EXECUTIVE …siteresources.worldbank.org/INTINDONESIA/Resources/CAS/CAS04-07.pdf · This “letter of intent to the Indonesian people” provides an agenda of time-bound actions,

CONTENTS

EXECUTIVE SUMMARY………………………………………………………………………i

COUNTRY CONTEXT AND DEVELOPMENT CHALLENGES ......................................... 1

A. POLITICAL, SOCIAL AND ECONOMIC CONTEXT AND CHALLENGES ......................................... 1

B. INDONESIA’S NEW ECONOMIC POLICY PACKAGE: THE SHORT-TERM AGENDA ...................... 5

C. THE EMERGING PRSP: A MEDIUM-TERM FRAMEWORK FOR POVERTY REDUCTION ............... 8

D. ECONOMIC OUTLOOK, EXTERNAL ENVIRONMENT AND FINANCING NEEDS ............................ 8

THE WORLD BANK IN INDONESIA: LEARNING FROM RECENT EXPERIENCE.. 10

A. LESSONS FROM THE TRANSITION PERIOD .............................................................................. 10

B. THE SPECIAL PROBLEM OF CORRUPTION............................................................................... 11

THE BANK GROUP’S ASSISTANCE PROGRAM .............................................................. 16

A. THE WORLD BANK GROUP’S STRATEGIC FOCUS .................................................................. 16

Objective I: Improving the Climate for High Quality Investment.................................... 16

Objective II: Making Service Delivery Responsive to the Needs of the Poor.................. 21

The Core Issue of Governance—Defining Selectivity ..................................................... 25

B. BUSINESS PLATFORMS—HOW THE WORLD BANK WILL DELIVER .................................. 27

The Community Driven Development Platform............................................................... 28

The Local Services Platform............................................................................................. 30

The Public Utility Platform............................................................................................... 31

The “National” Lending Platform..................................................................................... 32

DELIVERING THE WORLD BANK PROGRAM ................................................................ 33

A. MANAGING THE PORTFOLIO AND MONITORING FOR RESULTS .............................................. 33

B. BUILDING CAPACITY AND INFORMING DECISION MAKING .................................................... 34

C. LENDING SCENARIOS, TRIGGERS AND BANK EXPOSURE ....................................................... 37

D. IFC AND MIGA PROGRAMS................................................................................................. 42

E. PARTNERSHIPS....................................................................................................................... 43

MANAGING RISKS .................................................................................................................. 45

Indonesia Country Assistance Strategy

ANNEXES

A1: Key Economic and Program Indicators A2: Indonesia at a Glance B2: Selected Indicators of Bank Portfolio Performance and Management B3: Bank Group Program Summary—Base Case Lending Program B3: Bank Group Fact Sheet—IFC and MIGA Program B4: Summary of Non-lending Services B5: Social Indicators B6: Key Economic Indicators B7: Key Exposure Indicators B8: Operations Portfolio B8: Statement of IFC’s Held and Disbursed Portfolio B9: CAS Program Matrix B10: CAS Summary of Development Priorities B11: Key Environmental Indicators C. Macroeconomic Performance and Prospects D. Poverty Profile & Analytical Agenda E. Summary of CAS Consultations F. Environment G. Proposed Program of IFC & MIGA

TABLES

Table 1: Progress towards Achieving the Millennium Development Goals....................................4 Table 2: Government Policy Performance under Last CAS ..........................................................12 Table 3: Improving Investment Climate for Poverty Reduction: Targeted Results ......................17 Table 4: Making Services Work for the Poor: Targeted Results ...................................................23 Table 5: Governance: Targeted Results.........................................................................................25 Table 6: Indonesia CAS FY04--FY07: Expected Lending (US$ million) ....................................29 Table 7: The Performance of the Bank's Portfolio during the Last CAS Period (percentages)....33 Table 8: AAA Indicative Key Outputs By Theme .........................................................................36 Table 9: Indonesia CAS Trigger Matrix FY04—FY06 .................................................................38 Table 10: Expected Lending FY04-07...........................................................................................42

BOXES

Box 1: Lessons from OED Reviews and the Last CAS .................................................................11 Box 2: CAS Consultations Highlight Indonesia’s Development Challenges ................................13 Box 3. The Program for Eastern Indonesia SME Assistance (PENSA) ........................................19 Box 4: Support for Poor Rural Households and Farmers ..............................................................21 Box 5: Improving Service Delivery Through Greater Accountability .........................................22 Box 6: The Challenge of Forest Resources Management in Indonesia .........................................29 Box 7: Framework for Achievement of the “Enhanced” Base Case .............................................39 Box 8: Fiduciary Environment: Progress and Next Steps .............................................................40


FIGURES

Figure 1: A Snapshot of Indonesia’s Economy ...............................................................................2 Figure 2: Indonesia Country Policy and Institutional Assessment ..................................................6 Figure 3: The CAS Framework......................................................................................................16 Figure 4: Total External and IBRD Debt Outstanding ..................................................................41 MAP (IBRD No. 30903R4)


ABBREVIATIONS AND ACRONYMS

AAA Analytical and Advisory Activities ACC Anti-corruption Commission ADB Asian Development Bank ASEM Asia-Europe Meetings AusAID Australian International Development

Agency BCP Business Continuity Plan BKPM Chairman of Investment Coordinating Board BPK Supreme Audit Board BPS Indonesian Bureau of Statistics BRI Bank Rakyat Indonesia CAS Country Assistance Strategy CDD Community Demand Driven CGI Consultative Group on Indonesia CFAA Country Financial Accountability

Assessment COREMAP Coral Reef Rehabilitation and Management

Project CPAR Country Procurement Assessment Report CPI Consumer Price Index CPIA Country Performance Institutional

Assessment CPPR Country Portfolio Performance Review DFID Department for International Development

(United Kingdom) DPRDs Local Parliaments EFF Extended Fund Facility ESW Economic Sector Work FATF Financial Action Task Force FDI Foreign Direct Investment FEATI Farmer Empowerment through Agriculture

Technology & Information Project FY Fiscal Year GDP Gross Domestic Product GDS Governance and Decentralization Survey GEG Good Environmental Governance GOI Government of Indonesia IAIS International Association of Insurance

Supervisors IBRA Indonesian Bank Restructuring Agency IBRD International Bank for Reconstruction And

Development ICRG International Country Risk Guide IDA International Development Association IEDF Indonesia Eastern Development Facility IFC International Finance Corporation ILGRP Initiative for Local Governance Reform

Project IMF International Monetary Fund INT Dep. of Institutional Integrity IOSCO International Organization of Securities

Commissions IPO Initial Public Offering I-PRSP Indonesian Poverty Reduction Strategy

Paper

JBIC Japan Bank for International Cooperation JICA Japan International Cooperation Agency JITF Jakarta Initiative Task Force KDP Kecamatan Development Project KKN Corruption, Collusion, Nepotism KPPU Business Competition Supervisory

Commission LOI Letter of Intent MDG Millennium Development Goals M & E Monitoring and Evaluation MFA Multi Fiber Agreement MIGA Multilateral Investment Guarantee Agency MOF Ministry of Finance NGO Non Government Organization NPPO National Public Procurement Office OED Operations Evaluation Department PDAM Water Utility PENSA Program for Eastern Indonesia SME

Assistance PER Public Expenditure Review PERDAs Peraturan Daerah (local regulations) PERPAMSI Association of Water Enterprises PGN State Gas Company PHP Provincial Health Projects PLN State Electricity Company PPA Participatory Poverty Assessments PROPENAS GOI five-year plan PROPER Program for Pollution Control Evaluation

and Rating PRSP Poverty Reduction Strategy Paper QAE Quality Assessment Evaluation QAG Quality Assurance Group REPETA Annual Development Plan ROSC Report on Observance of Standards and

Codes SME Small- and Medium-size Enterprise SOEs State-owned Enterprises STPDN Public Administration Institute of the

Ministry of Home Affairs TA Technical Assistance TIMMS Third International Mathematics and Science

Study UNDP United Nations Development Fund UPP Urban Poverty Project USDRP Urban Sector Development Reform Program WASPOLA Water Supply and Sanitation Policy

Formulation and Action Planning Project WBI World Bank Institute WDR World Development Report WHO World Health Organization WISMP Water Resources and Irrigation Reform

Implementation Project WSSLIC The Water Supply and Sanitation for Low-

Income Communities

Indonesia Country Assistance Strategy i

EXECUTIVE SUMMARY

i. Country Context. Indonesia continues its transition from an autocratic, centralized state to a democratic, decentralized one. It has successfully regained macroeconomic and political stability, but economic growth remains below 4 percent, poverty reduction remains a challenge, and governance concerns continue to cloud its achievements. Public debt has declined from 100 percent of GDP to 72 percent, inflation is now below 7 percent, and income poverty has fallen from 27 percent in 1999 to 16 percent today. However, 110 million people still live on less than $2 a day, and remain vulnerable to falling back into severe poverty. Indonesia continues to under-perform its neighbors in access to quality health, education and other basic services, as reflected in the MDG indicators. Weak governance institutions are keeping investors away and undermining service provision, especially to the poor. Indonesia has undertaken reforms that could lead to a more effective and accountable government, and a restoration of growth. But sound implementation is now needed to turn the promise into reality.

ii. The Government’s Reform Program. Following its decision not to renew the IMF program after 2003,1 the Government prepared a comprehensive package of policy reforms through the end of 2004. This “letter of intent to the Indonesian people” provides an agenda of time-bound actions, covering macroeconomic management, financial sector reform, and policies to help raise investment and reduce poverty. The package is ambitious – especially for an election year -- but represents an important effort to spur the momentum of reforms, and serves as a mechanism to monitor the Government’s progress on the basis of its own stated benchmarks. With steady progress on this reform package, and an effective PRSP,2 growth over the CAS period is expected to reach 5 percent by 2006, enabling poverty to decline to 11 percent by 2007.

iii. The Bank Group Strategy. Further progress in reducing poverty is prevented by two major factors—low investment, and weak service provision—which in turn are caused primarily by problems of governance. The Bank Group’s entire efforts -- in the form of analytical and advisory services, lending, IFC and MIGA activities, and donor coordination -- will be to help address these problems.

• Improving the Climate for High Quality Investment. Bank Group support will be directed to address five key areas that are essential to raise the rate of investment from its current level of 20 percent of GDP: deepening macroeconomic stability, building a stronger financial sector, fostering a competitive private sector, building Indonesia’s infrastructure, and creating income opportunities for poor households and farmers.

• Making Service Delivery Responsive to the Needs of the Poor. Weak service delivery is undermining Indonesia’s goal of improving the quality of life of its citizens and the attainment of its MDGs. Bank Group support will thus be devoted to help revamp the management and accountability systems for service delivery to make providers more directly accountable to their clients. Focus will be given to implementing the principles of the World Development Report 2004, especially in health and education, but also in agricultural research, extension and irrigation, and in public services in general.

• The Core Issue of Governance. Advances in governance will be needed to address both CAS objectives. Four areas will be given priority: (i) making development planning more responsive to

1The IMF will engage in post-program monitoring beginning in 2004. 2As a blend country, Indonesia’s PRSP preparation is not directly linked to IDA access and was therefore not a pre-requisite for Bank CAS preparation. Indonesia’s I-PRSP was circulated to the Board in March 2003, and its full PRSP is due to be completed in mid-2004.

ii Indonesia Country Assistance Strategy

constituents; (ii) improving public financial management; (iii) strengthening the accountability of local governments under a more coherent decentralization framework; and (iv) enhancing the public credibility, impartiality and accessibility of the justice sector. Selectivity in the Bank’s activities will be determined less by sectoral priorities than by the opportunity to make progress in these areas. Corruption poses a special problem in Indonesia, and the country team aims to integrate governance and corruption issues through the entire Indonesia program, shaping how projects are selected, designed, implemented and monitored.

v. Business Platforms —How the World Bank will Deliver. Indonesia’s massive decentralization calls for a new approach to the delivery of development assistance. The Bank will leverage the projects it finances with analytical work, policy advice, technical assistance, strategic partnerships and capacity building to systematically increase standards of governance at each level of government the Bank engages. Four business platforms are envisioned:

• The Community Driven Development Platform: about 25 percent of all lending (about $200 million per year) would be allocated to scale up this successful program.

• The Local Services Platform: about 40 percent of lending would be allocated to help create accountability at the district and provincial levels.

• The Public Utility Platform: about 15 percent of lending would help support investments in good corporate governance and efficiency in water supply and energy.

• The National Lending Platform: about 20 percent of lending would be allocated to address central problems.

The CAS Framework

vi. Scale of World Bank Activities. Through these platforms the Bank proposes a Base case with lending in the range of $450 - $850 million, including $230 million in IDA resources. The Base case assumes continued, but incremental, progress on the Economic Policy Package. Evidence of decisive momentum in implementing the reform package could lead to an “enhanced” Base case, in which the Bank would offer an adjustment loan in late 2004. The actual amount of Base case lending would also depend on the number of districts and utilities that qualify through their governance reforms for Bank assistance. The CAS also includes a High case of up to $1.4 billion, and a Low case of less than $300

Investment Climate Service

Delivery

National Platform

Public Utility Platform

Local Services Platform

CDD Platform

GOVERNANCE

Indonesia Country Assistance Strategy iii

million. The High case triggers have all been selected from the Government’s Economic Policy Package as those most important to achieving target outcomes in the three CAS areas and putting the country on a path to stronger growth and better living standards.

vii. Program Delivery—Portfolio Management, Analytical and Advisory Services (AAA), and Partnerships. Despite challenges of portfolio management across a large country with significant corruption risks, portfolio performance has improved with commitments at risk down from 39 percent (FY02) to 12 percent (FY03), and disbursements remaining above 20 percent. Portfolio risks will be managed by building external monitoring mechanisms into project designs, requiring anti-corruption strategies for each project and using the platform approach to maximize the effectiveness of supervision. The platforms will also bring more coherence to capacity building activities with the World Bank Institute taking a strong role. The AAA program is being thematically developed around the CAS objectives to stay focused on results. Finally, partnerships will play a large role in the success of the platforms, through support for critical analytical, M & E, and capacity building contributions, and in support of specific sectoral reform programs through grant financing, TA and analytical inputs.

viii. International Finance Corporation (IFC) and Multilateral Investment Guarantee Association (MIGA) Programs . IFC’s activities, including the new SME Facility (PENSA), are directed to help the private sector and contribute to sustained economic growth and poverty alleviation, by focusing on: (i) strengthening of banks; (ii) deepening the financial sector; (iii) supporting export-oriented companies, mainly in the agribusiness sector; (iv) supporting infrastructure investments in power and telecommunications; and (v) supporting SMEs. MIGA is proposing to support privatization through the provision of political risk guarantees to foreign investors, to provide support to the investment promotion agency, and to undertake a comprehensive benchmarking study of Indonesia.

ix. Managing Risks. The program is designed to mitigate risks that could limit the effectiveness of Bank support. These risks include, a lack of political will to address governance issues, macroeconomic shocks arising from domestic or international factors, including a financ ial sector crisis; political and security instability threatening a loss of confidence, disruption in Bank activities, and a potential risk to Bank staff; stalled decentralization undermining the effectiveness of local governments; challenges to the Bank’s reputation and credibility stemming from continued public concerns about corruption and the impact of donor assistance. Risk management measures are described for each risk area.

Indonesia Country Assistance Strategy 1

COUNTRY CONTEXT AND DEVELOPMENT CHALLENGES

A. POLITICAL, SOCIAL AND ECONOMIC CONTEXT AND CHALLENGES

1. Indonesia continues its transition from an autocratic, centralized state to a democratic, decentralized one. In the five years since President Soeharto’s resignation and the fall of the New Order regime, Indonesia’s democracy has gained much ground. A multiplicity of voices is being heard from civil society, political parties, and the academic community, and communicated through a burgeoning and relatively free local media. Indonesia’s Parliament has seen its role increase dramatically, and is now actively engaged in the policy debate and providing an institutional check on the executive branch. After a rocky start, the political arena has stabilized over the past two years. Recent constitutional and legal changes have been passed that should further strengthen democratic accountability by paving the way for the first direct election of a President next year and phasing out of the military from Parliament. The successful implementation of the Big Bang decentralization as of 2001 has transferred considerable authority over public expenditures and public service delivery to over 400 local governments in the hopes of improving responsiveness to client needs. There are clear signs that decentralization is enhancing participation in decision-making in the most reform-minded regions.

2. Macroeconomic stability has been restored, and poverty has been reduced to near pre-crisis levels (Figure 1). The Rupiah has strengthened from over 10,000 per dollar at the start of the previous CAS period to 8,500 now, inflation has been brought down to below 7 percent, interest rates have fallen accordingly, and the stock market has risen sharply over the past year. Fiscal consolidation has been impressive, as the budget deficit has been reduced by two-thirds to an expected 1.9 percent of GDP in 2003, and 1.3 percent 3 in 2004, primarily through cuts in untargeted fuel subsidies. Government debt to GDP has fallen from almost 100 percent in 1999 to some 72 percent now, and total external debt has shown similar trends. Progress in structural reforms, notably bank sales and asset recoveries by IBRA, the bank restructuring agency, have supported the macroeconomic gains. (See Annex C on macroeconomic performance and prospects.) This stabilization of the economy supported a strong reduction in income poverty,4 which fell from over 27 percent of the population in 1999 to 16 percent in 2002, in part because a stronger Rupiah made key staples, including rice, more affordable after the crisis spike.

3. Nevertheless, the reduction of poverty remains a critical challenge for Indonesia. Despite progress since the crisis, the number of poor in Indonesia continues to be high: currently double that of the entire population of Australia. Moreover, while 6.7 percent of the population live below $1 per day, over 110 million people (53 percent of the population) live on less than $2 per day, and about that many remain highly vulnerable to falling under Indonesia’s poverty line. Eastern Indonesia continues to lag far behind the rest of the country, but there are also pockets of poverty within all regions, and the high population density of Java and Sumatra means that most of the poor in fact live on these islands. Female workers are three times more likely than men to

3 The World Bank estimate of a fiscal deficit of 1.3 percent in 2004, compared to the Government’s estimate of 1.2 percent is due to the World Bank’s projection of nominal GDP being slightly lower than the Government’s projection. 4 As measured through expenditures.

2 Indonesia Country Assistance Strategy

Figure 1: A Snapshot of Indonesia’s Economy Market sentiment continues to improve

(Rupiah/$ exchange rate and Jakarta Stock Exchange index) And inflation and interest rates are falling

(SBI interest rate and CPI inflation)

200

250

300

350

400

450

500

550

600

Feb-01 Jun-01 Oct-01 Feb-02 Jun-02 Oct-02 Feb-03 Jun-038,000

8,500

9,000

9,500

10,000

10,500

11,000

11,500

12,000Stock Index (1983=100) Exchange rate

Stock Index

Exchange rate Rp/US$

4

6

8

10

12

14

16

18

Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03

SBI 1 month rate

CPI Inflation (yoy)

(%)

Source: Bank Indonesia, BPS Source: Bank Indonesia, BPS

Fiscal consolidation continues (Government budget deficit, percent of GDP)

And poverty is down from crisis highs (Poverty headcount ratio, percent)

4.8%

3.7%

2.5%

1.8%

1.3%1.6%

2.7%

1.7%1.9%

0%

1%

2%

3%

4%

5%

6%

2000 2001 2002 2003 2004

Budgeted

Actual

draft budget

revised budget

15.7%

27.1%

16.0%

0%

5%

10%

15%

20%

25%

30%

1996 1999 2002

poverty incidence (%)

Source: MOF, staff estimates Source: BPS and staff estimates

But growth remains modest (GDP, Consumption, and Investment growth, percent)

And the investment outlook is subdued (Investment to GDP ratio, percent)

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

GDP Private consumption Investment

2000 2000 20002001 2001 20012002 2002 2002

(growth rate)

15%

17%

19%

21%

23%

25%

27%

29%

31%

1996 1997 1998 1999 2000 2001 2002

Source: BPS Source: BPS


have earnings below one dollar a day and have a lower chance of graduating from low pay jobs. Looking beyond income poverty, Indonesians continue to suffer in many ways. Progress in ensuring access to basic health, education, water, and sanitation services (e.g. as measured by births attended by traditional healers, child enrollment, household access to sanitation and to water), improvements have been slow. These are also reflected in poor MDG outcomes, particularly in health (see Table 1), relative to countries within the region. Women in particular suffer problems of access to quality services and bear the consequences: Indonesia’s maternal mortality rate is two times greater than the Philippines and five times greater than Vietnam. Where public services are available—in education and health, for example—they are often of poor quality as evidenced by student test scores and the high prevalence of communicable diseases such as TB. In addition, while Indonesia is doing well on educating young girls, democratization has so far reduced women’s representation in Parliament, and this trend is also being played out at the local level where local laws are being issued that discriminate against women. (See Annex D for a fuller poverty profile.)

4. The achievements of the past few years continue to be clouded by widespread concerns about governance and corruption across Indonesian society. The high hopes that the Reformasi movement would break the hold of the vested interests and the corruption, collusion, and nepotism that characterized the later years of the Soeharto era have not been realized. Few have been held to account for the theft of public resources, and there are signs that “money politics” is at work allowing old elites to reacquire their previous assets, and new elites to consolidate their positions. While corruption captures headlines, the issues created by Indonesia’s weak institutions have wider implications. The “please your boss”, upward- looking accountability and reward system of Indonesia’s centralized New Order civil service lingers on at the expense of citizen participation and accountability for results. The perception that corruption is still entrenched in the political system has damaged Indonesia’s investment climate and generated popular resentment and resignation. The uneven burden that corruption and poor governance place on poor families raises serious issues of equity and fairness. Indeed, addressing governance was identified in the Bank’s 2001 Poverty Report as the single-most important agenda for reducing poverty in all its dimensions. Many senior Indonesians recognize that the “crisis of governance” is becoming a “crisis of development”, and that a whole new mindset is needed, including tools, instruments and capabilities of a modern, responsive government.

5. Unlike many other countries facing similar governance problems, Indonesia has begun to undertake important structural reforms that could ultimately lead to more transparent and accountable government. An ambitious program of electoral reforms has been introduced that will, over the coming few years make policymakers at all levels of government directly beholden to voters. The mid-2004 national elections will be an important first test. Will “money politics” rule the day? Or will direct election of the President and parliamentarians spark greater responsiveness to public demands for integrity and good governance? In addition, a radical decentralization has brought responsibility for public expenditures and public service provision down to a level where government is likely to be more responsive to client demand. The legal framework for a more transparent system of public expenditure management is making progress with structural reforms soon to follow. And an institutional infrastructure is slowly being put into place to handle corruption cases.


Table 1: Progress towards Achieving the Millennium Development Goals

1990 2002 Poorest quintile Progress towards Goal

1. Halve between 1990 and 2015 the proportion of people who suffer from poverty and hunger Population below 1 dollar a day (%) a 20.6 6.7 33.6 Achieved Share of poorest quintile in National consumption b 0.086 0.0843 n.a. No change Prevalence of underweight children (under 5 years of age, %) c

37 26 n.a. On track, but slipping

Proportion of population below minimum level of energy consumption (less than 2100 Calories per person per day, %) b

70 65 20 Slow progress

2. Achieve universal primary education Ensure that by 2015 everywhere, boys and girls alike will be able to complete a full course of primary education Net enrollment rate in primary school b 93.2d 92.5 88.3 No change Proportion of children aged 16 that have completed primary school. b 88.4 d 94.2 88.1 Improvement

3. Promote Gender Equality and Empower Women Primary 1.06 d 1.08 1.06

Junior secondary 1.13 d 1.04 0.99 Ratio of boys to girls b Senior secondary 1.21 d 1.12 1.14

On track

Share of women in wage employment in non-agricultural sector (%) b 30 d 32 31 No change

Proportion of seats held by women in national parliament (%) e 13 8.8 n.a. Deterioration

4. Reduce Child mortality Under 5 mortality rate f 99 60 n.a. On track Proportion of children of 1 year immunized against measles (%)b 74 d 68 60 Worsening

5. Improve maternal health Maternal mortality ratioc (per 100,000 live births) 425 k 373 l n.a. Improving slowly Proportion of births attended by skilled health personnel b 39.6 d 67 46 Improving but low 6. Combat HIV aids, malaria and other diseases Contraceptive prevalence (% among married women aged 10-50)

52.2 d 53.3 52.2 No change

7. Ensure Environmental Sustainability Proportion of land covered by forest g 63h 57i n.a. Worsening Percent of population that has access to improved water j 63 d 78 65 Improving but low Note: The Government of Indonesia is in the process of preparing a Millennium Development Goals report. In this table we have made an effort to present the indicators as they are likely to feature in the GoI’s report. There are however likely to be differences and this table should not be considered the GoI’s view with respect to progress toward the MDGs. a. World Bank. April 2003. East Asia Update—Looking Beyond Short-term Shocks, Regional Overview. East Asia and Pacific Region, Washington D.C. b. World Bank Staff calculations based on Susenas. c. Health Profile of Indonesia, Ministry of Heatlh 2002. d. 1993 Susenas data. e. International Institute for Democracy and Electoral Assistance. 2000. Democratization in Indonesia: An Assessment. f. BPS publications, using population census, International Demographic and Health Survey and intercensal surveys. g. Holmes, Derek A. 2002. “Indonesia: Where have all the forests gone?” Discussion Paper. Environmental and Social Development, East Asia and Pacific Region. World Bank, Washington D.C. h. 1985 data. i. 1997 data. j. Improved water is derived from bottled, piped or pumped water, protected well or spring and rainwater. k. 1992 data. l. 1995 data.


6. But these bold reforms—in significant respects as far-reaching as any country in transition—have been undermined by weak implementation. As a result, the gap between the promise and the reality of reform in Indonesia has been large. Yet it is important to recognize that there is much to work with in seeking to support Indonesia’s future reform path. The legal framework for necessary structural reforms is in place; the challenge is more narrowly focused on strengthening the incentives for effective implementation. Despite a vibrant arena of political competition, the major parties tend to agree on the basic thrust of reform pointing towards more direct accountability, greater transparency and more responsible financial management. This suggests that there is a strong foundation for reform in the coming years even though there remains much work to be done to harness the bold initiatives of the Reformasi period into effective institutional and behavioral change.

7. This mixed story—of solid progress in economic policy-making, and halting progress on governance issues—is captured in the Country Performance Institutional Assessment (CPIA) ratings. Figure 2 shows that the good progress in macroeconomic policy and reasonable progress in structural policies is only beginning to be matched by progress in social indicators and in indicators of governance. While for most indicators Indonesia is well ahead of the average for IDA countries, performance on property rights and governance, transparency and accountability, and external debt management are lagging. Moreover, the fact that neither investment levels nor (broadly) the quality of public services have returned to their pre-crisis levels—in spite of impressive improvements in the macroeconomic context and opportunities provided by decentralization—is a reflection of the weaknesses of public institutions, a lack of transparency and accountability, and corruption.

8. Finally, Indonesia is not yet free from risks to political and social stability, against which democracy, growth and poverty reduction remain the best weapons. The recent resumption of military action in Aceh demonstrates that so far, decentralization and special autonomy, have not resolved separatist tensions. At the same time, extremist Islamic movements both within Indonesia and across the region, though representing a small minority, continue to pose a heavy burden of terrorism threats. The twin threats of separatism and terrorism raise concerns about security and uncertainty that impose high costs on the population and dampen the response of investors to Indonesia’s strong macroeconomic achievements. At the same time, these twin threats underlie a continued powerful political role for the military that weakens some of the recent gains in establishing greater transparency and accountability in the political system.

B. INDONESIA’S NEW ECONOMIC POLICY PACKAGE: THE SHORT-TERM AGENDA

9. The Government has decided not to renew the IMF program when it expires at the end of 2003, and in its place has announced a package of policy actions for the next eighteen months. Following much discussion among politicians, cabinet members, academic economists and civil society groups, President Megawati Soekarnoputri announced the Government’s decision in her budget speech to the nation on August 15, 2003.5 In place of the

5 The IMF will continue to be strongly engaged through its “Post Program Monitoring” missions.


Figure 2: Indonesia Country Policy and Institutional Assessment

Good progress on macro and structural, but limited progress on governance and social…

1. Macroeconomic Balances

2. Fiscal

3. External Debt

4. Development Program

5. Trade and FX

6. Financial Stability

7. Banking Efficiency

8. Private Sector Environment

9. Markets

10. Environment

11. Gender

12. Equity of Public Resource Use

13. Building HR

14. Social Protection

15. Poverty Analysis

16. Property Rights and Governance

17. Budget Management

18. Revenue Mobilization

19. Public Administration

20. Transparency & Accountability

Indonesia 2003 Indonesia 1999 Maximum

Generally better than the IDA average in all areas but governance and debt…

1. Macroeconomic Balances

2. Fiscal

3. External Debt

4. Development Program

5. Trade and FX

6. Financial Stability

7. Banking Efficiency

8. Private Sector Environment

9. Markets

10. Environment

11. Gender

12. Equity of Public Resource Use

13. Building HR

14. Social Protection

15. Poverty Analysis

16. Property Rights and Governance

17. Budget Management

18. Revenue Mobilization

19. Public Administration

20. Transparency & Accountability

Indonesia 2003 IDA average 2002 Maximum

Indonesia 2003 are preliminary ratings.

Letter Of Intent (LOI) which the Government prepared periodically for the IMF under its program, the Government has prepared a new time-bound package of economic policies, that will guide policy direction through 2004, covering the period of the elections and installation of a new administration. The package, signed by the President on September 15, covers three areas—


macroeconomic management, financial sector reform, and policies to restore investment and growth.

• Further Macroeconomic Consolidation. The Government’s aim is to reduce the fiscal deficit to zero by 2006, and the public debt to GDP to “safe levels” (the State Finances law specifies a level below 60 percent of GDP—equal to the so-called “Maastricht” norms). Measures to modernize the tax system include revisions of taxation laws, expanding the large taxpayers’ office, and reforms of the customs office. Measures to increase efficiency in spending include revised procedures on government procurement, establishment of a separate treasury and a treasury single account, and implementing regulations for budget preparation and government accounting standards. The plan calls for further reductions in untargeted fuel subsidies—and limiting these to household kerosene, a fuel mainly used by the poor. The program includes privatization of 10 state enterprises—an ambitious target for an election year—and a revamp of intergovernmental fiscal relations.

• Deeper Financial Sector Reform. Government plans include policies to solidify a financial sector safety net, continue bank restructuring, strengthen state bank governance, and improve capital market supervision. A “white paper” on the financial safety net would be prepared, a deposit insurance law submitted to Parliament, and the “lender of last resort” role of Bank Indonesia would be amended. Specific actions on bank restructuring include further sales of IBRA banks and assets, and introduction of risk-adjusted capital adequacy rules. State banks would be strengthened by appointment of independent commissioners, and by improving credit and risk management systems, and by launching an IPO for Bank BRI. Capital markets would be placed on a firmer footing by enforcement of capital adequacy standards, regulation of the mutual funds business, and consolidation and improved regulation in the insurance and pension sector. The anti-money laundering law has been revised to abide by FATF guidelines, and an anti-money laundering task force will be created.

• An Improved Investment Climate. Actions promised by the Government draw from consultations with the business community, and seek to begin to address deep seated constraints, such as corruption, the lack of a trusted legal system, the lack of access to land tenure, and the lack of adequate physical infrastructure as well as more immediate regulatory and labor issues. The Government will set up an Investment and Trade Team to identify and address constraints, and monitor progress. Specific actions include a revision of the investment law, a review of the negative list of sectors barred for foreign investors, and acceleration of tax refunds for exporters. The Anti-Corruption Commission will begin operation, a judiciary commission in charge of the appointment of judges will be established, and the law on the attorney general’s office will be revised. The bankruptcy law will be revised, and the commercia l court in charge of application of that law will be strengthened. To improve investment and management of physical infrastructure, additional public funds will be allocated; and private investment will be facilitated through revisions to the Transport Law, and the creation of an independent supervisor for the electricity market. The Government commits to improving service delivery to investors by improving tax and customs administration, and by requiring all agencies with services to the public to publish service delivery standards.


10. The Economic Policy Package has been received domestically and internationally as ambitious but welcomed. By announcing actions and dates, the Government has opened itself to public scrutiny and made itself accountable in an unprecedented manner. Existing planning documents, such as the five-year plan (PROPENAS) and annual plan (REPETA), discuss development objectives and list loosely related development spending programs, but do not include concrete time-bound actions, with allocated responsibilities. The new package can be criticized as containing too many items and being unfocused, and its success will only become evident over the coming months. Monitoring units are being established within Government and outside, and the Bank will support the Government’s efforts to refine the program, and will provide support for its implementation. Base and High case triggers for the Bank’s program are taken from the Government’s policy package, and it will also be the focus of the next Consultative Group meeting in December 2003.

C. THE EMERGING PRSP: A MEDIUM-TERM FRAMEWORK FOR POVERTY REDUCTION

11. A Poverty Reduction Strategy Paper (PRSP), scheduled for completion in May 2004, is expected to build on the Economic Package, and lay out a comprehensive medium-term development program for poverty reduction. In early 2003 Indonesia finalized its Interim PRSP, which provided a broad road-map and timetable for developing the full PRSP.6 The I-PRSP (circulated to the Boards of the Bank and Fund in March 2003) was consulted broadly with civil society and across the country. Consensus was developed on four fundamental themes for the national PRSP: (i) creating opportunities; (ii) empowerment; (iii) human capital and capacity development; and (iv) social protection. Four multi-stakeholder Task Forces are charged with putting substance behind these areas through a program of analytics and policy development. A Core PRSP Team, under the leadership of the Coordinating Minister for Social Development, is responsible for the overall strategy, and for seeking to link the strategy to the medium term plan and budgetary framework. A series of district-level poverty-reduction strategies, based on participatory poverty assessments (PPAs), are also being prepared. The CAS has been designed to be fully consistent with the emerging PRSP, and has been prepared in consultation with the PRSP Core Team. The CAS Progress Report, to be prepared at the end of 2004, will propose fine tuning of the CAS, in light of the full PRSP and the concerns of the new Government.

D. ECONOMIC OUTLOOK, EXTERNAL ENVIRONMENT AND FINANCING NEEDS

12. A gradual increase in growth characterizes the Base case economic outlook. Supported by a recovering international economy, and a slow but steady improve ment in the investment climate, Indonesia’s GDP growth rate is expected to reach 5 percent by 2006, up from the 3.5 percent in 2003, and broadly similar rates over the last CAS period. Inflation is expected to drop further to some 5 percent per annum and domestic interest rates to drop in line. Under this scenario, the poverty rate would fall from 16 percent in 2002 to 11 percent in 2007, less than half the 27 percent it was in 1999. The external environment is likely to be slightly more supportive of Indonesia’s growth than over the past years: the most recent World Bank

6 As a blend country, Indonesia’s PRSP preparation is not directly linked to IDA access and was therefore not a pre-requisite for Bank CAS preparation. Indonesia’s I-PRSP was circulated to the Board in March 2003.


projections envision a pick-up in the rate of global GDP growth and of world trade.7 Indonesia will face increasing competition on traditional markets, particularly from China, and that competition will intensify after expiry of the MFA agreement in 2005. At the same time, China will be a rapidly growing export market for Indonesia in the years ahead and, on balance, we therefore expect continued export growth. The real exchange rate, while having appreciated in recent years, remains below its pre-crisis levels. Nevertheless, a competitive exchange rate will be necessary to underpin Indonesia’s trade competitiveness.8 Imports will grow faster, as a result of recovering investment, and the current account surplus is thus expected to gradually decline from the record $7.5 billion, or 4.3 percent of GDP in 2002. (For more detail on macroeconomic performance and prospects, see Annex D.)

13. Our Base case projections include gradual increases in investment rates and factor productivity, which in turn are predicated on continued sound macroeconomic performance and a moderate improvement in the investment climate. We expect the Government to continue fiscal consolidation, although at a more moderate pace than the Government itself projects. We assume a balanced budget by 2007, down from 1.9 percent projected for 2003. Consolidation will not only come from further cuts in fuel subsidies—already down from over 5 percent of GDP in 2001 to 1.4 percent of GDP projected for 2003—but also from an increase in non-oil tax revenues on the back of accelerated revenue administration reforms. The Government debt to GDP ratio will continue to fall through 2007 from 67 percent by the end of this year to below 50 percent by 2007 given the debt repayment schedule, exchange rate assumptions, and nominal GDP growth. Likewise, the total external debt to GDP ratio, which had dropped to 76 percent in 2002 is projected to continue to decline to about 40 percent in 2007. We expect investments as a share of GDP to gradually rise from 20 percent now to 22 percent in 2007.

14. Despite further fiscal consolidation, financing needs will be particularly high in the first two years of the CAS period. With the expiration of the IMF EFF arrangement, Paris Club rescheduling ceases at the end of 2003, adding some $3 billion in additional financing needs. In addition, an increasing share of bank re-capitalization bonds will fall due over the coming years, while IBRA asset recoveries are tailing off, as are privatization receipts. As a result, higher financing is required to support a public investment program that complements private investment. With respect to domestic financing, the Government will look to the domestic bond market and a draw-down in deposits. However, increased foreign-financed disbursement will also be required as one important element in bringing about enhanced investment levels and growth. Foreign financed disbursements on the order of US$3 billion will be required annually over this period, relative to a level of $2.3 billion per annum over the last three years, excluding Paris Club.

7 The World Bank’s Global Development Prospects 2004 publication envisages world GDP growth climbing from 2 percent in 2003 to 3 percent in 2004-2005, and regional (East Asia and Pacific) growth rates rising to 6.6-6.7 percent in 2004-2005. World trade volume is expected to increase from 4.6 percent in 2003 to 8 percent in 2004-2005. 8 Bank projections anticipate a real exchange depreciation of about 1.2 percent annually over the CAS period.


THE WORLD BANK IN INDONESIA: LEARNING FROM RECENT EXPERIENCE

A. LESSONS FROM THE TRANSITION PERIOD

15. In the aftermath of the economic crisis, the World Bank was seen by many as part of the problem rather than the solution. To many Indonesians the Bank was associated with the Soeharto Government, which it had supported through loans and policy advice for 32 years. The Bank was a contributor to Indonesia’s external debt, perhaps the country’s most visible economic problem in the post crisis years, without being able to contribute to debt rescheduling or debt reduction. And the Bank’s reputation was damaged as it was perceived to have failed to take a stand against corruption, while lending large sums of money in support of the Soeharto regime. As of mid-2000, the Bank had $11.8 billion of IBRD funds outstanding to Indonesia. To many NGOs this was a millstone around Indonesia’s neck. And to the Bank’s risk managers, this posed one of the most risky parts of the overall portfolio.

16. Over the last few years, the Bank has sought to actively confront these issues, making progress and learning important lessons. First, our debt exposure to Indonesia has been lowered. In agreement with the Government, lending was reduced dramatically from an average of $ 1.3 billion per year before the crisis, to about $450 million over the last three years. As a result the Bank’s exposure to Indonesia has dropped by some $1.5 billion, and will fall by a further $700 million in FY04. Second, as the Bank’s portfolio has shrunk, portfolio performance has picked up. Consolidation, project restructuring and intensive supervision have helped portfolio performance recover from its FY02 post-decentralization dip. Commitments at risk, which reached 39 percent in FY02, dropped to 12 percent by end FY03. Third, the Bank shifted its focus (and its reputation) towards a major expansion of our work on community-driven development programs, governance and anti-corruption (see Section B), and engagement with civil society.

17. Recent project outcomes have been mixed. Recent OED ratings largely apply to projects that began before the crisis, and thus teach lessons about the need to be flexible at times of stress. Of the 30 projects closed in FY00-02, 60 percent were rated moderately satisfactory or above, while 37 percent were rated moderately unsatisfactory or below. Problems identified understandably included lack of counterpart funding and more generally a lack of ownership on the part of Government during the transition period. Lack of supervision from central Government and from the Bank was identified in several situations, as was more generally the break-down of traditional top-down project design and administration. During the past CAS period, therefore, an effort has been made to introduce a new generation of projects, giving much greater emphasis to participatory approaches, being sensitive to the capacities at local and central levels of Government, and introducing mechanisms for local level accountability. Some of the lessons from the past CAS period are summarized in Box 1.

18. Indonesia remained in the Base case throughout the last CAS period, but has now broadly achieved the High case. Triggers for the High case gave emphasis to the continuation of the post-crisis reforms. Table 2 summarizes progress made over the past three years on both


Box 1: Lessons from OED Reviews and the Last CAS

The lessons from the Operations Evaluation Department (OED) review of the Bank’s role leading up to the crisis,* which informed the last CAS, continue to provide a foundation for the Bank’s program:

In the area of structural reforms, the Country Assistance Note recommended:

• Strengthening Bank support to the Government in improving governance by improving fiscal/budget transparency, strengthening oversight and voice mechanisms, enhancing transparency in the incentive framework, and reforming the civil service.

• Concerted effort, including ESW, to help restore banking sector soundness.

• Updating poverty and distribution data and re-thinking long-term intra-sectoral commitments, with the aim of supporting poverty alleviation more directly.

This CAS has integrated these lessons:

• It calls direct attention to Indonesia’s poor governance and corruption and, through the innovation of operational platforms, is mainstreaming support for improving transparency, oversight and voice while continuing to pursue civil service reform.

• Poverty and income distribution data have been updated, and this CAS puts forward an intensive analytical program on poverty. (See Annex D). Community Driven Development efforts, which comprised over 50 percent of new commitments under the last CAS and channeled funds directly to grass-roots development projects selected by villagers, including the poor, are supporting poverty alleviation more directly. This CAS aims to build from this promising foundation.

• Intensive Bank support, including through ESW, will continue to help strengthen the financial sector.

A more recent OED Project Performance Assessment** which draws lessons from the Bank’s crisis-response adjustment and TA loans, has informed the assumptions which define this CAS: In a country with deeply rooted and widespread governance issues, and where authorities are not committed to deep governance reforms, the ability to affect fundamental reforms with adjustment and technical assistance support has been limited:

• Under this CAS the use of adjustment lending will continue to be very limited and only be employed in support of government-driven reform efforts.

• The overall CAS program and the High case triggers have been aligned to the Government’s program to support ownership and effective implementation.

This CAS also learns from other experience and lessons drawn from the last CAS period:

• Close partnerships with donor partners and civil society, such as through the CGI process and Partnership for Governance Reform, enhances our effectiveness, as does current high quality collaboration with the Fund.

• Decentralization is for real and affects everything we do. It poses real opportunities and real challenges which, going forward, we must address centrally in our strategy.

• More systematic monitoring and evaluation of the impacts of our interventions is essential to an innovative program such as ours. This requires priority going forward.

• Strong analytical work continues to be a strength of the Bank and is appreciated by the client and our partners. Increasing its leverage to better inform the design of operational interventions and affect policy change is key.

____________________ * OED Country Assistance Note, February, 1999

** Draft Project Performance Assessment Report (PPAR), July 31, 2003

the triggers and related measures in which the Bank Group provided technical support. By the end of FY03 only one High case trigger—the issuance of a new Procurement decree—remained unmet. This progress, however, must be tempered by the fact that much still remains to be done on the reform agenda, and implementation of policies and laws remains a serious issue.

B. THE SPECIAL PROBLEM OF CORRUPTION

19. More than 5 years after the fall of Soeharto, the salience of the issue of corruption has not diminished. Though it is nearly impossible to compare the actual levels of corruption


Table 2: Government Policy Performance under Last CAS

Action Area GOI Action and Progress To Date (High case trigger conditions highlighted in bold)

Bank and Corporate Restructuring

• IBRA sold $45 billion in distressed banking system debt. • 3 banks were privatized, but around 50% of banking assets remain publicly owned. • Jakarta Initiative Task Force (JITF) met corporate restructuring targets. • Parliament approved amendment to the Anti-Money Laundering Law in Sept. 2003.

Macroeconomic Stability

• Budget deficit down to an expected 1.9% of GDP in 2003. • Rupiah strengthened from over 10,000/US$ in July 2000 to 8,500 in Sept. 2003. • CPI inflation brought down from 12% in 2001 to below 7% in 2003. • Public debt to GDP fell from almost 100% in 1999 to 72% in June 2003.

Pro-Poor Policies • Rice tariff remained below 30 percent ad-valorem equivalent, but non-tariff measures remain and Bulog’s expanding role may jeopardize rice price support

• Land policy management clarified through Presidential Decree 34/2003, but implementation regulations yet to be prepared and adopted.

• Fuel subsidies reduced from over 5% of GDP in 2000 to 1.5% in 2003, but compensating safety net programs were poorly targeted and monitored.

• I-PRSP completed in March 2003. PRSP to be completed by mid-2004.

Competitive Private Sector Development

• Privatization of SOEs, despite commitments announced by the Government, remains controversial—little action taken to date.

• Competition agency (KPPU) established, but enforcement needs strengthening. • Some backtracking on the open trade regime, e.g., sugar restrictions.

Infrastructure Bottlenecks

• Oil and Gas Law passed in 2001, but issuance of implementing regulations is slow. • Electricity Law passed in Sept. 2002, but regulatory body not yet established. • Disputes with 26 out of 27 Independent Power Producers settled. • Tariff increases in electricity and telecommunications, but prices still inadequate to attract

investors.

Legal and Judicial Reforms

• Governance audit of the Supreme Court completed and follow-up ongoing. • Audit of Attorney General’s office completed, but no follow-up action. • Anticorruption Commission (ACC) Law passed in Dec. 2002, but ACC still not functional

Civil Service Reforms • Civil servants smoothly transferred to the regions following decentralization, but no progress made on a comprehensive civil service reform.

Public Procurement and Financial Management

• State Finance Law passed in March 2003, but treasury and audit laws still in draft . • Public Procurement Decree has been drafted and is awaiting presidential approval, and legal

framework still needs revision.

Management of Decentralization Process

• Smooth implementation of law 22 on decentralization, but conflicting implementation rules and sectoral laws need attention.

• Intergovernmental fiscal framework put in place (law 25), but revenue raising remains overly centralized and equity issues linger.

under the New Order and Reformasi regimes—including the impact of decentralization—it is clear that corruption has become less predictable in this more competitive and uncertain environment. Moreover, the unfulfilled expectations that Reformasi would quickly bring a new integrity to public life has generated resentment, fuelling perceptions that corruption has become endemic in the new system. For the Bank Group, corruption has become a triple threat: it undermines progress on the country’s broad development objectives, it remains a serious risk to the effectiveness of our programs, and it continues to weaken public credibility in development assistance overall, which is still too often portrayed within segments of the community as contributing to the problem.


20. A central lesson of the Bank Group’s experience in Indonesia is that our entire success will be judged by the contribution that our programs are seen to make towards greater transparency and accountability, and by the standards of integrity with which we implement these programs. This has consistently been one of the main messages of our enhanced CAS consultations with civil society (see Box 2) and the Indonesia Country Team’s own self-assessment of the Bank’s objectives over the next several years. Since the crisis, the Bank has responded to the triple threat of corruption by scaling back our lending, while seeking to build a capacity to act as a catalyst for anti-corruption reforms, cultivating partnerships to promote good governance, and strengthening the team’s own capacity for mitigating corruption risks to our projects. Much has been achieved in each of these areas, providing a stronger foundation for the Bank to respond to Indonesia’s increased need for development assistance.

Box 2: CAS Consultations Highlight Indonesia’s Development Challenges

As part of the preparation of this CAS, extensive consultations with various civil society representatives, both in Jakarta and in the regions, through focus groups, interviews and feedback sessions, highlighted priority development issues that participants thought the Bank should address. (See Annex E). They closely mirror and validate the key challenges posed above. First , participants saw “KKN” (corruption, collusion and nepotism) as the country’s core problem. As it was put by one participant, “corruption is the real root of poverty in this country”. Many called for particular attention to legal reform as a related development priority. Second, participants stressed the need to alleviate poverty, especially through job creation and economic growth. Third, consultations raised the need to improve essential services—especially in education and health—as a key development priority. With regard to service delivery, concerns were raised about corruption and quality. Fourth, related to both growth and governance, Indonesians felt there was a need to pay more attention to improving agriculture and environmental management.

21. Going forward, the Bank Group will integrate four key anti-corruption principles across its entire program in Indonesia:

• A clear and consistent voice raising corruption concerns and promoting feasible responses across all sectors of our operations. In the past three years the Bank invested considerable efforts in assisting the development of the Partnership for Governance Reform—an Indonesian-led, multi-donor supported effort to raise awareness of and devise solutions to governance problems. The Bank is complementing this work by raising its own voice on corruption through analytical and advisory work. In October 2003 a multi-sector Bank report dissecting “how corruption works” in a wide range of areas was launched, and televised nationally.9 This is being followed up by expenditure reviews and expenditure tracking targeted at key breeding grounds of corruption, more core diagnostic reports, and detailed studies of the effects of participation and transparency on corruption outcomes in community level programs. At the same time, the Bank has supported national- level reforms in procurement and financial management (see Table 2). The Bank will help the Government persevere in fending-off special interests to create a national procurement function and modernize its procurement law. We will also support the Government to implement the agenda that has been codified in the recent State Finance Law (and soon to be passed Treasury and Audit laws).

• Project selection to open multiple entry points in the fight against corruption. Instead of relying on the development of an overarching anti-corruption program or anti-

9 Combating corruption in Indonesia: Enhancing Accountability for Development, World Bank, October 20, 2003 Discussion Draft.


corruption institution, the Bank’s projects described in the pages ahead have been chosen to open up multiple anti-corruption entry points at different levels of government and across different sectors. CDD projects promote participatory planning and monitoring to reduce corruption in village level governments. District level projects will seek to select kabupaten (districts) and kota (municipalities) with a demonstrated commitment to greater accountability and transparency and work with them to improve their financial management and pro-poor planning capacity. Justice sector work will target both enhancing access to justice for the poor as well as providing technical assistance to the new central institutions designed to fight corruption. The Bank will respond in particular to partners with a demonstrated track record of commitment to anti-corruption reforms.

• Mechanisms to mitigate corruption risks for all projects through empowerment, participation and transparency. The lessons of our successful CDD projects in Indonesia demonstrate the impact of smart project design for reducing corruption risks and getting more development impact for less investment. Direct client participation in the selection and implementation of projects engages citizens as monitors with a direct incentive to reveal corruption problems. Public disclosure requirements at key stages of the project make asset diversion more difficult and build public credibility behind the project. Enhanced supervision through project facilitators in the community linked to national networks has been particularly successful in revealing corruption allegations. To ensure smart project designs, all projects are required to devise an Anti-Corruption Plan, assessing risks of corruption inherent in the project and proposing design and supervision mechanisms to mitigate those risks.

• Pre-emptive audits, vigorous investigation and follow-up to allegations of corruption in Bank projects, and public disclosure of the results. Having created better mechanisms to detect and handle corruption allegations in our projects, the Bank is now receiving and investigating considerably more corruption complaints. It is also proactively uncovering the methods and systems that allow corruption to flourish in each sector. Professionals from the Department of Institutional Integrity (INT) will continue to be brought in to investigate corruption allegations, and they will be supplemented by local investigative staff. Where misuse of funds has been confirmed, the Bank will declare mis-procurement, seek return of affected funds, blacklist offending contractors, and encourage the pursuit of appropriate disciplinary and legal action. Where satisfactory progress is not being made in responding to corruption allegations the Bank will discontinue further operations in the relevant sector, region, or government agency. Public disclosure of corruption cases will be made on the Bank’s Indonesia website, within the limits of safeguarding the Bank’s investigative and sanctions process, protecting the identity of individuals, and respecting domestic legal due process.

22. The Country Team has invested unprecedented resources into mainstreaming anti-corruption throughout our program. The Indonesia Country Office is the only mission worldwide with a Senior Governance Adviser to coordinate our anti-corruption dialogue, oversee governance-related operations, advise projects on governance and anti-corruption strategies, and develop a comprehensive research agenda and monitoring framework on governance. A strong field-based Operations Services Unit team has been put in place to lead the movement towards a systematic and effective supervision of fiduciary practices during project implementation. An in-


house Anti-Corruption Committee has been established with representation across the sectors, and from our field-based legal staff, to serve as a focal point for integrating anti-corruption mechanisms into project design, review procurement and corruption allegations, and liaise with our internal investigations unit. Full- time staff members are now being assigned to assist task teams in the design of anti-corruption strategies, and in the investigation of possible corruption within our portfolio. It is important to recognize, of course, that while this strong combination of preventative, investigative and corrective measures is expected to significantly reduce the risk and incidence of corruption, in the near term it may not result in fewer cases of corruption being identified. More important than the number of cases is the extent to which the Bank’s practices ensure greater integrity within our own portfolio and lead to broader improved practices within Indonesia.


THE BANK GROUP’S ASSISTANCE PROGRAM

A. THE WORLD BANK GROUP’S STRATEGIC FOCUS

23. For the coming CAS period the Bank Group will continue to focus its program on those areas most crucial to poverty reduction. At present there are two primary constraints to further reductions in poverty. These are: first, inadequate productive employment opportunities, which result from low investment and a weak investment climate; and second, the lack of quality service delivery to poor people. Progress in these two areas, in turn, is being compromised by the underlying problem of weak governance. The World Bank Group’s strategy will be to address the objectives of strengthening the investment climate and service delivery including, critically, the key issue of governance. Four delivery platforms – corresponding to the community, local, public utility, and national levels (see next section) – will be used to deliver results in these areas (see results matrix in Annex B9).

Figure 3: The CAS Framework

Objective I: Improving the Climate for High Quality Investment

24. A weak investment climate is undermining Indonesia’s future. Indonesia’s economy has been growing over the past three years at a rate of less than 4 percent per year—lower than what is needed to absorb the 2.0-2.5 million new entrants in the labor force every year. Unemployment is rising and wages in the informal sector are stagnant. At root is the lack of investment that at the time of the crisis declined from around 30 percent of GDP to around 20 percent, where it has remained since. While maintaining the gains of macroeconomic stability will continue to be critical through the elections and the next CAS period, deepening the financial sector, fostering a regulatory and institutional environment conducive to private sector growth, building the infrastructure for growth, and ensuring that growth benefits the poor will be fundamental. The Bank Group’s support will thus be focused in five areas, with improved

Investment Climate Service

Delivery

National Platform

Public Utility Platform

Local Services Platform

CDD Platform

GOVERNANCE


governance being an underlying theme throughout. Indicators for monitoring success are provided in Table 3.

Table 3: Improving Investment Climate for Poverty Reduction: Targeted Results

Strategic, Longer Term Country Outcomes

Illustrative Indicators of Indonesia’s Success which This CAS Aims To Impact

Maintain macroeconomic stability • Decrease in tax arrears • Deficit of 1.2% of GDP in 2004, 0.6% in 2005

Stronger and diversified financial sector with more equitable access

• Financial safety net is implemented (deposit insurance, lender of last resort established)

• Indonesia in broad compliance with international standards (such as BCPs, IOSCO, IAIS)

• No. of SMEs and poorer households with increased access to micro-finance

Supportive environment for competitive private sector

• Reduced time for approval of new businesses (from 168 days currently) • Reduced clearance time in customs • Improved corporate governance as verified by ROSC • Improved competition in key industries (e.g. telecom, oil and gas, power) • Investment climate in 40 regions participating in local services platform

projects above the national average

Refurbished infrastructure • Improved tariff structure for gas sector • Improved institutional arrangements for toll roads • Partial privatization of key infrastructure SOEs

Sustainable income creating opportunities for poorer households

• Land rights policies and legislation are reformed • 2.5 million new titles issued in project-assisted areas • 30,000 villages/cities with improved access to roads, bridges, irrigation and

other infrastructure through participatory planning and financing • Increase in productivity yields of agricultural irrigated land & food security in

70 project-assisted districts

25. Maintaining macroeconomic stability. In addition to continuing its ongoing macroeconomic monitoring and advice, the Bank will help strengthen the governance of institutions that are critical to underpin macroeconomic stability and growth. Under preparation, jointly with the IMF, is a project to support reform of the Ministry of Finance, including public financial management and tax and customs administration. Public expenditure reviews are planned for FY05 and FY07, and support for debt management will be provided through an ASEM grant. Advisory services for the wind-down of IBRA will be provided, and establishment of a sound safety net will be supported.

26. Building a stronger financial sector. Bank Group activities in the financial sector will gradually move from past emphasis on crisis response and management towards a medium-term focus on overall financial sector development and reform—including non-bank financial institutions, capital markets, rural and micro-finance, and improving access of the poor to financial services.

• Strengthening the banking sector. Advisory services for wind-down of IBRA and post-IBRA institutions, reform of state-owned banks, improvements to regulation and supervision, and establishment of a safety net will be supported. Technical assistance to


enhance financial sector skills will be provided. Ongoing financial sector monitoring will form part of the AAA agenda.

• Creating a diversified financial sector. The Bank will support non-bank financial institutions—including capital markets, insurance, and pensions—and their regulation and supervision through technical assistance, advisory services, and AAA. A lending project to support capital market infrastructure in FY05 is under discussion. A comprehensive strategy for reform of non-bank financial institutions and a diagnosis of the pension system will form part of the AAA agenda.

• Improving access of the poor to financial services. Micro-finance delivery is currently supported through the ongoing CDD and rural area development projects. A micro-finance project as well as analytical work will support increased linkages of these institutions with the formal financial sector and work with commercial banks to increase their outreach in rural areas.

• Anti-money laundering. The Bank will coordinate with other donors and provide advisory services and AAA to support Indonesia in implementing its recently revised anti-money laundering legislation.

• Joint IFC-Bank activities. IFC and the Bank will work together to assist in the development of financial market infrastructure such as credit bureaus, and key market segments such as housing finance and securitization.

27. Fostering a competitive private sector. Integrating private sector involvement into Bank projects as well as activities aimed at developing the private sector in a decentralized environment will be areas of key focus. Bank Group support will include:

• Building the institutions for a competitive economy. A policy-based loan programmed for FY05 linked to significant progress in the Government’s Economic Policy Package will support improvements in the regulatory environment that will enhance private sector competition. Support will also be aligned to improve competition in key industries, including support for the regulatory bodies in electricity, telecommunications, oil and gas. Ongoing power projects, as well as a new domestic gas project will promote unbundling and enhanced competition in the power sectors. The Bank will also seek greater clarity and predictability in the enforcement of environmental regulations, through support to the Government’s Good Environmental Governance (GEG) Program.

• Monitoring the investment climate and promoting dialogue. A program of national, local and rural business climate surveys is currently being set up, and will be supported by diagnostic work on private sector constraints, including a Diagnostic Trade Integration Study and a Domestic Trade Study. The national- level Private Sector Forum will continue to be organized by the IFC in the context of the Consultative Group meetings to enhance the dialogue between the Government and the private sector. Current topics include, for example, private investment in the power sector, mining, banking, the role of the commercial courts and corporate governance. At the local level,


the Bank will support improving the business climate through dialogue between private sector, including small-scale entrepreneurs, and the local government.

• Strengthening corporate governance and key oversight institutions. Corporate sector monitoring will form part of the AAA agenda. Assistance will continue to be provided to institutions such as the Competition Agency, the Corporate Directors’ Institute, and auditing and accounting bodies, and a review of corporate governance is being completed.

• Support for SME development. The IFC’s new Program for Eastern Indonesia SME Assistance (PENSA) will be the Bank Group’s main vehicle capacity building for SMEs (see Box 3). It will be supported by business climate programs through the Bank’s decentralized governance programs (see section B).

Box 3. The Program for Eastern Indonesia SME Assistance (PENSA)

Small and Medium Enterprises (SMEs) account for the vast majority of employment in Indonesia, yet they operate in an uncertain and often unhelpful environment. There are 17 million legally registered enterprises in Indonesia, almost all of which have less than 20 employees each. Those able to produce for a niche market, adapting quality and cost to market demand, have high growth potential, as evident in the rapid growth of exports of SMEs. The growth opportunities for Indonesian SMEs are a critical component to Indonesia's economy, investment climate and political stability. For these reasons, the IFC has initiated PENSA, a five year program funded at approximately US$20 million by Australia, Canada, Japan, the Netherlands and IFC. With offices in Denpasar, Balikpapan, Makassar, Surabaya and Jakarta it aims to stimulate the growth of small scale enterprises in the region. It will pay special attention to promoting sustainable, value-added upstream and downstream product and market relationships between SMEs and larger core businesses, access to finance to SMEs and improving the investment climate. PENSA’s five offices concentrate on different aspects of SME development (e.g. extractive industries, handicraft and furniture manufacturing, agribusiness processing, finance, and policy reform and deregulation). Key to PENSA’s approach is building the capacity of local consultants and institutions.

28. Building Indonesia’s infrastructure. The lack of investment in infrastructure over the past five years is a major threat to Indonesia’s economic prospects. Competitiveness is being undermined due to congestion costs; the prospect of power shortages hangs over Java. Over 40 percent of households, mostly rural, still do not have power connections. Only 15 percent of households have access to piped drinking water, let alone to public sewage systems (1.3 percent of the urban population, the lowest in coverage in Asia). The Bank Group is heavily committed to help confront these challenges, through analytical and advisory services and financing.

• Supporting a strategic framework for infrastructure. A major infrastructure strategy, prepared by the Bank in consultation with the Government, will be completed by end-2003, and will guide the Bank’s national- level policy dialogue and future engagement. A key feature of our support will be the development of sound implementing regulations for newly passed laws, and clarity of delineation of agency roles at national and regional levels. Implementation of the on-going Private Participation in Infrastructure TA loan will leverage private investment in the infrastructure sector.

• Providing power for growth. Working closely with the Asian Development Bank and others, the Bank’s focus in energy will be on completing the implementation of the legal and policy framework to help attract private investors and to complete the restructuring of the electricity and gas entities. A Bank project is supporting the restructuring of the state electricity utility (PLN) and the implementation of an appropriately sustainable tariff framework. Supported by a FY05 Domestic Gas Restructuring Project, the


restructuring of the state gas utility (PGN) would be completed and the pricing of natural gas would be rationalized and implemented. The access to electricity outside Java – Bali would be increased through a proposed Rural Electrification project that is under discussion for FY06.

• Building national transportation and communications infrastructure. In addition to several projects that support information technology systems, the Bank has several projects in the current portfolio that support the development of road infrastructure. The Bank will provide further support through the proposed Strategic Roads Infrastructure Project which will support capacity expansion in heavily trafficked corridors, principally in Java. Continued technical support for improvements in the institutional context for toll road development would be provided.

• Building sub-national infrastructure within a decentralized framework. The proposed Second Eastern Indonesia Transport Project will finance improvements in roads and other transport facilities that will support and promote growth in less developed regions. The East Java Regional Development and Reform Project will build capacity for decentralized management of sub-national infrastructure and finance targeted investment in provincial and multi- jurisdictional infrastructure. The Urban Sector Reform and Development Program (1 & 2) will support local government level infrastructure development.

• Improving the quality and coverage of water and sanitation. Indonesia’s 300 semi-autonomous water utilities (PDAMs) were already struggling in 1997, when they were devastated by the financial crisis. As a result, coverage rates for water supply have been dropping throughout Indonesia in both urban and rural areas during the past six years, making the achievement of the MDG in this area unlikely. Bank support, through two projects, will be provided by working with progressive PDAMs selected through a competitive process. Support for rural water supply will build on advances made by government in community based water supply and sanitation for rural areas. Approximately 2000 villages will benefit from these programs (WSSLIC 2 & 3).

32. Creating income opportunities for poorer households and farmers. In addition to the constraints posed by inadequate local infrastructure, poorer households also suffer from uncertain property rights, pressure to move to marginalized land and to resort to unsustainable resource management practices (whether it be forests or coasts). They have limited access to capital and limited access to the justice system. As many of these issues hold back rural and urban poor alike, a number of Bank programs are active in both settings. The Land Management Program (FY05) will critically focus on developing a national land policy, improving land tenure security, improving local government capacity in land management functions, and enhancing the efficiency, transparency and service delivery of land titling and registration. CDD programs seek to enhance incomes of both villagers and slum dwellers through participation in decision making and access to resources for poor men and women. The Bank’s poverty AAA agenda will have a particular focus in identifying the constraints to growth in investment and incomes for poorer households as well as reducing risks to these households. For example, analysis is being undertaken on the scope for foreign earnings to improve the welfare of female migrant workers, while support is also being provided to government for services to protect these women from the


risks and abuse they face. Likewise, the Bank will improve access to sustainable micro-finance through its new micro-finance project and components of proposed annual CDD projects. At the same time, the program is addressing the particular challenges faced by the 65 percent of Indonesia’s poor who rely, at least in part, on agriculture for their livelihood with activities focused on raising on-farm and off- farm incomes (see Box 4).

Box 4: Support for Poor Rural Households and Farmers

Getting agriculture moving will be critical to alleviating rural poverty in Indonesia, which despite recent improvements, remains at four times the level of urban poverty. At the same time, the continued structural shift in rural households’ incomes out of agriculture and into non-farm activities, will remain important in the overall poverty reduction strategy. Accordingly, this CAS significantly increases Bank support for agriculture and rural development, as compared to the past five years since the crisis. However, the earlier foundation for growth of the agriculture sector has weakened, and new directions are needed for revitalizing sector expansion. Growth was built on rice and on private plantation investment off-Java through the 1990s. In the future, gains in agricultural productivity will come from high value commodities (smallholder estate crops, horticulture, livestock, fisheries). Currently, these comprise around 55 percent of agricultural production, but will likely account for 80 percent of the growth in output. Rice is still important (26 percent of agricultural production), but will unlikely account for much of the incremental output. Accordingly, the CAS is focused on supporting sector growth in these new directions– it aims to enhance agricultural productivity, increase the role of producer organizations in marketing and commodity value chains, strengthen agriculture’s links to the rural economy, and focus on the Government’s role in supporting the transition.

Benefits of on-going projects will be realized during the coming CAS period, and in cases these are expected to be scaled up through follow-on projects. An on-going Decentralization of Agricultural and Forestry Extension Services Project, which pilots empowering small shareholders to drive the agricultural services agenda in 16 districts, will be scaled up in the proposed FEATI project, which will also tighten links to revitalized public agricultural research and commercial/agribusiness sector. IFC’s PENSA program will compliment these efforts by fostering links between farming communities and agro-processing. The CDD platform will beef-up its focus on the needs of smallholders and engage with and support emerging farmer organizations. The enabling environment to support increased diversification in the rural economy, will by supported by accelerated land titling (Land Management Project); better rural infrastructure—both in the water/irrigation sector (WISMP 1 and 2) and for rural access/roads (through CDD and ILGRP); and strengthen Government capacity (particularly at the decentralized level) to better deliver essential services, and rein in the explosion of local taxes and fees that burden small farmers and impede domestic commodity markets (ILGRP). In the coastal areas, the Bank will continue to support a national effort to engage communities in collaborative management of coral reef ecosystems (COREMAP 2), and support targeted poverty alleviation in poor coastal fishing communities, through the proposed Marginal Fishing Communities Project. Finally, the Catchment Protection Project would integrate community forestry with possible mobilization of carbon finance.

Recent and planned analytical and policy work will continue to underpin these directions in project design and investment focus. Recent outputs addressed: (i) decentralization of land administration as well as the broader framework of land policy; (ii) rural producer organizations and their emerging capacity and roles; (iii) micro/rural finance policy. Planned work on District level governance, on the rural investment climate survey, commodity value chains, and sources of rural incomes, will contribute to pipeline projects and policy dialogue.

Objective II: Making Service Delivery Responsive to the Needs of the Poor

33. Provision of essential services must improve if Indonesia is to reach its Millennium Development Goals. The obstacles to better outcomes across a range of services have many common elements. High on the list is the legacy of Indonesia’s centralized development planning and service delivery systems, which improved overall access to basic services but fell short in ensuring quality and relevance and in reaching the most vulnerable. Decentralization and community empowerment offer important new opportunities for service improvement, although in the near-term they may create extra costs. The Bank Group is willing to step up its support to improve service delivery within the new context. Central to success will be to establish mechanisms for improved accountability on the part of service providers, whether schools, agricultural research, or water companies – to the citizens they serve. Box 5 describes how these principles, which are described in the WDR 2004 (Making Services Work for the Poor), will be put into practice in our work. Education and health are described in the paragraphs below, but the same principles apply to agricultural extension, irrigation services, village level infrastructure


and many other services equally, and will be addressed in the same manner under Bank programs. Indicators to be monitored are summarized in Table 4.

Box 5: Improving Service Delivery Through Greater Accountability

The Bank Group’s program to improve service delivery draws from the WDR 2004 framework. Central here is to make the service providers – schools, clinics, extension services, public works departments, license agencies etc – accountable to those who are supposed to benefit from these services. The chart below shows three “routes of accountability”:

• The “long” route, whereby citizens give feedback (very indirectly) through central government.

• The “medium” route, whereby under Indonesia’s decentralization, local governments have the responsibility for many services, and are thus the channel for citizens’ voice on service quality.

• The “short” route, whereby users give direct feedback (and decision-making) to the provider.

In its support for improved services the Bank will be seeking to strengthen each of these routes of accountability to improve service delivery – and each project proposal will be assessed in the light of this framework. Particularly important will be a systematic emphasis on the “short route”, the bottom arrow below -- making providers more directly accountable to clients and citizens, and supporting community organizations that can articulate their needs and hold providers to deliver. Interventions will foster the responsiveness of providers to clients – whether they be parent-teacher associations, water-user associations, or farmers associations. Most directly, villagers will be involved in direct decision-making in how public funds are spent in all CDD projects.

Accountability links through local government will also be given a much greater emphasis than under earlier central government managed projects. This is the essence of the Local Government Platform, discussed in the next section. Our efforts will focus on governance reforms that, for example, enhance participatory processes in planning, transparent budgets, and citizen monitoring through the development of watch-dog citizen forums, media training etc. Our projects will also support benchmarking and performance ratings of local governments and providers to this end. The AAA agenda will strengthen the accountability to clients of government and providers alike, through monitoring surveys such as public expenditure tracking surveys and facility level surveys.

The central government also has a crucial role to play – and we will continue to provide support to enhance the policy framework for service delivery. For example, opening up service delivery to include competition will be important to enhanced service responsiveness. The Bank will provide support to build a financial flow database to foster transparency and accountability between the center and local governments.

Short Route

Long Route

Medium Route

Providers

Central Government

PATHS OF ACCOUNTABILITY

Local Government

Citizens / Clients


Table 4: Making Services Work for the Poor: Targeted Results


Illustrative Indicators of Indonesia’s Success which this CAS Aims To Impact

Accelerate attainment of key MDGs in education and health

• In Bank-assisted provinces, improved quality coverage and utilization of basic health and education services, especially for the poorest 40%

Better education outcomes for the poor

• Increase in enrollment rates at the jr. secondary school level • Increase in completion rates at the primary & jr. secondary school levels • Improvements in test scores, using international standards

Improved health outcomes for the poor

• Increased percentage of deliveries assisted by trained health workers • Increased percentage of childhood immunizations • Improved nutritional status, especially for children under 5 • Increased percentage of households with access to safe drinking water and sanitation

in 2000 villages and 20 urban areas.

Better Education for All

34. Until the economic crisis Indonesia made great strides in increasing primary school enrollment rates through massive investment programs, but has since lost ground. The challenges now are: to address the special needs of the remaining 10 percent of poor and vulnerable school-aged children who are not yet in school or drop out early, to ensure that those who start school complete at least the primary cycle, and to increase the number of students who make the transition from primary to secondary levels. Moreover, quality at all levels needs to be improved—Indonesia ranks third from the bottom of countries who participated in the latest international mathematics and sciences standardized tests (TIMMS). Specific constraints include weak accountability of education providers to parents and communities, under-funding of non-salary recurrent expenditures, the weak skills of teachers and administrators, and the perverse incentives guiding their work. Indonesia’s recent decision to move dramatically and decisively from heavy central control of service provision to one where districts take the lead role has presented both an opportunity and a challenge.

35. The Bank is shifting its focus from support to generalized access to primary education to address quality and completion issues in basic education. The seven projects currently in the portfolio, both in primary and secondary education, have been restructured to change the way services are managed and delivered top-to-bottom: roles for central, provincial and local governments are being clarified; budgeting, financing, planning and management procedures are being made more transparent and accountable while communities are being given a larger role; and new policies on teacher management and performance are being rolled out. In order to investigate the implications for the whole system in the new decentralized environment, the Government asked the Bank and other donors undertook an Education Sector Review which is now being reviewed by Government and is expected to guide its strategy and, in turn, that of the Bank and other donors going forward. A FY06 project will focus on improving the management and effectiveness of the educational system in a decentralized context, including support to enhance capacity both at the district level which is the new focal point of provision, as well as at the central/provincial levels. The latter have to change their roles from that of direct provider to facilitator, regulator and steward of functions such as assessment, quality monitoring, and curriculum development. Providing suitable educational opportunities for marginalized youth, including drop-outs, is a pressing social and economic issue—and of particular relevance


to poorer households—that will be addressed in a Community Based Education for Marginal Youth project. In addition, the Bank is helping the Government develop approaches to jump-start education where conflict has disrupted services and will continue to expand CDD in ways that will improve the voice of parents and community leaders in education provision.

Improving Health Outcomes

36. Poor delivery of health, nutrition, clean water and sanitation services contributes to poor health indicators, which represent an important part of multi-dimensional poverty in Indonesia. Indonesia’s high maternal mortality ratio (about 370 deaths per 100,000 live births) is nine times, and its under-five mortality rate five times, that of Malaysia. The proportion of children being immunized today is lower than in 1990, and about one-quarter of all children under five are underweight. A critical issue is under-funding: total health spending in 2002 was equivalent to 2.7 percent of GDP, half of what WHO recommends as a minimum requirement, and much of it from private sources. But health is also vexed by other institutional and management issues impeding better service delivery that are similar to those holding back education. In a random spot-check, the absenteeism rate of public health workers at primary care facilities was found to be as high as 42 percent. Like with education, these issues will have to be addressed in a decentralized environment. Moreover, in health, the private sector is playing an increasingly important role in service delivery, even for the poor.

37. The Bank’s support will be targeted to help build capacity within the new decentralized system, particularly in areas where Indonesia is lagging (such as maternal health, child health, and nutrition). The Bank got an early start in helping the Ministry of Health clarify the roles of the center, province and local government through a series of Provincial Health Projects (PHPs). On-going and planned projects in the health sector are aimed at raising the capacity of district health administrations and making service planning and delivery procedures more participatory and accountable. This is done by better tracking of fund-use, developing better frameworks for both public and private service provision and helping districts to match health goals with adequate funding. The Bank will help elevate the policy dialogue and awareness on HIV/AIDS, addressing analytical and funding gaps as required to do so. In addition, it is providing technical inputs to the Government’s new long-term nutrition strategy which will also feed into the design of the next (fourth) PHP. The Bank also recognizes the need for efforts beyond the health sector to attain health outcomes. Among these, the Bank’s community driven development and local level project platforms provide potential frameworks for multi-sectoral approaches to achieving improved health outcomes for the poor. For example, WSSLIC 2, a water and sanitation project, includes health awareness campaigns. Similarly the local services platform (see section B) will include support for the government’s Good Environment Governance program—contributing to better health through a cleaner environment. The Bank will also help the Government expand the successful PROPER program—which uses public disclosure of industry performance to promote behavior change with regard to water pollution—to other geographic areas and other media. (Annex F delineates the state of Indonesia’s environment and the cross-cutting measures this CAS employs to mainstream support for environmental protection.)


The Core Issue of Governance—Defining Selectivity

38. Selectivity in the Bank’s activities and the volume of Base case lending will be determined by opportunities to help improve governance. Investment needs in today’s Indonesia are vast, and the choice of where to allocate Bank activities - and how much -will be made on where there is scope for achieving, demonstrating and multiplying governance improvements. Rather than proposing a set of stand-alone governance and anti-corruption projects, these issues will be central to all aspects of the program. The entire lending and AAA program has been designed to foster transparency and accountability through two complementary approaches: (i) by enhancing the demand for good governance through greater public participation in policy-making and policy-monitoring processes across different levels of government, and (ii) by strengthening the institutions that are accountable for implementing the impressive body of laws to improve governance already passed during the Reformasi period. In the cases where there is willingness to reform, the Bank is coming in with support. Where commitment is still lacking, the Bank will wait on lending–thus the large Base case lending range (see para. 59). The goal of the program is to help Indonesia address what might be described as an increasing “accountability gap,” i.e. the perception that the tremendous gains in transparency and democratic competition since the fall of the New Order have not been matched by genuine government accountability for demonstrable results in restoring integrity to the public sector and reducing corruption. This is a very ambitious goal that will only be implemented over the long term, but the Bank’s program is designed to expand only in areas where support can be provided for demonstrated momentum in reforms towards this goal. Indicators to be monitored are summarized in Table 5.

Table 5: Governance: Targeted Results


Illustrative Indicators of Indonesia’s Success which this CAS Aims To Impact

Development planning made more responsive to constituents

• Core group of 40 regions participating in local services platform records significant improvements in governance outcomes

• One third of all villages in Indonesia engage in a participatory approach to development planning, execution, and oversight

Well-regulated and transparent system of public financial management at all government levels

• Improved performance of tax and customs collection (e.g., increased revenue to GDP, increase in registered tax payers, reduced tax arrears, and reduced clearance time in customs)

• Reduced leakage in expenditure flows to end-users

More effective implementation of decentralization

• Clarification of functions for each level of government through implementing regulations for Laws 22 and 25

• Increased transparency of finances, laws, and regulations at the district level through establishment of an accessible regional financial information system and a mechanism for cataloguing, reviewing, and publishing PERDAS

Establishment of a credible and impartial justice sector

• Significant improvement in corruption perception measures, and improved public satisfaction with the judiciary in project-assisted areas as measured by public opinion surveys

• Full compliance with wealth declarations by public officials as established by law • Doubling of the share of cases investigated as a result of irregularities revealed in

BPK audits • Increased percentage of poorer households and SMEs using legal, paralegal and

alternative dispute mechanisms in at least 40 districts


39. Creating demand for good governance at the local level. At the local level, the Bank’s expanding CDD work, which is planned to reach more than 30,000 villages and urban communities across the country by the end of the CAS period, is built around the principle of letting communities decide the best use of development funds and giving them the power and skills to monitor their investments. Supporting AAA work and extensive monitoring efforts for such programs as KDP and the Urban Poverty Projects are designed to ensure that the lessons of this participatory approach to investments “spill over” into the broader decision-making processes at the community level. In the coming CAS period, the Bank will take this demand-side approach up to the next level of the system, through extensive interactions at the district and provincial levels. By encouraging public participation in the process of choice and implementation, Bank projects are designed to foster genuine community ownership of programs and, hence, stronger incentives for citizens to hold their district and provincial governments accountable for honest and effective implementation of those programs. Similar participatory mechanisms are integrated into many of the Bank’s sectoral operations, such as WSSLIC, WISMP, COREMAP, Catchment Protection, FEATI, and PHP, where the users of the relevant services are extensively engaged in both decision-making and monitoring of investment programs.

40. Supporting the momentum for reform at the national level. The Bank will continue to contribute to the development of the Partnership for Governance Reform, a unique collaboration among civil society, government, and multiple donors to promote a high profile “center of excellence” on good governance through research, experimentation, capacity-building and advocacy. Beyond the Partnership, the Bank will seek opportunities to collaborate with a new range of organizations within civil society that have generally been overlooked in previous years—the large professional and mass-based associations with the membership and influence to build momentum for governance reforms. The national Islamic associations Nahdlatul Ulama and Muhammadiyah—with nearly 60 million members between them—have shown a strong interest in using their extensive grass-roots networks, educational establishments, and national authority to promote governance reform. Business and trade associations, trade unions, and chambers of commerce are also promising partners to help advance the governance agenda and enhance accountability through monitoring policy outcomes, especially in the area of the investment climate. All these efforts will require the Bank to take a higher profile in the policy dialogue on governance, which is planned through the addition of focused policy notes, a quarterly publication for monitoring development, and communications outreach to enhance the Bank’s traditional range of longer term, in-depth research and diagnostic products.

41. Developing the institutions of good governance: financial management and the civil service. A high priority will continue to be given to improving financial management systems, both at the national level (through ongoing TA and a FY05 project to support Ministry of Finance reform) and through virtually all of our operations at the local level. Recent developments in internet technologies will be taken into account. Civil service reform is less advanced and likely to be delayed further during the upcoming election period. However, the Bank will seek to strengthen our operational engagement on this issue through support for a comprehensive restructuring of the faculty and curriculum of one of the main training institutes for the civil service–STPDN. This capacity-building project, which is currently under discussion, is intended as an entry-point for strengthening the Bank’s work in civil service reform after the


2004 elections. The Bank will also emphasize support for local level experiments in implementing civil service reform.

42. Developing the institutions of good governance: the legal system. The Government’s Economic Policy Package lays out a concrete timeframe for a number of long-delayed institutional reforms in the justice sector, including the establishment of the Anti-Corruption Commission and the Judicial Commission, and revision of the law on the Attorney General’s Office. The Bank will incorporate these benchmarks into its lending triggers and will offer technical assistance and support to these institutions. More broadly, the Supreme Court has launched the results of a comprehensive blueprint to reform all aspects of the management of the court system, including judicial education, personnel and financial management of courts, functioning of the Judicial Commission and creation of an Anti-Corruption Court. The ambitious blueprint was developed through an unusual collaboration between a civil society organization–the Indonesian Institute for an Independent Judiciary–and the leadership of the Supreme Court. It will serve as an important mechanism for coordinating potential donor assistance in the justice sector. At the same time, the Bank will push forward with a new initiative to enhance access to the justice system for communities and the poor. Drawing lessons from a wide-ranging study of corruption cases in the Bank’s CDD projects, this Justice for the Poor program will seek to integrate into the CDD portfolio initiatives to strengthen alternative dispute resolution mechanisms, develop a network of community paralegals and legal assistance, lower the geographical and financial barriers to court access, and promote legal literacy.

43. Measuring and tracking results. A fundamental component of improving accountability is enhancing the capacity to measure results. The Bank has pioneered efforts to measure governance, and Indonesia will continue to be an important country for implementing and expanding monitoring techniques. The Governance and Decentralization Survey (GDS) first implemented in 2001 will be repeated to compare governance outcomes at both the national level and in individual districts with a concentration of Bank projects. An investment climate survey is currently in the field and will provide comparative data both within Indonesia and across East Asia on the governance problems faced by firms. A comprehensive program for monitoring corruption in our community development program is currently being implemented. Indonesia will also become a focus for developing a broader system for public expenditure tracking at the local level to enhance accountability over public resources. The broad participation of representatives of civil society in these monitoring efforts will be essential to their effectiveness and sustainability. The AAA program will include a major effort to bring all of these monitoring efforts at the local level together in a high profile, easily accessible format that will allow different users to track governance outcomes, including impact on services for the poor, across Indonesia’s diverse regions.

B. BUSINESS PLATFORMS—HOW THE WORLD BANK WILL DELIVER

44. Two factors—Indonesia’s decentralization, and our commitment to improved transparency and effectiveness in the use of Bank funds—call for new delivery mechanisms. The top-down provision of public services of the New Order regime is no longer an option for Indonesia or the Bank. Decentralization of responsibility to local levels forces a new way of doing business, posing significant challenges but offering great opportunities for more transparent and responsive service delivery and channels to improve investment climate.


The key will be to find, for each level of government, mechanisms that will ensure transparency of resource use and accountability of policy makers and service providers to users (inc luding businesses large and small) and to build capacity for their use.

45. The goal is to use World Bank supported projects, leveraged by AAA, partnerships and capacity building activities, to systematically increase standards of governance at each level of government at which we work so that we have an impact on poverty reduction. This will be done through agreeing upon standards—covering information disclosure, participation, financial management, procurement, and expenditure planning, etc.—and allowing local governments to request participation in the project. This approach has already proved highly successful at the community level, and is now particularly important at the district level, where most local government spending authority now lies.10 Underpinning this approach to our poverty reduction focus are two factors: the fact that there are the highest numbers of poor in the most densely populated areas of the country (within district inequalities are greater than across district inequalities; see Annex D); and the fact that solving problems often requires governance reforms at several levels of government, as illustrated in Box 6 for Forestry. It will take some years before the majority of the over 400 districts are able to raise their governance standards adequately, but the Bank believes that early investment and capacity building in those districts showing genuine willingness to change, will help to create a groundswell of reform. For those districts not included in this “early reformers” category the Bank would continue to provide support through the CDD programs and carefully supervised sectoral programs. The CDD approach will be the instrument by which we can provide support while further enhancing governance at the community level in poorer districts that are not well governed, including such districts that may be in lagging regions of the country. Four broad “platforms” are envisaged for the coming CAS period.

The Community Driven Development Platform: Scaling Up a Successful Program

46. The past three years have seen a major advance in the design and successful implementation of CDD programs in rural (KDP) and urban (UPP) areas. The third KDP loan/credit for $250 million was approved by the Board in June, and the Government has asked us to scale up the UPP program to a nationwide program in the current year (UPP3). These programs are effectively directing resources to small-scale investments, identified by poor communities, to improve their own livelihoods. Although the first funds under these projects were committed as recently as 1998, when Indonesia was still reeling from the economic crisis, the outputs and outcomes to date are already impressive.11 Field surveys and external independent evaluations done in connection with one of the programs, KDP, have all pointed to: greater community participation in the planning, decision-making and use of development funds, especially for women and poorer villagers; high economic rates of return for small-scale infrastructure; improved access to quality infrastructure and to neighboring villages, local markets, schools and other public facilities across every income spectrum for villagers; opening

10 The Bank will continue to work with Sectoral Ministries to build and support capacity and systems for appropriate management functions at each level of government, including the province. However, since the bulk of development funds will increasingly be administered by district governments, it is at that level that the Bank will help the Government make the big push for governance and financial management improvements. 11 Generally, outcome results can be expected within 5-7 years and long-term impact is only clear after 7-10 years.


Box 6: The Challenge of Forest Resources Management in Indonesia

Some 75 percent of Indonesia’s poor live in rural areas and probably half of these are affected by what happens inside state forest lands, which make up 60 percent of the country’s land area. However, Indonesia faces a challenge of staggering proportions over the coming years in managing its forest resources, and will need to deal with issues such as legal and illegal over-exploitation and clearing of natural forests; regularization of misclassified land uses and forest state boundaries; heavy subsidies, overcapacity and indebtedness for the wood-processing sector; institutional reform in response to the increasing emphasis placed on decentralization and good governance.

Over the coming years, the Bank will draw upon its delivery “platforms” to support efforts to improve governance in the forestry sector by:

• Extending decentralized natural resources governance to include participation of local communities in decision making for forest land resources upon which their livelihoods depend.

• Developing community-driven development (CDD) opportunities for direct and sustainable co-management of forestry resources in public lands by village communities, ranging from licensed management to natural resources stewardship.

• Strengthening analytical capacity for reform of sectoral and related policies and institutions coupled with effective outreach of the resulting knowledge.

• Supporting specific high profile initiatives as catalysts for reform towards good forest governance (e.g. Forest Law Enforcement and Governance) and transparency instruments such as the publication of annual forest cover changes

• Mainstreaming forest resource management lessons into Bank and other initiatives in some cases helping to bridge artificial divides that are often beset inter-institutional relationships that are key to sustainable forest land (and resources) management.

up of businesses and transport services due to new roads—19,000 kilometers—bridges, and piers; increase in agricultural production due to irrigation projects—now over 2,000; time savings in travel particularly with roads and new bridge construction, as well as due to ease of access to new water supply systems. These programs are now active in about 40 percent of communities (rural villages and urban wards) in the country. Transparency, inclusive participatory approaches and accountability are their hallmarks. These programs appear to be enhancing competition in local service delivery, helping break the information monopoly at the local level, and strengthening local level reform constituencies. A key result has been the enhanced participation and empowerment of women in decision-making, as well as in project implementation and supervision. An important part of the success of these programs has been strong M&E and feedback mechanisms which allow lessons to be taken up while programs are being implemented and in follow-on operations. For example, poor repayment of revolving funds in KDP led to a complete re-think and narrowing of that component under KDP 2 and 3.

Table 6: Indonesia CAS FY04--FY07: Expected Lending (US$ million)

CDD Local Services Utilities National Total

FY04 255 270 0 0 525

FY05 45 175 50 530* 800*

FY06 200 465 100 85 850

FY07 240 310 300 0 850

Total FY04-07 740 1220 450 615 3025

Share to Total FY04-07 25% 40% 15% 20% 100%

Note: Table shows base case, reflecting expected delivery of investment projects.

*This includes the $200 million adjustment loan as a “national” project in FY05. Eligibility for this loan would depend on achievement of the “enhanced” Base case as discussed in paragraph 62.


47. In the coming CAS period the Bank plans to invest around $200 million per year in this promising program. A deepening of the program in the coming three years is expected to see (i) stronger links with the private sector; (ii) establishment of a stronger legal basis for the model, to ensure sustainability; (iii) the use of this approach to address needs of specific communities—such as in conflict affected areas, forests and coastal communities; and (iv) even greater emphasis on M&E systems. Moreover, the Government is most interested in large-scale programs which work to reduce poverty. Emphasis will also be given to building accountability links “upward” to the district level.

The Local Services Platform: Creating Accountability at the District and Provincial Level

48. As a result of the decentralization of 2001, the main development challenges defined in this CAS have become, to a large extent, challenges at the district level. Decentralization has passed the bulk of authority, responsibility, and public funding for services to district governments. Advancing reforms in these areas, as well as building momentum for improving governance, will require substantial engagement with district, and in some cases provincial governments. But with over 400 districts and tremendous variation as to their capacity, their commitment to reform and their governance environment, the Bank requires a strategic framework for assistance at this level. Over the past two years the Bank has invested heavily—through district-focused sectoral projects, as well as through AAA and Trust Funded TA—in analyzing capacity and constraints, and in piloting appropriate mechanisms for service planning and financing, as well as, higher standards of client responsiveness and transparency at the district (and provincial) level. In the coming CAS period, we expect to build upon this knowledge base as more development assistance is channeled directly to the district level, through continued sectoral projects but increasingly through a broader local services platform.

49. The local services platform is built around four key principles:

• Define selection criteria to determine levels of Bank engagement with districts based on clear standards of governance reform. In this CAS period, the Bank will launch two local governance projects (for rural and urban localities, respectively) that are designed to eventually set the framework for our local level assistance. These projects—ILGRP and USDRP—are structured to select districts with a demonstrated commitment to an agenda of governance reforms and then to assist those districts in reaching governance standards along with investments in their own development and poverty alleviation objectives. Districts will compete to gain entry into these projects through their own programs of governance reform. These programs will cover information transparency, participation, financial management, procurement, including pilots in using electronic systems, and pro-poor public expenditure management. Exit criteria will also be established to encourage sustainable reform efforts. The projects will eventually serve as the Bank’s main mechanism for selecting districts for potential long-term relationships.

• Maximize complementarities across Bank projects in selected districts to promote a critical mass of reforms. Though the Bank currently has projects across a very wide range of districts, the goal of the district services platform is to eventually bundle diverse


Bank assistance instruments in selected districts on the basis of their adherence to good governance standards. Where feasible, sectoral programs in health, education, roads, land management and the like could be channeled to reform-minded districts to take advantage of the proven benefits of good governance for aid effectiveness. Such a critical mass approach to reforms would take advantage of the synergies across different Bank instruments, and facilitate innovative supervision approaches. Over time only districts willing to embark upon more systematic reform programs would be eligible for Bank funds for sectoral programs (although access to CDD funding would continue). Access to Bank funds would thus be self-selecting and competitive.

• Integrate capacity building into project designs. The success of Indonesia’s ambitious decentralization will depend fundamentally on the ability to build capacity among the 2.5 million civil servants who were transferred to local governments in 2001, and among the new local legislatures (DPRDs) now charged with determining spending priorities, managing service provision and establishing the legal and regulatory framework within their jurisdictions. Capacity building efforts need to go beyond local administrations to encompass DPRDs, media and civil society groups to enhance accountability at the local level, including special initiatives to increase the active participation of women. Experience has shown that stand-alone capacity-building projects have had limited success in Indonesia. Instead, Bank teams will advise Government on approaches for better integrating capacity-building efforts into project designs in close collaboration with WBI and the bilateral donors that have been active in these areas. A current example is WSSLIC 2, which has a $6.5 million capacity building technical assistance grant component funded by AusAID.

• Encourage cross-district sharing of best practices, with the aim of replication. To encourage districts to learn from each other, as well as to foster competition in reaching good governance standards, it is necessary to identify key measures of performance and to disseminate those measures widely. A cluster of AAA tasks will monitor and disseminate experiences at the local level, using extensive survey work, structured case studies, scorecards for service quality and user satisfaction, and easy-to-use tools to access information across districts. The role of the province level will be defined and strengthened, particularly in the planning and monitoring of networked services such as health and roads.

The Public Utility Platform: Demanding Good Corporate Governance and Efficiency

50. Analogous to the approach at the district level, Bank Group funding for water and energy utilities would be allocated on a competitive basis. The failure to reform the 300 water utilities led the Bank to withdraw support for the sector for the past eight years, and limit support to technical assistance to “rescue” utilities post-crisis. Now a spirit of competition is emerging, and many local governments are recognizing the need to apply sound governance procedures to the water utilities they own. Under design is a series of Bank operations that would allocate funds on a competitive basis to those utilities demonstrating the greatest willingness to improve governance with a view to improving their fiscal sustainability and to expand their coverage and responsiveness so that the poor are better serviced. This will be further supported by WBI


assistance to Indonesia’s Association of Water Enterprises (PERPAMSI) to build its capacity in supporting its members to improve service to customers. Within this new spirit in Indonesia we hope to create a demonstration effect, whereby governance and service standards would be improved.

The “National” Lending Platform: Addressing Central Problems

51. In selective instances, it will be interventions at the national level that will be most effective in getting the results desired in our strategic areas. In all areas of work the Bank will continue to engage strongly with the central government, including through central components of district focused projects or through stand alone initiatives. An essential element of the Bank’s support to Indonesia under this CAS is continued policy and analytical advice to central government through its AAA program. (See Section IV. B). Critical in this regard will be the Bank’s continued engagement and advice in the area of fiscal and administrative decentralization, with close links to the development of our sub-national lending program. With respect to lending at the national level, three areas will receive special focus:

• For national level governance reforms, such as projects to reform the customs and tax administration and public financial management.

• For high priority national level infrastructure (e.g. national roads on Java).

• For programs for which cent ral government has retained responsibility, or where central management is essential for effective implementation, such as in higher education and micro-finance.


DELIVERING THE WORLD BANK PROGRAM

A. MANAGING THE PORTFOLIO AND MONITORING FOR RESULTS

52. Portfolio performance is improving. A sharp improvement in the aftermath of the crisis was followed by another decline as a result of the uncertainties associated with decentralization. However, recently performance has picked up. Undisbursed commitments at risk dropped from 39 percent in FY02 to 12 percent last year. The number of problem projects has gradually declined as a result of performance improvements and cancellation of projects that could not be restructured. The negative impact that the decentralization program had on the portfolio is slowly waning, partly as Bank projects have been designed and restructured according to new local administrative structures. Disbursements have generally remained strong. A record high disbursement ratio was achieved in FY01 through a portfolio restructuring that brought down undisbursed commitments and reallocated funds to new priorities. Since then, disbursements have remained above 20 percent (see Table 7). The joint Country Portfolio Performance Review, which involves the World Bank, the ADB and JBIC, also contributed to better portfolio performance. The proactivity and realism indices remain above Bank targets. QAG assessments for Quality at Entry and Quality of Supervision of projects in Indonesia (overall about 60 projects since 1997) have registered overall satisfactory and above ratings. Areas requiring special attention were identified as risk assessment and risk mitigating strategies at QAE. Project teams are now paying greater attention to these areas during new project design. Similarly, learning from QAG findings, the country team is giving special attention to the supervision of risky projects and making sure project ratings are kept current with developments, especially as they relate to the achievement of results.

Table 7: The Performance of the Bank's Portfolio during the Last CAS Period (percentages)

Portfolio Indicators FY99 FY00 FY01 FY02 FY03

Percent problem projects 26 19 11 23 12

Realism Index 95 86 86 79 71

Proactivity Index 78 89 100 100 82

Disbursement ratio 13 21 32 23 23

Projects at Risk 28 2 13 29 17

Commitments at Risk 27 14 7 39 12

Over-aged projects ratio 0 2 0 4 5

53. The size of the Indonesia portfolio has declined by a third over the last CAS period. The portfolio declined from 61 projects with $2.8 billion in undisbursed commitments (end FY00) to 40 projects with $1.8 billion in undisbursed balance (end FY03). Under the Base case, the portfolio is expected to "bottom-out" in FY05 at around 35 projects before returning to around 40 projects by end of FY07. Disbursements on investment lending will likely follow a similar pattern, hovering around $375 million per year in FY04-05 and then growing to over $450 million by FY07. To quickly address emerging problems in ongoing projects, the Bank will continue to engage Quality Enhancement Reviews (QERs) for risky projects, monitor


supervision quality, and follow-up more consistently with agreed project-specific action plans. Timely project restructuring and loan cancellation will be vigorously pursued for projects with persistent problems.

54. Supervision of the Bank program poses major challenges and requires innovative solutions. The portfolio is spread geographically across many islands in local communities with widely different levels of development and project implementation capacities. Moreover, many of our projects are multi-sectoral, generating additional complexities. For effective supervision in this context, each project needs to have clear benchmarks and performance criteria to permit a high degree of self-supervision of input use and outcomes. Our experience with CDD projects shows that supervision can be built into projects by empowering consultants and facilitators to identify implementation problems as they arise and to assist the executing agencies in resolving them. The platform approach holds out the possibility that Bank teams could supervise broader portfolios of projects in specific regions. Supervision will engage other donors, NGOs, and local agencies. The Bank is also planning to open regional satellite offices (initially in conjunction with the IFC’s PENSA program) which will facilitate supervision, monitoring and capacity building activities.

55. This CAS is designed to help the Government achieve specific, measurable results over the CAS period. These results, in turn, will support the Government’s own development and poverty reduction objectives. Tables 3-5 and Annex B9, which list specific outcomes which the CAS will impact, are a first step in putting in place the infrastructure to make that happen. The Bank is now launching a comprehensive program to give a stronger results focus to all project-based monitoring and evaluation and major AAA efforts, drawing from and helping to develop the country’s own M&E tools. The program would help to develop better ways to aggregate these into program-level monitoring systems which would feed into regular discussions with Government. A dedicated M&E advisor has been brought on-board who, working closely with Government and the country team, will elaborate Annex B9 into a M&E framework, strategy and work-plan for the country team. This will include, a complete review and retrofit of M&E systems in ongoing projects. In many cases the first step will be more systematic collection of baseline data. This exercise is expected to lead to some minor revisions of the specific results to which this CAS will contribute which would be reported, along with more comprehensive baseline data in the planned CAS Progress Report.

B. BUILDING CAPACITY AND INFORMING DECISION MAKING — THE AAA AND WBI PROGRAMS

56. Four “breakthrough” areas. The AAA and capacity building programs will be organized around four key areas where we feel decisive breakthroughs in our level of knowledge are necessary to achieve the CAS outcomes. These themes serve to coordinate a large number of specific tasks to ensure that the research and assistance program in each area is targeted to a broader set of outcomes with strong links to our lending program. This work will draw upon and be supplemented by a special program of poverty analysis supported by DFID (see Annex D).

• Improving the investment climate. This theme brings together all AAA, WBI and TA activities under the first CAS pillar. It would identify constraints to growth and job creation, especially among the poor. Special efforts will be made to set up a


comprehensive monitoring framework to track the quality of the investment climate over time as a key element in monitoring progress in implementation of the Government’s Economic Policy Package. A major investment climate and governance survey is planned.

• Making services work better for the poor. Building on the WDR 2004 and our analytical support for the Government’s PRSP process, this breakthrough task aims at generating innovative ideas for service delivery in Indonesia, including analyzing the critical accountability relationships in service delivery and impact analysis of public spending with a view to improving service delivery, especially among the poor, at every level of administration. Regular poverty updates will inform much of the work in this area, as well as studies in the areas of education, environment, and land policy.

• Making local governments work. This theme is designed to address knowledge gaps in our understanding of developments at the district and provincial level to inform our local government platform. It will focus on building the basis for assessing and comparing the performance of local governments across a number of different dimensions. The goal is to disseminate this information widely to encourage districts to compete with each other to enhance their reputation and attract investment and other advantages. This theme will bring together in easily accessible formats household surveys, detailed case studies, reviews of local level regulations and laws, and data on local revenues and expenditure.

• Improving governance. This theme will focus on the more systemic problems of governance and corruption in Indonesia, including institutional reform and capacity building for key institutions such as the Supreme Court and national and local Parliaments. Support will also be provided for the Partnership for Governance Reform to strengthen its capacity to serve as a national center of excellence on governance issues. In addition to analytical work on governance issues at the national level, this theme will also include detailed studies of the impact of participation and transparency on development outcomes and conflict prevention at the community level through assessments of the Bank’s CDD projects.

57. The Bank will invest more in dissemination and outreach to reach diverse audiences. The potential audience for the Bank’s AAA program is much broader and more heterogeneous than in the past, calling for a more thoughtful approach to dissemination and a wider palette of products. For the coming year a series of short, focused briefing notes covering around 20 key topics are under preparation as a means of placing development challenges on the agenda of the policy debate, and informing the new Government. In addition, a new outreach strategy is under preparation that would manage more actively the dissemination of our policy messages across the country program. The team will also develop a Quarterly Economic and Social Review as a means to track developments more frequently and as a vehicle for more high-profile dissemination of findings.

58. Capacity building at the local level. Existing programs include large capacity building programs at the community level, which will be continued. These are designed to help villagers, especially women and marginalized populations, participate in the development and implementation of projects for improving their communities and livelihoods, including the


Table 8: AAA Indicative Key Outputs By Theme

FY04 FY05 FY06

Improving the Investment Climate

Averting an Infrastructure Crisis

Sources of Growth Domestic Trade Barriers Study

Trade and Competitiveness Non-Bank Financial Institutions Strategy

Pension Diagnostic

Investment Climate Survey Local Investment Climate Survey

Investment Climate Survey

Corporate Responsibility Project (WBI)

Making Services Work Better for the Poor

Education Sector Strategy Support for PROPER program

Environmental and decentralization

Land Policy Dialogue

Poverty Update Poverty Update

PRSP Support (including WBI)

PRSP Implementation

Integrated Water Resource Management (WBI)

Making Local Governments Work

Governance and Decentralization Survey

Regional Regulations Review

Governance and Decentralization Survey.

Environmental Scorecards for Local Governments

Local Taxes and Levies Review

Regional Expenditure Tracking

Study of Local Parliaments Local Service Delivery Standards

Local Parliament TA

Improving Governance Expenditure Tracking Report High Courts TA

Participatory Review of Intergovernmental Fiscal Relations (WBI)

Anti-corruption in CDD

Decentralization - Urban Program (WBI)

Justice for the Poor

Core Diagnostics CFAA PER CPAR

CGI Brief/DPR CGI Brief/DPR CGI Brief/DPR

Poverty Assessment

Note: WBI activities beyond FY04 are still under discussion.

procurement and bookkeeping skills necessary to implement and monitor those projects. A major new push will be required at the district and provincial levels, where capacity building will be focused on training the trainers on key governance issues such as financial management and service delivery standards and development of networks for peer learning across districts. In addition, programs will include training of local legislatures and media to play a stronger accountability role in their communities. Most such activities will be embedded in the new projects. WBI will play an important role in implementing these capacity building programs, as well as ensuring better coordination of donor efforts.


C. LENDING SCENARIOS, TRIGGERS AND BANK EXPOSURE

59. Base case lending of $450-$850 million per year, of which IDA would account for around $230 million. (See Annex B3). This level is well below lending during the 1990s, which averaged $1.3 billion, but higher than the Base case of the last CAS, which was set at $400 million. Under the last CAS, however, Indonesia has now broadly achieved the High case triggers, and would thus be eligible for $1 billion lending per year. The proposed Base case would include a higher FY04-07 IDA allocation of SDR500 million and assumes continued IDA access beyond IDA 13. Access to potentially higher borrowing in the Base case, including more IDA, reflects progress in macroeconomic stability and structural reforms, and poverty strategy preparation, as well as large financing needs and continued weak credit ratings.12 Actual lending amounts would depend primarily on progress in building the local services platform, how quickly local governments are willing and able to take up reforms, and the ability to prepare high quality operations in a timely manner. If reforms and capacity building move more slowly, lending levels would be toward the bottom end of the range.

60. The Base case is premised on continued but incremental reforms that lead to gradual improvements in governance and the investment climate. Under this scenario Indonesia would remain politically stable through the elections and the transition to a new Government. The country would make gradual, although not always linear, progress in key areas, preparing Indonesia for higher growth in the following CAS period. Greater attention to governance programs in select districts, accompanied by modest improvements at the national level in line with the Economic Policy Package, would be reflected in pockets of improvement in service delivery, a moderately improved investment climate, leading to slightly higher investment rates, which in turn would (barring external shocks) cause GDP to grow at 4-5 percent annually, and enable poverty to fall from 16 percent in 2002 to 12 percent in 2007. This scenario also envisions Indonesia maintaining macro-stability, increasing development expenditures gradually, while meeting fiscal targets laid out in the State Finances Law and lowering its debt-to-GDP below 60 percent by end 2006 (see Table 9).

61. In the event of sharply accelerated reform, High case lending of up to $1.4 billion per year is proposed, of which IDA would account for around $365 million. This case would require strong measures in the areas of governance and the investment climate that would result in a more immediate resumption of higher growth rates and more decisive action and results in reducing poverty. Table 9 presents the framework which will be used to determine achievement of the High case. The indicative measures (in parentheses) describe the types of measures that will be used to gauge performance. Quantitative indicators from data sources listed in the note to Table 9 will also be used to assess progress. All of the indicative measures for the High case are drawn from the Government’s new Economic Policy Package. Under this case, GDP growth rate is likely to rise gradually to 6 percent by the end of the CAS period and poverty headcount rates could fall to 10 percent in 2007 -- lower than pre-crisis levels. Annex B3 presents an indicative lending program under the High case. Additional support would be provided in two broad areas -- infrastructure and economic reform. Infrastructure constraints will become even more

12 The growing strength of the economy led to independent rating agencies raising Indonesia’s credit rating in 2003. Nevertheless, the country’s rating is still several discrete grades below minimum investment grade.


Table 9: Indonesia CAS Trigger Matrix FY04—FY06

Outcome Areas Base Case High Case

Objectives (Indicative Measures) a Objectives (Indicative Measures) a

Investment Climate for Growth

Macroeconomic stability and creditworthiness

• Maintain fiscal targets as per state finances law (by further reduction in deficit, and debt to below 60 percent of GDP by 2006)b.

• Maintain monetary program consistent with inflation below 10 percent .

• Cutting inefficient spending (by phasing out non-kerosene subsidy)

• Reduce reliance on debt financing (by divesting majority shares in Lippo, BII, Bank Permata; and satisfactory progress in gradually increasing non-oil and gas tax-to-GDP ratio above 2003 projection of 12.8 percent by strengthening tax administration.) b

Investment climate

• Improve infrastructure and infrastructure policy (by finalizing and issuing the white paper on infrastructure).

• Coordinate action to address investment constraints (by establishing an effective cabinet-level investment team).

• Strengthen financial sector (by establishing a financial safety net improving state bank governance, capital market supervision, and insurance and pension regulation).

• Increase private investment in power (by progress in establishing independent regulator in the electricity market, and continued tariff reforms).

• Reduce transaction costs for business (progress in reforming DG customs and DG tax, establishing one-stop shops for investment approval).

Governance and Anti -Corruption

Public Procurement and Financial management

• Improve government fiduciary management (by implementing the State Finances Law, making progress toward adopting Treasury and Audit laws).

• Strongly improve government fiduciary management (by issuing implementing regulations for State Finances Law; establishing Treasury Department in MOF; establishing Treasury Single Account; establishing NPPO; continuing special audit program for SOEs)

Decentralization • Improve local fiscal accountability (by revising Law 34/2000 and Law 25/1999 to limit number of local taxes and levies, increase tax rate flexibility for local government, improve the framework for local borrowing and increase equity of the intergovernmental fiscal system).

Justice sector and legal reform

• Improve the institutional framework for addressing corruption cases (by making satisfactory progress on the operationalization of the Anti Corruption Commission; implementation of capacity building program for public prosecutors and judges; and preparation for the Anti- Corruption Court).

• Improve governance in the justice sector (by ensuring effective operation of Anti Corruption Commission and the Anti Corruption Court, establishing an effective Judicial Commission, and adopting a reform program for AGO).

Making Services Work for the Poor

Service delivery • Improve service delivery to the poor (by increasing DAK to support poor regions in delivering basic services, and by publishing service standards for public service delivery units).

Poverty reduction strategy

• Improve poverty focus of public policy and enhance open dialogue on policy issues (by continued satisfactory progress toward completing a participatory PRSP).

• Improve poverty orientation of public spending (by reflecting the PRSP in the budget).

Portfolio Performance

Aid effectiveness • Improve implementation of decentralization framework to improve effectiveness of donor aid programs (by revising KMK 35/2002 to allow for better on-lending and on-granting arrangements).

a/ Refer to explanation in para. 61. In addition to the indicative measures listed above, we would look at various data sources—namely for Investment Climate and Growth (Moody’s, S&P, Fitch, BPS, the Bank’s own investment climate survey, ICRG assessment); for Governance (BPK audits, Transparency International, ICRG assessment, Kaufmann and Kraay); for Making Services Work for the Poor and Poverty Reduction (Susenas household survey data; MOF budget data and regional budget data; PER; administrative data from the health and education sectors; BPS).

b/ At constant prices and exchange rate.


pressing with higher economic growth. In addition, with high case policy progress, more active support for institutional reforms would be warranted, as would program lending in support of reforms to improve the investment climate and public procurement and financial management. The particular reform areas that would be supported would be clarified in the CAS Progress Report following consultations with the in-coming Government.

62. In response to the Government’s request, a policy-based program loan supporting the Government’s reform program is proposed for the first half of FY05. Over the next 18 months, the Government plans to forge ahead with measures outlined in its Economic Policy Package. While substantial progress is likely, it is unlikely that all the High case triggers, which will require a track record of sustained policy improvement, would be reached until late FY05 or early FY06. The proposed program loan would thus be made available under an “enhanced” Base case situation, requiring systematic implementation of the Government’s policy package over the coming year, particularly in the areas of improving the investment climate and strengthening public procurement and financial management. The single tranche operation of $200-300 million would support reforms – a subset of the High case triggers – in these specific areas. Within these High case “outcome” areas, Box 7 provides examples of the type of indicative measures which the Bank would use in determining eligibility for an “enhanced” base case adjus tment operation. In the fiduciary area, the loan would likely support progress in addressing weaknesses in public procurement and financial management identified in the CPAR and CFAA (see Box 8).

Box 7: Framework for Achievement of the “Enhanced” Base Case

Achievement of the “enhanced” Base case would give Indonesia access to an adjustment loan in FY05. At a minimum, the Bank would expect progress towards the objectives noted in the High case trigger areas of public procurement and financial management and investment climate. Examples of type of indicators that would be used to assess performance are drawn from actions planned under the Government’s own program and include:

• Issue revised Presidential Decree on public procurement • Finalization of the State treasury Law and State Audit Law • Issuance of implementing regulations of the State Finances Law • Establishment of a Treasury Department in the Ministry of Finance and a Treasury Single Account • Improvements in government debt management at central and local level • Operationalizing the National Procurement Policy Office • Progress in establishing a financial sector safety net • Establishing independent regulator in the electricity market • Effective functioning of the Investment Team • Progress in tax administration and customs reforms

These policy measures are also being flanked with lending support for implementing the State Finances law, and AAA for an in-depth public expenditure review to optimize budget allocations, and an expenditure tracking exercise to assess the use of budget allocations.

63. Indonesia’s external debt to GDP ratio and IBRD debt-to-GDP ratio are projected to continue to decline steadily under all proposed lending scenarios. If lending commitments were to gradually increase to US$850 million a year as projected under the Base case—and remain at this level for another decade—Indonesia’s exposure to the Bank would continue to decline. IBRD debt disbursed and outstanding would fall from about US$10.3billion at end FY03 to about US$3.6billion in FY11. The share of Indonesia’s IBRD and IDA debt to GDP will


fall from about 5.1 percent in 2003 to 1.6 percent in 2012 (see Figure 4). Even under the High case, net disbursements (from IBRD and IDA combined) would still remain negative through FY09 and IBRD outstanding loans would decline to around $6.5 billion by FY07. In addition, even under modest macroeconomic assumptions that take into account overall external financing requirements over the long term, the total external debt to GDP ratio is projected to continue to fall steadily, assuming present policies (see Figure 4).

64. Low case lending of less than $300 million per year would be appropriate in the event that progress on policy reform stalls, or if there is back-tracking on performance. The Low case would include an FY04-06 IDA allocation of SDR300 million and also assumes continued access beyond IDA13. The Low case is one in which the Government fails to make progress in improving governance and the investment climate, resulting in a failure of confidence, deteriorating or stagnant service delivery, and an increase in poverty. This would materialize, for example, if populist pressures resulted in serious back-tracking on key reforms already undertaken, such as in the areas of fiduciary management. Such pressures, which lead to a weakening of fiscal, monetary, and financial discipline, would likely bring about macroeconomic instability or a broader crisis. Back-tracking on policies that would directly harm the poor, such as protectionist trade policies, could also precipitate the Low case. In a low case environment the Bank would tailor its response to developments and opportunities. Lending would focus on CDD programs and other direct poverty reduction and social service interventions that show promise.

Box 8: Fiduciary Environment: Progress and Next Steps

Fiduciary core diagnostic reports on procurement (CPAR) and financial management (CFAA) were completed for Indonesia in 2001. While these reports highlighted major weaknesses in the public procurement system and overall fiduciary environment, progress has been made in several areas. In particular, the CPAR recommended reform of the legal framework and organizational structure for procurement. The CFAA called for reform of the legal framework to anchor future reforms in public financial management, greater clarity in the roles and responsibilities of key players in the budget process, and strengthening of audit functions. Several important actions in these areas have been completed to date:

• A draft Presidential Decree revising the existing Keppres 18/2000 has been prepared and is now awaiting presidential approval. It will establish a new procurement framework that is more consistent with international public procurement practices. Establishment of a National Public Procurement Office, professional certification, and wider competition are key features of this draft decree

• A draft procurement law has been prepared which provides clarity on procurement policies and procedures and strong enforcement mechanisms

• Procurement training modules for international and national competitive bidding procedures have been prepared by the Government to develop professional procurement expertise

• A pilot e-procurement system is being prepared by the Government

• Laws on state finances, treasury and audit have been drafted. The new state finance law, which was passed by Parliament in March 2003, reforms public accountability mechanisms. Passage of the remaining two laws and issuance of the implementing regulations for all three will consolidate reforms in this area

• The mandate of BPK (Supreme Audit Board) has been strengthened by the new finance law and constitutional amendments, and BPK continues to be modernized through an Institutional Development Plan supported by the Bank

• The Government has formulated a Public Sector Accounting Board to help develop and implement new and modern accounting standards. An initial set of three draft standards and a strategy for introducing these nation-wide have been prepared

Fundamental for further progress on the fiduciary environment will be quick and cumulative reform actions on the legal and institutional aspects of the procurement and financial management systems, supported by capacity building for people involved in implementing these reforms. In procurement, operationalizing the NPPO, certification of staff handling procurement, and progress in the procurement law could signify big changes in procurement practices in the near term.


Figure 4: Total External and IBRD Debt Outstanding

Indonesia’s external debt to GDP ratio

0%

20%

40%

60%

80%

100%

120%

1999 2001 2003 2005 2007 2009 2011 2013 2015

Actual Projection

% of GDP

65. Under all three lending scenarios, IDA resources will be directed to projects that target improving governance and reducing poverty for rapid MDG attainment. IDA will support the next generation of CDD projects, finance the flagship "local services platform", and projects aimed at improving delivery of health, education and basic infrastructure to the poor. The attent ion to improving M&E and better quantification of results will also enable clearer assessment of IDA's contribution to Indonesia's poverty reduction goals. (An indicative breakdown of IDA among pipeline projects is provided in Annex B3.)

IBRD debt outstanding

(US$ billion, end-of-calendar year)

IBRD debt outstanding as a share of GDP

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

CY1999 CY2001 CY2003 CY2005 CY2007 CY2009 CY2011 CY2013 CY2015

0

2

4

6

8

10

12

14

CY1999 CY2001 CY2003 CY2005 CY2007 CY2009 CY2011 CY2013 CY2015

US$ billion

Source: staff estimates


Table 10: Expected Lending FY04-07

FY03 (actual) FY04 FY05 FY06 FY07 CAS Period (FY04-07)

Base Case IBRD 438.5 295 570 620 620 2,105 Investment 438.5 295 370 620 620 1,905 Adjustment 0 0 200* 0 0 200 IDA 145 230 230 230 230 920 Total 583.5 525 800 850 850 3,025

High Case IBRD 885 885 885 2,950 Investment 485 635 635 2,050 Adjustment 400 250 250 900 IDA 365 365 365 1,325 Total 1,250 1,250 1,250 4,275

* Adjustment loan eligibility would depend on achievement of the “enhanced” Base case as discussed in paragraph 62.

D. IFC AND MIGA PROGRAMS

IFC Program

66. IFC’s activities in Indonesia are directed to help the private sector and contribute to sustained economic growth and poverty alleviation. IFC’s strategy focuses on: (i) strengthening banks and other financial institutions; (ii) deepening the financial sector by supporting new institutions; (iii) supporting export-oriented companies, mainly in the agribusiness sector; (iv) supporting investments in infrastructure, power and telecommunications; and (v) supporting SMEs. (See Annex G detailing IFC activities.)

67. In the financial sector, IFC will work to recapitalize some banks where appropriate strategic partners can be found to upgrade operating procedures, systems, and management practices. Potential activities could also include investments and technical assistance in the areas of housing finance, forfeiting, credit information (credit bureaus), and securitization. IFC will support export-oriented resource-based industries through investments in sectors such as palm oil plantation, where IFC can help with environmental and resettlement issues. IFC will also assist internationally competitive projects in textile, chemicals, light engineering and services serving the domestic market. In infrastructure, IFC will seek to invest in viable private sector power generation and distribution projects and support investments in telecommunications. For SME development, potential IFC support includes creating a credit bureau, establishing a Project Development Facility in the eastern islands of Indonesia, and investing in microfinance institutions. In the area of social services, IFC’s role would be to mobilize funds in support of private sector projects in health, education and housing.

MIGA Program

68. MIGA is proposing to support privatization through the provision of political risk guarantees to foreign investors, to provide aftercare capacity building support to the investment promotion agency, and to undertake a comprehensive benchmarking study.


MIGA intends to support foreign direct investment through the provision of political risk guarantees to investors in new projects, privatizations and modernizations of existing projects, in particular in the power and gas sectors. Based on the Miyazawa Initiative, MIGA intends to provide capacity building support in the area of investor aftercare to BKPM to help it address the needs of existing investors and facilitate expansions and reinvestments. This work will be provided in a regional context beginning in FY04-05. Once suitable partners are identified, MIGA is also proposing to undertake a comprehensive benchmarking study designed to analyze the competitiveness of several sectors in Indonesia in terms of their ability to attract FDI. (See Annex G for further details on MIGA’s program.)

E. PARTNERSHIPS

69. A new way of doing business. Since the economic crisis the Bank, together with Government, other donors and key representatives of civil society and the private sector have embarked upon a new approach to development assistance in Indonesia. There is now wide recognition that broad-based genuine partnerships that focus on the problems to be solved, and that bring together all relevant stakeholders with something to contribute to the solution are much more likely to succeed than earlier “expert-driven” approaches. This change has been prompted both by factors specific to Indonesia – including the multiplication of voices and decision-makers, and the complexity of problems to be solved -- and by the worldwide recognition that participation and partnership, done right, deliver results. The new approach, while adding short term costs, has led to genuine improvements in development effectiveness. Our range of partners is broadening – to include, for example, parliamentarians, professional associations, religious organizations and labor unions – but our engagement in such partnerships will be monitored, and judged by its impact on our development effectiveness. In the coming CAS period we are committed to deepening this process in a manner that will improve our effectiveness further. Annex B9 provides a listing of partnerships in each of the Bank’s areas of activity.

70. Joint analytical and advisory activities. Most of the Bank’s AAA work is now done in partnership with local research institutes, other donors, NGOs, and of course Government. Such partnerships include co-financing, joint research teams, consultant trust funds, and joint dissemination activities. Increasingly, the Bank and its partners are pursuing a programmatic approach to research and technical assistance, identifying key issue areas in Indonesia’s development path and framing a set of activities to provide analysis, policy recommendations and other support. The Partnership for Governance Reform in Indonesia provides a unique Indonesian- led vehicle, through which donors can pool their funds for legal and judicial reform, civil service reform and anti-corruption. The Strategic Poverty Partnership between the Bank and DFID focuses on analytical work to assist in the development of strategies and actions to reduce poverty and vulnerability. The Dutch Government has provided significant support through the Bank for analyzing and improving the implementation of decentralization, and works in close partnership with a program financed by GTZ. The Bank’s CDD work will continue to rely on a wide range of partners including DFID for the development of a monitoring and evaluation framework, AusAID for support of conflict resolution, Japan for support of our program for widows and other groups affected by conflict, and Denmark to increase women’s participation in CDD. In sensitive areas, joint teams have been fielded to implement analytical work such as the Regional Public Expenditure Review for the war torn Province of Aceh in


partnership with the ADB, USAID and UNDP. An important new partnership on the investment climate, led by official and private sector representatives from Japan and the US will help monitor and advise on private sector aspects of the Government’s new economic package. The above are just a few examples out of many.

71. From projects to programs through partnerships . The Bank’s program in Indonesia depends on our capacity to leverage the Bank’s own resources with significant additional funds from a range of bilateral partners to deliver on our common agenda. The Bank currently manages approximately US $165 million in trust funds from bilateral donors that are used for such activities as co-financing, project preparation, thematic partnerships, research and technical assistance, and consultant support. While fiduciary concerns still discourage the common pooling of donor funds for sectoral budget support, in a number of key sectors joint teams are working with Government to diagnose problems and develop sectoral strategies that will then be financed in a coordinated manner. A current example is education, where AusAID, the ADB, the Netherlands, EU, UNICEF and the Bank are working with the Government to design a strategy for the sector. Similar approaches are planned in Public Financial Management reform, micro-credit, infrastructure, and HIV/AIDS. The MDGs are expected to play an increasingly valuable role in helping donors and Government to focus on monitorable outcomes. A major baseline report is being completed by a multi-stakeholder working group under the leadership of the Government and UNICEF.

72. A more effective consultative group process. The Consultative Group for Indonesia (CGI), chaired by the Bank and the Government, continues to serve as the main forum for donor coordination and policy dialogue. Meeting in-country twice yearly (including the more informal mid-year meeting), the CGI has provided an important forum since the economic crisis for discussing Indonesia’s special policy and financing needs. The presence of civil society and the private sector has enriched the debate, and the creation of CGI working groups has helped inform the debate and focus the discussion. As Indonesia is now able to begin focusing on longer term issues, CGI members have recently agreed on a number of changes to improve the effectiveness and focus of the dialogue. Important here will be an enhanced role for Government-donor working groups throughout the year, and a set of technical workshops prior to the main CGI event, to enable the full plenary sessions to be more focused on genuine dialogue.

73. Towards greater development effectiveness. Partnerships are critical for the preparation, implementation and supervision of Bank projects. Through all stages of the project cycle, partnerships enable the Bank to improve the scope, quality and effectiveness of the investments we finance. As examples: project preparation grants from Japan play a critical role in project development across our program; DFID is a key partner in all stages of the development and implementation of the “local level platform”; and the Dutch Government co-finances with grants the KDP and education program. Partnerships among ADB, JBIC and the Bank are particularly important, given that these three lending institutions account for three-quarters of ODA flows, and share many common problems. In the coming months a fully-integrated joint portfolio review will be completed for the three institutions. ADB will continue to be a close ally in anti-corruption efforts, including in the planned country procurement review up-date, and on fiscal- transfer framework issues, where work is needed to clarify on- lending arrangements. The partnership with ADB and JBIC on portfolio issues is complemented by strong partnerships with the UN system on MDGs, poverty analysis and conflict-related issues.


MANAGING RISKS

74. The highest risk to the achievement of the CAS objectives is that the political will to address issues of governance will not be forthcoming. Indonesia is entering into an electoral period in which governance and corruption are likely to be critical issues around which political competition coalesces. While this will create potential opportunities for governance reforms which the Bank program is designed to enhance, there remain risks that political competition could deflect the Government from implementing its reform program or lead to new configurations of political power that utilize nationalist or populist pressures to reject governance reforms. Political instability or unrest associated with the electoral process itself cannot be ruled out at this early stage of Indonesia’s transition. In response to such risks, the Bank would seek to stay engaged on governance reform through its direct involvement with communities in CDD projects and through continued policy dialogue. Yet the consequences for making progress on the country’s growth and poverty reduction goals would be seriously compromised. In addition to this general risk to the program, a number of more specific risks can be identified below with appropriate Bank responses.

75. Macroeconomic risks. A macroeconomic shock could lead to another economic crisis, stalled or negative growth, capital flight, and increased poverty. The cause could be caused by domestic factors (lack of macro discipline resulting from election pressures, weak institutional capacity, financial sector instability etc), or external factors (commodity price shocks, escalation of international terrorism etc). In the case of a domestic shock, the Bank would continue to work in partnership with the Fund in advising the Government with a view to enhancing fiscal and financial sector management. In the case that a crisis is precipitated by poor governance and economic management, the Bank would likely be in the Low case. The CDD platform, as well as the planned technical work the Bank does to improve the social protection and safety net mechanisms would then be important to mitigating the impacts of crisis on the poor. In the case of a sudden externally driven shock, the Bank would react quickly to provide the Government with technical advice and, where appropriate, balance of payments support.

76. Financial sector risks. Further financial sector turbulence could impose significant fiscal costs, and putting macroeconomic and poverty reduction goals at risk. Over half the banking sector continues to be state-owned, making directed credit tempting, and enabling poor credit decisions that could lead to future contingent liabilities for the government. The blanket deposit guarantee tends to weaken market discipline, but removing it too abruptly risks triggering a loss of confidence in the system. The financial and operational restructuring of many companies hurt by the crisis is still incomplete, posing a large risk to bank asset portfolios. Capital markets are underdeveloped; the insurance and pensions sectors – widely known to be weak – could also impose significant fiscal costs on the government as part of any restructuring efforts. The Bank, in collaboration with other partners, will continue to provide TA and policy advice, will invest in AAA and capacity building efforts to monitor developments in the financial and corporate sectors and advise the Government on policy options on an ongoing basis.

77. Decentralization risks. Policy reversals on decentralization could undermine our local service delivery platform and slow disbursements overall. The main decentralization law is currently under review, and substantial backtracking or continued uncertainty could slow or


otherwise complicate progress in decentralization. Some central agencies are working actively to reinstate central control adding to the uncertainty. Concerted efforts to support the implementing regulations for decentralization will be key to mitigating this risk. If necessary, a scenario of stalled or compromised decentralization may result in a re-weighting of the portfolio to centrally or community implemented projects as projects designed for local- level implementation based on current policies are reformulated.

78. Reputational risks. The risk to the Bank’s credibility and ability to remain effective over the long term. Despite considerable progress in rebuilding the Bank’s reputation in Indonesia since the crisis, there remains substantial skepticism, in particular among a segment of civil society groups, about corruption in the handling of foreign assistance funds, and doubts about the value of donor financing overall, which they see as imbued with globalization and “Washington Consensus” ideology. More broadly, challenges to the Bank’s credibility as a result of corruption risks could undermine our effectiveness in promoting the reform agenda, particularly in the areas of transparency, accountability, and integrity associated with governance. The CAS is being designed to face this challenge head on. Transparency and accountability measures will be built into our CAS triggers and our programs. We will deal with corruption in our own projects vigorously and with full public disclosure.

79. Security risks. Though terrorism has now become a global threat, Indonesia remains among the countries more vulnerable. If terrorist attacks continue or worsen in Indonesia, the negative effects on general investor confidence and investment levels in Indonesia could be considerable with an associated impact on the poverty level. Increased terrorism threats could also spark broader political instability that might impact the Government’s attention and commitment to economic reform or, more seriously, provoke backtracking on Indonesia’s impressive transition to a more open, decentralized society. Indonesia’s history of military interference in domestic politics, and bouts of heightened nationalism all add to the risk scenario. In addition to the terrible costs such events might impose on the Indonesian people, they also impact on the Bank’s capacity to deliver effective assistance through threats to the security of Bank staff. Though several Bank projects are designed to address some of the underlying causes that generate these risks, direct assistance in the fight against terrorism and related security risks are beyond the bounds of the Bank’s program. The Bank’s response can only be to enhance the vigilance and sophistication of its monitoring of political and security risks through better analysis and relationship-building and to strengthen its crisis preparedness and response plans to give greater confidence to local and visiting staff. In the event that these risks materialize, the Bank will respond swiftly and decisively to protect staff and their families and to preserve, to the extent possible, those assistance operations that provide direct assistance to the poor and vulnerable who would suffer most from the after-effects of such events.

James D. Wolfensohn

President By:

Shengman Zhang Peter Woicke Motomichi Ikawa Washington, D.C. October 29, 2003


Annex A1Page 1 of 1

Economy (CY) 2000 a 2001 2002 2001 2002 2003 2004 2005 2006 2007Growth rates (%)

GDP 4.0 4.0 4.0 3.4 3.7 3.5 4.0 4.5 5.0 5.0Exports (Merchandise FOB) b 16.9 3.4 3.0 -12.3 2.5 4.4 0.9 2.7 5.3 4.8Imports (Merchandise FOB) b 19.7 12.6 6.4 -14.1 2.7 12.8 1.8 4.5 5.3 5.3

Inflation (CPI annual average, %) 5.0 8.0 8.0 11.5 11.9 6.5 6.0 5.0 5.0 5.0

National accounts (% GDP)Consumption 72 74 76 75 78 80 80 80 79 78Gross investment 17 16 16 22 20 20 20 21 22 22

Balance of Payments (% GDP)Current account balance 4.8 2.8 2.1 4.9 4.3 2.5 1.5 1.6 1.1 0.8

Public finance (% GDP)Fiscal balance -3.4 -3.6 -2.4 -2.9 -1.7 -1.9 -1.3 -0.8 -0.4 0.0Foreign financing 0.2 2.6 0.7 0.7 1.0 0.2 -0.8 -0.9 -0.9 -0.7

International reserves (as months of Imports (G&S)) .. .. .. 5.1 6.0 6.7 6.2 6.0 6.0 6.0

Program (Bank’s FY) FY01 FY02 FY03 FY02 FY03 FY04 FY05 FY06 FY07

Lending ($ million) 398 400 400 303 583 525 800 850 850Gross disbursements ($ million) 1,000 800 600 507 358 500 600 450 510

a. Government of Indonesia FY, April-December.b. Nominal Value of Export and Import growth in US$.

Key Economic & Program Indicators - Change from Last CAS

Forecast in Last CAS Actual Current CAS Forecast

Annex A2Page 1 of 2

Indonesia at a glance 12/4/2003

East POVERTY and SOCIAL Asia & Low-

Indonesia Pacific income2002Population, mid-year (millions) 211.7 1,826 2,511GNI per capita (Atlas method, US$) 710 900 430GNI (Atlas method, US$ billions) 149.9 1,649 1,069

Average annual growth, 1996-02

Population (%) 1.3 1.1 1.9Labor force (%) 2.2 1.3 2.3

Most recent estimate (latest year available, 1996-02)

Poverty (% of population below national poverty line) 16 .. ..Urban population (% of total population) 43 37 31Life expectancy at birth (years) 67 69 59Infant mortality (per 1,000 live births) 34 36 76Child malnutrition (% of children under 5) 25 12 ..Access to an improved water source (% of population) 78 74 76Illiteracy (% of population age 15+) 12 14 37Gross primary enrollment (% of school-age population) 110 107 96 Male 111 106 103 Female 109 108 88

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1982 1992 2001 2002

GDP (US$ billions) 94.7 139.1 141.3 172.9Gross domestic fixed investment/GDP 27.8 30.5 21.8 20.2Exports of goods and services/GDP 25.3 27.9 42.3 35.4Gross domestic savings/GDP 29.0 33.4 24.9 21.1Gross national savings/GDP .. 21.4 21.0 18.6

Current account balance/GDP -5.6 -2.0 4.9 4.3Interest payments/GDP 1.6 2.7 5.0 2.7Total debt/GDP 26.5 63.3 94.8 76.0Total debt service/exports 18.1 32.6 27.6 26.1Present value of debt/GDP .. .. .. ..Present value of debt/exports .. .. .. ..

1982-92 1992-02 2001 2002 2003-07(average annual growth)GDP 6.9 2.5 3.4 3.7 4.6GDP per capita 5.0 1.1 2.1 2.3 3.2Exports of goods and services 6.9 3.1 1.9 -1.2 4.0

STRUCTURE of the ECONOMY1982 1992 2001 2002

(% of GDP)Agriculture 24 19 17 17Industry 38 40 46 44 Manufacturing 12 22 25 25Services 38 42 37 38

Private consumption 59 58 67 71General government consumption 12 9 8 8Imports of goods and services 24 25 35 29

1982-92 1992-02 2001 2002(average annual growth)Agriculture 3.8 1.6 1.0 1.7Industry 9.2 3.2 3.3 3.7 Manufacturing 12.6 4.7 4.1 4.0Services 6.5 2.3 4.6 4.4

Private consumption 4.4 5.2 4.4 4.7General government consumption 4.9 0.4 9.0 12.8Gross domestic investment 9.6 -4.7 7.7 -0.2Imports of goods and services 3.0 1.9 8.1 -8.3

Note: 2002 data are preliminary estimates. Group data are through 2001.

* The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.

-60

-40

-20

0

20

97 98 99 00 01 02

GDI GDP

Growth of investment and GDP (%)

Indonesia

Low-income group

Development diamond*

Life expectancy

Access to improved water source

GNIpercapita

Grossprimary

enrollment

-60-40-20

02040

97 98 99 00 01 02

Exports Imports

Growth of exports and imports (%)

Indonesia

Low-income group

Economic ratios*

Trade

Domesticsavings

Investment

Indebtedness

Annex A2Page 2 of 2

Indonesia

PRICES and GOVERNMENT FINANCE1982 1992 2001 2002

Domestic prices(% change)Consumer prices .. 7.6 11.5 11.9Implicit GDP deflator 6.1 5.4 10.8 7.2

Government finance(% of GDP, includes current grants)Current revenue .. .. 20.7 18.6Current budget balance .. .. 0.0 0.6Overall surplus/deficit .. .. -2.9 -1.7

TRADE1982 1992 2001 2002

(US$ millions)Total exports (fob) .. 33,796 57,364 58,817 Fuel .. 10,671 12,648 12,139 Rubber .. 684 872 1,238 Manufactures .. 14,224 22,275 19,119Total imports (cif) .. 27,280 34,669 35,805 Food .. 1,274 2,497 2,852 Fuel and energy .. 2,104 5,523 6,558 Capital goods .. 11,700 9,050 8,606

Export price index (1995=100) .. .. .. ..Import price index (1995=100) .. .. .. ..Terms of trade (1995=100) .. .. .. ..

BALANCE of PAYMENTS1982 1992 2001 2002

(US$ millions)Exports of goods and services 20,251 37,187 62,864 64,004Imports of goods and services 22,716 34,874 50,549 51,498Resource balance -2,465 2,313 12,315 12,506

Net income -2,993 -5,664 -6,936 -6,881Net current transfers 134 571 1,521 1,826

Current account balance -5,324 -2,780 6,900 7,451

Financing items (net) 3,471 4,850 -8,278 -3,430Changes in net reserves 1,853 -2,070 1,378 -4,021

Memo:Reserves including gold (US$ millions) .. .. 27,890 31,911Conversion rate (DEC, local/US$) 661.4 2,029.9 10,260.9 9,311.2

EXTERNAL DEBT and RESOURCE FLOWS 1982 1992 2001 2002

(US$ millions)Total debt outstanding and disbursed 25,133 88,002 133,849 131,343 IBRD 1,735 10,640 11,435 10,729 IDA 707 814 722 794

Total debt service 3,856 12,457 18,212 17,364 IBRD 207 1,515 1,753 1,905 IDA 8 22 32 33

Composition of net resource flows Official grants 92 298 0 0 Official creditors 1,067 3,097 615 -440 Private creditors 1,401 2,655 -6,199 -339 Foreign direct investment 225 1,777 -5,877 -7,066 Portfolio equity 0 146 1,145 1,243

World Bank program Commitments 977 1,256 645 103 Disbursements 583 1,003 585 419 Principal repayments 82 692 853 1,065 Net flows 501 311 -268 -646 Interest payments 133 845 932 873 Net transfers 368 -533 -1,200 -1,519

Development Economics 12/4/2003

-4

-3

-2

-1

0

1

2

3

4

5

6

96 97 98 99 00 01 02

Current account balance to GDP (%)

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

96 97 98 99 00 01 02

Exports Imports

Export and import levels (US$ mill.)

0

20

40

60

80

97 98 99 00 01 02

GDP deflator CPI

Inflation (%)

G: 23,706A: 10,729

D: 6,676

C: 8,829B: 794

F: 43,660E: 36,949

Composition of 2002 debt (US$ mill.)

A - IBRDB - IDA C - IMF

D - Other multilateralE - BilateralF - PrivateG - Short-term

Annex B2Page 1 of 1

As Of Date 09/24/2003

Indicator 2001 2002 2003 2004Portfolio AssessmentNumber of Projects under Implementation a 52 47 40 39Average Implementation Period (years) b 4.4 4.6 4.4 4.5Percent of Problem Projects by Number a, c 11.5 23.4 12.5 12.8Percent of Problem Projects by Amount a, c 7.5 26.3 7.7 7.7Percent of Projects at Risk by Number a, d 13.5 29.8 17.5 17.9Percent of Projects at Risk by Amount a, d 9.8 38.9 12.4 12.5Disbursement Ratio (%) e 32.1 21.8 22.1 4.0Portfolio ManagementCPPR during the Year (Yes/No) No Yes YesSupervision Resources (total US$) 5,403 4,329 4,412Average Supervision (US$/project) 85.76 72.15 83

Memorandum Item Since FY 80 Last Five FYsProj Eval by OED by Number 227 37Proj Eval by OED by Amt (US$ millions) 20,841.2 3,499.9% of OED Projects Rated U or HU by Number 21.7 36.1% of OED Projects Rated U or HU by Amt 16.3 22.2

a. As shown in the Annual Report on Portfolio Performance (except for current FY).b. Average age of projects in the Bank's country portfolio.c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP).d. As defined under the Portfolio Improvement Program.e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: investment projects only.* All indicators are for projects active in the Portfolio, with the exception of the Disbursement Ratio, which includes all active projects as well as projects exited during the fiscal year.

Selected Indicators* of Bank Portfolio Performance and ManagementCAS Annex B2

Annex B3Page 1 of 1

CAS Annex B3 (IFC & MIGA) for IndonesiaIndonesia - IFC and MIGA Program, FY 2000-2003

2000 2001 2002 2003

IFC approvals (US$m) 31.37 153.00 15.18 74.00

Sector (%)Agriculture and Forestry 35Finance and Insurance 16 65 24 20Food and Beverages 76Industrial and Consumer Goods 27Oil, gas, and Mining 80 3 11Prof., Scient., and Tech. 2Textiles, Apparel, and Leather 0 21 7Transportation and Warehouse 9Wholes. and Retail Trade 4Total 100 100 100 100

Investment instrument(%)Loans 48 19 76 46Equity 26 2 24 47Quasi-Equity 26 1Other 78 0 7Total 100 100 100 100

MIGA Guarantees Gross Outstanding (US$m) 56.50 56.50 56.50 52.40

Annex B3Page 1 of 2

Strategic Rewards

ImplementationRisksb

Fiscal year Proj ID b IBRD IDA c (H/M/L) (H/M/L)

2004 Catchment Protection (LIL) 3 H MCoral Reef Rehabilitation and Management (APL 2) 46 29 M MInitiatives for Local Governance Reform 28 32 H HUrban Sector Development and Reform Program 78 22

Land Management & Policy Development 29 32 H HSupport of Conflict Ridden Areas 45 H HUrban Poverty Project 3 113 67 H MEastern Indonesia Region Transport 2 200 H M

Total 494 230

Expect Delivery of 5-6 Projects for $525 mln

2005 Domestic Gas Sector Restructuring 85 M HUrban Water Services Improvement 30 20 H MProvincial Health and Nutrition 75 M MHigher Education Project 65 35 M HStrategic Roads Infrastructure 200 M MSustaining Microfinance 20 40 M MEnvironment and Sanitation 40 60 H HGovernment Financial Management & Revenue Admin. 120 H HAdjustment Loand 200 H H

Total 560 230

Expect Delivery of 7 Projects for $800 mln

High Case (additional $135 million IDA will be allocated among all eligible projects)

Adjustment Loan 200 H HStrategic Roads Infrastructure (additional amount)e 100 M MEast Java Development Reform Program f 175 H H

2006 Strengthening Capacity for Decentralized Education 70 30 H HEast Java Development Reform Program 175 H HUrban Local Government Reform 2 100 50 H HWater Supply & Sanit. for Low Income Communities 3 80 20 H MInitiatives for Local Governance Reform 2 100 50 H MFarmer's Empowerment & Technology 40 30 M MUrban Water Supply 100 H M Local Community Support Project (KDP4) 50 50 H M

Total 715 230



Adjustment Loan 250 H H

Proposed IBRD/IDA Base-Case Lending Program,a FY2004-2007

US$(millions)

Annex B3Page 2 of 2

Strategic Rewards

ImplementationRisksb

Fiscal year Proj ID b IBRD IDA c (H/M/L) (H/M/L)

Proposed IBRD/IDA Base-Case Lending Program,a FY2004-2007

US$(millions)

Yogyakarta Regional Development & Poverty Reduction 50 H MWest Java Environment Management Project (APL 2) 70 M HEnergy Sector Project 200 H H

2007 Energy Sector Project 200 H HMarginal Fisher's Community Development 100 50 H HWater Resources and Irrigation Sector Mgt. (APL 2) 70 30 H MCatchment Protection 2 50 25 H MCommunity Based Education for Marginalized Youth 50 25 M MHealth Sector Project 60 40 M HUmbulan Spring/Greater Surabaya Water Project 100 M MUrban Community Development Project 100 50 H MProvincial Health & Public Health Functions 30 10 M M

Total 760 230



Adjustment Loan 250 H HNational Roads 150 M M

Other projects under discussion

Civil Service Training Reform (LIL) (FY04), Capital Markets Development (FY05),

Information, Communication, and Techology for Devt.(FY06), Audit Reform and Capacity Building (FY06),

Dam Safety Project 2 (FY06), Rural Electrification Project (FY06), Social Development & Inclusion (FY07),

Environment Sector Loan (FY07), Urban Transport (fY07), Land Policy & Management 2 (FY07), Papua Program (FY07)

a. This table presents the proposed program for the next four FYs and includes about 20% overprogramming per FY.

b. Note that project titles are subject to modification as projects are further developed over the CAS period.

c. IBRD/IDA breakdown is indicative.

d. Adjustment loan applicable only under "enhanced" Base Case.

e. Note that under the High Case $100 million would be provided in addition to the $200 million Base Case loan.

Annex B4Page 1 of 1

Product Completion FY Cost (US$000) Audience a Objective b

Recent completionsPublic Expenditure Review 2003 300 Government PS,KGRegional Public Expenditure Review 2003 200 Government, Bank, Public KGDevelopment Policy Review 2003 70 Government, Donors, Public PS,KGBali Impact Monitoring 2003 46 Government, Bank, Donors, Public KGUrban Competitiveness Study 2003 60 Government, Bank KGPromoting Peaceful Development in Aceh 2003 40 Government, Bank PS,KGIPRSP Support 2003 264 Government PDRural Services for the Poor 2003 91 Government, Bank KGFinancial Sector Strategy 2003 276 Government, Bank PS,KGPPI Framework 2003 26 Government, Bank PS,KGRoad Management Study 2003 73 Government, Bank PS,KGSectoral Perspectives on Corruption 2004 110 Government, Bank, Public KG

Underway*Aceh RPER 2004 30 Government, Bank, Donors PS,KGJustice and the Poor 2004 150 Government, Bank, Public PS,KGEducation Sector Study 2004 300 Government, Bank, Public PD,KGPRSP support 2004 250 Government PD,KGForest Policy Strategy 2004 50 Government, Public PD,KGAverting an Infrastructure Crisis 2004 300 Government, Bank, Public PS,KGMining Indonesia's Wealth Responsibly 2004 65 Government, Bank, Public PS,KGTrade Competitiveness Study 2004 260 Government, Public PS,KG

Planned*Policy Briefs for Incoming Government** 2004 890 /1 Government, Public PS,KGInvestment Climate Flagship** 2004-2007*** 565 /2 Government, Bank, Donors, Public PS,KGLocal Government Reforms Flagship** 2004-2007*** 520 /3 Government, Bank PS,KGCorruption and Legal Reforms Flagship** 2004-2007*** 335 /4 Government, Bank PS,KGCGI Brief/DPR 2004 80 Government, Donors Public PSPoverty Assessment 2005 225 Government, Bank, Public KG,PDMaking Services Work for the Poor 2007 150 Government, Bank, Public PS,PDPublic Expenditure Review 2007 300 Government PS,KG

WBI Capacity Building Program for the Government [FY04]

Integrated Water Resource ManagementCorporate Responsibility ProjectLocal Government Capacity BuildingParticipatory Review of Intergovernmental Fiscal RelationsDecentralization - Urban Program

a. Government, donor, Bank, public dissemination.b. Knowledge generation (KG), public debate (PD), problem-solving (PS).

* Estimated cost only.** Included other sub-tasks not listed in this annex. Budget ranging from $10k to $50k per task.*** Thematic tasks ongoing throughout the CAS period, with a series of deliverables. Butget for 2004 only.

CAS Annex B4 - Summary of Nonlending Services - INDONESIA

1/ includes sub-tasks (TA, Reports, Policy Notes, and Dialogue) not listed in annex plus the Education Sector Study, Forest Policy Strategy, Averting Infrastructure Crisis Study, and Mining Study listed under Underway tasks.

2/ includes sub-tasks (TA, Reports, Policy Notes, and Dialogue) not listed in annex plus the Trade Competitivenes Study listed under Underway tasks.

4/ includes sub-tasks (TA, Reports, Policy Notes, and Dialogue) not listed in annex plus the Justice and the Poor study listed under Underway tasks.

(FY03-06)

3/ includes sub-tasks (TA, Reports, Policy Notes, and Dialogue) not listed in annex.

Annex B5Page 1 of 1

Indonesia Social IndicatorsLatest single year Same region/income group

East

Asia & Low-1970-75 1980-85 2002 Pacific income

POPULATION Total population, mid-year (millions) 132.6 163.0 211.7 1,826.0 2,511.0 Growth rate (% annual average for period) 2.4 1.9 1.3 1.1 1.9Urban population (% of population) 19.4 26.1 43.0 37.3 30.8Total fertility rate (births per woman) 5.0 3.6 2.3 2.1 3.5

POVERTY(% of population)National headcount index .. ..1/ 16.0 1/ .. .. Urban headcount index .. ..1/ 7.5 1/ .. .. Rural headcount index .. ..1/ 23.1 1/ .. ..

INCOMEGNI per capita (US$) 230 530 710 900 430Consumer price index (1995=100) .. 46 283 .. ..Food price index (1995=100) .. 40 323 .. ..

INCOME/CONSUMPTION DISTRIBUTIONGini index .. 33.0 30.3 .. ..Lowest quintile (% of income or consumption) .. 8.0 8.4 .. ..Highest quintile (% of income or consumption) .. 42.1 43.3 .. ..

SOCIAL INDICATORSPublic expenditure Health (% of GDP) .. .. 0.6 1.8 1.1 Education (% of GNI) 2.8 2.0 1.2 2.3 2.8 Social security and welfare (% of GDP) .. .. 1.1 .. ..Net primary school enrollment rate(% of age group) Total 72 89 93 2/ 93 .. Male 78 90 93 2/ 92 .. Female 67 87 93 2/ 93 ..Access to an improved water source(% of population) Total .. 39 78 76 76 Urban .. 60 90 93 90 Rural .. 32 69 67 70Immunization rate(% under 12 months) Measles .. 26 68 3/ 76 60 DPT .. 27 60 77 61Child malnutrition (% under 5 years) .. .. 25 2/ 15 ..Life expectancy at birth(years) Total 51 59 67 69 59 Male 50 57 65 67 58 Female 53 60 69 71 60Mortality Infant (per thousand live births) 92 70 34 34 80 Under 5 (per thousand live births) 149 108 60 3/ 44 121 Adult (15-59) Male (per 1,000 population) 478 368 227 184 312 Female (per 1,000 population) 405 308 175 129 256 Maternal (per 100,000 live births) .. 450 373 4/ .. ..Births attended by skilled health staff (%) .. ..3/ 67 80 ..

Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment ratios exceeding 100 indicate discrepanciesbetween the estimates of school-age population and reported enrollment data. Group data are through 2001.

1/ World Bank Estimate

2/ Susenas 2002

3/ Susenas 1999

4/ Health Profile of Indonesia, Ministry of Health, 2002

Annex B6Page 1 of 1

Indonesia - Key Economic Indicators

<------------ Actual ------------> Estimate <---------------- Projected ----------------->Indicator 2000 2001 2002 2003 2004 2005 2006 2007

National accounts (% of GDP at market prices)Gross domestic product 100 100 100 100 100 100 100 100 Agriculture 17 17 17 17 17 16 16 16

Industry 46 46 44 45 46 46 46 46

Services 37 37 38 38 38 38 38 38

Total consumption 74 75 78 80 80 80 79 78Gross domestic fixed investment 22 22 20 20 20 21 22 22

Government investment a 4 3 3 4 3 4 4 4 Private investment 18 19 17 16 17 17 18 18

Exports (GNFS) b 43 42 37 32 31 31 31 31Imports (GNFS) 33 35 30 27 26 26 26 26

Gross domestic savings 26 25 22 20 20 20 21 22

Gross national savings c 18 21 19 17 16 17 18 19

Memorandum itemsGross domestic product 148 141 173 209 217 227 238 250(US$ billion at market prices)GNP per capita (US$, Atlas method) 570 680 710 820 930 1,020 1,050 1,080

Real annual growth rates (%) Gross domestic product 4.9 3.4 3.7 3.5 4.0 4.5 5.0 5.0 Gross domestic income 5.0 3.5 2.0 3.4 3.9 4.2 5.1 5.0

Real annual per capita growth rates (%) Gross domestic product 3.5 2.1 2.3 2.1 2.6 3.1 3.6 3.6 Total consumption 0.7 3.4 4.1 2.3 2.2 2.1 2.1 2.0 Private consumption 0.3 3.0 3.4 2.1 2.2 2.0 1.9 1.8

Balance of Payments (US$ Billion)

Exports (GNFS) b 70.6 62.9 64.0 67.1 67.9 69.7 73.1 76.4 Merchandise FOB 65.4 57.4 58.8 61.4 62.0 63.7 67.0 70.3

Imports (GNFS) b 55.4 50.5 51.5 56.3 57.5 59.9 62.9 65.9 Merchandise FOB 40.4 34.7 35.6 40.2 40.9 42.7 45.0 47.4 Resource balance 15.2 12.3 12.5 10.8 10.4 9.9 10.3 10.5 Current account balance 8.0 6.9 7.5 5.2 3.3 3.7 2.7 2.0

Memorandum itemsResource balance (% of GDP) 10.3 8.7 7.2 5.2 4.8 4.3 4.3 4.2

Public finance (% of GDP at market prices) d Total Revenues 19.8 20.6 18.6 19.1 17.4 17.8 18.2 18.6 Total Expenditures 21.0 23.6 20.4 21.1 18.7 18.7 18.6 18.6 o/w Current expenditures 18.8 20.7 16.9 17.4 15.3 15.1 14.8 14.6 o/w Development expenditures 2.2 2.9 3.4 3.7 3.4 3.6 3.8 4.0 Overall balance surplus (+) or deficit (-) -1.2 -2.9 -1.7 -1.9 -1.3 -0.8 -0.4 0.0 Foreign financing (net) 1.1 0.7 1.0 0.2 -0.8 -0.9 -0.9 -0.7Government debt/GDP (excl. IMF) 87.0 87.5 80.2 67.1 62.1 57.6 53.3 49.3

Monetary indicators M2/GDP 59.1 58.2 54.9 58.1 58.1 58.1 58.1 58.1 Growth of M2 (%) 15.6 13.0 4.7 16.7 10.2 9.7 10.3 10.3

Price indices( YR93 =100)

Real exchange rate (US$/LCU) e 66.2 63.1 76.8 68.5 68.2 69.3 69.9 70.6 Consumer price index (% change) 3.7 11.5 11.9 6.5 6.0 5.0 5.0 5.0 GDP deflator (% change) 9.6 10.8 7.2 6.5 6.0 5.0 5.0 5.0

a. Central government investment while regional government investment is included in private investment.b. "GNFS" denotes goods and non factor services.c. Includes net unrequited transfers excluding official capital grants.d. Central government.e. "LCU" denotes local currency units. An increase in US$/LCU denotes depreciation.

Annex B7Page 1 of 1

<----------- Actual ------------> Estimate <------------------ Projected ------------------>Indicator 2000 2001 2002 2003 2004 2005 2006 2007

Total external debt outstanding (TDO) (US$m) a 142,057 133,849 131,343 128,065 121,430 114,569 106,994 99,194

Net disbursements (US$m)a -8,934 -8,208 -2,506 -3,278 -6,635 -6,861 -7,575 -7,800

Total debt service (TDS) (US$m) b 18,730 18,212 17,364 19,537 23,238 22,572 22,858 19,817

Debt and debt service indicators (%)

TDO/XGS c 192.7 201.7 195.3 183.5 175.9 164.8 144.7 130.3

TDO/GDP 95.7 94.8 76.0 61.3 55.9 50.5 44.9 39.7

TDS/XGS 31.8 27.6 26.1 29.3 34.1 33.4 32.5 27.3

IBRD exposure indicators (%)

IBRD DS/public DS 20.9 19.6 20.3 25.1 25.1 24.3 23.5 22.4

Preferred creditor DS/public d 36.9 53.2 57.6 61.0 52.9 51.9 53.7 53.9

IBRD DS/XGS 2.3 2.7 2.9 2.9 3.0 2.8 2.6 2.5

IBRD TDO (US$m) 11,715 11,435 10,729 9,895 8,993 7,897 6,824 5,764

IDA TDO (US$m) 714 722 794 819 904 1,004 1,121 1,259

IFC (US$m) e

Loans 313 240 224 178 .. .. .. ..

Equity and quasi-equity 167 157 137 128 .. .. .. ..

MIGA

MIGA guarantees (US$m) 75 57 57 51 .. .. .. ..

a. Includes public and publicly guaranteed debt, private non-guaranteed debt, use of IMF credits and net short-term capital

b. Debt services include debt services from projected new loans.

c. "XGS" denotes exports of goods and services.

d. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the

Bank for International Settlements.

e. Includes equity and quasi-equity types of both loan and equity instruments.

Indonesia - Key Exposure Indicators

Annex B8 (IFC)Page 1 of 1

CAS Annex B8 (IFC) for Indonesia

Indonesia

Statement of IFC's

Held and Disbursed Portfolio

As of 9/30/2003

(In US Dollars Millions)

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic2003 Buana Bank 0 15.00 0 0 0 15.00 0 01994 KDLC Bali 0 0 0 0 0 0 0 01991 LYONMLFIbis 2.01 0 0 2.01 2.01 0 0 2.011985 Manulife 0 0.32 0 0 0 0.32 0 02002 P.T. Gawi 11.50 0 0 10.00 5.35 0 0 4.651997 PT AdeS Alfindo 0 6.98 0 0 0 6.98 0 01989 PT Agro Muko 0 2.20 0 0 0 2.20 0 01997 PT Alumindo 11.25 0 0 6.00 11.25 0 0 6.001989/1991/1994/2003 PT Astra 0 9.54 0 0 0 9.54 0 01997 PT Astra Graphia 0 2.00 0 0 0 2.00 0 01998 PT Astra Otopart 0 1.07 0 0 0 1.07 0 01993/1996 PT BBL Dharmala 10.29 0 0 19.13 10.29 0 0 19.131995 PT Bakrie Pipe 23.71 0 9.53 0 23.71 0 9.53 01997/2000/2002 PT Bank NISP 0 8.59 5.00 0 0 8.59 4.97 01997 PT Berlian 6.36 19.94 0 13.86 6.36 16.59 0 13.861995/1997 PT Grahawita 0 0 5.00 0 0 0 5.00 01990/1991/1993/1995/1999/2001/2003 PT IndoRama 5.01 11.80 0 0 5.01 11.80 0 01992/1994/1996 PT KIA Keramik 18.82 0 0 55.49 18.82 0 0 55.491995 PT KIA Serpih 15.00 0 0 49.50 15.00 0 0 49.501997 PT Kalimantan 20.00 15.00 0 2.09 20.00 15.00 0 2.091998/2000 PT Makro 0 3.93 0 0 0 3.40 0 01998 PT Megaplast 5.25 2.50 0 0 5.25 2.50 0 01993/1998 PT Nusantara 7.63 0 0 5.93 7.63 0 0 5.931996 PT Pramindo Ikat 0 2.13 0 0 0 2.13 0 01993 PT Samudera 0 5.00 0 0 0 5.00 0 01997 PT Sayap 5.83 0 0 2.00 5.83 0 0 2.002001 PT Sigma 0 3.00 0 0 0 3.00 0 01992/1995 PT Viscose 19.77 0 0 17.50 19.77 0 0 17.501997 PT Wings 5.06 0 0 2.13 5.06 0 0 2.132003 SMM 12.00 0 0 0 0 0 0 02001 Sunson 12.41 0 0 7.85 12.41 0 0 7.852003 Verdaine 14.00 0 0 0 0 0 0 0Total Portfolio 205.90 109.00 19.53 193.49 173.75 105.12 19.50 188.14

Approvals Pending CommitmentLoan Equity Quasi Partic

2003 PT SPA 8.00 0 0 0

Total Pending Commitment: 8.00 0 0 0

Annex B8Page 1 of 1

Closed Projects 267

IBRD/IDA *Total Disbursed (Active) 1,192.08

of which has been repaid 31.08

Total Disbursed (Closed) 22,395.35

of which has been repaid 14,772.43

Total Disbursed (Active + Closed) 23,587,431,240.74

of which has been repaid 14,803,506,413.33

Total Undisbursed (Active) 1,778.99

Total Undisbursed (Closed) 0.04

Total Undisbursed (Active + Closed) 1,779,030,912.68

Active Projects

Project ID Project NameDevelopment

ObjectivesImplementation

ProgressFiscal Year

IBRD IDA GRANT Cancel. Undisb. Orig. Frm Rev'd

P049051 BEPEKA AUDIT MODERNIZATION PROJECT S S 1997 16.4 0.9 6.341232 7.241232 6.341232P040061 ID - BENGKULU REGIONAL DEVELOPMENT S S 1998 20.5 5 10.34142 15.341424 10.34142P036048 ID - CORAL REEF MGM REHAB S S 1998 6.9 2.461138 2.4611381 2.127805P040062 ID - CORAL REEF MGMT REHA S # 1998 4.1 0.567798 0.4721419 1.679346P003701 ID ODS I- UMBRELLA HS S 1995 27 12.13853 2.1385273 3.571861P079156 ID Third Kecamatan Development Project # # 2003 204.3 45.5 249.3822P036047 ID-BALI URBAN INFRA. S S 1997 110 36.03013 15.80708 51.837206 6P003987 ID-CENTRAL INDONESIA SEC. EDU. S S 1997 104 0.001128 17.59286 17.593987P063732 ID-CORPORATE RESTRUCTRG S S 1999 31.5 24.5 0.919413 25.419413 0.705441P059930 ID-DECNT. AGRICULTURAL/FORESTRY EXT S S 2000 13 5 8.26118 3.5975851P037097 ID-E.JAVA SEC.EDUC. S S 1996 99 3.634526 12.01219 15.646717P036049 ID-EARLY CHILD DEVELOPMENT S S 1999 21.5 10.65148 3.892988 14.444472 14.43781P040578 ID-Eastern Indonesia Region Transport S S 2002 200 135.6214 30.621366P003967 ID-FIFTH HEALTH PROJECT S S 1999 44.7 5.005107 13.86395 18.859058P068051 ID-GEF-W. JAVA ENVT MGMT S S 2001 3.11 2.725293 4.3194443P073970 ID-GLOBAL DEV LEARNING (LIL) S S 2002 2.66 2.1334 0.9800667P073772 ID-Health Workforce & Services S S 2003 31.1 74.5 106.7977 5.32E-06P042540 ID-IODINE DEF. CONTROL S S 1997 28.5 9.7 2.903192 12.603192 10.10319P063913 ID-Java-Bali Pwr Sector & Strength # # 2003 141 141 7.04E-06P068949 ID-LIBRARY DEVELOPMENT PROJECT - LIL S U 2001 4.15 2.926242 1.5193695P076271 ID-PPITA S S 2003 17.1 17.1 0.3333333P049545 ID-PROVINCIAL HEALTH I S S 2000 38 24.27608 7.9035549P049539 ID-PROVINCIAL HEALTH II S S 2001 63.2 40 102.401 47.034667P040195 ID-QUALITY OF UNDERGRADUATE EDUC (QUE) S S 1997 71.2 9.89 10.94656 20.836559 10.94656P004026 ID-Railway Efficiency U U 1997 105 47.325 27.80948 75.134482 11.35208P036956 ID-SAFE MOTHERHOOD S S 1998 42.5 9.151939 7.365926 16.517865 10.51787P073025 ID-SECOND KECAMATAN DEVELOPMENT PROJECT S HS 2001 208.9 111.3 298.3441 -29.60832P041895 ID-SULAWESI BASIC EDUC. S U 1999 47.9 15.9 29.5786 28.73905P040196 ID-SUMATRA BASIC EDUCUATION S S 1999 54.5 20.1 27.716 22.135051P003993 ID-SUMATRA REG'L RDS S S 1998 234 50 40.95588 76.955883 1.289217P041894 ID-SUMATRA SECONDARY EDUCATION S S 1997 98 0.228151 9.157185 9.3853364P003700 ID-Solar Home Systems U S 1997 24.3 16.8179 0.861168 19.911944 0.625884P055821 ID-URBAN POVERTY S S 1999 100 21.57109 22.248645 15.35349P072852 ID-URBAN POVERTY II S S 2002 29.5 70.5 102.3314 8.3116667P039644 ID-W. JAVA BASIC EDUCATION S U 1998 103.5 3.760032 17.22804 -2.84193P040528 ID-W. JAVA ENVMT MGMT S S 2001 11.7 5.75 16.34627 8.4250829P064118 ID-WATSAL S S 1999 300 150 150 150P059477 ID-WSSLIC II S S 2000 77.4 69.77903 -11.11365P059931 ID-Water Resources & Irr.Sector Mgt Prog # # 2003 45 25 70.0924P048715 Indonesia - IIDP S S 1998 34.5 8.5 3.730481 12.230481 3.730481Overall Result 2541.56 633.1 58.51 241.0954 1795.28 707.63605 259.1237

Supervision Rating

Last PSR

Operations Portfolio (IBRD/IDA and Grants)

Original Amount in US$ Millions Disbursements a/

Difference Between

Expected and Actual

CAS Annex B8 - Indonesia

As Of Date 10/09/2003

a. Intended disbursements to date minus actual disbursements to date as projected at appraisal.

1

Annex B 9 – Framework for a Results-Based Country Program Pillar One: Improving Investment Climate for Poverty Reduction

Longer-Term Development Agenda for Indonesia Outcomes Influenced by the CAS Program During the 4 Year Period Bank Assistance

Strategic and Longer Term

Country Outcomes Issues and Obstacles

CAS Outcome(s) that the Bank expects to influence through its interventions and

Outcome Level Indicators

Intermediate indicators to track implementation towards expected

CAS outcome(s) Bank and partner programs Maintain macroeconomic stability • Inflation below

7%

• Debt to GDP below 60%

• Investment as % of GDP above 30%

• Growth of at least 5%

• Continued vulnerability to shocks because of high debt

• End of Paris Club restructuring

• Possible decrease in market confidence from IMF exit

• Weak tax and customs administration

• Nascent domestic government bonds market

• Vulnerable financial sector with contingent liabilities to the budget

• Decrease in tax arrears • Deficit of 1.2 % of GDP in 2004, 0.6 % in

2005 • Non-oil tax revenue to GDP up 1% point • Fuel subsidies restricted to household

kerosene • Gradual increase in development budget to

3.5% of GDP • Indonesia’s banks in compliance with

Basle Core principles

• Budget discipline maintained during election period

• Successful auctions of government bonds

• Increased disbursement ratios of foreign assistance

• Roll-out of large taxpayers’ concept to other offices

• Growing number of registered tax payers and filers

Lending – Proposed • Government Finan cial Management and

Revenue Administration Project (FY05) • Adjustment Loan (FY05) AAA • Briefings for new Government • CGI Briefs, PERs • Debt Management ASEM • Fiscal policy analysis improvement • Investment climate surveys • Local investment climate surveys • Trade and Competitiveness • WTO advice Partners IMF, AusAID debt management, USAID trade policy,CIDA, ADB, AusAID, Japan Public expenditure management

Stronger and diversified financial sector with equitable access

• Lack of alternatives to banking sector for access to capital

• Weak supervision in banking and non-banking sectors

• Public sector domination in bank ownership

• Unsustainable blanket deposit guarantee

• Inadequate access to financial services for SMEs and poorer households

• Poorly developed institutional investors

• At least 20% private ownership of all state-owned banks

• Increase in non-bank financial sector’s share of financial system assets beyond 10%

• Financial safety net is implemented (deposit insurance, lender of last resort established)

• Indonesia in broad compliance with international standards (such as BCPs, IOSCO, IAIS)

• Indonesia taken off the list of non- cooperative countries of the FATF

• No. of SMEs & poorer households with increased access to micro-finance.

• White paper on safety net published

• Commissioners in state banks appointed

• BAPEPAM’s regulatory and supervisory capacity strengthened

• Pension fund industry re-organized and restructured

• Unviable insurance firms resolved

• Anti-money laundering law revised per FATF guidelines

• Institutional framework for micro-finance in place

Lending – Proposed • Sustaining Micro-finance (FY05) AAA - On-going • Policy notes for next government • Financial sector monitoring

AAA – Proposed • Non-bank financial sector/capital market

development strategy • Study on pension diagnostics and reform

options • Strategy to improve access of poor to

financial services • Financial sector monitoring IFC Partners • IMF – Strengthening bank supervision

and creation of financial sector safety net (BI), ADB, AusAID, USAID, JICA

2

Pillar One: Improving Investment Climate for Poverty Reduction Longer-Term

Development Agenda for Indonesia Outcomes Influenced by the CAS Program During the 4 Year Period Bank Assistance Strategic and Longer Term





CAS outcome(s) Bank and partner programs Supportive environment for competitive private sector

• Weak regulatory frameworks

• Lack of inter-agency cooperation to remove investment impediments

• Unclear division of labor among levels of government

• Ineffective Competition Agency

• Lack of clarity & inconsistent enforcement of environmental regulations

• Poor quality of higher education (skills)

• Reduced time for approval of new business from current time of 168 days

• Reduced clearance time in customs • Improved corporate governance verified by

ROSC update • Clarity of functions of central and local

governments towards private sector development

• Effective average import tariff rate not higher than 9 % for agriculture and 7 % for manufacturing goods

• Improved competition in key industries (e.g., telecom, oil and gas, power) as indicated by: - new players supporting petroleum

fuels - PLN unbundling initiated - private firms’ shares in telecom industry increases • Investment climate in about 40 regions

participating in local services platform projects above the national average

• Appointment of Investment Team

• Implementation of customs reform

• Roll out of tax administration reforms

• Implementing regulations for Laws 22 and 25

Lending • Corporate Restructuring TA • Government Financial Management and

Revenue Administration Project (FY05) AAA - On-going • Diagnostic Trade Integration Study • Domestic Trade Study • PROPER Program AAA – Proposed • WBI Capacity Building – Corporate

Responsibility Project with Kenan Institute - CRS

• TA for GEG Program IFC • PENSA Partners ILO Youth Employment Network

Refurbished infrastructure

Overall • Lack of public

financing, and poor regulatory frameworks which preclude needed private sector participation

• Ill-defined government responsibilities with decentralization

Key sectors • Impending power

shortages • Poor road

maintenance • Low density of

telecom connections

• Improved institutional arrangements established for toll roads

• Increased no. of actors in the oil & power sectors

• Improved tariff structure for gas sector • Partial privatization of key infrastructure

SOEs (e.g. PGN link to proposed gas project)

• New PSP contracts concluded through transparent processes

• Issuance of “white paper” on infrastructure

• Appointment of regulators for electricity market

• Issuance of regulations for oil and gas law

• Pilot road fund and road board scheme established

• Cost-reflective tariff / user charges policies

• Improved road user charges regime implemented

• Automatic tariff adjustment mechanisms for power and toll roads

• Inter-regional transfer mechanism implemented in power sector

• OBA schemes implemented for telecom and other sectors (link to PPITA)

Lending - On-going • PPITA • Eastern Indonesia Regional Transport • Java-Bali Power Project Lending – Proposed • Domestic Gas Sector Restructuring

(FY05) • Strategic Road Infrastructure (FY05) • East Indonesia Regional Transport 2

(FY04) • Rural Electrification (FY06) AAA - On-going • Infrastructure Strategy Report IFC & MIGA Partners IFC, MIGA, JBIC, ADB

3

Pillar One: Improving Investment Climate for Poverty Reduction Longer-Term






CAS outcome(s) Bank and partner programs telecom connections

• Bankrupt water utilities

Sustainable income-creating opportunities for poorer households

Urban and rural • Uncertain property

rights and corrupt land management

• Lack of access to natural resources & coastal resources (e.g., community- managed forests, coral reef ecosystems)

• Limited access to capital

• Unfavorable SME environment

• Poor technology and a lack of information among farmers

• Irrigation network poorly maintained

• Land rights policies and legislation with emphasis on traditional tenure systems are reformed and implemented

• 2.5 million new titles issued (50% in womens’ names) in project -assisted areas

• Coral mortality index decreases by an average of 1% per year

• Avge income per capita of target groups of coastal communities increases by 5% per year in real terms

• Participatory forest land conservation management mechanisms established in pilot areas in the upper watersheds of Java

• 30,000 villages/cities with improved access to roads, bridges, irrigation and other infrastructure through participatory planning and financing

• Increased household income levels in the targeted 30,000 areas

• 20 % increase in income levels for farmers in the areas of improved irrigation systems

• Increase in productivity yields of agricultural irrigated land & in food security in 70 project -assisted districts

• Long-term leases for legalized forestry user organizations in project -assisted areas

• Viable reef management systems established in priority sites in 10 provinces

• Increased role of local government and stakeholder groups in planning and monitoring service delivery and funds utilization

• Increased involvement of women, marginalized & vulnerable groups in community planned projects and service delivery

Lending - On-going • COREMAP, UPP,KDP, Water

Resources & Irrigation Sector Mgmt, Decentralized Agricultural & Forestry Extension

Lending – Proposed • COREMAP 2 (FY04), Catchment

Protection Project (FY04), SCRAP (FY04), Local Community Support Project (FY06), Marginal Fishers’ Community Development (FY07), Land Management Policy Dev (FY05), FEAT Project (FY06), Sustaining MicroFinance (FY05)

AAA - On-going • National land policy strategy dialogue

AAA – Proposed • Indonesia Enterprise Development

Facility

IFC • PENSA Partners ADB, DFID, Dutch Trust Fund, JICA, Ford Foundation

4

Pillar Two: Making service delivery responsive to the needs of the poor Longer-Term



CAS Outcome(s) that the Bank expects to influence through its

interventions and Outcome Level Indicators

Intermediate indicators to track implementation towards expected CAS

outcome(s) Bank and partner programs Accelerate attainment of key MDGs in education and health Better education outcomes for the poor • Increases in

primary and junior secondary school net enrollment & completion rates (girls/ boys)

• Improvement in

Indonesia’s performance in international standardized assessment (e.g. FIMSS)

Legacy of overly centralized, unresponsive service provision: • Failure to account for

community needs and service quality

• Weak monitoring, evaluation and information dissemination

• Limited funds used sub-optimally (e.g., pay for inputs, not results)

• Limited private sector role

• Poor targeting and accountability of social safety net programs

• Roles of government levels not clearly defined

(including for environmental and natural resource management) • Lack of service

standards • Weak monitoring and

feedback at local level (including on environmental quality)

In Bank-assisted areas, improved quality, coverage, and utilization of basic education and health services, especially for the poorest 40%:1 Education: • Increase in enrollment rates at the

jr. secondary school level • Increase in completion rates, at the

primary & jr. secondary school levels

• Improvements in test scores, using

international standards • Increase in the number of primary

and jr. secondary schools which meet govt. quality standards

Education: • Increase in level of efficiency of public

financing for essential education programs

• Implementation of new system for

student assessments • Govt. adoption of new budgeting,

financing, planning, and management procedures for education delivery (including financing mechanisms to guarantee access for the poor)

• New policies on teacher management

and performance adopted and implemented

• New policies on quality standards

adopted and implemented • Increased participation of communities

in the delivery of education services

For Education and Health: Lending - Ongoing Education Basic Ed • West Java Basic Education • Sulawesi & Eastern Islands Basic

Education • Sumatra Basic Education Junior Sec.Ed • East Java & NTT Jr. Secondary Education • Central Ind. Jr. Secondary Education • Sumatra Jr. Secondary Education Other • Library Development, Early Childhood Dev. • CDD Projects (KDP 2, UPP 2) Health • Intensified Iodine Deficiency Control, Safe

Motherhood, Health V, Provincial Health Projects , Health Workforce & Services (PHP 3)

• WSSLIC 2 Lending – Proposed Education • Higher Education (FY05), • Strengthening Capacity for Decentralized

Education (FY06) Health • Provincial Health and Nutrition (FY05) • Health Sector Project (FY07) • WSSLIC 3 (FY06) Other • CDD: KDP 3, UDP 3, SCRAP • ILGRP/USDRP AAA - On-going Education • Education Sector Review

1 Baseline data collection for health and education will be done in FY04.

5

Pillar Two: Making service delivery responsive to the needs of the poor Longer-Term






outcome(s) Bank and partner programs Improved health outcomes for the poor Maternal mortality rate decreases from 373 per 100,000 (1995) Under 5 child mortality rate decreases from 60 per thousand live births (2002) % of under 5 children who are underweight decreases Increase in proportion of population with sustainable access to an improved water source and proper sanitation (urban/rural)

(Continued from previous page) • Local capacity weak • Political accountability

evolving • Persistent funding

shortages • Poor costing &

funding strategies • Conflict -induced

service disruption

Health (change in the listed indicators for the poorest 40% of the population in Bank-assisted areas) • Increased % of deliveries assisted

by trained health workers • Increased % of childhood

immunizations • Improved nutritional status,

especially for children under 5 • Increased % of households with

access to safe drinking water and sanitation in 2000 villages & 20 urban areas

• Increased % of households

practicing improved key hygiene practices in target areas.

Health: • Costed strategies for key health

priorities linked to the MDGs • Increase in level & efficiency of public

financing for priority health programs • Increase in number of district

governments with the capacity to implement pro-poor planning, monitoring & reporting of health services, outputs & outcomes.

• New policies on management of health workforce performance, adopted & implemented

• Central and % of local governments adopting enabling legal, regulatory & policy frameworks for community-managed WSS services.

• 20 operationally efficient and financially sustainable urban water utilities

• Implementation of the local governments’ good environmental governance program

• Increased participation of communities in health service delivery

Health • Decentralization, Private Sector, Cost Analysis of HIV Control • Environment, PROPER AAA – Proposed HD • Poverty Assessment • Delivering Local Services • Private Sector Constraints in HD Services Education • Education Policy Briefs • Yogya Education Sector Analysis Health • Health Policy Briefs • Nutrition Review • Decentralization • Analytic and Policy Basis of HIV Control • Environment • GEG program TA • WBI Capacity Building – Integrated Water

Resources Management Partners ADB, JBIC, JICA, Netherlands, AusAID, USAID, Unesco, Unicef, WHO, EU, DFID, WASPOLA

6

Pillar Three: Addressing the core issue: governance, accountability, corruption

Longer-Term Development Agenda for Indonesia Outcomes Influenced by the CAS Program During the 4 Year Period Bank Assis tance Strategic and Longer Term





outcome(s) Bank and partner programs Development planning is responsive to constituents

• Lack of political commitment to governance reform

• Poor accountability of political and economic elites

• Local level governments face a legacy of overcentralization with little capacity

• Weak civil society organization and hierarchical relations at the village level

• Core group of at least 40 regions participating in local services platform projects records significant improvements in governance outcomes

• One third of all villages in Indonesia engage in a participatory approach to development planning, execution, and oversight.

• Implementation of an effective independent monitoring system for verification and evaluation of government reform commitments as set out in the “White Paper”

• No. of local districts and cities with significant concentrations of Bank projects

• No. of local governments that open their budgeting, planning and financial mgmt. practices to greater public participation and scrutiny

• Adoption of improved financial control and public procurement procedures

• Enhanced disclosure and reporting procedures for policy-making and planning decisions are implemented

• Two thirds of the districts and cities participating in KDP and UPP projects adopt PERDAS

• Increase in civil society involvement in government policy-making and planning.

• Increased participation of women and marginalized groups in policy-making at the village level

Lending - On-going • KDP, UPP, WISMP Lending – Proposed • ILGRP, USDRP (FY04) AAA - On-going • Partnership for Governance Reform • Governance and Decentralization Survey • KDP/UPP Assessment tools • Monitoring and Evaluation programs AAA – Proposed • Governance and Anti-Corruption Flagship • Local Government Flagship • Evaluation and support for local legislatures IFC • Investment Climate Surveys Partners DFID, ADB, Netherlands, Japan, Partnership for Governance Reform

7

Pillar Three: Addressing the core issue: governance, accountability, corruption Longer-Term

Development Agenda for Indonesia Outcomes Influenced by the CAS Program During the 4 Year Period Bank Assis tance Strategic and Longer Term





outcome(s) Bank and partner programs Regulated and transparent public financial management

• Substantial capacity building needed to ensure effective dissemination across all levels of government

• Weak political commitment

• Demonstrable evidence of improved performance of tax and customs collection and greater transparency in implementation of tax and customs regulation as indicated by increased revenues to GDP, increase in registered tax payers and filers, reduced tax arrears, and reduced clearance time in customs

• Increased transpiring of finances, laws and regulations

• Reduced leakage in expenditure flows to end-users as measured by Public Expenditure Tracking Surveys

• Issuance of necessary implementing regulations for Laws 22 and 25 with respect to public financial management

• New sectoral laws are harmonized with Law 22

• Regions are assigned authority over land and real estate tax rates

Lending - Proposed • ILGRP, USDRP (FY04) AAA - On-going • Partnership for Governance Reform • Governance and Decentralization Survey • World Bank Dutch Trust Fund • Monitoring and Evaluation Programs

AAA – Proposed • Local Government Flagship • Evaluation and support for local legislatures • WBI Cap. Building for Local Governments Partners • DFID, ADB, Netherlands, USAID, GTZ,

Partnership for Governance Reform, Japan, IDF grants for disclosure & procurement

Effective implementation of decentralization

• Uncertainties in the delineation of autonomy at different levels of government

• Clarification of roles and responsibilities for supervision and regulation

• Greater clarity in functions at each level of government through Laws 22 and 25

• Percentage of district governments that can raise revenue to meet expenditure responsibilities

• Improved and more equalizing transfer system

• Increased transparency of finances, laws, and regulations at the district level through establishment of an accessible information system and mechanism for publishing PERDAs.

• Local governments adopt sound public financial management and procurement practices

• Enactment of laws and associated implementing regulations on state finances, treasury management and public procurement.

• Effective implementation of Ministry of Finance restructuring plan and program for reforming tax and customs administration as indicated by: -Establishment of National Public Procurement Office

-Implementation of Public Expenditure Tracking in selected areas where threats of leakage are high -Clarification of financial management standards for local governments.

Lending - On-going • BPK Improvement Project

Lending – Proposed • Government Financial Management and

Revenue Administration Project (FY05) • Program loan focused on fiduciary

environment AAA - On-going • World Bank Dutch Trust Fund for

Strengthening Decentralization • Local Civil Service Reform Options

(ASEM) AAA – Proposed • Public Expenditure Tracking Surveys • Expenditure Management Study • WBI Cap Building – Urban Decentralization • WBI Cap Building – Participatory Review of

Intergovernmental Fiscal Relations Partners GTZ, USAID, CIDA, Netherlands, DFID, ASEM, Japanese

8

Pillar Three: Addressing the core issue: governance, accountability, corruption Longer-Term

Development Agenda for Indonesia Outcomes Influenced by the CAS Program During the 4 Year Period Bank Assis tance Strategic and Longer Term





outcome(s) Bank and partner programs Establishment of a credible and impartial justice sector

• Formal justice system lacks credibility among most Indonesians

• Political commitment to reforming legal institutions is very weak

• Poor face significant obstacles in reaching the formal justice institutions.

• Significant improvements in corruption perception measures and in survey-based measurements of popular trust in court system in project -assisted areas

• Doubling of the share of cases investigated as a result of irregularities revealed in BPK audits

• Full compliance with wealth declarations by public officials as established by law

• Increased %of poorer households and SMEs using legal, paralegal and alternative dispute mechanisms in at least 40 districts

• Increased use of informal institutions and networks for protecting property and contract rights.

• Effective functioning of institutional framework for investigating and prosecuting corruption cases including: -Anti-Corruption Commission

- Anti-Corruption Court -Restructuring of Attorney General’s Office • Establishment of a network of paralegal

assistance, alternative dispute resolution mechanisms, and legal literacy training, with special focus on conflict areas

• Barriers lowered for entry into the formal court system by reducing costs of accessing justice sector.

Lending - On-going • SCRAP Lending – Proposed • ILGRP, USDRP AAA - On-going • Justice for the Poor • Partnership for Governance Reform • Governance & Decentralization Survey • Dissemination of Anti-Corruption Studies AAA – Proposed • High courts TA IFC Partners Partnership for Governance Reform, DFID

Annex B10Page 1 of 1

As of September 24, 2003

Network areaCountry

performance aMajor issue b Country priority c Bank priority c Reconciliation of

country and Bank priorities d

Poverty Reduction & Economic Management

Poverty reduction Good Develop and implement PRSP

High High

Economic policy Good Structural reform High High

Public sector Fair Decentralization/Governance/anti-corruption

High High

Gender Fair Decentralization Moderate Moderate

Human Development Department

Education Fair Quality of & access to basic education

High High

Health, nutrition & population

Fair Quality of & access to health services

High High

Social protection Good Effective targeting Moderate Moderate

Environmentally & Socially Sustainable Development

Rural development Fair Rural incomes and infrastructure

High High

Environment Fair Forests, water & sanitation Moderate Moderate

Social development Good Community development & participation

High High

Finance, Private Sector & Infrastructure

Financial sector Fair Bank restructuring High High

Private sector Fair Corporate restructuring, SMEs

Moderate High Slow progress in privatization

Energy & mining Fair Policy reforms Moderate Moderate

Infrastructure Poor Rebuilding High High

a. Uses “excellent,” “good,” “fair,” or “poor.”

b. Indicates principal country-specific problems (e.g., for poverty reduction, “rural poverty;” for education, “female secondary completion;”

for environment, “urban air pollution”).

c. Uses “low,” “moderate,” or “high.”

d. Provides explanation if priorities do not agree; for example, another MDB may have the lead on the issue, or there may be ongoing dialogue.

CAS Summary of Development PrioritiesCAS Annex B10 - Indonesia

Annex B11 Page 1 of 1

Indonesia: Key Environmental Indicators

Indonesia East Asia &

Pacific Low -Income Population (millions) 211.7 1826 2511 Urban population (% of total) 43 37 31 GDP ($ billions) 173 1,665 1,082 GNI per capita, Atlas method ($) 710 900 430 Agriculture Land area (1,000 sq. km) 1,812 15,885 33,031 Agricultural land (% land area) 23 48 .. Irrigated land (% of crop land) 14.4 38.4 25.2 Fertilizer consumption (100 grams/ha arable land) 1,207 2,286 663 Food production index (1989-91=100) 117 161 128 Population density, rural (people/sq. km arable land) 594 640 510 Forests Forest area (1,000 sq. km) 1,050 4,238 9,131 Forest area (% of total land area) 57.0 27.2 27.1 Annual deforestation (%, 1990-2000) 1.2 0.2 0.8 Biodiversity Mammal species, total known 436 .. .. Mammal species, threatened 147 .. .. Bird species, total known 1,519 .. .. Bird species, threatened 114 .. .. Nationally protected area (% land area) 19.7 9.2 9.2 Energy GDP per unit of energy use (PPP$/kg oil equiv) 4.2 .. 4.0 Commercial energy use per capita (kg oil equiv.) 706 871 569 Energy imports, net (% commercial energy use) -58 -2 -9 Electric power consumption per capita (KWh) 384 760 352 Share of electricity generated by coal (%) 31.1 66.2 45.0 Emissions and pollution CO2 emissions per unit of GDP (kg per PPP $ of GDP) 0.4 0.6 0.5 CO2 emission per capita (mt) 1.2 2.1 1.0 Consumption of CFCs (ODP metric tons) 5,411 57,075 20,096 Particulate matter (pop-weighted average-µg/m3) 102 69 64 Passenger cars (per 1,000 people) 14 10 9 Water & Sanitation Freshwater resources per capita (cubic meters) 13,759 6,020 6559 Freshwater withdrawal total (% total water resources) 2.6 .. agriculture (% total freshwater w ithdrawal) 93 81 90 Access to improved water source (% total population) 78 76 76 rural (% rural population) 69 67 70 urban (% urban population) 90 93 90 Access to sanitation (% total population) 55 46 44 rural (% rural population) 46 34 31 urban (% urban population) 69 72 72 Under-5 mortality rate (per 1,000 live births) 45 44 121 National accounting aggregates - 2001 Gross national savings (% GNI) 23.6 36.8 22.1 Consumption of fixed capital (% GNI) 5.4 9.3 8.8 Education expenditure (% GNI) 0.6 2.2 2.8 Energy depletion (% GNI) 12.0 3.9 6.6 Mineral depletion (% GNI) 1.2 0.3 0.4 Net forest depletion (% GNI) 0.0 0.2 0.3 CO2 damage (% GNI) 1.1 1.9 1.6 Particulate emission damage (% GNI) 0.5 0.8 0.6 Adjusted net savings (% GNI) 4.0 22.6 6.6

Indonesia Country Assistance Strategy 1 of 3

ANNEX C: MACROECONOMIC PERFORMANCE AND PROSPECTS

MACROECONOMIC PERFORMANCE DURING THE LAST CAS

• Moderate growth in 2000-2002. Indonesia’s average annual growth rate during 2000-2002 was 4 percent. Although investment grew strongly in 2000, the resumption was short- lived. Consumption was the main engine of growth, and private consumption was increasingly fueled by consumer credit. While Indonesia has gained macroeconomic and political stability, the investment climate remained weak throughout the period.

• Nominal GDP growth contributed to the decline in the government debt to GDP

ratio. The ratio improved from 88 percent in 2000 to 80 percent in 2002. During that period, debt outstanding increased by $6 billion, while nominal GDP increased by $23 billion. In 2000-2002, the primary balance was well above 3 percent of GDP on average, however interest payments led the balance into deficits. The Government had to rely on foreign financing to fill the deficits despite its efforts to collect resources through non-debt financing (e.g. privatization and IBRA asset sales). The average rupiah (Rp.) to dollar exchange rate depreciated from Rp.8,400 in 2000 to Rp.9,300 in 2002, which decreased the nominal GDP in dollars.

• High current account surplus . The average current account surplus in 2000-2002 was

$7.5 billion. During the period, oil prices ($25.3/bbl) were higher than historical average, which may have contributed $1.0-1.5 billion per annum to balance of payments. In addition, interest payments were less due to the global interest rate decline.

MACROECONOMIC PROSPECTS OVER THE NEXT CAS

• The Base case envisions that the real growth rate reaches 5 percent in 2006. The

Base case scenario assumes continued, but halting progress on reforms. This will in turn lead to improvements in the investment climate and actual investment. As a result, the growth rate is likely to gradually accelerate from the estimated 3.5 percent in 2003 to 5 percent in 2006. The main engine of growth will gradually switch from consumption to investment. The external environment is likely to be supportive of the economy.

• Conducive investment climate and potential GDP. Indonesia needs more investment in

new production capacity as well as in maintenance of existing capacity—both of which require a conducive investment climate. Ongoing fiscal consolidation is likely to enable the Government to increase investment in development over the CAS period. However, the resumption of private investment is also critical. The improvements in macroeconomic and political stability over the past 2 years have not yet successfully led to actual investment. Small investment volume in recent years may have prevented not only the growth of new production capacity, but also the proper maintenance of existing capacity. Unless the investment climate is quickly improved, Indonesia’s potential growth rate may face supply constraints.


• Productivity growth through accelerating reforms . The increase in production capacity is not the only way to accelerate the growth rate. Productivity efficiency also plays a key role. In the past 40 years, about one-third of Indonesia’s growth was achieved through productivity efficiency gains or TFP (total factor productivity), though this phenomenon was less pronounced in more recent years. In order to realize the growth rate envisioned in the CAS, productivity growth rates should be increased. Acceleration of reforms is a key for productivity growth, since reforms may reduce business transaction costs.

• Demand will pick up over the CAS period. In the short-term, demand plays an

important role. The main engine of growth will gradually switch from private consumption to investment, although the election is likely to increase consumption and decrease investment in 2004. External demand is likely to be supportive for the economy in coming years. The latest World Bank projection (Global Development Prospect 2004) foresees the world GDP growth rate to accelerate from 1.9 percent in 2002 to 2.9-3.0 percent in 2004-2005, and world trade volume growth rate to accelerate from 3 percent in 2002 to 7.9 percent in 2004-2005. These positive external factors are likely to contribute to Indonesia’s exports and FDI inflows. For example, Indonesia’s export volume would increase by 0.8 percent and real GDP growth rate would increase by 0.4 percent if world trade volume were to increase by 1 percent.

• A gradual depreciation of the real exchange rate. The real exchange rate is projected

to depreciate gradually over the CAS period. This is partly a reaction to the appreciation of the rupiah since April 2001 (between April 2001 and July 2003, real exchange rate appreciated by 45 percent). However, the real exchange rate is still below the pre-crisis level by 20 percent, and not out of line with other former Asian crisis countries (Annex Figure C1) Indonesia’s exports products are still competitive in terms of prices.1 The depreciation of the rupiah negatively

1 This depends on sectors. For example, electrical products exports, one of the main commodities, have large imports contents and therefore the exchange rate impacts are relatively small. On the other hand, textile exports, which have relatively large domestic contents, are affected by the recent exchange rate movements.

Annex Figure C.1: Real Effective Exchange Rate (December 1996=100)

20

30

40

50

60

70

80

90

100

110

120

Dec-96

Jun-97

Dec-97

Jun-98

Dec-98

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Dec-01

Jun-02

Dec-02

Jun-03

Indonesia

Malaysia

Thailand

Philippines

Dec 96=100

Source: IMF, staff estimates


affects the government debt to GDP ratio. However, further fiscal consolidation as well as the acceleration of growth would be able to offset this negative impact.

• Fiscal consolidation continues. The Government is committed to fiscal consolidation.

The budget is projected to balance in 2007.2 Non-oil and gas revenues are expected to increase through improvements in tax administration, which enable the government to allocate more resources on development expenditures. As the government is likely to focus on non-debt financing (e.g. privatization and bank financing), government debt outstanding will decline, which will lead to a further reduction of the government debt to GDP ratio. The government debt to GDP ratio is projected to decline to 49 percent in 2007.

2 World Bank projection. The government projects the budget will be balanced in 2006.


ANNEX D: INDONESIA POVERTY PROFILE AND ANALYTICAL AGENDA

POVERTY PROFILE

Indonesia has made remarkable progress in reducing expenditure poverty in recovering from its economic crisis but has not yet brought poverty down to pre -crisis levels. Whereas growth had assisted Indonesia in bringing its poverty headcount index down from 60 percent in 1970 to 15.7 percent in 1996, the economic crisis resulted in expenditure poverty rates exploding to 27 percent by 1999. Since then, the success in macroeconomic stabilization – by bringing inflation and the exchange rate under control – has underpinned Indonesia’s success in lowering its expenditure poverty rate to 16 percent by 2002. Maintaining macro-stability and generating faster growth through an improved investment climate are critical to poverty reduction in Indonesia.

But poverty is multidimensional, and looking beyond expenditure poverty shows that the problems of poverty are serious in Indonesia and are compounded by poor service delivery. Indeed if one considers access to basic health, education, water, and sanitation services (e.g. as measured by births attended by traditional healers, child enrollment, household access to sanitation and to water), improvements have been slow. These are also reflected in poor MDG outcomes, particularly in health (see Table 1 and as discussed in the text), relative to countries within the region. Women in particular suffer problems of access to quality services and bear the consequences: Indonesia’s maternal mortality rate is two times greater than the Philippines and five times greater than Vietnam. Moreover, even many expenditure non-poor households are deprived in terms of access to basic services as defined above. If lack of access to each of the above services is seen as a separate dimension of poverty, as many as 53 percent of Indonesians would be defined as poor on the basis of at least one such dimension of poverty. In other words, poor service delivery is failing the expenditure poor and is itself also the cause of poverty and deprivation in Indonesia. The problems of the poor are not limited to the problems of generating income. Traditional attempts at targeted income transfers or relying only on expanding access to credit will not solve these problems. Directed efforts to improve the delivery of basic services must thus be a critical facet of any effort to reduce multidimensional poverty in Indonesia.

The national headcount index masks wide disparities and variations in poverty incidence rates across the country. While the poverty rates are 15.7 percent and 4 percent on Java and Bali, the Eastern Islands lag, with poverty rates of 36.8 percent. The severity of poverty is similarly more serious in the Eastern Islands in general, with the depth of poverty at 7.8 percent in NTT/NTB relative to 2.5 percent in Java and Bali. The story on regional disparities and lagging regions is tempered by several additional facts. First, the recovery from the crisis in terms of expenditure poverty appears to have benefited almost all regions: indeed all but one province captured in the 2002 household survey saw an improvement in poverty rates, including strong recoveries from some regions in the East. Second, despite regional disparities, 78 percent of Indonesia’s expenditure poor live in Java, Bali, and Sumatra. Third, regional multidimensional


poverty maps show strong geographic correlations between expenditure poverty measures and other measures of poverty at the provincial level, with Nusatenggara having low levels of service access in general. Overall, Bengkulu, West Kalimantan, Central Java, East Java and Nusa Tenggara lag behind other provinces with respect to multidimensional, non-expenditure poverty measures. Addressing poverty in Indonesia will not only require efforts of bringing along the lagging regions but importantly also addressing poverty among the poor in non-lagging regions.

There are key rural and urban dimensions to Indonesia’s poverty. Most of Indonesia’s poor (78 percent) live in rural areas. Here a noteworthy fact is that whereas 65 percent of poor households are agricultural, only 50 percent of their income is from farming and 8 percent from agriculture wage work. Small landholdings and lags in productivity increases means that off- farm rural income sources are increasingly important for these poor. While 22 percent of the poor live in urban areas, this represents 7.6 million people. The problems of urban poverty are largely shaped by unemployment. Male, female and even youth unemployment rates are indeed much larger in urban areas. Male unemployment rate among the poor in urban areas, at 7.7 percent, is more than three times the rate in rural areas. The female unemployment rate, at 9.4 percent among the poor in urban areas, is almost twice the rural rate. Poverty reduction efforts must necessarily focus on the dual dimensions of urban and rural poverty in Indonesia, with an emphasis on creating economic opportunities and jobs, including off-farm income opportunities in rural areas.

An important characteristic of poverty in Indonesia is vulnerability to shock. The vulnerability to falling into poverty among many Indonesian households is simply reflected in the clustering of a large share of households just above the income poverty line. This phenomenon is reflected by the fact that 7.4 percent of Indonesians fall under the dollar-a-day poverty line whereas 53.4 percent fall under the two dollars-a-day poverty line. (The national poverty line is currently approximately 1.5 dollars a day.) Analysis has shown that the poor are vulnerable to a series of shocks, most important of which are price shocks to their consumption bundle (and particularly to rice, the main staple of the poor), catastrophic illness of household members, and crop failure. In addition, ongoing analysis shows that an important source of vulnerability among Indonesian households is conflict and related insecurity – in many regions throughout the country. Gender vulnerability is also a key issue. Females, even though having similar jobs with similar education levels, on average earn less and have more difficulty in securing good jobs, regardless of sector and level of education. Reducing vulnerability of households to poverty will mean lifting more people further above the poverty line through growth, mitigating the sources of vulnerability such as conflict and natural disasters, and enhancing informal and formal coping mechanisms for households, including through well targeted safety net programs.


POVERTY ANALYSIS

Background

Indonesia has a well developed system of surveys to monitor poverty but these are underutilized to address policy issues. There is no shortage of data on poverty. 1 The data have been mostly used to monitor changes in welfare, target expenditures across regions and monitor benefit incidence of government programs. The Government of Indonesia uses the data to support poverty monitoring and government programs, including geographic targeting of programs2.

Importantly, there is too little analysis of policy issues, and poverty analysis does not feed into the policy debate and the policy making process. There have not been many studies beyond measuring and looking at targeting issues. There have been too many trials of poverty alleviation programs that have not been properly evaluated.3 Several gaps in analysis are eminent, such as: What policy interventions will help raise the return to the assets, opportunities, and incomes of the poor? In the context of decentralization, how can the ability of local governments be enhanced to reach the poor? What measures will increase the voice of people so that public and private services are made more accountable to them? What do we learn from past poverty alleviations programs, and in the context of fiscal consolidation, how can social protection expenditures be made more efficient and effective in protecting the poor? Donor institutions, including the World Bank, heavily rely on the BPS data for monitoring and analyzing government policies. In 1993 the World Bank published an analysis of poverty, public services and poverty. 4 The poverty lines that were constructed for this report have formed the basis for World Bank poverty analysis since. The Voices of the Poor5 and Community, Poverty and Livelihoods6 studies were two additional qualitative poverty analyses undertaken with World Bank

1 BPS, the Indonesian Bureau of Statistics, fields the Susenas household survey which collects a key set of welfare indicators for a large sample – about 200,000 – households. Three modules are fielded along with this survey to one third of the sample on a rotational basis. They collect detailed information on consumption, education, health and household welfare. Since 2003 the Susenas also includes a 10,000 household panel component. In addition to the Susenas, BPS fields a community census every 3 years (PODES), a labor market survey every year (Sakernas), farmers terms of trade survey every month, a regular, agricultural and economic census every 10 years, and a mini census every 10 years in between the regular full censuses. BPS data are accessible to the public at reasonable cost. The RAND cooperation, with the University of Indonesian and later Gadjah Mada University, has fielded the Indonesian Family Life panel Survey in 1993, 1997 and 2000. Data are accessible at no cost but with a substantial lag. 2 PODES and Susenas data are used to rate wealth of regions and the central planning agency uses these scores to allocate poverty programs across regions. 3 Although local research institutes use the data frequently, and their publications are cited widely, there is a lack of cross check and peer review of findings. 4 World Bank. 1993. “Indonesia - Public expenditures, prices and the poor.” Report 11293. Washington D.C., and Ravallion, Martin and Benu Bidani (1994) “How Robust Is a Poverty Profile?” World Bank Economic Review v8, n1 (January 1994): 75-102. 5 World Bank. 1999. “Indonesia: Consultations with the poor,” prepared for global synthesis workshop held from 9/22-9/23 PREM, the World Bank. Or DFID report 6 DFID and World Bank. 2002. “People, Poverty and Livelihoods: Links for Sustainable Poverty Reduction in Indonesia”.


involvement. A Poverty Assessment by the ADB was completed in 2000.7 The last World Bank Poverty Assessment dates back to 2001.8 This report emphasized two themes that defined the needs for a new kind of poverty strategy. First, poverty definitions need to be redeveloped to acknowledge the broader, multidimensional, more dynamic reality of poverty. Second, Indonesia needs a poverty strategy consistent with an empowered populace and democratic policymaking mechanism through acknowledging that the poverty agenda is a governance agenda.

INDOPOV: A Poverty Analysis Program to Support this CAS

Over this CAS period, the World Bank is seeking to strengthen the analysis of poverty in Indonesia through the Indonesia Poverty Analysis Program (INDOPOV). This is a three year program of analytical, policy and operational work on poverty designed to feed into and support the Government of Indonesia in the preparation and implementation of its Poverty Reduction Strategy, as well as to enhance the poverty focus of work within the World Bank in Indonesia. In partnership with others, this program will seek to address key gaps in poverty analysis in Indonesia currently. INDOPOV will adopt a programmatic approach focusing on four key themes, aligned with both the CAS and the themes chosen by the Govenment for the preparation of the PRSP. These themes are:

• Poverty analysis and policy linkages—which will undertake high quality analytical work on poverty and vulnerability, broaden the policy debate on poverty issues, and improve capacity for monitoring and evaluation.

• Creating a pro-poor investment climate—which will analyze linkages between macroeconomic policy and poverty, quantify the constraints to pro-poor growth at the local level, promote a better understanding of the impact of labor market regulation on employment creation, and help to develop strategies for outlying and lagging regions.

• Making services work for the poor—which will seek to understand the determinants of poor development outcomes, strengthen client-provider relationships, and explore how public spending can be made more effective in three sectors, education, health and water and sanitation. In addition there will be a special program of work on social protection services.

• Governance and poverty – which will focus on linking planning and budgeting to poverty, understanding the determinants of pro-poor change, and determining the poverty payoff of specific governance reforms.

A mixture of qualitative and quantitative tools will be used, drawing on the many rich sources of data in Indonesia mentioned above. In each area the work will be closely integrated with policy and operational work. Coalitions of partners will be built around the work program and the results will feed into the ongoing policy dialogue in each area. 7 ADB. 2000. “Assessment of Poverty in Indonesia,” Manila. 8 World Bank. 2001. “Indonesia: Constructing a new Strategy for poverty reduction,” Report 23028-IND, Washington D.C.


Projects and platforms will provide an operational home for much of the work ensuring that results influence World Bank policy and practice.


ANNEX E: SUMMARY OF CAS CONSULTATIONS

Several methods were used to elicit input to the CAS from about 400 civil society representatives, including regional focus groups (conducted in five cities), thematic and issue-specific discussions, as well as interviews with diverse stakeholders.

The in-depth interviews were held in five different regions with approximately 60 respondents, mainly important stakeholder leaders and opinion makers. The two-day focus groups were organized in four regions, involving various segments of civil society, including the private sector. Thematic discussions covered governance, decentralization, micro-credit, land reform, investment climate, rural development, public service delivery, and macroeconomic issues.

The consultations were organized between March and July 2003. Findings were assimilated into drafts of the CAS and discussed by the Indonesia Country Team, including at its CAS planning retreat in May 2003.

Separately, the Bank has also undertaken CAS consultations with central and regional governments and their development partners, all of whom have been informed of the CAS time-line. These consultations were held on different issues at critical times during the CAS process.

A follow-up consultation was also organized in Jakarta in October, involving representatives from the regional groups, where the points of recommendations from civil society were further discussed. In this follow-up consultation, civil society representatives were presented a response matrix where each of their recommendations were provided written response. The follow-up consultation was kindly financed by the Norwegian Government through their trust fund.

The main recommendations from the civil society and local governmental consultations are reflected below.

MAIN RECOMMENDATIONS FROM CIVIL SOCIETY CONSULTATIONS

• Economic crisis had a damaging impact on basic infrastructure related to the lives and needs of the general population. In response, poverty reduction programs must employ World Bank loan assistance to remedy this damage. These loans should be focused on developing basic services and infrastructure, particularly in primary education, water supply and sanitation, nutrition and basic health services, as well as power generation and road transportation. The primary focus should be on developing rural areas.

• One of the main challenges Indonesia must confront after the economic crisis is job creation. The World Bank should prioritize overcoming unemployment and reducing social problems by supporting SMEs and labor intensive sectors such as agriculture, transportation, and infrastructure.


• World Bank loans to regions should be based on two main considerations: (i) that the region has the capability to repay the loan, and (ii) that the regional government has applied accountability and transparency principles of governance. The World Bank can provide incentives to kabupatens or municipalities to foster greater accountability and transparency and improve governance. Governance improvements can also be achieved by building capacity of sub-national institutions.

• The World Bank should urge the Government of Indonesia to strengthen its anti-corruption efforts through improved law enforcement and heavier punishment of perpetrators. Special requirements should be integrated into loan packages to ensure the Government of Indonesia’s commitment to eliminating corruption, collusion and nepotism (KKN), namely by encouraging more extensive public involvement as a control mechanism. Corruption cases should also be announced publicly. In the projects it is financing, the World Bank should apply an early warning system that will detect corruption at its early stage.

• The World Bank should urge the Government to pass legislation on public participation in the law making process, both at regional and national levels. The freedom to access information should also be encouraged to promote disclosure and transparency in all levels of government.

• Every year the World Bank should publicize through easily accessible media channels a list of its ongoing projects—containing project names, locations, and fund allocations—in addition to relevant World Bank policies. Efforts to disseminate information should also be focused on local levels where projects are located. The World Bank needs to provide information on project accountability and transparency, in addition to supplying a mechanism for public complaints.

• The World Bank’s involvement in the land sector should focus on increasing the government’s “political will” to promote agrarian reform, particularly related to the use, rights, and redistribution of land, among other things.

• The World Bank should not support projects that damage the environment and natural resources, or violate the rights of indigenous communities.

• Education represents a very important investment for the future of Indonesia. The World Bank needs to support education by providing grants and/or technical assistance to comprehensively reform the national education system. The World Bank should work to increase accessibility of the poor to education, namely through building and rehabilitating school buildings and providing teaching aids, especially in rural and remote areas. This includes investing in the training of teachers and promoting programs for the interest of women.

• The World Bank should support the institutional building of media councils. In its various reports, the World Bank has acknowledged the important role the media is


playing in development. This statement should be transformed into concrete contributions and help in building capacity of this sector.

MAIN RECOMMENDATIONS FROM CONSULTATIONS WITH REGIONAL GOVERNMENTS

• The World Bank should urge the central Government to finalize the decrees supporting the implementation of the decentralization laws (Laws No. 22 and 25/1999). This priority is also echoed by civil society representatives. The implementing regulations would include authority over the management of natural resources, forestry, mining, investment, land matters, fiscal matters, as well as oil and gas. There is a noticeable need for a combined bottom-up and top-down planning process in the form of spatial planning that unites the central interests and local needs.

• The World Bank should support capacity building initiatives within sub-national governments, namely to improve managerial and administrative skills to help institutions provide first-rate public service.

• The World Bank should help the government to create minimum public service standards for sub-national governments. Doing so would help promote innovations and improve the quality of public service delivery.

• The World Bank should support the development of infrastructure and basic services in health, education, irrigation, water supply and sanitation, and roads and transportation, in addition to supporting poverty alleviation programs to revitalize the economy.

• The World Bank should assist small and medium enterprises (SMEs) by developing policies and facilities that further expand broad-based economic growth, namely through SME credits. This priority is also echoed by civil society representatives.


ANNEX F: ENVIRONMENT

Over the years, rapid economic growth has paid rich dividends to Indonesians; however it has also resulted in significant environmental degradation.

• While there are some significant achievements in pollution management in Indonesia, such as the phase-out of lead in gasoline in Jakarta and the reduction in use of ozone depleting substances, many challenges remain. Air Quality is under threat due to increasing pollution from urbanization, motorization, industrialization and the impacts of forest fires. Poor solid and hazardous waste management is degrading land, air and water, contributing to flooding (much of the waste finds its way into drainage channels) and also having an impact on human health. Sewerage coverage is one of the lowest in Asia, and this is causing widespread contamination of surface and groundwater in urbanized areas, which is resulting in repeated epidemics of gastrointestinal infections and high incidence of typhoid.

• High rates of deforestation are driven by excessive capacity in the wood processing industry and corruption and inefficiency in allocating and regulating forest use. While there does appear to be a real foundation for forest policy reform thanks to the Government’s acknowledgment of the serious nature of the forest problems, progress on the ground has been insufficient to stem the rate of forest loss. Indonesia is perhaps the world’s most biologically diverse country. However, it is experiencing a dramatic loss in natural habitats, and is doubtless threatening lesser-known aquatic and terrestrial species as well. Habitat loss also brings with it reduction in environmental services provided by ecosystems, such as carbon sequestration, control of microclimate, slope stabilization, recreation and ecotourism. The impacts of loss of services and natural resources are often felt more at local level by poorer communities, who are the most dependent on biological resources for their livelihoods and welfare.

• Mining and mineral related products account for about 13 percent of Indonesia GDP and 19 percent total exports, with gold being the largest revenue earner. Of the three mining types, large-scale mining has had a relatively limited impact on the environment, and responsible international companies have improved their environmental performance. Small scale mining, much of it illegal, continues to have adverse impacts on natural systems and on miners’ health and safety as well. Among the most relevant issues currently facing the mining industry is the need to reconcile provisions made by a Presidential Decree, which gave mining priority over other land uses, with those of Law 41 of 1999 concerning forest management, which essentially prohibits any surface mining in state forest land, regardless of its classification. The Ministry of Energy and Mineral Resources and the Ministry of Forestry need to find a constructive way forward to deal with this matter, especially in light of the growth and poverty alleviation perspectives that the issue encompasses.


Short-term gains in economic growth and poverty reduction can be significantly undermined by over-exploitation and degradation of the natural resource base and by inappropriate handling of pollution resulting from production processes, transportation and consumption patterns. The resulting costs to society reflect opportunities foregone or expenditures on mitigation, reducing net national savings. The Bank thus recognizes environmental and natural resource management issues as key cross-cutting dimensions of the challenge that Indonesia faces in pursuing sustainable growth and poverty alleviation, embedded in all three pillars of its assistance strategy.

Pillar 1: Improving the investment climate. Three main issues are relevant: (i) Support to macroeconomic stability, and trade policy specifically, will need to take into account the role of the forestry sector, which represents 10% of the country’s total exports. Under-reporting and ineffective collection of resource fees in the sector and ineffective management of the Reforestation Fund are fur ther concerns from a fiscal standpoint; (ii) One of the pre-conditions for increasing private sector investment and promoting competitiveness is clarity of regulations and their consistent, predictable enforcement. Environment is thus one of the many dimensions of the proposed reforms of the justice sector, civil service, and financial management institutions; and (iii) Promotion of productive investment in rural areas may include community forestry and watershed protection, possibly leveraging carbon finance and the payment for environmental services. The above points will be dealt with through mainstreaming in AAA, TA and lending operations.

Pillar 2: Improving services for the poor. Environmental concerns will be dealt with on three fronts: (i) ensuring that project impacts are minimized and that effective mitigation and compensation measures are built into project design (through the safeguards process); (ii) exploring synergies in project design (as in the use of carbon finance or GEF funds associated with agriculture and energy projects to reduce greenhouse gas emissions or to promote biodiversity protection); and (iii) enhancing institutional capacity in sectors and provinces where investment is concentrated. The use of strategic environmental assessment (either sectoral or regional) can greatly facilitate the planning process and reduce transaction costs associated to project preparation. Specifically mainstreaming will be promoted through: (i) USDRP, in connection with expansion of sewerage systems; (ii) ICGRP, in connection with the protection of headwaters; and (iii) roads and energy projects.

Pillar 3: Improving governance. The Government has piloted information disclosure in the environmental field through the PROPER Program, focusing on water pollution in industry. It is proposing to scale up this initiative to cover other media and sectors. With decentralization, the Ministry of Environment also faces the challenge of clarifying mandates, defining priorities for capacity building, and putting in place incentives to promote good environmental governance in the country’s 400+ districts. The Bank’s program will seek to support Indonesia’s broader Good Environmental Governance (GEG) Program through a stand-alone operation centered on: (i) consolidating the PROPER and GEG Programs, which promote environmental compliance in the private sector and at the district (kabupaten and kota) level; (ii) improving health through expansion of urban environmental services (sewerage and solid waste) using matching


grants that would be accessed by districts that meet GEG performance criteria; and (iii) capacity building and development of management tools (economic instruments, information systems, state-of-the-environment reporting, etc) for environmental agencies.


ANNEX G :PROPOSED IFC AND MIGA PROGRAM: FY04-07

IFC PROGRAM

IFC’s activities in Indonesia are directed to help the private sector, contribute to sustained economic growth, and help improve the investment climate in the country. Indonesia’s post-crisis economic performance has not matched that of Malaysia, Thailand or Philippines largely on account of a weak investment climate. Although modest improvements have been noted in the country’s legal, 9 regulatory, labor and fiscal environments, substantial further progress is needed to attract much needed foreign direct investment, as well as to rejuvenate internal lending by commercial banks.10 IFC will work closely with the Bank to support the Government’s efforts in these areas, with a particular emphasis on the development of a healthy financial sector and the proper functioning of commercial courts.

IFC’s lending operations over the CAS period will be aimed at supporting reputable companies in key sectors to undertake restructuring or initiate growth activities. IFC will focus on: (i) strengthening of banks and other financial institutions; (ii) deepening the financial sector through supporting new institutions; (iii) supporting export oriented companies, mainly in the agribusiness sector; (iv) supporting investments in infrastructure in power and telecommunications; and (v) supporting SMEs through the Program for Eastern Indonesia SME Assistance.

In the financial sector, the slow recovery of the fragile banking system has contributed to the stability of the economy. While some large banks have been handed over to the private sector in landmark transactions, further reform in this sector is needed. It is critical to identify and revitalize well-managed banks, help them restart lending to creditworthy customers and reintegrate them with inter-bank and international financial markets. Test for success would be the emergence of a sound banking system, resolution of the problems of weak banks and deepening the financial system. IFC will work to recapitalize some banks where appropriate strategic partners can be found to upgrade the banks’ operating procedures, systems and management practices. In the area of financial sector institution-building, potential IFC’s activities could include investments combined with technical assistance in the areas of housing finance, forfaiting, credit information (credit bureaus), and securitization. In addition, IFC will work to facilitate and promote the dialogue between the banking industry and the Government through continued sponsorship of the Private Sector Forum.

IFC will support export oriented resource based industries through investments in sectors such as palm oil plantation, where IFC can help with environmental and resettlement issues. IFC will also assist internationally competitive projects in textile, chemicals, light engineering and services serving the domestic market.

9 Both the Manulife and Panca Overseas cases were resolved to IFC’s satisfaction. 10 Close to 25% of Indonesian bank assets are held in Government securities. This compares to 9% in Thailand (year-end 2002).


In infrastructure , IFC will seek to invest in viable private sector power generation and distribution projects, and support investments in telecommunications. Investments in these sectors will require significant progress in investor perceptions of the investment climate in Indonesia. IFC’s capacity to invest and mobilize private sector financing will be constrained by investor perceptions of the sanctity of contracts and progress in judicial reform in Indonesia.

SME development is an important potential means of mitigating unemployment and helping Indonesia resume a more balanced growth path. SME development also allows the benefits of this growth to be enjoyed by a larger cross-section of the population, including many disadvantaged groups. IFC has recently established the Program for Eastern Indonesia SME Assistance to meet the need for improving business skill development in the Eastern Islands. Further IFC support in this area is expected to be: (i) the creation of a credit bureau in Indonesia; and (ii) investment in microfinance institutions helping to consolidate the microfinance industry in Indonesia.

In the area of social services, there is an urgent need for market based solutions for the provision of health care and education given the pressure on the government budget. IFC’s role would be to mobilize funds in support of private sector projects in health, education and housing.

In the real sector, IFC’s support will be primarily directed to reputable Indonesian companies to assist them in concluding their corporate restructuring and redirecting their efforts to sustainable growth. IFC will support these companies in the restructuring of their balance sheets through the provision of term financing (both in foreign and local currency), as well as assistance in the adoption of international best practices in the areas of management and operations.

IFC’s current portfolio in Indonesia is US$ 530 million in 32 projects, of which US$335 million is for its own account and US$195 million is for the account of participant banks.

MIGA PROGRAM

MIGA's goal in Indonesia is to promote foreign direct investment for productive purposes. To date, MIGA has facilitated an estimated US$3.9 billion of foreign direct investment into Indonesia. MIGA paid a claim in the power sector in Indonesia in 2001. Full salvage was negotiated with the Government, and the final payment was paid by Indonesia under the claim settlement agreement in mid-June 2003 as expected.

In the coming CAS period, MIGA intends to support foreign direct investment (FDI) into Indonesia through the provision of political risk guarantees to investors in new projects, privatizations and modernizations of existing projects. A particular sectoral focus for these guarantees will be on infrastructure, including power, and oil and gas.

MIGA will continue to support Indonesia’s efforts to attract foreign direct investment by profiling potential investment opportunities in the country through its online investment services, namely PrivatizationLink and FDI Xchange. In this respect, one area of potential focus is likely to be privatizations . Where appropriate partners can be found,


MIGA will support the GOI’s efforts to reenergize privatization, combining the agency’s expertise in investor outreach and targeting and its information services products with in-depth knowledge on the ground about the GOI’s divestiture pipeline. In addition, MIGA will leverage PrivatizationLink, IPAnet and FDIXchange, and other state of the art MIGA information product tools to disseminate the information extensively to potential investors.

Based on MIGA's experience under the Miyazawa Initiative, MIGA intends to provide Capacity Building support in the area of aftercare to BKPM, the country's investment promotion agency, to allow it to help meet the needs of existing investors and facilitate expansions and reinvestments. This work will be provided in a regional context, beginning FY04-05.

Once suitable partners are identified, MIGA is also proposing to undertake a comprehensive focused Benchmarking Study of Indonesia. The primary objective of the Benchmarking Study would be to analyze the competitiveness of several sectors in Indonesia in terms of their ability to attract FDI.

The output could then be used in the short term to see how the various locations compare in terms of costs and conditions and in terms of industry attractiveness. This would enable investment promotion intermediaries to focus their promotion efforts and subsequent location recommendations according to the strengths of a community, help them address location weaknesses, improve their knowledge of industry-specific investment criteria, help them better understand the concept of niche opportunities, and help determine why some disinvestment is taking place, the understanding of all of which is necessary to ensure long-term sustained competitiveness.

Documents

EXECUTIVE …siteresources.worldbank.org/INTINDONESIA/Resources/CAS/CAS04-07.pdf · This “letter of intent to the Indonesian people” provides an agenda of time-bound actions,