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Policy Reform in Indonesia: Agenda and Challenges

Mohamad IkhsanAdvisor to Coordinating Minister for Economic Affairs Republic of Indonesia and

Senior Research Associate at the Institute for Economic and Social Research University of Indonesia

Presented at The First OECD-Southeast Asia Regional Forum: Peer Review Mechanism for Policy ReformHotel Nikko Jakarta, Indonesia

23-24 January 2007

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Outlines

• Overview on the state of Economy since the crisis time• Policy Uncertainty Issues in Indonesia

– Macro Uncertainties– Micro Uncertainties

• The Impact of Policy Uncertainties on Performances– TFP– Investment– Employment

• Major Causes for Uncertainties• Policy Reform Agenda• Conclusion

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Overview of State of Economy

• Indonesia’s economy has steadily improved since the crisis time.

• Per capita income has been backed to pre crisis level since 2004 and growth rate now accelerating to a 6 % p.a

• More balance and sustainable sources of growth

• Macroeconomic risks improved significantly indicated by a sharp reduction in public and external debt ratio and short term debt over international reserve

Grafik 2: GDP/Kapita

0

200

400

600

800

1000

1200

1400

2001 2002 2003 2004 2005 E)

Debt GDP Ratio for Several Emerging Countries

0

20

40

60

80

100

120

Korea China India Taiwan Malaysia Thailand P hilippines Indonesia

Per

cen

t

2000 2004(Est) 2005(proj)

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But many (economic) problems remain

• Our productivity remains lagging behind pre crisis period or other regional competitors.

• Unemployment both open and under employment are still higher than pre crisis.

• Poverty trends are moving away of the paths.

Table 2.1: Growth accounting

Contribution to growth of:

Growth in output per

worker Physical capital

Human capital TFP

Indonesia

1961-03 2.9 1.7 0.5 0.6 1967-80 5.0 2.0 0.5 2.4 1981-97 3.8 2.5 0.5 0.8 1998-99 -8.8 0.9 0.5 -10.0 2000-03 2.1 0.4 0.4 1.2 Comparator economies 1961-03* East Asia (5) 3.6 1.9 0.5 1.2 Korea 4.7 2.7 0.7 1.3 Malaysia 3.6 2.2 0.6 0.8 Philippines 1.0 0.8 0.4 -0.2 Thailand 4.1 2.3 0.4 1.4 OECD 2.4 1.0 0.4 1.0 All developing 1.4 0.8 0.3 0.3 Source: Bosworth and Collins (2003) and World Bank staff estimates. * Simple averages for comparator groups. OECD and All Developing are 1961-00.

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Firm and industry level data amplify those fundamental problems

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In short, mostly caused by policy uncertainties

0 10 20 30 40 50 60 70 80

TelecomAccess to Land

Customs & trade localCustoms & trade national

TransportBusiness permits national

AnticompAccess to Finance

Skills and educationBusiness permits local

CrimeElectricity

Lab reg localTax admin

Lab reg nationalLegal system

Costs of FinanceTax rates

Corruption nationalCorruption local

Pol & Reg UncertaintyMacro Uncertainty

Percentage of firms reporting constraint to be severe or very severe

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Sources of Uncertainties• Political transition to democratic

regime– No clear majority and expected to

continue up to the next 10 year• Bigbang decentralization.

– Authority vis a vis responsibility• Financial crisis has limited the

central government power.– Crisis increases government debt

services cost and limit the power of central government

• Most of regions rely on central government transfers.

– Inducing regional government to take progressive and in many cases unnecessary new tax and retribution.

• High debt also rises the country’s risks and degree of vulnerability.

– Debt intolerance in Indonesia is about 35% of GDP. It implies focusing on reducing debt burden still the agenda over 1-2 years ahead.

– Vulnerability in financial sector have forced the government to take another burden on contingent liability.

• The crisis also reduced the ability of the state to up grade infrastructures.

– Government spending on infrastructures reduced to only 3-4 % of GDP compared to 7% during the pre crisis time

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Improving investment climate

Macro adjustment

Quality of public spending

Lower taxes and cost of

capital

Structural and institutional

reforms

Low costs

Better risk x return

Greater demand

and output

More investment

Increase competition

Raise efficiency

Lower risk

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Policy Reform Constraints

• Political constraints hinder the ability for GOI to eliminate political uncertainties except for the areas where all parties and/or interest groups relative have common ground.

– Improving one areas may open the other Pandora.• Lack of trusts and lack of responsibility

– Regional government regulation• Some dilemmas:

– Need to focus on the process rather than outcomes (but at the cost of relative slow of implementing and results)

– High expectation ( partly due to the past memories) also increases the demand for quick outcomes.

– Inherent dilemmas: look example in fiscal trilemmas.• PR Problem

– “Take it for granted” behavior on the government sides.– Intermediary problem– Asymmetric problems of reform: cost of reform always up front while benefit

usually appear in the medium term. Benefit per capita in many cases always less than cost per capita.

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A reform agenda

• Macro reform:

– Fiscal Policy trilemma

– Stabilization policy

• Micro Reform: Three Pillars

– Investment Climate

– Infrastructure Acceleration

– Financial Sector Reform

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Fiscal policy trilema

Reduce public debt/GDP

Lower taxes

Increase public investment

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Fiscal reform

• Reduce public debt / GDP ratio:– Sustain a high primary surplus– Lower the cost of debt

• Restructure public spending to accommodate rise in public sector investment

• Reduce tax burden • Develop a medium-term fiscal framework that lowers

political risk.• Gradually reduce contingent liability

– Abolish the financial sector blanket system while introducing new deposit insurance companies

– State Owned Companies Restructuring including initiating new law on Regional State Owned Companies

• Most of them have been achieved and further reforms are underway.

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Three Policy Packages

InvestmentClimate

Improvement

Infrastructure

Financial

1 Investment Law & Procedure

2 Tax & Custom Reform

3 Labor & Immigration

4 Trade Licenses

9 Coordination Monetary & Fiscal Authority

10 Financial Institution (Banking & Non Banking)

11 Capital Market and SOE Privatization

5 Cross Sector Strategic Policy Reform

6 Sector Restructuring, Corporatisation and Policy Reform

7 Regulation on natural monopoly & investment protection

8 Clear separation on the role of policy maker, regulator, contracting agency, and operator

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Milestones For Improving Regulatory Environment for PPP

InstitutionalStrengthening

KKPPI - Interministerial Committee for Infrastructure Development

Cross Sector - PPP

Regulatory

Framework

Issuance of

Presidential Regulation No.67 /2005 (Perpres 67/2005)

Project PreparationEstablishment of

Project Development Facility - PDF

Government

SupportIssuance of

Minister of Finance Regulation No.38/2006

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Infrastructure Policy Package

Road & Toll Road Water & Sanitation

Road Law

Law No. 38/2004

GR on toll road

GR No.15/2005

Law on Water Resources

Law No.7/2004

Water Supply

GR No.16/2005

Telecommunication

Interconnection regulation

MCI regulation No. 8/2006

Regulation on Retain Revenue

GR No. 28/2005

Energy & Power

GR on electiricity procurement & utilization

GR No. 3/2005

Establishment New Electricity Law

Submitted to parliament

Draft New Energy Law Submitted to parliament

Transportation

Draft new laws on sea, air, land, and rail transport

Submitted to parliament

One important theme in these laws is the phasing out of the monopoly position of the SOEs in infrastructure services…..

Wider opportunities will be open up for private investments in railways, harbors and airports and other sectors.

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Investment Climate Improvement

General

Draft Investment law

Submitted to parliament

Simplified Trade licenses

Done

Model for National Single Window

Done

Delegation authority of licenses

Done

Supervision Cent & Regional Regulation

On going

Tax

Draft Tax Law

Submitted to parliament , expected to be passed on 2007

Customs

Custom law Passed

Regulations to simplify customs process

done

Draft of other regulations

On going

Labor

comprehensive study on Review of Labour Law

On going

Strengthening service institutions

Transparency Equal treatment Settlement mechanisms

Synchronization of regulations

Clear and transparent criteria on tax

Service desks on Large Tax Office

Revision of VAT

Improving processing time

Implementation of EDI system to improve efficiency

Review of Labor Law no.13/2003,

Development of Employment Dispute Information System

Development of an online job search

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Financial Policy Package

Strengthen the coordination between fiscal and monetary authorities

Strengthening banking institutions and policy on improving the performance of SOE Banks

Strengthening non bank financial institutions (insurance, pension funds, finance companies & venture capital firms)

Improving the liquidity, efficiency and integrity of the capital market

Clarify Government privatization policy direction

• The establishment of Mediation Agency for Indonesia Insurance in September 2006.

• The establishment of road map pension fund program in September 2006.

• The issuance Bank Indonesia regulation regarding incentive for banks merger and consolidation.

• The establishment of Committee for Privatisation of State Enterprise. A clear legal ruling on separate maintenance of state assets in regard to the management of non-performing loans at state-owned banks

Launched June 2006, as joint effort between GOI and BI

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New Initiatives: 2007-2008

• Continue to implement three previous packages– Carry over some delay policy actions– Refocusing on some important issues– Eliminate some irrelevant policy actions

• Take special actions for several important issues– Employment Creation and Poverty: SME, CCT,

Poverty Community Development, and Urban Housing Programs

– Energy: Deregulation in Oil and Gas and Energy Alternative

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Conclusion: How to create an effective and do-able agenda

• It must start with credible and feasible agenda– Taking to account political constraint is necessary– Consider all possible negative side effects

• Priority is essential• Need to manage expectation

– Reform should not be oversold• Setting the pace and sequence of reform is really art.

– Need to have a full knowledge on all constraints and opportunities– Crisis in many times opens the opportunity.

• In many cases, establishing oversight mechanism will help the credibility of reform

• Educating the public is the part of success element of reform.– Broadening the base of reform supporters part of the objective of the PR.

• Need to have a champion of reform.– Role of bureaucracy is important.