Countries and Regions

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p. 5 of 6 BACK | NEXT I. Current Development Trends and Issues II. The Government's Development Strategy III. ADB’s Development Experience IV. ADB’s Strategy V. ADB’s Assistance Program VI. Risks and Performance Monitoring and Evaluation

Country Strategy and Program Update 2002-2005: Indonesia

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V. ADB’s Assistance Program

A. Overall Assistance Level

56. ADB’s lending to Indonesia is shown in Figure 6. The lending level is influenced by needs indicated in the national investment strategy as well as the capacity to utilize loan funds; if lending commitments consistently exceed disbursements, undisbursed loan funds will accumulate.⁷ Disbursements from ongoing loans averaged $700 million during the 5 years before the crisis, about 10% lower after the crisis (1998-2001). As noted, continued program lending is envisioned during the CSP period, although at a reduced level. In the 2001 COS, a lending range of $600 million to $1,200 million each year had been indicated. However, given the impact of decentralization and concomitant uncertainties on the program, the higher end of this lending range would be infeasible in the earlier years. The realistic upper limits targeted are $1,000 million in 2003; $1,100 million in 2004; and $1,200 million in 2005. The upper end in each of these years would be reachable if:

1. an on-lending policy is determined and local governments have fiscal capacity and are willing to participate in externally funded projects involving cost sharing;
2. the Government significantly steps up implementation of projects, including strengthening of governance;
3. the Government takes timely actions to facilitate investments to reduce poverty; and
4. agreed-upon structural reforms, crucial for sectors where ADB projects are being implemented, are undertaken.

57. Under the 1998 Graduation Policy, Indonesia was classified as a group-B2 country, eligible for limited amounts of ADF resources, but placed on the watch list for graduation from ADF. With the crisis, which led to a sharp reduction in per capita GDP, limited access to ADF has been continued during the ADF VIII period (until 2004). ADF support beyond this period will be assessed in the context of the next ADF replenishment. Indonesia’s short-term access to ADF will be consistent with ADB’s policy on performance-based allocation. Key performance indicators will be monitored as triggers for ADF availability. For 2003, for instance, two lending cases have been adopted: a base case of $100 million and low case of $80 million. Consistent with the larger program, the base case is predicated on satisfactory progress in a number of those areas needed to move to a high level of OCR lending (Appendix 1, Table A1.12).

B. ADB Assistance for the Strategic Priorities

58. The following sections describe how ADB's program in 2003-2005 supports the new strategy. Table 4 summarizes the expected sectoral involvement under the CSP and shows primary areas of ADB operations (where substantial loan packages and/or advisory assistance are planned) and secondary areas (which complement primary focus areas, or where past commitments have been made). Work in secondary areas will generally involve limited resources. Details on the principal sectors of operations are in Appendix 3.

1. Improving Governance: Anticorruption and Legal and Judicial Reforms

59. The serious and long-standing challenges posed by poor governance call for active ADB support for reforms. Improved governance is, for example, key to the proper functioning of the financial and corporate sectors. ADB's efforts will focus directly on anticorruption, legal and judicial reforms, and decentralization. ADB must mainstream good governance considerations in its own operations. Its efforts to maintain its own projects as models of development assistance are discussed in Box 2 and in sections III.C and IV.D.

60. ADB's operations will aim to reduce corruption and support critical legal, judicial, and administrative reform. These are vast tasks. Most international funding agencies, including the World Bank and United Nations (UN), as well as many bilateral assistance agencies, are involved in some aspect of these areas. A principal forum of coordination is the Partnership for Governance Reform, where ADB has been playing a major role as a founding member. The partnership is increasingly led by Indonesian staff and can approach sensitive governance issues with multilateral support. ADB’s work with the partnership is important to meeting governance goals. The program will target a number of agencies or problems related to (i) strengthening external accountability mechanisms such the Anticorruption Commission and Ombudsman Commission, (ii) improving audit functions at the national and regional levels, and (iii) reinforcing administrative capacity for such activities as procurement. These actions can help improve the environment for providing development assistance.

61. Legal and judicial reforms will be pursued in light of their contribution to reducing corruption as well as improving governance in general. ADB will help strengthen government capacity in selected key areas by improving procedures for drafting laws and regulations and administrative decision making, and supporting improved access to justice for the poor.

2. Meeting Local Needs through Decentralization

62. The program will focus on improved local governance to provide better service delivery and to meet the challenges in rural and urban development at the local level. As almost all funding agencies support decentralization, their efforts will be closely coordinated through frequent meetings of the Working Group on Decentralization.

63. ADB will support improved delivery of basic services. Building local government capacity is an important aspect of this work. Of equal importance is the need to strengthen local civil society. To complement these basic activities, ADB will seek to develop mechanisms to enable local governments to adequately finance development investments through the establishment of an efficient municipal credit market. Support in these areas has already begun, with ADB projects either being implemented or processed. Considerable project assistance (56% by number) will be directed to local governments and will address capacity building, governance, and related issues. ADB’s geographic focus is expected to heighten ADB's involvement in local development.

64. ADB's goal is to help establish a vibrant, sustainable rural economy and to reduce rural poverty by 40% from 2001 to 2020. This is an ambitious goal, demanding a structural transformation of the economy to allow the proportion of those employed in agriculture to fall by almost half. However, the steps toward the goal are worthwhile in themselves. In particular, substantial productivity growth in agricultural and nonagricultural activities is called for, requiring

64. ADB's goal is to help establish a vibrant, sustainable rural economy and to reduce rural poverty by 40% from 2001 to 2020. This is an ambitious goal, demanding a structural transformation of the economy to allow the proportion of those employed in agriculture to fall by almost half. However, the steps toward the goal are worthwhile in themselves. In particular, substantial productivity growth in agricultural and nonagricultural activities is called for, requiring utilization of potential comparative advantages, removal of market distortions, and infrastructure development.

65. Regionally specific sector strategies are expected to be developed, consistent with the evolving geographic focus, to better identify future programs of assistance. Broadly, however, in the agriculture sector ADB’s program will emphasize improving market access, providing market-based production incentives, improving the management of research under decentralization, and supporting infrastructure investment. The last, for example, is critically needed for sustained productivity growth in tree crops. For the rural economy as a whole, areas of support will include continued emphasis on community empowerment, including improved access to microfinance and multisector antipoverty interventions in poor regions.

66. Indonesia is rapidly urbanizing, with the urban population expected to rise from 42% of the total population to 60% by 2025. Almost half of all urban households may be vulnerable to poverty. Managing rapid urbanization and tackling urban poverty is now the responsibility of local governments. Many localities have scant fiscal resources and capacity for good governance. Private sector involvement in urban services is low. Urban infrastructure is inadequate.

67. Recent project administration work has revealed significant weakness in implementation capability at the local level—in procurement, contracting, and supervision. Oversight capability in national agencies similarly needs strengthening. ADB is providing TA to support the improvement of national agency oversight and has increased staff resources for project implementation in the sector. Without demonstrable progress, ADB may not be able to meet sectoral goals.

68. ADB’s focus will be on two main areas: improving local governance, and providing basic services for the urban poor. The program will help regional governments improve urban management and service delivery systems to make them responsive to local needs. Decision making must be expanded to allow widespread participation, especially by the poor. Basic services and infrastructure in improved community environments will be emphasized. Shelter for the poor is an important component of the ADB program. ADB will help urban local governments improve shelter planning and management systems in partnership with the private sector and civil-society organizations. Development of an efficient shelter finance market will also be a priority. Improved access to clean water supply and hygiene for poor households is another goal. Strengthening water supply enterprises will be one tactic, in partnership with the private sector where possible. The water supply and sanitation needs of rural and fringe urban communities will be met through community-based service schemes along with public health and hygiene programs.

3. Human Development

69. The program will emphasize social service provision and reduction of gender inequalities. Basic education and health services are now the responsibility of district governments. Thus, in both sectors the important issue is to support decentralization. Finding mechanisms to operate in a decentralized environment and a focus for operations within the sectors will be severe challenges in the next few years. Strengthened education and health sectors will be complemented by social protection activities that seek to incorporate successful interventions mounted during the crisis. Gender inequalities will be tackled by working to mainstream or introduce sensitivity to gender issues in government activities.

70. The focus of ADB’s education programs will be on basic education and technical education at higher levels. Complementary activities may also be undertaken to promote nonformal education and the capacity to use information technology. ADB’s programs will not otherwise support higher education, which receives some attention from bilateral funding agencies and increasingly involves private sector participation. The central focus on basic education reflects the needs of the country and is consistent with the Government’s long-term goals of achieving universal and high-quality nine-year education by 2010. Schools should provide students with skills that are in demand in the labor market to encourage children to stay in school, meet the Government’s goal of higher participation in secondary and tertiary education, and help those who do not stay in school.

71. Any effort to better target the poor will demand efforts to raise education quality and relevance. Children, especially of poor families, need to see real benefits to staying in school. Management capacity of schools must also be improved by strengthening governance, using school-based management and community participation to enhance transparency and accountability. One major problem is the dual education system: the national or mainstream system is complemented by the religious-based, madrasah schools. The core curriculum of madrasah schools must be brought up to the standards of mainstream schools. Little, however, will be accomplished without solving fundamental problems in education finance, especially how to ensure that poor districts can provide quality education for all. Developing the capacity to reap benefits from the information technology revolution is important to help develop a globally competitive economy, and projects should target poor students and girls and support private sector participation.

72. In the health sector, an important focus is on reproductive health and nutrition and bringing down the maternal mortality rate. Efforts must be intensified to control infectious diseases and prevent chronic and noncommunicable diseases. ADB will work through decentralized, regional health services and not primarily through national programs. ADB will try to tap grant funding especially to tackle such problems as malaria, tuberculosis, and HIV/AIDS. The Government receives some support for this from the UN system and bilateral funding agencies. This commitment is consistent with the Government’s long-term vision in Healthy Indonesia 2010, which recognizes the need to ensure equitable access to effective health services by evolving partnerships among families, communities, and health professionals. The vicious circle of poverty and ill health must be broken by developing effective social protection mechanisms, including family welfare and planning services; ensuring access to quality health services for all; and improving the nutrition status of the poor. Financing must improve service provision at the district level and support expanded service in a sustainable fashion that allows access to the poor.

73. ADB's social protection initiatives will complement the sector programs in health and education and help reduce the vulnerability of the poor. In particular, social protection measures developed during the crisis will be converted into formal schemes addressing child protection, the labor market, social insurance, and social welfare. Better access to quality education and health services for the poor will be complemented by income support and viable pension systems. Where possible, larger ADB-financed programs will provide basic services to meet the special needs of internally displaced persons.

74. ADB’s long-term goal is to reduce gender gaps in human development by ensuring that (i) women are treated equally by the legal and judicial system, (ii) gender inequality in access to social services is reduced, (iii) participation of women in public decision making is strengthened, and (iv) regional governments build their capacity to deal with gender issues. Mainstreaming must, however, begin at home—in ADB's own policies and programs. ADB will focus on projects where gender equity is particularly relevant, set targets for women’s participation and access to benefits, and ensure that women are involved in project planning and implementation. The list of such projects is in Table 8.

4. Environmental Management and Sustainable Use of Natural Resources

75. Management of Indonesia’s natural resources on a sustainable basis is key to fostering sound economic development. A strong relationship exists between the quality of the environment and poverty. Natural resources provide livelihood support to many rural poor.

76. The program will focus on three principal areas: (i) marine and coastal resources, (ii) water resources management, and (iii) air quality. Ancillary activities will support land rehabilitation, especially in areas that could promote watershed management or sustainable livelihood activities for the poor. ADB will not be involved in primary forest protection, mineral sector development, or construction of large water system infrastructure. These are areas where others are active, the private sector should take the lead, or ADB programs are not likely to have positive outcomes. In forestry, for example, the policy environment is not consistent with long-term sustainable development goals, and other international funding agencies (European Commission and bilateral agencies, United States Agency for International Development (USAID), World Bank, international NGOs) are actively involved. ADB supports the efforts of its partners but should direct its resources to areas receiving less attention from others and where programs have greater potential.

77. Two themes will dominate ADB assistance: (i) mitigation of environmental degradation and (ii) improvement of natural resource management. The first will involve, where possible, restoring degraded resources but also reducing pollution (Box 3), which requires strengthening governance, clarifying the policy and regulatory frameworks, and enforcing laws. People at the local level must be involved in decision making, and ADB should promote community and civil-society participation in resource assessment, allocation, and use. Capacity building of sectoral agencies and local governments for environmental protection and natural resource management will be an important element of many exercises. However, if governance is not strengthened, improved administrative capacity is unlikely to have much impact. Environmental concerns will also be mainstreamed into all projects in the pipeline that could have implications for the environment.

78. Marine and coastal resource management projects will adopt an integrated approach to rehabilitation and protection of coastal ecosystems. Projects will aim to (i) reduce fishing to regenerate fish stock and protect biodiversity, (ii) improve social services and provide alternative livelihood for participating coastal communities, and (iii) promote water conservation and system efficiencies through appropriate charges and regulation and increasing public awareness of the problems. Integrated river basin and flood management systems will be developed. Improving water delivery services will involve support for autonomous service providers, private sector participation, and expanded service for the poor. Improving air quality will involve clean energy initiatives, especially in urban areas, but also prevention of forest fires (including prevention of haze) and drought management, following the recommendations in recent ADB-assisted studies. Subregional cooperation possibilities exist in several of these areas and will be actively explored.

79. The list of proposed activities (Table 9) also includes ADB projects that could contribute significantly to environmental improvement, particularly in the urban sector. All ADB projects with possible adverse impacts will be carefully designed and monitored.

5. Raising Long-Term Growth Prospects and Economic Potential

80. The recent lack of investment in and maintenance of physical infrastructure puts at risk the potential for sustainable growth. Critical investments in the country's infrastructure should be supported, especially through private sector participation. Private sector development, however, is severely hampered by governance issues—corruption, collusion, and nepotism (KKN) discourages foreign and domestic investment. Policy reforms, especially in the legal and judicial sector, are sorely needed to underpin private sector business confidence.

81. In the energy sector, ADB will target programs to increase energy efficiency and promote private sector participation. Recent laws to dismantle oil and natural-gas monopolies and to establish competitive electricity markets are steps toward these goals. Realistically, given the newness of reforms, public sector investment will continue in areas such as renewable energy, rural electrification, and removing transmission bottlenecks, as the private sector builds confidence and identifies new opportunities. Over time, the public sector is expected to focus on policy formulation and planning for clean energy use, for example, leaving infrastructure investment increasingly to the private sector. However, given Indonesia’s vast size and many underdeveloped regions, continual public investment will be needed where private sector participation will be limited, such as isolated community electrification, and to provide targeted support for energy use by the poor.

82. The ADB program in the energy sector will support reforms, help improve infrastructure, and emphasize renewable energy projects. Given vast domestic reserves and environmental benefits of natural gas, its expanded use will be explored. ADB will promote private investments in power generation. The Java-Bali grid is especially critical and must have continuous adequate capacity. In the short term, private investments in generation must be complemented by public sector support such as for transmission projects.

83. The transport sector is critical in promoting economic growth and balanced regional growth. ADB will support selective development, rehabilitation, and maintenance of strategic transport systems, focusing on roads and interisland transport. In the road subsector, ADB will support the national goal of extending the paved road network to achieve nationwide coverage by 2010. Support will also be extended to improve road conditions at all levels, especially to reduce traffic accidents. Private sector participation should thus be increased in such activities as road maintenance. Medium-term goals will include the enactment of a national road law and completing an action plan for the road sector. To overcome the problem of inadequate funds, ADB will support the establishment of a road maintenance fund from user charges.

84. In interisland transport, ADB will help remove critical bottlenecks. The first step is the preparation of an integrated national transport sector strategy focusing on interisland transportation. A legal framework to facilitate private sector participation could ease public investment requirements and improve operations. ADB's program will also explore subregional cooperation through the subregional groupings such as BIMP-EAGA and Indonesia-Malaysia-Thailand Growth Triangle (IMT-GT), as well as new opportunities in Indonesia-East Timor cooperation.

85. The infrastructure sectors traditionally require substantial external support. Although ADB will focus on encouraging the private sector, external assistance will continue to be needed in many areas. The World Bank and JBIC also assist some of the sectors targeted by ADB. JBIC, for instance, has traditionally supported the power sector. The three funding agencies actively exchange information and coordinate well on projects, avoiding duplication and waste of development resources.

86. Indonesia's current modest growth path and limited progress in diversification largely reflect weak business investment. The factors shaping business sentiment are complex. However, failure to significantly improve governance and reduce corruption, and problematic policies affecting trade and capital flows, have deterred long-term investment. Recent well-reported problems in the legal and judicial system, in particular, have sent the wrong signals to investors, domestic and foreign.

87. The CSP pays special attention to fostering a vibrant and competitive private sector. ADB will use its public sector operations as well as direct investments by its Private Sector Operation Department (PSOD). In public sector operations, ADB will focus mainly on two areas: (i) financial and corporate governance (including SOE reforms) and (ii) SME development. In financial and corporate governance, ADB is the lead international funding agency, although the World Bank, IMF, and some bilateral agencies such as USAID also play key roles. In SME development, ADB plays a major role in a field that includes the World Bank and JBIC. Assistance efforts for SMEs are coordinated through the CGI Working Group.

88. Financial and Corporate Governance. ADB's overall financial goal is to support the reform and development of a diversified and sound financial sector that can provide effective intermediation of savings through improved financial institutions and markets, including banks, asset and capital markets, insurance companies, and pension and provident funds. Disclosure, transparency, and enforcement of regulations must be strengthened. A legal framework for anticorruption and anti-money-laundering efforts will be developed and implemented, and a new institution for financial sector supervision and regulation created. Legislative reform of financial markets to strengthen prudential supervision and to bring standards in line with international best practices will also be pursued. In the pension and insurance sectors, improved social protection for consumers and better preservation of capital are priorities.

89. In corporate governance, the program will strengthen and enforce standards and encourage a competitive environment and level playing field for businesses. Privatization of SOEs and implementation of corporate governance standards for them are elements of the program. To succeed, privatization must be free of corruption, as the perception that corruption robs the country of potential benefits weakens public support for privatization.

90. SME Development. ADB's SME development program will emphasize a private sector-led sustainable assistance package, focusing on the regulatory framework, business support services, and financing. Structural reforms in finance and trade will be deepened with advisory support to local governments to improve the business environment.

91. Private Sector Operations. ADB’s private sector operations can play an important role in developing the private sector. Private sector investments will be considered where a strong demonstration impact is anticipated. Target areas include local infrastructure projects in such areas as energy, transportation, or water supply, where several hurdles remain (Box 4). Support for the establishment of an equity fund to support business investment is also under consideration.

C. External Funding Coordination and Partnership Arrangements

1. Development Partners

92. Following decentralization, local governments have emerged as important partners of ADB along with the central Government. In response, the CSP and project consultation have been developed to provide local governments more ownership of the assistance program. The COS was discussed continually in 2001, and consultations were held to discuss the draft CSP with regional governments, particularly development issues, projects of interest, and current constraints such as uncertainty of on-lending. Dialogue with local governments within ADB’s geographical focus will be intensified in the CSP's implementation phase. Country programming missions will broaden consultations with local governments supported by the Indonesia Resident Mission (IRM). This process is not costless, as project preparation periods will need to be lengthened to allow sufficient time for local concerns to be built into project design. ADB is examining the possible use of opening temporary project administration offices in selected regions where project components are highly concentrated, to better supervise project implementation.

93. Civil-society organizations are emerging as important contributors to development. If sufficiently strengthened, their impact on development and ADB’s operations can be significant. Civil-society groups can be particularly important in some areas of ADB’s program, such as working for gender equality. ADB has established an NGO and Civil Society Working Group for IRM that meets regularly and interacts on country and programming issues and with ADB project teams. The group played an important consultative role along with regional NGOs during the CSP drafting. Consultative groups in regions within the geographical focus are being established alongside capacity building to enable NGOs to participate more effectively in ADB assistance.

94. ADB’s active program of private sector development, especially in financial governance and privatization, bring ADB staff into regular contact with interested private sector actors. Consultations were also undertaken with private sector groups for the CSP. These consultations will be continued, particularly in areas of private sector development emphasized in the CSP: corporate and financial sector governance, privatization, SME development, infrastructure development, and operations of the ADB PSOD.

95. The World Bank, JBIC, and ADB contribute roughly 90% of total development assistance to the country. The World Bank's 2001 Country Assistance Strategy (CAS) emphasizes three areas: (i) sustaining economic recovery and broad based growth, (ii) building national institutions for accountable government, and (iii) delivering better public services to the poor. The first emphasizes macroeconomic performance, bank and corporate restructuring, public expenditure management, private sector growth, and human and capital infrastructure development. The second calls attention to broad governance needs, including legal, judicial, and civil service reforms; better public financial management; and sustainable management of natural resources. The third centers on decentralization, including support for regional governments and community development, and selective assistance to postconflict areas. The CAS strategic areas of concern track well with those of this CSP. A variety of existing coordination mechanisms can reduce the risk of wasteful duplication of effort and improve the impact of assistance.

96. JBIC provides a large and broad program of loan assistance. Its primary objective, similar to ADB's, is poverty reduction focusing on (i) human resource development (especially education and training); (ii) social infrastructure development (health, family planning, education, water supply, and waste treatment); and (iii) economic infrastructure (roads, air and sea ports, railways, power plants, and telecommunications). Close coordination with JBIC is needed.

97. Coordination with other multilateral agencies is also important. IMF has a critical role in macroeconomic performance. ADB staff participate in IMF missions as warranted. Contact with UN agencies has been growing and IRM staff now participate in UN country team meetings. Important bilateral funding agencies include Australian Agency for International Development (AusAID), Canadian International Development Agency (CIDA), United Kingdom’s Department for International Development (DFID), German Agency for Technical Cooperation (GTZ), Netherlands, and United States Agency for International Development (USAID). These rely mainly on grant assistance. Valuable inputs to the CSP have been provided by bilateral partners, which have also expressed interest in providing cofinancing support, particularly DFID in poverty reduction, and the Netherlands in capacity building, education, and environmental protection and natural resource management.

98. ADB is committed to continuing to invest in the important partnerships during the CSP.

2. Consultation and Coordination Mechanisms

99. Especially with the increase in IRM staff, consultations with the international funding community are conducted continually, in the context of CGI and country programming as well at the project level. CGI is organized around sectoral or issue-oriented working groups involving the Government and international community. The ability of these working groups to express common viewpoints is testimony to a broad consensus on development strategy. The 2001 COS characterized this as follows:

In what can be called a "Jakarta consensus," nearly all programs have a heightened emphasis on addressing poverty and recognizing the importance of good governance; of encouraging regional autonomy and environmental protection; and of supporting human development through social sector, social infrastructure, and social protection efforts.

100. Coordination is effected in several ways (Table 12). Sometimes the working group provides a forum for coordinating efforts. A GTZ-led working group on decentralization, for example, provides effective channels for communication, particularly for understanding capacity-building needs. Similarly, a working group on basic education, chaired by ADB, is enhancing coordination in project planning and policy advice. During the past 2 years, ADB has also shared responsibility for organizing groups on poverty reduction and aid effectiveness. In other areas, such as infrastructure, the small number of active funding agencies and keen government interest allows for coordination project by project. In some areas, particularly in the social sectors, the needs are so great and assistance so large that a geographic focus is employed to ensure that efforts are not duplicated and that the country is well covered. ADB is seeking to focus more of its operations in certain provinces to enhance program effectiveness. This will likely demand increased coordination efforts, which IRM will facilitate. Finally, in some areas, a sectoral division of labor can be utilized. For instance, in the financial sector, ADB has emphasized corporate and financial governance, while other funding agencies will focus on the banking sector. Regular consultation provides for sharing of information and coordination.

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