Country Strategy and Program 2006-2009 (Draft for Consultation) - Indonesia

Table of Contents

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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

A. Overall Assistance Level

B. ADB Assistance for the Strategic Priorities

C. External Funding Coordination and Partnership Arrangements

D. Indicative Internal Resource Requirements

VI. Risks and Performance Monitoring and Evaluation

Country Strategy and Program 2006-2009 (Draft for Consultation): Indonesia : V. ADB's Assistance Program

B. ADB Assistance for the Strategic Priorities

1. Pro-Poor Sustainable Growth

a. Infrastructure and Infrastructure Services

99. The Infrastructure Reform Program (IRP), a program cluster comprising three subprograms, to be implemented over 2006-2010, provides the main vehicle to help develop infrastructure and infrastructure services. The objective of the IRP is to strengthen the investment climate in Indonesia and thereby support the medium-term macroeconomic goals of the Government, in particular achieving an average annual growth of 6-7 percent per annum during 2005-2009. The expected outcome of the IRP is accelerated infrastructure development through private sector participation and additional public sector resource.⁴⁴ The policy framework for IRP is based on the ongoing reforms (for subprogram 1) and the Government’s own medium-term reform agenda. The World Bank and the Government of Japan are actively involved in the policy dialogue. The IRP will facilitate a strong pipeline of infrastructure projects in energy development, power development, roads, and urban infrastructure for possible ADB financing starting in 2008, and continuing thereafter. This approach will also allow for a considered utilization of all of ADB’s available instruments, including the IEI products and private sector investments. ADB’s guarantee facility is of special interest in this context, as it will enable the mobilization of financing for PPPs. ADB could consider funding a guarantee facility to support infrastructure investments, possibly with the World Bank. TA to support Government utilization of guarantee instruments will considered.

100. ADB recently announced the second phase of its Energy Efficiency Initiative (EEI), which focuses on designing and implementing renewable energy and energy efficiency projects, in order to make energy development in Asia environmentally and economically sustainable. In 2007, ADB will support an Energy Efficiency project that is expected to result in important savings for the average electricity consumer, and to avoid potential shortages. It is expected to be designed as an MFF with two PFRs, in 2007, and in 2009.

101. As part of its support for economic growth, ADB will support a Senior Secondary Education Project in 2007, which will provide needed skills, and a regional roads project in 2009. ADB will continue to support development of rural infrastructure, an area unattractive for the private sector. Through the Rural Infrastructure Support Project II (RISP II), ADB will continue its support to Government programs for providing basic infrastructure to the poor and disadvantaged in remote and isolated villages, empowering communities to prioritize their own infrastructure needs, and plan and implement the works. The expected outcome of RISP II is to reduce rural poverty through improving access of the poor and near poor in rural areas to basic rural infrastructure, as well as to contribute to job creation. An integrated approach to site development, services provision and urban renewal is being prepared through the Integrated Settlements Development Project (2008), aimed at the urban poor.

b. Financial Sector Deepening

102. Continued support will be provided for the Government’s financial sector reform program, through the second and third Financial Governance and Social Security Reform Program (2007 and 2009). The focus of the support will be on strengthening the supervision of non-bank financial institutions, the insurance industry and the pension fund industry, and the development of the capital market. Support will be provided to the development of the secondary mortgage market through a combination of public sector, non-sovereign and guarantee operations. TA support will also be provided through a cluster modality.

c. Development Policy Support

103. The Development Policy Support Program (DPSP) cluster aims to provide broad-based, cross-cutting policy reform support to the Government's medium-term investment climate and governance reform agenda. The DPSP cluster will be processed in conjunction with the Development Policy Loans (DPL) of the World Bank. The first DPL was approved in 2004 to provide implementation support to the post-IMF reform program adopted by the Government. Through 2004, ADB provided parallel support in areas related to the DPL agenda through financial sector and state-owned enterprise reform programs. In 2005, at the Government's request, ADB provided cofinancing support through DPSP-1⁴⁵. The second phase of DPSP is being formulated for approval in 2006. Subsequent phases of DPSPs will be designed in close collaboration with the Government, and the World Bank and the Government of Japan. Continuous dialogue and progress meetings ensure that the WB DPLs and ADB's sectorfocused program loans are well coordinated, with the DPLs providing the broad framework for detailed sector reforms, avoiding overlaps. The aim of the DPSP cluster is to: (i) achieve and sustain higher economic growth through improving fiscal management and investment climate and strengthening and deepening the financial sector; and (ii) reduce poverty and unemployment by reorienting public expenditures to productive needs and by strengthening governance in public financial management.

d. Private Sector Operations

104. Private sector operations will selectively support the development and financing of important infrastructure projects in the energy, transport and urban water supply, sanitation and waste management sectors. Target activities will include power generation, toll road construction and operation, upstream oil & gas field development, oil & gas transportation and storage, oil refining and urban water supply. ADB will be flexible in selecting private sector projects for support if they have a strong demonstration effect, are innovative and pioneering and are replicable by ADB and others in Indonesia and elsewhere. ADB will look to support projects sponsored by technically capable developers who are committed to long term investment in the project. ADB would expect to provide direct loan financing to projects on a project finance basis but is also seeking opportunities to fund infrastructure investment through non-guaranteed corporate lending to sub-sovereign companies where these entities have some element of private sector ownership and/or demonstrate a high degree of management autonomy, financial transparency, high standards of corporate governance and a commercially based management philosophy. In addition, given the current levels of appetite of international commercial bank lenders for Indonesian sovereign risk, ADB would expect that its political risk guarantee product could play an important role in ensuring the successful financing of privately sponsored projects. Finally, the provision of long term local currency financing could play an important role in the financing of privately sponsored infrastructure projects, especially those with local currency revenues, during the CSP period.

105. Investments by ADB’s private sector operations department are needed to promote savings and achieve better allocation and intermediation of funds to support development. Potential operations include support for better regulation and supervision of markets, bond market development, development and enhancement of mortgages, securitization, assistance to non-finance companies, and innovative financing for infrastructure. ADB's support to deepen the financial sector will also include possible non-sovereign lending to SOEs, municipal entities, and financial institutions; issuance of local currency bonds to provide local currency funding for projects, and the promotion of a Rupiah bond market. PSOD will explore opportunities in the financial sector, for examples, (i) provision of a financial intermediation loan to a local SME bank or to a non-bank finance company catering to SMEs (i.e., leasing company); (ii) asset-backed securitization (domestic and cross-border) as a means of structured debt financing through the capital market; and (iii) debt capital market development such as ADB’s support to the issuance of corporate bonds that might face difficulties on a stand-alone basis in form of credit enhancements through a partial credit guarantee or a liquidity facility.

2. Improved Welfare

a. Decentralization

106. ADB will continue to support the Government’s decentralization agenda by remaining focused on policy reforms and capacity development Mainly through follow-up programs to ongoing support for Local Governance and Finance, State Audit Reform, and Sustainable Capacity Building for Decentralization, it will assist with enhancing local public services delivery particularly for education, water supply and sanitation, in selected provinces and districts. The Decentralization Support Facility (DSF)⁴⁶ has become an important instrument to further align these initiatives with Government needs, and harmonize policies and interventions with those of other agencies. The Partnership for Governance Reform, a multi stakeholder institution founded by the Government, ADB, UNDP and WB in 2000, has by now a strong track record in facilitating progress in areas such as anticorruption, decentralization, civil service, and legal and judicial reforms, and will continue to be an important center for reform on all levels of government.⁴⁷

107. The objective of achieving improved social services delivery can not be achieved without continued reforms and capacity development to strengthen the decentralization framework, putting local government finances on a more sustainable basis, and introducing financial accountability at local government levels. Following the Local Government Finance and Governance Reform Sector Development Program (LGF) in 2005⁴⁸ further support will be provided in 2008 to ensure continued momentum of the necessary institutional and policy reforms, and the introduction of pro-poor and gender-responsive budgeting at local levels.

b. MDG Acceleration

108. Accelerating the attainment of the MDGs is an important part of the Government’s program. ADB support will take the form of necessary policy and institutional reforms, and investments in specific project interventions. Key support will be provided through the Poverty Reduction and MDG Acceleration Program (PRMAP). The PRMAP has the objectives of supporting the Government’s goals of improving the efficiency of public spending and delivery of social services, and achieving the medium term poverty reduction targets. Through a program cluster approach, policy actions and reforms will be supported to improve quality of and access to social services over 2006-2009. Additional specific investments to support the attainment of the MDGs will be through the Madrasah Education Support Project (2006), the Nutrition Improvement through Community Empowerment Project (2007), the Water Supply and Sanitation Project (2008), the Metropolitan Sanitation Management and Health Project (2009), the second Community Water Supply and Health Services Project (2009) (Box 2) and the second Neighborhood Upgrading and Shelter Project (2009). The Second Community and Local Government Support Project (2008), will also invest in infrastructure to tackle rural poverty. The project will be adjusted as appropriate to the Government’s new Community Driven Development initiative.

Box 2: Example of MDG Related Project

The objective of the Community Water Services and Health Project¹ (combined loan and emergency grant) approved in April 2005 is to enhance the health status of low-income communities in rural areas based on better hygiene behavior and sustained access to safe drinking water and improved sanitation. The Project has four components: (i) improving the capacity of local governments for facilitating, regulating, and delivering quality services in water and sanitation to the target communities; (ii) strengthening the community capability to design, cofinance, build, operate, and manage community-based water and sanitation facilities; (iii) improving access to water and sanitation services through construction of adequate facilities based on community demand; and (iv) increasing hygiene awareness through information, education, and communication campaigns. The Project will cover about 1,000 communities in 20 districts in the provinces of West Kalimantan, Central Kalimantan, Jambi, and Bengkulu. An additional 400 communities in Aceh and Nias-North Sumatra are being covered by the Aceh/Nias emergency grant. The project follows a community-driven development (CDD) approach in which the communities themselves decide on the type of facilities they would like to have in their villages, plan and implement - with the help of community facilitators - community action plans (CAPs) detailing community capacity building, health and hygiene, and infrastructure activities, manage the funds for CAP implementation, take charge of operation and maintenance of the infrastructure, and monitor and evaluate the sustainability. Communities are required to demonstrate their commitment by contributing at least 20% of the total CAP cost (16% in kind, 4% cash, the latter except in Aceh and Nias) and by covering all O&M costs.

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1 Loan 2162 and 2163(SF)-INO: Community Water Services and Health Project, approved for $65 million on 7 April 2006. Grant 2003-INO: Community Water Services and Health Project, approved for 16.5 million on 7 April 2005.

c. Environment and Natural Resources Management

109. In Environment and Natural Resources Management ADB support will focus on water resources management primarily through project financing. Support will be provided for integrated water resources management, including investments in infrastructure and management of multipurpose facilities developed in a basin context. Two projects are under preparation. The Integrated Citarum Water Resources Management Project, is developed as an MFF for approval in 2007, with subsequent PFRs in 2009 and after. The project will support the implementation of a strategic road map for development and sustainable management of the Citarum river basin following an integrated program. It will help improve quality and supply of water to cities of Jakarta and Bandung and to farmers in West Java. The Flood Management in Selected River Basins Project is also being developed as an MFF for approval in 2008. The Integrated Coastal Resources Management Project (2008) will assist local governments to improve coastal resources management, with a view to protect the marine environment and biodiversity.

110. Furthermore, support will provided for reforms and investment leading to an improvement in urban air quality. This is based on a strong policy dialogue between the ADB and the Government in the context of the Clean Air Initiative for Asian Cities. The Urban Air Quality Sector Development Program will promote the use of clean fuels and a reduction of mobile and stationery sources of pollution.

3. Governance and Anti-corruption

111. In line with the MTS II and ADB’s Governance and Anticorruption policies, ADB will focus its operations in Indonesia on Public Financial Management, particularly fiscal decentralization, to support clarification of responsibilities and improved interaction between the three levels of government. This should result in improved fiscal equality between regions; improved efficiency and equality in financing of local governments; effective mechanisms for regional borrowing; development and implementation of performance standards for decentralized functions; capacity building of regional governments; and a gradual expansion of own revenue sources for local governments.

112. ADB will continue its support to the Commission for Eradication of Corruption in Indonesia (KPK) focusing on its prevention activities as well as on its coordination, supervision and monitoring capacities in order for KPK to become fully operational within its full mandate, as defined in the recently ratified UN Convention on Anticorruption⁴⁹.

113. ADB will continue its joint efforts with JBIC and WB to harmonize procurement, through an expanded technical assistance for harmonization and to improve project implementation to reduce corruption in line with the Paris Declaration on Aid Effectiveness⁵⁰.

114. ADB supported the most recent Country Financial Accountability Assessment⁵¹ in 2001. With support from other development partners, including World Bank and AusAID, this was updated during the processing of the Development Policy Support Program (DPSP) in late 2005. At a broad level, Indonesia has introduced significant reforms in fiduciary management, and put in place systems providing adequate oversight on the use of public funds. There are, however, significant implementation challenges which can be effectively dealt with only at the level of individual projects or programs. Through governance cluster TA (2008), ADB will support the Government in undertaking a public financial management assessment using the PEFA framework,⁵² and update that on a regular basis, providing a monitoring tool to both the Government and ADB. This will also address concerns over the transparent use of revenues from extractive industries, in support of any PSOD involvement.

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The reforms included in the IRP cluster relate to the legal, policy, and institutional framework for the following activities: transportation (roads; ports airports; and railways); power; oil and gas; telecommunication; and water supply and sanitation.
Loan 2228-INO: Development Policy Support Program, approved on 21 December 2005 for $200 million.
The DSF was established early in 2005 by ADB, DFID, Netherlands, UNDP and World Bank, and fully financed by DFID. Based on lessons learned, DFID is reviewing and re-designing the DSF in order to make it more effective and get the Government more involved. A second phase of the DSF started in mid-2006.
Outcome Evaluation Agenda for Governance Reform in Indonesia, 2000-2005. Commissioned by UNDP, final report, Jakarta, 5 May 2006.
Loans 2192/2193(SF)-INO: Local Government Finance and Governance Reform Sector Development Program, approved for $330 million on 3 November 2005.
An ADB staff member is currently seconded to the KPK to strengthen its capacity.
The Paris Declaration on ownership, harmonization, alignment, results and mutual accountability resulted from the high-level forum organized by the OECD-DAC, held in Paris, France, in March 2005.
ADB and World Bank, Indonesia Country Financial Accountability Assessment, Jakarta, 2001.
PEFA=Public Expenditure and Financial Accountability, a multi-donor initiative lead by the World Bank. The assessment will follow the Public Financial Management Performance Measurement Framework, Washington, June 2005.

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A. Overall Assistance Level

C. External Funding Coordination and Partnership Arrangements

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