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Countries and Regions Country Partnership Strategies Document
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Country Strategy and Program Update 2005: Indonesia
I. Development Context1. Opportunities and Challenges. A new dynamism is taking hold in Indonesia. After 4 months in office, the Government of President Susilo Bambang Yudhoyono has shown the vision and drive required to tackle the myriad problems that have plagued Indonesia since 1997. While obviously preoccupied with the tsunami disaster in Aceh and North Sumatra, the Government managed to (i) address some key legislative issues, (ii) focus national and international attention on infrastructure investment needs, (iii) improve perceptions of the business climate, and (iv) present a new 5-year plan. The domestic and international goodwill required to move forward rapidly has been created. As one sign of this, the Government, for the first time, chaired the Consultative Group on Indonesia meeting in January 2005. 2. The country faces numerous challenges. The Government has identified the sustainable acceleration of economic growth as its top priority. Long-overdue investments in infrastructure, backed by substantial improvements in the investment climate, are viewed as the means to achieve this objective. Faster growth is necessary to absorb 23 million entrants to the labor force every year and reduce poverty. While the incidence of poverty has fallen to pre-crisis levels, it remains widespread. Large numbers of people are still vulnerable, and substantial regional imbalances remain. Moving forward, policies on decentralization must be rationalized to improve policy consistency, and to provide a context in which poorer regions can accelerate development. Major investments in agriculture are required to modernize the sector and increase productivity in a sustainable way. Environmental degradation continues to threaten future development. More and better health and education services are needed urgently, and serious human capacity constraints are hampering efforts to accelerate broad-based growth. In most areas, poor governance and weak capacity to govern hamper progress—and the perception that corruption is rampant remains widespread. 3. Vulnerability. Indonesia remains vulnerable to natural disasters and armed conflict. The earthquake and tsunami that hit the Indian Ocean on 26 December 2004 devastated the province of Aceh and some coastal areas of the province of North Sumatra. At the end of February 2005, the estimated death toll stood at around 130,000, with tens of thousands of people still missing. An estimated 500,000 people have been displaced, and the civil service— including administrators, teachers, and health staff—have suffered serious losses. This disaster represents a significant challenge to the Government, as well as to the international community, that together completed a joint damage and needs assessment in January. That assessment estimated the total damage and loss at $4 billion–$5 billion, roughly equivalent to provincial gross domestic product (GDP). The Government hopes to complete the reconstruction strategy by the end of March 2005, which would provide the direction required for international pledges of assistance to be realized. 4. Indonesia also continues to face security problems. In Aceh, a ceasefire between the Free Aceh Movement and the Indonesian military generally has allowed emergency relief operations to proceed, although security incidents continue to be reported. In other areas, open conflict continues sporadically in Ambon, while ethnic tensions still plague some areas of Sulawesi and West Papua. Beyond the human costs, these conflicts act as a serious barrier to the development of these fragile islands. Moreover, car bombs and other terrorist attacks over the past few years have provided serious challenges to the Government, as well as civil society. 5. Recent Economic Developments. The smooth political transition helped restore confidence in the economy and solidify gains made over the past few years. Real GDP grew 5.1% in 2004, the fastest since 2001. Overall investments increased 11.3% year-on-year for the first three quarters of 2004, compared to 1.9% in 2003. In recent years, capital investments and imports of machinery remained almost flat. This trend was reversed in the first three quarters of 2004, when domestic capital investments grew 14.7% and capital goods imports 44%, indicating a recovery in investments. However, evidence of new “greenfield” investments in plant and equipment is minimal. In line with regional trends, private and public consumption have continued to be the dominant economic factors, although public consumption expenditures grew slower in 2004 relative to 2003. Indonesia's international reserves increased to $37.4 billion in 2004, the highest since the crisis. While debt levels remain high, the ratio of public debt to GDP has declined to about 56% from above 58% in 2003. 6. Inflation slowed to 6.4% at the end of 2004, the exchange rate remains stable, and the central bank reference interest rate has fallen to 7.4%. Market participants have accepted the Government’s commitment to encourage higher growth, while pursuing macroeconomic stability, which has aided monetary policy. The budget deficit at the end of 2004 was 1.2% of GDP—only slightly above the target. Subsidies on fuel oil rose to Rp60 trillion in 2004, compared with the budgetary target of Rp14 trillion, effectively equaling development expenditures. To contain the fiscal deficit, the Government raised fuel prices and reduced subsidy payments. The increase in fuel prices, effective 1 March 2005, will represent one of the first significant tests of the Government’s political will.
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