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Southeast Asia

Indonesia, Malaysia, Philippines, Singapore

Subregional Perspective

Southeast Asia has made solid economic progress since the financial crisis of 1997. Overall the subregional economy has bounced back, with strong performance in particular in Malaysia and Singapore, though political uncertainty, weak finances, and governance challenges to varying degrees have clouded the picture in Indonesia and the Philippines. Significant challenges remain in poverty reduction, with a total of more than 60 million people in poverty in Indonesia and the Philippines.

The Philippine economy’s challenges are many, as illustrated in the 2005 numbers. GDP growth slowed to 5.1%, from 6.0% in 2004, which ADB economists have said is not enough for rapid progress in reducing the country’s deep poverty. In the past, the Philippine economy has been prone to boom and bust, rising and falling with the unstable political climate and inconsistent policies.

It has settled down in recent years, but as the 2005 numbers show, the economy is still struggling to maintain strong enough growth to absorb the rapidly expanding population. Higher growth requires better public resource management and incentives to spur private sector involvement. The key to meeting the government’s hoped-for GDP growth of 7–8% by 2010, say ADB economists, is annual investment in capital stock of at least 10% of GDP in net terms, substantially higher than the current rate of 3%.

The government took strong measures in 2005 to avert a fiscal crisis. Expansion of the value-added tax has contributed to a 20% drop in the deficit, an 8% strengthening of the peso, and a drop of more than 100 basis points in government borrowing costs.

The private sector—and a well-educated population—will be critical for achieving growth and creating jobs

The slower 2005 economy was in part due to a weaker agricultural performance and slower growth in the services sector. Exports also slowed sharply to 3.7%, from 9.8% in 2004.

A revival in investment bolstered Indonesia’s economy in 2005, with GDP expanding by 5.6%, compared with 4.9% in 2004, fueled by an 8.1% expansion in fixed capital investment. The pickup follows the relatively seamless transition to a new government after elections in 2004, and expectations of greater regulatory certainty and a recovery in infrastructure spending.

The Indonesian government earned high marks from around the world for its firm measures to avert a fiscal crisis threat caused by surging oil prices, while at the same time the government provided programs to lessen the impact on the poor (see page 97). By slashing fuel subsidies, it relieved pressure on finances and helped shore up investor trust.

Inflation rose due to the fuel price increases but by year-end, the Bank of Indonesia’s aggressive monetary stance had stopped the surge in prices and also led to a rebound in the rupiah, which had lost more than 10% of its value earlier in the year.

Longer term, the private sector will be critical to achieving the government’s growth and job creation objectives.

In Malaysia and Singapore, strong exports fueled growth, with GDP expanding by 5.3% in Malaysia and 6.4% in Singapore, the second outstanding year for the city-state.

The year saw the end of the peg of the ringgit to the US dollar and a series of reform steps, including preparation of major consumption-based tax reforms aimed at improving the business environment, further cementing Malaysia’s position as one of Asia’s strongest emerging economies.

Regional Cooperation

Indonesia, Malaysia, Philippines, and Singapore have been at the forefront of regional cooperation initiatives in Asia for nearly 40 years as core members of ASEAN and as participants in the ASEAN Free Trade Area and the ASEAN Vision 2020, which foresees an integrated Southeast Asian market by 2020. The countries also take part in other leading international cooperation forums, such as the Asia-Pacific Economic Cooperation.

A series of external and internal crises in recent years has reinforced the need for strengthened cooperation: the financial crisis of the late 1990s, severe acute respiratory syndrome (SARS), HIV/AIDS, avian flu, haze from forest fires, and terrorism and other security threats are all spurring deeper cooperation.

ADB sees opportunities for subregional energy resource sharing, transport, financial sector development, and safeguarding marine and fisheries resources. Consultations have been held in Indonesia, Malaysia, and Philippines.

Separately, in December 2005, the heads of government and state from the Brunei Darussalam– Indonesia–Malaysia–Philippines East ASEAN Growth Area and Indonesia–Malaysia–Thailand Growth Triangle agreed to meet annually. ADB has been asked to help the two subregional initiatives formulate methods to track development progress and identify opportunities for private sector investment in the poorer islands of Southeast Asia.

Malaysia is playing a lead role in consultations for cooperation, and participating in several subregional technical assistance activities, including support for strengthening institutions in the Brunei Darussalam– Indonesia–Malaysia–Philippines East ASEAN Growth Area, and for developing Islamic financial services.

In 2005, ADB began preparing a regional cooperation strategy and program for the four nations, which is targeted for completion in 2006.

ADB Assistance

ADB’s lending programs in Indonesia and the Philippines were overhauled and revitalized during the year as the organization more than doubled loan approvals and disbursements, reflecting a move toward greater responsiveness and relevance in its operations. Total ADB assistance in 2005 was about $1.7 billion.

Cushioning High Fuel Oil Prices

The rural poor were hard hit by the sudden increase in the price of kerosene The cost of living for Indonesia’s rural poor increased overnight when national fuel oil subsidies were slashed in October 2005 as an essential measure to maintain macroeconomic stability. The price of kerosene, the most widely used fuel in poor households, rose by more than 185%. To help lessen the impact, the government launched programs to bring in more investment into rural infrastructure, health, and education. ADB was asked to step in and quickly approved a $50 million, 3-year loan to support the government’s Fuel Subsidy Reduction Compensation program in eastern provinces, where vulnerability to the shock was greatest. The loan finances communitydriven construction and repair of village roads, bridges, culverts, irrigation systems, water supply and sanitation, and drainage works. About 1,800 mostly isolated villages in East Java, East Nusa Tenggara, Southeast Sulawesi, and South Sulawesi provinces will benefit.

Highlights included approval of $1.3 billion for nine loan projects, including the private sector, well up from $671 million in 2004; and $1.3 billion in disbursements, a 122% increase over 2004. ADB also provided a $300 million Asian Tsunami Fund grant to Aceh for reconstruction after the tsunami.

Improving rural infrastructure is key to reducing poverty

In the Philippines, the expanded assistance included $180 million in loans to support the development of small- and medium-sized enterprises and microfinance.

ADB has improved management of its active loan portfolio, and is breaking with the past under a new country strategy and program for 2005–2007 that changes ADB’s operating partnership with the Philippines. Specific annual lending targets have not been included in ADB’s overall 3-year envelope of $1.5 billion of possible financial support. This provides the flexibility to respond to changes in the lending environment.

The new Philippines country strategy and program is part of a batch of country guides that place acute focus on results, in particular, through identifying clear measures that can be monitored and evaluated.

In Indonesia, two major loans made up the bulk of lending: one to support local government finance and governance reforms, and the other for the country’s medium-term growth and poverty reduction program. ADB also backed the government’s program for improving rural infrastructure with a $50 million loan in 2005.

ADB took steps to draw the private sector into its development efforts. A major loan will back the $6.3 billion Tangguh Gas Project in West Papua, ADB’s first private sector project in Indonesia’s oil and gas sector, as well as ADB’s first private sector operation in Indonesia since the 1997 financial crisis. In the Philippines, a $25 million public-private sector loan will help boost development of small- and medium-sized enterprises.

In Malaysia, ADB continues to expand its private sector operations, with equity positions taken in new funds such as the Flagship Capital Corporation.

Indonesia

Strengthening Governance

Loan approvals in 2005 reached $1.1 billion in Indonesia, including a private sector loan, with particularly strong focus on governance and infrastructure.

In November, ADB approved a $300 million loan to the country to strengthen and rationalize the policy, legal, and regulatory frameworks for decentralization, and to establish a more effective mechanism for coordination among different levels of government. Local governments are assigned responsibilities for most public functions including service delivery under Indonesia's decentralization laws, which were approved in 1999 and amended in 2004, but inconsistencies in the legal and regulatory frameworks and undeveloped local level capacity have made implementation of their responsibilities extremely challenging.

The loan supports revisions to the original decentralization framework and adoption of related rules and regulations to streamline and clarify responsibilities among different levels of government to ensure greater transparency and accountability in the flow of funds to finance the provision of public services by local governments. A national action plan for next steps in fiscal decentralization is also supported. These reforms promote development of a clear mandate for the delivery of education, health services, and public works.

A separate $30 million loan will develop integrated regional systems to support preparation of more reliable and consistent financial statements by 71 local governments and provide access to an integrated regional financial information system to these local governments as well as to 100 more, supporting the devolution of funding to address regional inequities in basic public services and strengthening the framework for local government borrowing.

ADB also supported the Indonesian government’s efforts to improve macroeconomic management. Under its medium-term development plan for 2005–2009, Indonesia aims to boost sustainable economic growth to 7% by 2009, from about 4% in the years before 2004. It is also a government target to halve the poverty rate to 8.2% by 2009, from 16.6% in 2004.

A $200 million loan for the Development Policy Support Program is being provided in conjunction with World Bank assistance of $400 million, and further assistance is planned from the government of Japan. The harmonized assistance focuses on sound public financial management and more effective use of fiscal resources through measures to improve governance and combat corruption with an eye at enhancing the efficiency of public expenditures, improving the investment climate, and strengthening the financial sector.

Infrastructure for Growth

Investment in public infrastructure in Indonesia collapsed after the Asian financial crisis, slumping to $1.5 billion by 2002 from $16 billion in 1996. In a recent study, Indonesia’s infrastructural investments ranked last among countries with populations of more than 20 million.

Upgrading Neighborhoods in Indonesia and the Philippines

a grant fund is providing social safety nets to female vendors in Mindanao, Philippines Half the urban population of the Philippines lives in makeshift housing in informal settlements, where drinking water, sanitation, and drainage systems are grossly inadequate, according to official figures. In Indonesia, where about 91 million people live in cities, the housing and land markets have also not kept pace with rapid urban growth. Housing and land markets in Indonesia have not kept pace with rapid urban growth Recent initiatives challenged shortcomings in urban upgrading projects and opened new areas of microfinance. The Philippines’ Development of Poor Urban Communities Sector project and the Indonesian Neighborhood Upgrading and Shelter Sector project work with local governments and NGOs to make affordable plots available and to ensure access to loans. The Indonesian project is helping 180,000 households secure tenure. In the Philippines, as well as helping over 20,000 poor urban households secure accommodation, microfinance for small enterprises provided through 10,000 loan packages has benefited about 100,000 poor urban residents. A $100 million Metro Manila Urban Services for the Poor project, now under preparation, will include a long-term metro-wide strategy for upgrading slums in the National Capital Region. The Strategic Private Sector Partnerships for Urban Poverty Reduction project has harnessed the power of the private sector to help the poor in Metro Manila. It brings together the Philippine Business for Social Progress and ADB. Homes are being built, day-care facilities set up, flood-prone streets paved, and water systems and proper drainage installed. With a $3.6 million grant from the Japan Fund for Poverty Reduction and $3.6 million from the Philippine Business for Social Progress, it covers 26 communities in eight metro area cities. Further afield, a 3-year project in Mindanao, run by the Notre Dame Foundation for Charitable Activities, Inc.–Women in Enterprise Development —with a $1 million grant from the fund—is providing social safety nets for poor female market vendors in eight cities.

The rural areas are particularly poorly served: a recent study found that only 15% of rural households had access to piped or pumped drinking water, and just 21% had septic tanks. More than half of rural villages were not connected by paved roads, and a third lacked year-round access. The number of rural poor in Indonesia in 2004 was about 24.7 million, or one fifth of the rural population.

According to its medium-term development plan, Indonesia needs to invest about $145 billion in infrastructure projects to sustain an annual GDP growth of 6% through 2009.

ADB approved three infrastructure-related loans last year: Road Rehabilitation 2, Community Water Services and Health Project, and Rural Infrastructure Support Program.

Road Rehabilitation 2, the second phase of an earlier project, focuses on restoring and improving safety in key sections of national roads in Sumatra and Kalimantan islands. It will provide farmers and local entrepreneurs with better access to markets; reduce transport costs; make it easier for governments to deliver administrative and social services; and create other income-earning opportunities, including the operation of ojek or motorcycle taxis. HIV/ AIDs awareness campaigns will also run parallel with road construction activities in Kalimantan and Sumatra.

As part of its efforts to obtain private sector support for major infrastructure projects, ADB approved a $350 million loan for the Tangguh Liquefied Natural Gas Project in West Papua, which will extract gas from fields in the Berau and Bintuni Bay areas, a big step in the revival of ADB’s private sector operations in Indonesia.

PHILIPPINES

A Boost for Enterprise

The $180 million in loans approved in 2005 for the Philippines included support for financial sector development, with a focus on microfinance and smalland medium-sized enterprises. In addition is a loan for $5 million, without government guarantee, for the purchase and resolution of nonperforming loans and assets of Equitable PCI Bank.

general store owner

The lending program is also closely linked to and supports the fiscal consolidation agenda to which the authorities have demonstrated a strong commitment.

The budget deficit, the primary indicator of national fiscal health, fell from 3.9% of GDP in 2004 to 2.7% in 2005. The expansion of the value-added tax removed formerly exempted transactions in November 2005 and set the rate at 10%. (In February 2006, the expanded value-added tax was raised to 12%.) Administration of the tax system is being strengthened, and the challenge now is to implement hard-won policy changes to ensure that incremental revenues are collected.

A new $150 million loan for the Microfinance Development Program aims to improve the access of the poor to financial services. The loan supports the government’s program to encourage private sector participation in the delivery of microfinance services, address systemic weaknesses, and promote competitively priced financial services for the poor and their enterprises.

Making microfinance loans available helps provide income-generating opportunities for women such as this basketmaker

Microfinance is central to the government’s strategy for reducing poverty under the Social Reform and Poverty Alleviation Act, and the Philippines has made good progress. More than two thirds of the country’s poor, or 17 million people, do not have access to microfinance services and rely on costly informal sources. Access to microfinance gives poor people the chance to build viable businesses and livelihoods.

Among its many features, the new ADB loan will help remove restrictions on competition for microfinance services, improve governance, and promote efficient operations and the expansion of private sector-led microfinance institutions. It will make borrowing costs clearer by introducing greater transparency and “truth in lending” to all types of microfinance institutions. Also, it will clarify the tax regime governing the institutions.

In September, ADB approved the loan for small- and medium-sized enterprise development, a project that includes a $25 million loan that will support the Small its portfolio of loans to small- and medium-sized enterprises. The project also includes a partial credit guarantee facility of about $18.4 million, and an equity investment of up to $1 million.

By 2010, the government wants the enterprises to contribute about 40% of value-added to the economy, up from about 32% now, but it faces constraints in unsupportive policies, cumbersome and costly registration and licensing processes, and the lack of a national business and collateral registry.

The partial credit guarantee, equivalent to about 1 billion Philippine pesos ($19.5 million), will be offered to encourage selected private sector financial institutions to also expand their portfolios for small- and mediumsized enterprises, particularly to medium-sized enterprises outside the corporation’s target group. The facility will cover up to 50% of well-defined loan portfolios. The equity investment will help establish a comprehensive and credible credit information system, one of the factors constraining development of the sector.

Improving Housing Finance and Upgrading Slums

Urban housing is being improved in the Philippines through a program that promotes the development of low-income housing units by the private sector

ADB assisted the Philippine National Home Mortgage Finance Corporation in resolving its portfolio of highly delinquent mortgage loans through a P1.6 billion loan approved in December 2004, which reached financial closure in November 2005. The loan to Balikatan Housing, Inc., a special purpose company, financed its purchase of the portfolio of nonperforming loans from the National Home Mortgage Finance Corporation. The sale of the troubled housing portfolio through this transaction will allow the corporation to more effectively allocate its resources to developing and providing a secondary market for home mortgages to low- and middle-income households.

ADB is also taking a 10% equity stake in Bahay Financial Services, Inc., a new loan servicing company that will restructure and service the nonperforming loans on behalf of Balikatan Housing, Inc. A major portion of the funding for the peso-denominated loan came from an ADB Philippine peso-denominated bond priced in October 2005.

To help alleviate the worst effects of poverty, the Strategic Public-Private Partnerships for Urban Poverty Reduction project, with funding from the Japan Fund for Poverty Reduction, continued in 2005 to combine the business sector, local government units, and NGOs in the Philippines to address the delivery of basic services and livelihood programs. Operating in 26 marginalized communities in eight cities of Metro Manila—Caloocan, Malabon, Marikina, Muntinlupa, Navotas, Pasig, Quezon City, and Taguig—its many achievements have financed construction of better homes and local infrastructure for 894 households, given micro loans for businesses, and provided hundreds of individuals with scholarships, business training, and skills enhancement.

Energy Restructuring

In 2005, ADB continued work to strengthen the Philippines’ Energy Regulatory Commission and to advise the Power Sector Assets and Liabilities Management Corporation on the privatization of assets of the National Power Corporation under a technical assistance grant approved in 2004.

Restructuring the power sector has reached a crucial juncture. While the new legal and regulatory framework for introducing competition is largely in place, privatizing generation and transmission assets has been slow.

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