For more information, see Indonesia and the IMF

The following item is a Letter of Intent of the government of Indonesia, which describes the policies that Indonesia intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Indonesia, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.
 
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Jakarta, Indonesia
March 16, 1999

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

Dear Mr. Camdessus:

Steady progress continues to be made in implementing the Government of Indonesia's economic program, supported under an extended arrangement from the Fund, and set out in the Memorandum of Economic and Financial Policies (MEFP) of July 29 and in the Supplementary Memoranda of September 11, October 19, and November 13, 1998. We have taken a number of additional steps to strengthen the program, especially banking system and corporate restructuring, described in the attached Supplementary MEFP.

We met the performance criteria for end-December 1998 for net domestic assets of Bank Indonesia, overall central government balance, net international reserves of Bank Indonesia, the contracting of new external debt with an original maturity greater than one year, and the stock of short-term external debt. We met the indicative targets for end-January 1999 and end-February 1999 for net domestic assets and net international reserves. The end-January target for the central government balance was also met; data for end-February are not yet available.

We request a waiver for the nonobservance of the structural performance criterion to reduce the export tax on logs and sawn timber to 20 percent at end-December 1998. This measure has now been implemented.

We have set end-March and end-May performance criteria for the full set of monetary, fiscal and external variables, and indicative targets for the rest of 1999/2000. We have also set key structural performance criteria and benchmarks through September 1999.

We request that the arrangement be augmented by the equivalent of SDR 714 million and that the purchases scheduled through end-1999 be rephased and would consequently be subject to reviews to be completed by May 15, 1999, July 15, 1999, September 15, 1999, and November 15, 1999.

We believe that the policies set forth in the attached MEFP are adequate to achieve the objectives of the program, and will take any additional measures necessary for this purpose. During the remaining period of the arrangement, the authorities of Indonesia will maintain close contact with the Fund and will consult on the adoption of any measures that may be needed in accordance with the Fund's practices on such consultations. We will also provide the Fund with such information as it requests on policy implementation and achievement of program objectives.

Sincerely yours,
For the Government of Indonesia,

/s/


Ginandjar Kartasasmita
State Coordinating Minister
For Economy, Finance, and Industry

Jakarta, Indonesia
March 16, 1999

Indonesia

Supplementary Memorandum of Economic and Financial Policies

Fourth Review Under the Extended Arrangement

  1. Progress continues to be made in implementing the Government of Indonesia's economic program, despite difficult domestic and external conditions. The recent volatility in the rupiah has underscored the fragility of the economic situation and the imperative of adapting the program to consolidate the stabilization gains already achieved. At this review, the government has developed a macroeconomic framework for 1999/2000, and bank resolution and corporate restructuring policies have been strengthened (see Boxes 1 and 2); policy actions also continue to be guided by the matrix shown in the November 1998 MEFP. The program continues to be developed in consultation with the IMF, World Bank, and the Asian Development Bank (AsDB).


  2. I. RECENT DEVELOPMENTS

  3. The macroeconomic targets of the program for 1998/99 remain within reach. The decline in real GDP is still estimated at 16 percent, while average inflation should be contained at about 66 percent, close to the program projection. Despite the recent depreciation of the rupiah, we expect that the average exchange rate for 1998/99 will be more appreciated than the original assumption under the program (Rp 10,600 to the U.S. dollar). The restoration of gross official reserves has proceeded somewhat better than earlier projected. These achievements are testimony to the resolute implementation of macroeconomic policies, although a number of constraints will contain the budget deficit well below the program target (paragraph 8).


  4. Careful management of the rice situation, along with the improved macroeconomic environment, has contributed to lower retail and wholesale prices for rice. Public stocks of rice are adequate, and will be boosted by contracted import deliveries. Related policy initiatives agreed with the World Bank include: (i) the recent elimination of BULOG's exchange rate subsidy for imports of rice; (ii) a public procurement floor price policy that will aim at keeping domestic rice prices broadly in line with world prices; and (iii) the unhindered import of rice by the private sector. Most eligible families (7-8 million) benefited immediately from the decision to double the subsidized rice ration with effect from December 1, 1998.


  5. The social impact of Indonesia's crisis is serious and of great concern. Recent evidence points to the increase in poverty being more unevenly spread by region and income level than previously assessed. Urban areas, especially in Java, have been the worst hit. Those with less linkages to the formal economy, in the outer islands, or involved with the production of export commodities have experienced less adverse effects. While most of Indonesia's workforce is still engaged in agriculture, and many more have been absorbed in the informal sector since the crisis began, formal urban employment has fallen considerably, accompanied by substantial declines in real wages.


II. MACROECONOMIC FRAMEWORK AND POLICIES FOR 1999/2000

Output, Prices, and Balance of Payments
  1. The key objectives of the 1999/2000 macroeconomic framework are as follows:


    1. Our central projection is for real GDP in 1999/2000 to be about unchanged, based on the expectation that the economy will bottom during the first half of the fiscal year, and that a modest recovery will begin thereafter.


    2. Average inflation is expected to be contained in the 15-20 percent range during 1999/2000, with a monthly inflation rate of under 1 percent in the last quarter of the fiscal year.


    3. The balance of payments is also anticipated to improve steadily. Export volume growth should contribute to a somewhat larger external trade surplus in 1999/2000. In addition, external financing from bilateral and multilateral sources for the budgetary program is expected to remain strong. Gross external reserves are expected to increase to a more comfortable level of about $29 billion.


    4. In support of the above objectives, we also expect that an agreement with external private creditors will be reached on a second interbank exchange offer to cover maturities falling due in 1999/2000. To this end, a meeting of the Steering Committee is expected to be held in the coming weeks.


    However, a number of domestic and external risks apply to this outlook, and the macroeconomic framework will need to be reviewed regularly to ensure that policies remain consistent as the outlook evolves.

Monetary and Exchange Rate Policy

  1. Maintaining market confidence in the economic program and, in particular, in the demand for domestic financial assets is crucial to delivering the above macroeconomic objectives. We reaffirm our commitment to keep base money firmly under control so as to stabilize prices and reduce volatility in the exchange rate. The level of the exchange rate will remain market determined.


  2. Thus, we have reviewed and adjusted the monetary program. For the period immediately ahead, and until there is more evidence of stabilization, monetary policy will be guided by a very cautious assessment of money demand. Base money, which rose in late February because of uncertainty regarding the bank restructuring process, is being brought down, and we expect base money to be within Rp 74.5 trillion by March 31, 1999, somewhat lower than the original base money indicative target (Table 1). This adjusted monetary program has already resulted in some firming of interest rates and is expected to contribute directly to an appreciation of the rupiah toward the assumption incorporated in the 1999/2000 budget. Beyond that, the 1999/2000 monetary program allows base money expansion of about 14 percent and accommodates some recovery in the demand for money during the fiscal year, as confidence in the currency and the banking system return (Table 2).


Fiscal Policy, Development Spending, and Social Safety Net

  1. Fiscal policy became expansionary in the second half of 1998/99, primarily because of higher social expenditures. However, the overall growth in spending is much less than expected, slowed by efforts to strengthen monitoring, limit leakages, and ensure accountability; official external financing has also fallen below program projections. In addition, interest outlays on bank restructuring will be less than budgeted, mainly because of delays in issuing bonds. Toward reducing untargeted subsidies, fertilizer subsidies were eliminated effective December 1, 1998; electricity tariffs to 55,000 large household users were increased by about 40 percent in December 1998; and aviation fuel subsidies were eliminated on February 1, 1999. These factors more than offset the lower-than-expected receipts from the privatization program (paragraph 16), and the loss of revenue from the reduction in the palm oil export tax (effective February 1, 1999) to a range of 15-40 percent for different products (from 35-60 percent). The overall budget deficit is now forecast to be about 4 percent of GDP, well below the program target of 8.5 percent of GDP.


  2. The 1999/2000 budget, which has now been approved by Parliament, has four main objectives. First, it incorporates a high-quality targeted fiscal stimulus to support demand, especially through higher development spending. Second, steps are being initiated to rebuild the revenue base over the medium term. Third, gross interest costs of bank restructuring of about 3 percent of GDP have been incorporated in the budget. Fourth, the traditional principle of avoiding domestic bank financing for regular budgetary operations will be maintained, if necessary, by invoking contingency measures. Government bonds will be issued only for bank recapitalization.


  3. The overall budget deficit is projected at nearly 6 percent of GDP in 1999/2000. This assumes that the exchange rate averages Rp 7,500 per dollar and depends on realizing privatization proceeds of Rp 13 trillion. The deficit is expected to be financed from external sources and bank asset recoveries of Rp 17 trillion. The underlying revenue situation has become more difficult, and is now a source of considerable concern, beyond its cyclical decline related to weak world prices and the weak state of the economy. As a first step to rebuilding the revenue base, we have appointed an inter-departmental task force to report within two months on the efficacy of all existing and recently announced tax incentives. This study is being undertaken with the assistance of the IMF. Until this study is available, we will not introduce any additional tax incentives. A new tax administration program will be adopted during 1999 with IMF technical assistance, including the strengthening of audits, better control of large tax payers, and improvements in import processing procedures.


  4. Development spending is projected at 5 percent of GDP in 1999/2000, about one percentage point more than the expected outcome for this year. Emphasis has been placed on efficient social safety net programs, and details are under discussion with the World Bank in the context of a proposed safety net adjustment loan. Expenditures in the first quarter of the fiscal year will be boosted by administrative steps already taken to extend into the new fiscal year spending authority on undisbursed expenditure allocations for social safety net programs from 1998/99. Care has been taken to exclude large capital-intensive and import-intensive public investment. We have ensured adequate funding for the most successful and cost-effective programs, including stay-in-school, supplementary school feeding and nonformal education. A five-point program will be adopted to improve the design, implementation and monitoring of the social safety net by (i) adjusting the geographic targeting of expenditure in light of new information on the differing regional effects of the crisis; (ii) transferring responsibility for most key safety net programs to local communities; (iii) ensuring the cost effectiveness of programs; (iv) launching adequately funded monitoring campaigns for all key programs; and (v) strengthening high-level, independent monitoring and implementation involving representatives of civil society.


  5. We do not expect that a formal mechanism for the regular adjustment of administered prices, including fuel and electricity, will be in place as previously envisaged by April 1, 1999, although we remain committed to such an approach over the longer term. In the meantime, through regular ministerial level reviews, we will minimize differentials with world market prices by more frequent adjustments on an ad-hoc basis. Meanwhile, untargeted fuel, electricity and interest rate subsidies are budgeted at less than 2 percent of GDP in 1999/2000.


  6. The budgetary framework for 1999/2000 is critically dependent on the timely availability of external financing. The framework anticipates additional official external support of about $5 billion, in addition to the project aid that is already committed, as well as implementation of the restructuring agreement with official creditors. We are confident that the full amount of official external financing will be available for the fiscal year as a whole.


  7. A number of risks apply to the budgetary framework. The revenue and expenditure situation will need to be monitored very closely in light of developments in the real economy and external financing. Additional measures to raise revenue and reduce expenditure (excluding social sector spending) will be taken, if necessary, to adhere to the announced framework. Possible revenue measures include higher excise taxes on selected commodities, reductions in import duty and other tax exemptions, and a wider coverage of VAT. These measures could raise full-year revenue by about 1-1 percent of GDP. Possible expenditure reduction measures could include untargeted subsidies.


  8. Fiscal and administrative decentralization pressures have also increased as part of the ongoing political transition. While essential to meet the legitimate demands of regional governments for greater control over financing and expenditure responsibilities, such decentralization will be implemented without endangering the macroeconomic framework. Fiscal decentralization legislation that is now in Parliament has been coordinated closely with the IMF and the World Bank. This legislation recognizes the importance of careful sequencing of decentralization reforms, with administrative decentralization and expenditure assignments preceding the revenue assignments.


III. PRIVATIZATION, STATE ENTERPRISE AUDITS AND POWER SECTOR RESTRUCTURING

  1. The privatization program has fallen behind schedule this year, principally because market conditions remain unfavorable. We have so far concluded two transactions totaling close to $200 million in the current fiscal year, through the sale of shares in a cement producer and a food processing company. We have made intensive efforts to divest, by end-March 1999, majority interests in a Jakarta container terminal concession company, and minority interests in the Jakarta airport concession company, the largest palm plantation company in Indonesia, and further shares in international telecommunication and mining companies, consistent with the target of $1 billion for the year. The key to this is the sale of further shares in the international telecommunication concern. However, delays have been experienced because policies concerning future market structure, cross-ownership, and regulation still need to be decided and the operator license finalized; this is planned for completion in the next 1-2 months.


  2. The privatization program for 1999/2000 is based on the recently published Master Plan which outlines the program and processes for the divestiture of all of the present 150 state enterprises over the medium term, except for a specified short list. Targeted receipts from privatization are the equivalent of $1.5 billion or 1 percent of GDP in the next fiscal year. The list of individual enterprises gives priority to those originally planned for privatization this fiscal year. In total, it is intended to sell stakes in 11 enterprises including toll roads, the Bali airport, ports, the domestic telecommunication concern, fertilizer and cement producers, a steel company, and plantations, in addition to privatizing several small enterprises.


  3. The Government has already clarified that strategic foreign investors are permitted to secure management control, even in cases where the sale of equity investment to foreigners in state enterprises is limited to less than 49 percent. There is no legal limit to foreign equity investment and we will generally be prepared to allow majority interests, unless strategic or national security interests are involved.


  4. The Government engaged international accounting firms in December 1998 to undertake special audits of Pertamina, PLN, and BULOG focusing on assessing the efficiency of operations, capital budgeting and financing, and on identifying possible fraudulent and corrupt practices. These audits cover the five-year period 1994 to 1998 for Pertamina and PLN and 1993/94 to 1997/98 for BULOG. Work is expected to be completed as agreed by end-June 1999. A special audit is also being commissioned for the Reforestation Fund, jointly with an international accounting firm, and will be completed by end-June 1999. The future role of the Reforestation Fund is currently under review and will be determined shortly in consultation with the World Bank. In future, we also intend to subject all enterprises scheduled for privatization in the Master Plan to financial compliance audits of international standards so as to improve credibility and investor confidence and, thereby, enhance sale values. Where considered appropriate, additional special audits may also be commissioned.


  5. The Government intends to restructure the power sector to improve efficiency and reduce the fiscal burden. With the support of the World Bank and AsDB, the government will (i) establish the legal and regulatory framework to create a competitive electricity market; (ii) restructure the organization of PLN; (iii) adjust electricity tariffs; and (iv) rationalize power purchases from private sector power projects. The government has commenced renegotiations with independent power producers; will initiate the organizational restructuring of PLN by June 1999; and will enact a new Electricity Law by December 1999.


IV. BANKING SECTOR REFORMS

  1. Banking reforms have entered a decisive stage. The resolution strategy has been elaborated, and implementation is moving ahead, in all the four major areas: (i) state bank resolution; (ii) private bank recapitalization; (iii) resolution of banks under IBRA control; and (iv) improvement of the legal, regulatory, and supervisory framework. The strategic objectives are contained in Box 1, and structural benchmarks are shown in Table 3. Overall responsibility rests with the inter-ministerial Financial Sector Action Committee, which will meet as frequently as necessary to monitor progress in line with the commitments of this memorandum.


State Bank Resolution

  1. We have agreed on the following principles for state bank resolution: (i) the capitalization of Bank Mandiri and the recapitalization of the other state banks will follow operational restructuring, namely, the implementation of decisions regarding downsizing staff, branches, and functions, and the intensification of asset collection; (ii) clear deadlines will be set for key elements of restructuring and asset recovery so that capitalization or recapitalization can proceed in step with compliance with the deadlines; and (iii) actions for asset recovery are being intensified against the largest delinquent borrowers.


  2. On the basis of these principles, the framework for the resolution of four previously separate state banks (Bapindo, Bumi Daya, BDN and EXIM) and the creation of Bank Mandiri (expected to comprise 30 percent of banking system deposits) has been finalized. It provides for the phased capitalization of Bank Mandiri, beginning in May 1999, and to be completed as far as possible by end-December 1999 and no later than March 2000 (consistent with the budgetary framework). Capitalization will be in step with the resolution and integration of the four component banks, and after finalizing decisions regarding staff and branch rationalization, and making substantial progress toward their implementation. Thus, Bank Mandiri will be kept solvent and profitable at all times. Unresolved branches and staff will be retained in their parent banks until their resolution can be completed. The eventual merger of Mandiri and the four component banks will be at the end of the process, expected no later than March 2000, after redundant staff and branches have been separated from the component banks. All aspects of the resolution and integration process are being designed and implemented with the assistance of a major international bank under a letter of engagement with the government of Indonesia.


  3. As part of the Bank Mandiri restructuring process, portfolio reviews of the four banks have been completed. The loss loans of the four component banks will be transferred to the Asset Management Unit (AMU), and their non-loss nonperforming corporate loans will be sold to the AMU at net book value, by March 31, 1999. It is anticipated that the non-loss loans will be collected by Bank Mandiri under a servicing contract. Corporate performing loans will be transferred to Mandiri by May 1999. Deposits and other performing loans of the four banks will be transferred to Bank Mandiri after operational restructuring of the four component banks has been completed (as far as possible by December 1999 and no later than March 2000). A voluntary redundancy and severance plan has been presented to the staff of the component banks with the aim of completing the phased downsizing of staff by December 1999, in line with the integration of the four banks. Meanwhile, centralized control over the treasury operations and credit functions of the four banks, particularly over all new lending and work-outs of existing loans, is expected to be achieved by end-May 1999; the new management structure is already operational.


  4. Three additional state banks await restructuring: BNI, BRI, and BTN. We have already established an inter-departmental planning committee (including Bank Indonesia) to prepare a detailed blueprint, on the basis of the above principles, and with the assistance of international consultants. A comprehensive restructuring plan for each bank will be prepared by March 31, 1999, for consultation with the IMF and the World Bank, and will be publicly announced in April. Loss loans will be transferred to the AMU by March 31, 1999. We will take all necessary steps to facilitate restructuring. Our strategic objective is to complete the restructuring of the banks by September 30, 1999. Recapitalization will be phased, and only take place after implementation of the agreed restructuring programs.


  5. As indicated above, debt recovery efforts are being intensified. In particular, each state bank (including banks and assets controlled by IBRA) has targeted its 20 largest delinquent corporate borrowers for loan recovery, restructuring, or bankruptcy filing. This effort will be facilitated by the earliest transfer of loss loans to IBRA's AMU, and this transfer will be completed by March 31, 1999 for the four component banks of Bank Mandiri. Bankruptcy filings will take place by April 30, 1999 against recalcitrant debtors (paragraph 40). The process of debt recovery will be carried out with full transparency.


Private Bank Restructuring

  1. We have announced on March 13, 1999 which private banks qualify for recapitalization in line with the previously approved government program. These banks could contribute to retaining an element of private ownership and management in the banking system. We have maintained transparency in the private bank recapitalization program by reaching recapitalization decisions on the basis of pre-specified criteria, and have required unanimity in the three interagency committees responsible for the evaluations (each including Bank Indonesia, Ministry of Finance, and IBRA). The interagency committees and the Financial Sector Action Committee consulted closely with the IMF, World Bank, and AsDB throughout the process.


  2. We have determined that 73 A category private domestic banks (i.e., with capital adequacy ratios (CARs) above 4 percent), comprising about 5 percent of bank deposits, have no need to participate in this program. The evaluation committees have unanimously verified the cash injections in those banks that have needed new capital in order to be classified in the A category, and have made an initial determination of these banks' compliance with the fit and proper test for owners and managers. All A category banks will be subjected to comprehensive review of business plans (as was done for the B category banks), audits of the additional capital injections, and the fit and proper test by April 21, 1999, to confirm their eligibility to A category status. Thereafter, there will be regular six-month reviews of all banks to ensure their continued compliance with the highest prudential standards, using audits by international accounting firms for the foreign exchange banks.


  3. Business plans for all 38 B category banks (those with CARs below 4 percent but above minus 25 percent) were reviewed and the eligibility for recapitalization of 9 banks, comprising about 12 percent of bank deposits, was approved unanimously by the interagency evaluation committees. The successful B category banks will need to provide their share of new capital in cash from unborrowed resources, in the case of listed banks after shareholders' meetings. In this way, all necessary audits and the investment contracts for the 9 banks will be completed by mid-May 1999 and the banks fully recapitalized by June 30, 1999. We have issued the necessary decrees regarding the government's share of the banks' recapitalization and will specify the terms and conditions for the issuance of government bonds by March 25, 1999. The government's stake will be in the form of common stock; however, written contracts with each bank will ensure that the government's role will be limited to strategic decisions, will provide the private bank owners with full autonomy for all business decisions, and that the private owners will have the first right to buy back the shares within a three-year period (Box 2). Bank Indonesia has established procedures to ensure full compliance with the banks' commitments under their business plans and investment contracts, including settlement of all excess connected lending in line with the prudential norms on connected lending. If a bank fails to comply with its commitments, the government may exercise full ownership rights.


  4. Seven B category banks have been taken over by IBRA and will be restructured quickly to minimize the public cost of their resolution. Although these banks did not qualify for the recapitalization program, the public interest favored their being kept open and restructured in light of their large depositor base (over 80,000 accounts, amounting to 2  percent of bank deposits) and to minimize the disruption of banking services. However, their owners' right have effectively been fully revoked and their managements will be reviewed and replaced as judged necessary by IBRA; previous owners will still need to reach settlements with IBRA on connected lending obligations.


  5. Twenty-one B category banks and all 17 C category banks with a total of about 5 percent of bank deposits, which did not qualify for participation in the recapitalization program, or meet the public interest need for takeover, have been closed, effective March 13, 1999. We have taken all possible arrangements to avoid any disruption to depositors in these banks who have been fully protected through the transfer of their deposits to designated banks. Previous owners of these banks are required to reach settlements with IBRA on connected lending. Finally, a decision regarding one bank is still pending verification of its ownership status and will be settled within one week.


IBRA-Related Restructuring

  1. Obstacles that have delayed the liquidation process for the 10 banks frozen in April and August 1998 have been resolved. The government has issued the necessary bonds to BI related to previous BI liquidity support to these banks, and promulgated the implementing regulations to the Banking Law, notably those relating to the establishment of IBRA. These actions were needed to complete the transfer to the AMU of the assets of the ten banks. For those banks not listed on the stock exchange, Bank Indonesia has revoked the licenses, and the banks are being liquidated. For the banks that were publicly traded, a formal request for delisting will be made by March 25 prior to liquidation of the banks, and after the necessary shareholder meetings. IBRA's AMU has finalized plans for managing its assets, to maximize recovery. We will ensure that the AMU is fully financed at all times.


  2. The restructuring of the four remaining functioning banks taken over by IBRA in 1998--BCA, Danamon, Tiara Asia, and PDFCI--is the next major task for IBRA. Their restructuring plans will be prepared by March 31, 1999, with the assistance of international banks or international financial advisors, for discussion with the World Bank and the IMF. In the case of BCA, we have already strengthened its management, and anticipate private participation in its ownership structure over the course of 1999. Bank Danamon is being downsized and restructured, and prepared for early privatization. In line with earlier announcements, Bank Tiara and PDFCI will be sold by April 30, 1999, or merged with Bank Danamon.


  3. The holding company structure for receiving assets from the former owners of 10 banks closed or taken over by IBRA in settlement of their obligations to the government arising out of liquidity support and connected lending has been established. The assets received from the former owners of six (BCA, BDNI, Danamon, BUN, Subentra, and Surya) out of the 10 banks where irregularities have been discovered so far are being transferred to their respective holding companies, and the process will be completed by June 30, 1999. The prospective settlement in the case of one other bank is expected shortly, pending resolution of some technical issues. In cases where the government has been unable to reach agreement on settlement terms, the government will prosecute the former owners involved in irregular practices.


Legal, Regulatory, and Supervisory Framework

  1. We recognize that the legal, regulatory, and supervisory framework needs to be substantially reformed to establish the strongest possible basis for the emergence of a sound banking system. The Central Bank Law has been submitted to Parliament and is expected to be passed by mid-April 1999, and eight prudential regulations have been issued as previously envisaged. All of these have been reviewed by the IMF, the World Bank, and the Asian Development Bank.


  2. The implementing regulations to the banking law amendments clarifying that all legal and administrative restrictions to the entry of foreign investment into the banking system have been removed, will be issued by March 25, 1999, after consultation with the international finance institutions. It has been confirmed that BAPEPAM (the capital market supervisory agency) regulations are not in conflict with the banking law amendments on this issue. In August 1998, BAPEPAM issued a regulation permitting the use of non-rights issues (direct placements) for raising capital under certain specified conditions. It has been confirmed that this regulation remains available for those banks participating in the recapitalization program to undertake a capital increase without giving pre-emptive rights to shareholders; this should facilitate recapitalization by outside investors in the present bank restructuring.


  3. Notwithstanding progress achieved so far, a second phase of review of the financial and regulatory framework is planned. In the light of experience, we are prepared to make any additional modifications that may be needed, specifically to ensure the full effective functions of IBRA to which the Government is firmly committed, and to modify the confiscatory provisions presently in the Banking Law. We will conduct an assessment of the framework with IMF and World Bank assistance, by June 30, 1999.


V. CORPORATE RESTRUCTURING AND BANKRUPTCY REFORM

  1. Corporate restructuring and banking reform are interdependent; a strengthened corporate sector will also help reverse continuing negative spreads experienced by most banks. Further progress has been made in implementing the Jakarta Initiative. Over 125 companies are now seeking assistance from the Jakarta Initiative Task Force in the context of $17.5 billion of foreign currency debt and Rp 7.8 trillion in domestic currency debt. These firms employ approximately 220,000 people. Under the Jakarta Initiative, 15 companies have reached some form of arrangement with their creditors, addressing about $2.0 billion in foreign currency debt and Rp 600 billion in domestic currency debt. These firms employ about 17,000 people. One large company has reached an agreement in principle with its creditor committee. Several debt restructuring deals involving small and medium enterprises have been completed, and AsDB assistance will be provided to help with future similar deals. Other deals are expected in the coming months as a wide range of companies try to benefit from the INDRA scheme. The government has provided the rupiah equivalent of $3.5 million in start-up, counterpart funds, enabling the Jakarta Initiative Task Force's staffing situation to improve significantly. The corporate restructuring framework is being strengthened further with the support of a $2 million advance on a World Bank technical assistance loan that has been submitted for World Bank board approval. Additional steps have been taken to ensure efficient project management and smooth implementation of the technical assistance loan in accordance with World Bank procurement procedures. The Indonesian Private Sector Debt Settlement Team has overall coordinating authority for INDRA, the Jakarta Initiative Task Force, and Bank Indonesia in addressing the restructuring of private corporate sector debt. Although closely coordinated each of these programs are independently accessible to creditors and debtors, foreign and domestic, on a voluntary and individual basis.


  2. The following steps seek to strengthen the corporate restructuring framework (Box 3): (i) a regulatory facilitation group ("one-stop shop")is being established, comprising senior officials from key ministries, to expedite restructuring filings; (ii) a regulation removing company law limitations on debt-to-equity conversions has become effective; (iii) as a follow up to last year's decree providing tax neutrality for restructurings, the Ministry of Finance has passed a supplementary decree providing more favorable treatment of cancellation of indebtedness income in restructurings; (iv) the Registrar of Companies is making information more accessible to the public, including audited 1998 reports by end-June 1999; (v) during the current parliamentary session, we will submit legislation for the registration of security interests that will give certainty concerning the priority rights of lenders, including lenders providing working capital to restructuring enterprises; (vi) by April 30, 1999, in consultation with the private sector, we will make recommendations for improvements in governance through strengthening securities regulation, stock exchange listing requirements, and the company and accounting laws; and (vii) the tax office intends to issue guidance to consolidate the legal materials related to tax aspects of restructuring.


  3. The government is committed to the creation of a consistently applied bankruptcy system that provides the appropriate incentives for corporate restructuring. Anti-corruption legislation has been submitted to Parliament establishing, inter alia, an independent permanent commission, reporting to Parliament, the Supreme Court and the President, to combat corruption in the public sector, including in the judiciary through a judicial subcommission. The judicial subcommission will in no way compromise the principle of the independence of the judiciary, and is modeled after similar legislation in other countries. We expect the commission to be operational by early April 1999. In addition, the government has submitted to Parliament separate legislation to revise and increase the effectiveness of the existing anti-corruption law.


  4. Among other previously announced initiatives: (i) the President will appoint by March 25, 1999 well regarded private practitioners and other experts as ad hoc judges to the Commercial Court; (ii) a transparent court fee system for the Commercial Court has been established; (iii) the salary structure of the Commercial Court judges will be reviewed and adjusted by April 30, 1999; and (iv) judges and other Commercial Court personnel are receiving training in the new law and in bankruptcy procedures.


  5. As indicated above, all state banks have been instructed to initiate immediate bankruptcy filings against debtors who fail to cooperate within the context of the Jakarta Initiative. We expect that IBRA and each of the state banks will have initiated restructuring or bankruptcy filings against their largest 20 corporate debtors, which are not performing, by end-April 1999. The Bank Indonesia Task Force to facilitate the Restructuring of the State Bank Debts, established in December 1998, will assist in identifying appropriate cases.
VI. OTHER STRUCTURAL INITIATIVES

People's Economy

  1. At a special People's Consultative Assembly session in November 1998, a decree was enacted aimed at broadening ownership and participation in the economy, especially the development of small- and medium-sized enterprises and cooperatives. Such an initiative will be designed and implemented in a manner that promotes economic efficiency and growth, and respects existing property rights. An inter-ministerial task force will be created with representation from all the relevant ministries to coordinate government programs and policies. We will also (i) review commercial lending practices to the sector and its financing needs with the support of the AsDB and the World Bank; (ii) transform BRI into a specialized bank with a mandate to lend only on commercial terms, and (iii) simplify directed credit schemes to cooperatives and small- and medium-size enterprises and ensure that lending rates are positive in real terms and adjust them periodically to reflect market conditions. In view of the potential significance of the measures being considered under this initiative, we will be consulting with a wide range of opinion, including the World Bank, AsDB, and the IMF.


  2. We will create a firm, PT Madani, which will initially provide venture capital funds, in consultation with the AsDB and the World Bank. The role of PT Madani may later be expanded to other activities designed to increase economic opportunities, especially for small and medium enterprises. We are increasing the provision of farm credit next year to ensure that farmers are able to increase food production while the government eliminates distortions in the agricultural sector, including fertilizer subsidies. However, we will reinstate risk sharing with financial intermediaries to ensure prudent lending practices and tighten eligibility requirements for borrowers with arrears.


  3. The competition law prohibiting monopoly practices and unhealthy competition has been passed by Parliament. It is designed to preserve the public interest and increase efficiency by prohibiting anti-competitive business practices with regard to the control of production and the marketing of goods and services. This includes price fixing cartels and agreements between companies to reduce competition by dividing product ranges and marketing territories. In doing this, the law focuses on the actual behavior of businesses, rather than on existing market structures. Particular attention is given to the governance structure and judicial process to enforce the law. It will be administered by an independent commission, which will report directly to the President and have the authority to impose penalties.


Environment and Forestry

  1. Major reforms are ongoing to protect the environment. First, a new forestry regulation was signed by the President on January 27, 1999, authorizing the auction of forestry concessions and the transfer of concessions by sale. This eliminates the requirement that concessionaires must either own or develop wood processing facilities, lengthens the concession period, and establishes a framework for forest concession performance bonds. Implementing regulations for performance bonds are being developed in consultation with the World Bank. Second, the Ministry of Forestry and Estate Crops is observing a moratorium on the award of new permits for forest land conversions while new land allocation procedures and conversion targets are being developed. Third, the formula for the forest resource rent tax that was introduced in 1998 will be reviewed and, if necessary, revised in consultation with the World Bank to ensure that it continues to capture most of the economic rent as international market conditions change. Fourth, implementing regulations for the Environmental Management Law have been drafted covering air pollution control, hazardous waste management, and environmental impact assessment. The environmental protection program is being further developed in consultation with the World Bank. The reduction of export taxes on logs and sawn timber to 20 percent at end-December 1998, which was a performance criterion, was not accomplished. This measure has now been implemented.


Trade Finance

  1. To alleviate difficulties that importers and exporters continue to face in accessing trade and working capital credit, we will take the following steps with support from the Japan Export-Import Bank and other institutions such as the World Bank: (i) review and restructure the Trade and Working Capital Credit Guarantee Facility; (ii) establish a specialized trade finance institution with full details of the proposal to be finalized by end-March; (iii) collaborate with nonbank domestic and foreign intermediaries to facilitate the use of the guarantee facility to channel import and working capital lines of credit; and (iv) identify domestic banking institutions that, as a result of the recapitalization exercise, will be sufficiently sound intermediaries to channel funds for trade finance.


Foreign Exchange Monitoring

  1. With technical assistance from the IMF, Bank Indonesia is making progress toward establishing an improved monitoring system for foreign exchange flows. A consultant from the Statistics Department of the IMF is to provide further technical assistance over the next three months and the monitoring system is expected to be in place by June 1999.