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Cablegate: Generally Positive Assessment of Indonesia's Economy

VZCZCXRO0415
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #2745/01 2710336
ZNR UUUUU ZZH
R 280336Z SEP 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 6482
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 0876
RUEHBJ/AMEMBASSY BEIJING 4350
RUEHBY/AMEMBASSY CANBERRA 1274
RUEHUL/AMEMBASSY SEOUL 4223
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 002745

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DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN
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E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV KMCA KCOR ID
SUBJECT: GENERALLY POSITIVE ASSESSMENT OF INDONESIA'S ECONOMY
PROVIDED BY KEY OFFICIALS

REF: JAKARTA 13559

1. Summary: Several key economic officials proviced a generally
positive assessment overall of Indonesia's economy. Coordinating
Minister for the Economy Boediono chaired a high-level briefing for
donors and the private sector on September 25, noting that
Indonesia's economy has grown more than 6% for the past four
quarters. Bank Indonesia Senior Deputy Governor Miranda Goeltam
said that monetary and banking sector reforms are improving
stability. Indonesia's interest rates are still the highest in the
region attracting portfolio investment. A new investment survey of
businesses shows a perception of less corruption overall. Finance
Minister Mulyani continues a vigorous reform program, replacing
1,300 customs officials at Jakarta's Tanjung Priok, Indonesia's
largest port. End Summary.

2. Coordinating Minister for the Economy Boediono held a meeting for
donor and private sector on September 25 to provide an update on the
macroeconomy, financial sector and investment. Finance Minister Sri
Mulyani Indrawati, Senior Bank Indonesia Deputy Governor Miranda
Goeltam (financial and banking sector), State Minister for
Administrative Reform Taufiq Effendi (regulatory issues) and
Director of the Institute for Economic and Social Research at the
University of Indonesia Dr. Chatib Basri (investment survey) also
gave presentations.

Momentum Building for Stronger Growth
-------------------------------------

3. (U) Coordinating Minister for Economic Affairs Boediono opened
the forum with a review of Indonesia's strong macroeconomic
performance over the past year. He noted that the Indonesian
economy grew more than 6.0% during each of the past four quarters,
with the non-oil economy expanding 7.0% over the first half of 2007.
Commodity exports and domestic consumption continue to drive growth.
Investment rates have also picked up considerably in 2007.
Investment approvals rose 145% during the first half of the year
compared to the same period last year.

4. Boediono predicted that the Indonesian annual economic growth
rates would exceed 7.0% by 2010, on the back of continued strong
world demand for Indonesian commodities, increased domestic
spending, and new infrastructure capacity set to come on line in
2008. Boediono also expects continued progress on investment
climate reforms and a low interest rate environment to spur growth.
In addition, the GOI plans to expand spending on infrastructure
significantly in the coming years, further reducing supply-side
constraints to growth. Boediono downplayed the impact of a global
economic slowdown on Indonesia's export performance citing the
Indonesia's well-diversified export product and destination mix.

5. Boediono reported renewed momentum in the fight against poverty
and unemployment. According to GOI data, the rate of open
unemployment in Indonesia declined form 11.2% in November 2005 to
9.2% in February 2007. Boediono expects the rate to fall to the
8-9% range by the end of 2008. The incidence of poverty also fell
from 2006 to 2007. However, the drop in 2007 followed a rise in the
rate of poverty during the previous year. Nevertheless, in
recognition that poverty remains a significant problem in Indonesia,
Boediono announced plans for a significant increase in spending on
community empowerment and poverty reduction programs in 2008. The
GOI has also attempted to rationalize price stability programs for
rice, sugar and fuel by easing import restrictions and targeting
price subsidies to the poor, in an effort to relieve pressure on
households with low incomes. The GOI expects inflation rates to drop
to the regional average of 3-4% over the medium term.

Monetary and Banking Sector
Reforms Yield Results
---------------------------

6. Bank Indonesia Senior Deputy Governor Miranda S. Geoltom
described BI's success in maintaining price stability in recent
years. Price levels in Indonesia continue to fall, with volatility
limited to the energy and food sector. The Rupiah remains on an
appreciating trend, despite the recent dip attributed to global
financial turmoil. Strong macroeconomic fundamentals, including

JAKARTA 00002745 002 OF 003


current account surpluses, a large pool of foreign exchange reserves
and a manageable external debt burden have limited capital outflows
during the recent global credit market slump. While BI has moved
the reference rate to down 450 basis points over the past year and a
half, Indonesian interest rates are still the highest in the region,
making Indonesia more attractive to foreign capital. Miranda
affirmed that BI is committed to maintaining a flexible exchange
rate regime, intervening in the foreign exchange market only to
smooth volatility.

7. BI's effort to strengthen Indonesia's banking sector has paid
dividends. The Indonesian banking industry is well capitalized
(industry capital asset ratio above 20%), profitable (industry
return on assets 2.8%), highly liquid (industry ratio of government
bonds to assets 26%), and healthy (industry nonperforming loans
ratio 6.4%). Skill levels among Indonesian bankers have improved,
reducing the level of asymmetric information between banks and their
clients. However, risk aversion leftover from the financial crisis
of the late 1990s has continued to suppress credit growth in
Indonesia. While credit growth has begun to recover in recent years,
the rate of growth of loans remains well below the pre-crisis rate.


8. As a result, BI is attempting to implement policies that
encourage lending or "improve the bank intermediation function"
while maintaining the integrity of the banking sector. In line with
the effort to promote lending activity, BI introduced policy changes
in 2006 that eased rules for classifying certain types of credits
such as shariah instruments, loans to SMEs and loans for disaster
relief. BI has also established a credit bureau, improved data
collection, and facilitated meetings between banks and potential
borrowers in order to improve information flows.

Investment Survey
-----------------

9. Dr. Basri presented the results of the fourth investment climate
monitoring survey (since 2005) of 589 firms in five metropolitan
areas: Medan, Jabotabek, Semarang, Surabaya and Makassar. The
survey also interviewed 56 notary offices in depth on business
start-up times. Major conclusions:

-- Perceptions of investment climate improved overall.

-- Biggest perceived obstacles are macroeconomic instability,
transportation, corruption and economic policy uncertainty.
Perceptions of infrastructure quality, especially transportation and
electricity have worsened since late 2005.

-- The impact of economic shocks from higher fuel prices, inflation
and interest rates has eased.

Obstacles to Business: Corruption
---------------------------------

10. The perceptions of corruption mostly showed improvement. From
the end of 2005 to 2007, those who cited central government
corruption as an obstacle dropped from 47% to 43%; local government
corruption dropped from 52% to 48%. Both regional and national
customs dropped from 36% to 33% and from 36% to 32% respectively.
Central and government licenses and permits remained the same at 29%
Land procurement increased from 16% to 20%. Import clearance time
has improved from 7.6 days to 5.9 for the red lane, and from 6.1 to
3.1 for the green lane. Unfortunately, the percentage of those who
say they never pay bribes has dropped: 19% said they never paid
bribes in mid-2005 but only 9% in 2007. Informal payments to
government officials as a percentage of production costs declined to
1.3% in 2007 from 1.7% in 2005.

Small Tax Improvements
----------------------

11. The value-added tax (VAT) refund as a percentage of the initial
claim has increased from 80.3% to 83.9% from 2005 to 2007. The time
to process a VAT refund has decreased to 5.1 months from 6.3 in
mid-2006. However, more than half of the respondents reported they
needed to make unofficial payments and negotiate with tax officials

JAKARTA 00002745 003 OF 003


to obtain a VAT refund. In 2005, 65% of respondents reported VAT
regulations as unclear, which improved to 43% in 2007. Businesses
are still required to file seven different types of tax returns each
month, devoting 32 man days to the task, down from 41 man days in
2005.

Labor Issues: Mixed Picture
---------------------------

12. In most areas the percentage of respondents experiencing labor
problems declined: demands for wage increases, worker
demonstrations, conflicts with labor unions and worker strikes.
However social security problems increased from 6% in 2005 to 9% in
2007. Severance pay and lay-off procedures are still the biggest
obstacles. Concerns about overtime regulations, minimum wage,
social security, foreign workers and government monitoring also
increased. The cost of handling labor problems as a percentage of
total production cost is 4.1%, up from 3.7% in 2005.

Starting a Business: From 80-86 Days
------------------------------------

13. One of the biggest unpleasant surprises of the briefing was the
increase in the days to start a business from 80 in 2005 to 86
calendar days in 2007, despite the GOI's efforts to reduce it
eventually to 30 days. The additional time was attributed to the
delegation of authority to legalize limited liability companies to
the provincial offices of the Ministry of Justice under Presidential
Instruction (INPRES) No. 3/2006. The provincial offices:

-- Lack strong internal controls;
-- Lack equipment and skilled information technology staff
to operate an online legalization system;
-- Have low volume so cannot spread fixed costs resulting
in higher costs to the applicant;
-- Required more face-to-face contact and thus corruption.

In a follow-on presentation by State Minister for Administrative
Reform Taufiq Effendi, Effendi said the Ministry of Justice and
Human Rights was drafting a regulation to re-centralize the
authority for establishing a business, taking it back from the
provincial offices, and suggested 14 additional actions to speed up
the process of starting a business. On September 26, the
International Finance Corporation (IFC) issued its "Doing Business"
Report showing that Indonesia had moved up overall from position 135
to 123. However, the country still ranks below other regional
economies.

Bureaucratic and Civil Service Reforms
--------------------------------------

14. Minister Mulyani discussed some of her priorities for
bureaucratic reform:

-- Tax and Customs Administration;
-- Budget, Treasury and Debt Management;
-- Business Process and Civil Service Performance.

On tax administration, she is focusing on expanding the Medium and
Small Taxpayer offices on the model of the successful Large Taxpayer
Offices (LTO), which have improved customer service and reduced
corruption. "We want to change the way we serve the taxpayer,"
Mulyani said. On Customs reform, Mulyani fired 1,300 customs
officials at Jakarta's large port of Tanjung Priok, replacing them
with 800 officials who had to pass a tough new exam, and have to
satisfy mandatory codes of conduct. On budget, treasury and debt
management, Mulyani has this year introduced a Treasury Single
Account, a primary dealers market, Treasury bill auctions and hopes
to begin issuance of sharia sovereign bonds. In her Ministry, she
has also implemented key performance indicators for all positions
and better remuneration and recruitment for important skills. "I
want to earn the trust of the public with better performance so they
won't think we are wasting their money," she said.

HEFFERN

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