P D S C D P L US$300 R I O 23, 2013 - World Bank · 2016. 7. 14. · INKINDO Ikatan Nasional Konsultan Indonesia (National Association of Consulting Professionals) SUN Rupiah-denominated

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 76870-ID

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT

FOR A PROPOSED

SECOND CONNECTIVITY DEVELOPMENT POLICY LOAN

IN THE AMOUNT OF US$300 MILLION

TO

THE REPUBLIC OF INDONESIA

OCTOBER 23, 2013

Poverty Reduction and Economic Management Department

Indonesia Country Department

East Asia and Pacific Region

This document has a restricted distribution and may be used by recipients only in the performance of their official

duties. Its contents may not otherwise be disclosed without World Bank authorization.

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REPUBLIC OF INDONESIA

GOVERNMENT FISCAL YEAR

January 1 – December 31

CURRENCY EQUIVALENTS

(Exchange Rate Effective as September 4, 2013)

Currency Unit Rupiah (IDR) US$1.00 = Rp.10,983

ABBREVIATIONS AND ACRONYMS

AAA Analytical and Advisory Activities JTA Jabodetabek transportation authority

ADB Asian Development Bank Kadin Kamar Dagang dan Industri (Indonesian

Chamber of Commerce and Industry)

ADEKSI Asosiasi DPRD Kota Seluruh Indonesia (City

Council Association of Indonesia) Keppres Keputusan Presiden (Presidential Decree)

ADSL Asymmetric Digital Subscriber Line KKPPI

Komite Kebijakan Percepatan Penyediaan

Infrastruktur (Committee for the Acceleration

of Infrastructure Provision)

AMAN Aliansi Masyarakat Adat Nusantara (Association

of Indigenous Peoples of the Archipelago)

KOMNAS HAM Komisi Nasional Hak Asasi Manusia

(National Committee on Human Rights)

AMDAL Analisa Mengenai Dampak Lingkungan

(Environmental Impact Assessment) KPK

Komisi Pemberantasan Korupsi (Corruption

Eradication Commission)

APPSI Asosiasi Pedagang Pasar Seluruh Indonesia

(Association of Market Traders) LIBOR London Interbank Offered

ASEAN Association of Southeast Asian Nations LPI Logistics Performance Index

Ausaid Australian Agency for International Development M&E Monitoring and Evaluation

Bappenas Badan Perencanaan Pembangunan Nasional

(National Development Planning Agency) MDFTIC

Multi Donor Facility for Trade and

Investment Climate

BI Bank Indonesia MDGs Millennium Development Goals

BOS Bantuan Operasional Sekolah (School Operational

Assistance) MDRI Multilateral Debt Relief Initiative

BPJT

Badan Pengatur Jalan Tol (Indonesia Toll Road

Authority)

MIC Middle-Income Country

BPK Badan Pemeriksa Keuangan (State Audit Agency)

MIS Management Information System

BPN Badan Pertanahan Nasional (National Land

Agency) MoF Ministry of Finance

BPOM

Badan Pengawas Obat dan Makanan (Drug and

Food Supervisory Agency) MoHA Ministry of Home Affairs

BPS

Badan Pusat Statistik (Central Bureau of Statistics) MP3EI

Masterplan for Acceleration and Expansion of

Indonesia’s Economic Development

CDP Cikarang Dry Port MTEF Medium-Term Expenditure Framework

CMEA Coordinating Ministry for Economic Affairs Musrenbang Musyawarah Rencana Pembangunan (Multi

stakeholders consultation forum)

CPI Consumer Price Index NGO Non-Governmental Organization

CPS Country Partnership Strategy NILITS

National Integrated Logistics and Intermodal

System

CPSPR Country Partnership Strategy Progress Report NLB National Logistics Blueprint

CY Calendar Year OBA Output Based Aid

DAK Dana Alokasi Khusus (Special Allocation Funds) OECD

PEACH

Organization forEconomic Co-operation and

Development

Public Expenditure Analysis and Capacity

Harmonization

DG Director General PER Public Expenditure Review

DPR Dewan Perwakilan Rakyat Daerah (People’s

Consultative Assembly) PFM Public Financial Management

DSF Decentralization Support Facility PINTAR Project for Indonesian Tax Administration

Reform

EU European Union PKH Program Keluarga Harapan (Conditional

Cash Transfer)

FDI Foreign Direct Investment

PMK

Peraturan Menteri Keuangan (Minister of

Finance Regulation)

FIRM DPL Financial Sector and Investment Climate Reform

and Modernization Development Policy Loan PNPM

Program Nasional Pemberdayaan

Masyarakat (National Program for

Community Empowerment)

FX Foreign Exchange PP Peraturan Pemerintah (Government

Regulation)

GFMIS Government Financial Management Information

System PPP Public-Private Partnership

GFMRAP Government Financial Management and Revenue

Administration Project

PPPITA

Private Participation in Infrastructure

Technical Assistance

GoI Government of Indonesia PSO Public Service Obligation

GoJ Government of Japan PT. KAI PT Kereta Api Indonesia (Indonesia Railway

Company)

ICR Implementation Completion and Results RPJMN

Rencana Pembangunan Jangka Menengah

Nasional (National Medium Term

Development Plan)

ICT Information and Communication Technology RTRWN Rencana Tata Ruang Wilayah Nasional

(National Area Management Plan)

IDPL Infrastructure Development Policy Loan SBI Sertifikat Bank Indonesia (Bank of Indonesia

Certificate)

IGF Infrastructure Guarantee Fund SBUN Sub Bendahara Umum Negara (General

Operation Treasury)

IIFF Indonesia Infrastructure Financing Facility Sistranas Sistem Transportasi Nasional (National

Transportation System)

ILGR Initiative for Local Government Reform SOE State Owned Enterprise

IMF International Monetary Fund SSO Single Sign-On Mechanism

INKINDO Ikatan Nasional Konsultan Indonesia (National

Association of Consulting Professionals) SUN

Rupiah-denominated tradable Government

securities

INPRES Instruksi Presiden (Presidential Instruction) UKP4

Unit Kerja Presiden Bidang Pengawasan dan

Pengendalian Pembangunan (Presidential

Working Unit for Supervision and

Management of Development)

INSTANSI DPL Institutional, Tax Administration, Social and

Investment Development Policy Loan VGF Viability Gap Financing

INSW Indonesia National Single Window system USDRP Urban Sector Development and Reform

Project

INTR Indonesia National Trade Repository VSL Variable Spread Loan

ITB Institute Technology of Bandung WDR World Development Report

JABODETABEK Greater Jakarta WINRIP Western Indonesia Roads Project

Jamkesmas Jaminan Kesehatan Masyarakat (Health Insurance

Reform Scheme)

JICA Japan International Cooperation Agency

Vice President: Country Director:

Sector Director: Sector Manager :

Task Team Leader:

Axel van Trotsenburg Rodrigo A. Chaves Sudhir Shetty James A. Brumby Sjamsu Rahardja


CONNECTIVITY DEVELOPMENT POLICY LOAN

TABLE OF CONTENTS

LOAN PROGRAM SUMMARY ................................................................................................................... i

I. INTRODUCTION .................................................................................................................................. 1

II. COUNTRY CONTEXT ......................................................................................................................... 3

A. THE CURRENT STATE OF THE INDONESIAN ECONOMY ........................................................................ 3 B. MACROECONOMIC OUTLOOK ................................................................................................................ 8 C. POVERTY, VULNERABILITY AND SHARED PROSPERITY ..................................................................... 12 D. THE POLITICAL AND SOCIAL CONTEXT .............................................................................................. 14

III. THE GOVERNMENT’S REFORM PROGRAM AND BANK SUPPORT...................................... 15

A. INDONESIA’S OVERALL DEVELOPMENT AGENDA .............................................................................. 15 B. KEY REFORM DIRECTIONS SUPPORTED BY THE CONNECTIVITY DPL ............................................. 16

B.1. The Connectivity Challenge ............................................................................................................ 16 B.2. The Agenda for Reform in Connectivity ......................................................................................... 18

C. ANALYTICAL UNDERPINNINGS FOR CONNECTIVITY AGENDA SUPPORT ...................................... 20 D. OTHER RELATED REFORM PRIORITIES AND AREAS OF DEVELOPMENT .......................................... 21

D. 1. Infrastructure: Public-Private Partnerships (PPP) .......................................................................... 21 D.2. Trade Competitiveness .................................................................................................................... 22 D.3. Subnational Development ............................................................................................................... 23 D.4. Procurement .................................................................................................................................... 24 D.5. Governance and Anti-Corruption .................................................................................................... 24

IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM ........................................................... 24

A. LINKS TO THE 2013-2015 COUNTRY PARTNERSHIP STRATEGY (CPS) ............................................. 24 B. RELATIONSHIP TO OTHER BANK OPERATIONS .................................................................................. 25 C. COLLABORATION WITH OTHER DEVELOPMENT PARTNERS AND THE IMF ..................................... 27 D. LESSONS LEARNED FROM OTHER DEVELOPMENT POLICY LOAN (DPL) SERIES ............................ 27

V. THE PROPOSED OPERATION ............................................................................................................ 29

A. OVERVIEW OF THE CONNECTIVITY DPL ........................................................................................... 29 B. KEY REFORM DIRECTIONS AND POLICY AREAS SUPPORTED BY THE CONNECTIVITY DPL .......... 33

B.1. Policy Area I: Strengthening National Coordination and Regulation ............................................. 33 B.2. Policy Area II: Strengthening Intra-island Connectivity ................................................................. 35 B.3. Policy Area III: Improving Inter-island Connectivity ..................................................................... 39 B.4. Policy Area IV: Improving International Connectivity ................................................................... 41

C. FUTURE OPERATION ............................................................................................................................ 43

VI. OPERATIONAL AND IMPLEMENTATION ISSUES ..................................................................... 44

A. MONITORING AND EVALUATION .......................................................................................................... 44 B. CONSULTATIONS ................................................................................................................................... 44 C. ENVIRONMENTAL, POVERTY AND SOCIAL ASPECTS .......................................................................... 45 D. GENDER ................................................................................................................................................. 46 E. FIDUCIARY ASPECTS, DISBURSEMENT AND AUDITING ....................................................................... 47 F. RISKS ..................................................................................................................................................... 48

MAP…………………………………………………………………………………………………………77

List of Annexes

Annex 1: Letter of Development Policy ........................................................................................... 50 Annex 2: Connectivity DPL Two-Year Program Policy Matrix and Results Framework ................ 56

Annex 3: The Government of Indonesia Broader Connectivity Agenda .......................................... 62 Annex 4: Environmental and Social Review of Connectivity DPL-2 .............................................. 68 Annex 5 Indonesia at a Glance .......................................................................................................... 74

List of Tables

Table 1: Selected macroeconomic indicators, 2008-12....................................................................... 8 Table 2: Selected macroeconomic indicators, actual and projection ................................................ 12

Table 2 . Strengthening national connectivity – integration and synergies across GoI plans ........... 19 Table 3: Prior Actions in Connectivity DPL-2 ................................................................................. 30

Table 4: Adjustment of Indicative Triggers Identified in Connectivity DPL-1 ................................ 32 Table 5: Potential Indicative Triggers for a Possible Connectivity DPL-3 Operation ...................... 44

List of Figures

Figure 1: Net exports were the major drag on GDP growth in 2012, followed in recent quarters by

slowing investment .............................................................................................................................. 4 Figure 2: The movement of the current account into deficit has weighed on overall balance of

payment inflows .................................................................................................................................. 4

Figure 3: Indonesian asset prices worsened abruptly in Q2 2013 and remained volatile in Q3… .... 5

Figure 4: …amidst a sharp reversal in portfolio capital inflows, particularly for equities ................. 5

Figure 5 Indonesia’s Logistics Performance Index, which is lower than most of its regional peers.

........................................................................................................................................................... 16

Figure 6: Infrastructure spending in Indonesia (percentage of GDP) ............................................... 18 Figure 7: 2013-2015 CPS alignement of engagement areas ............................................................. 25

The Indonesia Connectivity Development Policy Loan has been prepared by a World Bank team

supervised by James A. Brumby (Sector Manager, EASPI), Ndiame Diop (Lead Economist, EASPI) ,

and led by Sjamsu Rahardja (EASPI). Members of the team are: Dara Lengkong, Henry Sandee,

Ashley Taylor, Alex Sienaert, Yue Man Lee, Yulia Immajati, Nina Herawati, Titis Pusparesmi (all

EASPI), Amilia Aldian, Lis Nainggolan, Andri Wibisono, Elisabeth Goller, Werner Kornexl (all

EASIS), Kalpana Seethepalli (EASSH), Natasha Beschorner (TWICT), Mariangeles Sabella, and Ria

Nuri Dharmawan (all LEGES)

The team worked closely with Edimon Ginting (ADB), Tanaka Shinichi (JICA) and Milan Zavadjil

(IMF) to coordinate policy advice.

The team worked under the overall guidance of James A. Brumby (Sector Manager, EASPI), Sudhir

Shetty (Sector Director, EASPR) and Rodrigo A. Chaves (Country Director, EACIF).

i

LOAN PROGRAM SUMMARY


CONNECTIVITY DEVELOPMENT POLICY LOAN

Borrower Republic of Indonesia

Implementing

Agency National Development Planning Agency (Bappenas) and Coordinating Ministry of Economic Affairs

Financing Data IBRD Variable Spread Loan, US$300 million

Operation Type The second single tranche operation of a multiple year programmatic development policy loan series.

Main Policy

Areas Institutional Strengthening, Domestic Transport and Trade, and International Trade

Key Outcome

Indicators

The proposed Second Connectivity Development Policy Loan (DPL) continues to support the reform efforts

that were initiated through the previous Connectivity DPL. The proposed operation is expected to deepen the

reform efforts towards the following targeted outcomes by 2014:

Strengthened National Coordination and Regulation, as demonstrated through increased Government

effectiveness and rapidity in supporting infrastructure development, and use of the Viability Gap

Financing;

Strengthened intra-island connectivity, as measured by effective application of the legal and regulatory

frameworks for land acquisition, clear PSO compensation for the railway operator and use of performance

based contracts in the national road network;

Improved inter-island connectivity, as measured through increased share of Indonesian population with

broadband access and informed policy-making on sea port development; and

Improved international connectivity through improved customs and border management in facilitating

trade.

Program

Development

Objective(s)

and

Contribution to

CPS

The proposed Connectivity DPL-2 supports the broader goal of the 2013-15 CPS, which is to enhance

Indonesia’s domestic capacity for reducing poverty and boosting equitable and sustainable prosperity. The

CPS highlights the Connectivity DPL program as a key World Bank Group instrument, particularly in the

pro-growth engagement area, by promoting prosperity through enhanced connectivity, strengthened

competitiveness and promotion of infrastructure development.

The overall goal of the proposed Connectivity DPL program is to assist the Government of Indonesia (GoI)

to strengthen the policy framework for improved national trade logistics, transportation, ICT, and trade

facilitation. Policy reforms supported by this operation will focus on the following pillars:

(i) Strengthening National Coordination and Regulation through establishment of regulatory and

institutional frameworks for improved coordination and effectiveness in implementation of the

connectivity agenda;

(ii) Strengthening Intra-island Connectivity through improved connectivity among and between growth

poles, with improved regulatory framework for land acquisition for public purpose development and

optimal use of resources for sustainable improvement and maintenance of island-transport network;

(iii) Improving Inter-island Connectivity through improved access, efficiencies and service performance

in ICT and domestic shipping; and

(iv) Improving International Connectivity (trade facilitation) by strengthening the institutions and

processes in handling traffic and trade volume.

The proposed Second Connectivity DPL (Connectivity DPL-2) continues the reform efforts supported by the

previous Connectivity DPL, which emerged as part of the revamping of the core DPL series that had been

implemented since 2004. With that, three separate DPL series emerged in 2012: Institutional Strengthening

and Social Inclusion (INSTANSI-DPL), Connectivity DPL and Financial Sector and Investment Climate

Reform and Modernization DPL (FIRM -DPL). To date, the GoI has made formal request to continue with

only two of these DPL series, namely the Connectivity DPL-2 and INSTANSI DPL-2.

ii

Risks and Risk

Mitigation

Macoreconomic risks could disrupt the potential to implement the reforms supported through the

Connectivity DPL-2 Recently, Indonesia has seen increasing pressures on its external accounts, with the

current account deficit widening after a negative terms-of-trade shock and international financing

conditions becoming more uncertain. Recent shifts in market sentiment have resulted in sudden, large

and potentially disruptive reversals of capital inflows. The external accounts and growth outlook remain

sensitive to softening global commodity prices and demand, particularly from China. With portfolio

investors focusing on near-term policy responses, there is a risk that this diverts attention from longer-

term reforms. However, the GoI has adopted key policy measures aimed towards improving national

connectivity, as supported by the ongoing DPL series, which are expected to help shield the risk of a

crisis, and mitigate the impact of any economic downturns on households. The Government has

developed a track record in precautionary and proactive measures to try to counter such shocks. This

includes, for example, policy measures supported under the PERISAI DPL, approved in May 2012,

which, along with parallel facilities from other development partners, also explicitly aims to mitigate

GoI financing concerns in the face of a crisis. The Government has also been quick to introduce a

package aimed primarily at longer-term structural measures to support exports and employment,

moderate import growth, while limiting food price pressures. This has been accompanied by a tightening

in monetary policy. There remain questions over the implementation of the policy package and it is

likely that further policy adjustments will be required. However, there is the potential that the current

macro-economic pressures that Indonesia is facing could allow policymakers the opportunity to make

progress on medium-term structural reforms, although this must be offset against the political pressures

in the run-up to the 2014 elections.

Bureaucratic complexity can hinder coordination and implementation of the reform agenda in

Connectivity, which may exacerbate as the election period approaches. First, the multiplicity of

implementing agencies and their varying institutional capacities could create a challenge in coordinating

and implementing the reform efforts. Second, overlapping authorities among national and local

governments in setting policies affecting domestic connectivity, such as infrastructure investment and

transport policy, can slow down or even derail policy reforms. Although the proposed Connectivity DPL

is expected to help address this critical issue, the results of such a reform process will largely depend on

priorities that were developed and consensus involving the various agencies and stakeholders. Third, the

Connectivity DPL will engage agencies that have not been regularly participating in previous DPL

programs. All of these challenges will increase as the election period approaches and uncertainty over

institutional roles in the next administration increases. To mitigate those risks, the proposed actions

under the first pillar of this DPL are expected to strengthen inter-agency coordination and effectiveness

in the policymaking process. Equally important, the Connectivity DPL series has been benefiting from a

high level support from the Vice Minister of Bappenas, who is also the Chair of the Connectivity

Working Group, to ensure that the reform agenda spelled out in this DPL is on track. Past experience

also indicates continued GoI commitment to reforms overall, regardless of election outcomes.

Inconsistencies in implementing regulations could potentially disrupt the Government’s

achievement of its medium-term development objectives. Regulatory certainty is a key driver of

investment, as firms need to rely on a consistent policy environment in order make decisions on whether

to invest or expand their businesses. As such, it is critical that the Government ensure a consistent policy

environment if Indonesia is to meet its medium-term economic development and poverty reduction

goals. In recent years, however, recent policy announcements have raised some concerns about the

direction of trade and investment policymaking. These measures include, for example, restrictions on

imported horticulture products, and new divestment regulations and processing requirements in the

mining sector. While the aims of these policies may originate in the development objectives of

promoting domestic productivity, jobs and growth, their presentation, which has often been changing,

highlights coordination and communication issues. As well as the uncertain effectiveness of these

policies to meet the stated objectives, there is concern that the expansion of such policies could weaken

the confidence of investors in the domestic economic outlook. The risk to the Connectivity DPL is that

the continuation of such policies, along with other perceived "policy missteps", could weaken some of

the confidence of investors in domestic policymaking, potentially offsetting some of the benefits of the

reforms supported in this operation. In August 2013 the Government overturned import volume

restrictions on horticulture and beef as part of efforts to curb inflationary pressure. The Government also

seeks to relax restrictions on exports of raw minerals. Given that the Indonesian economy is adjusting to

iii

recent external and macroeconomic pressures, the DPL program, along with the Bank’s technical

assistance on trade and investment climate, is expected to strengthen policy dialogue with key GoI

counterparts, contributing to stronger GoI coordination and consultation in key reform areas.

While the new regulatory framework on land acquisition for public use represents a substantial

improvement over the previous process, and should make a positive contribution to development

objectives, there are some risks associated with the coordination of executing agencies to fully meet

the spirit of the new legal framework, including interpretation of the new legal framework among

the various government levels. For acquisition of private lands for public infrastructure, the new

regulatory framework deals only with legitimate owners of such private lands and not with people living

without formal title on private lands. Although the regulatory framework mentions cash or relocation as

options for compensating squatters living in state lands, the absence of a clear process for the

government to facilitate relocation will likely to cause the government to rely mostly on cash

compensation. Nevertheless, the new legal framework for land acquisition for public use provides

greater certainty, due process, and compensation for people whose land is acquired by the Government,

pursuant to the referred framework, including recognizing squatters in good faith on state lands. The

implementing regulations that were recently issued also provide more clarity over implementation of the

new legal framework. While these represent positive developments, many challenges remain. Several

civil society organizations voiced concerns over aspects of this framework and brought a legal challenge

to the Constitutional Court, which was ultimately ruled against. That challenge, which itself is a sign of

the maturation of Indonesian institutions, may well result in an even more inclusive and transparent

implementation of the legal framework for land acquisition for public use by the Government. The

National Law Agency (BPN) has been selected as focal point for implementing the process of land

acquisition for public use. The Government of Indonesia is improving BPN’s capacity through

development and training programs to strengthen the implementation of the land acquisition process for

public use at all levels.

Operation ID P144774

1

I. INTRODUCTION

1. The proposed Second Connectivity Development Policy Loan (Connectivity DPL-2) to

Indonesia for US$300 million is aimed at supporting the Government’s reform agenda on

connectivity. Enhancing domestic connectivity within and between the different islands of the archipelago

and further strengthening Indonesia’s global connectivity are crucial to the realization of Indonesia’s

development objectives. The Government’s ambitious Master Plan for the “Acceleration and Expansion of

Indonesia’s Economic Development 2011-2025” (MP3EI) considers connectivity as the lever to: (i) unleash

the growth potential and prosperity across various economic corridors in Indonesia; (ii) connect lagging

regions to urban growth poles to share prosperity more widely; and (iii) reduce poverty by increasing

opportunities, market reach and economies of scale. Improving connectivity is also crucial if Indonesia is to

gain the most from the process of regional economic integration. Indonesia is embracing full implementation

of the ASEAN Economic Community (AEC) by 2015 and is actively exploring a framework to promote

more integration with Asia through the Regional Comprehensive Economic Partnership (RCEP) and with

countries in the Asia Pacific through APEC. Improved connectivity will increase Indonesia’s capacity to

respond to opportunities, boost cost competitiveness of businesses, and strengthen its attractiveness to

investment.

2. The Government’s ambition and efforts are, however, strongly hampered by complex

institutional and regulatory issues. Specifically, difficulties in coordinating the actions of multiple

government agencies and other stakeholders, regulatory weaknesses in many areas (e.g., land acquisition for

public infrastructure projects) and insufficient mechanisms for private sector participation are key

hindrances. Annual budget allocations to infrastructure development are often left largely unspent due to

these challenges. Addressing them upfront is therefore expected to accelerate connectivity. The proposed

DPL thus aims to support the deepening of the policy, regulatory and institutional framework for improved

national trade logistics, transportation, information and communication technology (ICT) and trade

facilitation following the first phase of the operation completed last year.

3. Significant progress has been achieved since the launch of the Connectivity DPL program

last year. The proposed Connectivity DPL-2 continues the series of the single-tranche Connectivity DPL-1

that began in 2012. The program has contributed to strengthening policy dialogue by bringing key

government agencies to support a series of reform packages on connectivity. This Second Connectivity DPL

is envisioned to continue to deepen the reforms that were initiated since the onset of the Connectivity DPL

program last year. To ensure full ownership of the program, a detailed mapping of the programmatic series

has been developed jointly with Bappenas, the Coordinating Ministry for Economic Affairs and relevant line

ministries/agencies.

4. As in the DPL-1, the proposed operation is structured around four pillars:

i) Strengthening National Coordination and Regulation through the establishment of regulatory

and institutional frameworks for improved coordination and implementation of the connectivity

agenda;

ii) Strengthening Intra-island Connectivity through improved connectivity among and between

growth poles, with an improved regulatory framework for land acquisition for public purpose

development and the optimal use of resources for sustainable improvements to, and maintenance of,

the island-transport network;

iii) Improving Inter-island Connectivity through strengthened ICT connectivity between eastern and

western Indonesia and more competition in broadband services; and improving the efficiency of

domestic shipping, which is crucial to lowering logistics costs in an archipelago like Indonesia; and

iv) Improving International Connectivity (trade facilitation) by strengthening the institutions and


2

5. The proposed Connectivity DPL-2 operation is fully consistent with the World Bank’s

strategic goals to end extreme poverty and promote shared prosperity. Indonesia has made significant

progress towards reducing poverty, with the national poverty rate halved from 24 percent in 1999 to 12

percent in 2012 thanks to sustained strong economic growth. However, despite robust growth the rate of

poverty reduction has been slowing in recent years, and the degree of vulnerability among many non-poor

households remains high, thereby highlighting the relevance of the World Bank’s strategic goals to end

extreme poverty and promote shared prosperity. In this respect, as mentioned above, the Connectivity DPL

is expected to be among the key instruments to achieve these goals, by accelerating growth to 7 percent and

above, facilitating a structural transformation, and linking lagging regions with their nearest growth centers.

Reforms supported under this DPL operation are expected to lead to improvements in Indonesia’s public

services and institutional capacity to advance the connectivity agenda, which can translate available

resources into better development outcomes.

6. The proposed Connectivity DPL-2 operation forms an integral part of Indonesia’s broader

program lending. Supporting Indonesia’s relatively ambitious policy reforms is at the core of the World

Bank’s program in Indonesia. In light of the deepening engagements in several priority areas, three sectoral

DPLs emerged in 2012 at the request of GoI (INSTANSI DPL, Connectivity DPL and Financial Sector and

Investment Climate Reform and Modernization/FIRM DPL). The sectoral operation is an integral part of an

approach that aims to maximize synergies across the Bank’s program in Indonesia, increase ownership of

the reforms by the relevant institutions, and improve targeting of complementary technical assistance

programs. The proposed operation also builds on previous policy reform support such as the Infrastructure

DPL (closed in FY11), and the Public Expenditure Support Facility (PESF DDO) and the PERISAI DPL-

DDO, both of which provide critical support to Indonesia during periods of heightened global financial

uncertainty. Furthermore, the proposed operation also continues to complement the World Bank assistance

to Indonesia, which is provided through a variety of instruments (i.e. investment projects, technical

assistance, and advisory services).

7. As elaborated below, the implementation of the proposed operation occurs as Indonesia’s

economy and policy settings are now adjusting to a number of external and macroeconomic pressures.

These include weak export performance contributing to the notable deterioration in the current account

balance; volatile external financing conditions; higher subsidized fuel prices and associated temporary

inflation; and a moderation in domestic demand growth. Monetary, exchange rate and fiscal policy

adjustments so far have been significant, but more may be required, combined with strong communication

and coordination of policies. Ongoing pressures on the external balances, and the prospects of a less

supportive international environment with higher global interest rates and less buoyant commodity demand,

underscore the need for more policy reforms in a number of areas to support faster and more inclusive

growth and poverty reduction, notably the regulatory environment and in manufacturing and trade policy.

Nevertheless, the overall macroeconomic policy framework is proving to be generally responsive to the risk

of macroeconomic imbalances, thereby remains adequate for continued support through a development

policy operation. Policy buffers, although reduced, remain ample, and the structural underpinnings of

resilient growth remain in place, suggesting a favorable medium-term outlook for Indonesia. The reforms

supported by the proposed operation are expected to also support Indonesia’s medium-term outlook, for

instance by enhancing private sector confidence in the regulatory framework for participation in Indonesia’s

ambitious infrastructure projects aimed at strengthening connectivity. More generally, in an environment in

which external pressures are affecting emerging economies such as Indonesia, improvements in

infrastructure and the investment climate can help strengthen the path to recovery such that inflows are put

to productive use and are shifted towards more stable forms such as FDI.

8. The proposed Connectivity DPL-2 was previously envisioned to be the second of a two-year,

programmatic DPL series. Notwithstanding, the Government has recently indicated the possibility of

continuing the engagement through a follow-on Connectivity DPL operation. Ideas on policy reforms in

3

connectivity have emerged and will need to be adjusted and refined as progress is made and discussions with

the GoI counterparts evolve.

II. COUNTRY CONTEXT

A. The Current State of the Indonesian Economy

9. Following a resilient economic performance since the global financial crisis, Indonesia’s

economy and policy settings are now adjusting to a number of domestic and external pressures: weak

export performance contributing to a notable deterioration in the current account balance, volatile external

financing conditions, higher subsidized fuel prices and associated temporary inflation, and a moderation in

domestic demand growth. Monetary, exchange rate and fiscal policy adjustments so far have been quite

significant, but more may be required, combined with strong communication and coordination of policies.

Ongoing pressures on the external balances, and the prospects of a less supportive international environment

with higher global interest rates and less buoyant commodity demand, underscore the need for more policy

reforms in a number of areas to support faster and more inclusive growth and poverty reduction, notably the

regulatory environment and in manufacturing and trade policy.

10. The Indonesian economy has performed strongly over the past decade. Real annual GDP

growth averaged 5.7 percent from 2003 to 2012, lifting real GDP per capita by 54 percent to US$ 3,563 (in

2012 US dollars). This solid performance was underpinned by sustained domestic private demand growth,

fueled by favorable demographics (a growing labor force and falling dependency ratio), accompanied by

rapid urbanization and a growing domestic market. Consumer and investor confidence levels, and the

availability of investment funding, were supported by prudent macroeconomic management which, along

with strong economic growth, resulted in greatly improved private and public sector balance sheets.

International demand for Indonesia’s abundant natural resources, particularly from emerging economies

such as China, also played its part, with around two-thirds of exports commodity-related.

11. The economy proved resilient to the 2008/9 global financial crisis and the subsequent slow

and uneven recovery in high-income economies. Growth slowed from 6.0 percent in 2008 to 4.6 percent

in 2009, but subsequently rebounded and has remained in the 5.8-6.5 percent range in every quarter since

the beginning of 2010. This resilience can be attributed to strong initial conditions going into the crisis, the

related availability and deployment of sizable fiscal and monetary buffers to cushion the shock, and

Indonesia’s lower dependence on external demand relative to many of its regional peers. Consumer inflation

also moderated, from an average of 8.7 percent per year in 2003-08 to 4.9 percent in 2009-12, helped by the

absence of any major food or administered price shocks through mid-2013. This solid performance, which

contributed to Fitch and Moody’s returning Indonesia to investment grade status in late 2011 and early 2012,

attracted strong investor interest, fueled by abundant global liquidity. However, portfolio investment

inflows, although generally strong, were prone to bouts of significant volatility, providing a reminder that

Indonesia remains susceptible to external shocks through the financial channel, given high foreign

ownership shares of both stocks and bonds. Inbound foreign direct investment also trended higher,

contributing to rapid investment growth rates through 2012 (with fixed investment expenditure reaching one

third of nominal GDP).

12. Indonesia’s economy, having been hit by a negative trade shock as global commodity prices

and demand have fallen since 2011, is now showing signs of a slowdown. Over 2012, the major drag on

growth was net exports, with export volumes rising just 2.0 percent but import volumes increasing by a

more robust 6.7 percent, reflecting the strength of domestic demand; net exports consequently reduced

growth in 2012 by 1.5 percentage points. Investment growth also fell over the second half of 2012, and by

the start of 2013 had become the main driver of the overall GDP growth moderation, decelerating from 12.5

percent yoy in Q2 2012 to 4.7 percent yoy in Q2 2013. The main cause of weaker investment growth has

been a sharp slowdown in machinery and equipment spending, reflected in falls in capital goods imports.

4

Fixed investment has shown a strong historical link with commodity sector conditions, and the softening in

international commodity prices since early 2011 has likely now filtered into investment. On the production

side, weakness is concentrated in commodities sectors, such as mining and quarrying (contracting 1.2

percent yoy in Q2 2013), compared with more robust performance in manufacturing (up 5.8 percent),

construction (up 6.9 percent), and especially the services sector (up 7.5 percent).

Figure 1: Net exports were the major drag on GDP growth

in 2012, followed in recent quarters by slowing investment

(contributions to real GDP growth, percentage points)

Figure 2: The movement of the current account into deficit

has weighed on overall balance of payment inflows

(nominal US$ billion)

Source: Bank Indonesia (BI); World Bank staff calculations Source: BI; World Bank staff calculations

13. The negative commodity-related shock to exports has resulted in a sharp weakening in the

trade balance. The annual goods trade balance declined from US$ 34.8 billion in 2011 to US$ 8.6 billion in

2012, reflecting weaker merchandise export values (down 6.0 percent in 2012) coupled with ongoing growth

in merchandise imports (which rose by 8.0 percent in 2012). Pressure on the trade balance has persisted so

far in 2013, with export revenues down 6.1 percent yoy in H1 2013, and import values down a more modest

2.2 percent yoy, resulting in a cumulative trade deficit of US$ 3.3 billion (compared with a US$ 512 million

surplus in H1 2012). Initially, most of the swing in the trade balance could be attributed to the erosion of the

non-oil and gas trade surplus, but since mid-2012 the oil and gas trade deficit has also widened substantially,

having previously tended to be close to neutral.

14. This has contributed to a marked deterioration in Indonesia’s current account balance since

2011. In 2012 Indonesia recorded its first annual current account deficit since 1997, of US$ 24.2 billion or

2.8 percent of GDP, compared with a small surplus of 0.2 percent of GDP in 2011. Pressure on the current

account has persisted in 2013, with quarterly deficits of US$ 5.8 billion (2.6 percent of GDP) and US$ 9.8

billion (4.4 percent of GDP) recorded in Q1 and Q2. While the bulk of this swing has been due to the

erosion of Indonesia’s historically strong goods trade surpluses, sizable structural deficits on the services

trade and, especially, income sub-accounts, which have been broadly flat over recent quarters, also continue

to weigh on the overall current account balance.

15. The re-emergence of current account deficits has placed an increased focus on the

availability and quality of external financing, with Indonesia having tended to run a basic balance of

payments deficit on a quarterly basis since late 2011, despite robust FDI inflows (of US$ 20 billion in 2012

and US$ 8.3 billion in H1 2013). Portfolio investment remains volatile and reported private external debt

has also risen significantly, almost doubling since 2008 to be US$ 131 billion in May 2013, and while

external debt solvency metrics remain sound (with total external debt to GDP standing at 28.7 percent of

GDP at the end of 2012 according to official estimates), gross external funding needs have consequently

-4

-2

0

2

4

6

8

10

12

14

Jun-10 Mar-11 Dec-11 Sep-12 Jun-13

Private cons. Gov cons.

Investment Net Exports

Discrepancy GDP

-16

-12

-8

-4

0

4

8

12

16

Jun-10 Jun-11 Jun-12 Jun-13

Overall balance

Basic balance

Net direct investment

Net other capital

Current account

Net portfolio

5

increased significantly. External debt disbursements and principal repayments totaled US$ 184.4 billion and

US$ 164.3 billion, respectively, in 2012.

16. Indonesian asset markets have been significantly affected by the recent pullback in emerging

asset markets globally, following the pricing-in of QE “tapering” in the US since early May.

Particularly sharp falls in Indonesian asset prices were seen from mid-August (with an 8.6 percent decline in

the equity market over 19-20 August). The rupiah has been under pressure, depreciating by 12.2 percent

over August and September, to IDR 11,532 per US dollar (down 19.2 percent since the start of the year).

Rupiah-denominated government bond yields have been volatile and, though off their recent peaks at the

end of August, remain up 220 to 300 basis points since the start of 2013). The context for these market

moves has been one involving the release of weak domestic data, particularly on the second quarter balance

of payments, and ongoing domestic and international policy adjustments.

Figure 3: Indonesian asset prices worsened abruptly in Q2

2013 and remained volatile in Q3…

(Equity index, 4 Jan 2011=100, Rupiah and 5-year bond

yield)

Figure 4: …amidst a sharp reversal in portfolio capital

inflows, particularly for equities

(cumulative foreign investor net equity purchases and change in

holdings of IDR-denominated government bonds, SUNs, since

Jan-2012, IDR trillion)

Source: Bank Indonesia (BI); World Bank staff calculations Source: BI; World Bank staff calculations

17. The macro policy adjustments to these recent pressures are ongoing, but have been seen in

both fiscal and monetary policies. On fiscal policy, the revised Budget for 2013 increased the targeted

deficit by 0.7 percentage points to 2.4 percent of GDP, on the back of weaker revenue growth (in line with

moderating nominal GDP growth and weak export revenues). Most notably, the Government increased

subsidized fuel prices in June for the first time since 2005, increasing the subsidized petrol price by 44

percent to IDR 6,500 per liter and the subsidized diesel price by 22 percent to IDR 5,500 per liter (still well

below the market price at the time of over IDR 9,000 per liter). This price rise, which followed the missed

opportunity to follow through on proposed reform in 2012, marked a major step forward in increasing the

quality of public spending and safeguarding fiscal sustainability. The impact on the poor was cushioned by a

significant temporary compensation package for 2013, amounting to just under IDR 30 trillion.

18. The increase in subsidized fuel prices, while welcome, has contributed to a rise in inflation.

Headline inflation rose sharply to 8.6 percent yoy in July and then 8.8 percent in August, up from 5.9

percent yoy in June and well above the ceiling of Bank Indonesia’s 3.5-5.5 percent target band. These

moves also reflected the seasonal impact of Ramadan. Prices fell and yoy inflation came down to 8.4 percent

in September. The one-off impact of the subsidized fuel price increase is expected to abate fairly rapidly in

the coming months (in month-on-month terms, before dropping out of the base by Q3 2014) although

4

5

6

7

8

9

10

11

12

76

82

88

94

100

106

112

118

124

130

Sep-11 Mar-12 Sep-12 Mar-13 Sep-13

5-yr IDR government bond yield

(RHS)

JCI equity (LHS)

IDR 000 per USD (RHS)

-10

0

10

20

30

40

50

60

70

80

Jan-12 Jun-12 Dec-12 Jun-13 Dec-13

Equities SUNs

6

pressures may remain from second-round effects or from the exchange rate pass through. Core inflation,

although moderate, has picked up somewhat, moving to 4.7 percent yoy in September, from 4 percent in

June.

19. In response to the deterioration in financial markets, and significant pressure on the rupiah,

the Government announced a policy package in mid-August. The package has four pillars: (1) Improving

the current account balance. This involves measures to encourage exports, such as fiscal incentives for

export-oriented firms in labor-intensive sectors and relaxing the quota on mineral exports, and measures to

reduce import growth, such as increasing the required use of bio-diesel in the domestic energy consumption

mix. (2) Maintaining economic growth and employment, including fiscal incentives to support labor-

intensive sectors, aiming to limit lay-offs. Notably, revisions are also proposed to the setting of the

minimum wage in support of a more rational process and fairer outcome. (3) Lowering inflation, including

replacing quotas with tariffs for imports of beef and horticulture products. (4) Enhancing investment to

support both growth and capital inflows, including measures to simplify licensing, to expedite the approval

of the Revised Negative Investment List, and to move forward with “debottlenecking” key strategic

investment projects. While focused on many of the important structural issues faced by the economy, the

implementation, both in terms of timing and substance, will clearly be key in determining the impact of the

package.

20. Ahead of the recent period of adjustment, monetary policy was highly accommodative. Key

policy rates remained unchanged from February 2012, when Bank Indonesia cut the lower bound of its

interest rate corridor to a record low of 4 percent, and June 2013. In mid-2012, however, BI announced new

loan-to-value limits for vehicle and real estate lending, and this appears to have contributed to a decline in

credit growth from a peak of 26 percent in May, to a still robust 22 percent in August 2013. These macro

prudential adjustments also reflected the pronounced price pressures in some pockets of the property market

(e.g. residential apartments, commercial office, and industrial space, in Jakarta up 45 percent, 43 percent and

22 percent, respectively, yoy in December 2012). The macroeconomic stability risks posed by such sharp

property price increases are mitigated by the fact that overall property-related exposures in the banking

system remain comparatively small at 14 percent of total bank assets, and by BI’s prudential measures.

21. Since June 2013 the monetary policy stance has shifted markedly towards tightening, in line

with the focus on facilitating the adjustment in external balances and limiting inflationary pressures. Pre-

empting the increase in subsidized fuel prices, and with pressure on the rupiah intensifying since May, BI

surprised markets on June 11 by increasing its overnight deposit facility (FASBI) rate by 25 basis points,

followed by a 25 basis point increase in its reference rate at its subsequent June policy meeting. This was

followed by a 50 basis point increase in these key policy rates in July. However, policy rates were left

unchanged in August and this raised some concerns in the markets, even though new macro prudential

measures were also announced. Following the release of weak second quarter balance of payments statistics

and intensifying downward pressure on the rupiah, the FASBI and reference rates were lifted by a further 50

basis points at an extraordinary policy meeting held on August 29 (in addition, the upper bound of the

interest rate corridor, the BI lending facility rate, was also increased by 25 basis points). This was followed

by a further 25 basis point increase in the FASBI, reference and lending facility rates at the scheduled

meeting on September 12. Thus, since June 2013, BI has raised its overnight deposit facility (FASBI), and

reference, rates by 150 basis points (to 5.5 and 7.25 percent, respectively), and its key lending rate by 50

basis points (to 7.25 percent). A number of macro prudential measures with a tightening bias, and steps to

facilitate liquidity management, have also been taken: loan-to-deposit limits have been lowered from 100 to

90 percent, both government bonds and BI certificates of deposit have been allowed to be counted against

banks’ secondary reserve requirements, and shorter tenor BI deposit securities have been introduced.

22. Exchange rate policy has remained flexible in as much as the rupiah has been allowed to

depreciate through mid-2013, but improving currency market liquidity and transparency remains a

challenge. Foreign currency reserve growth stalled in 2012 (compared with growth of US$ 14 billion in

7

2011), and the rupiah has weakened materially, with the nominal effective exchange rate trending lower

since late 2010, to lose 11.8 percent between its late 2010 peak and July 2013. August has seen further,

pronounced currency weakness, as also seen in many other major emerging markets (such as Brazil, India

and Turkey), taking the rupiah’s depreciation over 2013 through the end of August to 15 percent, and 19.2

through the end of September. While the depreciation has mostly been gradual and orderly, there have been

some periods (in mid-2011, early 2012, early 2013 and July and August 2013) of very tight foreign currency

liquidity, leading to a wide spread between official and market-quoted rupiah spot rates. Foreign currency

demand in the commercial currency markets was cut early in 2012 by BI’s decision to meet the US dollar

needs of the state-owned oil company (Pertamina) directly, a move which coincided with a stabilization of

the US$/IDR exchange rate, but was also followed by a substantial drawdown in currency reserves, which

fell from US$ 112.8 billion in December 2012 to just below US$ 105 billion in March 2013. Following the

bout of global emerging market volatility and outflows beginning in May and continuing into the third

quarter, reserves have subsequently fallen further, to US$ 93 billion in August 2013.

23. Recent measures by BI may help somewhat to improve currency market conditions. These

include: initiating US Dollar swap auctions to deepen hedging opportunities and, potentially, dampen spot

US Dollar demand at times of market uncertainty, reversing the 2011 regulation that imposed a minimum 6-

month holding period for foreign investors purchasing BI bills (SBIs) by cutting the required holding period

to 1 month, and increasing official foreign exchange buffers, by extending a US$ 12 billion-equivalent swap

facility with the Bank of Japan (in late August) and US$ 16 billion-equivalent swap facility with the

People’s Bank of China (in October), and announcing a new US$ 16 billion-equivalent swap facility with

the Bank of Korea (also in October).

24. Despite the recent pressures in the financial markets, slowdown of growth and depreciation

of the rupiah, Indonesian banks have shown resilience to the impact of recent developments. Bank

credit growth is slowing with the rise in new loan approvals weakening. Overall aggregate level banking

health indicators remain sound, with low non-performing loans of 2 percent, and high capital adequacy of 18

percent have proven to serve as buffers. Another factor limiting the impact has been banks’ relatively low

foreign-currency exposures. However, despite this sound financial performance to date, the banking sector

could still face pressure from further decelerating growth or additional market turmoil in upcoming months.

Such pressures may well impact on smaller banks more markedly, with reports of some tightening in their

liquidity in recent months, leading them to raise deposit rates. Substantial efforts have been made to improve

crisis communication and protocols among the various institutions (BI, MoF, the new unified financial

supervisory authority, OJK, and the deposit insurance agency). However, the transition to the new unified

financial supervisory agency, OJK, and the absence of a financial sector safety net law do raise potential

risks on the policy response should any systemic bank enter liquidity difficulties. Financing conditions for

non-bank corporates have also tightened. Again, while leverage levels remain low, the concern is more of

the potential for increased borrowing and repayment costs, particularly for those corporates with external

debt without a natural currency hedge, or who have been impacted by declines in global commodity prices.

8

Table 1: Selected macroeconomic indicators, 2008-12

(in percent of GDP unless indicated otherwise)

2008 2009 2010 2011 2012

GDP

Real GDP growth rate (percent) 6.0 4.6 6.2 6.5 6.2

GDP (in billions of US dollars) 510 540 709 846 878

Contributions to growth (percent)

Consumption 3.7 3.9 2.6 2.8 2.9

o/w Private 2.9 2.7 2.6 2.5 2.8

Gross fixed capital formation 2.5 0.7 1.9 2.0 2.3

Net exports 0.7 1.1 0.8 1.5 -1.5

Exports 4.3 -4.6 6.1 6.0 0.9

Imports 3.6 -5.7 5.3 4.5 2.4

Change in inventories -1.2 -1.3 0.6 -0.1 2.2

Composition of nominal GDP:

Consumption 69.0 68.3 65.6 63.6 63.4

Investment 27.7 31.1 32.0 32.0 33.2

Money and credit

Credit growth (percent) 33.0 16.1 17.5 24.4 24.2

M2 growth (percent) 14.8 12.0 11.3 19.2 14.4

Prices

Consumer price inflation (eop, percent) 11.1 2.8 7.0 3.8 4.3

Fiscal sector

Central government revenues 19.8 15.1 15.5 16.3 16.2

Central government expenditures 19.9 16.7 16.2 17.4 18.0

Central government balance -0.1 -1.6 -0.7 -1.1 -1.8

Primary balance 1.7 0.1 0.6 0.1 -0.6

Gross government debt 33.0 28.4 26.0 24.3 24.0

External sector

Current account balance (in billions of US dollars) 0.1 10.6 5.1 1.7 -24.4

in percent of GDP 0.0 1.9 0.7 0.2 -2.8

Goods and services balance (in billions of US dollars) 9.9 21.2 21.3 24.2 -1.7

Export growth (fob, percent) 18.3 -14.3 32.1 27.0 -6.1

Import growth (fob, percent) 36.9 -24.0 43.7 30.3 8.4

Net direct investment (in billions of US dollars) 3.4 2.6 11.1 11.5 14.0

Net portfolio investment (in billions of US dollars) 2.5 10.3 13.2 3.8 9.2

Net other investment (in billions of US dollars) -7.3 -8.2 -2.3 -1.8 1.9

Gross external debt 34.3 29.0 28.2 27.5 29.6

Central Bank reserves (in billions of US dollars) 52 66 96 110 113

Reserves (months of imports & official debt

repayments)

4.0 6.6 7.2 6.4 6.1

Source: Central Bureau of Statistics (BPS); Central Bank of Indonesia (BI)

B. Macroeconomic Outlook

25. Growth prospects have dimmed appreciably and risks to the outlook have risen. In the base

case, GDP growth is expected to shift down fairly moderately, responding to weaker terms of trade, higher

interest rates and the negative impact of higher inflation on consumption. This expected, moderate

deceleration would be broadly positive for safeguarding macroeconomic stability, and particularly for

reducing the current account deficit to more sustainable levels in the context of subdued export performance

and tighter international liquidity conditions. However, a more severe growth deceleration cannot be ruled

out, with specific risks including a more disorderly currency adjustment and financial market volatility

having a more pronounced impact on real economic activity.

9

26. GDP growth in 2013 is projected to be 5.6 percent, down from 6.2 percent in 2012, and

moving down to 5.3 percent in 2014. Private consumption is expected to remain the main driver of growth,

potentially boosted by early pre-election spending towards the end of 2013 and into 2014. Investment is

expected to expand at a much more moderate pace than in 2012. Unlike 2012, net exports are not expected

to be a significant drag on growth over 2013, as import volume growth decelerates in line with slower

investment growth, and export volume growth remains positive, albeit sluggish. The 2013 growth projection

of 5.6 percent is higher than the IMF assessment letter projection of 5.4 percent, reflecting a difference in

the profiling of the feed-through of recent policy tightening, moderation in credit growth and financial

market developments to growth (with the IMF figure expecting a sharper slowdown in the second half of

2013). Based on recent higher frequency data, the World Bank expects such impacts to flow through with a

slightly longer lag. Looking forward to 2015, growth is expected to rise to 5.8 percent, although there is a

substantial range of uncertainty around this baseline and risk of moving to a lower growth trajectory. Such

risk could materialize in the absence of progress in addressing well-known impediments to medium-term

growth in Indonesia and sufficiently supportive external conditions (in terms of trade and FDI inflows in

particular).

27. The current account deficit is expected to widen in 2013, to US$ 29 billion, or 3.4 percent of

GDP, before narrowing in 2014 to 2.6 percent of GDP. The overall balance of payments is expected to

record a sizable deficit in 2013, reflecting a shortfall in net investment inflows relative to the current account

funding need, and resulting in a drawdown of about US$ 20 billion in foreign currency reserves. The overall

balance of payments deficit is expected to shrink significantly in 2014, reflecting a smaller current account

deficit and sustained overall net investment inflows.

28. Inflation pressures are expected to abate after the mid-2013 price surge triggered by the

June subsidized fuel price increase and the seasonal impact of Ramadan. Headline inflation in Q4 2013

is projected at 9.8 percent compared with 4.4 percent in Q4 2012, and inflation to average 7.3 percent in

2013 and 6.7 percent in 2014. This base case assumes that second-round inflation will remain contained,

allowing the price impact of the June fuel price increase to drop out of the base by mid-2014. However,

while core inflation has so far remained little-changed, there is a clear risk of some second-round effects

from the recent spike in headline inflation, particularly given other cost-push inflation pressures.

Exceptionally high minimum wage increases for 2013 were granted (including 44 percent for Greater

Jakarta), and while the direct impact of this on the CPI basket is very small, such increases may feed into

higher wages across the economy and hence spill over into consumer prices, particularly if reinforced by

sizable additional minimum wage increases for 2014. More pass-through from the significant nominal

depreciation of the rupiah can also not be ruled out. A further uncertainty for inflation is the possibility of

additional reforms to administered prices, notably fuel subsidies. While welcome on equity, efficiency and

fiscal grounds, the possibility of additional measures adds upside, albeit largely temporary, inflation risk.

Bank Indonesia will need to gauge the risk of these supply-side factors feeding through into higher

generalized inflation, which may necessitate further tightening monetary policy.

29. Risks to the growth outlook are to the downside, given uncertainties over consumer and

investor confidence, and downside risks to domestic demand growth. While domestic demand has

remained resilient so far, the headwinds have mounted since June: higher fuel prices and higher generalized

consumer price inflation in recent months (eroding purchasing power and consumer confidence), higher

interest rates (dampening hitherto rapid credit growth), and potential negative wealth and corporate

investment activity impacts from the stock price declines seen since May. These increased challenges are

occurring against the backdrop of a continued weakening in international commodity prices, with the US

dollar price basket of Indonesia’s top six commodity export products declining by 8 percent in 2013 through

August (down 35 percent from the post global financial peak reached in February 2011). Commodity prices

are a key driver of domestic demand conditions, due to their importance for export revenues, company

profits, and for household incomes in parts of the country where the resources sector is important for labor

10

income, such as oil palm growing regions. Looking further ahead into 2014, investment is likely to face

some headwinds from the ongoing failure to address regulatory issues, some policy missteps, and general

uncertainties surrounding the electoral process and outcome as the 2014 elections draw nearer. Indonesia

also continues to face competition from its peers in the region for export-oriented investment, at a time when

labor costs, at least for minimum wage workers, have risen sharply.

30. Indonesia’s fiscal and monetary policy settings will need to continue to adjust to a shifting

macroeconomic outlook. Monetary policy faces the challenge of recalibrating interest and exchanges rates

so as to improve the external balances, and guarding against a build-up of inflationary pressures due to

supply-side price increases (from higher subsidized fuel prices and the weaker currency), without unduly

crimping economic growth and weakening public and private sector balance sheets. The interest rate and

exchange rate increases seen so far over 2013 argue that the monetary policy stance has indeed been shifting

in the right direction, although more will likely be needed. On the fiscal side, policy planning will need to

account for the persistence of slower revenue growth and higher nominal debt-financing costs, placing

further focus on the need to lift the quality of spending, in terms of its technical and allocative efficiency,

and so as to meet the Government’s development objectives. The 2014 Budget, scheduled to be approved by

late October 2013, will provide an important gauge of how fiscal policy is adjusting, with the adoption of

realistic macroeconomic assumptions, continuation of the hitherto prudent overall fiscal stance, and

continued emphasis on redirecting spending away from energy subsidies and towards capital expenditures,

being desirable (including a move towards further subsidy reform, although this may prove difficult to

achieve given the 2014 elections).

31. Management of the external balance will be a particularly key challenge and the projection

of stable macroeconomic performance is predicated on the avoidance of significant policy missteps in

this area, as well as more clarity and implementation progress on the Government’s response package

(outlined above). With many of the policies likely to realize an impact only in the medium term, many

investors and commentators felt they did not go far enough to bring about a near-term adjustment in the

external balances through dampening domestic demand. These fears appear to have been allayed, at least in

the short term, by the subsequent rate increase by BI. However, more information on the substantive content

of the proposals is still needed, and the degree to which they are seen as being mutually consistent across

government, and the manner in which they are implemented, will matter. Investor risk perceptions will

likely hinge, in particular, on the extent to which policymakers are seen to be tolerant of somewhat lower

domestic demand growth in order to ease balance of payments pressures, making policy coordination and

communication paramount, particularly against the backdrop of an intensifying political cycle. Should they

be implemented, a number of specific measures mooted in the policy package to encourage investment, such

as a less restrictive negative investment list (DNI, governing the restrictions on foreign investment by

sector), have the potential to send a positive signal to the market by helping create positive expectations in

terms of future FDI flows, and thus bring more stability to the currency market.

32. In the event of further negative external shocks, Indonesia will feel the effects through the

trade, financial and domestic confidence channels, but is in a relatively strong position to respond.

Monitoring and coordination mechanisms are in place to facilitate a flexible response to major market

dislocations, with the Forum for the Coordination of Financial Sector Stability having met to discuss

developments since financial market conditions began to deteriorate in May 2013, and the BOP monitoring

task force of the Ministry of Finance and Bank Indonesia having been reactivated to monitor bank liquidity,

FX liquidity and short-term debt exposures.

33. On both the fiscal and external sectors, the focus is more on ensuring adequate near-term

financing than concerns over medium-term debt sustainability. Private external debt has trended

upwards, but was under 30 percent of GDP at the end of 2012, supporting external debt solvency metrics.

However, as mentioned, Indonesia’s gross external financing needs are substantial, and those arising from

the servicing and repayment of external debt are considerably larger than those generated by the current

11

account deficit. Gross external debt repayments in Q2 2013 totaled US$ 43.1 billion versus a quarterly

current account deficit of US$ 9.8 billion. Tighter external financing conditions and Rupiah depreciation

make for a more costly and challenging environment for refinancing existing external debt, over half of

which (or 15 percent of GDP) now consists of private external debt. This is particularly the case for

corporates without access to natural currency hedges (through US Dollar revenues) and those heavily

exposed to the recent weakening in global commodity prices. Official gross reserves of US$ 95.7 billion at

end-September, while well down from their recent high of US$ 124.6 billion in August 2011, remain more

than sufficient to cover Indonesia’s short-term external financing needs, despite the ratio of short-term

external debt to official reserves having risen from 40 percent to around 50 percent at end-2011. However,

more importantly, external liquidity risks have risen, with the debt service ratio rising to 80 percent in June

2013, from around 30 percent in mid-2011. Bank Indonesia projects that repayments of external debt

excluding trade finance, revolving loans and currency and deposits will total US$ 32.6 billion over August

to December 2013, of which US$ 28.8 billion is private debt, with a further US$ 33.4 billion in gross

repayments expected in January-July 2014. As mentioned above, in support of contingency arrangements,

Bank Indonesia has recently extended bilateral currency swap arrangements with China, Korea and Japan.

34. Gross fiscal financing needs do remain substantial but the overall fiscal balance sheet

remains strong. Central government debt was just under 24 percent of GDP at the end of 2012, with its

downward trajectory in recent years supported by strong nominal GDP growth, exchange rate appreciation

and relatively low deficits. Debt sustainability analysis points to the debt-to-GDP ratio picking up somewhat

(by 2-3 percentage points) over the next couple of years due to declining nominal GDP growth, the weaker

exchange rate and projected higher fiscal deficit (albeit still less than 3 percent of GDP). The baseline

projection is for debt-to-GDP to remain in the range of 25-30 percent of GDP over the medium-term, absent

significant shocks. Turning to fiscal financing risks, in the event of major disruption to local or international

bond markets, crisis management protocols and continent financing facilities with development partners

have been set up to support financing of critical public expenditures. The World Bank PERISAI DPL-DDO

operation, in addition to supporting short-term policy measures aimed at enhancing crisis preparedness,

provides contingent budget support through end June 2014, which the Government intends to draw down

only in the event of a significant worsening of the financing conditions. The Government has also secured

additional contingent financing of around US$ 3 billion from the Government of Japan (JPY 120 billion),

Australian Treasury (AUD 1 billion) and the Asian Development Bank (US$ 500 million). The Government

continues to view the contingent budget support as last resort financing to be used only if the required

financing cannot be raised due to a fiscal financing crisis. For 2013, as of 8 October, the Government had

reached 82 percent of its revised annual securities issuance target of IDR 331 trillion. Efforts are also being

made to support the financing position through, for example, additional funding via program loan operations

such as the World Bank DPLs.

35. Overall, Indonesia’s macroeconomic framework is adequate for the proposed operation.

Economic growth is moderating, and in the base case this is projected to stabilize at a pace which is still

solid but more commensurate with a sustainable current account deficit. The key risk is that external funding

needs continue to place a strain on the rupiah or reserves, for example due to a further weakening in key

export commodity prices or weak net inward investment dynamics, requiring additional monetary policy

tightening, denting confidence and further crimping growth. The risks of such a scenario resulting in a loss

of macroeconomic stability are mitigated by the fact that the policy framework is proving generally

responsive to the risk of macroeconomic imbalances. Policy buffers, although reduced, remain ample, and

the structural underpinnings of resilient growth remain in place, suggesting a favorable medium-term

outlook for Indonesia, predicated, as discussed above, on the implementation of supporting reforms, for

example on the investment climate, on enhancing skills and improving infrastructure provision.

12

Table 2: Selected macroeconomic indicators, actual and projection

Actual Projection

2009 2010 2011 2012 2013 (p) 2014 (p) 2015 (p)

National accounts

Real GDP (% change) 4.6 6.1 6.5 6.2 5.6 5.3 5.8

Real investment (% change) 3.3 8.5 8.8 9.8 5.3 4.9 6.1

Real private consumption (% change) 4.9 4.7 4.7 5.3 4.8 5.1 4.6

Real exports (% change) -9.7 15.3 13.6 2.0 5.6 5.7 7.4

Real imports (% change) -15.0 17.3 13.3 6.6 2.4 4.8 7.0

Agriculture (% change) 4.0 3.0 3.4 4.0 3.4 2.4 2.7

Industry (% change) 3.6 4.9 5.3 5.2 4.3 4.1 4.7

o/w manufacturing (% change) 2.2 4.7 6.1 5.7 2.9 2.8 3.7

Balance of Payments

Current account balance (% of GDP) 1.9 0.7 0.2 -2.8 -3.4 -2.6 -1.9

Fiscal variables

Central government balance (% of GDP) -1.6 -0.7 -1.1 -1.9 -2.5 -2.3 -2.1

Revenue (% of GDP) 15.1 15.5 16.3 16.2 16.0 16.0 16.0

o/w Tax (% of GDP) 11.0 11.3 11.8 11.9 12.1 12.4 11.8

Expenditure (% of GDP) 16.7 16.2 17.4 18.1 18.6 18.3 18.1

o/w subsidy (% of GDP) 2.5 3.0 4.0 4.2 4.3 4.1 3.5

Central government debt (% of GDP) 28.4 26.0 24.3 24.0 23.5 24.1 24.0

Prices

GDP deflator (% change) 8.3 8.3 8.1 4.5 2.6 4.2 5.5

CPI inflation (%) 4.8 5.1 5.4 4.3 7.3 6.8 4.5

Exchange rate (IDR/US$) 10,390 9,090 8,770 9,415 .. .. ..

C. Poverty, Vulnerability and Shared Prosperity

36. Sustained growth has allowed poverty reduction to continue, with the national poverty rate

falling to 11.4 percent in 2013, but the rate of reduction in recent years has slowed. Since recovering

from the Asian Financial Crisis (AFC), Indonesia’s national poverty rate has halved from 24 percent in 1999

to 12 percent in 2012.1 Despite sustained strong economic growth, however, the rate of poverty reduction is

slowing. The 0.5 percentage point fall in poverty between 2011 and 2012 was the smallest decline in the

past six years. One of the reasons for a slowing rate of poverty reduction in recent years is that the poverty

basket inflation has been considerably higher than both headline and core inflation. In 2013, the fall in

poverty picked up slightly as the rate dropped to 11.4 percent, 0.6 of a percentage point from 2012 levels.

Even so, about 28 million Indonesians—out of the current population of 246 million—still live below the

poverty line (for 2013, the poverty line was set at IDR 271,600 per person per month). Approximately half

of these households can be considered as being chronically poor, or consistently measured as poor in three

consecutive years.

37. Extreme poverty has also been falling, but at a slower pace. Indonesia identifies those

households living below 0.8 times the official poverty line as being extremely poor. Since the AFC, the

national extreme poverty rate has fallen from 9.39 percent in 1999 to 3.79 percent in 2012. This reduction

1 Indonesia’s national poverty line is the weighted average of the provincial urban/rural poverty lines.

13

has occurred at a slower pace than the drop in the official poverty rate. Based on international comparisons,

however, the rate of extreme poverty is higher. In 2010, 18 percent of households in Indonesia fell below the

international benchmark for extreme poverty set at PPP$1.25 per day.2 Despite methodological problems

with calculating an international comparable rate of extreme poverty, this indicates that Indonesia continues

to face challenges in eradicating extreme poverty.3

38. The falling poverty rate masks a high degree of vulnerability among many non-poor

households in Indonesia. Despite a relatively low official poverty rate, much of the population is clustered

near the poverty line. In 1999, 39 percent of households lived below the official near-poor line of 1.2 times

the poverty line. This fell to 23 percent by 2012. Despite this drop, about 55 million people lived below the

official near-poor line as of March 2012, at which point the line was set at IDR 298,400 per person per

month. More alarmingly, 94 million Indonesians lived below 1.5 times the poverty line (IDR 373,000 per

person per month). This bottom 40 percent of the population is highly vulnerable to small shocks, such as

food price increases, that can send these households into poverty. Consequently, Indonesia experiences a

high rate of churning in and out of poverty. Half of the poor in 2010 were not poor in 2009, with over 80

percent of them coming from the poorest 40 percent the year before. As such, many households have

experienced poverty: during the past three years a quarter of all Indonesians have been in poverty at least

once.4

39. Female-headed households, in particular, experience much more volatile poverty rates than

the male-headed households. Currently, the labor participation rate of women is substantially lower than

that of men (Female: 51.2%; Male: 76.3%, based on WB data), and there is a large gender wage gap with

women earning only about 70 percent of what men earn. While poverty rates for female-headed households

(FHH) and male-headed ones (MHH) experienced a similar reduction over the 2000s, the FHH poverty rate

was much more volatile than the MHH rate over the first half of the decade. This suggests that FHH interact

with labor markets differently to MHH, face different risks to income and consumption, or have differential

access to coping mechanisms and are less able to smooth consumption when shocks occur. The Maternal

Mortality Rate (MMR) is still high, and there is a risk that this key MDG target may not be reached (MMR

2015 target of 102 per 100,000 live births, vs. 220 in 2010, according to WB data). Data also suggests that

FHH tend to adopt the negative coping strategies through child labor. Despite tangible progress (e.g., gender

parity in enrollment rates at all levels of education), persistent gender disparities remain.

40. Inequality of household consumption has been increasing since 2000. The Gini coefficient fell

from 0.33 in 1997 to 0.30 in 2000 with the AFC having a more deleterious effect on the non-poor.5 The

Gini, however, has steadily increased since 2000, reaching 0.41 by 2012.6 This level is high by OECD

standards, and while around the lower middle income average, is high for the East Asian region and amongst

the fastest rising. This recent increase in equality is being driven by stronger consumption growth at the top

end of the distribution. After the equalizing effects of the AFC and recovery, the 90th percentile of household

per capital consumption had fallen from 3.7 times the 10th percentile in 1996 to 3.1 in 2003, and 2.1 times

the 50th percentile to 1.9. However, since then, the trends have reversed, with the 90

th-10

th ratio increasing

to 4.7 by 2012, and the 90th-50

th to 2.5. The relatively stable ratios for the 50

th-25

th and 50

th-10

th indicate that

2 World Bank, as calculated by PovcalNet. 3 The calculation of extreme poverty in Indonesia for 2010, based on the PPP$1.25 measure is likely an overestimation due to

methodological challenges related to the survey data used to calculate the CPI. The data was predominantly based on Jakarta prices,

and some of the survey data was collected during a period of high inflation following an increase in the price of subsidized fuel in

the fourth quarter of 2009. 4 Further analysis and discussion on the nature of poverty and vulnerability in Indonesia, and the effectiveness of social assistance

programs in addressing them, can be found in recent World Bank's major reports (2012), Targeting the Poor and Vulnerable in

Indonesia, and Protecting the Poor and Vulnerable in Indonesia. 5 The Gini coefficient is a number between 0 and 100, with 0 representing perfect equality, and 100 representing a single person

holding all consumption/income/wealth. 6 Official consumption Gini (nominal) from Statistics Indonesia (BPS).

14

it is the increasing consumption at the top end of the distribution relative to the rest, which is driving most of

the increase in the Gini coefficient, rather than the middle also pulling away from the bottom.

41. The relatively low consumption growth of Indonesia’s poorest 40 percent, and resulting

inequality, may begin to adversely affect social and political cohesion. Despite strong economic growth,

and official poverty approaching 10 percent, there is still a strong public perception that many more

Indonesians are not well-off, and that growth has not been shared by all (a perception supported by the data).

Moreover, around half of poor and vulnerable households do not receive major social assistance programs,

while half of benefits go to the non-poor. There is some evidence that these inequities in access to social

assistance have increased crime and decreased social capital.7

D. The Political and Social Context

42. Over the course of 15 years of political and institutional reforms, Indonesia has made

remarkable progress towards the goal of becoming a vibrant multi-party and decentralized

democracy. However, at this particular juncture the country is moving towards an election year in 2014.

Next year will see the election of a new president by direct vote for only the third time in Indonesia’s reform

era, and this forthcoming changeover of power is creating tensions within the political system. For most of

the life of this second Yudhoyono administration, tensions within and between the three branches of

government—the legislative, judicial and executive branches—have been building. Nevertheless, there is

commitment by reformers within the Government to push forward on important reform agendas.

43. The political outlook is clouded by uncertainties over who might become the next president.

Adding to the uncertain political outlook is the limited choice of potential candidates for the post of

president in 2014 and uncertainties over the prospects for the continuation of market-oriented policymaking.

The current Jakarta governor has increasingly gained popularity, as a clean governance reformer with a

focus on improving public service delivery, especially to the poor. However, despite the relatively strong

political support for presidency, his formal candidacy has yet to be declared. Meanwhile, as election year

approaches, the political pressure for the government to take more populist policies is mounting. Resistance

for reduction in fuel subsidies, regulatory uncertainties in the extractive sectors (i.e., mining, oil, and gas),

and pressure to increase regional minimum wage rates are among the politically sensitive issues that the

government is currently confronting.

44. There has been a trend towards more interventionist policy making, many of them have

involved restrictive measures. In the past couple of years, economic policymaking has become more

driven by aspiration to increase domestic value addition through facilitating investments in agro-industry

and downstream processing of commodities and natural resources. Given Indonesia’s large pool of labor and

increased exposure to commodity and natural resources activities, such aspiration has a strong development

dimension. However, many of the policy instruments used to promote the aspiration may have caused

adverse results on trade and investment. The decision to restrict exports of minerals by the mining sector

together with the forcing of mining companies to invest in high-investment downstream processing in

Indonesia had the effect of stifling the mining sector—one of Indonesia’s most important drivers of

investment and earners of foreign exchange. Furthermore, interventionist policies in the agricultural sector,

especially restrictions on imports of beef and horticultural products, had served to stoke inflation and eroded

consumer purchasing power at a time when the economy was largely being driven by consumer spending.

45. As a result of the recent market downturn, the Government responded with a package of

measures to reassure market on the medium-term economic reform agenda. Given the potential costs

and consequences of not following a reformist path in policymaking, a silver-lining could be that the

reformer agenda has been strengthened in the short term by recent macro volatility. In August 23rd

, 2013 the

7 See Cameron and Shah (2012).

15

government announced economic stabilization package containing measures intended to achieve the

following: (i) improve current account; (ii) safeguard purchasing power and facilitate growth; (iii) contain

inflationary pressure; and (iv) maintain investment flows. Some the reform measures involved retracting

interventionist policies on trade and proposal for improving certainty in business environment. However, it

remains to be seen whether the measures go far enough to achieve the required adjustment in the external

balances to alleviate financing pressures and provide confidence to financial market investors. Strong

political interests in policymaking as the election approaches may undermine confidence in the reform

process.

III. THE GOVERNMENT’S REFORM PROGRAM AND BANK SUPPORT

A. Indonesia’s Overall Development Agenda

46. A series of five-year development plans has provided the framework for reinforcing

economic stability and initiating structural reforms. Within the first five years after the 1998 crisis, both

economic and political stability were largely in place. When President Yudhoyono came to power in late

2004, plans for macroeconomic and fiscal consolidation and a series of structural reforms to restore

confidence in the Indonesian economy were included in the National Long-Term Development Plan for

2005-2025. In its second term, the GoI adopted Indonesia’s Medium-Term Development Plan (RPJMN)

2010-2014, with responsibility for monitoring progress assigned to the newly established Presidential

Delivery Unit (UKP4). With the target of increasing economic growth to 7 percent and reducing the poverty

rate to 8-10 percent by 2014, the RPJMN highlights the need for growth with equity and a range of cross-

cutting policies to ensure that development is both sustainable and inclusive. The RPJMN gives a special

emphasis to increasing investments in infrastructure and strengthening the poverty agenda. Further, it

commits the Government to a more equitable and inclusive development for, among others, women and

children. The Ministry of Women Empowerment and Child Protection embodies this commitment.

47. The Government’s approach to economic policy is based on its four strategic objectives of

pro-growth, pro-jobs, pro-poor and pro-green development. Equity remains a basic principle for

balancing economic growth and development amongst large cities and smaller cities and more isolated parts

of the country to deliver more even economic development in collaboration with the private sector and job

creation across the country. It also includes a focus on reaching Indonesia’s poorest. The Government

concentrates on 13 programs, which include education, health, poverty reduction, employment creation,

infrastructure development, food security, energy, good governance, electoral reform, anti-corruption

enforcement, inclusive and equitable development, climate change and environmental protection, and

cultural development. Collaboration with the private sector to complement the Government’s efforts through

investments, job creation and innovation is prioritized. Reducing reliance on external finance and

maintaining a low debt-to-GDP ratio is also a key GoI priority. In some but not all of these areas, the

Government has sought assistance from the World Bank Group.

48. The Master Plan for Economic Development seeks to accelerate growth and increase equity

with a goal of becoming one of the 10 largest economies in the world by 2025. In May 2011, the GoI

launched the Master Plan for “Acceleration and Expansion of Indonesia’s Economic Development 2011-

2025” (MP3EI) based on three strategies: (i) fostering centers of growth across economic corridors by

faciliting industrialization; (ii) strengthening national connectivity to link growth poles across and within

economic corridors; and (iii) complementing connectivity by improving human resources capabilities and

increasing investments in research and development. The plan sets an ambitious target for Indonesia to grow

beyond 7 percent annually and achieve a status of an emerging industrialized country by 2025. Under the

plan, the private sector has a central role in driving economic development, particularly in generating

investment, creating employment opportunities and fostering innovation. Meanwhile, the plan also states the

16

responsibility of the Government for creating conducive macro-economic and regulatory conditions for the

acceleration and expansion of investment.

B. Key Reform Directions Supported by the Connectivity DPL

B.1. The Connectivity Challenge

49. Poor connectivity is

identified as one of the major

impediments to growth, undermining

Indonesia's development agenda. Poor

connectivity has been associated with

poor logistics performance suggested by

the World Bank 2012 Logistics

Performance Indicator, which ranks

Indonesia 59th out of 155 countries,

behind middle-income comparators in

the region. Despite improvement from

the previous 2010 ranking, capacity

constraints in connectivity infrastructure

and institutional arrangements continue

to adversely affect the overall logistics

performance of Indonesia. Poor

connectivity also undermines efforts to

attract investment in manufacturing

process activities, as transport costs of

imported materials or materials from

other locations in Indonesia are

relatively more expensive. Such a situation constrains businesses from developing downstream activities

with locally sourced materials and reduces the opportunity for raw material producers to tap growing

opportunities in regions with high manufacturing activities. To the extent that remote regions in Indonesia

have higher incidence of poverty (see Annex 1), lack of connectivity limits opportunities for those lagging

regions to link themselves with their nearest growth centers. Households in remote regions are also

relatively more exposed to higher risk of food insecurity as food prices tend to fluctuate more in remote

regions. Therefore, poor connectivity has significant adverse impact for inclusive growth.

Figure 5 Indonesia’s Logistics Performance Index, which is

lower than most of its regional peers.

Sources: World Bank Logistics Performance Index, 2010 and 2012.

0 2 4 6

Myanmar…

Laos (109)

Kamboja…

Indonesia…

Vietnam (53)

Filipina (52)

Thailand (38)

Malaysia…

China (26)

Singapura…

2.37

2.5

2.56

2.94

3

3.02

3.18

3.49

3.52

4.13

2010 2012

17

Box 1 Examples of the implications of Indonesia’s poor connectivity

The price of a bag of cement in certain parts of Papua is 20 times that in Java. The price of a gallon of water in

Medan is double that in Jakarta. Oranges shipped from China are cheaper than oranges from Pontianak

(Kalimantan). High domestic transport costs are the main reason.

70 percent of the differences in rice prices across provinces can be explained by the degree of remoteness, which

in turn is a reflection of poor logistics and inadequate transport infrastructure (World Bank, 2010).

Availability and prices of basic commodities fluctuate widely in remote areas. For instance, gasoline prices in Di

Kisar Island are three times higher in the rainy season than in the dry season.

High quality products with great potential, such as shrimps from eastern Indonesia, cannot be commercially

processed in Java, and commodities, such as pineapples, are canned abroad because it is cheaper to transport

them to Malaysia than to ship them to Java.

Indonesia’s manufacturing sector is poorly integrated into international production networks because of

unreliable transport and high logistics costs. According to the World Bank Enterprise Survey, transport

problems rank as the third most important constraint to doing business for manufacturing exporters after

electricity and corruption.

The costs of bringing a container from Jakarta’s main industrial sites are double those in Malaysia and Thailand.

Some 10 percent of Indonesian exports leave ports too late and consequently do not reach the regional

transshipment ports on time. Ships destined for local destinations are frequently delayed.

In some export sectors, such as cocoa, rubber and coffee, more than 40 percent of total logistics and transport

costs come from pre-shipment and inland transportation expenses in Indonesia before international shipment.

About 70 percent of freight in Indonesia is transported by truck. The majority of the trucks on the roads in

Indonesia are old and poorly maintained.

A truck making a round-trip from Bandung to Jakarta may spend up to 75 percent of its time parked due to

customs processes, warehouse delays, and lift-on and lift-off queues.

Trade and transport logistics are still mainly ‘paper-based systems’, which increases logistics costs in addition to

illegal fees.

Different national and regional authorities continue to issue laws and regulations without any clear assessment

of their impact on trade flows and logistics costs.

Source: World Bank Trade Logistics Roundtables, 2009-10.

50. The biggest connectivity challenge is weak infrastructure development, which has been

undermining Indonesia’s economic growth and poverty reduction efforts. Indonesia’s infrastructure

investment fell sharply after the Asian financial crisis in the late 1990s, and has still not recovered to pre-

Asian crisis levels. Indonesia’s level of investment during the 2010-11 period was still lower than 4 percent

of GDP, or less than half of that reported during the 1994-97 period of almost 8 percent of GDP (

51. Figure 6). Such low levels of investment are attributed to the GoI’s focus on fiscal consolidation

and cutting of public debt, as well as the decline in infrastructure spending by the private sector and state-

owned enterprises. When compared with other fast-growing countries in the region, such as China, Thailand

and Vietnam, all of which reported infrastructure investment rates of more than 7 percent of GDP,

Indonesia’s infrastructure investment is among the lowest in Asia. This signifies the major challenges faced

by Indonesia towards meeting the demand for infrastructure necessary to enhance competitiveness, growth

and poverty reduction.

18

Figure 6: Infrastructure spending in Indonesia (percentage of GDP)

52. From a regional and global competitiveness perspective, poor connectivity undermines

Indonesia’s trade and investment competitiveness. Indonesia will be fully joining the ASEAN Economic

Community (AEC) by 2015 where single production networks and equitable development are two of the

four main pillars. Meanwhile, economies in the region are stepping up their efforts to forge closer economic

integration through the Regional Comprehensive Economic Partnership (RCEP), which is expected to

include ASEAN countries + 6 (Australia, China, Japan, India, South Korea and New Zealand).

Improvements in connectivity are fundamental if Indonesia is to fully benefit from any initiatives on

economic integration. In addition to improving domestic connectivity, better infrastructures in trade

facilitation can attract more investment, both domestic or export oriented, to Indonesia. The need to improve

connectivity becomes even more important when seen in the context of compensating for increases in

nominal wages and rising costs that are undermining competitiveness of Indonesia’s economy.

B.2. The Agenda for Reform in Connectivity

53. To address its connectivity challenges, the Government needs to coordinate with

stakeholders and identify priorities for reforms that address the most critical issues. Addressing

connectivity challenges involves various government agencies at multiple levels and active consultation

with the private sector. Thus it is important to develop a structured approach that encompasses the different

initiatives, prioritizes reform actions, and promotes a high level of coordination between government

agencies. In this regard, appointing key reform champions in the Government to lead the coordination effort

has been proven to be effective. The identification of appropriate priority activities to improve connectivity

at the intra-island, inter-island and international levels will facilitate a higher level of integration between

the different blueprints and master plans. To the extent that infrastructure development plays a key part in

improving connectivity, better capacity to mobilize and optimize fiscal resources plays a significant role in

boosting investment and improving maintenance of public infrastructure. Given the financing needs for

infrastructure investment and the provision of efficient logistics services, attracting the private sector’s

participation will work only if there is clarity and certainty in the regulatory environment. Therefore, reform

actions in connectivity will have to incorporate the following aspects:

Source: MoF, annual reports for state-owned enterprises,

World Bank’s Public-Private Infrastructure database for private investment

0

2

4

6

8

10

0

2

4

6

8

10

1995- 1997 1998- 2000 2001- 2006 2007- 2009 2010- 2011

Central gov. Sub-national gov.

SOE Private

Percent of GDP Percent of GDP

19

Establish strong inter-agency coordination mechanisms to identify, synergize, implement, and

monitor an action plan to address connectivity challenges;

Improve incentives and clarity in the decision-making process for using public funds for

maintenance and provisions of connectivity infrastructure and services;

Strengthen confidence and inclusiveness in the mechanism in the land acquisition process for

public connectivity infrastructure; and

Improve the institutional set-up and regulatory regime to encourage efficiency and growth in trade

logistics and logistics services.

54. The Government has stepped up efforts to address connectivity challenges by introducing

master plans to guide policy reforms. A key strategy underpinning the MP3EI is the connectivity agenda

that focuses on improving inter-connectedness of different economic corridors. Achieving the goals of the

MP3EI will not be possible without improving Indonesia’s connectivity, i.e. the supply chain linking

producers to consumers. Increasing connectivity between domestic producers and domestic consumers in

dispersed locations across Indonesia will need strong intra- and inter-islands links. The improvement of

logistics and connectivity has been high on the GoI agenda for several years, and has been supported by the

World Bank. The connectivity challenges identified in the MP3EI will need to be addressed in a more

comprehensive and holistic manner, linking connectivity explicitly to regional development plans, as well as

the improvement of competitiveness of the business sector through R&D and technological capacity.

55. The first phase of implementation of the MP3EI aims to integrate different national,

regional and sectoral plans into a single roadmap for action. In the first phase, different existing

national, regional and sectoral plans are being integrated into a single roadmap for action (Table 3Error!

eference source not found.). In particular, to strengthen national connectivity, components from four

different Government plans will be integrated: (a) National Logistics System (Sislognas), (b) National

Transportation Systems (Sistranas), (c) Regional Development (RPJMN and RTRWN); (d) Information and

Communication Technology (ICT). In order to ensure effective implementation of the various strategies,

policy coordination is a key challenge that the MP3EI needs to address. Therefore, the plan mentions a new

dedicated committee chaired by the President to enhance efficiency in coordination, monitoring, evaluating,

and strategic decision-making.

Table 3 . Strengthening national connectivity – integration and synergies across GoI plans

20

Source: GoI, Master Plan for the Acceleration and Expansion of Indonesia Economic Development 2011-25.

56. Engagement in regional economic fora is also strengthening the agenda on connectivity.

Indonesia is a member of ASEAN, which has committed to the successful implementation of an ASEAN

Economic Community (AEC) Blueprint in 2015. This is expected to further enhance trade and investment

integration among member states through the formation of a regional single-production base. To support this

objective, Indonesia and other member states have committed to step up trade facilitation by establishing a

Single Window that enhances customs data exchange, increases the use of ICT for border agencies, and

increases transparency in border clearance processes. In addition to forming a single production base,

ASEAN members also agreed to form a competitive and economically resilient region. In this respect,

ASEAN has introduced an ASEAN Connectivity Master plan to further support commitments to establish

the AEC. The Master plan aims to accelerate implementation of cooperation initiatives and investment

projects across ASEAN that can better connect member states through: (I) physical connectivity (ICT,

infrastructure, and energy); (ii) institutional connectivity to facilitate trade and investment; and (iii) people-

to-people connectivity.

57. Strong support for implementing and monitoring the reform progress is important to ensure

steady progress towards achieving the aims of the connectivity agenda. Various laws and regulations

have been issued, which have major ramifications for advancing the connectivity agenda. The Law on Land

Acquisition for Public Infrastructure (Law No. 2/2012), a Minister Finance Decree on Viability Gap Fund

for public infrastructure, a Minister of Communications and Information Regulation on the use of the ICT

Fund to develop broadband services in remote areas, the Presidential Regulation on Restructuring in the

Railway Sector, and the Presidential Regulation on the Indonesia National Single Window (INSW) are some

of the high-level regulations that have been issued recently and acknowledged by Connectivity DPL-1. The

next challenge is to drive for effective implementation of the connectivity agenda. This partly will involve

reforms through the change of existing, or issuance of new, implementing regulations and technical

guidelines to establish certainty for relevant agencies in implementing policies, and the private sector to

increase participation in the provision of infrastructure and logistics services.

C. Analytical Underpinnings for Connectivity Agenda Support

58. Underpinning the policy dialogue and the design of support to Indonesia’s connectivity

agenda is a series of analytical and advisory activities (AAAs). There have been a number of studies in

recent years that underpin the connectivity policy dialogue and design. These include:

A connectivity study was conducted to identify priorities to integrate Indonesia as a whole,

focusing on intra-island, inter-island and international connectivity issues (Connecting

Indonesia: A Framework for Action (2010)). The Bank has also provided extensive support to

the Go to clarify the objectives of the connectivity framework using the WDR 2009 on

Reshaping Economic Geography and identify a detailed plan of action in priority areas.

The Bank has hosted a series of logistics roundtables bringing together government officials and

the private sector to discuss various facets of connectivity issues. The Bank has also undertaken

a study on Indonesia's Logistics Performance Index 2012, a study of regulatory reform to

support the upgrading of logistics service providers, and the Bank is also developing a

monitoring system to track the implementation of the logistics blueprint.

The Bank undertook the Sub-National Public Expenditure Review 2012 that shows that

decentralized service delivery and finance has not resulted in major improvements in service

outcomes, including in infrastructure. The weak service delivery outcomes can be explained to

a large extent by inefficient subnational government spending. First, subnational governments

spend too much on administration and not enough on other sectors. The latest subnational fiscal

data show that local governments spend more than 25 percent of their budgets on general

administration (the international standard is around five percent). Second, subnational

governments allocate too much to personnel across all sector budgets and not enough to

21

operations, maintenance, and capital (spending on personnel now makes up over 40 percent of

total expenditure budgets). Hence infrastructure spending has not kept pace with the rate of

Indonesia’s urbanization and the resulting congestion has severely constrained growth. One of

the policy recommendations suggested by the study is to move toward performance incentives

designed with a view explicitly improving infrastructure service outcomes. Such outcomes

could potentially reflect those stipulated under the connectivity agenda.

The Bank conducted a study on Constraints on Productivity and Investment in Indonesia’s

Manufacturing Sector: Survey-based Analysis of Business Constraints (2012). The findings

suggest that problems with transportation are among the worst business constraints for

manufacturing firms, particularly export oriented firms, in Indonesia.

On transportation issues, the Bank’s ongoing Infrastructure Public Expenditure Review has

produced extensive policy notes on Rail (2011) and Road (2012), which help highlight critical

infrastructure issues and challenges. As one of the priority areas under connectivity, the Bank

has commissioned a study to better understand the inter-island transport market and ways to

improve the provision of transport services. An assessment of the road construction industry in

Indonesia was recently undertaken by the World Bank to gain a better understanding of the

constraints and issues, and to identify opportunities for improvement of the investment climate

of the sector.

The Bank is also providing technical assistance on reform actions in ICT. With an AusAID

facility, the Bank provided policy input to Bappenas and the Ministry of Communications that

shapes the reform agenda on ICT investment.

The Bank is also engaged in policy dialogue on improving port efficiency and trade facilitation,

through on-going technical assistance via the Multi-Donor Trust Fund for Trade and Investment

Climate (MDFTIC) and AusAID facility. The Bank has conducted several analyses on

improving ports, including dwell time surveys, a domestic shipping study, a study on the use of

the newly established dry port in West Java, and development of a SAP for dry ports.

On gender, the Bank’s study of Making Infrastructure Work for Women and Men: A Review of

World Bank Infrastructure Projects (1995-2009) provides a tool for more effective and efficient

implementation when the different needs and interests of, as well as possible benefits that can be

obtained by, women and men are taken into consideration in project design and implementation.

Success stories include women’s increased access to finance due to the joint titling of resettled

households in Mumbai, India and in Aceh post-tsunami areas in Indonesia; increased school

enrollment of girls from 30 to 50 percent in Morocco; and a more effective maintenance due to

women’s participation in Peru.

D. Other Related Reform Priorities and Areas of Development

59. Outside of the main pillars of reform covered by the DPL, there are three major areas of

reform in which the World Bank is also involved that are relevant to the success of this DPL series. These areas include infrastructure finance/Public-Private Partnerships (PPPs), trade competitiveness and

decentralization. The Government is actively addressing the challenges of reform in these areas, with

support from development partners.

D. 1. Infrastructure: Public-Private Partnerships (PPP)

60. Public Private Partnerships (PPP) offer a potential partial solution towards addressing

Indonesia’s infrastructure gaps. Inadequate infrastructure currently acts as a constraint to Indonesia’s

growth potential and with it, efforts to reduce the nation’s poverty. Indonesia experienced a significant

decline in infrastructure investment as a share of GDP in the years following the Asian financial crisis,

which it is only now beginning to recover. The decline in spending was reflected in a deterioration of

22

services across many sectors.8 PPP can potentially offer a new source of capital for infrastructure

development—a window for infrastructure financing by the private sector—aside from that by national and

subnational governments, and SOEs, for example. More importantly, it can provide increased efficiency

from the resources available, using the competitive and management efficiencies of the private sector to

achieve the cost reductions, speed of completion and life-cycle oriented maintenance that the Government so

desperately needs in its infrastructure program. The use of private sector capacity also provides the

Government with the additional human and technical resources needed to achieve an increase in

infrastructure development, including for example in a technologically complex and difficult projects.

61. The GoI has a strong commitment to delivering the sector reforms and institutional

arrangements needed to improve private investment in infrastructure. For example, the GoI is changing

many of its infrastructure laws, by dismantling public monopolies and opening the infrastructure sector and

market to private sector investors. Under the new legal framework, the private sector can invest in the

development and operation of financially viable infrastructure projects, without being obliged to enter into

joint ventures with state-owned enterprises (SOEs).

62. The Bank’s engagement with the GoI on infrastructure finance during recent years includes

a significant effort dedicated to PPP, focused primarily on institutional, legal and capacity reform.

The Bank’s Private Participation in Infrastructure TA Loan (PPITA) provided capacity support and

institutional reform support to the different line ministries and helped to design Perpres No. 67/2005

(amended by President Regulation No. 13/2010, and President Regulation No 56/ 2011), the legal

foundation for the PPP program, and create the Risk Management Unit (RMU) in the MoF, a team dedicated

to resolving the fiscal risks associated with PPP and helping the MoF become a more proactive party to the

PPP program. The PPITA also helped set up two key units in Ministry of Public Works to handle

preparation and transaction in toll and water infrastructure projects, namely the Toll Road Authority Board

(BPJT) and Drinking Water Advisory Board (BPPSPAM)-. These reforms were then reinforced and

developed through the Infrastructure DPL series 1-4, the creation of and Bank lending to the Indonesia

Infrastructure Finance Facility (IIFF) and the Bank’s support for the Indonesia Guarantee Fund (IGF). While

private investment in public infrastructure is important for Indonesia’s growth, it should not be over-sold as

a panacea for the country’s infrastructure needs. In 2010, private investment in public infrastructure was

below 1.5 percent of GDP in such large middle-income countries as Thailand, the Philippines and Russia,

and below 1.0 percent of GDP in others (including Brazil, Malaysia, Vietnam and Indonesia). Improving

Indonesia’s infrastructure endowments will require an increased effort by national and subnational

governments, as well as SOEs and private investors.

D.2. Trade Competitiveness

63. Trade is an important part of the Indonesian economy, driving growth and productivity

improvement. The export of goods represents 22 percent of nominal GDP, while the export of services has

started to expand. Indonesia exported about US$200 billion of goods in 2011, which would rank Indonesia

within the top 25 exporters in the world. Excluding oil and gas exports, more than 70 percent of Indonesia’s

exports are natural resources and manufacturing products. Within Indonesia’s manufacturing exports, almost

half are natural resource-based manufacturing products, such as palm oil, processed rubber, and processed

minerals. Although markets in the EU and the US remain important, Indonesia is increasingly trading with

emerging markets and countries in the region such as China, India, Malaysia, and South Korea.

64. Indonesia has been reforming its trade policies to make them more effective and responsive

in promoting growth and competitiveness. Significant reform has taken place in improving trade

facilitation and promoting more inclusive and evidence-based trade policymaking. As a member of ASEAN

8 Total infrastructure investment fell from 8.2 percent of GDP in 1997 to a low of 3.1 percent in 2002, and recently averaged 3

percent in the course of 2011 and 2012.

23

and the G20 process, Indonesia has been embracing openness to trade and investment and leaning towards

greater integration in the global economy. Indonesia took a bold step in harmonizing the structure of its

import tariffs and Indonesia’s current average import tariff is one of the lowest among emerging

economies—the simple average tariff is about 5 percent. On trade facilitation, Indonesia has made progress

in improving customs clearance and transparency on trade regulations through the Indonesia National Single

Window (INSW). Meanwhile, Indonesia is developing a process to increase transparency in reviewing non-

tariff measures that affect trade flows.

65. With the support of Multi-Donor Facility for Trade and Investment Climate (MDFTIC), the

Bank is working with the Government to foster a more transparent trade regime that will contribute to

improvements in competitiveness, economic productivity, and job creation; making informed policymaking

on strategic food commodities that contribute to food price stability; and strengthening the reform agenda to

improve connectivity in order to lower transportation costs of goods across the country, improve

competitiveness, and reduced inter-regional economic inequality. This program also seeks to strengthen

policy dialogue around trade and investment climate through AAA work and just in time briefing notes to

inform the opportunities from continuing process for economic integration and priorities to address

challenges in trade and investment competitiveness.

D.3. Subnational Development

66. With the ‘big-bang’ decentralization of 2001, Indonesia went from being one of the most

centralized countries in the world in administrative, fiscal and political terms, to one of the most

decentralized; but the transition is far from complete. While some surveys show an improvement in

satisfaction with local service delivery, significant challenges remain. Overlapping responsibilities without a

coordinated decentralization framework undermine effective service delivery, and limit accountability and

transparency mechanisms at the subnational government level. Much central funding devolved to the

subnational governments—at around 31.4 percent of budgets—is spent on personnel salaries and other

administrative costs, reducing the incentive to address civil service costs. While the Special Allocation Fund

(DAK) has been growing rapidly, there are still some challenges in the implementation of DAK by local

(district/municipal) governments. Unlike most decentralized countries, Indonesia has not transferred

significant revenue-raising power to local governments, distorting incentives and creating an unhealthy

dependence on transfers. Meanwhile, many local governments misuse the revenue-raising authority they do

have, constraining business development, growth and job creation. Transfers provide the bulk of financing,

but they are rarely used as a strategic instrument to improve local government performance. Given the

important role of subnational governments in public investment, particularly in the infrastructure sector

where the needs are great, amending the law on subnational government taxes and fees, as well as fine-

tuning on-lending and on-granting regulations and application, is urgent. Most regions also need to improve

technical capacity to implement reforms.

67. To support the reform of the framework for subnational development, the Bank, together

with development partners, will continue to improve the environment within which local governments

operate. The Bank continues its on-going support by providing resources and coordination for both central

level agencies and local governments around analysis and critical-capacity building through various

programs and activities. Beginning in 2010, the Bank has provided resources and assistance to improve the

DAK, with an initial emphasis on enhancing accountability and reporting of the DAK transfer to

infrastructure sub-sectors within pilot local governments, as well as providing incentives for good

performance by local governments. World Bank programs also work directly with local governments to

enhance capacity and improve financing in districts across Indonesia, including through the Urban Sector

Development and Reform Project (USDRP), which aims to change governance behavior in the context of

decentralized public service delivery by targeting reform-minded local governments and encouraging

increased accountability through citizen participation. In addition, the Public Expenditure Analysis and

Capacity Harmonization (PEACH) program carries out subnational public expenditure reviews (PERs)

24

designed to better inform spending decisions at the local level. Subnational PERs have been completed in 10

provinces with local governments working closely with local academic institutions and local stakeholders to

improve policy and analytical capacity, including mainstreaming gender analysis into expenditure reviews.

D.4. Procurement

68. In recent years the Government has also made significant progress on the regulatory side of

government procurement, which is a core element of the overall PFM reform agenda. Specific steps

include the creation in 2007, the national procurement policy and regulatory agency (LKPP), enactment of

Presidential Regulations Perpres No. 54/2010 and Perpres No. 70/2012, mandating the establishment of

dedicated Procurement Service Units (ULPs) and use of e-procurement, and the issuance in 2013 of updated

standard bidding documents for e-procurement. The priority now is to enable effective implementation of

the procurement regulations so that the goals of competition, economy, efficiency and transparency

envisaged for the new framework are actually achieved. This would include strengthening oversight

institutions and mechanisms to ensure that procurement regulations are followed, a particularly challenging

objective in such a decentralized government setting; to develop capacity of staff working on procurement

so that executing agencies can get the most benefit out of the procurement rules through a wide range of

implementation options; to introduce modern procurement tools such as framework contracts/e-catalogues

for enhancing efficiency and getting greater value for money; and to establish a procurement performance

monitoring system to enable collection and analysis of actionable and reliable data to inform procurement

policy-making, as well as to monitor and evaluate results. LKPP has initiated work on some of these areas

which are currently at varying levels of progress. Going forward, establishing a fully functional public

procurement system will require the Government to continuously assess the performance and outcomes of

the system, obtaining feedback from stakeholders, and making the appropriate adjustments in policies and

implementation tools for further improvement.

D.5. Governance and Anti-Corruption

69. The Government has made progress in combating corruption during the second term (2010-

14) of the President. Evidence for this has been identified in a performance review and evaluation reports

of state agencies/institutions, which were undertaken by KPK (Anti-Corruption Commission) and BPK

(State Audit Agency). For instance, the KPK's Annual Integrity Survey highlighted that the Integrity Index

improved substantially from 5.42 in 2010 to 6.37 in 2012. At the same time, BPK's summary of annual

audits during 2010-12 mentioned that the majority of findings reflected mis-administration. Moreover, as

part of efforts to move forward with the National Anti-Corruption Agenda, the heads of the KPK, AGO and

National Police agreed on a Memorandum of Understanding in March 2012, outlining the strategic actions

necessary for strengthening coordination, supervision, support to pre-investigation and investigation, as well

as the prosecution proceedings of high-profile corruption cases. To address the human resources challenges

within the KPK, the President also issued an instruction in October 2012 to the KPK, the AGO, and the

National Police, to ensure the availability of investigators in KPK. Specifically, the instruction postpones the

withdrawal of AGO and the National Police investigators from the KPK, and also facilitates the KPK to start

recruiting its own investigators for greater independence.

IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM

A. Links to the 2013-2015 Country Partnership Strategy (CPS)

70. The proposed Connectivity DPL-2 supports the broader goal of the 2013-15 CPS, which is to

enhance Indonesia’s domestic capacity for reducing poverty and boosting equitable and sustainable

prosperity. The CPS highlights the Connectivity DPL program as a key World Bank Group (WBG)

instrument, particularly in the pro-growth engagement area, by promoting prosperity through enhanced

25

connectivity, strengthened competitiveness and promotion of infrastructure development. Complemented by

other WBG financing instruments and knowledge services, the proposed Connectivity DPL-2 is expected to

support development results that will enhance Indonesia’s logistics performance, improve access to

broadband and reduce costs for exporting and importing. The proposed operation will also support the GoI’s

reform efforts to improve the policy framework, regulatory environment and coordinated interventions for

productivity, competition and innovation. Further, the proposed operation will support efforts to reignite

investment in infrastructure, which are aimed at increasing public investment and promoting private sector

participation. Overall, the CPS recognizes that the key to addressing connectivity challenges lies in policy

coordination and implementation across multiple levels of government and consultation with the private

sector, which is a key thrust of the proposed operation.

Figure 7: 2013-2015 CPS alignement of engagement areas

B. Relationship to Other Bank Operations

71. The Bank is supporting the Government’s connectivity agenda using mutually supportive

instruments. While with the DPL series the Bank supports the Government’s ownership and commitment

towards the achievement of reform milestones, with other technical assistance and financing instruments it

supplements that support through the necessary advisory, human and financial capacity to carry out the

reforms. Various types of Bank investment lending support of the connectivity agenda., including: (i) the

US$300 million Western Indonesia Roads project (WINRIP) which is upgrading key sections of the

Western Sumatra road corridor (from North Sumatra to Lampung) to increase travel speeds and capacity; (ii)

US$660 million for the Upper Cisokan Pumped Storage power plant in West Java and US$300 million in

lending for geothermal power plants in south Sumatra and north Sulawesi that increases generation capacity

to keep up with steeply increasing demand; and (iii) US$325 million in Bank lending for power transmission

in FY13 (on top of US$225 million in FY11). The Connectivity DPL is also complemented by other

technical assistance that supports through the necessary advisory, human and financial capacity the

26

underlying reforms. In particular, the MDFTIC funded by the Netherlands and Swiss Governments supports

institutional and capacity building initiatives, as well as analytical and advisory work that is aimed towards

improving trade and investment climate, which are highly relevant for the operation. These include the

World Bank Logistics Performance Index (LPI) that has helped to make the GoI aware that, compared with

other middle-income countries in the region, Indonesia’s logistics performance still ranks relatively low,

with weak logistics infrastructure and customs clearance processes that are already undermining Indonesia’s

economic competitiveness.9 Through the MDFTIC, the Bank has also provided policy inputs to strengthen

policy coordination on the Indonesian National Single Window (INSW), the flow of cargo clearance, and

the regulatory framework for logistics services industries. Support was also provided to the GoI in its

development of the National Logistics Strategy (Sislognas), which presents a long term strategy to improve

logistics efficiency in Indonesia and includes action plans, an institutional coordination structure, and

mechanisms for private sector engagement.

72. The parallel INSTANSI DPL-2 supports measures to enhance Indonesia’s capacity and

institutions to enhance poverty alleviation and shared prosperity efforts, and strengthen public

financial management, which directly contributes to the effective implementation of the proposed

Connectivity DPL-2. In the same way, the DPL series support to the GoI’s Connectivity agenda directly

contributes to the effective implementation of the other investment lending operations in the country.

Support that has been provided through the core DPL series covers the following policy areas that are highly

relevant for the proposed Connectivity DPL:

Enhancing poverty alleviation and shared prosperity efforts

73. The GoI’s intention to enhance poverty alleviation and shared prosperity efforts is largely

consistent with the Connectivity agenda. Since the 2009 elections, there has been renewed commitment

by the Government to intensify policy reforms towards enhancing poverty alleviation and shared prosperity

efforts. The RPJMN 2010-2014 highlights the Government’s aim to lower the poverty rate to 8-10 percent

by 2014. The INSTANSI DPL series supports policy reforms that aim towards improving governance and

institutional accountability in poverty alleviation and shared prosperity efforts, through better measurement

and targeting of the poor and vulnerable in social assistance programs, as demonstrated by the

comprehensive compensation package for the subsidized fuel price increase, and implementation of a new

national social security system. Overall, these renewed and committed poverty reduction actions are

consistent with the proposed Connectivity DPL’s goal of ensuring inclusive development.

Strengthening public financial management (PFM)

74. The reform of public financial management systems will address some of the core problems

faced in the delivery of key investments, including those aimed at strengthening connectivity. The

PFM reforms supported under the INSTANSI DPL series complement the Connectivity DPL efforts, as they

are aimed at improving the medium-term results orientation of the budget process, introducing a more

efficient and effective automated budget and treasury system, and improving accounting, audit, tax

administration and sub-national fiscal management. All of these would greatly contribute to more efficient

delivery of key investments for strengthening national connectivity. Since adoption of a new regulatory

framework in 2003/4,10

the Government has embarked on a broad-based and ambitious PFM reform agenda.

The Government has been undertaking remarkable efforts to improve business processes and systems

throughout the entire budget cycle, including audit, legislative oversight and civil service reform. It has

9 Compared to other middle income countries in the region, Indonesia ranks relatively low in the Logistics Performance Indicator

(LPI) of the World Bank. Indonesia ranked 43rd (out of 150 countries) in 2007, 75th (out of 155 countries) in 2010, and 59th (out of

155 countries) in 2012. 10 The most noteworthy laws issued include the State Finance Law No. 17/2003, the State Treasury Law No. 1/2004 and the State

Financial Audit Law No. 15/2004.

27

thereby addressed a multitude of risks related to capacity constraints, poor infrastructure, and weak

governance across the PFM institutional and stakeholders’ landscape.

C. Collaboration with Other Development Partners and the IMF

75. The proposed Connectivity DPL-2 has been prepared in collaboration with the Asia

Development Bank (ADB) and the Government of Japan/JICA, which are providing parallel

financing to the GoI in implementing its connectivity agenda. The Bank has liaised closely with ADB

and the Government of Japan/JICA, since the onset of the Connectivity DPL program last year, in order to

ensure harmonization of their support program overall. Such harmonization has allowed the World Bank,

ADB and GoJ/JICA to build upon the natural synergies and complementarities that exists across their

respective portfolios. The harmonized approach to policy-based lending through the DPL program has also

provided a solid foundation to deepen the harmonization agenda in Indonesia with other development

partners surrounding this or other initiatives and programs.

76. The Bank continues to liaise closely with the IMF. The IMF and the World Bank in Indonesia

continue to consult regularly on macro and sectoral issues, and the Bank coordinates closely with the Fund

in its missions, which help ensure that continued DPL support is warranted. In addition, the Bank, the Fund

and development partners have worked closely on the PFM agenda and the DPL’s indicative triggers have

been developed in close coordination. The DPL has thus provided a platform to push the reform agenda in

these crucial areas where both institutions are working.

D. Lessons Learned from other Development Policy Loan (DPL) Series

77. Important lessons have been learned over the course of the core DPL and IDPL series,

which are relevant for the Connectivity DPL. These lessons stem from the nature and evolution of the

relationship between the Bank and the Government, and also from the characteristics of the DPL program as

a means of offering policy support, together with the changing policy environment on the ground. Some of

the lessons may be particular to the Indonesian case because of the broad scope and depth of the Bank’s

engagement with the Government, and the range of resources that the World Bank program in Indonesia has

access to through trust funds. As highlighted in the Implementation Completion and Results (ICR) Reports

for DPLs (7-8), the Indonesian DPLs benefit from a large field team presence that is actively engaged with

the Government through various other instruments in addition to the DPL. The socialization on both sides is

deep and the processing has become standard. As a result, although the task team leaders for the DPLs

change, the lessons learned from previous DPLs are seamlessly incorporated into future operations, and the

series has become more mature and efficient. The following lessons are particularly worth highlighting:

78. Lesson 1: Strong government ownership and committed counterparts are vital, but just as

important is ownership over the pace of the reform process. As a growing middle-income country,

Indonesia can access domestic and international capital markets, thus offering it a range of financing

choices. While the Bank’s financing is attractive, the driving reason for the Government’s engagement with

the Bank through the DPL program is the utility of the instrument in bolstering, locking in and accelerating

critical reforms. To succeed, DPLs not only need the commitment of the Government at the highest level but

also that of mid-level officials responsible for implementing the reforms and following progress on a daily

basis.

79. Lesson 2: Reflecting on the previous I-DPL series, ongoing Bank collaboration with

counterparts and support from a high level on policy dialogue are crucial for the success of DPL

operation. The Connectivity DPL has benefited from a high-level support through coordination meetings

chaired by the Deputy Minister of Bappenas to identify areas of policy reform that the Government wants

this DPL to support and to assess whether those reforms are on track. Such a level of government support

28

also helps increase commitment from the mid-level officials responsible for delivering the policy reforms.

Finally, as in other DPL program, constant dialogue between the Government and the Bank is fundamental

and is best facilitated by a strong field presence across sectors that views policy discussions as a natural part

of ongoing support.

80. Lesson 3: As in I-DPL and other DPL operations, progress on institutional reforms need not

be linear and there should be sufficient flexibility for modifications and increased complexity as the

reform program evolves. Institutional reforms that involve changing the way the Government works,

especially in the face of entrenched interests and organizational cultures, are complicated, often

unpredictable undertakings for which there are no simple recipes. What is needed in this context is

commitment to reform, a continued sense of urgency, and preparedness so that when the right opportunity

presents itself, reforms that had otherwise been apparently slowed, may be advanced rapidly. This approach

can allow for progress through incremental reform.

81. Lesson 4: DPLs are only one instrument among many that are available in a multi-faceted

engagement, and the choice of instrument should be contingent on the issue, the political context and

the institutional circumstances. This is particularly applicable in the Indonesian case because of the size

and scope of the World Bank program here. The Bank program in Indonesia is one of the largest of any

country in terms of number of staff and overall resources. Large teams are working closely on a daily basis

with government counterparts on a wide range of issues from public financial management and trade and

investment, to finance, public expenditures and poverty. In this context the DPL is not the only instrument

for supporting reform, but one of several important tools including analytical work, knowledge sharing, and

technical assistance.

82. Lesson 5: Policy-based operations provide an important instrument to convene policy

makers, policy implementers, donors and others stakeholders for ongoing dialogue on sector issues.

As highlighted in the previous I-DPL operation, across the board, and particularly in the areas of PPP, the

water sector, and land acquisition, the convening power of the program was important to integrate related

programs and foster peer learning among unrelated activities. The land working group successfully brought

a complex land acquisition law to Parliament through an “action plan” developed by the inter-ministerial

working group (as part of I-DPL). Cross-fertilization across sectors took place in the case of Output-Based

Aid (OBA). The water sector’s success demonstrated to the road sector how OBA could be applied to road

maintenance.

83. Lesson 6: The application of a set of basic principles has contributed greatly to the

successful implementation of the Indonesian DPL series. Based on earlier experience processing the DPL

series, the Bank team outlined a few principles to guide them when selecting policy areas and prior actions.

First, there has to be a robust engagement and relationship with key high-ranking counterparts who were

“champions” of reform, had reasonably well-defined agendas, and the authority to advance their agenda,

thereby ensuring strong government ownership and execution of the reforms. Second, the GoI counterpart

has to see some value to adding some element of their reform agenda or work program into the DPL process

and would therefore make the time and reform commitment to participating process. Third, there also has to

be a champion on the WB side for including the reform in the DPL process, which incentivized staff to

engage in the DPL if it was in parallel support to their work program. These three basic principles ensured

that the prior actions would be actively monitored by both sides for completion in a timely way.

84. Lesson 7: For a mature DPL series, a broad program scope limits the breadth of the reforms

that can be taken. Given the coordinating nature of the DPL program across the three distinct pillars, in

order to keep it operational, the number of implementing agencies engaged has to be kept limited. This in

turn affects the policy areas and actions that can be selected. Also, as the key value of the DPL process is in

elevating reforms—a broad DPL is kept manageable by limiting the number of reforms selected. Therefore,

to deepen the reform agenda it makes sense to move to a sectoral DPL, which will allow involving a broader

29

set of institutions and increase the number of reforms in the policy area. This approach will maximize

synergies across the Bank’s program in Indonesia, increase ownership of the related policy reforms by the

relevant institutions, and improve targeting of complementary technical assistance programs. A similar

action was done in the first DPL series, when the infrastructure component was spun out into its own DPL

series, this allowed the management of the DPL for PREM related actions to be set in the core DPL and the

infrastructure-related items to rest with the SD team.

85. Lesson 8: The splitting of the DPL series is a positive reflection that the value of the DPL

series extends beyond the financial disbursements. Although the new DPL series will provide a combined

financing similar to the core DPL series, the Government’s willingness to invest more of its time to process

three DPL highlights the benefits gained from the DPL process. DPLs have provided a convening forum for

the various units within the Government, but also within the Bank, to discuss reform priorities, progress, and

cross-agency issues, e.g. M&E. Development partners, even with no financial involvement in the DPL, have

attended the DPL meetings as a useful means of gauging the priorities and issues in the Government’s

reform agenda.

86. Lesson 9: A gradual approach should be taken when working with newly created

institutions. In the case of DPL-7, there was a great sense that the creation of the new task force TNP2K

would help energize the policy reforms areas of Pillar 3 and an ambitious reform agenda was envisioned.

However, there were complications in the relationship between TNP2K and Bappenas that contributed to a

complex environment for achievement of the prior actions. Moreover, it also served to distract from other

poverty reform areas that the Bank and Bappenas/TNP2K were working on, as more time was spent

resolving DPL issues. Therefore, although Pillar 3 was an established reform area, and both government

counterparts had committed champions, it would have been better to have gradually introduced the reform

agenda to test out the political dynamics of the two units.

V. THE PROPOSED OPERATION

A. Overview of the Connectivity DPL

87. The GoI has requested that the Bank continues to support implementation of the

connectivity agenda, as outlined in the National Connectivity Strategy and Action Plan, through the

proposed US$300 million Connectivity DPL-2. The proposed operation will continue to deepen reform

efforts that have been initiated under the previous Connectivity DPL, which are aimed at improving the

efficiency of domestic logistics and strengthening inclusive development. The proposed operation is

expected to strengthen the mechanisms and time-bound processes for the GoI to coordinate and identify the

second batch of reform actions that are necessary to unlock key regulatory barriers towards improving

connectivity. The operation will also help facilitate important decision-making processes by the GoI on the

allocation of public resources to improve the access and quality of public infrastructure and public services,

with regards to improving national connectivity. An integral part of MP3EI and the RPJMN 2010-2014, the

National Connectivity Strategy looks at both the physical and institutional arrangements that need to be

strengthened in order to achieve better development outcomes.

88. This proposed Connectivity DPL-2 is the second of a multi-year programmatic DPL series.

The operation is envisioned to be the second of a programmatic DPL series focused on strengthening

Indonesia’s connectivity. To ensure full ownership of the program, a detailed mapping out of the

programmatic DPL series has been developed jointly with Bappenas, the Coordinating Ministry for

Economic Affairs and relevant line ministries/agencies, since the onset of the Connectivity DPL last year,

which provides a time-bound process for the GoI to coordinate and implement policy reforms on

connectivity. This process is critical to ensure sustained follow-up from recent government and

parliamentary initiatives in issuing high-level regulations to support the connectivity agenda, which were

30

acknowledged by the Connectivity DPL last year. Given that implementation of the GoI’s connectivity

agenda involves GoI agencies beyond core economic ministries, the proposed operation’s support for the

GoI’s efforts to strengthen the coordination and reform processes among the various agencies, including the

Ministry of Finance, Ministry of Transport, and Ministry of Public Works, is critically important. The

Government has recently indicated the possibility of continuing the engagement through a follow-on

Connectivity DPL operation. Ideas on policy reforms in connectivity have emerged and will need to be

adjusted and refined as progress is made and discussions with GoI counterparts evolve.

89. The proposed Connectivity DPL-2 policy actions have been developed based on the program

that was identified in the previous year, with some modifications to ensure consistency with the

ongoing progress in GoI development efforts and initiatives. Aligned with the RPJMN 2010-2014 and

MP3EI, the policy actions surround the following pillars:

i) Strengthening National Coordination and Regulation through establishment of regulatory and

institutional frameworks for improved coordination and implementation of the connectivity agenda;

ii) Strengthening Intra-island Connectivity through improved connectivity among and between

growth poles, with improved regulatory framework for land acquisition for public purpose

development and optimal use of resources for sustainable improvement and maintenance of island-

transport network;

iii) Improving Inter-island Connectivity through strengthened ICT connectivity between eastern and

western Indonesia and more competition in broadband services, and improving the efficiency of

domestic shipping which is crucial to lower logistics costs in an archipelago like Indonesia; and

iv) Improving International Connectivity (trade facilitation) by strengthening the institutions and


90. A Connectivity Working Group, chaired by a Deputy Minister of Bappenas, has been

established, which helps put in place a clear coordination structure for implementation of the

connectivity action plan. The Working Group distinguishes issues of intra-island, inter-island and

international connectivity. There is awareness that successful improvements of connectivity in these three

areas will involve a wide range of stakeholders in both the public and private sector. Consequently, the need

for a proper institutional framework and strong coordination in the implementation of the connectivity

strategy has been recognized. This establishment is also expected to strengthen the Bank engagement with

Bappenas on connectivity, which evolved during the preparation of the National Connectivity Strategy.

Table 4: Prior Actions in Connectivity DPL-2

Objective

Prior actions acknowledged by Connectivity DPL-2

Pillar 1: Strengthening National Coordination and Regulation

To establish

transparent processes

for channeling public

funds to viable

infrastructure PPP

projects for further

market uptake

1 The Borrower has signed a Minister of Finance Regulation on operational

procedures to implement Minister of Finance Regulation No. 223/2012 on the

channeling of government funds to public-private partnership projects in

infrastructure

Pillar 2: Strengthening Intra-island Connectivity

To support effective

implementation of the

new regulatory

framework on law

2 The Borrower, through the National Land Agency, has assigned roles to, and

has established the processes for, the relevant agencies of the Borrower when

acquiring land for public purpose development through the issuance of

technical guidelines (Regulation of the Head of BPN No.5/2012) to

31

acquisition for public

infrastructure (Law

No. 2/2012) that is

critical for making

progress in

development of

connectivity

infrastructure

implement Law No. 2/2012 and Presidential Regulation No. 71/2012.

3 The Borrower has issued a Minister of Finance Regulation

(No.13/PMK.02/2013) stating which expenditures related to land acquisition

for public purpose development are eligible to be covered by the national state

budget, and the Borrower has issued a Minister of Home Affairs Regulation

(No.72/2012) stating which expenditures related to land acquisition for public

purpose development are eligible to be covered by local government budgets

To carry out the

restructuring process

in Indonesia’s railway

sector to make it

respond better to

growing demand for

better services and

improved accessibility

4 The Borrower has issued guidelines (Minister of Transportation Regulations

PM.10/2013 and PM.56/2013) for the provision and reimbursement of Public

Service Obligation in the railway sector to provide affordable passenger

railway services

5 The Borrower has issued guidelines for provision of (i) Infrastructure

Maintenance Operation (Minister of Transportation Regulation PM.67/2013),

and (ii) Track Access Charges (Minister of Transportation Regulation

PM.62/2013) to support the restructuring process in the railway sector as

mandated by the Borrower’s Law No. 23/2007 and by Presidential Regulation

(No. 53/2012)

Pillar 3: Improving Inter-island Connectivity

To close the “digital

divide” between

eastern and western

Indonesia through

facilitating the

development of

broadband services to

remote and under-

served areas in eastern

Indonesia using the

ICT Fund

6 The Borrower has completed the identification of the remote districts

(kabupaten) to be covered by the ICT Fund and has estimated the budget

requirements for the first phase of telecommunications broadband projects to

be financed by the ICT Fund

To strengthen

development roadmap

in Indonesia’s port

sector and improve

domestic sea shipping

7 The Borrower has issued Minister of Transportation Regulation No.

KP414/2013 establishing a classification and location for all Indonesian sea

ports based on traffic projections in order to establish development plans for

each individual sea port for the next twenty years

Pillar 4: Improving International Connectivity

To strengthen the

institutional set-up in

trade facilitation to

better handle the

increasing volume of

international trade

8 The Borrower has expanded the Indonesia National Single Window System

by linking the requests for permits made to the Ministry of Trade and the

Agency for Plant Quarantine through the Single Sign-On Mechanism to

streamline and make more efficient the export and import processes and the

quarantine procedures

9 The Borrower has decided the legal nature of the agency to be created for the

management of the Indonesia National Single Window System

91. The proposed prior actions represent critical policy and institutional actions towards longer-

term reforms, over which the GoI has demonstrated strong ownership and commitment. These prior

actions (Table 4) have undergone an extensive consultation and consensus-building process among the key

GoI stakeholders. The GoI has demonstrated strong ownership and commitment over these actions, and their

32

very inclusion in the DPL helps to ensure sustained focus on the policy issues, the ongoing deliberation of

policy options and the eventual reform breakthroughs. In addition to the prior actions, the operation also

supports a set of benchmark actions that do not pose any conditionality over the disbursement of the DPL

financing. The GoI specifically requested that these benchmarks be acknowledged in order to demonstrate

its pace and the broad scope of the reform process surrounding the connectivity agenda. The distinction

between prior actions and benchmarks helps ensure sustained GoI ownership and commitment, and the

mapping out of a comprehensive and multi-year DPL program. A detailed list of prior actions and

benchmarks is provided in Annex 2: Connectivity DPL Two-Year Program Policy Matrix and Results Framework .

92. The list of previously identified triggers for Connectivity DPL-2 was adjusted to reflect more

recent developments in the connectivity agenda. The following Table 5 illustrates the evolution of several

indicative triggers identified during the preparation of the Connectivity DPL-1 in 2012 (April – August

2012).

Table 5: Adjustment of Indicative Triggers Identified in Connectivity DPL-1

Indicative triggers

identified in Connectivity

DPL-1 (April – August

2012)

Prior actions in Connectivity DPL-2 Rationale for adjustment

The Minister of Transport has issued

guidelines (Ministry of Transport

Regulations PM.10/2013 and PM

56/2013) for the provision and

reimbursement of a Public Service

Obligation in the railway sector

Both were not specified as

triggers in 2012. These came out in

the early stage of preparation of

Connectivity DPL-2 because they

are considered important milestones

for the restructuring process in the

railway sector The Minister of Transport has issued

guidelines for provision of (i)

Infrastructure Maintenance Operation

(Ministry of Transport Regulation

PM.67/2013), and (ii) Track Access

Charges (Ministry of Transport

Regulation PM.62/2013) to support the

restructuring process in the railway sector

as mandated by the Borrower’s Law No.

23/2007 and by Presidential Regulation

No. 53/2012

Issue Presidential Regulation

establishing the Jabodetabek

Transportation Authority

This trigger has been excluded. More consultations between central

and local governments (Jakarta,

Bogor, Depok, Tangerang, and

Bekasi ) are needed to determine

the proper institutional arrangement

for the proposed Transportation

Authority

Operationalize the ICT Fund,

as demonstrated by the

completion of the tender

process and contract award

for the first phase of

telecommunications

broadband projects under the

ICT Fund

The Minister of Communications and

Information has completed identification

of the remote districts (kabupaten) to be

covered by the ICT Fund and has

estimated the budget requirements for the

first phase of telecommunications

broadband projects to be financed by the

ICT Fund

This trigger has been adjusted. The tender process has been

delayed due to finalization of

documents and the establishment of

a selection panel to ensure

transparency in the tender process.

The Minister of Transportation has issued

Ministerial Regulation No. KP414/2013

establishing the classification and

location of all Indonesian sea ports based

This was not specified as a trigger

in 2012. A draft regulation was

finalized in 2012 but issuance was

uncertain due to the need for more

33

on traffic projections in order to establish

development plans for each individual sea

port for the next 20 years

consultations with stakeholders

Finalize the organizational

set-up for an INSW agency

that could be operated by the

private sector

The Borrower has decided the legal

nature of the agency to be created for the

management of the INSW system

This trigger has been adjusted. The Government has indicated that

the INSW agency should be a

public institution

B. Key Reform Directions and Policy Areas Supported by the Connectivity DPL

B.1. Policy Area I: Strengthening National Coordination and Regulation

a. Background

93. The Connectivity DPL has supported efforts to strengthen the policy coordination needed to

move forward on the connectivity agenda. The GoI has stepped up efforts to strengthen the inter-agency

coordination and decision-making process on connectivity. Through the issuance of Presidential Regulation

No. 32/ 2011, the GoI appointed the Coordinating Minister for Economic Affairs (CMEA) as the executive

chairman for implementing MP3EI, which makes connectivity an important pillar among a 3-pillar strategy

to accelerate growth and development in Indonesia. The regulation also provides a basis for the GoI to

ensure that various proposed policies and national strategies around connectivity, such as in the medium-

term development plan (RPJMN), the national logistics strategy (Sislognas), and the national transport

master plan (Sistranas), are coherent. Subsequently, the CMEA has established various inter-ministerial

teams11 involving the private sector in order to coordinate and implement different elements of MP3EI,

supported by a dedicated Secretariat (KP3EI). In this respect, the Connectivity Working Group led by the

Deputy Minister of Bappenas is playing an important role in coordinating policy actions.12

94. Nevertheless, a weak mandate in resolving bottlenecks on decisions over key priority

infrastructure projects can weaken public confidence to invest in connectivity infrastructure. Ideally,

there should be a cabinet-level institution or a senior minister with a mandate to coordinate and take

decisions on the implementation of large connectivity infrastructure projects. Indonesia had a successful

experience with the Recovery and Reconstruction Agency (BRR), which was responsible for coordinating

and implementing reconstruction efforts in Aceh after the 2005 tsunami. Similar institutional arrangements

applied to key infrastructure projects can help to send a strong signal that the Government is serious about

tackling bottlenecks in infrastructure development, such as the land acquisition process, project preparation,

and conflicting regulations across agencies or between central and local governments. The ability to address

bottlenecks in decision-making is crucial given that some of the projects are already listed as priorities under

MP3EI. The Government currently relies on the Committee for Accelerating Infrastructure Development

(KKPPI), an inter-ministerial coordination facility established by Presidential Regulation No. 42/2005,

designated to promote and champion infrastructure provision and coordination of infrastructure policy and

planning across line ministries, SOEs, and local governments responsible for project preparation and

implementation. However, KKPPI so far has not been able to perform optimally due to the absence of a

strong mandate to take decisions, too many members, and a lack of resources for its Secretariat. As a result,

there have been numerous cases of project delays, poor project preparation, and red-tape, all of which have

hindered the development of key infrastructure projects.

11

Through CMEA Regulation No.PER-06/M.EKON/08/2011, CMEA Decree No.KEP-35/M.EKON/08/2011 and CMEA Decree

No.KEP-36/M.EKON/08/2011. 12 These include working teams on: regulation, connectivity, human resources and science technology, and the six economic

corridors (Sumatra, Java, Kalimantan, Sulawesi, Bali and Nusa Tenggara, and Papua and Maluku islands).

34

95. The Connectivity DPL has also supported government efforts to introduce a clear and

transparent mechanism to channel public funds to viable PPP infrastructure projects. Both the

RPJMN 2010-2014 and MP3EI envision public-private partnerships (PPPs) playing a key role in mobilizing

private sector investment for infrastructure development. Despite recent efforts to establish a framework for

PPPs and pursuing several PPP transactions, progress has generally been slow due to various factors. These

include the poor quality of project preparation prior to bidding, a weak pipeline of bankable PPP projects,

and the absence of a consistent framework and procedures on the processing of PPP projects. In order to

address these key bottlenecks, the GoI has in recent years strengthened the institutional architecture

supporting PPPs and established dedicated agencies/policies. These include the Indonesia Infrastructure

Guarantee Fund, Indonesia Infrastructure Finance and SMI, Viability Gap Financing (VGF) program, and

more recently, the GoI is working to establish a PPP Unit and Project Development Facility (PDF). The

challenge now is to make these institutional mechanisms operational and well-coordinated. The

Connectivity DPL-1 supported the issuance of Finance Minister Regulation (PMK No. 223/2012), which

sets up Indonesia’s Viability Gap Financing (VGF) program as a mechanism to provide public sector

financial support to well-prepared PPPs in order to make them financially viable. The key next step is to

develop detailed operational procedures to implement the provisions of VGF PMK No. 223/2012 so that

VGF support can be channeled to well-prepared PPPs. Such an achievement will send an important signal

of the Government’s readiness and commitment to address the private sector’s concerns surrounding project

viability, while also fulfilling the Government’s objective of affordability.

b. Proposed Policy Actions

Reform aim: Strengthen policy coordination and reforms surrounding connectivity

96. The Government is currently working on a draft Presidential Regulation that would allow

KKPPI to accelerate delivery of key infrastructure projects. To this end, the government has allocated

budget in the FY2014 Financial Notes and Draft Budget to support a committee responsible for the

preparation of said priority infrastructure projects. Recently the Coordinating Ministry for Economic Affairs

has been tasked with drafting a Presidential Regulation to empower KKPPI with a more effective process in

making decisions and supporting infrastructure development. In particular, the new process will include only

the Head of Bappenas, the Minister of Finance, and the Head of the National Land Agency as team members

led by the Coordinating Minister for Economic Affairs. The revised decree is also expected to provide

KKPPI with the necessary mandate to make decisions on the implementation of key infrastructure projects.

To the extent that the Government wishes to increase the private sector’s participation in public

infrastructure investment, KKPPI will also have the resources to do project preparation and the power to

decide on the financing arrangements of proposed infrastructure projects (i.e., government investment, full

private sector, or PPP).

97. The GoI has established a clear, transparent market-based mechanism to promote

infrastructure PPPs. The World Bank has supported the GoI in developing a Viability Gap Financing

(VGF) program that will provide public sector financial support to well-prepared PPPs to make them

financially viable for greater market uptake. The GoI, with technical advice from the World Bank, is now

developing detailed operational procedures to implement the provisions of VGF PMK No.223/2012 that

established the VGF program in December 2012. The proposed operation provides strong support for the

operation of the VGF through Ministerial signing a Minister of Finance Regulation on operational

procedures to implement Minister of Finance Regulation No. 223/2012 on the channeling of government

funds to public-private partnership projects in infrastructure. The Regulation lays out clear eligibility criteria

for VGF support, VGF approval processes, VGF allocation and disbursement, and procedural and

documentation requirements of CAs and private investors to secure VGF support, as well as contractual and

monitoring arrangements. The Regulation also provides operational rules and procedures to guide the

allocation of public VGF contributions to carefully selected PPPs with high social/economic returns, and

35

introduce fiscal discipline. The proposed operation is therefore well-aligned with, and provides an additional

push to, the GoI’s efforts to implement the VGF mechanism. Specifically, the corresponding policy trigger

is the submission to the Minister of Finance of a draft MoF regulation on operational procedures to

implement VGF PMK No. 223/2012 for channeling government funds to infrastructure PPPs in order to

make them financially viable. It is noteworthy that the VGF mechanism does not entail contingent liability

to the Government, as the funding is subject to an appraisal process and will be of a specific amount that is

budgeted for annually, with disbursement based on construction milestones.

c. Expected results

98. The expected result from this policy area will be enhanced policy coordination and reforms

surrounding national connectivity, as demonstrated by the various GoI authorities taking timely and

appropriate measures to undertake the necessary reforms. This will be measured by:

Improved guidance in policy formulation in trade logistics reform;

Increased government effectiveness and rapidity in supporting priority infrastructure development;

and;

Establishment of an Indonesian VGF Program to attract private investments in PPP projects that

improve connectivity

B.2. Policy Area II: Strengthening Intra-island Connectivity

a. Background

99. The first Connectivity DPL supported the strengthening of the legal and regulatory

framework for the land acquisition process for public infrastructure projects. The previous operation

acknowledged the enactment of new Land Acquisition Law No. 2/2012 for Public Infrastructure and

Presidential Regulation No. 71/2012, which set the institutional arrangements for implementing the law. The

law marks an important development and significant improvement in the procedures for acquiring land for

public infrastructure. Areas of significant improvement surround the process for land valuation, the

mechanisms for grievances, and compensation for affected persons.13

In particular, the new regulation

governs the inventory of affected people and assets, the consultation process, compensation, and dispute

settlement. It also sets a specific timeframe for each of the acquisition stages and sub-stages, including the

maximum time that a court may take to resolve disputes related to land acquisition. The issuance of the law

and the Presidential Regulation is expected to promote greater clarity and transparency over the land

acquisition process, which will ultimately help to strengthen public confidence in the Government’s efforts

to push forward with public infrastructure investment, including those efforts aimed at improving

connectivity.

100. Issuance of technical guidelines, socialization, and capacity building are important

remaining issues in order to effectively implement the new regulatory framework to procure land for

public infrastructure. The Government aims to apply the new regulatory framework on new public

13

In 2012, the GoI issued several pieces of legislation relating to land acquisition to be carried out for projects of public purpose

(Law No. 2/2012 in January 2012; Presidential Regulation No. 71/2012 in August 2012; and technical guidelines issued by the

relevant ministries). These replaced previous presidential regulations that had been unable to support accelerated infrastructure

development in Indonesia while ensuring that people affected by the negative impacts of associated land acquisition were adequately

protected. Pursuant to Law No. 2/2012, Presidential Regulation No. 36/05 as amended is valid until 31 December 2014. The new

legislations procedure applies to the acquisition of land under the authority and control of the National Land Agency. If land needed

is under the authority of other ministries such as Ministry of Forestry, then before such land can be dealt with under the new

legislations procedure, it must be released from forest zoning pursuant to applicable forestry legislation or other relevant legislation

like mining, natural gas, etc

36

infrastructure projects.14

To support that, the government has tasked the National Land Agency (BPN) to

develop technical guidelines to process land acquisition for public infrastructure development. These are

critical guidelines for providing clarity on roles and responsibilities of BPN and relevant government

agencies to organize four stages of processing, namely planning, preparation, implementation, and transfer

of the acquired land. The guidelines are also important for establishing more detailed steps in the

identification and verification of affected persons and their assets, valuation, and payment of compensation.

Meanwhile, the Ministry of Finance and Ministry of Home Affairs have issued guidelines for the use of

central government or local government budget to cover operational expenses for acquiring land for public

infrastructure. The Coordinating Ministry for Economic Affairs has been coordinating efforts to socialize

the new regulatory framework to regional government agencies. These three guidelines are expected to play

a critical role in paving the way for pushing ahead priority public infrastructure projects, which in turn can

serve as a “demonstration effect” for other public connectivity infrastructure projects.

101. The first Connectivity DPL operation supported the GoI’s effort to restructure the railway

sector to become more competitive and responsive to public needs. Indonesia is laying the regulatory

foundation for moving from a state run, single railway operator, towards line-of-business railway model

with multi operators, private sector participation, and open access to railway infrastructures. Subsequent to

the enactment of Law No. 23/2007 on Railways, the previous Connectivity DPL operation supported the

Government’s issuance of Presidential Regulation No. 53/2012, which sets the institutional arrangements

and general rules for the provision of subsidized passenger services under public service obligations (PSO),

infrastructure maintenance operations (IMO), and track access charges (TAC) in the railway sector. The

Presidential Regulation serves as an important milestone to encourage operators in the sector to move

towards a line-of-business type of model (i.e., passenger service provider, freight service provider, railway

track operator).15

The new regulatory framework also opens up the Indonesian railway sector to private

investment, which is expected to increase competition levels in commercial cargo and passenger rail

services, and in the maintenance of railway infrastructure.

102. Nevertheless, there is a need for the Government to provide greater certainty over the sums

to be provided to the railway operator, in terms of PSO compensation. Ensuring minimum access to

reliable rail services for low-income passengers has a desirable impact from an equity standpoint and also

from an economic efficiency point of view as such passengers will be less likely to opt for less energy

efficient road transport.16

The Government requires the provision of PSO on passenger rail services for low-

income passengers at subsidized tariffs that are then reimbursed. However, past experience suggests that

there has been a lack of clarity in the process of reimbursing PSO on passenger rail services. This situation

has deteriorated service levels and undermined incentives for PT KAI and prospective operators to provide

PSO services. More importantly, a lack of credibility in reimbursing PSO services can undermine the

restructuring process in Indonesia’s railway sector as there will be much less incentive for the existing

railway operator to move away from the integrated railway business, which allows cross-subsidization from

cargo services to loss-making passenger services.

103. The absence of clear guidelines on reimbursing infrastructure maintenance and charging

access to railway track could weaken the restructuring process in the railway sector. Until this year,

these had been uncertainties as to whether the railway operator, PT KAI, would be compensated for

maintaining railway infrastructure, which covers tracks, bridges, railway crossings and signaling systems.

So far, the Government has taken a simplified approach by considering the IMO reimbursement to the rail

14

Meanwhile, land procurement for infrastructure projects that are currently on-going or were proposed prior to the new regulatory

framework will continue to be accommodated by the old law and regulations mentioned above until 31 December 2014. 15

This was initiated by the transformation of the state railway agency (Perumka), which operated railway services and owned

railway infrastructure, into a state-owned railway company (PT KAI) in 1999. Today, PT KAI only operates railway services and

maintains railway infrastructure on behalf of the Government. 16

Government estimated diesel consumption for railway and bus passenger transport are 0.002 litre/km/passenger and 0.012

litre/km/passenger, respectively.

37

operator, PT KAI, as being equal to the TAC that the Government should receive from PT KAI, without

considering potential increases in wear due to an increase in traffic volume or potential revenues from

providing track access to other prospective railway operators. The absence of any clear guidelines for

reimbursing infrastructure maintenance could seriously undermine the capacity of this railway infrastructure

to function properly, which in turn will also undermine safety. Therefore, the current practice of setting IMO

as being equal to TAC also undermines the process of PT KAI moving towards a line-of-business model and

discourages other prospective operators from participating in the provision of railway services.


Reform aim: Increase investor confidence and stakeholder participation in the national connectivity

agenda

104. The GoI continues to strengthen the regulatory framework for land acquisition for public

interest projects, which will help improve investor confidence in infrastructure investments, as well as

improve the due process and compensation standards for affected parties. Following the enactment of

Law No. 2/2012 and issuance of Presidential Regulation No.71/2012 on land acquisition for public purpose

development, the National Land Agency has assigned roles to, and has established the processes for, the

relevant agencies of the Borrower when acquiring land for public purpose development through the issuance

of technical guidelines (Regulation of the Head of BPN No.5/2012) to implement Law No. 2/2012 and

Presidential Regulation No. 71/2012. The guidelines stipulate: (i) organizational structure of the land

acquisition implementing team; (ii) compensation in emergency conditions; and (iii) coordination of the

implementation of land acquisition. To the extent that most of the land acquisition process happens at the

local level, the Government also needs to increase the capacity of BPN’s resources and staffing to

effectively implement the process of land acquisition for public infrastructure.

105. The GoI also clarified the financing mechanisms for land acquisition for public interest

projects. The GoI has issued a Minister of Finance Regulation (No.13/PMK.02/2013) stating which

expenditures related to land acquisition for public purpose development are eligible to be covered by the

national state budget, and a Minister of Home Affairs Regulation (No.72/2012) stating which expenditures

related to land acquisition for public purpose development are eligible to be covered by local government

budgets. Ministry of Finance Regulation No. 13/PMK.02/2013 stipulates: (i) operational and supporting

costs for implementation of land acquisition sourced from APBN (state budget); and (ii) establishment and

honoraria for the team. Whereas Ministry of Home Affairs Regulation No. 72/2012 stipulates: (i)

operational and supporting costs for implementation of land acquisition sourced from local government

budget (APBD); and (ii) determination of the price for implementation of land acquisition sourced from

APBD (provincial/regent/city budget). Altogether, these guidelines and regulations are expected to play a

critical role in paving the way for pushing ahead priority public infrastructure projects, which in turn, can

serve as a “demonstration effect” for other public connectivity infrastructure projects.

106. At the same time, the Government continues to socialize the new legal and regulatory

framework for land acquisition. In July 2013, Bappenas organized a workshop inviting BPN as the

initiator of the new law, and relevant ministries/state companies as the users of the new legislation, such as

the Ministry of Public Works, Ministry of Energy and Mineral Resources, and PLN, as well as development

partners (ADB, World Bank, and JICA), to better understand the likely effects of the new legislation. With

respect to the development partner-financed projects in particular, the possibility of using the country system

for land acquisition activities involving development partners’ projects was explored. Although it was found

that there is not much difference between the new legislation and development partners’ policy in

investment lending, there is a need to elaborate on the option for non-cash compensation during project

preparation, particularly in relation with land-to-land compensation or resettlement plans. The valuation of

38

compensation is mandated to be assessed by independent appraisers under MAPPI,17

with guidelines for

compensation involving market price, transaction and other costs, plus a premium (to cover costs over and

above the valuation, such as emotional loss). The Bank continues to collaborate with CMEA as the

Secretariat of the Socialization and Assistance Team for implementation of land acquisition for public

purpose development, which is responsible in coordinating and monitoring the implementation and

application of the new legislation. Furthermore, the Team organized a national workshop in April 2013 to

disseminate the new law and regulations to state and provincial-level companies, such as the power

company (PLN), gas, and the railway operator (PT KAI). Going forward, the Team plans to disseminate the

new law and regulations to judges at the Supreme Court, and to prosecutors at the Attorney General’s

Office, and policymakers in central and local governments. The Team will also continue to provide

facilitation in handling land acquisition problems and monitoring the land acquisition plan, as well as its

implementation.

Reform aim: Strengthen progress in restructuring of the railway sector

107. The Government continues with efforts to alter the incentive structures and regulatory

environment in the railway sector. Despite the issuance of Presidential Regulation No. 53/2012 on

provisions of PSO, at present there is no mechanism for calculating and reimbursing a PSO in railways.

Similarly, PT KAI as operator of rolling stock and rail has never received payment for maintaining public

rail track (IMO) from the Government as it has always been considered equal to the access charge that PT

KAI would have paid to the Government. The absence of clear guidelines will deter potential investors in

the railway sector. To address these concerns, the Minister of Transport has issued guidelines (Minister of

Transportation Regulations PM.10/2013 and PM.56/2013) for the provision and reimbursement of a Public

Service Obligation in the railway sector to provide affordable passenger railway services. Subsidies for PSO

per passenger are calculated based on the difference between the tariff per km per passenger (determined

using a MoT Regulation) and the (actual) fare per km charged to passengers (the fares are determined by the

Government) plus a reasonable margin. Meanwhile, the IMO is the cost of railway infrastructure

maintenance and operation that is the responsibility of the infrastructure operator or the Government, and

TAC is the cost of using the track that must be paid by rolling stock operators to the infrastructure operator.

The GoI has issued guidelines for the provision of (i) Infrastructure Maintenance Operation (Minister of

Transportation Regulation PM.67/2013), and (ii) Track Access Charges (Minister of Transportation

Regulation PM.62/2013) to support the restructuring process in the railway sector as mandated by Law No.

23/2007 and by Presidential Regulation (No. 53/2012). The regulations will be the basis for Government to

allocate public funds for PSO subsidies, payments for IMO and for calculating TAC to charge the rolling-

stock operators. For provisions of passenger PSOs in railways, the guidelines establish procedures by which

the Government can procure PSOs, process contracts, and ensure deliverables from railway operators. The

Government is also establishing clear definitions on eligible items or services that can be reimbursed by the

Government on services provided by railway operators for low-income passengers. Guidelines for TAC

establish a methodology for calculating track access charges for railway operators who wish to use public

railway facilities.

c. Expected results

108. The expected results from this policy area will be progress in intra-island connectivity that

will be measured by:

Greater clarity, certainty, and transparency in the land acquisition process for public infrastructure

projects;

Improved clarity and transparency in the provisions and reimbursement of a Public Service

Obligation (PSO) in the railway sector; and

17

MAPPI (Indonesian Society of Appraisers) is a professional organization of appraisers under supervising Ministry of Finance.

39

Improved clarity and transparency over reimbursement for Infrastructure Maintenance Operations

(IMO) and payment of Track Access Charges (TAC) in the railway sector

B.3. Policy Area III: Improving Inter-island Connectivity

a. Background

109. Expanding access to information and communication technology (ICT) is an efficient means

for connecting business or personal activities across Indonesia. Access to ICT has improved

considerably during the past decade, as a result of major investments by Indonesia’s

telecommunications/ICT industry. Access to basic telephone services has also improved considerably over

the past decade. Similarly, mobile networks have grown in terms of size, capacity and coverage, with both

Telkomsel and XL reporting more than 95 percent population coverage. As of Q1 2012, the total number of

mobile and fixed wireless had grown to about 282 million, with mobile penetration exceeding 100 percent of

the population.18

Access to broadband is increasing, particularly with regard to mobile broadband, with

about 100 million mobile internet users. Fixed broadband access is also increasing, albeit more slowly, with

PT Telkom being the only company allowed to offer ADSL services over fixed copper lines. The company

is approaching 2 million subscribers. These services are increasingly being offered not only in major cities,

but also at the kecamatan level throughout Java, Bali and Sumatra.

110. However, Indonesia faces significant challenges in order to meet the rapidly growing

demand for ICT. Demand for broadband internet, for instance, is accelerating throughout Indonesia,

ranging from large and small businesses, to universities, to government institutions. In eastern Indonesia,

Maluku and Papua have no terrestrial (e.g., fiber optic) backbone and are totally dependent on expensive and

limited capacity satellite connectivity. Hence, broadband access is very limited and restricted by a lack of

affordable capacity. Although ADSL and 3G have been deployed as access technology, providers cannot

offer sufficient broadband capacity due to the lack of infrastructure. Other access gaps are found in other

economically disadvantaged or geographically remote areas across the country. In order to meet the rapidly

growing demand quickly, Indonesia requires not only ongoing investments from the telecommunications

industry, but also proactive regulatory measures to increase the competitiveness of the fixed broadband

market. Without these measures, Indonesia’s broadband access gap will continue to grow. Specifically,

Indonesia will need to: (i) close the access gap by extending the reach of broadband internet to rural and

remote areas, particularly those that the industry considers as commercially unviable; (ii) develop “next-

generation” broadband networks, including high-speed communications fiber optic backbone infrastructure,

broadband access networks (including fiber optic access), and mobile broadband services wherever there are

mobile telephony services (over 95 percent of the population); and (iii) stimulate further investment in the

sector, including through private-public partnerships, by enhancing competition, maintaining the momentum

of policy and regulatory reform, and taking into account global trends in communications technology change

and market structures.

111. The previous Connectivity DPL supported an important mechanism to boost the process of

connecting remote areas with broadband services. The Government established the ICT Fund financed

by a levy on the telecoms industry of 1.25 percent of net revenues to support development of ICT

infrastructure to unserved or underserved areas in Indonesia that the industry considers commercially less

viable. Connectivity DPL-1 supported the issuance of Ministry of Communications and Information

Regulation No. 23/2012 on the use of the ICT Fund to support the development of broadband ICT

infrastructure in underserved areas in Indonesia. The decree marked an important step stimulating public

investment in ICT using fees collected from private operators.

112. Improving domestic sea freight is another critical area for Indonesia’s national connectivity. The archipelagic setting of Indonesia means that sea freight plays an important role in logistics chains. A

18 This reflects multiple SIM card ownership (typically 2), so the actual mobile user base is estimated to be closer to 135 million

persons (55 percent penetration).

40

significant proportion of the population and economic output are concentrated on the island of Java.

However, the lion’s share of deposits of natural resources and the production of raw materials are dispersed

in other areas/islands throughout the country. Meanwhile, regions on other islands are also experiencing

rapid urbanization as income per capita increases along with population. However, inter-island shipping

services in Indonesia are currently characterized by high costs and low levels of reliability, creating a major

constraint in the transportation of consumer goods to remote and often poor islands. These high costs are an

important contributing factor to the generally higher and more volatile prices of consumer goods in remote

provinces. They are also a constraint in bringing commodities to processing facilities and bringing products

to market (usually in Java and overseas). In order to improve inter-island connectivity, the key objective

should be to reduce the cost of inter-island cargo transportation and make this transportation more reliable.

For example, shipping a container from Jakarta to Banjarmasin (Kalimantan) on average takes 16 days.

However, there is considerable variation, with actual sailing times ranging from 4 to 47 days. This

uncertainty increases logistic costs of inter-island trade. Therefore, establishing an efficient and reliable sea

freight network across the archipelago is important for the Indonesian economy to facilitate domestic supply

responses to meet the increasing demand for goods. The challenge for Indonesia is to develop the necessary

infrastructure and regulatory framework to improve sea freight services, which help to link different nodes

or poles of production and consumption in different islands across the archipelago.

113. The Government realizes that upgrading the productivity of sea ports is an important

element in developing a more efficient and reliable sea freight sector. Poor productivity at the country’s

ports is believed to contribute to the high cost of domestic shipping and is likely to have undermined the

incentives for vessel operators to upgrade their fleets. According to Law No. 17/2008 on Shipping, the

Government should put in place incentives and a regulatory structure that facilitate efficiency in port

operations across Indonesia. The Government has since issued guidelines and regulations to restructure the

port sector, such as separating port operators from port authorities. The Government has also put forward a

procedure for tendering port development to the private sector or state-owned companies.

114. Nevertheless, progress in developing Indonesia’s port sector suffers from uncertainties over

the Government’s plans and priorities. The absence of a baseline assessment on port capacity, traffic

volumes and projection on traffic volumes based on regional and national development prospects have

caused differing views on where and what type of ports the Government should facilitate. The local

government once promoted Bojonegara in Banten as a location for an international port to replace Tanjung

Priok in Jakarta, and offered it for further uptake to potential investors. Meanwhile, there has been

uncertainty over whether Cilamaya in West Java will be considered as an alternative location for future

development of an international port to replace Tanjung Priok and serve the manufacturing belt in Bekasi,

Cikarang, and Cikampek. There is a need for the Government to establish an agenda for port sector

development that can act as a guide to the prioritization and strategy of individual port development plans.


Reform aim: Strengthen ICT connectivity between eastern and western Indonesia, and introduce

more competition in broadband services

115. Stimulating increased and more equitable access to ICT, particularly broadband internet, in

Indonesia requires a combination of supportive investment and regulatory measures on the part of

the Government. On the regulatory side, the GoI is undertaking various reforms such as: (a) the preparation

of convergent (non-service-specific) licensing to replace Telecommunications Law No. 36/1999; (b) the

introduction of updated regulations on infrastructure sharing; and (c) the revision of regulations on radio

spectrum (frequency) management, including reframing in the light of emerging needs. On the investment

side, as supported under the first Connectivity DPL, the Ministry of Communications and Information

issued Ministerial Regulation No. 23/2012 on the use of the ICT Fund to support the development of

broadband ICT infrastructure in underserved areas of Indonesia. This basically establishes a mechanism to

41

utilize the ICT Fund financed through a levy on the telecoms industry of 1.25 percent of net revenues, to

stimulate investment in unserved and underserved areas that the industry considers commercially less viable.

To ensure effective implementation of the ICT Fund, the Minister of Communications and Information has

completed the identification of the remote districts (kabupaten) to be covered by the ICT Fund and has

estimated the budget requirements for the first phase of telecommunications broadband projects to be

financed by the ICT Fund.. There is significant progress towards implementing the GoI's universal access

program for broadband, and represents the culmination of substantial work including technical, economic

and financial analyses and regulatory measures to address the country's "digital divide". The program is also

being implemented through a PPP mechanism, in itself a significant achievement.

Reform aim: Improve the policy environment for domestic sea shipping

116. Advancing the agenda of port development is an important pre-requisite for improving

domestic sea freight in Indonesia. In MP3EI and the National Logistics Blueprint, the Government has laid

out an ambitious plan to enhance connectivity between economic corridors through improvements in

domestic sea freight. To support this, the GoI has issued Minister of Transportation Regulation No.

KP414/2013 establishing the classification and location of all Indonesian sea ports based on traffic

projections in order to establish development plans for each individual sea port for the next 20 years. The

Regulation will serve as a basis for developing detailed investment plans for each individual sea port across

Indonesia. The Master Plan also indicates some policy changes and regulations needed to implement the

plan. This information is also important for stakeholders to anticipate policy changes and give their input to

the proposed regulations. From a policy sequence point of view, this is an important process for guiding

subsequent actions for prioritizing development, resource allocation, and signaling to the public and private

sectors about plans for the port sector. To support the task, development partners such as AusAID have

been providing technical assistance to help the Government prioritize policy in the port sector based on

projections of traffic demand for containers and bulk freight across regions in Indonesia.

c. Expected results

117. The expected results from this policy area will be improved inter-island connectivity, as

demonstrated by:

Progress made in the development of broadband services to remote and under-served areas in

eastern Indonesia; and

Progress made in the development of individual ports.

B.4. Policy Area IV: Improving International Connectivity

a. Background

118. International connectivity is a key factor if Indonesia is to maximize the benefits of

globalization. Improving efficiency in international connectivity enables domestic products to reach foreign

markets at competitive prices. It also enables domestic manufacturers and consumers to obtain imported

inputs and consumer goods at good prices and according to schedule, which is important in the global

economy where just-in-time production and delivery are increasingly valued. Currently, high transaction

costs due to port inefficiencies, congestion, and border transactions are the largest obstacles preventing

Indonesian businesses from fully benefiting from globalization. These inefficiencies also make it necessary

for manufacturers to keep larger stocks in warehouses than would be optimal, driving up inventory costs.

Although Indonesia has demonstrated improvements in facilitating trade, the capacity of physical

infrastructure and public institutions in facilitating the movement of goods across borders is lagging behind

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Indonesia’s major regional competitors. The ability to move goods and services across borders rapidly,

cheaply, and with a high degree of predictability, is a critical determinant of export competitiveness.

119. Growth of the export-import trade and the lack of handling capacity in Indonesian ports

have led to longer dwell times. Currently, the dwell time in the port of Jakarta (which handles more than 70

percent of Indonesia's external trade) is more than 8 days, which is longer than that in ports in other ASEAN

countries. In Indonesia, dwell times are long mainly because of the considerable length of pre-clearance (the

time needed to prepare the Customs declaration). Many processes during pre-clearance have to be done

sequentially and cannot be done in parallel. In addition, there is a delay because most pre-clearance

activities can only be undertaken after the ship has arrived in the port of Jakarta. The Government has

already established an informal team, chaired by Customs, which aims to identify the bottlenecks to reduce

pre-clearance. Subsequently, the team aims at regulatory reform to reduce the pre-clearance dwell time. So

far, efforts have borne little success and it remains necessary for Indonesia to continue learning from

regional practices, given that several neighboring countries have been able to reduce the length of their

dwell times successfully. Key policy instruments used by neighbors include a greater participation by the

private sector in the management of terminals, which has promoted competition, better formulation of

measures affecting trade, and the introduction of dry ports at which some of the import clearance process

can take place, rather than in the congested ports themselves.

120. In Connectivity DPL-1, the Bank supported the reform initiative on the INSW as the main

portal for facilitating cross-border trade. INSW is part of an ASEAN regional trade facilitation initiative

introduced in 2007 to reduce face-to-face interaction in customs clearance by facilitating data exchange for

import/export documents for clearance across different border agencies. The launch marked a major step

towards reducing the time for importing and exporting, and is expected to strengthen Indonesia’s trade

competitiveness. Further development was conducted in stages, and currently 18 permit/license issuing

agencies (fewer than 15 ministries/government agencies) are participating as they grant permits or licenses

for export or import with at least 48 different export documents, 106 different import documents and 23

supporting documents. Currently, six ports and three airports, which together represent about 80 percent of

Indonesia’s total international trade volume, have implemented the INSW system. About 8,279 users

(exporters, importers, customs brokers) have registered and obtained user-IDs from the INSW system. In

2012, the Government amended the Presidential Decree to make INSW the only single reference portal for

cross-border trade regulations in the Customs clearance process.

121. Sustaining INSW requires proper institutional arrangements and great participation from

government border agencies. Currently, INSW is temporarily coordinated by an ad-hoc team and

implemented by Customs as the leading agency in border clearance processes for trade. To ensure effective

operation of INSW as mandated by the regulation, the Government has decided to form a dedicated agency

to manage INSW. This arrangement is expected to strengthen the ability of INSW to focus on developing a

system for facilitating trade involving many agencies, not only focused on Customs clearance. Another

important implementation issue is the single-submission and/or sign-on, which provides ease in processing

exportation/importation clearances through a single user-ID. The in-house system of the Food and Drug

Supervisory Agency (BPOM) implemented a single-sign-on (SSO) facility in December 2011. The in-house

systems of two other key permit/license-issuing agencies, the Ministry of Trade and the Agency for Plant

Quarantine (under the Ministry of Agriculture), implemented this in 2012, with other permit/license-issuing

agencies to follow in 2013. A recent review by the Presidential Monitoring Unit (UKP4) shows that the SSO

for procedures of the Ministry of Trade and Plant Quarantine has been succesfully concluded.

43


Reform aim: Reduce the time needed for and the cost of importing and exporting

122. A clear organizational set-up for the INSW will be needed as it will play an increasingly

significant role in facilitating trade in the coming years. The first Connectivity DPL supported the GoI’s

effort to provide more clarity and transparency in trade regulations by amending Presidential Regulation No.

10/2008 through the issuance of Presidential Regulation No. 35/2012 to make the INSW system the single

reference portal for cross-border trade regulations in the Customs clearance process. This entailed the

issuance of Presidential Regulation No.35/2012 in March 2012 on the usage of ICT in the

establishment/development/implementation of the INSW system. With this, all regulations will be

incorporated into the INSW list of trade regulations and made accessible to the public, and users will be

informed whether or not their exportation/importation requires permits/licenses for clearance. This offers

ease and requires less time to process the clearance. Furthermore, as the INSW needs to be implemented

efficiently, the GoI has decided the legal nature of the agency to be created to manage the INSW system. In

September 2013, discussions were held with relevant public stakeholders to determine the appropriate lay-

out of the agency. This proposal is expected to go through further series of policy dialogues and

consultations involving various stakeholders before being finalized, and is expected to move forward

together with the recently started modernization process in the Customs ICT system.

123. Single-submission and sign-on are the final goals of the INSW, which will facilitate speedier

import/export clearance processes. In this context, a trader will be able to seek import/export clearance by

submitting all data required by each clearance agency with a single sign-on of the INSW portal. With those

features, the INSW system will significantly improve the efficiency of the cargo clearance process, reducing

costs for exporters/importers and in turn strengthening competitiveness in trade logistics. The GoI therefore

has introduced the Drug and Food Supervisory Agency (BPOM), one of the major issuers of import/export

permits, into the INSW using the Single Sign-On (SSO). This has allowed exporters/importers now using

only a single-user ID to access the INSW/BPOM in-house system, since December 2011. The Coordinating

Minister for Economic Affairs has expanded the Indonesia National Single Window System by linking the

requests for permits made to the Ministry of Trade and the Agency for Plant Quarantine through the Single

Sign-On Mechanism to streamline and make more efficient the export and import processes and the

quarantine procedures. The Ministry of Trade connected its INATRADE portal, which manages the issuance

of trade permits, with the INSW through SSO in 2012. Meanwhile, after establishing an SSO manual in

2012, in 2013 the Agency for Plant Quarantine finally used SSO to connect its portal with the INSW.

c. Expected results

124. The expected results from this policy area will improve customs and border management in

facilitating trade as measured by:

Improvement in the management of the INSW system; and

Improved processes in submitting documents for customs clearance process through the INSW

system.

C. Future Operation

125. The Government has recently indicated the likelihood of extending the DPL series from two

to three years, thereby continuing the DPL operation in 2014. The Government is presenting its

financing needs and desired composition for 2014, consistent with its debt-management strategy that reflects

macroeconomic volatility. The Government has indicated that it will likely continue the INSTANSI DPL

engagement by extending the series until 2014, when the elections and change in government administration

are expected to take place. In that regard, a set of tentative policy actions for a possible subsequent

INSTANSI DPL operation have been tentatively identified and will continue to be developed in consultation

44

with the GoI. As demonstrated in the past, the ownership and commitment to these reforms are expected to

continue, despite the imminent change in the administration.

Table 6: Potential Indicative Triggers for a Possible Connectivity DPL-3 Operation No. Indicative Triggers for 2014


1. Introduction of a new process by which the Government can accelerate the delivery of key connectivity

infrastructure projects

2. Establishment of set of logistics indicators to monitoring reform progress in trade logistics


3. Establishment of Task Force to monitor implementation of land acquisition process for public infrastructure

4. Establishment of an-interim Task Force to coordinate development of transportation infrastructure

development and service provisions in Jabodetabek


5. Establishment of individual port master plans

6. Finalized draft regulation on sharing of ICT bottleneck infrastructures


7. Begin the transformation of current INSW management towards an INSW Agency

8. Implementation of action plan to reduce import dwell time in Tanjung Priok

VI. OPERATIONAL AND IMPLEMENTATION ISSUES

A. Monitoring and Evaluation

126. Monitoring the implementation and attainment of the Connectivity DPL prior actions is

done through regular meetings between the GoI and development partners, as well as the ongoing

engagement with agencies responsible for different prior actions. The GoI has established monitoring

committees and/or technical groups that are responsible for ensuring the implementation of agreed prior

actions, as well as progress follow-up. In addition, the DPL benefits from regular joint development partner-

Government meetings to discuss interim progress in achieving agreed milestones in the reform agenda and

future triggers for the DPL series and ongoing policy dialogue between the GoI and World Bank teams.

127. With the overall monitoring plan in place, it is anticipated that assessing the results of the

Connectivity prior actions in achieving their expected outcome will be relatively straightforward in

many cases. Annex 2 provides expected outcome of the Connectivity DPL prior actions and how progress

towards achieving the expected outcome will be measured. The Bank will work closely with the relevant

agencies to monitor and assess reform progress and impacts during the life of the program. In addition to

ongoing monitoring of activities, the Bank prepares an Implementation Completion and Results Report

(ICR) at the end of each series. The ICR, prepared in consultation with the Government and development

partners, is a Bank self-evaluation reporting tool that highlights the key achievements and results, as well as

lessons learned.

B. Consultations

128. Democratic consolidation, free media, and decentralization of authority in Indonesia have

translated into a political preference for wide buy-in and participatory, consensus-building

approaches to decision-making, not only in terms of regulatory reforms but also planning and

45

budgeting processes. While this is believed to have slowed or blunted some reform measures, it is also

believed to mitigate against radicalism, steadily improve public participation, and contribute to more

democratic, accountable, professional and responsive governance. This commitment has been formalized

and endorsed through several regulations (e.g., Law No. 25/2004 on National Development Planning and

Joint Ministerial Decree 2006 and 2007 on Musrenbang), including those institutionalizing the creation of

multi-stakeholder consultation forums, or Musrenbang (Musyawarah Rencana Pembangunan) at all levels,

concerning several time frames. Musrenbang is the principal process for negotiating, reconciling and

harmonizing differences between government and nongovernment stakeholders, and reaching collective

consensus on development priorities, including regulatory reforms and the 2012 budget. While challenges

still remain, the instrument is being increasingly adopted at all government levels. Finally, the democratic

environment in Indonesia has significantly strengthened the role of media and civil society organizations in

providing critical feedback on all government programs.

129. The policy actions supported under the Connectivity DPL-2 have been subject to

considerable consultations with stakeholders. The supported policy actions are drawn largely from the

Government’s overall development program, which had been discussed and had gone through a series of

consultations with stakeholders. The process of democratic consolidation also allows the Parliament (DPR)

to provide checks and balance by holding hearings with the Government and civil society organizations

before passing laws, as in the case of the Railway Law in 2007 and the Land Acquisition Law in 2012. With

decentralization of authority, the central government facilitated a series of consultations with local

governments to refine the draft presidential regulations for establishing an urban transport authority in

greater Jakarta. The Indonesian Chamber of Commerce and Industry (Kadin) is also actively providing input

on the implementation of the INSW. Kadin is also included as a partner in implementing the National

Logistics Blueprint. Extensive consultations were also held with the relevant government ministries to

discuss the establishment of the Connectivity DPL and to identify prior actions throughout the preparation of

the operation. A roadmap of milestones was then developed, which conforms to the Government’s own

reform agenda, as laid out in the DPL program matrix in Annex 3. This program matrix will continue to be

adjusted and refined as progress continues to be assessed and discussions mature.

C. Environmental, Poverty and Social Aspects

130. The specific country policies supported by this operation focus on upstream policy reform,

strengthened processes, improved budgeting, and enhanced national connectivity. Over the medium

term, these policy reforms are expected to lead to specific investments in key infrastructure sectors, which

can have significant environmental and social effects that need to be carefully assessed and managed.

131. In the Bank’s assessment, the GoI has laws, institutions and systems in place for reducing

adverse effects and enhancing positive effects. The GoI’s legal, institutional and procedural systems for

assessing, addressing, and mitigating environmental effects is well established and adequate under Law No.

32/2009 and its predecessors, as well as through the environmental impact assessment (AMDAL) process.

These systems are being continuously strengthened through ongoing capacity building and technical

assistance. The GoI has long-standing and well-regarded collaborations with the Governments of Germany,

Denmark and Canada on programs of this nature. The Bank also has extensive engagements with the GoI

on the specific policy issues supported under this operation, including at the national coordination level, on

transport and infrastructure, and on environmental issues. The Bank assisted in upgrading the legal and

institutional capacity of the Ministry of Environment through a series of loans in the 1990s and has more

recently provided grant-financed TA on improving the implementation of the AMDAL process at the

decentralized level.

132. In addition to the environmental effects described above, specific downstream investments

requiring land acquisition for public infrastructure projects may have negative social effects that will

need to be reduced and significant positive social effects that will need to be enhanced. The new

46

regulatory legislation does not cover squatters without good faith, while renters and laborers are also not

covered. If they are squatting on private land the compensation is the responsibility of the land owner.

Parties in possession on state/public land with good faith are recognized by the new legislation and eligible

for compensation; therefore, final compensation is the result of negotiation. In the past, the relevant agencies

of local government have a right to assess the value of compensation for affected non-land assets, while the

affected land is valued by the licensed appraisal. Local government valuations were frequently below market

price; these low valuations have often been the most significant points of contention between the World

Bank’s, as well as ADB’s, safeguard policy requirements, and local governments and implementing

agencies. MAPPI gave an opportunity to the Bank to share its draft guidelines of compensation and the

Bank supports the guidelines where the value of compensation reflects the market price plus transaction and

other costs, plus a premium (to cover costs such as emotional loss). This approach would make those

affected by land acquisitions better off after the process has been completed.

133. These processes are being strengthened, including through support by development

partners. ADB, which is also a partner in this policy operation, is establishing a technical assistance

program for capacity building to improve national consistency in the implementation of these rules.

The Bank is also working on land acquisition in several of its investment projects (separate from this

Connectivity DPL), which provide opportunities for hands-on engagement in capacity development to

support land acquisition processes in line with best practices.

D. Gender

134. Whilst the proposed Connectivity DPL-2 is considered to be gender neutral as a whole, it

may bring significant changes to women’s lives by providing more access to important public services,

such as education, health, job opportunities and markets. The proposed Connectivity DPL-2 is expected

to further expand households’ livelihoods and incomes. Studies suggest that better connectivity has

increased women’s mobility for better education and work and increased incomes, which in turn assist poor

households, especially female-headed households (FHH), to overcome poverty and in coping with economic

shocks. A recent study using census data 1995 and 2005 (SUPAS) shows that better connectivity has

increased women’s mobility to Jakarta from the Bodetabek suburban areas (Bogor, Depok, Tangerang, and

Bekasi).19

The study suggests that better connectivity significantly increased numbers of both women and

men commuters from Bodetabek to Jakarta in 2001-05. Better connectivity provided better access for

women to commute for educational reasons and increased the number of women commuting for work. A

survey on rural women groups in Indonesia shows that women have been able to earn additional incomes

through their increased access to internet through which they acquired skills in manufacturing superior

products or providing services. In addition, better connectivity will further assist in the delivery of support to

women survivors of violence. Indeed, in its most recent reports on cases of violence, the National

Commission on Violence against Women in Indonesia (Komnas Perempuan) identified domestic violence at

the top cause of cases of violence in Indonesia, wherein women are mostly the survivors that need

assistance. Furthermore, the proposed Connectivity DPL-2 also supports the RPJMN 2010-2014 goal of

enhancing gender equality in development. The background study on gender equality for RPJMN IV, to

which the Bank provided technical support, identified increased access to public services, especially health,

and to market and economic opportunities, along with women’s protection against violence, as among the

key priorities.

19 Sri Hartini Rachmat, Ardi Adji, and Dendi Handiyatmo, 2012, on the “Gendered patterns of urban commuting with better

connectivity in Jakarta megapolitan area”.

47

E. Fiduciary Aspects, Disbursement and Auditing

135. Public financial management (PFM) is a central policy area for the GoI that is supported by

the Bank’s ongoing DPL series. The Fiduciary Assessment for Indonesia has been carried out and the

Fiduciary Risk is rated as Moderate. This discussion and the conclusions therein are appropriate for the

proposed Connectivity DPL-2.

136. In summary, significant strides have been made in recent years in the way Indonesia’s

public finances are managed and in increasing transparency and independent oversight. In the past

three years, progress has been made in the area of budget execution, with the development of a unified

budget and a Treasury Single Account (TSA) to strengthen the comprehensiveness and control over

spending and cash management. In addition, there have been improvements in the coverage of fiscal

accounts, accounting practices, payroll, internal controls and fiscal risk management. Notably, the 2009

audit report was the first to achieve a qualified audit opinion, as opposed to a disclaimer, with around 40

percent of ministries and agencies achieving unqualified audit opinions. Since then, the audit report has

continued to be qualified. However, the number of ministries and agencies receiving an unqualified opinion

increased to over 70 percent for FY 2012. Further improvements are required in several areas including

refinement in performance-based budgeting, strengthening internal and external audit, and improving

spending outturns. Weaknesses in financial management and accountability continue to be gradually

addressed through the Government’s PFM reform program. Also, key elements of the reforms are supported

by the DPL series, as well as the GFMRAP project and other initiatives supported by development partners.

Furthermore, the Government has also demonstrated increased focus on budget transparency by publishing

the annual budget in a timely manner, through the MoF website.

137. The borrower is the Republic of Indonesia and this operation is a single-tranche IBRD loan

of US$300 million. The loan will be made available upon loan effectiveness, provided that the Bank is

satisfied with the progress achieved by the Borrower in carrying out the Program and with the adequacy of

the Borrower’s macroeconomic policy framework. The Government has confirmed that Indonesia will

borrow this amount as a Variable Spread Loan (VSL) in US dollar currency with an annuity repayment

schedule linked to commitments.

138. The loan disbursement will follow the standard Bank procedures for Development Policy

Lending. The loan amount will be disbursed into a foreign currency account of the borrower at Bank

Indonesia that forms part of Indonesia’s official foreign exchange reserves. The equivalent rupiah amount

will immediately be transferred to the General Operational Treasury (SBUN) account of the borrower that is

used to finance budget expenditures, as the loan is intended to be used to support the general Government

budget. This arrangement has been followed for the previous DPLs. The borrower, within 30 days, will

provide to the Bank a written confirmation that this transfer has been completed, and provide to the Bank

any other relevant information relating to these matters, including the exchange rate of the conversion from

US dollars to rupiah, that the Bank may reasonably request. Disbursements of the loan will not be linked to

any specific purchases and no procurement requirements have to be satisfied, except that the borrower is

required to comply with the standard negative list of excluded items that may not be financed with Bank

loan proceeds, as defined in Schedule 1 to the loan agreement. If any portion of the loan is used to finance

ineligible expenditures as so defined in the loan agreement, the Bank has the right to require the

Government to promptly, upon notice from IBRD, refund the amount equal to such payment to the Bank.

Amounts refunded to the Bank will be cancelled from the loan.

139. The foreign exchange control environment is assessed to be generally satisfactory. The

country is no longer subject to the Extended Arrangement from the IMF. Bank Indonesia (BI) was last

subject to the transitional procedures under the Fund’s safeguards assessment policy in 2002. That

assessment recommended remedial action to address a number of vulnerabilities in the audit arrangements

of Bank Indonesia. The main recommendations have been implemented, including the establishment of an

48

independent audit committee at Bank Indonesia and the publication of Bank Indonesia’s audited financial

statements. Audited financial statements for Bank Indonesia for 2012 have been reviewed and the audit

report issued by the BPK contained an unqualified opinion.

F. Risks

140. Macroeconomic risks could disrupt the potential to implement the reforms supported

through the Connectivity DPL-2. Recently, Indonesia has seen increasing pressures on its external

accounts, with the current account deficit widening after a negative terms-of-trade shock and international

financing conditions becoming more uncertain. Recent shifts in market sentiment have resulted in sudden,

large and potentially disruptive reversals of capital inflows. The external accounts and growth outlook

remain sensitive to softening global commodity prices and demand, particularly from China. With portfolio

investors focusing on near-term policy responses, there is a risk that this diverts attention from longer-term

reforms. However, the GoI has adopted key policy measures aimed towards improving national

connectivity, as supported by the ongoing DPL series, which are expected to help shield the risk of a crisis,

and mitigate the impact of any economic downturns on households. The Government has developed a track

record in precautionary and proactive measures to try to counter such shocks. This includes, for example,

policy measures supported under the PERISAI DPL, approved in May 2012, which, along with parallel

facilities from other development partners, also explicitly aims to mitigate GoI financing concerns in the

face of a crisis. The Government has also been quick to introduce a package aimed primarily at longer-term

structural measures to support exports and employment, moderate import growth, while limiting food price

pressures. This has been accompanied by a tightening in monetary policy. There remain questions over the

implementation of the policy package and it is likely that further policy adjustments will be required.

However, there is the potential that the current macro-economic pressures that Indonesia is facing could

allow policymakers the opportunity to make progress on medium-term structural reforms, although this must

be offset against the political pressures in the run-up to the 2014 elections.

141. Bureaucratic complexity can hinder coordination and implementation of reform agenda in

Connectivity. First, the multiplicity of implementing agencies and their varying institutional capacities

could create a challenge in coordinating and implementing the reform efforts. Second, overlapping

authorities among national and local governments in setting policies affecting domestic connectivity, such as

infrastructure investment and transport policy can slow down or even derail policy reforms. Although the

proposed Connectivity DPL is expected to help address this critical issue, the results of such reform process

will largely depend on priorities that were developed and consensus involving the various agencies and

stakeholders. Third, the Connectivity DPL will engage agencies that have not been regularly participating in

previous DPL programs. All of these challenges will increase as the election period approaches and

uncertainty over institutional roles in the next administration increases. To mitigate those risks, the proposed

actions under the first pillar of this DPL are expected to strengthen inter-agency coordination and

effectiveness in the policymaking process. Equally important, the Connectivity DPL series has benefited

from a high level support from the Deputy Minister of Bappenas, who is also the Chair of the Connectivity

Working Group, to ensure that the reform agenda spelled out in this DPL is on track. Past experience also

indicated continued GoI commitment to reforms overall, regardless of the election outcome.

142. Coordination problems and inconsistencies in implementing regulations could potentially

disrupt the Government’s achievement of its medium-term development objectives. Regulatory

certainty is a key driver of investment, as firms need to rely on a consistent policy environment in order

make decisions on whether to invest or expand their businesses. As such, it is critical that the Government

ensures a consistent policy environment if Indonesia is to meet its medium-term economic development and

poverty reduction goals. A key challenge in this area is policy coordination among various government

agencies. In the past year, however, recent policy announcements have raised some concerns about the

direction of trade and investment policymaking. These measures include, for example, restrictions on

imported horticulture products and new divestment regulations and processing requirements in the mining

49

sector. While the aims of these policies may originate in the development objectives of promoting domestic

productivity, jobs and growth, their presentation, which has often been changing, highlights coordination

and communication issues. As well as the uncertain effectiveness of these policies to meet the stated

objectives, there is concern that the expansion of such policies could weaken the confidence of investors in

the domestic economic outlook. The risk to the Connectivity DPL is that the continuation of such policies,

along with other perceived "policy missteps", and could weaken some of the confidence of investors in

domestic policymaking, potentially offsetting some of the benefits of the reforms supported in this

operation. The DPL program, along with the Bank’s technical assistance on trade and investment climate, is

expected to help put in place the platform for policy dialogue with key GoI counterparts, contributing to

stronger GoI coordination and consultation on key reform areas, thereby providing more regulatory

certainty.

143. While the new regulatory framework on land acquisition for public use represents a

substantial improvement over the previous process, and should make a positive contribution to

development objectives, there are some risks associated with the coordination of executing agencies to

fully meet the spirit of the new legal framework, including interpretation of the new legal framework

among the various government levels. For acquisition of private lands for public infrastructure, the new

regulatory framework deals only with legitimate owners of such private lands and not with people living

without formal title on private lands. Although the regulatory framework mentions cash or relocation as

options for compensating squatters living in state lands, the absence of a clear process for the government to

facilitate relocation will likely to cause the government to rely mostly on cash compensation. Nevertheless,

the new legal framework for land acquisition for public use provides greater certainty, due process, and

compensation for people whose land is acquired by the Government, pursuant to the referred framework,

including recognizing squatters in good faith on state lands. The implementing regulations that were recently

issued also provide more clarity over implementation of the new legal framework. While these represent

positive developments, many challenges remain. Several civil society organizations voiced concerns over

aspects of this framework and brought a legal challenge to the Constitutional Court, which was ultimately

ruled against. That challenge, which itself is a sign of the maturation of Indonesian institutions, may well

result in an even more inclusive and transparent implementation of the legal framework for land acquisition

for public use by the Government. The National Law Agency (BPN) has been selected as focal point for

implementing the process of land acquisition for public use. The Government of Indonesia is improving

BPN’s capacity through development and training programs to strengthen the implementation of the land

acquisition process for public use at all levels.

50

Annex 1: Letter of Development Policy

51

52

53

54

55

56

Annex 2: Connectivity DPL Two-Year Program Policy Matrix and Results Framework

Reform Aim No Policy Actions supported by

the First Connectivity DPL (by

September 2012)

Prior Actions supported by the

Second Connectivity DPL (by

September 2013)

Results Indicators

Pillar 1: Strengthening National Coordination and Regulation Indicator Baseline and Target

To strengthen

coordination

of policy

reforms

surrounding

national

connectivity

1 The Borrower has issued a

Presidential Regulation (No.

26/2012) establishing the

Borrower's national logistics

system blueprint and the

Coordinating Ministry for

Economic Affairs has issued a

Ministerial Decree (No.

49/2012) establishing the

working team that will

coordinate, monitor and

evaluate the implementation of

the national logistic system

blueprint, in support of the

connectivity agenda

Improved guidance in

policy formulation in

trade logistics reform

Baseline: As of 2011, the

absence of a national

framework caused policies on

trade logistics to be driven by

ad-hoc sectoral regulations

Target: By end of 2014

National Logistics Strategy

have been internalized by

relevant agencies for

formulation and identification

of policy reforms agenda in

trade logistics

To establish

transparent

processes for

channeling

public funds

to viable

connectivity

infrastructure

PPP projects

for further

market uptake

2 The Fiscal Policy Office of the

Borrower’s Ministry of

Finance has submitted a draft

Ministerial Regulation to the

Minister of Finance

establishing the mechanism for

channeling Government funds

to PPP in infrastructure.

The Borrower has signed a Minister

of Finance Regulation on operational

procedures to implement Minister of

Finance Regulation No. 223/2012 on

the channeling of government funds

to public-private partnership

projects in infrastructure.

Establishment of

Indonesia VGF

Program to attract

private investments in

PPP projects that

improve connectivity

Baseline: As of 2012 no PPP

project has benefited from such

a mechanism

Target: VGF is budgeted in the

2014 Budget and used to make

at least one infrastructure PPP

project that was brought to the

MoF for VGF support

processed through the VGF

lifecycle to make it financially

viable and thereby advancing

development of privately

financed infrastructure

57


To improve

investor

confidence

and

stakeholder

participation

in the

national

connectivity

agenda


land acquisition Law (No.

2/2012) and a Presidential

Regulation (No. 71/2012) on

land acquisition for public

purpose development.

The Borrower, through the National

Land Agency, has assigned roles to,

and has established the processes for,

the relevant agencies of the Borrower

when acquiring land for public

purpose development through the

issuance of technical guidelines

(Regulation of the Head of BPN

No.5/2012) to implement Law No.

2/2012 and Presidential Regulation

No. 71/2012.

Greater clarity,

certainty, and

transparency of the land

acquisition process for

public infrastructure

projects

Baseline:

As of 2011 there was

uncertainty concerning the cost,

compensation level, and length

of the land acquisition process

for public infrastructure

projects

Target:

By the end of 2014, adoption

and effective application of the

provisions in the new legal

framework on land acquisition,

in particular on due process,

public notice, compensation,

independent review of pricing

of affected assets leading to a

speedier and less conflict-

ridden process of land

acquisition for public purposes

4 The Borrower has issued a Minister

of Finance Regulation

(No.13/PMK.02/2013) stating which

expenditures related to land

acquisition for public purpose

development are eligible to be

covered by the national state budget,

and the Borrower has issued a

Minister of Home Affairs Regulation

(No.72/2012) stating which

expenditures related to land

acquisition for public purpose

development are eligible to be

covered by local government budgets.

To strengthen

the

restructuring

process of the

railway sector

to make it

respond better

to growing

demand for

better

services and

improved

accessibility

5

The Borrower has issued a

Presidential Regulation

(No.53/2012) on Public Service

Obligation in railway services,

reimbursement of

infrastructure maintenance

operation, and track access

charges, which serves as a

catalyst for implementing the

first step to separate assets of

the state-owned railway

company (PT KAI) and move

towards a line-of-business

management structure

The Borrower has issued guidelines

(Minister of Transportation

Regulations PM.10/2013 and

PM.56/2013) for the provision and

reimbursement of Public Service

Obligation in the railway sector to

provide affordable passenger railway

services.

Improved clarity and

transparency in the

provisions and

reimbursement of a

Public Service

Obligation (PSO) in

railway sector

Baseline: As of 2011 PSO

calculations were negotiated

and therefore imposed great

uncertainty on the railway

operator

Target: By the end of 2014

PSO service by the railway

operators are compensated

based on the calculation

method determined in Minister

of Transport guidelines, which

provides certainty on the

amounts to be received and thus

58

the possibility to undertake

service improvements

6 The Borrower has issued guidelines

for provision of (i) Infrastructure

Maintenance Operation (Minister of

Transportation Regulation

PM.67/2013), and (ii) Track Access

Charges (Minister of Transportation

Regulation PM.62/2013) to support

the restructuring process in the

railway sector as mandated by the

Borrower’s Law No. 23/2007 and by

Presidential Regulation (No.

53/2012).

Improved clarity and

transparency over

reimbursement for

Infrastructure

Maintenance Operation

(IMO) and payment of

Track Access Charges

(TAC) in the railway

sector

Baseline: As of 2011, the

Government considered

expenses for IMO by the

railway operator equals the

TAC that the Government

should received

Target: By the end of 2014, the

Government has included

provisions of IMO in the State

Budget which will provide

funds for infrastructure

maintenance and trigger the

need to pay TAC. This in turn

will lay the background to open

access to rail infrastructure for

different operators

59

To improve

planning and

implementati

on of public

road

investment

7 The Borrower has issued DG

Highways Circular

(No.06/SE/06/2012), which

recommends the use of

performance based

contracting for any road

project and has started to

award contracts using the

referred performance based

methodology.

Acceptance by DG-

Highway of a

performance-based

contract to support

more efficient

management of national

road maintenance and

rehabilitation

Baseline: As of 2011, road

maintenance and rehabilitation

are mostly carried out by force

account (managed by DG-

Highway) and there is no

performance-based contract

(except for two pilots)

Target: By the end of 2014,

Performance-based contracts

will be used for at least 50 km

of the national road network,

leading to better maintenance

of road and greater satisfaction

of users


To close the

“digital

divide”

between East

and West

Indonesia

through

development

of broadband

services to

Eastern

Indonesia

8 The Borrower, through the

Ministry of Communications

and Information Technology

has issued a Ministerial

Regulation (No. 23/2012) on

the use of the ICT Fund to

support the development of

broadband ICT infrastructure

in underserved areas in

Indonesia.

The Borrower has completed the

identification of the remote districts

(kabupaten) to be covered by the ICT

Fund and has estimated the budget

requirements for the first phase of

telecommunications broadband

projects to be financed by the ICT

Fund.

Progress made in the

development of

broadband services to

remote and under-

served areas in eastern

Indonesia

Baseline: As of 2011, ICT

Fund was not used due to

absence of implementing

guidelines


completion of tender processes

for the ICT Fund to support the

first phase of broadband

development to underserved

areas in eastern Indonesia

60

To

strengthen

development

of the

roadmap in

Indonesia’s

port sector

and improve

domestic sea

shipping

9 The Borrower has issued Minister of

Transportation Regulation No.

KP414/2013 establishing a

classification and location for all

Indonesian sea ports based on traffic

projections in order to establish

development plans for each

individual sea port for the next

twenty years.

Progress made in the

development of

individual ports

Baseline:

As of 2011, absence of

guidelines for modernizing

Indonesia’s sea port network

leading to fragmented and

ineffective policy-making in

sea ports development

Target

By the end of 2014, informed

policy-making in sea port

development as demonstrated

by finalization of at least 2

individual port development

plans based on the Ministry of

Transport Regulation to

modernize Indonesia’s

domestic port network


To increase

institutional

capacity in

trade

facilitation to

better handle

the increasing

volume of

international

trade

10 The Borrower has amended

Presidential Regulation No.

10/2008 through the issuance

of Presidential Regulation No.

35/2012 to make the Indonesia

National Single Window

(INSW) system the single

reference portal for cross-

border trade regulations in the

customs clearance process.

The Borrower has decided the legal

nature of the agency to be created for

the management of the Indonesia

National Single Window System

Improvement in the

management of the

INSW system

Baseline: As of 2011 the

INSW is temporarily managed

by an ad-hoc team

Target: By the end of 2014 the

Government has started

transforming the managerial

and institutional set-up of the

INSW towards an INSW

agency that manages the

customs clearance process in

the future

11 The Borrower has introduced

the Agency of Drug and Food

Control into the INSW system

using the Single Sign-On

The Borrower has expanded the

Indonesia National Single Window

System by linking the requests for

permits made to the Ministry of

Trade and the Agency for Plant

Quarantine through the Single Sign-

On Mechanism to streamline and

make more efficient the export and

import processes and the quarantine

Improved process in

submitting documents

for the customs

clearance process

through the INSW

system

Baseline: As of 2011 traders

had to submit documents for

import clearances to different

agencies ICT systems using

different identifications


Single-Sign On feature

facilitates submission of

61

procedures. documents for import clearance

to the Food and Drug Agency,

Ministry of Health, Ministry of

Trade, and the Quarantine

Agency

62

Annex 3: The Government of Indonesia Broader Connectivity Agenda

(Connectivity DPL-supported actions are indicated in bold)

Reform Aim No 2012 2013 2014


Strengthen

coordination

of policy

reforms

surrounding

national

connectivity



(No.26/2012) establishing the

Borrower's national logistics system

blueprint and the Coordinating

Ministry for Economic Affairs has

issued a Ministerial Decree

(No.49/2012) establishing the

working team that will coordinate,

monitor and evaluate the

implementation of the national

logistics system blueprint, in

support of the connectivity agenda.

CMEA established a monitoring system to assess

progress in implementation of the national

logistics system

GoI established a debottlenecking mechanism to

enhance the implementation of prioritized national

connectivity infrastructure

CMEA prepared a draft presidential decree to

revitalize the Policy Committee for Acceleration

of Infrastructure Delivery (Komite Kebijakan

Percepatan Penyediaan Infrastruktur/KKPPI)

CMEA completed the selection of 56 MP3EI

priority projects

3 The Coordinating Minister for Economic Affairs

has allocated budget to support the preparation of

said priority infrastructure projects in the FY2014

Financial Notes and Draft Budget.

Establishment of a process to accelerate

delivery of 14 out of 56 priority

infrastructure projects identified in MP3EI

To establish a

transparent

process for

channeling

public funds

to viable

connectivity

infrastructure

PPP projects

for further

market uptake

4 The Fiscal Policy Office of the

Borrower’s Ministry of Finance has

submitted a draft Ministerial

Regulation to the Minister of

Finance establishing the mechanism

for channeling government funds to

public-private partnership projects

in infrastructure.

The Borrower has signed a Minister of Finance

Regulation on operational procedures to

implement Minister of Finance Regulation No.

223/2012 on the channeling of government

funds to public-private partnership projects in

infrastructure

The VGF facility is ready to process

proposed PPP infrastructure projects to

make them financially viable for private

investors.

MoF prepared the draft framework and business

process of a PPP Unit within the MoF to

strengthen its internal coordination for preparing

public finance support on proposed PPP projects

Submit the draft budget of project preparation

facilities (Pre FS Fund, PDF/TA Fund) to support

63

PPP infrastructure projects

MoF increased the capital of PT SMI to enhance

infrastructure and PPP project preparation


Increase

investor

confidence

and

stakeholder

participation

in the

national

connectivity

agenda

5 The Borrower has issued a land

acquisition Law (No.2/2012) and a


(No.71/2012) on land acquisition for

public purpose development.

The Borrower, through the National Land

Agency, has assigned roles to, and has

established the processes for, the relevant

agencies of the Borrower when acquiring land

for public purpose development through the

issuance of technical guidelines (Regulation of

the Head of BPN No.5/2012) to implement Law

No. 2/2012 and Presidential Regulation No.

71/2012.

6 The Borrower has issued a Minister of Finance

Regulation (No.13/PMK.02/2013) stating which

expenditures related to land acquisition for

public purpose development are eligible to be

covered by the national state budget, and the

Borrower has issued a Minister of Home

Affairs Regulation (No.72/2012) stating which

expenditures related to land acquisition for

public purpose development are eligible to be

covered by local government budgets.

7 Dissemination of the New Legislations to Judges

(Supreme Court), Prosecutors (General Attorney)

and Police in central level.

Establish process to monitor the

implementation and socialization of the new

regulatory framework on land acquisition

by the Task Force (Tim Sosialisasi dan

Asistensi)

64

To

strengthen the

process in

restructuring

of the railway

sector to

make it

respond better

to growing

demand for

better

services and

improved

accessibility



(No.53/2012) on Public Service

Obligation in railway services,

reimbursement of infrastructure

maintenance operation, and track

access charges, which serves as a

catalyst for implementing the first

step to separate assets of the state-

owned railway company (PT KAI)

and move towards a line-of-business

management structure.

Ministry of Transport conducts audit for the Public

Service Obligation (PSO) on the basis of Article

23 of Perpres 53/2012 which requires all railway

operators to have separate accounts to facilitate the

conduct of PSO audits

9 The Borrower has issued guidelines (Minister of

Transportation Regulations PM.10/2013 and

PM.56/2013) for the provision and

reimbursement of Public Service Obligation in

the railway sector to provide affordable

passenger railway services.

10 The Borrower has issued guidelines for

provision of (i) Infrastructure Maintenance

Operation (Minister of Transportation

Regulation PM.67/2013), and (ii) Track Access

Charges (Minister of Transportation

Regulation PM.62/2013) to support the

restructuring process in the railway sector as

mandated by the Borrower’s Law No. 23/2007

and by Presidential Regulation (No. 53/2012).

Improve

efficiency of

railway traffic

11 The GoI allocated budget in FY2012

for double-track rail between

Semarang-Cirebon by 2014

The GoI allocated budget in FY2013 to complete

double-track rail between Semarang-Cirebon by

2014

Improve

mechanism

for allocation

of grant funds

to sub-

national

governments

12 The GoI completed the review of the

framework to strengthen the allocation

of road infrastructure grant funds to

sub-national governments

The GoI piloted a new mechanism for the

allocation of road infrastructure grant funds to sub-

national governments

65

To improve

planning and

implementati

on of public

road

investment

13 The Borrower has issued DG

Highways Circular

(No.06/SE/06/2012), which

recommends the use of performance

based contracting for any road

project and has started to award

contracts using the referred

performance based methodology.

DG Highways implemented performance based

contracts for 3 new projects

The DG Highways issued regulation on Medium-

Term Development Plan for the National Road

Network to support domestic connectivity

Improve

urban

transportation

system in the

JABODETA

BEK area

14 CMEA prepared the (i) draft

presidential regulations on

JABODETABEK (the Greater

Jakarta) Urban Transportation Master

Plan; and (ii) draft presidential decree

on the establishment of

JABODETABEK Transportation

Authority to accelerate regional

development of transport in the

Greater Jakarta area

CMEA updated the JABODETABEK Urban

Transportation Master Plan

Update the JABODETABEK Urban

Transportation Master Plan


To close the

“digital

divide”

between

eastern and

western

Indonesia

through

development

of broadband

services to

Eastern

Indonesia


Ministry of Communications and

Information Technology has issued

a Ministerial Regulation (No.

23/2012) on the use of the ICT Fund

to support the development of

broadband ICT infrastructure in

underserved areas in Indonesia.

The Borrower has completed the identification

of the remote districts (kabupaten) to be

covered by the ICT Fund and has estimated the

budget requirements for the first phase of

telecommunications broadband projects to be

financed by the ICT Fund.

Issue regulation on mandatory infrastructure

-sharing and open access to bottleneck

infrastructure.

16 Finalized the revision of Minister

Communications and Information

Decree No. 1 of 2006 and No. 7 of

2006 on 2.1 GHz band

Ministry of Communications and Information draft

of policy and regulation on spectrum reframing for

mobile broadband

Issue regulations on (a) spectrum neutrality

(utilization irrespective of technology) to

enable the use of spectrum (in 850, 900,

and 1800 Mhz) for mobile broadband

services, and (b) “digital dividend” , to

prepare for the freeing up of 700 MHz of

spectrum through the planned analogue-

digital migration in 2017 .

66

To

strengthen the

development

roadmap in

Indonesia’s

port sector

and improve

domestic sea

shipping

17 The GoI conducted market sounding

of selected PPP investment project in

port

The Borrower has issued Minister of

Transportation Regulation No. KP414/2013

establishing a classification and location for all

Indonesian sea ports based on traffic

projections in order to establish development

plans for each individual sea port for the next

twenty years.

Issuance of several development plans of

individual sea port identified in the Minister

of Transport Regulation KP414/2013

(National Port Master plan)

18 MoT issued Ministerial Regulation on

the Master Plan for Port Development

in Greater Jakarta Port

MoT issued a regulation to increase shipping

routes to the eastern part of Indonesia

19 The GoI issued a joint decree of DGs

of (i) Sea Transport, (ii) Labor

Supervision, and (iii) Cooperatives

Institutions that grants more

competitive pricing to increase

competition in cargo handling services

at seaports


To increase

institutional

capacity in

trade

facilitation to

better handle

the increasing

volume of

international

trade

20 The Borrower has amended

Presidential Regulation No. 10/2008

through the issuance of Presidential

Regulation No. 35/2012 to make the

INSW system the single reference

portal for cross-border trade

regulations in the customs clearance

process.

The Borrower has decided the legal nature of

the agency to be created for the management of

the Indonesia National Single Window System.

Start transforming the management of the

INSW System from an ad-hoc team to an

INSW agency

21 The Borrower has introduced the

national Agency of Drug and Food

Control into the INSW system using

the Single Sign-On

The Borrower has expanded the Indonesia

National Single Window System by linking the

requests for permits made to the Ministry of

Trade and the Agency for Plant Quarantine

through the Single Sign-On Mechanism to

streamline and make more efficient the export

and import processes and the quarantine

procedures.

22 Extended INSW system and services

coverage to Cikarang dry port

Finalize an action plan for reducing import

container dwell time in Tanjung Priok or other

Introduction of reform policies to improve

dwell time in Tanjung Priok

67

major ports in Indonesia

The GoI operationalized quarantine services in

CIkarang dry port

68

Annex 4: Environmental and Social Review of Connectivity DPL-2

The consideration of environmental and social aspects of this operation has been carried out following the

provisions of OP 8.60 (Development Policy Lending) which mandates the Bank to determine whether

policies supported by the operation are likely to have significant poverty and social impacts or significant

environmental effects. For policies with likely significant effects, the Bank summarizes analytic knowledge

of these effects and of the borrower’s systems for reducing adverse effects and enhancing positive effects,

also describing how any significant gaps would be addressed before or during program implementation. This

review relied on Bank guidance on analysis of “likelihood of significant effects,” including the (i) Good

Practice Note: Using Poverty and Social Impact Analysis to Support Development Policy Operations; (ii)

Assessing the Environmental, Forest, and Other Natural Resource Aspects of Development Policy Lending –

A World Bank Toolkit (2008), (iii) Good Practice Note on Environmental and Natural Resource Aspects of

Development Policy Lending. A broader overview of Indonesia's environmental and social issues is updated

annually for the Country Policy and Institutional Assessment (CPIA).

In the Bank’s assessment, policies supported by Pillar 1 of this DPL (Strengthening National Coordination

and Regulation for Improved National Connectivity) are not likely to have significant negative effects. In

general, improved connectivity typically involves increasing access to services and information, stimulating

growth and employment, and linking less developed regions with more developed regions, thus reducing

both poverty and disparities. Action under this pillar will further strengthen transparency and governance

arrangements by strengthening the capacity to implement and coordinate the national logistics system

blueprint. The definition of the operational procedures to implement the Minister of Finance Decree on

Viability Gap Fund will also add operational certainties on fund flows, together with better transparency and

improved planning procedures. The strengthening of planning, monitoring and coordination arrangements is

expected to lead to better investment decisions.

Actions under Pillar 2 related to strengthening intra-island rail and road connectivity are mainly focused on

improving planning, budgeting and efficiency. Efficiency increases will add benefits to the country in terms

of reduced costs and potentially more economic operations with benefits to the poor. Road construction has

the potential for significant social and environmental effects, if not mitigated through appropriate design,

assessment and mitigation measures. The Bank has substantial experience with road infrastructure projects

in Indonesia and there is evidence that the Ministry of Public Works/DG Highways has significant and

increasing capacity for AMDAL/environmental review of projects. The Connectivity DPL program also

recognizes the importance of the Environmental Impact Assessment/AMDAL process at the national and

local levels. The previous IDPL series recognized the substantial improvements to the environmental

management and accountability framework through Law No. 32/2009 on Environmental Management and

Projection. Implementation of the new framework has been accompanied by substantial capacity building

from development partners, including GIZ, DANIDA, CIDA and others.

In general, improved rail access and capacity should lead to improved services, operations and maintenance,

which will benefit rail users and has the potential to reduce GHG emissions. It will therefore support the

national Climate Change Action Plan (RAN-GRK). Increased rail capacity can provide a more

environmentally friendly transportation alternative and reduced congestion. Over the medium term, specific

investments that may emerge on individual railways can have negative environmental and social impacts in

specific locations, if not managed and mitigated through systems and procedures of the Ministry of

Transport (MoT). The Bank’s review indicates that the MoT’s strategies and plans for these sectors include

recognition of the environmental and social issues, appropriate mitigation efforts, and capacity building

efforts to ensure that environmental and social impacts are identified and mitigated by rail authorities and

operators. The Bank has discussed with counterparts and reviewed the National Railways Master Plan (April

69

2011) and the MoT’s Strategic Plan for Railways 2010-2014 to assess the MoT’s systems and capacity for

addressing environmental issues, for reducing adverse effects and enhancing positive effects.

Under this pillar, the World Bank policy support for guidelines for Public Service Obligations (PSO), the

Infrastructure Maintenance Operation and the Track Access Charges (TAC) will essentially strengthen the

operational capacity and governance of the railway sector by setting clear procedures on how to engage with

and compensate for services provided by the private sector. It is not expected that these policies will have

any adverse social or environmental impacts. The Railways Master Plan recognizes environmental issues

and has programs for addressing them. Increased implementation capacity for maintenance operations and

more clarity on track access charges are further strengthening the railway system with all the inherent

environmental benefits by improving governance, transparency and efficiency.

In 2012, the Government was successful in issuing several pieces of legislation relating to land acquisition

for projects destined for public purpose (Law No. 2/2012 in January 2012 (Law No. 2/12); Presidential

Regulation No. 71/2012 in August 2012 (PR No. 71/12); and technical guidelines issued by the relevant

ministries.20

The new legislation clearly recognizes that principles of justice, transparency, agreements and

participation are important, and is also aimed at balancing the interests of development and society, and

ensuring that land necessary to support development efforts is acquired in a timely manner. Compensation

covers the loss of land and assets, and also other losses that can be accounted for that are caused by the

acquisition of land for a public project. Affected parties are given opportunities to comment on project

proposals, to negotiate the size and form of compensation, and to seek legal redress in the courts in the case

of grievances that cannot be otherwise resolved.

The new legislation provides compensation mainly in cash, although this must include loss of business time

and transaction restitution and could consist of land-for-land compensation. Although resettlement is an

option for compensation and once fair compensation has been provided, further consideration and impact

mitigation are not elaborated. Nevertheless, the new legislation mandates that the value of compensation

must be assessed by licensed appraisal. Indonesia has an independent organization for appraisal called

MAPPI (Indonesian Society of Appraisers) which is a professional organization of appraisers. MAPPI has a

standard for property valuation in Indonesia called SPI (Indonesian Valuation Standard).. Cash

compensation is a very efficient approach if social impact caused by land acquisition is minor or relatively

straightforward. For more complex projects, non-cash compensation and livelihood restoration should be

elaborated. It depends on the social assessment of the proposed project to determine the complexity of the

social impact covered in a feasibility study as required during the preparation stage.

Squatters with good faith on state/public land are eligible for compensation, while squatters are squatting on

private land the compensation is the responsibility of the private owner.

A Bank conducted AAA on Forest and Non-Forest Lands in Indonesia, highlighted the fact that there was

very poor public awareness of the new regulation, and a similar lack of awareness also applied to national

and subnational authorities. As a result, the capacity to apply this regulation within an already weak

institutional context is very poor. Recognizing the need for dissemination and information, the Coordinating

Ministry for Economic Affairs and other relevant institutions organized a national workshop in April 2013

to disseminate the new legislation for strengthening capacity at the provincial level, and for state companies

such as PLN, PT. Gas, and PT. KAI. The Coordinating Team will also disseminate the new legislation to

judges at the Supreme Court, prosecutors at the Office of the Attorney General and the police at the central

level. In a following phase, more discussion with district/city level entities will be promoted, as well as the

20

Regulation of Head of BPN No. 5/2012 concerning with technical guideline for implementation of land acquisition for public

purposes.; Regulation of MoHA No. 72/2012 concerning operational and supporting costs for implementation of land acquisition for

public purpose uses APBD (local budget); Regulation of MoF No.13/PMK.02/2013 concerning operational and supporting costs for

implementation of land acquisition for public purpose uses APBN (state budget).

70

facilitation of handling land acquisition problems and strengthening the monitoring arrangements for the

implementation of the new legislation.

Under Pillar 3, the DPL supports implementation of the Information Communication and Technology (ICT)

Fund, which should help improve access and communication. There is also the potential to improve the flow

of goods and services, and improve access to information and data management. No adverse environmental

or social impacts have been identified.

Under the same pillar, the DPL will strengthen the regulatory environment to facilitate long-term port

development, and increase handling efficiency and reduce costs of domestic shipping, by using a Ministerial

Regulation classifying the hierarchy of sea ports around Indonesia. Increased efficiency of ports, more

transparency, and improved governance should lead to a reduction of waste and pollution in port operations

both on- and off-shore.

Finally, actions under Pillar 4: Improving International Connectivity is expected to have overall governance,

institutional development and capacity benefits, and have no significant effects on the environment. It is

expected that increased efficiency and quicker handling of goods will reduce the overall pollution impact at

and around sea ports.

Connectivity DPL – II: Proposed Prior Actions and Likely Effects

Reform Aim No. CDPL-II (by early Sept

2013)

Potential negative effects Potential positive effects

To establish a

transparent

process for

channeling

public funds to

viable

connectivity

infrastructure

PPP projects for

further market

uptake

1 The Borrower has signed a

Minister of Finance

Regulation on operational

procedures to implement

Minister of Finance

Regulation No. 223/2012

on the channeling of

government funds to

public-private partnership

projects in infrastructure

Operational procedures for

the fund will support and

strengthen due process in

effective fund management.

It will also add operational

certainties on fund flow,

transparency and improved

planning procedures. The

strengthening of planning,

monitoring and coordination

arrangements is expected to

lead to better investment

decisions.

Increase investor

confidence and

stakeholder

participation in

the national

connectivity

agenda


National Land Agency,

has assigned roles to, and

has established the

processes for, the relevant

agencies of the Borrower

when acquiring land for

public purpose

development through the

issuance of technical

guidelines (Regulation of

the Head of BPN

No.5/2012) to implement

Law No. 2/2012 and


This new regulatory

framework represents

progress, as it includes

more certainty on the time

frame; specific periods for

public notice, consultations,

and negotiations; improved

compensation provisions,

including independent,

third party assessments of

value of both land and

affected assets. Affected

parties are given

opportunities to comment

on project proposals, to

Under this pillar the DPL

supports clearer guidelines

on how to apply this new

regulation for operational

and supporting expenses for

acquiring land for public

infrastructure development

and dissemination of the

guidelines to judges and

public entities. It therefore

addresses one of the

operational weaknesses of

the regulation by supporting

dissemination and

71

No. 71/2012 negotiate the size and form

of compensation, and to

seek legal redress to the

courts in case of grievances

that cannot be otherwise

resolved. As part of an

AAA forest and non-forest

lands in Indonesia, the

identified issues were that

the new regulation was

very little known to the

public and to the national

and subnational authorities

and the capacity to apply

this regulation within an

already weak institutional

context is very poor.

operationalization.


Minister of Finance

Regulation

(No.13/PMK.02/2013)

stating which expenditures

related to land acquisition

for public purpose

development are eligible

to be covered by the

national state budget, and

the Borrower has issued a

Minister of Home Affairs

Regulation (No.72/2012)

stating which expenditures

related to land acquisition

for public purpose

development are eligible

to be covered by local

government budgets

Strengthen

progress in

restructuring of

the railway

sector

4

The Borrower has issued

guidelines (Minister of

Transportation

Regulations PM.10/2013

and PM.56/2013) for the

provision and

reimbursement of Public

Service Obligation in the

railway sector to provide

affordable passenger

railway services

No likely significant effects Improved rail access and

capacity could lead to

improved service, operation

and maintenance, which

benefits rail users and has

the potential to reduce GHG

emissions and will therefore

support the national Climate

Change Action Plan (RAN-

GRK). Increased rail

capacity can provide a more

environmentally friendly

transportation alternative

and reduced road congestion

and improved living

conditions.

72

5 The Borrower has issued

guidelines for provision of

(i) Infrastructure

Maintenance Operation

(Minister of


PM.67/2013), and (ii)

Track Access Charges

(Minister of


PM.62/2013) to support

the restructuring process

in the railway sector as

mandated by the

Borrower’s Law No.

23/2007 and by


(No. 53/2012)

Strengthen ICT

connectivity

between eastern

and western

Indonesia and

introduce more

competition in

broadband

services

6 The Borrower has

completed the

identification of the

remote districts

(kabupaten) to be covered

by the ICT Fund and has

estimated the budget

requirements for the first

phase of

telecommunications

broadband projects to be

financed by the ICT Fund

No likely significant

effects.

Strengthen

regulatory

environment to

facilitate port

development and

reduce costs of

domestic sea

shipping

7 The Borrower has issued

Minister of Transportation

Regulation No.

KP414/2013 establishing a

classification and location

for all Indonesian sea

ports based on traffic

projections in order to

establish development

plans for each individual

sea port for the next

twenty years


effects.

Improving International

Connectivity is expected to

have overall governance,

institutional development

and capacity benefits and

have no significant effects

on the environment. It is

expected that increased

efficiency and quicker

handling of goods will

reduce the overall pollution

impact at and around ports.

Reduce time

needed for and

cost of

importing and

exporting

9 The Borrower has decided

the legal nature of the

agency to be created for

the management of the

Indonesia National Single

Window System


effects.

73

10 The Borrower has

expanded the Indonesia

National Single Window

System by linking the

requests for permits made

to the Ministry of Trade

and the Agency for Plant

Quarantine through the

Single Sign-On

Mechanism to streamline

and make more efficient

the export and import

processes and the

quarantine procedures

No likely significant effects

74

Annex 5 Indonesia at a Glance

Indonesia at a glance 9/17/13

East Lower

Key Development Indicators Asia & middle

Indonesia Pacif ic income

(2012)

Population, mid-year (millions) 237.5 1,974 2,533

Surface area (thousand sq. km) 1,905 16,302 20,842

Population growth (%) 1.3 0.7 1.6

Urban population (% of total population) 51 49 39

GNI (Atlas method, US$ billions) 764.5 8,387 4,488

GNI per capita (Atlas method, US$) 3,450 4,248 1,772

GNI per capita (PPP, international $) 4,500 7,266 3,837

GDP growth (%) 6.2 8.3 5.5

GDP per capita growth (%) 4.9 7.6 3.9

(most recent estimate, 2005–2012)

Poverty headcount ratio at $1.25 a day (PPP, %) 18 14 30.2

Poverty headcount ratio at $2.00 a day (PPP, %) 46 33 59.5

Life expectancy at birth (years) 69 72 66

Infant mortality (per 1,000 live births) 25 17 46

Child malnutrition (% of children under 5) 19 5 24

Adult literacy, male (% of ages 15 and older) 96 96 80

Adult literacy, female (% of ages 15 and older) 90 91 62

Gross primary enrollment, male (% of age group) 117 110 106

Gross primary enrollment, female (% of age group) 119 112 102

Access to an improved water source (% of population) 84 90 87

Access to improved sanitation facilities (% of population) 59 66 47

Net Aid Flows 1980 1990 2000 2012 a

(US$ millions)

Net ODA and off icial aid 941 1,716 1,653 415

Top 3 donors (in 2010):

Australia 48 77 72 356

France 44 122 22 262

United States 117 31 174 180

Aid (% of GNI) 1.3 1.6 1.1 0.1

Aid per capita (US$) 6 10 8 2

Long-T erm E conomic T rends

Consumer prices (annual % change) 9.5 7.7 3.7 4.3

GDP implicit deflator (annual % change) 31.0 7.7 20.4 4.5

Exchange rate (annual average, local per US$) 627.0 1,842.8 8,421.8 9,481.9

Terms of trade index (2000 = 100) .. 107 100 133

1980–90 1990–2000 2000–12

Population, mid-year (millions) 145.5 178.6 208.9 237.5 2.1 1.6 1.4

GDP (US$ millions) 78,013 114,426 165,021 869,218 6.1 4.2 5.3

Agriculture 24.0 19.4 15.6 14.4 3.6 2.0 3.4

Industry 41.7 39.1 45.9 46.9 7.3 5.2 4.1

Manufacturing 13.0 20.7 27.7 23.9 12.8 6.7 4.7

Services 34.3 41.5 38.5 38.6 6.5 4.0 7.2

Household f inal consumption expenditure 51.4 58.9 60.7 57.3 5.2 6.6 4.7

General gov't f inal consumption expenditure 10.5 8.8 6.5 8.9 4.6 0.1 8.2

Gross capital formation 24.1 30.7 22.2 35.3 7.7 -0.6 5.9

Exports of goods and services 34.2 25.3 41.0 24.3 2.7 5.9 7.8

Imports of goods and services 20.2 23.7 30.5 25.8 1.2 5.7 8.6

Gross savings .. .. 26.1 30.9

Note: Figures in italics are for years other than those specif ied. 2011 data are preliminary. .. indicates data are not available.

(average annual growth %)

(% of GDP)

10 5 0 5

0-4

15-19

30-34

45-49

60-64

75-79

percent of total population

Age distribution, 2011

Male Female

0

10

20

30

40

50

60

70

80

90

1990 1995 2000 2011

Indonesia East Asia & Pacific

Under-5 mortality rate (per 1,000)

-20

-15

-10

-5

0

5

10

15

95 05

GDP GDP per capita

Growth of GDP and GDP per capita (%)

75

Indonesia

Balance of P ayments and T rade 2000 2012

(US$ millions)

Total merchandise exports (fob) 65,408 188,496

Total merchandise imports (cif) 44,404 197,866

Net trade in goods and services 15,243 -1,712

Current account balance 7,998 -24,431

as a % of GDP 4.8 -2.8

W orkers' remittances and

compensation of employees (receipts) 1,190 6,924

Reserves, including gold 29,268 112,781

Central Government Finance

(% of GDP)

Current revenue (including grants) 19.7 16.2

Tax revenue 11.1 11.9

Current expenditure 15.6 18.1

T echnology and Inf rastructure 2000 2011

Overall surplus/deficit -1.8 -1.9

Paved roads (% of total) 57.1 56.9

Highest marginal tax rate (%) Fixed line and mobile phone

Individual .. 30 subscribers (per 100 people) 5 119

Corporate 30 28 High technology exports

(% of manufactured exports) 16.4 8.3

E xternal Debt and Resource Flows

E nvironment

(US$ millions)

Total debt outstanding and disbursed 143,344 254,852 Agricultural land (% of land area) 25 30

Total debt service 16,624 36,641 Forest area (% of land area) 54.9 51.7

Debt relief (HIPC, MDRI) – – Terrestrial protected areas (% of land area) 13.6 14.1

Total debt (% of GDP) 86.9 29.7 Freshwater resources per capita (cu. meters) 9,218 8,332

Total debt service (% of exports) 26.2 80.1 Freshwater withdrawal (billion cubic meters) .. ..

Foreign direct investment (net inflows) -4,550 19,404 CO2 emissions per capita (mt) 1.2 1.9

Portfolio equity (net inflows) -1,021 1,716

GDP per unit of energy use

(2005 PPP $ per kg of oil equivalent) 3.6 4.5

Energy use per capita (kg of oil equivalent) 727 867

W orld Bank Group portfolio 2000 2011

(US$ millions)

IBRD

Total debt outstanding and disbursed 11,715 10,468

Disbursements 1,051 1,199

Principal repayments 761 449

Interest payments 950 268

IDA

Total debt outstanding and disbursed 714 2,200

Disbursements 59 25

P rivate S ector Development 2000 2012 Total debt service 31 121

Time required to start a business (days) – 47 IFC (f iscal year)

Cost to start a business (% of GNI per capita) – 23.5 Total disbursed and outstanding portfolio 880 749

Time required to register property (days) – 22 of which IFC own account 480 517

Disbursements for IFC own account 20 202

Ranked as a major constraint to business 2000 2011 Portfolio sales, prepayments and

(% of managers surveyed who agreed) repayments for IFC own account 43 196

Economic & regulatory policty uncertainty .. 48.2

Corruption .. 41.5 MIGA

Gross exposure 56 657

Stock market capitalization (% of GDP) 16.3 53.1 New guarantees 0 450

Bank capital to asset ratio (%) 6.0 11.0

Note: Figures in italics are for years other than those specif ied. 2011 data are preliminary. 9/17/13

.. indicates data are not available. – indicates observation is not applicable.

0 25 50 75 100

Control of corruption

Rule of law

Regulatory quality

Political stability

Voice and accountability

Country's percentile rank (0-100)higher values imply better ratings

2011

2000

Governance indicators, 2000 and 2011

Source: Kauf mann-Kraay -Mastruzzi, World Bank

IBRD, 10,468IDA, 2,200

Other multi-lateral, 10,408

Bilateral, 38,541

Private, 145,427

Short-term, 44,764

Composition of total external debt, 2012

US$ mill ions

76

Millennium Development Goals Indonesia

With selected targets to achieve between 1990 and 2015(estimate closest to date shown, +/- 2 years)

Goal 1: halve the rates for extreme poverty and malnutrition 1990 1995 2000 2011

Poverty headcount ratio at $1.25 a day (PPP, % of population) 54.3 43.4 47.7 18.1

Poverty headcount ratio at national poverty line (% of population) .. 17.6 23.4 12.0

Share of income or consumption to the poorest qunitile (%) 9.4 9.0 9.6 7.3

Prevalence of malnutrition (% of children under 5) 31.0 27.4 24.8 18.6

Goal 2: ensure that children are able to complete primary schooling

Primary school enrollment (net, %) 95 92 90 96

Primary completion rate (% of relevant age group) 92 93 93 109

Secondary school enrollment (gross, %) 46 47 53 77

Youth literacy rate (% of people ages 15-24) 96 .. .. 99

Goal 3: eliminate gender disparity in education and empower women

Ratio of girls to boys in primary and secondary education (%) 92 93 96 101

W omen employed in the nonagricultural sector (% of nonagricultural employment) 29 29 32 32

Proportion of seats held by women in national parliament (%) 12 11 8 19

Goal 4: reduce under-5 mortality by two- thirds

Under-5 mortality rate (per 1,000) 82 65 53 32

Infant mortality rate (per 1,000 live births) 54 45 38 25

Measles immunization (proportion of one-year olds immunized, %) 58 63 74 89

Goal 5: reduce maternal mortality by three- fourths

Maternal mortality ratio (modeled estimate, per 100,000 live births) 600 420 340 220

Births attended by skilled health staff (% of total) 41 50 67 82

Contraceptive prevalence (% of women ages 15-49) 50 54 55 61

Goal 6: halt and begin to reverse the spread of HIV /AIDS and other major diseases

Prevalence of HIV (% of population ages 15-49) 0.1 0.1 0.1 0.3

Incidence of tuberculosis (per 100,000 people) 206 205 204 187

Tuberculosis case detection rate (%, all forms) .. .. .. ..

Goal 7: halve the proportion of people without sustainable access to basic needs

Access to an improved water source (% of population) 70 74 78 84

Access to improved sanitation facilities (% of population) 35 41 47 59

Forest area (% of land area) 65.4 .. 54.9 51.7

Terrestrial protected areas (% of land area) 10.0 10.9 13.6 14.1

CO2 emissions (metric tons per capita) 0.8 1.1 1.2 1.9

GDP per unit of energy use (constant 2005 PPP $ per kg of oil equivalent) 3.8 4.1 3.6 4.5

Goal 8: develop a global partnership for development

Telephone mainlines (per 100 people) 0.6 1.7 3.1 15.9

Mobile phone subscribers (per 100 people) 0.0 0.1 1.7 103.1

Internet users (per 100 people) 0.0 0.0 0.9 18.0

Households with a computer (%) .. .. .. 12.0

Note: Figures in italics are for years other than those specif ied. .. indicates data are not available. 9/17/13

Indonesia

0

25

50

75

100

125

2000 2005

Primary net enrollment ratio

Ratio of girls to boys in primary & secondary

education

Education indicators (%)

0

10

20

30

40

50

60

70

80

2000 2005

Fixed + mobile subscribers Internet users

ICT indicators (per 100 people)

0

25

50

75

100

1990 1995 2000 2011

Indonesia East Asia & Pacific

Measles immunization (% of 1-year olds)

Puncak JayaPuncak Jaya(5030 m)(5030 m)

ObiObi

CeramCeram

BuruBuru

SULAWESISULAWESISUMATERASUMATERA

BaliBali

KALIMANTANKALIMANTAN

RabaRaba

PematangsiantarPematangsiantar

SorongSorong

TimikaTimika

FakfakFakfakAmahaiAmahai

PaluPaluJambiJambi

MataramMataram

BandungBandungSurabayaSurabaya

SemarangSemarang

PalembangPalembang

PekanbaruPekanbaru

PalangkarayaPalangkaraya

Bandar Bandar LampungLampung

SerangSerang

PAPUAPAPUA

1919

2121

2222

2727

3030

2020

2323 2626

2525

29292828

3131

3333

3232

3434

1212

1111

1313

14141515

8

67

3

54

2

1

1616

1717 1818

1010

9

2424

PAPU

APA

PUA

NEW

GU

INEA

NEW

GU

INEA

A U S T R A L I AA U S T R A L I A

THAILANDTHAILAND

MYANMARMYANMAR

19

21

22

27

30

20

23 26

2524

2928

31

33

32

34

12

11

13

1415

8

67

3

54

2

1

16

17 18

10

9

Balikpapan

Parepare

Baubau

Tarakan

Raba

Ende

Waingapu

Pematangsiantar

Sorong

Merauke

Timika

FakfakAmahai

Palu

Ambon

Gorontalo

Jambi

Medan

Kupang

Padang

Manado

Mataram

Bandung

Kendari

Denpasar

Surabaya

Semarang

Bengkulu

Jayapura

Palembang

Samarinda

Tanjung Selor

PontianakPekanbaru

Yogyakarta

Banda Aceh

Bandjarmasin

PalangkarayaPangkalpinang

Makassar

Ternate

Bandar Lampung

Serang

Manokwari

Mamuju

Tanjungpinang

JAKARTA

PAPU

AN

EW G

UIN

EA

A U S T R A L I A

SINGAPORE

VIETNAM

THAILAND

MYANMAR

TIMOR-LESTE

BRUNEI

PHILIPPINES

MA L A Y

SI

A

CelebesSea

Java Sea BandaSea

Arafura Sea

SuluSea

PACIFIC OCEAN

I N D I A N O C E A N

PAPUA

AruIs.

KaiIs.

TanimbarIs.

Halmahera

Biak

Yapen

Morotai

Misool

Waigeo

Peleng Obi

Muna

Ceram

Buru

SULAWESI Sula Is.

Timor

FloresAlor

WetarMoa

Babar

Sumba

SumbawaLombokJAWA

NatunaBesar

Belitung

Madura

SUMATERABangka

Lingga

Nias

Siberut

Enggano

Simeulue

TalaudIs.

Bali

KALIMANTAN

Men t a w

a i I s .

Puncak Jaya(5030 m)

0°

5°

5°

10°

10°

15°

0°

5°

10°

15°

15°

10°

95° 100° 105°

115° 120° 125°

95° 100° 105° 110° 115° 120° 125°

130° 135° 140°

135° 140°

INDONESIA

NANGGROE ACEH DARUSSALAMSUMATERA UTARARIAUSUMATERA BARATJAMBIBENGKULUSUMATERA SELATANLAMPUNGBANGKA-BELITUNGBANTEND.K.I. JAKARTA

123456789

1011

PROVINCES:

1213141516171819202122

JAWA BARATJAWA TENGAHD.I. YOGYAKARTAJAWA TIMURBALINUSA TENGGARA BARATNUSA TENGGARA TIMURRIAU KEPULAUANKALIMANTAN BARATKALIMANTAN TENGAHKALIMANTAN SELATAN

KALIMANTAN TIMURKALIMANTAN UTARASULAWESI UTARAGORONTALOSULAWESI TENGAHSULAWESI BARATSULAWESI SELATANSULAWESI TENGGARAMALUKU UTARAMALUKUPAPUA BARATPAPUA

232425262728293031323334

0 200

0 100 200 300 400 Miles

400 Kilometers

IBRD 33420R3

DEC

EMBER 2012

INDONESIACITIES AND TOWNS

PROVINCE CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

PROVINCE BOUNDARIES

INTERNATIONAL BOUNDARIES

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, o r any endo r s emen t o r a c c e p t a n c e o f s u c h boundaries.

Documents

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