Policy Reform in Indonesia: Agenda and Challenges

1. Policy Reform in Indonesia: Agenda and Challenges Mohamad Ikhsan Advisor to Coordinating Minister for Economic Affairs Republic of Indonesia and Senior Research Associate at the Institute for Economic and Social Research University of Indonesia Presented at The First OECD-Southeast Asia Regional Forum: Peer Review Mechanism for Policy Reform Hotel Nikko Jakarta, Indonesia 23-24 January 2007

2. Outlines • Overview on the state of Economy since the crisis time • Policy Uncertainty Issues in Indonesia • Macro Uncertainties • Micro Uncertainties • The Impact of Policy Uncertainties on Performances • TFP • Investment • Employment • Major Causes for Uncertainties • Policy Reform Agenda • Conclusion

3. Overviewof State of Economy • Indonesia’s economy has steadily improved since the crisis time. • Per capita income has been backed to pre crisis level since 2004 and growth rate now accelerating to a 6 % p.a • More balance and sustainable sources of growth • Macroeconomic risks improved significantly indicated by a sharp reduction in public and external debt ratio and short term debt over international reserve

4. But many (economic) problems remain • Our productivity remains lagging behind pre crisis period or other regional competitors. • Unemployment both open and under employment are still higher than pre crisis. • Poverty trends are moving away of the paths.

5. Firm and industry level data amplify those fundamental problems

6. In short, mostly caused by policy uncertainties

7. Political transition to democratic regime No clear majority and expected to continue up to the next 10 year Bigbang decentralization. Authority vis a vis responsibility Financial crisis has limited the central government power. Crisis increases government debt services cost and limit the power of central government Most of regions rely on central government transfers. Inducing regional government to take progressive and in many cases unnecessary new tax and retribution. High debt also rises the country’s risks and degree of vulnerability. Debt intolerance in Indonesia is about 35% of GDP. It implies focusing on reducing debt burden still the agenda over 1-2 years ahead. Vulnerability in financial sector have forced the government to take another burden on contingent liability. The crisis also reduced the ability of the state to up grade infrastructures. Government spending on infrastructures reduced to only 3-4 % of GDP compared to 7% during the pre crisis time Sources of Uncertainties

8. Increase competition Raise efficiency Lower risk Greater demand and output Low costs Better risk x return Structural and institutional reforms More investment Lower taxes and cost of capital Macro adjustment Quality of public spending Improving investment climate

9. Policy Reform Constraints • Political constraints hinder the ability for GOI to eliminate political uncertainties except for the areas where all parties and/or interest groups relative have common ground. • Improving one areas may open the other Pandora. • Lack of trusts and lack of responsibility • Regional government regulation • Some dilemmas: • Need to focus on the process rather than outcomes (but at the cost of relative slow of implementing and results) • High expectation ( partly due to the past memories) also increases the demand for quick outcomes. • Inherent dilemmas: look example in fiscal trilemmas. • PR Problem • “Take it for granted” behavior on the government sides. • Intermediary problem • Asymmetric problems of reform: cost of reform always up front while benefit usually appear in the medium term. Benefit per capita in many cases always less than cost per capita.

10. A reform agenda • Macro reform: • Fiscal Policy trilemma • Stabilization policy • Micro Reform: Three Pillars • Investment Climate • Infrastructure Acceleration • Financial Sector Reform

11. Fiscal policy trilema Reduce public debt/GDP Increase public investment Lower taxes

12. Fiscal reform • Reduce public debt / GDP ratio: • Sustain a high primary surplus • Lower the cost of debt • Restructure public spending to accommodate rise in public sector investment • Reduce tax burden • Develop a medium-term fiscal framework that lowers political risk. • Gradually reduce contingent liability • Abolish the financial sector blanket system while introducing new deposit insurance companies • State Owned Companies Restructuring including initiating new law on Regional State Owned Companies • Most of them have been achieved and further reforms are underway.

13. 1 Investment Law & Procedure 2 Tax & Custom Reform 3 Labor & Immigration 4 Trade Licenses 5 Cross Sector Strategic Policy Reform 6 Sector Restructuring, Corporatisation and Policy Reform 7 Regulation on natural monopoly & investment protection 8 Clear separation on the role of policy maker, regulator, contracting agency, and operator 9 Coordination Monetary & Fiscal Authority 10 Financial Institution (Banking & Non Banking) 11 Capital Market and SOE Privatization Three Policy Packages Investment Climate Improvement Infrastructure Financial

14. Milestones For Improving Regulatory Environment for PPP Institutional Strengthening KKPPI - Interministerial Committee for Infrastructure Development Cross Sector - PPP Regulatory Framework Issuance of Presidential Regulation No.67 /2005 (Perpres 67/2005) Project Preparation Establishment of Project Development Facility - PDF Government Support Issuance of Minister of Finance Regulation No.38/2006

15. Infrastructure Policy Package One important theme in these laws is the phasing out of the monopoly position of the SOEs in infrastructure services….. Wider opportunities will be open up for private investments in railways, harbors and airports and other sectors. Energy & Power Telecommunication Road & Toll Road Water & Sanitation Transportation

16. Investment Climate Improvement General Tax Customs Labor • Review of Labor Law no.13/2003, • Development of Employment Dispute Information System • Development of an online job search • Strengthening service institutions • Transparency • Equal treatment • Settlement mechanisms • Synchronization of regulations • Clear and transparent criteria on tax • Service desks on Large Tax Office • Revision of VAT • Improving processing time • Implementation of EDI system to improve efficiency

17. Financial Policy Package Strengthen the coordination between fiscal and monetary authorities Launched June 2006, as joint effort between GOI and BI • The establishment of Mediation Agency for Indonesia Insurance in September 2006. • The establishment of road map pension fund program in September 2006. • The issuance Bank Indonesia regulation regarding incentive for banks merger and consolidation. • The establishment of Committee for Privatisation of State Enterprise. A clear legal ruling on separate maintenance of state assets in regard to the management of non-performing loans at state-owned banks Strengthening banking institutions and policy on improving the performance of SOE Banks Strengthening non bank financial institutions (insurance, pension funds, finance companies & venture capital firms) Improving the liquidity, efficiency and integrity of the capital market Clarify Government privatization policy direction

18. New Initiatives: 2007-2008 • Continue to implement three previous packages • Carry over some delay policy actions • Refocusing on some important issues • Eliminate some irrelevant policy actions • Take special actions for several important issues • Employment Creation and Poverty: SME, CCT, Poverty Community Development, and Urban Housing Programs • Energy: Deregulation in Oil and Gas and Energy Alternative

19. Conclusion: How to create an effective and do-able agenda • It must start with credible and feasible agenda • Taking to account political constraint is necessary • Consider all possible negative side effects • Priority is essential • Need to manage expectation • Reform should not be oversold • Setting the pace and sequence of reform is really art. • Need to have a full knowledge on all constraints and opportunities • Crisis in many times opens the opportunity. • In many cases, establishing oversight mechanism will help the credibility of reform • Educating the public is the part of success element of reform. • Broadening the base of reform supporters part of the objective of the PR. • Need to have a champion of reform. • Role of bureaucracy is important.