INDONESIA - MINISTRY OF FINANCE AND BANK INDONESIA

UNCLAS SECTION 01 OF 04 JAKARTA 000486

SIPDIS

SIPDIS

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS
COMMERCE FOR 4430/GOLIKE
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR FINEMAN
DEPARTMENT PASS EXIM BANK

E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: INDONESIA - MINISTRY OF FINANCE AND BANK INDONESIA
LAUNCH REFORM EFFORTS



1. Summary. On December 27, 2006, Minister of Finance Sri
Mulyani Indrawati officially launched a new organizational
structure for the Directorate General for Tax (DGT) that
reduces the operational role of the DGT headquarters in
Jakarta, divides the DGT headquarters into functional
Directorates, and establishes formal work units to lead the
further modernization of the DGT. Two days later, the
Minister signed a new decree outlining parameters for a
Primary Dealer system for government bond auctions. The
Ministry of Finance (MOF) is currently accepting
applications for Primary Dealers with the first auctions to
take place in March. The MOF will also issue Indonesia's
first T-bills on April 3, July 10 and December 4, 2007 and
will again issue the popular "retail bonds" launched in

2006. At Bank Indonesia's (BI) annual policy speech event
on January 12, BI Governor Burhanuddin Abdullah announced
several policy initiatives for 2007 to help support
economic growth, and encourage lending to the real sector.
BI also plans to issue bank guidelines limiting foreign
manpower at the middle-management level and requiring a
"transfer of knowledge" to domestic employees within three
years. This report uses an exchange rate of Rp 9,115 to
the dollar. End Summary.

Tax Administration Reform Picks Up Speed
--------------


2. On December 27, 2006, Minister of Finance Sri Mulyani
Indrawati officially launched a new organizational
structure for the DGT that reduces the operational role of
the DGT headquarters in Jakarta, divides the DGT
headquarters into functional Directorates, and establishes
formal work units to lead the modernization of the DGT.
The new structure dissolves separate Directorates that
formally administered all aspects of Indonesia's income,
value-added (VAT),and land and building taxes from
taxpayer relations to audits, and replaces them with units
that perform a specified function for all tax types. This
reform reduces duplication of multiple investigative units
for each tax type. In addition, for the first time, the
DGT will have dedicated, full-time staff to lead
Indonesia's ambitious tax modernization program. Tax
authorities mainly concentrate tax modernization efforts in
the new directorates of "Internal Compliance and
Organizational Transformation;" "Communication and
Technology Transformation;" and "Business Process
Transformation." Under the new structure, DGT headquarters
will function as a policy-making body that also provides
back office support to local tax offices, which will have
the main operational tasks.

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Table 1: DGT: Old vs. New Structures
--------------
Previous Directorates/ New Directorates/
Units Units
--------------
Secretary General Secretary General

SIPDIS

Taxation System and Potential, Compliance,
Potential Planning and Collection

Tax Regulation Tax Regulation I

--- Tax Regulation II

Tax Audit, Collection, Audit and Collection
And Investigation
--- Intelligence and
Investigation

Tax Information Tax Information Technology

Tax Dissemination Tax Dissemination,
Service, and PR

Income Tax ---


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VAT and Electricity Tax ---

Land & Building Tax and
Land & Building
Acquisition Tax ---

--- Tax Extensification and
Appraisal

--- Tax Objection and Appeal

--- Internal Compliance and
Resources Transformation

--- Information & Communication
Technology Transformation

--- Business Process
Transformation

Regional Offices Regional Offices

--- Data Processing Center

Source: DGT


3. On December 29, 2006, Minister Mulyani also swore in 81
new Echelon II (director level) officials at the MOF, 44 of
whom work at DGT. The DGT also officially opened 13
"Medium Tax Offices" (MTOs) in Jakarta and eight other
large cities in December 2006 which will start operations
in April 2007. Like Indonesia's Large Tax Offices (LTOs),
which have provided improved service to the country's
largest corporate taxpayers since 2002, the MTOs aim to
provide better and faster services, simplify tax compliance
and optimize tax audits through online tax filing. The tax
audit process will include a closing conference with the
taxpayer, at which the taxpayer can submit any objections.


4. Foreign and domestic investors and businesses welcome
the tax reform: lack of transparency in the tax office had
been a frequent source of complaints. A number of donors,
including International Monetary Fund (IMF),the Australian
Agency for International Development (AUSAID),USAID, World
Bank, the Japan International Cooperation Agency (JICA),
Australian Taxation Office (ATO),and Swedish Tax
Administration (under SIDA),are providing DGT with
technical assistance on a range of tax administration
reform issues, including tax return management, audit,
database development, internal compliance and human
resource development.

New MOF Regulation on Primary Dealer System
--------------


5. On December 29, 2006 Finance Minister Sri Mulyani
Indrawati signed Ministerial Decree No. 144/2006
establishing a Primary Dealer System for rupiah-denominated
government securities. The decree outlines the
requirements, rights, and obligations for financial
institutions (banks and securities firms) that wish to
serve as MOF-appointed primary dealers. The decree
obligates the primary dealers to report regularly to the
Director General for Debt Management, and sets out
procedures relating to price quotations. The MOF began
accepting applications for primary dealers on February 2
and plans to organize the first auctions under the new
system in March 2007. Indonesia's existing Inter-Dealer
Market Association's 24 members (14 domestic banks, six
foreign banks, and four securities companies) had
previously acted as a de facto primary dealers market.


6. The decree specifies a facility under which the MOF
could lend government securities to primary dealers if the
demand for bonds in the secondary market is heavy. Under
the facility, primary dealers can borrow government bonds
from the MOF by submitting a guarantee worth 1.2 times the
value of the bonds. The MOF will impose a weighted average

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interest rate of the inter-bank overnight rate plus two
percent. Primary dealers can also obtain loans from BI in
the case of excessive sales or bond market volatility by
putting up bonds as a guarantee.

Indonesia Announces First T-Bills
--------------


7. The MOF announced on January 22 a schedule for the first
ever issuance of short-term Treasury Bills (T-bills) in
Indonesia. Director General for Debt Management Rahmat
Waluyanto said the proceeds from the T-bill issuances will
help finance the state budget deficit, expected to be 1.1%
of GDP in 2007. BI officials stated the issuance will
probably not exceed Rp 7.5 trillion ($823 million) in 2007.
According to Waluyanto, the MOF will issue the T-bills on
April 3, July 10 and December 4, 2007. The Ministry also
plans to issue popular retail treasury bonds in March, June
and November 2007. The MOF issued Rp 3.3 trillion ($364
million) in retail bonds in July 2006, which proved popular
with investors. Waluyanto also said that the MOF has
tentatively scheduled Indonesia's first sharia bond
issuance for September 2007, pending approval of related
legislation by lawmakers. Legislation to facilitate sharia
bond issuance has been pending in Parliament since at least
early 2005.

BI Relaxes Bank Lending Regulations
--------------


8. During his annual policy speech on January 12, BI
Governor Burhanuddin Abdullah described several new policy
initiatives for 2007 aimed at stimulating bank lending and
economic growth in the wake of high-interest rates and slow
loan growth in 2006. BI Governors traditionally use the
annual speech to announce policy priorities and
initiatives, allowing banks time to provide feedback before
BI issues implementing regulations. Analysts particularly
focused on initiatives relating to the bank intermediation
function, guidelines to evaluate credit collectibility and
prudential principles.


9. During a press briefing prior to the speech, BI Deputy
Governor Muliaman Hadad explained that BI designed the
lending stimulus package to reduce loan provisioning by
domestic banks in order to free up capital that they could
then steer to private sector lending. In order to
implement the policy package, BI intends to relax the asset
quality classification regulation No 8/2/PBI/2006 from
January 2006, which followed on a regulation first issued
in January 2005. The introduction of the regulation in
January 2005 led several state banks to significantly raise
the amount of their non-performing loans (NPLs) in the
first half of 2005 (state-owned Bank Mandiri's NPLs rose
from 7% to 25% at that time). BI plans to issue detailed
regulations later in 2007 to implement the package.


10. According to Hadad, BI intends to make the following
changes to BI's credit collectibility guidelines and
prudential regulations to encourage lending:

- Adding machinery and inventory (warehouse receipts) to
the types of collateral that banks can use to secure loans
and reduce the provisioning levels for NPLs. This
initiative aims at boosting lending to small-and-medium
enterprises (SMEs),which are often unable to meet current
loan collateral standards.

- Confirming a previous regulation allowing banks to lend
an amount up to 30% of their capital to state-owned
enterprises (SOEs) operating in the infrastructure sector.
In addition, BI plans to expand the coverage of the
regulation to allow lending up to the same level to SOEs
operating in "other sectors".

- Clarifying the definition of "related parties" under
Indonesia's Maximum Credit Allocation Limit to permit more
liberal lending to jointly-financed projects. BI plans to

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issue implementing regulations to set forth the new rules.

- Reiterating that it is possible to provide new loans to
problem borrowers providing: a) the borrowers ""maintain
good intentions" to repay and; b) the loan is distressed
for reasons beyond the borrower's control.

- Raising the ceiling for loans subject to "timely
repayment" criteria from Rp 500 million ($55,000) to Rp 5
billion ($550,000). Currently, banks must consider three
parameters when considering loans over Rp 500 million
($55,000): business prospects of the borrower, debtor
performance, and promptness of payment. BI intends to
revise current regulations to drop the requirement that
banks evaluate the business prospects and performance of
debtors for loans to micro enterprises and SMEs. In
addition, BI intends to grant exceptions to the three
parameters for specific project-related loans that have
government guarantees and are a high priority for the
government. Banks still must consider business prospects
and performance in classifying loans above Rp 5 billion
($550,000). Currently, 54% of domestic banking sector
lending is for individual loans of less than Rp 5 billion
($550,000),according to Hadad.


11. Abdullah also announced that BI intends to further
restrict the number of expatriates employed in banks in
Indonesia. For foreign banks, BI will limit the expatriate
personnel to two levels below the board of directors,
except for specialized functions local employees cannot
fill. For specialized functions, BI plans to give foreign
banks three years to train and "transfer knowledge,"
gradually replacing expat workers with local staff.

HEFFERN