INDONESIA AND MCC COMPACT ELIGIBILITY

UNCLAS SECTION 01 OF 03 JAKARTA 012687

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR EAP DAS JOHN AND EB/IFD DAS DIBBLE
AID FOR ANE/AA-KUNDER
TREASURY FOR IA-BAUKOL
DEPT PASS USTR FOR WEISEL AND KATZ

E.O. 12958: N/A
TAGS: EINV ECON KMCA KCOR ID
SUBJECT: INDONESIA AND MCC COMPACT ELIGIBILITY

Ref: A) Jakarta 12254 (Anti-Corruption Update)
B) 05 Jakarta 13647 (Indonesia and MCC)
C) Jakarta 5420 (Tax, Customs Chiefs Fired)
D) Jakarta 11379 (2007 Budget)


1. (SBU) Summary. President Susilo Bambang Yudhoyono's
(SBY) administration has made important progress in the past
year implementing a broad-based development strategy
emphasizing poverty reduction, private sector growth, and
good governance. SBY's bold anti-corruption efforts
continue to dismantle decades of public sector corrupt
practices in Indonesia, and Indonesia's score on the MCC's
"Control of Corruption" indicator now lies within the margin
of error of the median. Budgets for social spending have
increased significantly two years in a row, and SBY has
placed a strong emphasis on educational spending, with the
highest ever budget for 2007. As in previous years, the
MCC's primary education data for Indonesia fail to capture
the majority of spending that flows through local government
channels--the best estimate available calculates that 2006
spending was between 1.77 - 1.85% of GDP, far above
Indonesia's MCC scores. Health spending is also rising, and
in response to a 2005 polio outbreak, the GOI and
international donors conducted a series of National
Immunization Days (NIDs) in 2005-06 costing $70 million.
The GOI reduced the number of days to start a business by a
third in 2006. Although Indonesia's 2007 Millennium
Challenge Corporation (MCC) scores fall short of the median
on corruption and several "investing in people" categories,
Indonesia has made important progress in the last two years
in these areas and has bought fully into the MCC development
model. We see little sign that SBY will change his highly-
regarded, pro-western economic team in an expected upcoming
cabinet reshuffle, making continued progress on key reforms
likely through the 2009 election. With a Threshold Program
set for MCC Board approval in the near future, we recommend
Washington agencies support Indonesia's next step to compact
eligibility in 2007. End Summary.

Bold Anti-Corruption Efforts Continue
--------------


2. (SBU) Indonesia's 2007 MCC scores provide a useful
benchmark of the country's development successes and
challenges, but fail to reflect the full reform
accomplishments or momentum underway. Indonesia's score on
the MCC "Control of Corruption" indicator has improved in
three consecutive years, testimony to the anti-corruption
efforts of the GOI and changing attitudes toward corruption
among the Indonesian public. However, many of the GOI's
most robust anti-corruption efforts have taken root only
since the SBY Administration came to power in October 2004.
As a result, the MCC data do not fully capture the progress
in the past two years given the lag time for compilation of
corruption perception indices. We anticipate that
Indonesia's future MCC corruption scores will more fully
reflect the positive impact of the SBY Administration's
reform agenda, and propel Indonesia's score - already for
the past two years within the statistical margin of error to
achieve the median - clearly into positive territory.


3. (SBU) SBY's anti-corruption efforts remain strong two
years after he took office. Indonesia's corruption fighting
bodies (Corruption Eradication Commission, Interagency
Corruption Eradication Team, Attorney General's Office,
Financial Intelligence Unit) are energized and becoming more
institutionalized. SBY or his Ministers have replaced or
sidelined corrupt senior officials, including the
notoriously corrupt Directors General for Tax and Customs
and the entire management board of state-owned oil company
Pertamina. More changes of corrupt or ineffective ministers
are likely soon. Police Chief Sutanto, appointed in July
2005, has proven to be an effective reformer who has
dismissed the heads of two provincial police forces for
misconduct. The list of officials convicted or under
investigation for corruption continues to grow and now
includes a former Minister of Religious Affairs, the former
Chairman of the Investment Coordinating Board (BKPM),a
prominent Jakarta judge, several senior officials of state-
owned enterprises, an Indonesian diplomat and two former
police generals. Although SBY's record is not perfect and
his cabinet is uneven, for the first time in Indonesia's
recent history there is a clear sense that the good guys are
winning. .


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4. (SBU) Decentralization remains a challenge and anti-
corruption efforts are uneven at provincial levels. Some
local leaders/bodies feel free to ignore mandates from
Jakarta. However, the President and reform-minded Cabinet
members continue to push from the top, using limited
executive authority over an unwieldy bureaucracy as a
positive force for change. SBY has kept anti-corruption
high on the political agenda. He has granted permission for
investigations of high-ranking officials to proceed and made
strong statements against corruption in domestic and
international speeches. Parliament, while dodging internal
reform, has helped by ratifying the United Nations
Convention against Corruption, and passing whistleblower
protection legislation this year.


5. (SBU) The 2006 and 2007 budgets showed increases in
spending for education, health, the judiciary, police and
military (Ref C). The 2007 budget also contains an overall
23.3% increase in personnel spending for the civil service,
which many view as vital to reducing public corruption.
This includes a 15% increase in base salaries for the civil
service, military and police; higher civil service pensions;
a higher allowance for teachers; and a 20% increase in
official per diem for the police and the Ministry of
Defense.

Social Spending Increasing, Especially Education
-------------- ---


6. (SBU) The central government is backing its new
priorities with funding. The major funding vehicle for
local governments in Indonesia is the "General Allocation
Fund" or DAU. The DAU has grown steadily since 2001 to Rp
145.7 trillion (US $15.8 billion or 4.7% of GDP) in 2006.
Its nominal value rises to Rp 163.7 trillion (US $17.8
billion or 4.6% of GDP) in the GOI's initial draft FY 2007
budget. Salaries of Indonesia's 1.48 million teachers as
well as those of health workers are paid by DAU funds.
Local governments now account for about a third of total
government spending. However, the ability of local
government units to formulate, allocate and monitor budgeted
funds and reporting to the central government is very
uneven. This reality continues to complicate data
collection for several MCC indicators, an important point
the GOI has repeatedly sought to clarify with USG
counterparts including the MCC.


7. (U) The GOI is raising education spending to a historic
high in 2007, and is committed to raising it further in
years ahead. The President announced in August that
education would receive its highest budget allocation ever
at Rp 51.3 trillion (US $5.7 billion) or 10.3% of total
government spending for 2007. This is an increase from Rp
43.9 trillion (US $4.8 billion in 2006, and includes Rp 12.6
trillion (US $1.4 billion) to continue two nationwide
education assistance programs launched in 2005. The
President urged the regions, in a speech to the Council of
Regional Representatives on August 23, to give education a
top priority, including the improvement of school
facilities.


8. (U) Actual primary education spending continues to be
difficult to calculate because there is no single source of
centralized data. However, USAID developed a sophisticated
model to calculate the total public expenditure for primary
education in Indonesia for 2004-2006. This model is based
on extensive collaboration with officials at the Education,
Religion, Finance, Development, and Social Welfare
Ministries, plus analyses of actual education spending in 17
districts. For 2006, the model estimates total primary
education spending at 1.77 - 1.85% of GDP, significantly
above the reported MCC data points. (Note: The GOI adjusted
this slightly to 1.74% as noted in its submission to the MCC
on October 6, 2006. End Note.) Primary education spending
has been increasing since 2004 and the positive trend is
expected to continue in the 2007 budget.

Health Spending - Polio and Other Challenges
--------------


9. (U) Health spending in Indonesia is also rising. The
2007 central budget allocation for health increased by 20%
from 2006 to Rp 15.3 trillion (US $1.7 billion). This
includes an additional Rp 3.6 trillion (US $387 million) in
spending for rural health clinics (Puskesmas) and local

JAKARTA 00012687 003 OF 003


hospitals. In response to a 2005 wild polio outbreak, the
GOI sponsored a series of National immunization days in 2005-
06 targeting 24 million children under age 5 at a total cost
of US $70 million. This program has been highly successful,
and no new cases have been reported since February 2006.
Routine immunization coverage remains challenging, however,
especially among poor and hard-to-reach populations in
Indonesia's remote areas. The Ministry of Health recognizes
the urgent need to re-invigorate the routine immunization
system, while also struggling with high-profile, competing
priorities such as avian influenza, HIV/AIDS, and
tuberculosis. Indonesia's Threshold Plan is designed to
addresses the vaccination challenge for this huge nation of
33 provinces, 440 districts, 349 regencies and 91
municipalities.

Days to Start a Business Reduced
--------------


10. (U) One of the SBY Administration's top economic policy
priorities is to improve the investment climate by reducing
Indonesia's "high-cost economy." In September 2006, the
International Financial Corporation (IFC) reduced
Indonesia's oft-cited "151 days to start a business" figure
to 97 days. The GOI achieved this reduction mainly by
speeding the approval process for company articles of
incorporation at the Ministry of Justice.

Comment: A MCC Compact and Indonesia's Reforms
-------------- -


11. (SBU) Indonesia's GDP is more than 25 times larger than
the largest MCC compact country (Ghana),and three times
larger than the next largest threshold country (Ukraine).
Its large population and diversity, huge size, cultural
complexity, and decentralized political system create
development challenges that smaller countries do not face.
Nonetheless, the SBY Administration is pushing through
public sector reforms in a variety of areas and levels, some
of which were never touched before. These new initiatives,
combined with the country's diversity and complexity, create
significant challenges for data collection. Precise
indicator scores aside, Indonesia has bought into the MCC
development approach and its development program is aligned
with MCC goals.


12. (SBU) The upcoming Presidential visit offers an
extraordinary opportunity to maximize the impact of an
announcement of MCC compact eligibility for Indonesia. A
high profile announcement during the visit would send the
strongest possible signal of USG support for Indonesia's
reformers, and demonstrate U.S. determination to see
Indonesia succeed, despite its myriad challenges. With
Indonesia's Threshold Program likely set for board approval
on November 8, we strongly urge Washington agencies to make
Indonesia eligible for a MCC compact in FY07.

PASCOE