Indonesia - Public Expenditure Support Facility Development Policy Loan with Deferred Drawdown Option Project

 Document of The World Bank Report No: ICR1952 IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-76580) ON A PUBLIC EXPENDITURE SUPPORT FACILITY IN THE AMOUNT OF US$ 2 BILLION TO THE REPUBLIC OF INDONESIA FOR A DEVELOPMENT POLICY LOAN WITH DEFERRED DRAWDOWN OPTION (DPL-DDO) December 14, 2011 Poverty Reduction and Economic Management Unit East Asia and Pacific Region  CURRENCY EQUIVALENTS (Exchange Rate Effective December 14, 2011) Currency Unit = Rupiah 1.00 = US$ [0.0001] US$ 1.00 = [9,017] FISCAL YEAR 2011 ABBREVIATIONS AND ACRONYMS AAA Analytic and Advisory Assistance FSAP Financial Sector Assessment Program ADB Asian Development Bank FY Fiscal Year ASEAN Association of Southeast Asian Nations GDP Gross Domestic Product AusAID Australian Agency for International GOI Government of Indonesia Development BAPPENAS National Development Planning Agency IBRD International Bank for Reconstruction and Development BI Bank Indonesia ICR Implementation Completion Report BKPM Investment Board IDR Indonesian Rupiah BPS Central Bureau of Statistics MDFTIC Multi-Donor Fund for Trade and Investment Climate CAS PR Country Assistance Strategy Progress Report MOF Ministry of Finance CG Central Government NGO Non-governmental organizations CPI Consumer Price Index NPL Non-Performing Loans CPS Country Partnership Strategy OECD Organization for Economic Cooperation and Development CMRS Crisis Monitoring Response System PEPI National Team for the Development of Exports and Investment DDO Deferred Drawdown Option PESF Public Expenditure Support Facility DIPA Budget Activity Lists PKH Conditional Cash Transfer Program DNI Negative Investment List PNPM National Community Empowerment Program DPL Development Policy Loan TA Technical Assistance EITI Extractive Industries Transparency Initiative TNP2K National Team for the Acceleration of Poverty Reduction EMBI Emerging Market Bond Index USD United States Dollar ESW Economic and Sector Work YoY Year on Year FDI Foreign Direct Investment Vice President: James Adams Country Director: Stefan Koeberle Sector Director (Acting): Robert Taliercio Lead Economist: Shubham Chaudhuri Task Team Leader: Enrique Blanco Armas ICR Primary Author: Elaine Tinsley  INDONESIA Development Policy Loan with Deferred Drawdown Option CONTENTS Data Sheet  A. Basic Information ........................................................................................................ i  B. Key Dates .................................................................................................................... i  C. Ratings Summary ........................................................................................................ i  D. Sector and Theme Codes............................................................................................ ii  E. Bank Staff ................................................................................................................... ii  F. Results Framework Analysis ..................................................................................... iii  G. Ratings of Program Performance in ISRs ................................................................. iv  H. Restructuring (if any) ................................................................................................ iv  Main Document 1. Program Context, Development Objectives and Design ............................................ 1  2. Key Factors Affecting Implementation and Outcomes .............................................. 3  3. Assessment of Outcomes ............................................................................................ 6  4. Assessment of Risk to Development Outcome ......................................................... 18  5. Assessment of Bank and Borrower Performance ..................................................... 19  6. Lessons Learned........................................................................................................ 21  7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners........... 23  Annex 1 Bank Lending and Implementation Support/Supervision Processes.............. 24  Annex 2. Beneficiary Survey Results ........................................................................... 25  Annex 3. Stakeholder Workshop Report and Results ................................................... 25  Annex 4. Summary of Borrower's ICR and/or Comments on Draft ICR ..................... 25  Annex 5. Comments of Cofinanciers and Other Partners/Stakeholders ....................... 25  Annex 6. List of Supporting Documents ...................................................................... 25 MAP …………………………………………………………………………………. 26 A. Basic Information Public Expenditure Country: Indonesia Program Name: Support Facility (DPL- DDO) Program ID: P115199 L/C/TF Number(s): IBRD-76580 ICR Date: 01/06/2012 ICR Type: Core ICR REPUBLIC OF Lending Instrument: DPL Borrower: INDONESIA Original Total USD 2,000.00M Disbursed Amount: USD 0.00M Commitment: Revised Amount: USD 0.00M Implementing Agencies: Coordinating Ministry of the Economy Cofinanciers and Other External Partners: AUSTRALIA Government of Japan Asian Development Bank B. Key Dates Revised / Actual Process Date Process Original Date Date(s) Concept Review: 12/09/2008 Effectiveness: 08/12/2009 08/12/2009 Appraisal: 01/15/2009 Restructuring(s): Approval: 03/03/2009 Mid-term Review: Closing: 12/31/2010 12/31/2010 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Highly Satisfactory Risk to Development Outcome: Low or Negligible Bank Performance: Satisfactory Borrower Performance: Highly Satisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Satisfactory Government: Highly Satisfactory Implementing Quality of Supervision: Satisfactory Highly Satisfactory Agency/Agencies: Overall Bank Overall Borrower Satisfactory Highly Satisfactory Performance: Performance: i C.3 Quality at Entry and Implementation Performance Indicators Implementation QAG Assessments Indicators Rating: Performance (if any) Potential Problem Quality at Entry No None Program at any time: (QEA): Problem Program at any Quality of No None time (Yes/No): Supervision (QSA): DO rating before Satisfactory Closing/Inactive status: D. Sector and Theme Codes Original Actual Sector Code (as % of total Bank financing) Banking 15 15 Central government administration 31 31 General finance sector 23 23 General industry and trade sector 23 23 Mining and other extractive 8 8 Theme Code (as % of total Bank financing) Export development and competitiveness 8 8 International financial standards and systems 21 21 Other accountability/anti-corruption 8 8 Other economic management 34 34 Regulation and competition policy 29 29 E. Bank Staff Positions At ICR At Approval Vice President: James W. Adams James W. Adams Country Director: Stefan G. Koeberle Joachim von Amsberg Sector Manager: Shubham Chaudhuri Tunc Tahsin Uyanik Program Team Leader: Enrique Blanco Armas P.S. Srinivas ICR Team Leader: Enrique Blanco Armas ICR Primary Author: Elaine A. Tinsley ii F. Results Framework Analysis Program Development Objectives (from Project Appraisal Document) The proposed Public Expenditure Support Facility (PESF) of USD 2 billion is a DPL with Deferred Drawdown Option (DDO). Its main objective is to assist the Government of Indonesia (GoI) in addressing the potential adverse impacts of the ongoing global financial crisis on public expenditures during 2009/10. Learning the lessons from the crisis of 1997/98, the Go1 would like to ensure that essential public expenditures are maintained even during this period of stress. Therefore, the GoI would like to put in place arrangements that would give international and domestic markets confidence to enable it to raise needed resources from them. These arrangements include a set of confidence- boosting policy measures and back-up financing arrangements - a part of which is the proposed loan. This support would be available, if the current stress in the market continues and is aimed at reducing the possibility of a financing shortfall. The loan will support the GoI’s efforts in the following policy areas: (1) reassuring financial markets and maintaining financial system stability (2) sustaining critical public expenditures while maintaining budget discipline and (3) facilitating private investment and supporting exports. Revised Program Development Objectives (if any, as approved by original approving authority) (a) PDO Indicator(s) Original Target Formally Actual Value Values (from Revised Achieved at Indicator Baseline Value approval Target Completion or documents) Values Target Years Indicator 1 : Reassuring financial markets and maintaining financial system stability Avert financial crisis or if occurs, Uncertain financial authorities environment. Potential Value responded with risk of not meeting appropriate 2009 financing measures. Meet requirement. 2009 financing requirement. Date achieved 02/01/2009 12/31/2010 Comments 2009 financing needs were met from financial markets as projected. Financing costs reduced significantly as the operation was finalized and approved. Maintain share of a) social spending and b) infrastructure investments in Indicator 2 : central government expenditure relative to 2008. a) Social spending is Maintain share of Social Expenditures 5.9% of central a) social spending in 2009: 11.7% Value government and b) Infrastructure expenditure infrastructure Expenditures in b) Infrastructure investments in 2009: 8.4% iii  investment is 7.8% of central central government government expenditure expenditure relative to 2008. Date achieved 12/31/2008 12/31/2010 12/31/2009 Comments Spending in both infrastructure and social expenditure was increased in 2009 Indicator 3 : Increase capital expenditure disbursement rates in first half relative to 2008. Increase in percentage of 22.3% of capital Value capital expenditures disbursed 27% expenditures in first half disbursed in first half. Date achieved 12/31/2008 12/31/2010 06/30/2009 Comments Disbursements of capital expenditures increased to 27% in 1st half of 2009 (b) Intermediate Outcome Indicator(s) Original Target Actual Value Formally Values (from Achieved at Indicator Baseline Value Revised approval Completion or Target Values documents) Target Years Indicator 1 : GoI access to financial markets - credit rating Value S&P:BB-/Stable/B Moody: Ba1 Maintain or Fitch:BB Fitch: BB+ improve rating Moody:Ba3 S&P: BB+ Date achieved 02/02/2009 12/31/2010 12/31/2010 By end 2010 Indonesia was one notch below investment grade by all major Comments ratings agencies G. Ratings of Program Performance in ISRs Actual Date ISR No. DO IP Disbursements Archived (USD millions) 1 06/30/2010 Satisfactory Satisfactory 0.00 H. Restructuring (if any) Not Applicable iv 1. Program Context, Development Objectives and Design 1.1 Context at Appraisal Entering the global financial crisis in late 2008, Indonesia was in a strong and stable position. Growth was at 6 percent, debt-to-GDP had fallen to about 30 percent, the current account was in surplus, reserves were high and rising, and the exchange rate had been stable since mid-2006. Numerous improvements in the government’s tax collection system, along with expenditure restraint, had also strengthened Indonesia’s fiscal position, leading to annual primary budget surpluses and a sharp improvement in tax revenues in 2008. A track record of prudent economic management and higher growth led to strong improvements in Indonesia’s poverty and employment numbers. By mid-September of 2008, the ripple effects of the global turmoil were adversely and significantly affecting Indonesia’s financial markets. After broadly tracking the US dollar since mid-2006, the rupiah came under pressure, losing one-third of its value against the US dollar by late November. At the same time, the stock market index declined by over 50 percent from a year earlier. Government debt markets were especially hard hit by the increase in global risk aversion, with yields on both IDR and USD bonds rising sharply. Spreads on USD sovereign bonds jumped almost 800 bps, approximately 300 bps higher than across the region. Relatively high amortization levels and reliance on foreign investor funding made government finances more vulnerable to tighter global liquidity and higher risk premiums. Risks in the economy rose as the adverse impacts of a growth slowdown were beginning to be felt and with the OECD economies in recession, a pronounced growth slowdown was anticipated. Sharp falls in commodity prices were cutting export values, and also the stimulus they had been providing to Indonesia’s domestic demand over the past few years. Slowdowns in other economies were expected to reduce exports and investment further, and also accelerate the return of migrant workers. Further depreciation and falls in domestic demand were likely to affect corporations’ profitability and result in rising non- performing loans and the erosion of banks’ capital. Although Indonesian corporations have reasonably well diversified sources of finance and are not significantly leveraged, tighter financing conditions would make new and rollover financing for corporations more difficult, further dragging on investment and growth. In addition, domestic capital markets had historically been subject to sudden changes in sentiment – which increased the concerns about capital outflows. The potential for capital flight by both foreign and domestic investors remained a problematic issue. The combination of Indonesia’s relatively open capital account, significant foreign presence in its stock and bond markets and the legacy of the 1998 crisis, left investors sensitive to exchange rate movements and leaving the economy prone to capital flight. Therefore despite sound macroeconomic fundamentals, there were sizeable risks that the spillover effects of the global financial crisis could negatively impact the economy and Indonesia’s development progress, and the government stepped in aggressively to address it. 1 The 2009 budget law passed in November 2008 provided the government with the flexibility to respond to the evolving economic conditions and to implement a fiscal stimulus program and to accelerate budget execution, a prerequisite for enhancing the impact and timeliness of any fiscal stimulus package. The 2009 budget law detailed a number of steps that the government could use to sustain critical public expenditures, including provisions to ensure that priority publicly-funded infrastructure projects were financed even under unfavorable market conditions– to avoid repeating the experience of the 1998 Asian crisis, when infrastructure spending fell drastically. The budget also protected social sector spending, in particular, funding for the flagship community-based poverty alleviation program, so as to provide a cushion for households adversely affected by any growth slowdown. In addition, in January 2009, the government announced a 1.4 percent of GDP stimulus package, providing tax cuts, social safety net support, expanded infrastructure investment, and support to industries most affected by the crisis. Though developments in early 2009 provided some indication that Indonesia’s financial markets were stabilizing, the risk of further disruption remained. The GoI sought to address this by proposing additional policies in several areas to address the impacts of the crisis. It proposed increasing transparency and confidence in the financial sector; improvements to the investment climate aimed at giving further confidence to private investors immediately as well as to position Indonesia as an investment destination of choice post-crisis, and measures to maintain and speed up public spending as well as mitigating the poverty impacts of the crisis. Rationale for Bank Assistance: In the event that the government would face financing constraints if global liquidity conditions did not ease, the government requested budget support from the World Bank in the form of a USD 2 billion Public Expenditure Support Facility (PESF) which the Government stated it only intended to exercise when certain conditions would be met. Several development partners (Australian Government, Japanese Government, ADB) also supported GoI on similar terms, bringing the total package of assistance to US$5.5 billion. Despite strong macroeconomic fundamentals and relatively benign growth slowdown forecasts, it became clear that increased volatility in international financial markets had become a real risk to Indonesia’s development efforts. The contingent financing provided by both the World Bank and other partners would allow Indonesia to continue accessing market financing at reasonable rates, supporting Indonesia’s development efforts. Although the Country Partnership Strategy (CPS) did not explicitly envisage such crisis support, the policy reform agenda supported by the operation, which aimed at improving institutional response by Indonesia to the global financial crisis, was fully in line with the emphasis of the CPS on strengthening Indonesia’s institutions. The PESF was also intended to complement the regular DPL program, as it focused on a subset of policy areas covered under the DPL, but with a focus on supporting critical stroke-of-the-pen measures that were needed to deal with a pressing financial situation, yet also helped to advance policy actions that were part of the regular DPL pillars. 2 As with the regular DPLs, the Bank was also able to bring in other donors and thereby leverage the Bank amount for a more substantive package. 1.2 Original Program Development Objectives (PDO) and Key Indicators (as approved) The Public Expenditure Support Facility (PESF) of USD 2 billion is a DPL with Deferred Drawdown Option (DDO). Its main objective is to assist the Government of Indonesia (GoI) in addressing the potential adverse impacts of the ongoing global financial crisis on public expenditures during 2009/10. Learning the lessons from the crisis of 1997/98, the GoI would like to ensure that essential public expenditures are maintained even during this period of stress. Therefore, the GoI would like to put in place arrangements that would give international and domestic markets confidence to enable it to raise needed resources from them. These arrangements include a set of confidence-boosting policy measures and back-up financing arrangements - a part of which is the proposed loan. This support would be available, if the current stress in the market continues and is aimed at reducing the possibility of a financing shortfall. The loan will support the GoI’s efforts in the following policy areas: (1) reassuring financial markets and maintaining financial system stability (2) sustaining critical public expenditures while maintaining budget discipline and (3) facilitating private investment and supporting exports. 1.3 Revised PDO (as approved by original approving authority) and Key Indicators, and Reasons/Justification n/a 1.4 Original Policy Areas Supported by the Program (as approved) (i) Reassuring financial markets and maintaining financial system stability. (ii) Sustaining critical public expenditures while maintaining budget discipline. (iii) Crowding in private investment and supporting exports. 1.5 Revised Policy Areas (if applicable) n/a 1.6 Other significant changes n/a 2. Key Factors Affecting Implementation and Outcomes 2.1 Program Performance 3 The PESF was done in response to a potential impact the global financial crisis could impart on Indonesia. The operation, the largest one prepared for Indonesia, was completed within 6 months from the time the concept note was reviewed. As the DPL prior actions were met prior to signing of the loan agreement, all conditions in the program document were fulfilled. DPL-DDO List conditions from Legal Agreement/ Program Document Status Policy Area 1: Financial Market Reassurance and Stability 1. Issued a financial safety net government regulation in lieu of law that clarifies the Fulfilled roles, responsibilities and procedures that govern the actions and responses of Bank Indonesia, the Minister of Finance, and the Deposit Insurance Corporation in the event of the failure of a financial institution. 2. Steps to maintain the stability of the banking system by: Fulfilled a) issuing a government regulation in lieu of law increasing ceiling on deposit insurance from 100 million to 2 billion rupiah and allowing the Government to provide a blanket guarantee of all bank deposits if necessary. b)Issuing a government regulation in lieu of law that amends the Bank Indonesia Law regarding the types of assets that banks can use as collateral for borrowing from the central bank 3. Initiated a Financial Sector Assessment Program Fulfilled 4. Issued and committed to implement a financing program for 2009 that specifies the Fulfilled terms and circumstances under which the government would draw on the support available from the PESF and from Indonesia's other development partners providing related support. Policy Area 2: Sustaining Critical Expenditures and Budget Discipline 5. Established a crisis monitoring and response system in anticipation of a possible Fulfilled growth slowdown or crisis. 6. Submitted a Presidential decree on Coordination of National Poverty Reduction Fulfilled efforts to the President for his signature. 7. Included specific provisions in the 2009 budget law to sustain, and if necessary, Fulfilled increase critical public expenditures in the event of a pronounced growth slowdown. 8. Implemented specific regulatory measures and socialization efforts to expedite Fulfilled budget disbursement and enhance the ability of government to rapidly direct public expenditures to preempt, as well as mitigate, any adverse impacts of a growth slowdown. Policy Area 3: Crowding in Private Investment and Supporting Exports 9. The Borrower has prepared and undertaken inter-ministerial review of a draft of a Fulfilled Presidential Regulation on the 2007 Investment Law and Investment Negative List (DNI) that accommodates Indonesia’s international commitments on sectoral restrictions and clarifies the status of publicly listed companies, foreign equity limits for direct investment, grandfathering and the creation of investment restrictions beyond those stipulated in the Investment Negative List. 10. Took steps to increase transparency regarding revenues from extractive industries Fulfilled by: a. Issuing a memorandum of understanding among the Coordinating Minister for Economic Affairs, Minister of Finance and Minister of Energy and Mineral Resources on Transparansi Pendapantan Negara Yang Diperoleh dari Industri Ekstraktif b. Issuing a letter from the Coordinating Minister for Economic Affairs, to the Secretariat of the Extractive Industries Transparency Initiative initiating the process of application to EITI. 11. Opened a re-discount window for trade finance through Bank Indonesia and created Fulfilled an Export Financing Agency 4 2.2 Major Factors Affecting Implementation: Urgency to mitigate the uncertainty. The high level of uncertainty created by the global financial crisis – with memories of the social and economic turmoil of the 1997/1998 financial crisis still resonating in Indonesia-- created an urgency to push through the reforms in order to obtain the contingent financing package. Unlike in the crisis of the late 1990s, this time Indonesia’s macroeconomic framework was on a solid footing. The government did not want the domestic financial market impact of increased global risk averseness to derail its development efforts and there was a shared sense of urgency at all levels and branches of government that made them highly committed to undertaking the reforms and to demonstrate that they were active in taking preventive measures. The GoI would frequently cite that they were securing contingent financing, and having announced so to markets and the public, this also became an additional motivator to follow through. Leveraging donor partnerships. The size of the contingent financing was critical in persuading financial markets that the government would meet its financing needs. The total package from all four development partners was USD 5.5 billion, of which USD 2 billion was from the World Bank. The package covered 21 percent of financing needs, sending a strong market signal. And, although the full amount from all partners was not ready by the time the PESF went to the Board, there was sufficient credibility that it would be put in place. Strong government partnership and field presence. The PESF was able to move forward quickly in great part thanks to the presence of an actively engaged team on the ground that already had strong working relationships with involved government counterparts. In addition, several of the reforms supported by the PESF operation built upon reforms previously supported in past DPLs. As a result there was a continuation of dialogue and counterpart involvement on the critical issues as opposed to starting from scratch. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization: The key M&E issue was to monitor the progress on the government’s financing plan and whether conditions for withdrawal had been met. As part of the PESF prior actions, this was agreed to be done through quarterly reviews of the status of the financing plan with the government and development parnters. The financing situation never deteriorated to the point that withdrawal triggers were met, but GoI and partners significantly increased their economic surveillance and monitoring efforts to ensure they would be able to act quickly should the need arise. This was facilitated by financing from AusAID provided to the World Bank as an ‘Externally Funded Output’ – EFO. Although the PESF operation is now closed, monitoring of progress in the areas supported by the operation continue as part of regular economic monitoring activities of the World Bank and as part of the broad engagement that the World Bank has in a number of areas, e.g. ongoing macroeconomic and financial assessments, ongoing monitoring of the time profile of budget disbursement, public expenditure composition 5 and poverty and employment effects of economic shocks; and ongoing monitoring of investment climate and trade-related activities (through the Multi Donor Fund for Trade and Investment Climate). Other monitoring activities were incorporated in the PESF program prior actions, including:  Implementation of the Financial Sector Assessment Program;  Establishment of DIPA monitoring committee consisting of the relevant senior MoF and Bappenas officials to track on a monthly basis the progress on expediting budget disbursement;  Establishment of a crisis monitoring and response system with GoI; and  Information gathering and diagnostic work as part of the EITI preparation 2.4 Expected Next Phase/Follow-up Operation (if any): The Bank had encouraged the government to seek a cost-free extension of the PESF beyond its closing date of December 31, 2010. However, market conditions had stabilized and the government did not feel that extending the PESF was warranted and the operation was closed. As a result, follow-up work in the different policy areas will continue under different instruments and projects, as mentioned in the M&E Section. Part of the reason for the closing was that the operation, despite the very low probability of the loan being drawn down given market conditions and the Government’s intention to use it only if market conditions significantly deteriorate, counted 100 percent toward the capital headroom of Indonesia. A closing of the operation would free up capital to undertake other loans. Although not a follow-up operation, currently the government and the Bank are working together on a separate DDO, the Indonesia Food Access Program, with a similar logic (contingent financing for an emergency). The operation seeks to support GoI efforts to improve food security in Indonesia, through a series of policy interventions along three lines: (i) long-term revitalization of agricultural production, (ii) stabilization of domestic food prices, and (iii) introduction of emergency measures to support the poor and vulnerable should food prices spike. 3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation Rating: Highly Satisfactory The PESF was a highly relevant instrument that was successful in achieving its primary objective of sustaining public expenditures by lending credibility to the government at a time of high uncertainty in global financial markets. The PESF was structured to provide financing in tranches matching the government’s financing plan when market conditions reached a certain threshold and the government requested withdrawal. At the same time 6 as financing conditions started to improve in many emerging countries, the decisive policy actions taken by GoI, as reflected in the PESF policy matrix, combined with access to contingent financing in case of deteriorating financing conditions, contributed to a calming of markets which allowed GoI to meet its financing needs from markets as planned. Conditional Drawdown Design. The PESF was designed to avoid being drawn-down fully and immediately by being subject to a) a pre-determined worsening of market financing conditions and b) in line with the country’s immediate financing needs. The World Bank assisted GoI in the design of the facility in a way that it would boost Indonesia’s credibility with investors -- by having access to these funds it meant that Indonesia could weather a rise in borrowing costs or restricted market access due to the externally-driven financial crisis over a longer period of time. At the same time, by making the support contingent in nature, GoI ensured that it would tap these funds only when needed. This nature of the PESF played favorably in the market and investors were also reassured by the fact that Indonesia, as opposed to many other countries, did not draw down the loan immediately but kept it as an insurance mechanism. Spreads on government bonds started to decline around the time of the signing of the DDO. Though the drop also coincided with some calm in global markets, investor surveys show that they were reassured about Indonesia’s prospects because the contingent financing was in place, though other factors were also important, such as the policy measures taken by the Government, including those supported by the PESF, global developments and the fact that Indonesia’s macroeconomic indicators remained favorable. Another related design issue was determining the thresholds triggers for disbursement. This was kept confidential to avoid market manipulation. Some government officials expressed concerns that threshold triggers might have been too high. Unlike other countries that drew down their DDOs, the GoI had to continue meeting its financing needs from markets at relatively higher rates even though they had secured more favorable funding. This, however, was the trade-off— if Indonesia used up the DDO and conditions deteriorated, there would be no more such emergency financing available, or they could save the DDO for when conditions were prohibitively high and they would be insured longer. Given the finite amount of funds the DDO could provide, and the volatility Indonesia was facing, the latter seemed the more appropriate route. This said, there were a number of discussions to reach consensus that this was the appropriate course. The nature of the facility may not have been fully understood by all government stakeholders, nor did the fact that the World Bank would need to set aside the US$2 billion in the event Indonesia called the funds. The World Bank often had to explain why the front-end fee for US$5 million was necessary and also put it in perspective with expected savings. In part this was because, in such a turbulent period, it is almost impossible to state definitively how much the market spread was reduced by having the contingency financing in place, or what the counterfactual would have been had there been no package. 7 However, some rough calculations give an indication that the benefits of the PESF may well have been more substantial than the cost of the front-end fee. For example, in the first quarter of 2009 - the peak time of the crisis in which the DDO would have had its strongest impact on the market – Indonesia issued around US$ 600 million in domestic currency fixed rate government securities, by face value. If the weighted average coupon of these instruments of 11 percent was just 0.15 percent below what it would have been in the absence of the PESF DDO operation, then the lower coupon payments over the life of the securities would have offset the US$ 5 million front-end fee. Alternatively, domestic interest payments in 2009 implied an average interest rate of 9.19 percent. If the interest rate without the PESF was just 0.007 percent higher, ie 9.2003 percent, the higher interest payments in 2009 alone would have been greater than the front-end fee. Although it is difficult to precisely estimate the exact impact that the facility had on financing costs, the numbers in this paragraph show, particularly based on discussions with government officials and market analysts, how likely it is that the PESF DDO saved the Government of Indonesia significant resources. Selection of Priority Actions. Given the crisis response nature of the operation, the team had to select reforms that were feasible to achieve in a short period of time and yet substantive enough to provide reassurance to investors. Not surprising, this limited the field of potential priority actions. Still, the priority actions were substantive and in some cases represented a push in clearing some major bottlenecks in pending reforms—e.g. enacting financial safety net regulations, crisis coordination, investment law, and EITI— and on most of these there was no back tracking but even an acceleration of activity post- PESF. On other priority actions, the urgency with which reforms were pursued was limited to the emergency period, e.g. reforms to accelerate budget disbursements. In 2009, the government increased efforts increase budget disbursements earlier in the year, and threatened lower budgets for those line ministries that did not. This incentivized the ministries to spend as there was close monitoring of the spending. However, by 2010, the pressure had eased off and there was less political will to carry out the threat of budget cuts to ministries with poor execution performance. Ideally, it would have been better if that reform had been designed to be more sustainable—but given the time frame in which the PESF was prepared, trigger selection had to be prioritized to ensure that government spending could stimulate domestic demand in 2009. The financial safety net government regulation has since expired, and the legal framework for Bank Indonesia or Ministry of Finance to intervene troubled banks is currently inadequate. 3.2 Achievement of Program Development Objectives Overall Rating: Satisfactory Policy Area 1: Financial Markets and Financial System Stability Rating: Satisfactory Decomposing the impact of the PESF on Indonesia’s financial market indicators from that of other domestic policy and political developments, and global policy responses to the crisis is clearly a difficult task. Domestic and international bond yields (Figure 1 and Figure 2) point to the particularly sharp increase in financing costs seen by Indonesia in 8 late 2008 and the marked decline in the first half of 2009. For example, at its peak in October 2008, the spread in local currency five-year yields between Indonesia and Malaysia/Thailand was about 1500 basis points compared to around 500 bp a year earlier. Likewise on the Emerging Markets Bond Index (EMBI) index, the decrease in Indonesia’s spreads between March 2009, when the operation was approved, and May 2009, was the third largest decrease of the 41 emerging economies covered by the EMBI (only Ukraine and Kazakhstan had higher percentage spread declines). Figure 1. 5-Year Local Currency Government Bond Yields for Select Asian Economies Percent Percent 25 25 20 20 Indonesia 15 15 10 10 5 Philippines 5 Malaysia Thailand 0 0 Jan-08 Jan-09 Jan-10 Jan-11 Source: CEIC Figure 2. External sovereign government bond yields and international market volatility Spread, VIX EMBIG Indonesia spread, LHS basis index points EMBIG spread, LHS VIX equity market volatility index, RHS 1200 90 1000 75 800 60 600 45 400 30 200 15 0 0 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Source: JP Morgan Note: VIX is a measure of equity market volatility as implied by options on US S&P 500 equity index. 9 The PESF appeared to play a stabilizing role in reassuring financial markets and keeping the financial system stable in the first half of 2009. In the period running up to the signing of the PESF, Indonesia’s secondary market spreads came down sharply from their peaks of late 2008. Discussions with international and domestic investment analysts conducted for this ICR pointed to the role of the contingent financing of the PESF, along with the supporting policy measures, in this downturn in market yields. However, other domestic factors were also cited, including the strength of policy leadership from the Ministry of Finance, the level of reserves and strong underlying domestic macro conditions, plus the political stability of the outcome of the April 2009 elections. In addition, as seen in the parallel falls in the gradual declines in overall emerging market sovereign bond spreads and international equity market volatility, global factors may also have played a role. These include, for example, announcements of fiscal stimulus packages and quantitative easing in the US and the significant expansion in the financing available from the IMF. Since mid-2009 Indonesia has seen strong capital inflows, reduced financing costs and strong increases in equity prices. Indonesia’s sovereign ratings have been upgraded a few notches and now stand one notch below investment grade. However, the experiences of sharp outflows in May 2010 and in August and September 2010 serve as reminders of the ongoing sensitivity of portfolio capital flows to Indonesia to reversals in international investor sentiment. Banks have continued to report healthy profits and high levels of capital. Following the crisis, the measures put in place – regulations on a financial safety net, increase in deposit guarantee, and widening assets banks can use as collateral for borrowing from the central bank—demonstrated the ability of the government to move quickly to reassure the markets. As a result, despite the rapid depreciation of the rupiah and the rising cost of credit, no banking crisis ensued and real growth was relatively unscathed. Banks continue to do well and are highly profitable—in 2010, driven by credit growth of 23 percent, bank profits were up 27 percent from 2009 levels. Current indicators are also strong with system wide capital adequacy ratio of 17.6 percent and non-performing loans are at historic lows of 2.8 percent (June 2011). In addition to the short-term measures to shore up the system, the PESF was successful in bringing about actions with benefits in the medium term. The first, as part of the financial safety net, was the shortening of time that banks can be placed under surveillance. Prior to this there was no exit strategy and in the case of Bank Century, without a strict time frame, it remained under government sponsorship for over a year. The lack of action is partly what led to its problems as there was no deadline and therefore no push to be resolved. With the new regulation in place, this ensured timely action on bank failure resolution, reducing the risk of transmission to the rest of the banking sector. Unfortunately the financial safety net government regulation has since expired and not legislation has been put in place to replace it. This leaves Bank Indonesia and the Ministry of Finance with an inadequate legal framework to intervene troubled banks should the need arise again. The recently passed Financial Services Authority or OJK Law will regulate and supervise the banking sector, capital markets and non-bank 10 financial institutions and provides an opportunity for improved coordination in supervision across the financial sector. However, implementation will go through a transition period in which there will be supervisory risks. The Law does not necessarily provide the relevant Indonesian authorities with an appropriate legal mandate and framework to deal with financial institutions under stress, and it will therefore be important to put in place a financial sector safety net law that does this. Since the PESF, Indonesia’s first Financial Sector Assessment Program was completed (March 2010), a process initiated under the PESF. In addition to being a requirement for G-20, having the process in the PESF helped jumpstart the process and marked a significant step forward in Indonesia’s commitment to financial and regulatory transparency. Though initially there was skepticism on conducting an FSAP and what it might reveal, in the end the report was generally positive and very complimentary of the work done since the Asian crisis. The emergency measures supported by the PESF–such as regulations on the higher deposit guarantee and broader collateral acceptance--are still in place, though not being used and therefore incur no cost. However, when the deposit guarantee was increased, the premiums were not increased and as such the guarantee fund is technically not adequately funded. But as the system is currently not under stress, it is not a critical issue, though the government should address this mismatch either by increasing the premiums or lowering the deposit guarantee ceilings. Policy Area 2: Sustaining Critical Public Expenditures Rating: Satisfactory In the 1997-98 crisis, the economy was hit hard twice—first through the financial implosion, and then later when this affected the government’s ability to borrow, spending was cut, negatively impacting the economy again. This time around, the government sought to prevent this from occurring and therefore the principle objective to this policy area was to maintain, and if necessary, increase critical public expenditures to preempt and mitigate adverse economic impacts of any growth slowdown. In this respect, the triggers supported the stimulus package which included specific provisions in the 2009 budget law to sustain, and if necessary, increase critical public expenditure in the event of a pronounced growth slowdown. The PESF also supported the implementation of regulatory measures to expedite budget disbursement and enhance the government’s ability to rapidly spend public expenditures. The government was successful in maintaining public expenditures – and in fact both social and infrastructure investments as a share of CG expenditures rose significantly in 2009 relative to 2008. Social expenditures share of CG expenditures rose 3.4 percent to account for 11.7 percent of CG expenditures. Likewise, the share of infrastructure expenditures also rose 2.2 percent. Government spending was effective in stimulating demand, with GDP growing at 4.6 percent (third fastest in G-20 behind China and India). 11 The government also made impressive strides in smoothing out their capital expenditure disbursements, an area Indonesia consistently underperforms in. Capital expenditure disbursements in the first half of 2009 rose to 27% from 21% in 2008, underscoring the government’s commitment to execute the budget and stimulate domestic demand. The change in disbursement pattern however did not last beyond the 2009 crisis year and in fact deteriorated notably. The change was not sustainable because the effort to increase budget disbursement was based on a relatively intensive monitoring of line ministries expenditures with threats of budget cuts of unused amounts, but not a systemic institutional change. Therefore when the political motivation wore off as the economy recovered, so did the monitoring efforts. Table 1. Monitoring Indicators for Public Expenditure Unit 2008 2009 2010 Social expenditures % of CG exp 8.3 11.7 10.0 Infrastructure expenditures % of CG exp 6.2 8.4 6.0 % disbursement in first Capital expenditures 20.9 26.7 17.3 semester of revised budget Fiscal deficit % of GDP -0.1 -1.6 -0.6 GDP growth % 6.0 4.6 6.1 Inflation % 9.8 4.8 5.1 While the above triggers focused on the short-term need to expedite budget disbursements, other triggers in the policy area addressed improving the government’s institutional ability to protect the poor. These triggers included the establishment of a crisis monitoring and response system in anticipation of a growth slowdown, and a decree for the formal coordination of the country’s national poverty reduction efforts. The national Crisis Monitoring and Response System (CMRS) was established to deepen the understanding of how the global economic crisis was affecting households and individuals, which responses were required and where, and how effective these responses were in alleviating the adverse effects of the crisis. The system was established at the National Development Planning Agency (Bappenas) in close collaboration with Statistics Indonesia (BPS). Technical support was provided by SMERU Research Institute and the World Bank, and the project was financed by the Australian Agency for International development (AusAID). The system monitored household outcomes through a panel household survey that covered about 15,000 households across Indonesia. The survey collected data on key indicators that were not available through existing data sources, or could not be collected in a timely manner so that response mechanisms could be quickly triggered if needed. Statistics Indonesia conducted three rounds of the survey during August 2009, November 2009 and February 2010. The first and third waves piggybacked with the National Labor Force Survey (Sakernas), while the second was a stand-alone survey. Quantitative analysis based on the survey data was complemented by qualitative studies conducted by SMERU. The findings from all studies were synthesized in a joint final report. 12 A prototype dashboard reporting system was developed which displayed national, provincial and district-level results from the CMRS surveys and other selected data. This dashboard was shared with selected developers and end-users to collect feedback on functionality and interface. The monitoring system indicated that households in Indonesia experienced the negative effects of the global crisis only mildly. Therefore, little government response was required. Some additional funds, however, were made available through the government’s National Community Empowerment Program (Program Nasional Pemberdayaan Masyarakat Mandiri, PNPM). Targeted regions were selected taking into account the CMRS monitoring results. Considerable experience was gained over the CMRS project which was a successful partnership in response to the global economic crisis. As different kind of crises and shocks may occur anytime, the GoI has shown a strong interest in establishing a long- term, permanent vulnerability and shock monitoring and response system based on this prototype. As a follow up of the efforts to better coordinate anti-poverty programs during the crisis, the President issued a regulation (No. 15/2010) that formally established a National Team for the Acceleration of Poverty Reduction (Tim Nasional Percepatan Penaggulangan Kemiskinan, TNP2K). This cabinet-level body is responsible for leading the coordination and oversight of all poverty reduction programs under all three clusters of the national poverty reduction strategy. Vice-President Boediono chairs the National Team, which will include all government agencies responsible for the planning, financing and implementation of poverty reduction programs. The regulation mandated the establishment of an Executive Secretariat, which is housed in the Office of the Vice-President. The Secretariat is responsible for: drafting policies guiding reform and expansion of national programs, supporting coordination and integration functions, and conducting analyses and providing technical and administrative support for the National Team. To carry out these functions, the Secretariat has established a number of working groups covering household-based social assistance programs; community-driven development programs; support for micro- and small-sized enterprises to support job creation; developing a national targeting system; and integrating monitoring and evaluation functions. The National Team's Secretariat has already made some headway in integrating poverty reduction efforts, such as the preparation of a national registry from which agencies implementing anti-poverty programs will be required to extract their beneficiary lists. Methods used to establish the registry will help improve the accuracy of the targeting of household-based social assistance programs. Other efforts are also underway to prepare an integrated monitoring and evaluation system, which will help improve inter- departmental accountability and can be used to support improvements in the design and implementation of individual poverty reduction programs. 13 Policy Area 3: Facilitating private investment and supporting exports Rating: Satisfactory Policy Area 3 also combined addressing short term needs -- a trigger on opening a re- discount window for trade finance-- and longer term reforms that would facilitate the private investment climate by removing elements of uncertainty and improving transparency (clarity on the investment law and investment negative list and initiating the application process for EITI— thereby improving transparency in the energy and minerals sector). As the global financial crisis spread, addressing the tightening of trade finance was seen as a critical issue to sustain trade flows for Indonesia. The cost of trade was rising, with bank customers asking to put 80-100% cash margin to get a letter of credit, whereas before the margin was 20-30%. As a result, the volume of trade financing fell while its cost increased. Recognizing that easing trade financing would help diminish the slowdown in export growth at a time of a slowing economy, Bank Indonesia activated a re-discount window for trade receivables. Although it was not used--because it ended up being too expensive-- it served as a strong signaling effect that the government was willing to provide liquidity to promote trade financing. By the first quarter of 2009, trade financing had eased and returned to normal. To ensure that such a facility would exist past the crisis, Parliament passed a law establishing the Indonesian Eximbank to provide an additional window of trade financing, which will support rediscount facilities for commercial banks and extend access to trade financing to small and medium exporters. Recently the government injected Rp 3 billion in capital to Eximbank, since then the bank has been actively providing guarantees for pre-export financing to Indonesian exporters and providing a more competitive field in the banking sector for trade financing. To ease investor uncertainty and encourage investment in the medium-term, the PESF sought to improve the investment climate by clarifying the rules and relaxing restrictions of the 2007 investment negative list. Following the review of the DNI supported by this operation, in May 2010, Indonesia’s President signed a new Decree on Indonesia’s Investment Negative list – Perpres 36/2010. The Perpres is a major implementing regulation for Indonesia’s Investment Law of 2007, and replaces the previous investment negative list from 2007. According to BKPM, 40 business fields are more open to investment while 10 are more closed. However, it is difficult to determine whether the net effect of the change is an improvement in the investment climate. This depends on how narrowly or broadly one defines sectors. The sectors that are more open include heath, creative industries, and construction services. The most significant sector that is now more closed to investment is cell towers. Cell towers are highly politicized and reflect growing protectionist sentiment with the Ministry of Communications and Information Technology. Cell towers were added to the investment negative list following a joint ministerial decree originally issued in 2008. Although it had been hoped that the Perpres 36/2010 would resolve the uncertainties regarding implementation of Indonesia’s Investment Law, discussions with the private sector indicate that considerable uncertainty remains. As a result, the Investment 14 Coordinating Board has been reviewing implementation problems and plans on submitting recommendations for improved implementing language to the Investment Working Group of Timnas PEPI. With the exception of cell towers, government ministries have refrained from adding new restrictions on investment. Such restrictions are only added after passing through the inter-ministerial process. Parliament, though, has passed several sector laws that include restrictions on foreign investment, or have the potential to restrict investment pending implementing regulations. These include the laws on Shipping, Mining, Post, Horticulture, and Land Protection for Sustainable Food. Overall, investor sentiment has continued to trend positively and this is supported by higher foreign direct investment. FDI is projected to reach a record net inflows worth US$11 billion in 2011, significantly higher than prior to the 2008 crisis. Strong foreign investment numbers, up 52 percent in 2010 on 2009, were also reported by the investment agency, BKPM, which is forecasting a further 22 percent rise in 2011. This said, the ratio of FDI to GDP remains below many of Indonesia’s regional peers. Nevertheless, the positive outlook is supported by anecdotal evidence of new investment projects and country agreements, for example, with Japan, India, Singapore, China, Korea and the US. In particular, the PESF sought to improve the investment climate in the Mining and Minerals Sector, an area of great potential in Indonesia, but also fraught with legal uncertainty. Indonesia has had a steady decline in oil production, and hence related government revenues, for more than a decade—and indeed, since 2004, it has shifted from being a net oil exporter to a net oil importer, despite having a quarter of its petroleum basins still unexplored. A key impediment to new investment has been the lack of certainty with regard to tax and revenue issues. Recognizing the need to demonstrate the government’s solid commitment to improve transparency of public institutions and its dealings with the private sector on the issue of revenue from extractive industries, the government issued a letter to the Secretariat to initiate the process of application to Extractive Industries Transparency Initiative (EITI), the international standard of oil, gas and minerals transparency. EITI improves the transparency or revenue collection by reconciling reports of revenue and production streams from the oil, gas and mining firms (including state-owned) with those from government agencies collecting the revenues. The two reports are submitted to a multi-stakeholder Steering Group, which hires an independent Reconciler to cross- check the two figures. The results of that reconciliation are then published Since the PESF, progress has been notable. The initial letter fulfilled the first of 20 validation indicators for Indonesia to become EITI-compliant. The letter also served as a platform from which an EITI Presidential Regulation was issued a little over a year later (April 2010). Five months later Indonesia requested entrance into EITI as a candidate country and was admitted into candidacy in October 2010. Indonesia now has two years from that month to complete the process. 15 Considerable work has been done to complete negotiations between government, industry and NGO stakeholders on what will be the scope of the first round of EITI reporting and reconcilation in Indonesia – specifically which firms and government agencies will submit templates and what revenue streams to include. Reaching agreement on the templates will accurately and meaningfully capture oil and gas production sharing (which together account for about 20 percent of government revenue) and represents a significant accomplishment in revenue transparency in the sector. The private sector has responded favorably to Indonesia’s candidacy. Recently a group of 24 extractive industry firms (including oil and gas operators, hard rock mineral firms and coal firms) actively participated in discussing and filling out the EITI reporting templates. 3.4 Justification of Overall Outcome Rating Rating: Highly Satisfactory As the key objective of the PESF was to enable the government to continue financing its public expenditures --and they were able to do so in part because the markets had reassurance that they had access to finance-- then the PESF was highly satisfactory in achieving this objective. Despite the initial punitive reaction of the markets and rapid depreciation of the currency, Indonesia’s growth was one of the least impacted by the crisis. Strong economic fundamentals were a strong part of its resilience, but the actions by the government, supported in the PESF, also served as strong signaling mechanisms that the government was taking the right measures to address the crisis. The outcomes from the medium-term reforms/actions undertaken for the PESF have also been satisfactory to highly satisfactory. With the issuances of the FSAP report, a significant first step in improving transparency in the financial system was achieved and more importantly the strengthening of a dialogue with the IMF on improving the financial system. On public expenditure, crisis monitoring is now being integrated into government systems and improvements in poverty coordination is being addressed at the highest government level. The groundwork has been laid for improving transparency of mineral revenues through the government’s commitment to EITI. While much work remains on improving the investment climate, and there is sometimes back tracking, investment levels are strong and continue to rise. 3.5 Overarching Themes, Other Outcomes and Impacts (a) Poverty Impacts, Gender Aspects, and Social Development During the 1997/98 crisis, the poverty rate rose considerably from 17.7 percent in 1996 to 24.2 percent in 1998, before trending down again in 1999. The government was keen to avoid a repeat performance, and succeeded notably in that this time the poverty rate continued to fall throughout the crisis, from 15.4 percent in 2008 to 14.2 in 2009, and as low as 12.5 percent in 2011 -- showing that despite the economic crisis the government was able to shield the poor. 16 (b) Institutional Change/Strengthening Doing the PESF, has also set a precedent in the country to perhaps allow more insurance- natured products that could provide a measure of stability in public finances. Indonesia’s public financial management system is not set up to manage budgetary risks through risk sharing mechanisms and the associated budgetary costs. However, the success of the operation has brought in a new line of thinking for economic risk management. With a tightening of financial markets a real risk for 2012, the Government has asked the World Bank and other development partners support similar to that provided by the PESF, contingent in nature and in support of a policy package that enhances Indonesia’s resilience to economic and financial market shocks. (c) Other Unintended Outcomes and Impacts (positive or negative, if any) One of the key impacts of the PESF has been the kick-off of the EITI process and the government’s strong willingness to promote it. Prior to the PESF, momentum for EITI had been stagnant as coordination and buy-in was not a priority. However, since the process was initiated, the government has grabbed the momentum and pushed for the participation of other ASEAN countries, notably for Malaysia, Thailand, the Philippines and Vietnam to follow suit. Currently, of the East Asian countries, only Indonesia is an EITI candidate, and Timor-Leste is the only East Asian country already EITI compliant. Outside of the government, the EITI process has helped mobilize other stakeholders. An organization called Publish What You Pay was formed comprising of 38 NGOs that will monitor the implementation of EITI. Gas and oil companies are also actively participating. Bringing transparency to the sector helps both the privates sector and the general public—e.g. the total size of areas covered by permits that have been issued by local governments across Kalimantan, in terms of hectares, is bigger than Kalimantan itself. By having to report on permits, clarity in the licensing process should bring greater reassurance to firms while ensuring the public also receives the correct royalties. 3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops An informal survey of key stakeholders in the investment community was undertaken for this ICR to find out whether the impact of the contingent financing, policy measures or both impacted how they viewed Indonesia. Almost all respondents were aware that the government had received the contingent financing, and more importantly this was a factor – to varying degrees—of their improved outlook for Indonesia in 2009. Many also referenced the steady macroeconomic conditions as a key factor for their improved outlook. Less well known was what were the accompanying reforms, and it seemed the nature of the accompanying reforms had a lesser impact on the investors. One respondent, however, did note that, since this was a package from the World Bank they assumed the reforms would take the country in the right direction, and therefore they were less concerned about the details. However, while investors may not have been aware of the 17 specific reforms supported through the DDO, as the measures were approved— particularly the financial safety net measures—the market did respond favorably. 4. Assessment of Risk to Development Outcome Rating: Negligible to Low The key development objective was the continued provision of financing for critical government expenditures in the wake of the global financial crisis. As the PESF was an emergency operation, its primary focus was on the country successfully navigating the short run horizon. Having successfully weathered the crisis—and with relatively modest impact on growth-- risk to the key development outcome is no longer an issue. However, the PESF also supported policy reforms with medium-term outcomes, and the risk across these varies as discussed below. Financial Stability (Medium): Financial markets have since stabilized, the exchange rate has strengthened, and the government continues to successfully access the market with financing costs coming down to historic lows. Turbulences in financial markets since August 2011 have once again shown that Indonesia remains exposed to sudden reversals of investor sentiment and significant capital outflows. But they have also shown that Indonesia is more resilient and has also built the necessary defense mechanisms to overcome periods of heightened financial market volatility. As mentioned before, the financial safety net government regulation has expired and an adequate legal framework has not been put in place to replace it, making an intervention by Bank Indonesia and the Ministry of Finance in troubled banks less likely. And finally, Indonesia’s first FSAP report, which was highly complementary of the financial system, was completed and submitted to the Board in May 2011. Public Expenditures (Low): While the key objective was to expedite budget disbursements for that year, and this the government successfully achieved, less successful was its ability to smooth out capital disbursement beyond that one year. The medium-term policy reform to develop a national crisis monitoring and response system is underway and has full political support. The benefits of coordination are likely to keep the momentum underway. Investment Climate (Moderate - Low): Reforms to the investment climate are often highly political and as such there is always the risk of backtracking of reforms and growing protectionist sentiment, as occurred recently when the government slapped levies on foreign films to promote domestic films. While the general trend is toward improvement of the investment climate and reduced uncertainty for investors, too often vested interests can get in the way. Overall though, investors are finding Indonesia an attractive investment destination as evidence by the growing investment inflows. On EITI, the risk that Indonesia will not make it through EITI is low. Several factors are supporting its candidacy. First, EITI has an internal enforcement mechanism and all candidate countries must undergo independent validation 2.5 years after becoming candidates (Indonesia's validation deadline is April 2013). The validation process is 18 rigorous, and requires that 20 different indicators be fulfilled – of which Indonesia has completed 9, placing it ahead of schedule. Second, as a part of its Chairmanship of ASEAN, Indonesia has been aggressively promoting EITI, therefore there is strong commitment and effort underway to see EITI through. Given the leadership role it has taken in promoting EITI, it is unlikely that Indonesia will want to be part of the small group of countries (two so far) that have been delisted. 5. Assessment of Bank and Borrower Performance 5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry Rating: Satisfactory Though the operation was done in a short period of time, it was highly effective in identifying short term measures that had strong signaling effects to the market, and it also supported significant reforms in all three policy areas that will likely have a lasting longer term impact. The operation was able to draw from an extensive array of other Bank instruments, including several programmatic trust-funded TA and AAA programs. These ensured the veracity of the needed reforms, and the continuity of the TA programs meant team members had productive relationships with their government counterparts. The team also worked in close collaboration with the other development partners— Government of Japan, Government of Australia, and the Asian Development Bank—to leverage the operation and provide a harmonized policy front. During a period of crisis, the Bank team was able to design an innovative DDO –one that could provide fuller coverage throughout the crisis, rather than a standard DDO that principally provides a lower cost financing option to the markets. The Government committed to draw down the loan only under certain circumstances as specified in the Financing Plan for 2009, and this ensured that Indonesia would only be drawing down if the cost of market borrowing was prohibitively high, rather than using the DDO to substitute for lower cost financing but then not having any other recourse once the DDO was exhausted (optimal buffer stock management). At the time of preparation, there were internal discussions in the Bank on whether it was appropriate to make the ability of GoI to withdraw the funds contingent on borrowing costs going above a certain level. In the end, the team, both from the GoI and WB side, was able to push for the former, and this too the team achieved in a short period of time. In the end, tightening the contingent nature of the PESF was highly beneficial. To the GoI, it helped provide assurance that there was a cap on the cost of debt, it allowed GoI to successfully issue bonds in the market and it also boosted the country’s credentials that they did not unnecessarily tap the funds. 19 (b) Quality of Supervision Rating: Satisfactory As this was a DPL type operation, all conditions were completed upfront. Intensive economic surveillance and monitoring was carried out by GoI and the Bank, supported by development partners, throughout the duration of the operation. This resulted in increased capacity on GoI side to monitor economic developments and formulate macroeconomic projections. After the closing of the operation, ongoing monitoring is conducted through work on existing projects and engagements. (c) Justification of Rating for Overall Bank Performance Rating: Satisfactory Overall rating for Bank Performance is Satisfactory. The Bank worked closely with the government to ensure that the reforms were appropriate, feasible, and delivered in a timely fashion. The innovation and effectiveness of the loan earned the team a Regional Vice President Award, and stands as a model of how to leverage Bank instruments and donor coordination. 5.2 Borrower Performance (a) Government Performance Rating: Highly Satisfactory The government’s commitment to seeing the PESF through was very high, this was an operation that was given top priority. It had high level support and the Bank team worked with some of the most able Indonesian government officials in the preparation of this operation. The government was able to push for traction on items that had previously stalled (e.g. EITI, FSAP) or were traditionally weak, (e.g. capital disbursement). More notable is that momentum on several of the reforms continued beyond the loan signing. Concerns about the sustainability of results discussed in this ICR (on the financial safety net government regulation, further progress on improving budget disbursements) are noted, but to a certain extent this is natural. The sense of urgency that made this operation possible in such a short period of time waned as the economic situation improved and financial markets normalized, and the reforms supported by this operation now have to compete with other priority reforms. In light of the above, the team considers that the borrower’s performance at the time of the crisis, in the preparation and implementation of this operation, was highly satisfactory. (b) Implementing Agency or Agencies Performance Rating: Highly Satisfactory Implementation was done through Coordinating Ministry of the Economy and the Ministry of Finance. Throughout the process they provided constant attention to ensure that needed measures were taken, effective cross-ministerial coordination maintained, and conditions fulfilled. Their drive to achieve the needed frameworks and reforms, 20 particularly those that required over coming strong political resistance, was quite commendable. (c) Justification of Rating for Overall Borrower Performance Rating: Highly Satisfactory Given the strong signaling effects the government reforms made and the strong continuing efforts on the medium-term reforms beyond what was required in the PESF, the borrower’s performance is deemed Highly Satisfactory. 6. Lessons Learned As with the DPL series, strong government ownership and the Bank’s extensive engagement on the ground were key contributing aspects of a successfully executed operation. Still, the use of a DDO was a new experience for the Indonesia office and some key lessons came to light. When uncertainty is high, but a country’s fundamentals are strong, the Bank can be an effective partner in helping to reassure the markets. As it was the first time since the 1997-98 Asian crisis that market volatility was so severe, there was a great fear that the country would be ensnared in the global financial crisis, despite the sounder macroeconomic fundamentals it held this time around. Given the market conditions it was facing, the GoI was highly motivated to secure contingent financing in the form of the PESF. They sought to implement reforms that would demonstrate their commitment to aggressively addressing the crisis head on, but also to market that they had the backing of the international community. As such, the PESF represented a prime opportunity to harness the government’s motivation and reforms with an almost costless solution to their market problems. Access to financing was not sufficient on its own to calm markets. As several investors in the survey pointed out, Indonesia’s strong macro fundamentals, such as the government’s decision to a limited budget deficit despite potential revenue short falls, were key to reassuring markets that Indonesia was stable. Without the government’s strong commitment to prudent economic policies, the DDO would probably have had limited success. The credibility of the DDO package is only as effective as the government’s credibility in maintaining macro stability. Sending a strong signaling effect can be as effective as providing straight financial support. The PESF-DDO provided an innovative approach to support the government by reassuring markets that Indonesia had access to resources should market volatility be too punitive. The signaling effect was made stronger by having other development partners commit $3.5 billion in contingency support – even as it took nearly a year later for some of those funds to be properly programmed through the partner’s respective legislative process. The sustainability of results in such emergency operations depends on post-crisis priorities. The Government of Indonesia and all parties involved in the preparation of 21 this operation devoted much attention at the time of the crisis. Economic surveillance and monitoring was significantly increased by GoI and partners during supervision. However, as the sense of urgency wore off, so did the attention of government officials to follow up on some of the crisis-related policy actions, such as replacing the financial safety net regulation with the necessary legal framework, or efforts to continue improving government disbursement of capital expenditure. As a result, any future crisis will have to revisit these issues. Therefore, although it may be possible to advance long term reforms through this type of emergency operations, support will be better continued through longer term reform operations (such as the regular DPL program). Refining the DDO package. Unlike other DDO operations, the purpose of this DDO was not to serve as a lower cost financing option, but rather as insurance against prohibitively high financing costs which would jeopardize Indonesia’s development efforts. Securing financing at accessible prices for a rainy day was more beneficial to GoI than securing financing at cheaper prices in a relatively benign market environment, as it was in mid 2009 and until the closing of the operation. GoI understood that the funds the World Bank and other partners could provide were finite and it was therefore better to keep them in store for when they would be really needed – which fortunately was never the case. In many respects, the contingent nature of the financing and the fact that it was available for such a long period of time was the best insurance and provided better crisis management than a straight draw down of the DDO. Counting 100 percent of the PESF percent towards Indonesia’s borrowing limit ignored the contingent nature of the support being provided. Although the PESF- DDO was specifically designed not to be drawn down immediately, its curtailed headroom was assigned a probability of 100 percent, and even when it became clear that the crisis had abated and it was extremely unlikely to be drawn down, the headroom remained. For instruments such as this, particularly given the size, curtailing headroom by the full 100 percent unfairly penalizes the lending program. This was an emergency operation and the Bank should perhaps consider what should be a more appropriate headroom treatment, such as allowing a separate headroom for emergency style operations or to only count a percentage of the contingent financing until it is disbursed. By combining restrictive drawdown conditions with extra headroom, the Bank could offer a larger loan package, which in turn would strengthen market signaling and help bring market rates down faster, as was the case in Indonesia. Dissemination of the merits of a contingency-based operation is important to ensure stakeholders have a good understanding of its costs and benefits. People that were closely involved in discussions during the preparation of the PESF are well aware of the benefits of the operation, particularly relative to the very low costs incurred by GoI. Government counterparts in the Ministry of Finance and the Coordinating Ministry for Economic Affairs mentioned that in a similar situation they would again go for the same instrument – acknowledging that the design can always be improved. In fact, as the external environment worsened at the end of 2011 and a tightening of financial markets seems a very real possibility, the Government of Indonesia has requested support from the World Bank and other development partners similar to that provided under the PESF. 22 However, there is also lack of understanding of what the operation was trying to achieve and how successful it was in doing so. It would be important to better disseminate the merits of the operation, and the results achieved, to ensure that it can be used again, both in Indonesia and in other countries, should the need arise. 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners (a) Borrower/Implementing agencies (b) Cofinanciers (c) Other partners and stakeholders (e.g. NGOs/private sector/civil society) 23 Annex 1 Bank Lending and Implementation Support/Supervision Processes (a) Task Team members Names Title Unit LENDING P.S. Srinivas Task Team Leader EASFP Enrique Aldaz Economist EASPR William Wallace Lead Economist EASPR Preeti S. Ahuja Country Program Coordinator EACIQ Shubham Chaudhuri Sr Country Economist EASPR Melinda Good Senior Counsel LEGES Peter Rosner Investment Climate Specialist EASFP Djauhari Sitoris Finance Specialist EASFP Susan Wong Sr. Social Development Specialist EASID Yogana Prasta Sr. Operations Officer EACIF Timothy Bulman Consultant EASPR Tim Brown Sr Environment Specialist EASIS Adam Sack IFC Director for Indonesia CEAR6 Hari Purnomo Finance Specialist EASFP Vivi Alatas Sr. Poverty Economist EASPR Sjamsu Rahardja Trade Economist EASPR The Fei Ming Private Sector Specialist EASFP David W. Brown EITI Specialist SEGOM Shienny Lie Team Assistant EACIF Imad Saleh Senior Procurement Specialist EAPPR ICR Enrique Blanco-Armas Senior Economist EASPR Elaine A. Tinsley Consultant LCSPE Ashley Taylor Economist EASPR (b) Staff Time and Cost Staff Time and Cost (Bank Budget Only) Stage USD Thousands (including No. of staff weeks travel and consultant costs) Lending Total: 44 283.00 Supervision/ICR Total: 18 76.00 24 Annex 2. Beneficiary Survey Results n/a Annex 3. Stakeholder Workshop Report and Results n/a Annex 4. Summary of Borrower's ICR and/or Comments on Draft ICR n/a Annex 5. Comments of Cofinanciers and Other Partners/Stakeholders n/a Annex 6. List of Supporting Documents 1. WB Documents: Report No. 47280-ID, ICR00001677 2. Draft FSAP Aide-Memoire. Financial Sector Assessment Program March 2010. 3. CoalAsia. Issue Volume 5. March 20-April 20, 2011 4. Draft IEG Report on The World Bank’s Group Response to the Global Economic Crisis: Phase II. 25  95° 100° 105° 110° 115° 120° 125° This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and INDONESIA any other information shown on this map do not imply, on SELECTED CITIES AND TOWNS the part of The World Bank Group, any judgment on the PROVINCE CAPITALS legal status of any territory, 15° or any endorsement or NATIONAL CAPITAL acceptance of such INDONESIA boundaries. RIVERS MAIN ROADS MYANMAR VIETNAM RAILROADS PHILIPPINES PROVINCE BOUNDARIES 10° 10° INTERNATIONAL BOUNDARIES THAILAND Sulu Sea 135° 140° Banda Aceh L A Y 5° A S BRUNEI 5° 1 Medan M Natuna I Celebes Talaud Is. Pematangsiantar Besar Tarakan Sea PACI F I C OCE AN 24 A Simeulue 19 Morotai 2 Manado SINGAPORE 23 Nias Tanjungpinang Ternate Halmahera Pekanbaru 25 0° 3 Pontianak AN TAN K AL IM ANTAN 26 Gorontalo Waigeo 0° Lingga 20 Samarinda Manokwari Me Padang 30 Biak Balikpapan Palu Sorong 4 5 Peleng Obi nt Siberut Jambi Bangka 21 aw Pangkalpinang SULAWESI Misool 32 Yapen Jayapura SUMATERA Palangkaraya Mamuju Sula Is. Ceram ai 9 22 6 Palembang Belitung 27 Amahai Fakfak 28 Is Buru 7 Bandjarmasin 29 Kendari 33 PAPUA . NEW GUINEA Bengkulu Parepare Ambon Timika Puncak Jaya 8 Muna (5030 m) 5° Bandar Java Sea Makassar Kai PAPUA Enggano Lampung 11 Baubau Banda 31 Is. JAKARTA 0 200 400 Kilometers Serang Sea Aru Is. 12Bandung Semarang Madura 10 13 Wetar Surabaya Babar Tanimbar 0 100 200 300 400 Miles JAWA Yogyakarta 16 Sumbawa Alor Moa Is. 15 Bali Lombok Raba Flores 14 Merauke 95° 100° 105° Denpasar Mataram Ende Arafura Sea 18 TIMOR-LESTE 17 PROVINCES: 10° Waingapu Sumba Timor 10° Kupang 1 NANGGROE ACEH DARUSSALAM 12 JAWA BARAT 23 KALIMANTAN TIMUR 2 SUMATERA UTARA 13 JAWA TENGAH 24 SULAWESI UTARA 3 RIAU 14 D.I. YOGYAKARTA 25 GORONTALO 4 5 SUMATERA BARAT JAMBI 15 16 JAWA TIMUR BALI 26 27 SULAWESI TENGAH SULAWESI BARAT INDIAN OCEAN 6 BENGKULU 17 NUSA TENGGARA BARAT 28 SULAWESI SELATAN IBRD 33420R2 7 SUMATERA SELATAN 18 NUSA TENGGARA TIMUR 29 SULAWESI TENGGARA AUGUST 2008 8 LAMPUNG 19 RIAU KEPULAUAN 30 MALUKU UTARA 15° 15° 9 BANGKA-BELITUNG 20 KALIMANTAN BARAT 31 MALUKU 10 BANTEN 21 KALIMANTAN TENGAH 32 PAPUA BARAT AUSTRALIA 11 D.K.I. JAKARTA 22 KALIMANTAN SELATAN 33 PAPUA 115° 120° 125° 130° 135° 140°