GENERALLY POSITIVE ASSESSMENT OF INDONESIA'S ECONOMY

UNCLAS SECTION 01 OF 03 JAKARTA 002745 SIPDIS SIPDIS DEPT FOR EAP/MTS, EB/IFD/OMA TREASURY FOR IA-BAUKOL SINGAPORE FOR TREASURY-BAKER COMMERCE FOR 4430-BERLINGUETTE DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN DEPARTMENT PASS EXIM BANK E.O. 12598: N/A TAGS: EFIN EINV ECON PGOV KMCA KCOR ID SUBJECT: GENERALLY POSITIVE ASSESSMENT OF INDONESIA'S ECONOMY PROVIDED BY KEY OFFICIALS REF: JAKARTA 13559 ¶1. Summary: Several key economic officials proviced a generally positive assessment overall of Indonesia's economy. Coordinating Minister for the Economy Boediono chaired a high-level briefing for donors and the private sector on September 25, noting that Indonesia's economy has grown more than 6% for the past four quarters. Bank Indonesia Senior Deputy Governor Miranda Goeltam said that monetary and banking sector reforms are improving stability. Indonesia's interest rates are still the highest in the region attracting portfolio investment. A new investment survey of businesses shows a perception of less corruption overall. Finance Minister Mulyani continues a vigorous reform program, replacing 1,300 customs officials at Jakarta's Tanjung Priok, Indonesia's largest port. End Summary. ¶2. Coordinating Minister for the Economy Boediono held a meeting for donor and private sector on September 25 to provide an update on the macroeconomy, financial sector and investment. Finance Minister Sri Mulyani Indrawati, Senior Bank Indonesia Deputy Governor Miranda Goeltam (financial and banking sector),State Minister for Administrative Reform Taufiq Effendi (regulatory issues) and Director of the Institute for Economic and Social Research at the University of Indonesia Dr. Chatib Basri (investment survey) also gave presentations. Momentum Building for Stronger Growth -------------- ¶3. (U) Coordinating Minister for Economic Affairs Boediono opened the forum with a review of Indonesia's strong macroeconomic performance over the past year. He noted that the Indonesian economy grew more than 6.0% during each of the past four quarters, with the non-oil economy expanding 7.0% over the first half of 2007. Commodity exports and domestic consumption continue to drive growth. Investment rates have also picked up considerably in 2007. Investment approvals rose 145% during the first half of the year compared to the same period last year. ¶4. Boediono predicted that the Indonesian annual economic growth rates would exceed 7.0% by 2010, on the back of continued strong world demand for Indonesian commodities, increased domestic spending, and new infrastructure capacity set to come on line in ¶2008. Boediono also expects continued progress on investment climate reforms and a low interest rate environment to spur growth. In addition, the GOI plans to expand spending on infrastructure significantly in the coming years, further reducing supply-side constraints to growth. Boediono downplayed the impact of a global economic slowdown on Indonesia's export performance citing the Indonesia's well-diversified export product and destination mix. ¶5. Boediono reported renewed momentum in the fight against poverty and unemployment. According to GOI data, the rate of open unemployment in Indonesia declined form 11.2% in November 2005 to 9.2% in February 2007. Boediono expects the rate to fall to the 8-9% range by the end of 2008. The incidence of poverty also fell from 2006 to 2007. However, the drop in 2007 followed a rise in the rate of poverty during the previous year. Nevertheless, in recognition that poverty remains a significant problem in Indonesia, Boediono announced plans for a significant increase in spending on community empowerment and poverty reduction programs in 2008. The GOI has also attempted to rationalize price stability programs for rice, sugar and fuel by easing import restrictions and targeting price subsidies to the poor, in an effort to relieve pressure on households with low incomes. The GOI expects inflation rates to drop to the regional average of 3-4% over the medium term. Monetary and Banking Sector Reforms Yield Results -------------- ¶6. Bank Indonesia Senior Deputy Governor Miranda S. Geoltom described BI's success in maintaining price stability in recent years. Price levels in Indonesia continue to fall, with volatility limited to the energy and food sector. The Rupiah remains on an appreciating trend, despite the recent dip attributed to global financial turmoil. Strong macroeconomic fundamentals, including JAKARTA 00002745 002 OF 003 current account surpluses, a large pool of foreign exchange reserves and a manageable external debt burden have limited capital outflows during the recent global credit market slump. While BI has moved the reference rate to down 450 basis points over the past year and a half, Indonesian interest rates are still the highest in the region, making Indonesia more attractive to foreign capital. Miranda affirmed that BI is committed to maintaining a flexible exchange rate regime, intervening in the foreign exchange market only to smooth volatility. ¶7. BI's effort to strengthen Indonesia's banking sector has paid dividends. The Indonesian banking industry is well capitalized (industry capital asset ratio above 20%),profitable (industry return on assets 2.8%),highly liquid (industry ratio of government bonds to assets 26%),and healthy (industry nonperforming loans ratio 6.4%). Skill levels among Indonesian bankers have improved, reducing the level of asymmetric information between banks and their clients. However, risk aversion leftover from the financial crisis of the late 1990s has continued to suppress credit growth in Indonesia. While credit growth has begun to recover in recent years, the rate of growth of loans remains well below the pre-crisis rate. ¶8. As a result, BI is attempting to implement policies that encourage lending or "improve the bank intermediation function" while maintaining the integrity of the banking sector. In line with the effort to promote lending activity, BI introduced policy changes in 2006 that eased rules for classifying certain types of credits such as shariah instruments, loans to SMEs and loans for disaster relief. BI has also established a credit bureau, improved data collection, and facilitated meetings between banks and potential borrowers in order to improve information flows. Investment Survey -------------- ¶9. Dr. Basri presented the results of the fourth investment climate monitoring survey (since 2005) of 589 firms in five metropolitan areas: Medan, Jabotabek, Semarang, Surabaya and Makassar. The survey also interviewed 56 notary offices in depth on business start-up times. Major conclusions: -- Perceptions of investment climate improved overall. -- Biggest perceived obstacles are macroeconomic instability, transportation, corruption and economic policy uncertainty. Perceptions of infrastructure quality, especially transportation and electricity have worsened since late 2005. -- The impact of economic shocks from higher fuel prices, inflation and interest rates has eased. Obstacles to Business: Corruption -------------- ¶10. The perceptions of corruption mostly showed improvement. From the end of 2005 to 2007, those who cited central government corruption as an obstacle dropped from 47% to 43%; local government corruption dropped from 52% to 48%. Both regional and national customs dropped from 36% to 33% and from 36% to 32% respectively. Central and government licenses and permits remained the same at 29% Land procurement increased from 16% to 20%. Import clearance time has improved from 7.6 days to 5.9 for the red lane, and from 6.1 to 3.1 for the green lane. Unfortunately, the percentage of those who say they never pay bribes has dropped: 19% said they never paid bribes in mid-2005 but only 9% in 2007. Informal payments to government officials as a percentage of production costs declined to 1.3% in 2007 from 1.7% in 2005. Small Tax Improvements -------------- ¶11. The value-added tax (VAT) refund as a percentage of the initial claim has increased from 80.3% to 83.9% from 2005 to 2007. The time to process a VAT refund has decreased to 5.1 months from 6.3 in mid-2006. However, more than half of the respondents reported they needed to make unofficial payments and negotiate with tax officials JAKARTA 00002745 003 OF 003 to obtain a VAT refund. In 2005, 65% of respondents reported VAT regulations as unclear, which improved to 43% in 2007. Businesses are still required to file seven different types of tax returns each month, devoting 32 man days to the task, down from 41 man days in ¶2005. Labor Issues: Mixed Picture -------------- ¶12. In most areas the percentage of respondents experiencing labor problems declined: demands for wage increases, worker demonstrations, conflicts with labor unions and worker strikes. However social security problems increased from 6% in 2005 to 9% in ¶2007. Severance pay and lay-off procedures are still the biggest obstacles. Concerns about overtime regulations, minimum wage, social security, foreign workers and government monitoring also increased. The cost of handling labor problems as a percentage of total production cost is 4.1%, up from 3.7% in 2005. Starting a Business: From 80-86 Days -------------- ¶13. One of the biggest unpleasant surprises of the briefing was the increase in the days to start a business from 80 in 2005 to 86 calendar days in 2007, despite the GOI's efforts to reduce it eventually to 30 days. The additional time was attributed to the delegation of authority to legalize limited liability companies to the provincial offices of the Ministry of Justice under Presidential Instruction (INPRES) No. 3/2006. The provincial offices: -- Lack strong internal controls; -- Lack equipment and skilled information technology staff to operate an online legalization system; -- Have low volume so cannot spread fixed costs resulting in higher costs to the applicant; -- Required more face-to-face contact and thus corruption. In a follow-on presentation by State Minister for Administrative Reform Taufiq Effendi, Effendi said the Ministry of Justice and Human Rights was drafting a regulation to re-centralize the authority for establishing a business, taking it back from the provincial offices, and suggested 14 additional actions to speed up the process of starting a business. On September 26, the International Finance Corporation (IFC) issued its "Doing Business" Report showing that Indonesia had moved up overall from position 135 to 123. However, the country still ranks below other regional economies. Bureaucratic and Civil Service Reforms -------------- ¶14. Minister Mulyani discussed some of her priorities for bureaucratic reform: -- Tax and Customs Administration; -- Budget, Treasury and Debt Management; -- Business Process and Civil Service Performance. On tax administration, she is focusing on expanding the Medium and Small Taxpayer offices on the model of the successful Large Taxpayer Offices (LTO),which have improved customer service and reduced corruption. "We want to change the way we serve the taxpayer," Mulyani said. On Customs reform, Mulyani fired 1,300 customs officials at Jakarta's large port of Tanjung Priok, replacing them with 800 officials who had to pass a tough new exam, and have to satisfy mandatory codes of conduct. On budget, treasury and debt management, Mulyani has this year introduced a Treasury Single Account, a primary dealers market, Treasury bill auctions and hopes to begin issuance of sharia sovereign bonds. In her Ministry, she has also implemented key performance indicators for all positions and better remuneration and recruitment for important skills. "I want to earn the trust of the public with better performance so they won't think we are wasting their money," she said. HEFFERN