Indonesia—Letter of Intent

Jakarta, September 16, 2003

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

1. This letter updates progress under our economic program for 2003 as described in the Memorandum of Economic Policies (MEFP) of March 18, 2003 and the supplementary letter of June 11, 2003. In recent months we have continued to make progress in policy implementation and in meeting the program's objectives. Notwithstanding the fallout from the recent terrorist attack in Jakarta, the rupiah is stable, inflation is on a firmly declining trend, the foreign reserves position continues to improve, and the economic recovery is advancing. Our updated macroeconomic framework for 2003 maintains a GDP growth target of 4 percent and, on the basis of recent positive price developments, we now expect inflation to be around 6 percent or lower by the end of the year (Table 1).

2. All end-June quantitative performance criteria and indicative targets were met (Table 2), and we have now implemented all but one of the structural benchmarks set for this review (i.e., for June; Table 3). The outstanding benchmark relates to the sale of BI's overseas subsidiary which, with its restructuring nearing completion, is expected by December. With the recent finalization of the blueprint for strengthening the treasury and budget functions of the Ministry of Finance, we have also implemented the one benchmark carried over from the previous review.

3. Budget performance is on track to achieve the 2003 program ceiling of 1.9 percent of GDP, with the deficit outturn for the first half of the year well within programmed levels. Nevertheless, non-oil tax revenues are running below expectations, due in part to temporary factors and, in the context of our mid-year budget review, we have presented to Parliament a slightly higher deficit limit of 2.0 percent of GDP. Given the budget execution so far and our plans to maintain expenditure restraint, however, we will continue to target the deficit outturn for the year to remain in line with the original program ceiling. We have continued to strengthen tax and customs administration, and the estimated revenue gains so far are in line with the anticipated yields. We are expanding the number of taxpayers under large taxpayer offices, with a view by the end of the year to covering one-third of all non-oil tax revenues, and we plan to issue regulations to streamline audit procedures for the VAT and income tax. Our efforts to strengthen provincial and local budget reporting are also yielding results, with compliance now above 85 percent for the end-2002 reports, in line with the June benchmark. Our 2004 budget proposal, presented to Parliament in August, aims to advance fiscal consolidation further by targeting a deficit of 1.2 percent of GDP.

4. The stability of the rupiah and decline in inflation in recent months have enabled further interest rate reductions. Bank Indonesia (BI) will maintain a cautious monetary policy stance in the period ahead. The program's monetary and reserves targets have again been met with sizeable margins; we propose to adjust the targets for the remainder of the year to bring them in line with recent performance and the current policy stance.

5. With regard to financial sector policies, we are pressing ahead with our efforts to develop a sound financial sector safety net, with a view to implementing the comprehensive plan adopted in June by the Ministry of Finance and BI. In addition, following consultation with Parliament, we have implemented the agreement to resolve issues related to the extension of bank liquidity credits during the crisis. Accordingly, a new government bond has been placed on BI's balance sheet. We are also discussing with Parliament amendments to the BI Law. The amendments include proposals for a lender of last resort facility as well as a supervisory board aimed at enhancing institutional credibility while preserving policy independence.

6. IBRA is making good progress toward meeting its annual asset recoveries target. Cash collections through June exceeded their target, and proceeds from ongoing sales (which include IBRA's largest loans) should enable the full-year target to be met. In the area of bank divestment, preparations for the sales of Lippo and BII are well advanced. In addition, compliance under the shareholder settlement agreements with former bank owners has improved. There have been further payments under the agreements related to banks closed in 1999-2000; at the same time the payment deadline has been extended to end-September to allow proceeds from the ongoing sale of assets to be credited toward the obligations.

7. We continue our efforts to strengthen the oversight and accountability of the state banks. Following the successful IPO of Mandiri, we are appointing an additional commissioner and will strengthen the bank's management by the end of September; we are also monitoring closely the bank's performance under its business plan. With the recent appointment of additional commissioners at BRI and BTN, all state banks will have a full complement of commissioners. As expected, the state banks have all prepared corrective action plans, based on the results of their external audits. The Ministry of State-Owned Enterprises has reviewed these plans and established benchmarks to monitor implementation. Meanwhile, preparations for the IPO of BRI are underway.

8. Improving public sector governance remains an important element of our structural reform agenda. We continue to work toward making the Anti-Corruption Commission operational by the end of the year. The fourth round of special audits of public enterprises has also now been launched.

9. In view of the progress made under the program, we request completion of the tenth review under the Extended Arrangement. As discussed above, we propose to revise our monetary and reserves targets for the remainder of the year, as shown in Table 2. We request waivers of applicability for the end-September quantitative performance criteria; while we expect them to be observed, the data needed to assess the targets will not be fully available at the time the review is to be considered. We will continue to consult with the Fund in the period ahead on economic policies, and we expect to complete the final review under the arrangement by December 2003.

10. To provide a strong framework for economic policy in 2004, we have developed a comprehensive economic program that was announced on September 15. The program aims to maintain macroeconomic stability, strengthen the financial sector, and generate higher investment, exports, and employment. As we implement our program, we intend to maintain a close policy dialogue with the Fund and the rest of the international community.

Table 1. Indonesia: Macroeconomic Framework, 2002-03

2002

2003

Real GDP growth

3.7

4.0

Inflation (end of period)

10.0

5-6

Current account balance

        In billions of U.S. dollars

7.4

5.5

        In percent of GDP

4.3

2.7

Gross reserves (in billions of U.S. dollars)

32.0

34.8

Central government balance (in percent of GDP)

-1.8

-1.9

        Revenues and grants

18.6

18.7

        Expenditures and net lending

20.4

20.7

Base money growth (end of period)

8.3

10-11