Sunday, January 07, 2007

Country Assistance Strategy for Indonesia: Changes, Impacts, and Improvements *)

The outbreak of the financial crisis 1997 and the deep recession that followed suit has highlighted the important role of foreign assistance in Indonesia. Recently, the IMF and the World Bank (the Bank) have been criticized for their roles in guiding the Indonesian government towards economic recovery. This has raised questions about the effectiveness of foreign aid to Indonesia. Within this circumstance, on November 2003, the World Bank’s Board of Executive Directors discussed the Bank Group’s Country Assistance Strategy (CAS) for Indonesia covering the period 2004-2007.

Following the CAS Public Information Notice, the Bank described Indonesia as follows:
Indonesia continues its transition from an autocratic, centralized state to a democratic, decentralized one. It has successfully regained macroeconomic and political stability, but economic growth remains below 4 percent, poverty reduction remains a challenge, and governance concerns continue to cloud its achievements. Public debt has declined from 100 percent of GDP to 72 percent, inflation is now below 7 percent, and income poverty has fallen from 27 percent in 1999 to 16 percent today. Today, 110 million people still live on less than $2 a day, and remain vulnerable to falling back into severe poverty. Indonesia continues to under-perform its neighbors in access to quality health, education and other basic services, as reflected in the MDG indicators. Weak governance institutions are keeping investors away and undermining service provision, especially to the poor. Indonesia has undertaken reforms that could lead to a more effective and accountable government, and a restoration of growth. However, sound implementation is now needed to turn the promise into reality.

The Bank Group Strategy
Based on this discussion, the Bank focuses on the so-called “The Bank Group Strategy” to address these problems, which include:
1. Improving the Climate for High Quality Investment.
Bank Group support will be directed to address five key areas that are essential to raise the rate of investment from its current level of 20 percent of GDP: deepening macroeconomic stability, building a stronger financial sector, fostering a competitive private sector, building Indonesia’s infrastructure, and creating income opportunities for poor households and farmers.
2. Making Service Delivery Responsive to the Needs of the Poor.
Weak service delivery is undermining Indonesia’s goal of improving the quality of life of its citizens and the attainment of its MDGs. Bank Group support will thus be devoted to help revamp the management and accountability systems for service delivery to make providers more directly accountable to their clients. Focus will be given to implementing the principles of the World Development Report 2004, especially in health and education, but also in agricultural research, extension and irrigation, and in public services in general.
3. The Core Issue of Governance.
Advances in governance will be needed to address both CAS objectives. Four areas will be given priority: (i) making development planning more responsive to constituents; (ii) improving public financial management; (iii) strengthening the accountability of local governments under a more coherent decentralization framework; and (iv) enhancing the public credibility, impartiality and accessibility of the justice sector. Selectivity in the Bank’s activities will be determined less by sector priorities than by the opportunity to make progress in these areas. Corruption poses a special problem in Indonesia, and the country team aims to integrate governance and corruption issues through the entire Indonesia program, shaping how projects are selected, designed, implemented and monitored.

To deliver its business platforms, the Bank will leverage the projects it finances with analytical work, policy advice, technical assistance, strategic partnerships and capacity building to increase standards of governance at each level of government the Bank engages systematically. Four business platforms are envisioned:
1. The Community Driven Development Platform: about 25 percent of all lending (about $200 million per year) would be allocated to scale up this successful program.
2. The Local Services Platform: about 40 percent of lending would be allocated to help create accountability at the district and provincial levels.
3. The Public Utility Platform: about 15 percent of lending would help support investments in good corporate governance and efficiency in water supply and energy.
4. The National Lending Platform: about 20 percent of lending would be allocated to address central problems.

Through these platforms, the Bank proposes a Base Case with lending in the range of $450 - $850 million, including $230 million in IDA resources. The Base Case assumes continued, but incremental, progress on the Economic Policy Package. Evidence of decisive momentum in implementing the reform package could lead to an “enhanced” Base Case, in which the Bank would offer an adjustment loan in late 2004. The actual amount of Base Case lending would also depend on the number of districts and utilities that qualify through their governance reforms for bank assistance. The CAS also includes a High Case of up to $1.4 billion, and a Low Case of less than $300 million. The High Case triggers have all been selected from the Government’s Economic Policy Package as those most important to achieving target outcomes in the three CAS areas and putting the country on a path to stronger growth and better living standards.

The programs were designed to mitigate risks that could limit the effectiveness of bank support. These risks include a lack of political will to address governance issues, macroeconomic shocks arising from domestic or international factors.

Changing Features of ODA (Official Development Assistance)
Traditionally, the Bank and the ADB (Asian Development Bank) played the major role in implementing multilateral aid projects in Indonesia. The Bank always enjoyed a constructive relationship with successive governments, providing policy advice through the country economic memoranda and country strategy reports. The constructive nature of the relationship between both sides were especially highlighted during the late 1980s and early 1990s when the Bank did not attach any policy conditionalities to loans (World Bank 1999, p.15). However, the Bank also failed in several instances to persuade the government to implement important policy reforms. Corruption issues were raised a couple of times, but were ignored (World Bank, 1999, p.16). Warnings on financial sector insolvency, overheating of the economy and social stress went also unheeded.

In terms of sectoral allocation of aid, the infrastructure development absorbed the largest share at 40% of the total, followed by agriculture at 19%; education, health and nutrition/population at 13% and sanitation at 10% (World Bank Brief on Indonesia). Over time, the composition changed: the share of agriculture fell in favor of a rise in other categories. In the forestry sector, the Bank insisted on policy conditionalities to reform the sector and this caused the government to stop borrowing for forestry projects from the Bank. Together with a decline in the focus on transmigration (also explained by increased international criticism on the resettling program), this explains the declining share of agriculture.

Interestingly social infrastructure (consisting of education, health and urban development projects) is the main beneficiary with infrastructure development in the traditional sense (i.e. energy, transport and communications) following in second place. The overall operational strategy prior to the crisis was an emphasis on three areas: improvement of physical infrastructure, human development and sustainable resource management. Decentralization, specifically in the Eastern Islands was a priority. With the crisis, lending shifted towards poverty alleviation again, with the ADB providing $1.84 billion in 1998 (ADB 2000, p.19). The crisis has also brought the IMF into the centre stage of aid policies in Indonesia. So far, 8.3 billion $ SDR have been approved, of which 3.7 billion have been drawn. The IMF has been much criticized for its role in handling the crisis. Its insistence on wide - ranging structural reforms to restore investor confidence rather than to focus only on macroeconomic management (its traditional role) continues to be subject political debate among Indonesian policymakers.

Negative Impacts of Aid
Looking at the fiscal burden of debt in Indonesia, one cannot avoid the conclusion that the country will be dependent from external resources for a long time to come. After completing the bank recapitalization program, government debt will be 94 % of GDP, up from a pre-crisis figure of 23 %. An estimated 1.1% of GDP had to be repaid in debt in 2000 and for 2001; the figure will be about the same. Accordingly, debt service will increase in 2002 and subsequent years, when budget-supported loans from the crisis years and bank recapitalization bonds become due and rescheduling agreements phase out. The debt service will reduce development spending further, resulting in cuts in all areas of public spending, including spending on social infrastructure (World Bank 2000, CGI Brief, p.23).

The debt burden also raises issues of aid dependency and unequal relations between donor community (and single large donors like Japan) and Indonesia. To obtain financing for covering budget deficits, policy conditions are attached, primarily in the Letter of Intents between the government and the IMF. For instance, to ensure fiscal sustainability, the government must improve budget management, raise revenues though better tax administration, phase out fuel subsidies, and accelerate privatization and asset recovery, and so on. It is easy to see that many of these policies are politically sensitive. For instance, the recent delay in disbursement of IMF loans is caused by the If’s concern about the independent status of the central bank. This is seen by many as political interference.

Moral hazard and corruption also hamper the effectiveness of aid flows. One big structural problem is that Indonesia mixes development spending with recurrent items. Items such as wages and project management fees are included in the development budget. Routine maintenance is put into project spending and thus falls within the development budget. Thus, donor funded projects, which are fully integrated into the development budget; regularly finance recurrent spending such as books and medicine. This is a major incentive for inefficient spending and corruption, especially considering the low salaries of public servants (World Bank 2000, CGI brief, p.23).

In the past, aid flows were also subjected to a highly centralized fiscal system that fostered the unequal relations between central government and provinces. Revenues of the center, for instance, constitute almost 90 percent of all revenues. Sub - national governments depend for almost 60% of their spending on central government grants (World Bank 2000b). This unequal relationship can also be detected if one looks at several human development indicators. Moreover, there is also a clear relationship between lack of infrastructure development and slower economic growth in the regions. The current decentralization program is about to change this anomaly. Two regulations are the central instruments to push for decentralization: Law No.22/1999, which empowers district governments and Law No.25/1999, which regulates the fiscal balance between the center and the provinces and districts.

Improving Bilateral Aid Program - Current Approaches
In essence, there seems to be a consensus among major donors about the direction of future aid to Indonesia. Principles and guidelines are formulated in documents like the New Development Strategy by DAC or the last World Development Report by the World Bank (JICA 200, World Bank 2000). There is a broad consensus about attacking poverty and focusing on participatory approaches to growth, environmental sustainable development and open trade regimes. The main problem is that donors have frequently failed to coordinate aid efforts, countries have not taken ownership and policy conditionalities on the project and program level have reduced incentives to implement aid more effectively.

Sector-wide development cooperation is one possible future solution to overcome coordination problems. The idea is that the recipient country formulates a sector strategy in consultation with key stakeholders and a budget framework. Donors put their money into a central expenditure pool for the sector. Thus, the approach ensures donor and recipient coordination and provides for country ownership of sector strategies.

Although far from being close to this ideal situation, some efforts have been made into this direction in Indonesia. As part of an IBRD balance of payments support commitment, a sector - wide reform in irrigation and water management is under way. Based on public consultations, the reforms are being prepared by an intergovernmental committee with NGO participation under the Coordinating Minister for Economy and Finance with support from several donors. Donors collaborate with the government to develop a national water management program. The program encompasses several individual donor projects. They follow common program principles and strategies under joint oversight (World Bank, CGI brief, 2000, p.28).

While more coordination is undoubtedly important to harmonize efforts and to make aid more effective, the push for reform ultimately depends on internal political stability. Current lack of coordination among government agencies themselves and the shaky nature of the political transition process in Indonesia make it difficult to implement efficient and coordinated policies. However, future aid strategies for Indonesia have to take account of the increasingly worrying debt situation. Without substantial debt rescheduling and even canceling of debt, the unequal relation between donors and Indonesia is likely to continue, as the heavy fiscal burden caused by large debt repayments makes it very difficult for Indonesia to return to a high growth path in near future. Instead, the government will have to constantly rely on external financing and more policy conditions attached to it.

What Next?
Based on the above discussion and take into account the evaluation from external expert hired by the Bank, in the future the Bank should:
 strengthen operational guidance and oversight for the application of Bank safeguard policies and fiduciary compliance,
 design the program as an integral part of the overall assistance strategy, and carry out periodic assessment of on-going projects to ensure relevance and effectiveness to the country context, and
 give priority to helping countries build-up existing indigenously matured initiatives; where such initiatives do not exist, tailor project to country and community context while undertaking selective, rigorous, impact assessments to ensure learning.

Source of reading
1. ADB (2000), “Country Assistance Plan (2000-2002)”, January.
2. Indonesian Law No.22.1999, “The Regional Governance”.
3. Indonesian Law No.25/1999, “The Fiscal Balance between the Central Government and The Regions.
4. Japan International Cooperation Agency (2000), “Japan's Official Development Assistance to Indonesia “.
5. World Bank (1999), “Indonesia - Country Assistance Note”, Report no.19100, March 29.
6. World Bank (2000), “Indonesia: Accelerating Recovery in Uncertain Times”, Brief for the Consultative Group on Indonesia (CGI), October 13.
7. World Bank (2000b), “Public Spending in a Time of Change”.
8. World Bank (2003), “Country Assistance Strategy for Indonesia, October, 29.

*) International Technology and Management 4E (ITM) – 70671
Professor NAKAMURA Shuzo

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