Report No. 18691 -IND Indonesia Public Expenditure Review The Budget, Off-Budget Items, State-Owned Enterprises October 7, 1998 Document of the World Bank CURRENCY EQUIVALENTS Before November 15,1978, US$1.00= Rp.415 Annual Average: 1979 US$1.00= Rp.623 1980 US$1.00 = Rp.627 1981 US$1.00= Rp.632 1982 US$1.00 = Rp.661 1983 US$1.00= Rp.909 a 1984 US$1.00 = Rp.1,026 1985 US$1.00= Rp.1,111 1986 US$1.00 = Rp.1,283b 1987 US$1.00= Rp.1,644 1988 US$1.00= Rp.1,686 1989 US$1.00= Rp.1,770 1990 US$1.00 = Rp.1,843 1991 US$1.00= Rp.1,950 1992 US$1.00= Rp.2,030 1993 US$1.00= Rp.2,079 1994 US$1.00 = Rp.2,160 1995 US$1.00 = Rp.2,249 1996 US$1.00 = Rp.2,342 1997 US$1.00= Rp. 4,667 1998 US$1:00= Rp. 10,632 (estimated) FISCAL YEAR Government April I to March 31 Bank of Indonesia - April 1 to March 31 a On March 30, 1983 the Rupiah was devalued from US$1.00 = Rp.703 to US$1.00 = Rp.970. On September 12, 1986 the Rupiah was devalued from US$1.00 =Rp.1,134 to US$1.00 =Rp.1,644. Vice President: Mr. Jean-Michel Severino Sector Manager Masahiro Kawai Task Manager John Shilling MAIN ABBREVIATIONS, ACRONYMS AND DEFINITIONS ASEAN Association of South East Asian Nations BAPPENAS National Development Planning Board BULOG State Logistical Agency CEM Country Economic Memorandum DIP List of Project Contents GDP Gross Domestic Product GOI Government of Indonesia IBRA Indonesia Bank Restructuring Agency IMF International Monetary Fund INPRES Instruction of the President IOMP Irrigation Operation and Maintenance Policy IPP Independent Power Producer IPTN National Aircraft Development Company MOSE Ministry of State Enterprises O&M Operations & Maintenance Pertiminia National Oil Company PGN National Gas Company PLN National Electricity company PTPNs State Owned Plantations PTTelkom National Telephone Company RDA Regional Development Fund RDI Investment Funds Account REPILITA 5-Year Development Plan SLA Subsidiary Loan Agreement SOE State Owned Enterprise VAT Value Added Tax WUA Water User Association Note: Data included in this report were those available in June 1998 and had in many cases been compiled in difficult circumstances. Thus there may be some inconsistencies which will have been corrected in subsequent information. i INDONESIA PUBLIC EXPENDITURE REVIEW TABLE OF CONTENTS Pages Preface .................................................................. iii CHAPTER 1: INTRODUCTION .................................................................I Scope of the Public Expenditure Review .............................................................3 The Role of Government .............................................................4 CHAPTER 2: MACRO-ECONOMIC FRAMEWORK FOR PUBLIC EXPENDITURES 7 Impacts of the Crisis on Public Resources .................................................................8 Budget Impacts ................................................................ 10 CHAPTER 3: THE BUDGET ................................................................ 14 Current Expenditures ................................................................ 17 Development Expenditures ................................................................ 22 Annex A: Management of Irrigation O&M .......................................... 40 CHAPTER 4: OFF-BUDGET ACCOUNTS ................................................................ 41 Quasi-Budget Expenditures ................................................................ 42 Revolving Loan Funds for Public Investment Programs .............................................. 46 Publicly Managed Funds for the Benefit of Individuals ............................................... 49 Special Purpose Chartered Charity Funds ................................................................ 52 BULOG ................................................................ 54 CHAPTER 5: STATE OWNED ENTERPRISES ............................................................... 59 Extent of the SOE Sector ................................................................ 61 Impacts of the SOEs on Public Finances ................................................................ 64 Effectiveness of Financial Resource Use by SOEs ....................................................... 66 The Future of the SOEs ................................................................ 70 Strategic Options for SOEs: Better Management and Privatization ............................ 71 CHAPTER 6: SUMMARY AND RECOMMENDATIONS ......................... ..................... 75 Budget ................................................................ 77 Off Budget Accounts ................................................................ 84 State Owned Enterprises (SOEs) ................................................................ 84 TABLES IN TEXT Pages Table 2.1: Basic Economic Data ........................................................8 Table 2.2: Resource Envelope ....................................................... 12 Table 2.3: Subsidies ....................................................... 13 Table 3. la: Current Expenditures by Functio .15 Table 3.1 b: Current Expenditures by Functio .16 Table 3.2a: Current Expenditures by Sector .17 Table 3.2b: Current Expenditures by Sector (Constant 1993/94 Prices) ............................ 19 Table 3.3: Development Budget ....................................................... 23 Table 4.1: Summary of off-budget Accounts ..................................... .................. 41 Table 4.2: Education Sector Financing ....................................................... 42 Table 4.3: Ministry of Forestry Reforestation Fund ....................................................... 44 Table 4.4: Ministry of Finance Special Accounts ....................................................... 46 Table 4.5: Social Insurance and Pension Funds ....................................................... 49 Table 4.6: Ministry of Republic Housing Civil Servants' Housing Fund ............ ............ 5 1 Table 4.7: Takesra/Kukesra Savings and Credit Funds .................................................... 52 Table 4.8: Income Transfers between BULOG and Producers, Consumers .................... 54 and Central Government Table 5.1: State Owned Enterprise Basic Indicators 1996 ................................................ 61 Table 5.2: Cash Flow From Government to SOEs .65 Table 5.3: Return on Total Capital Employed by Non-Banking Public .66 Companies: 1996 Table 5.4: Summary Data of Public Companies: 1996 .67 Table 5.5: Valuation of Selected Companies in 1996 .68 Table 6.1: Resource Envelope .74 Table 6.2: Development Budget .76 Annex Tables ..87 Table 1: Government Revenue ........................................................ 88 Table 2: Government Expenditures (GOI Format) ....................................................... 89 Table 3: Fiscal Summary (trillion of rupiahs) ....................................................... 90 Table 4: Fiscal Summary (% of GDP) ....................................................... 91 Table 5: Government Revenues (billions of rupiah) ..................................................... 92 Table 6: Government Expenditures (Bank Format) ....................................................... 93 Table 7: Investment Budget (billions of rupiah) ....................................................... 94 Table 8: Investment Budget (Development Budget) ..................................................... 95 Table 9: Sales and Earnings Before Interest and Taxes of 22 Companies .................... 96 Text Boxes Box 5.1: Pertamina .61 Box 5.2: PLN .63 Preface This report was prepared at the request of the Indonesian government as part of the program agreed with the IMF and the World Bank. In recoginitioni of the tight resource constraints it would face as a result of the economic crisis that had occurred, it deemed it important to undertake a broad review of government expenditures to see where priorities could be reoriented and where less necessary expenditures could be cut. In this review, it asked that off---budget items and state owned enterprises also be included in the ambit of the analysis. The review was undertaken by a team led by Mr. John Shilling and includinig Messrs. Jorge Garcia-Garcia (RSI), Jay Rosengard (Consultant), Peter Scherer (Consuiltanit), and Mark Gersovitz (Consultant). The team commissioned a financial study of the state-owned enterprises by the firm of HLB, Mann-Judd of Australia, assisted by the firm of Hadori and Rekan in Indonesia. This group collected a massive amount of data that has been made available to the government to assist in its program to reform and privatize SOEs. The PER team received a great deal of help and advice from staff in RSI and headquarters and from many officials in the government of Indonesia. We greatly appreciates their assistance at a time when they were preoccupied with many other important matters. We would also like to express our appreciation to the governments of Australia and Canada, which provided trust funds to support this activity. The continued technical and word processing support of Cynthia Abidin and Joseph Israel was exceptional under difficult circumstances and is greatly appreciated. No report would have been possible without it. This Report was discussed with the government on July 2, 1998. A draft was circulated to the Consultative Group on Indonesia in Paris on July 29, 1998. CHAPTER 1: INTRODUCTION' 1. The events of the past year have imposed an unprecedented series of challenges on the Government of Indonesia and its people. The worst drought in over 50 years and a financial crisis have wreaked havoc on the country and have raised questions about the sustainability of many of the lpractices and policies that have been part of Indonesia's development strategy. After years of 7+ percent growth, GDP advanced only 4 percent in 1997/8, and it is expected to fall by 10-15 percent in 1998/9. Positive growth is not expected to return unltil 2001. The massive devaluation and sharp inflation that have already occurred will seriously erode real incomes.' 2. This crisis came as a shock to many and is a serious setback to the gains Indonesia had achieved over the past 30 years. Progress under the Suharto governments had been impressive and were widely commended. Growth has averaged about 5 percent per capita in 1970-96, poverty had been reduced from 70 percent of the populationi to 12 percent prior to the crisis (it has since risen to an estimated 25 percent and may go higher), universal primary education has been achieved, illiteracy reduced to 9 percent. and infant mortality has declined to 50 per 1000 live births. These achievements were due in part to the commitment, policies, and actions of the government, and in part to the rich natural resources and high levels of foreign assistance available to the government. Nevertheless, the economy also accumulated serious structural weaknesses over this period, which were easy to overlook or downplay when growth was high. The public sector had become inefficient and wasteful, excessive favoritism and rent-seeking behavior had undermined both the strength and credibility of many large private corporations. and the banking system was fragile and undercapitalized. These fault lines fractured in late 1997, forcing the government to confront a steep economic downturn. 3. Initial responses of the Suharto Government to these many challenges were halting, but became stronger as the full extent of the crisis was realized. A serious reform program was launched by early 1998, but it was not credible enough to prevent popular pressure from forcing a change in government. The brief, but intense, violence that led to the change in governmenit has delayed some reforms and will add to the costs of transition. Thie newly named Habibie government has committed itself to honor the past commitments to reform, and new agreements have been negotiated with the IMF and the Bank to take account of the further deterioration of the economy.2 These programs include measures to protect the poor, to stabilize the economly, to remove structural distortions, and to reform the financial sector. Chapter 6, Summary and Recommendations can be read as an Executive Summary and listing of the major recommendations for readers who do not need to see the details. iThe Rupiah has lost about 80% of its value and inflation has been about 60% in July 97-June 98. Estimates for 1998 and beyond are subject to a high degree of uncertainty due to both economic and political factors. 2Details of the macro programs and expected results can be found in the Letters of Intent signed with the IMF, documentation of the Bank's SAL, the Country Economic Memorandum, and other sources. 2 4. Economically, one of the most critical problems is the sharp decline in revenues available to the government. Total normal revenues will drop 25 percent in real terms and from 16.4 percent of GDP in 1997/8 to 14.1 percent in 1998/9; Many expenditures will have to rise, even though revenues drop. Based on the June 1998 IMF program, total expenditures are expected to increase from Rp. 138.7 Tr. in 1997/8 to Rp. 277.1 Tr. in 1998/9, or from 20 percent to 29 percent of GDP. Proposed development expenditures will increase from 5.5 percent (estimated actuals for 1997/8) to over 7.5 percent of GDP and by 18 percent in real terms. Extraordinary increases in foreign lending are expected to allow the government to make these increased expenditures. It is important to note at this time that all these estimates are subject to a high degree of uncertainty. The 1998/9 figure is the budget allocation. It is not certain that the government will be able to appropriate and spend the increased allocations. Foreign dlonors supported the Government's request for additional support during the Consultative Group meeting in July 1998 with pledges of$7.9 billion. Priorities will still have to be setfor the money that is channeled to spending ministries. 5. The government is putting high priority on measures to respect Indonesia's long term commitment to reducing poverty and spreading the benefits of development. Within this envelope, the government is undertaking a massive redirection of development expenditures in the short run. The additional costs of the financial sector crisis and higher debt service payments due to the devaluation absorb a larger share of total expenditures and will stay high for a number of years. Together they amount to 70 percent of government revenues (excluding privatization receipts, 63 percent including them) and 40 percent of expenditures in 1998/9; including subsidies, the percentages are 114 percent of domestic revenues and 65 percent of expenditures. In comparison, subsidies and debt service accounted for 40 percent of revenues and 36 percent of expenditures in 1997/8, which included some of the initial impacts of the crisis, and lower percentages in earlier years. 6. Despite these costs, the government is taking exceptional measures to expand social safety net and poverty alleviation programs to mitigate the impacts of the crises on the population. As part of this program, current expenditures for subsidies (primarily food and energy) will increase sharply, though presumably only temporarily. Other programs are being initiated to create more employment, assure continued access by the poor to basic education and health care, and provide targeted food support. 7. The negative impacts on the budget will endure for several years. It will take time for revenues to recover; increased expenditures for subsidies, financial restructuring, and debt service will continue. Dependence on foreign assistance will increase. If extraordinary official foreign assistance does not continue, significantly more severe budget constraints are in the offing. 8. The extent of reduction in the public sector's discretionary domestic resources over time and the structural reforms to respond to the crisis are so large that the government has no choice but to consider fundamental changes in its development program, in the type and scope of its interventions in the economy, and in its treatment of State Owned Enterprises (SOEs). The Indonesian economy cannot be resurrected into its form ex ante, nor should it. The need to reform the basic flaws in Indonesian public policy, the rapidly changing structure of international markets, and the developments that have occurred in Indonesia as a result of the crisis have 31f the extraordinary privatization revenues of Rp. 15 Tr. are included, the decline in real terms is 16% and the share of 1998/9 GDP is 15.6%. altered the environment to such an extent that fresh approaches are needed to emphasize efficiency, reduce direct interference, and reorient government involvement in the economy. 9. The current government has recognized the necessity of manking fundamenital shifts in policy and has begun to shift expenditure priorities in the revised 1998/9 budget. Some of the priority shifts are directed at mitigating the immediate effects of the crisis, such as the employment creation programs. Others represent the beginning of a reallocation of spendilng toward longer term priorities that will be much more important in the future, such as improving quality and access to health and education, especially for the poor. In the short term, these shifts will entail cutting many other projects, and the government has begun a medium term process of reassessing priorities in infrastructure and other sectors, focusing on maintenance in the short term and new priorities in the medium term. This whole process of reorienting priorities will take several years under severe resource constrainits. More public involvemenit in the decision-making process will also be expected. 10. Indonesia is by no means ullique in this regard. Other countries in the region are facing many of the same demands to rethinik the role of government and reform their financial sectors. Countries in the rest of the world -- developed and developing alike -- have been confronted with similar challlenges of how to accommodate to fewer public resources, how to increase efficiency of the public sector, how to deal with capital volatility, and how to best use private resources to help achieve public objectives. Indonesia can profit from the experiences of others, but must formulate its own strategy for renewed growth. 11. The reforms needed are far-reaching. Most initial reactions have understandably conicentrated on short-term and transition measures to meet immediate needs. However, it is important that the transition measures be consistent with and supportive of a sustainable long- term strategic vision that will restore sustainable growth and redress the structural weaknesses that have been revealed by this crisis. Serious reflection is now needed on both the transition and permanient elements of the government's reform program. This PER is a contribution to that process. Its recommendations are designed to provide both short and medium-term guidance. Scope of the Public Expenditure Review 12. This Review will focus on the government's immediate reaction to the crisis through its reallocation of public expenditures and on the fundamental changes in its longer-term role in the economy that must also begin now., It will address the questions of what economic role the government should play in the future, and how its own expenditures and its power to affect the allocation of other resources can be used most effectively in weathering the crisis, restoring growth, and achieving the government's development, poverty alleviation, and equity objectives. It will also analyze the implication of the crisis for state-owned enterprises and their effects on public resource use. 13. The report will examine three areas of govemment involvement and impact on the economy: (i) the budget, (ii) a variety of funds controlled by the government that have heretofore been carried 'off-budget,' and (iii) the State Owned Enterprises, including the strategic industries. The rest of this Chapter will review the role that governments should play in the economy and how the Indonesian govemment has structured its interventions through the three 4There are other related structural issues in the financial sector, regulatory and industrial policy, and employment and poverty issues which are being addressed elsewhere. 4 channels just identified. Chapter II will examine the overall macro-economic framework that will determine the resources available for the budget in the short and medium term. 14. Chapter III will analyze the budget, with primary focus on the development budget. It will examine the changing allocation of expenditure and the directions new policies and strategies should consider. Chapter IV will examine a selection of off-budget items and how they can be better integrated into government priorities and more transparently managed. Chapter V will present our analysis of State Owned Enterprises, their impact on the economy, and the role they should play in the future, including the potential for more privatization. Chapter VI will summarize the conclusions and recommendations of the review, looking both at those measures that can be taken in the short term to reallocate expenditures and at medium term measures needed to restructure the economy. The Role of Government 15. The Indonesian government has accepted as an article of faith that it should play a central, active, and directive role in economic development. The chaotic state of the economy after independence and again at the beginning of the Suharto regime, the need to promote widespread growth for reasons of both equity and political stability reasons, and the lack of a large and skilled private sector with capital to invest all contributed to that rationale for intervention. As part of its strategy, the government expanded the civil service, created subsidy programs, and provided preferential treatment to select enterprises (both public and private). They were ostensibly to promote public ilterests, but they also generated large private rents5 -- thereby contributing to inefficiencies in the economy. The circumstances that justified many of the government's early interventions no longer prevail. The many successes of the government's program to develop the economy and raise income levels as well as the deficiencies that have been highlighted by the crisis urge a re-examination of the government's involvement in the economy.. 16. In addressing this issue, one can best begin by asking the question: What is the rationale for public intervention -- market failure, redistribution, or some other public objective? The answers to this question are likely to be very different now than 20-30 years ago. The next question is: If a rationale for public intervention exists, what is the best instrument of intervention -- direct expenditures, targeted subsidies, creation of public institutions, or regulatory measures? And where expenditures or subsidies are warranted, how can they be rationally allocated and efficiently executed? These questions will underlie the approach and analysis of this report. Time and resource constraints will not permit detailed exposition across all sectors covered. The broad outlines will be indicated; detailed analysis is available in some areas and further work should be pursued in other areas of immediate interest. 17. Fortunately, there is one critical aspect of this question that is not likely to be an issue in Indonesia. In many countries, the provision of various types of public infrastructure and public goods, such as education and health, is restricted to the government or public enterprise sector. This is not the case in Indonesia. The principle of private participation in procuring or supplying many traditional public goods has long been accepted and practiced in Indonesia. There are, however, many practical issues concerning the form of private involvement and of public regulation of that involvement to be resolved in order to make the public-private partnership more efficient. 5Some of which were reportedly funneled back to support the old regime and party structure. 5 18. The Developnment Budget: Under the auspices of BAPPENAS, the investment budget reflects the government's development priorities as set forth in each 5-year REPELITA. . The bulk of the activities in the development budget are supported by foreign assistance programs and come under scrutiny in that regard. The immediate resource constraint is so severe, however, that many justified public sector activities cannot be financed in the short run. In these circumstances, proportional reductions of most expenditure categories is not the answer. Given administrative inefficiency and inevitable leakages in expenditures, pro rata reduction across most or all of the approximately 3500 projects in the development budget would most likely result in little being accomplished and a large increase in inefficiency. Many projects will simply have to be postponed due to lack of funds. 19. While few major projects in the development budget would be classified as outright wasteful, many no longer meet the rationale for public involvemenit or have greatly reduced value in the changed economic situation. The government is currently revising and reducing non- critical expenditures. The immediate program should concentrate on i) allocating funds to maintaining existing htiman, institutional, and physical capital rather than new construction, ii) maintaining expenditures for basic education and health, and iii) supporting short-term programs to mitigate the crisis, such as employment creation. Looking ahead, it is critical that the government review the contribuItion of each program to its post-crisis strategy with a view to permanently canceling those that are no longer justified and delaying others that do not have an immediate imupact. 20. It may be desirable to postpone the formal REPELITA VII planning exercise for a couple of years until the short-term political and economic reforms are in train. In its place, the governmenit should produce a crisis recovery plan focusing on the next two years. The document should set out the key criteria for the allocation of expenditures in the short-term and define important medium-term objectives. A longer-term document can be prepared later once the immediate crisis is past and the government has been able to undertake a thorough reassessment of its role and priorities. 21. Off-Budc7get Iletnis: Over the years, a number of special funds have been established off- budget, sometimes to avoid scrutiny, other times to protect certain funds from mis-use by 'spendthrift politicians.' This report has taken a fairly broad definition of 'off-budget' in order to investigate a wide range of public and quasi public uses of public resources which are not accouintable through the normal budgetary procedures. In addition to the 'normal' off-budget items, we look at the Pension funds, the Foundations, and BULOG. At this stage, this Report can contribute to demystifying what these accounts do and to questioning their role, particularly the extent to which the expenditures under the off-budget items are in accord with the priorities of the government and whether their impacts are beneficial or otherwise. Increased transparency and accountability will be essential for all such accounts, whether they are eventually included in the budget or not. 22. Stat-Oivned Enterprises. Like many other developing countries, Indonesia has established a number of state-owned enterprises to carry out important functions of providing public utility services (e.g., electricity, telecommunications, transport). It also created public enterprises to lead industrial expansion in strategic sectors and other important industries. At the time, it was believed that the domestic private sector lacked the capital and skilled manpower to undertake such activities, and so soon after independence, there was a desire not to rely too 6 heavily on foreign capital.6 Now the private domestic sector has become large and dynamic, and many SOEs function in markets dominated by private firms7. There were private investors involved in some infrastructure.a 23. The rationale for the continued government ownership of many public enterprises is now much weaker, and the govemment has begun a gradual privatization program. Assuring the delivery of public utility services is still a government responsibility, but there is now scope for much greater private participation in supplying these services, subject to more competitive market discipline. This requires a stronger regulatory framework than Indonesia currently possess, and progress is needed in this area in parallel with its privatization program. The Strategic Industries are a special case because of the high level of political support they have received and their putative strategic role. While the tactics for dealing with them may have to be different, they are included with the analysis of the other SOEs. 6Foreign capital at the time was interested only in natural resources, where DFI did take place Only recently have mechanisms been developed to attract private investment into public utilities and infrastructure, and it is primarily in the past decade that there has been sufficient interest among investors in such projects. 7Liberalization these markets further to increase their competitiveness is a major element in the government's reform. 8 There are questions of the transparency, efficiency, and regulation in some of the contracts for private contractors of infrastructure that will be discussed in Chapter V. 7 CHAPTER 2: MACRO-ECONOMIC FRAMEWORK FOR PUBLIC EXPENDITURES The economic crisis has cauised a large reduiction in real GDP. This has diecreased the base for government revenues, and they will be depressedfor several years. Revenues as a share of GDP will decline, while expenditures on subsiclies and dlebt service, including for the financial sector restructuring., will rise sharply, curtailing clom77estic resources avtailable for norn7al cuirrent and development expenditures. Ind7conesia wvill have to relv entirely on foreign borrowing to finacnce development expenditures as well as somwe current e.xpenditures for several years. It is not yet clear how tmtuch foreign1 assistance will be forthcomting beyond the commitments made for 1998/99. The government will have to mzake every effort to reduce expenditures for subsidies, bank restructuring, and debt service in the mediumo termn in ordler 1o preserve enouigh resources for vital development expenditures. Major chtages in the structure and level of the expenditure program will be required. 1. The impacts of this crisis on the Indonesian economy have been among the most severe faced by any counitry. The shock is particularly severe compared to the rapid growth the economy had enjoyed until immediately before the crisis struck. GDP had sustained about 7 percent p.a. growth until mid 1997, inflation was moderate (less than 10 percent p.a. and falling), the budget was in balance, the exchange rate followed a managed, depreciating crawl (roughly maintaining a constant real exchange rate), and the current account deficit (due to an excess of private investment over savings) was readily financed with large net private capital flows., 2. Prior to the crisis, government revenues absorbed about 15 percent of GDP, and expenditures were about the same level. Indonesia's own resources financed about two-thirds of the development budget. Foreign borrowing by the government, mostly official assistance, financed the rest. However, new disbursements were slightly less than amortization. In recent years, all the foreign assistance has been for specific projects and depends on government counterpart funds being available. As will be discussed in Chapter IV, the off-budget accounts that could be added to the budget would represent at most 1-2 percent of GDP and probably showed a modest net surplus in 1996/97 of well under I percent of GDP.2 3. The government's budget management and its abstinence from undue borrowing had been prudent. As a share of GDP, the size of the budget is small compared to other countries in the region. Government consumption had been about 8 percent of GDP, compared to 10-12 percent for other major ASEAN countries and 14 percent for low income countries as a group.' INet borrowing of the government has been slightly negative for several years. 2 The Central Bank, however, had large domestic liabilities due to the issuance of SBIs to sterilize part of the large private capital inflows. 3 World Development Report, World Bank, Washington, D.C., 1997. 8 The public enterprises were not a large direct drain on the budget, and their foreign borrowing, which was supervised by the government, was not considered excessive. 4. In addition to the economic crisis, Indonesia has just endured one of the worst climatic crises of this century due to the effect of El Nino. Muchi of the country had suffered a severe drought in 1997, and it continued into 1998. This substantially reduced food production and contributed to massive forest fires that afflicted Kaliinantan and Sumatra. These created health problems ranging from long-term respiratory illnesses to increased dengue fever outbreaks. These, plus the reduction in food production, have imposed added costs o01 the budget, requiring additional spending to finance rice and other food imports and distribution prior to the onset of the financial crisis. The fires also reduced productivity in the affected provinces. Because of the burdens already visited upon many of the most vulnerable by the droughlt, thle government has been reluctant to add to those burdens by passing on the full costs of the economic crisis. Table 2.1: Basic Economic Data FY9516 FY96/7 FY97/8 FY98/9 FY99/0 FYOO/1 (estimated (projected) (projected) GDP Growth (% pa) 8.2 8.0 4.6 -12.0 0.0 3.0 Inflation (% pa) 9.5 8.9 12.0 68.2 30.0 10.0 Exchange Rate (Rp./$) 2,280 2,381 4,667 10,632 10,000 10,000 GDP(Tr. Rp.) - 471.5 1550.1 679.1 952.0 1241.3 1406.3 GDP (Tr. Rp Constant 1994) 383.8 414.4 433.7 381.6 381.6 393.1 Government Revenues (Tr. Rp.) Current 71.8 88.1 111.3 134.3 149.4 160.0 Constant 60.9 68.6 77.3 55.5 47.5 46.2 Share of GDP % (cur) 15.3 16.0 16.4 14.1 12.0 11.4 Deflator 117.9 128.8 144.0 242.0 315.0 346.0 .Source: Government of Indonesia: Staff estimates. Note: Data for 1998/9 and beyond are subject to a great deal of uncertainty. Impacts of the Crisis on Public Resources 5. The macro economic situation will limit the government's ability to raise revenues. These impacts are felt through the impacts on GDP growth, through the devaluation of the currency, and through high interest rates. Obviously, these effects are interrelated, but they can be analyzed separately. 6. GDP Growth: After growing at over 7 percent p.a. for the past decade and more, growth fell to 4.6 percent in 1997/98. GDP is expected to decline by 12 percent or more in 1998/99, before recovery begins in 2000/01. See Table 2.1. Inflation rose to 12 percent in 1997 and is expected to be 68 percent or more in 1998 before declining. Government revenues will rise in nominal term in 1998/99 compared to 1997/98, but they will decline by25 percent in real terms (excluding privatization revenues), and the real decline will continue into 1999/2000 beyond. 7. Revenue raising capacity was a constraint on government activity prior to the crisis. The still low incomes of large segments of the population have limited the potential to raise resources from that part of the tax base, and liberalization of trade has reduced indirect taxes. Oil and gas 9 related taxes have declined in recent years, and additional taxes, including the expansion of the VAT, have just been able to make up for that decline. The government has been reluctant or unable to raise taxes on affluent individuals and corporations, and in fact, cut taxes three years ago. 8. In the recent past, the overall revenue elasticity to GDP has been slightly more than one. However, the impact of the crisis on the corporate sector is so severe that corporate profit and personal incomne taxes are expected to fall much more rapidly than GDP. Recent tax reforms will increase some other revenue collections (VAT), but other reforms such as lowering import tariffs, will work in the opposite direction. Declining petroleum prices will reduce income from that source. There is little scope to raise revenuies sharply in the short term. In the medium term, the government will have to address the issue of tax reforn and improving its overall collection effort. 9. Lower GDP growth will also increase the demands for certain categories of government expenditure. The loss of food production due to the drought has required massive imports of food and distribution of rice and other essential food stuffs by the government. The exchange rate depreciation has added to the costs of this. The government has not wanted to pass on the full increase in the costs of food and energy products to consumers, so it has increased subsidies. Other programs to provide short-term employment to compensate for large scale job losses will also weigh on the budget. 10. The Devaluation: By July 1998, the Rupiah has lost 80 percent of its value since mid 1997, and even the IMF program only sees a recovery to about a 70 percent loss in value (to 10,000 Rp./$) by the end of 1998.4 Further appreciation would reduce the impact on the budget, but it is difficult to predict when it will occur. The real depreciation will end up being less due to the effects of domestic inflation. For the government, a major impact of the devaluation has been a dramatic increase in the Rupiah value of servicing its official foreign debt. Furthermore, a number of public enterprises that have borrowed abroad with government guarantees lack the liquidity to pay their foreign obligations and will have to rely on support from the government. 11. Public enterprises, such as PLN and Pertamina, whose inputs are priced in dollar terms and whose outputs are priced in Rupiah terms, face large losses from the devaluation on foreign borrowing and dollar denominated purchase contracts. The government has been slow to allow the tariffs for electricity and petroleum products to rise after the crisis in order to prevent social unrest, which has further eroded their financial positions. As a result, the government has to carry large subsidies for these products in the short-term. Even after the subsidies are reduced or eliminated, the cash flow situation of many SOEs will be precarious, reducing taxes and dividends, and increasing the need for financial support from the government. 12. The increase in the Rupiah cost of external debt repayments has severe impacts on the viability of the corporate sector as well as on individual real incomes. It has contributed to their severe lack of liquidity and access to credit, leading to production cuts, closure of firms, and substantial losses in real assets and productive capacity. This, of course, translates with loses in jobs and taxable income. The contingent liabilities of the government's guarantee of foreign liabilities of the banking sector (in Rupiah terms) may well add further costs to the budget. The 4In late 1998, the exchange rate rose to the 8000/$ range around end October. 10 devaluation has made Indonesian exports more attractive, and some firms have benefited. Others have been constrained by lack of access to credit and have not been able to expand exports. 13. High Interest Rates: The increase in interest rates has raised the number of corporations and banks facing severe illiquidity, if not insolvency, compounding the impact of the devaluation. Corporates have not been able to borrow for working capital and many have reduced or ceased production, and many construction projects have been slowed or halted. Lack of access to foreign and domestic credit has diminished the economy's capacity to expand exports. Banks have been doubly affected by the direct effects of the interest rates and devaluation on their cash flow and on their assets, as many loans have become non-performinig. The traditional practice of high debt-equity ratios and use of 'evergreen" credit by private corporations in Indonesia (and other South East Asian countries) has ireant that the impact of higih interest rates is particularly severe. 14. In response to the wide-spread weakness in the banking sector and rapidly growing volume of bad loans, the governmenit has established a deposit guarantee scheme and a program to take over failed banks and manage their bad assets. It was initially estimated that the losses due to these bad assets would amount to at least 15 percent of GDP and will have to be absorbed by the government budget over time. This estimate has since been nearly doubled. Rather than monetize these losses immediately, the governmeit has issued domestic bonds worth more than Rp 120 Tr. on which it will have to pay interest and eventually repay principal. This figure is likely to be revised upward. The bonds are currently being held by Bank Indonesia until it becomes appropriate to begin to place them in the capital market. The costs of the contingent liabilities resultinig from the deposit insurance scheme have not yet been estimated. Budget Impacts 15. Table 2.2 shows the impacts of the crisis and changing expenditures imperatives on the availability of resources for development expenditures. The presentation is non-standard to illustrate how severe the problem is. The normal presentation is available in the annex (Annex Table 1). Total revenue is shown in nominal terms. This includes the proceeds from the governmenits more aggressive privatization program, which is expected to raise an additionalRp. 15 Tr. in 1998 and beyond.5 16. Current expenditures on personnel, materials, and transfers to regional and local governments (which cover the normal governmental activities at that level) will rise in current terms in 1998. Civil servants will receive a 15 percent wage increase, but their total remuneration will still fall substantially in real terms, and civil service salaries are generally considered low to begin with,. Real expenditures on materials are expected to remain about constant. Current transfers to regional and local governments were level in nominal terms in 1997/98 and will rise in 1998/99, but will decline in real terms. Maintaining such transfers is vital to preserve local government institutions and enhance their ability to administer a major portion of the government's expanded program of employment generating activities during the crisis. 5 Technically, these are not current revenues, but use of capital assets for current expenditures. This is not generally advisable, but an exception is being made in the crisis. 6 The government has also announced this will be no lay off of civil servants this year. I1 17. While these normal expenditures will decline in real terms (about 15 percent), the government has vastly increased expenditures on subsidies for food, petroleum products, and electricity in 1998/9 (see Table 2.3). They will amount to nearly Rp. 60 Tr., or over 6 percent of GDP and 25 percent of total government expenditures, compared to Rp. 10.3 Tr. in 1997/98 and Rp. 1.8 Tr. in 1996/97. Although instituted for emergency purposes, subsidies have a tendency to become politically very difficult to remove, especially when the country is moving into the open elections scheduled for 1999. As is clear in Table 2.2, how rapidly these subsidies decline will have a major impact on the availability of resources for critical public expenditures in the future. Improvements in the exchange rate will help reduce the amounts of the subsidies, but it is not clear how ralpidly that recovery will occur. 1 8. The government's revenues also must service the public debt, and the Rupiah value of debt service payments has more than tripled as a result of the devaluation;. How large a burden this constitutes is critically dependent on the exchange rate. On current assumptions that the exchange rate will average Rp. 10,632/US$ in 1998/9 and Rp. 10,000/US$ thereafter, foreign debt service payments will amount to Rp. 77.5 Tr. (Rp. 31 Tr. for interest and Rp. 46.5 Tr. for amortization) in 1998/99. To this must be added Rp. 16.9 Tr. in domestic debt service and service on the special bonds issued by IBRA for the bank restructuring program. This brings the total debt service burden to 8 percent of GDP, or 45 percent of current expenditures. Amortization is included here as it must be paid regardless of the program of new loans. 19. At this point it is clear that the government does not have enough of its own resources to fund all of its current expenditures, much less the dev/elopment budget. It must rely on foreign assistance. The amounts already in the pipeline, for project aid will not be sufficient, and a substantial amount of additional, untied foreign official borrowing will be required to cover current expenditures this year. Furthermore, the existing commitments are all linked to ongoing projects. To the extent that these projects must be postponed, the associated foreign borrowing will not be automatically available to the government unless the donors agree to reprogram that aid, to increase local cost financing, and to redirect it to other, higher priority activities. The Bank and other donors have begun this process, but it is time consuming, and not all aid can be reprogrammed, particularly that associated with large infrastructure projects that should be postponed. 20. Gross foreign borrowing of nearly Rp. 130 Tr. is expected to be available in 1998/9 to cover the budget deficit and amortization payments. This includes about Rp. 80 Tr. in exceptional ,quick disbursing foreign lending,8 which will have to finance current expenditures as well as the development budget. Similar levels of additional aid will be required for several years, and it is uncertain whether the donors have the capacity for prolonged increases in their commitments of fast disbursing aid.9 7The precise amount depends on the exchange rate on the day payments are made. 8This includes additional lending and reprogramming of existing loans by the World Bank, the Asian Develop-ment Bank, and other donors. It does not include disbursements from the IMF program, which are below the line. 9Bilateral donors are facing difficulties in increasing aid on this scale. Indonesia is near the exposure limits for the World Bank and the ADB after the increases in lending this year. 12 Table 2.2: Resource Envelope (in trillions of rupiah) 1995/6 1996/7 1997/8 1998/9 1999/0 2000/1 Total revenues 74.7 88.1 111.3 149.6 161.4 161.1 Oil Rev 16.1 20.1 30.6 49.7 52.4 39.9 Non-Oil tax 48.7 57.3 70.9 72.9 81.2 91.6 Non tax 7.8 10.2 9.8 11.7 13.3 15.1 Grants 0.5 0.5 0.0 0.3 2.5 2.5 Privatization 1.7 0.0 0.0 15.0 12.0 12.0 Current expenditures 31.9 38.1 50.7 62.1 79.5 89.6 Personnel 13.0 14.5 18.3 24.8 34.1 38.8 Materials 5.2 8.1 7.0 11.4 13.4 15.1 Transfers to Regions 8.2 9.4 9.5 13.3 17.7 20.3 Other 5.5 6.2 15.9 12.6 14.2 15.3 Surplus after Current Expenditures 42.8 50.0 60.6 87.5 81.9 71.6 Subsidies 0.1 1.6 10.4 58.8 20.5 20.5 Surplus after Current Expense and Subsidies 42.7 48.4 50.2 28.7 61.3 51.0 Debt Service 22.1 27.5 31.1 79.5 74.5 76.3 Internal Interest 1.6 4.6 1.6 1.9 2.1 2.3 External Debt Service 20.5 22.9 29.5 77.5 72.3 74.0 Principal 13.9 16.3 17.2 46.5 43.5 44.5 Interest 6.6 6.6 12.3 31.0 28.8 29.5 Surplus after CE, Sub. and Debt Service 20.6 20.9 19.1 -50.8 -13.1 -25.3 Bank Restructuring costs 0.0 0.0 0.0 15.0 15.0 15.0 Available for development budget 20.6 20.9 19.1 -65.8 -28.1 -40.3 Gross foreign lending conventional 12.5 12.3 26.4 42.8 37.5 45.5 Additional Quick disbursing lending 77.1 16.0 8.0 Available For Development Budget 33.1 33.2 45.5 54.1 25.4 13.2 Development Budget (GOI Format) 28.8 35.9 37.1 71.6 72.9 73.5 Net 4.3 -2.8 8.4 -17.5 -47.5 -60.3 Source: Government, IMF, and World Bank, Mission estimates of future years. 21. The above scenario is only one of many that could be generated. It is based on current official estimates, which are uncertain. It is more optimistic than many estimates of private economists in Indonesia and outside. The CEM explores growth scenarios further, however, it is likely that it will be several years before Indonesia returns to the high growth rates it enjoyed in the recent past. It should plan accordingly. 13 Table 2.3: Subsidies (billions of rupiah) Category 1995/96 1996/97 1997/98 1998/99 1999/2000 2000/02 Actual Estimate Preliminary IMIF Projection Projection Realization Estimate TOTrAl SBSIDIES 212 1.784 10.362 58.810 20.524 20.524 Food Subsidy 0 0 0 13.840 4.202 4202 Petroleum Subsidy 0 1.416 9.814 27.534 8.702 8.702 Fertilizer Subsidy 212 368 547 1.065 200 200 Gas price subsidy for fertilizer industrV n.a n.a n.a 1.060 0 0 Electricitv S,ubsidy 0 0 0 8.473 7.421 7.421 Other Subsidies (including interest) n.a n.a n.a 6.838 0 0 Source: World Bank, International Monetary Fund estimates. 22. The eventual outcome will depend on political as well as economic events. Even with these assumptions, the situation is bleak in 1998/9, and, more important, is likely to get worse before it gets better. If there are more disruptions and stabilization is delayed, revenues are likely to be lower and foreign assistance slower in coming. Key factors in the evolution of this deficit will be the rate at which subsidies can be reduced, the amount of income that can be generated from sales of public enterprises, the extent to which the costs of restructuring the banks can be postponed, and the extent to which debt service can be reduced. 23. The above analysis demonstrates that the combination of reduced real resources available to the budget and increased crisis related expenditures will result in a large and lasting shortfall in resources available for normal development expenditures on public investment. This will require some major changes in the whole development strategy as well as substantial short-term reallocation within the budget, as will be discussed in the following chapters. The budget will face sev ere cdifficulties for several years. 24. Recommendations: * Efforts should be made to improve revenue collection where possible. * Subsidies should be reduced as quickly as possible. * The government should consider reducing payments on the IBRA bonds through 2000/2001. Since they are held by BI, a reduced payment schedule could be negotiated. * The government should negotiate with official creditors for maximum flexibility in reallocating existing cormiitmients and seek new commitments from all sources. * The government should consider other ways to reduce the external debt service burden.'0 '° Discussion of a partial rescheduling of principal on some public debt with the Paris Club is scheduled for September 1998. 14 CHAPTER 3: THE BUDGET The share of government spending in GDP, both current and capital, has historically been low by regional and income level comparisons. Despite remarkable achievements in some areas, many public services have been of relatively poor quality and subsidies have been inefficient. The private sector has been involved in supplying public services, but often to supplement, rather than complement, core government services. There are several areas where reducing expenditure in the short to mnedium term will not cause loss to the economy, but other areas where expendituires need to be increased to improve quality standards (public health and primtary education). Basic reformis and better allocation of expenditures are needed across the board, including in the civil service, but these will take time and will probably not reduce the total expenditure share in GDP below the historic levels. Better regulations and programs are needed to improve the quality and effectiveness of already substantial private sector involvement in the provision of public goods. In response to the crisis, the governtment is undertaking a major restructuring of the budget to protect the poor and to meet other short-term demands. This is just the first step in a medium-term program of reorienting priorities. and expenditure allocation, which will preoccupy the government for several years. I The government cannot finance budget deficits with domestic borrowing (by law), but it has financed about 40 percent of its development budget by long-term foreign borrowing, largely from official sources. Gross borrowing for the capital budget has been about 2-3 percent of GDP, but net borrowing has been about nil in recent years. Indonesia's 15 percent share of expenditures in GDP is relatively low by regional standards, even adjusting for Indonesia's income level before the crisis. These figures do not indicate profligacy or excessive demand from the government, and the budget was not the source of the disequilibrium that led to the crisis. Nevertheless, as demonstrated in the previous chapter, the development budget will face severe constraints in the short and medium term. 2 The share of expenditures in GDP are projected to rise from 15 percent in 1996-97 to 24 percent in 1998-99, before falling back to 17 percent in 2000-01, depending on how fast subsidies can be reduced and the evolution of debt service payment. However, the share of expenditures devoted to normal government operations and development, after all debt service, financial sector restructuring, and subsidy payments, stays constant at about 12 percent of GDP--roughly the level of 1996/97--if the current projections can be realized. This is a decline of about 15 percent in real terms. The disbursements on debt service and financial restructuring will have to be made, and the liabilities for the subsidies will be incurred (but possibly carried temporarily as arrears to SOEs). -Expenditures on development activities are subject to availability of funds and administrative processes that may lead to shortfalls in these expenditures. 3. Even if the government maintains these shares in GDP, there will be deep cuts in real terms in many programs. The government faces a huge challenge to allocate the limited resources to meet its highest priority objectives of mitigating the effects of the crisis on the most vulnerable (social safety net, new employment creation programs) and of restoring growth. Although some of the short-term transition costs should diminish in 1-2 years (primarily subsidies and job creation), the financial sector restructuring costs and higher debt service payments will be more persistent and reduce resources available for other budget priorities over a much longer term. The high level of overall expenditures in 1998/9 is only achievable if extraordinary levels of external financing are available to the budget to finance a deficit of 15 about 8.5 percent of GDP. If this level of assistance is not forthcoming, deeper cuts will be inevitable. The additional foreign borrowing during the crisis will, however, add to the debt service requirements in the medium term. Table 3.1a: Current Expenditures by function (in billions of rupiah) Category 1994/1995 a/ 1995/1996 a! 1996/1997 b/ 1997/1998 bl 1998/1999 c/ Abs % Abs % Abs % Abs % Abs % TOTAL 44,069 100.0 50,435 100.0 62,561 100.0 87,133 100.0 178,912 0.0 Ordinary Expenditures 24,187 54.9 26.403 52.4 31.921 51.0 34,852 40.0 57,203 32.0 Personnel Expenditures 12.596 28.6 13.001 25.8 14.455 23.1 18.347 21.1 32.488 18.2 Wages & Salaries 8.959 20.3 9.220 18.3 10.153 16.2 12,568 14.4 16.685 9.3 Supplement (rice) 0.973 2.2 0.734 1.5 0.768 1.2 1,187 1.4 1.872 1.0 Pensions 2.663 6.0 3.048 6.0 3.534 5.6 4.592 5.3 13.931 7.8 Materials 4.319 9.8 5.175 10.3 8.109 13.0 6.976 8.0 11.425 6.4 Transfer to Regions 7.272 16.5 8.227 16.3 9.358 15.0 9.529 10.9 13.290 7.4 Personnel 6.918 15.7 7.807 15.5 8.874 14.2 9.010 10.3 12.607 7.0 Non-Personnel 0.354 0.8 0.419 0.8 0.484 0.8 0.519 0.6 683 0.4 Other 19,882 45.1 24,032 47.6 30,640 49.0 52,281 60.0 121,709 68.0 Debt Service Payments 18.403 41.8 22.109 43.8 27.491 43.9 31.112 35.7 66.236 38.7 Petroleum and Electricity 0.687 1.6 0.000 - 1.416 2.3 9.814 11.3 27.534 5.1 Subsidies Bulog and Other Exp. dI 0.793 1.8 1.923 3.8 1.733 2.8 11.354 13.0 27.939 16.3 Notes: a/ Actual; b/ Revised Budget; c/ Estimate; d/ Other Routine Expenditures includes General Election Expenses; Giro Post, Free Porto (Bebas Porto), Inspection of Pre-shipment, National Sport Committee (Koni), Rice Maintenance (Bulog), State Railways Co. (Perumla) and others. Due to different sources and estimates, figures may differ among tables for the budget. Source: Government of Indonesia. 4. The basic structure of government interventions has been in place since the beginning of the Suharto regime, and many elements date back earlier. The overall results in terms of growth and poverty alleviation confirm that the basic priorities and programs were sound, and the government deserves full credit for its accomplishments. However, the growth achieved heretofore has masked many inefficiencies, contributed to inertia and slowed the pace of change, even where shortfalls have been recognized. 5. This chapter will examine the major components of government expenditures. It will concentrate on the general issues of setting priorities and changing allocations and increasing the selectivity and efficiency of resource use. It will not attempt a complete review of the approximately 3500 projects in the investment budget. In the short term, the changes in expenditure allocations will be dictated by the exigencies of the crisis--more resources to immediate relief activities to sustain employment and reduce school drop-out rates--and constrained by ongoing contractual obligations for projects under way, the 16 structure of foreign funding in the portfolio,l and administrative capacity. Bank staff have been working closely with the government to assist in adapting the 1998/9 budget allocations to these immediate concerns, and there is little room for discretion within the existing envelope beyond the immediate priorities just stated. Table 3.1b: Current Expenditures by function (in billions of rupiah) Constant 1993/94 prices Categoy 1994/1995 a/ 1995/1996 a/ 1996/1997 b/ 1997/1998 b/ 1998/1999 c/ GDP Deflator 1.08 1.18 1.28 1.66 2.66 Abs % Abs % Abs % Abs % Abs % TOTAL 40,805 100.0 42,742 100.0 48,876 100.0 52,490 100.0 67,260 0.0 Of which: Ordinary Expenditures 22,395 54.9 22,376 52.4 24,938 51.0 20,995 40.0 21,505 32.0 Personnel Expenditures 11.663 28.6 11.018 25.8 11.293 23.1 11.052 21.1 12.214 18.2 wages & Salaries 8.296 20.3 7.814 18.3 7.932 16.2 7.571 14.4 6.273 9.3 Supplement (rice) 0.901 2.2 0.622 I.* 0.600 1.2 0.715 1.4 704 1.0 Pensions 2.466 6.0 2.583 6.0 2.761 5.6 2.766 5.3 5.237 7.8 Materials 3.999 9.8 4.386 10.3 6.335 13.0 4.202 8.0 4.295 6.4 Transfer to Regions 6.734 16.5 6.972 16.3 7.311 15.0 5.741 10.9 4.996 7.4 Personnel 6.406 15.7 6.616 15.5 6.933 14.2 5.428 10.3 4.739 7.0 Non-Personnel 0.328 0.8 0.355 0.8 0.378 0.8 0.313 0.6 257 0.4 Other 18,409 45.1 20,366 47.6 23,937 49.0 31,494 60.0 45,755 68.0 Debt Service Payments 17.039 41.8 18.736 43.8 21.478 43.9 18.742 35.7 24,901 37.0 Petroleum and Electricity 0.636 1.6 0.000 - 1.106 2.3 5.912 11.3 10,351 15.4 Subsidies Bulog and Other Exp. d/ 0.734 1 8 1 630 3.8 1,354 2.8 6.840 13.0 10.503 15.6 Notes: a! Actual; b/ Revised Budget; c/ Estimate; d/ Other Routine Expenditures includes General Election Expenses; Giro Post, Free Porto (Bebas Porto), Inspection of Pre-shipment, National Sport Committee (Koni), Rice Maintenance (Bulog), State Railways Co. (Perumla) and others. Soutrce: Government of Indonesia 6. This is not a study of revenues, but it should be emphasized that increasing revenues will be important to help meet the increased expenditure demands on the government. Efforts must be made to identify new tax revenues and to improve collection rates on existing taxes. Areas to consider would be measures to improve income tax collection, returning to the system of managing and collecting customs tariffs by contract to an external agency (which would also have efficiency gains), eliminating tax holidays, and completing the reform of local tax collection. 'These decisions will be complicated by the structure of aid. Foreign donors finance individual projects and each is likely to try to preserve its priority projects. Where rationality dictates stopping or delaying some, and continuing others, delicate negotiations are likely to ensue and may delay efficient short-term restructuring. 17 Current Expenditures 7. Current expenditures account for slightly more than two-thirds of the total budget, a shiare that has increased substantially due to the increase in subsidies and debt service payments. These two categories now absorb 70 percent of current expenditures including debt amortization. The share of current expenditures going to core government services has declined from 46 percent in 1996/97 to 36 percent in 1997/98 to 26 percent in 1998/99. Most of this is for personnel costs. There is little that can be done about this in the short term. Tables 3.1 a and 3.1 b show the allocation by expenditure category of the current budget in current and constant term. Table 3.2a and 3.2b show the major sector expenditures. Current expenditures excluding subsidies and debt service have declined substantially in real terms since 1996/97. Table 3.2a: Current Expenditures by Sector Current Price (in billions of rupiah) Category 1994/1995 a/ 1995/1996 a! 1996/1997 b/ 1997/1998 b/ 1998/1999 c/ Abs % Abs % Abs % Abs % Abs % TOTAL 44,069 100.0 50,435 100.0 62,561 100.0 87,133 100.0 171,205 100.0 Ilealth 0.554 1.3 0.644 1.3 0.757 1.2 0.762 0.9 1,037 0.6 Education & Training 2.697 6.1 3.103 6.2 3.692 5.9 3.579 4.1 4,740 2.8 TIransfer to Regions 7.272 16.5 8.227 16.3 9.358 15.0 9.529 10.9 13,290 78 Trade, Finance & Supports for SME 3.641 8.3 4.135 8.2 4.659 7.4 7.043 8.1 9,763 5.7 Gov't Apparatus & Politics 2.775 6.3 3.227 6.4 4.909 7.8 5.348 6.1 8,160 4.8 National Defence 3.896 8.8 4.470 8.9 5.250 8.4 5.150 5.9 7,618 4.4 Sub Total 20,837 47.3 23,804 47.2 28,624 45.8 31,412 36.1 44,608 26.1 Others Including debt service and 23.232 52.7 26,631 52.8 33,937 54.2 55,721 63.9 126,598 73.9 subsidies d/ I I I I Notes: a/ Actual: b/ Revised Budget; c/ Estimate; d/ Other Routine Expenditures includes General Election Expenses; Giro Post, Free Porto (Bebas Porto), Inspection of Pre-shipment, National Sport Committee (Koni), Rice Maintenance (Bulog), State Railways Co. (Perumla) and others. Source: Governlment of Indonesia. 8. Subsidies are viewed as an important element of the government's efforts to mitigate the impacts of the crisis and to maintain political stability. This position has been supported by the IMF program, and subsidies have grown to over 6 percent of GDP in 1998/9 (30 percent of current expenditures including amortization). Part of the reason for this increase in subsidies is the steep devaluation of the Rupiah and resulting increase in prices of imported food and energy products and the debt service payments due by the energy producers. Domestic prices of subsidized goods are now well below world prices. There are already reports that sizable quantities of these goods are being smuggled out of Indonesia into nearby 2Although Indonesia is a major oil producer, its net exports are small and these products should be priced at international prices. A portion of the fuel subsidies are off set by higher oil revenues to the government. The amounts of some subsidies are also affected by inefficiencies in the distribution system, which can be improved in the short term. 18 markets. It is imperative that subsidies be reduced in the medium term from their current level to a sustainable one. 9. There is a temporary justification for some food subsidies as a result of the drought and rapid price increase in the price of key food items. However, this is a short-lived need, and they should be phased out quickly, with the possible exception of rice. A much more targeted program has been enacted, that will sell limited quantities of rice to identified poor at a greatly reduced price. Once it is fully implemented, the general rice price subsidy can be reduced. There is no justification for the wheat flour subsidy, which benefits primarily the well to do, the flour mill, and industrial users (noodles), nor for sugar or soybeans, which also provide little benefit to the consumers. In September 1998, the Government implicitly reduced the special rice subsidy by raising the target price for sales. It also announced the end of subsidies for wheat, flour, soybeans and sugar. Furthermore, much of the apparatus in BULOG for administering food subsidies could be reduced at considerable savings. (See Chapter IV for a more detailed discussion of BULOG and the food subsidy program.) Bank studies have shown that only a relatively small portion of most subsidies reach the poor, so they have little positive distributional impact and are inefficient.' The subsidy on rice, by depressing the market price, also has a major detrimental effect on the income of domestic rice producers and reduces incentives for domestic rice production and sales to markets, lowering rural incomes. 10. The electricity and petroleum- subsidies have become very large because of the government's reluctance to allow tariffs and prices for these goods to reflect world prices for energy products or even cover production costs at the current exchange rate. Since most of the consumers of these products are relatively well off and urban, the motivation has been more a concern for political stability than for the poor, who in any case can be protected through lifelines rates and other measures at much lower cost. The government agreed to reduce these subsidies in an earlier IMF agreement, but its action to raise prices provoked a violent reaction that led to the resignation of PresidentSuharto and to rescinding about one third of the price hikes. Despite current reluctance to touch energy prices, a program to reduce and eventually eliminate these subsidies needs to be implemented with appropriate public relations. The long-term costs to growth and economic efficiency of maintaining these subsidies will be very high if the implied relative prices become locked into the economy, as experience elsewhere has amply demonstrated., I. The government had been phasing out the fertilizer subsidies, and this should be continued. There is no need for the subsidies in terms of assisting farmers. The administrative apparatus is costly and has led to less efficient use of fertilizers than would have otherwise been the case. See the section on agriculture below for a fuller discussion of these subsidies. Similarly, interest subsidies on housing should be eliminated. They distort markets and tend to favor middle and upper class consumers, not the poor. 3Although the expansion of subsidies is in part to mitigate the effects on the poor and in part to help keep political stability, the effectiveness of such subsidies in assisting the poor is very low. For the rice subsidy, it is estimated that it costs $3.30 to get $1.00 worth of rice to the bottom 30% of income recipients, and more than double that if the negative effects on rice producers is taken into account. Other subsidies are much less efficient. By comparison, low income employment creation schemes may effect the same $ transfer to the poor for about $2.50 if well designed and monitored. 4The relative price distortions also have serious long-term effects on the economy, as consumers are not encouraged to conserve energy and, for example, PLN makes uneconomic selections among primary energy sources. 19 12. Taking these vital concerns into account, the government and the World Bank have agreed to launch a high priority effort to operationalize schemes for targeting food and fuel subsidies to the poor much more effectively that the current general price support programs. As soon as these schemes can be implemented, the food and energy subsidies can be reduced and the resources allocated to other high priority expenditures or to reducing the overall budget shortfall. Table 3.2b: Current Expenditures by Sector Constant 1993/94 Prices (in billions of Rupiah) Category 1994/1995 a/ 1995/1996 a/ 1996/1997 b/ 1997/1998 b/ 1998/1999 c/l GDP Deflator 1.08 1.18 1.28 1.66 2.66 Abs % Abs % Abs % Abs % Abs % TOTAL 40,805 100.0 42,742 100.0 48,876 100.0 52,490 100.0 62,370 100.0 Health 0,513 1.3 0.545 1.3 0.591 1.2 0.459 0.9 390 0.6 Education & Training 2,498 6.1 2.629 6.2 2.884 5.9 2.156 4.1 1.782 2.9 Transfer to Regions 6.734 16.5 6.972 16.3 7.311 15.0 5.741 10.9 4.996 8.0 Trade, Finance & Supports for SME 3.372 8.3 3.504 8.2 3.640 7.4 4.243 8.1 3.670 5.9 Gov't Apparatus & Politics 2.569 6.3 2.735 6.4 3.835 7.8 3.222 6.1 3.068 4.9 National Defence 3.608 8.8 3,788 8.9 4.101 8.4 3.102 5.9 2.864 4.6 Sub Total 19,293 47.3 20,173 47.2 22,363 45.8 18,923 36.1 16,770 26.9 Others Including debt service and 21,511 52.7 22,569 52.8 26,513 54.2 33,567 63.9 45,600 73.1 subsidies d/ Notes: a/ Actual; b/ Revised Budget; c/ Estimate; d/ Other Routine Expenditures includes General Election Expenses; Giro Post, Free Porto (Bebas Porto), Inspection of Pre-shipment, National Sport Committee (Koni), Rice Maintenance (Bulog), State Railways Co. (Perumla) and others 13. Recommendations: * Reduce food subsidies further following the elimination of those on wheat, flour, soybeans and sugar. As soon as possible, replace the rice price maintenance subsidy with targetedfood subsidies. This will have to accompany reforms to BULOG indicated in Chapter IV. * Reduce and eliminate energy subsidies and put in place specifically targeted programsto protect the poor. * Initiate a program for automatic price and tariff increases for energy products. * Eliminate other subsidies, such as those on housing, credit schemes, andfertilizer. 14. Personnel remuneration makes up the largest part of the discretionary current budget, and it is projected to fall from about one quarter of the current budget to 18 percent. This represents a decline in real terms. The 15 percent increase in nominal civil servant salaries will fall well short of the expected rate of inflation. The share of the budget or of GDP going to civil servant wages is relatively low in comparison to other countries at this level of income or in the region. The Indonesian civil service is viewed by many as too large and grossly underpaid. This may be true, and in the medium-term, it needs reform. The sector analyses that follow will indicate major changes in the scope of the government 20 involvement in key sectors, with corresponding implications for the size of the civil service in that area. Prior to undertaking reforms in the design and delivery of major sector services, it would not be appropriate to undertake a civil service reform, but it must figure prominently in the medium-termii reform agenda. 15. There is, however, scope for two observations. First, it is unlikely that a civil service reforn which would aim to reduce numbers employed and improve quality would lead to overall expenditure reductions. Greater efficiency should be targeted. This has to do with the low general wage level and the basic formula for civil service remuneration. Base pay is calculated as a minimumii payment simply for reporting to work, plus supplements or premiums. for specific assignmlenits undertakeni, a kind of piece- work pay system. Over time, the funds supposedly allocated to pay the task premiums have been diverted to other uses, leaving civil servants underpaid. To compensate, a rather elaborate system has evolved to obtain additional income from charges to clients and users of government services and from diverting shares of government contracts. 16. These additional payments distort incentives and are poorly documented. It is reported that most of the time, the system was "well managed," the additional "take" kept at 'reasonable" levels (thoughlt to be 10-30 percent of most local contracts), and distributed according to a well-established pattern. Minimum quality performance was expected, so it was assumed the major impact was on raising costs not lowering quality, but that cannot be verified. This system compensated for deficiencies in the formal pay system and had the effect of implicitly increasing 'actual' tax revenues and of shifting some expenditures from the development budget to remuneration. Nevertheless, the possibilities for inefficiency, misapplication, and abuse abound; and there is evidence that in recent years, the orderliness of the system gave way to progressive greed. 17. One implication of this system is the vested interest of civil servants in havilg a large number of separately funded projects, which are more amenable to diversion of funds. This makes a rational reduction of the development budget more difficult, and longer-term reforn of the approach to development spending more important. Another is that the level of government services after the budget cuts that reach the intended beneficiaries will depend a great deal on how much gets passed through these diversions. Reforming this pay structure will require substantial government commitment and a carefully designed program. Civil service reform is likely to reduce the size of the civil service, but would also have to increase pay levels of the remaining civil servants to be effective. 18. Second, there is one reform that could be instituted on civil service remuneration that would reduce expenditures in the short term without adversely affecting their net income. As part of their current pay, all civil servants and military personnel receive a "rice ration." nominially in kind,'that accounts for around 10 percent of wages, depending on the price of rice. Currenitly, BULOG procures and delivers the rice. In most cases, recipients sell the rice in the market to augmnenit their incomes, especially since the rice is often of poorer quality than what recipients prefer. The inefficiencies and potential for waste are evident. There is no longer any need for BULOG to purchase, store, and distribute rice to civil servants and military. The added costs are estimated at several hundred billion Rupiah in normal years and do not benefit the recipients, who receive only what they can sell the rice for, less their transactions costs. This year, there may be a net benefit to recipients, but the government will have to reimpose BULOG, plus the costs. 5This dates from the last century and may have had a rationale at one time when markets did not function well. 21 19. Recommendations: * The government should convert this in-kind rice ration into a sm1aller cash payment that would leave the recipient with the same or slightly higher welfare. This would save 2-3 percent of wage costs.6 * A review of the Civil Service structure and remuneration should be undlertaken after the immediate phase of the crisis is past. 20. Current Transfers to the Regions: Local governments in Indonesia now account for 25 percent of total expenditures. About 60 percent of the local budget is normally for current expenditures and 40 percent for investment. Current expenses are primarily for local civil service salaries. Two thirds of these expenditures are financed by a combination of tied and untied bloc grants from the center, compared to three-quarters 20 years ago., The rest is financed by local taxes, by local government shares of nationally-collected taxes, or by borrowing. The trend toward decentralization and shifting more expenditures and decision making closer to the people is desirable and should be supported, particularly during the crisis. The experience of the Bank is that the allocation of public funds at the local level is more responsive to the needs of the people. And the untied grants are more effective than the tied grants. In terms of poverty alleviation and mitigating the effects of the crisis, locally administered funds are likely to be more effective than central funds. 21. Current transfers to regions have been declining marginally as a share of the budget and in real terms. Existing programs need to be protected to preserve the functioning of local governments and shifted more to bloc grants. In addition, the government, with the assistance of the Bank and others, is increasing transfers through the development budget to the local governments in order to expand employment creating programs. These programs will stretch the administrative capacity of local governments, and their current capacity must be maintained to be sure that the additional development funds are used effectively. 22. A reform program has just been completed to rationalize the tax base of local governments. A large number of small return 'nuisance' taxes have been eliminated. They introduced distortions and had high collection costs. In their place, several larger taxes were proposed to give the local government a reasonable tax base. The key added taxes include a 5 percent surtax on gasoline sales and property tax reform. In response to the crisis, imposition of these additional taxes has been postponed. Failure to complete this municipal revenue reform will cripple the capacity of local governments to perform their functions and will set back the decentralization program. 23. Recommendations: * The current transfers to governments should be maintained and increasingly converted to discretionary grants. The rules governing use of the funds should be revised to improve the incentives for more efficient utilization. 6There is already some evidence that this is happening in some areas force of circumstances. It should become policy. he share financed centrally is larger for poor and rural jurisdictions, whose revenue bases are smaller. 22 * The local tax reform program should be completed and the new resource base for local governments put in place immediately, as proposed 24. Expenditures on goods and services maintain about the same share of the 1998/9 budget as in previous years' projects. In time of crisis, it is easy to cut these expenditures disproportionately, but this greatly reduces the value of services that can be delivered by the government. It remains to be seen how actual expenditures will evolve in the 1998/9 budget, but it is important that minimum levels be maintained. More, attention should be paid to efficient procurement and eliminating waste, as this is an area where diversion of funds has also been reported. Development Expenditures 25. Indonesia's program of development expenditures has been managed through a series of five- year REPELITA plans. Each has been promulgated following the election of the President for a new term and the selection of a new government. Each reflects the priorities of the government for that period. In the past, foreign assistance has funded about one third of the development expenditures, and about two thirds of the projects (by Rupiah amount) have foreign financing. The remaining third are projects that the government funds entirely on its own account. Tables 3.3 shows the distribution of development expenditures by sector. 26. There have been a number of short-comings in the picture of public expenditures. Perhaps most important for Indonesia's development prospects is that the quality of most of the services leaves a great deal to be desired, in absolute terms and in comparison to Indonesia's comparators and competitors. 'These deficiencies have been recognized for some time and are attributable to inefficient implementation of generally good policies, lack of clear priorities, and attempts to meet too many competing objectives with too few resources. 27. If the exceptional financing being sought this year materializes and can be disbursed, the 1998/9 development budget will increase substantially in nominal terms and as a share of GDP. There is a significant increase in allocations for crisis relief measures at the expense of investment. Revisions of expenditure plans are underway as the extent of the resource limitations are becoming understood. This will require extensive reprogramming within BAPPENAS, with the line ministries, and with donors. 28. The government will still have to make some difficult choices among the roughly 3,500 development projects currently being implemented: Which to continue, which to postpone or eliminate in the medium term? This process will have to be spread over several years of very constrained budgets and should take place increasingly within the context of the new long-term development priorities. Past preferences for extensive rehabilitation of major infrastructure over regular maintenance will be too costly in the future. Programs that fail to deliver high quality will not be acceptable. Tighter management and more efficiency will have to become the rule. Indonesia cannot afford to return to many of its wasteful old ways. 29. To aid in the short run reallocation process, the government should establish some selection criteria along the following lines:s * Maintenance and short-term rehabilitation should take precedence over long-term rehabilitation and new construction. 8 These are indicative, not absolute, but expenditures must be fully justified. 23 * Projects which will begin to deliver intended results within a year should have priority over projects which will not yield results until later. * Projects with greater direct impact improvinig the lot of the poor shoiuld have priority over projects with less inmpact on the poor. * Project having relatively larger enmployment components should be given priority so long as they meet the above criteria. * Projects selected should be funded at a level that achieves the intended results in termis of completion, employment generation, etc., or postponed. Partialfunding will be ineffective. Table 3.3a: Development Budget (in trillions of rupiah) 1994/95 1995/96 1996/97 1997/98 1998/99 Category Realization Realization Realization Actual Plan Rp.Tr. % Rp.Tr. % Rp.Tr. I % Rp.Tr. I % Rp.Tr. I % Industry 0.6 1.8 0.8 2.8 0.7 2.0 0.9 2.5 0.8 1.1 Agriculture and Forestry 1.7 5.4 0.9 3.1 1.4 4.2 2.2 6.0 4.2 5.9 Water Resources 1.9 6.3 1.9 6.6 2.1 6.3 2.4 6.5 5.5 7.8 Manpower 0.1 0.4 0.1 0.5 0.2 0.5 0.2 0.5 1.3 1.9 Trade. Dev. of Ent, Finance and 1.4 4.7 0.9 3.2 0.9 2.7 0.5 1.2 0.9 1.3 Coops Trans. Meteo and Geop 5.7 18.4 5.4 18.7 6.1 18.1 6.6 P-.9 9.5 13.5 Mining&Energy 4.4 14.4 3.1 10.8 3.9 11. 7 4.4 11.8 6.2 8.8 Tourism. Posts & Telecom 1.0 3.2 0.5 1.6 0.8 2.3 0.9 2.5 1.2 1.7 Regional Devp.& Transmigration 5.5 17.8 6.2 21.5 6.8 20.2 6.8 18.2 19.1 27.0 Environment 0.4 1.4 0.4 1.5 0.6 1. 0.6 ii' 0.8 1.1 Education. Culture., Belief in 3.0 9.7 3.1 10.9 3.6 10.9 4.2 11.3 8.0 11.3 Almighty God Youth and Sports 0.3 0.9 0.3 0.9 0.3 0.9 0.5 1.5 0.6 0.8 Population, Social Welfare. Health, 1.0 3.2 1.0 3.4 1.3 3.8 1.9 5.1 4.5 6.4 Role of Women Housing& Human Settlements 1.1 3.6 1.0 3.6 1.1 3.4 1.4 3.7 2.9 4.2 Religion 0.2 0.5 0.2 0.8 0.2 0. (0.3 0.- 0.4 0.5 Science & Technology 0.4 1.3 0.4 1.5 0.7 2.2 0.8 2.2 1.1 1.6 Law 0.1 0.3 0.l 0.4 0.2 0.5 t )l 0.4 0.2 0.3 Govemment Apparatus 0.6 1.8 0.6 2.2 0.8 2.3 0.7 2.0 0.9 1.3 Politics. Int Rel. Info. Comm. 0.2 0. - 0.1 0.5 0.2 0.5 0.2 0.6 0.4 0.5 NationalDefense&Sec. 1.3 4.2 1.6 5.5 1.7 5.1 1.4 3.8 2.1 3.0 TOTAL 30.7 100.0 28.8 100.0 33.5 100.0 37.1 100.0 70.8 100.0 Own Resources 20.9 67.9 19.8 68.7 22.4 67.0 23.6 63.5 35.2 49.8 ForeignResources 9.8 32.1 9.0 31.3 11.0 33.0 13.6 36.5 35.5 50.2 Deflator 1993/4 = 100 108 117.9 127.8 166.2 266.0 Exchange rate, Rp/US$ 2160 2.280 2.381 4.890 10,600 Source: Government of Indonesia. 24 Table 3.3b: Development Budget (in trillions of rupiah) - Constant - Base Price 1993/1994 1994/1995 199511996 1996/1997 1997/1998 1998/1999 Category Realization Realization Realization Realization Plan GDP Deflator 1.08 | 1.18 1.29 1.44 2.42 Abs L% Abs % Abs % Abs % Abs % INDUSTRY & TRADE 1.9 6.5 1.5 6.0 1.8 6.6 1.0 3.7 7.2 18.9 AGRICULTURE AND 1.5 5.4 0.8 3.1 1.0 3.6 1.6 6.0 3.1 8.1 FORESTRY WATER RESOURCES 1.8 6.3 1.6 6.6 1.6 5.8 1.7 6.5 2.0 5.2 MANPOWER 0.1 0.4 0.1 0.5 0.2 0.5 0.1 0.5 0.5 1.4 TRANSPORT, 5.2 18.4 4.6 18.7 4.4 15.7 4.6 17.9 4.0 10.4 METEOROLOGY & GEOPHYSICS MINING AND ENERGY 4.1 14.4 2.6 10.8 2.5 9.0 3.0 11.8 2.9 7.6 TOURISM, POSTS AND 0.9 3.2 0.4 1.6 0.4 1.6 0.6 2.5 0.5 1.3 TELECOMMUNICATIONS REGIONAL DEVELOPMENT 5.1 17.8 5.2 21.5 5.5 19.9 4.7 18.2 7.9 20.6 AND TRANSMIGRATION ENVIRONMENT AND 0.4 1.4 0.4 1.5 0. 1.6 0.4 1.7 0.3 0.8 SPATIAL EDUCATION, CULTURE. 2.8 9.7 2.7 10.9 3.0 10.7 2.9 11.3 3.5 9.0 YOUTH AND SPORTS HEALTH & POPULATION 1.2 4.1 1.1 4.4 1.2 4.5 1.7 6.6 2.0 5.2 HOUSING AND HUMAN 1.0 3.6 0.9 3.6 1.1 3.8 0.9 3.7 2.3 6.1 SETTLEMENTS NATIONAL DEFENCE AND 1.2 4.2 1.4 5.5 2.7 9.7 1.0 3.8 0.9 2.3 SECURIT'Y OTHERS 1.3 4.7 1.3 5.4 1.6 5.6 1.5 5.8 1.2 3.2 TOTAL 28.4 I ()0 24.4 100.0 27.9 100.0 25.8 100.0 38.3 100.0 Own Resources 19.3 67.9 16.8 68.7 18.6 66.9 16.4 63.5 21.5 56.3 Foreign Resources 9.1 32.1 7.6 31.3 9.2 33.1 9.4 36.5 16.8 43.7 25 30. The 1998/9 Development Budget: The Rupiah component of the development budget has increased in nominal terms, but it has fallen 7 percent in real terms. The expected increase in foreign assistance will allow the development budget to achieve its currently planned level. This is partly due to the higher Rupiah value of existing loans and partly due to the new lending. Whether the government is able to realize this program will depend on donors ability to increase the share of total project costs they can fund, to reallocate their funding to higher priority projects, and to increase the total of quick- disbursing budget support. The quick disbursing lending that goes to the general budget will, in effect, fund the counterpart and local expenditure components of the development budget, as well as some current expenditures. 31. The government's crash program to mitigate the effects of the crisis will make sweeping changes in the distribution of funds in the development budget for 1998/9. Increases in social safety net expenditures (2.5 percent of GDP) will raise the share of the development budget to 7.4 percent of GDP, an increase from about 5.5 percent in the past two years. The increased social expenditures and other reallocations within sectoral allocations to increase employment and reduce school drop-out rates are not properly investment expenditures (however desirable and necessary), so the reduction of bonafide public investment in the short term is more severe, and will have to be reversed once funds are available. These normal investment expenditures will fall by 0.6 percent of GDP, and by over 20 percent in real terms. 32. Political uncertainty, changes in government, and renegotiation of macro-economic programs have delayed the budget allocation process three months into the fiscal year. In many cases, funds for the development budget have yet to be put in the hands of the line ministries, and expenditures have come to a halt. Once the budget is finally decided and distributed, actual expenditures can begin. However, the delays mean that it will be hard this year to spend all of the funds that have been allocated, particularly for the infrastructure related investment projects where various design and bidding processes take time. This may ease the problem of meeting the overall budget constraint, but will aggravate the problem of mobilizing foreign assistance associated with these projects. 33. The Bank and others have moved quickly to reprogram assistance to cover a larger portion of local costs and additional activities, but the combination of falling international prices for some works and capital goods., lower domestic costs in terms of foreign exchange, and project delays suggest that drawings of foreign assistance may also lag. The government is aware of this problem and is making every effort to speed up actual expenditures once allocations have been made. This will require exceptional efforts to reduce bureaucratic delays and accelerate procurement, without opening up opportunities for corruption. Once the fundamental transition in the budget has been made this year and new allocations decided, it should be easier in the future to get expenditures up to the new revised allocations. 34. In this section, we will concentrate on the expenditure programs in Agriculture and Water Resources, Urban and Regional Development, Transport, Energy, Health, and Education. 35. Agriculture: Increasing agricultural output and farm incomes have been a keystone of Indonesia's policy since the beginning of Suharto's regime. The objectives have been to reduce Indonesia's dependence of food imports, to alleviate poverty by providing improved incomes to the bulk of the rural population (mostly rice farmers), and to assure low priced wage goods for the growing urban areas. On all of these counts, this policy has been successful. Agricultural growth has averaged 3.8 percent annually, or about 2 percent higher than the population growth rate, though agricultural growth has slowed to 2.9 percent in 1990-95. Agriculture contributes 17 percent to GDP and employs 44 percent of the labor force. Poverty in rural areas has been greatly reduced. 26 36. The major policy initiatives in support of these objectives have been expansion of irrigation systems, subsidies for seeds and fertilizers, direct price support for certain crops, and a procurement system designed to control prices through BULOG.9 Over time, a number of inefficiencies have become apparent in these policies, and the need for others has diminished or disappeared. They have remained through bureaucratic inertia and lack of motivation to change. 37. The share of government investment in agriculture has declined and that of the private sector increased substantially in recent years. These private expenditures have been concentrated in commercial areas such as agro-processing and high value crops affecting 4 percent of the sector. The distribution system for rice, wheat, soy bean, and sugar cane has been managed through BULOG. Although a number of private agents carry out most of the activity, it is not done through competitive market activities, such as in Thailand. (See Chapter IV for a discussion of BULOG.) 38. Most public expenditures in the sector have been aimed at achieving rice self-sufficiency, and little attention devoted to improving productivity in other crops. Crisis not withstanding, the limits to expanding irrigated rice production may be approaching. The growth of farmer's technical capacity and of commercial markets has rendered obsolete many earlier instruments, such as co-ops, rural credit schemes, public marketing organizations. These and many other fragmented and overstaffed agricultural support programs are no longer cost effective and often have few lasting benefits. They should be phased out at considerable savings to the budget. 39. Water Resources and Irrigation: Sustainability of irrigated rice production is closely linked to water availability and management. Population growth, urbanization, and industrial expansion have all increased the demand for water (both for direct use and for dilution of effluents), and this is coming into competition with rice production, particularly during periods of low flow. Past practices of providing water for agriculture as nearly a free good are no longer sustainable and contribute to waste and misuse. Broader river basin approaches to water management have been started, and greater efforts are needed to implement the necessary policies to achieve more efficient management and pricing. 40. Most of the country's irrigable land on Java has been brought under irrigation, and the priority should be on the maintenance of the systems there. However, average annual growth rates of rice production on Java have fallen from 5.7 percent in 1980 to 1.1 percent in 1996, the last year before the drought. Production growth rates have increased off Java in the same period from 3.5 percent to 4.1 percent p.a. as the outer islands have benefited from improvements in technology and expanded irrigation, similar to the earlier success on Java. These differences in growth rates are good indicators of where spending priorities should flow. 41. Past preference of rehabilitation over O&M is costly. Most of Indonesia's 3 million ha. of government irrigation systems have been rehabilitated in the past 25 years and over one third has been rehabilitated twice. It is estimated that this is 6-7 times more expensive than diligent O&M. However, there may be perverse budgetary incentives which discourage adequate allocation to O&M. Central institutions have preferred financing large works and rehabilitation schemes, which depend on foreign financing. They have not made adequate resources available to assure maintenance. 9Part of this agricultural program has been associated with the transmigration program, which aims to resettle large numbers of people from Java to the outer islands on newly converted agricultural land. This has been evaluated as generally inefficient and should be cut back. 27 42. Since 1987/8, the share of expenditures on new construction has increased and that for maintenance decreased. This was reversed in 1995/6, but the change was not dramatic. O&M yields the highest return to investment in the sector, followed by rehabilitation and completion of canals systems. New works generate the lowest rate of return. Furthermore, expenditures on O&M have not kept pace with the expansion of the irrigation network. On Java, there is little scope for expanding irrigation into new areas, and the priority should be for maintenance and some critical rehabilitation. Off Java, there are several irrigation networks that need to be completed in order to bring 5-700,000 hia. of new land into production before major new works would be justified. These should receive priority. There are also some well drilling projects with high immediate return, otherwvise, new projects should be postponed. 43. Of particular concern is the investment budget is the Kalimantan Swamp Development Project intended to irrigate I million ha. of reclaimed swamp land. OverRp. I Tr. hlave already been spent, and the project is less than half completed. Some Rp. 400 billion was included in the 1998/9 budget for this project, since reduced to Rp. 100 billion. Already it is estimated that less thian half the intended areas will be suitable for rice production; the economic rate of return is highly questionable; and the number of beneficiaries will fall far short of what had been intended. The initial design of the scheme failed to consider adverse technical and environmental factors, impacts on indigenous people, and on wildlife. Continuing expenditures at this point would exacerbate these deficiencies and lead to even lower rates of return and worse impacts. Work on the project should be stopped entirely and an assessment of the damages undertaken to determine what, if anything, should be done to prevent worse damage. 44. At present, user fees cover less than 10 percent of the O&M costs of the irrigation system. There is inadequate fundiing of maintenance, little user involvement, and little incentive to economize on water. Water user groups have been a traditional way to manage irrigation in Indonesia. The 1987 Irrigation Operations and Maintenance Policy (IOMP) was designed to provide adequate resources to rehabilitate small schemes and turn them over to small Water User Associations. Despite demonstrations in Indonesia and elsewhere that WUAs can be much more efficient in managing the distribution of water and maintenance of systems than central authorities, little progress has been made in implementing this policy. It is essential that the IOMP be changed to increase participatory irrigation management for the sector as a whole by: (i) shifting more O&M management and fundinlg responsibility of secondary canals to formal WUAs and federations of WUAs; (ii) giving farmers a greater voice and ownership in irrigation scheme management; (iii) relating irrigation revenues to O&M budgets and assuring an adequate O&M funding level for works remaining under government managemenit. By shifting more responsibility to water user associations (as private associations, not through the government dominated co-ops) and increasing water user charges, the government can reduce budget expenditures, increase the efficiency of irrigation, and improve the availability of water for other uses. 45. Recommendations: * Delay or cancel expenditures for newi, irrigation projects to the extent possible inl the short run. In particular, the Kalimantan project shouldl he stopped and a review of possible revision undertaken by independent experts. * Allocate development budget resources that are available beyond those for maintenance to the completion of irrigation projects alreadly begun, concentrating on projects off-Java. * VRevise the policy on O&M to accelerate the transfer responsibility for local management of distribution systenms to WUAs, including imposing appropriate user fees by the WUAs. (See Annex A for further details of how to improve O&M) 28 46. Subsidies on Agricultural Inputs: As part of its program to promote agriculture, the government has provided subsidies to farmers to buy seeds and plant material, fertilizer, and for various forms of credit. They represent about Rp. I Tr. per year in total, though some forms of credit subsidies are not directly reflected in the budget. In addition, the government provides subsidies to fertilizer producers. Most of the subsidies are associated with the cooperatives. These have become inefficient instrumenits of government interference in agriculture. They are of little if any positive benefit to farmiers. Dimniishing their role and eventually eliminating them will improve agricultural efficiency and help in reducinig subsidies, which are no longer necessary to assure high productioll levels or assist efficient production. 47. Farm budget studies have demonstrated that farmers can well afford to pay market prices for fertilizer. Furthermore, eliminating the subsidy and the distributioll network that goes with it would lead to more efficient use of fertilizer. The current, controlled system encourages over-use and does not always provide the right quality and mix on a timely basis to farmers. The trend, until last year, was to reduce the subsidy. Part of the government's reaction to the crisis has been to increase it. although it is not clear that the net benefit to the farmers justifies the increase.',, The fertilizer subsidies seem to primarily benefit the large corporations that have invested in fertilizer production capacity, which is only profitable if the subsidy and government promotion schemes continue. 48. Subsidies for credit (both through low interest rates and high tolerance of arrears) are relatively small compared to the fertilizer subsidy and are no longer justified either. They distort efficient market decisions and are a drain on the budget. 49. Recommendations: * The fertilizer subsidy shouldJ be eliminacitedl as sooni as possible ancld the government should stop using the subsidy to promiote certaiin types of fertilizer to support fcavored procducers. The credit ancd other subsidies shouldJ also be eliminiaited. 50. Government progranms in research, extension, andiel assuring seedJ qwldllitiy are important public goods to maintain growth in the agricultural sector. Unfortuliately, the performance of these activities in Indonesia has been rather poor and the organization of these services has not been effective. Agricultural research has lost its edge in Indonesia and useful output from research stations has fallen drastically. For example, the rice research agency has not developed improved varieties of rice in recent years and was not proactive in advising farmers to shift varieties in the face of tile droughit. The extension service has not generally been very effective. 51. These research and extension programs still containi humani and intellectual capital that is valuable. The basic capacity needs to be retained, but the activities and research must be reinvigorated. This could be done by closer association with university researcih programs and by setting performance targets. Once the institutional reform is complete, there may be reason to increase expenditures, but in the meantime, reductions in these programs would be acceptable. '°The government has also begun to promote use of certain types of fertilize (urea pill) through the subsidy program, and this may be risky. It is not certain that the proposed form is as effective as the traditional form of urea. It requires a great deal of labor at a time when rural labor is scarce. 29 52. Recommendations: * Redesign the agricultural research program to be more effective before increasing expenditures. * Focus research activities on improving rice varieties and on improving prodlctivity in other crops. * Reduce expenditures on extension and other short-term produlction enhancing schemes to the minimum pending a reform of the programs to make thenm more effective, then increase expenditures as needed. 53. Urban and Regional Development: Over the past 20 years, Indonesia has been shifting responsibility for providing urban infrastructure from the center to provincial and local units of government. The emergency measures in the 1998/9 budget that are designed to create additional employment will largely pass through transfers to local government. The first priority is to assure that the expanded funding is channeled through the existing programs which have the capacity to absorb sharp increases effectively and that can put the additional laborers to work of productive projects. To the extent they support enhanced O&M using existing local contractors who deliver quality works, there will be real benefits. However, there is a risk that funds will also flow into make-work programs with little lasting benefit. Our experience is that several of the INPRES based programs can be run effectively if properly monitored. Added precautions should be instituted to improve the effectiveness of the use of these funds, including local disclosure of the amounts and purposes of the transfers, clear rules for administering the programs, proper local accounting procedures, and full accountability 54. A general concern being addressed by those designing these emergency programs is to be sure that they are appropriately targeted. The bulk of the unemployment generated by the crisis is among urban construction workers, service workers, and urban (female) garment workers.', In Indonesia, most of those laid off will attempt to find some income earning opportunities in the informal sector, and the public programs will provide a supplement to any earnings they obtain there. Nevertheless, there will be those among the poor who cannot benefit from the employment creation programs, and food relief will have to be provided. 55. Although the current increase in funds to local governments is commendable, it should be put in the perspective of over a decade of declining per capita investment in urban infrastructure. Normally, one would expect the demand for infrastructure to grow along with per capita incomes, so this implies a significant and growing gap in the availability of urban infrastructure services. It is not possible to estimate how large the gap is, though it is widely recognized that urban water and sewage availability is inadequate and that roads are not sufficient to support the growing traffic demands, which will, however, ease for a while as a result of the crisis. Most of the decline is attributable to the relative decline in central government DIP transfers (executed by central agencies for local governments). INPRES (transfers to local governments for their execution) grants were relatively constant until this year. "Cuts in public infrastructure construction naturally aggravate unemployment in the construction industry. However, the government is restructuring the remaining programs to be as labor intensive as possible. 30 56. Serious deficits in urban infrastructure must be made up in the medium term. The emergency programs can help if managed properly. In addition to the higher transfers from the central government, more opportunities for local governments to raise their own revenues or increase their borrowing have to be created. Programs to enhance their use of borrowed funds will have to be premised on increasing the revenue-raising capacity of local governments. 57. Recommendations: * Manage the increased transfers for employment creaition throuigh existing programns to the extent possible and install the enhanced safegulards discussed above. * Preserve a higher level of transfers to local governments to expand iurbcwii infirastruictutre. * Increase the share of discretionary grants in the total tran.sfers to locail governinents. * Complete the Municipal finance reform to strengthen the revenue basis of local governments. 58. Transport: The sector covers roads, railways, and air and sea transport and is one of the largest components in the development budget. The bulk of the expenditures are for roads, and in recent years, the government has attracted private investment for some toll roads. The road network has grown three- fold since 1970 to 220,000 km in 1994 and paved roads sixfold to 120,000 km. Usage has grown even faster and congestion, until the crisis hit, was a problem in many areas. The road system is divided into a hierarchy of national, provincial, and local roads with responsibilities divided among different levels of government. Funding for national roads is from the central budget, which provides adequate flexibility in the use of funds for various types of road works as dictated by network needs. Provincial and kabupaten roads are funded through a combination of budgetary channels, including both central direct financing and tied transfers to local govemment. This fragmentation of budget sources and channels and associated criteria and constraints has produced substantial rigidities in the use of funds. 59. An effective system for setting priorities for maintenance and rehabilitation for national and provincial roads was installed in the early 1980s. As a result, from REPELITA IV to REPELITA VI, the length of roads in good to fair condition nearly doubled from 22,000 km to 40,000 km. Most of the improvement occurred during REPELITA V when funds were doubled in real terms for road maintenance and betterment. Before the crisis, the most critical issue had become the need to deal more effectively with rising traffic congestion. Given the contraction of the economy and the drop in traffic in the near term, most of the capacity expansion investments should be postponed. Minor widening works can also be postponed. However, considering the long lead times involved in preparing capacity expansion investments, planning for capacity expansion should not be curtailed, including in particular: (i) preparation of a master plan for development of the arterial road network in coordination with toll roads; and (ii) the preparation of high priority individual investments. 60. In the short term, the objective should be to at least maintain the present condition of the heavily trafficked road network through fully adequate routine and periodic maintenance and minor betterment. This will avoid a much more costly recurring cycle of rehabilitation/reconstruction works which over time not only involves much higher road expenditures but also much higher vehicle operating costs. Road expenditures in Indonesia in 1992 were estimated at Rp. 5 Tr., while total vehicle operating costs were estimated at Rp. 29 Tr.. This relationship indicates that a reduction in road expenditures which leads to a 31 deterioration in the condition of the road network can have an impact on vehicle operating costs (and hence on resource costs for the nation) of much higher magnitude. 61. The kabupaten road network nearly tripled in length from 65,000 km in 1979 to 190.000 km in 1994, following rapid increases in funding. However, per km of road, the annual expenditures remained almost constant in real terms, and overall, these roads are in rather poor condition. Unfortunately a significant part of these new roads were not well selected and to maintain them in stable conditioni is not economically justified. It is now no longer financially feasible. 62. In view of the recent rapid extension of the kabupaten roads and its relatively poor condition, the contraction of the economy and slow down in traffic dictates that the network should not be expanded further and road rehabilitation and preservation works should be focused on a strategic network to be identified on a regional basis. Such a network would comprise all key linkages, i.e. inter kabupaten roads, linkages between towns and national/provincial roads, linkages to locations of substantial economic activity, and essential linkages to provide access. 63. Works on national and provincial roads are relatively equipment intensive. Forkabupaten roads, there is somewhat greater scope to increase the direct labor content and hence employment. However, this requires careful design of the works, training of laborers and supervisors and intensive supervision. Hence, there is a high risk of wastage if such substitution would be introduced in haste. 64. Toll roads. A large number of toll road projects have been launched in recent years in the form of joint venture BOT project companies between Jasa Marga, the state owned toll road corporation, and private investors. These projects were initiated without a proper master plan for the development of the arterial and toll road network and without sound economic and finanlcial feasibility stLdies. As many of these roads were not economically nor financially viable, the economic and finanicial crisis has suddenly exposed their fragility. Many project companies have become insolvent, and Jasa Marga may have to assume the financial obligations. There is now an urgent need to establish a plan for completing worthwhile projects and unraveling the financial implications for Jasa Marga. 65. With constrained budgets, even for maintenance, it will be imiportant to prevent premature pavement deterioration (and hence higher road maintenance and reconstrtiction costs coupled with higher vehicle operating costs for all traffic) caused by heavily overloaded trucks. More effective enforcement of weight restrictions to keep overloaded vehicles off the roads should be put in place. In addition, pricing of diesel fuel needs to be brought in line with its economic cost and the aniual motor vehicle tax for commercial vehicles should be adjusted to reflect road damage and to provide incentives to use vehicles with the correct axle configuration. 66. Railways. The railway expenditure program finanices mainly the improvement of the Government-owned infrastructure, including large investmenits in the upgradinig of the Jabotabek commuter system and investments in rolling stock by Perumiika, the state-owned railway enterprise. It receives subsidies since economy passenger tariffs are controlled by Governmenit at well below the level needed to cover the associated costs, which are rising due to the increased prices of fuiel and imported spares. Rates for some principal freight business-coal transport in South Sumatra-are constrained by the terms of the coal supply contract between Bukit Asam and PLN. However, rates for freight services and tariffs for non-economy class railway services should quickly be increased at least covering their long-run avoidable costs. Any freight services that have no prospect of covering their long run avoidable costs should be discontinued. 32 67. All proposed investments in railway infrastructure and rolling stock should meet rigorous economic and financial viability criteria using high hurdle discount rates and realistic traffic and tariff assumptions. Projects that do not meet these criteria and are not central to development of core railway businesses should be deferred or canceled. It will be important--from the dual standpoints of containing lifetime costs and improving safety--to ensure that adequate funds are allocated for infrastructure maintenance. The primary objective for the railway subsector in the near term will be to ensure that Perumka is able to continue to operate services safely and reliably under severe financial constraints. 68. Similar principles should be applied to the other land transport subsectors. In particular, expenditures in the inland waterways and ferries subsector should be focused primarily on maintaining and ensuring the safety of existing wharves and terminals rather than expanding capacities or building new facilities. 69. The largest ports and airports are structured as public enterprises. The government also builds and operates some smaller port and airport facilities on its own account. The budget constraints require that new activities in these areas must be postponed or scaled back significantly and available resources concentrated on essential maintenance in the short term. The government has postponed regional airport construction and will reduce planned improvements in several ports this year. The decline in economic activity has greatly lowered demand for these services. 70. Recommendations: * Concentrate available resources on the necessary minimum maintenance and rehabilitation, subject to honoring outstanding contracts. * Review longer term betternment and new construction projects and re-rank the priorities for a minimum new investment program once resources become available. Improve efficiency of planning and coordination. *8 Speed up cofinancing of budgeted programns to assure minim um necessary investment takes place. * Reduce subsidies in the sector, particularly fuel, with an objective of eliminated them as soon as possible. * Review the economic viability of private roads to cletermiine potential government liabilities and establish better rules of coordincation with the rest of the road network. * Postpone other new investments and expansion in transport capacity and concentrate on safety and proper use. 71. Energy: This sector is the story to three public enterprises: Pertamina (petroleumn), PLN (electricity), and PGN (gas). They are responsible for managing the oil and gas reserves of Indonesia, supplying the domestic market (commercial, industrial, and residential) with their respective products, and transferring subsidies through government price controls on their products. Most oil production is from fields operated by international oil firms under production sharing agreements. The payment for the production share of Indonesia goes directly to the government. Pertamina does own and operate several smaller fields, as well as several refineries and the petroleum distribution system. It also imports some 33 product.'2 60 percent of its net revenues go to the government under a shiaring agreement in lieu of taxes. It may also make other transfers by agreement with the governmenit. Since the domestic price of petroleum products is set by the government, Pertamina may realize a gain or loss on its refinery and distribution business (the net subsidy for fuels). This is calculated by a complex formula and is normally settled at the end of the year. This year, the subsidy is so large that Pertamina has requested more frequent transfers. The government is in substantial arrears. Pertamina claims that it is out of cash and has to borrow from the banks to make ends meet. It is also in substantial arrears to its suppliers of crude. It is vital to Pertamina's financial stability and credibility that it remain solvent. Eliminiating most of the fuel subsidies should be part of this. 72. A lot of Pertamina's business for processing and distribution has been conducted through noni- competitive contracts. They reportedly have involved larger than normal margins, siphoning off a large part of the oil revenue to private hands. The government is investigating these contracts and intends to replace them witlh more competitive ones. The analysis of the SOEs profitability in Chapter 5 does not show a high rate of return for Pertamina, suggesting that surpluses have been inefficiently used or costs have been inflated. The critical issue to address with Pertainina is reducing waste and inefficienicy and increasing the competitiveness of operations in the hydrocarbon sector. Many elemenits of distribution and processing should be shifted to the private sector. Pertamina should concentrate on its core responsibilities o:f managing Indonesia's oil and gas resources. For further discussion, see Chapter 5. 73. PLN generates, transmits, and distributes nearly all electricity in Indonesia. Some firms generate their own power. PLN has recently been restructured as a public enterprise. However, its off-shore borrowing (much of it from the Multilateral Development Banks) is still guaranteed by the governmenit and passes through the development budget.' Along with PGN, this borrowing and investmenit program accounts for most of the expenditures under the Ministry of Energy and Mines. To reduce its public expenditures on new generating capacity, Indonesia, like other developing couLitries, has encouraged private participation in power generation and several IPPs have been signed. Some were political deals that PLN had opposed, but it was overruled by the President. As a result, Indoniesia will have a large excess of capacity over demand, and PLN will have to purchase from the IPPs even though it has enough of its own capacity to meets demand. This adds to its cash flow and profitability problems, which will be discussed in Chapter 5 on PLN's financial situation. 74. In the short run, PLN is undertaking a major retrenchmenit of its investmelit program. Many planned facilities will not be needed nearly as soon as planned, and PLN does not have the finanicial capacity to fund them in any case. They are being postponed. Its prime operating concerni is continuing to deliver power despite its financial difficulties. This will require maintaininig its current network capacity. PLN is facing potential shortages of spare parts due to its difficulty in obtaining foreign exchange. The Bank is reprogramming some of its existing loans to hielp assure operating capacity. The next priority is to reorient critical investments. There is excess generationl capacity on Java, but other areas are still facing deficiencies in capacity. In the current circumiistanices, planned new generation capacity in South Sumatra could be replaced at lower cost by ruiilinig a higih voltage line from Java, absorbing some of the excess capacity there. There are a few very critical projects that should be brought to completion if funding can be found. Most important is the high voltage trunk liie in south Java that is necessary to hook up some of the new generating capacity that PLN is contractually obliged to absorb. 2It also purchases some crude from the production share producers for refining and distribution locally to supplement its own production. 3See Chapter 4 for a description of how this works with SLAs and the RDI. 34 The extent to which these projects can be carried out will depend on the ability of PLN and the government to raise the necessary funds in these difficult circumstances. PLN will require a longer term work-out from this situation. Increases in its tariffs will help. But it will also need more permanenit debt relief to restructure its finances. 75. PGN is in a similar, though less dire situation to PLN, and can probably recover with a well designed restructuring and renegotiation of some of its supply contracts. 76. Recommendations: * Subsidies in the sector should be reduced caic elimincted cIs soonI as possible hb( revising fuel and electricity tarif policies. * Pertamina's accounts should be auclited by outside experts to identifi whether there are savings that can be derived froml revising its contracts for supJlv aCnd distribution. These changes should be mnade to redluce the cost of the sutbsicdy to the government, atlonig wiith reforms to liberalize acturties in the sector. * Pertamina s operations and activities shoutldc be reviewed to see what cani be reaidilv privatized, incluclinig the distribution network andl refineries. These shoulcd be addled to the government 's privatization program. * The role of Pertamtina should be reconsidered to determine whether it shouild become more of a regulatory agency with most prodluctioni aictivities handled bhy the priveate sector. * PLN 's investment prograc,m should be revised to concentlralte on, maintaining operatfing capacity and minimium criticail investments to strengthen the network. * PLN should develop a fintncial uworkout plaii that includtes stlabiliing PLN S cash flow renegotiating the IPPs, corporate restructuring andicl revising ils privatization prograin in new circumstances. 77. Health: The government of Indonesia has adopted a policy of providing health services as extensively as possible. It has established a nationwide network of healthi centers staffed with doctors, nurses, and other trained personnel as appropriate. It is backed up by a system of hospitals and trainiig units. This has spread health professionals throughout the counitry and made basic care nominally available to all. The government has also encouraged, both directly and indirectly, the development of private provision of medical care. About two thirds of expenditures on healthi care are from private sources, and three quarters of these are out of pocket rather than covered by institutions (primarily insurance). A substantial share of the private expenditures go to public healthi care officers working on their own time. As incomes fall, the poorest will be least able to continlue paying kor private services, and the share of private health provision to them is likely to fall. 78. The overall level of health related expenditures in Indonesia is low in comparison to its neighbors in East Asia and to other low income countries. The overall quality of services reflects this low expenditure level. Prior to the crisis, per capita health spendinig by the government was $3-4. About 15 percent of the government expenditures on health and chanieled through local goverinments. Foreign aid normally finances about 15 percent of the government's health expenditure. 35 79. Low expenditures are reflected in key health indicators, which were 40 percent below what would be expected given Indonesia's income and literacy rates in 1990. There is little reason to expect the situation has improved. Relative expenditures and practices have remained unchanged in the intervening years. Spending reached a nadir during 1988-89 and has recovered somewhat since then, outpacing GDP growth by about I percent since 1990. 80. The allocation of expenditures across different activities in the past has reflected competing priorities. Primary care receives the largest share of expenditures, and these are used by all income classes at about the same usage rates. There is a special allocation to assure that the poor have access to hospital care without the usual fees, but actual use data suggests that hospitals are used to a proportionally greater extent by the more affluent. They receive the second largest share of the health budget. Nearly all public health facilities charge additional fees to supplement the resources from the government. Some of these fees are allocated at the discretion of the directors of the health units and local authorities. At present, they are not all recorded or subject to scrutiny. Preventative care and public health services (vaccinations, vector controls, etc.) have received a small portion of the budget despite their being the purest public goods in the sector. Related public health activities to provide clean water and remove sewage are also important to reduce the chances of major disease outbreaks from contaminated water. These are usually part of the local governmeit infrastructure programs. 81. Low expenditures are not the only explanation of the unsatisfactory performance in the health sector. The wide distribution of health outlets was not accompanied by a similar decentraliztion of funding and responsibility. Allocations of resources are centrally controlled and channeled through a large number of earmarked transfers organized around specific activities, diseases, or other health objectives. Professionals in the field have to try to manage many different earmarked sources of funds or supplies in kind over which they have very little input or control. They have no incentives to manage the delivery of services efficiently and very little flexibility in resource use if they wanted to. Central allocation of supplies often results in local shortages of critical material, even when there are adequate supplies available nationally, contributing to the low overall quality of care. This partly explains the collectioni of fees locally to supplement discretionary resources for each health unit. 82. The advent of the crisis has deepened to the challenges to the health system to continue to provide basic rninimal health services as resources are more constrained and income are falling. Shortages of medicines and medical supplies have been widely reported. Most of these are imported as materials for local final processing, and the combination of the sharp devaluation and the restricted access to trade credits has greatly reduced the supply of medicines. This issue is being addressed by several donors with emergency assistance, but it must be watched closely. In the short term, the government has decided to substantially increase the budget of the sector in real terms. 83. The increased allocation to health in the 1998/9 budget goes beyond what is required to maintain other expenditures at their constant 1996/7 level and should mark the beginning of a major reorientation of the government's priorities to improve the delivery of health care to the poorest. Whether this occurs depends, first, on whether the increases are appropriated and spent; and second, on whether the strategy in the health sector can be revised to assure more effective delivery of services. This is critically important to assure the longer-term objective of improving the quality of health care. Making the basic delivery strategy more efficient is vital to achieving Indonesia's objective. 84. Effectiveness of health service delivery will be greatly enhanced by reducing the number of discrete, centrally directed, managed, and funded special purpose programs and expanding the amounts of discretionary funds transferred to individual health units as bloc grants. The total funding reaching the 36 units should increase and the amount of earmarking should substantially decrease. This change in funding must be accompanied by increased accountability of the local units to deliver quality services and greater incentives to do so. The short-term increase in funding should be allocated to the poorest areas and areas with the largest health problems rather than through earmarked, special objective programs. This strategic change will have to be implemented with appropriate training programs and measures to assure accountability. It is encouraging that the general funding for pubic health activities has been expanded sharply 85. In the medium term, the transition to more discretionary financing should be spread throughout the whole system. It will increase the effectiveness of delivery of health services throughout the country and assure that whatever resources are available are used efficiently to address the most pressing local health problems. As increased finding is made available, fees should be reduced for the poorest and a more graduated fee structure instigated so that public health care expenditures are focused more on the poor. The more affluent should be expected to bear a larger portion of normal health care services. Accountability and incentive programs will have to be strengthened beyond the initial steps in the crisis. This will be a major change in the government's health care strategy and have a lasting effect on the delivery of care. The Bank has been working with the government to lay the basis for this change in approach. 86. The share of the health budget that can be financed by foreign assistance will increase due to the change in Rupiah value of foreign exchange. However, using this effectively will require a significant reprogramming of this aid. Fortunately, the sector allocation of foreign assistance projects is broadly consistent with the government's revised priorities, but details will have to be worked out at the individual project level to make full use of the additional Rupiah resources now available from the loans. This should receive priority attention from all concerned. 87. The private sector is already involved extensively in providing direct health services. However, there is little private institutional support for health care, such as insurance or HMOs There is some government sponsored health insurance for civil servants, but little broader institutional risk sharing structure for health care through well designed insurance systems. The reform of the health system should begin to develop private sector based health insurance for middle and upper income individuals to reduce their use of public health services. 88. Recommendations: * The increased real level of health expenditures must be used effectively through existing priority programs to transfer funds to health care units on an unconstrained basis. The increased grants should go in first priority to assure access to the poorest. * The government should assure that there is adequate funding for importing essential mnedicines and medical products. * The fee structure for medical services should be revised to introduce more progressivity and make sure that the accounts of public units are audited and available to the public. * The health strategy in Indonesia should be revised, including establishing requirements for adequate performance on health indicators, increasing the autonomy and accountability of public health units, focusing on the priority areas for the government to provide health care, and estimating realistic budgets to achieve the objectives in relation to available resources. 37 * CConsideration should be giveni to designin7g a better health insurcanice regimie to rationalize public and private expenditures in the sector. 89. Education: The education sector receives one of the largest shares of the budget, this has been a critical sector for the government. Its accomplishments have been remarkable. Universal primary education has been essentially achieved, and over half the educationi budget goes to primiary education. Junior secondary and secondary education have expanded to enrollment rates comparable to countries with twice Indonesia's per capita income, and the gender gap has been narrowed at all levels. 90. Funding and management of education has been partly decentralized, with more responsibility being shifted to local levels of government. FuLnding is from several sources. Nearly all current expenditures on primary education are on the budget of the Milistry of Home Affairs. The investment budget is under the Ministry of Education, but most funldinig for primary education is transferred to local governments for implementation. Local governments also provide some additional funding from other sources. All this makes coordination complicated, and it is difficult to estimate total expenditures in the sector. 91. The sector has been open to private providers of education, and private schools educate 17 percent of primary, 41 percent of junLior secondary, 55 percent of upper secondary, and 66 percent of tertiary students. In addition, parents are expected to contribute to public school education through fees, buying books. etc. Some of these fees are set locally, and may make some adjustment for income levels, but burdenis are still poorly distributed, especially beyond primary school level. For the lower income households, these charges constitutes a significant expenditure, up to 43 percent of per capita household expenditures for the lower income quartile for junior secondary, compared to 27 percent for the highest quartile. This is a substantial disincentive for many poor families to continue their children's education beyond primary, especially since the quality is regarded as poor. 92. Despite significant success, the education sector was already facing many problems when the crisis struck. Expanding the reach of education has been the prime objective of the government, quality concerns have received lower priority. Education expenditure as a share of GDP has been falling since 1985/6, and the 1996/7 share of GDP (2.8 percent ) was substantially below what was spent in other East Asian countries. With such a low level of funding, the quality of services was well below what would be desired. Achievements of Indonesian students in primary school fall below those of students in neighboring countries, and measures of mastery of basic subject matter have not improved since the 1970s'4 Junior secondary attendance in Indonesia is below that of its neighbors and economic competitors. However, that level typically offers the highest social rate of return to investment in education for countries at Indonesia's level of development, and quality improvement should have a very high priority in Indonesia. 93. The economic crisis thus presents both an immediate and longer-term challenge to the government. It the short term, the government must prevent a major fall in attendance rates among the poor as falling incomes reduce the ability of poor families to pay the costs of education and to afford the loss of potential income the children could earn.'5 This supports the earlier emphasis on quantity and increasing (or at least prevent a fall) in attendance rates. In response to the crisis, the government, the 14They have not fallen either despite rapid expansion of attendance. '5The creation of additional unskilled rural jobs from the expanded government programs may create perverse incentives for poor youth to quite school to earn some income. This should be carefully managed. 38 Bank, and other donors have designed an emergency integrated assistance program. One component is bloc grants to primary and junior secondary schools in poor areas (40 percent of the total) to make up for lost income to schools as compulsory fees were abolished and to give local authorities funds to defray other expenses that would discourage poor families from sending their children to school, such as book and examination fees, cost of other scholastic materials, etc. A second component is giving scholarships to about 16 percent of the poorest students in lower secondary level. These students would otherwise not be able to continue schooling. These programs will add Rp. 700 billion to the 19898/9 development budget for education and will continue for five years. 94. The most important long-run feature of this program is the major public relations campaign government is conducting to be sure that the potential beneficiaries are aware of the program and the schools understand what is expected. In addition to trying to maintain enrollnents, the campaign is designed to open up a broad dialogue on basic education involving parents, educators, and the ministry. The ensuing discussions are expected to focus attention on a number of key issues, including improving the quality of basic education, and bring lasting results. 95. This high priority on education has led to an increased allocation in the budget that should maintain the real value of the proposed expenditures in education at about the same level in 1998/9 as in prior years, although the allocation within the sector is changed to focus more on supporting attendance by the poor and improving quality. 96. The medium term nature of the budget constraints raise questions about the viability of the government's pre-crisis plans to improve the quality of education in Indonesia going into the 21st Century. Four major policy initiatives had been identified and supported: i) Nine years of basic education for all, ii) Improving the quality of basic education, iii) Expanding senior vocational education, and iv) Expanding public higher education. A major objective has been to equip Indonesian workers with levels of education that will meet the requirements of a growing modern industrial sector. 97. This strategy needs to be revised. Assuming a constant share of GDP going into education and the continued high growth rates that prevailed prior to the crisis, the government would have only been able to fund one third of the incremental costs of these programs by 2004 and two thirds by 2010. Post crisis, a great deal less funding is available (beyond the emergency program to maintain enrollments described above). It is clear the new priorities will have to be set for the sector, both relative to other sectors and for allocation within the sector. 98. The highest priority has been to improve the quality of primary and junior secondary education in Indonesia and to increase enrollments in junior secondary, and these priorities have been maintained. High returns to junior secondary are dependent on improving the quality of primary education. Allocations within the sector should be directed to these objectives--the first two elements of the government's strategy. This year's budget makes an impressive start in that direction. 99. The government's plan to expand senior vocational education and technical faculties for higher education is based on the assumption that these are relatively more expensive facilities, and the private sector will be less inclined to expand in these areas. The government, however, sees a public benefit from increasing the technical competence of the Indonesian work force. Experience from labor markets indicates that it is much more important for the public education system to provide sound basic education in the fundamentals of mathematics, science, and reading and comprehension. Private sector employers 39 can then more effectively provide the technical training.I6 The programs for senior vocational and technical higher education should be left to the private sector, or run on a full cost recovery basis if the private sector does not take up the challenge. 100. Recommendations: * Implement the emergency program of grants and scholarships to nmcintain enrollments of poor students in primary and lower secondary education. * Revise tIhe fee structure on a nmore permcrnent basis to nmake sure that the poor are encouraged to conmplete their basic ecducation, aiming to achieve universal basic (1-9 years) education. * Cosncentrate on im7proving the quality ofpriniary and lower secondary education * Leave expansion of vocational and technical trainzing to the private sector or fully charge for it ifprovided by the government. * The governmnent should strengthen its role in setting standards, etc. for private education. 101. The possibility that the 1998/9 expenditure target will not be reached and the prolonged nature of the resource constraints imply that basic changes will be needed in what services the government provides and how it provides them. The above sections have indicated both short and medium terms recommendations. There are underlying studies in each sector that outline in much more detail the issues and the possible responses. Additional work will needed for the government to set its priorities, redefine its responsibilities, and make the necessary reallocation of resources as Indonesia works out of the crisis. In the end, the result will not likely lead to a reduction in the demand for government expenditures (compared to pre-crisis levels). The target should be to provide better, higher quality, more relevant and effective governm-ient interventions in the areas where the government should be involved, an efficient framework governing private sector involvement in public services where the government need not be directly involved, and withdrawal from areas where there is no longer a rationale for public involvement. '61t is estimated that it is six time more expensive to provide basic skills through subsequent training than to provide it in the public education system. 40 Annex A: Management of Irrigation O&M The governance and management of irrigation O&M and rehabilitation expenditure policies should be amended as follows: (a) Participatory Management. Revise irrigation decrees relating to public irrigation to: (i) expand O&M and rehabilitation responsibility of irrigators to include all secondary canal networks of a size that could be reasonably managed by community resources to legally registered and democratically governed WUAs, or federations of WUAs, that have the authority to operate bank accounts, incur debt and collect service fees from all irrigators; and (ii) provide for transparent joint government and irrigator financial and operational management oversight of schemes havilng canals large enoughl to require government responsibility for their rehabilitation and O&M. The joint management funiction would be exercised through WUA, or WUA federation, representation on a Scheme-Level Management Committee (SLMC) having access to scheme annual budget and works procurement information related to O&M and rehabilitation. (b) O&M Fundinig Arrangements. Revise the IOMP to: (i) operationalize the EOM concept for works remaining under governmenit responsibility by placing incremental PBB revenues from each irrigation scheme in an earmarked scheme account at the disposal of the respective Provinicial or District irrigation agencies as a supplement to earmarked and/or discretionary INPRES O&M funding made available from central sources; and (ii) require mandatory irrigator payment of an appropriate level of annual ISF into an audited WUA or WUA Federation bank account. The ISF rate should be set by individual WUAs or federations to cover their cash expenditures (net of labor contributions) and should be approved by the SLMC to ensure an adequate level of O&M for works under each WUA's or WUA federation's jurisdiction. In the evenit of a shortfall between WUA ISF assessments and payments, irrigation agencies and SMLCs should have the authority to proportionally reduce the priority of government O&M and/or rehabilitation expenditures for the defaulting area's supply canals until payments have been made. (c) Rehabilitation Prioritization and Funding. Given the medium term shortage of capital funds, rehabilitation of canal systems not turned over to WUA management should be limited to the minimum determined by a SLMC as necessary to ensure adequate irrigation service. Rehabilitation of networks placed under WUA management should be funded on a priority and competitive basis by a Provincial WUA Irrigation Rehabilitation Fund based on an appropriate WUA cash equity contribution and/or subsidized loan obligation. WUA or WUA federation eligibility for funding should be based on evidence of: (i) a functioning WUA entity with joint bank account and deposited ISF payments; (ii) a costed design prepared with government assistance under WUA oversight; and (iii) a credible WUA funding program for the equity and/or loan portion of the design cost. 41 CHAPTER 4: OFF-BUDGET ACCOUNTS The Off-Budget items are little understood anld nmuch suspected. In fact, those which could be brought onto the budget would amnount to a relativelv smlall portion of the budget. The investment funds need to be more transparent1v managed, but may benefit from retaining their revolving fund nature. M1Iore critical in the m7ediumn7 ternm is improving the mt7anagemzent of the public pension fJunds and reducing the contingent liabilities of the governmnent. Several Off- Budget funds care ill conceived and should be closed Across the board, the most important thing is to requiire open and transparent accounting of all these activities, which should help build agreement abouit their ulitimate disposition. BULOG turns out to be a very costly operation for the governmenit anitd for consuxmers. Its fiunctionis should be greatly reduced as soon as more efficient alternatives can be establishedi. 1. A number of so-called "off-budget" accounts have grown over time with quite different objectives. Data on some have been closely held, data are not collected systematically for others, and fairly complete data are available for several. There are widespread misconceptions about many of these accounts, fueled by their general lack of transparency and widespread rumors as to their size and use. One objective of this chapter is to demystify these accounts. They are important, but not budget busters.' 2. The government passed legislation in 1997 to get a better handle on non-tax revenues, and this also had the effect of bringing some of the off-budget items onto the budget and treating them more transparently. As part of its reform program, the government formally brought the Reforestation Fund and the two Investment accounts into the 1998/9 budget. Whether and how all the off-budget accounts will or should be brought on budget depends on one's definition of these accounts and their structure. In this report, we have taken a rather expansive view of off- budget accounts to give a picture of the various ways the government can impact resource allocation. As will be clear, some of the accounts discussed should not be brought 'on-budget,' though there are good reasons why all those that are not eliminated should be subject to more disclosure, transparency, and accountability than has been the case in the past. 3. In general, the off-budget funds have been used for well-defined purposes and have development objectives. Some have been created to solve other budget problems. Like many on-budget expenditures, they have not been used as effectively as possible, and some have wasted resources. Table 4.1 shows annual expenditures for each of the off-budget funds This report does not pretend to have discovered and brought to light all such accounts. We have tried to include the largest and most important. In most cases, we have been able to obtain the data required for this analysis from the Ministry of Finance or other official sources. In some cases we have used existing research studies as the best source of information. In a few cases, particularly the Reforestation Fund, we have not been able to obtain up-to-date information, and have presented what is available. 42 Table 4.1: Summary of off-budget accounts (in billions of rupiah) 1996 Account Inflows Outflows Cumulative Balance Education 9.686 9,686 na Forestry (1993/4 955 474 2,700 RDA 210 193 209 RDI 6.031 6,514 3,149 Govermiienit Pensioni Fulids I .110 573 14,981 Housinig Fuid 313 123 543 Foulidation ( 1996-97) 797 228 569 .Sozirce: Data collected by Mission considered. All are not strictly comparable to budget expenditures so they cannot be aggregated as a Lsupplemenet to the budget. For this report, we will look at four types of off-budget accoulits managed by the public sector in declining order of budget likeness: i) Quasi budget expenditures, ii) Revolving funds for public investment programs, iii) Publicly managed funds for the benefit of individuals, and iv) Special purpose, chartered charity funds. We will also consider BULOG, which lies somewhere between an off-budget institution and a Public E nterprise. Quasi-Budget Expenditures 4. A number of fees and charges are imposed by government agencies and retained by that agency for its own use. In some cases, an amount representing these fees has been recorded in the budget unider noni-tax revenue, and corresponding amounts added to the expenditures of the collecting and usin1g agency. In reality, the funds never passed through the budget process, so actual amoun1ts were not recorded as either income or revenue. In some cases, the amounts to be charged for these fees were statutorily fixed, in other cases they are not. Many of these fees were collected to supplement government allocations in such areas as health and education, and they have increased normal expenditures beyond that recorded in the budget. Stories abound of actual fees charged being quite different from the statutory ones, and there are also questions of whether the fees fund the delivery of the intended service. There is no systematic way to obtain accurate estimates. It is hard to assess the efficiency or equity of the allocation of the additional funds. We can gain some insights from Education and the Reforestation Fund. 5. Education: Fees are charged for public schools at all levels to cover additional materials, to augment teachers' salaries, and sometimes to contribute to capital improvements. Since these fees are handled at the level of the individual institution or by the local level of govemment, there are no central records of many of them, nor their eventual use. Even those recorded at the central level and passed through the budget under the new law would not cover fees/expenditures above the statutory levels (see Table 4.2). As discussed in the previous chapter, a number of education 43 fees have been suspended during the crisis and replaced by additional bloc transfers from the government. A recent study of education indicates the importance of supplemental expenditures for the sector.2 6. According to this study, 45 percent of the expenditures on education in 1995/6 were from off-budget sources, including foundations, families, and community services. This amounted to almost Rp. 10 Tr. Unfortunately, the study does not give a more detailed breakdown of the sources of these funds or their uses. The figures may include some expenditures on private education. It should be noted that the share of government funding declines at higher levels of education, and private payments increase. This is due to the larger percentages of students enrolled in private schools and to the relatively higher school fees charged for higher education. At this point, it is not possible to determine how effectively such fees are being used. It is unlikely that all such fees can be made part of the national budget. However, the accounting of each individual institution should be transparent and available for local authorities and parents to be able to review these budgets and hold school officials accountable for the funds collected from all sources for education. Table 4.2: Education Sector Financing (billions of rupiah) FY 1995-96 SOURCE OF FUNDS Central Government Ministry of Education and Culture 6,081.5 28.1 Ministry of Finance 58.3 4.0 Ministry of Home Affairs 4,569.0 21.1 Ministry of Religion 54.5 2.1 Subtotal 11,963.3 55.3 Foundations, Family, and Community 9,686.0 44.7 Total 21,649.3 100.0 APPLICATION OF FUNDS Primary Schools 7,329.0 33.9 Junior Secondary Schools 3,672.0 17.0 Senior Secondary Schools 3,286.0 15.2 Tertiary Schools 6,084.0 28.1 General Admin. & Other Education 1,279.0 5.9 Total 21,650.0 100.0 Source: --Hickling Corporation, "Indonesia: Education Finance Study Final Report" (2 volumes) prepared for Bappenas and Asian Development Bank, May 1997. 21997 Hickling Corporation, "Indonesia: Education Finance Study Final Report" (2 volumes) prepared for Bappenas and Asian Development Bank, May 1997. 44 7. Similar fees are collected for a variety of health services. Estimates of these fees and expenditures are not currently available. They are believed to be substantial. Some are treated on the budget like the education fees, and others are not. They also supplement insufficient public expenditures to deliver health services. They should also be recorded and treated transparently at the local level, as recommended for education. 8. Reforestation Fund: This is perhaps the most notorious of the off-budget funds. It was established in 1980 by Presidential decree. All concessionaires wNere required to pay USS 4.00 per cubic meter per sawnwood/plywood and US$ .50 per cubic meter of chipwood. The funds were to be used toward reforestation or refunded if the private concessionaire undertook the reforestation. In 1989, the sawnwood fee was raised to US$ 7.00 per cubic meter and became non-refundable. Concessionaires wvere still required to carry out reforestation in their areas without compensation. In 1997. the fees were US$ 10.50-20.00 for sawnwood/plywood, and US$ 2.00 for chipwood. Its current mandate is to carry out reforestation in and outside concession areas and on unproductive land and to finance development of industrial forest areas. 9. The funds have been managed by the Ministry of Forestry and are supposed to be allocated by a defined process, subject to Presidential approval. The Ministry of Finance takes account of the expenditures authorized under the Reforestation Fund in setting the budget of the Ministry of Forestry (MoFr), so most of the approved expenditures are not additional to the budget allocation. In the 1998/9 budget, the revenues from the Reforestation Fund have been placed on-budget, and the allocation to the MoFr increased by a similar amount. Prior to this year, the allocation of Reforestation funds was not transparent. It has been reported that in 1993, Rp. 400 billion was transferred to the IPTN to support development of the national airplane. Other transfers from the Reforestation have been reported in the press, and the available accounts do not show a destination for large portions of expenditures. 10. The Reforestation Fund had accumulated a substantial surplus of Rp. 2.7 Tr. in the most recent year for which data is available, 1993-94.3(see Table 4.3). In that year, the Fund collected revenues of Rp. 955 B, of which Rp. 720 B were payments from concessionaires and Rp. 235 B interest on accumulated reserves. Expenditures in 1993-94 were Rp. 475, of which Rp. 136 B were accounted for by activity in this study. Over the five year period ending in 1994, about 40 percent of expenditures can be so accounted. There is no accounting available for the rest of the funds. 11. It is hoped that bringing the Reforestation Fund on-budget will increase the transparency and efficiency of its use. The annual flows through the budget represent less than 1 percent of public expenditures. Available information from the past indicates that most of the funds have not gone for reforestation and related activities. There is a need for enhanced expenditures in this area. Forestry fees have been restructured as part of the current reform program, along with other resource management fees on the basis of sound conservation principles and sustainable forest management. The funds should flow to general funds and expenditures allocated to forestry activities according to overall budget priorities. The outstanding balance in the fund is now likely to be more than Rp. 4 Tr. It should also be brought under the control of the budget. Since the funds were collected to support forest activities, a substantial part of this sum should be used to 3This is from an external study, and the government has not released details on the functioning of the fund. 45 establish a trust fund for sustainable forest conservation activities managed in a transparent manner, perhaps with the help of local NGOs. Table 4.3: Ministry of Forestry Reforestation Fund (in billions of rupiah) 1989/90 1990/91 1991/92 1992/93 1993/94 Total % SOURCE OIF FUNDS Concessionaires 283.7 305.2 517.9 563.4 720.4 2,390.6 66.9 Interest 122.5 161.9 321.0 341.5 234.8 1,181.7 33.1 Total 406.2 467.1 838.9 904.9 955.2 3,572.3 100.0 APPLICATION OF FUNDS BY SOURCE' DR Funds (IDR) 7.9 63.4 213.7 289.8 392.0 966.8 73.7 DR Interest (BDR) 64.3 64.8 57.2 76.6 82.4 345.3 26.3 TIotal 72.2 128.2 270.9 366.4 474.4 1.312.1 100.0 BY ACTIVITY Forest Production n.a. 24.7 55.1 12.4 11.6 103.8 20.2 Education Programs n.a. 4.3 9.3 16.8 19.8 50.2 9.8 Research n.a. 3.0 6.3 7.5 21.5 38.3 7.5 Government Support n.a. 36.2 40.7 28.6 53.0 158.5 30.9 Conservation n.a. 1.0 1.0 23.4 4.7 30.1 5.9 Inventories n.a. 4.7 14.0 8.9 9.0 36.6 7.1 Rehabilitation n.a. 20.5 25.8 33.3 16.5 96.1 18.7 Coastal Management n.a. 0.0 0.1 0.0 0.0 0.1 0.0 Total n.a. 94.4 152.3 130.9 136.1 513.7 100.0 FUND BALANCE Accumulated Capital and Interest n.a. n.a. n.a. n.a. 2,700.0 ----- ----- Per 30 November 1993 Source: Mission estimates and outside reports. 12. Recommendations: * Require education, health and other public institutions that collect supplemental fees to maintain audited accounts of the use of suchfunds and open those accounts to the relevant officials and to those asked to pay the fees. * Audit the Reforestation Fund to determine how the funds have been used and what is currently available in the current balance. * Use part of the current balance in the Reforestation Fund to establish a Conservation Trust Fund and manage it in an open and transparent manner 46 Revolving Loan Funds for Public Investment Programs: 13. There are two revolving funds, the Regional Development Fund (RDA) and Investment Funds Account (RDI). Both were designed to handle government lending to public authorities (State Owned Enterprises and Local Governments), and both have links to the budget. They support development projects and were managed by the Ministry of Finance with designated accounts in Bank Indonesia. They are being brought onto the budget, but their characteristics as loan funds rather than current period payments will require special treatment. The government has made full information on these accounts available. 14. The RDA was created as a facility to finance infrastructure investment carried out by local governments and enterprises. Eligible sectors are water supply, wastewater and solid waste treatment/disposal, drainage, local market improvements, terminals, neighborhood improvements, and local roads. Lending is based on the financial and technical capacity of the borrower, and projects must have a development focus. The RDA was intended to facilitate a transition by local governments from dependence on grants from the central government to use of national capital markets to finance local infrastructure. The RDA was designed to help local authorities learn to design bankable projects, establish a repayment history, and wean themselves from the public grants that had previously funded local infrastructure. The second half of the transition has yet to occur, in part because capital markets serving municipal did not develop and in part because some beneficiaries still treat these funds as grants. This situation unlikely to change for some time, but the objective of improving local finance should be continued. 15. The RDA fund itself is relatively small (see Table 4.4). Annual expenditures are about Rp. 150 B. Initially the source of most of the funds was the budget, but repayments have increased so that reflows now constitute about two thirds of the inflows to the fund. Interest rates were close to market (12 percent) until recently. As a result of the crisis, the budget transfers were cut by more than half. The Fund has an accumulated balance of about Rp. 200 B, so it could continue at about its current level of activity with modest transfers from the government. So far, the repayment record has been mixed, with arrears of up to 20 percent prior to this year. We do not know the default rate. The rate of arrears has increased markedly since the crisis began. 16. Overall, this is a relatively small program that benefits local governments and should help move them toward market-based financing for infrastructure. It has already introduced many localities to better project analysis and cost recovery. The expenditures serve desirable development objectives. The re-lending of resources in the fund has managed to recycle some development funds rather than allowing them to be treated as grants. This has helped instill market discipline in local authorities, who are learning that loans need to be repaid. From an accounting point of view, it may be simpler to retain the fund as an annex to the budget for the time being, rather than try to run it entirely on the budget. The incentives for borrowers to repay would be reduced if the funds were to come entirely on budget. There would also be accounting difficulties in carrying over the account balances. 17. In the medium term, the initial objectives of the fund should be reviewed and revalidated. If there is continued justification for its existence, it should be revised to be fully market based with an independent charter. Otherwise, it should be wound down. 47 Table 4.4: Ministry of Finance Special Accounts (in billions of rupiah) 1993194 1994/95 1995/96 1996/97 1997/98 1998/99 Total % (estimate) (estimate) SOURCE OF FUNDS RDA APBN 124.3 185.5 140.0 127.3 48.0 50.4 675.5 2.5 Loan Repayments 15.9 25.8 31.2 83.0 91.3 100.5 347.7 1.3 Subtotal 140.2 211.3 171.2 210.3 139.3 150.9 1.023.2 3.7 RDI RDI Loans 427.5 338.2 151.5 105.1 106.6 219.9 1.348.8 4.9 SLA Loans 3.238.6 2.378.3 2.812.2 5.716.0 6.312.8 4.480.1 24.938.0 91.3 Subtotal 3.666.1 2.716.5 2.963.7 5,821.1 6.419.4 4.700.0 26.286.8 96.3 Total 3,806.3 2.927.8 3.134.9 6.031.4 6.558.7 4,850.9 27,310.0 100.0 APPLICATION OF FUNDS RDA 99.6 168.4 149.6 193.0 151.1 166.2 927.9 3.5 RDI RDI l,oans 51.1 5.613.0 528.2 4.167.1 899.3 1,055.5 12,314.2 47.1 State Treasurn 1.100.0 400.0 2.125.0 2.154.0 3,500.0 3,644.4 12.923.4 49.4 Subtotal 1.151.1 6.013.0 2.653.2 6.321.1 4.399.3 4,699.9 25,237.6 96.5 Iotal 1.250.7 6.181.4 2.802.8 6,514.1 4.550.4 4,866.1 26,165.5 100.0 LOANS OUTSTANDING (per 31 March) RDA n.a. 544.5 678.9 864.0 919.1 984.9 ----- 2.8 RDI RDI L.oans 2.440.4 2.213.9 2,265.2 2.159.0 3,934.7 4.316.9 --- 12.3 SLA l oans 18,796.2 20.347.3 21.105.5 24.077.4 27.214.0 29,935.3 ----- 85.0 Subtotal 21.236.6 22.561.2 23,370.7 26.236.4 31,148.7 34.252.2 ----- 97.2 Total 21.236.6 23.105.7 24.049.6 27.100.4 32.067.8 35,237.1 ----- 100.0 ACCOUNT BALANCE RDA 127.4 170.2 191.8 209.1 197.3 n.a. ----- 4.1 RDI 7.545.2 4.248.7 4.560.6 3.148.5 4,637.2 n.a. ----- 95.9 rotal 7.672.6 4,418.9 4,752.4 3,357.6 4.834.5 n.a. ----- 100.0 Source.- Ministry of Finance. 18. Recommendation: The RDA should be retained for the time being as an annex to the budget and used as a loan fund The accounts of the fund should be made fully transparent, strict criteria for lending and loan management be established, and a formal repayment program to the budget be established In the medium term, it should be reviewed, and if warranted, restructured as afully market basedfund 19. The RDI operates in a similar fashion to the RDA, but it is much larger and the source of its funds is different. When state enterprises borrow abroad from official sources, the government will borrow from the external lender and on-lend the funds to state enterprises through Subsidiary Loan Agreements (SLA). These are called two stage loans--a common practice for official development lending. The distribution of these funds has been energy and mining, 42 percent; posts and telecommunications, 23 percent; development banks, 18 percent, 48 and the remaining 17 percent to a variety of projects including local government, forestry, strategic industries, and transport. 20. These loans pass through and are recorded in the development budget as part of the investment program financed from abroad. The government is the borrower or guarantor of record, and the State Enterprise has a repayment obligation under the SLA to the RDI rather than to the foreign creditor. For example, borrowing by PLN, the national electricity company, from the World Bank is channeled through the development budget to PLN, which signs a SLA. PLN then makes repayments to the RDI, and the government repays the Bank form its own budget, usually on a different schedule than the SLA. 21. Since in most cases, the maturity of the SLA is shorter than the maturity of the loan taken on by the government and the interest rate higher, the RDI generates that can be used as resources a rolling source of funds. The RDI recycles those funds to other projects before they have to be repaid, benefiting from a reverse maturity transformation. Lending for new projects from the RDI own funds has been between Rp. 500 and 1000 B per year. It also transfers funds to the budget to assist in debt repayment. These transfers are not linked to specific loan repayment schedules, but are made on an as needed basis.4 22. Over the past five years, over 90 percent of the resources into the RDI have come from repayments of SLA loans, with the remainder from repayment of loans originating from the RDI. Of the resources available to the RDI, about 85 percent have been transferred back to the Treasury for repayment of the original loans. SLA loans generate about Rp. 5 Tr. per year in repayments, and the balance in the fund was Rp. 4.8 Tr. at the end of 1997/98 (see Table 4.4). 23. With the crisis, it is clear that some borrowers will not be able to make their full payments into the RDI. Arrears are running about 40 percent and likely to grow, adding to the pressure on the government and increasing the implicit government support to the State Owned Enterprises as it assumes more of the debt service directly. It is likely that the government will need to transfer more funds than normal out of the fund to the budget to meet its obligations. The current positive balance would not endure such a mismatch of flows for long. 24. Recommendation: Like the RDA, the investment fund nature of the RDI makes it difficult to place it entirely on budget on a par with normal expenditures. It should be kept in a special fund to protect the investment fund feature. The transactions between the RDI and the budget should be fully transparent and based on the repayment schedule of the underlying foreign loans., The investment and repayment criteria for RDI loans should be clear and rigorous. 4 One reason given for this was to use the fund as a buffer to keep the budget balanced and shield some resources in times of surplus. 5 Often countries which on-lend official loans capture the difference for unrestricted budget use. This practice increases budget revenues. Whether it is in the long-term interest of the country depends of the overall efficiency of budget allocations and the government's objective in managing the financing for public enterprises. Until the governments' strategy for public enterprises is further refined, it would be best to maintain the RDI and manage it carefully. 49 Publicly Managed Funds for the Benefit of Individuals: 25. The government has established pension funds and housing funds for civil servants and other individuals. These funds are legal entities with the government as sole owner. Regular contributions are made and participants are eligible for the prescribed benefits. The funds are managed by public corporations, about which relatively little information is available. 26. Pension Funds: There are five Government managed pension funds: JAMSOSTEK (Employees' Social Security system for private firms and State Owned Enterprises that provides pensions as well as health, life, and accident insurance), TASPEN (Government Social Insurance, Pension, plus lump-sum retirement payment); ASABRI (Armed Forces Social Insurance and pension); ASKES (Government Health insurance), and JASA RAHARJA (Personal Accident Insurance). The first two are by far the largest with Rp. 14 Tr. in assets in 1996, and they will be discussed here. There are also private pension plans provided by employers that had nearly Rp. 13 Tr. in assets in 1996. They are not under government control. The total assets in all pension plans represented 5.6 percent of GDP in 1996. which is low by international and regional standards (see table 4.6). 27. Participation in JAMSOSTEK is mandatory for formal sector workers. It collects 5.7 percent of wages (2 percent from employees and 3.7 percent from employers). In 1977, 14.6 million workers, out of 27.1 million paid workers and a labor force of 90 million were covered. It is a defined contribution plan. As currently funded in 1996, it would provide only about 10 percent income replacement on retirement, compared to a normal rate of 40-60 percent for similarly funded plans. Its investments are concentrated in bank deposits (76 percent) and government bonds (10 percent). Equities make up the remaining 14 percent. As an asset class, the real rate of return on deposits was 9 percent in 1988-95, below the return that would have been available on other assets. The reported rate of return for JAMSOSTEK was slightly more than 3 percent, indicating gross mismanagement of the funds.6 (See Table 4.6). 28. There are many pension issues associated with JAMSOSTEK, most of which are not the topic of this report and are addressed in other studies., What is worth noting is that JAMSOSTEK's investment in bank deposits and notes greatly increases the contingent liabilities of the government to the pension fund under its deposit insurance scheme. As a defined contribution scheme, the government has no direct liability for pensions beyond what can be paid from the funds in JAMSOSTEK. However, if pension payments are low in real terms and if the government's role in the mismanagement of the fund is established, claims will undoubtedly be made on the budget to supplement these payments. In view of the state of JAMSOSEK, it should either be closed or completely reformed. The latter would be preferable and should begin this year. 29. TASPEN is the largest government pension fund, with Rp. 10 Tr. in assets. It covers all civil servants--4 million active members and 1.6 million retirees. Each active member must contribute 8 percent of salary, and the government makes no additional contribution. Like 6Based on the accounting study of state owned enterprises done for this report. 7Reforming Indonesia 's Pension System, Chad Leechor, World Bank Policy Research Working Paper No. 1677, October 1996. 50 JAMSOSTEK, most of the assets are invested in bank deposits (70 percent) and government bonds (12 percent), and the rate of return is estimated to be quite low, similar to JAMSOSTEK. Table 4.5: Social Insurance and Pension Funds (in billions of rupiah) | 19992 1993 1994 1995 1996 Total % SOtURCE OF FU'N'DS (contribution receipts) Mandatory Plans JAMSOSI'EK (Employees Social Sec. System) 280.8 504.2 724.8 883.2 1.110.3 3.503.3 ---- TASPEN (Government Social Insurance) n.a. n a. n.a. n.a. n.a. n.a. ASABRI (Armed Forces Social Insurance) n.a. n.a. n.a. n a. n.a. n a. ---- ASKES (Government Hiealth Insurance) nia. n.a. n.a. n.a. n.a. nia. JASA RAIHIARJA (Personal Accident Insurance) n.a. n.a. nia. n.a. n.a. n a. Subtotal 280.8 504.2 724.8 883.2 1.110.3 3,503.3 ---- Voluntary Plans Employer Pension Funds n a. na. n.a. n.a. n.a. n.a. Financial Institution Pension Funds n. a. n.a. n.a. n.a. n.a. n.a. Subtotal n a. n.a. n.a. I.171.9 1471.6 2.643.5 ---- Total 280.8 504.2 724.8 2.055.1 2.581.9 6.146.8 ---- APPLICATION OF Ft'NDS (benefit payments) Mandatory Plans JAMSOS'I'EK (Employees Social Sec. System) 52.4 92.6 123.3 210.4 270.9 749.6 ---- TASPEN (Govemment Social Insurance) nia. -n a. 231.0 252.0 302.0 785.0 ---- ASABRI (Armied Forces Social Insurance) n.a. n.a. n.a. n.a. n.a. n.a. ASKES (Government Hlealth Insurance) n.a. n.a. n.a. n.a. n.a. n.a. JASA RAIIARJA (Personal Accident Insurance) n.a. n.a. n.a. n.a. n.a. n.a. Subtotal 52.4 92.6 354.3 462.4 572.9 1.534.6 ---- Voluntary Plans Employer Pension Funds n.a. n.a. n.a. n.a. 63.5 63.5 ---- Financial Institution Pension Funds n a. n.a. n.a. n.a. n.a. n.a. Subtotal n.a. n.a. n.a. n.a. 63.5 63.5 ---- 'Total 52.4 92.6 354.3 462.4 636.4 1,598.1 ---- FUND INVESTNIENTASSE'rS Mandatory Plans JAMSOSTEK (Employees Social Sec. System) L.408.1 1.841.8 2.481.0 3.218.3 4,198.2 ---- 15.2 TASPEN (Government Social Insurance) n.a. n.a. 8.282.0 9.124.0 9.788.0 ---- 35.4 ASABRI (Anned Forces Social Insurance) n.a. n.a. n.a. 391.8 475.1 --- 1.7 ASKES (Govemment Health Insurance) n.a. n.a. n.a. 362.6 329.4 1.2 JASA RAIIARJA (Personal Accident Insurance) n.a. n.a. n.a. 168.4 190.3 --- 0.7 Subtotal L.408.1 1.841.8 10,763.0 13,265.1 14,981.0 ---- 54.1 Voluntary Planis Employer Pension Funds n.a. n.a. 7.429.0 10.050.0 12,463.3 ---- 45.0 Financial Institution Pension Funds n.a. n.a. 89.0 157.0 240.0 ---- 0.9 Subtotal n.a. n.a. 7.5 18.0 10.207.0 12.703.3 ---- 45.9 Total 1.408.1 1.841.8 18.281.0 23,472.1 27.684.3 ---- 100.0 Sources: Ministry of Finance; PT Jaminan Sosial Tenaga Kerja (JAMSOSTEK). 30. TASPEN is a defined benefit plan that provides pension and post-retirement health benefits to participants. In 1994, the most recent year for which full information is available, it was estimated that the unfunded liabilities of the Fund were about 30 percent of concurrent GDP on a present value basis. Currently pension payments to retirees are about 30 percent of the government wage bill. They will rise to 70 percent of the wage bill in the year 2020, however by the year 2010, TASPEN's assets would have been depleted and pension payments would require additional budget outlays. 31. It has not been possible to estimate the impact of the crisis on TASPEN. Like JAMSOSTEK, its assets in banks could become a contingent liabilities of the government through the deposit insurance scheme. However, inflation may erode the real value of the 51 payments due under the scheme, while the current high interest rates may increase the return on the assets. Both measures may extend the life of the fund. On the other hand, the government may be tempted to increase benefits to reduce pressures from the civil service. 32. Recommendations: * Decide whether to reformn JAMSOSTEK on accepted pension management principles or close it and return the assets to the contributors * Reform Management of TASPEN to improve the rate of return. * Establish clear guidelines for managenient of the government owned pension funds and bring in professional managers, including foreign managers, to maximize rates of return. * Require that audited information on the assets, liabilities, and returns of the pension funds be made public on a regular basis according to standard accounting principles. 33. The government established the Civil Servant's Housing Fund (TAPERUM-PNS) in 1993. Civil servants are required to make fixed monthly contributions based on their grade level. They are able to withdraw a fixed amount, also based on their grade level, for a down payment on a home purchase, to help pay for home construction, or as a lump-sum (equal to contributions without interest) on leaving the civil service. Applications are made through the civil servant's supervisor to the managing bank (BTN) for down payment assistance and directly to TAPERUM-PNS for construction assistance. 34. From inception in September 1993 to January 1998, the fund received payments of Rp. 1.3 trillion in payroll deductions and interest earnings and disbursed Rp. 511 billion, 87 percent for purchase down payments and about half to civil servants in Java (see Table 4.6). The fund shows a balance of Rp. 543 billion, or about Rp. 250 billion short of the amounts calculated independently that should be the residual amount in the fund. Audited accounts are not available. 35. It is clear that this fund is not well designed nor well managed. It does not follow normal banking principles on the use of money, and it is a tax on those who do not use the fund to purchase a house relatively early in their tenure in the civil service. It is not clear what criteria are used to approve withdrawal of funds or what are the net benefits or costs to different levels of civil servants. It is likely this fund was created to partially compensate for low wages of civil servants. However, it is neither equitable nor efficient. 36. Recommendation: The fund should be closed and unused amounts returned to depositors. Outstanding loans should be converted to regular mortgages. If the government wants to provide housing assistance to civil servants, this scheme should be replaced by one with a sound economic andfinancial structure. There should not be a subsidy element in the scheme. 52 Table 4.6: Ministry of Republic Housing Civil Servants' Housing Fund (in billions of rupiah) 9/93 -3/94 1994/95 1995/96 1996/97 4/97 -1/98 Total % SOURCE OF FUNDS (Author's Estimate) Payroll Deductions 140.0 240.0 240.0 240.0 200.0 1,060.0 81.6 Interest 4.7 31.7 51.6 72.5 78.8 239.3 18.4 Total 144.7 271.7 291.6 312.5 278.8 1,299.3 100.0 APPLICATION OF FUNDS (From BAPERTARUM-PNS) BY PURPOSE (9/93 through 1/98) Home Purchase Downpayment n.a. n.a. n.a. n.a. n.a. 442.7 86.7 Home Construction n.a. n.a. n.a. n.a. n.a. 24.6 4.8 Savings Pay-Out n.a. n.a. n.a. n.a. n.a. 43.2 8.5 Total n.a. n.a. n.a. n.a. n.a. 510.5 100.0 FUND BALANCE (From BAPERTARUM-PNS) Accumulated Capital and Interest Per 31 January 1998 Ministry of Finance Account n.a. n.a. n.a. n.a. n.a. 378.2 69.7 Ministry of Public Housing n.a. n.a. n.a. n.a. n.a. 164.7 30.3 Account Total n.a. n.a. n.a. n.a. n.a. 542.9 100.0 Source: Board for the Consideration of Home Savings for Civil Servants (BAPERTARUM- PNS) and author's estimates. Special Purpose Chartered Charity Funds 37. There are a number of foundations (Yayasans) in Indonesia that are publicly chartered and which raise funds from the public, often with strong government support. They are designed to perform good works and are often presided over by government officials. However, their activities and use of funds do not receive scrutiny, and their accounts are not available to the public. As a result, little is known about their overall activities or effectiveness, though many good works are attributed to them. If these were private foundations, this would not be an issue in a public expenditure review. However, to the extent public officials in their official capacity are involved, that the power of the government is used to obtain funds, or that they receive special tax benefits, they deserve attention. We have examined one such fund. 53 Table 4.7: Takesra/Kukesra Savings and Credit Funds (billions of rupiah) February 1996 - April 1997 SOURCE OF FUNDS External Contributions Amount (%) Individuals 57.1 7.2 Companies 682.0 85.6 Subtotal 739.1 92.8 Participant Payments Savings Deposits (TAKESRA) 23.3 2.9 Loan Repayments (KUKESRA) 34.4 4.3 Subtotal 57.7 7.2 Total 796.8 100.0 APPLICATION OF FUNDS TAKESRA (Savings) 22.9 10.0 KUKESRA (Credit) 205.1 90.0 Total 228.0 100.0 FUND BALANCES TAKESRA (Savings) 46.2 5.8 KUKESRA (Credit) 239.5 30.1 Yayasan Dana Sejahtera Mandiri 511.1 64.1 Total 796.8 100.0 Sources: Yayasan Dana Sejahtera Mandiri and author's estimates. 38. The Prosperous Family Savings and Credit Funds (TAKESRA and KUKESRA) were created in 1996 by Presidential Decree to assist low income families in starting savings accounts and to provide credit to small business activities of these families. To fund this activity, all individuals and companies earning more than Rp. 100 million after tax were required to deposit 2 percent of that income in a special account in BNI and notify the Directorate General of Tax, which had enforcement responsibility. Rp. 800 billion had been collected between February 1996 and April 1997, including about 7 percent in matching savings deposits and loan repayments for participants (see Table 4.7). 54 39. The Fund was managed by the YDSM, a Yayasan chaired by the President, with the Coordinating Minister for People's Welfare and Poverty Alleviation/Chairman of the Family Planning Coordinating Board as deputy. Funds were distributed through the BNI branch network and PT Pos Indonesia to eligible families. 90 percent of the funds used to date (Rp. 205 billion) have been for loans, and 10 percent for savings accounts (Rp. 23 billion). Over Rp. 500 billion have not yet been used. 40. The surtax supporting this fund was abolished by the new government in June 1998, and this foundation has been closed. The ability of other such funds to use public pressure to raise money should also be curtailed. To the extent that any of these Yayasans benefit from special tax status on their investment or can offer tax free benefits to contributions, they are implicitly using public funds (tax revenues foregone). It is not possible to estimate these amounts, nor is it possible to determine whether the funds of the Yayasans are used for further any public interest as their activities since their accounts are not made public. So long as these institutions receive any public benefit, they should be subject to public scrutiny. 41. Recommendations: * All publicly chartered foundations that receive any tax of other public benefits should be required to have their accounts audited and made public annually. a No government pressure, explicit or implicit, should be applied to assist in firnd raising for these foundations. * Public officials should not serve infunctional positions in these foundations. BULOG BULOG occupies a special place in Indonesia and is responsible for marketing several agricultural commodities. BULOG receives transfers from the government to perform certain services, such as supplying the rice ration to civil servants, and it conducts its trading business with certain privileges and monopolies granted by the government in exchange to assuring price stability. It also has access to credit from State Banks at 12 percent, a rate subsidized by the government. It is not responsible for returning any net surpluses to the government. Until recently, the workings of BULOG have not been well understood and its accounts have not been published, which has contributed to suspicions about its activities. This study has been able to put together an initial accounting of the practices of BULOG and estimate its income.' 42. BULOG oversees all imports and supplies about 10 percent of the rice consumed in Indonesia (more imports this year due to the crisis). This represents close to half the marketed surplus (the rest is rural household consumption and local trade). BULOG determines prices at 8 Jorge Garcia-Garcia is preparing a more detailed analysis of BULOG's accounts and operations which will be available shortly. This section draws from that study. 55 Table 4.8: Income Transfers between BULOG and Producers, Consumers and Central Government (in trillions of rupiahs) 1994/95 1995/96 1996197 1997/98 1998/99 RICE Net Total Revenues for BULOG 0.1 0.1 -0.2 -1.6 -7.9 Net Total Revenues for Ministry of Finance -1.2 -1.4 -1.5 -1.8 -3.6 Net Total Revenucs for Farmers 0.2 0.1 0.3 -0.3 -0.4 Net Total Revenues for Consumers 0.9 1.2 1.5 3.7 11.9 Consumers a. Budget Group 1.0 1.2 1.5 2.6 5.9 b. Final Direct Consumers -0.1 0.0 0.0 1.0 6.0 Net Total Revenues for Traders 0.0 0.0 0.0 0.5 1.3 St'GAR Net Total Revenues for BULOG 0.7 0.9 0.9 -1.0 -1.6 Net Total Revenues for Ministry of Finance 0.3 0.3 0.4 0.4 0.4 Net Total Revenues for Sugar Mills 0.2 0.4 0.6 0.6 -1.2 Net Total Revenues for Consumers -0.9 -1.3 -1.5 0.4 2.8 Consumers a. Final Direct Consumers -0.3 -0.4 -0.5 0.0 0.5 b. Industrial Consumers -0.6 -0.9 -1.0 0.4 2.3 Net Total Revenues for Traders 0.2 0.3 0.4 0.2 1.7 WHEAT FLOUR Net Total Revenues for BULOG 0.7 0.6 0.0 0.6 -0.3 Net Total Revenues for Ministry of Finance -0.9 -1.0 -1.0 -3.1 -3.7 Net Total Revenues for Wheat Millers 0.3 0.3 0.4 0.6 1.2 Net Total Revenues for Consumers -0.3 0.2 0.3 1.5 2.3 of which: a. Final Direct Consumers -0.2 -0.2 -0.2 0.0 0.3 b. Industrial Consumers 0.0 0.4 0.5 1.4 2.0 Net Total Revenues for Traders 0.0 -0.2 0.3 0.7 1.2 Net Revenues for Traders, Millers & 0.3 0.6 1.1 2.7 4.4 Industrial Consumers SOYBEAN Net Total Revenues for BULOG 0.3 0.2 0.3 0.0 -0.6 Net Total Revenues for Ministry of Finance 0.0 0.0 0.0 0.0 0.0 Net Total Revenues for Farmers 0.0 0.0 0.0 0.0 0.0 Net Total Revenues for Final Consumers -0.3 -0.2 -0.3 0.0 0.6 Net Total Revenues for Traders 0.0 0.0 0.0 0.2 0.1 SU,.IMARY OF NET REVENlUES Net Total Revenues for BULOG 1.8 1.8 1.1 -1.9 -10.4 Net Total Revenues for Ministry of Finance -1.8 -2.0 -2.2 -4.4 -6.9 Net Total Revenues for Producers 0.7 0.8 1.3 0.9 -0.3 Net Total Revenues for Consumers -0.6 -0.1 -0.1 5.5 17.6 a. Final Consumers -0.9 -0.8 -1.0 1.0 7.4 b. Budget Group 1.0 1.2 1.5 2.6 5.9 c. Industrial Consumers -0.7 -0.5 -0.6 1.9 4.3 Net Total Revenues for Intemational Traders 0.2 0.1 0.7 1.5 4.3 SUNIIARY OF NET REVENUES (USS million) Net Total Revenues for BULOG 832 779 446 -396 -979 Net Total Revenues for Ministry of Finance -804 -883 -920 -909 -651 Net Total Revenues for Producers 332 362 532 175 -33 Net Total Revenues for Consumers -254 -51 -34 1e125 1,654 Net Total Revenues for Intemational Traders 106 63 291 312 606 Memo Items: 2.191 2,282 2,368 4.894 10,632 Exchange Rate Sossrce: World Bank staff estimates. 56 which it buys and sells to influence the overall price level. It also purchases and delivers rice rations to government employees, for which it is paid by the Ministry of Finance. It also controls the markets in sugarcane, wheat flour, soybeans, and some minor crops. In some cases, it acts on its own account, in others through selected intermediaries. Because of its monopoly power, it is able to set purchase and sales margins well above international norms. 43. We have estimated the net financial flows resulting from BULOG's operations. Using available market data, information from traders, plus some information from BULOG on quantities purchased and sold, prevailing international market prices, normal trading margins by crop, and domestic market prices, net gains and losses were calculated for four major crops. These results are shown in Table 4.8. In normal years, BULOG receives net revenues of about Rp. 1.5 Tr. This is well above their costs of operations (not included in the netting). The government pays for the rice that is distributed to civil servants and the military, plus the interest subsidy and some other crop specific payments. The structure of transactions and margins on all crops leads to major resource reallocation among producers, consumers, processors, and traders and contributes to BULOG's overall surplus, which also funds some cross-subsidies. Overall, processors and traders have benefited at the expense of consumers and producers --a perverse outcome.9 The amounts and distribution of the benefits varies by crop and year. 44. These figures confirm the very high margins BULOG allows on its contracts and its ability to exploit it monopoly powers to favor particular interests. In the case of wheat flour, large benefits have accrued to the mills and industrial consumers, and they export a substantial part of their product. In many cases, the consumers have ended up paying higher prices than they would have if more competitive conditions had prevailed. 45. Since the crisis began, the devaluation has resulted in much higher prices for imported food, and the government has instituted large scale food subsidies managed through BULOG. Much larger payments to BULOG will be required than in the past. However, as the analysis shows, a substantial portion of those subsidies do not reach the consumers. Excluding the budget group, less than half the subsidies reach the final consumer. This includes all consumers. The portion reaching the poor is much less. It would be very small indeed for wheat flour and sugar. 46. As part of its stabilization program, the government has agreed to rescind BULOG's monopolies on marketing every commodity but rice. This is a step in the right direction. However, BULOG's control over commodity market extends to a variety of special deals with favored traders and millers. The controlled marketing system managed by BULOG assures high margins. The current traders benefit handsomely from the arrangement and may not be eager to move to a more competitive system, as that would result in lower profits. Although the government's special crisis related measure to provide foreign exchange at a preferential rate (Rp. 6000/$) is supposed to be available to all, only BULOG seems to have access at that rate. Similarly, its access to trade credits at preferential rates gives it a substantial advantage over 9 The consistent net benefit to the 'budget' group for rice is due to the fact that these are the civil servant/military recipients of the rice ration as part of their remuneration. This is an estimate of the market value of their rice distribution, which is normally less that the government is charged by BULOG. 57 private competitors.", Simply declaring an end to BULOG's monopoly is not sufficient to open up the commodity markets. Eliminating thede facto monopoly of BULOG will take more time and effort. The government must instigate a more active program to eliminate BULOG's special privileges and encourage more direct competition, including opening up the market to foreign operators. Furthermore, the lack of trade credit and exodus of many private traders during the crisis means that the potential for competition is limited in the short run. 47. Consumers and the government would benefit greatly from increased competition. Our analysis indicates that BULOG protects large margins that accrue to the intermediaries and that only a part of the funds that are classified as subsidies actually reach the intended beneficiary. Instead they are diverted in the system. There is no reason to preserve BULOG's special status due to market failures. On the contrary, if private traders had access to credit and foreign exchange on the same terms, they could carry out the same functions less expensively, and they should be encouraged to do so on a competitive basis. 48. Beyond assuring some minimum rice security, it is hard to justify the continued existence of BULOG. It is costly to the government and to the consumers, and it results in market inefficiencies. However, designing a transition away from BULOG will have to take account of the current uncertainties faced by in the markets and the need to establish credible alternative systems. For example, BULOG owns most of the off-farm storage capacity for rice in the country. These would have to be privatized as quickly as possible. In the meantime, opening markets to foreign competition, requiring greater transparency in its accounts, and insisting on lower margins would improve welfare and lower the cost of delivering the remaining subsidies. 49. Reforming BULOG and introducing more competition will reduce the excess margins and benefits going to processors. Obviously, not all of these savings can or should be captured by the budget. Much of it should flow directly to producers and consumers through more market-based prices. These savings will help mitigate the impacts of the crisis by reducing margins and thus the marketed price of these foods at any level of exchange rate and direct subsidy. The government should enjoy direct savings from eliminating the rice ration to civil servants and replacing it with a cash payment and through lower costs of supplying subsidized rice and other food products. 50. Recommendations: * The government should adopt a program to phase out most of BULOG 's activities in favor of comipetitive market processes. It shouldl also require BULOG to publish its trading accounts and maurgins. * It should establish a schedule for BUJLOG to ptrivatize its storage facilities and to open its trading and distribution contracts for rice and other food (including imports) to competitive bidding. All qualified anid successful bidlders should have access to the same credit and foreign exchange facilities necessary for assuring food imports (so long as 10 BULOG is currently running a large deficit due to arrears in subsidy payments from the government and larger than normal imports. As a result, it has drawn heavily on its credit lines, squeezing out credit that would have otherwise gone to agricultural producers within the bank's overall credit limits. In the short run, the government is indirectly financing part of its budget deficit by borrowing from the banking sector through BULOG. 58 they are in place--they should be phased ol(t). This program should reduce trading margins to international norms and rely on comipetitive m,,arkets. As soon cas possible, BULOG should cease functioning as a major trader. * The role of BULOG in rice security should be re-examined. alnd a targeted food assurance program designed to replace the expensive program of rice price supports. (This is now underway.) 59 CHAPTER 5: STATE OWNED ENTERPRISES The government has established a number of public enterprises to aichielve certalin policy objectives, provide essential services, ancd promote technical development. Despite Iarge investments, the record shows that the State Owned Enterprises have been nieither efficient nor effective in achieving these objectives. Even in relatively goodl vears, theSOEs contribution to government revenues have been motdest, and they have constituttedl a net cdrain on public resources when capital transfers have been taken into account. As an investnent, thev hcave not earned the cost of the capital invested in themw. They have creaitecd other distortions and inefficiencies in the economy and achieved their public service objectives (wshere definecd) at relatively high cost. These are strong arguments for privaoizing nanmy SOEs nmch nmore aggressively than the government has contenmplated heretofore, clivesting all of those that function in competitive markets and some of those in regulated markets. The governnment does not have the resources to invest in their continued operation and growth. Willingness to sell majority or controlling interests will be important to assure needed improvements in perfornmance and competitiveness as well as to obtain the best price. However, such a progranm should be prepared carefully to get the best value and to establish a satisfactory regulatory framework for firms that operate in non-competitive markets. The current depressed values for Indoonesian assets and the precarious financial situation of nmanySOEs suggest that it will still be dlifficult to obtain full value, but a strong effort is being made. The government is preparing a Master Plan for privatization, and it should be made public to help get the best results. I . Indonesia's Constitution mandates the government to assure the supply of essential goods and services and to promote the growth of the economy. This mandate has been interpreted narrowly as an obligation of the government to directly manage activities considered essential for the nation and to advance technology for competitive economic gain. State Owned Enterprises were the chosen vehicle. This narrow interpretation has given way more recently to a broader view of the role of the government, implying less direct involvement and paving the way for the private sector to enter areas that hitherto had been the exclusive domain of state owned companies. However, the actual transactions to increase private sector involvement prior to the crisis have achieved mixed results due to favoritism shown to certain investors and the lack of competition, transparency, and efficiency is letting contracts for private provision of infrastructure. 2. The government of Indonesia has supported the establishment of a number of public enterprises since independence. Some were taken over from colonial holdings (e.g. plantations), others were created as public utilities (e.g. PLN, PT Telekom), and others were established to meet certain perceived strategic needs that the private sector was not willing to fulfill (e.g. Krakatau Steel, IPTN). Pertamina was established to manage the country's hydrocarbon resources in the state's interest and has a special status. Doubtless, many of the smaller SOEs 60 were set up for more immediate and idiosyncratic reasons. Over time, the number has expanded and there are currently about 160 SOEs.' 3. The primary objective of this Review is to look at the impact of the SOEs on government expenditures. Basic accounting data on all SOEs was supplied by the Ministry of Finance. More detailed analysis was carried out on a sample of 22 SOEs, which represent about 75 percent of the total assets of the non-financial SOEs. Within the total sample, it is important to distinguish three groups of non-financial SOEs: those that function in non-competitive, regulated markets; those that function in competitive markets; and those that present special circumstances, essentially the Strategic Industries. These categories correspond to classifications being used by the new Ministry of State Enterprises, and they have particular relevance in defining the privatization program. The state owned banks will generally be treated separately. The losses of these banks and the contingent liabilities from the government's deposit insurance program constitute a large overhang of potential claims on the government. The immediate budget impact is covered in the line for financial sector reform in Table 2.2. 4. The bulk of the data available is for the 1994 to 1996 period. Preliminary 1997 data is being analyzed, along with estimates for 1998. The 1994-6 data show the performance of the SOEs during a relatively favorable period. That this performance is unsatisfactory on a number of counts suggests that major changes would have been needed for the sector regardless of the advent of the crisis. Trying to return to the situation ex ante is not a viable option. 5. Subsequent events have greatly increased the difficulties faced by the SOEs. Preliminary information suggests that some SOEs are able to weather the crisis and still generate profits. These are the ones with low external debt and continuing markets for their output at uncontrolled prices, for example the agricultural plantations (which export). Others are illiquid, if not insolvent. These have large external debts, foreign exchange denominated obligations, and/or Rupiah denominated revenues and controlled prices. Examples include PLN, Pertamina, and Garuda Airlines. They will require large transfers of government resources to meet debt service payments and to reimburse them for the subsidies they deliver. 6. In the rest of this chapter, we will discuss the extent of the SOE sector and its relation to the rest of the economy, its contribution to public finances, the effectiveness of its use of public resources, and future options for the sector, including priorities for its privatization program. I A few are technically Perums, which do not have a formal corporate structure and have no tax and dividend obligations. These have been traditionally included with the SOEs and amount to a small proportion of the set. 2 The firm of Mann Judd was used, in association with Hadori & Associates of Jakarta to analyze this data. A great deal more information was gathered and analyzed that was needed for this report. The data has been made available to the authorities for their further work with SOEs. 3 There is already an extensive program underway to deal with the severe problems facing the banking sector. Balance sheets of banks differ fundamentally for non-financial institution, so their exclusion from most of the analysis of the SOE sector will permit a more consistent viewpoint. 61 Box 5. 1: Pertamina Pertamina is by far the largest SOE in terms of revenues and earnings. Created as government agent to develop and manage the national hydrocarbon resources, Pertamina has acquired almost sovereign status. A special legal statute gives the management of Pertamina exceptionally strong powers without, however, defining their accountability and oversight. Reforms of national petroleum companies in other developing countries have already moved away from this approach toward far less sweeping powers and more accountability. Pertamina has its own oil and gas development and production activities (though most production is done by foreign firms under production sharing contracts), and it is responsible to obtaining the best return on those assets. It is also responsible for domestic refining and distribution of petroleum products, and channels fuel subsidies through its pricing of domestic products. Beyond these core activities, Pertamina has become involved in a variety of non-core businesses, including hotels, an airline, and office buildings. There is no public accounting for the profitability of these activities, and they (along with oil refining and distribution) have reportedly been the source of highly lucrative contracts let on a non-competitive basis. The new government has moved to eliminate the worst of these deals, which should result in savings to consumers and the government through more efficient distribution and less need for subsidies. Lack of reliable information precludes a meaningful assessment of Pertamina's performance by commercial standards. Available evidence suggests that the annual costs of supplying the domestic market and generating exportable surplus could be cut roughly by between Rp 8 and Rp. 12 Tr. These calculations, however weak the underlying data, underscore the need for a thorough assessment of Pertamina's operations and contractual arrangements. There is no reason why its transactions should be any less transparent than Indonesia's other mineral extraction activities. Pertamina has a number of dollar denominated contracts to suppliers that it is having difficulty making payments on because the government is in substantial arrears on its subsidy payments, and Pertamina cannot raise its sales prices. It is likely the govemment will "owe' Pertamina as much as Rp. 40 Tr. this year for all its activities and subsistance. Pertamina is tapping its credit lines, accumulating arrears, and reducing maintenance and other operating costs as a result. This is likely to lead to significant problems with the major oil companies and lenders with whom Pertamina deals. The government should begin modernizing Pertamina and transforming it into a world class operator. As a first step, to reduce inefficiency or rent generation contracts, operation of Pertamina fields, refining and distribution activities, and other overhead activities should be subject to independent expert assessment. Such an assessment would establish whether the Indonesian public gets its money's worth from Pertamina's operations. It would also indicate the parameters for a reform program. In line with international experience and within the confines of existing legislation, reforms should revise onerous contracts, introduce competitive bidding for new contracts, divest non-core activities, including the distribution network, and eventually allow full competition in the various segments of the hydrocarbon market. In the short run, attention should be focused on revising the most questionable contracts, obtaining a full accounting of Pertamina's activities, and beginning the divestiture process. Extent of the SOE Sector 7. The SOEs covered generated Rp. 122.9 Tr. in sales and Rp. 15 Tr. of profit in 1996. Their sales and profits represented 21 percent and 2.6 percent of GDP in that year. The companies employed nearly one million persons and had total assets and equity of Rp. 437 Tr. and Rp. 1 14 Tr., respectively., Seven banks are included in these totals. They employed 86,653 4In effect, the combination of high margin contracts to favored individuals and subsidies on the final price served to transfer public resources to the favored contractors rather than protect the public. 5The valuation of assets is based on the financial statements, and there are several reasons why it may not accurately represent the real assets used by the firms. Physical assets may be carried at acquisition value and not revalued to reflect changes in prices that have occurred, thus understating value. In other cases, assets may have been acquired at inflated prices, overstating value. The assets of the SOEs will be affected by the crisis, adversely in most cases. 62 Table 5.1: State Owned Enterprise Basic Indicators, 1996 (in trillions of rupiah; labor in 000 units) Sector Revenue Operating Tax Dividends Total Equity Labor Profit Payments Assets Force Competitive 27.4 3.9 0.9 0.3 49.7 21.0 545.9 Strategic Industries 4.2 -0.1 0.1 0.0 11.0 6.6 39.3 Regulated 67.1 7.8 0.9 0.5 126.6 69.9 264.2 Other 2.0 0.3 0.0 0.1 6.2 1.0 39.5 Total (ex. commercial banks) 101.5 10.1 1.9 0.9 193.7 97.8 837.3 Commercial Banks 22.1 1.7 0.5 0.7 178.0 12.8 86.7 Total 122.9 14.2 2.4 1.6 371.6 111.3 975.6 Sample of 22 62.0 138.0 1.1 0.9 123.0 79.0 429.9 Source: Mann and Judd and Hadori and Rekan. 1996 Sectoral Analysis and Value Added report prepared for The World Bank, May 1998 persons and had Rp. 178 Tr. in assets and Rp. 12.8 Tr. in equity in 1996:' The non-bank SOEs employed 834,000 persons, and had Rp. 193 Tr. in assets and Rp. 98 Tr. in equity (See Table 5.1). The 1997 and 1998 data will show a different picture when it is available. Three enterprises dominate the SOE sector in terms of revenues and assets. Pertamina, PLN, and PTTelkom account for 40 percent of sales and 30 percent of assets. The PTPNs (plantations) are the dominant employers among the SOEs with 38 percent of the aggregate work force. 8. Regulated Industries: Although as a share of GDP or employment, the SOE sector is modest, efficient performance of the larger SOEs is essential to a well functioning economy, especially the public utilities. Enterprises in the regulated sector represent by far the largest public holdings among the non-financial SOEs. They account for 65 percent of non-financial assets and revenues, 70 percent of equity, and nearly 80 percent of the operating profits. These are the public utilities that most directly address the constitutional requirement for the government to assure the provision of essential goods and services 9. The Strategic Industries: The creation of Indonesia's Strategic Industries was motivated by two principle objectives: (i) to accelerate the development of domestic technology-based capabilities so that Indonesia could become a leader in high-technology applications; and (ii) to promote the integration of Indonesia's archipelago by creating domestic transport and communication production capabilities. Ten companies have received special government support for this purpose. Their product range covers steel, aircraft, ships, rolling stock, digital exchanges, hIeavy equipment, and military products. They account for 6 percent of non-financial assets and 4 percent of revenues of SOEs. 10. The Strategic Industries have made significant progress in mastering some advanced technology applications, establishing technical and commercial agreements, and creating a core of highly trained engineers. These technical achievements contrast starkly with the commercial failure. They have generated substantial losses and have not been able to produce and market 6 For the banks, many of the assets may be non-performing loans which have not been written down. By some estimates, bad loans represent a very substantial portion of the recorded assets of state banks, which were not admitted in 1996, but have surfaced since the crisis began. 63 competitive products. In the aggregate, Strategic Industries suffered losses of R. 40 billion on revenues of Rp. 4.2 trillion in 1996. This is in part due to inefficiency in operation, and in part due to the high cost and great difficulty in breaking into world markets in some these products. The current crisis strongly suggests that the whole rationale for the strategic industries must be reconsidered. The holding company approach through BPPI is no longer valid, and the strategic industries will have to be evaluated and disposed of as other SOEs. Only two companies -- PTKS (steel) and PTINTI (telecom switches) -- have been marginally profitable, and Krakatau Steel is a prime candidate for privatization. The non-profitable Strategic Industries will require deep corporate restructuring (including reduction of product lines and sale of some assets) or privatization, and some may not survive. The government has stopped exceptional funding of some, such as IPTN (airplane manufacturing), and is investigating what value can be salvaged, if any. Work on development has been halted. Box 5.2: PLN PLN ran an operating surplus of Rp. 1.2 Tr. in 1996, it is projected to run a loss of Rp. 8.3 Tr. in 1998 -- assuming that electricity tariffs will be increased by another 36% during the remainder of the year. as announced previously, and that the government will service PLN's multinational and bilateral debt obligations. Including direct subsidies, it is estimated that PLN will require transfers from the govemment equivalent to almost 70% of revenues from operations. PLN is not viable as a "going concernm- under present circumstances: it has a negative net worth. Compliance with rapidly increasing payment obligations under existing power purchase and fuel supply contracts would require ever increasing transfers from the government, which could not be met within very tight fiscal constraints. At the same time, due to lack of demand, PLN would have to back down its efficient base load plants in order to absorb the power it has to purchase from the IPPs. Present tariffs are equivalent to about 1.7 cents per kWh. which do not even cover the variable costs of power generation. Substantial increases in electricity tariffs beyond those planned at present would be required to ensure PLN's financial viability. It will take time to bring tariff levels up to average long run marginal system costs (about 7 cents per kWh), a necessary condition for sustainable power sector development. Recent events have rendered the govemment's approach of private sector entry into generation and gradual restructuring of PLN obsolete. Immediate action to keep PLN functioning and to create a foundation for sustainable sector development in the medium-term is required in four areas: * rationalize power purchase and fuel supply contracts in line with PLN's medium- and long-term payment capacity as well as requirements for sound sector development to ensure efficient capacity utilization; * rationalize tariff structures in line with payment capacity, ensuring life-line support for social groups at risk: * raise the average tariff to a level that would cover variable costs at the minimum. Press further tariff increases toward the limits of social feasibility to allow for recovery of capital charges and hence recovery of asset value; * restructure PLN into independent operating companies for divestiture to strategic investors with the aim of raising efficiency and ensuring future investment requirements. The government may have to assume some existing debt to allow divestiture to private investors. If so, it should obtain some long-term (but non-voting) interest in the privatized entity that would give it the potential for a returr on its capital investment. II. Competitive Market SOEs: There are a large number of SOEs that operate in competitive markets, some 113 firms, including the plantations. They tend to be small, with 25 percent of total assets and revenues and 4 percent of operating revenues. However, they are the largest employers with 65 percent of the workforce, and their tax payments were equal to those of the 64 SOEs in regulated industries. Whatever the reason for their creation, there is no public policy reason for SOEs in competitive markets to receive special treatment of the type extended to those in regulated industries. They should have been held to the same standards of private firms, but they weren't There is no reason either to retain them in the public portfolio, and they should be sold expeditiously. 12. Other Impacts: Most of analysis in this report concerns the financial relations between the government and the SOEs and their direct impact on the budget. Achieving policy objectives in the regulated sectors may imply lower profits and taxes to the government. In addition to these direct financial impacts, policies and interventions by the government in the operations of the SOEs, their relations with each other, and with the rest of the economy have had many impacts on economic efficiency which are not addressed in this study. This may also reduce profits. 13. The economic efficiency of SOEs may be affected by government's actions in a variety of ways, and most have been negative. Regulations and directives governing procurement and sourcing of inputs often specify certain suppliers or do not require competitive procurement practices, thus leading to higher costs and lower quality services. Regulation of tariffs and prices are used to implement cross-subsidies, which lower profits and distort price signals. If the distortions are large enough, as is currently the case, the solvency of the SOEs is threatened, and large transfers are required to make up for the deficits. The government has directed credit allocations and established preferential rates in state banks for certain borrowers, which has distorted the allocation of resources and contributed to the banking crisis. It has also directed SOEs to develop certain business lines or undertake certain investments without due regard for the economic benefits. Senior personnel appointments have been largely based on political rather than commercial considerations, which creates unclear incentives for managers and has led to overstaffing and poor performance.7 14. Examples of such interference includes: Requirements for state shipping companies to buy ships for inter-island transport from the state shipbuilding company raised costs for this activity, undermining the government's objective to improve internal communications. The steel company produces relatively high cost steel that domestic producers were often obliged to buy, thus raising their costs. Impacts of the SOEs on Public Finances 15. The most immediate measure of the impact of SOEs on public finances is the direct flows paid and received. These include taxes and dividends paid to government and investment and subsidy transfers from government to the SOEs. SOEs paid the government Rp. 4.0 trillion in 1996 (See Table 5.1), of which Rp. 2.4 trillion represented taxes and the rest dividends. In addition, SOEs are required to assist small and medium scale industries out of their profits, which was an implicit tax of Rp. 183 billion.8 The non-financial public companies paid taxes ofRp. 1.9 7Senior staff often come from the supervising ministries. They often lack the commercial experience and skills needed. The expectation of appointments in a SOE also blunts the interest of the civil servants in the ministry from exercising tough oversight with the SOE. 8 However well intentioned, this is a diversion of management and financial resources with no clear link to each SOE's business. There has been no evaluation of whether this has been an effective program. Such contributions are being cut as a result of declining profits due to the crisis. 65 trillion, and the commercial banks paid Rp. 0.5 trillion Profit taxes from the public companies represent less than 10 percent of the government's revenue from income taxes. Dividends from all SOEs accounted for Rp. 1.6 trillion, of which Rp. 0.9 trillion were paid by non-financial SOEs. Dividends represent about 15 percent of government's non-tax revenues. The 20 largest companies with 85 percent of the assets of the SOE sector paid 60 percent of the income taxes and 75 percent of the dividends of all public companies. Pertamina, the government-owned oil company, does not pay taxes or dividends, however, it makes payments to the government through profit-sharing agreements and other arrangements. These amouLited to Rp. 1 .5 trillion in 1996. PLN, the electricity company, paid no income taxes and only Rp. 18 billion in dividends in 1996. 16. The actual average tax rate paid was 22 percent (excluding Pertamina). compared to a statutory rate of 30 percent for SOEs. Tax rates paid by public companies varied widely across sectors. This shortfall is probably due to the SOEs taking advantage of accelerated depreciation and other tax benefits to reduce tax liabilities. Some SOEs have large equity bases that facilitate such tax accounting, but contribute little to their production and profits. If the companies had not been able to benefit from these tax breaks, their payments would have been Rp. 0.6 trillion higher. 17. Dividend rates differed substantially by sector and by company, ranging from as low as 3 percent of after-tax profits in agricultural companies, which have generally been quite profitable, to 31 percent in the public works companies. Dividends may have been set to meet government revenue needs9 or to allow enough resources to remain with the SOE to carry out an investment program. The revealed variation indicates a great deal of discretion and a lack of transparency in setting dividend policy. 18. However, taxes and dividends are not the whole story of the impacts of SOEs on government finances. Looking at Table 5.2 for the sample of 22 SOEs, the government transferred Rp. 7.7 trillion in 1995 and Rp. 3.0 trillion in 1996 in capital transactions, more than the Rp. 4.1 trillion in payments it received from the SOEs in 1995 and Rp. 5.0 trillion in 1996. 75 percent of these transfers were in the form of equity contributions, while the rest were government arranged or guaranteed loans. In some cases, the equity was in the form of loan forgiveness to improve the financial statements of the SOE. The net flows from the SOEs to the government was a negative Rp. 3.6 trillion in 1995 and a positive Rp. 2.0 trillion in 1996.'> 9For example, in the recent negotiations with the IMF, the government canvassed SOEs for higher dividends to help reduce the deficit. °0This comparison mixes current and capital transfers. The net flow is a measure of the impacts of the SOEs on the government's cash position for the year. Whether a positive or negative flow is good or bad depends on the evaluation of the investment made and the target for profits. 66 Table 5.2: Cash Flow from Government to SOEs (in billion rupiahs) Twenty Two Twenty One Companies Companies (excluding Pertamina) 1995 1996 1995 1996 1. Central Government Current Revenues and Dividends 4,149 5,018 1,537 1,898 A. Tax Revenue 1,976 2.680 872 1.028 B. Dividends Received 1,081 854 654 854 C. Oth er 11 17 11 17 D. Government Rebates 1,081 1,467 0 0 11. Capital Outlays 7,725 2,997 7,725 2,997 A. Cash Flowfrom Investment Activities 5,735 2,822 5,735 2,822 B. Cash Flowfrom Financing Activities 1,991 175 1,991 175 Ill. Net Transfers to Government (1-11) -3,576 2,021 -6,188 -1,099 IV. Price Support to SOEs (subsidies) 513 3,459 542 602 V. Total Cash Flow (III-IV) -4,089 -1,438 -6,730 -1,700 VI Net Current Flows (I-IV) 3,636 1,559 995 1,297 Total Debt and Equity Held by Gov. 63,438 66,435 63,438 66,435 Source: Mam-Judd HLB, ibid Note: Pertamina is included in the cashflow of the 22 companies However, excluding Pertamina, the total flows were negative in both years--Rp. 6.2 trillion and Rp. 1.1 trillion In 1998, it is clear that taxes and dividends will be much lower, and the need for equity infusions will be very large. 17. In addition, there have been transfers to certain SOEs (primarily Pertamina and PLN) to reimburse them to subsidies that have been effected through lower prices charged for their products. These are payments in excess of the implicit subsidies and cross subsidies that the SOEs were able to manage by accepting lower profits. These amounted to Rp. 0.5 trillion in 1995 and Rp. 3.5 trillion in 1996. The direct energy subsidies throigil Pertamina and PLN will amount to Rp. 36.0 trillion in 1998. It is important to note that the subsidies are a result of other government policies, not an added burden of the SOEs themselves. Effectiveness of Financial Resource Use by SOEs 18. Public investment in SOEs has been large, and in recent years the need for capital infusions has exceeded the net revenue to the government. This raises the question of whether the investments have been productive and yielded a good return on the government's funds. By examining the yield on the total capital employed in their operations and comparing it with the average cost of capital, we can estimate the financial performance of the public companies. The return on total capital employed (ROCE) and the ratio of profits to capital (net operating profits after tax but before interest/total capital employed in the business) indicate whether the public funds have been well invested. 19. The average cost of capital measures the cost of financial resources invested in the SOEs (equity and debt). It is calculated as a weighted average of the cost of the debt and equity that a firm employs. The weighted average cost of capital for all SOEs in Indonesia was estimated by the consultants at 19.8 percent in 1996, based on an estimate of 32.4 percent for equity capital 67 and 15.4 percent for debt. When the return on capital employed exceeds the company's average cost of capital, the business adds value for its shareholders; when thie return on capital falls below the cost of capital, the business loses value. These financial measures indicate the return to the owner (the government). They do not measure economic performance, since low returns to the government may be due to policies that transfer those returns to other parts of the economy. 20. Most public companies in Indonesia subtract value for the government, as a look at Table 5.3 indicates. The data show that only 19 companies earned 20 percent or more on their capital employed, while 129 companies earned less than that amount. The 19 companies that earned over 20 percent on their capital have assets equal to 4 percent of the total assets of the 159 companies. Firms owning 80 percent of assets earned less that the cost of debt financing. Moreover, 21 companies representing about 3 percent of the total assets have negative returns on the capital employed. Since 1996 was a good year for public companies, we can safely assume that the SOEs have generally reduced the resources available to the government below what they should otherwise have earned. Table 5.3: Return on Total Capital Employed by Non-Banking Public Companies: 1996 Return on Capital Number of Share in Total Value of Assets Share in Total Assets Employed Companies Number (percent) (percent) (in billion) (percent) > 50 5 0.6 430 0.2 30.0 - 49.9 6 3.1 1,439 0.6 20.0- 29.9 10 8.2 7,699 3.1 10.0- 19.9 33 23.9 38,069 15.6 0.0 - 9.9 70 50.9 189,388 77.4 < 0 24 13.2 7,653 3.1 Total 148 100.0 244,679 100.0 Source: HLB Mann Judd in association with HLB Hadori & Rekan ibid (May 1998) This table will be revised, pending new information from hadori). 22. All the non-financial SOEs earned Rp. 14.2 trillion in profits before tax in 1996. Had they earned their cost of capital," profits would have been Rp 63.9 trillion. The companies, thus, fell Rp. 49.7 trillion short of the mark, and the government, as owner, suffered a substantial loss of return on investment. Even if the SOEs had earned only the cost of debt capital, they should have earned Rp. 38.8 trillion more. The taxes that would have been payable on these earnings would have raised government revenues by Rp. II trillion at the 30 percent corporate tax rate or about 12 percent of government revenues. The rest of the profits would have been available for investment, reducing the requirement for more capital infusions from the government, or reducing borrowing (mostly from abroad). For public utilities, it may be argued that there were social benefits to offset these costs, however, the effective cost (to the economy) of delivering these benefits was Rp. 9.5 trillion for SOEs in regulated markets. The cost in lost profits from the state banks was Rp. 23 trillion and from the Strategic industries, Rp. 1.0 trillion For those SOEs i "Recalling that the estimates of assets are subject to errors. 68 in competitive sectors, the shortfall in return represents a clear loss to the government. In terms of opportunity costs to the government, the state banks and public utilities have been much greater drains than the strategic industries. It is also noteworthy that theSOEs in the competitive sectors earned a higher rate of return than those in the regulated sector (see Table 5.4). Table 5.4: Summary Data of Public Companies: 1996 (in trillion of rupiah; ROCE in %) Company Group Sales Total Capital Equity ROCE Assets Employed (percent) All Companies 124 372 340 111 4.4 Banks 22 178 169 13 1.4 Non-Financial Companies 102 194 171 98 8.2 Competitive 27 50 41 21 9.5 Strategic Industries 4 11 10 7 -0.4 Regulated Industries 67 127 115 70 6.8 Other 2 6 6 1 4.6 Twenty Two Companies 62 138 123 79 5.6 Share of 22 in Non-Bank (%) 75 80 77 84 Sozurce: Mann Judd and Hadori and Rekan, Sectoral Analysis Report, May 1998 ibid. 23. Benchmarking Comparisons: Another way to evaluate the performance of enterprises is to benchmark them against similar firms elsewhere. This can be a complicated exercise and done thoroughly requires both detailed financial and physical (engineering) comparisons. For this Report, there was only time and resources for a more limited comparison based on financial comparisons of the set of 22 SOEs, and on 'reasonable' estimates of what changes would be possible in Indonesian firms to match the performance of the benchmarks. The benchmark firms identified for the 22 companies are mostly in Southeast Asia and are as similar as possible to the Indonesian SOEs. The findings give an approximate measure of how well Indonesian SOEs stacked up to others in 1996, but cannot be interpreted as targets for SOE performance. 24. This exercise was carried out by comparing actual and potential market value of the firms. The first step estimates the market value of the 22 SOEs using standard market valuation techniques. Based on their performance in 1996, there firms had a combined market value of Rp. 27.3 trillion. Pertamina had the largest value, Rp. 15.7 trillion, followed by PT Telekom, Rp. 7.0 trillion, and Indosat, Rp. 2.3 trillion. Although most companies had a positive value, four of them--PLN, Garuda, IPTN and Pelni--had a negative value. 25. Then the question was posed: what would it take for the Indonesian SOEs to earn the same rate of return as their compartors? Reasonable assumptions were made about how each Indonesian firm could alter its prices, revenues, cost of sales and operating expenses, assets, cash holdings and liabilities in order to improve its performance to the level of thecomparator.'2 If these 22 Indonesian SOEs had been able to match the rate of return of the selected benchmarks, 12When the Indonesian company earns a higher return on capital than the benchmarking partner, we maintain the initial conditions of the company. 69 their market valuation would increase from Rp. 27.3 trillion to Rp. 60.8 trillion.,, (Table 5.5) In this analysis, estimated sales revenues remain almost unchanged relative to actual revenues, but gross earnings increase from Rp 11 trillion to Rp. 16.8 trillion. The improved performance comes primarily from reducing expenses, interest payments, and operating costs, i.e. improving management. The return to capital remains below the average cost of capital in Indonesia, but the shortfall is much less. 26. The benchmark firms also did not always earn their full cost of capital. perhaps reflecting the fact that they may have been used to achieve public objectives where they were also state owned. A second estimate was conducted to see what would happen if the Indonesian firms were able to earn the same return relative to the cost of their capital as thecomparators did relative to their own cost of capital. This is a higher standard because the cost of capital in Indonesia was relatively high in 1996 compared to that faced by the benchmarks. As in the previous section, the potential earnings and market valuation of the companies have been estimated under assumptions of changes in cost and expenses, increases in revenue, changes in assets, liabilities and the debt- to-equity ratio, etc. If Indonesian SOEs would have met this standard, their earnings before interest and tax would have increased to Rp. 23.0 trillion. The market valuation of the companies would have risen to Rp. 122.9 trillion. Under this scenario, sales would need to increase from Rp. 76.6 trillion to Rp. 83.7 trillion, which may not have been feasible in all cases. Thus this comparison is more indicative of a potential rate of return reference in a better environment. Table 5.5: Valuation of Selected Companies in 1996 (in trillion rupiah) Value based on Value achieve ROCE of Value achieve relative cost Current Performance Benchmark of capital of benchmark Garuda Indonesia -0.38 0.99 1.75 Indosat 2.28 2.28 4.34 IPTN -0.77 0.87 2.11 Jasa Marga 1.22 1.22 1.22 PLN -3.23 2.91 39.41 PTPN fi III 0.72 0.65 0.65 PTPN ri IV 0.57 0.57 0.57 PTPN A IX 0.08 0.08 0.08 Semen Gresik 0.76 1.74 1.74 Krakatau Steel 0.40 1.12 2.94 TELEKOM 6.99 10.67 18.25 Total of all 22 27.30 60.76 122.89 Sozurce: Mann and Judd, Hadori and Rekan. 27. The results of this exercise show that for the majority of companies, the most significant changes in their performance come from reductions in costs and expenses, rather than from '3Table 5.8 in Annex shows the value of sales and earnings before interest and taxes, debt-to-equity ratio, the cost of capital, and the market valuation of each company. The table also shows the assumptions about price, cost, expenses and other drivers of profits that generate the new gross earnings (EBIT) and the market value of the company. 70 increases in the prices of the products and services they produce. The companies generate low earnings and have low market valuation because they have not acted effectively to contain their costs. The govemment, as owner, has not insisted on a high return on its investment. It must be noted that these are illustrative figures about the relative performance of the SOEs, not actual targets. The situation in 1998 would be different, and probably much worse. 28. The findings from this modeling exercise are consistent with the results of a direct survey made by HLB of the managers of the companies studied. The managers reported that the companies have more workers than needed and that their other operating costs and expenses could be trimmed significantly. For the public companies to generate more profits and value for the government, they must cut labor and material costs and make their operations more efficient. The current economic crisis and the difficult fiscal situation call for radical reforms in public company management and ownership. The Future of the SOEs 29. The SOEs have played a special role in the government's development strategy to assure the provision of certain goods and services and to lead development in selected areas. The above analysis has demonstrated that this has been achieved at a high cost. SOEs have not been efficiently run, and subsidies administered through low prices have been wasteful and poorly targeted. In addition, recent attempts to bring more private sector participation into financing public infrastructure have raised questions about regulatory frameworks, effective contracting and the longer-term costs and benefits of such arrangements. This section will elaborate on these concerns in the context of the government's plans for accelerating its privatization program.. 30. The new government has set an ambitious agenda to reduce the cost of doing business in Indonesia, including an overhaul of incentives, laws, and regulations that govern the economic conduct of the state and the private sector. Corporate restructuring of SOEs, realignment of administrative functions, and privatization will be core elements of this agenda. The government has created a new ministry (MOSE) with exclusive authority to control, restructure, and privatize SOEs. It also has authority to appoint commissioners and managers". The authority of the line ministries has been limited to sector policy reforms and regulatory oversight, and the Ministry of Finance no longer exercises SOE ownership rights on behalf of the government. 3 1. Within this new structure, the interface of MOSE, line ministries, BAPPENAS, and MOF in targeting social service obligations, setting tariffs, and transferring subsidies for regulated industries needs clarification. The economic recession and severe budgetary constraints call for a strengthened and more transparent framework to ensure viable tariff levels, effective subsidy targeting and transfer, and realistic development objectives across, sectors including a coordinated approach in defining the rules for private sector involvement in infrastructure. While MOSE has the mandate for privatization (transfer of existing public assets to private investors), BAPPENAS has the mandate for concessions (new entry of private investors in infrastructure). This institutional set-up provides for checks and balances, but it also calls for an overarching game plan with a strong commitment for constructive cooperation. Although the government is setting ambitious privatization targets, privatization in and of itself is not the goal. Meeting 14MOSE has introduced a flat management structure and kept staff to a minimum, backed up by contracted technical expertise as needed. MOSE needs to remain lean to be credible in achieving its ultimate objective: working itself out of business. 71 public objectives of efficient management of utilities and cost-effective service delivery is. This means that establishing a well -functioning regulatory framework is necessary before privatizing public utilities, especially where there are monopoly elements in the market. 32. The Regulatory Framnework: Privatizing public utilities poses complex regulatory issues of controlling prices, assuring quality of service, and encouraging efficient operating and investment decisions. On the one hand, consumers need protection from possible monopoly abuse and rent seeking behavior. On the other hand, investors need a buffer against arbitrary government interference in investment and pricing decisions. The establishment of a transparent and sound regulatory framework is indispensable for effective privatization of state enterprises. While there are ways to introduce competition and reduce monopoly factors in these industries, the need for a regulatory structure remains. 33. Indonesia's regulatory system needs a major overhaul to facilitate the privatization program. Legal foundations are considered weak and specific sector laws do not allow consistent application of rules across sectors. Indonesia must be able to offer a satisfactory regulatory system if it is going to attract quality investors in the future. Regulatory authorities need to be independent in order to gain credibility with investors and consumers. While regulators or regulatory commissions cannot be totally independent of political considerations, decisive action to create an arms-lengths relationship between policy and regulatory functions is urgently called for. 34. International experience has shown that there are ways to enhance the de facto independence and accountability of the regulatory framework short of enacting sweeping legislative change. In Indonesia, this could be done by establishing--as is presently being considered for the energy sector-regulatory authorities, Badans, outside the line ministry, yet reporting directly and exclusively to the respective line minister. CreatingBadans would allow for credible regulatory actions: appointing regulators for fixed terms; setting out their powers and duties clearly; giving them financial autonomy (through special levies) to create technical capacity; prohibiting them permanently from working for the companies they regulate; establishing clear reporting requirements, including published annual reports. To economize on scarce talent, one of these institutions could be given responsibility for several sectors. Strategic Options For SOEs: Better Management and Privatization 35. The earlier rationale for some public ownership of public utilities is not without value. There are many areas where the private sector is not directly interested in investing for a variety of reasons. I-owever, in the case of Indonesia, there are good strategic reasons why more SOEs should be privatized, particularly those that function in competitive markets. But in the end, the government will have to evaluate the costs and benefits of privatization as a tool for meeting its development objectives in the current circumstances. Resource constraints and the need for greater management efficiency would argue for privatization wherever possible, or at least greater use of competitive processes. In areas where privatization is not selected, measures should be taken to improve management performance and accountability. The rest of the section will address the issue of privatization. 36. Indonesia has partially privatized six SOEs since 1990. These experiences were mixed. The earlier privatization of the joint ventures of PTTelkom, creating independent regional telephone companies under so-called KSO arrangements, was well received by the market at the 72 time. Bidding variables were clear, pre-qualification was strictly adhered to, and the award process was transparent from beginning to end. In contrast, the IPO of PTTelkom, the most recent and by far largest privatization in Indonesia, was not well managed. International investors did not consider it a success, and a subsequent block sale of shares on favorable terms to well-connected domestic investors was not carried ont transparently. 37. The rather cautious steps taken in privatization prior to installation of the new government in May indicated a reluctance to really give up control. This was revealed by the preference to maintain intact government appointed management teams and to" privatize" SOEs by selling minority shares. Since one of the main problems identified with the sector has been the lack of effective incentives for management to operate the SOEs efficiently, reluctance to change management would preclude or delay the infusion of the private management control that is needed for quick improvements in the efficiency. Whatever process is followed, incentives for current SOE managers need to be changed and oversight strengthened during the transition period. For the SOEs that remain in the public portfolio, these management reforms should be institutionalized. 38. As the first stage in its reform program, GOI has set an agenda for privatizingSOEs. It has committed to concluding privatization transactions (primarily through sale of minority equity shares) for 12 SOEs by March 1999, with expected sales revenues of $1 billion. The new government lias reaffirmed this commitment, undertaken to move beyond the initial target as soon as possible. . However, in view of the continued deterioration of the economy and financial situation of the SOEs--this has become an even more formidable challenge. Internationally traded Indonesian stocks have hit record lows and the domestic capital market is highly illiquid. The sharply eroded net worth of virtually all SOEs--a result of unhedged debt obligations in foreign currencies and lack of tariff and price adjustments--will severely restrict the potential proceeds from privatization in the near term. Nevertheless, substantial progress is being made with some firms. 39. The GOI is concentrating its efforts on companies with sizable revenue potential. Of the 12 SOEs selected for the first round of divestiture, 5 are listed SOEs where a secondary (minority) offering of government shares is planned, accompanied by IPOs of shares in 7 unlisted SOEs. These latter may be preceded by a strategic sale to enhance company value. The first round privatization candidates comprise candidates in regulated and competitive markets, including one agricultural estate. All transactions are scheduled for completion by March 1999. There are several important regulatory and corporate issues to be resolved for some of these firms. Several SOEs are proving interesting to reputable investors, if they can get a controlling interest (steel, cement). Serious negotiations are under way for several firms. 40. While maximizing revenues from the disposition of its equity holdings inSOEs is a key element in the government's economic stabilization program, this objectives must be balanced by concerns to avoid the risk of creating private monopolies or perpetuating inefficiencies in operation. It is important for the government to be guided by medium and long-termn considerations of economic competitiveness as well as short-term revenue needs. Privatization is a potentially powerful tool to change the ways business has been done in sectors in which SOEs have had dominant roles. Losing this opportunity would be largely irreversible. 41. Recent discussions indicate that MOSE is taking a transaction oriented stance--focusing on actual results while building a conceptual design. It is proposing fast track procedures to 73 expedite closure of transactions. Although it retains the preference to sell minority shareholdings, it is considering structures that will allow strategic partners to obtain management control immediately and majority shareholding in a relatively short period of time through a system of irrevocable warrants. 42. This approach requires careful management to be sure that the new strategic partners will have enough control to really change things while protecting public interests in the regulated sectors. Selling a controlling interest is likely to attract a much higher sales price per share, since the new owner-manager would be able to extract much more value and return, as indicated by the benchmark comparisons. There are many safeguards available to ensure compliance with public interests, including competitive market structures and effective regulatory oversight. By removing constraints on the share of private sector participation, GOI most likely would elicit a broader and higher priced response to its privatization program. ' 43. There is one area where additional privatization should be considered in the short run: the agricultural plantations. Tlhey have high rates of return in export markets and the studies indicate that their management is comparable to international benchmarks. There is likely to be interest among institutionial investors for such commodity based investments with high returns. This possibility merits further consideration. 44. Master Plcn: Designing and publicizing a viable Master Plan that outlines the government's objectives, the rules of the game, and the expected results would be a valuable aid to a successful privatization program. It would increase public understanding of the program, lay out a consistent plan for all concerned government agencies to follow, and clarify the governments program for potential investors. The Master Plan should articulate: the future role of the government as owner, operator, policy maker and regulator; * the use of competition in infrastructure markets to raise efficiency, lower prices, and improve service quality; -- the plan for effective regulatory oversight and legal reform to safeguard legitimate consumer and investor interest and to ensure compliance with social service obligations as appropriate; * the options in regulated markets for privatization (sale of government assets to private investors) and concessions (entry license for private investors) in providing infrastructure services; * the policies for share holding and management control of individual SOEs; * the policies for corporate governance, including management incentives and accountability, to improve performance of government managed SOEs during the transition period to eventual privatization; * the safeguards in protecting legitimate labor interests in cases where downsizing is needed for efficiency improvements; and * clear policies for using financial and other advisors that avoid conflicts of interest. 5Ultimately, the GOI could always reserve a veto right on limited fundamental corporate issues through "golden" shares. 74 Success or failure of this program ultimately will be measured by the change in efficiency of SOE operations and the quality and coverage of service of the companies operating in regulated markets. The key to successful privatization is good planning and careful execution. Increases in national welfare will depend on an equitable distribution of efficiency gains from private operations after divestiture among owners, managers, workers, consumers, and the government. 45. Recommendations: * The governlmenit should set out a Master Strategy along the lines described above for its privatization program, includcing the extent of privati-ation intended, the firm1s likely to be restructured and retainec, the legal and reguilatory framework, and transparent rules ofprivatization. * Within this Master Plan, the government should set out its goals to A. C'omplete the initial rouncl ofprivati_ations as expeditiously as possible. B. Quickly privatize all SOEs in competitive markets or where markets situations can readily be mnade competitive (e.g. through eliminating government price controls andc liberailizing imports). These SOEs represent a large number of firmns, but relatively small asset value and only a few cases would be worth an extended process. C. Clarifv its decision to be willing to give up management control wherever there are competitive mlarkets and/or an adequate regulatory framework. It sho1uld aim at the joint objective of maximizing returns from sales and getting the greatest improvement in performmace. * Set out a consistent and transparent regime governing the social responsibilities of the regulatedppublic enterprises and the associatedperformance expectation. * Put in place a satisfactory retrenchnenti policy to take care of workers laid off as al result ofprivatization to reduce opposition from labor. * Sales of component parts of SOEs and/or sub-units and discrete assets should be considered in cases where full sale may take time or create undesirable market results. This would apply to the PTPNs, some ports, Pertamina, and perhaps some of the strategic indcustries. 75 CHAPTER 6: SUMMARY AND RECOMMENDATIONS 1. The current economic and political crisis faced by Indonesia poses two critical challenges. Not only must it adjust to a huge reduction in the resources available to the public sector--at a time when private incomes and wealth have also taken a major hit--but it must do so while it is mraking fundamental political changes and opening up the political process to much wider participation. The increased openness will require that the government justify the rationale and benefits of its actions while resisting pressures to overspend (e.g. continue subsidies). The political uncertainty is an impediment to the economic recovery. 2. Per-capita incomes have fallen drastically, and poverty has risen sharply as a result of the crisis. The economy has a core base of infrastructure, human capital, and private sector capacities that give it the ability to recover. If they can be maintained and used effectively, the economy can return to the standards of living enjoyed in recent years. However, full recovery will be neither easy nor quick. Achieving reasonable rates of growth will take several years of hard work and fundamental reorientation of the government's involvement in the economy. Returning to the system that prevailed before the crisis in not an option. 3. Domestic resources are severely constrained this year and will remain so for several years to come. Domestic revenues have declined as a share of GDP, and there are expanded demands for expenditures to cope with the immediate impacts of the crisis (subsidies and social safety net programs), higher debt service payments due to the devaluation, and the costs of structural reform in the financial sector. These will burden the budget for several years. In addition, the government faces unpredictable, but potentially large, contingent liabilities due to its guarantee of banking liabilities, outstanding IPP contracts, and debts of State Owned Enterprises. Table 6.1: Resource Envelope (in trillion of rupiah) 1995/6 1996/7 1997/8 1998/9 1999/0 2000/1 Total revenues 74.7 88.1 111.3 149.6 161.4 161.1 Current expenditures 31.9 38.1 50.7 62.1 79.4 89.6 Subsidies 0.1 1.6 10.4 58.8 20.5 20.5 Debt Service 22.1 27.5 31.1 79.5 74.5 76.3 Bank Restructuring costs 15.0 15.0 15.0 Current Expenditures (plus amortization) 54.1 67.2 92.2 215.4 189.4 201.4 Net Domestic Resources 20.6 20.9 19.1 -65.8 -28.0 -40.3 Gross foreign lending conventional 12.5 12.3 26.4 42.8 37.5 45.5 Additional Quick disbursing lending 77.1 16.0 8.0 Available for Development 33.1 33.2 45.5 54.1 25.5 13.2 Dev Budget (GOI Format) 28.8 35.9 37.1 71.6 72.9 73.5 Shortfall -4.3 -2.8 8.4 -17.5 -47.4 -60.3 4. Total expenditures (including all debt service) will increase toRp. 277 trillion in 1998/99 from Rp. 139 trillion last year. The real increase is 25 percent. Domestic revenues, including 76 privatization receipts are expected to be Rp. 150 trillion. To meet the expenditures currently planned for 1998/99, the government will have to rely on a very exceptional expansion in quick- disbursing foreign lending to help meet current expenditures and, in effect, its entire development budget. In addition to new loans, existing foreign loans will have to be reprogrammed to meet current high priority needs. If the additional foreign resources cannot be mobilized in time, actual expenditures will fall short of these objectives, with serious consequences for the government's program. 5. The development budget, including additional programs to mitigate the effects of the crisis, is programmed increase in real terms compared to 1996/97, but realizations may fall short of the allocated amounts. Both to respond to immediate crisis needs and to begin reorient medium term priorities, substantial reprogramming is required within the development budget. Crisis mitigation and social safety net measures will account for about Rp. 25 trillion of the Rp. 72. trillion budget, leaving slightly less in nominal terms in the development budget for ordinary development expenditures than 1997/8. These are being reoriented to essential maintenance, and many major works are being postponed. The decline in real terms is, of course, substantial. 6. The constraints on the budget will be as bad or worse in the following several years. There is little prospect for a significant recovery of revenues. The corporate sector will be depressed for some time, and growth will only recover to positive terms in 2000 and then at a modest rate. Subsides must be reduced, and some of the social safety net expenditures will decline after this year. Debt service will increase as Indonesia's public borrowing is skyrocketing and the costs of financial restructuring may increase. Unless extraordinary foreign borrowing or other resources are available in 1999 and beyond, the development budget cuts faced in the future risk being more extreme than this year. 7. The sharp reduction in domestic resources and the weakness in the economic fabric of Indonesia revealed by the crisis mean that the government can no longer afford to play the central and directive role in the economy that it has in the past, nor can it provide as many economic services through State Owned Enterprises, nor can it offer rich incentives to private firms. In fact, it has become apparent that many of these interventions were highly inefficient, introduced substantial distortions in the economy, and all too often contributed more to the private benefit than to the public weal. 8. The government must reconsider all of its interventions to determine where actual market failures or welfare benefits call for public intervention and where it can reduce or eliminate its direct involvement. For those programs where public intervention is necessary, authorities should then determine the best way to provide the service--by direct provision, by funding provision by others, or by creating a regulatory structure and incentives so that the market can provide it. 9. This triage is necessary because the cutbacks in public expenditure after this year will be so severe that simply reducing most programs proportionally will not be effective. Even where programs are identified that can be phased out, it may not be possible to stop funding them immediately until alternative ways of providing the services are developed. In response for the immediate crisis, the government has begun resetting priorities, and as time goes on, it will have to extend the difficult process of reordering its priorities and determining how to achieve them post-crisis. 77 10. In the short term, the highest priorities for government expenditures will have to be reinforcing the social safety net and maintaining essential services, including preserving government institutions. Any remaining discretionary resources are being directed to projects that contribute to maintaining essential human, institutional, and physical capital; ongoing projects that have an immediate payout and benefits; and honoring of existing contracts for other projects that cannot be delayed. Major new construction, continuation of large investment projects, new initiatives and programs are being postponed unless directly related to the social safety net activities or critical to continued economic activity. Table 6.2: Development Budget (in trillion of rupiah) 1994/95 1995/96 1996/97 1997/98 1998/99 Categorv Realization Realization Realization Actual Plan Rp.'l'r. % Rp.Ir. % Rp.Tr. % Rp.r. /o T % Industrv 0.6 1.8 0.8 2.8 0.7 2.0 0.9 2.5 0.8 1.1 Agriculture and.l Forestr\' 1.7 5.4 0.9 3 1 1.4 4.2 2.2 6.0 4.2 5.9 Water Resources 1.9 6 3 1.9 6.6 2.1 6.3 2.4 6.5 5.5 .8 Manpowver 0.1 0.4 (.1 0.5 0.2 0.5 0.2 0.5 1.3 1.9 'ITrade. D)ev. of l.nt. Finance and 1.4 4.- 0.9 3.2 0.9 2.7 0.5 1.2 0.9 1.3 Coops 'I'rans. Meteo and Geop 5.7 18.4 5.4 18.7 6.1 18.1 6.6 1 9 9.5 13.5 Mining & IEnergy 4.4 /4.4 3.1 10.8 3.9 11.7 4.4 11.8 6.2 8.8 'I'ourisimi. Plosts & 'I'elecom 1.0 3.2 0.5 1.6 0.8 2.3 0.9 2.5 1.2 1.7 Regional D)evp. & 'I'ransmigration 5.5 1-.8 6.2 21.5 6.8 20.2 6.8 18.2 19.1 27.0 Environment 0.4 1.4 0.4 1.5 0.6 1.7 0.6 1.7 0.8 1.1 Education. Culture. Belief in 3.0 9.- 3.1 10.9 3.6 10.9 4.2 11.3 8.0 11.3 Almighty (God Youth and Sports 0.3 0 9 0.3 0.9 0.3 0.9 0.5 1.5 0.6 0.8 Population. Social Welfare, 1.0 3.2 1.0 3.4 1.3 3.8 1.9 5.1 4.5 6.4 Health. Role of Women llousing& Iliman Settlements 1.1 3.6 1.0 3.6 1.1 3.4 1.4 3.7 2.9 4.2 Religion 0.2 0.5 0.2 0.8 0.2 0.7 0.3 0.7 0.4 0.5 Sciencc & Technology 0.4 1.3 0.4 1.5 0.7 2.2 0.8 2.2 1.1 1.6 Law 0.1 0.3 0.1 0.4 0.2 0.5 0.1 0.4 0.2 0.3 Government Apparatus 0.6 1.8 0.6 2.2 0.8 2.3 0.7 2.0 0.9 1.3 Politics. Int Rel. Info. Comm. 0.2 0.7 0.1 0.5 0.2 0.5 0.2 0.6 0.4 0.5 National Defense& Sec. 1.3 4.2 1.6 5.5 1.7 5.1 1.4 3.8 2.1 3.0 TOTAL 30.7 100.0 28.8 100.0 33.5 100.0 37.1 100.0 70.8 100.0 Own Resources 20.9 6-.9 19.8 68.7 22.4 67.0 23.6 63.5 35.2 49.8 Foreign Resources 9.8 32.1 9.0 31.3 11.0 33.0 13.6 36.5 35.5 50.2 Deflator 1993/4= 100 108 117.9 127.8 166.2 266.0 Exchange rate. Rp/US$ 2160 2.280 2.381 4,890 10,600 11. State Owned Enterprises have been a substantial drain on government resources and have introduced distortions into the economy. The immediate impact of the crisis the SOEs is a reduction in their contributions to government revenues through profit, taxes, and dividends and 78 an increase in their call on the public purse. Many of them have large external debt obligations that they may not be able to honor, and the government will have to cover those obligations directly. The bulk of the expanded subsidy programs are implemented through general price subsidies on goods produced by the large SOEs, (energy and fuel), and those will also have to be paid by the government to the SOEs. Past rationales for direct government involvement in production are no longer valid in many cases, but there remains an important role for regulation where private enterprises operate in non-competitive sectors. The government has begun an accelerated program of SOE privatization that is expected to yield some revenues in the short term, although it is not clear how much can be gained given the depressed values for Indonesian assets. A Master Plan is being developed for a comprehensive privatization program beyond the initial 12 firms that have been identified which will have to identify which SOEs to sell and which need to stay public and be subjected to better management. 12. The Report looks at both the short-term measures that the government must implement quickly to address the immediate demands of the crisis, some of which are necessarily temporary in nature, and at the medium-term changes that need to be initiated to reform the government's priorities and programs as it emerges from the crisis. Beyond the crisis response, planning should begin to set new priorities for the future as and when additional discretionary funding as it becomes available. In what follows, the short-run actions will be distinguished from the medium-term program. To the extent that the government undertakes a REPELITA planning exercise, it should be divided into a 2-3 year emergency action plan and a medium-term program. Recommendations: Budget 13. Revenues: While not the main focus of this report, the fact that revenues fall as a share of GDP. indicates that increasing revenues should be a high priority. Much of the tax base has eroded. However, in the past, collection rates were uneven and often below what the law required. Short Term: Improved tax collection should be a high priority. In addition, recently lapsed programs, such as the use of independent collectors of customs duties, should be re-imposed. The government should also audit the accounts of major public entities such as Pertamina and BULOG to be sure that all available resources are identified and transfers to the government maximized (or transfers to the enterprises minimized). Medium term: The tax collection system should be audited by external experts and reforms instituted as needed to make it more efficient, equitable, and transparent in operation. 14. Current Expenditures: The bulk of current expenditures are for personnel remuneration. A 15 percent wage increase has been announced for civil servants, but this will still result in a substantial decline in their real incomes. The government has announced a policy of no lay-offs this year, so there is limited scope for further adjustments in the current operational budget (as distinct from subsidies, debt service, and financial reform costs). 79 Short Term: The in-kind rice ration for civil servants should be replaced with a cash allotment equal to about what the rice would have been sold for on the market in normal times (thus not reducing the real income to the civil servants). The government would save on the associated procurement and distribution costs of BULOG. In addition, procurement processes for goods and services should be subject to more scrutiny and transparency to reduce waste and misuse of funds. Medium Term: A substantial reform of the civil service should be undertaken in conjunction with medium-term reform programs in several major sectors (e.g. education and health). The objective of the reform would be to reduce the size of the civil service, as it no longer needs to be the employer of last resort, and to improve the quality of services. This will require an increase in salaries to retain qualified people, so it is unlikely to result in lower total expenditures on the civil service. 15. Subsidies: The crisis has greatly increased the demand for subsidies to ease the impacts on the most vulnerable. Price increases on basic commodities are politically very sensitive, and price stability is a major objective of this government. However, trying to maintain general price subsidies benefits a large number of non-poor at a high cost to the budget (6.2 percent of GDP in 1998/9). At best, the current price subsidy on rice costs over $3 to deliver $1 worth of rice to the population in the bottom 30percent on the income distribution. Other subsidies are even less efficient in assisting the poor, and they introduce other distortions in the economy. They are also encouraging the smuggling of subsidized goods to neighboring countries. Short Term: It is imperative to gain control of the subsidies and direct them as much as possible to the poorest. While politics will dictate the timing, the government must begin reductions, or the budget situation next year will be even tighter than this year. * Food subsidies should be limited to rice (the Government should complete the recently announced elimination of the subsidies on wheat flour, sugar, and soy bean immediately). The government has just announced a targeted program of controlled sales of low cost rice in the poorest areas. This will facilitate reducing the general rice subsidy and help the income of rice producers by not depressing the price at which they market their surplus. * Subsidies on energy and fuel should be phased out as quickly as possible, beginning with premium gasoline and large consumers of electricity. Targeting programs should be introduced to protect the poor where appropriate. The World Bank is working with the government to design such schemes for food and energy expeditiously. * Food and fuel distribution contracts should be reviewed and revised to reduce their costs where excess intermediation costs are found. This may reduce the costs of delivering subsidies. Medium term: All direct subsidies should be eliminated or very narrowly targeted to the poor for basic food and energy inputs (kerosene, for example) with special distribution programs. Other subsidies (fertilizers, housing credits, etc.) should be phased out as soon as possible. 80 16. Transfers to Regions: These are made on both the current and capital budgets and contribute about two-thirds of the revenues for provincial and local expenditures. Local governments currently have few independent sources of revenue, so these transfers must be continued to preserve the decentralization program and allow local governments to carry out the expanded employment creation and crisis relief programs being implemented. Short term: The integrity of the regional and local government financial systems should be maintained. * Maintain the real value of current transfers to local governments so that they can continue functioning and manage the expanded employment programs. * Untied INPRES transfers to the lower levels of government should be expanded relative to tied funds. * The expanded job creation programs should be run to the extent possible through the existing programs that have proven their effectiveness. * These programs should provide discretionary funds. Proper controls should be put in place to monitor the expanded programs, including expanded publicity, audits, and clear accountability. * The program to increase the tax base of the local governments should be implemented as previously agreed.' Medium term: The local governments need to develop more local fiscal autonomy. This will relieve pressures on the central budget, but not necessarily the total tax burden. Measures should be put in place to increase the transparency and accountability of local government finance. Developing lending and bond markets that local governments can tap will contribute to this. 17. Development Expenditures: The development budget for the rest of the decade will effectively be funded from foreign assistance, and its level will be subject to the availability of foreign lending and domestic counterpart funds. This will require a major effort to reprogram existing projects in order to transfer funds to the highest priority activities, close others, and increase quick disbursing aid. All donors will have to participate in this exercise in an open manner designed to yield the most effective package of expenditures. The major sectors of concern are agriculture, transport, energy, health and education. Actions in energy and transport will also concern SOEs, which play an important role in those sectors. 18. Agriculture: In addition to the subsidy reduction mentioned above, there are several important actions to be taken in this sector. The irrigation is a major component of expenditures and a source of potential savings. Short term: The major emphasis should be on effective ways to improve production. ]The current situation is that a number of old nuisance taxes that funded local governments have been abolished, but the new replacement taxes such as a surtax on gasoline and expanded property tax, have not been put in place. Failing to do so will result in a major drop in income to local and provincial government. 81 * The Kalimantan Rice project should be stopped, and studies begun to determine the best way to close it down. This has become an important symbol of waste, thus stopping it will send a good signal. * Maintenance and rehabilitation programs in irrigation should be continued and labor intensive programs used as much as possible to create additional jobs in the crisis. * Expenditures on other major irrigation works and rehabilitation should be postponed and available resources allocated to finishing distribution canals off Java that will increase production in the short run, and to selected well drilling programs. * Water users associations should be set up as quickly as possible to take over distribution management from the government. They should be charged with responsibility for O&M and funded through water user charges. * Expenditures for Research and Extension and other ad hoc programs to increase production should be reduced until their effectiveness can be demonstrated. Medium term: Government direction of planting certain crops (such as sugarcane) should be eliminated. Government sponsored cooperatives should be phased out. Research and extension services should be strengthened, better coordinated with IRRI and universities, and made responsible for increasing yields in all major crops. Efforts shoulcl be concentrated on improving yields off-Java and on introducing high value crops where appropriate. 19. Tramsport : Land and sea communications are essential in Indonesia. A reasonable network of roads, rail, and sea and air links has been established, but has been seriously weakened by the crisis, in particular the air links. A program of private toll roads has recently begun, and SOEs are active in several sub-sectors. Although congestion had been a growing problem (eased by the crisis), there are few major deficiencies in the system. Short Term: Maintaining existing capacity is a critical objective, particularly for roads, where a deterioration of the existing stock will lead to a sharp increase in vehicle operations costs in the near term, off-setting any savings from reduced expenditures. * Revise priorities under the existing maintenance and essential rehabilitation programs to maintain critical roads. Institute measures to speed up procurement in the short term without increasing opportunities for corruption. * Encourage reductions in wear on roads by enforcing loading limits and reducing fuel subsidies. * Postpone planned new construction of airports and ports and resize on-going projects to changed circumstances after the crisis. * Reach agreements on the private toll roads to assure their continued operation and improve their coordination with the rest of the network. * Maintain essential rail links for Jabotabek urban transit and coal lines to supply PLN, consider closing others or raising tariffs to cover variable crops. 82 * Assure adequate support for transport safety. Medium Term: Revise transportation plans to take account of the changed circumstances. Improve road planning and coordination. Set clear priorities for new projects as funds become available. 20. Energy: Maintaining adequate energy supplies, both electricity and fuel, is critical to restoring growth. This supply is the responsibility to three State Owned Enterprises, (Pertamina, PLN, PGN), which are in very difficult financial condition due to large foreign debts and other foreign exchange denominated obligations and to government policies Imniting price increases. While there may be scope for some efficiency gains from reviewing existing contracts, major financial restructuring or rescue efforts will be needed to prevent defaults on contracts to suppliers. This could have serious implications for the supply of energy and Indonesia's international reputation. Short term: Assuring a continued flow of energy is vital. * Reduce the subsidies in the sector. * Develop short-term workout programs for the financial crises in the energy corporations, especially in PLN. * Assure that PLN has the resources for spares to maintain current operation and to complete or redesign essential links in the transmission network. Facilitate renegotiation of critical contracts for PLN (IPPs and fuel supply) and Pertamina. *t Audit Pertamina and review distribution refining and other contracts to find short term savings from excess margins, etc. Medium term: Revise and implement the privatization plan for PLN and review the long-term role of Pertamina, with a view to spinning off activities unrelated to its core responsibility of managing Indonesia's hydrocarbon resources (e.g. privatize service stations and other unrelated business). Audits of both companies should be undertaken. 21. Health. The health sector is characterized by widespread availability of low quality services supplemented by private providers for those who can pay. The government has increased the share and real level of expenditure on health as part of its reorientation of priorities. Short term: The first priority is making sure basic medicines and services continue to be available to all, and particularly the poor. * Emergency allocations (with donor support) need to be put in place as agreed to assure the import and distribution of essential medical supplies and drugs. * Funds for basic staffing and maintenance of primary health care units needs to be assured. The current budget alHocations should allow this. 83 * The relative increase in budget allocations should be directed through existing discretionary programs to health delivery units to enhance their capacity to provide access to health services and reduced fees to the poor. * The provision of basic public health services (vaccinations, vector controls, clean water, etc.) is being enhanced. * Training programs should be instituted to improve the responsiveness of health personnel. Medium term: The sector should be subject to a major review and reform to improve the delivery and quality of health care. Programs should be started to improve the quality services in the sector by increasing local autonomy and accountability with adequate funding and more training. A clearer delineation of the roles of the public and private sectors is needed along with developing some appropriate insurance function for catastrophic illnesses. 22. Education: Indonesia has managed to increase literacy and to attain near universal primary education. However, overall public spending on education was relatively low before the crisis and the quality poor. It is important to protect the achievements in education so far and to prevent the poor from dropping out, and the government has responded with a dramatic program of grants to schools in poor areas (primary and lower secondary) and scholarships for poor lower secondary student to reduce dropout rates. This is being accompanied by a major public relations campaign that should engage a lasting dialogue to improve the overall quality of education. Short term: The major objective is to prevent a sharp decline in school attendance particularly among the poor. * The program of supplementary bloc grants to primary and lower secondary schools should be implemented as planned and well publicized to assure that poor parents continue to sent their children to school. * The scholarship program for poor lower secondary students should be implemented as agreed. Both of these programs will continue over five years. * Efforts to achieve universal and high quality primary and lower secondary education should continue. Medium term: The government should reassess its overall strategy in education and concentrate its resources where they will have the greatest impact. This will ensure continuing quality improvements in primary education and extending lower secondary education toward universal coverage. Previously planned programs in technical and tertiary education will have to be postponed and shifted more to the private sector. The government should support the expansion of private schooling by providing an appropriate regulatory and accreditation framework (possibly through the private sector) to assure quality and comparability of degrees. 84 Off Budget Accounts: 23. The review of the off-budget items reveals a wide variety of accounts. With the exception of the Reforestation Fund, it is not clear that the other accounts should come fully on budget. They perform functions that are specialized and require special treatment. Some should be eliminated and others should be managed apart from the budget and not necessarily by the government. Short term: In all cases there should be much more accountability and transparency in the management of the funds, including making audited accounts public. * The past accounts of Reforestation Fund need to be made public as the program is being integrated into the budget of the Forest Ministry. If there remain accumulated funds, some portion should be preserved in a trust fund for long-term forest conservation with the involvement of civil society--the original purpose they were collected for. * Funds collected for public service in education, health, etc. should be fully accounted for by the relevant local authority and those accounts accessible to interested parties. * The Investment Funds (RDA and RDI) should be made fully transparent and clear criteria established for their use. They should remain as investment funds in the short term under these criteria with rules established for making payments to the budget, pending more reflection on their long term role. * The Pension Funds have very poor performance. They should be put under competent private management and their earnings and processes made public pending further reform. Consideration should be given to closing JAMSOSTEK, returning the funds and starting over. * Specific funds with little rationale should be closed (such as the civil servants' housing fund). * Foundations should be required to make public full accountings and should not be able to use government power to raise funds. The 2 percent surcharge on income tax for the YDSM foundation has been abolished. Medium term: The structure and rationale for the Investment Funds should be reviewed to determine whether they should be restructured as investment funds with clear goals and accounts or closed. The Pension Funds should be reformed and properly managed to be self-sustaining. Transparency and accountability should be required appropriately for the remaining items, whether they remain public or are transferred to the private sector. State Owned Enterprises (SOEs) 24. The report has grouped the SOEs into categories that correspond to the government's own classification: primarily those functioning in competitive markets, those in non-competitive (regulated) markets, and special cases (strategic industries). Banks need to be dealt with separately. The SOEs have been a net drain on government resources in recent years. Even in the best of times, most earned a rate of return much less that the cost of capital (even assuming only 85 the cost of debt capital), implying a substantial net loss to the government. Benchmark comparisons suggest this was due to poor management and lack of the proper incentives to operate efficiently. The crisis has aggravated this problem. Most SOEs are insolvent and will require substantial transfers to survive. The government has properly decided it is time to cut loose from most SOEs and has embarked on an aggressive privatization strategy. The details of the strategy still need to be worked out and a Master Plan adopted. The government has to accept the proposition that privatization, to be effective, means transfer of controlling interests to private managers and establishing a satisfactory regulatory framework. 25. The strategy for SOEs should be based on a Master Plan and have two guiding elements: i) proper incentives for management of the SOEs to improve performance and achieve greater efficiency (including longer-term incentives for those SOEs which remain publicly owned), and ii) a coherent strategy for privatization of as many SOEs as possible. The privatization strategy should aim to achieve results quickly, subject to concerns about the transparency of the transactions, establishment of necessary regulatory structures, and obtaining good value. 26. Looking at the different categories of SOEs, those in competitive markets should be subject to rapicl privatization. In total, they only account for 13 percent of total assets, or 25 percent of non-financial assets, and most of that is concentrated in a small number of SOEs. Except for the largest, speed should be the primary objective, and getting them off the books will establish good precedent for privatization. These firms are in competitive markets: if they fail, then others will provide similar goods and services. If they succeed, then the government can benefit from the taxes they will pay. 27. For the few large firms in this category, a careful and structured privatization should be planned with competitive bidding to get the best value quickly. Controlling interests should be sold to strategic investors who can identify and will pay for the long-run value of these enterprises. Since all these firms are in competitive markets, there is no need for the government to retain any interest. In some cases, the government may want to sell components separately if that would bring a higher total price. Good investment advisors can help in this area. 28. For the SOEs in non-competitive markets, the government will have to develop a more careful plan. In some cases, selected assets of the firms may be sold relatively quickly if they are not part of the core business and can compete in competitive markets (e.g. land holdings, transport subsidiaries, etc.) For the rest, the government needs to define a clear operating and regulatory framework that will make the industry attractive to private buyers and that will protect public interests., In general, the government should sell controlling interests to bring in strategic investors who will have incentives to improve management and efficiency and realize the longer term benefits. This is likely to fetch a higher price and to result in improved performance. 29. The government should not invest in major restructuring expenditures prior to privatization, but may have to undertake some basic restructuring in the firm or market to make the deal attractive2. The government may also have to make provisions for reducing redundant labor prior to the actual transfer to private hands. Sale of minority shareholdings can only be viewed as a stopgap measure. It is unlikely in the present circumstances that minority share sales will attract much interest or very high prices. 2E.g. opening phone licenses to competition or separating PLN functions between generation, transmission, and distribution and selling separate entities. 86 30. Several firms pose particular problems that will require careful treatment to salvage any value. These include some of the strategic industries as well as a few others which will require careful planning. For some, such as Garuda Airlines, which is making large loses, quick action is needed. Reforming others, such as IPTN, would be of lower priority so long as no further government transfers are made to prop them up. 87 -- -------- ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~. NNEX TABLES~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~: A AL JL~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 88 TABLE 1: INDONESIA: GOVERNMENT REVENUE (in billions of rupiah, GOI format) 1995/96 1995/96 1996/97 1996/97 1997/98 1998/99 1998/99 Budget Actual Budget Estimate 23-Jan-98 16-Jul-98 A. Domestic Revenues 66,265 71,558 78,204 83,584 91,595 114,966 149,302 1. Oil Revenues 13,276 14,849 14,120 19,872 15,800 34,582 49,711 1. Crude Oil 24,061 32,909 2. Gas 10,521 16.803 53.0 11. Non-Oil Revenues 52,990 56,709 64,084 63,712 75,795 80,384 99,590 1. Income tax 19,239 20,520 23,708 25,496 30,544 25,618 25,846 2. Value added tax 16,655 18,350 21,788 20,393 23,957 27,872 28,940 3. Import duties 3,543 3,248 3,451 2,807 3,157 3.562 5,494 4. Excises 3,299 3,668 4,033 4,217 4,954 4,922 7,756 5.Exporttax 44 201 160 70 100 115 943 6. Land & building tax 1,923 1,924 2,277 2,280 2,697 3,411 3,411 7. Other taxes 319 510 570 570 661 540 540 8. Non-tax receipts 6,491 7,801 7,268 7,879 9,727 14,344 26,660 9. Proceeds from petroleum 1,475 488 829 0 0 0 0 sales B. Development Revenues 11,759 11,170 12,414 12,400 14,527 32,255 127,836 1. Program aid 8,500 87,295 11. Project aid 23,755 40,541 Total 78,024 82,728 90,617 95,984 106,122 147,221 277,137 Source: Govemment of Indonesia 89 TABLE 2: INDONESIA: GOVERNMENT EXPENDITURES (In trillions of rupiah, GOI Format) 1994/95 1995/96 1995/96 1996/97 1996/97 1997/98 1998199 1998199 Budget Budget Actual Budget Estimate 23-Jan-98 16-Jul-98 A. Routine Expenditures 42,351 47,241 52,541 56,114 62,279 66,533 97,829 205,538 1. Personnel Expenditures 13,011 15,347 15,372 18,281 18,021 20,880 22,591 24,781 1. Wages& Salaries 10,456 12,416 12.351 14.763 14.507 16,812 17,406 19,120 2. Rice allowance 1,039 1,140 1,134 1.194 1,139 1.320 1,588 1,872 3. Food Allowance 783 835 866 1.122 1,175 1.362 1,484 1,484 4. Others 392 511 572 710 748 867 1,155 1,155 5. Extemal 341 445 449 492 451 519 958 1,150 0 0 0 0 0 0 11. Material Expenditures 3,751 4,745 5,274 6,589 7,244 8,392 10,909 1 i,425 1. Domestic 3.526 4,457 4,969 6.258 6,914 8,013 10,060 10,060 2. Extemal 225 288 306 332 330 380 849 1,365 111. Subsidies to Regions 7,095 8,409 8,344 10,012 9,841 11,404 12,284 13,290 1. Personnel Expenses 6.665 7,932 7,863 9,496 9.322 10,803 11,601 12,607 2. Non-personnel Expenses 430 477 481 516 519 601 683 683 IV. Debt Service 17,970 18,215 21,435 20,217 24,143 23,886 39,740 94,486 1. Domestic 317 319 1,779 291 1,311 1,442 1,940 16,940 2. Extemal 17,652 17,896 19,655 19,936 22,832 22,444 37,800 77,546 a. Principal 24,877 46,512 b. Interest 12,923 31,035 V. Other Expenditures 525 524 2,117 1,005 3,031 1,971 12,305 61,555 1. Petroleum subsidies 0 0 0 0 1,416 100 7,453 27,534 2. Others 525 524 2,117 1,005 1,615 1,871 4,852 34,021 0 0 0 0 ,0 0 B. Development Expenditures 27,398 30,784 29,812 34,503 34,500 39,848 49,392 71,600 1. Rupiah Financing 17,386 19,025 18,642 22,089 22,100 25,321 25,637 31,059 2. Project aid 10,012 11,759 11,170 12,414 12,400 14,527 23,755 40,541 Total 69,749 78,025 82,353 90,616 96,779 106,381 147,221 277,138 Source: Govemment of Indonesia 90 Table 3: INDONESIA: FISCAL SUMMARY (in trillon rupiahs, Bank Format) 94/95 94/95 95196 915/96 96/97 96/97 97198 97198 98/99 Budget Actual Budget Actual Budget Estimate Budget Realization Budget from Preliminary -Ministry of Finance. July 16 Revenue & Grnnts 60.2 64.9 65.5 73.0 78.2 85.3 87.8 111.3 134.3 *Oil/LNGtaxes 12.9 13.5 13.3 16.1 14.1 19.9 14.9 30.6 49.7 - Non-oil taxes 40.1 44.4 45.0 48.7 56.0 55.8 64.7 70.9 72.9 - Non-tax revcnues 6.8 6.4 6.7 7.8 7.6 9.1 8.2 9.8 11.4 - Grants 0.5 0.5 0.5 0.5 0.6 0.5 0.0 0.0 0.3 Current Expenditures 31.5 31.9 36.1 37.9 43.1 44.8 49.6 58.1 168.9 a. Pcrsonnel Expcnditures 13.0 12.6 15.3 15.4 18.3 18.0 21.2 18.1 24.8 b. Material Expenditures 3.8 4.3 4.7 5.3 6.6 7.2 8.9 6.9 11.4 c. Transfers to Regions 7.1 7.3 8.4 8.3 10.0 9.8 11.5 8.8 13.3 d. Intemal debt service 0.3 0.1 03 1.8 0.3 1.3 0.3 1.6 1.9 e. Extemal interest 7.1 6.1 7.2 6.9 7.8 6.6 7.5 12.3 31.0 r. Total subsidies 58.8 g. Other current expenditures 0.2 1.5 0.1 0.2 0.1 1.8 0.1 10.4 12.6 h. Bank Restructuring 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 15.0 Capital Expenditures (on- 24.0 24.9 27.0 26.0 30.2 28.9 34.0 32.1 61.7 budget. Bank basis) Total Budgetary Expenditures 55.4 56.8 63.2 63.8 73.4 73.7 83.7 90.2 230.6 Estimated Off-Budget Spcnding 0.0 7.2 0.0 4.5 0.0 0.4 6.1 0.0 0.0 (net) Total Spending - Budget & Off-Budget 68.3 78.5 79.9 89.7 90.2 230.6 Budget Balance Overall Budget Balance 4.8 8.1 2.4 9.2 -0.3 11.6 4.1 21.1 -96.3 Cap Exp.& Net Lending (incI 24.0 32.1 27.0 30.4 30.2 29.3 40.1 32.1 61.7 off-budget) Overall Fiscal Balance (inc off- 1.0 0.8 -1.8 4.7 -0.3 5.4 -1.9 21.1 -96.3 budget) Financing -1.0 -0.8 1.8 -4.7 0.3 -5.4 1.9 -21.1 96.3 1. Extemal (net) -1.0 -0.3 0.5 -1.0 -0.3 -2.6 1.3 5.0 81.3 Disbursements 9.5 1 1.8 11.2 12.5 11.8 12.3 13.0 24.3 127.8 Amortizations 10.5 12.1 10.7 13.5 12.1 14.9 11.7 19.2 46.5 2. Domestic (nct financial 0.0 -2.3 1.3 -5.5 0.5 -4.1 0.6 -28.5 0.0 drawdown) 3. Privatization 0.0 1.7 0.0 1.8 0.0 1.4 0.0 2.3 15.0 Unidentified Financing 0.0 Source: World Bank 91 TABLIE 4: INDONESIA: FISCAL SUMMARY (as % of GDP, Bank Format) 1994/95 1995/96 1996/97 1997/98 1998/99 Actual Actual Estimate Realization Budget from Estimate Ministry of Finance, July 16 Revenue & Grants 16.7 15.3 16.0 16.4 14.1 - Oil/LNG taxes 3.4 3.4 3.7 4.5 5.2 - Non-oil taxes 11.6 10.5 10.4 10.4 7.7 - Non-tax revenues 1.6 1.3 1.8 1.4 1.2 Current Expenditures 9.1 8.6 9.3 11.0 17.7 a. Personnel Expenditures 3.1 2.8 2.6 2.7 2.6 b. Material Expenditures 1.1 1.1 1.5 1.0 1.2 c. Transfers to Regions 1.8 1.8 1.7 1.4 1.4 d. Intemal debt service 0.0 0.3 0.8 0.2 0.2 e. External interest 1.5 1.4 1.2 1.8 3.3 f. Total subsidies 0.4 0.0 0.3 1.5 6.2 g. Other current expenditures 1.1 1.2 1.1 2.3 1.3 h. Bank Restructuring 0.0 0.0 0.0 0.0 1.6 Capital Expenditures (on-budget, Bank basis) 6.6 5.3 5.7 4.7 6.5 Total Budgetary Expenditures 15.6 13.9 14.9 15.8 24.2 Estimated Off-Budget Spending (net) 0.4 0.3 -0.5 0.0 0.0 Total Spending - Budget & Off-Budget 16.0 14.2 14.5 15.8 24.2 Budget Balance Overall Budget Balance 1.1 1.4 1.1 0.6 -10.1 Cap Exp.& Net Lencling (incl off-budget) 7.0 5.6 5.2 4.7 6.5 Overall Fiscal Balance (inci off-budget) 0.7 1.1 1.5 0.6 -10.1 Financing -0.7 -1.1 -1.5 -0.6 10.1 1. Extemal (net) -0.1 -0.3 -0.8 1.0 8.5 Disbursements 3.0 2.7 2.2 3.6 13.4 Amortizations 3.1 3.0 3.0 2.5 4.9 2. Domestic (net financial drawdown) -0.6 -1.2 -0.7 -1.7 0.0 3. Privatization 0.0 0.4 0.0 0.0 1.6 Unidentified Financing 0.0 0.0 0.0 0.0 0.0 Memo Items: Development Spending (GOI basis) 7.7 6.1 6.5 5.5 8.5 Development Spending (Bank basis) 6.6 5.3 5.7 4.7 13.4 Govemment Savings 7.6 6.7 6.8 5.3 4.9 Domestic Impact of Spending-Revenue -8.7 -8.2 -8.5 -6.7 0.0 Source: World Bank 92 TABLE 5: INDONESIA: GOVERNMENT REVENUES (In billions of rupiah, Bank Format) 1994/95 1995/96 1996/97 1997/98 1998/99 Actual Actual Actual Realization Budget from Mlinistry Preliminary of Finance, July 16 Total Revenues and Grants exc Privatization 66,904 71,841 88,106 111,315 134,603 1. Oil revenues 13,537 16,055 20,137 30,559 49,711 1. Oil 10.004 11.964 14.783 22.264 32.909 2. LNG 3,533 4.091 5.354 8.295 16.803 11. Non oil taxes 46,448 49.174 57,340 70.916 72,931 1. Income tax 18,764 21,012 27,062 34.364 25.846 2. Sales tax (VAT) 16.545 18,519 20.35l 25.195 28,940 3. Import duties 3,900 3,029 2.579 3.000 5.495 4. Excises 3,153 3.593 4.263 5,102 7,756 S. Export tax 131 186 81 126 943 6. Property taxes 1,647 1.894 2.413 2.644 3,411 7. Other taxes a/ 302 453 591 487 540 8. Oil Surplus 2,006 488 0 0 0 III. Non-tax Receipts 6,433 6,111 10,153 9,840 11,660 1. PE Transfers 1,332 1,604 2,650 2,341 4,000 2. Education 283 50 58 81 598 3. Services 1,878 742 1,364 1,577 842 4. Refund Revenues 2,461 887 1,384 1,446 1,477 S. Investmnent Fund Revenuc bt 400 2,132 2,562 3,547 2,828 6. Scif Financing (incl. Reforestation Fund) 0 583 2,031 728 1,838 7. Others 80 114 105 120 78 IV. Grants 486 501 476 0 300 TOTAL NON-OIL REVENUES 52,881 #### 67,493 80,756 84,591 CAPITAL REVENUES (Privatization) 0 1,674 15.000 Share (as %) of Total Revenues Oil revenues 200/ 22% 23% 27% 37% Of which: LNG 5% ... ...... ... Non oil taxes: of which 69% 68% 65% 64% 54% Income tax 28% 29% 31% 31% 19% Sales tax (VAT) 25% 26% 23% 23% 22% Import duties 6% 4% 3% 3% 4% Property taxes 2% 3% 3% 2% 3% Non-tax Receipts 10% 9% 12% 9o/, 9% Total Non-oil revenues 79°/o 77% 77% 73% 63% at Mainly stamp duties & auction fees. b/ Starting fiscal year 1998/1999, the Investment and Forestry Funds were included in the budget. Source: World Bank 93 TABLE 6: INDONESIA: GOVERNMENT EXPENDITURES (In billions of rupiah, Bank Format) 1994/95 1995/96 1996/97 1997/98 1998199 Actual Actual Actual Realization Budget from Preliminary Ministry of Finance, July 16 TOTAL CURRENT EXPENDITURES 36,322 40,251 50,929 74,991 168,895 A. PERSONNEL EXPENDITURES 12,596 13,001 14,455 18,347 24,781.4 1. Wages & salaries 10,181 11,048 13.005 14,941 19,120 2. Rice allowance 973 734 768 1.187 1,872 3. Food allowances 756 560 101 979 1,484 4. Others 368 370 480 681 1,155 5. External 317 290 103 559 1,150 B. MATERIAL EXPENDITURES 4,319 5,175 8,109 6,976 11,425 1. Domestic 4,101 4,876 7,825 6.631 10,060 2. Extemal 218 300 284 344 1,365 C. TRANSFERS TO REGIONS 7,272 8,227 9,358 9,530 13,289 i. Personnel 6.919 7,807 8,874 9,010 12,606 2. Non-Personnel 354 419 484 520 683 D. INTERNAL DEBT SERVICE 104 1,620 4,589 1,628 1,940 E. EXTERNAL INTEREST 6,145 6,615 6,610 12,298 31,035 F. SUBSIDIES 1,502 143 1,602 10,362 58,810 i. Food Subsidy 0 0 0 0 13,840 2. Petroleum Subsidy 687 0 1,416 9,814 27,534 3. Fertilizer Subsidy 815 143 186 547 1,065 4. Gas price subsidy for fertilizer industry n.a. n.a. n.a. 1,060 5. Export Cenificates 0 0 0 0 0 6. Electricity Subsidy 0 0 0 0 8,473 7. Other subsidies 0 0 6,838 G. OTHER CURRENT EXPENDITURES 4,385 5,470 6,206 15,851 12,615 1. Defense (Rp part of Development Exp) 671 759 999 934 3,656 2. Current Component of Dev.Exp.al 2.921 2,788 3,475 3,563 6,213 3. Other 793 1,923 1,733 11,354 2,746 H. BANK RESTRUCTURING 0 0 0 0 15,000 1. Bail outs 0 0 0 0 0 2. Interest cost equivalent of servicing debt 0 0 0 . 0 15,000 Memo Item: Development Spending (GOI basis) 30,692 28,781 35,932 37,111 71,600 Development Spendling (Bank basis) b/ 26,285 25,091 31,272 32,067 61,731 EXTERNAL DEBT 18,403 20,489 22,902 29,485 77,547 Amortization (Rp.) 12,258 13,874 16,292 17,186 46,513 External Interest (Rp.) 6,145 6,615 6,610 12,298 31,035 INTERNAL DEBT IBRA Debt Outstanding with BI 125,000 Interest Rate 12% Index linked bonds-effective rate Market-related bonds al 10% of development expenditure, excluding defense, fertilizer and gas prices b/ Excluding defense, fertilizer, gas price subsidy and current component of development spending. Source: World Bank Table 7: Investment Budget (Development Budget) (in billions of rupiah) 1994/1995 1995/1996 1996/1997 1997/1998 1998/1999 No Category Plan Realization Plan Realization Plan Realizatiun Plan Actual Plait Abs % Abs I %Ab Abs % Abs % Abs % % Abs % Abs I Industry 450.5 1.6 565.2 1.8 497.3 1.6 805.4 2.8 50t6.6 1.5 684.4 2.0 58'9.7 1.5 915.1 2.5 1100.0 Own Rcsources 143.8 223.6 173.6 619.5 207.8 418.6 245.0 580 7 318 8 Foreign Resources 306.7 341.6 323.7 185.9 298.8 265.8 3448 3344 481 2 2 Agriculture And Forestry 989.6 3.6 1,657.5 5.4 1,103.8 3.6 891.0 3.1 1,294.4 3.8 1,390.8 4.2 1,513.0 3.9 2,237.6 6.0 4,190.0 Own Resources 662.4 1,351.2 666.5 676.8 823.3 969.4 9668 1.682 4 2.1624 Foreign Resources 327.3 306.3 437.3 214.2 471 i 4213 5462 5552 2.0 7 th 3 Water Resources 1,687.0 6.2 1,932.1 6.3 2,042.1 6.6 1,897.0 6.6 2317.4 6.7 2,118.7 6.3 2,616.1 6.7 2,412.9 6.5 5.535.0 Own Resources 809.4 999.5 874.2 1,I 15.4 1,239.8 1.178.4 1,472.6 1.093 3 1,703 8 Forcign Rcsources 877.6 932.6 1.167.9 781.6 1.0776 9403 1.1436 1.3196 3.8312 ,2 4 Manpower 146.5 0.5 109.0 0.4 170.6 0.6 139.3 0.5 187.1 0.5 174.5 0.5 269.4 0.7 202.0 0.S 1,324.) Own Resources 119.4 104.8 132.8 121.6 160.3 150.7 1979 1407 1.177 3 Foreign Resources 27.1 4.2 37.8 17.7 26.8 23.9 71 5 61 4 1476 5 Trade, Development Of Business 736.3 2.7 1,439.6 4.7 533.7 1.7 912.4 3.2 401.5 1.2 902.2 2.7 549.9 1.4 455.7 1.2 9t10.41 Enterprises, Finance And Cooperatives Own Rcsources 144.8 1,138.X 153.7 605.3 181.8 704.7 226.2 191 9 275 7 I:oreign Resources 591.5 300.8 380.0 307.1 219.6 197.5 323.7 26658 6243 6 Iransport, Meteorology & 5,225.5 19.1 5,656.8 18.4 5,897.9 19.2 5,382.6 18.7 6,771.2 19.6 6,060.7 18.1 6,849.9 17.6 6,637.1 17.9 9,520.0 Geophysics Own Resources 3,606.6 3,920.4 3.822.2 3,678.4 4,228.5 3.832.7 4.687.9 4.075.7 3.966 A Foreign Resources 1,619.0 1,736.4 2,075.7 1,704.2 2,542.7 2,228.0 2,162 0 2.561.4 5.553.9 'Iabie 3.2a. cottd 1994/1995 1995/1996 1 1996/1997 j 1997/1998 1998/1999 No Category Plan | Realization Plan Realization Plan Realization Plan | Actual Plan % Abs I Abs I % Ab7|oA Abs I %/@ Abs I % Abs I% Abs 7 Mlining And Energy 3,581.8 13.1 4,407.3 14.4 3,894.8 12.7 3,111.5 10.8 4,101.5 11.9 3,903.7 11.7 4,423.0 11.4 4,364.6 11.8 6,200.0 Own Resources 803 7 1,432 3 871.5 825.0 939.4 889.5 1,081.0 778 6 1.062 1 Foreign Resources 2,778.1 2,975.0 3,023.3 2,286.5 3,162.2 3,0143 3,342.0 3.586 1 5.1379 8 TIourism, Posts And 721.9 2.6 973.3 3.2 1,005.8 3.3 458.2 1.6 1,043.2 3.0 784.2 2.3 962.7 2.5 935.9 2.5 1,215.4 'I'elecommunications Own Resources 69.5 299.9 78.1 68.9 94.7 90.0 107.5 75.9 86 7 Foreign Resources 652.4 673.4 927.7 389.3 948.5 694.2 855.2 860.1 1,128.7 9 Regional Development And 5,504.2 20.1 5,461.2 17.8 6,139.2 19.9 6,187.5 21.5 6,509.1 18.9 6,762.1 20.2 7,164.1 18.4 6,767.6 18.2 19,124.1 Transmigration Own Resources 5,119.5 5,222.5 5,615.4 5,747.3 6,222.6 6.507.3 6.881.9 6.4653 11.864 1 Foreign Resources 384.7 238.7 523.8 440 2 286.5 254.9 282.2 302.2 7.260 0 10 Environment And Spatial 452.3 1.7 419.7 1.4 517.3 1.7 439.0 1.5 615.6 1.8 567.2 1.7 685.8 1.8 616.5 1.7 798.9 Own Resourecs 243.3 252.3 277.2 256.5 322.4 306.3 420.8 344.0 391.9 Foreign Resources 209.0 167.4 240.1 182.5 293.2 260.9 265.0 272 5 407 0 I Educalion, Culture, Belief In 3,061.1 11.2 2,988.4 9.7 3,359.2 10.9 3.130.3 10.9 3,970.6 11.5 3,636.2 10.9 4,676.9 12.0 4,185.2 11.3 8,000.0 Almighty God, Youth And Sports Own Resources 2,358.6 2,409.0 2,608.0 2.45(0.9 3.057.4 2.823.5 3,735.4 3,245.5 4.566 4 Foreign Resources 702.5 579.4 751.2 679.4 913.2 812.7 941.6 9397 3,4336 12 I'opulation 290.2 1.1 269.8 0.9 300.3 1.0 265.6 0.9 328.0 1.0 308.6 0.9 690.9 1.8 545.8 1.5 587.5 Own Resources 244.8 221.5 252.5 234.3 277.9 264.0 634.8 483 3 303.9 Foreign Resources 45.5 48.3 47.8 31.3 50.1 44.6 56 1 625 283.6 13 Social Welfare, Ilealth, Rule Of 1,031.0 3.8 987.2 3.2 1,051.8 3.4 987.1 3.4 1,364.9 4.0 1,274.2 3.8 2,097.2 5.4 1,892.5 5.1 4,500.0 Women, Children And Adolescent Own Resources 816.6 839.4 860.2 825.3 1,090.5 1,029.9 1,527.6 1,362.7 3,025.8 Foreign Resources 214.4 147.8 191.6 161.8 274.5 244.3 569.6 529.8 1,474.2 l abic 3.2s. conid 1994/1995 1995/1996 1996/1997 1997/199 199Ulffl No Category Plan i Relization Plan |Realization Plan F Rlkatii n Plan Actual Plan Abs |_% | Abs % A Abs Abs . Abs |% Abs V% Abs I % Abs 14 llousing And Human Settlements 888.0 3.2 1,103.4 3.6 1,102.1 3.6 1,037.6 3.6 1,325.6 3.8 1,127.6 3.4 1,533.8 3.9 1362.1 3.7 2.940.6 Own Resourecs 469.4 614.3 514A1 469.1 596.3 478.6 671.3 539.1 1.473 1 Forcign Resourccs 418.6 489.1 588.0 568.5 729 2 649 0 862 5 823 0 1.467 5 15 Religion 121.9 0.4 165.6 0.5 183.3 0.6 238.4 0.8 253.7 0.7 236.4 0.7 304.0 0.8 254.7 0.7 374.7 OwnResources 112.3 159.2 139.6 194.1 177.9 169.0 226.2 161.8 209.4 Forcign Resources 9.5 6.4 43.7 44.3 75.7 67.4 77.S 93.0 165.3 16 ScIence And Technology 529.8 1.9 394.1 1.3 711.2 2.3 431.6 1.5 805.6 2.3 743.4 2.2 881.8 2.3 817.0 2.2 1,122.7 Own Resources 423.7 358.2 500.6 396.5 606.8 566.4 701.4 548.3 615.9 Foreign Resources 106.1 36.0 210.6 35.1 19S 8 176.9 180.4 268.7 506 8 17 Law 111.4 0.4 90.8 0.3 138.7 0.5 117.3 0.4 172.9 0.5 153.4 0.5 195.0 0.5 137.0 0.4 200.0 OwnResources 101.4 90.6 130.8 117.2 159.9 141.8 193.6 1353 1901 Foreign Resources 9.9 0.2 7.9 0.1 13.1 11.6 1.4 1.7 9.9 18 Gov't Apparatus And Supervision 557.0 2.0 567.0 1.8 664.4 2.2 624.0 2.2 818.6 2.4 765.3 2J 911.0 2.3 725.9 2.0 919.5 Own Resourees 468.7 417.9 543.5 528.5 663.0 626.8 689.2 524.6 574.7 Foreign Resources 88.3 149.1 120.9 95.5 155.5 138.4 221 7 201.3 344.8 19 Politics, Internttional Relations, 157.3 0.6 219.2 0.7 152.7 0.5 130.6 0.5 183.2 0.5 170.9 0.5 286.1 0.7 228.9 0.6 379.0 Information, Communications And Mass Media Own Resources 78.7 123.3 85.9 82.2 140.0 132.5 148.7 99.9 140 2 Foreign Resources 78.6 95.9 66.8 48.5 43.2 38.5 137.4 129 0 238 8 20 National Derence And Security 1,154.6 4.2 1,278.0 4.2 1,317.3 4.3 1,594.1 S. 1,531.8 4.4 1,689.7 S.1 1,7217.5 4.4 1,413.8 3.8 2.122.7 Own Resourecs 589.3 671.4 724.1 759.0 898.7 1.126.2 1.086.2 1.021.8 1.122.7 Foreign Resources 565.3 606.6 593.2 835.1 633.1 563.5 641.4 391.9 1.000.0 rotal 27,397.9 100.0 30,68S.2 100.0 30,783.5 100.0 28,780.5 100.0 34,502.7 100.0 33.454.2 100.0 38,927.9 100.0 37.110.9 100.0 70.755.0 Own Resources 17,386.0 63.5 20,850.2 67.9 19,024.5 61.8 19.771.8 68.7 22.089.1 64.0 22.406.2 67.0 25.901.9 66.5 23.550.9 63.5 35.231.1 Foreign Resources 10,011.9 36.5 9,835.0 32.1 11,758.9 38.2 9,008.8 31.3 12,413.6 36.0 11 .048.1 33.0 13,026.0 33.5 13.560.0 36.5 35.5239 Source: Government of Indonesia Table 8: Investment Budget (Development Budget) (in billions of rupiah, Constant 1993 prices) - 199J/1 "5 1995/1996 1996/1997 1997/1998 3991199 GDP Deflator 1908 j 1.18 li1.oS P l1.66 n 2.Au No Category Plan Realization plan 1 Res.6z.ion Pbn I Realizaion pln 6Acevl Plan Abs % Abs % Abs | % Ab | Ab | | % AbA|Abs % Abs Industry 417.1 1.6 523.3 1.8 421.4 1.6 682.5 2.8 395.8 3.5 534.7 2.0 355.3 1.5 551.3 2.5 300.8 Own Resources 133.1 207.0 147.1 525.0 162.4 327.0 147.6 349.8 1198 IForcignResourccs 284.0 316.3 274.3 157.5 233.4 207.7 207.7 2014 18119 2 Agriculture and Forestry 916.3 3.6 1,534.7 5.4 935.4 3.6 755.1 3.1 1,011.3 3.8 1,086.5 4.2 911.4 3.9 1.3J7.9 6.0 1,575.2 Own Resources 613.3 1,251.1 564.8 573.6 643.2 757.4 582.4 1.013.S 8129 Foreign Resourccs 303.0 283.6 370.6 181.5 368.0 329.2 329 0 334 4 762 3 3 Water Resources 1,562.0 6.2 1,789.0 6.3 1,730.6 6.6 1,607.6 6.6 1,810.5 6.7 1,655.3 6.3 I.576.0 6.7 I.453.6 6.5 2.080.8 Own Resources 749.4 925.5 740.8 945.3 968.6 920.6 887.1 658.6 640 5 Iorcign Resources 812.6 863.5 989.7 662.4 841.9 734.6 688.9 794 9 1.440 3 4 Manpower 135.6 O.S 100.9 0.4 144.6 0.6 118.1 O.S 146.2 0.5 136.4 0.5 162.3 0.7 121.7 0.5 498.1 OwnResourmes 110.6 97.1 112.5 103.1 125.2 117.7 139.2 84.7 442.6 Foreign Resources 25.1 3.9 32.0 15.0 21.0 18.7 43.1 370 55 5 S TIrade, Development of Busin 681.7 2.7 1,333.0 4.7 452.3 1.7 773.2 3.2 313.6 1.2 704.9 2.7 331.3 1.4 276.3 1.2 33r.3 Enterprises,, Finance and Cooperatives Own Resourecs 134.1 3.054.4 130.3 S13.0 142.0 55(06 1363 1156 lO)t, Iorcign Resources 547.6 278.5 322.0 260.3 171.6 154.3 195.0 1607 2347 6 Transport, Meteorology & 4,838.4 19.1 S,237.8 18.4 4,998.3 19.2 4,62.5 S18.7 5,290.0 19.6 4,734.9 18.1 4,126.4 17.6 3,998.3 17.9 3.S78.9 Geophysics Own Resources 3,339.4 3,630.0 3.239.2 3.117.3 3,303.5 2.994.3 2.824.0 2.455.2 1.491 Foeign Resources 1.499.0 1,607.8 1,759.1 1,444.2 1.9S6.5 1,740.6 1.302 4 1.543.0 2.087.9 7 MINING AND ENERGY 3,316.5 13.1 4,080.8 14.4 3,300.7 12.7 2,636.9 30.8 3,204.3 11.9 3,049.8 11.7 2,664.4 32.4 2.629.3 11.8 2,330.8 Own Resources 744.2 1,326.2 738.6 - 699.2 733.9 694.9 651.2 469.0 399.3 Fortign Resources 2,572.3 2.754.6 2,562.1 1,937.7 2.470.4 2.354.9 2.013.3 2.1603 I.931 ' ________________________________ ________________________________ Table 3.2b.ale 3 c2b onco n d 1994/1995 1995/1996 1996/1997 1997/1998 al3 b 99 GDP Deflator 1.18 1.28 1.66 2.66 No Category Plan Realization Pis"lan | ealization Plan Realization Plan Actual Plan Abs % Abs % Abs | I%% Abs | I Abs I % Abs I % Abs 8 lourism, Posts And 668.4 2.6 901.2 3.2 852.4 3.3 388.3 1.6 815.0 3.0 612.6 2.3 579.9 2.5 563.8 2.5 456.9 Telecommunications Own Rcsources 64.4 277.7 66.2 58.4 74.0 70 3 64.7 45.7 32 6 Foreign Resources 604.0 623.5 786.2 329.9 741.0 542.3 515.2 518.1 424.3 9 Regional Development And 5,096.5 20.1 5,056.7 17.8 5,202.7 19.9 5,243.6 21.5 5,085.3 18.9 5,282.9 20.2 4,315.7 18.4 4.076.8 18.2 7,189.5 Transmigration Own Resources 4,740.3 4,835.6 4,758.8 4.870.6 4.861.4 5,083.8 4,145.7 3.894.8 4,4602 Foreign Resourecs 356.2 221.0 443.9 373.1 223.9 199.1 170.0 182.1 2,729.3 10 Environment And Spatial 418.8 1.7 388.6 1.4 438.4 1.7 372.0 1.5 480.9 1.8 443.1 1.7 413.1 1.8 371.4 1.7 300.3 Own Rcsources 225.3 233.6 234.9 217.4 251.9 239.3 253.5 207.2 1473 Foreign Resources 193.5 155.0 203.5 154.1 229.1 203.8 159.6 164.1 153 II Education,Culture,Beilief in 2,834.4 11.2 2,767.0 9.7 2,846.8 10.9 2,652.8 10.9 3,102.1 11.5 2,840.8 10.9 2,817.4 12.0 2,521.2 11.3 3,007.5 Almighty God, Youth And Sports Own Resources 2,183.9 2,230.6 2,210.2 2,077.0 2,388.6 2.205.9 2.250.2 1,955.1 1.716,7 Foreign Resources 650.5 536.5 636.6 575.8 713.4 634.9 567.2 566.1 1.290 8 12 Plopulation 268.7 1.1 249.8 0.9 251.5 1.0 225.1 0.9 256.3 1.0 241.1 0.9 416.2 1.8 328.8 1.5 220.9 OwnResources 226.6 205.1 214.0 198.6 217.1 206.3 382.4 291.1 114.2 IForeign Rcsources 42.1 44.7 40.5 26.5 39.2 34.9 33,8 37.7 106 6 13 Social Welfare, llealth, Role Of 954.7 3.8 914.0 3.2 891.4 3.4 836.5 3.4 1,066.4 4.0 995.4 3.8 1,263.4 5.4 1,140.1 5.1 1,691.7 Women, Children And Adolescent Own Resources 756.1 777.2 729.0 699.4 851.9 804.6 920.2 820.9 1,137 5 Foreign Resources 198.6 136.8 162.4 137.1 214.4 190.9 343.1 319.2 554.2 rTablc 3.2b. conitd.. 1994/1995 1995/1996 1996/1997 1997/1998 1998/1999 CDP Deflator 1.08 1.18 1.28 1.66 2.66 No Category Plan Realization Plan | Realization Plan Realization Plan | Actual Plan Abs | % Abs | % Abs | % Abs | % AbsI I | I Abs Abs I % Abs | % Abs _~~~~~~~~~~~~~~b I_ Abs I _. Ab I . T- /g 14 hlousing And lluman 822.2 3.2 1,021.7 3.6 934.0 3.6 879.3 3.6 1,035.6 3.8 880.9 3.4 924.0 3,9 820.5 3.7 1,105.5 Settlements Own Resourccs 434.6 568.8 435.7 397.5 465.9 373.9 404.4 324.7 553.8 Foreign Resources 387.6 452.9 498.3 481.8 569.7 507.0 519.6 495.8 551.7 15 Religion 112.8 0.4 153.3 0.5 155.3 0.6 202.0 0.8 198.2 0.7 184.7 0.7 183.2 0.8 153.4 0.7 140.9 Own Resources 104.0 147.4 118.3 164.5 139.0 132.1 136.3 97.5 78.7 Foreign Resources 8.8 5.9 37.0 37.5 59.2 52.7 46.9 56.0 62.1 16 Science And Technology 490.6 1.9 364.9 1.3 602.7 2.3 365.8 1.5 629.4 2.3 580.8 2.2 531.2 2.3 492.2 2.2 422.1 Own Resources 392.3 331.6 424.2 336.0 474.0 442.5 422.5 330.3 231.5 Foreign Resources 98.2 33.3 178.5 29.7 155.3 138.2 108.6 161.9 190.5 17 Law 103.1 0.4 84.0 0.3 117.5 0.5 99.4 0.4 135.1 0.5 119.9 0.5 117.5 0.5 82.5 0.4 75.2 Own Resources 93.9 83.9 110.8 99.3 124.9 110.8 116.7 81.5 71.5 Foreign Resources 9.2 0.2 6.7 0.1 10.2 9.1 0.8 1.0 3.7 18 Gov't Apparatus And 515.7 2.0 525.0 1.8 563.0 2.2 528.8 2.2 639.5 2.4 597.9 2.3 548.8 2.3 437.3 2.0 345.7 Supervision Own Resources 434.0 387.0 460.6 447.9 518.0 489.7 415.2 316.0 216.1 Foreign Resources 81.7 138.0 102.4 80.9 121.5 108.1 133.6 121.2 129.6 19 Politics, International Relations, 145.7 0.6 203.0 0.7 129.4 0.5 110.7 0.5 143.1 0.5 133.5 0.5 172.4 0.7 137.9 0.6 142.5 Information, Communications And Mass Media Own Rcsources 72.9 114.2 72.8 69.6 109 4 103.5 89.6 60.2 52.7 Foreign Resources 72.8 88.8 56.6 41.1 33.8 30.0 82.8 77.7 89.8 20 National )efence And Security 1,069.1 4.2 1,183.4 4.2 1,116.3 4.3 1,350.9 5.5 1,196.7 4.4 1,320.1 5.1 1,040.7 4.4 851.7 3.8 798.0 Own Resources 545.6 621.7 613.6 643.2 702.1 879.8 654.3 615.6 422.1 Foreign Resources 523.4 561.7 502.7 707.7 494.6 440.2 386.4 236.1 37S.9 TOTAL 25,368.4 100.0 28,412.2 100.0 26,087.7 100.0 24,390.3 100.0 26,955.2 100.0 26,136.1 100.0 23,450.5 100.0 22,356.0 100.0 26,599.6 Own Resources 16,098.1 63.5 19,305.7 67.9 16,122.5 61.8 16,755.7 68.7 17,257.1 64.0 17,504.8 67.0 15,603.5 66.5 14,187.3 63.5 13,244.8 Foreign Resources 9,270.3 36.5 9,106.5 32.1 9,965.2 38.2 7,634.6 31.3 9,698.1 36.0 8,631.3 , 33.0 7,847.0 33.5 8,168.7 36.5 13,354.8 Source: Government of Indonesia 96 TABLE 9 : SALES AND EARNINGS BEFORE INTEREST AND TAXES OF 22 COMPANIES: ACTUAL RESULTS IN 1996 AND SIMULATIONS ACTUTAL RESULTS SIllULATION I SIMULATION 2 Sales EBIT Cost of EcROC Sales EBIT Cost of EcRO Sales EBIT Cost of EcROCE Capital E Capital CE Capital (in billion rupiahs) (in billion (in billion rupiahs) rupiahs) Angkasa Pura 11 374 139 32% 7% 374 139 32% 7% 385 194 290/ 11% Garuda Indonesia 4,111 -135 27% 7% 3,885 167 26% 9% 4,199 401 26% 1% Indosat 1,223 712 32% 27% 1,223 712 32% 27% 1,61S 1.070 2S% 44% IPTN 380 -158 22% -6% 593 204 24% 7% 614 377 22% 1I% Jasa Marga 632 384 26% 14% 632 384 26% 14% 632 384 26% 14% Pal Indonesia 257 8 31% 0% 257 8 31% 0% 257 8 31% 0% Pelindo 15 470 213 30% 5% 416 322 26% 20% 416 322 26% 20%/o Perumka 660 1 S 27% 1 % 690 140 26% 8% 905 442 26% 27% Pctrokimia Gresik 890 168 23% 14% 910 193 23% 17% 979 347 22% 37% PLN 9,646 2,117 24% 4% 9,115 2.517 23% 6% 9,646 2.117 23% 4% Posindo 511 73 31% 12% 513 86 27% 14% 576 171 27% 38% Pelni 433 34 32% 2% 432 92 29% 6% 625 278 28% 21% Pertamina 43,274 3,698 25% 13% 44,676 6.955 25% 31% 44.995 8.660 25% 40% PTPN -1I 466 120 24% 11% 450 122 24% 12% 450 122 24% 12% PTPN - IV 466 139 31% 17% 466 139 31% 17% 466 139 31% 17% PTPN -IX 212 8 30% 2% 212 8 30% 2% 212 8 30% 2% Pupuk Sriwijaya. 2,504 250 30% 15% 2,504 250 26% 15% 2.692 651 26% 43% Rajawali 440 58 25% 5% 428 86 25% 9% 559 172 25% 19% Nusantara Semen Gresik 1.363 350 27% 7% 1,293 416 27% 14% 1,293 416 27% 14% Krakatau Steel 2.595 153 32% 3% 2,335 253 28% 6% 3.212 805 28% 19% Taba 625 143 26% 6% 778 281 26% 14% 830 389 25% 20% TELEKOM 5,076 2.523 25% 11% 5.583 3.324 25% 18% 8.141 5.501 24% 31% Totals 76.608 11.014 77.768 16.798 83.701 22.973 EBIT = earnings before interest and taxes EcROC = Net of tax rate of return Source: Mann & Judd. Hadori and Rekan. Individual Company Reports. MAP SECTION IBRD 26570 9^---~-THAILAND" R:oBndo AtHo,,oF,. t -Hi. (I PHILIPPINES INDONESIA ,Ro,don MALAYSIA \ -! ® PROVINCE HEADQUARTERS 7 . . ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~NATIONAL CAPITAL ' / PROVINCE BOUNDARIES MALAYSIA 5 / INTERNATIONAL BOUNDARIES -_SINGAPORE W-d0 IW FNkonbory _____________ SUMATERA Jomb'o 0 I' , i ' S, A H i D l YOGYA i ~- FAI AT)=n EAAGEA po} Ub=km _; §'' AW S! DR, JJLRAMPN eguu EIU9 Bftlongko,oy e -, B 2oda 'ER >?oB JAY P.d-gOTA KEAA A , I AA "A N T3 A' Pd)g P. TAP! D KALLAKANTA TIMUR 3k 1IJLAS -ES , £0, JAWAARAT PoI800bonI I j UAWAS TENG-AH coobLu i'' J-'Lm''/,, , _ AWATIMU UR -omTIITron5 ond ony osln 2 d. L mbiL -ALSA DENGKW 0 >06 SUMATERNASELATANRm Rono RIAU~0RIuRRnogn, SUMARSERA BRATS ', UMALUKU DEMO 1ol oLGop I3 ', ACEN 0A.E JAKARTA RAAR T oENOM ˇWAU L KAUMANOTAN SELATANO J- M.qAn > RAUVANOTAN ISMUR 3OOAD SUL-AWEI TENCAH onkd -A2 SULAWOSS UTARAt I sSULAWES SELATAN ,ro SULAWESI TENGGARA TA. b--dr.. S,0oo.MnB.r Abo 3 NUSA TENGGARA aRHAT on. tooo 000 .~24no NUSA TENGGMAATIMUR TIMORo Aoonno OOOR IRIAN JAYA800iAooSntolgo 1 TIMORTIMUodnRo. nOn00AUSTRALIA DECEMBER199A4