Memorandum of Economic and Financial Policies

Government of Indonesia and Bank Indonesia

I. Introduction

1.  The government remains committed to the macroeconomic framework and structural reforms set out in the Memorandum of Economic and Financial Policies (MEFP) of January 20, 2000. At this first Review, the focus has been on elaborating aspects of the approved FY2000 budget, and carrying forward banking and corporate sector reforms. Box 1 summarizes measures implemented since the January MEFP.

II. Macroeconomic Policies

3.  The fiscal deficit in 1999/2000—at 1½ percent of GDP—was below the targeted level. The spending program was achieved, while tax revenues—including from higher oil prices—were larger than expected. The FY2000 budget, approved by Parliament on March 2, is in line with the January MEFP. Some modifications were agreed with Parliament whose net effect is a slightly reduced deficit target of 4.8 percent of GDP, compared with the original budget target of 5 percent of GDP. In three key areas—energy tariffs, subsidies, and wages—consensus was reached as follows:

• Electricity tariffs for large and industrial users were raised by an average of 29 percent on April 1, with no increase this year for households using up to 900 VA.

• Petroleum product prices were agreed to be raised by an average of 12 percent, but their full implementation has been delayed in order to better prepare the people for this increase, as well as to finalize measures to protect the poor. We are working toward a mechanism involving a lumpsum cash transfer to targeted households, and using the safeguards established for the social safety net program, in consultation with the World Bank.

• Regarding the wage increase, the original budget provided for a 20 percent base wage increase, to be implemented in two equal installments (implying an average increase in total personnel expenditure of 16 percent during FY2000). During the budget debate, Parliament decided to allocate sufficient resources for a base wage increase of 30 percent. However, agreement was only reached on an initial increase of 15 percent in the base wage on April 1. The size of any wage increase to be implemented on October 1 will be decided later in the fiscal year. That decision will be made in light of macroeconomic developments and the state of the recovery.

• On April 1, the allowances payable to a small number of state officials and upper echelon civil servants were also increased, thereby significantly narrowing the pay gap with the private sector, as part of the government's anti-corruption strategy.

• By October 1, 2000, a plan for civil service reform will be developed by an inter-ministerial task force led by the Minister of State Apparatus, and in consultation with the World Bank. The task force will also include the Chairman of the National Civil Service Board.

4.  We also agreed with Parliament on higher IBRA cash recovery and privatization targets for FY2000 totaling Rp 25.4 trillion (2.8 percent of GDP). On this basis, foreign financing of the FY2000 budget is expected to be Rp 18.7 trillion (2.0 percent of GDP), within the range of commitments made by donors at the recent meeting of the Consultative Group for Indonesia, and consistent with the April 12 Paris Club meeting. We also plan an early meeting of the London Club to restructure certain obligations falling due to commercial banks on comparable terms to the Paris Club rescheduling.

5.  Other aspects of the financial program for 2000 are being broadly maintained (Table 1). Bank Indonesia will begin to publish during May foreign exchange data on reserves consistent with the SDDS standards.

III. Structural Fiscal Reforms

6.  The fiscal reform agenda is being implemented as envisaged. Consistent with the approved budget, we expect Parliament to approve the amendments to the VAT law, the Tax Procedure law, and certain other tax laws by July 2000. Other tax reforms affecting the tax privileges for the Integrated Economic Development Zones (KAPETs); the rationalization of import tariffs on capital goods; and the imposition of a flat 5 percent duty on all exempted goods with non-zero rates have been implemented. Regarding the collection of VAT from Batam island, we have deferred its implementation to ensure that the necessary institutional framework for tax collection is in place, and to secure a wide consensus for this measure.

7.  We remain committed to delivering the increased fiscal transparency that is part of the program: (i) a performance audit of the Tax Office by the State Audit Board (BPKP) will begin in June and is expected to be completed by end-November; (ii) the special audit of the KUT program has been initiated and is expected to be completed by October; however, corrective actions will begin in June based on the results of Eastern and Central Java audits; (iii) BPKP and the Supreme Audit (BPK) have initiated steps to take account of all extrabudgetary funding in its audits of public institutions, including the military; (iv) a draft law bringing private foundations under government review and audit has been finalized and sent to the President for approval before submission to Parliament in May; (v) a Presidential instruction was issued in early-May to improve compliance with the ongoing review of remaining off-budget accounts—this review is now expected to be completed by end-June, and specific measures in light of this review will be taken in the context of the next (second) program review; and (vi) the Minister of Finance has established a task force headed by the Director General for the Budget to improve treasury management procedures, consolidate the number of bank accounts of government agencies, and ensure consistency between monetary and fiscal data, and a timetable for this work will be established by the next program review.

8.  We have intensified preparation for implementing fiscal decentralization in 2001 within the framework of Laws 22 and 25, and will be guided by the following key principles: (i) revenue transfers to sub-national governments will be consistent with expenditure responsibilities; (ii) expenditure responsibilities will be devolved in keeping with the capacities of the sub-national governments; (iii) specific mechanisms will be developed to ensure that any borrowing by sub-national governments is kept within strict limits. In this way, we are determined to preserve fiscal neutrality while implementing decentralization.

9.  The decentralization process is being led by the recently established Regional Autonomy Advisory Council (RAAC) and the Coordinating Team (CT). The Minister of Finance is taking the lead in all fiscal aspects of decentralization. A full-time decentralization expert has been appointed to the Ministry of Finance. A working group under the Ministry of State Apparatus has been appointed to resolve any impediments to the transfer of civil servants. A firm timetable for implementation of fiscal decentralization will be prepared by the time of the next review, in consultation with the forthcoming IMF/World Bank fiscal decentralization technical assistance mission.

IV. Banking System Reforms

Governance

10.  IBRA has concluded its evaluation of all outstanding interbank claims under the guarantee scheme. Settlements have now been made in all cases, except for very small claims under litigation. IBRA and BI are implementing plans to ensure that those banks whose claims were deemed ineligible remain adequately capitalized. During the second half of May, the Ministry of Finance will issue a new decree on the government guarantee scheme, and strengthened procedures for the processing and evaluation of new claims will be published.

11.  We remain committed to a professional IBRA, free from political interests and transparent in its operations. With the assistance of an international consulting firm, and in collaboration with the World Bank, we are developing a new governance and oversight framework for IBRA. Interim recommendations have been received, with final proposals by end-May, slightly behind schedule because of delays in appointing the consulting firm. A new governance framework for IBRA, including an independent governing body, will be established by end-June.

12.  Meanwhile, we have taken steps to improve IBRA's transparency. IBRA has commenced regular publication of its activities, which includes monthly reports of sales and collection activities, progress in loan restructuring, and disposal of industrial assets, in addition to quarterly financial reports by the BTO banks. IBRA will publish the audit reports of its end-1999 accounts by June 2000, with the assistance of an international accountancy firm. Also, IBRA will issue its first comprehensive annual report during the third quarter.

IBRA loan collection and asset recovery

13.  IBRA's net asset recoveries totaled Rp 17.1 trillion in 1999/2000, with Rp 4.2 trillion in the form of the redemption of outstanding bonds. In FY2000, the net cash recovery target is Rp 18.9 trillion.

Asset Management Credits (AMC) operations

14.  On April 3, state banks completed the legal transfer to IBRA of all category 5 loans in excess of Rp 5 billion as of September 30, 1999 (including other loans with provisions exceeding 50 percent). Virtually all physical documentation has now been transferred to IBRA; remaining loan documentation will be transferred shortly.

15.  IBRA is implementing its sequenced approach to restructure its loans, with particular attention to the 21 largest conglomerate obligors (as of end-April 2000), who account for about 36 percent of IBRA's total loans (about $12.4 billion) and represent about 340 individual company debtors. IBRA's strategic objective is to reach the stage of finalizing restructuring term sheets, or initiating legal actions against uncooperative debtors, for at least 35 percent of the nominal loan value of these obligors by June 2000, and for all the 21 obligors by end-2000. Progress will be monitored on a monthly basis, and the effectiveness of the strategy assessed at the next (second) program review. All noncooperating debtors will be subject to automatic sanctions, involving public disclosure, insolvency petitions, or other legal actions. Legal actions were taken on April 3 against five noncooperating debtors, and we will take further actions as necessary. Restructuring agreements for debtors whose nominal value of debt exceeds Rp 1 trillion will be reviewed by the FSPC, with the assistance of outside consultants where necessary, to ensure they incorporate operational restructuring on the part of debtors and maximize value for the government. The threshold for FSPC approval may be adjusted once IBRA's new governing body is in place (paragraph 11 above).

16.  IBRA has launched a tender to outsource about Rp 30 trillion of its commercial loans (from Rp 5 billion to Rp 50 billion in value per obligor) through an open system of competitive bidding. We expect to complete the outsourcing of these loans by end-June 2000. All loans, once restructured, will be offered for auction to all banks. IBRA intends, by September 2000, to offer for sale by open tender, under similar procedures, all its loans under Rp 5 billion.

Asset Management Investments

17.  IBRA is also accelerating efforts to sell its listed assets through the transparent disposal of shares in the capital market. In particular, the agency sold its 39.5 percent stake in Astra in March in an open, competitive process. Key future sales include plantations, shipping, tyres, and forestry companies.

18.  By end-June, IBRA expects to conclude final settlement agreements with all cooperating shareholders from the fourteen 1998 BTO/closed banks. Asset transfers from five of these shareholders have already been completed, and the remaining three transfers should be concluded by end-September, 2000. Four noncooperating shareholders were referred to the Attorney General for prosecution on March 28, 2000. Negotiations with the shareholders of the 1999 BTO/closed banks will be concluded by September 2000.

19.  IBRA has completed an investigative audit into deposit guarantee payments that were made by closed Bank Putera. The audit was conducted by an independent accountancy firm. Withdrawals by connected parties (about $ 3 million) will be recovered through settlements with the former shareholders of the bank, expected to be concluded by end-September.

Mechanism for resolving recalcitrant debtors and shareholders

20.  We will establish by end-May through a Presidential Decree a new body to coordinate the government's response to uncooperative debtors and former bank shareholders. This Committee, entitled the Committee for Resolving the Cases of Recalcitrant Debtors, is chaired by the Attorney General, with the Coordinating Minister for the Economy, and the Chief of Police as the Vice Chairmen. The Finance Minister, the Chairman of the State Audit Board (BPKP), the Chairman of IBRA, and the Minister of Law are members of the Committee. Henceforth, all IBRA's noncooperative debtors and bank shareholders, not resolved through IBRA's special legal powers, will be referred to the Committee for resolution. If cases are not resolved within 90 days after referral, the Attorney General will take appropriate legal actions.

State and BTO bank restructuring

21.  The Ministry of Finance has established a governance and oversight unit for the state-owned and recapitalized banks. This unit is responsible for overseeing the stakeholders' interest in these banks and ensuring compliance with their business plans. With technical assistance from donors, and in consultation with the World Bank, the Ministry of Finance will assign new staff and international consultants, and make the unit fully operational by June 30.

22.  Bank Mandiri's restructuring remains on track, and its branch, staff, information and technology rationalization programs are proceeding on schedule. The international audit of Bank Mandiri's end-1999 accounts was completed in March. Mandiri's final performance contract has now been signed and its capitalization has been formally completed.

23.  There has been progress in restructuring and recapitalizing Bank BNI, the second largest state bank. Since February, a new President Director and two Commissioners have been appointed; an interim performance contract has been signed; BNI has received the first tranche of recapitalization bonds (Rp 30 trillion) after approval by the Restructuring Committee; BNI has entered into contracts with an international bank and two consultancy firms to help implement operational restructuring and prepare for privatization. In addition, BNI plans to sign a contract for credit risk management and loan workouts by June. The second and final recapitalization tranche is expected to be provided by end-June, upon the completion of a financial audit (as of March 31, 2000), and verification by an international firm of its compliance with its interim performance contract.

24.  Progress is also being made in the restructuring of BRI and BTN, in close consultation with the World Bank. A new roster of commissioners and management has been installed. BRI has begun to divest its corporate loans, and intends to reduce their stock to no more than 20 percent of its total portfolio by end-2000. During 2000, no new loans will be authorized for corporate borrowers, with the exception of a small number of traditional clients closely linked to the bank's microfinance activities. The first tranche of recapitalization is expected to be provided by about end-May, upon review and approval of the Restructuring Committee of the business plan, conclusion of an interim management contract with the new management team, and progress with the above reforms. The remaining tranche will follow the completion of the mid-year financial audit and satisfactory implementation of the business plan, expected by about September. As for Bank BTN's future role, the Ministries of Finance and Housing have formed a working group with other stakeholders to develop a new housing finance strategy during the second quarter of 2000. The recapitalization of BTN will be based on the housing strategy adopted.

25.  We have launched an IPO for Bank BCA and expect to sell up to 30 percent of IBRA's share in Bank BCA during May. It remains our objective to achieve majority privatization of Bank BCA during 2000 through seeking a strategic partner or private placement. Niaga will be the next BTO bank to be recapitalized in May. The strategy for its privatization will be finalized during the second half of the year. We expect to complete the resolution strategy of Bank Bali as soon as the current legal hurdles are overcome.

26.  Danamon will serve as a platform bank for resolving the eight remaining BTOs; their legal merger with Danamon will be completed during the second quarter of 2000, and the operational mergers concluded by end-September. On this basis, Danamon will be provided with about Rp 30 trillion in recapitalization bonds, in step with the legal merger, and after approval by Parliament. The bank will be prepared for majority privatization in 2001.

Supervisory and regulatory framework

27.  Bank Indonesia is implementing a comprehensive Master Plan to upgrade bank supervision and comply with international regulatory norms by end-2001, assisted by international experts. A quarterly cycle will be maintained for forward-looking monitoring of the business plans and financial condition of all private banks, including the seven banks that were recapitalized with the support of public funds. BI has initiated a permanent supervisory presence at each state bank; a full on-site inspection of Bank Mandiri has begun and will be completed by end-August. The Master Plan will also focus on improving the quality and timeliness of offsite reporting data on all banks and on making operational a program of special surveillance for systemically important and problem banks.

28.  Bank Indonesia is also upgrading its regulatory framework. It is developing a set of corrective measures that supervisors will use as it becomes apparent that a bank is falling into difficulty; to this end, BI issued a decree on March 30, setting out the conditions under which it will transfer banks to IBRA, when this becomes necessary.

29.  Nonbank financial institution reform is also on the agenda, to strengthen the regulatory and governance structure of the pension and insurance industries, finance companies, and capital markets. These reforms are being designed with assistance from the AsDB. By end-September, a time-bound plan for bringing the supervisory structure and regulations into line with international standards of governance and transparency will be drawn up.

Bank Indonesia audit

30.  BI has been implementing in a timely way measures aimed at addressing the issues raised by the Supreme Audit (BPK) report to Parliament on December 31, 1999 and clarifying BI's financial position, as outlined in the January MEFP. By end-June, BI will publish an audited statement of its financial accounts for end-1999. Over the coming months, BI, in consultation with BPK, will take steps to address remaining audit issues, including the full divestment of financial subsidiaries, as well as the aggressive strengthening of management information systems, financial and operational controls, and accounting policies to reflect best practices. A due diligence of all BI's subsidiaries will be completed by June 2000 ahead of their planned disposition to be substantially completed by end-2000.

Bond market

31.  We have begun the development of a domestic bond market in Indonesia by making an initial share (10 percent) of the bonds issued for bank recapitalization eligible for trading. A debt management office (DMO) in the Ministry of Finance has become operational, with the assistance of advisors from AusAid. The DMO will coordinate future bond issues and the development of a debt management strategy in consultation with Bank Indonesia. Bank Indonesia has established a book-entry system to record transfers of title of the bonds and a system to ensure delivery against payment. We are examining—with technical assistance being provided through the IMF—further ways to strengthen the institutional framework for debt management and to enhance the prospects for secondary market trading. The government will also submit to Parliament a draft law on debt management which will ensure automatic appropriations of debt-service payments for all government bonds issued.

V. Corporate Restructuring, Legal Reform, and Governance

32.  The enhanced corporate restructuring strategy described in the January MEFP has now been put fully in place, after consultation with market participants. All enabling regulations and decrees have been issued, including those related to the FSPC's referral of strategically important cases to the JITF and the use of time-bound procedures for negotiations under the JITF; debt and debt-service reduction by IBRA and legal protection of IBRA's staff in connection with such transactions; and the authority of the Attorney General to file "public interest" bankruptcy petitions against uncooperative debtors. In addition, a permanent secretariat has been established to assist the FSPC in overseeing bank and corporate restructuring.

33.  The JITF is being strengthened in its staffing and resources in order to carry out its mandate more effectively. Specifically: (i) the FSPC has issued a decree placing the JITF under the FSPC and giving it broad powers to engage in activities related to corporate sector restructuring; (ii) a new Chairman and full-time Chief Operating Officer have been appointed for the task force; (iii) the Chairman of the JITF will be an invited member of the FSPC; (iv) the JITF has retained a core group of staff members and facilitators; and (v) new budgetary and disbursement arrangements have been adopted, with the approval of the Ministry of Finance, that will ensure that the JITF can meet its future obligations in a timely manner.

34.  As of April, the FSPC has directed the cases of three companies to the JITF, under a recently issued FSPC decree, and these companies and their creditors are expected to start negotiations under the JITF's new time-bound mediation procedures immediately. We expect to direct additional companies to the JITF by end-June. If the JITF determines that a debtor or creditor is not negotiating in good faith, then the FSPC may take certain actions against the uncooperative party. Such actions include publishing the names of uncooperative debtors and creditors, requesting the Attorney General to file a civil suit or bankruptcy petition against an uncooperative debtor, and/or requesting the relevant government agencies to revoke or refuse to extend licenses, concessions and other facilities previously granted to uncooperative parties. However, if the JITF determines that a debtor or creditor is negotiating in good faith, it will qualify the cooperative parties for agreed tax and capital market regulatory incentives. In addition, the FSPC has issued procedures for accelerated processing and approval of restructuring-related applications under the JITF's One-Stop Facilitation Group; all Ministries and agencies responsible for handling such applications are required to observe the new procedures.

35.  We will keep under review the scope for expanding the corporate restructuring strategy and providing additional tax and other regulatory incentives for debtors and creditors to accelerate restructuring.

36.  The JITF will undertake periodic surveys to assess progress in corporate restructuring and gather information on key restructuring parameters. The first such survey will be conducted by July 2000, and quarterly thereafter.

37.  Key reforms have also been put in place to address governance problems in the court system. The Chairman of the Joint Investigating Team (JIT) has been appointed and the JIT will become fully operational during May. The JIT will function under the direction of the Attorney General, focusing on complex corruption cases and the court system. The JIT is retaining a core group of staff members to facilitate its work, and we have made available adequate budgetary and infrastructure support for it. External technical assistance is expected from the Netherlands and other donors to assist the efforts of the Team.

38.  The Independent Commission for the Audit of State Officials (including its judicial subcommission) is expected to be appointed by Parliament during the current quarter and to become fully operational shortly thereafter, as a key part of our anti-corruption efforts.

39.  We are giving high priority to resolving the issues that delayed the appointment of ad hoc judges in recent Commercial Court cases where they were requested. The Supreme Court has expanded the class of professionals who can serve as ad hoc judges to include private practitioners that do not have a conflict of interest; and the President is expected to appoint shortly a new slate of ad hoc judges that can be assigned to cases in the Commercial Court.

40.  The strategy for corporate governance reform proposed by the National Committee on Corporate Governance has been adopted. The strategic objective is to amend the Company Law, and the Company Registration Law within the next 12 months, thereby strengthening key aspects of corporate governance, especially monitoring and disclosure rules. Meanwhile, we have strengthened the enforcement of existing regulations in these key areas. The AsDB is providing technical assistance for implementing the corporate governance framework and coordinating the activities of other donors.

VI. Reform of State-Owned Enterprises and Other Key Structural Reforms

Privatization

41.  The government has updated its masterplan for state enterprise reform and privatization for the period 2000-2002. This masterplan, which is to be published by end-May 2000, promotes fast-track privatization for enterprises in competitive industries, and deals with loss-making enterprises that have no prospect of returning to commercial viability. The planned privatization transactions for FY 2000 are expected to yield Rp 6.5 trillion. The Ministry for Investment and State Enterprises is also preparing to issue shortly guidelines on improved privatization procedures, drawing on a review of completed transactions, these guidelines have been prepared with the assistance of international consultant.

Other enterprise reforms

42.  The masterplan accords very high priority to moving ahead quickly with privatization of the telecommunications sector. Toward this end, we remain firmly committed to transforming the telecommunication sector into a fully competitive business environment. In preparing for their privatization, Telkom and Indosat will rationalize their holdings in other telecommunications enterprises and divest stakes in non-core businesses during 2000. In parallel, the government will, by June 2000, and in consultation with the World Bank, finalize the implementing Government Regulations for the 1999 Telecommunications Laws and complete the other related actions listed in the January 2000 Letter of Intent. To ensure effective coordination, we will establish an inter-ministerial team, headed by the Deputy Minister of Restructuring and Privatization to guide and oversee the sector's restructuring and privatization. This team will be responsible for preparing a detailed and comprehensive action plan by June 2000.

43.  The government also remains committed to the reforms of the energy sector outlined in the January MEFP. Management changes have interrupted progress in some areas but we expect to achieve all the strategic objectives of regulatory reform during 2000, including a plan for medium-term energy pricing reforms.

44.  The MISOE, assisted by AsDB, will soon issue corporate governance guidelines for all SOEs. Strategies to improve the governance and efficiency of state infrastructure monopolies in ports, airports, and toll roads will be prepared and phased-in during 2000 by the Ministry of State-Owned Enterprises (MISOE) in coordination with the respective line ministries. As part of a two-year restructuring program, assisted by the AsDB, 32 state enterprises have been identified to have their accounts audited by independent auditors by end-2000; this plan will be extended to a further 30 state enterprises in 2001.

45.  We have begun implementing corrective actions for the findings of the recently completed special audits of BULOG, PLN, Pertamina, and the Reforestation Fund. Commencing in June 2000, the Coordinating Minister for the Economy will require publication of quarterly reports on the implementation of the corrective actions related to the audit reports. We are also commissioning special audits, to be conducted with the help of international firms, for five additional state enterprises (the national airline, the national toll road company, the domestic telecommunications company, the largest public port corporations, and a plantation company). These new special audits will be completed and the results publicized by end-2000. Progress in other structural reform areas is summarized in Box 1.

Independent Power Producers

46.  The ministerial-level PLN restructuring and rehabilitation team, supported by legal and technical advisors, has invigorated the process of resolving contractual disputes with independent power producers (IPPs). Legal actions filed by PLN and the developer of one plant have been withdrawn, and a number of interim agreements have now been concluded. The ministerial-level team has met with representatives of six Export Credit Agencies (ECAs) with IPP exposures, and a joint working team has been established to formulate a common basic framework within which long-term commercial solutions for individual IPPs will be negotiated.