field for both domestic and foreign investors and thereby assure investor confidence. To these ends, the government has established regulations on government procurement and contracting for which the implementation guidelines will be issued by the end of 1997.

Privatization is another element of the structural reform effort. Responsibility for the management and restructuring of public enterprises has been shifted from line ministries to the Ministry of Finance, and a new Privatization Board established. A clear framework for the management and privatization of government assets is being developed, which will establish explicit criteria for determining whether an enterprise should be closed, restructured, or privatized. For enterprises remaining in the public sector, the framework will ensure that these operate efficiently, including through establishing profit and performance targets, which will be made public and reported annually.

Social Safety Net

Maintaining Indonesia’s impressive record of poverty reduction over the past 30 years through the provision of basic education, health, and other social services, is an integral part of the government’s policy framework. Expenditures in these essential areas will be protected from budget cuts. Moreover, the special assistance programs for poor villages, which have provided a very cost effective means to target social expenditures to those most in need, will be increased under the next five-year development plan, Repelita VII.

Financing Needs

In addition to the IMF funding of about US$10 billion (SDR 7.3 billion), the reform program will be supported by substantial financing from the World Bank and the Asian Development Bank, which have made notable contributions to the design of the program, particularly in the field of financial sector rehabilitation and structural reform. These institutions intend to contribute to the program through technical assistance and loans, with financing amounting to US$4 1/2 billion and US$3 1/2 billion, respectively. In addition, taking account of other expected contributions to the financing package, including the use of part of Indonesia’s own substantial external assets, there is a first line of financing of the order of US$23 billion. At the same time, a number of important economies (including at this stage Australia, China, Hong Kong SAR, Japan, Malaysia, Singapore, and the United States) have indicated that in the event that unanticipated adverse external circumstances create the need for additional resources to supplement Indonesia’s reserves and the resources made available by the IMF, they would be prepared to consider making available supplemental financing in support of Indonesia’s program with the IMF.