Regions and Countries

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p. 2 of 4 BACK | NEXT I. Current Development Trends and Issues II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Assistance Levels

Country Strategy and Program Update 2004-2006: Indonesia

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II. Implementation of the Country Strategy and Program

A. Progress under the Poverty Reduction Partnership Agreement

7. The Government and ADB signed a 3-year Poverty Reduction Partnership Agreement (PRPA) in April 2001, drawn up on the basis of a detailed country poverty assessment study. In mid-2002, the Coordinating Minister for People’s Welfare initiated preparation of a Poverty Reduction Strategy Paper in consultation with the donor working group on poverty, in which ADB is an active member. The strategy paper is expected to be finalized by May 2004³ and will utilize inputs from several planned and ongoing ADB technical assistance (TA) efforts. It will also provide the framework for the second PRPA for 2005–2009. The poverty assessment study will be reviewed in 2004 in order to provide inputs to both the strategy paper and ADB’s second PRPA.

8. The first review of the PRPA was conducted in April 2002. The second review, conducted as part of this CSPU exercise, has noted several positive developments. These include:

1. steady improvement in the incidence of poverty, dropping from the crisis peak of 23.5%, to 18.2% in 2002. Rural poverty remains high, however, as a result of poor agricultural performance
2. special budgetary appropriations to support capital spending in poor regions through Special Allocation Grants (DAK)
3. prudent macroeconomic management reducing the nation’s vulnerability to shocks
4. growing civil society participation
5. adoption of a policy for channeling external funds to regional governments (although clear implementing procedures are still lacking)

On the other hand there are several concerns, such as low growth, high unemployment, continued threats to security, slow progress in some human development indicators, and inadequate progress in tax efforts. ADB’s operations continue to emphasize the CSP’s core objective of poverty reduction through activities that directly impact on the well-being of the poor and that support broad-based growth.

B. General Issues

1. Geographic Focus Implementation in 2003

9. A geographic focus emphasizing poverty reduction was adopted as part of the CSP. The projects currently being processed for approval in 2003 and beyond are concentrated mainly in the geographic focus areas. Of those that are not national in scope, eight have selected their geographic locations. Out of 54 provincial locations selected so far, 40 have been located in the geographic focus areas. The geographic spread of these projects is illustrated on the map. The program will continue efforts at comprehensively covering the areas of focus through projects in the 2004–2006 pipeline.

2. Issues Affecting Program Implementation

10. With decentralization, responsibility for public investments in most sectors including provision of basic public services has been devolved to regional governments. The central Government has also transferred substantial staff and revenues to regions. It expects regions to share a significant portion of the burden of external loan repayments channeled to them. The terms and conditions and general arrangements for channeling external support for regional-level projects have therefore been a major issue for external lending agencies who have been encouraging the Government to formulate a policy in this regard. Although a recent ministerial decree (KEPMEN) has promulgated a policy framework for channeling funds, major implementing issues remain (see details in the Box). ADB is adapting to the new framework by intensifying consultations with regions, modifying the sector loan modality for new investment loans in preparation, and helping the Government resolve the regions’ loan arrears problems. However, problems arising from the adjustment to the new procedures are bound to affect loan processing in the transition years.

11. In addition, policy uncertainty in general is leading to delays in the processing of projects. The uncertainty arises both from the evolving role of Parliament in overseeing executive decision making, as well as the slippages in the economic legislative agenda due to the upcoming elections. Concerns over debt and allegations of corruption in the utilization of foreign assistance have created a lack of confidence in the efficacy of foreign assistance in some quarters. While this has led to a welcome improvement in the level of scrutiny of potential projects, it has also slowed down decision making.

3. Millennium Development Goals

12. Indonesia’s progress toward the Millennium Development Goals (MDGs) is mixed with good performance in some sectors such as education but slow progress in others such as environment and gender equality (see Appendix 1, Table A1.1). The ADB program aiming at creating the appropriate environment for pro-poor growth and eradication of poverty will provide direct support for MDG attainment. In education, Indonesia has made good progress toward the MDGs and ADB is strongly supporting this effort, particularly at the regional level. ADB’s health sector program focuses on strengthening decentralized regional health services, which are essential for meeting the MDG targets in health areas such as malnutrition, maternal and under-5 mortality, HIV/AIDS, malaria, and tuberculosis. As health expenditures represent only 1.6% of gross domestic product (GDP) in Indonesia, compared with an average of 4.5% for low-income countries, ADB policy dialogue will emphasize the need to substantially increase health sector outlays at central and regional levels. Water supply and sanitation and housing are also high priorities of the ADB program. ADB assistance is expected to improve the lives of thousands of slum dwellers through upgrading slum infrastructure and improving housing conditions. Social security and social protection will receive attention. In the environmental area, support for rehabilitation of degraded land is being provided. Support in other MDG areas such as private sector development is also being programmed. Because of decentralization, regional governments are primarily responsible for most MDG areas and ADB is carrying out an intensive policy dialogue with them.

C. Developments and Progress in the Country Strategy and Program Focus Areas

13. Governance: The Government’s recent legislative agenda indicates some intent to improve governance, although implementation of existing legislation and public accountability remain weak and few actions have been taken to allay public perceptions about corruption. The Law on State Finances (see Appendix 3) has been passed and draft bills on state treasury and state audit are in process. A presidential decree to establish the National Procurement Office and to improve procurement procedures is expected soon, but the crucial Law on Procurement is not yet on the Government’s priority legislative agenda. There has been little progress in legal and judicial reform although this is critical for building investor credibility. Given these concerns, ADB is providing TA support this year to define an action plan to improve the performance of judicial institutions and better prepare its planned project support for the government’s judicial branch. Project preparation for comprehensive reform and upgrading of public audit is well under way. An ADB TA is also scheduled later this year to support capacity building of the Anticorruption Commission after it begins functioning.

14. Decentralization. The Government has announced that it will undertake a review of Law 22 on regional autonomy this year.⁴ Improvement of provision of basic services by regional governments depends on clarifications of obligatory functions and agreement on minimum service standards. On the latter, ADB is providing key support in their introduction. The large arrears in debt repayments by regional governments will restrain many of them from new borrowing under KEPMEN 35/2003. Some are related to borrowings by water enterprises, which ADB is helping reform and better regulate.

15. ADB assistance for rural development is increasingly concentrating on the poorest regions, supporting the strengthening of regional government capacities for aiding agricultural and rural development. A new Water Law being considered by Parliament emphasizes integrated water resources management within a river basin for multisector uses. ADB will help implement the Water Law and facilitate the decentralization of the management of irrigation schemes to regional governments and water users’ associations. An agriculture and rural development strategy study started in June 2003 to review domestic policies and implications of World Trade Organization (WTO) and regional trade agreements on the agriculture sector.

16. Human Development. The ADB program in health continues support to MDGs with new interventions in nutrition, child and maternal mortality, and improved basic health services for the poor. Attention will be paid to reproductive health services and control of communicable diseases. A new intersector approach is being attempted, to improve the health status of the population. It combines provision of clean water supply and improvements in hygiene standards with health services. With the emergence of the severe acute respiratory syndrome (SARS) epidemic this year, ADB offered immediate support, targeting strengthening of the surveillance system, as well as upgrading referral health facilities in areas covered by ADB health projects. The Global Fund to Fight AIDS, Tuberculosis and Malaria approved a 2-year grant program in June 2003 for controlling these diseases. The Global Fund grants will complement ADB's efforts at communicable disease control. In supporting decentralization in the health sector, ADB works in close collaboration with other development partners, in particular the World Bank.

17. The Education Law (see Appendix 3) was passed in June 2003, underlining the state’s commitment toward 9-year basic education backed by a minimum of 20% budgetary outlays. An education sector review supported by several funding agencies has been initiated in 2003 with ADB taking the lead role in the assessment of the madrasah sector.

18. After a series of conferences and workshops that were led by funding agencies and that highlighted the problem, the Government has begun emphasizing the need for prevention of human trafficking—particularly of women and children—and the social protection of women. Increased attention is being paid also to social security and social protection to cover workers in both the formal and informal sectors, as well as the poor. ADB will provide assistance in these areas.

19. Environment: A country environmental analysis is in preparation. This will consider measures to support the Environment Ministry’s current strategy and suggest new areas for priority action. In a few areas, work has been started. In urban air pollution, the Environment Ministry is preparing action plans with ADB support for reducing vehicular emission and using nonpolluting compressed/liquefied gases. In response to recent large-scale floods, the Government is moving toward a more integrated river basin management approach to flood management, to be supported by ADB. Public hearings are being conducted on a coastal resources management law. ADB plans to support the implementation of this law, particularly with respect to strengthening regional government capacity in sustainable development of marine and coastal resources. Support will also be provided for reduction of greenhouse gas emissions and measures for carbon sequestration.

20. Support for Investments in Infrastructure and Private Sector Development: Following the passage of the 2002 Electricity Law, which set out a timetable for establishing an electricity market supervisory board and a competitive market for power generation, the Government issued, in April 2003, a Blueprint for the Development of the National Electricity Industry, 2003–2020. This indicates the start of competition in Batam in 2004, and in the Java- Madura-Bali power grid by 2007. The Government has renegotiated the power purchase agreements from independent developers to reflect the impact of the Asian crisis. The retail electricity tariff is being gradually raised to fully cover costs. In the natural gas subsector, the Government sold, with ADB support, 40% of the shares in a transportation pipeline company to a strategic private investor. Recognizing the turnaround in the sector, foreign official assistance from the World Bank, Japan Bank for International Cooperation (JBIC), and ADB was resumed. These institutions have also begun a coordinated effort to support the Government’s effort to restart private investments. Reforms in the transport sector have been slow but the Government is at present considering some policy initiatives, including establishment of a road fund, creation of a system of performance-based contract awards for road maintenance, unbundling of rail and air transport businesses, and public transport operation contract arrangements. The World Bank and ADB are providing TA to help develop and implement policy and regulatory reforms to enable, promote, and facilitate efficient and sustainable large-scale private investment in infrastructure. ADB is also attempting to promote public-private partnerships in infrastructure.

21. Recognizing the importance of improving the investment climate, President Megawati declared 2003 as Indonesia Investment Year. However, actual action, such as progress with the draft investment law, has been slow. ADB’s support toward reviving investments involves direct investment support in infrastructure, facilitating private-public partnerships in infrastructure development, and support for improved governance (para. 13). In addition, ADB is making efforts to spur private sector development. In this, results have been mixed. Although the Government submitted the draft Financial Supervisory Authority (OJK) law to Parliament in May 2003 (for the planned integrated financial sector regulatory agency), there is considerable debate as to its contents and the timing of agreed reforms. In June 2003, an amendment to the Anti-Money- Laundering Law was submitted to parliament. This aims to address concerns of the International Financial Action Task Force countries on the existing law, and to forestall the imposition of sanctions by them. Considerable progress has been made on divestment of banks and privatization of several state-owned enterprises is being finalized. A State-Owned Enterprise Law (Appendix 3) has recently been enacted. The new law is seen as positive, providing greater legal certainty to the process of privatization, and removing potential causes for delay. Good progress is being made in establishing, with support from ADB and the International Finance Corporation (IFC), a credit information bureau for improved information to potential lenders to small and medium enterprises (SMEs).

D. Highlights in Coordination of External Funding and Partnership Arrangements

22. The 12th annual meeting of the Consultative Group for Indonesia (CGI) was held in Bali in January 2003. It emphasized the need for sustained efforts at improving the investment climate, especially with macroeconomic stability returning, through a focus on microeconomic issues and governance. The meeting pledged support of $2.7 billion for the Government. At the interim CGI held in June 2003, funding agencies expressed concerns again that actual improvements in the investment climate had been slow to materialize.

23. Following the terrorist attacks in Bali, the international development community responded quickly to accelerate ongoing projects and approve new ones in order to mitigate the economic impact of the tragedy. Following the bombings, ADB has taken measures to speed up components of its health and education projects. In addition, special attention will be paid to assisting SME exporters in Bali as part of the SME Export Development Project, in close coordination with IFC.

24. Prior to the resumption of hostilities in Aceh, concerted coordination efforts by external agencies were undertaken for restarting development activities there. ADB was gearing up to resume implementation of its stalled projects in the province. A participatory Regional Public Expenditure Review (RPER) process was initiated to transparently coordinate assistance by funding agencies to Aceh. ADB was to have led the coordination of the RPER module on infrastructure (transport, power, and irrigation). This initiative has stalled, however, due to absence of security.

25. As part of this CSPU process, an intensive effort is being made to coordinate ADB’s programs with those of other agencies. These include the World Bank, Japan, United States Agency for International Development (USAID), Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ), Kreditanstalt für Wiederaufbau (KfW), Department for International Development (DFID), Government of the Netherlands, and Australian Agency for International Development (AusAID). The bilateral ADB partnership with DFID in Indonesia for poverty reduction has been ongoing since 2002 with DFID providing valuable cofinancing support in several TA areas such as participatory design of projects and more effective targeting of the poor. The Government of the Netherlands has provided grant cofinancing to a regional capacitybuilding project and has expressed interest in partnering projects in education, environment, and water resources management. AusAID cofinancing is envisaged in education and finance.

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