State-Owned Enterprise Governance and Privatization Program · privatization and restructuring of state-owned enterprises (SOEs),2 and the second, for the commercialization of public

Completion Report

Project Number: 32517 Loan Number: 1866 November 2008

Indonesia: State-Owned Enterprise Governance and Privatization Program

CURRENCY EQUIVALENTS

Currency Unit – rupiah (Rp)

At Appraisal At Program Completion (28 February 2000) (7 October 2005)

Rp1.00 = $0.000137 $0.000097 $1.00 = Rp7,305 Rp10,305

ABBREVIATIONS

ADB – Asian Development Bank MOF – Ministry of Finance MSOE – Ministry of State-Owned Enterprises OECD – Organisation for Economic Co-operation and Development PPP – public-private partnership PSO – public service obligation SCI – statement of corporate intent SOE – state-owned enterprise TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government ends on 31 December. “FY” before a calendar year denotes the year in which the fiscal year ends.

(ii) In this report, “$” refers to US dollars.

Vice President C. Lawrence Greenwood, Jr., Operations Group 2 Director General A. Thapan, Southeast Asia Department (SERD) Director J. Ahmed, Governance, Finance, and Trade Division, SERD Team leader K.-P. Kriegsmann, Senior Financial Sector Specialist, SERD

CONTENTS

Page BASIC DATA i

I. PROGRAM DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 2

A. Relevance of Design and Formulation 2 B. Program Outputs 3 C. Program Costs and Disbursements 10 D. Program Schedule 10 E. Implementation Arrangements 10 F. Conditions and Covenants 11 G. Related Technical Assistance 11 H. Consultant Recruitment and Procurement 12 I. Performance of Consultants, Contractors, and Suppliers 12 J. Performance of the Borrower and the Executing Agency 12 K. Performance of the Asian Development Bank 12

III. EVALUATION OF PERFORMANCE 13 A. Relevance 13 B. Effectiveness in Achieving Outcome 13 C. Efficiency in Achieving Outcome and Outputs 14 D. Preliminary Assessment of Sustainability 14 E. Impact 14

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 15 A. Overall Assessment 15 B. Lessons 15 C. Recommendations 15

APPENDIXES 1. Program Framework 17 2. Compliance with First-Tranche Release Conditions 21 3. Financial Performance of State-Owned Enterprises in Indonesia 24 4. Privatization Indicators 25 5. Compliance with Second- and Third-Tranche Release Conditions 27 6. Compliance with Monitorable Actions under the Second and Third Tranches 31 7. Recommendations for Future Corporate Governance Reform 36 8. Compliance with Assurances 38

BASIC DATA A. Loan Identification 1. Country 2. Loan Number 3. Program Title 4. Borrower 5. Executing Agency 6. Amount of Loan 7. Program Completion Report

Number

Indonesia 1866 State-Owned Enterprise Governance and Privatization Program Republic of Indonesia Ministry of Finance $400,000,000 PCR: INO-1077

B. Loan Data 1. Appraisal – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness – In Loan Agreement – Actual – Number of Extensions 6. Closing Date – In Loan Agreement – Actual – Number of Extensions 7. Terms of Loan – Interest Rate – Maturity (number of years) – Grace Period (number of years)

10 February 2000 28 February 2000 29 October 2001 01 November 2001 04 December 2001 14 December 2001 14 March 2002 18 December 2001 0 31 December 2004 07 October 2005 1 London interbank offered rate (LIBOR)–based 15 3

8. Disbursements a. Dates Initial Disbursement

21 December 2001

Final Disbursement 07 October 2005

Time Interval 45 months

Effective Date 18 December 2001

Original Closing Date 31 December 2004

Time Interval 36 months

b. Amount ($ million) Original Allocation Amount Disbursed Undisbursed Balance 400,000,000 400,000,000 0

ii

C. Program Data Ratings

Implementation Period Development Objectives Implementation Progress From December 2001 to September 2004 S S From October 2004 to March 2005 S PS D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Membersa

Reconnaissance 19 Mar–10 Apr 1999 3 45 a, b, c Fact Finding 10–28 May 1999 3 57 a, d, e Sr. Policy Consultation 1 16–21 Jul 1999 3 18 a, d, f Sr. Policy Consultation 2 10–15 Feb 2000 3 18 c, f, g Appraisal 10–28 Feb 2000 6 50 a, b, d, h, i, j Inception 11–14 Dec 2001 1 4 a Loan Review 1 21–26 Jan 2002 1 6 a Loan Review 2 18–19 Feb 2002 1 2 a Loan Review 3 13–17 Mar 2002 1 5 a Loan Review 4 15–20 Apr 2002 1 6 a Loan Review 5 30-May–1 Jun 2002 1 3 a Loan Review 6 11 Jul 2002 1 1 a Loan Review 7 26 Aug–7 Sep 2002 1 13 a Loan Review 8 21–24 Oct 2002 1 4 a Loan Review 9 17–20 Feb 2003 1 4 a Loan Review 10 21–27 May 2003 1 7 a Loan Review 11 24–26 Jul 2003 1 3 a Loan Review 12 3–6 Sep 2003 1 4 a Special Loan Administration 1

4–6 Sep 2003 1 3 f

Loan Review 13 12–15 Nov 2003 1 4 a Special Loan Administration 2

28 May 2004 1 1 f

Loan Review 14 13–15 Jun 2004 1 3 c Loan Review 15 Project Completion Review

14 Mar 2005 28 Jul to 05 Aug

2008

2 1

2 7

a, f c

a a = financial economist; b = social sector development specialist; c = senior financial sector specialist; d = senior programs officer; e = young professional; f = manager; g = lead financial sector specialist; h = senior counsel; i = senior environment specialist; j = senior social development specialist.

I. PROGRAM DESCRIPTION

1. With the overall objective of improving resource allocation in the public sector and promoting private sector participation in economic activities that have traditionally been controlled by the state, the Asian Development Bank (ADB) approved the State-Owned Enterprise Governance and Privatization Program (the Program) for $400 million on 4 December 2001.1 ADB also approved two technical assistance (TA) grants—the first, for the privatization and restructuring of state-owned enterprises (SOEs),2

and the second, for the commercialization of public service obligations (PSOs)3 to help the Ministry of State-Owned Enterprises (MSOE) implement the Program. 2. The Program was aimed at reforming the SOE sector by (i) subjecting SOEs to sound corporate governance practices, (ii) separating SOEs’ commercial activities from their PSOs to improve resource allocation, (iii) restructuring and privatizing SOEs to increase their profitability and revenue flows to the Government, (iv) establishing fair and transparent labor practices, and (v) strengthening and effectively enforcing procurement guidelines for SOEs.4 3. The Program comprised policy actions in these five areas supported by the $400 million loan, which was disbursed in three tranches. The first tranche of $150 million was released in December 2001 when the loan took effect and after the 26 conditions for its release were met (see Appendix 1). The second tranche ($150 million) was originally scheduled for disbursement in July 2003, and the third tranche ($100 million) in July 2004; both were released in October 2005, after the Government had substantively complied with the 7 tranche release conditions and 17 monitorable actions for the second tranche and the 7 tranche release conditions and 14 monitorable actions for the third tranche (see Appendix 2 for the tranche release conditions and Appendix 3 for the monitorable actions). The Program met its development objectives. With the help of the improvements it made in corporate governance and operational efficiency, the overall profitability of the SOE sector increased in 2000–2005. 4. The SOE reforms under the Program involved transferring ownership and management to the private sector. The Government took a strategic approach to implementing the Program. First, it identified more than 30 enterprises for restructuring and privatization. Second, it gave priority to divesting state shares in high-value enterprises to mobilize revenues that financed part of the fiscal costs associated with the economic restructuring in the post-crisis period. This move in turn facilitated fiscal consolidation and contributed to macroeconomic stability. Third, the Government leveraged the restructuring of state-owned banks and successfully divested shares in several large and medium-sized banks under the Program. 5. SOEs remain significant in the Indonesian economy. At the end of 2007, 139 SOEs (versus 152 at the end of 2005) and 21 enterprises with minority state shareholdings (compared with 17 at the end of 2005) together contributed about 40% to gross domestic product (GDP). This contribution is partly due to the rise in business activity over the last few years in key segments of the economy with SOE concentration, and also to the reclassification of the 1 ADB. 2001. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the

Republic of Indonesia for the State-Owned Enterprise Governance and Privatization Program. Manila. 2 ADB. 2001. Technical Assistance to the Republic of Indonesia for the Privatization and Restructuring of

State-Owned Enterprises. Manila (TA 3714-INO, for $2.6 million, approved on 5 September 2001). 3 ADB. 2001. Technical Assistance to the Republic of Indonesia for the Commercialization of Public Service

Obligations. Manila (TA 3728-INO, for $1 million, approved on 25 September 2001). 4 The Program Framework can be found in Appendix 1.

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national energy company, PT Pertamina, and the national basic food distributor and price control agency, Badan Urusan Logistik (BULOG), as SOEs. Further, the transfer of 13 large SOEs to private sector ownership through the capital markets means that SOEs now make up a sizable portion—about 35% of the value of all listed securities—of the capital markets. Indonesian equity market capitalization grew from $32.6 billion at the start of the Program to $72.3 billion at the end of 2004, and to $192.3 billion by the end of June 2008.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

6. Indonesia, among the Southeast Asian economies, was hit hardest by the Asian financial crisis. In 1998, GDP contracted by 14% after three decades of high growth. The economy was vulnerable, as the crisis showed, largely because of inherent structural weaknesses in key sectors. In the corporate sector, the complex structures of holding companies that also owned banks encouraged the growth of an opaque web of highly leveraged conglomerates. These conglomerates indulged in lending to related parties, expanded their operations without regard for economic or prudential considerations, exploited depositors of their banks, and dispossessed minority shareholders of their listed subsidiaries. Amid the excessive leveraging, and without adequate prudential regulation and supervision, the fragile domestic banking sector was overexposed. A currency and maturity mismatch on the banks’ balance sheets heightened the impact of the reckless lending and borrowing. After the currency devaluation, a large segment of the corporate sector—mostly enterprises with foreign currency borrowings—became insolvent. Corporate losses and debtors unable or unwilling to repay their obligations wiped out the equity of many banks that were overly exposed to the commercial and speculative adventures of their majority owners. Although less leveraged and not so severely affected as private enterprises, SOEs also suffered from growing operational and financial inefficiencies, and many needed restructuring. 7. ADB’s support for the Government of Indonesia (the Government) was an integral part of a multidonor rescue package led by the International Monetary Fund to help the country overcome the financial crisis. In 1998, ADB approved the Financial Governance Reforms: Sector Development Program for $1.2 billion. That program was centered on helping restructure the banking sector, strengthening financial governance, and reinforcing the legal and regulatory framework of the financial sector. The intent was to help Indonesia respond to the immediate demands of the crisis, as well as to make the country less vulnerable to adversity. While the failure of the financial sector was the major cause of the economic crisis, the notoriously under-perfoming SOEs were the major obstacle to economic recovery. 8. The Government requested the ADB Policy Consultation Mission in September 1998 to support the MSOE in dealing with the issues facing the SOE sector. In December 1998, ADB approved an advisory TA to address the corporate governance and privatization of SOEs.5 But the processing of the loan was delayed between August 2000 and September 2001 by problems related to the transfer of MSOE functions to the Ministry of Finance (MOF), political changes stemming from President Wahid’s impeachment, and delays in the resolution of issues surrounding the macroeconomic stabilization program and structural reforms. When these 5 ADB. 1998. Technical Assistance to the Republic of Indonesia for Corporate Governance and Enterprise

Restructuring. Manila (TA 3149-INO, for $2.47 million, approved on 29 December 1998).

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issues were resolved after the inauguration of the new government under Megawati Sukarnoputi, and the MSOE was reestablished, a follow-up mission in September 2001 updated the State-Owned Enterprise Governance and Privatization Program in light of the developments and firmed up understandings on the Program. B. Program Outputs 9. Outputs under the Program can be grouped into five broad areas.

1. Sound Corporate Governance

10. To comply with the requirements of the Program, MSOE (i) issued appointment agreements for all newly appointed directors and commissioners;5 (ii) received statements of corporate intent (SCIs) 6 for 86 SOEs; and (iii) made certain that all 125 SOEs under its jurisdiction at the end of 2005 submitted audited annual financial reports for 2001–2003 to shareholders at the annual general meeting, according to the Company Law. MSOE introduced sound corporate governance norms through measures outlined in Appendix 2, particularly to improve transparency in SOEs not listed on the stock exchange. It also required listed SOEs to comply fully with the listing rules of the Jakarta Stock Exchange. 11. The Program introduced substantial improvements in the corporate governance regime for SOEs, after an almost complete absence of rules before 2002. A 2004 evaluation7 of the Indonesian corporate governance framework against international best practice for SOEs developed by the Organisation for Economic Co-operation and Development (OECD)8 found only minor deviations from the international benchmarks. 12. The SOE Law and associated regulations set out the requirements for SOEs regarding (i) conflicts of interest on the part of directors, commissioners, and other officers; (ii) mandatory internal supervisory units and audit committees; (iii) compulsory audits of financial statements; (iv) adherence to the principles of good corporate governance issued by MSOE; and (v) special circumstances, such as privatization and restructuring. 13. In addition, the Ministerial Decree on Corporate Governance of August 2002, which was adopted by the Program, emphasizes the following principles:

(i) Transparency—openness in decision making and in the disclosure of material and relevant information about enterprises.

6 Going beyond the financial and corporate information required in the annual report of a listed company, the SCI

provides specific and strategic directions to the board of directors. It defines (i) the objectives and scope of SOE activities; (ii) the business and corporate restructuring plan and an assessment of cost and savings; (iii) accounting policies; (iv) performance targets against prescribed objectives; (v) the information requirements of the shareholding ministry; (vi) compliance with environmental legislation to be certified by the accredited agency (e.g., ISO 14000); (vii) the employment status of staff and compliance with labor laws and regulations; (viii) procedures for the acquisition or sale of shares and divestment of subsidiaries; (ix) compensation for SOE activities from the public sector, if any; and (x) procedures for the financial valuation of SOEs.

7 ADB. 2003. Technical Assistance to the Republic of Indonesia for State-Owned Enterprise Restructuring. Manila (TA 4280-INO, for $600,000, approved on 18 December 2003).

8 The OECD Steering Group on Corporate Governance in June 2002 mandated the Working Group on Privatisation and Corporate Governance of State-Owned Assets to develop a set of nonbinding principles and best practices in the corporate governance of state-owned assets. TA 4280 analyzed the Indonesian SOE framework against these.

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(ii) Independence—professional management of enterprises without influence from any party contrary to applicable laws and regulations and good corporate principles.

(iii) Accountability—clarity of functions and responsibilities of corporate organs, to allow effective enterprise management.

(iv) Responsibility—management compliance with applicable laws and regulations and adherence to good corporate principles.

(v) Fairness—equity in upholding the rights of shareholders under agreements and applicable laws and regulations.

14. Within the SOEs the key outcomes were (i) improved corporate governance practices in unlisted SOEs, including qualitative changes in the composition of boards of commissioners and directors; (ii) an appropriate number of independent commissioners appointed in proportion to the number of shares held by noncontrolling shareholders in listed SOEs; (iii) a performance incentive system for SOE managers;9 (iv) audit committees established in listed SOEs; (v) audit committees, comprising one commissioner and two outside experts, established in 26 unlisted large SOEs; (vi) a corporate secretary appointed in each listed SOE and in those that were to be listed within the next 12 months; and (vii) independently audited annual reports submitted by unlisted SOEs. The implementation of these measures was facilitated by an ADB TA that was approved before the Program.10

15. Improvements in the corporate governance of SOEs are reflected in their improved financial performance (Appendix 3, Table A.3.1). SOE profits grew almost 2.5 times in 2000–2003 to Rp18 trillion ($2.0 billion). Receipts in the form of dividends and corporate income taxes to the Government as a shareholder also grew by more than 140%, to more than $2.6 billion in 2003. The financial turnaround is significant, as several SOEs reported losses in 1997–2000 from mismanagement and the impact of the Asian financial crisis. 16. The SOE balance sheet strengthened in 2000–2003 (Appendix 4, Table A.4.2). Total assets grew by 32%, largely because of higher retained earnings but also because of revaluations, and current assets grew faster than current liabilities. This trend was reflected in a 140% increase in total equity in the selected SOEs, to Rp277 trillion ($30.5 billion).

2. Separation of Commercial Activities from PSOs

17. Traditionally, the Government often used SOEs to provide public goods and services.11 Frequent political interference in the pricing of such services and inadequate accountability of SOEs resulted in inefficient delivery of goods and services, with profitable business units within the SOEs cross-subsidizing PSO delivery. The Government usually provided no compensation 9 MSOE is now working to improve the incentive system for SOE management and give it a broader base of

value-added indicators rather than just profits and the timely submission of reports. 10 ADB. 2000. Technical Assistance to the Republic of Indonesia for Corporate Governance Reform. Manila

(TA 3484-INO, for $300,000, approved on 28 August 2000). 11 PSOs—(i) goods and services produced and supplied below cost, (ii) public sector infrastructure projects

contracted at prices below cost, (iii) services provided without compensation, and (iv) social services such as education and health for nonemployees—are the noncommercial programs and activities of SOEs designed to meet community and social objectives determined by the Government. Their provision is the result of specific government directives to SOEs regarding the conditions (e.g., price) of their supply. PSOs would not be supplied by SOEs, or at least not on the same terms, if they were acting primarily in their own commercial interest. Instances of “good corporate citizenship” such as sponsorship are not PSOs.

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or made only inadequate subsidy payments to meet the SOEs’ costs of delivery. Given the adverse impact of such practices on the commercial viability of several SOEs, the Program supported the reform of PSOs in selected enterprises. 18. With support from an ADB TA (footnote 3), MSOE (i) identified PSOs in 15 SOEs, and (ii) quantified the costs and environmental impact of PSOs. It received substantial cooperation in this exercise from the SOEs involved, which are now requesting the commercialization or other alternative treatment of PSOs. The treatment of PSOs will become increasingly important, as it may increase the costs, and complicate the design and the delivery, of the massive infrastructure investments in Indonesia over the next 5–10 years. So far, all efforts of SOEs, with MSOE support, to be paid for the supply of PSOs, have been rejected by MOF for budgetary reasons. MSOE has nonetheless set up a division under a deputy minister to resolve the matter. Its importance is clearly recognized by MSOE.

3. Corporate Restructuring and Privatization

19. MSOE strengthened the legal and regulatory framework for corporate restructuring and privatization reform through the SOE Law of June 2003 and through presidential and ministerial decrees outlining the various privatization procedures.

a. Financial Assessment, Restructuring, and Liquidation

20. To prepare for the Program, MSOE assessed the financial and operational viability of 60 SOEs, with ADB TA support (see footnote 4). Then, as a first step toward implementation, MSOE developed policies and procedures for privatization and issued a ministerial decree to guide employee buyouts, strategic sale, free share transfers, initial public offerings, joint ventures, lease of operating assets, concessions, and cash auctions. 21. A condition for the release of the second and third tranches was the comprehensive financial audit of at least 30 SOEs, covering remuneration and all expenses of the members of the board of commissioners and directors, and the submission of the audited accounts. The number of SOEs that complied far exceeded this requirement: 111 submitted audited financial reports for the 2001 audit cycle, 99 for 2002, and 100 for 2003.12

22. Corporate restructuring, as defined under the Program, involved operational and financial restructuring. Operational restructuring dealt with changes in at least one of the following: management information systems, production and logistics planning, distribution network, marketing strategy, workforce strength and composition, and organizational structure. Financial restructuring involved one or more of the following: sale of subsidiaries or surplus assets, equity injection from third parties, merger or acquisition, debt restructuring, and liquidation. Under the Program and with support from ADB TA (footnote 2), 36 SOEs submitted restructuring plans at their annual shareholders’ meetings; all were approved. 23. The preparatory actions and the operational and financial assessment of 60 SOEs enabled MSOE to identify 12 SOEs for liquidation and to prepare and initiate a time-bound liquidation plan for 11 of these. Of the 11 SOEs, 4 had been fully liquidated by the end of the

12 SOEs are now required to submit their audited statements to both MSOE and the Ministry of Industry and Trade.

The numbers given here include only those SOEs that complied fully with this requirement.

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Program, 1 was at an advanced stage of liquidation, the closure of 5 SOEs had been finalized, and a merger partner had been identified for the remaining SOE. 24. To improve the performance and viability of SOEs, MSOE prepared and adopted corporate restructuring plans for 45 SOEs (36 of these with ADB support; footnote 2). The restructuring program covered these key industry segments: (i) fertilizer (7 SOEs); (ii) plantation (14); (iii) construction (2); (iv) financial institutions (1); (v) airlines (2); (vi) electricity (1); (vii) fisheries (5); (viii) trading (3); and (ix) forestry (6). 25. From a review of annual reports13 and discussions with MSOE and SOE officials, it is clear that a large number of SOEs have been restructured, both during and after the Program. PPPs are increasingly being used to bring the private sector into SOE restructuring, thereby circumventing parliamentary proceedings. Appendix 4, Table 4.1 shows that several PPPs had already been established in large SOEs14 before the Program, and even before the Asian crisis struck. Besides the PPPs listed in the table, 15 plantation SOEs have set up more than 50 PPPs since 2002, following on analytical and advisory support under ADB TA for the restructuring of plantations (footnote 6).

b. Privatization

26. Recognizing that its various roles as owner, regulator, supervisor, and manager of SOEs have led to serious conflicts of interest, and constraints on potential growth, the Government has made privatization a key strategy to increase economic efficiency, promote growth, and generate revenues for debt repayments and bank recapitalization. The Program acted as a catalyst, leveraging the Government’s commitment to achieve reforms in a systematic manner. The Government took a number of strategic steps in 2002–2004 with ADB support to prepare for the divestment of its shares in SOEs. It

(i) assessed the operational and financial viability of 60 SOEs, finalized and implemented liquidation plans for 12 SOEs, and adopted corporate restructuring plans for 36 SOEs;

(ii) strengthened the legal and regulatory framework for privatization, first through presidential and ministerial decrees on privatization procedures and then through the Law on State Finances of March 2003 (Law 17/2003), which regulates revenue generation for the state budget, including SOE privatization;

(iii) passed the Law on SOEs in June 2003 (Law 19/2003) to empower SOE management and to elaborate on the implementation of corporate governance and privatization procedures;

(iv) formulated privatization options for 42 of the 60 SOEs assessed, prioritized the privatization of 28 SOEs, and submitted a program for parliamentary consideration in early 2003; and

(v) sequenced the privatization of larger and strategic SOEs to (a) restructure and privatize commercial banks, and recover the liquidity

support given to such institutions during the Asian financial crisis, and (b) meet budgetary needs in 2002–2004 and sustain macroeconomic stability.

13 Under TA 4280-INO (see footnote 6). 14 This list is not complete. Among others, it excludes PT Pertamina, which is known to have PPP arrangements.

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27. With regard to the actual divestment of state shares, the Program required MSOE to make satisfactory progress in privatizing at least seven SOEs for the release of the second tranche) and at least eight SOEs for the release of the third tranche.15

In satisfactory compliance with these conditions, MSOE obtained parliamentary approvals and completed all government actions for the privatization of at least 15 SOEs. Table 4.2 in Appendix 4 gives details on the privatization transactions. 28. The Government has taken a strategic approach and concentrated on privatizing large institutions to provide adequate support for the state budget. This approach has been backed by (i) significant investor interest in financial institutions and other large SOEs whose viability or value was not affected by security concerns stemming from events in 2002–2004, and (ii) continuing momentum for banking sector restructuring and reforms. The sale of shares in Bank Mandiri, Bank Rakyat Indonesia, PT Persuhaan Gas Negara, PT Indosat, PT Telcom, and PT Indocement fall into this category. The Government has also privatized state assets to improve economic efficiency, while mobilizing the required resources to support the budget. The privatization initiatives in the banking sector have increased competition and improved financial services. Table 4.3 in Appendix 4 presents the outcomes of the sale of large and strategically important SOEs during the Program.16

c. Sale of Government’s Minority Shareholdings

29. In addition to the divestment of majority positions, the Program required MSOE to achieve satisfactory progress in selling all state shares in at least 12 companies in which the Government was a minority shareholder. In preparation for the Program, the Government had drafted plans for divesting its minority ownership shares in 20 enterprises. The 2004 privatization program presented to Parliament covered the Government’s minority shareholdings in 12 enterprises—5 for the release of the second tranche and 7 for the release of the third. 30. Given the Government’s strategic focus on larger SOEs and budgetary needs, lower-value transactions related to the divestment of minority shareholdings and smaller enterprises have not progressed as quickly. Labor sensitivities in some enterprises and uncertainty surrounding elections and the government transition in 2003–2005 have complicated privatization in these cases. The Government hadtherefore taken significant steps to fully comply with the conditions of the Program, with the following results:

(i) All of the remaining holdings in PT Wisma Nusantara (42.0%) were divested in December 2002, and those in PT Indocement (16.9%) in October 2003.

(ii) All valuations and assessments needed to facilitate immediate sale upon approval by Parliament have been completed by end 2005.

(iii) The President of Indonesia approved Government Regulation 33/2005 (PP 33/2005) on SOE privatization procedures, authorizing the Government to divest its shareholdings once approved by Parliament as part of the annual budget deliberations.

15 For the purposes of the Program, satisfactory progress in the privatization of SOEs was defined as (i) the transfer

of more than 50% of the voting shares of an SOE to private investors, or (ii) the transfer of up to 50% of the voting shares of an SOE combined with the transfer of a majority of the seats on the boards of commissioners and directors of an SOE to private investors, or (iii) the formulation of an action plan for implementing either of these transfers if adverse economic or other circumstances do not allow the transfer to take place.

16 Since the end of the Program three more SOEs have been partially privatized through initial public offerings: PT Jasa Marga, a toll road operator; PT PGN, the national gas reticulation company; and PT BNI, a bank.

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(iv) Plans for the sale of the Government’s remaining minority positions in various banks and other enterprises in which it earlier planned to retain some ownership had been finalized.

31. Among these measures, item (iii) relating to the adoption of Government Regulation 33/2005 by the President marked a significant milestone, breaking the deadlock between Parliament and the executive over procedures for the privatization of SOEs. In particular, the two key relevant laws in this area—the Law on State Finances and the Law on SOEs—both passed in 2003 within 4 months, were inconsistent with regard to the approval authorities of the two branches of government. The regulation, adopted after consultation with commissions of Parliament, reinforced the authority of Parliament to approve in principle the Government’s privatization plan and the annual value of privatization proceeds in the budget, while vesting the executive with adequate authority to decide on the mode as well as the timing of the privatization once the foregoing approvals were obtained. 32. However, the privatization and sale of minority shareholdings was again excluded from the parliamentary debate on the 2006 budget, and therefore had to be deliberated separately. Only in May 2008 did Parliament give the executive a free hand in the sale of minority shareholdings, which can now be processed on the basis of cabinet approval alone.

4. Fair and Transparent Procedures for Managing Labor Redundancy

33. With assistance from an ADB TA (footnote 2), MSOE drew up a labor rationalization policy for (i) severance payments and gratuity based on length of service; (ii) early retirement; (iii) re-employment, training, or retraining of employees, and financing of entrepreneurial initiatives; and (iv) employee rights in assessing claims against pension funds. A monitoring mechanism was also developed to oversee the implementation of the policy by the SOEs and improve it. 34. But by 2003, midway through the implementation period, Parliament had introduced new labor legislation that went far beyond the Program’s prescriptions and is now considered by many analysts as a major obstacle to Indonesia’s economic growth. According to the OECD, job creation has slowed in recent years, unemployment is high, particularly among youths, and the informal economy is widespread. Important contributory factors are a tightening of employment protection legislation (EPL), especially with the passage of the Manpower Law of 2003, and sharp increases in the real value of the minimum wage. Strict EPL does not provide effective social protection for the needy, because it is not binding in the informal sector. It is also affecting Indonesia’s trade competitiveness, because the country has a comparative advantage in labor-intensive manufacturing, whose former dynamism has waned.

5. Strengthened and Effectively Enforced Guidelines for Procurement

35. A condition for the release of the second and third tranches was the submission of independent procurement audit reports by at least 40 SOEs. Twenty SOEs submitted such reports for FY2001 and 20 others submitted reports for FY2002. They were audited by audit companies against (then) current procurement regulations outlined in Presidential Decree 18/2000, which applied to SOEs and all public sector projects (and were consistent with ADB’s Procurement Guidelines [2007, as amended from time to time]). The findings were assessed by MSOE, in line with the three monitorable actions under the Program.

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36. Although the independent audits uncovered no corruption, they identified inefficient practices that could provide fertile ground for corrupt activity and the waste of resources. Standard operating procedures for procurement by individual SOEs were also found to deviate from global best practices. MSOE appointed a committee to improve the standard operating procedures for procurement (Decree 80/2003 of 3 November 2003, replacing Decree 18/2000), and consultants to assist in the process. But the procedures drafted by the committee were never issued, apparently because they were incongruent with regulations for the public sector.

6. Summary

37. For compliance with (i) release conditions see Appendix 5, and (ii) monitorable actions see Appendix 6. The basic premise of the Program was that reforms that transferred SOE ownership and management and confined the Government’s role to policy making and regulation would release scarce resources for poverty reduction and social programs. In this regard, the Program satisfactorily

(i) established sound policy, legal, regulatory, and operational frameworks for corporate governance in the SOE sector;

(ii) increased awareness of international norms and practices in corporate and financial governance;

(iii) improved the financial performance of the SOE sector in 2001–2003, partly through good governance measures introduced under the Program;

(iv) promoted transparency and disclosure by stipulating the regular submission of financial, operational, and procurement audits of financial outcomes, board compensation, and compliance with legislation (labor, environmental, and procurement);

(v) initiated a robust restructuring program for SOEs (for instance, supporting the liquidation of 8 nonperforming SOEs and the restructuring of 36 others) that the Government could use as a model as it moves forward with SOE management and reforms;

(vi) catalyzed the gradual divestment of state control in 15 large SOEs, including several important financial institutions, and initiated the privatization of 13 other SOEs as part of the Government’s privatization program, thereby contributing significantly toward meeting budgetary needs—a crucial factor in Indonesia’s macroeconomic recovery; and

(vii) addressed efficiency issues in the SOE sector by facilitating the divestment of shares held by the Government in sectors like construction, where the state has no sound basis for involvement;

38. The Program has had clear and significant development impact, resulting in better corporate governance and a focused and strategic approach to privatization. There is demonstrable evidence of greater awareness of corporate governance norms in SOEs during the implementation of the Program. The Program has also succeeded in facilitating the privatization of several large SOEs. As reported in Table 3 above, the divestment of the Government’s shareholdings in SOEs in the real sector contributed Rp6.7 trillion ($652 million) to the budget during the Program, and the sale of government ownership in the banking sector contributed Rp30.3 trillion ($2.9 billion). 39. With the first phase of divestment of state shares in larger and more strategic SOEs completed, the Government plans to concentrate on improving efficiency in its management of

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SOEs and to continue to transfer assets to the private sector. In particular, it intends to privatize SOEs in infrastructure, natural resources, plantation, and other sectors. The Government is likely to direct its attention to improving macroeconomic growth performance by addressing competitiveness and employment promotion issues. The comprehensive reform agenda that the Program helped formulate should be a good foundation for further reforms in the SOE sector.

C. Program Costs and Disbursements

40. The Program was supported by a loan of $400 million from ADB’s ordinary capital resources, which was to be released in three tranches. The first tranche ($150 million) was disbursed in December 2001, right after the loan took effect. The second tranche ($150 million) was originally scheduled to be released in July 2003, and the third tranche ($100 million), in July 2004; both were disbursed only in October 2005. Despite the Government’s active pursuit of the implementation of the Program and its tranche conditions, the complexity of the agenda and the wide-ranging implications across many segments of the economy gave rise to delays in implementation. In particular, the Law on State-Owned Enterprises, introduced after the start of the Program but separately from it, delayed a number of privatizations because of delays in the required parliamentary approval.

D. Program Schedule

41. The loan closing date was extended from July 2004 to December 2005 because of parliamentary opposition to privatization. Parliament halted all scheduled privatization in 2002 and asked MSOE to submit a law for SOEs. By the middle of 2002, MSOE and the Cabinet had complied, but then parliamentary committees introduced changes in the law requiring parliamentary approval (after long and extensive deliberations) for every privatization transaction. The parliamentary processing created inconsistencies with the Law on State Finances with respect to the approval authorities of the executive and the legislative. These inconsistencies prolonged deliberations on each privatization transaction, and therefore required an extension of the closing date, but all other areas of the Program were implemented as scheduled.

E. Implementation Arrangements

42. MOF, as the Executing Agency, coordinated and monitored the overall implementation of the Program and administered the use of the loan proceeds. MSOE, the Implementing Agency, coordinated with other agencies as required. To monitor progress, the Government created a high-level steering committee with representation from MSOE (chairperson), MOF, the Coordinating Ministry for Economy Affairs, the National Development Planning Agency (Badan Perencanaan Pembangunan Nasional, or BAPPENAS), and the Ministry of Manpower. The committee reviewed SOE restructuring and privatization strategies and endorsed these or recommended changes if required, but the primary authority for approving the strategies remained with MSOE. The steering committee reviewed program implementation every quarter and reported to ADB. It was supported by a corporate governance and privatization working group set up in MSOE to oversee the development and implementation of financial and corporate restructuring, privatization, and corporate governance policy in the targeted SOEs, as well as implementation of the related TA (footnote 2). A separate working group oversaw the implementation of the TA for the commercialization of PSOs (footnote 3). The steering committee was also supported by a consultative working group on labor redundancies.

11

F. Conditions and Covenants

43. The policy matrix of the Program covered its three loan tranches and 71 covenants—26 for the first tranche, 24 for the second, and 21 for the third (Appendix 3). All 26 tranche conditions for the first tranche were fully met upon loan effectiveness. The unexpectedly strong involvement of Parliament in the privatization delayed the implementation of some covenants for the release of the second and third tranches; both tranches were deferred and were eventually released together. While loan reviews were conducted regularly, the policy dialogue with senior government officials intensified throughout 2004 and 2005 to gain a better understanding of the delays in privatization. These exchanges led to progress in compliance with outstanding conditions. Privatization eventually proceeded, and the regulations were changed to allow the disposal of minority shareholdings. The Government achieved compliance with all assurances given. These assurances and the status of compliance are summarized in Appendix 8.

G. Related Technical Assistance

44. An associated TA (TA 3714-INO in the amount of $2.6 million) was approved to support MSOE in strengthening corporate governance by implementing SCIs and appointment agreements with commissioners and directors. A new performance incentive system for the targeted 30 SOEs was introduced to reward management and staff for improving defined performance indicators. The TA also supported the financial and operational restructuring of at least 10 SOEs, and the privatization of at least five SOEs in line with the privatization options developed under an earlier TA (footnote 4). In addition, TA 3714-INO resulted in restructuring and privatization plans for 30 other SOEs for the next 3 years. Legal advice on privatization transactions and debt restructuring was provided to the Government, which was also assisted in ensuring the fair treatment of redundant employees by using the best international and Indonesian practices and by complying with Presidential Decree 3/1996. The assistance to the Government included the organization and conduct of (i) seminars on SOE reform; (ii) corporate governance workshops for SOE commissioners and directors; (iii) courses in privatization procedures and techniques for MSOE staff; (iv) post-privatization workshops for MSOE staff; and (v) a conference on labor legislation and fair treatment of redundant employees. A TA completion report17 (TCR) prepared in June 2004 rated this TA a success. 45. Another associated TA (TA 3728-INO in the amount of $1.0 million) was approved to support the identification and measurement of PSOs in SOEs, and the recommendation of more efficient provision mechanisms, including business opportunities in this regard for private sector companies. SOEs were surveyed to identify PSOs, assess their impact on the financial performance of the selected SOEs, and examine whether the accounting systems of SOEs could allocate the general cost components. Alternative ways of separating PSOs from commercially viable activities of SOEs were identified. These included (i) creating separate profit centers, (ii) setting up a subsidiary or an independent company, and (iii) returning the activities to the relevant government department or a provincial authority. Rules and regulations for allowing private companies to supply PSOs were identified, and the financial impact of these

17 ADB. 2004. Technical Assistance Completion Report for Indonesia for Privatization and Restructuring of

State-Owned Enterprises. Manila (TA 3714-INO).

12

regulations on the SOEs and their fiscal impact on the budget were estimated for a limited number of SOEs with PSOs. A TCR18 prepared in June 2004 rated this TA highly successful.

H. Consultant Recruitment and Procurement

46. Consultants under both TAs were recruited according to ADB’s Guidelines on the Use of Consultants (2007, as amended from time to time) through consulting firms that submitted full technical proposals. No contractors or suppliers were engaged.

I. Performance of Consultants, Contractors, and Suppliers

47. The performance of the consultants was evaluated in June 2004 (footnotes 17 and 18).

J. Performance of the Borrower and the Executing Agency

48. The Government actively pursued the broad agenda of the Program, which had wide-ranging implications across all segments of the economy and required intensive consultations among stakeholders and the public. The Government advanced a host of new and amended laws and regulations and put in place mechanisms to facilitate their passage and dissemination. After the Program was approved, the Government undertook significant policy measures, including (i) the design and implementation of a corporate governance framework with the associated regulations for SOEs; (ii) the establishment of a directorate general for PSOs and regulations for PSO measurement and treatment in SOE accounts; (iii) the rehabilitation and privatization of SOEs; (iv) fair treatment of SOE employees, active as well as redundant; and (v) ongoing scrutiny of procurement by SOEs. Overall, the performance of the Borrower, the Executing Agency, and the Implementing Agency was satisfactory.

K. Performance of the Asian Development Bank

49. The performance of ADB was satisfactory. The original schedule for compliance with the terms of the Program was ambitious, as most of the governance and legislative actions required lengthier consultations than anticipated with stakeholders and with several parliamentary committees, resulting in the delayed release of the second and third tranches. ADB maintained active policy dialogue with the Government on the implementation of the Program throughout its duration and intensified its deliberations with the Government in the area of privatization in 2004 and early 2005. In this way ADB elicited renewed assurances from the Government that the momentum of the reforms would be maintained and that the outstanding conditions would be complied with. A mission in July 2008 confirmed the commitment of the Government: reforms in corporate governance, PSOs, and procurement have been sustained, and privatization is regaining momentum. MSOE attributed both developments to ADB’s support and the design of the Program.

18 ADB. 2004. Technical Assistance Completion Report for Indonesia for Commercialization of Public Service

Obligations. Manila (TA 3728-INO).

13

III. EVALUATION OF PERFORMANCE

A. Relevance

50. The Program was highly relevant. The Asian economic crisis hit Indonesia hardest among the Southeast Asian economies. One of the severest consequences of the insolvency of the financial sector was the collapse of public sector finances. The public sector deficit rose rapidly and peaked at 3.5% in 2001, despite the austere fiscal policy prescribed by the International Monetary Fund, which wiped out much of Indonesia’s social security network. Public health expenditure for one decreased by 26% in real terms between 1997 and 2001. In this dire economic situation, privatization was seen foremost as a means of correcting the fiscal imbalance. In contrast to other countries, which pursued privatization as the centerpiece of SOE reform to strengthen market forces and competition while reducing the state’s role to regulation, Indonesia privatized for purely fiscal reasons and enthusiasm for the measure was expected to flag as the fiscal situation improved. The Program therefore took a holistic approach to SOE reform that comprised, besides privatization, corporate governance, fiscal treatment of PSOs, corporate restructuring, social security, and the control of corruption in procurement. This holistic approach ensured the relevance of the Program during implementation and thereafter.

B. Effectiveness in Achieving Outcome

51. The Program was effective in achieving its goals. In the area of corporate governance, MSOE (i) negotiated and signed appointment agreements for all newly appointed directors and commissioners, (ii) received SCIs from 37 SOEs in 2002 and from 46 SOEs in 2003, and (iii) achieved the filing of annual reports with the company registrar in the Ministry of Industry and Trade (more than 80% of the SOEs under MSOE’s jurisdiction submitted reports for FY2001 and FY2002) and with MSOE (all SOEs submitted reports), in full compliance with the legal requirements. MSOE also implemented a performance incentive system in all profitable SOEs, assessed corporate governance in listed SOEs, and determined the quality and composition of the board of commissioners in about 30 SOEs. All these achievements have been sustained. Public service obligations were identified in 15 SOEs and recommendations developed for their financing and sustained delivery. Ongoing budget constraints, however, held back the MOF from agreeing to an accountable mechanism for financing the PSOs. Under the Program and with support from an ADB TA (footnote 2), 36 SOEs submitted restructuring plans at their annual shareholders’ meetings, and all of the plans were approved. In satisfactory compliance with the Program’s conditions, MSOE obtained parliamentary approvals and completed all government actions for the privatization of at least 15 SOEs. Although privatization lost momentum after the Program, it continued, albeit more slowly. Instead of a labor law, MSOE drafted a labor rationalization policy for (i) severance payments and gratuity based on length of service; (ii) early retirement; (iii) reemployment, training, or retraining of employees and financing of entrepreneurial initiatives; and (iv) employee rights in the assessment of claims against pension funds. A monitoring mechanism was also developed to oversee the implementation of the policy by SOEs and point out needed improvements. But midway through implementation, Parliament passed a restrictive labor law, which went far beyond the Program’s recommendations. MSOE conducted procurement audits in 40 SOEs, identified inefficiencies, and required SOEs to improve on their deficiencies.

14

C. Efficiency in Achieving Outcome and Outputs

52. The Program was efficiently managed, both by MSOE and ADB. Despite its risky and complex design—a large number of individual interventions in the SOE sector were bundled into one package and social issues were included—most of the conditions and covenants were fully met by the end of the Program. The loan conditions were limited to those that the executive was empowered to implement (the need to pass legislation, for example, was avoided), yet Parliament still got in the way of some conditions relating to privatization, delaying the release of loan tranches. Both MSOE and ADB, however, reacted appropriately by intensifying dialogue with Parliament and shifting privatization toward the creation of joint ventures. The shift had positive results: compliance with outstanding conditions improved, and one condition was waived in view of the overachievements in others. Implementation benefited from the strong involvement of ADB staff and TA support.

D. Preliminary Assessment of Sustainability

53 All outcomes achieved under the Program have proven to be sustainable in the 3 years since it ended. Some measures in the area of corporate governance have been further improved and the established levels of accountability and transparency have been maintained. The treatment of PSOs, as developed by MSOE with TA support (footnote 3), continues. The cost of PSO delivery is identified in the yearly accounts of 15 SOEs, and proposals for appropriate subsidies for SOEs are made to MOF—and regularly rejected because of budget constraints. Privatization through the sale of shares (three cases) and through joint ventures (more than 50 cases) likewise continues; strong objections from Parliament have had to be overcome in the case of sales of shares, but the joint ventures have proceeded smoothly, as these do not have to be approved by Parliament. Most joint ventures have assets supplied by SOEs, and capital for restructuring and expansion provided by the private sector joint-venture partner. In all cases the private partner appoints a majority on the board of directors and the management, thereby taking control of the venture. From the little information that is available, the joint ventures are successful, the assets are essentially privatized, but no moneys flow to the budget.

E. Impact

54. The Program, classified as environment category B, had a positive impact on the environment. Its direct impact on the poor was similarly positive. The Program allowed all 16 plantation companies to survive the economic crisis, and even increased employment through investments in processing activities financed by joint ventures with the private sector. More than one million of the rural poor depend on state-owned plantations for their income. Actions taken under the Program, particularly the creation of a rigorous corporate governance framework for listed companies and SOEs as well as corporate restructuring and privatization, are expected to promote sustainable growth and enable the development of a more robust and efficient state sector. The electricity sector, which was explicitly excluded from the Program and therefore did not benefit from its reforms, is still riddled with problems and the country, though rich in resources, is burdened with electricity shortages. In contrast, the telecommunications sector, after undergoing corporate governance reform, corporate restructuring, privatization, and competition under the Program, has developed into a world-class provider, offering among the lowest-cost telecommunications services in Asia. Furthermore, the listing of some large SOEs on the Indonesian stock exchange has deepened the market and heightened its attractiveness.

15

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS

A. Overall Assessment

55. The Program is rated a success overall. It (i) introduced sound corporate governance structures; (ii) established a system for recognizing PSOs in SOEs—a first in Asia; (iii) restructured a large number of SOEs, both during and after the Program; (iv) privatized large SOEs through initial public offerings, and smaller ones through joint ventures; and (v) achieved the analysis-based reform of the procurement system. The Government made genuine efforts to achieve reform, complied substantially with the policy conditions, and demonstrated its continued commitment to the SOE reforms through further privatization.

B. Lessons

56. Broad-based reforms like those pursued by the Program require long-term institutional development, which is insufficiently accommodated in even a three-tranche program loan. A program cluster approach would have been more useful, as it combines a long-term approach that permits a wide range of policy and institutional reforms with flexibility to adjust to changing circumstances. Critical components like corporate governance and the optimal treatment of PSOs can be gradually introduced. A program cluster is also useful in setting benchmarks and unifying policy makers who advocate reforms. A move from a multitranche program cluster approach to a medium-term framework based on single-tranche programs within a program loan cluster could be recommended to provide more flexibility while emphasizing achievable outcomes up-front. With such an approach ADB could also support genuine commitment from relevant stakeholders over a longer period.

C. Recommendations

1. Program-Related

57. Future Monitoring. The Government and ADB should continue monitoring the progress of key reform measures, in particular, activities requiring extended periods for effective and sustained implementation, such as the further strengthening of corporate governance, corporate restructuring measures (in particular, debt workouts), and the privatization of SOEs and the sale of minority shareholdings. During the implementation of the Program MSOE excluded the investment fund account (Rekening Dana Investasi, or RDI) debt of many SOEs from corporate restructuring. These were two-step foreign currency loans to MOF from multilateral and bilateral development agencies onlent to SOEs in local currencies at floating interest rates. Many SOEs stopped servicing these debts during the Asian economic crisis in favor of immediate survival. However, now that 10 years have passed, and debts of individual SOEs have grown exponentially, it is time to finally settle these debts in a rational manner. 58. Overall Governance Framework. Disclosure of information by the MSOE about the SOE sector, and by individual SOEs about their operational and financial performance, could improve further. Centralized control under one ministry allows significant yet quick reform, given the will to carry it out. But MSOE neither produces nor discloses to the public time-bound targets for itself as shareholder of the Government’s SOE portfolio. It issues no annual statement of its achievements and its targets for the coming year. In other words, it does not subject itself to any

16

form of verifiable accountability. MSOE could also provide a public governance interface with other shareholders, such as labor unions, environmental groups, and Parliament. 59. Corporate Governance in SOEs. Assessments of corporate governance in SOEs over the years show the impressive achievements of the Program. Further achievements are possible, however. Thanks to the past assessments, we have sound knowledge of the corporate governance areas in need of further improvement. Future reforms should recognize that a number of good corporate governance tools were introduced during the Program (statements of corporate intent, transparent appointment of commissioners after fit-and-proper tests, prompt delivery of annual reports, etc.) and that there is now a need to work on their efficient use (including modification where necessary). A future reform program could (i) introduce other tools (see Appendix 5), (ii) disseminate more corporate governance concepts and implementation solutions among SOEs, (iii) penalize noncomplying SOEs, and (iv) reform MSOE itself to perform its role as shareholder more effectively. 60. Corporate Restructuring. The PCR Mission had the opportunity to review management reports of SOEs that still have to undergo corporate restructuring. Two major issues are involved: (i) workouts of SOE debts with the RDI fund of the MOF and (ii) reduction of the cost burden through workforce reduction. As the restructuring will have to take place eventually, and will involve labor displacement, managing its social impact will be a major concern, and assistance from ADB could be required. 61. Privatization. The major privatization vehicle has become PPP through joint ventures. PPPs were first used in the infrastructure industries of electricity, ports, and telecommunications. The have played a major role in privatization in recent years and are likely to play a major role in the future, mainly as a way of bringing together the public and private sectors to meet the capital demands of SOEs, particularly in infrastructure. A sizable number of PPPs have also been introduced in other sectors, notably the plantation sector. Nobody knows the exact number of PPPs, but at the end of 2005 there were 55, most of them created since 2003. A short survey by the PCR Mission of the 2006 annual reports of the 18 largest SOEs identified 69 joint ventures. The Mission also noted that PPP transactions in the plantation sector are not subject to the same transparency and disclosure standards as privatization transactions.

2. General

62. ADB has been supporting the SOE sector in Indonesia for some time, and has directed its attention at long-term issues like corporate governance, PSOs, corporate restructuring, and privatization. Other international financial institutions recognize ADB’s lead role in the SOE sector, in view of the deep understanding of the sector and of the overall policy environment that ADB has acquired. The wealth of experience gained and achievements under the Program, two associated TA projects, and one subsequent TA can provide the basis for continued ADB support to help develop resilient SOEs that can play a major role in the development of Indonesia’s infrastructure sectors alongside private investors.

Appendix 1 17

PROGRAM FRAMEWORK

Design Summary Targets Monitoring Mechanisms Risks/Assumptions

Goal Promote poverty reduction through sustainable pro-poor growth by (i) improving the efficiency of resource allocation, (ii) increasing profitability in the SOE sector, (iii) improving the financial health of companies in the SOE sector, and (iv) raising revenues from privatization for the state budget.

Rise in GDP growth, underpinned by (i) increasing revenue of 130

SOEs (1997: Rp53.2 trillion)

(ii) increasing operating profit (1997: Rp5.5 trillion)

(iii) increasing average debt-to-equity ratio (1997: 0.90)

(iv) increasing dividend payments to state budget (1997: Rp0.8 trillion)

(v) revenues from privatization of Rp6.0 trillion yearly (2000–2002)

• Reports from MSOE on privatization revenues and number of deals

• Annual reports of SOEs monitoring improvements in operating profitability and financial indicators

• Review missions establishing profitability of SOEs

• Economic recovery delayed or reversed by external circumstances

• Reform and privatization program slowed down or even derailed by affected interest groups.

• Reduced offers from strategic investors because of perceived risks, given the current crisis, unless a sound process is established

• Weakened commitment of Government to undertake reform

Purpose (i) Improve resource allocation in the public sector, (ii) increase profitability of Indonesia’s SOEs and (iii) promote private sector participation in all commercial activities of SOEs. By reforming SOEs and moving from ownership and management to selected regulation, the Government will release scarce resources, which can be allocated for poverty reduction, and stimulate the private sector to drive economic growth

• Use of SOE dividends for development initiatives and social service expenses; use of privatization revenues to pay the cost of bank restructuring

• Reduced losses and improved profits of SOEs through corporate governance, corporate restructuring, and liquidation

• Implementation and execution of regulations for the commercialization of PSOs

• Successive budgets throughout the Program identifying revenues in the form of dividends and privatization proceeds and expenditure for social safety net and poverty alleviation

• Annual reports, appointment agreements with commissioners and directors, SCIs of SOEs, reports from MSOE on the revenue from privatization

• Increased willingness to reform and privatize and greater political acceptability of privatization program as a result of success of corporate governance reform and restructuring of SOEs

• Continued macroeconomic stabilization during implementation period

• Cooperation from stakeholders and SOE management

Outputs 1. Corporate Governance 1.1 Develop and introduce

corporate governance policy framework for SOEs to empower managers to create shareholder value under adequate supervision in a transparent environment promoting accountability

The policy statement will include: • Appointment criteria, roles,

responsibilities, and accountability of BOC and BOD and templates for appointment agreements between the Government and the commissioners and directorsa

• Objectives and scope of the SCI,b as a mechanism for implementing and enforcing improved transparency and accountability standards

• PISc to reward management for improvements in defined performance indicators

• Steering committee review; ADB oversight

• Working group on corporate governance, reporting to the steering committee

• Delays in consultations between MSOE and SOEs

18 Appendix 1

Design Summary Targets Monitoring Mechanisms Risks/Assumptions 1.2 Implement corporate

governance policy

• Implementation of the following corporate governance measures for 60 SOEs: (i) Review and comment

on the composition of the BOC and BOD, including number of members, skill mix, and qualificationsd

(ii) Negotiate and sign appointment agreements and SCIs (including reasonable PIS) for SOEs, applying new corporate governance policy)

• Submission of PRR on

implementation of corporate governance policy (appointment agreements, SCIs, and PIS) for SOEs with at least 1 year of experience; PRR should include key benefits of contracting system and suggested improvements


• SCIs submitted to MSOE

• Delay in fielding consultants

• Delay in preparing SCIs • Opposition from SOE

commissioners and directors

1.3 Improve transparency of SOEs

• Creation of a new corporate secretary position for all SOEs to be listed

• Filing of annual reports by all SOEs with the company registrar in line with regulations for listed companies

• Publication by MSOE of annual reports (including audited financial statements) of SOEs with majority government ownership on a specially designed Web page; 100 SOEs to establish own website and publish their annual report

• Establishment of audit committees (with one commissioner and two outside experts) to report directly to BOC


• Consultants’ reports and confirmation from company registrar

• Steering committee reports, annual reports of SOEs

• Resistance from directors and commissioners

• Lack of funds in MSOE to establish website

1.4 Build capacity for effective implementation of corporate governance mechanisms

• All MSOE deputy ministers, directors, commissioners, and directors of 60 SOEs to attend corporate governance workshops

• Steering committee review • Consultants’ reports

• Lack of interest of directors and commissioners

2. Public Service Obligations (PSOs) 2.1 Quantify PSOs and

develop regulations for their tender

• Identification of PSOs in 15 SOEs

• Quantification of PSO costs and environmental impact

• Consultants’ reports • Delay in fielding consultants

• Opposition from line ministries

Appendix 1 19

Design Summary Targets Monitoring Mechanisms Risks/Assumptions • Development of rules and

regulations for tendering such services (allowing bidding by private companies) to minimize subsidies

• Public opposition to changing delivery system for services

2.2 Implement policy • Introduction of rules and regulations for allowing private companies to provide PSO to minimize subsidies

• Contracting oute by line ministries of the provision of selected public services to most competitive bidder, which may or may not be the SOE that previously provided the services


• PSO contracts • Consultants’ reports

• Inability of the Government to allocate funds for transparent subsidization of PSOs

• Prolonged negotiation over pricing of PSO

3. Corporate and Financial Restructuring of SOEs in Preparation for Eventual Privatization 3.1 Liquidate nonviable

SOEs • Identification of nonviable

SOEs and SOE business lines to be discontinued

• Liquidation of nonviable SOEs


• Delay in MSOE decision • Opposition/Protest from

nonviable SOEs and their employees

3.2 Undertake financial restructuring of SOEs

MSOE implementation of corporate restructuring plansf for 25 SOEs identified, considering all relevant legislation and policies stipulated under the Program


• Delay in negotiations with banks and other lenders, IBRA, or JITF

• Disagreement between the steering committee and the consultants

3.3 Improve quality of financial audits

Independent (non-BPKP) 3-year financial audit including remuneration and all expenses (direct as well as fringe benefits) of the members of the BOC and BOD


• Audit reports

• Disagreement between MSOE and SOEs on selection for audit

3.4 Privatize SOEs • Determination of privatization optionsf for 25 SOEs and 10 minority shareholdings

• Privatization of at least 10 SOEs

• Sale of minority shareholdings in 10 companies


• Delay due to unfavorable market condition for flotation or search for investment partner

• Disagreement about valuation of SOEs between the Government and strategic investors

3.5 Review legislative measures to ease corporate restructuring

MSOE assessment of impact of specified measures on efficiency of corporate restructuring


20 Appendix 1

Design Summary Targets Monitoring Mechanisms Risks/Assumptions 4. Establishment of Fair and Transparent Procedures for Managing Labor Redundancies 4.1 Develop labor redundancy

policy for all SOEs • Drafting of labor

rationalization policy by MSOE

• Facilitation by MSOE of establishment of consultative working group on labor rationalization to expand the labor rationalization policy and foster dialogue between labor unions, SOE management, and MSOE


• Uncooperative working group members

4.2 Implement labor redundancy policy for all SOEs

• Submission by SOEs of labor restructuring plans, if any (including cost implications), to MSOE and MOM for endorsement

• Recording by MOM of financial assistance being provided by Government to SOEs unable to meet the expenses for redundancies


• MSOE reports • MOM reports

• Opposition from labor union or workforce

• Inability of the Government to allocate enough funds for redundancy payments for SOEs

5. SOE Procurement Less corruption in SOE procurement

• Random independent or BPKP audit of procurement by SOEs, and presentation of audit reports to steering committee and ADB

• Publication of summary findings and identification of measures for recovering losses and prosecuting culprits


• Procurement guidelines for SOEs

• SOE opposition to the implementation of guidelines

ADB = Asian Development Bank, BOC = board of commissioners, BOD = board of directors, BPKP = Badan Pengawasan Keuangan dan Pembangunan (Indonesian state finance and development surveillance committee), IBRA = Indonesian Bank Restructuring Agency, JITF = Jakarta Initiative Task Force, MOM = Ministry of Manpower, MSOE = Ministry of State-Owned Enterprises, PIS = performance incentive system, PRR = performance review report, PSO = public service obligation, SCI = statement of corporate intent, SOE = state-owned enterprise. a These contractual arrangements can be documented in the minutes of the shareholders’ meeting. b The SCI will be prepared by the board of directors (company management), approved by the board of commissioners, and

submitted to MSOE. c The PIS will form an integral part of both the SCIs and the management contracts, linking management remuneration with

the achievement of performance targets outlined in the SCI, considering commercial, labor, and environmental legislation. d Including a review of the role, obligations, and composition of the BOC and BOD to verify whether BOC has guided and

monitored the implementation by BOD of (i) SOE’s long-term plan, (ii) annual business plan, and (iii) budget. e In the contracting process (open tender), compliance with environmental legislation should be taken into account in the

technical specifications. f Corporate restructuring is either financial or operational restructuring. Financial restructuring can take one or more of the

following forms: (i) sale of subsidiaries or surplus assets, (ii) equity injection from third parties, (iii) merger or acquisition of SOEs by SOEs, (iv) debt restructuring, and (v) liquidation. Operational restructuring can involve changes in one or more of the following: (i) management information systems, (ii) production and logistics planning, (iii) distribution network, (iv) marketing strategy, (v) workforce number and composition, and (vi) organizational structure.

g The privatization options are: employee buyout, strategic sale, free share transfer, initial public offering, joint venture, lease of operating assets, granting of concessions, golden share arrangement, and cash auction.

Appendix 2 21

COMPLIANCE WITH FIRST-TRANCHE RELEASE CONDITIONS

Policy Actions Completed Actions,

1998 to Nov 2001 A. Corporate Governance 1. For SOEs not listed on a stock exchange: Develop and strengthen corporate

governance policy framework for SOEs to empower the managers to create shareholder value under adequate supervision in a transparent environment promoting accountability. Introduce a new corporate governance policy for SOEs which will mandate: (i) appointment criteria, roles, responsibilities and accountability of Board of

Commissioners (BOC), and Board of Directors (BOD) and templates for appointment agreements between the Government as shareholder through the general meeting of shareholders with the Commissioners. Likewise there will be templates for appointment agreements between the Government as shareholder through the general meeting of shareholders with the Directors;a

(ii) the objectives and scope of Statement of Corporate Intent (SCI),b as a mechanism for implementation and enforcement of improved transparency and accountability standards. SCI will set out the objectives and scope of the SOE’s activities, and define the business plan (including all corporate restructuring measures), accounting policies, performance targets, disclosure requirements, compliance with environmental legislation,c status of employees and compliance with laws and regulations regarding labor relations, and procedures to be followed before subscribing for, purchasing, or acquiring shares in organizations;

(iii) a performance incentive system (PIS)d to reward management for improvements in defined performance indicators.

Complied with.

2. Implement corporate governance policy through the following measures: (i) Review and comment on the composition of the BOC and BOD, including the

numbers on the Boards, and the skills mix and qualifications of the BOC and BOD; e

(ii) negotiate and sign appointment agreements for all newly appointed Directors and Commissioners;

(iii) implement performance incentive system for remuneration of managers to reward for improvements in defined performance indicators by issuing Ministerial Decree; and

(iv) prepare SCIs for the following number of SOEs:f (a) first group of 3 SOEs,

Complied with.

Complied with.

Complied with.

Complied with.g

3. Ensure all listed SOEs are fully complying with the listing rules of the Jakarta Stock Exchange (JSX) in particular with the following provisions on corporate governance: (i) appointment of independent commissioners in proportion to the number of

shares held by non-controlling shareholders; (ii) establishment of an audit committee comprising at least three members, one of

whom is an independent commissioner and the others independent professionals in accounting and/or finance recruited from outside the company;

(iii) appointment of a corporate secretary. The position must be held by one member of the Board of Directors or a corporate officer specifically appointed to this function.

Complied with.

Complied with.

Complied with.

4. Improve transparency of SOEs:

(i) Create a new Corporate Secretary position for all SOEs to be listed during next 12 months. The Secretary is to be appointed within four months of the expected listing date of the SOE, and will be responsible for corporate communications.

Complied with.

(ii) MSOE to require that all SOEs have to prepare an annual reporth including statement on compliance with environmental legislation and audited financial statements in line with existing regulations applying to: (a) all companies with limited liability,i (b) companies whose line of business involves public fund raising or have assets of at least Rp50 billion or have issued an acknowledgement of indebtedness,j and (c) publicly listed companies.k

Complied with.

(iii) At least 80 percent of SOEs under jurisdiction of MSOE to file such annual reports complying fully with legal requirements stipulated above with the Company Registrar.

Complied with.l

22 Appendix 2


1998 to Nov 2001 (iv) MSOE to publish annual reports (including audited financial statements) of SOEs

with majority Government ownership on a specially designed web page accessible through the Internet. The system will also be used for SOEs to submit data to MSOE.

(v) Establish audit committees in 30 SOEs annually (incl. one commissioner and two outside experts) that should report directly to BOC to evaluate the audit results of the company, review compliance of company with statutory requirements, adequacy of audit procedures, and to make recommendations about the internal control systems and their implementation.

Complied with.m

(vi) Capacity building for effective implementation of corporate governance mechanisms by attending corporate governance workshops covering all items in A.1. with support of ADB, World Bank or other providers, to be attended by at least 40 MSOE Directors and Deputy Directors.

Complied with.

B. Public Service Obligations (PSOs)

C. Corporate and Industry Restructuring

1. Launch a major financial and operational review of at least 60 SOEs with the objective of (i) evaluating commercial and financial viability of firms and their business prospects, (ii) assessing labor retrenchment requirements, (iii) recommending assessment of compliance with environmental legislation.

Complied with.

2. Develop policies and procedures for the following privatization processes: employee buy-out, strategic sale, free share transfer, initial public offering, joint venture, leasing of operating assets, granting of concessions, golden share arrangement, and cash auction. This will include procedures for selecting auditors, investment bankers and other technical advisors.

Complied with.

3. Bring to effect a new telecommunications law (NTL) which provides key guidelines for industry reforms, including industry liberalization, facilitation of new contracts and an intense competitive structure. The NTL will eliminate the concept of organizing entities, thus ending the monopolistic structure of the industry. It will explicitly prohibit monopolistic practices and unfair competition among telecommunication operators. The role of the Government will be transformed from owner/regulator to an impartial policy maker and supervisor of telecommunications sectors.

Complied with.

4. Indosat and Telkom to resolve their cross-ownership in several affiliates, including Telkomsel, Satelindo, and Lintasarta. Additionally, Telkom to surrender control of one of seven regional operators, KSO IV, to Indosat. These transactions, which are considered material and involving conflict of interests by the Boards of Commissioners of both companies, are to be approved in Extraordinary General Meetings. The representatives of the major shareholder, the Government, are to abstain from voting in both meetings.

Complied with.

5. Based on the review in C.1. and with assistance from Bank TA “SOE Privatization and Restructuring”: (i) Identify 12 nonviable SOEs and SOE business lines to be discontinued

Complied with. 6. MSOE to implement corporate restructuring plansn for 30 SOEs identified under

C.1., with appropriate consideration for all relevant legislation and policies stipulated under this program: (i) at least 5 SOEs for first tranche

Complied with. 7. Based on the review in C.1. above and in accordance with Program Implementation

Schedule: Complete independent (non-BPKP), three-year financial audit that should include remuneration and all expenses (direct as well as fringe benefits) of the members of the BOC and BOD. (i) at least 18 SOEs before first tranche release.

Complied with. 8. For SOEs identified under C.1. MSOE to determine the privatization optionso for 30

SOEs and 12 minority shareholdings. Complied with.

9. For SOEs identified under C.9. MSOE to (i) IPO 2 SOEs in preparation of privatization during 2002;

Complied with.

D. Labor Redundancies

1. MSOE to:

Appendix 2 23


1998 to Nov 2001 (i) prepare a draft Labor Rationalization Policy based on legal standards for

severance and service payments as outlined in Presidential Decree 3/1996; (ii) facilitate establishment of a consultative working group on labor rationalization.

The Group will expand the Labor Rationalization Policy to include early retirement regulation, assistance for redeployment, including training or retraining of workers, financing of entrepreneurial initiatives, access to pension funds, etc. for managing seminars and workshops on labor relation legislation, and foster dialogue between labor unions, SOE management, and MSOE. Additionally, the Group will hold seminars and workshops on labor legislation, and foster dialogue between labor unions, SOE management, and MSOE. Members to be selected from human resource managers in SOEs, Federation of SOE Labor Unions, Legal Aid Society, ILO, MOM, MSOE, and BAPPENAS;

(iii) approve recommendations of consultative working group;

Complied with.

Complied with.

E. Procurement

1. MSOE to require compliance by SOEs with transparent and fair procurement practices ensuring full accountability.

Complied with.

2. MSOE to: (i) prepare TORs for the procurement auditors (ii) initiate random, independent or BPKP audits of the procurement by SOEs,

present audit reports to Steering Committee and ADB, publish summary findings, and identify measures to recover losses and prosecute culprits: (a) for 20 SOEs (b) for another 20 SOEs.

Complied with.

ADB = Asian Development Bank, BOC = board of commissioners, BOD = board of directors, BPKP = Badan Pengawasan Keuangan dan Pembangunan (Indonesian state finance and development surveillance committee), ILO = International Labor Organization, MOM = Ministry of Manpower, MSOE = Ministry of State-Owned Enterprises, NTL = new telecommunications law, PSI = performance incentive system, SCI = statement of corporate intent, SOE = state-owned enterprise, TA = technical assistance, TORs = terms of reference. a These contractual arrangements can be documented in the minutes of the shareholder meeting. b The SCI will be prepared by the board of directors (company management), approved by the board of

commissioners, and submitted to MSOE. c Where appropriate, this will be confirmed through appropriate certification (e.g., ISO 14000) by the accredited

agency. d The PIS will form an integral part of both SCIs and management contracts, linking management remuneration with

the achievement of performance targets outlined in the SCI, considering commercial, labor, and environmental legislation.

e Including a review of the role, obligations, and composition of BOC and BOD to verify whether BOC has guided and monitored the implementation by BOD of (i) SOE’s long-term plan, (ii) annual business plan, and (iii) budget.

f In selecting the SOEs, preference will be given to those that are not to be privatized in the Program. g Process of developing SCIs and contractual arrangements, including reasonable performance incentive systems for

SOEs applying new corporate governance policy, has begun in five SOEs. h The annual report, including the audited financial statements, must conform to the Company Law and the General

Accepted Accounting Principles (GAAP) approved by the Indonesian Institute of Accountants. i Consistent with Company Law, articles 56, 57, 58, and 86. j Consistent with Government Regulation 24/1998 of 14 February 1998 on corporate annual financial information. k In line with the Decision of the Chairman of BAPEPAM KEP-80/PM/1996 of 17 January 1996 on the obligation to submit

periodic financial statements. l For FY1998, FY1999, and FY2000. m Fifty SOEs have already set up their own websites. n Corporate restructuring is either financial or operational restructuring. Financial restructuring can take one or more of the

following forms: (i) sale of subsidiaries or surplus assets, (ii) equity injection from third parties, (iii) merger or acquisition of SOEs by SOEs, (iv) debt restructuring, and (v) liquidation. Operational restructuring can involve changes in one or more of the following: (i) management information systems, (ii) production and logistics planning, (iii) distribution network, (iv) marketing strategy, (v) workforce number and composition, and (vi) organizational structure.

o The privatization options are: employee buyout, strategic sale, free share transfer, initial public offering, joint venture, lease of operating assets, granting of concessions, golden share arrangement, and cash auction.

24 Appendix 3

FINANCIAL PERFORMANCE OF STATE-OWNED ENTERPRISES IN INDONESIA (2000–2003)

Table A3.1: Profits and Losses, 111 SOEs (2000–2003)

Rp Million Change 2000–2003 Profits and Losses 2000 2001 2002 2003 Rp million % Revenues 130,454,454 157,954,686 180,248,385 195,050,395 64,595,941 50

Gross Profits 37,638,500 45,184,186 53,821,664 67,217,014 29,578,514 79

Overhead 26,363,081 30,254,800 47,068,055 52,782,538 26,419,457 100

Other (non-operating income/ expenses)

999,818 (10,192,771) (14,855,156) (13,637,491) (14,637,309) (1,464)

Earnings before interest and taxes

10,275,601 25,122,157 21,608,765 28,071,967 17,796,366 173

Interest Expense 22,061,648 11,051,898 9,645,612 11,301,748 (10,759,900) 49

Profits before Taxes (11,786,047) 14,106,259 11,963,153 16,770,219 28,556,266 242

Taxes 3,642,463 3,562,605 6,237,946 8,137,686 4,495,223 123

Extraordinary Items (38,452) (240,761) (2,767,948) (1,481,986) (1,443,534) (3,754)

Net Profits (15,390,058) 10,784,415 8,493,155 10,114,520 25,504,578 166

Dividends 3,040,666 4,450,840 5,724,577 6,802,753 3,762,087 124

Adjustments 3,991,597 3,013,891 3,228,134 (242,365,577) (246,357,174) (6,172)

Adjusted Retained Earnings

(22,422,321) 3,319,684 (459,556) 245,677,344 268,099,665 1,196

( ) = negative, SOE = state-owned enterprise. Note: The table includes 111 SOEs for which data were available on a reliable and consistent basis for 2000–2003. Source: Ministry of State-Owned Enterprises.

Table A3.2: Balance Sheets, 111 SOEs (2000–2003)

Rp Million Change 2000–2003 Balance Sheet Items 2000 2001 2002 2003 Rp million % Current Assets 238,149,675 301,040,351 301,214,435 335,643,102 97,493,427 41

Noncurrent Assets

434,194,564 421,478,371 556,013,577 543,710,614 109,516,050 25

Total Assets 672,344,239 722,518,722 857,228,012 879,353,716 207,009,477 31

Current Liabilities

411,700,625 479,464,655 471,405,013 491,200,869 79,500,244 19

Noncurrent Liabilities

162,481,523 144,331,692 145,736,585 137,001,304 (25,480,219) (16)

Total Liabilities 574,182,148 623,796,347 617,141,598 628,202,173 54,020,025 9

Equity 98,162,097 98,722,375 240,086,412 251,151,543 152,989,446 156

Liabilities and Equity

672,344,245 722,518,722 857,228,010 879,353,716 207,009,471 31

( ) = negative, SOE = state-owned enterprise. Note: The table includes 111 SOEs for which data were available on a reliable and consistent basis for 2000–2003. Source: Ministry of State-Owned Enterprises.

Appendix 4 25

PRIVATIZATION INDICATORS

Table 4.1: Public-Private Partnerships, by Type Type of PPP

Company and Sector JV BOT Lease/ Rent

PPA/ GPA Total

PT Perusahaan Listrik Negara (electricity)

4 9 13

PT Telkom (telecommunications) 3 5 8 PT PUSRI (fertilizer) 12 12 PT Perushaan Gas Negara (gas) 4 2 6 PT PELNI (shipping) 3 3 PT Kereta Api (railways) 7 7 PT PELINDO III (seaports) 1 1 PT PELINDO I (seaports) 2 2 Total 24 12 5 11 52 BOT = build-operate-transfer, GPA = gas purchase agreement, JV = joint venture, PPA = power purchase agreement, PPP = public-private partnership. Source: Ministry of State-Owned Enterprises.

Table 4.2: Compliance with Privatization Conditions, 2002–2005

Government Shareholding (%)

SOE and Sector Before the Program As of Aug 2005

Board Appointments

Divestment of Shares to Fulfill Second-Tranche Release Condition PT Indosat (telecommunications) 66.0 15.0 Majority by private

investor PT Bank Central Asia 100.0 5.0 PT Bank Danamon 100.0 0.0 PT Bank Internasional Indonesia 100.0 5.5 PT Bank Niaga 100.0 0.0 PT Angkasa Pura Ia (airport) 100.0 49.0 PT Angkasa Pura IIa (airport) 100.0 49.0 Divestment of Shares to Fulfill Third-Tranche Release Condition PT Bank Lippo 100.0 1.2 Majority by private

investor PT Bank Permata 97.0 26.2 PT Batubara Bukit Asam (mining) 100.0 65.8 PT Pembangunan Perumahan (housing construction)

100.0 51.0

PT Adhi Karya (construction) 100.0 51.0 PT Hotel Indonesia 100.0 30-year lease PT Hotel Wisata 100.0 30-year lease PT Merpati Nusantara Airlinesb 100.0 49.0 To be determined

SOE = state-owned enterprise. a The privatization options for the two Angkasa Pura companies, involving the transfer of 49% of share

ownership and the majority of board positions to the private sector, had been developed to the transaction stage in 2002. But investor interest was adversely affected by the terrorist attacks in Bali and has yet to revive, given the uncertainty in tourism forecasts. Current share ownership refers to intended ownership.

b On 27 September 2004, Parliament approved a restructuring program for PT Merpati consisting of debt restructuring and the strategic sale of majority state ownership to foreign or local investors. Current share ownership refers to intended ownership.

Source: Ministry of State-Owned Enterprises.

26 Appendix 4

Table 4.3: Major Privatization Initiatives, 1999–August 2005a

SOE % Sold Method Revenue

(Rp trillion) PT Indosat 51.0 SS 4.3 PT Perusahaan Gas Negara 39.0 IPO 1.2 PT Indocement TP Tbk. 16.7 SS 1.2 PT Bank Mandiri Tbk. 30.0 IPO and P 5.4 PT Bank Rakyat Indonesia 45.0 IPO and ESOP 2.5 Bank Central Asia 95.0 SS 6.6 Bank Danamon 100.0 SS 5.1 Bank Internasional Indonesia 94.5 SS 3.4 Bank Niaga 100.0 SS and P 2.9 Bank Lippo 60.8 SS 1.4 Bank Permata 71.0 SS 2.9

Total Privatization Proceeds in 2002–2004 37.0 ($3.6 billion)

Privatizations since 2005 PT Jasa Marga 30.0 IPO 3.5 PT PGN 5.4 P 2.1 Bank Negara Indonesia (BNI) 12.2 P 8.1

Total Privatization Proceeds since 2005 13.7 ($1.5 billion)

ESOP = employee stock option plan, IPO = initial public offering, P = placement in the capital market, SOE = state-owned enterprise, SS = strategic sale. Note: In addition to the above, the Government raised Rp120 billion ($13.2 million) from the sale of PT Pembangunan Perumahan, PT Bukitbara Asam, and PT Adhi Karya. a Measured by proceeds to the budget. Source: Ministry of State-Owned Enterprises.

Appendix 5 27

COMPLIANCE WITH SECOND- AND THIRD-TRANCHE RELEASE CONDITIONS

Core Tranche Release Conditions under Second and Third Tranches

Compliance with Second-Tranche Release Conditions

Compliance with Third-Tranche Release Conditions

A. Sound Corporate Governance Principles for SOEs A.2.(i) Negotiate and sign appointment agreements for all newly appointed directors and commissioners (both tranches).

Complied with. SOE commissioners and directors have been appointed in line with MSOE guidelines that have been in effect since 2001.

Complied with. MSOE issued a ministerial decree (59/2004) in June 2004 stipulating a revised template for appointment agreements with complete terms and conditions for all newly appointed directors. This decree provides an updated implementation framework for the 2003 SOE Law and the August 2002 Ministerial Decree on Corporate Governance. MSOE is updating the previous guidelines for appointments of new commissioners.

A.2. (ii) Prepare SCIs for 35 SOEs (second tranche).a

(iii) Prepare SCIs for 50 SOEs (third tranche)

Complied with. A total of 36 SCIs for 2003–2005 were completed. These were reviewed and endorsed by MSOE and published on its website.b

Complied with. MSOE has identified 76 SOEs and issued instructions to them to complete SCIs for 2004–2006. Fifty SOEs have completed draft SCIs and 49 of these have obtained the approval of their shareholders at annual general meetings and the endorsement of the MSOE shareholder nominees.c

A.4.(iii) At least 80% of SOEs under MSOE jurisdiction to file annual reports with MSOE and the company registrar at the Ministry of Industry and Trade that comply fully with legal requirements (for both tranches).

Complied with. All 125 SOEs under MSOE jurisdiction had filed their 2001 annual reports with MSOE by 31 August 2002, fully complying with the legal requirements for such annual reports. For 2002 financial statements, MSOE had received all 125 annual reports by December 2003. The subission of these reports had, however, been delayed because of a dispute about the right to audit between MSOE as the shareholder and the State Audit Agency, resulting in a delay in the annual shareholders’ meetings. About 50% of these reports have been registered at the Ministry of Industry and Trade.d

Complied with. MSOE has reported almost full compliance with regard to SOEs’ submission of audited financial statements at the annual general meetings of shareholders, the subsequent endorsement of the statements by the shareholders at the meetings, and the submission of the reports to MSOE. A uniform electronic reporting format that will be suitable for submission to the Ministry of Industry and Trade has been developed with technical assistance support.e

C. Corporate Restructuring and Privatization of SOEs C.5. Conduct a complete independent (nonfinancial and Development Supervisory Board), 3-year financial audit that includes remuneration and all expenses (direct as well as fringe benefits) of the members of the Board of Directors and Commissioners of 30 SOEs (both tranches).

Complied with. This requirement has been exceeded, in that a total of 111 SOEs had submitted audit reports (including the remuneration and expenses of members of boards of directors and commissioners) from independent private sector auditors to MSOE by the end of August 2002.

Complied with. More than 100 SOEs submitted their audit reports from independent auditors for fiscal years 2002 and 2003, including remuneration and expense information relating to directors and commissioners. Support was provided under ongoing technical assistancee

to improve disclosure and reporting requirements, with particular focus on disclosing remuneration and expense details by category of expenses and by individual directors and commissioners.

28 Appendix 5




Complied with. The Government has fully complied with the third-tranche release condition through various actions in the following 8 SOEs: (i) Divestment of 49% of state

shares in PT Pembangunan Perumahan, with the Government currently owning 51%, but ceding majority of board positions to private investors

(ii) Divestment of 49% of state shares in PT Adhi Karya, with the Government owning 51% but listing the company on the Jakarta Stock Exchange and ceding majority of board positions to private investors

C.7. MSOE to achieve satisfactory progress in privatizing at least seven SOEs (second tranche) and at least eight SOEs (third tranche)

Complied with. The Government has fully complied with the second-tranche release condition through various actions in the following 7 SOEs: (i) Divestment of majority state

ownership (85%) in PT Indosat (ii) Divestment of majority ownership

in 4 commercial banks (Bank Central Asia, Bank Danamon, Bank Internasional Indonesia, and Bank Niaga)

(iii) Completion of all transaction steps with regard to the privatization of PT Angkasa Pura I and PT Angkasa Pura II, the SOEs managing the international airports in Bali and Jakarta, after parliamentary approval in 2002

With support from the Program, the Government expedited privatization. In 2003–2004, it proposed to Parliament the divestment of shares in 23 SOEs. The Government has adopted a strategic focus on divesting state shares in the largest enterprises and financial institutions and is using a combination of privatization methods, including strategic sale, divestment or new issue of shares through the stock market, and employee and management buyouts. As a result of these actions, the Government ceded all of its shares in 11 SOEs during the program period, including: (i) the divestment of minority positions (see C.8); (ii) the sale of 39%–49% of shares in 3 other SOEs, (iii) the divestment of majority ownership in 5 commercial banks, and (d) the divestment of 40%–49% of shares in 2 of the largest state-owned commercial banks.

(iii) Divestment of 35% of state shares in PT Batubara Bukit Asam, with the Government owning 65% but listing the company on the Jakarta Stock Exchange and ceding majority of board positions to private investorsf

(iv) Ceding of state management and operational control over the major assets of PT Hotel Indonesia through a 30-year, long-term lease

(v) Ceding of state management and operational control over the major assets of PT Hotel Wisata through a 30-year, long-term lease

(vi) Divestment of almost 99% of state shares in Bank Lippo through strategic sale

(vii) Divestment of almost 74% of the Government’s shareholding in Bank Permata; a consortium consisting of Standard Chartered Bank and PT Astra International has acquired the bank

(viii) Finalization of the restructuring of PT Merpati Nusantara Airlines and the securing of Parliament’s approval for the privatization of up to 51% of the company

The Government also divested itself of its shareholdings in a few strategic SOEs, as follows: (i) 39% of state shares in PT PGN,

with the Government owning 61% and Parliament approving the sale of 7.5% more in 2005

Appendix 5 29




(ii) 30% of state shares in Bank Mandiri, the largest state-owned financial institution, with the Government currently owning 70%

(iii) 40.5% of state shares in Bank Rakyat Indonesia, the largest microfinance institution and the third-largest commercial bank, with the Government owning 59.5%

In addition to the successful divestments or transfer of management control in 18 SOEs, the Government targets another 10 SOEs for privatization—9 nonfinancial SOEs and 1 financial institution—and has presented plans for their full or majority divestment to Parliament. These SOEs are: (i) PT Bank Negara Indonesia (30%

of 99%) (ii) PT Indah Karya (all 100%) (iii) PT Indra Karya (all 100%) (iv) PT Virama Karya (all 100%) (v) PT Bina Karya (all 100%) (vi) PT Yodya Karya (all 100%) (vii) PT Cambrics Primissima (all

52.8%) (viii) PT Perkebunan Nusantara III

(30% of 100%) (ix) PT Timah (14% of 65%) (x) PT Aneka Tambang (14% of

65%) C.8. For minority shareholdings, MSOE to achieve satisfactory progress in completely selling shares in at least five companies (second tranche) and in at least seven companies (third tranche).

Partially complied with. Through the Program, the Government has divested itself of all its shareholdings in PT Wisma Nusantara (42.0%), and PT Indocement (16.7%). In addition, the Government’s privatization program includes the divestment of minority shareholdings in 12 enterprises. The Government has finalized a regulation to be signed by President, which authorizes the Government to sell once the divestments are included as part of the budget and upon approval by Parliament.

Partially complied with. The President of Indonesia approved Government Regulation (PP33/2005 of 7 September 2005) which provides for clarity in the privatization procedures and confers divestment authority on the national Government once Parliament approves the sale as part of the annual budget deliberations. In 2004, the Government divested itself of its remaining 10.5% shareholding in Bank Danamon and 16.3% in Bank Niaga. The Government intends to divest itself of its remaining minority shareholdings in 6 banks (Bank Central Asia, 5%; Bank Internasional Indonesia, 5.5%; Bank Lippo, 1.2%; Bank Permata, 26.2%; BTPN, 28.4%; and May Bank, 6.1%).

E. Strengthening and Effective Enforcement of Procurement Guidelines for SOEs E.2.(ii) MSOE will initiate Complied with. Procurement audits for Complied with. Procurement audits for

30 Appendix 5




random, independent (nonfinancial and Development Supervisory Board) audits of procurement for 40 SOEs (20 SOEs each under the second and third tranches), present audit reports to the Steering Committee and the Asian Development Bank, publish summary findings, and identify measures to recover losses and prosecute culprits.

2001 were undertaken and reports were submitted by October 2002 for 20 SOEs.g

2002 were undertaken and reports submitted by December 2003 for 20 SOEs.h

MSOE = Ministry of State-Owned Enterprises, SCI = statement of corporate intent, SOE = state-owned enterprise. a In selecting the SOEs, preference was given to those that were not to be privatized during the Program. b www.bumn-ri.com. The 36 SOEs were PT Pelni, PT PN-II, PT PP, PT Jasa Marga, PT Sarinah, PT Pusri, PT Bio

Farma, PT Petrokimia Gresik, PT Garam, PT Angkutan Sungai, PT Garuda Indonesia, PT RNI, PT Dok Perkapalan KB, PT IPTN, Perum RRI, PT Pos Indonesia, PT Asuransi Jiwasraya, PT Taspen, PT Inhutani I, PT Bank Ekspor, Perum Pegadaian, PT Perusahaan Gas Negara, PT Asuransi Jasa Rahardja, PT Jakarta Lloyd, PT Sucofindo, Perum DAMRI, Bhanda Ghara Reksa, PT Balai Pustaka, PT TWC Borobudur, PT Shang Hyang Seri, Kawasan Berikat Nuantara, PT Tirtaraya Mina, PT Dahana, PT PP Berdikari, Perum Percetakan Uang RI, and PT Wijaya Karya.

c Danareksa, Wastika Karya, Nindya Karya, Jamsostek, Asuransi Kesehatan, Surveyor Indonesia, Taspen, Industri Sandang Nusantara, Kereta Api Indonesia, Pelindo IV, Merpati, Hotel Indonesia, Dok Perkapalan Sur, PDIP Batam, Bali Turism, Kima, Rukindo, Kawasan Industri Medan, INTI, PLN, Pindad, PTPN IV, PTPN V, PTPN VI, PTPN VII, PTPN VIII, PTPN X, PTPN XII, PTPN XIII, Perhutani, Percetakan Negara, PAL Indonesia, Krakatau Steel, Industri Soda, RRI, Jasa Marga, ASDP, Pusri, and TVRI.

d SOEs are required to send an electronic copy of the annual report to the company registrar in the Ministry of Industry and Trade. This procedural requirement has not been fully complied with. However, a fundamental issue here is the state of disarray of the ministry’s database. The database problems worsened dramatically in 2002, when all the staff responsible for the database were transferred to the newly empowered regional governments, but the responsibility for database maintenance remained with the central Government. This shortage of manpower and technology persists and has resulted in an essentially unreliable database. MSOE is now reviewing this policy of dual submission.

e ADB. 2001. Technical Assistance to the Republic of Indonesia for the Privatization and Restructuring of State-Owned Enterprises. Manila (TA 3714-INO, for $2.6 million, approved on 5 September 2001).

f However, the Government owns a golden share in some enterprises, which gives it control over key operational decisions regardless of the size of its ownership.

g PT PN IV, PN PN IX, PT Kertas Leces, PT Pertaini, PT Garuda Indonesia, PT Perikanan Samodra Besar, PT Sarinah, PT Kawasan Berikat Nusanta, PT PELINDO III, PT Kimia Farma, PT Asuransi Ekspor Indonesia, PT Jasa Rahardja, PT Sucofindo, PT Wijaya Karya, Perum Sarana Pengembang Usaha, PT Industri Sandang Nusantara, PT Gas Negara, PT Tambang Batubara Bukit Asam, PT Semen Baturaja, and PT Pindad.

h Asuransi Jasa Indo, Asuransi Kesehatan, Danareksa, Wasita Karya, Brantas Abipraya, Pelni, Angkasa Pura I, Angkasa Pura II, Pos Indonesia, BTDC, Perebunan Nusantara V, Perebunan Nusantara VI, Pupuk Sriwijaya, Perum Peruri, PNRI, PAL Indonesia, Krakatau Steel, Batan Teknologi, Perjan TVRI, and Semen Kupang.

Appendix 6 31

COMPLIANCE WITH MONITORABLE ACTIONS UNDER THE SECOND AND THIRD TRANCHES

Monitorable Actions

Compliance with Monitorable Actions under the Second Tranche

Compliance with Monitorable Actions under the Third Tranche

A. Sound Corporate Governance Principles for SOEs A.2. MSOE to implement corporate governance policy for SOEs not listed on a stock exchange through the following measures:

(i) Review and comment on the composition of boards of commissioners and directors, including numbers of people on the boards, their skills mix, and their qualifications (second and third tranches); and the role, obligations, and composition of boards to verify whether the board of commissioners has guided and monitored the implementation by the board of directors of an SOE’s long-term plan, annual business plan, and budget.

Complied with. The June 2003 SOE Law and the MSOE Decree on Corporate Governance of August 2002, based on the Best Practice Code formulated by the Indonesian National Committee on Corporate Governance, provide a substantive set of rules and regulations on corporate governance in SOEs. In line with these guidelines, corporate governance practices in 28 SOEs,a including their boards of commissioners and directors, were assessed.

Complied with. Corporate governance practices in nine SOEs were assessed.b

(ii) implement a performance incentive system for remunerating managers to reward them for improvements in defined performance indicators by means of a ministerial decree (second tranche).

Complied with. The minister for SOEs issued guidelines for a performance incentive system to be applied by individual SOEs. TA 3714-INOc

provided recommendations based on an assessment of performance incentive systems in a group of 30 SOEs that were reviewed by MSOE.

Not applicable.

(iii) Submit a performance review report on the implementation of corporate governance policy covering SOEs with at least 1 year of experience (third tranche).

Not applicable.

Complied with. The performance review reports were supported under TA3714-INO (footnote 2). Actual performance review reports were completed for 35 SOEs under TA4280-INO, in the format developed.c

A.3. MSOE to ensure that listed SOEs substantially comply with the listing rules of the Jakarta Stock Exchange, in particular, with the following provisions on corporate governance.

(i) Appointment of independent commissioners in proportion to the number of shares held by non-controlling shareholders.

Complied with. By July 2002, all listed SOEs had appointed additional independent commissioners in sufficient numbers to comply with the requirements.d

Complied with. The appointment practices have been adopted by a newly listed company, PT Adhi Karya.

(ii) Establishment of an audit committee consisting of at least three members, one of whom is an independent commissioner and the others of whom are independent professionals in accounting and/or finance recruited from outside the company.

Complied with. Assessments done in the following listed SOEs indicate that the audit committee requirement has been met: PT BNI, PT Kimia Farma, PT Indofarma, PT Aneka Tambang, PT Timah, PT Batubara Bukit Asam, PT Perusahaan Gas Negara, PT Telkom, and PT Semen Gresik.

Complied with. In addition to those listed under the second tranche, the new SOEs that went for listing or whose shares were divested—PT Bank Mandiri, PT BRI, and PT Adhi Karya—have also complied with this requirement.

32 Appendix 6

Monitorable Actions



(iii) Appointment of a corporate secretary. The position must be held by a member of the board of directors or a corporate officer specifically appointed to this function.

Complied with. The list of SOEs is the same as in A.3(ii).

Complied with. The list of SOEs is the same as in A.3(ii).

A.4. Improve transparency of SOEs not listed on a stock exchange.

(i) Create a new corporate secretary position for all SOEs to be listed in the next 12 months. The secretary is to be appointedwithin 4 months of the expected listing date of the SOE and is to be responsible for corporate communications with shareholders, the company registrar, and the stock exchange.

Complied with. As of 2002, PT Bank Mandiri and PT BRI were the only state-owned institutions that were preparing to undertake initial public offerings in the next 12 months and that had appointed corporate secretaries.

Complied with. Subsequently, this requirement was met by the other SOE preparing for listing in 2003, PT Adhi Karya.

(ii) MSOE to require that all SOEs prepare an annual report,e including statement on compliance with environmental legislation (where appropriate) and audited financial statements in line with existing regulations applying to (a) all limited liability companies,f (b) companies whose line of business involves public fund raising or which have assets of at least Rp50 billion or have issued an acknowledgement of indebtedness,g and (c) publicly listed companies.h

Complied with. The state minister for SOEs issued a letter in March 2002 outlining the reporting requirements. Compliance was verified in annual reports, and audit reports for fiscal year 2001 were submitted to MSOE.

Substantially complied with. Compliance with the requirements during fiscal year 2002 was verified in 2003. After the minister’s letter was issued in March 2002, the requirements for compliance with environmental legislation were incorporated in the Law on SOEs, passed by Parliament in June 2003.

(iii) MSOE to publish SCIs and annual reports, including audited financial statements, of SOEs with majority Government ownership on a specially designed web site. The system will also be used for SOEs to submit data and reports to MSOE.

Complied with. A total of 36 SCIs have been published on www.bumn-ri.com. The website has links to the websites of all SOEs. Financial statements are also on the website.

Complied with. MSOE periodically updates the information submitted to the Government by SOEs.

(iv) Establish audit committees in 30 SOEs (to include one commissioner and two outside experts) that will report directly to the board of commissioners to evaluate the audit results of the company, review the company’s compliance with statutory requirements and the adequacy of audit procedures, and make recommendations about internal control systems and their implementation.

Complied with.

Complied with. In 2002–2004, 30 SOEs formed audit committees, of which 13 were listed on the Jakarta Stock Exchange.

A.5. Capacity building for effective implementation of corporate governance mechanisms by attending corporate governance workshops covering all items in A.1 organized with the support of ADB, the World Bank, or others, to be attended by at least (i) all MSOE deputy ministers, directors, and deputy

Complied with. Under TA 3714-INO (footnote 2) a total of 34 workshops, seminars, and conferences were held, with contributions from 178 speakers. The events were attended by 368 staff members of MSOE, including senior staff; 1,327 SOE employees; and 494 others.

Not applicable.

Appendix 6 33

Monitorable Actions



directors and other relevant staff, and (ii) commissioners and directors of all SOEs to be subjected to the new corporate governance system under the second and third tranches. B. Separating SOEs Commercial Activities from

their PSOs

B.1. MSOE, with the support of TA for the commercialization of PSOs, will (i) identify PSOs in 15 selected SOEs, (ii) quantify PSO costs and their environmental impact, and (iii) develop rules and regulations for tendering such services (allowing bidding by private companies) with the objective of minimizing subsidies.

Complied with. Significant advisory support was provided under TA 3728-INO: Commercialization of Public Service Obligations,i as follows: (i) More than 15 SOEs were initially selected and an assessment of their PSOs were assessed, but following the transfer of various special-purpose agencies (such as schools and hospitals) from MSOE’s purview, the number of SOEs with direct and significant PSOs were reduced to 14; (ii) the survey undertaken helped quantify PSO costs (which were further elaborated in the accounting report) and assess the environmental impact of the PSOs; (iii) MSOE drafted appropriate rules and regulations, although actual compliance has differed from company to company.

Not applicable.

B.2. MSOE to work closely with the relevant line ministries to (i) introduce the rules and regulations for tendering PSOs by private companies with the objective of minimizing subsidies; and

Not applicable.

Complied with. The June 2003 SOE Law recognizes the existence of PSOs and the need for their approval by the technical ministries. In addition, the draft rules (referred to in B.1) requiring open tendering have been adopted by MSOE, which is now disseminating the rules to the relevant technical ministries.

(ii) line ministries to contract out the provision of selected public services to the most competitive bidder, which may or may not be the SOE that had previously been providing the services.

Not applicable.

Complied with. A framework for the sustainable contracting of services has yet to emerge. However, the state budget currently provides for PSOs in only two SOEs—PT Kereta Api (railways) and PT Pelni (shipping)—because the former is the only provider of railway services by law, while the latter has come to enjoy a monopolistic position because of the exit of several private shipping operators. These two SOEs have entered into service contracts with the technical ministries.

C. Corporate Restructuring and Privatization of SOEs

C.2. Develop policies and procedures and issue a ministerial decree for the following privatization processes: employee buyouts, strategic sales, free share transfers, initial public offerings,

Complied with. Presidential Decree 122 of 2001 (30/11/01) reinstated and defined the authority of MSOE. As agreed with ADB, the new decree states that SOEs will retain the proceeds from the issue of new shares. MSOE

Not applicable.

34 Appendix 6

Monitorable Actions



joint ventures, leasing of operating assets, granting of concessions, share arrangements, and cash auctions. This will include procedures for selecting auditors, investment bankers, and other technical advisers.

Decision Letter of Minister 35/M.BUMN/2001 of 28 December 2001 regulates privatization policies and procedures, fully in line with recommendations developed under TA 3149-INO, including all modalities defined in the condition.

C.3. MSOE to provide a time-bound plan and initiate liquidation of eight SOEs.

Complied with. After the identification of 12 nonviable SOEs as part of the first tranche, MSOE adopted a time-bound plan with support from TA 3714- INO on the liquidation of 11 SOEs—PT Cipta Niaga, PT Barata Indonesia, PT B Pakarya Industri S, PT Dok & Perk. Kadja, PT Industri Kapai, PT Industri Soda, PT Kerta Niaga, PT Lokanata, PT Perhotelan, PT Pradnya Paramita, and PT Sarana Karya. Of these, PT B Pakarya Industri S and PT Kerta Niaga were liquidated by July 2002 and PT Lokanata and PT Perhotelan Indonesia by December 2002. The liquidation of PT Sarana Karya is under way. MSOE has initiated the liquidation of all the other SOEs in the list, except for PT Pradnya Paramita, which is likely to merge with PT Balai Pustaka, another profitable SOE.

Not applicable.

C.4. MSOE to implement corporate restructuring plans for 10 SOEs (second tranche) and 15 SOEs (third tranche), with appropriate consideration for all relevant legislation and policies stipulated under the Program.

Complied with. The following 26 SOEs have, with assistance from TA 3714), presented restructuring plans to shareholders at their annual general meetings; the plans have been accepted and restructuring has been initiated: (i) fertilizer industry (7 SOEs)—Pupuk Sriwijaya, Pupuk Kalimantan Timur, Pupuk Kujand, Pupuk Iskander Muda, Petrokimia Gresik, Rekayasa Industri, and Mega Eltra; (ii) plantation industry (14 SOEs)—PT PN I to XIV; (iii) construction Industry (2 SOEs)—PT Hutama Karya and PT Jasa Marga (financial restructuring); (iv) financial Institutions (1 SOE)—PT Danareksa (financial restructuring); (v) airlines (1 SOE)—PT Garuda (debt restructuring plan); and (vi) electricity industry (1 SOE)—PT PLN (20 independent power purchase agreements).

Complied with. In addition to the 26 SOEs for which restructuring plans were formulated and initiated, the following 10 other SOEs have subsequently formulated such proposals: (i) 6 SOEs in fisheries, which were in the process of merging as of September 2004; (ii) 3 SOEs in the trading sector, which will be merging; and (iii) PT Merpati Airlines, whose management has submitted a debt restructuring plan and sought government approval to privatize the company in order to seek fresh cash injections from a strategic investor.

D. Establishing Fair and Transparent Procedures for Managing Labor Redundancy

D.1. MSOE to approve the consultative working group’s recommendations on labor policy.

Complied with. MSOE has endorsed the recommendations of the working group.

Not applicable.

D.2. MSOE will implement a labor rationalization program in accordance with the policy as follows: (i) SOEs will lodge their labor restructuring plans, if any, including cost implications with MSOE and the

Complied with. MSOE sent a letter to all SOEs informing them about the Program. Several SOEs have submitted plans for labor restructuring to MSOE and the Ministry of Manpower. However, the Ministry of Finance is reviewing

Complied with. A number of SOEs referred to in C.4 have submitted restructuring plans.

Appendix 6 35

Monitorable Actions



Ministry of Manpower to provide endorsement of the restructuring options; and (ii) the Ministry of Manpower to record financial assistance being provided by the Government to SOEs unable to meet the costs of redundancies.

its policy of providing financial support to SOEs to manage labor rationalization.

E. Strengthening and Effectively Enforcing Guidelines for Procurement in SOEs

E.3. Based on the results of random procurement audits (see E.2 under core conditions), MSOE will (i) develop guidelines for procurement by SOEs, including requirements for compliance with environmental legislation in technical specifications of tender documents, differentiated by industry groups if necessary; (ii) introduce these new guidelines for necessary action.

Complied with. Consultants under TA 3714-INO have assessed the 20 procurement audit reports commissioned by MSOE in August 2002 and received in October 2002. According to these 20 reports, the current procurement regulations outlined in Presidential Decree 18/2000, which are applicable to SOEs as well as to all public sector projects (and are consistent with ADB’s Procurement Guidelines [2007, as amended from time to time]), are fully sufficient for procurement by SOEs. Therefore, there is no need to formulate and monitor compliance with new guidelines. However, the audit reports also assessed the standard operating procedures for procurement in these SOEs, and recommended improvements. MSOE is prioritizing the recommendations for implementation.

Complied with. On the basis of the more than 40 procurement audits, MSOE is drafting guidelines for electronic procurement, with the idea of handling all future procurement over the Internet, including updating information on the tendering process, to promote transparency.

ADB = Asian Development Bank, MSOE = Ministry of State-Owned Enterprise, PSO = public service obligation, SCI = statement of corporate intent, SOE = state-owned enterprise, TA = technical assistance.

a PT Garuda, PT Jasa Marga, PT PN IV, PT Telkom, PT PELINDO II, PT Indofarma, PT Kimia Farma, PT Aneka Tambang, PT Timah, PT Indo Farma, PT BNI, PT Semen Gresik, PT Indosat, PT Telkom, PT Kimia Farma, PT Danareksa, PT Tima, PT PLN, PT BNI, PT PN VIII, PT Telkom, PT Adhi Karya, PT Asuransi Ekspor Indonesia, PT Surveyor Indonesia, PT Krakatau Steel, PT PELINDO II, PT Hotel Indonesia Natour, and PT Kereta Api Indonesia.

b PT Aneka Tambang, PT Timah, PT Indofarma, PT Bank Negara Indonesia, PT Indosat, PT Telkom, PT Kimia Farma, PT Bank Mandiri, and PT Tambang Batubara Bukit Asam.

c ADB. 2003. Technical Assistance to the Republic of Indonesia for State-owned Enterprise Restructuring. Manila (TA 4280-INO, for $600,000, approved in December 2003).

d The SOEs and the number of additional independent commissioners appointed were as follows: PT Telkom (two), PT Indosat (one), PT Semen Gresik (3), PT Tambang Timah (two), PT Aneka Tambang (two), PT Indofarma (two), and PT Kimia Farma (one).

e The annual report, including the audited financial statements, must conform to the Company Law and the Generally Accepted Accounting Principles approved by the Indonesian Institute of Accountants.

f Consistent with Company Law, articles 56, 57, 58, and 86. g Consistent with Government Regulation 24/1998 of 14 February 1998 on corporate annual financial Information. h In line with the Decision Letter of chair of BAPEPAM KEP-80/PM/1996 of 17 January 1996, on the obligation to submit periodic financial statements. i Corporate restructuring is either financial or operational restructuring. Financial restructuring can take one or more of the following forms: (i) sale of subsidiaries or

surplus assets, (ii) injection of equity from third parties, (iii) merger or acquisition, (iv) restructuring of debt, and (v) liquidation. Operational restructuring can involve changes in one or more of the following: (I) management information systems, (ii) production and logistics planning, (iii) distribution networks, (iv) marketing strategy, (v) workforce number and composition, and (vi) organizational structure.

Source: Ministry of State-Owned Enterprises.

36 Appendix 7

RECOMMENDATIONS FOR FUTURE CORPORATE GOVERNANCE REFORM

1. It is recommended that the Ministry of State-Owned Enterprises (MSOE)

(i) take action to guide state-owned enterprises (SOEs) and penalize those that do not comply with the prevailing commercial laws, the SOE Law, and regulations.

(ii) improve the MSOE monitoring capacity of SOEs. This is linked to capacity building through training, recruitment, and a better internal information platform within the ministry.

(iii) establish clear protocols for dealing with other stakeholders, including government regulatory officials, public organizations, regional and national government officials, when they want to engage with SOE officials.

(iv) establish the principle of securing the best person for the position of director and commissioner on the basis of merit. In addition, build into the system a protocol for ensuring that the views of the existing commissioners and president director are considered in principle when new appointments are made.

(v) ensure that the potential for conflict of interest is explicitly considered in identifying and evaluating candidates.

(vi) review the high number of board of commissioners (BOC) and board of directors (BOD) meetings in SOEs, and the general effectiveness of this practice of frequent meetings.

(vii) undertake disclosure initiatives including the development of (a) a public annual statement of corporate intent for the ministry itself and

then annual reporting of achievements against stated key performance indicators, and

(b) content for the English version of BUMN (Badan Usaha Milik Negara, the Indonesian state-owned enterprises) Online, which is currently empty.

(viii) implement a better performance incentive system that addresses the following: (a) tougher achievement targets before performance bonuses are paid, (b) targets that are more directly connected to the key performance indicators of

the SOE, (c) individual as well as collective performance targeting, and (d) refinements in the performance incentive system formula to avoid the

implicit weighting repetition that currently exists, and to recognize director effort in turning around loss-making or low-yielding SOEs. This should be included as part of an overall review of the pay structures for BOC and BOD to ensure that remuneration is aligned as close as possible to market, and avoids inefficient practices (e.g., unnecessary meetings, which are wasteful of senior management time).

(ix) introduce appointment agreements outlining terms and conditions for all newly appointed commissioners, similar to those for directors. In addition the appointment agreements for both commissioners and directors should identify individual as well as collective performance indicators.

(x) develop a corporate governance handbook to apply to all SOEs. This activity can be driven by the MSOE to achieve economies of scale, but the handbook needs to be developed in a way that encourages ownership by the SOEs themselves, and allows insertions to accommodate individual company and sector characteristics when rolled out to the SOEs.

(xi) establish an MSOE corporate governance help desk to assist SOEs with queries concerning the implementation of corporate governance in their companies.

Appendix 7 37

(xii) establish a training program for commissioners and directors. (xiii) take further steps to ensure that the views of minority shareholders are considered

in the general management of the company, and particularly in dividend policy, mergers, and capital expansion.

(xiv) institutionalize the interdepartmental teams (or their equivalent) that were formed in 2003 to help drive reform in the MSOE in corporate governance and related areas—statements of corporate intent, public service obligations, and procurement. The disappearance of these teams was partly responsible for the decline in the impetus of reform in 2004 (the absence of sufficient TA support was another factor). Deputies should also be encouraged to enforce compliance by the SOEs with the many new corporate governance requirements.

2. It is recommended that SOEs

(i) have in place formal and written policies with respect to various elements of corporate governance beyond that which is in the SOE Articles, including codes of corporate governance (the policies and practices affecting the senior decision-making structures and processes in the company).

(ii) have in place formal and written codes of conduct that reflect expected compliance by all employees and the company with acceptable behavior in dealings with stakeholders, and a process whereby employees regularly acknowledge such compliance with the code of conduct.

(iii) consider increasing the size and mix of skills of the board of commissioners to allow a fuller range of competencies to help the company.

(iv) use audit, nomination, remuneration, and risk management committees more extensively. The more widespread use of nomination and remuneration committees is linked to a need for the MSOE to allow these committees to play a meaningful role once established.

(v) undertake disclosure initiatives to (a) comply with the Company Law to register their annual financial

statements with the Company registry, (b) comply with the spirit of the SOE Law requiring identification and

budgeting approval of public service obligations, (c) put the full set of annual financial statements on their websites, (d) comply with the production and issue of the statement of corporate intent, (e) provide in the annual financial statements more detail on material

transactions, potential conflicts of interest, cross-shareholdings, cross–debt guarantees, risk management, BOD and BOC profile, BOD and BOC compensation, principal external job held by commissioners, and PSOs.

(vi) ensure that potential conflicts of interest are continuously managed at the board level in the SOEs by establishing protocols for identifying and then handling potential conflicts when they arise.

(vii) implement more formal orientation training for commissioners and directors to reinforce understanding of the expectations of the Government and the SOE from the new appointees. Where directors have been appointed from within the company, the orientation needs to focus on individual and collective legal responsibilities of directors rather than familiarization with the company. For commissioners the orientation should also include commercial, finance, industry, and company issues as well as corporate governance. strengthen annual performance reviews of the company’s BOC and BOD so that individual as well as collective accountability become a focus over time.

38 Appendix 8

COMPLIANCE WITH ASSURANCES Assurance Compliance In addition to the standard assurances, the Government has given the following assurances, which have been incorporated in the legal documents:

(i) the policies adopted and actions taken prior to the date of Loan Agreement, as described in the development policy letter and the attached policy matrix (Appendix 1), will be in effect for the duration of the program period;

Complied with. See main text.

(ii) corporate restructuring and privatization of SOEs will be undertaken in a fair, transparent, and (to the extent commercially practicable) competitive manner, and only after a thorough analysis of the benefits of the chosen restructuring option has taken place; and the Government will make the necessary funds available for debt restructuring of SOEs in a timely manner;

Complied with. See main text.

(iii) the Government shall ensure that MSOE is provided with appropriate budgetary allocations to cover expenses relating to (a) dissemination of corporate information from SOEs (including annual reports and SCIs) through print media or the Internet, (b) dissemination of information about the Program through the Internet, (c) engagement of procurement and financial auditors, and (d) engagement of advisors for privatization transactions and debt rescheduling negotiations;

Complied with. (a) see (v) below; (b) see (v) below; (c) see section C in Appendix 4; and (d) see section C in Appendix 5

(iv) labor retrenchments will be carried out in accordance with the laws of Indonesia, and the Government will make the necessary funds available for voluntary retirement schemes in a timely manner;

Complied with. Compare section D in Appendix 4 and Appendix 5.

(v) public awareness campaigns will be developed and implemented to advertise the benefits of the privatization program; and

Complied with. Medium used is MSOE’s own web page.

(vi) proceeds from the loan will not be utilized for SOE investment in modernization and capacity enlargement.

Complied with. No transfer of public money to any SOE since 2001.

Documents

State-Owned Enterprise Governance and Privatization Program · privatization and restructuring of state-owned enterprises (SOEs),2 and the second, for the commercialization of public