Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-4429-IND REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$300 MILLION TO THE REPUBLIC OF INDONESIA FOR TRADE POLICY ADJUSTMENT December 30, 1986 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Rupiah US$1.00 = Rupiah (Rp) 1,644 Rp 1 million = US$608 GOVERNMENT OF INDONESIA FISCAL YEAR April 1-March 31 SYSTEMS OF WEIGHTS AND MEASURES Metric ABBREVIATIONS AND ACRONYMS BAPPENAS - National Development Planning Agency BULOG - Badan Urusan Logistik (The National Logistics Agency) CBU - Completely built-up CCCN - Customs Coordination CounciL Nomenclature CKD - Completely knocked-down 0OI - Government of Indonesia TGGI - Inter-Governmental Group on Indonesia IPEDA - Turan Pembangunan Daerah (the old land tax) NTB - Nontariff barrier O&M - Operations and Maintenance REER - Real Effective Exchange Rate REPELITA - National Five-Year Development Plan SGS - Societe Generale de Surveillance S.A. SOE - Statement of Expenditure VAT - Value-added tax Import License Categories: AT - Agen Tunggal (licensed agent) IP - Importir Produser (actual user) IT - Importir Terdaftar (approved trader) IU - Importir Umum (general importer) PI - Produsen Importir (producer importer) FOR OFFICIAL USE ONLY INDONESIA TRADE POLICY ADJUSTMENT LOAN Table of Contents Page No. LOAN SUMMARY ............................................... i I. ECONOMIC BACKGROUND ......................ee ....g ... 1 A. The Oil Boom (1973-81) .... ................................. 1 B. Declining Oil Prices and Policy Response (1982-85) ...... 2 II. ADJUSTMENT IN 1986 ........................ 5 A. The Oil Price Collapse ...* ........................... 5 B. Macroeconomic Adjustment ................................ 6 C. Trade Policy and Foreign Investment ............... 8 D. Impact on Economic Performance .......... .. .............. 10 III. MEDIUM-TERM PROSPECTS AND POLICY FRAMEWORK ................. 12 A. Economic Outlook ........................................ 12 B. Policy Framework ........................................ 14 C. Social Impact ......................................... 16 IV. TRADE POLICY REFORM ................................... .. . 17 A. Evolution of the Import Regime .......................... 17 B. May 6 Package ........................................ 23 C. October 25 Reforms ......................... ........... 24 V. THE PROPOSED LOAN .................................. . ....* 33 A. Loan Objectives . . . .................. 33 B. Loan Administration ..... ................. 33 C. Monitoring and Follow-up .......................... ....... 34 D. Program Benefits and Risks ........................ ... 34 VI. BANK GROUP OPERATIONS IN INDONESIA . ................ 35 VII. RELATIONS WITH IMF ................... . ..................... 37 VIII. RECOMMENDATION ........................................... 37 ANNEXES I. Country Data Sheet ........................................ 38 II. The Status of Bank Group Operations in Indonesia .... ....... 40 III. Supplementary Project Data Sheet ........................... 43 IV. COI Policy Statement ......... .............................. 45 V. Policy Matrix .................................................... 54 VI. Economic Tables ................... 57 This document has a restricted distribution and may be uscd by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization ENDONESIA TRADE POLICY ADJUSTMENT LOAN Loan Summary Borrower: Republic of Indonesia Executing Agencies: Bank Indonesia and Ministry of Finance Amount: US$300 million equivalent Terms: 20 years, including 5 years of grace, at the standard variable interest rate Project Description The proposed loan would support the Government of Indonesia's (GOI's) efforts to respond appropriately to the sharp fall in oil prices, through reducing dependency on oil while regaining stability in the balance of payments and government budget. Specifi- cally, the loan would support steps taken by the Government in 1986 to: (i) restrain government spending through a 24Z cut in the 1986/87 development budget; (ii) maintain an appropriate exchange rate, including a 31Z devaluation; and (iii) reform trade policy through measures designed to provide inter- nationally-priced inputs to exporters and to reduce import restrictions. Important aspects of these measures are steps to shift from nontariff barriers (NTBs) to tariffs as the primary instrument of import policy, and to promote foreign investment, especially in export activities. The loan of US$300 million equivalent would finance general imports of goods to meet part of Indonesia's near-term foreign-exchange requirements, while supporting GOI's ongoing deter- mination to take appropriate measures to promote the efficiency and longer-term viability of the economy. It is envisaged that such further actions could form the basis for a subsequent loan in about a year.I\ Benefits and Risks: The adjustment measures taken by COI over the past year will provide balance of payments and fiscal stability, in the face of sharply lower oil prices, and help develop the non-oil economy over the medium term. In particuilar, the recent trade reform measures represent an imiportant first step in COI's efforts to reduce long-standing distortions in Indonesia's highly protected industrial structure; improve international competitiveness of non-oil exports; and increase potential for foreign invest- ment, especially in export-oriented industries. In addition, greater transparency and administrative simplicity would be introduced in Indonesia's trade regime. The principal risk in that the far-reaching nature of the policy reforms could encounter domestic opposition to full implementation of already- announced meamures and to efforts to take additional measures after further study. These risks are offset by GOI's demonstrated ability in the past to carry out difficult and sensitive reforms. Estimated Disbursement: US$300 million equivalent would be disbursed in FY87 Economic Rate of Return: Not applicable Appraisal Report: None Map: IBRD No. 11038R1 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUICTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED TRADE POLICY ADJUSTMENT LOAN TO THE REPUBLIC OF INDONESIA 1. I submit the following report and recommendation on a proposed Trade Po.icy Adjustment Loan to the Republic of Indonesia for the equivalent of US4300 million. The loan would have a term of 20 years, including 5 years of grave, at the standard variable interest rate. PART I - ECONOMIC BACKCROUND 2. An economic report, entitled "Indonesia: Adjusting to Lower Oil Revenues" (No. 6201-IND, dated May 20, 1986), was distributed to the Executive Directors on May 27, 1986. Annex I gives selected economic indicators for the country. A. The Oil Boom (1973-81) 3. At the time of the first large oil price increase in 1973, the Indonesian economy had already begun to respond favorably to the new economic policies instituted in the post-1967 period. This response was reinforced by the advent of higher oil (and later, LNG) earnings, which led to a period of unprecedented growth. Net oil/LNG earnings (i.e., after accounting for all import and service payments from the sector) rose from US$0.6 billion in 1973174 to a peak of US$10.6 billion in 1980/81. In that year, the oil/LNG sector accounted for 24% of total value added in the economy, 76% of gross export earnings and 68% of budget revenues. Compared to many other oil- exporting countries, Indonesia used these additional resources well. GDP grew on average by 7.5% p.a. during 1973-81, supported by a steady expansion of agricultural output, especially rice, and a rapidly growing manufacturing sector. Significant improvements were also made in education, health and social services. By many social indicators (e.g., primary school enrollment, per capita food availability, poverty incidence) Indonesia reached approximate parity with the relevant reference group of countries, despite having started from a lower base in the early 1970e. 4. During this period, the Covernment of Indonesia (COI) maintained sound macromanagement and a prudent external borrowing strategy. By the end of the decade, the current account of the balance of payments was in surplus and the debt-service ratio was less than 13%. However, the economy still suffered from several structural weaknesses. The agenda for policy action included: (a) reducing economic dependence on oil; (b) moderating the high rate of inflation (average 17% p.a. in 1973-81); Cc) expanding and diversifying the manufacturing base; (d) training skilled manpower for more rapid socioeconomic development; and (e) strengthening the weakly developed administrative and financial systems. -2- B. Declining Oil Prices and Policy Response (1982-85) 5. After nearly a decade of rapid progress, Indonesia suffered major economic setbacks in 1982 and 1983, primarily due to the weakening of oil and other commodity prices from the high levels of the 1979-80 period. By 1982/83, the current-account position had deteriorated substantially to show a deficit of US$7.2 billion (8.0% of GNP). The adverse impact of international economic events persisted, leading to a 15% decline in the overall terms of trade between 1981 and 1985. In response, a comprehensive process of adjust- ment was initiated by the Government in 1983. The specific objectives were the mnaintenance of balance of payments and fiscal stability and a reduction of dependence on oil/LNG earnings. The major policy initiatives introduced through 1985 for macroeconomic adjustment and structural change are summarized below. 6. Macroeconomic Adjustment. From the first signs of weakness in the oil market, GOI acted promptly to control public spending and adjust the exchange rate: (a) Public Investment. The buoyancy of oil revenues in the late 1970s had led to optimistic market forecasts and the initiation of several large capital-intensive projects. Reacting to the changed macro- economic outlook, COI announced a major rephasing of these invest- ments in May 1983, resulting in foreign exchange savings estimated at US$10 billion. Since 1984/85, the Government has also placed strict limits on the utilization of import-related credits for public investment. (b) Budget Subsidies. Subsidies channelled through the budget reached Rp 1.9 trillion in 1981/82, accounting for 152 of government spending and 2% of CDP. Since then they have been steadily reduced. Subsidies for food were phased out in 1982/83, with BULOC's funding shifted entirely to the banking system. Petroleum subsidies decLined steadily after 1981/82, mainly due to domestic price increases totalling more than 200%. Despite price increases of 11% in 1984/85 and 25% in 1985/86, fertilizer subsidies continued to rise as fertilizer consumption increased. Overall, budget subsi- dies were reduced to Rp 1.2 trillion (6% of government spending) by 1985/86. (c) Exchange Rate. The Rupiah was devalued by 28% (from Rp 703 to Rp 974 per US dollar) in March 1983, and the exchange rate was subsequently set by a managed float against a basket of curren- cies. As domestic inflation was brought under control, the real effective exchange rate (REER) remained relatively stable over the next two years, and the rupiah was allowed to depreciate from mid- 1985. By March 1986, the REER was about 10% lower than immediately after the 1983 devaluation. 7. Financial Sector. In June 1983, the Government launched a far- reaching reform of the financial sector, aimed at increasing domestic resource mobilization, improving the allocation of credit and encouraging greater market orientation in the operation of financial institutions. The reforms included the removal of interest rate controls on state bank deposits, elimi- nation of credit ceilings for all banks, and reduction in the qumber of programs qualifying for new Bank Indonesia liquidity credits.- Subsequently, Bank Indonesia introduced a range of new monetary instruments to improve monetary management and encourage the development of an active interbank money market. Bank deposit rates are necessarily market-related, as there are no constraints on Indonesian residents holding financial assets abroad, and are heavily influenced by anticipated changes in the exchange rate. Following the financial deregulation of 1983, lending rates have risen sharply and now average around 17%. 8. Taxation Policy. The Government introduced a comprehensive package of tax reform, aimed at increasing non-oil revenues by broadening the tax base, simplifying the structure of rates and improving administration. The major elements of the package are as follows: (a) The income tax reform introduced in January 1984 included: (i) a vastly simplified tax structure, based on three relatively low rates (15%, 25Z and 35%) and limited deductions; (ii) "self-assessment' of tax liability, with considerable emphasis on withholding at source; and (iii) a drastic simplification of the tax code, including revised procedures for appeals and refunds. These changes were designed to increase the number of income-tax payers and improve the administrative efficiency of tax collection. (b) The value-added tax (VAT) introduced in April 1985 replaced the old sales taxes and the transition has been smoothly implemented. The basic VAT rate is 10%. Although confined to the manufacturer- importer level, the VAT has increased revenue potential by; (i) subjecting domestic sales of petroleum and tcbacco products to VAT; and (ii) imposing an additional tax (10-20%) on luxury goods. Cc) The new property tax introduced in January 1986 replaced seven ordinances, including the old land (IPEDA) and net wealth taxes. The new law is conceptually simpler than its predecessors, based on a proportion of the market value of land and buildings, and a single tax rate of 0.5%. Implementation arrangements still require a lot of work. A related action plan is being defined by GOI for review by the Bank under the proposed urban and irrigation sector loans. As a result of the tax reforms, non-oil tax revenues have risen by about two- thirds since 1983/84 and the medium-term buoyancy of revenues is expected to be significantly improved. There are also plans to mobilize additional revenues through further improvements in tax administration. 1/ In addition, the on-lending rate for most loans under the liquidity- credit programs was set at 12% (previously there was a range of rates, with the average considerably below 12%). -4- 9. Customs, Ports and Shipping. The reorganization of customs, ports and shipping operations in April 1985 represented a direct attack on the problems of overregulation in an important section of the Indonesian economy. The major elements of the reorganization were: (a) Custom procedures were reduced almost to a formality. Imports are now inspected at the points of origin by government-appointed private surveyors (ScS). Exports and interisland traffic are no longer subject to customs inspection in Indonesia. (b) Port charges were simplified and related directly to services provided. Dues payable by foreign-flag vessels were reduced to the same level as for Indonesian oceangoing ships. Cargo handling charges were reduced. (c) Foreign-flag vessels are now free to call at any Indonesian port open to international trade, without prior approval. They may also choose any local agent to act on their behalf. Tnese measures have had a major impact on port delays and costs of shipping and freight handling. For example, the cost of shipping is estimated to have been reduced by 20-40%, the average time spent on customs procedures for imports has been cut by several weeks, and the cost of freight forwarding has declined enormously (due primarily to savings in payments to intermediaries and reduced paperwork). 10. Table 1 summarizes recent developments in the major economic indicators. Clearly, the boLd measures uindertaken by the Government since 1982 had succeeded by 1985/86 in restoring macroeconomic stability. The external deficit declined from 8% of GNP in 1982/83 to less than 3Z in 1985/86. Significant progress was made in mobilizing domestic resources, and inflation had been brought down below 5%. Inevitably, these adjustments had corresponding costs in the form of slower growth of output and incomes (relative to the 1970s), reduced private and public investment, low rates of capacity utilization, and the emergence of financial problems among many industrial and construction enterprises. Problems in the manufacturing sector were compounded by high and variable levels of protection provided by a proliferation of import licensing restrictions. Nevertheless, prior to the collapse in oil prices in 1986, Indonesia seemed by and large to have overcome its balance of payments and macroadjustment problems, and was set 0!. a path which would potentially restore stable growth to the economy. Table 1: RECENT ECONOMIC DEVELOPMENTS Ia Actuals Estimates 1973-81 1982 1983 1984 1985 1986 Real growth rates (% p.a.) CDP 7.5 -0.3 3.3 6.6 1.1 0.2 Non-oil CDP 7.9 4.1 3.8 4.9 3.6 0.4 - Agriculture 3.4 1.1 1.9 5.9 3.2 1.5 - Industry 12.8 1.8 3.9 2.9 3.5 -1.7 - Services 9.5 7.4 5.3 5.3 4.0 0.5 Domestic income 11.0 -1.5 1.4 6.5 -0.3 -8.9 Non-oil exports 3.9 4.8 24.1 12.2 6.1 5.4 Non-oil imports 9.8 14.6 -9.3 -9.7 -13.5 -12.6 Prices Oil price (US$/bbl) 35.4/b 32.9 28.9 28.4 25.0 12.5 Terms of trade (1983=100) 111.1Th 107.4 100.0 99.7 94.1 61.0 Domestic inflation (Z p.a.) 17.1 9.5 11.8 10.4 4.7 9.1 Ratios (Z) Debt service/exports 11.0/b 17.2 17.7 21.6 26.0 36.9 Current account/GNP -3.17i -8.0 -6.1 -2.6 -2.7 -7.8 Gross investment/GDP 28.0Th 32.1 27.4 27.5 25.7 24.5 /a Balance of payments data are for fiscal years (starting April 1). Other indicators are for calendar years. lb End of period. Source: Annex Table VI.1 and World Bank estimates. PART II - ADJUSTMENT IN 1986 A. The Oil Price Collapse 11. Indonesia's crude oil export price collapsed from US$28/barrel in January 1986 to below US$10/barrel by August. Althoigh some recovery has since occurred, the price for 1986/87 is expected to average around US$12.50/barrel, half the level of the previous year. As LNG earnings are zalso partially linked to the price of crude oil, Indonesia will experience a sharp decline in total oil/LNG export receipts for the year. It is estimated that gross oil/LNG export earnings for 1986/87 will fall to US$6.9 billion, compared to US$12.5 billion in 1985/86. Even more striking, net oil/LNG earnings are estimated to drop from US$5.7 billion in 1985/85 to US$2.2 bil- lion; this is only 20% of the peak level in 1980/81. Combined with the fall in other export prices, the overall terms of trade are projected to deterio- rate by 35% during the year, resulting in a decline of 8-9% in national income. -6- 12. In the face of such a large external shock and in the absence of timely adjustment measures, it was clear that a severe imbalance would appear in the external payments account. In 1986/87 alone, the current account deficit would have widened to well over US$5 billion and, even with higher oil prices in 1987/88 and 1988/89, the cumulative deficit for the 3-year period could have exceeded US$13 billion. In the short term, Indonesia had available over US$10 billion in external reserves and over US$2 billion in undrawn lines of commercial credit to help finance a larger current account deficit. However, faced with a high debt service ratio and an uncertain oil price outlook, it would not have been possible, nor prudent, to continue financing such large deficits over the medium term. B. Macroeconomic Adjustment 13. Anticipating its payments difficulties, GOI put into place a series of adjustment measures intended to narrow the balance of payments deficit by bringing national spending, especially public expenditure, more closely in line with the reduced level of national income. In January, an austere budget was announced for 1986/el (see Table 2). The budget was based on the assump- tion of lower oil prices (US$25/barrel) and a crude-nil production level (including condensates) averaging 1.33 mbd. A conservative projection of non- oiL tax revenues was adopted (8% higher than in 1985/86), despite the signifi- cant tax reforms that were introduced in the previous two years. Overall, revenues (i.e., including oil/LNC taxes) were projected to decline by about 4%, SO that cuts in government expenditures were required to maintain budget stability. 14. Current expenditures, other than interest on external debt, were budgeted to remain basically flat in nominal terms. Capital expenditures (including transfers to public enterprises) were reduced by almost 25%, with the Rupiah development budgets of government departments cut by 40-55%. In making these cuts, COI has also focussed the composition of the public invest- ment program, giving priority to: (a) the completion of ongoing projects; (b) the provision of counterpart funds for foreign-aided projects; (c) proj- ects with a particular focus on equity and employment; and (d) the funding of operations and maintenance (O&HM) expenditures. The expenditure allocations suitably reflect the findings of the public investment review carried out by the Bank in 1985. The World Bank also assisted GOI in identifying expenditure priorities in selected sectors, including the counterpart funding requirements for foreign-aided projects. There is now very little scope for further reduc- tions in COI's capital expenditures without jeopardizing medium-term growth prospects. However, savings could be realized from closer scrutiny of the financial performance and investment plans of public enterprises. The Govern- ment has requested technical assistance from the IMF and the World Bank in this area (see para. 35). Table 2: CENTRAL COVERNMENT BUDGET (Rp trillion) Actuals Bud et Estimates 1981182 1985186 1ii6/87 1986/87 Revenue and grants 12.2 18.6 17.9 14.0 Oil/LNG taxes 8.6 10.4 9.7 4.8 Non-oil taxes 3.2 6.6 7.1 7.3 Other 0.4 1.6 1.1 1.9 Current expenditure /a 7.9 12.7 12.9 12.9 Interest on external debt 0.5 1.7 2.1 2.6 Subsidies 1.9 1.2 1.2 0.9 Other 5.5 9.8 9.6 9.4 Government savings 4.3 5.9 5.0 1.1 Capital expenditure 5.2 8.5 6.4 6.1 Overall balance -0.9 -2.6 -1.4 -5.0 Financed by: - External loans (net) 1.0 1.7 1.4 5.0 - Domestic loans (net) -0.1 0.9 - - Ratios (% of CDP) Revenues and grants 20.9 23.2 21.5 16.8 - Oil/LNG taxes 14.7 12.9 11.7 5.7 Total expenditure 22.4 26.3 23.3 22.8 Government savings 7.4 7.4 6.1 1.3 Overall balance -1.5 -3.2 -1.7 -6.0 /a Routine expenditure adjusted to exclude amortization payments and include both the fertilizer subsidy and the recurrent component of development expenditure. Source: Annex Table VI.3. 15. The budget for 1986/87 had projected an overall deficit of Rp 1.4 trillion (1.7% of GDP). However, with the unexpected coLlapse in oil prices, oil/LNG tax revenues are now projected at only Rp 4.8 trillion, less than half the budgeted level. Some of this shortfall has bec. made good by increased non-tax revenues from domestic sales of petroleum products (esti- mated at Rp 1 trillion in 1986/87), improved non-oil tax performance and selected cuts in expenditure (e.g., funding of BULOG's food stocks). Never- theless, the budget deficit is still expected to rise to Rp 5.0 trillion (6.0Z of CDP). Given projected drawings of external commercial loans for balance of payments purposes, the Government will not have to resort to domestic financ- ing of the budget. - 8 - 16. By itself, the austere budget for 1986187 would not have been suffi- cient to bring the current account deficit down to manageable levels. There- fore, faced with the prospect of lower oil prices over the medium term, the Government decided to devalue the rupiah by 311 (from Rp 1,134 to Rp 1,644 per US dollar) on September 12. This adjustment is considered appropriate in light of the projected loss of oil revenues and helped to preempt speculative capital outflows. GOI also wishes to alter the present market psychology, which focusses almost exclusively on the rupiah/US dollar exchange rate, making it difficult to accommodate sharp or sustained changes in the relation- ship of the US dollar to the yen or major European currencies. To this end, Bank Indonesia now quotes five mid rates and the SDR rate for the rupiah. It is hoped that this strategy will permit greater flexibility in future exchange-rate management. 17. Throughout 1986/87, a significant component of GOI's adjustment effort has been the maintenance of a conservative monetary stance. During the first 6 months of 1986/87, total rupiah liquidity grew at an annual rate of 14% and domestic credit at 28Z. This marks a considerable slowdown from the previous year (1985/86), when rupiah liquidity rose by 27% and domestic credit by 42%. As already noted, the Covernment is not expected to draw on domestic financing during 1986/87. In addition, only a part of the increased demand for credit emanating from the public enterprise sector (resulting from slug- gish market conditions and the impact of the devaluation on cash flows) is likely to be accommodated. Similarly, preliminary data suggest that credit to the nonfinarncial private sector will be substantially less than in 1985/86. Deposit rates ac financial institutions continue to range around 11-14%, which are compc ltive with interest rates elsewhere in the region and a powerful instrument for resource mobilization within Indonesia. Lending rates average around 17%, which implies a high real interest rate given the current rate of inflation. The growth in domestic liquidity is judged to be broadly consistent with the Government's objectives of moderating inflation, and supporting both the projected level of economic activity and the balance of payments. C. Trade PoLicy and Foreign Investment 18. While C0I's performance has been outstanding in macroeconomic management, a conspicuous exception with regard to structural reforms has been its policy framework for trade and industry. In general, the trade regime has been inward-looking, promoting industrial investment with high levels of pro- tection from imports, often in the form of nontariff barriers (NTBs). By the end of 1985, more than 1,000 products (20% of the total number in the tariff schedule) were subject to import license restrictions. Not all of these restrictions were binding, and only about 300 items were subject to formal quotas. Even so, the proliferation of NTBs created distortions in the struc- ture of protection, which often led to high costs for downstream industries and reduced the competitiveness of Indonesia's non-oil exports. Consequently, recent Wcrld Bank economic reports have strongly advocated the replacement of NTBs by tariff-based protection as a first step in trade policy reform. 19. The first major shift in the direction of trade policy came in May 1906, when the Government announced a package of measures designed to provide - 9 - internationally priced inputs to exporters. Under the scheme, "producer- exporters" were given the option of importing their inputs free from licensing restrictions and exempt from import duties. Preliminary results suggest that the scheme is being implemented efficiently and is highly effective in sup- porting exporters (see paras. 47-49). During the first four months of opera- tion, producer-exporter status has been granted on US$228 million worth of imports, with over 90% of these items (by value) under license restrictions. On an annual basis, this amounts to roughly 6% of non-oil imports. However, while the May 6 measures are highly significant in providing a free-trade environment for producer-exporters, they do not address the fundamental distortions arising from the system of protection granted to Indonesia's manufacturing sector. 20. The September 12 devaluation significantly improved incentives for domestic producers of import substitutes and exports alike. As such, it provided an opportunity for rationalizing the disparate additionaL incentives provided to some import-substitution activities by the existing trade regime and to reverse the tendency toward proliferation of NTBs. GOT seized this opportunity through a package of trade reforms announced on October 25, designed to reduce import restrictions, improve industrial efficiency and promote non-oil exports. In particular: (a) all restrictive import licensing arrangements have been removed for 165 items (e.g., tires, glass, paper, dyes, synthetic fibers, some electrical appliances and vehicle parts); (b) import licensing restrictions have been relaxed on 110 items (e.g., chemicals and machinery) for actual users and licensed agents; (c) tariff rates were increased for 154 items, to compensate for the removal of NTBs noted above; and (d) tariff rates for another 152 items not produced domestically (e.g., certain chemicals, steel products and electrical components) were lowered, mostly to the range of 0-5%. 21. The significance and impact of these recent trade reforms are analyzed in Part IV of this report. In summary, the 275 items for which license restrictions were removed or relaxed account for 27% of all items and 44% of total import value previously restricted (i.e., could be imported only by approved importers). Equally important, the reform signals the Govern- ment's intention to shift to tariffs rather than NTBs as the primary instru- ment of import policy and provides a systematic framework for further reduc- tions in NTBs and rationalization of the system of protection. 22. Related changes have also been made in the regulatory environment for foreign investment. As part of the May 6 package, the Government took a number of steps to promote foreign investments: (a) the requirements for local participation in joint ventures have been relaxed for investment in certain priority subsectors which are important for exporters and employment generation; (b) the validity of investment licenses has been extended to 30 years; and (c) the operational limitations on joint ventures with majority local participation have been eased. Further changes were introduced in October 1986, to treat foreign investors more like domestic investors. In particular: (i) foreign investment is now allowed in existing firms in priority sectors, especially for exports (whereas previously foreign investors had to set up new joint-venture companies); (ii) investment by multilateral financial institutions (IFC, ADB, IDB) is to be treated as national participa- - 10 - tion; (iii) foreign-investment companies have been given access to export credit from state banks on the same terms as domestic firms; (iv) foreign- investment companies may now be allowed to act as a marketing channel for export products of other companies; and (v) ceilings on the swap facility for foreign exchange coverage have been removed, thereby providing joint ventures access to investment credits from state banks on roughly the same terms as for domestic companies. Combined with the recent devaluation and trade reforms, these measures are expected to lead to a significant improvement in the environment for foreign investment, especially in exporting activities. The impact on actual investment flows, however, is difficult to predict, as market prospects in Indonesia are currently weak and other regulatory constraints on investment remain (see para. 34). D. Impact on Economic Performance 23. Real growth in the economy is expected to slow during 1986, as the contractionary effects of cuts in government spending and the devaluation are felt. Most seriously affected will be the construction sector, which could decline by 8% during 1986. Agricultural growth is expected to be less than 2%, reflecting a slight decline in rice production from the record level of 1985. However, there has been a noticeable shift to other food crops, includ- ing soybeans and corn. Production of tree crops, especially palm oil and kernels, is also expected to rise during 1986. In the manufacturing sector, activity has been surprisingly resilient to date. However, the sluggish domestic economy is expected to constrain manufacturing output over the remainder of the year, reducing its annual growth rate to about 2%. Overall, non-oil CDP growth is projected to be less than 1% in 1986. With output restraint in the oil sector, in line with OPEC quotas, there will be little growth in total GDP. 24. Prior to the September devaluation, slack demand conditions and the Government's conservative monetary management had succeeded in holding annual inflation (as measured by the consumer price index) below 5%. Following the devaluation, consumer prices rose by 2.8% in September and 2.0X in October. However, stocks of basic commodities (especially rice) are high and the Govern- ment has announced that it will not immediately increase prices of electricity, teleconmunications, railway and city bus transport. Therefore, with continued monetary restraint, it should be possible to keep inflation to an average rate of 9% during 1986 (12% on a year-end basis). Although some spillover of the postdevaluation price increases into the next year is likely, Indonesia is expected to retain most of the gains in competitiveness obtained from devaluation. - 11 - Table 3: BALANCE OF PAYMENTS (US$ billion) Actuals Estimates 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 Oil/LNG earnings (net) 9.6 7.0 7.2 7.8 5.7 2.2 - Exports 18.8 14.7 14.4 14.4 12.5 6.9 - Payments -9.2 -7.7 -7.2 -6.6 -6.8 -4.7 Non-oil earnings (net) -12.3 -14.2 -11.5 -9.6 -7.6 -6.5 - Exports 4.2 3.9 5.4 5.9 6.2 6.7 - Imports -14.6 -15.8 -14.2 -12.7 -11.0 -10.5 - Services (net) -1.9 -2.3 -2.7 -2.8 -2.8 -2.7 Current account baLance -2.7 -7.2 -4.3 -1.8 -1.9 -4.3 Public MLT debt (net) 1.5 2.9 3.5 1.7 1.0 2.9 - Disbursements 2.7 4.2 5.0 3.8 3.7 5.6 - Amortization -1.2 -1.3 -1.5 -2.1 -2.7 -2.7 Other capital (net) /a 0.2 0.9 2.5 0.7 1.4 1.2 Use of reserves 1.0 3.4 -1.7 -0.6 -0.5 0.2 /a Includes direct foreign investment and private debt. Source: Annex Table VI.2. 25. The combination of demand restraint, devaluation and trade reform is expected to lead to a significant improvement in the balance of payments, com- pared to the "without adjustment" case (para. 12). Despite weak world market conditions and falling prices, earnings from non-oil exports are projected to rise by 8% during 1986/87. Manufactured exports, including plywood, textiles and garments, and some public sector products (e.g., cement, fertilizer and steel) are doing particularly well. At the same time, non-oil imports are expected to continue falling, leaving them more than one-third lower in real terms than in 1982183. Overall, the current account deficit is estimated to be around US$4.3 billion (7.8% of CNP) in 1986/81. 26. The current account deficit will be partialLy financed by estimated net disbursements of US$1 billion from the Inter-Covernmental Croup on Indonesia (IGGI) members. The Indonesian authorities are also expected to make substantial use of external commercial bank borrowing (gross disburse- ments of US$2.7 biLlion) in 1986/87. This amount includes a partial utiLiza- tion of credit lines negotiated during the previous year, in anticipation of a tighter resource position. A strengthening of private capital inflows follow- ing the devaluation should enable the authorities to hold official reserve use to about US$200 million. Including the net foreign assets of commercial - 12 - banks, totaL external reserves are estimated to remain over US$10 billion at the end of 1986/87, equivalent to 9.7 months of imports. After excluding prepayments, debt servicing is estimated to rise from US$5.1 billion in 1985/86 to US$5.5 billion in 1986/87. With the sharp oil-price-induced decline in gross export earnings, the total debt-service ratio will rise from 26% in 1985/86 to about 37Z in 1986/87. PART III - MEDIUM-TERM PROSPECTS AND POLICY FRAMEWORK A. Economic Outlook 27. Indonesia's medium-term prospects will be tightly constrained by the balance of payments. In particular, the oil outlook remains uncertain and it is difficult to plan on a substantial recovery in oil prices in the near fu- ture. Nevertheless, as a result of the impact of measures already taken and the Government's commitment to prudent macroeconomic policies and further structural adjustment, as well as a somewhat more favorable external outlook than in 1986, Indonesia is expected to reduce its external imbalance rapidly, allowing for a recovery of growth and incomes over the medium term. 28. Indonesia's oil prices had recovered to above US$13/barrel in November 1986. Based on the Bank's latest forecasts, crude oil prices are projected to continue rising to US$18/barrel over the next two years (see Table 4). Combined with some recovery in volumes, this would boost Indonesia's net oil/LNG export earnings to US$4.4 billion in 1988/89, about double the current level (see Table 5). Subsequently, oil/LNG earnings are projected to flatten out, as prices stabilize and production constraints limit grow:h in export volumes. Non-oil exports are expected to grow strongly in respanse to the recent devaluation and trade reform measures. Assuming con- tinued progress on trade reform and related policies volume growth is pro- jected to average about 6% p.a. through 1990/91. The declining trend in world prices for Indonesia's non-oil exports also appears to be arrested, with a mo- dest recovery projected over the medium term. The result is a relatively rapid expansion in export earnings by more than 50% over the next 4 years. 29. Following the impact of the devaluation and recent budget cuts, non- oil imports are projected to decline in real terms during 1987/88. This would leave the volume of non-oil imports about one-third lower than their peak level four years earlier, and help reduce the current account deficit to about 5% of GNP. Over the medium term, the current account deficit needs to be brought down sharply to sustainable levels. However, given the projected export earnings, there would be scope for real increases in import levels in later years. Accordingly, non-oil GDP and domestic income could recover to a mediumr-term growth rate of close to 4Z p.a. by the end of the decade. With prudent fiscal and monetary policies, inflation could be brought back down to below 7% by 1988/89. This is important, as higher rates of inflation in the medium term would jeopardize the effectiveness of the recent exchange rdte adjustment. - 13 - Table 4: HEDIUM-TERM PROJECTIONS /a Actuals Estimates Projections 1981-85 1986 1987 1988 1989 1990 Real growth rates (Z p.a.) CDP 2.6 0.2 1.7 2.9 3.8 3.5 Non-oil CDP 4.1 0.4 0.9 2.7 3.8 4.1 - Agriculture 3.0 1.5 1.5 2.5 3.0 3.0 - Industry 2.4 -1.7 -0.4 3.7 5.8 6.2 - Services 5.5 0.5 1.0 2.5 3.5 4.0 Domestic income 1.5 -8.9 3.7 4.1 3.8 3.8 Non-oil exports 11.6 5.4 8.5 5.1 5.2 5.4 Non-oil imports -5.1 -12.6 -3.2 2.3 3.0 3.2 Prices Oil price (US$/bbl) 25.0/b 12.5 16.0 18.0 18.0 18.0 Terms of trade (1983=100) 94.1Th 61.0 67.9 72.6 73.0 73.7 Domestic inflation (Z p.a.) 9.1 9.1 10.7 4.3 3.2 3.0 Ratios (Z) Debt service/exports 26.0/b 36.9 34.4 34.3 34.3 32.9 Current account/GNP -2.7Th -7.8 -5.1 -3.1 -1.8 -1.5 Gross investment/GDP 25.77T 24.5 23.8 24.0 24.1 24.4 /a Balance of payments data are for fiscal years (starting April 1). Other indicptors are for calendar years. lb End of period. Source: Annex Table VI.1 and World Bank estimates, 30. Debt service on MLT loans contracted through 1985 is projected to rise from US$5.1 billioz; in 1985/86 to a peak of US$6.4 billion in 1988/89 (accounting for 312 of projected export earnings). Therefore, despite the expected recovery in export earnings and even with continued restraint on import demand, there will be a substantial financing requirement. As defined in Table 5, the financing gap is to be covered by special IGGI assistance, new commercial borrowing and ura of reserves. A number of IGGI members (e.g., Japan and ADB) have already committed additional assistance, especially for local-cost financing. Several fast-disbursing Bank adjustment and sector loans, including this trade policy adjustment loan, are also planned. It is estimated that disbursements from this quick-disbursing assistance could total US$2 billion over the next two years. In addition, based on the projected amortization payments, commercial banks could lend Indonesia up to US$1.5 bil- lion over the next 2 years without increasing their net exposure. Together with special ICGI assistance noted above, this would be sufficient to cover the projected financing gap, without any reserve use, through 1988/89. With the projected adjustment in the balance of payments, the financing gap is steadily reduced in later years. - 14 - Table 5: BALANCE OF PAYMENTS PROJECTIONS (US$ billion) Actuals Estimates Projections 1985/86 1986/87 1987/88 1988/89 1989/90 1990i91 OillLNG earnings (net) 5.7 2.2 3.3 4.4 4.9 4.8 - Exports 12.5 6.9 9.0 10.6 11.1 11.2 - Payments -6.8 -4.7 -5.7 -6.2 -6.2 -6.4 Mon-oil earnings (net) -7.6 -6.5 -6.0 -6.1 -6.0 -5.6 - Exports 6.2 6.7 7.5 8.2 9.0 9.9 - Imports -11.0 -10.5 -10.7 -11.1 -11.6 -12.2 - Services (net) -2.8 -2.7 -2.8 -3.2 -3.4 -3.3 Current account balance -1.9 -4.3 -2.7 -1.7 -1.1 -0.9 Public MLT debt (net) 1.0 2.9 0.6 -0.2 -0.4 -0.7 - Disbursements /a 3.7 5.6 3.7 3.4 3.6 3.3 - Amortization -2.7 -2.7 -3.1 -3.6 -4.0 -4.0 Other capital (net) /b 1.4 1.2 0.3 0.2 0.4 0.6 Use of reserves -0.5 0.21 Financing gap /c -- 1.8 1.7 1.1 1.0 /a Projections assume no new commercial borrowing (after 1986187) and "business as usual" by IGGI members. lb Includes direct foreign investment and private debt. 7c Projected gap to be financed by special IGGI assistance, new commercial borrowing and use of reserves. Source: Annex Table VI.2. B. Policy Framework 31. As already noted, the projected adjustment in the Indonesian economy assumes continued restraint on aggregate demand over the next couple of years. Accordingly, as noted in the Policy Statement (Annex rv), the Government intends to maintain its prudent fiscal and monetary stance as well as its strong commitment to the present exchange rate system. Exchange rate policy will also remain flexible, so as to preserve Indonesia's competitiveness in international markets. It is equally important for the Government to continue the process of structural reform, so that economic growth can recover over the medium term. To this end, the Policy Statement identifies a number important areas for follow-up action to the recent trade reforms: (a) further elimination of NTBs and preparation of a plan for tariff rationalization; (b) review of restrictions on domestic investment and trade, with the objective of initiating extensive - 15 - deregulation in this area; and (c) review of the performance of selected public enterprises, to identify appropriate areas for reform. 32. The Government intends to announce another austere budget for 1987/88. Revenues ore projected to rise due to higher oilLNUG taxes and improved implementation of the recent non-oil tax reforms. Proposals have been made to extend the coverage of VAT. COI also is working with the World Bank to define an action plan to improve collections from the new property tax. Even so, total expenditure will have to be severely constrained. As noted in the Covernment's Policy Statement, highest priority will be given to providing satisfactorily for operations and maintenance (0M) expenditures, so that greater output can be obtained from available capital stock, especially in infrastructure facilities. Ongoing projects will be reviewed and only those that promise satisfactory economic returns will be funded. This implies that several projects, including some supported with foreign aid, may have to be cut cack. New projects will be undertaken provided they have very high economic benefits and only where external financing is available on suitable terms. An important consideration will be the capacity of the project implementing units to execute projects at the required pace. 33. In the area of trade policy, the October 25 measures reduced the scope of import license restrictions and signalled the Government's intention to move to tariffs as the primary instrument of import policy. However, non-tariff barriers (NTBs) still affect a number of important agricultural and manufactured products. As noted in the Policy Statement, it is the Government's objective to eliminate gradually all NTBs on imports except on a small group of products that are harmful to health, strategic to national defense or involve special economic and social considerations. Tangible progress in this direction is expected within the next year. Over the medium term, it will also be necessary to rationalize the tariff structure in order to reduce excessive and disparate protection. The Government intends to prepare a plan for tariff rationalization, based on regular monitoring of the levels and dispersion of tariff rates. The process of tariff rationalization will start with an early review of imports that currently attract tariffs above the notional maximum rate of 60Z established in the 1985 tariff reform, followed by a gradual reduction in the tariff ceiling. 34. To realize the full potential of these trade reforms, complementary actions will be required to relax restrictive licensing arrangements on private investment and domestic trade. The three important economic objectives of the licensing system are to: (a) prevent excess capacity in domestic industry; (b) encourage domestic competition by avoiding monopolistic or oligopolistic market structure; and (c) achieve balanced regional development. However, the Government needs to consider whether investment licensing is the most efficient instrument to achieve these objectives. For example, recent experience indicates that government projections of market demand are not necessarily any more accurate than those of the private sector. More fundamentally, this policy can block the competitive pressure generated by the entry of more efficient pro- ducers, which is probably the most effective way to keep costs low. In the case of industries where scale economies are significant, import competition could be used to control monopoly power, thereby limiting differentials between domestic and import prices. Finally, given the present difficult economic environment, - 16 - use of the licensing system to encourage investments in the Outer Islands may simply dissuade some potential investors from investing at all. Therefore, the emphasis of licensing policy needs to shift from investment regulation to investment promotion. Important steps in this direction for foreign investors have already been taken in the May 6 and October 25 packages. As noted in the Policy Statement, the Government intends to study other restrictions on domestic investment and trade with the objective of initiating extensive deregulation in this area. We expect the study to be completed in about one year. Greater freedom from licensing procedure would unleash entrepreneurial talent and mobilize more financial resources for investment. 35. The unsatisfactory financial and operating performance of public enterprises has imposed a major burden on the Government's budget and, even more importantly, has inhibited progress toward enhancing the efficiency of economic activity in Indonesia. A range of factors impinge on public enterprise perform- ance. Some can be addressed through relatively simple improvements in internal planning and operational procedures; others are outside the control of the enterprise (e.g., government policies and market conditions) or require long- term solutions (e.g., management weaknesses). Recognizing these concerns, the Government has initiated a program to review the performance of public enter- prises and to identify appropriate areas for reform, including changes in the system of government supervision and control, as well as in the management and financial structure of individual public enterprises. During the next year, the Government expects to prepare consolidated accounts for the public enterprise sector, develop an appropriate classification for public enterprises, and prepare a plan for sector restructuring through rehabilitation, merger or divestiture. This program will be supported by technical assistance from the IKF and the World Bank. C. Social Impact 36. The recent collapse in oil prices has had a major impact on incomes and employment in Indonesia. Adjusting for the terms of trade loss, per capita incomes fell by about 3X from 1981 to 1985 and by another 11% during 1986. The Government has acted to contain the social costs by: (a) giving priority to public spending on agriculture and local infrastructure; (b) promoting non-oil exports, which are generally more labor-intensive; (c) containing the infla- tionary impact of adjustment measures; and (d) adopting a more supportive attitude toward informal sector activities, particularly in urban areas. For example, the share of agriculture and regional development programs in develop- ment expenditure was increased from 18.3% in 1985/86 to 24.7% in the 1986/87 budget. Social programs were also protected, with the share of education, health and urban services rising from 19.7% to 21.6%. Since the devaluation in March 1983, the volume of non-oil exports has risen by more the 50%. Many of the fastest growing items--including agricultural products, textiles and garments--are important employment-generating activities. Finally, by following prudent fiscal and monetary policies, the Government has succeeded in containing the inflationary impact of the September 12 devaluation. Monthly price increases were held to 2.8% in September and 2.0% in October. - 17 - 37. Despite these efforts to minimize the social costs of adjustment, the Government remains legitimately concerned about the medium-term prospects for income growth and employment. Indonesia's labor force is expected to expand by an estimated eighL million over the next five years. The Bank has previously estimated that a non-oil CDP growth rate of 4-5% p.a. is required tS absorb this growing labor force at adequate levels of productivity and incomes.- As already noted, the prospect of reaching these growth rates over the next two years, consistent with financial stability, is bleak. However, with the projected recovery in oil prices, it should be possible to restore medium-term growth to 4% p.a. by the end of the decade. The Government's program of trade reforms, together with the proposed actions on domestic regulation and public enterprises, are essential to achieve this objective. In the interim, continued attention to public spending priorities and inflation control will be required to avoid unnecessary erosion of incomes and employment opportunities. PART IV - TRADE POLICY REFORM A. Evolution of the Import Regime 38. At the start of the decade, Indonesia's import regime was charac- terized by high and disparate tariff rates (from 0% to 225%, with 25 tariff categories) coupled with a range of nontariff barriers (NTBs). The NTBs included an importer licensing system, import bans and quotas, and various informal quantitative restrictions (e.g.. the complex port and customs clearance procedures). 39. The licensing system classified products into two broad categories. The majority of products were classified under the general import licensing category. This is the standard type of license used in many countries to register importers, and is not considered restrictive. To obtain this license the applicant must have assets above a given level and a bank reference. The remaining products could cnly be imported by holders of an "approved-importer" license. Initially, the approved-importer license was to be used to encourage product specialization and develos, an after-sales service capacity, with no limit on the number of license ho'dera- However, over time, these licenses were issued on a restrictive basis to a smaller number of traders or large producers which created a significant NTB. The actual degree of restriction depended on various factors, such as the number of license holders and whether there was a formal quota on the permissible amount of imports. 40. During the 1980s, there have been significant shifts in trade policies and the relative importance of the different instruments. The first trend was toward increased government control via an expansion of the product coverage and a reduction in the availability of approved-importer licenses. This partly reflected an industrial strategy, backed by public investment financed from the oil boom, designed to push the process of import- 2/ See the World Bank Report, Indonesia: Policies for Growth and Employment (Report No. 5597-IND, April 23, 1985). - 18 - substitution "upstream" toward basic goods such as cement, chemicals, fertilizers, synthetic fibers, and iron and steel. Some of these activities required a higher level of protection than that nrovided by the existing trade regime, particularly after 1982 when the onset of the world recession lowered the prices of a wide range of traded goods. Pressures for increased license restrictions also arose from the slowdown of the domestic economy, wkich left many of these newer upstream plants carrying excess capacity. 41. Due partly to these pressures and partly to the deterioration in the overall balance of payments, the Ministry of Trade issued several decrees in late 1982 increasing the number of products requiring an approved-importer license. At the same time, the number of approved traders was reduced, often to as few as two or three (usually state-owned) companies. Besides nominating who may import, each decree also established the Ministry of Trade's authority to fix quotas. For manufactured goods these decisions were based on consulta- tion with the Ministry of Industry, and were often linked to the deletion pro- gram: a program designed to increase the local content of various domestic assembly activities (e.g., motor vehicles, tractors, diesel engines, and motorcycles). 42. The iniitial strategy was to select an approved importer for all products (i.e., put all goods under the approved-importer license category). The bulk of the decrees extending the coverage of approved-importer licenses occurred in 1982 and 1983. By 1986, some 1063 CCCN items (202 of the total) required an approved-importer license, bringing US$2.7 billion worth of imports (27% of the total) under license restriction (see Table 6). This control of traders apparently had other objectives besides providing protection. One such rationale was to establish traders that had a long-term commitment and professional expertise to import a particular group of products. It was felt that the approved traders could reduce the range of brands of a particular imported commodity, which in turn would assist in developing an after-sales service and eventually an indigenous production capacity limited to one or two product types. - 19 - Table 6: PREVALENCE OF IMPORT LICENSING IN EARLY 1986 No. of CCCN items Imports (US$ m) lb Value added Under Under Under (US$ m) /a Total license quota Total license Manufacturing Ic 5,095 4,066 763 231 8,082 2,459 Agriculture Id 10,039 1,024 288 64 127 262 Minerals /e 15,127 139 12 1 1,451 25 Total 30,261 5,229 1,063 296 10,260 2,746 /a Estimate for 1984 from input-output table. Excludes non-traded sectors (especially services and subsistence agriculture). Due to differences in classification, these numbers may vary from national account estimates. lb Based on BPS import data for 1985, which vary from balance of payments estimates for 1985/86. Ic Manufacturing defined as CCCN Chapters 28-99. 7d Agriculture defined as CCCN Chapters 1-24, and therefore includes prepared foodstuffs and beverages. /e Minerals defined as CCCN Chapters 25-27, and therefore includes cement. Source: BPS and World Bank estimates. 43. Partly because the rationale for bringing a particular commodity under an approved-importer license varied, the degree of protection provided by the license also varied. In the most restrictive cases (e.g., some iron and steel, plastic and agricultural products), imports have been channelled through one approved importer, often accompanied by a binding quota. In other cases, the one or two approved trading companies apparently set their own limits on import quantities with consequent price-raising effects. At the other end of the spectrum, approved-importer licenses were awarded to severaL trading companies with no overall quota. Of the 1,063 items under approved-importer license, less than one third (accoijying for 4-6Z of total imports) are or have been subject to official quotas.- As a result of the complexities associated with license status, the degree of protection provided by the license restriction varied significantly across products. 3/ Of the 296 items listed as eligible for quotas, 7 have zero quotas, 149 have had value or volume quotas, and 140 have no fixed quotas (but require administrative approval at the time of import). In addition, there are 9 products for which imports are banned (including automobiles, motor cycles, TVs and radios in CBU condition). Banned items are not included in the number of items under license and quota in Table 6. - 20 - 44. While license restrictions were on the increase, the Covernment implemented two policy reforms designed to reduce other trade-policy-related distortions. First, in March 1985 the Government announced an across-the- board reduction in the range and level of nominal import tariffs. The tariff ceiling war reduced from 225% to 601, with tariff rates for most products ranging from 5% to 35%. The number of tariff categories was also reduced from 25 to 11 (see Table 7). The full benefits of this tariff rationalization were mitigated by the proliferation of license restrictions. Even so, the fact that over 80% of the CCCN product items were not under license, together with the non-discretionary nature of the change in the tariff schedule, resulted in an unambiguous improvement in the trade regime. For the first six months of 1986, it is estimated that 2yer 70% of total imports by value entered Indonesia at a 0-5% tariff.' 45. Second, in April 1985 the Government completely reorganized the customs, ports and shipping operations. It placed the sensitive job of certifying imports in the hands of private surveyors (SCS). As SCS has the capacity to inspect goods at the point of origin, this enabled the Government to reduce customs procedures in Indonesian ports considerably. After SCS has certified the import duty rate and the value of the shipment, the importer pays the import duty directly to his bank. This has reduced both the numbers of custom officials required and the discretion used at the port of entry. As a result, the average time spent on customs procedures has been cut by several weeks, and the cost of freight forwarding has declined enormously (see para. 9). 4/ This includes those imports that have a tariff greater than 5% but are exempt under the May 6 export scheme (see paras. 47-49). - 21 - Table 7: RECENT CHANCES IN THE TARIFF SCHEDULE /a 1980 schedule 1985 schedule Present schedule /b Tariff No. of Z of No. of Z of No. of X of rates tariff CCCN items tariff CCCN items tariff CCCN items (x) categories covered categories covered categories covered 0% 1 6.5 1 S%3 1 7.5 Up to 5Z 4 29.2 2 32.0 2 33.8 Up to 10% 6 39.5 3 44.9 3 46.0 Up to 15X 7 41.9 4 50.3 4 51.0 Up to 20% 8 47.8 5 64.0 5 63.6 Up to 30% 10 58.7 6 81.8 6 80.4 Up to 40% 12 70.6 7 91.5 7 89.9 Up to 50% 14 77.9 8 96.2 8 95.0 Up to 60% 15 90.1 9 99.6 9 99.5 Up to 80% 17 95.1 9 99.6 10 99.6 Up to 100% 19 99.6 10 99.9 11 99.9 Up to 200X 24 99.9 11 100.0 12 100.0 Up to 225% 25 100.0 /a Table shows cumulative number of tariff categor.es and percent of CCCN items covered at various tariff rates. Speci!ic tariffs are excluded. lb After October 25, 1986. Source: l45nistry of Finance. 46. Thus, at thie beginning of 1986, the relative importance of the different tariff and NTB policy instruments had changed. The distorting effects of the tariff structure had been reduced and important NTBs-- especially the port and customs clearing procedures--had been removed. However, by reducing the impact of these instruments and by expanding the coverage of approved-importer licenses, the Government increased the relative importance of the import licensixig system. As shown in Table 8, this system has led to Wy1atively high rates of protection in many important manufacturing activities.- The high level and variability of protection undermines the efficient development of the economy in a 'ariety of ways: 51 These estimates relate to 1984. Recent events, in particular the devaluation, are likely to have narrowed the difference between domestic and international prices. Nevertheless, the table still provides a broad indication of the degree of protection provided to these activities. - 22 - Table 8: PROTECTION FOR SELECTED MANUFACTURING ACTIVITIES IN 1984 la Nominal Effective Value protection rate of added on output protection lb Activity (US$ m) (Z) (Z) Pharmacautical products 65 25 40 Painta, varnish, dyes 76 35 92 Plastic products 107 35 425 Tires and tubes 27 30 175 Wood pulp 16 18 290 Paper and priating 155 20-40 45-ioO Teztile spinning and weaving 325 15-50 65-500 Class and glass products 29 40 425 Basic iron and steel 150 30 60 Other metal products 389 5-35 35-260 Mechanical machinery 31 15 20 Electrical machinery 23 15 10 Electrical appliances 37 20-15 70-145 Communication equipment 62 40 110 Motor vehicles 410 85 4,800 Motorcycles 94 50 125 Subtotal for 16 activities 1,973 Total manufacturing 5,095 /a These activities are among the most highly-protected activities in the manufacturing sector, and accDunt for 39Z of manufacturing value added as defined in Table 6. lb Calculated as the difference between value added at domestic prices and value added at world prices, as a percentage of value added at world prices. For activities where value added at world prices is very low (e.g., motor vehicles), the effective rate of protection can be very large. Source: World Bank estimates. (a) Users in Indonesia have to pay more for the products they purchase. This reduces consumer welfare and limits the size of the domestic market. Furthermore, industries that enjoy the highest protection are those which have tended to show the slowest improvements in efficiency over the past decade. (b) The high protection for upstream industries draws resources into relatively inefficient capital-intensive activities. This imposes additional costs on downstream producers and reduces their competi- - 23 - tiveness. Restraining the growth of efficient downstream producers is particularly undesirable because they are generally more important in providing employment. (c) Protection levels are higher for import-competing than for export- oriented industries. Consequently, the structure of protection imposes a bias against exports of manufacturers that could jeopardize Indonesia's non-oil export drive and inhibit the development of a dynamic and efficient manufacturing sector. (d) Finally, the system of import licensing and quotas creates "rents" for those who are allowed to import. This in turn diverts resources and manpower from productive activities, eliminates a potential source of government revenue (tariffs), and creates opportunities for abuse. Recognizing these problems, the Government has introduced two important policy reforms in 1986 aimed at reducing the impact that import licensing has on the trade regime. B. May 6 Package 47. Indonesia's accession to the GATT Code on Subsidies and CoueteEyail- ing Duties in 1985 required withdrawal of the Export Certificate Scheme.- As a result, it became necessary to attack directly some of the factors affecting the competitiveness of Indonesia's non-oil exports. Accordingly, on May 6, 1986, the Government announced a package of measures designed to provide internationally priced inputs to exporters. The program allows all "producer- exporters" (defined as those who export at least 85Z of their total production) the option of importing their inputs free of restrictions and exempt from import duties. The significance of this reform goes beyond allowing imports to be brought in duty-free as it also allows producer- exporters to bypass the approved traders. Non-specialist exporters (firms exporting less than 85% of output) are also covered by the scheme, if it can be established that local suppliers of their raw material are not matching import competition in regard to quality or price. The scheme also allows indirect exporters to reclaim import duties through a duty drawback facility. 61 As a scheme for rebating exporters, the Export Certificate Scheme suffered a number of drawbacks. The level of payment often did not relate to actual duty cost and was often viewed in importing countries as a direct subsidy. In addition treatment was uneven, in some cases actual payment was less than the duties borne: usually for the more competitive exporters able to compete without subsidy. A final difficulty was that even if import duties were fully rebated the scheme did not provide a method for bypassing the approved traders, and therefore did not compensate exporters for the costs imposed on them by the restrictive import license system. - 24 - 48. Preliminary indications are that the system is working far more smoothly and covering a larger percentage of imports than might have been anticipated. As opposed to limiting the scheme to producers that export 85% of their total production, access is being granted to any 9porter on the basis of past export history and a confirmed export order.- This approach removes the need for the producer-exporter to prove that he is exporting 85% of total production and enables the executing agency (P4BM) not to become drawn into the difficult administrative decision of deciding whether local and foreign prices are comparable, to what extent sole importers are manipulating their quoted prices, and whether quality considerations are being taken into account. These characteristics have greatly assisted in implementing the scheme quickly and in a nondiscretionary manner. Indeed, P4BM has been able to reduce and standardize the information required to grant producer-exporter status (basically an export order verified by the exporter's bank and a "treconciliation" of input-output coefficients). This has several benefits: (a) it enables P4BM to remain at arm's length from exporters, which reduces the possibility of negotiations over each application (applications are only accepted by post or courier); (b) the discretionary power of officials in determining eligibility is lessened; (c) once exporters become familiar with the scheme, the costs of applying will be small; and, more importantly, (d) it should encourage new exporters, as potential investors should be able to readily assess whether they will have access to the scheme. 49. The results to date are impressive. During the first 4 months of operation, producer-exporter status has been granted on US$228 million worth of imports (see Table 9), with over 90% of these items (by value) under license restrictions. This entailed exemption from US$46 million in taxes. If we extrapolate from this base to a full year, the scheme would cover about 6% of non-oil imports. As with previous export schemes, the major bene- ficiaries are textile and garment producers (accounting for 54% of all imports approved for exporters). However, the scheme is also important for other export activities, including processed foods, chemicals and wood products. The scheme has therefore been successful in reducing the restrictiveness of both tariffs and import licensing restrictions across activities. C. October 25 Reforms 50. Overview. On October 25, the Government announced two decrees concerning trade policy. The first, issued by the Ministry of Trade, revoked six previous docrees under which 321 items had been restricted to the approved-importer license category. Over haLf of these items were shifted to the general-importer category, while the remaining items were reclassified into four license categories. Two of these categories (allowing imports by actual users and licensed agents) represent a significant relaxation of previous license restrictions. Furthermore, these more clearly-defined and open license categories provide a systematic framework which can be extendtd 71 For example, a domestic firm that sells only 20% of its total production on the export market can be granted producer-exporter status for the imports required to produce that 20%. - 25 - to cover items not affected by this reform. The second decree, issued by the Ministry of Finance, altered the import duty applicable to 306 product groups and stipulated a list of 33 imported goods which could have a surcharge imposed. About half of the tariff changes were increases, to moderate the effects of license removal on domestic manufacturers. The tariff reductions were for inputs not produced domestically, to offset the impact of the recent devaluation. Table 9: IMPLEMENTATION OF MAY 6 SCHEME /a (US$ million) Imports Exemption from Activity approved Duty VAT Exporters 228.1 28.7 17.2 Textiles & garments 124.2 2.3 1.1 Processed foods 53.4 5.5 6.0 Chemicals 15.3 11.7 2.7 Wood products 15.1 2.3 3.0 Other 20.1 6.9 4.4 OI projects /b 24.2 25.6 - Total 252.3 54.3 17.2 /a From July 1 to November 15, 1986. 7T The May 6 scheme also applies to contractors for GOI foreign-assisted projects. However, the text discussion focuses on exporters only. Source: Ministry of Finance. 51. The primary objective of the two decrees was to move the majority of these products away from binding license restrictions toward tariff-only protection. As such, the October 25 measures signal GOI's intention to shift to tariffs as the primary instrument of import policy. As noted in the Policy Statement, this decision is based on several considerations. First, tariffs provide a more transparent form of protection which automatically prevents domestic suppliers from increasing prices above world prices by more than the tariff rate. Second, tariffs are simpler to administer; NTBs create the potential for abuse and can lead to protracted negotiations among the parties concerned. Third, tariffs are easier to adjust so as to rationalize the structure of protection. Finally, tariffs will contribute to GOI's budgetary revenues and help support priority development programs. 52. The major impact of the October 25 measures was to remove or relax import restrictions on 276 items, accounting for 27Z of all items and 44Z of total import value previously restricted (see Table 10). As discussed below, the reform focussed an a number of highly protected activities: in parti- - 26 - cular, most chemicals, paints and dyes, tires and tubes, paper an4,glass. The October 25 measures had little impact on the agricultural sector.- Within the manufacturing sector, a number of important import licensing restrictions remain, particularly for basic iron and steel, plastics and textiLes (other than clothing). Table 10: SUMMARY OF OCTOBER 25 LICENSE CHANGES CCCN Items Import Value No. affected Z of res- US$ m % of res- License by reform tricted affected by tricted category la /b items reform items General importer (IU) 166 16 350 13 Actual user (IP) 60 6 495 18 Licensed agent (AT) 50 5 354 13 Licenses removed or relaxed 276 27 1,199 44 Producer importer (PI) 6 1 9 - Approved trader (IT) 39 4 241 9 Total covered by measures 321 30 1,449 53 /a Initials relate to the Bahasa Indonesia terms for each of these categories (see inside front cover). lb Where the reform entailed splitting an existing CCCN category, we have counted each item separately. Thus, the number of items differs slightly from that given in the government decrees. Source: Ministry of Trade. 53. Import Licensing. The underlying rationale of the first decree on import licensing was to reduce both license coverage and the degree of restriction implied by a particular license. Over half (166 items) were moved into the general-importer (IU) category. These products account for 162 of the CCCN items and 13% of the import value previously restricted to approved importers. This effectively removes all license restrictions on some important blocks of products such as tires, glass, paper and dyes (see 8/ About two thirds of the agricultural import value affected by import restrictions is accounted for by three items: soybeans and soya flour/meal, cloves and milk products. The World Bank is presently looking at the impact of these restrictions within the context of an agricultural incentives study. The findings are expected to be available for discussion with GOI before the end of the fiscal year. - 27 - Table 11). Other important import items affected include synthetic fibers (for the textile industry), akyl benzene (for detergent manufacturers), some electrical appliances (e.g., air conditioners, deep freezers, washing machines, irons and telephones) and motor vehicle parts (e.g., shock absorbers, radiators and mufflers). Within the manufacturing sector, the proportion of items removed from restricted licensing is 21% for intermediate goods, 212 for capital goods and 26% for consumer goods. Most of the items (127) are intermediate goods, reflecting the prevalence of NTBs (602) in this category prior to the reform. Tariffs have been raised for 70Z of these products to offsetyhe removal of license restrictions. However, except for three minor items,- the new tariffs are within the 60% ceiling set in the March 1985 tariff reform. 54. The license restrictions on the remaining items that had been covered by the six previous decrees were cLarified and, in some cases, relaxed. For this purpose, four categories of license have been defined, of which only the first two may be viewed as relaxations of the existing licensing system: (a) Sixty items were classified under the actual-user (IP) license category. These items can now be imported without restraint by any producer in the amounts required as inputs in his production process. Prior to October 25, most domestic producers could only obtain direct access to those inputs that were on the general import list. To import commodities on the approved importer list, domestic producers either had to go through a local approved trader or, in very few cases, become an approved importer themselves. For those activities that are characterized by a number of smaller firms, which may not be able to import directly, approved traders are also permitted to import the inputs. The direct access of domestic producers to importer status should prevent the exercise of monopoly power by any one importer. Most of the items classified in the IP category are CKD kits or components for machinery and vehicles. (b) Fifty items were classified under the licensed-agent (AT) category. The licensed agent to import a particular brand of product will be selected by the overseas supplier, subject to approval by Ministry of Industry. The licensed agent will be free to appoint subagents. The rationale is to encourage the licensed agents to provide a limited number of products by brand type, so as to encourage the development of improved after-sales service capacity and to standardize spare parts reauirements. Under the new decree, there will be competition between brands and no import restrictions on approved product types. All of the products placed under the AT license category are either mechanical and electrical equipment or vehicles. Most of these (excluding motor vehicles) are the completely built-up (CBU) counterparts of the CKD kits placed under the IP license category. For the most part, the CBU units 9/ The tariff rate was set at 80% for hinges, bolts and staples. Table 11: CHANGES IN IMPORT LICENSING BY ACTIVITY Domestic No. of CCCN value items under No. of CCCN items % of license restrictions lb added license covered by Oct. 25 decree Kemoved or Covered Activity /a (US$ m) before Oct. 25 IU IP AT FL IT Total Removed relaxed by decree Manufacturing 5,095 763 164 60 50 3 31 308 22 36 40 Chemicals 225 44 25 8 - - - 33 57 75 75 Pharmaceutical products 65 11 - - - - - - Paint, varnish, dyes 76 9 9 - _ - _ 9 100 100 100 Explosives - 3 - - - 3 - 3 - - 100 Fertilizer and pesticides 1,348 5 - - - - - - - - - Plastics 107 41 6 - - - - 6 15 15 15 Tires and tubes 27 15 15 - _ _ _ 15 100 100 100 Hides and leather 246 27 - - - - - - - - - Wood pulp 16 6 - - - - - - Paper and printing 155 23 18 - - - - 18 78 78 78 Textile spinning and weaving 325 171 6 - - - 1 7 4 4 4 Apparel and clothing 575 - - - -- - - - Other textiles 31 73 - 2 - - - 2 - 3 3 N Glass and glass products 29 13 12 - - - - 12 92 92 92 X Basic iron and steel 150 95 1 - - - - I 1 1 1 Other metal products 389 40 8 - - - 12 20 20 20 50 Mechanical and electrical equipment 153 129 40 38 34 - 14 126 31 87 98 Vehicles and transportation equipment 527 44 16 9 16 - 2 43 36 93 98 Other manufacturing 651 14 8 3 - - 2 13 57 79 93 Agriculture 10,039 288 1 - - - - 1 - - - Minerals 15,127 12 1 - - 3 8 12 8 - 100 Total 30,261 1,063 166 60 50 6 39 321 16 26 30 /a Defined as follows: manufacturing, CCCN Chapters 28-99; agrictilture, CCCN Chapters 1-24; minerals, CCCN Chapters 25-27. For manufacturing subsectors we liave used corresponding CCCM Chapters as defined in the Indonesian Tariff Schedule 1985. lb License restrictions on items moved to LU are removed, while those on items reclassified as IP and AT are assumed to he relaxed. The total items covered by the reform includes all five license categories. Source: Ministry of Trade. - 29 - under the AT license have tariffs about 20% above the corresponding CKO kits, and many are covered by the surcharge provision discussed below. (c) Six product groups were classified under the producer-importer (PI) license category. This restricts access to the domestic producer of the same final product. Only explosives and cement (3 items each) were placed in this restricted category. (d) Last, 39 items were kept under the approved-trader (IT) license category, which restricts the importation of these products to a few trading companies. Although no fundamental change has tak87 place, t.ie number of approved traders has been broadened to six - for all products. Prior to October 25, imports of these products were restricted to only one or two trading companies. The use of the IT category has been limited primarily to iron and steel products and the remaining mechanical and electrical equipment. 55. In evaluating the significance of the October 25 measures, three broad judgments are necessary: (a) do the measures focus on those activities that were highly protected under the previous regime; (b) to what extent are the new licenses less restrictive than the previous approved-importer license; and (c) at what level were the tariffs set for those products moved from license to tariff control. These judgements are best made at the industry or subsector level where the degree of protection and the extent of the change in license coverage can be more clearly assessed. 56. By relating the license changes to the relevant CCCN chapters, the "block" nature of the October 25 changes becomes apparent. This is illustrated by the relatively large percentage of items removed from license restriction or reclassified under the IP or AT category. By comparing tables 8 and 11, it can be seen that the October 25 measures did focus on several highly protected activities: in particular, most chemicals, paints and ::yes, tires and tubes, paper and glass. For equipment and vehicles, the story is more complex. For approximately one third of these products (primarily electrical appliances and motor vehicle spare parts) license restrictions have been completely removed. Another one third have been placed in the actual user (IP) category. These products are mostly mechanical and electrical machinery--such as bulldozers, tractors and road graders--that are imported as completely knocked-down (CKD) kits. Before October 25, only a few manufacturers would have been allowed to import directly and assemblers would also have been disadvantaged by the deletion program. Under the October 25 measures, all domestic assemblers will be able to import IP products. In addition, some locally produced components (such as shock absorbers, mufflers and radiators) have been moved from license to tariff protection which increases competitive pressures. The remaining items in the categories of mechanical and electrical equipment and vehicles are mostly completely built- 10/ The six trading companies are P.T. Niaga, P.T. Dharma Niaga, P.T. Tjipta Niaga, P.T. Kerta Niaga, P.T. Mega Eltra and P.T. Sarinah. - 30 - up (CBU) units and these have been placed in the licensed-agent category. The tariff margin of 20% between the CKD and the CBU should result in increased competition for domestic assemblers (except for automobiles and motorcycles, where CBU imports are stiLl banned). 57. It is our judgement that both the Ir and AT license categories represent a significanL relaxation of the import licensing restrictions. The goods under these license categories are no longer subject to quantitative restrictions, and the access of either domestic producers or traders will be more open. In particular, the broadening of the import-producer (IP) status to include all domestic producers, coupled with the movement of a number of important items into this category, supports the Government's strategy of moving toward tariff-only control. In the case of the licensed-agent (AT) category, the fact that the License is defined by brand and not product type, together with the removal of quantitative restrictions and the freedom to appoint subagents, should increase competitive pressure in the domestic markets. For the products classified within these two license categories, the NTB created by the previous approved-importer system is substantialLy dismantled. The same cannot be said of the items classified under either the IT or PI license category, although there is some move toward increasing domestic competition in the IT category. 58. As with the May 6 package of reforms, realizing the full benefits of these trade reforms will require careful monitoring of their implementation. In particular, the Government needs to monitor licensing under the IP and AT categories. In the IP category it is important to ensure that the licensing requirement is not used to deny producers direct access to imports of their inputs; and in the AT category sole agents should not be required to restrict the import of specific items to designated levels. In implementing the new importer arrangements, other industrial regulations will have to be reviewed and adjusted in order to avoid negating the positive impact of the trade reforms. 59. After the October 25 measures, import license restrictions probably provide significant protection to less than one-third of domestic value added in the manufacturing sector.-lt Import license restrictions remain important in the following manufacturing activities: (a) the most severe license restrictions (i.e., those generating high effective rates of protection) are on pharmaceutical products, plastics, hides and leather, textiles (other than clothing) and basic iron and steel. Together, these activities account for about 18% of value added in the manufacturing sector. For the textiles 11/ In addition, there are import licensing restrictions on fertilizer and pesticides (accounting for 26% of manufacturing value added). However, these do not provide significant protection to domestic industry. In 1984, the effective rate of protection on this activity was close to zero, and the Indonesian fertiLizer industry has demonstrated that it can operate at high capacity-utilization and efficiency rates. - 31 - and steel subsectors, the World Bank is presently financing studies aimed at helping the Government design appropriate programs of subsector restructuring and trade policy reforms. It is expected that action programs can be defined and some tangible programs achieved in about a year. In the interim, exporters can import these items under the prGvisions of the May 6 scheme. (b) For other metal products, vehicLes and transport equipment (accounting for another 18Z of manufacturing value added) the October 25 reforms made significant inroads into import licensing restrictions. However, some important restrictions remain, especially import bans on CBU automobiles and motorcycles (para. 56). Although the number of restricted items is now less than 10Z of the total in these product groups, they still affect a relatively large share of the value added in these activities. 60. Tariffs and Surcharges. The changing structure of the Indonesian tariff schedule is illustrated by the frequency distribution of tariff rates in Table 7. As can be seen, the major tariff reform occurred in 1985, and the net impact of the October 25 changes is relatively small. Of the 154 items for which tariffs were increased, 147 items were directly related to the reuoval or relaxatior. of license restrictions. Based on estimates of nominal protection rates and selected case studies of activities affected by the reform, it would appear that the new tariff rates reasonably approximate the protection provided by the license restrictions. However, the Government intends to monitor the situation and reduce tariffs if there is evidence of excessive protection. This will be done in the context of a systematic medium-term plan for tariff rationalization, which will lead to lower and more uniform levels of effective protection. 61. One of the important objectives in moving from NTB to tariff protection is to set a clear and observable ceiling to the degree of protection, which is uniform across all domestic producers. Given an appropriate tariff, this increases the competitive pressures on the least efficient producers and encourages structural change. The October 25 packages represents a step toward achieving this objective for a number of important activities. For example, both container glass and flat glass are manufactured in Indonesia. Prior to October 25, glass imports were predominantly under license, with an import ban being used to protect the less efficient flat glass producers. This has been replaced by an across-the-board tariff on all glass of 60%, a level at which the domestic manufacturer of flat glass will face increased competition. In the case of tires, a new specific duty replaces a virtual ban on imports. While the specific duty does appear to be on the high side, dowz 7tic producers are likely to face increased competition for some tire types.- For paper, license restrictions have been replaced by a 60% tariff. However, in this case, domestic prices are already close to 121 The new specific duty is Rp 6,000/kg, which translates into an ad valorem duty of 30-70% depending on the tire weight and value. Domestic prices in 1984 were 20-40% above world prices. - 32 - world prices for many grades of paper due to domestic competition. The main change is therefore the replacement of a nonbinding import license with a nonbinding duty. But having established tariff-only protection, the tarirf can be lowered to increase competitive pressure. The October 25 reform also removed rayon and polyester staple fiber from license control with the tariff rate left at 15%. Synthetic staple fiber is produced by four domestic firms. with imports previously restricted to one approved trader. According to Bank estimates, the more efficient domestic producers would be able to operate witn tariff protection of 15%, but some of the less efficient producers would be under competitive pressure to reduce costs. This item is covered by the surcharge provision, but to date this has been set at zero. 62. The 152 tariff reductions focused on industrial inputs that are not produced locally. These inputs were apparently selected on the basis of iheir importance in local production costs, with the objective of offsetting the cost-raising effects of the SepLember devaluation. For those items that are inputs into export or lightLy protected import-substituting activities, the changes have improved the structure of assistance by raising low levels of effective protection. But for those items that are inputs into license- protected import-substituting industries, the reduced cost of imported inputs will encourage domestic output in already highlv protected activities. An analysis q3 the items for which tariffs were reduced produces a fairly mixed picture.> In general, the significance of the changes is small and no overall pattern emerges. 63. The October 25 package also specifies 33 goods as potentially surchargeable. The Covernment intends to use import surcharges as a safeguard mechanism to protect domestic oroducers against predatory dumping. however, they will only be imposed on a highly selective and temporary basis, and only after balancing the interests,2j producers and consumers. To date, oniy three surcharges have been applied.- Most of the surchargeable items remain under a restricted license category. In some cases, the duty has been lowered (e.g., tin of the type used for packaging goods under pressure) and the sur-- charge provision appears to be a basis for protecting the local tin plate producer as required. The surcharge provision also applies to the two impor- tant man-made Fibers taken off license (poiyester fiber and rayon fiber). 'n t;his case, the degree of protection will involve balancing the demand& of a large number of downstream users and a few local fiber producers. The rera.n- der are focussed on CHU imports of h-eavy machinery (e.g., road rolers, bull- 131 For example, 60 of tle items w-hnich had duties lowered to 0-5% rema:n under license restriction. Of these. 40 were iron and steel goods. a further 20 items had license rest,-ctions removed at the same tuae as duties were lowered. In addition, some 80 items are newly defined, i-e., involve a partitioning of an existing tariff item. For example, the CCCY classification for wire rope was split into two, which will allow wire rope over 64 mm to enter at 5% while all other wire rope will be at 20% and under license. 141 Zinc chloride, duplicating paper and metal files. - 33 - dozers, hydraulic excavators, motor graders, tractors and forklifts) to protect the local assembly of CKD kits. PART V - THE PROPOSED LOAN A. Loan Objectives 64. The proposed loan was prepared following COr's announcement of the October 25 reform measures and builds on ongoing active consultations between the Bank and GOI on macroeconomic management and trade policy issues, both of which were highlighted in the most recent economic report "Indonesia: Adjusting to Lower Oil Revenues" (No. 6201-IND, dated May 20, 1986). The loan was appraised in November/December 1986; negotiations were held in Jakarta from December 15-19, 1986. The Indonesian delegaLion was led by Mr. Sujitno Siswowidagdo, Managing Director, Bank Indonesia and included representation from BAPPENAS and the Ministries of Finance and Trade. Supplementary loan data are provided in Annex IrI. 65. The objectives of the proposed loan of US$300 million equivalent are to: (a) support the substantial reforms, especiaily in the area of trade policy, undertaken by the Government during 19e6 and to ensure that they are i.;plemented well; (b) assist CO.. to bring about an earLy recovery in economic activity consistent with external and domesLic financial stability; and (c) maintain the policy dialogue on further reforms for promoting the effici- er.cy and longer-term viability of the economv. These objectives would be achieved in part through support to the balance of payments provided by the proposed Toan and in part through ongoing dialogue on policy issues and improved institutional arrangements for administration of the trade system. A related technical assistance loan will be presented to the Executive Directors in the near future. B. 'oan Administration 56. Disbursement. The proposed loan of US$2-00 million equivalent would be available for disbursement upon loan effectiveness and would be used to reimburse 10O0 of foreign expenditures for eligible imports for uhich payments are made after the date of Loan signing. The list of ineligible imports for the purnoses of this loan would be the standard, i.e., goods intended for military or paramilitary purposes, or for luxury consumption; goods financed fron, other official multilteera! or bilateral sources; uranium; and goods procured under contracts of less than US$100,000. Disbursement for reimburse- ment of eligible import expenditures would be based on documentation prepared by Societe Generele de Surveillance S.A (SGS) in the course cf their customs inspecti.on services (see para 9) and which is routinely provided to Bank Indonesia. The SCS certificate provideS verification of shipment of goods and their value as well as other information needed to ensure compliance with eligibility requirements for purposes of the Bank l oan. Disbursement for eligible import expenditures would be based on Statements of Expenditures 'SOEs) for imports valued at less than US$5 million; for imports valued above this amount full documentation would be provided. Applications for withdrawals based on SOEs would be submit-ted in amourns not less than US$1 -- 34 - million and supporting documentation would be retained by Bank Indonesia. All of the proposed loan is expected to be disbursed by June 30, 1987. 67. Procurement. Both private and public sector imports would be eligible for financing. Contracts under U5$5 million each would be awarded on the basis of normal procurement practices of the purchaser. Contracts for goods and services estimated to cost US$5 million or more each, would be procured through International Competitive Bidding in accordance with Bank Guidelines. 68. Accounts and Audits. Bank Indonesia would maintain loan accounts and supporting documentation. Audits would be carried out by independent auditors acceptable to the Bank within six months of the closing of the GOI Fiscal year in which disbursements under the loan are made. C. Monitoring and Follow-up 69. The Bank would monitor closely, through frequent consultation with GOI, the progress on implementation of GOI's package of neasures on trade reform and macroeconomic management. Particular regard would be given to: (a) continued prudence on fiscal and monetary policies, including scrutiny of the public investment program; (b) continued appropriate exchange rate manage- ment; (c) further measures to reduce NTBs and rationalize the tariff structure; and (d) progress on studies of investment regulations and public enterprises. Satisfactory progress in these areas could be the basis for a follow-up loan from the Bank in about a year. D. Program Benefits and Risks 70. The adjustment measures taken by GOI over the past year will provide balance of payments and fiscal stability in the face of lower oil prices, and help develop the non-oil economy over the medium term. In particular, the recent trade reform measures represent an important first step in COI's efforts to reduce long-standing distortions in Indonesia's highly protected industrial structure; improve international competitiveness of non-oil exports; and increase potential for foreign investment, especially in export- oriented industries. In addition, greater transparency and administrative simplicity would be introduced in Indonesia's trade regime. The principal risk is that the far-reaching nature of the policy reforms couLd encounter domestic opposition to full implementation of already-announced measures and to efforts to take additional measures after further study. These risks are offset by GOI's demonstrated ability in the past to carry out difficult and sensitive reforms as described in Parts I and II above. - 35 - PART VI - BANK GROUP OPERATIONS IN INDONESIA 71. As of September 30, 1986, Indonesia had received 48 IDA credits totalling US$908.10 million (leas cancellations) and 113 Bank loans amounting to US$8,835.10 million (less cancellations). IFC commitments totalled US$163.2 million. Annex Ir contains a summary of IDA credits, Bank loan" and IFC investmenti as of September 30, 1986. The share DE the Bank Group in Indonesia's public (disbursed) external debt outstanding at the end of 1985 was 14.8%, and the share of debt service 9.72, compared with 14.5% and 8.8%, respectively, in 1984q From 1968 until 1974, all lending to Indonesia was made through IDA. Due to the country's improved creditworthiness following the commodity and oil price boam in 1973174, the bulk of the Bank Group's lending in the remainder of the 1970. was through [BRD loans, with a modest amount of IDA lending being justified primarily on poverty grounds, as the per capita GNP was well below the IDA cut-off level. IDA lending was discontinued in FY80. Given the critical importance of agriculture (including transmigration) for employment, food security and exports, over one third of Bank Croup-assisted projects have been in this sector. In addition, loans and credits have been extended to virtually all other sectors of the economy, including transportation, education, urban development, water supply, ruraL development, industrial development financing (including small-scale industry), power, telecommunications, population and nutrition, and technical assistance. 72. During Repelitas I (1969-74) and II (1974-79), and in line with the objectives of these first two Five-Year Plans, a high proportion of Bank Group lending was directed initially toward the rehabilitation and then the expan- sion of infrastructure and production facilities. Special attention was also given to meeting the shortage of skilled manpower and technical assistance needed for preinvestment studies and project execution. Repelita III (1979- 84), published in early 1979, stressed the need for continued high growth and stability, but departed from previous plans by placing special emphasis on more equitable income distribution and poverty alleviation. This focus, which was fully in line with the conclusions of the basic economic report, required greater attention to employment generation (particularly in the industrial sector) and to improvements in basic public services. W}:le Bank lending was already consistent with these objectives, increased emphasis has been given to these prioritics. However, the adverse economic developments that occurred in the latter half of the plan period, and the measures taken to address them, led to a reshaping of development objectives for Repelita IV (1984-89). These emphasize restoring growth of incomes and employment whil. continuing finan- cial prudence, promoting structural change toward a more aiversified economy, and maintaining efforts to improve income distribution an' alleviate poverty. This shift in focus has underscored the need to follow through on reforms that have already been initiated, seek increased efficiency in the economy, mobilize domestic resources to finance needed investments and recurrent expenditures, and foster a policy environment conducive to the achievement of required changes. 73. The Bank has geared its lending and economic work program to address these needs and to maintain a high level of resource transfer. The approach is to continue to emphasize the ongoing dialogue on economic policy that has -- 36 - been a cornerstone of the Bank's relationship with the Government for many years, and to coordinate discussion of macroeconomic issues with advice on institutional and policy reform in important sectors and subsectors, coupled with lending operations and technical assistance that meet priority needs and suppcrt institutional improvements in specific areas. Emphasis in economic work is being given to trade and industrial issues, development of the finan- cial system, and public resource management. In the lending program, agricul- ture continues to receive the most attention. However, the program is broadly based, and includes increasing emphasis on efficiency improvements in the infrastructure sectors and on education and human resource development. Continued attention is being given to power and energy, where the Bank is con- centrating on policies to diversify Indonesia's energy base, rationalize pricing and improve sector planning. In transportation, the Bank is focusing on efficiency improvements in the maritime sector and on improving the national network of highways and rural roads. In urban development and water supply, lending is being directed toward establishment of appropriate sector policies and institutional development aimed at strengthening local government and regional enterprises, in order to minimize demands on the central govern- ment budget and decentralize the responsibility for addressing basic needs. In all, the Bank's lending program is intended to contribute about 20% of Indonesia's capital requirements during the next three years and is expected to be an important catalyst in attracting other funds. Where possible, we are seeking also to widen the impact of Bank lending through technical assistance, as well as complementary investments and coordinated policy dialogue with other donors. 74. Implementation, as reflected by disbursements, has gyn steadily improving gyer the past three years. The disbursement ratio - has risen from 15X 1 in FY84 to about 18.5% in FY86. Although this is not yet a satisfactory level, this improvement reflects the results of efforts which the Government and the Bank have been making to address key implementation problem areas. These include budgeting and budget-release procedures, procurement procedures, managerial capacity, capacity in the local consulting and con- tracting industries and land acquisition. Several special Bank missions have addressed various aspects of these problems and made recommendations, many of which have been adopted by the Government. Seminars on procurement and dis- bursement procedures, as well as others which have addressed implementation problems of specific sectors, have been held, in addition to regular formal meetings between the Bank and the Government to review implementation and disbursement performance and project- and sector-specific problems. As a consequence of these joint initiatives, the Government has acted to streamline some complex budgetary and financial procedures, improved its information system, and instituted training programs in procedures and project manage- ment. In addition, a ministerial-level committee responsible to the president 15/ The ratio of actual disbursements during the fiscal year to the cumula- tive undisbursed amount at the beginning of the fiscal year. 16/ Excluding the Special Assistance Program (SAP)-related disbursements which added 2.81. - 37 - has been established to monitor implementation performance, as well as a ministerial comittee on land acquisition. To continue to assist in alleviat- ing the problems which persist, the Bank has been, and will be in future, working with the implementation monitoring committee as well as on specific problem areas agreed with the Government. Activities already underway include: developing the consulting and contracting industries, improving budgeting and financial procedures, simplifying reimbursement procedures, and strengthening management information systems for procurement and pout-contract implementation monitoring. PART VII - RELATIONS WITH IMF 75. The latest IMF Consultation Report, under Article IV, was released in January 1986, and this year's consultation mission has recently been completed. OI has not had any standby or extended arrangements with the IMF since 1973. COI's last purchase from the IMF was for SDR 360 million in 1983 under the compensatory financing facility (CFF). Of the total amount, SDR 318 million had been repurchased by end-1985, and the remaining SOR 42 million is due in 1988. The authorities are considering making a request for a CFF drawing based on an anticipated export shortfall in 1986. After the last consultation report, the IMF Executive Board expressed its satisfaction with Indonesia's exchange rate arrangement. PART VIII - RECOMMENDATION 76. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments December 30, 1986 Washington, D.C. -38 - AE I INDONA - eCOM4IC I80ICAITON Page 1 of 2 Proulstlo 162.2 million (mid-191) CC per cepita! use3s (196s *atImte) Annuml qgrorh rate CU) (Pt eon-tont 1$=3 p.itea) (.i tI eon Ll at Actial Eat. Projected current lpr.m_) ---------------------------------- ------ ------------------------------------------------ Indicator 1983 1461 19S2 1'43 1064 10w1 1ow 1987 1981 1W89 1990 1301 NATIONAL ACCDO.RS Qeoss domestic product /e 81.076 7.4 -0.3 3.3 5.6 1.1 0.2 1.7 2.9 3.0 3.6 4.3 Agriculture 10.468 4.6 1.1 1.0 6.0 2.2 1.15 1.5 2.5 3.0 3.0 3 0 Industry 29,4S7 5.0 -6.1 2.0 *.4 -3.3 -1.0 2.7 3.5 4.7 3.2 3.1 Sercice- 32S152 12.1 ?.4 6.3 5.3 4.0 0.6 1.0 2.5 3.6 4.0 6.0 Consumption 58.712 11.7 2.1 -0.8 1.0 3.0 -1.0 1.2 1.7 3.2 3.2 4.9 Gross in.eteent 22.187 32.9 8.3 -10.4 6.6 -7.2 -12.3 -0.4 4.3 3.7 5.3 6.3 E.porn_ of awFS 21.049 -9.8 -10.0 14.6 4.6 -2.6 5.0 3.4 4.5 8.0 2.7 1.3 Imports of CNF5 - 21.773 20.6 4.4 -11.1 -10.2 -7.7 -16.3 -0.5 3.3 3.3 3.3 4.9 Groms national mu-ings 17.567 -1.7 -11.3 12.0 23.3 -2.1 i3.7 1.4 3.0 6.1 4.5 2.0 PrICES GOP S.flstar (193.100) 62 as 100 102 104 105 127 122 126 130 161 Euchenos rate (Rp per lU) 632 681 909 1028 1111 1412 Share of CP at market pri can (U) Awsrsgs anmul incr.asm (U) (at currant prie,n) /c (st conetant 1963 prices) 1970 1975 1080 lo06 1940 1005 1970-75 1975-80 1980-65 1095-00 1090-95 Grosn domestic product 100 100 100 100 10o 1O0 6.4 7.4 3.6 2.4 3.9 Agriculturs 47 32 25 24 24 23 4.1 3.3 3.4 2.3 3.0 Industry 16 34 41 3S 31 34 12.0 9.6 0.6 2.6 3.1 S."ivCos 36 36 35 40 40 42 9.7 9.5 6.n 2.3 5.0 Consumptlon 89 79 71 70 67 60 6.4 9.2 3.4 1.5 4.2 Cross inreetment 14 20 28 25 22 24 18.3 12.2 5.0 -0.1 5.8 E.port of CNS 13 23 32 26 28 25 9.2 2.0 -1.2 4.2 1.6 Iports of 04FS -16 -22 -27 -21 -17 -17 22.1 14.0 -1.5 -1.7 4.3 Cross national saeings 9 17 2S 24 29 28 23.1 14.2 3.4 5.9 3.5 As * of COP 1970 1975 190D 1965 PIBLIC FINANCE lb Current revenues 10.1 17.4 20.9 22.4 Currant eapenditure. 8.4 9.9 11.9 15.3 5urplus 1.8 7.5 9.0 7.1 Capital mependitur. 5.0 11.3 12.1 10.2 Foreign financing 3.5 3.7 3.1 2.0 1970-75 1978-80 1980-85 1965-90 1990-05 OTHER INDICATORS Annust CNI growt" rate (U) 7.6 7.1 3.4 2 7 4.0 Annual CP per capita growth rste (S) f.1 4.7 1.2 0.5 1.9 Annusi *hsrgy consumption growth rste (8) 11.2 11.0 NA. SN.A. N.A. IC0R 2.2 3.3 7.9 9.2 5.9 Marginsal mainga rata 0.48 0.28 0.23 0.63 0.25 rsport elasticity 2.8 0.84 -0.42 -0.71 1.10 /a At market prices. A Central Onwornasnt only, on an April-to-arch fical yper hbaia. /c At constant prices from 198 on. Eaet Asie and Pac;fic Regionsl Offic December 19965 - 39 - A I Dsifiuma - OKA= OF PAWNS, faWL cArnAL Am ca - - ______--_-_____________ --_ --_ - _______ --- - Pg 2 of 2 (UU mlIon .t current price) Populeblon 162.2 mlIIIon (mId-1966) oe per CepIt tot M550 (1US estlscte) _ i-- -__ _ _ i--- ------_ 2- - - 1 - - - - 7 -- ---- I_W - --- 989--- --o--- 1931 1962 1968 2966 106 18 1667 1086 1069 1990 1995 BALANCE OF PAW40S la 1. E.por. 23,809 19.172 20.291 20.920 19,912 14.300 17.864 10.730 22.134 :12,243 33.374 (.3 Oil end LM (urns.) 16.624 14,744 14.449 14.489 12.4S 6.927 0.045 10.500 11,072 11,229 14,672 (b) Manoll 4,170 3,926 6.870 6.96 1.1a *6,693 7,533 0.242 9.023 0..62 16.836 (c Wts 81s a80 42 675 am *o no 887 1.033 1.162 1.665 2. Imports 12,66 22,60 20.125 17,624 16.548 15,010 18.604 18,550 17,336 10.195 2C.623 (.a) 0l sector 5,407 4,602 .689 2,945 3.246 2,477 2,892 3.179 3.387 2.579 5.340 (b) Moncohl Ieports 14.561 316,84 14.24 12.745 11,010 10,462 10.661 11.067 11,575 12,124 17,066 (c) SFF 2.017 2,218 2,042 2,174 2.260 2.120 2,260 2.314 2.305 2,403 38397 3. Resource alslcse 424 (8.667) 168 8.096 2,763 (780) 1.562 3,119 3777 4,048 6,751 4. Factor services (8,209) (8,620 (4,820) (504) (4.7167) (3.685) (4.364) (4.909) (4,004) (5.109) (6.724 ) (a) Receipt.. 1,678 1.109 696 "a6 745 669 799 796 744 166 835 (b) Peysents (4.641) (4.729) (5,426) (6,041) (6.512) (4,306) (5.163) (3.798) (5,727) (5.775) (7.5=0) 6. Cupital grants 67 l06 96 100 110 115 1SO 150 150 150 150 6. Beltec. - current aecount (2,717) (7.182) (4,270) (1.649) (1.894) (4.801) (2.662) (1.660) (1,056) (911) 177 7 Direct foresin inv.staet 142 811 198 246 290 280 326 428 460 562 1,131 o Public N & LT lons /b 1.640 2,711 3.678 2,600 1,160 3.236 804 (10) (304) (327) (321) 9 Oth-e capit l (hct) (253) 6s10 1.98 (357) 949 637 (330) (309) (203) (358) (726) 10. Chonge in reserves (- increse) 9" 3.10 (1.66) (680) (515) 176 ) 11. Fnancing gp c )1,772 1,669 1.074 1.034 (260) 12 Net official resrves 62854 ,004 4.698 8.312 5,847 6,f71 Resrves in months of nonei I ieports v N; 4.4 2.0 8.6 4.8 5.3 8.5 Mesorendvs Item Net foreign sect of the banking system /d 10,622 6,Al2 e.466 0,671 10,625 10.449 Tots reserves in months of nooi4l imports * NFt 7.3 4.2 6.2 7.7 9.6 9.9 EXITL CAPITAL AND OEr /s Groes Disbursments 2,613 4,192 4.066 3.%45 2.262 Concessional Loses 794 69 606 562 gOo Hi steres 716 602 41 469 5L6 IDA 69 78 60 U4 a Other U 6 a 19 8L Nocconctesion-l Loens 1,679 3.606 4.357 3.211 2, 9 Official aeport crediLt 170 617 466 404 121 Igo 514 06 469 772 789 Other multilaeurel as 12 IGO 1683 16 Private-source 1,300 2.,56 3.:20 1,94 1.68 Eaternel Debt If Debt outstanding A disbursed 15,670 16,615 21,657 22,672 2e,642 fficiel-source e10.060 11,118 12,086 12,624 14.974 of whicht lERD 1,309 1.735 2,136 2,798 3,376 Privet-source 5,631 7 402 9,649 102046 11e.68 Undisbured debt 11.367 12.670 13,775 13.978 15.095 Debt Service total service payments 2,047 2,246 2,546 3.251 4,019 of *hich) Iw: E 146 207 254 319 410 InZtrset (994) (1.145) (1,235) (1.624) (1.654) Paymnnt as S exports /o 6.2 11.1 12.0 14.6 17.9 Totel debt service ratio it 10.4 16.4 16.7 19.4 23.7 Av-rage nterest Ruts on Now Loen. CX) 6.7 0.2 6.8 9.1 5.1 Official-sourc 7.6 61 6 8.7 T .6 7.6 Privete-sourcs 9v6 0.8 e.a .e. a 6.5 A-erege Msturity of New Loens (ysre) 1U.6 15.2 15.1 15.9 15.9 Officsil-ource 20.5 20.6 22.8 20.9 21.7 Pri.sts-curce, 11.1 11.1 10.3 9.2 7.6 As- t o debt outstanding ut end of 1085 Meturity structure of dbt outstanding --------------------------------------- lituritise due within 6 yjars 6 Meturities due Wi;tin 10 yjers 57 interest structure of deb euteted ing Interest due within fi- year 45 /e Orn - April-tr-Nrch fiscl jeer besis- /b Projections an_e no ne comercial borrowing (mfter 196/57) mnd Ob;ine_ so uel' by 100! members. /c Projecte p to be financed by seeci-l Xot1 seltnce. ne coseercial borrowing end use of resrves. /d Includes foreim, usets of deposit m_on benks in addition to official reserve. /a Eeclude, prvate nonu sarent-ed loas end La expansion. If At ed of priod. to 0;I escorts trusted on gross bais. Export inelude oorvic_e. Debt service exclude the Lff eapension end prepsysnt of syndicstsd loans in 1985. /h Includes privets negueranteed Ions. East Amis end Pacific ReUional Office December 1981 ANNEX II - 40 - Page I of 4 pages THE STATUS OF BANK GROUP OPERATIONS I' INDONESIA &. STATEMENT OF BANK LOANS AND IDA CREDITS (as of September 30, 196) /a Loan/ Amount (US$ million) Credit Fiscal (less cancellations) number year Purpose Bank IDA Undisbursed Forty-one Loans and forty-five Credits fully disbarsed 1,950.45 819.70 - 1578 1978 Tenth Irrigation 107.00 - 16.34 1604 1978 Nucleus Estate and Smallholders II 50.50 - 4.71 1653 1979 Third Urban Development 53.60 - 5.34 1107 1979 Transmigration II 54.00 - 28.14 1708 1979 Eighth Power - 169.00 - 25.46 1709 1979 Second Mater Supply 35.49 - 3.56 946 1980 Yogyakarta Rural Development - 12.00 5.35 1751 1980 Nucleus Estate and Smallholders III 92.00 - 15.67 995 1980 Fifteenth Irrigation - 37.40 3.77 996 1980 National Agriculture Extension II - 39.00 14.49 1811 1980 Fourteenth Irrigation 116.00 - 28.32 1835 1980 Nucleus Estate and Smallholders IV 30.00 - 14.42 1840 1980 National Agricultural Research 35.00 - 31.32 1872 1980 Ninth Power 235.00 - 39.82 1898 1981 Smallholder Coconut Development 25.00 - 1.79 1904 1981 University Development 45.00 - 20.80 1950 1981 Tenth Power 250.00 - 7.16 1958 1981 Swamp Reclamation 22.00 - 9.89 1972 1981 Fourth Urban Development 43.00 - 17.33 2007 1981 Nucleus Estate and Smallholders V 134.00 - 75.07 2049 1982 Jakarta-Cikampek Highway 85.00 - 60.76 2056 1982 Eleventh Power 170.00 - 30.47 2066 1982 Second Seeds 15.00 - 8.92 la The status of the projects listed in Part A is described in a separate report on all Bank/IDA financial projects in execution, which is updated twice yearly and circulated to the Executive Directors an April 30 and October 31. - 41 - ANNEX II Page 2 of 4 pages Loan/ Amount (US$ million) Credit -Fiscal (less cancellations) number year Purpose Bank IDA Undisbursed 2079 1982 Bukit Asam Coal Mining Development and Transport 183.70 - 48.49 2083 1982 Rural Roads Development 85.00 - 31.02 2101 1982 Second Teacher Training 79.59 - 54.11 2102 1982 Second Textbook 25.00 - 18.65 2118 1982 Sixteenth Irrigation 37.00 - 13.63 2119 1982 Seventeenth Irrigation (East Java 70.00 - 30.10 Province) 2120 1982 National Fertilizer Distribution 40.09 - 3.46 2126 1982 Nucleus Estate and Smallholders VI 55.50 - 41.23 2153 1982 Coal Exploration Engineering 25.00 - 11.92 2214 1983 Twelfth Power 300.00 - 203.85 2232 1983 Nucleus Estate and Smallholders VII 138.90 - 130.35 2235 1983 Provincial Health 27.00 - 20.15 2236 1983 Jakarta Sewerage and Sanitation 22.40 - 18.44 '2-48 1983 Transmigration III 101.00 - 40.35 2258 1983 Public Works Manpower Development 30.00 - 22.35 2275 1983 East Java Water Supply 30.60 - 12.36 2277 1983 Fifth BAPINDO 208.90 - 117.41 2288 1983 Transmigration IV 63.50 - 58.16 2290 1983 Second Polytechnic 107.40 - 103.06 2300 1983 Thirteenth Power 279.00 - 144.31 2341 1984 Third Agricultural Training 63.30 - 42.39 2344 1984 Nucleus Estate and Smallholder Sugar 79.20 - 43.32 2355 1984 Second Non-Formal Education 43.00 - 30.41 2375 1984 Second Provincial Irrigation Dev. 89.00 - 44.76 2404 1984 Highway Betterment 240.00 - 138.16 2408 1984 Fifth Urban Development 39.25 - 30.87 2430 1984 Third Small Enterprise Development 204.65 - 27.20 2431 1984 Second Swamp Reclamation 65.00 - 60.33 2443 1984 Fourteenth Power 210.00 - 184.23 1950-1 1985 Supplemental Loan for Tenth Power (1950-IND) 50.00 - 8.38 2472 1985 Secondary Education and Management Training 78.00 - 72.87 ANNEX II - 42 - Page 3 of 4 pages Loan/ Amount (US$ million) Credit -Fiscal ((les cancellations) number year Purpose Bank IDA Undisbursed 2474 1985 Upland Agriculture and Conservation 11.30 - 11.27 2494 1985 Smallholder Rubber Development II 131.00 - 130.98 2529 1985 Fourth Population 46.00 - 45.31 2542 1985 Second Health (Kanpower Development) 39.00 - 38.66 2543 1985 Kedung Ombo Multipurpose Dam and Irrigation 156.00 - 150.63 2547 1985 Second University Development 147.CO - 147.00 2560 1985 West Tarum Canal Improvement 43.40 - 43.01 2577 1985 National Ports Development 111.00 - 109.73 2578 1985 Transaigration V 160.00 - 159.56 2599 1986 Science and Technology Training 93.00 - 88.90 2628 1986 Smallholder Cattle Development 32.00 - 31.74 2632 1986 Second East Java Water Supply 43.30 - 43.30 2636 1986 Second Nutrition and Cocmunity Health 33.40 - 31.97 2638 1986 Nusa Tenggara Agriculture Support 33.00 - 33.00 2649 1986 Central and West Java Irrigation 166.00 - 166;.00 2690 1986 Cas Distribution Ia 34.00 - 34.00 2702 1986 Export Development /a 64.50 - 64.50 2705 1986 Manpower Development and Training 58.10 - 58.10 2717 1986 Highway Maintenance and Betterment 300.00 - 300.00 2725 1986 Housing Sector Loan /a 275.00 - 275.00 2748 1987 Third National Agricultural Extension 70.00 - 70.00 Total Bank loans and IDA credits 8?B35.19 908.10 Of which has been repaid -671.36 -26.22 Total now outstanding 8,163.83 881.88 Amount sold to third party -57.56 - Total now held by Bank and IDA lb 8,106.27 881.88 Total undisbursed Ic 4,317.20 /a Not yet effective. 7i Prior to exchange adjustment. 7i Includes loans not yet effective. ANNEX II - 43 - Page 4 of 4 pages B. STATEMENT OF IFC INVESThENTS (as of September 30. 1986) Fiscal Loan Equity Total year Obligor Type of businems -- (US$ million) -- 1971 P.T. Semen Cibinong Cement 10.6 2.5 13.1 1971 P.T. Uniter Textiles 2.5 0.8 3.3 1971 P.T. Primatexco Indonesia Textiles 2.0 0.5 2.5 1971 P.T. Kabel Indonesia Cable 2.8 0.4 3.2 1972 P.T. Daralon Textile Mfg. Corp. Textiles 4.5 1.5 6.0 1973 P.T. Jakarta rnt. Hotel Tourism 9.8 1.6 11.4 1973 P.T. Semen Cibinong Cement 5.4 0.7 6.1 1974 P.T. Primatexco Indonesia Textiles 2.0 0.3 2.3 1974 P.T. Monsanto Pan Electronics 0.9 - 0.9 1974 P.T. PDFCI Dev. fin. co. - 0.5 0.5 1974 P.T. Kamaltex Textiles 2.4 0.6 3.0 1976 P.T. Semen Cibinong Cement 5.0 1.5 6.5 1976 P.T. Semen Cibinong Cement - 1.1 1.1 1977 P.T. Daralon Textile Mig. Corp. Textiles 0.4 - 0.4 1977 P.T. Iamaltex Textiles 1.3 0.2 1.5 1979 P.T. Daralon Textiles 0.9 - 0.9 1980 P.T. Papan Sejahtera Capital market ,4.0 1.2 5.2 1980 P.T. Indo American Industries Class dinnerware 11.1 0.9 12.0 1980 P.T. Semen Andalas Indonesia Cement and construc- tion material 48.0 5.0 53.0 198215 P.T. Saseka Celora Leasing Capital market 5.0 0.3 5.3 1984 P.T. Semen Cibinong Cement 25.0 - 25.0 Total gross commitments 143.6 19.6 163.2 Less: sold or repaid and cancelled 116.7 8.1 124.8 Total held by IFC 26.9 11.5 38.4 44 - ANNEX III INDONESIA TRADE POLICY ADJUSTMENT L(A& Supplementary Data Sheet Section I: Timetable of Key Events (a) Time taken to prepare project : 2 months (b) Agency which prepared project : Bank Indonesia (c) First presentation to the Bank : October 1986 (d) First mi,sion to consider project : October 1986 (e) Departure of appraisaL mission : November 1986 (f) Completion of negotiations : December 1986 (g) Planned date of effectiveness : February 1987 Section II: Special Bank Implementation Actions None. Section III: Special Conditions None. - 45 - ANNEX IV Page 1 of 9 MINISTER COORDINATOR FOR THE ECONOMY. FINANCE, INDUSTRY AND DEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA Jakarta, Decenber 19, 1986 ib : SR-42f/it.EKUI/l986 Mr. Barber Conable President Te 'World Bank 1818 H St., NM.W Washingto, D.C. 20433 U. S. A. Dear Mr. President: Governunnt's Statemnnt on Economic and Trade Policy Me Covernuent of Indonesia wishes to request a loan from the World Bank in support of a program of economic adjustment, especially in the area of trade policy. Ihis letter provides a description of the current situation, the actions which the GovenrrEnt has taken and the direction of future actions. Macro-Ecoomc Background 1. Indonesia has faced many challenges in the economic sector mainly caused by the start of a considerable oil price decline and the wrld ecomic recession. In order to cope with the toug situation, the Gaverrrent in 1983 started to take various actions that were of a short- term nature as well as those that had a long-term scope, beginning with the rephasing of large projects, devaluation, overall and fundamental revision of the taxation system, reductions in subsidies and deregulation of the banking sector. For the purpose of increasing non-oil export, fiPRES (Presidential Instruction) No. 4 of 1985 was issued with the objective of overcoming the "hi'Et cost econofy"' problem, particularly in the custons, port operation and sea transportation sectors. -46 - ANNEX rv Page 2 of 9 MINISTER COORDINATOR FOR THE ECONOMY. FINANCE. INDUSTRY AND DEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA - 2- 2. In 1986, the sharp drop in the international price of oil caused severe deterioration in Indonesia's balance of payments and the Govern- ment's budget. The Govenrnent has taken a series of measures to deal with the situation as it unfolded. Anticipating weakness in the oil marcet, tie Govenmyant intwduced an austere budget. incorporating sharp cutbacks (24'A) in development expenditures. With the exception of some. foreip aided Projects, there were no new investments started with govern- umnt funding in this fiscal year. Mnetary policy was also tightened, leading to a considerable slowing down of credit expansion. As oil prices continued to slip in mid-year and as it became clear that even in the medium term the oil price would remain far below the levels prevailing in 1985, the Government decided to devalue the Indonesian RuLpiah by 31 percent. This substantial devaluation prevented the loss of foreign excLange reserves throughl speculation and should be a powerful means of stabilizing the balance of payments and inproving the conditions for an early recovery in ecornmic activity and incones. 3. With continued prudence in fiscal and mnnetary policies, the GovenlTnt expects to halt the deterioration in the balance of paymWnts. Rapid adjustlient of the balance of paynnts is essential because the burden of extLrnal dkebt, despite recent constraints (A public borrowing. is high in relation to the now reduced levels of export earnings. kIile che tocal debt service ratio was 26% in 1985/86, it is now estimted at about 377. in 1986/87. While the current account deficit will unavidably widen to about ; 4.1 billion in 1986/87, an inportant objective of macro- ecormic management would be to reduce the anual current accotft deficit to a level below $ 2 billion within the next two years. 4. The key to ipro t in the balance of payments is accelerated growth of non-oil exports. Lthe Governmt is heatened by their growth - 47 - ANNEX IV Page 3 of q MINISTER COORDINATOR FOR THE ECONOMY, FINANCE. INDUSTRY AND OEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA -3- in recent years, from $ 3.9 billion in 1982/83 to $ 6.2 billion last year. No doubt, the recent devaluation will give an added boost to non-oil exports, encouraging the utilization of available excess capacity in the short run and enhancing opportunities for profitable export-oriented inves tIrents in the medium term. Recogaizing the vical iuporrance of encouraging non-oil exports, the Govenment introduced i-n Mav L986 a special package of measures designed to ensure that exporters are able to buy their inputs at internationally compecitive prices. One elenanc of this scneme is the icport duty exemption/draack available to exporters. Another important facility provided by this scheme is that major exporters can irport their inputs directly as needed, corpletely bypassing the prevailing non-tariff restraints to inports. Our experience in the last several mnths indicates that the May 6 scheme is being inplemnted suDothly and efficiently, providing tangible support to exporters. *. The Goverruent is fully aware that providing special exemrptions to exporters is only an interim stage in completing the necessary reforms in the underlying trade regulation themselves. Sustained growth in non- oil exports in a highly competitive international market, with the ever- piesent threat of protectionism in the industrial countries, requires that Indonesian manufacturing enterprises operate at much higher levels of efficiency. Achieving this goal will require changes in the structure of incentives to redress their current bias against exports- Twe present system of protection is contriouting to the high costs in the Indbnesian economy and it is the intention of the Governnent to rationalize this system as speedily as possible. Principles of Trade Policy 6. Mhe policy of rationalization of protection is aimed at the following objectives - 48 - ANNEX IV Page 4 of 9 MINISTER COORDINATOR FOR THE ECONOMY, FINANCE. INDUSTRY AND DEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA -4 - - establislhng a protection structure based mainly on tariffs rather than import licenses and thus permitting nmre precise neasurement of the actual degree of protection granted to Indonesian producers; - reducing the current bias in incentives against export activities and in favour of imort substitution; and - limiting the level of protection, with special provision for infant industries which would enjoy higher levels of protection for specified time periods. 7. The decision to mnie away from non-tarff barriers and rely on tariffs is based on several considerations. First, tariffs provide a more transparent forn of protection, which automatically prevents domestic suppliers from increasing prices above world prices by mnre than the tariff rate. Second, tad ffs are simpler to administer; non-tariff barriers create the potential for abuse and can lead to protracted negotiations amongst the parties concerned. Third, tariffs are easier to adjust so as to rationalize the structure of protection. Finally, tariffs will contribute to the Government's budgetary revenues and help support priority development programs. Recent Trade Measures and Future Directions 8. During the early 1980s, restrictive importer arrangements were imposed on a range of products. By 1985, about one quarter of inports were subject tc licensing restrictions. Of these, very few were actually subject to formal quotas. There have been no new inport restrictions introduced since March 1986 and the measures of October 25 siguify the beginning of the trend in the apposite direction. - 49 - - ANNEX IV Page 5 of 4 MINISTER COORDINATOR FOR THC ECONOMY, FINANCE. INDUSTRY AND DEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA -5- 9. Under the October 25 nrasures, the Govenrrent revoked 6 decrees restricting import licensing for 317 items. bbst importantly, approved importer restrictions were abolished for 165 itans, including tires, glass, paper and some engineering goods. Another 55 iteim, including chemicals and knocked-down equipment, can now be inporred without restraint bv any producer in the mi.ts r-euired is inutCS in. '-3 production process. For 50 items, primarily transport machinery, selected overseas suppliers will be allowed to appoint licensed agents approved by the Ministry of Industry, for the purpose of standardizing the product types and ensuring satisfactory after sales services. There will be no other restriction placed on these agents by the Government. The remaining 47 items will continue to be inported by approved traders and producers of the items only. 10. For 154 of the item where import licensing restrictions were renuved or relaxed, tariffs were increased to protect the balance of paymmts and provide transitional protection to donestic producers. Hwever, with only 3 exceptions, the naw- tariffs are within the tariff ceiling of 6C0/.. Tariffs on another 152 items not produced dotistically were reduced, mostly to 0-57.. To protect domestic producers against predatory duxAping, inport surcharges may be incroduced on specified itces. However, the Governumt will only do this on a highly selective and temporary basis, and only after balancing producer and consuner interests. 11. The recent package of neasures has still left import restrictions in place on some important product groups such as agricultural output, steel, plastics, etc. These areas are currently being scrutinized with a view to achieving further progress in rationalising the system of protection as rapidly as possible. It is the Government's objective to -50- ANNEX IV Page 6 of 9 MINISTER COORDINATOR FOR THE ECONOMY. FINANCE. INDUSTRY ANO OEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA -6- eliminate gradually all non-tariff restrictions an imports except on a small group of products that are hanful to health, strategic to national defense or involve special economic and social considerations. We expect to make further tagible progress in this direction within the next year. 12- The process of aving frm o-canr:r^ oar-.ers co a car:±: f ased system of protection has involved some increases in tariff levels. The Coverrint has accepted this as an interim measure in order to gain wider acceptance of the removal of imporc restrictions. In the xediun term, however, it will be necesse-y to rationalize the structure of tariffs in order to make the industrial sector more efficient, rationalize the excessive level of protection and increase export capacity. 13. The process of rationalizing tariffs will start with an early review of imports that currently attract tariffs above the national matnun rate of 607. escablised in the 1985 tariff reform, followed by a phased reduction in the maxinuma nominal tariff rate over the next couple of years. Thn Governmnt intends to prepare a systeuatic medium term plan for tariff reform. For this purpose, it will establish appropriate organization and processes to uonitor regularly the levels and dispersion of tariff rates, both nominal and effective, with a view to reducing the differential between maxnmm and miniman rates. Investuent Licensing and Public Enterprises 14. The purpose of tih progressive rationalization of the level and system of protection is to expose Indonesia's industry to increased competition from abroad. This will induce it to make the structural adjustmeats necessary to improve the efficient utilization of existing resources and foster the creation of a productive system capable, of ccmeting with foreigi goods an a firm footing. The Government - 51 - ANNEX IV Page 7 of 9 MINISTER COORDINATOR FOR THE ECONOMY. FINANCE, INDUSTRY AND DEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA -7- recognizes that realizing the full potential iirpact of these inprovemnts wuld also require relaxation of restrictive licensing arrangements on private investment and domnestic trade. Inportant steps in this direction for foreign investors have already been taken in the May 6 and October 25 packages. Restrictions on donestic investmnt and trade will be thoroughly studied during the next year. mhe objective would be to nitiate extensive deregulation in this area based on the findings of the study. Greater freedM, from licensing procecdures would unleash entrepreneurial talent and nobilize rwre financial resources for investment. 15. The unsatisfactory financial and operating performance of public enterprises has inposed additional strain on the Govenmnt budget and, even more inportantly, has inhibited progress towards enhancing the efficiency of economic activity in Indonesia. The Goverrnent has initiated a program to review the performance of selected public enter- prises and to identify aPpropriate areas for reform, including changes in the systen of government supervision and control, as well as in rhe management and financial structure of individual public enterprises. During the next year Goverlnent expects to cormplete the consolidat-ion of p-ibLic e.nctrprise accotnts, dWvlop ;an :rrprnlria-rv 1. ..<-i:ic..1ti0n fur pLblie ente rl,s.s, m1d prupa.Ir 1i pLan for sL'ctor rcstrucLurirng, through rehabilitmW7n, rnerger or divestiture. Macro Policy Frawork. 16. A stable macro-econonic environmet is iiportant in promoting an outward oriented industrial structure and enhancing produtive efficiency. As noted earlier, regaining stability in the balance of payments in the face of lower oil prices is an irportant objective of the GovennPt. - 52 - ANNEX IV Page 8 of 9 MINISTER COORDINATOR FOR THE ECONOMY, FINANCE. INDUSTRY AND DEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA - 8 - Ever since the first sigis of weakening in the oil markets, the Covnnet has imposed strict limits on external borroing and austerity in its own budget operations. The-se policies have helped to restrain inflation to low levels, but have also led to a dramatic slowdown in economic growth. It is hoped that the ongoing reform of industrial and trade policies will provide the incentives to tap new sources of growth and lead gradually to a recovery in economic activity and incomes. At the same time, continued budgetary and monetarr restraint is vital in maintaining macro economic stability and achieving the required adjust- ment to lower levels of oil revenues. 17. In view of the continued uncertainty regarding the price of oil, it is necessary to continue an austere budget for 1987/88. The Goverrmnt is taking steps to mobilize greater domestic revenues and intends to restrain budgetted expenditures to the same level in real terms as in the current year. In allocating development expenditures, the highest priority will be given to providing satisfactorily expenditures for operation and maintenance so that greater output can be obtained from available capital stock, especially in infrastructure facilities. Ongoing projects will be reviewed and only those projects that promise satisfactory econanic returns will be funded- This will iMply ChaL several projt4cts, including sore with foreign aid, may have to be cut back. New projects wilt be undertaken providedr they have very high economic benefits and only where foreign assistance is avaiLable on suitable tenns. An inportant consideratimn will be the capacity of the project inplementing units to execute the project at the required pace. 18. The Governent maintains its strong comitment to the present foreign exhange system. Exdhange rate policy will continue to epbhasize the objective -53 - ANNEX IV Page 9 of 9 MINISTER COORDINATOR FOR THE ECONOMY. FINANCE. INDUSTRY AND DEVELOPMENT SUPERVISION REPUBLIC OF INDONESIA -9- of maintaining international corpetitiveness of the Indonesian econWy, taking account of price and exchange rate mnemets in trading parmers and competitor countries. An austere budget will assist in restraining the growth of mney and credit to levels consistent with the growth of real incomes. While some price increases are inevitable in the afternath of the last devaluation, the Governmnt ains to reduce the ixxflation rate to below 7 percent per arrnmn by 1988. 19. As in the past, the Goverrmnt will act prorrptly to make the requisite policy adjustments if a fundamental macro-econordc disequili- briuw emarges. Yours sincerely, I-5- f' Y Ali Wardhana Mliniscer Coordinator for the Econorny, Finance and rndus try P-23l3t/IN-696/ICU-IND/12-l8-86/rmb/-mjd/ Vage -rof 3 INDONESIAI PDLICY FRAUIWORX FOR TRADC POLICY ADJUSTNENT LOAN Policy luaue. Actiona taken 1981-85 Actiona taken 148 Areea for Follow-up A. Trade Policey Iefors (a) Tariffs and Non- tariff Barriera 1985. Tariff catling reducad from 225t to AlI[ Export cearifteatee abolished, 3initor impact of reeant macaea oa bal- 601, barring a few exceptione. NIMuber of tollowing Indonexixa xcceacion to GAIT, sac of paymntes doxeetic prlce. of altec- tariff eategoriae reduced from 15 to ii. Duty drawbck/exaemption scheme intreJucel. ted ttem end on induetriatl etivity. Hoaevar, non-tariff arrilers (RTE.) contin- Develop suitable followvp actions, tIncld- ued to proliferate. By the end of 1981, a. "Producer axpertara" allewad to in- lag modlicstloa of mptort tariff/ear- mote thao 1.000 product groups were subject port Inputa. without resiriclion and axet11t chs,ges. Exainoe acope for further move- to NTI1 of ona form or anutbir. from Import duties. Other exportere alo meet from NT5s to tariffa. tatabitah a alloved to import tipute (with duties plan fat Cationallaing the tariff structure ISoS. Declalon to acceda to OArr Code on refunded), If domestic aupplirsr not able aid aystam of Protection. =ubsidies end Countervilling Duties. to provide them at oeopetitiva pricee. October. 16 Industrial Inpute (e.g., tire, glees, paper, vehtcle part.) ware ree opened to geniral Importers and another liO (e.g., chemicela. aachinexy) to actual users and liernsed egente. For abuut bhlf of these producta. tariffs were increasdc to limit the Impact ot the balsoce of pay- ments and pruvids cranasiLional proLaCLior. for domnaicileindustries. October. Tariffs reduced ea 152 products (e.gS. certain chenicala, steel producte, celjricsel coaponenta), vith most eut to a-5. Thema era primarily Induatriel ID- pute not produced doeatically, whets eoLS were Increased by the devalustion. (b) Exchange Rate 183. Rupieh develued by 285 and the ax- September. Ruptah devalued by 311. To it- Active exchange rate management by Bank change rate aubequently met by a managed e phesIac the rupish/US dollar rates lak Ino'ooess, allowing lmcEtasioen in Inter- fleet egainat a beaket of cucrenctea. Indnnesia now quoate five aid-drtee end te national close tatee of the US dollar to be 5Ot raca for tha rupiah. reflected cure fully to the setting of the rupish exchings rate. (c) Custo Ports end 1985. Iport and export procedures reduced Further actions to improve port operAting 5 Ipp___ to a minimes laports are now tnopected at elficiency as agreed under the National the porta of origin by governnent-xppointed Port Develepsent Project (Loana No. 2577- surveyora (SCS), while exports and Inter- 2ND). Island traffic are no longar aubjact to customse Inspection, Fort charges simpli- fled and reduced, and restrictiona on foraign-flag veasela reaoved. P-ls3tlleti-69613i1-iND/12-iBSSIrasbIEjd/ Tage 2 el 2 INDONESIAu POLICT FRARVORX IOR TRADE POLICY ADJUSTtNIT LOAN (cont'd) Policy leluea Actions taken 1983-85 Actions taken 395 Arens for tollc.-up A. Sgoportans Mate?e eeaonode Pel cy (a) Public Investment 1983. Nany large capital-Intenstiv pro]- 3snuer. Uudget announced for 1986i18 ii.- Frepare auctere developeent budget for mete rephased. Najor invstmentse affected Iru3d1 26t reductton in deeelcpmenc mupea- 19S7/Ul, applying similar Criteria for ax- Included listen aluminau, PlaJo aromatie. ditore. tupiab budgets of deperteents cut lendizurs allocattoua lelcludieg priority Mudl refinery, Aceb lefine cud several by 40-552. Priority given tot (e) couple- for OaK) em in ISo6/e?. nitiate program power projecte. Toral foreign exclanxe tlon of onoing projaetal (b) provietin of to review the performance of public sacer- eavioSe estimated at $10 bIlilon. counterpart funda for toreign-aided proj- prixea and to Ideatlfy anroprpaete area ects; (e) projecte wtth particular locue n for relorm. equlty and seplrsent; and (d) fundlog of _OH expendlturee. (b) financial Policy 198. F1ineoclal reform tncludeds (a) te- October. Itemoved ceilings on foreign aPurme prudent maoetery policy. acilitatea moael of intereet rate controle on state exchinge eswp feeilitls offered by bankha. developmat of a comercial market tn Ut banke deposits; (b) elimination of eTedit aystem. etchinge rate evape. ceilings for all banks; and Cc) reduction in numbet of program qualifying for new lank Indocosia liquldity credtte. (c) Investmnt Rhguletaone 31985. Procedurem for approval and imple- May. Conditions for entry of foreign Device imaple procedoree for tiplmentitc mentation of private investment mimplitimd. capital eased and operating environmnt these macures &ad momitor their affective- A major reorgenixation of 1MPN elso couple- improved. In particular, (a) requiremeita node. Aeseas scope tor farther ratlonali- ted, reflecting change in focus trom in- for local participation in joint ventuusa cation of investmant regulstias. Study westment regulation to ptomotion. relaxed for priority aectore; (b) the vall- restrlctlona on do_natic nveateser and dity of InvEetnent liceaems exiended to 30 trade, with the objectivo of *intleatt4 yasre; and (c) the liitse an joint ventures extenaive deregulation In 't'a area. vith majority local partelpation eased. October. foreign Inveators granted more Tequac trmanc wtth dommslc invemtors. In particular; (a) foreign investment oow allowed In extering firm In pitority eec- tore, captcisllr for exports; (b) Ineset- ment by wultilstcral financlal inmcitucgone treated as national narticlpation; (e) foreign-inveatoent companies given access to export credit on sam tars cn do_xtic fires; end (d) toreign-investmons companies allowed to export productm of other enapa- / J~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ ?-23it/IN-696/1CUI-ND/l 2-1-86/rmb/mjd/6 Anun v Page 3 of 3 INDONESIAi POLICf FLAXEWORI TOR TRADE POLICY ADJUSTaENT LOAN (cont4d) policy Islues Action, taken 1953-ES Actions take. 1986 Areas for Follw-op (d) Taxation 1984. Inco_a tax reform included: (a) a Jan Kew property tax replaced eAlvn Attla program for laplewntatton of the ateplifted tax structure, based on thrae ifl-iinc.e, Including the old land (IPCOA) new property tax esetem la under disceusion relatively low rates (152. 15I end 35S) and And not Wealth taxes. The nev law Is con- for the proposed urban and irrigatica lImltsd deductions; (b) "all-aeeeeement" ceptually simpler, based on a proportion of aector loanm. of tax lIabtllty, with eaphamla on with- the machet valua of land end buildings. and holding at source; and Cc) a simplification a single tax rate of 0.52. of the tax code, Including eviased proce- duree for appeale and refunde. 1985. Value-added tax CVAT) replaced sales tax. Although confined to the manufacturer -importer level, the VAT bas Increamed revenue potenttial byl (a) subjectinl doeaatie sales of petroleuw and tobacco products to VAII and (b) Laposlng an addi- Ch tional tax (10-202) on luSury goode. The I baeic VAT rate is IOS. - 57 - ANNEX VI Page 1 of 4 INDONESIA TRADE POLICY ADJUSTMENT LOAN Economic Tables Table No. Title VI.1 Medium-Term Projections VI.2 Balance of Payments VI.3 Central Government Budget -58- PAWe 2Vof lNDONESIA TRADE POLICT ADJIIS1EINT l OAN Table VI.1: MEDIUH-TEN PROSWCTIONS /A Actuala Estimtem Projections 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 External Environment Oil price (USS/bbl) 35.4 32.9 28.9 26.4 25.0 12.5 16.0 18.0 18.0 18.n Term of trade (1983-100) - Totel 111.1 107.4 100.0 99.7 94.1 61.0 67.9 72.6 73.0 73.7 - Non-oLl 95.1 90.1 100.0 99.2 97.6 92.1 91.0 93.3 95.7 97.7 Output *nd Prices (2 p.-.) GDP 7.4 -0.3 3.3 6.6 1.1 0.2 1.7 2.9 3.8 3.5 Non-oil CDP 9.4 4.1 3.8 4.9 3.6 0.4 0.9 2.7 3.8 4.1 Dmestic income lb .. -1.5 1.4 6.5 -0.3 -8.9 3.7 4.1 3.8 3.8 Consumer prices 12.2 9.5 11.8 30.4 4.7 9.1 10.7 4.3 3.2 3.0 tnvestmenc and Savings CZ of '.P) Ic Cross inLveamat 28.0 32.1 27.4 27.5 25.7 24.5 23.8 24.0 24.1 24.4 National saving. 25.1 24.4 21.7 25.1 23.1 17.2 19.1 21.2 22.4 23.0 Domestic savlngs 28.5 28.2 27.6 31.5 29.4 23.2 26.5 29.3 30.1 30.7 Current Account (USS billion) Net oil/LNC earnings Id 9.6 7.0 7.2 7.8 5.7 2.2 3.3 4.4 4f9 4L. Non-oil exports 4.2 3.9 5.4 5.9 6.2 6.7 7.5 8.2 9.0 9.9 Non-oll imports 14.6 15.1 14.2 12.7 11.0 10.5 10.7 11.1 11.6 12.2 Interest on ILT debt 1.3 1.5 1.6 2.0 2.2 2.3 2.5 2.7 2.7 2.8 Current account balance -2.7 -7.2 -4.3 -1.8 -1.9 -4.3 -2.7 -1.7 -1.1 -0.9 - 2 of GNP (-3.1) (-8.0) (-6.1) (-2.53 (-2.7) (-7.8) (-5.1) (-3.11 (-1.8) (-1.5) External Financing (USS billion) Disbarsemente of MLT debtc 3.1 4.6 5.9 4.8 4.4 6.4 4.3 4.1 4.3 4.2 - i0CI 1.2 1.3 1.3 1.5 1.5 1.6 1.8 2.0 2.2 2.3 - Import-related credit. 0.7 1.7 2.1 1.8 1.7 1.3 1.2 1.4 1.3 1.0 - Commercial credits 0.8 1.2 1.6 0.5 0.4 2.7 0.7 - - - - Privute nonguaranteed 0.4 0.4 0.9 1.0 0.8 0.6 0.6 0.7 0.8 0.9 Financing gap /f 1.8 1.7 1.1 1.0 External MLT Debt & Credit- worthiness (USS billion) Total DOD 22.2 24.3 25.1 28.6 32.2 35.2 36.9 38.0 38.9 39.4 - Z of GNP (25.1) (27.2) (35.6) (40.0) (4665) (63.6) (70.3) (69.4) (67.9) (66.0) Total debt service 2.8 3.5 3.7 4.7 5.5 5.5 6.2 7.0 7.5 7.6 - 2 of exports (11.0) (17.2) (17.7) (21.6) (26.0) (36.9) (34.4) (34.3) (34.3) (32.9) External reserves IL 10.6 6.3 8.5 9.6 10.6 10.4 - Montbs of imports (6.4) (3.7) (5.6) (7.3) (8.9) (9.7) /a Balance of pyments and external debt data are for fiscal years (starting April 1). other lndicanore are for calendar years. lb after term of trade adjustment. 7; At current prices. 7t Net of oilfLNC importe and service payments. 7e Projeetions asmume no new coercial borrowlng (after 1986/87) and 'buainess as usual" by 100I members. 7 Projected gap to be financed by special ICGI assistance, new commercial borrowing and use of reserves. T Total net foreign assets of the banking system. Future use of reserves Included In financing gap. -59- ANMNx VI Page O af 4 INDONGSIA TRADE POLICY AWJUSYMENT LOAN 'fTble VI.2: BALANCE 0 PAYMENTS (US$ blllion) Actuals E_timates Proietiona 1981182 1982/83 1983/84 1984/85 1985/86 1986187 1iB7/68 198889 19R9/90 1890/91 ZTwortSeof Cood l23.0 18.6 19.8 20.3 18.7 13.6 16.5 18.8 20.1 21.1 18.8 14.7 14.4 14.4 12.5 6.9 9.0 10.4 11.1 11.2 - Non-oil 4.2 3.9 5.4 5.9 6.2 6.7 7.5 8.2 9.0 9.9 Iops rea of Goods -20.0 -20.6 -18.0 -1S.6 -14.2 -13.0 -13.6 -14.3 -15.0 -15.8 -Oil/LNG -5.4 -4.8 -3.1 -2.9 -3.2 -2.5 -2.9 -3.2 -3 4 -3.6 - Non-oil -14.6 -15.8 -14.2 -12.7 -11.0 -10.5 -10.7 -11.1 -11.6 -12.2 Nonfactor Sarvices (net) -2.6 -1.7 -1.6 -1.6 -1.7 -1.4 -1.5 -1.4 -1.4 -1.3 - Oil/LNC -1.0 -0.4 -0.5 -0.6 -0.7 -0.6 -o.7 -7.1 -1.) -I.) - Non-oil -1.6 -L.3 -1.1 -1.0 -1.0 -0.8 -o.a -0.7 -0.7 -o.o Interest on MLT Debt -1.3 -1.5 -1.! -2.0 -2.2 -2.3 -2.5 -2.7 -2.7 -2.7 - Ol1/LNG -0.1 -0.1 -0.1 -2.2 -0.4 -0.3 -0.2 -0.1 -0.1 -0.1 - Non-oil -1.2 -1.4 -1.5 -1.8 -1.8 -2.0 -2.3 -2.6 -2.6 -2.6 Other Factor Services (net) -1.9 -2.1 -3.0 -3.0 -2.6 -1.3 -1.8 -2.3 -2.3 -2.4 - Ol/ILNG -2.7 -2.4 -2.8 -2.9 -2.5 -1.3 -1.9 -2.2 -2.0 -2.0 - Non-oil 0.8 0.3 -0.2 -0.1 -0.1 - 0.1 -0.1 -0.3 -0.4 Net Transfers 0.1 0.L 0.1 0.1 0.1 0.1 0.2 0.2 0.2 0.2 Current Account Balance -2.7 -7.Z -4.3 -1.8 -1.9 -4.3 -2.7 -1.7 -1.1 -0.9 - Oil/LNG 9.6 7.0 7.2 7. 8 5.7 2.2 3.3 4.4 4.9 4.8 - Son-oil -12.3 -14.2 -11.5 -9.6 -7.6 -6.5 -6.0 -6.1 -6.0 -5.6 Direct Foreign rnveut- mert (net) 0.1 0.3 0.2 0.2 0.3 0.3 0.3 0.4 0.5 0.6 Public MLT Loans (net) 1.5 2.9 3.5 1.7 1.0 2.9 0.6 -0.2 -0.4 -0.7 - Disburaswents /a 2.7 4.2 5.0 3.8 3.7 5.6 3.7 3.4 3. 6 3 3 - Amortlzatlon -1.2 -1.3 -1.3 -2.1 -2.7 -2.7 -3.1 -3.6 -6.0 -4.0 Private MLT Loans (net) 0.2 -0.3 0.2 0.4 - 0.1 - - _ _ Disburseents -a 04 0.4 0.9 1.0 0.8 0.6 0.6 0.7 0.8 0.9 - Amortization -0.2 -0.7 -0.7 -0.6 -0.8 -0.5 -0.6 -0.7 -0.8 -0.9 Other capital (net) /b -0.1 0.9 2.1 0.1 1.0 0.8 - -0.2 -0.1 - Use of officlal reserves 1.0 3.4 -1.7 -0.6 -0.5 0.2 } 1.8 1.7 1.1 1.0 Financing gap /c - - - - - } /a ProjectLons sasume no mm commercial borroving (after 1986/87) and "business as usual" by ICCI members. 7b- Includes valuation adjustments and errors and oisations. 7S Projected gsp to be financed by special IGGI assistance, new commercial borrowing and usa of reserves. -60- ANNEX VI Page 4 of 4 INDONFSIA TRADE POLICY AOJUSTHENT LOAN Table VI.3: CENTRAL COVERNKENT BUDGET (Rp trillion) Actuals Budgea Estimates 1981182 1982183 1983/84 1984/85 1985/86 198i f87 1986787 Revenue and Grants 12.2 12.6 15.4 19.3 18.6 17.9 14.0 Oil/LNG taxes 8.6 8.3 10.4 1 3.7/a 10.4 9.7 Non-oil taxes 3.2 3.8 4.4 4.8 6.6 7.1 7.3 Non-tax revenue. /b 0.3 0.4 0.5 0.7 1.5 1.0 1.8 Grants 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Current Expenditures 7.9 8.1 9.1 10.5 12.7 12.9 12.9 Interest on external debt 0.5 0.7 1.1 1.6 1.7 2.1 2.6 Subsidies lc 1.9 1.4 1.3 1.2 1.2 1.2 0.9 Other /d 5.5 6.0 6.8 7.7 9.8 9.6 9.4 Government Savings 4.3 4.5 6.2 8.8 5.9 5.n 1.1 Cavital Expenditure le 5.2 7.0 8.2 11.4 8.5 6.4 6.1 Overall Belance -0.9 -2.5 -2.0 0.4 -2.6 -1.4 -5.0 Financed by: External loans (net) 1.0 2.0 3.9 2.6 1.7 1.4 5.0 Disburmements (1.5) (2.6) (4.9) (4.0) (3.9) (3.5) (7.8) Amortization If (-0.5) (-0.6) (-1.0) (-1.4) (-2.2) (-2.1) (-2.8) Domestic loans (net) -0.1 0.5 -1.9 -3.0 0.9 - - Ratios (X of GDP) Revenue and grants 20.9 20.1 20.9 22.6 23.2 21.5 16.8 - Oil/LNG taxes 14.7 13.2 14.1 16d1 12.9 11.7 5.7 Total expenditures 22.4 24.1 23.6 22.1 26.3 23.3 22.8 Government savings 7.4 7.2 8.4 10.3 7.4 6.1 1.3 Overall balance -1.5 -4.0 -2.7 0.5 -3.2 -1.7 -6.0 /a Includes payment of back taxes by Pertadins. 7u Includes domestic oil surplus in 1986/87. te Includes fertilizer subsidy, recorded as development expenditure In COl-s formt. T7 Includes the current component of development expenditure. 7T Residual. 7 Recorded as routine expenditure in GOI-s format. , THAILAND 'it -i .r *. , . b' **. ! '7~ ., MALAYSIA * BRUNEI tuft. --s ,; fea f 1 0> -\XUUtM Isbolga o .-A. MAI AY$1A ) \\ j %< 2 Q7,! SINGAPORE _. *a- - SB 4 , + !,\ :'- KAtc[MANT.j; 0~~~~~~~~~~~ r j5badoixr>^~r^/f mnarindo >= 1, 1~~~~~~.. I . if#Z ,, 1_-> toniwv Pin o tongpdan PROVINCES: \ ' > au- - f *.> - .> /. -. 22; 4~~~~~~~~~~~~~~ 2 JMATERA UTARA Ungliflin ' 4i KAU = 5JPSI~~~~~~~~~~~~~ 6WDUATERA SELATAN C 8 . UhsgPmnd.nJD 7> UEOgKUW _-- -' F; -4 , LAWIJO CT..K*ww.g| 9 D.K,I. JAKARTA . A G,A 10 AWA ARAT - .9. . b 2 PVJAIIIA TENGAH IEJAKAT J. TUN I? D.J YGAKAT ENhe.MA ISMATENAGUARA RA( 11-Sea 16 NUSATEOGR TIMUR A t V 13SL 17 BRIA JAVA Yow & rn y' g 2 GU>WESil UtARA 12 -. 14 I9SULAWISITliiAR . - * 15 S . .: -21 SILLAESI TEIUARA CA @BA WA - 22SJLAWEU SILATAF4 23 KAUMMiTANI TlhMlt 324KAUMAETAI 5ELATAN 25 KAUIANTAN nGA 26 KALIASITAN SARATA : Z7 tN*R TUPU I I JAWA TV4Woo JAKARTA 14 DAU 11-d 112 11 15 ,UAEWR BANA IlIAC)7 I I O:fIIR I PHILIPPINES N DE , ~~~~~~I N DO0N E SlI A * Cities or Towns Rivors Prouince Boundaries I Irotepiaotional Boundaries J H~~~~~~~~~~~~AIMA HERA r /~~, 20 ** (CI \KLPULAiIAUN 5(iVIA si 0Kendmo Kokernou Wen,s o AgnIs Booubo )-r Mourn.. FtOPES~ 0. - 16 om vruoi o IDD 200 300 400 16 L. n.I __ -Warngopu rtiMO 27 MlES . - ° rICwmwrepornenimul*Neolt--winrblsonewef °l 1|3D 200 3aID4000'0,0 -: , M 1rn.k*r. end e enpk.e.o_. 'C. A. ,hnnh mul tIn. dIAnUIJk rb' Pm KILOMEtERS rden Copr*o.Mn rfhe d m.u mud ne VW bW W C mEno ao dol C. M P. P.1 O' *.id dhien- end I.eMCe Iuf Cun, fto -_V hda- Oh vio giaol or ow fenPmv or mrl mksmnV u. mwmE r ol Do*oqFi 124- 130- 130 AAY IV!H,