Min Boediono's Speech on the Economy and Investment

Wednesday, 22 March 2006

<h4>Keynote Address
Indonesia Investment Conference
Accessing the Capital Markets
By Dr. Boediono, Coordinating Minister for Economic Affairs, Republic of Indonesia
Bali, 20 March 2006</h4>


First let me add my warm welcome to that of the Vice President. We very much appreciate the opportunity that BKPM, Euromoney Conference and sponsors have provided for us to make our case for why you should be interested in Indonesia. There is of course a buzz in international markets about high growth in China and India and we too are feeling the impact, especially on exports. However, I would like to make the case today that the international community should and will be taking Indonesia more seriously in the near future.

It could be argued that you are already taking us seriously, after all the Stock Market hit its all time high last week and the rupiah is one of the best performing currencies in the world this year. However, we also appreciate that we have more work to do and I don’t want to overstate the case, or underestimate the difficulties in delivering a reform agenda, but I can assure you that this government is committed t
o economic stability and core reforms that should dramatically change the perception of Indonesia in the next few years.

Macro Review

Let’s start with economic growth. Compared to other countries in the region, Indonesia has been slow in reviving its economy from the crisis. This is mainly because simultaneously it has undergone a far reaching political transition toward democracy. Politics and economics sometimes do not work in sync. But now after 8 years of this challenging journey, we are convinced that the political transition is on track and the economy is on its way towards a steady recovery.

A 5.6% annual growth in 2005 was still well below our pre-crisis performance, but it was the highest growth performance since the crisis.
We may recall that in the crisis year of 1998 Indonesia registered perhaps the sharpest decline in economic activity in any country in the post war period - minus 14 percent in one year.

The economy has since then been recovering slowly but quite impressively. Barring exceptional circumstances we expect our economy to grow by close to 6 percent this year and in the range of 6 to 7 percent in the subsequent two to three years. Since 2004 investment and exports have increasingly become the main driver of growth.

On the stability front the trend in the past 4 years or so has been toward sustainable macroeconomic balances. Last year, due to both internal and external factors our financial markets experienced turbulence. But we are now witnessing a dramatic recovery from this turbulence. We believe that this recovery reflects a growing market confidence and the anticipation of a dramatic turn-around in growth later this year and next. As I indicated the Rupiah is now trading around 9,200, dramatically stronger than the 11,000 per USD level of only 6 months ago.
Recent bond issues both international and domestic have also been equally successful. The spread on foreign bonds and domestic longer-term interest rates, particularly important for economic activity, are already lower than they were six months ago.

These positive policy and market developments are now recognized and reinforced by ratings agencies with upgrades for banks, companies and the government debt. We believe that our macroeconomic and reform strategies are now on track to deliver investment grade ratings reasonably soon, lowering borrowing costs for both the government and the private sector.

On the fiscal front our strategy continues to focus on reducing government debt to GDP levels to the low 30 percent range by 2009. We believe that lower debt levels provides more macroeconomic stability especially in view of relatively high interest rates we face on debt, and
the variability in oil prices.
Here we face a crucial policy issue. Despite our potential we are now no longer a net oil exporting country, though we are still an important net energy exporter.

As most observers now believe that higher oil prices are likely to persist, we have to make our economy oil and energy efficient sooner rather than later and we have to smartly tap our potential in oil and energy to achieve our fiscal consolidation targets, while simultaneously increasing much needed productive government spending in many sectors. We have to revamp our policies in the energy sector to revive production and promote efficient use of the variety of energy sources that we possess. And for long-term fiscal sustainability none is more crucial than a fundamental reform in our taxation system. We are currently developing a comprehensive energy strategy and are taking steps to reform our taxation system.

On the monetary front our independent central bank, Bank Indonesia, has been increasingly more adept in managing monetary and financial stability.
In handling last year’s financial "mini crisis" for instance, Bank Indonesia, admittedly after some initial hesitation, took a decisive step by raising interest rate by over 5 percent in a series of moves beginning in mid 2005. Arguably this was what stabilized the rupiah and Bank Indonesia now begins the process of fine-tuning its monetary policy in line with the progress in the stability condition. Bank Indonesia has been consistent in its message, and reinforced in its policy, that its prime objective is to bring inflation down into single digits by the end of 2006 and to regional averages over the next few years.

But while growth and stability are necessary macroeconomic goals, what matters most to the ordinary people (and this is crucially important in a democracy) is whether there is any improvement in their welfare. One of most basic conditions for such improvement is the creation of more jobs and here we have our greatest challenge. The latest data indicate that the economy is currently adding a net 1.2 to 1.4 million jobs a year.
However, with new additions to the workforce at approximately 1.6 to 1.8 million workers, we are not making progress, in fact we are losing ground especially when you factor in those already unemployed that need jobs.

Another, closely related, issue is the stagnation in growth in formal sector employment. These are the jobs we really want to create, jobs that come with higher wages, insurance and training. This challenge is especially difficult during structural adjustment and especially as closures in labor intensive industries increase. There has been some positive news in this area as export growth, even in labor intensive industries such as garments and footwear, has picked up.
However, the government will have to do more to bring the unemployment rate to 8.5 percent in 2009.

Overall priorities

Addressing the challenges of macro stability, economic growth and job creation requires an agenda with three key government priorities in 2006. First, we need to nurture increasing confidence in economic stability, in particular by getting the inflation rate back down to single digits (around 8 percent).
This is best delivered through continued prudential monetary policy with the government helping as needed to improve the flow of goods and avoid price spikes in key commodities.

Next, we need to do our best to accelerate growth to 6 percent or above. To address this problem in 2006 the government has taken a number steps on the fiscal front. First, we have allowed the carry over of more than 1 billion USD in spending from the 2005 budget. Second, we have made sure that the budget delays last year are not repeated this year with preparation completed by New Year. Finally, we are urging regional governments to accelerate their processes so that they too can add to the stimulus we need as the year goes on. However, in all likelihood government spending patterns will not shift dramatically and government demand will be greatest later in the year when we expect it to be complemented by the private sector as interest rates fall and consumers and producers continue their adjustment.

Restoring stability and accelerating government spending are necessary but not sufficient to sustain higher growth in the longer term. The key to sustaining growth is to use increasing confidence in our macro and fiscal position to encourage private investment, especially in the context of reforms that reduce the obstacles investors face. Let me turn to the reform strategy designed to do just that.

Reform Strategy

We have adopted a three pillars strategy designed to create incentives for private investment in anticipation of higher growth later this year and especially in the years to come.

First, we need to address the investment climate issues that face all firms including importantly the infrastructure sector.
Second, we need to take steps to expedite the implementation of high profile cases that are important in their own right but maybe even more important for the perceptions they create. Finally, we need to address some issues in the financial sector to restart lending and improve the structure of capital markets more broadly.

The first pillar is not difficult to describe as we have just issued policy packages in infrastructure and investment that include numerous measures in multiple areas. In both cases these packages are based on numerous surveys and discussions with stakeholders which allowed us to identify areas where there are obstacles for all or almost all investors. From this list we created policy matrices where issues are dealt with according to a clear timetable and responsibility at the Ministerial level. As an aside we realize that the problems of today are not necessarily the problems of tomorrow and these policy packages will need to be dynamic with new issues added as needed.

The infrastructure reform agenda is organized around issues in the regulatory framework, the role of government in the provision of infrastructure and especially our partnership with the private sector, and infrastructure finance.

Briefly the policy matrix goes into detail in sector policy where changes are needed to provide more certainty, transparency, and accountability. This is needed but does not address key private sector complaints about the quality of projects being proposed and the lack of a risk sharing framework. To improve these areas we are strengthening the committee to accelerate infrastructure provision (KKPPI) to provide better oversight and coordination in the context of government support for projects and we have accepted that such support must include an acceptable risk sharing framework, including the provision of partial or limited guarantees to selected projects. This infrastructure program will receive direct guidance from the Vice President and will be coordinated under my office with the assessment of guarantees done by the Minister of Finance.
Finally, we are looking at the complex issues around infrastructure finance, including financing land acquisition, the guarantees I talked about, and even an infrastructure fund where the government would share risks directly with the private sector. This is very brief and for more information I urge you to go to the website of the committee (www.kkppi.go.id).
We have also completed another set of reforms that are included in Presidentia Instruction No. 3/2006. The policy actions here include measures to improve the general regulatory/investment regime. While again I can not go into detail I believe that we are proposing some reasonably radical breakthroughs. For example we propose to cut the time it takes to open a business from 151 to 30 days. The foundation of this reform is a new investment law which we hope to present to Parliament this month. When the Investment law is passed we will move forward on the required implementing regulations.
I should point out a few important features. The new law is designed to improve legal certainty, provide for equal treatment (foreign and domestic investment) and codify international arbitration. The associated implementing legislation will clarify the negative list and improve the certainty around fiscal incentives.
The next focus area of this package is tax. There are a number of reforms proposed in four different tax laws. Briefly they include such things as gradually reducing the corporate tax rate from the current 30 percent to 25 percent by 2010; addressing problems in tax administration and especially a perceived lack of balance between tax payers and tax officials, and reducing trade and business distorting regional taxes. For example current laws allow regional governments to set taxes and charges not prescribed by the central government. Under the new law this will be reversed and the areas that regional governments are allowed to tax or apply user charges will be limited to a positive list. To compensate regions for lost revenues their share of transfers from the national budget has been raised.

In customs, reforms are focused on the currently burdensome logistics costs that are a major source of reduced competitiveness in Indonesia. The proposed reforms are not limited to changing the customs law, although we are doing that, but focus also on improving the soft and hard infrastructure in the ports and the links between the ports and producers, including such things as the share of imports to go through the red lane or the normal inspection process, and adding substantially to the number of importers that can access priority lanes.

To improve employment generation we are proposing to amend labor legislation to improve the flexibility of the labor market. This requires revisiting such issues as the size of severance payments, limits on work contracts, outsourcing and the determination of minimum wages.

The two policy packages on infrastructure and investment aim at improving investment climate, the first pillar in our strategy. The next pillar of our reform strategy involves the acceleration of some key outstanding high profile cases. These cases take special handling as they are important in and of themselves, they often reflect unique circumstances to influence broader perceptions. Thus we have adopted a more proactive policy, for example in the case of the Cepu oil field dispute between Pertamina and Exxon-Mobil which was resolved last week. Earlier there was an agreement with Newmont on the civil charges around Buyat Bay.
We are also looking at the problems hampering the implementation of 91 infrastructure projects that we offered for investment in the Infrastructure Summit in January last year. We are trying to improve project preparation and as I indicated earlier, the Government has decided that it is prepared to go forward with risk sharing on selected infrastructure projects. We are now reviewing a number of electricity and toll road projects that have been on hold for years with a view to resolving some of them using this framework.

The final reform pillar includes access to credit at reasonable cost and appropriate maturities. Financing is normally not an important problem for international investors but it is often a crucial one for domestic investors, especially for small and medium enterprises. The availability of adequate and reasonably priced sources of financing for small and medium enterprises is economically and politically important as we take the democratic route to development. We need to widen the sources of finance available to the corporate sector and where possible extend maturities, a particular problem for infrastructure. Part of the job is, of course, to reduce inflation hence the interest rate, and the other part is to improve the institutional and regulatory framework in capital markets. To do this we have agreed with Bank Indonesia that an additional package addressing financial sector reforms is needed and this is underway.
We believe strongly that this third pillar is needed to support the reforms in pillars one and two.

Before concluding let me talk for a moment about implementation. We have presented the reforms I have outlined today in numerous forums in recent weeks and the reception has invariably been positive with one key exception – implementation. And by implementation people do not mean that we check off a box, a law submitted, a regulation drafted but rather whether the actions have improved the investment climate on the ground. And I assure you we are listening. The government plans to create a continuing forum for consultation between the government and the business community. To do this the existing national team to promote exports and investment chaired by the President (called Tim Nasional Peningkatan Ekspor dan Promosi Investasi of PEPI) is being reorganized. We are also creating a team charged with not only determining whether each action in the packages has been taken but also assessing whether it has delivered the change needed.
But we need to reinforce this monitoring process further and we are working with others including the Indonesian Chamber of Commerce and the international community to assess progress as well. I would offer the same invitation to you. My staff and I welcome your comments and critiques and our door is always open.


Let conclude by reiterating some key messages. First, the Government is committed to manage and navigate the economy prudently but innovatively to achieve economic progress along the democratic route. The focus is on economic stability, growth and job creation. Second, we believe that at last we have now succeeded in establishing a firm start toward that path. Economic stability is firmly restored and growth is steadily on the upward trend while our democratic reform continues to be on course. Third, the main driver of sustained and productive growth, namely private sector investment, is beginning to revive. We need much more of it than we have seen so far. Our aim is to achieve investment rate similar to what we achieved before the crisis over the next 2-3 years corresponding to annual growth in the order of 6 to 7 percent. To achieve that we have launched reform packages in infrastructure, investment and a forthcoming package on the financial sector.
These packages should reinforce attractiveness to the private sector and extend economic momentum. We are also moving to systematically address the high profile cases that are outstanding. Finally, we intend to improve small and medium enterprises access to financing.
I hope you share my optimism about the prospect of this country and we look forward to working with you.
Thank you,
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