Jakarta, Indonesia
January 20, 2000

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431
U.S.A.

Dear Mr. Camdessus:

The government of Indonesia has developed a new economic program that is firmly grounded in the State Policy Guidelines developed by Indonesia's first democratically elected Parliament. This program is designed to reinvigorate the economic reform agenda and usher in a new era of sustained growth based on social justice and good governance. Its main elements are presented in the attached Memorandum of Economic and Financial Policies (MEFP).

Therefore, the government of Indonesia requests that the extended arrangement that was approved on August 25, 1998 be cancelled and replaced by a new extended arrangement that will be in support of the new economic program. We request that the new arrangement be for the period through December 2002 and in an amount equivalent to SDR 3,638 million (175 percent of Indonesia's quota).

The program will be monitored through quantitative performance criteria and indicative targets in the monetary, fiscal and external sectors. Thus, in these areas, the MEFP (Table 2) proposes performance criteria for end-February and end-April 2000, and indicative targets for the second half of 2000. The program will also be monitored through structural performance criteria and benchmarks which are contained in Table 3 of the MEFP.

The government believes that the policies and measures set forth in the attached MEFP are sufficient to attain the objectives of its strengthened economic reform program. However, it will take any further measures that may be needed toward this end. The government will consult periodically with the Fund, in accordance with the Fund's policies on such consultations, about the progress being made in implementing the reform program described in the MEFP, and in advance of any revisions to the policies covered by the MEFP. We will also provide the Fund with such information as it requests on policy implementation and achievements of program objectives. In any event, during the first year of the arrangement, the government will complete reviews with the Fund no later than March 30, May 31, July 31, September 30 and December 15, 2000, in order to assess progress in implementing the program and reach understandings on any additional measures that may be needed.

Sincerely yours,

 
Attachments

1.  With the completion of Indonesia's political transition, and the election of a government with a wide popular mandate, Indonesia now has an historic opportunity to join its neighbors in a strong recovery and enhance the wellbeing of the Indonesian people.

2.  Much was achieved under the previous extended arrangement when Indonesia made significant progress in restoring macroeconomic stability, dealing with the financial crisis, advancing structural reforms, and assuring food security. The macroeconomic achievements include the elimination of inflation, the stabilization of the rupiah, and recovering foreign exchange reserves. The financial sector has begun to stabilize, interest rates have fallen below pre-crisis levels, and bank restructuring and recapitalization have started.

3.  However, much remains to be done to revive the real economy and lay the foundation for a sustained recovery that would increase employment, reduce poverty, and assure equality of opportunity. These challenges constitute the principal agenda of the State Policy Guidelines that have been approved by Indonesia's democratically elected Parliament. Based on these guidelines, the government has now adopted a comprehensive economic program that would accelerate the restructuring of Indonesia's economy and meet these challenges.

4.  The medium-term strategy has four main planks. First, to make the macroeconomic policy mix fully supportive of recovery while entrenching basic price stability. Second, to reinvigorate bank, corporate, and other restructuring policies, which are crucial to sustaining an economic recovery accompanied by lasting poverty reduction. Third, to rebuild key public institutions, thereby strengthening Indonesia's capacity to implement economic and social policies with popular support, transparency, and good governance. Fourth, to improve greatly natural resource management, arrest the long-term deterioration in the environment, and ensure the sustainable use of natural resources for future generations.

5. The strategy envisages restoring a growth rate of 5–6 percent over the medium term, and Bank Indonesia (in the context of the new Central Banking Act) has adopted a target of keeping inflation below 5 percent annually (Table 1). Although the external current account would weaken over the next several years, as investment picks up, official financing and improvements in private capital flows (including the return of flight capital) should readily offset the decline in the current account surplus. We are confident that the need for exceptional balance of payments financing would be eliminated by the end of the program period, while the import coverage of liquid reserves would be maintained at about 6 months. The government debt-to-GDP ratio should decline from its recent peak of about 100 percent to about 65 percent by 2004, helped by falling interest rates and IBRA's asset recovery.

6.  Key to attaining these objectives will be a range of fiscal reforms, affecting both revenues and expenditures. These reforms will be introduced concurrently with implementing fiscal decentralization by June 2001, consistent with the Regional Governance and Fiscal Balance Laws, and without increasing the General Government deficit.

7.  Financial and corporate reforms lie at the heart of the program, and the government is resolved to carry these forward in an integrated and coherent way. The strategic objectives of our bank restructuring program are four-fold: (i) capitalize all banks to at least 8 percent CAR by end-2001, as a precondition to the eventual replacement of the comprehensive guarantee by self-financed deposit insurance; (ii) ensure that the banking system is restructured at minimum public cost; (iii) enhance supervision and instill much improved governance in the banking sector; and (iv) deepen bond and equity markets, allowing dependence on bank finance to be reduced.

8.  In tandem with bank restructuring efforts, corporate restructuring needs to move ahead with much greater momentum in order to restart credit flows that are needed to sustain the recovery. This will require changing the incentive structure faced by corporate debtors and strengthening the institutional structure for corporate restructuring. The government intends to do this by giving new political leadership and direction to the corporate restructuring strategy, improving the implementation of the bankruptcy law, enhancing the governance framework in the judiciary, instructing IBRA to intensify implementation of its sequenced strategy toward its corporate debtors, and strengthening procedures for non-IBRA-led restructuring.

9.  To ensure that the benefits of economic recovery are widely shared among the Indonesian people, the strategy includes a wide range of structural measures. Thus, reforms to strengthen agriculture, increase the opportunities to the small scale sector, improve targeted spending programs, and upgrade the human infrastructure will help ensure that recovery is accompanied by sustained poverty reduction. They will be supported by measures to deepen competition in the economy, inter alia, through the restructuring and reform of the state-owned enterprises, especially in the energy sector.

10.  In particular, the program for the reform and privatization of the state-owned enterprises represents a central element of the government's broader strategy for improving the performance of the public sector, and enhancing overall corporate competitiveness. While privatization is expected to generate considerable revenues over the coming years, and support public debt reduction, this is not seen as its sole objective. Rather, the ultimate objective of the privatization program is to create efficient and viable enterprises. In all instances, privatization will be undertaken transparently using best practice procedures.

11.  There is widespread consensus in Indonesian society that key economic institutions need to be rebuilt or strengthened in order to command the trust of the people and allow the smooth implementation of the medium-term policy agenda. Insufficient attention to institution building over a long period led to a steady erosion in the governance framework for economic and social activities, contributing to the depth of Indonesia's financial crisis, and burdening the recovery process. Reversing this situation will not be easy; our early priorities will be in the public sector (fiscal management and civil service reform), financial sector (IBRA, the state-owned banks, and the regulatory and supervisory institutions), the judiciary, and the institutions responsible for corporate governance.

12.  The task of improving governance in fiscal management is vast and complex, and crucial to regaining public confidence as well as sustaining fiscal adjustment and public debt reduction. The tax system needs to be reformed to ensure that it is broad-based, nondistortionary, equitable, and transparent. Tax administration has to be overhauled to ensure that regulations are implemented faithfully and in an even-handed manner. The governance of spending programs must be greatly improved and the allocation of funds redirected toward poverty alleviation to promote interregional equity and increase efficiency in the provision of public goods. Fiscal transparency needs to be enhanced by identifying and auditing off-budget activities and bringing them under the consolidated budget. Wages to public servants need to be increased, in line with improved governance and within the government's fiscal capacity, so as to create a more professional civil service with high standards and integrity.

13.  Implementing fiscal decentralization will require new institutions which will need to work in close consultation with regional authorities and civil society. A Consultative Regional Autonomy Council will be established shortly to oversee implementation of decentralization. A grants administration (a Fiscal Balance Secretariat) will be established to design the rules for transfers. The Ministry of Finance has been designated as the lead agency for implementing all fiscal aspects of decentralization, in consultation with the Fiscal Balance Secretariat. A full-time fiscal decentralization advisor is being appointed to the MOF. The accountability of lower levels of government will need to be developed, and the regional tax base increased; toward these ends, a review of tax legislation and administration has been launched, and regulations for regional financial management will be developed by June 2000. A central database for regional government financial information will be established to support central policy formulation.

14.  The newly independent Bank Indonesia (BI) has a great responsibility to support the recovery, by maintaining price stability, rebuilding bank supervision, and ensuring a high level of disclosure of banking activities. Prudential supervision of the financial system needs to be carried as quickly as possible to international standards. Effective oversight of BI will be exercised through regular reporting to Parliament.

15.  Improving public confidence in the integrity of the judiciary and in the efficacy of the legal process is a vital objective of institutional reform and key to economic restructuring. Thus, we have adopted a comprehensive agenda of legal and judicial reform with four key programs aimed at: good governance in the legal system and administrative law reform; improved administration of justice; legal education, testing and discipline; and improved legislative capabilities. The program includes measures to reduce the opportunities for corruption (by improving the transparency and speed of legal proceedings) while, at the same time, creating powerful disincentives for corrupt practices (including prosecutions of the parties that engage in such practices). We also intend to enhance the role of the Attorney General's Office, reform the court system, and seek parliamentary confirmation for all appointments to the Supreme Court. The IMF, World Bank, and AsDB will assist in mobilizing financial and expert assistance to the Attorney General's Office.

16.  IBRA is crucial to meeting the objectives of restoring a sound banking system as well as promoting corporate restructuring and asset recovery to reduce the public debt. To accomplish these tasks, IBRA needs to be protected from narrow political interests; it also needs to be administered by professionals in a transparent manner, and have an unassailable governance structure, including a strong oversight body. The government is committed to assuring these conditions, and establishing a fully effective governance structure in consultation with the IMF, the World Bank, and the AsDB. We expect that IBRA will largely complete its work in restructuring financial institutions and recovering asset value during the period of the program.

17.  The governance structures of other economic institutions are also being reviewed and improved to upgrade corporate governance. This will include adopting a new code of corporate governance, strengthening capital market regulation at the Securities and Exchange Commission (BAPEPAM), and improving the oversight of nonbank financial institutions at the Ministry of Finance.

18.  Indonesia's natural environment has continued to deteriorate during the crisis. Weak policy implementation and weak market institutions have combined to undermine Indonesia's base of natural resources. We recognize the key role natural resources play in the Indonesian economy and are determined that our policies and programs ensure their sustainable use for the benefit of this and future generations.

19.  Our policy and institutional framework for natural resource management will focus on three key objectives. First, we will include greater consultation and stakeholder participation in decisions affecting our natural resources, particularly in the formulation of new policies, and the location and selection of public investments. To ensure that these decisions are based on good information, we propose to expand and improve environmental monitoring of Indonesia's air, water, forests, and marine resources. Second, we will move towards a pricing structure for natural resources that better reflects their true value. And third, we will pay special attention to improving forest management and ensuring a sustainable production of goods and services from our forest resources.

20.  Consistent with the medium-term framework, our near-term macroeconomic policies are based on growth being in the 1–2 percent range in 1999/2000, strengthening to the 3–4 percent range during FY 2000.¹ Low single-digit inflation will be entrenched. The external reserve position will be further strengthened. Fiscal, monetary, and external policies have been formulated to contribute to these outcomes, and will be regularly reviewed to address risks that may materialize.

Fiscal Policy and the Social Safety Net

21.  The fiscal deficit for 1999/2000 is currently estimated at about 3¾ percent of GDP. Inclusive of the settlement of arrears, the budgetary financing need is estimated at about 5 percent of GDP. This is below the original program because of development spending shortfalls in the first half of the year (associated with the political transition), and higher oil prices and revenues. An ongoing recovery in development spending should ensure positive fiscal stimulus during the second half of the fiscal year. The financing need will be fully met by privatization receipts, asset recovery, and foreign financing.

22.  We have established clear principles for the FY 2000 budget which was submitted to Parliament today. First, to strike a careful balance between supporting the economic recovery and starting the process of reducing government debt. Second, to continue to avoid domestic bank financing. Third, to initiate a range of structural tax reforms (elaborated in Section IV.A), whose full impact will accrue over the medium term. Fourth, to start the process of gradually reducing untargeted subsidies, while protecting small household users from their impact, and strengthening targeted poverty-alleviation programs (elaborated in paragraph 24 and Section IV.F). Fifth, to begin to restore public sector wages, especially for the most senior officials, concurrently with administrative reform and stringent penalties on corruption. On this basis, we expect that the FY 2000 budget deficit will be 5 percent of GDP, financed about equally from domestic (asset recovery and privatization) and foreign sources.

23.  The wage differential with the private sector is very high, particularly at the top echelons, and correcting this differential is an integral part of civil service reform, and will be accompanied by anti-corruption efforts. With these key objectives in mind, we have decided to raise the basic wages of public employees in two installments of 10 percent each, to be implemented on April 1 and October 1, 2000, thus achieving a total wage increase of 20 percent during the year. Larger increases will be given to higher civil service echelons, including state officers and the judiciary. With these increases, total personnel expenditure is projected to increase by 16 percent to Rp 45.7 trillion.

24.  There are three main elements to our social spending: the social safety net (SSN); poverty alleviation programs; and targeted fuel and energy subsidies. Overall social spending is projected to be Rp 8.5 trillion in FY 2000. Of this total, SSN programs are projected at Rp 2.7 trillion and have the following principal components: (i) the rice distribution (OPK) program; (ii) a health component; (iii) specific employment programs, including to enhance women's employment; (iv) a program to provide funds directly to communities; (v) scholarships to needy students and block grants to targeted schools; and (vi) poverty alleviation. These programs have enhanced monitoring provisions and other safeguards to prevent abuse and protect implementation, including frequent reporting on key performance indicators, independent verification, and close involvement by NGOs and civil society. They are being supplemented by the new poverty-alleviation programs (mentioned in paragraph 22) which are projected at Rp 4.5 trillion in FY 2000, and are being designed also in close consultation with the World Bank and the AsDB. The new programs will be implemented with the same monitoring provisions and safeguards. The proposed mechanisms aimed at protecting low income households from the energy tariff increases are projected at Rp 1.3 trillion in FY 2000 (Section IV.F).

Monetary and Exchange Rate Policies

25.  Firm base money control, combined with a flexible exchange rate policy, have anchored prices and strengthened the rupiah, and there will be full continuity of these policies. Although the uncertainties of August-October interrupted the process of making monetary policy fully supportive of recovery, the declining trend of money market interest rates has now resumed. Given the absence of inflation, there remains room to guide interest rates down cautiously further, as in the other Asian countries.

26.  The monetary program for the remainder of 1999/2000 results in a base money increase for the fiscal year as a whole of about 9½ percent, to Rp 86 trillion. Compared with the previous projection, this program is based on a slightly higher level of net BI reserves (Table 2). An indicative monetary program for 2000 has also been formulated to accommodate anticipated higher growth. With improved confidence reducing currency demand, base money is targeted to increase to about Rp 92 trillion by end-December 2000. This base money program provides for the recovery of bank credit to the private sector, and will be reviewed periodically to ensure that it remains fully supportive of recovery and responsive to unanticipated capital inflows.

Balance of Payments and External Policies

27.  The external current account surplus in 1999/2000 is projected to reach about $5 billion (3.1 percent of GDP), about $2½ billion above previous projections because of the reduced fiscal expansion and stronger oil export prices. Liquid reserves are now projected to be $25 billion by the end of the fiscal year, or about 6 months of imports; its coverage of short-term debt will improve to over 70 percent.

28.  With the onset of recovery and a strengthened currency, we expect the current account surplus to decline in 2000, consistent with the pattern experienced in the other Asian countries. Current projections point to the current account surplus falling to about $2 billion in FY 2000. Export volume growth should strengthen, although this is expected to be outweighed by a recovery of imports (which will still remain well below the pre-crisis level). In the capital account, private capital flows should improve, but new pressures are expected from at least two sources: (i) corporate reschedulings are likely to be associated with prepayments on account of arrears; and (ii) banks are expected to make payments consistent with contractual obligations under the first exchange offer.

29.  Consequently, we expect an external financing gap to emerge again in FY 2000, of about $4.3 billion, linked closely to the fiscal deficit. We are confident that the full amount of official external financing will be available. We have requested another principal rescheduling from The Group of Official Creditor Countries of Indonesia for the 24-month period through March 2002; estimated relief during FY 2000 is about $2.1 billion. We have been in touch with our multilateral creditors (especially the World Bank and the AsDB) and bilateral creditors (especially Japan) and have received assurances that the remaining amount of financing should be available from these sources during FY 2000.

30.  A range of structural fiscal reforms is being implemented to underpin the increased efficiency, transparency, and institution building planned for the public finances (Box 1). Policies governing tax holidays and free trade zones are being rationalized to keep the tax system from being used to promote or discourage specific sectors, industries, or regions, thus reducing abuse and evasion. The efficiency of the value-added tax (VAT) is being improved by phasing out unnecessary exemptions. Concrete steps are being taken to improve tax and customs administration, improve the targeting of large taxpayers, and combat fraud. An audit of the tax office is expected to be completed by March 2000. Two new amendments to tax laws (the VAT law and the Tax Procedure law) are being prepared for submission to Parliament by February 2000 to strengthen the auditing and refund procedures and broaden the tax base. A reform plan is also being implemented to rationalize excise taxes on cigarettes. We will complete an audit of the agricultural credit program (KUT) by March 2000 to improve its efficiency and clarify its future role.

31.  The Ministry of Finance intends to complete two reviews aimed at delivering much increased fiscal transparency by end-March 2000. The first review aims at consolidating information on all bank accounts controlled by government agencies. The second review takes stock of off-budget funds. Based on these reviews, we will consolidate off-budget accounts and funds, where appropriate, by June 30. Any funds remaining outside the budget will be subject to annual audit. In addition, we have instructed the State Audit Board (BPKP) that any future internal audits of financial operations of all government agencies take full account of all extrabudgetary sources of support. This will begin in 2000 and will include the military.

32.  We recognize that quasi-fiscal activities may also arise from the operations of foundations and we intend to bring their activities and accounts under government review and audit. The Ministry of Law and Legislation will form a working group to make policy recommendations and to draft legislation on foundations to be submitted to Parliament by end-April 2000. The legislation will require foundations to file a public statement of activities, including audited accounts.

33.  We reaffirm our commitment to maintain a liberal trade regime, avoid introducing any new trade barriers, and remove remaining distortionary elements in the trade structure. As part of the 1995 tariff reduction plan, we recently reduced the import tariff on a number of items from 10 percent to 5 percent and, by end-2003, we will establish a three-tiered tariff structure (0, 5, and 10 percent) for all goods except alcohol and automobiles. During the program period, we will eliminate all exemptions to import tariffs (except those which are part of international agreements), and remove all existing non-tariff barriers (except those for health and safety reasons). Tariff policy for rice and sugar is elaborated in paragraphs 86 and 90 below. As a step toward replacing all export taxes and levies by resource rent taxes, the maximum export tax on logs, sawn timber, and minerals was reduced to 15 percent by end-December 1999. This will be followed by a review of forestry sector taxation policy starting January 2000, in consultation with the World Bank. At the same time, we will ensure that the forest resource royalty rate (PSDH) captures at least 60 percent of the economic rent from logs and, thereby, protect Indonesia's forests. Finally, we will eliminate all other export restrictions (e.g., licensing requirements or government approval on logs, coffee, and wood products), by end-2000, with the exception of those needed under the multi-fiber agreement.

34.  The government is committed to implementing fiscal decentralization according to the approved legal framework. The timetable for the principal preparatory steps is contained in Box 2. The decentralization framework specifies principles for sharing natural resource-based government revenue, notably of oil (devolution of 15 percent of onshore nontax revenue), gas (30 percent of onshore nontax revenue) and forestry (80 percent of revenue) to regional authorities, and establishes a General Allocation to regional authorities (at least 25 percent of total domestic revenue). Implementation of these principles would double transfers and shared revenues to 6 percent of GDP by 2002, in step with the decentralization of most administrative and social welfare functions. As a result, the share of regional government spending is expected to double, to about 40 percent of total spending by 2002, by which time it should total 7 percent of GDP. We will ensure that fiscal transfers to the regions promote equity by taking regions' revenue capacity and spending needs into account; this will be the task of the grants administration.

35.  Banking reforms lie at the heart of the economic program, and an ambitious agenda for the year 2000 has been adopted (Boxes 3 and 4). In many areas, strong measures have already been taken to signal the government's determination. The Financial Sector Policy Committee (FSPC), which reports directly to the President, has been established to give clear political leadership and direction in the areas of banking and corporate restructuring. The FSPC is headed by the Coordinating Minister for Economy, Finance, and Industry, and includes the Minister of Finance, the Minister for Investment and State-Owned Enterprises, the Minister of Trade and Industry, and the Chairman of BAPPENAS. The Governor of Bank Indonesia will be invited to attend meetings. The FSPC is in the process of establishing a secretariat, including a coordinator to liaise with IBRA and the JITF.

Improved Governance in Banking

36.  The government has taken a strong set of measures to reassure the public, as well as markets, that the Bank Bali investigation is being credibly advanced, and that systems and procedures have been strengthened to prevent any recurrence. The Attorney General is undertaking an investigation into the corruption aspects of the Bank Bali matter, assisted by PwC, and has so far made one indictment in the case; additional actions are expected to be forthcoming as the investigation proceeds.

37.  We are taking steps to ensure that future settlements under the guarantee scheme are made expeditiously and that the process is not compromised in any way. Thus, an international accounting firm contracted by IBRA completed a preliminary examination of all pending interbank claims in mid-December 1999, allowing a first round of eligible claims to be paid at end-December. Based on this examination, and in close collaboration with the IMF, the World Bank, and the AsDB, IBRA will publicize new and fully transparent procedures for processing claims under the guarantee in February 2000. The eligibility of the remaining claims is expected to be determined during February through a further review conducted with the full cooperation of BI. All of the claims deemed eligible in that review will be settled promptly thereafter.

38.  A comprehensive study, in collaboration with the World Bank, has been launched to develop a strengthened governance and oversight framework for IBRA, and an interim report is expected during February 2000. On the basis of this report, recommendations will be developed and final decisions taken no later than March 31, 2000. Meanwhile, a number of essential steps have been taken to strengthen IBRA: (i) the government has reconfirmed IBRA's status as the sole publicly funded entity in charge of asset recovery; (ii) the President has issued an instruction clarifying that IBRA will report to his office on all policy issues; (iii) IBRA is finalizing its accounting policies on the basis of advice from international auditors; (iv) the first audited accounts of IBRA's operations, covering its position as of December 1999, will be publicized by end-April 2000, followed by regular quarterly and annual audited financial statements; and (v) an Ombudsman's office will be established within IBRA by end-January, 2000 to respond to all inquiries from the public. The Independent Review Committee continues to exercise oversight over IBRA.

39.  The institutional framework and sequenced strategy for loan collection and asset recovery, focused on the largest borrowers, continues to be implemented as elaborated in Box 3. The strategic objectives for March 31, 2000 are to complete restructuring MOUs for about 50 percent of the loan value of IBRA's cooperating Category A debtors; and to complete the valuation of the assets of at least 50 percent of loan value of cooperating Category B borrowers. We are resolved to take timely and evenhanded action against all noncooperating debtors (Categories C and D). Their loan obligations and payment records have already been made public, and IBRA's Legal Department is now pursuing a strategy to ensure these accounts are settled in an expeditious manner. The first round of formal legal actions were taken in December 1999. In addition, all state/BTO banks and IBRA will start in February releasing quarterly reports on recovery performance on loans in categories 3, 4, and 5.

40.  IBRA is on track with its recovery schedule aimed at collecting at least Rp 17 trillion in cash by March 2000; and had already recovered Rp 7.9 trillion by November 30, 1999. IBRA has adopted a minimum cash recovery target of Rp 16.3 trillion for FY 2000, including sales of assets and companies from its AMI (Asset Management Investments) and recoveries on loans from its AMC (Asset Management Credits). In addition, IBRA is launching a transparent process of outsourcing and/or sale of its smaller loans (less than Rp 50 billion), with the first such disposition scheduled to take place by end-March 2000. IBRA publishes frequently, through the press, a schedule of auctions of noncore assets, as well as transparent procedures for all asset sales.

41.  IBRA has also made decisive progress toward completing discussions with, and transferring shareholder assets from, former owners of 1998 and 1999 BTOs (banks taken over) and BBOs (banks closed). With regard to the 13 1998 BTO and BBO banks that had violated prudential regulations, the asset transfers from seven bank owners were completed by December 31, 1999; those from two further bank owners are expected to be completed by April 2000. The cases of the noncooperating shareholders of the remaining four banks will be publicized in February 2000 and, if not resolved, referred for prosecution to the Attorney General, who will initiate court proceedings during March 2000. We expect to finalize negotiations with the 46 1999 BTO/BBO banks by May 2000, and complete all associated asset transfers by end-October 2000.

State and BTO Bank Restructuring

42.  State bank restructuring is being implemented under the oversight of an interdepartmental Restructuring Committee, and with the following safeguards. All state banks have been required to prepare business plans with the help of international advisors, and to contract with international banks for their loan work-outs. The Ministry of Finance is establishing a fully funded and staffed monitoring unit to ensure compliance of the state banks with their performance contracts. The monitoring unit has ensured that all state banks have transferred to IBRA all of their category 5 loans (as well as any loans with provisions of more than 50 percent), as of September 30, 1999, together with all loan documentation. Henceforth, all state banks will be subject to an annual audit by international accounting firms, beginning with their end-1999 positions.

43.  Progress is most advanced in Bank Mandiri. Two tranches of capital have now been injected into the bank, the latest one (for Rp 75 trillion) on December 28, 1999, bringing the total bonds provided to Rp 178 trillion. As a result, the bank's CAR has been raised to above 4 percent, based on the December position estimated by an international accounting firm. Any difference with the final audited end-1999 accounts will be met by (or repaid to) the government in early 2000, as soon as these accounts become available.

44.  At the same time, Bank Mandiri is taking decisive actions to improve its operational performance in line with operational and financial targets specified in the interim investment and management performance agreement signed on December 28, 1999. Efforts are underway to improve services by hiring additional line managers, and outsourcing the information technology system at headquarters. To improve financial management, the bank has established special teams to secure full information on the bank's daily cash flow, and to complete the reconciliation of interbranch items inherited from its component banks by February 29, 2000. To improve transparency, the bank is publicizing the terms and conditions of all its loan restructuring deals.

45.  Concerning BNI, we intend to follow a similar restructuring sequencing, starting with a management review. Following an international executive search, a new management team will be appointed following the shareholders' meeting. The government and the new management will sign performance contracts by February 29, 2000. Thereafter, the new management will finalize agreement with an international firm to enter into a twinning/management agreement by March 31, 2000 to implement the full business plan, with special emphasis on governance, risk management and the workout of non-performing loans. The first tranche of recapitalization will be provided only upon completion of the preceding actions, expected by March 31, 2000. The remaining tranche will follow the completion of the end-1999 financial audit, and implementation of the business plan, expected by June 30, 2000.

46.  BRI's financial plan, refocusing the bank on its traditional activities of retail banking and microfinance, has been reviewed by an international consultant and the full business plan is expected to be reviewed and approved by the Restructuring Committee in February 2000. Management is being reviewed and new members recruited through an international executive search. We expect that a new management team will be in place by February 15, 2000. BRI will begin in March to divest its corporate loans except for certain traditional customers that will constitute a maximum of 20 percent of its total portfolio. The process of divesting corporate loans will be completed by end-2000. The first tranche of recapitalization is expected to be provided by April 15, 2000, upon completion of the preceding actions; the remaining tranche will be provided following the completion of the end-1999 financial audit and satisfactory implementation of the business plan, expected by June 30, 2000. As for BTN, before proceeding with its restructuring and recapitalization, the government will formulate a strategy for the housing finance sector by February 2000, including the future roles of BTN and of the housing credit program.

47.  We intend to achieve majority privatization of BCA in 2000. Toward this end, we intend to launch BCA's initial public offering of shares in March 2000; as a first step, a filing will be made with BAPEPAM by-end January.

48.  Danamon's divestment process will be delayed until its mergers with eight BTO banks can be completed. One bank (PDFCI) was merged into Danamon in late-December 1999, following approval of the merger by BI; the remaining mergers should be completed by September 2000. We have provided Danamon with a strong management team, which was approved by Bank Indonesia on December 15, 1999, and business plans and a management contract were completed in January 2000. On this basis, in May 2000, Bank Danamon will be provided with recapitalization bonds of about Rp 30 trillion to allow it to finance the remaining mergers. A timetable for achieving majority privatization in 2001 will be drawn up by September 2000.

49.  Steps are also being taken to resolve two banks—Bank Bali and Bank Niaga—which were taken over when their owners failed to come up with the funds necessary to participate in the private bank recapitalization scheme. We plan to sell both banks by open tender during the first half of 2000.

Private Bank Restructuring

50.  BI is determined to ensure the soundness of the 73 A-category banks. All owners and managers of these banks have been subject to fit and proper tests, and those who failed have been replaced. BI further required owners of banks whose capital fell below 4 percent to raise capital to that level by January 20, 2000, and it will take corrective actions against those banks where the owners fail to comply with the requirement. Banks whose business plans needed revision or correction to ensure compliance with the requirement to achieve CARs of at least 8 percent by end-2001 have now submitted revised business plans, and these have been reviewed. All A-category banks will be monitored on a quarterly basis to ensure they comply with their business plan; BI will take appropriate corrective actions in all cases where these targets are not being achieved. Performance of the private banks jointly recapitalized with the government will also be subject to quarterly monitoring by IBRA and BI, and any substantial deviations will be reported to the Ministry of Finance for appropriate resolution.

Legal, Regulatory, and Supervisory Framework

51.  The first audit of Bank Indonesia under the new central bank law, conducted by the Supreme Audit (BPK) with the assistance of an international accounting firm, was completed and sent to Parliament on December 31, 1999. In response, BI has adopted a timebound program of follow-up actions, aimed at addressing the issues raised by the audit, which will be implemented in cooperation with the BPK during the coming year. The action program, detailed in Box 5, comprises a range of measures to clarify BI's financial position, improve the bank's internal controls, and strengthen its supervision standards. Special audits are being commissioned to verify and revalue BI's financial and tangible fixed assets, and assess the bank's off-balance sheet positions by end-April 2000. Should this work reveal the bank has a capital shortfall, the government will provide an immediate injection of funds so that the bank meets statutory requirements. At the same time, BI will take steps to divest its financial subsidiaries, and to tighten internal controls and strengthen information systems. The overall aim would be to obtain an unqualified auditor's opinion for the end-2000 financial accounts.

52.  The authorities are adopting a comprehensive approach to achieve and maintain the soundness of the overall financial sector. Bank Indonesia will provide the IMF with monthly bank-by-bank data beginning with end-December 1999. The Board of Bank Indonesia has approved a master strategy for enhancing bank supervision. The strategy—to be assisted by the IMF—will guide implementation of the reforms necessary to bring supervisory and examination activities up to international standards, consistent with the Basle Committee's Core Principles, and ensure that technical assistance projects on bank supervision are effectively coordinated. It is envisaged that BI will maintain substantial on-site supervisory presence at each state bank. Similar master plans will be developed by end-March 2000 for the oversight of the nonbank financial sector (pension funds, insurance companies, and finance companies), and securities markets by the Ministry of Finance, with the assistance of the World Bank and the AsDB. We will also review and strengthen the law on pension funds during 2000.

53.  We have issued additional bonds for bank capitalization and are taking steps to develop a government bond market. The Ministry of Finance, with the assistance of AusAid, has established a unit to manage the public debt. Our progress and plans in this area include the following:

• As of end-December 1999, the government has issued bonds, totaling about Rp 500 trillion rupiah, for the capitalization of Bank Mandiri, the private and BTO banks, and to compensate BI for its past liquidity support and the settlement of interbank claims. It is expected that some Rp 140 trillion in additional bonds will need to be issued by mid-2000, principally to complete the recapitalization of the state banks. The interest burden on the budget of these bonds is projected to peak at about 4.7 percent of GDP in FY 2000 before declining in subsequent years.

• A portion of the capitalization bonds for banks with net open foreign currency positions will be in the form of foreign exchange-linked (rupiah-denominated) bonds, to enable these banks to close their positions in an orderly manner.

• A number of steps have been taken to begin secondary market trading of government bonds over the next year. A committee is being formed with participation from the Ministry of Finance and BI to facilitate development and regulation of the market, and a book-entry system is now operational within Bank Indonesia for record-keeping and transfers of government bonds in paperless form.

• Regarding the tradability of the recapitalization bonds, banks have (since December 9, 1999) been permitted to transfer up to 10 percent of their bonds into a "trading portfolio." Initially, these bonds may be used as collateral for borrowing. Starting in February 2000, banks will be permitted to trade these bonds in the secondary market. The portion of bonds in the trading portfolio will thereafter be increased progressively.

54.  Continued efforts will be needed to ensure that the newly recapitalized banking system is able to operate profitably on a sustainable basis. With these efforts, and the achievement of 8 percent CAR by end-2001, a sound banking system should be re-established. The government intends, thereafter, progressively to limit the scope of the blanket guarantee, with a view to replacing it by 2004 with a limited deposit insurance fund financed by the banking system.

55.  The government has developed a strategy to give fresh momentum to corporate restructuring with the following key elements: (i) ensuring that IBRA plays an active role in the workout process with the ability to engage in various forms of debt restructuring; (ii) for non-IBRA-led cases, establishing a procedure under which the Government may direct cases to the Jakarta Initiative Task Force (JITF), and may refer to the Attorney General for the initiation of bankruptcy proceedings those debtors that refuse to negotiate in good faith in accordance with the principles and timetables established under the new JITF mediation procedures; (iii) strengthening the insolvency system; and (iv) more generally, improving the corporate governance framework, and subjecting companies to greater market discipline. In accordance with a Presidential Decree issued on December 28, 1999, the Financial Sector Policy Committee (The FSPC) has been established to oversee bank and corporate restructuring. As indicated in paragraph 35 above, the FSPC, which reports directly to the President, consists of key ministers and will be assisted by a permanent secretariat. The FSPC will play a central role in the strengthened corporate restructuring strategy described below.

56.  It is essential for IBRA, as a major creditor to the corporate sector, to be able to engage in a full range of commercially acceptable methods of debt restructuring, including debt-for-equity conversions and, where appropriate, debt reduction. To that end, the FSPC has announced—and will approve before end-January—a set of policies and procedures for IBRA that specify the conditions under which debt and debt-service reduction decisions may be taken. Under these policies and procedures, debt reduction will only be made available to cooperating debtors where: (i) it is in the best commercial interests of IBRA as a creditor and (ii) there is no evidence of criminal or fraudulent activity on the part of the debtor. Also by end-January, an FSPC decree will be issued that commits the government to provide the officers of IBRA and the members of the FSPC with personal legal assistance in cases where decisions consistent with the above mentioned policies and procedures are challenged.

57.  Efforts are also underway to allow IBRA to make more effective use of the insolvency system. Specifically, in cases where debtors fail to enter into good faith negotiations with IBRA in accordance with the timetable agreed upon with the debtor, IBRA will, where appropriate, file insolvency petitions in the Commercial Court. Two test cases have been filed as of January 20, 2000.

58.  The government has also announced measures to strengthen procedures for restructuring through the JITF's collective negotiating framework. In accordance with a decree to be issued shortly, the FSPC will be able to direct cases that cannot expeditiously be led by IBRA (because, for example, IBRA is a minority creditor) for restructuring under the JITF. A first list of such companies will be referred to the JITF by end-January 2000. Any case being negotiated under the Jakarta Initiative framework (including those cases that have come voluntarily to the JITF and those directed by the FSPC) may be referred to the Attorney General by the FSPC for the initiation of bankruptcy proceedings against the debtor. The basis for such referrals will be a recommendation by the JITF that the debtor has failed to negotiate in good faith in accordance with the JITF meditation procedures. A Government Regulation will be issued establishing this referral authority before end-January, 2000. At the same time, the FSPC will approve new time-bound mediation procedures to be administered by the JITF that will provide the basis for the exercise of the referral authority. It is recognized that the leverage this authority provides to the JITF will also facilitate the sale of assets by IBRA, by giving greater assurance to the buyers that their claims can be enforced.

59.  IBRA will take steps to ensure that it participates in the Jakarta Initiative framework when such participation is necessary for effective restructuring. The FSPC will be responsible for ensuring adequate coordination between IBRA and the JITF.

60.  The above measures recognize that the JITF has a critical role to play in accelerating the pace of corporate restructuring. The government is committed to provide adequate resources and the necessary budgetary support to ensure that the JITF has the necessary institutional capacity and will be able to fulfill its strengthened mandate in a timely manner.

61.  By end-January 2000, we will obtain the agreement of concerned ministries and agencies to the procedures for accelerated regulatory approval of restructurings and will adopt and publish them. By mid-February 2000, we will make these procedures fully operational under the Regulatory Facilitation Group ("one-stop shop") within JITF.

62.  The government recognizes that a key incentive for debtors to enter into negotiations with their creditors has been ineffective, namely the threat that creditors will initiate bankruptcy (including rehabilitation) proceedings against recalcitrant debtors. A primary problem in this area has been the capacity of the judiciary to implement the insolvency law, including the perception of governance problems. To this end, a number of measures are being implemented to strengthen the judiciary.

63.  First, in accordance with recently enacted legislation, the President has submitted to Parliament a list of candidates to be appointed as members of the Independent Commission for the Audit of State Officials. The Commission includes a judicial sub-commission responsible for obtaining information and conducting investigations regarding the wealth of judges and referring evidence of corruption to the Attorney General for prosecution. Other sub-commissions will gather information regarding the wealth of state officials. The Commission will be fully functional by March 31, 2000, with an adequate budget and supporting infrastructure.

64.  Second, the Attorney General will, in coordination with the Commission for the Audit of State Officials, give priority to the investigation and prosecution of any judges and members of the legal profession that have engaged in corrupt practices under the newly enacted Anti-Corruption Law. For this purpose, a Government Regulation is being issued establishing a Joint Investigating Team which will be coordinated by the Attorney General. The Attorney General will, in turn, issue shortly a policy directive indicating that the Joint Investigating Team will be initially charged with investigating and prosecuting corruption within the court system in accordance with procedures established under the Anti-Corruption Law. A number of reputable professionals, including representatives from civil society, will be appointed to this team and adequate budgetary resources will be appropriated to ensure that it has the capacity to pursue its mandate. The Joint Investigating Team plans to expand its investigations of corruption into other areas as its capacity increases.

65.  Third, after considerable delays, transparent procedures were published on December 10, 1999 regarding the method by which the appointment of ad hoc judges from the private sector can be requested by involved parties. IBRA will request ad hoc judges for future cases that are filed in the Commercial Court.

66.  The government recognizes that the ineffectiveness of the bankruptcy system stems from problems in implementation rather than from the structure of the law itself. Thus, only procedural changes in the law are anticipated in the near future (e.g., guidance on prepackaged bankruptcy procedures), and substantive changes to either the liquidation or suspension of payments (rehabilitation) chapters of the existing law are not judged necessary.

67.  Given slow progress in the past, the corporate restructuring strategy will be kept under continuous review. The Corporate Restructuring Advisory Committee (consisting of a representative group of debtors, creditors, IBRA and the JITF) has been consulted regarding the new mediation procedures to be adopted by the JITF and will continue to be consulted regarding the effectiveness of the strengthened strategy.

68.  Finally, sustainable progress in this area requires the adoption and implementation of a new and enhanced corporate governance framework. Progress is being made in adopting and implementing such a framework (Box 6). The high-level committee on corporate governance policy has made recommendations in a number of areas related to accountability, disclosure, enforcement, and oversight. Recommendations will be adopted by March 15, 2000 and implemented over the next six months.

69.  The new government has been carefully reviewing the privatization program. We are in the process of examining all of the completed privatization transactions, to assess whether they were handled satisfactorily in accordance with current laws and regulations and in line with best practice procedures. Based on this review, we will decide, by end-January 2000, how procedures could be further improved. The government has also been reviewing the privatization schedule of the masterplan for state enterprise reform and privatization. Particular attention was given to the privatization transactions that were scheduled to be completed during the remainder of 1999/2000; those transactions that remain sound and feasible under current market conditions will be expedited. Overall, we expect privatization revenue to amount to Rp 8.6 trillion during 1999/2000.

70.  Based on these reviews, and with the assistance of the AsDB, the government has prepared a soundly based privatization program for FY 2000, designed to yield Rp 5.9 trillion. The program will focus on enterprises—including small enterprises—operating in competitive markets where there is no compelling case for public ownership. The government is also preparing a liquidation plan for loss-making and heavily indebted enterprises that have no prospect of achieving commercial viability. This plan will be completed by end-March 2000 and fully implemented during FY 2000.

71.  Among the larger enterprises, the two publicly listed telecommunications enterprises, PT Telkom and PT Indosat, are strong candidates for further rapid privatization. Toward this end, as well as to promote private investment in the sector, we will (i) adopt a new tariff policy (by March 2000) and adopt new network interconnection rules; (ii) finalize the implementing regulations for the new Telecommunications law (by June 2000); (iii) finalize modern, new licenses for major operators, and (iv) establish an agency to provide transparent and predictable regulation. By end-2000, the government will also strive to reduce Telekom's and Indosat's extensive cross-ownership in the sector, and to secure a mutually acceptable resolution of the issues concerning the revenue-sharing contracts between PT Telkom and its private partners (KSOs). This resolution will be consistent with the new Telecommunications Law, and promote competition by enabling both Telkom and Indosat to evolve into competing full service providers.

72.  The government does not plan to establish holding companies for public enterprises, as such arrangements would dampen competition and slow privatization. Indeed, where appropriate, the government will unbundle monopolies and encourage effective competition. Plans for restructuring Pertamina and PLN are being prepared and will be accelerated (see below). A strategy to improve the performance of other state monopolies, including ports, airports, telecommunications, and toll roads, will be prepared by end-March 2000 with assistance from the AsDB and the World Bank.

73.  Concrete steps are being taken to require state enterprises to adhere to the same standards of corporate governance as required for listed companies. Accordingly, all state enterprises will be required to lodge their annual reports with the Company Registrar, with 1998 reports being lodged by March 2000 and 1999 reports by June 2000. The government will also ensure that all audits of state enterprises are disclosed to the public. For a group of 30 state enterprises, the government is preparing a plan (with the AsDB) whereby their annual financial audits would be conducted by independent auditors, and completed by end-2000. This plan will be extended to a further 30 SOEs in 2001.

74.  The government will continue the process of undertaking special audits for key enterprises and taking corrective actions in light of their results. Those with respect to Pertamina and Bulog were previously completed and their main findings made public. The audits for PLN and the Reforestation Fund have also now been completed and made public. A program of remedial actions for Bulog and the Reforestation Fund will be drawn up by January 2000, and implemented by mid-2000. Remedial actions for the problems identified at PLN and Pertamina will be addressed as part of the comprehensive restructuring of these enterprises (described below). The remedial actions will include the initiation of more narrowly focused investigative audits where judged necessary. Claims of subsidy payments by Pertamina, PLN, and BULOG will be audited no later than June 30, 2000, and budgetary arrears will be eliminated by then. Any over-statement of subsidy claims will be investigated.

75.  The government has identified a further list of major enterprises that will be subject to the next round of special audits which will also identify instances of corruption and other illegal practices. These enterprises include the national airline, the national toll road operator, the domestic telecommunications company, the public port corporations, and the major plantation companies. These audits will be conducted by international auditors and be completed by June 2000. Legal proceedings will be instigated in all cases where laws are revealed to have been broken and public losses incurred.

76.  The government is firmly committed to continuing and accelerating the initiatives already underway to resolve the deep-seated problems that are impairing the performance of the electric power and oil/gas sectors. The near-term policy agenda is summarized in Box 7.

77.  In the electric power sector, the restructuring policy announced in August 1998 maps out the actions needed to restore commercial viability, improve efficiency, and attract private investment. The government's agenda for the coming year includes the passage of a new electricity law, establishment of an independent regulatory agency, and adoption of a tariff restructuring plan designed to restore tariffs progressively to commercially viable levels while limiting the impact on the poorer segments of society. Toward this end, the FY 2000 budget is based on an increase in the average tariff; however, we will shield the poor from this increase during FY 2000, and will not raise tariffs for households with a connection of less than 450V.

78.  The government will also take steps to accelerate the corporate and financial restructuring of the electricity company, PLN. A new ministerial level PLN Restructuring and Rehabilitation Team was established on December 31, 1999 to guide and oversee the implementation process, as well as PLN's renegotiations with independent power producers (IPPs). PLN is in the process of selecting international management consultants to assist it to implement the restructuring, and an appointment will be made by March 2000. The government will ensure that the implementation program incorporates appropriate corrective actions for problems identified by the recently completed special audit.

79.  The government will take steps to accelerate efforts to negotiate solutions for reducing the massive financial burden imposed by the power purchase obligations. It is recognized that the handling of this issue will have ramifications that extend beyond the energy sector. Accordingly, the government will ensure that the new oversight team is adequately supported by competent legal, strategy, and other specialist advisors, and that PLN conducts negotiations on individual agreements within a soundly based and transparent policy and strategy framework. The oversight team will report progress to the World Bank, IMF, and AsDB on a monthly basis.

80.  In the oil and gas sector, the government is firmly committed to the following actions: replacing existing laws with a modern legal framework; restructuring and reforming Pertamina; ensuring that fiscal terms and regulations for exploration and production remain internationally competitive; allowing domestic product prices to reflect international market levels; and establishing a coherent and sound policy framework for promoting efficient and environmentally sustainable patterns of domestic energy use.

81.  The draft oil and gas law that was presented to the previous parliament will be reviewed and resubmitted with a view to its passage during 2000. This law will provide for the establishment of a special purpose agency to allocate acreage and supervise exploration and production contracts; the establishment of an independent agency to regulate monopoly elements of downstream businesses; the enabling of effective competition in the supply of fuels to the domestic market; and the transformation of Pertamina into a limited liability enterprise. In parallel, domestic fuel prices will be progressively increased so as to encourage more efficient energy choices and to phase-out the budget subsidy; toward these ends, an initial increase will be implemented for FY 2000. Low income households will be protected by targeted subsidy schemes that are being developed in close consultation with the World Bank.

82.  The government remains committed to building a world class oil and gas industry in which a reformed Pertamina will continue to play a key role. The recent special audit and an earlier internal management review commissioned by Pertamina identify clearly where performance needs to be substantially improved. The government will require Pertamina to develop and publicize, by March 2000, a comprehensive restructuring plan that will include corrective actions in all problem areas identified by the special audit.

Competition and Investment Policy

83.  In March 1999, the Law regarding Prohibition of Monopoly Practices and Unhealthy Competition (Competition Law) was enacted. By end-March 2000, we will fully establish the Commission for Business Supervision (CBS), which is designed to enforce the law; this will include appointing the Commissioners, and issuing all necessary implementing regulations. After a short period to give training to CBS staff and to disseminate information about the law to the wider public, enforcement of the new law will begin by end-July 2000.

84.  The government places the highest importance on improving the business environment and reviving foreign direct investment which declined precipitously during the crisis. We have completed a review of investment policies, with the assistance of the AsDB, and intend to reduce the number of sectors where foreign investment is prohibited by March 2000.

Agricultural Policy

85.  Our focus in agricultural policy will be to maintain food security and promote efficient production, processing, and marketing of agricultural products.

86.  A key aim of our rice policy framework will be to ensure food security by promoting competition in this sector. Accordingly, trade in all qualities of rice has been opened to general importers and exporters. However, with the strengthening of the rupiah and world price declines, domestic rice prices have been declining. Thus, there is a case for providing transitional protection to rice farmers through an import tariff, while balancing the impact on consumers. This tariff will be set at Rp 430 per kg and will apply only through August 2000, when we will review whether it is still needed. At the same time, we will also assess the BULOG procurement price, which acts as a floor price for rice.

87.  We are also preparing a strategy for a broader reform of our food security approach. Until such strategy defines future directions, BULOG will focus on procuring rice for its special subsidized rice program (OPK) and for emergency stocks. We expect that BULOG will balance this procurement between domestic and international markets, so as to strengthen demand for domestic supply during the peak harvest period. We are also preparing a strategy for a phased restructuring of BULOG, to follow up on the recommendations of the recent special audit. This reform will aim at a more transparent accounting system and efficient operating structure for BULOG through, inter alia, a change in its legal status.

88.  Agricultural input policy will emphasize competitive, private market delivery of fertilizers and rural credit. We will continue to liberalize fertilizer marketing by permitting general importers to engage in trade, by opening domestic marketing to new participants, and by preparing by end-February 2000 a plan for placing PT Pusri's domestic marketing capacity under autonomous management. Increased competition and a stronger rupiah should result in lower domestic fertilizer prices, and so no reintroduction of fertilizer subsidies is planned. However, for social reasons, we will continue with subsidies for transportation and fertilizers to remote areas, as identified by decree.

89.  With a return to normal agricultural conditions, we propose to revert as quickly as possible to meeting farmers' credit needs through the commercial banking system. As an interim measure, twelve domestic banks have committed to financing KUT credits of Rp 1.9 trillion for the current planting season (through March 2000). This constitutes the ceiling under the scheme, and no new funds will be raised under this scheme. From April 1, 2000, the working capital needs of farmers will be met by commercial banks only. Such banks will bear all the risks of nonrepayment of principal and will be given full independence in making credit decisions. All lending quotas and targets will be eliminated. In parallel, we will develop a strategy jointly with the AsDB and the World Bank to improve the rural credit system. Work on this strategy will be completed by end-June 2000 and implementation will begin on September 1, 2000.

90.  For sugar we will pursue a policy of restructuring the domestic industry by consolidating the number of sugar factories on Java and promoting private sector-led investment off-Java in new capacity. To achieve this, by end-January, we will replace the decree (expiring end-December 1999), that limits imports to selected traders, with a 25 percent tariff to be phased down over 3 years and, at the same time, open sugar trade to all general importers. We also are committed to closing a minimum of four sugar factories once the crushing season is completed in 2000. By June 2000, we will prepare, in consultation with the World Bank, a plan to consolidate the rest of the Java-based sugar industry; the plan will include detailed and time-bound factory restructuring, privatization or closure plans, as well as budget costs and implementation mechanisms. Firms implementing their restructuring plans according to schedule will be provided with adequate budgetary resources to subsidize operations and closing costs for a limited period. We also reiterate our commitment to farmers being free to make their own crop choices.

Forestry

91.  On November 9, 1999, the Ministry of Forest and Estate Crops (MoFEC) launched a strategic planning and consultative process to establish a National Forest Program. This process should provide the mechanism for stakeholder participation in future policy and regulatory decisions by MoFEC. The initial design work for the process is being carried out by two groups of stakeholders, supported by the Consultative Group on Indonesian Forestry; preliminary results of these proposals are expected by end-February 2000. The government will ensure adequate support in implementing the consultative mechanism; thus, we will convene a high-level meeting on forestry on January 26, 2000, and establish a ministerial working group to deal with forestry issues.

92.  The project to determine where forests still exist is proceeding well, with updated maps of forest cover completed for Kalimantan, Sumatra, and Sulawesi. Making the results publicly available is an essential next step, to increase awareness of the perilous state of the forests and allow interested stakeholders make informed decisions. MoFEC has made the maps and statistics for Kalimantan and Sumatra available to the public on its website; it will add Sulawesi by December 31, 1999 and the other provinces as they are completed. MoFEC continues to observe its moratorium on new forest conversion licenses. It will do so until transparent, rules-based procedures are developed to minimize further conversion of the remaining natural forest.

Environment

93.  The government is committed to increasing urban air quality. A high-level Steering Group chaired by the Minister of Communications, and an Implementation Team chaired by the Director General of Land Transport, were formally established in June 1999 to coordinate Indonesia's conversion to cleaner vehicle fuels. In October 1999, the government tightened vehicle fuel specifications and mandated the elimination of lead in gasoline by January 2003. In moving toward that objective, we will continue with the earlier plan to convert to unleaded gasoline in a geographically-phased manner, with Jakarta the first priority.

94.  We are also accelerating the implementation of the Environmental Management Law (Number 23 of 1999). Until now, only four of the nineteen implementing regulations had been issued, but by December 31, 2000 we will promulgate five new regulations, including the one for water pollution control. At least five additional regulations will be issued by December 31, 2001, and the remainder will be issued in 2002. Finally, the Reforestation Fund will only be used for maintaining natural forests and for reforestation; transparent criteria and budgeting procedures to upgrade this Fund will be developed by the Ministry of Forestry and the MOF, in consultation with the World Bank, and will be implemented beginning April 1, 2000.

Small and Medium Enterprise Policy

95.  The government is committed to empowering small and medium enterprises (SMEs). However, we recognize that many current SME support programs have failed to meet the needs of the SME community. We are thus committed to reevaluating government interventions so as to increase private sector involvement in SME support programs.

96.  A government task force is preparing a medium-term SME strategy with the assistance of the AsDB and World Bank. An Action Plan is being developed, which provides for the following to be completed by March 30, 2000: (i) developing an institutional framework for SME policy implementation; (ii) making business development services more responsive to SME needs; (iii) expanding access to finance for SMEs; (iv) streamlining government regulations affecting small and medium businesses; and (v) monitoring and evaluation of government SME programs.

97.  The role of BI in funding and administering SME credit schemes has been eliminated. The SME credit schemes have been transferred to BRI, PT Madani and BTN. By December 31, 1999, PT Madani has finalized plans for consolidating SME credit lines to two, at most, and program parameters will be consolidated. Then new credit lines will be introduced on April 1, 2000, and will be based on commercial principles with full risks of nonpayments being borne by participating banks. Any interest rate subsidy will be supported by adequate provisions in the budget. In addition, by June 30, 2000, Bank Indonesia will announce a plan to phase out mandatory requirements on commercial bank lending to SMEs.

98.  SMEs as well as larger firms need access to trade finance in order to compete in international markets. The government has created a new institution, Bank Expor Indonesia with the aim of expanding access to trade finance. By March 31, 2000, the government will present the Law on Bank Expor Indonesia to Parliament, establishing BEI as an independent Export Credit Agency for Indonesia.

Net domestic assets (NDA) of BI are defined as the difference between base money and net international reserves of BI (NIR) as defined in Annex III, converted into rupiah at an accounting exchange rate of Rp 7,000 per U.S. dollar. Base money is defined as currency in circulation, bank deposits at BI in rupiah, private sector demand deposits at BI, and the aggregate reserve deficiency. The aggregate reserve deficiency is defined as the amount by which aggregate statutory reserves against rupiah third party liabilities exceed bank deposits at BI. Net domestic assets, base money and NIR at the test date will be measured as the average of its value on the last business day of the month, the four preceding business days, and the five following business days.

The NDA targets will be subject to the following adjustors:

(i)  In the event of shortfalls of balance of payments support from that assumed in Annex IV, NDA will be adjusted upward by the rupiah equivalent of the shortfall, up to a maximum of US$1.0 billion.² NDA will be adjusted downward by the rupiah equivalent of any excess of balance of payments support over that set out in Annex IV.

(ii)  The limits will be adjusted downward by the rupiah equivalent of the amount by which BI deposits in foreign branches of Indonesian banks exceed US$2.5 billion.²

(iii)  BI will not extend any new pre-shipment export drafts. Otherwise, the floor will be adjusted downward by the rupiah equivalent of the amount of any new pre-shipment export draft over the end-November level (US$0.6 billion). The volume of post-shipment export drafts will be capped at the rupiah equivalent of the end-November 1999 level (US$1.3 billion). The floor will be adjusted downward by the rupiah equivalent of the amount of any excess over the end-November 1999 level.²

(iv)  Changes in reserve requirements will modify the NDA ceiling according to the formula:

NDA = (rB₀ + r₀B + rB)

where NDA denotes the change in the ceiling on NDA of BI; r₀ denotes the reserve requirement prior to any change; B₀ denotes the rupiah reservable base in the period prior to any change; r is the change in the reserve requirement ratio; and B denotes the immediate change in the rupiah reservable base as a result of changes in its definition.

2.  Indicative Targets on Base Money

Base money is defined above. The target on base money will also be adjusted by changes in reserve requirements according to the same adjustor applied to NDA in the previous section.

ANNEX II

Government deposits in foreign exchange as of March 31, 1999 will be evaluated at constant exchange rates (Annex IV). Monthly changes in government foreign currency balances will be converted into rupiah at the average exchange rate prevailing for that month.

(i) the U.S. dollar value of gross foreign assets in foreign currencies minus gross liabilities in foreign currencies; (ii) the net forward position of BI; and (iii) reserves against foreign currency deposits. NIR will be measured on a 10-day average basis (see Annex I).

Gross foreign assets will include all foreign currency-denominated claims of BI, including monetary gold, holdings of SDRs, and the reserve position in the IMF. Excluded from gross foreign assets will be participation in international financial institutions, as well as holdings of nonconvertible currencies, and claims on residents. Gross foreign liabilities are all foreign currency denominated liabilities of contracted maturity up to and including one year plus the use of Fund credit. All assets and liabilities will be valued using the exchange rates and gold price shown in Annex IV.

The net forward position is defined as the difference between the face value of foreign currency-denominated BI off-balance sheet claims on nonresidents (forwards, swaps, options, and any futures market contracts) and foreign currency obligations to both residents and nonresidents.

The NIR floors will be subject to the following adjustors:

(i) In the event of shortfalls of balance of payments support from those assumed in Annex IV, NIR will be adjusted downward by the amount of the shortfall, up to a maximum of US$1.0 billion.² NIR will be adjusted upward by the amount of any excess of balance of payments support over that set out in Annex IV.

(ii) The floors will be adjusted upward by the amount by which BI deposits in foreign branches of Indonesian banks exceed US$2.5 billion.

(iii) BI will not extend any new pre-shipment export drafts. Otherwise, the floor will be adjusted upward by the amount of any new pre-shipment export draft over the end-November level (US$0.6 billion). The volume of post-shipment export drafts will be capped at the end-November 1999 level (US$1.3 billion). The floor will be adjusted upward by the amount of any excess over the end-November 1999 level.

The adjustors and definition of NIR will be subject to review to take account of new sources of financing not anticipated under the program.

2.  Performance Criterion on Contracting or Guaranteeing of New External Debt

The limit applies to the contracting or guaranteeing by the non-financial public sector of new nonconcessional external debt with an original maturity of more than one year, which is defined as loans containing a grant element of less than 35 percent on the basis of currency-specific discount rates based on the OECD commercial interest reference rates. Excluded from the limits are credits extended by the IMF and balance of payments support loans, and guarantees related to financial sector and debt restructuring in the context of the Frankfurt agreements. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time the contract is entered into, or guarantee is issued.

3.  Performance Criterion on the Stock of Short-term Debt Outstanding

The limits apply to the stock of debt of maturity of one year or less, contracted or guaranteed by the non-financial public sector. Excluded are balance of payments support loans, normal import-related credits, reserve liabilities of Bank Indonesia, forward contracts, swaps, and other futures market contracts, and guarantees related to debt restructuring in the context of the Frankfurt agreements.

4.  The non-accumulation of external arrears during the program period will constitute a performance criterion and will apply on a continuous basis.

ANNEX IV