Countries and Regions

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p. 3 of 6 BACK | NEXT I. Development Context II. Government Vision and Plan III. Progress with the Adoption of the Poverty Reduction Strategy Framework IV. New Directions V. Portfolio Management VI. 2005 Operational Program

Country Strategy and Program Update 2005: Indonesia

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III. Progress with the Adoption of the Poverty Reduction Strategy Framework

11. Poverty Reduction. The incidence of poverty declined from 19.1% in 2000 to 16.6% in the first half of 2004, although weak growth and job creation risk a reversal. Moreover, the lack of formal labor market opportunities suggests that the large number of near-poor remain vulnerable to adverse changes in the economy. Table A1.1 in Appendix 1 summarizes the country's progress toward the Millennium Development Goals (MDGs) and targets. As a direct contribution to poverty reduction, the Asian Development Bank (ADB) is processing an innovative community water supply and health project, which includes a component for tsunamiaffected communities in Aceh. ADB also is processing a housing finance project (project preparatory technical assistance approved in August 2004) to follow up on the Neighborhood Upgrading and Shelter Sector Project (approved in 2003).

12. Pro-Poor Sustainable Economic Growth. The recent Infrastructure Summit reinforced the point that this will be one of the focal areas of the new Government. Without a conducive investment climate and the required legal framework, financing of infrastructure development in the short to medium term has to come from the public sector, including support from multilateral development banks and the Japan Bank for International Cooperation (JBIC). The proposed Road Rehabilitation II Project is scheduled for approval in 2005. To promote investment in infrastructure by local governments in urban areas, an innovative project is proposed that supports Public-Private Partnership for Urban Infrastructure Project. ADB is completing an assessment of the private sector. Combined with the Investment Climate Study conducted in 2003–2004, this assessment will guide how ADB might support the private sector directly. In addition, the Government and ADB recently signed the Framework Agreement for Private Sector Guarantees, which will have a positive impact on ADB's private sector operations, especially its ability to use the guarantee mechanism.

13. Inclusive Social Development. The promotion of inclusive social development in ADB’s program is closely related to contributing to the achievement of the MDGs. ADB aims to continue supporting the madrasah¹ education system—most madrasah students are poor and girls form the majority. The proposed Madrasah Education Development Project (project preparatory technical assistance approved in 2004) will contribute to achieving universal education and gender equality. ADB’s strategy focuses on narrowing gender gaps in human development by ensuring that (i) gender inequality in accessing social services is reduced, (ii) women’s participation in public decision-making is strengthened, and (iii) regional governments increase their capacity to deal with gender issues. A country gender assessment is being prepared to improve targeting of assistance in this vital area.

14. Indonesia has maintained a relatively low incidence of HIV.² In recent years, however, the number of cases has grown rapidly among high-risk groups, reaching levels that threaten to spill over into the general population. By September 2002, the number of adults and children with HIV/AIDS³ was estimated at 130,000, with an estimated 80,000 more Indonesians infected in 2003. The Government’s efforts are well coordinated but under-resourced, especially given the large population. ADB will work with the Joint United Nations Programme on HIV/AIDS to develop an HIV strategy for the Ministry of Public Works, helping especially in a pilot activity to mainstream efforts to combat the spread of HIV in infrastructure project design and implementation.

15. Good Governance. Indonesia’s governance systems and public institutions continue to be plagued by systemic corruption and weak capacity. Domestic and foreign investors are reluctant to invest because of the poor performance of the judiciary and the courts.⁴ A number of legal milestones were achieved recently, providing a public expenditure framework in line with good international practice.⁵ However, many implementing regulations are still required, and effective implementation of the laws demands capacity building at all levels of government. The Government’s reluctance to make an early and clear commitment to civil service reform might frustrate other reforms. ADB continues its support for public expenditure reform through the State Audit Reform Sector Development Program,⁶ as well as the proposed Local Government Finance and Governance Reform Program. A presidential decree (Keppres 80/2003) on public procurement, prepared with ADB assistance and issued late 2003, introduced a procurement scheme largely in line with good international practice.

16. New laws were accompanied by the establishment of new institutions. The Constitutional Court, established in late 2003, began operating by July 2004. The Commission for Eradication of Corruption was established in December 2003. ADB is implementing technical assistance (TA) to help strengthen the capacity of the commission. Blueprints for long-term institutional reforms of the Supreme Court were completed in 2003, as a framework for all reform efforts. ADB will support strengthened court administration, initially through TA.

17. Few countries have chosen to decentralize as fast, or as sharply, as Indonesia. While progress with decentralization is considerable, the remaining major challenges focus on two broad sets of issues: (i) the legal framework lacks clarity and a coordinated approach; and (ii) the administrative and fiscal aspects of decentralization are disparate, leading to a divergence between the standards that are set for public services and the resources that are allocated. Key legislation, governing many important aspects of decentralization, include the Law on Regional Governance (Law 32/2004, previously Law 22/1999) and the Law on Financial Balance Between Central and Local Government (Law 33/2004, previously Law 25/1999). These laws contain important revisions compared with the 1999 versions. However, the new Government has not analyzed fully the implications of the changes involved in the required implementing arrangements. ADB supports the implementation of the decentralization laws through ongoing TA and the Local Government Finance and Governance Reform Sector Development Program Loan, which is proposed for 2005.

18. Environmental Management. ADB’s strategy emphasizes the need to manage Indonesia’s natural resources on a sustainable basis as a key to fostering sound economic development. The focus is on three principal areas: marine and coastal resources, water resources management, and air quality. The country environmental analysis, now in draft form, will be completed as an input to the next Country Strategy and Program (CSP). In the meantime, ADB is proposing to continue strengthening its work on coastal fisheries, marine resources management, and aquaculture development. The proposed pipeline includes a project focusing on flood management in three selected water basins on Java. The country environmental analysis also will be an important input to the marine and coastal resources sector assessment, which will be prepared in 2005. Here, as in other areas, weak capacity in government and problems of corruption will reduce the impact of specific sector reforms.

19. Regional Cooperation. The draft ADB regional cooperation strategy aims to enhance the competitiveness of the region to help generate sustainable high rates of economic growth, complemented by the integration of poorer regions into regional and extra-regional trading networks. The draft strategy has four pillars: (i) transport infrastructure development; (ii) energy infrastructure development; (iii) support for strengthening and harmonization of regional financial regulatory and legal frameworks; and (iv) support for subregional initiatives in outlying regions, in particular in the Brunei Darussalam, Indonesia, Malaysia, and Philippines-East ASEAN Growth Area (BIMP-EAGA). This area includes southern Mindanao and the island province of Palawan of the Philippines; all Indonesian provinces on the islands of Sulawesi, Maluku, Papua, and Borneo; the neighboring Malaysian territories; and Brunei Darussalaam. A number of ADB’s planned infrastructure assistance projects will have regional impacts, including interisland transport projects, focusing on ports and airports.

20. Private Sector Development. Creating the conditions for private sector development is critical to achieving the Government’s economic growth targets. Since the financial crisis affecting the major Southeast Asian economies, Indonesia has had the lowest foreign direct investment. Political instability, the rising cost of labor,⁷ and the general inefficiency of public administration and the judiciary have increased the costs of doing business in the country, depressing Indonesia’s competitiveness. Rapid decentralization has exacerbated this climate of uncertainty. The roles, responsibilities, and regulatory authority of subnational governments have not been defined clearly. The heavy involvement of state-owned enterprises⁸ (SOE) in the economy further limits the opportunities for private sector development, as monopoly market positions and/or preferential market access effectively crowd out private competitors. This is particularly true in the infrastructure sectors, where SOEs often have dual regulatory and operational roles.⁹

21. In this context, regulatory reform will be central to promoting private sector development. Regulatory reform means reducing the myriad government controls and licensing requirements on private business, and allowing competition to create investment opportunities. By creating a level playing field for businesses that compete against SOEs, and redefining the role of the Government in the infrastructure sectors, the new Government could exploit a unique opportunity to restore investor confidence and place Indonesia on a growth path led by the private sector. The proposed pipeline for 2005 includes a rehabilitation project of major roads, and a financing facility intended to promote private sector investments in urban infrastructure. An investment in a number of ports is also included. Finally, the pipeline has a project preparatory TA for a public-private partnership project for Medan airport.

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