RECENT ECONOMIC REPORTS

INDONESIA TAKES STOCK OF ECONOMIC REFORMS

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Positive Macroeconomic Outlook and MOF Reforms

Boediono, Minister of Finance Sri Mulyani Indrawati, and BI Governor Abdullah provided uniformly upbeat assessments of Indonesia’s macroeconomic situation, noting that GDP growth is rising, public debt and inflation are falling, the Rp/USD exchange rate and overall balance of payments situation are steady, and banking system indicators are improving.  However, Boediono noted that Indonesia still needs a “growth push” to create more jobs. The non-oil sector is growing well at approximately a 6.5% rate, he said, but the oil and gas sector suffers from “specific problems,” and is stagnant.  The GOI “needs to do something” about this situation, he said.  Boediono also stated that the GOI is working to stabilize rice prices and would “do whatever it takes” to normalize the situation.  Burhanuddin repeated recent BI statements cautioning that the potential exists for increased inflationary pressures in 2007, requiring prudent monetary policy.   

Mulyani provided some details on the ambitious internal reform program underway at the MOF.  As part of the GOI’s fiscal consolidation efforts, which have seen budget deficits drop from 2.4% of GDP in 2001 to approximately 1% in 2006 and 2007, Mulyani said the MOF is pursuing “fundamental reforms” in its treasury operations.  President Yudhoyono created a new Director General for State Treasury position in November as part of an overall restructuring at the MOF.  The MOF is working to manage its cash and risk better, and adopt a multi-year budget framework, a Treasury Single Account system, and accrual basis accounting.  The MOF is also taking a “disciplined approach” toward contingent liabilities from state-owned enterprise capital injections, infrastructure risk-sharing, Rp 11 trillion ($1.2 billion) in unpaid value added tax refunds from 1999-2001, and local government borrowing.  On the latter, the Mulyani said the MOF will control both the total level of local government borrowing as well as the procedures local governments must follow to issue bonds, including obtaining approval by the Minister of Finance.

Internal reforms in the Directorates General for Taxation (DGT) and Customs and Excise (DGCE) are also moving forward, Mulyani said.  The MOF has finalized a draft Presidential Decree “radically changing” the structure at DGT from one based on type to tax to one based on functional directors.  The MOF is also trying to improve governance by modernizing the structure of tax offices, implementing an enhanced code of conduct, and raising discipline and enforcement.  Mulyani said the MOF is also working closely with the Corruption Eradication Commission (KPK) in cases of suspected misconduct in the DGT.  If there are indications that DGT officials have committed acts “close to criminal activity,” the KPK will launch an investigation.  Mulyani added that she has asked DGT to review the functioning of existing Large Taxpayer Offices (LTOs).  Although revenue from these offices has increased on average by 40% a year, 7-10% of complaints from firms covered by LTOs are still related to governance.  “This is unacceptable,” Mulyani said, and the GOI needs to reduce complaints so it can expand the LTO system further.

In an effort to improve the functioning of Indonesia’s customs clearance system, Mulyani said the MOF is establishing pilot “Major Customs Offices” in Batam and Tanjung Priok port in Jakarta, which together process 60-70% of Indonesia’s exports and imports.  These offices are similar in concept to the LTOs--they will have more modern organizational structures, and officials stationed at them will receive significantly higher salaries but be subject to much stronger discipline.

Draft Tax Laws and Investment Laws

Mulyani noted that the MOF is ready to discuss the draft laws with Parliament “anytime, even during the holiday recess.”  Boediono said that he hoped Parliament can pass the three tax bills “in the early months of 2007” so that parts of the laws could be partially implemented in 2007.

Minister of Trade Mari Pangestu expressed optimism that Parliament would pass the draft investment law soon after it returned from recess on January 8.  She reported that consultations between GOI and Parliament on the draft law were nearly complete and that she expected to appear once more before Parliament’s Commission VI before Parliament votes on the draft law in a plenary session.  Pangestu asserted that the GOI had already made considerable progress in drafting the law’s accompanying regulations, including the creation of a clear and concise negative list, and that they would be issued in conjunction with the enactment of the law. 

Investment Incentives and Streamlined Procedures

Investment Coordinating Board (BKPM) Chairman Mohammed Lutfi reported that the GOI is in the process of revising Government Regulation 148/2000 which establishes a set of standard incentives for qualifying investments.  Specifically, the draft regulation allows qualifying investors to deduct up to 30 percent of their realized investment from gross taxable income (five percent of the realized investment per annum for the first six years of the project); carry forward losses for up to 10 years; and utilize an expedited depreciation schedule. According to an Indonesian language MOF presentation, the draft regulation would also reduce from 15 to 10 percent the income tax rate on dividends paid outside Indonesia.  Pangestu explained that the incentives will be available to new investors in selected “pioneer sectors” and regions. 

Lutfi said that the GOI has made considerable progress in reducing the time needed to obtain approvals for starting a business on Batam Island through a newly-established “Integrated Investment Services Center” (IISC).  The IISC is a one-stop-shop that houses all GOI agencies responsible for issuing business approvals in Batam, including the BKPM, the MOF, the Ministry of Transmigration and Manpower, the Ministry of Law and Human Rights, the Batam regional government, and the Batam Authority.  According to Lutfi, BKPM approvals processed through the Batam IISC now take just one to two days on average.  Lutfi also said that the Batam IISC now processes approvals for a dozen required permits and licenses in a cumulative 59 days, less than the 97 days in other areas as cited in a 2006 IFC survey.   

Pangestu added that her Ministry continued to reform its business regulation and licensing systems and had implemented significant reforms in December 2005 and March 2006.  She cautioned, however, that meeting the GOI’s target of reducing the number of days it takes to start a business from 150 to 30 days would take time.

Batam Special Economic Zone

Lutfi noted that, at its height in 2001, the Batam FTZ accounted for 14 percent of Indonesia’s non-oil and gas domestic exports and created over 200,000 new jobs.  The export figure had fallen to eight percent by 2005, and Lutfi said the GOI’s goal is to lure $1 billion in new investment in 2007-2010 and create 100,000 new jobs.  To reinvigorate the area, Lutfi said the GOI planned to clarify its status, laws and regulations; remove import duties except for consumable goods; create model customs and tax offices; ease labor restrictions; and reduce to 33 days the time it takes to start a business.  Pangestu added that the GOI had already established a pilot ASEAN Single Window in Batam -- a one stop service for processing import and export documents -- and that the DGCE would establish the next Single Window in Jakarta’s Tanjung Priok port, Indonesia’s busiest.   

Pangestu said that the GOI hopes to use Batam as a model for creating similar special economic zones or “areas of excellence” in strategic locations across Indonesia.  She noted that it is easier to remove “supply-side constraints” in such small geographical areas than throughout the entire country.  Like Batam, each zone would have a single authority that would employ best practices in providing services to investors, such as licensing and permitting, dispute resolution, and import and export procedures.  Pangestu said the GOI is still considering where to locate the zones, but is basing its assessment on supporting infrastructure and industries, and access to inputs of production, such as raw materials and skilled labor.

Labor Reform

Boediono said there has been only slow progress on labor issues following the July release of a GOI-commissioned study on draft labor legislation by six local universities.  Proposed revisions to Indonesia’s labor law, especially those related to levels of severance pay and outsourcing, spurred labor demonstrations in April and May 2006.  The study reportedly recommends against the GOI’s proposed revisions to the Labor law and suggested adjustments to existing regulations as a better approach to alleviating investor concerns.  Boediono suggested that all parties need to come together to discuss these sensitive issues.  He quickly added, though, that the GOI is “not close” to reaching consensus on the issue, and that progress on labor issues would have to wait for the right moment politically. 

Movement on Infrastructure Priorities

Boediono reiterated the importance of infrastructure investment to the GOI. Although overall investment remains low, spending on infrastructure is rising.  Boediono was optimistic on the passage of transportation, postal, electricity, and energy reform laws reducing or eliminating SOE monopolies in these sectors and opening them up to private investment. Boediono assured investors, “the laws are in a high level committee of the DPR” and expected to pass in the early part of 2007. He also reiterated the GOI’s commitment to bringing a list of 10 GOI model projects to completion next year, an important step for investor confidence.  However, he acknowledged that almost two months after the November 1-3 Infrastructure Forum, none of the model projects are yet ready for tendering.  Mulyani also reiterated her intent to scrutinize government support for “non-compliant and high profile” projects handled outside of the formal public private partnership system established by Presidential Decree 67/2005.  Although not compliant with Decree 67/2005, Mulyani noted that these projects are not necessarily bad, and need to be reconciled with the Decree 67 framework.  She urged participants not to view GOI support for these projects as a deviation from “good or best practices.”  

Investment Climate Survey

 The University of Indonesia’s Institute of Economic and Social Research (LPEM) presented the conclusions of the third and last round of its World Bank-funded “Investment Climate Monitoring Survey.”  LPEM conducted the survey from June through August of this year, and their results show some decrease in business confidence in the investment climate from the previous survey taken at the end of 2005.  The biggest constraints to business remain macroeconomic stability, policy uncertainty, and corruption.  However, the survey showed a significant increase in the number of manufacturers concerned with electricity supply and transportation infrastructure, due to frequent brownouts and transportation delays.

 According to the survey, labor indicators (labor regulations, labor skills/education) also continue to worsen with severance pay and lay-off procedures seen as the biggest obstacles.  Respondents noted that Indonesia’s labor laws reduce the competitiveness of manufacturing firms and that both the number and cost of labor disputes are rising.  The survey noted that the majority of labor problems affect large, export-oriented manufacturing firms in sectors where Indonesia has the potential to be regionally competitive.  The survey also noted some areas of improvement in the customs and trade regulations at both the local and central government level. Firms reported decreased times and informal payments for customs clearance.

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