Indonesia—Letter of Intent
Jakarta, Indonesia
June 11, 2003

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

Dear Mr. Köhler:

1. This letter updates progress in meeting the policy objectives under our economic program for 2003 described in the Memorandum of Economic Policies (MEFP) of March 18, 2003. The program is continuing to restore market confidence and enhance growth prospects. In recent months, the rupiah has appreciated further, inflation has remained on a downward trend, there has been an additional build-up in international reserves, and economic growth has been sustained. These developments have occurred against the backdrop of turbulent international economic and political events, revealing the Indonesian economy's growing resilience to adverse shocks.

2. All end-March quantitative performance criteria and indicative targets were met (Table 1). IBRA's cash recoveries for the first quarter fell short of the target, but with promising results from the ongoing asset sales program, the program is back on track and the cumulative Rp 7 trillion cash target for June is expected to be met. With regard to the other policy actions covered by the structural benchmarks through April, all have now been implemented except for finalization of the blueprint for strengthening the treasury budget functions of the Ministry of Finance, which has been was delayed. Additional time was needed to finalize the blueprint pending an independent review by an external consulting firm; we now expect the blueprint to be finalized by mid-year.

3. Fiscal policy is on track to achieve the 2003 deficit target of 1.8 percent of GDP. In the first quarter, the budget unexpectedly recorded a surplus, in part reflecting temporary expenditure shortfalls. Revenue performance was largely on target, and we are continuing to make steady progress in improving tax and customs administration. Given the recent fall in world oil prices, fuel subsidies are now declining. In the area of provincial and local budget reporting, we are strengthening efforts to minimize reporting delays, including through the imposition of sanctions on regions that fail to submit their end-2002 reports by the middle of the year.

4. Monetary policy remains firmly geared toward supporting the downward trend in inflation and maintaining exchange rate stability. While reducing interest rates further, Bank Indonesia has achieved its monetary and reserves targets with sizeable margins, which we expect to maintain in the period ahead.

5. A comprehensive plan for a sound financial safety net has been developed by the Ministry of Finance and Bank Indonesia. As expected, the plan provides for the creation of a deposit insurance scheme, lender of last resort capability for BI, and a supervisory and regulatory agency for the financial sector. It defines the primary roles of the various authorities in the safety net, and specifies the sequencing of reforms for an orderly phase-out of the blanket guarantee in due course. We now intend to prepare legislation in line with this plan for submission to Parliament during the second half of this year; we have also established a joint working group to develop operational modalities.

6. IBRA continues to make good progress toward achieving its annual asset recoveries target. Results from the recently completed loan sale program were encouraging, and IBRA has recently launched the sale of virtually all of its remaining asset holdings. The bank divestment program is also advancing; we have completed the sale of Bank Danamon, have announced our plan to launch the majority sale of Bank Lippo this month, and have advanced preparations for the divestment of BII. With regard to the shareholder settlement agreements with former bank owners, we remain committed to full settlement of the commercial terms under the agreements by end-June. To this end, while we continue to work with cooperative debtors to receive cash and other assets against their obligations, we are taking steps to strengthen the legal basis to enable the use of nonjudicial means to pursue recalcitrant debtors.

7. Improving the governance of state banks remains a priority of the government. The Ministry of State-Owned Enterprises has begun strengthening its staff resources to monitor state bank performance, additional commissioners are being appointed at BRI and BTN, and new annual performance contracts for bank managers have been prepared as needed. We are also requesting each of the state-owned banks to submit corrective action plans, based on their recently completed annual audits, by July. With respect to Bank Mandiri, we have strengthened the Bank's management through the appointment of five new Directors, and are proceeding with plans for the launching of the IPO during the second quarter. A comprehensive, time-bound restructuring plan for BTN has been approved, and implementation initiated by the bank's Directors. Having reduced its nonperforming loans, BNI has prepared a detailed plan to eliminate its remaining impaired assets during 2004.

8. We have also made progress in other elements of the structural reform agenda. In the legal area, we continue to work toward establishing the Anti-Corruption Commission (ACC) by end-year. The amendments to the Foundations Law were recently submitted to Parliament. During the debate of the amendments, the legal basis for the Supreme Audit Agency (BPK) to undertake audits of military and other foundations receiving state funds or financing of state activities will be clarified. In the area of public sector governance, we are making progress in implementing our program of state enterprise audits.

9. In view of the progress made under the program, we request completion of the ninth review under the Extended Arrangement. It is proposed to leave our targets for the remainder of the year unchanged, while converting the indicative nature of the relevant quantitative targets for September established at the time of the eighth review into performance criteria. We will continue to consult with the Fund in the period ahead on economic policies, and we expect to have the remaining two reviews completed by September and December 2003.

Sincerely yours,

/s/