Indonesia: Inclusive Growth through Improved Connectivity Program - Subprogram 1

Transport / Transport policies and institutional development

Indonesia's economic growth performance and poverty. GDP growth edged up to 6.5% year on year in 2011, the highest since the Asian financial crisis, supported by sustained private consumption, stronger investment, and expanding net exports. Despite improved growth rates, recent economic growth is still significantly below the country's growth potential. For 2014-2016, IMF estimates a baseline potential growth rate of 7.1%, but which would increase to 7.9% if infrastructure development and economic reforms are accelerated. The recent ADB Study Diagnosing the Indonesian Economy also identifies inadequacies in infrastructure as one of the critical constraints to economic growth. Indonesia's overall ranking in the Global Competitiveness Index is at 46 out of 142 countries. However, the country only ranks 76 out of 142 on overall quality of infrastructure, far below its overall ranking, implying that infrastructure is a drag on the country's competitiveness (Figure 1a). The impact of lagging infrastructure appears in a number of forms. Deteriorating road systems in the provinces and districts increases domestic transport and logistics costs. Congested port and underdeveloped inter-island transport systems have led to expensive domestic shipping costs. Congested and unproductive international ports have made Indonesia's manufacturing sector not well integrated into international production networks. Achieving and sustaining higher growth rates over the medium-term will require an enabling environment for much higher investments in infrastructure.

Poverty reduction. Growth of 6.5% in 2011 resulted in about 1.5 million new jobs being generated, exceeding the number of new entrants to the labor force. The quality of employment also improved as formal employment rose by 16.0% (5.7 million positions). Most jobs were in construction, manufacturing, and services. Employment in the informal sector fell by 5.9%, or 4.2 million, as workers left the agricultural labor force. However, significant challenges remain in reducing poverty incinence further. About 62% of the employed labor force (about 68.2 million people) still works in the informal sector, where wages and job security are low. Poverty incidence fell to 12.4% in September 2011, from 13.3% in March 2010. While poverty and unemployment have trended downward, many Indonesians remain vulnerable to economic shocks. More than 60 million people still live just above the poverty line and are at high risk of falling back into poverty. The national rural poverty rate of 15.6% is still much higher than the national urban poverty rate of 9.1%. Poverty rates in some provinces in eastern Indonesia are much higher than elsewhere in the country

Inclusive growth through improved connectivity. Addressing the country's multidimensional poverty will require not only accelerated economic growth but also a more inclusive growth process that provides rural areas and disadvantaged regions with improved economic opportunity and access to social services. As the largest archipelagic state in the world by area and population and the largest economy in the Association of Southeast Asian Nations (ASEAN), Indonesia requires improved connectivity to make growth more inclusive. The country's connectivity can be improved with: (i) better intra-island connectivity to connect rural areas with regional growth poles, which is essential for reducing rural poverty; (ii) better inter-island connectivity between the western and the eastern parts of Indonesia, which is indispensable to reducing higher poverty incidence in the east; and (iii) improved international connectivity to make the country's productive sector more competitive, which is vital in reducing poverty overall and improving the quality of employment by reducing the size of the labor force employed in the informal sector.

Convergence of government's national strategies and ADB strategy. The government recognizes that lagging infrastructure, underdeveloped intra- and inter-island connectivity, weak international connectivity, and inefficient logistics constrain achieving its medium- and long-term targets of higher growth and faster poverty reduction. Strategically, the government's National Medium-Term Development Plan (RPJMN) 2010-2014 provides direction for the two pillars of ADB's Indonesia country partnership strategy (CPS) 2012-2014: inclusive growth and environmental sustainability. Reforms supported by the proposed program will support the inclusive growth pillar of the CPS. In addition, improving connectivity is a strategic focus of the government's long-term Master Plan for Acceleration and Expansion of Indonesia's Economic Development, 2011-2025 (MP3EI). The MP3EI will guide the convergence of ADB's policy-based, sector and thematic interventions related to connectivity and the government's vision of accelerated economic development.

Connectivity coordination on regulatory frameworks strengthened

Key initiatives to upgrade intra-island connectivity implemented

Measures and strategy to improve inter-island connectivity put in place

Key policies executed to enhance international connectivity

The TA had been supporting the government in its connectivity reform priorities. These included the following:

i. Assisted to develop effective and integrative national connectivity policy at the national and regional level. These included providing a framework for an efficient and integrative network of transport (land, sea, and air), energy, information and communication, and housing and water provision. The TA also assisted to synchronize policy recommendation on national connectivity in the government'.

ii. Assisted to incorporate the Strategic Environment Assessment Framework in connectivity programs of the Master Plan for the Acceleration and Expansion of Economic Development (MP3EI) 2014-2025.

iii. Assisted the government in preparing the Indonesia Broadband Plan (IBP) 2015-2019, which included discussion with external stakeholders and recommendation for changes and additions to the IBP. The IBP was successfully launched in mid-October 2015 through a Presidential Decree.

iv. Provided legal advice on the revision to the existing regulation on Public-Private Partnership (PPP) for infrastructure development. The input of the TA included: regulatory mapping related to PPP in infrastructure development, legal opinion on the main laws related to PPP, initial draft of a revised regulation on PPP, and further in-depth discussion with all key sectors related to PPP.

v. Assisted on the analysis of maritime intra-island freight transport costs and identification of conditions and interventions for reducing transport costs in the eastern part of Indonesia.

vi. Assisted on logistic cost analysis. These included: (i) measuring Indonesia's logistic performance by using National Logistic Cost Indicator and National Logistic System (Sislognas) Performance Index (SPI); and (ii) develop a proposal for a standard cost of port.

The TA also supported the new government in its connectivity reform.