Indonesia and the IMF

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IndonesiaLetter of Intent

Jakarta, Indonesia
June 11, 2002

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.

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

Dear Mr. Köhler:

Our comprehensive economic program for 2002 was set out in the Memorandum of Economic and Financial Policies (MEFP) of December 13, 2001, and our supplementary Letter of Intent of April 9, 2002. This letter provides an update on our policy intentions to achieve the objectives of the program as described therein.

All end-March quantitative performance criteria were met with the exception of the target for the central government deficit (Table 1). The indicative target for base money was also met. The completion of the structural benchmark on assessing compliance of the shareholder settlement agreements was delayed beyond the envisaged end-April timeframe due to the significant volume of legal documentation involved. The government is taking actions in these areas to achieve our program goals, as described below. Accordingly, we propose to leave our targets for the remainder of the year unchanged, while converting the indicative nature of the quantitative targets for September and December established at the time of the fourth review into performance criteria. As described below, we propose to reschedule the end-June structural benchmark on completing a majority sale of Bank Niaga to mid-September and, to strengthen the program, propose additional structural benchmarks for the remainder of 2002 as shown in Table 2.

The conduct of fiscal policy has remained prudent under the program, oriented firmly toward restoring fiscal sustainability. Nevertheless, the budget deficit for the first quarter reached Rp 5.6 trillion (1½ percent of GDP on an annual basis) compared to the program target of Rp 2.7 trillion. This modest excess reflected weaknesses in revenues, due to the temporary impact of the severe floods that took place in January and February as well as some delays in implementing tax policy measures approved under the 2002 budget. It also reflected higher interest payments.

The government remains resolute in its determination to contain the deficit for the year within the target of 2.5 percent of GDP established by Parliament. Accordingly, we have taken a number of steps to ensure that the annual deficit target is achieved and that the deficit returns to the program path by end-June. These steps include, notably, eliminating the VAT exemption on capital goods and securing higher dividends and other nontax revenues owed by state-owned enterprises. With these steps in place, and with interest savings generated by the resolution of the BLBI issue consistent with the recommendations of the independent team, the original program targets remain achievable. Expenditure is expected to be somewhat above our expectations at the time of the budget, as interest payments are now higher and fuel subsidies are running somewhat ahead. However, revenues are expected to be correspondingly higher reflecting more favorable macroeconomic assumptions and larger nontax revenues.

In the area of monetary policy, the recent decline in inflation has been encouraging, and with a strengthening of the exchange rate and slow growth in base money, the central bank has been able to begin to bring interest rates down. We will maintain a cautious stance in the period ahead, however, consistent with the objective of bringing inflation down to single digits by the end of the year.

Steady progress is being made in the area of bank resolution and divestiture. In light of the fact that the final bids received for Bank Niaga were significantly below the market price, we have revised the strategy for selling the bank. Under the new strategy, the government will sell up to 20 percent share of the bank directly into the market and will relaunch the sale of a majority stake in the bank by end-June 2002, with a view to completing the sale by mid-September. The government has finalized a comprehensive plan to divest the remaining IBRA banks, and submitted that plan to Parliament in early June. As part of this strategy, we will launch the sale of a majority stake in Bank Danamon in July, with completion of the sale by end-year, to be followed by the launch of the sale of a majority stake in Bank Lippo by year-end.

As regards the resolution strategy for the five smaller IBRA banks, all are now under IBRA management. The legal merger of these banks is expected to be concluded by end-September, and their operational merger by end-December. With regards to BII, we have installed a new independent management team and a rights issue to strengthen the bank's capital base remains on course for completion in June. The government is committed to act as stand-by buyer, but is encouraging strategic investors to exercise their rights to participate in the issue. It remains the government's firm intention to ensure both that BII is adequately capitalized and that it will be financially viable on an on-going basis.

As for the state banks, the government remains committed to initiating the sale of Bank Mandiri this year. To allow for a strengthening of the bank's business plan, the sale of a 30 percent share will be launched in the third quarter, a little later than had been envisaged under the 2002 program.

Reforms aimed at normalizing the financial operations of the central bank and its relations with the government are proceeding well. We are studying the report prepared by the independent team to resolve the long-outstanding BLBI issue and are in agreement in principle with its recommendations. We will seek the introduction of any amendments to the central bank law that may prove necessary to implement our final decision on this issue. Advisors have been engaged by Bank Indonesia to assist in the divestiture of its overseas subsidiary. By end-October the subsidiary will have been comprehensively restructured and its sale will be completed by the first half of 2003. Assets removed from the bank under the restructuring process will be sold by the end of next year.

We remain committed to achieving IBRA's targets for asset recoveries. To that end, IBRA launched in June a new broad-based auction mechanism to sell its corporate and commercial loans. Following the completion of the auction sale period in August, the remaining stock of loans will be sold in bulk packages through a variety of auction mechanisms. As regards the shareholder settlement agreements with former bank owners, we have published initial determinations of compliance for six such agreements and the remaining will be published in stages by July. As envisaged in the government decree of March 18, the government remains committed to taking strong actions against former bank owners who fail to meet their outstanding obligations at the end of the three-month grace period following the initial determination of compliance.

We have also made progress in other areas of the structural reform agenda. In the area of privatization, a sale of 8 percent of Indosat yielded Rp 1 trillion in May, and we are continuing strong efforts to meet the targets under the program. In the area of legal reform, a revised bankruptcy law has been submitted to Parliament. The legislation on the Anti-Corruption Commission is expected to be enacted soon and the commission established shortly thereafter. We have reviewed our policies to promote growth in the small- and medium-sized enterprise (SME) sector through improving the business and regulatory environment of SMEs. In this last regard, the Ministry of State-Owned Enterprises, as shareholder of state-owned banks, will remove any impediments in the bank's bylaws or regulations in order to enable these banks to undertake voluntary and commercially based restructuring of nonperforming SME loans according to the existing regulations of Bank Indonesia. At the same time, the government will continue to encourage all banks to expand credit to SMEs with favorable business prospects and to restructure nonperforming SME loans on commercial terms. On the basis of requests from banks, the State Auction Directorate-General (DJPLN) will return SME loans to banks in order that they can be restructured on commercial terms. IBRA will also renew its cash settlement program for the SME sector for a limited period, with the remaining stock of these loans to be disposed by September 2002.

In view of the corrective actions taken, we request a waiver of compliance with respect to the end-March performance criterion on the overall central government balance and the completion of the sixth review under the extended arrangement. In the period ahead, we will continue to consult with the Fund on future economic policies and we hope to complete the next review of the program by September 2002.

Sincerely yours,

Dorodjatun Kuntjoro-Jakti
Coordinating Minister for
Economic Affairs
Minister of Finance
Syahril Sabirin
Bank Indonesia

Table 1. Indonesia: Quantitative Performance Criteria (PC) and Indicative Targets (IT)
Under the Extended Arrangement, 2001-021

  PC2,3 Actual   PC2 Actual   PC2 Actual  

Monetary and fiscal targets                        
Net domestic assets (NDA) of Bank
5.3 -2.7   -3.8 -12.0   -8.8 -13.1   -11.0 -8.5 3.9
Base money (indicative target) 5 122.9 124.7   117.8 115.6   117.8 115.0   123.7 128.2 138.2
Overall central government balance6 -54.6 -52.1   . . . . . .   -2.7 -5.6   -14.0 -27.9 -42.1
External targets (in billions of U.S. dollars)                        
Net international reserves (NIR) of Bank
16.8 18.2   . . . . . .   18.3 18.6   19.5 19.8 19.8
Contracting or guaranteeing of new
      nonconcessional external debt8
1.5 1.2   . . . . . .   0.3 0.3   0.6 1.0 1.5
   Of which: Government debt to commercial
. . . . . .         0.2 0.0   0.2 0.2 0.2
Stock of short-term external debt
2.5 0.5   . . . . . .   2.5 0.3   2.5 2.5 2.5
Public external arrears 0.0 0.0   . . . . . .   0.0 0.0   0.0 0.0 0.0

1Definitions are contained in the Technical Memorandum of Understanding dated December 13, 2001. Continuous performance criteria are: the non-accumulation of external arrears and no securitization or forward sale of receipts from natural resources.
2Adjusted program targets for NDA and NIR.
3Monetary targets for December 2001 are indicative due to seasonality effects associated with end-calendar and end-fiscal years. Instead, a performance criterion on NDA is set for January 2002
4Targets for NDA and NIR through January 2002 are based on one-month averages centered on end-month. Thereafter, targets are end-period values.
5Base money targets are one month averages centered on end-month.
6Cumulative balances from beginning of fiscal year (floor). Central government bonds issued to district and provincial governments are included as financing of the central government deficit.
7Outstanding stocks (floor).
8Cumulative amounts from beginning of fiscal year (ceilings). End-March 2002 outturn was US$ 0.25 billion.
9End-March 2002 outturn was US$ 0.04 billion.

Table 2. Structural Benchmarks (June 2002-December 2002)
June 2002
•  Finalize and implement burden-sharing agreement on BLBI credits between BI and the government.1
•  Commence operations of Large Taxpayer Directorate at headquarters of the Directorate-General of Tax, and 1-2 large taxpayer offices in Jakarta.
•  Produce report on 2001 local government finances.
•  Achieve at least half of 2002 target for privatization receipts.
•  Establish Anti-Corruption Commission.
•  Collect at least Rp 13.0 trillion in cash by IBRA (net of expenses).
July 2002
•  Begin primary auctions of treasury bills.
•  Implement new tax filing and payment systems at large taxpayer office(s).
•  Under the Bank BII strategy, reduce fully the equity position of the original shareholders and install an independent management team.
•  Finalize and publish initial determinations of former bank owners' compliance for each of the shareholder settlement agreements.
•  Launch sale of a majority stake in Bank Danamon.
September 15, 2002
•  Conclude majority sale of Bank Niaga.
September 2002
•  Collect at least Rp 23.5 trillion in cash by IBRA (net of expenses).
October 2002
•  Complete restructuring of BI's overseas subsidiary in preparation for its divestiture.
December 2002
•  Complete third round of special audits of state enterprises and adopt corrective actions.
•  Collect at least Rp 36.1 trillion in cash by IBRA (net of expenses).
•  Launch sale of a majority stake in Bank Lippo.
•  Complete sale of a majority stake in Bank Danamon.

1Performance criterion.