For more information, see Indonesia and the IMF
Mr. Michel Camdessus
Dear Mr. Camdessus:
1. In support of the Government of Indonesia’s adjustment and structural reform program set out in the Memorandum of Economic and Financial Policies (MEFP) of October 31, 1997, the Executive Board approved a three-year stand-by arrangement on November 5, 1997. The program was subsequently modified and strengthened, with substantial expansion of its structural elements including with respect to the social safety net, banking system and corporate restructuring, bankruptcy reform, trade deregulation, and privatization of state enterprises. These revisions were outlined in supplementary MEFPs that were sent to you on January 15 and April 10, in connection with the first review, which was completed on May 4, and on June 24, in connection with the second review, which was completed on July 15.
2. In view of the deep-seated nature of the structural and balance of payments problems facing the economy and the development of the strong and comprehensive structural components of the program to address them, the government requests the cancellation of the current stand-by arrangement for Indonesia and its replacement with a new extended arrangement through November 5, 2000 (for about 26 months) in an amount equivalent to SDR 4,669 million, which represents 142 percent of Indonesia’s quota on an annual basis. The extended arrangement would cover the remaining period of the stand-by arrangement and the proposed amount would be equivalent to the unused amount under the stand-by arrangement.
3. The attached MEFP of the Government of Indonesia summarizes our economic program to be covered by the extended arrangement. Since the program has been described in detail in previous documents, this MEFP focuses on the main areas where modifications have been introduced, including budgetary management, corporate debt, and bank restructuring. We have established monetary, fiscal, and external performance criteria for end-September 1998 and indicative monetary, fiscal, and external targets for end-July, end-August, and end-December 1998 and end-March 1999, which are contained in Annexes A-D. Structural performance criteria and benchmarks are contained in Annex E.
4. The government believes that the policies and measures set forth in the attached memorandum are sufficient to attain the objectives of the 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 made on the implementation of the strengthened reform program described in the MEFP and any other policy adaptations needed for achieving its objectives. In any event, the government will complete reviews with the Fund no later than September 25, October 25, and November 25, 1998; February 15, May 15, August 15, and November 1999; and February 15, May 15, August 15, and October 2000; to assess the progress made in the implementation of the program and reach understandings on any additional measures as needed.
For the Government of Indonesia
1. Our revised economic program, as set out in the Second Supplementary Memorandum of Economic and Financial Policies (MEFP) signed on June 24 under the stand-by arrangement approved on November 5, 1997, has been kept on track through firm policy implementation, and remains appropriate to Indonesia’s still very difficult economic circumstances. Nevertheless, we have decided to bolster the strategy for corporate restructuring and elaborate our bank restructuring program, in order to help reestablish as speedily as possible the necessary preconditions for the restoration of economic growth. In the meantime, we are also improving the distribution—and approach to subsidizing—of essential items. This MEFP briefly summarizes the latest developments under the economic program and elaborates on those policy areas where it is being strengthened.
Macroeconomic Framework and Medium-Term Outlook
2. The macroeconomic framework remains broadly as described in the MEFP of June 24. The decline in output is likely to significantly exceed 10 percent and could be as much as 15 percent in 1998/99. Inflation, although declining quickly, is still projected to be on the order of 80 percent during calendar 1998. An appreciation of the exchange rate from its recent level of Rp 13,000-15000 to around Rp 10,000 per dollar by the fourth quarter of 1998, as envisaged under the June program, is still regarded as feasible, with continued tight domestic financial policies, progress in the restructuring of debt to foreign financial institutions, and in light of the additional external financing of $6 billion that has recently been secured for the program.
3. With this additional foreign financing, the projected fiscal deficit of 8½ percent of GDP in 1998/99 is more than fully financed from foreign sources, permitting the substantial planned rise in social spending, as well as providing a safety margin against adverse shocks. The budget balance so far in this fiscal year has been broadly in line with the program target. Tight monetary policy, with base money and the net domestic assets of Bank Indonesia held broadly constant in coming months, remains a cornerstone of our stabilization strategy. While base money was somewhat above the program target in late June and early July, Bank Indonesia has tightened liquidity conditions and base money has been declining. Bank Indonesia introduced an auction system for central bank certificates (SBIs) in late July.
4. The main structural elements of the program for the period up to 2000, which include further deregulation, trade liberalization, privatization of state enterprises, banking system restructuring and corporate restructuring were discussed in detail in earlier MEFPs and are listed in the attached matrix. The structural reform process is being monitored closely by a high level group, under the direction of the Secretary General of the Economic and Monetary Resilience Council, and including, among others, high level representatives of the Ministries of Industry and Trade, Finance, Forestry and Agriculture, Bank Indonesia, and the Indonesian Bank Restructuring Agency (IBRA). To support this group, working level teams have been formed and activities are being organized at the field level, with nongovernmental participation.
5. While the medium-term outlook remains uncertain given the severity of the crisis, our objective is to restore sustainable economic growth with low inflation as quickly as possible. We tentatively expect that the decline in output will bottom out by early next year and that significant positive economic growth will resume no later than 2000. Inflation is to be reduced to a single digit annual rate within no`more than two years. The present level of the overall budget deficit is unsustainable, and it is our intention to cut it at least in half in 1999/2000, and restore the budget to close to balance within three years. This fiscal retrenchment is to be achieved through actions to better target subsidies to the needy, improve revenue performance and streamline public expenditure management (see below); the recovery of output will also help to strengthen the fiscal position.
6. The external current account is projected to record a surplus of 2 percent of GDP in 1998/99 and to remain in significant surplus until the recovery gets fully underway. The overall balance of payments position has been strengthened by the additional external financing (including the prospect of official debt rescheduling) recently secured and by the agreements related to foreign bank debt reached in Frankfurt. Gross official reserves are now projected to rise to about $24 billion by end 1998/99 (about 5½ months of imports). Outstanding external debt and the debt-service burden, though high, are expected to decline steadily in terms of GDP over the medium term as the economy recovers.
Food Security and Distribution Network
7. We attach the highest priority to ensuring that food and other essential items are available at affordable prices to the entire population. However, food prices, in particular the prices of rice and cooking oil, have risen drastically since the beginning of May, causing serious social hardship. In addition to the increase in subsidies provided for in the budget, and the special program for rice (see paragraph 10 below), the stabilization of prices for these items will also require that the distribution system functions fully and efficiently.
8. While most private trade is functioning well, we are taking a number of actions to ensure that there are no remaining impediments to the efficient movement of supplies of basic commodities throughout the country. These steps include the physical protection of traders to reassure them that their business can be carried out normally; the protection of warehouses, trucks, and containers on trading routes to encourage them to build up stocks; and assistance to traders who suffered damage during the riots, to rebuild their facilities. We are also enhancing the daily monitoring of all relevant aspects of food security including price developments, movements of goods including imports, stocks, and releases of commodities by BULOG. A special team headed by the Minister of Food and Horticulture has been created with overall responsibility for monitoring the food situation.
9. We are concerned about pressures on food prices because substantial exports of subsidized commodities have occurred over the past several weeks, driven by the wide differential between domestic and international prices. As an emergency measure, we have therefore imposed a temporary ban with effect from July 26 on exports of rice, wheat and wheat flour, soybeans, sugar, kerosene, and fishmeal. Within three weeks from July 26, these bans will be replaced by export taxes. These taxes will be phased down as price differentials are reduced.
10. As part of our efforts to eliminate the fiscal deficit over the medium term, we are looking into ways of better targeting of subsidies and other elements of the social safety net, in conjunction with the World Bank. A program was initiated in July to provide rice at about one-half of the market price to low income families in the Jakarta area and will be extended to cover at least 7½ million very poor families throughout the country by September. Monitoring and evaluation of employment generating, health and education programs is being enhanced to ensure that the poor are the main beneficiaries. While the severity of the recession limits the feasibility of administrative price rises, we intend to make selective price adjustments during this fiscal year. Also, we are committed to adopting a mechanism based on transparent criteria for regular and more automatic price changes for most subsidized items, with effect from April 1, 1999.
11. Improving budgetary revenue performance and expenditure management is essential for the achievement of our short- and medium-term fiscal objectives. A Committee on Fiscal Monitoring has been established by the Minister of Finance to coordinate fiscal and monetary policy, with the participation of Bappenas (the development planning agency) and Bank Indonesia. A public expenditure review was completed with the World Bank in late July. Contingency planning is to become a regular feature of budgetary policy, in recognition of the need for greater flexibility to cope with fiscal and economic uncertainty. An IMF technical assistance mission in July 1998 provided recommendations on strengthening public expenditure management, including clearer establishment of spending priorities, more efficient budgetary preparation, cash management controls, and comprehensive, accurate, and timely reporting. Two long-term IMF advisors have been identified to help follow-up on the implementation of these proposals. An IMF technical assistance mission is scheduled for August 1998 to provide advice on improving the overall revenue system and tax administration. Further technical assistance will be needed over the medium term.
12. The overall strategy for bank restructuring remains as described in the June MEFP; full details are provided in the matrix. Specific actions recently taken or to be taken in the near future to implement this strategy are summarized below:
Corporate Debt and Bankruptcy Reform
13. Good progress has been made in implementing the agreements reached in Frankfurt in early June regarding debt to foreign commercial banks. The response to the trade facility has been encouraging, with maintenance letters from banks accounting for a substantial proportion of the trade exposure already received. Also, preparations for the exchange offer for interbank debt are well advanced. Regarding the agreement on corporate debt, a Presidential Decree establishing the Indonesia Debt Restructuring Agency (INDRA) has been issued, suitable premises obtained, a Chairperson and other personnel selected, and a foreign bank appointed as Administrative Agent. INDRA will be officially launched on August 3, 1998. We intend to have all the necessary documentation completed by end-August 1998.
14. In order to accelerate the process of restructuring the corporate sector and addressing its debt overhang, the government will adopt a strategy that consists of two mutually reinforcing elements, both of which are designed to complement INDRA and the newly adopted bankruptcy law. The first element involves the adoption of key legal, regulatory and administrative reforms that would serve to remove obstacles to restructuring and, in the longer term, to improve corporate governance. The second element of the strategy involves the establishment of a framework of nonbinding principles that will guide—but not control—negotiations between debtors and creditors and seek to ensure that the information provided by companies is accurate and timely.
15. The legal and administrative reforms would include the lifting of restrictions on debt for equity conversions; the removal of tax disincentives for restructuring (while limiting the erosion of corporate tax collections); and the streamlining of procedures and approval requirements applicable to the admission of foreign direct investment and, more generally, corporate restructuring. A new arbitration law will be adopted and measures will be introduced to provide for the registration of collateral. A review will be conducted for the purpose of the adoption and implementation of accounting and auditing rules that meet international standards. This is not necessarily an exhaustive list and we are actively seeking to identify and remove any other impediments to the restructuring process.
16. The framework of principles would be established in consultation with creditors and debtors and would apply to both domestic and external debt. The principles are expected to follow standard corporate workout techniques that have been developed in other countries, and are likely to cover: (i) the formation for each company of a manageable creditors’ steering committee representing different categories of debts; (ii) the provision of all relevant information by the company to the creditors committee; (iii) voluntary agreement to a standstill and priority for new financing over existing claims during the workout; (iv) the preparation of restructuring plans by the companies, which could include debt forgiveness and debt for equity exchanges. Finally, the framework might provide, in circumstances where a restructuring plan has received support from a significant majority of the creditors, for the debtor to be able to bind the minority dissenting creditors by availing itself of the provisions of the bankruptcy law. The Minister of Finance has direct responsibility for bank and corporate restructuring. The measures in these areas are complimentary and simultaneous and will be overseen by the Coordinating Minister.
17. Parliament ratified the revised bankruptcy law without amendment on July 24. The law will enter force on August 20, 1998 and the Special Commercial Court created to implement it will open on the same date. Supported by IMF technical assistance (financed by the Japan administered account) and bilateral assistance from the governments of the Netherlands and Australia, the future judges of the Special Commercial Court and the prospective private sector receivers and administrators have completed an intensive training program that is designed to assist them in the implementation of the bankruptcy law. In consultation with experts from the Netherlands, the Supreme Court is actively preparing detailed procedures for the administration of the Commercial Court with the objective of ensuring that proceedings of the Commercial Court are efficient, predictable, and transparent. A training program is being put in place to ensure that the public prosecutor and the police are in a position to conduct criminal investigations in circumstances where there is evidence of asset stripping.
Export Credit Guarantee Scheme
18. The need to promote exports under the present difficult financing conditions is urgent. As outlined in the June MEFP, Bank Indonesia has established a preshipment export credit guarantee program has been established to facilitate import and preshipment export financing of exporters holding export letters of credits, with any costs to be borne by the budget. Guarantees extended will be limited to a maximum of 80 percent of the credit extended by the bank and available only for a limited period. Total outstanding guarantees will not exceed US$0.5 billion.
19. We have established quantitative fiscal, monetary, and external performance criteria for end-September 1998, which are consistent with the earlier agreed indicative targets. Structural performance criteria and benchmarks were agreed earlier. Details are shown in the attached annexes to this memorandum.
1. Indicative Targets on Net Domestic Assets
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 C, converted into rupiah at an exchange rate of Rp 10,000 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) The limits will be adjusted for changes in the composition of external financing from that assumed in Annex D. In the event of a shift in the composition of external financing from loans not counted as a reserve liability of BI to loans counted as a reserve liability, NDA will be adjusted upward by the rupiah equivalent of the amount of this shift in the financing mix relative to the program baseline.1 In the event of shortfalls of total balance of payments financing, NDA will be adjusted upward by the rupiah equivalent of the shortfall, up to a maximum of US$1.5 billion. NDA will be adjusted downward by the rupiah equivalent of any excess of balance of payments support over that set out in Annex D.
(ii) The limits will be adjusted upward (downward) by the rupiah equivalent of the amount of any reduction in the external arrears of domestic banks in excess of (less than) US$1.0 billion, with the adjustment not to exceed US$0.5 billion.2
(iii) 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$2.9 billion.2
(iv) The limits will be adjusted downward by the rupiah equivalent of the amount by which BI holdings of export drafts exceeds US$2.9 billion.2
(v) The limits will be adjusted upward by the rupiah equivalent of any use of reserves in connection with the pre-shipment export guarantee program being considered by BI for an amount of up to US$0.25 billion.2
(vi) Changes in reserve requirements will modify the NDA ceiling according to the formula:
NDA = (r B0 + r0 B + r B)
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 and Liquidity
Base money is as defined above. Liquidity support is defined as the sum of the nominal value of lending to banks under various instruments including all SBPUs, subordinated loans and emergency liquidity credit, borrowing through various discount windows and aggregate debit (negative) balances of banks with BI. Also included in liquidity support are net claims on IBRA, BI holdings of government bonds related to bank restructuring, and claims on liquidated banks including negative balances and bridging loans; and foreign-currency denominated credits extended by BI to domestic banks in connection with the clearance of these banks’ external arrears. The targets for liquidity support will be adjusted upward (downward) by the rupiah equivalent of the amount by which these foreign-currency denominated credits exceed (fall short of) US$0.8 billion, up to a maximum of US$1.5 billion.3 As in the case of base money and NDA, liquidity support will also be measured on a 10-day average basis.
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.
BI will publish weekly, with a three-day lag, key monetary data,4 including base money, gross international reserves of BI, NDA of BI and NIR of BI (the information could be made available through special press releases and/or by updating BI’s web-site).
1Converted at the exchange rate of Rp 10,000 per U.S. dollar.
2Converted at the exchange rate of Rp 10,000 per U.S. dollar.
3Converted at the exchange rate of Rp 10,000 per U.S. dollar.
4The data will be preliminary and may be subject to revision.
1. Indicative Targets on the Overall Central Government Balance
For the purposes of the program, the interest costs associated with bonds and other debt issued by the government to cover the costs of bank restructuring and the receipts from privatization up to a maximum of Rp 17 trillion will be placed above the line. The balance is therefore defined as the negative of the sum of: (i) net foreign borrowing; (ii) the change in net credit from the banking system, excluding the amount of bonds and other government obligations, if any, incurred for the purpose of recapitalizing banks, but including the interest on these loans and obligations as well as the operating costs of IBRA; and (iii) net financing from all other sources to the government, including receipts from privatization and divestiture in excess of Rp 17 trillion.
Net foreign financing is defined as government foreign borrowing less amortization (including debt prepayments) of foreign debt, with transactions translated into rupiah each month at the average exchange rates for that month. Net credit from the banking system is defined as the change in net credit to government (including SBI holdings and commercial loans and the extrabudgetary funds), as reported in the consolidated government accounts in the monetary survey. Net financing from all other sources includes receipts from the sale of government assets, including from privatization as described above.
Government deposits in foreign exchange as of March 31, 1998 will be evaluated at constant exchange rates (Annex D). Monthly changes in government foreign currency balances will be converted into rupiah at the average exchange rate prevailing for that month.
External Sector Targets
1. Indicative Targets on Net International Reserves of Bank Indonesia
For monitoring purposes, net international reserves of BI (NIR) are defined as the sum of: (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 a10-day average basis (see Annex A).
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 D.
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) The floor will be adjusted for changes in the composition of external financing from that assumed in Annex D. In the event of a shift in the composition of external financing from loans not counted as a reserve liability of BI to loans counted as a reserve liability, NIR will be adjusted downward by the amount of this shift in the financing mix relative to the program baseline. In the event of shortfalls of total balance of payments financing, NIR will be adjusted downward by the amount of the shortfall, up to a maximum of US$1.5 billion. NIR will be adjusted upward by the amount of any excess of balance of payments support over that set out in Annex D.
(ii) The floors will be adjusted downward (upward) by the amount of any reduction in the external arrears of domestic banks in excess of (less than) US$1.0 billion, with the adjustment not to exceed $0.5 billion.
(iii) The floors will be adjusted upward by the amount by which BI deposits in foreign branches of Indonesian banks exceed US$2.9 billion.
(iv) The floors will be adjusted upward by the amount by which BI holdings of export drafts exceed US$2.9 billion.
(v) The floor will be adjusted downward by any use of reserves in connection with the pre-shipment export guarantee program being considered by BI for an amount of up to US$0.25 billion.
The adjustors and definition of NIR will be subject to review to take advantage of new
sources of financing not anticipated under the program.
2. Indicative Target 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. Indicative Target 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.
Program Assumptions and Reporting
1. Program Baselines for Balance of Payments Financing Package
2. Exchange Rates and Gold Price to be Used Under the Program 1/
Monitoring the program will require accurate and timely data. All information on performance criteria, indicative targets, and balance of payments support loans will be reported to Fund staff within one week of the reference date. In addition, detailed data on government revenues and expenditures, costs of financial sector restructuring, and the monetary survey will be provided monthly within 22 days of the reference date. Monetary statistics covering developments in the banking system, including third party liabilities, monetary accounts, and deposit and lending rates will be provided weekly (with a 12-day lag). Data on base money (showing all the factors affecting reserve money), foreign exchange intervention in both the spot and forward markets, as well as use of reserves for financing and liquidity support will be provided daily (with a 2-day lag). The net forward position, net foreign assets, liquidity support to banks under various facilities, and open market operations (including the stocks of SBIs and SBPUs) will be provided daily (with a 2-day lag). Information on access by individual banks and non-banks to BI credit (either in rupiah or foreign currency) will be provided on request.
Structural Performance Criteria and Benchmarks
STRUCTURAL POLICY COMMITMENTS1
New and strengthened commitments are shown in italics
1Excludes commitments that were both scheduled for completion and actually completed earlier than June 30, 1998.
2Two Indonesian members have been nominated and three foreign members are expected to be appointed from candidates nominated by the IMF, World Bank, and Asian Development Bank.