Indonesia—Letter of Intent

Jakarta, November 20, 2002

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

1. This letter reaffirms and updates our policy intentions under the economic program for 2002 described in the Memorandum of Economic Policies (MEFP) of December 13, 2001, and our supplementary letters of intent of April 9 and June 11, 2002.

2. Continued progress has been made in implementing our program. Monetary prudence and a fiscal policy aimed at restoring medium-term sustainability have fostered macroeconomic stability. At the same time, important structural reforms have been undertaken. Looking ahead, the tragic events in Bali pose new economic challenges, which we intend to address strongly. We believe that pressing ahead with reforms is the best way to shore up confidence and contain any adverse effects associated with that incident, thereby laying the basis for an enduring economic recovery.

3. All end-June and end-September quantitative performance criteria and indicative targets were met (Table 1). The structural performance criterion related to the resolution of the long-standing BLBI issue, which was to have been implemented by end-June, is in its final stages of completion, as described below in paragraph 8. Most of the structural benchmarks through October have been met, albeit some with delays. As for those missed, on bank divestment, the sale of Bank Danamon is expected to be launched in November in the area of privatization, the government has taken action to reinvigorate its program; on the reporting of 2001 local government finances, although coverage was not complete, the vast majority of regions submitted the relevant data; with regard to treasury bill auctions, the legal framework has now been established; with respect to the establishment of the Anti-Corruption Commission (ACC), several preparatory steps are being undertaken; and finally, the restructuring of Bank Indonesia's overseas subsidiary is expected to be completed shortly. For the remainder of the year, we propose to leave the quantitative targets unchanged and reset the structural performance criterion related to the BLBI issue for end-December, while adding new structural benchmarks (Table 2).

4. Notwithstanding the economic fallout from the Bali events, fiscal policy is on track to achieve the 2002 full-year deficit target of 2½ percent of GDP. The deficit through end-September was Rp 7.8 trillion, well within the program target of Rp 27.9 trillion. Revenue performance improved in the second and third quarters, although the pace of collections for non-oil revenues has remained below the budget plan. Expenditure was below expectations in a number of areas. For the year as a whole, both revenues, which are benefiting from higher oil prices, and expenditures are expected to be broadly in line with the budget.

5. The government remains committed to fiscal consolidation in order to reduce the public debt to sustainable levels, while boosting the provision of key social services. For 2003, economic growth is likely to be somewhat weaker than previously anticipated owing to the events in Bali-we are now targeting growth in the 3½-4 percent range, compared with 5 percent previously. In response, we are providing additional resources to support activity and employment in the regions and economic sectors most severely affected by the attack. To this end, the government is reviewing with Parliament its 2003 budget proposal, with a view to increasing the deficit target to 1.8 percent of GDP. To achieve this target, the government has also proposed a package of measures to enhance non-oil tax revenues, including steps to broaden the VAT base and adjustments in excises. In addition, remaining fuel subsidies (with the exception of that on household kerosene) would be eliminated. At the same time, we are discussing with Parliament supportive measures including an increase in development spending. The proposed budget also would accommodate a significant hiring of new teachers and a 10 percent increase in civil service wages.

6. To strengthen the monitoring of local government finances, we are commencing regular quarterly reporting. At the same time, the government will develop uniform accounting standards for these reports by January 2003; adoption of these standards will be phased in over the course of next year.

7. Significant steps have been taken to strengthen public debt management. The Sovereign Debt Securities Law has been approved by Parliament, paving the way for the initiation of primary auctions of government securities later this year. The government has also finalized a plan, approved by Parliament, to reprofile the maturity of recapitalization bonds held by state banks, the principal holders of these bonds. This reprofiling will be done on market-based terms, smoothing the debt repayment schedule in the coming years while preserving the sound financial condition of these banks. Initiatives have also been taken to foster the development of a secondary bond market, including through the creation of an Inter Dealer Market.

8. Financial issues related to the BLBI are close to resolution. An agreement between the government and Bank Indonesia (in line with recommendations of the independent team) was reached earlier this year. The government has sent its final proposal, which is in line with this agreement, for review by the Supreme Audit Board ahead of further consideration by Parliament. Under the agreement, a new government note will be issued to the central bank to replace the bulk of existing letters of indebtedness. This arrangement, which is expected to be implemented by the end of the year, will generate savings for the budget while ensuring the financial soundness of the central bank.

9. Monetary policy remains on track. In the third quarter of the year, base money growth remained well within program targets, and the steady decline in inflation and stable exchange rate enabled the central bank to reduce interest rates further. Following the events in Bali, Bank Indonesia has kept interest rates steady but will monitor developments closely in the period ahead to ensure the achievement of the program's inflation objectives.

10. IBRA's asset recovery program for 2002 is well advanced. Cash recoveries through September (Rp 31½ trillion) exceeded their target by Rp 8 trillion. With the successful completion of its new broad-based loan sale program, IBRA's annual recovery target is well within reach. The unsold loans remaining from this program are being offered in bulk packages through a variety of auction mechanisms. IBRA plans to complete the disposal of its retail and SME loans by early 2003, and remains committed to completing the restructuring of all of its largest loans (over Rp 750 billion) so as to initiate their sale by year-end.

11. With regard to IBRA's bank shareholder settlement agreements, initial determinations of compliance have been completed for all 39 signatories. To expedite the resolution of these agreements, the government has revised its policy as set out in the November 18 decision of the government. The government will initiate legal and other enforcement actions by end-November against all remaining noncompliant shareholders.

12. Significant progress has been made in the divestiture of the government's holdings in the banking system. The sale and purchase agreement for Bank Niaga was concluded in early November, and we have announced our revised timetable for the divestment of Bank Danamon, which we aim to launch in November. Progress has also been made to strengthen IBRA's other banks. The rights issue to inject new capital into Bank BII was completed in July. The legal merger of the five smaller IBRA banks was finalized in early October and the banks' operational merger is expected to be concluded by end-December.

13. We are also making progress in restructuring the state banks. In preparation for the IPO of Bank Mandiri shares, we have taken steps to improve the transparency of the bank's financial statements and strengthen its business plan. With regard to BTN, the government has decided to restructure the bank, and is formulating its plans for the restructuring. The divestment strategy for banks BRI and BNI will be announced in the next few months.

14. We are also pressing ahead with plans to meet the privatization target for state-owned enterprises. In addition to the earlier sale of shares in Indosat and Telkom, which yielded Rp 2 trillion against the annual target of Rp 6.5 trillion, the government has launched the sale of strategic stakes in Indosat and Indofarma to be completed by the end of this year.

15. The government is pressing ahead with legal and judicial reforms. The immediate priority is to establish the Anti-Corruption Commission. To this end, the government will propose to Parliament revised provisions of the legislation that clarify the powers of the ACC as well as the procedures for nomination and dismissal of commissioners. We are also working to clarify the allocation of responsibilities amongst the ACC, the police and the Attorney General's Office for the prosecution of corruption cases. In addition, the government has established an inter-agency committee to prepare for the creation of the ACC and has allocated adequate budget financing for both the committee and the ACC. The government has also implemented the regulations on the compensation of ad hoc judges for the Commercial Court.

16. In view of the progress made under the program, we request a waiver of nonobservance with respect to the end-June structural performance criterion on the resolution of BLBI financial issues, and completion of the seventh review under the Extended Arrangement. In the period ahead, we will continue to consult with the Fund on economic policies and we aim to complete the next review by February 2003.

/sd/		/sd/		/sd/
Dorodjatun Kuntjoro-Jakti		Boediono		Syahril Sabirin
Coordinating Minister for Economic Affairs		Minister of Finance		Governor, Bank of Indonesia

Table 1. Indonesia: Quantitative Performance Criteria (PC) and Indicative Targets (IT) Under the Extended Arrangement, 2001-02 1/
	2001				2002
	Dec.				Jan.			Mar.			Jun.			Sep.			Dec.
	PC 2/3/		Actual		PC 2/	Actual		PC 2/	Actual		PC 2/	Actual		PC 2/	Actual		PC
Monetary and fiscal targets
Net domestic assets (NDA) of Bank Indonesia 4/	5.3		-2.7		-3.8	-12.0		-8.8	-13.1		-4.0	-13.0		-1.5	-19.0		3.9
Base money (indicative target) 5/	122.9		124.7		117.8	115.6		117.8	115.0		123.7	118.0		128.2	120.8		138.2
Overall central government balance 6/	-54.6		-52.1		...	...		-2.7	-5.8		-14.0	-6.6		-27.9	-7.8		-42.1
External targets (in billions of U.S. dollars)
Net international reserves (NIR) of Bank Indonesia 4/ 7/	16.8		18.2		...	...		18.3	18.6		18.5	19.0		18.8	20.4		19.8
Contracting or guaranteeing of new nonconcessional external debt 8/	1.5		1.4		...	...		0.3	0.3		0.6	0.3		1.0	0.3		1.5
Of which: Government debt to commercial creditors 9/	...		...					0.2	0.0		0.2	0.0		0.2	0.0		0.2
Stock of short-term external debt outstanding	2.5		0.5		...	...		2.5	0.3		2.5	0.2		2.5	0.0		2.5
Public external arrears	0.0		0.0		...	...		0.0	0.0		0.0	0.0		0.0	0.0		0.0
1/ Definitions are contained in the Technical Memorandum of Understanding dated December 13, 2001. Continuous performance criteria are: the non-accumulation of external arrears and no securitization or forward sale of receipts from natural resources.
2/ Adjusted program targets for NDA and NIR.
3/ Monetary targets for December 2001 are indicative due to seasonality effects associated with end-calendar and end-fiscal years. Instead, a performance criterion on NDA is set for January 2002.
4/ Targets for NDA and NIR through January 2002 are based on one-month averages centered on end-month. Thereafter, targets are end-period values.
5/ Base money targets are one month averages centered on end-month.
6/ Cumulative balances from beginning of fiscal year (floor). Central government bonds issued to district and provincial governments are included as financing of the central government deficit.
7/ Outstanding stocks (floor).
8/ Cumulative amounts from beginning of fiscal year (ceilings). End-December 2001 outturn revised. End-March, end-June and end-September 2002 outturns were US$0.25 billion, US$0.26 billion, and US$0.31 billion, respectively.
9/ End-March, end-June, and end-September 2002 outturns were US$0.04 billion.

Table 2. Structural Benchmarks (November-December 2002)

November 2002

• Initiate legal and other enforcement actions against former bank owners issued final determination of noncompliance in relation to the shareholder settlement agreements.¹


• Launch sale of a majority stake in Bank Danamon.²

December 2002

• Implement burden sharing agreement on BLBI between BI and government.³


• Complete third round of special audits of state enterprises and adopt corrective actions.


• Collect at least Rp 36.1 trillion in cash by IBRA (net of expenses).


• Establish Anti-Corruption Commission.²


• Begin primary auctions of government securities.²


• Produce quarterly report on local government finances through June 2002 with coverage of at least 85 percent of jurisdictions.¹